The audit committee headed by R P Aggarwal, which finalised its report on October 7, was set up to look into ITC Global's cigarette sales to Russia and its transactions with ILTD.
The report said it "suspects" that the sales of leaf tobacco from ILTD to ITC Global deviated from the "arms length concept" -- transactions between a company and its wholly-owned subsidiary abroad should be independent of any special favours dispensed by either company --and the Fera "point of view" on various counts.
These include:
ITC Global purchased tobacco leaf from ILTD and then sold it at an unusually high profit margin of an average of 38 per cent to ILTD customers like Intabex and Standard Commercial. This deal could attract charges of Fera violation against ILTD for dealing with a 100-per cent subsidiary. Had this tobacco been sold by ILTD to its customers directly, ILTD would have made this additional profit, which in this case it had to forgo;
the $1.034-million profits from tobacco leaf sales were used by ITC Global to adjust unpaid dues from Global's cigarette exports to Russia. However, these "adjustments" resulted in incorrect accounting entries, and there was no approval for write-off of debts nor any adequate documentation for the justification of write-off or irrecoverability of the debt;
the transaction was back to back, that is, the consignment was booked by ILTD to the country where the ultimate buyer existed and not to ITC Global.
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The committee did not agree to ILTD's justification that the transactions were in accordance with the laws and did not violate Fera. A note dated October 7 written by ITC Ltd deputy chairman Saurabh Misra says: "...the transactions with ITC Global by...ILTD...were independent and on a principal-to-principal basis. ...ILTD earned normal export contributions on all such sales...and there is full compliance with Fera."
The audit committee notes that while ITC Global agreed to pass correct entries and obtain board approval for bad debts written off, it has disagreed with the audit recommendation regarding the "arms length principle" and compliance with Fera guidelines as it feels that it is the responsibility of the ITC divisions and not of ITC Global to ensure that.
The committee recommended immediate measures which included bringing the matter to the "attention of the chairman and the committee of directors urgently for deliberations and take a view in this regard". The group also recommended that the matter should be examined in detail by some independent agency.
Meanwhile, the committee also advised the ITC's audit department to examine certain issues on an urgent basis and revert to the committee of directors. These include:
Details of the price at which similar variety of tobacco was sold by ILTD to other international customers during the same period;
Whether ITC Global, since 1992-93, sold tobacco to the direct buyers of ILTD other than those investigated by the committee;
ILTD's margin on export of tobacco from year to year as also ITC Global's margin on tobacco exports, in respect of tobacco brought by ITC Global from ILTD from year to year;
The nature of transactions in ITC Global, the pattern of trade with respect to sourcing and advising sellers to export the merchandise directly to the country where buyers exist, and ITC Global selling such consignments by such buyers during transit. Is this a normal practice in the international trade; and
Any evidence of ILTD extending unwritten options during the same period to other international players.
Investigation on unwritten options was prodded by the fact that ILTD's view that ITC Global had an "option" on certain tobacco stocks (ILTD had accumulated Rs 100 crore of stocks to help framers and the surplus was sold by granting options to tobacco dealers) therefore they could not be sold to any other customer was questioned by K Vaidyanath, executive vice-president (audit) of ITC.
Vaidyanath in a note questions ILTD's contention and points out that "there is absolutely no documentation to evidence the existence of the option on these stocks. Globally...options are entered into on the basis of standardised written contracts".
AUDIT COMMITTEES STRICTURES
The sale transactions between ILTD and ITC are suspect under the `arms length concept' and from the Fera angle
ITC Global sold the tobbaco to long standing ILTD customers at a profit of 38%. Had this tobbaco been sold by ILTD to its long-standing customers directly, ILTD would have made this additional profit which it had forgone.
The transaction is of back-to-back nature in as much as the consignment was booked by ILTD to the country where the ultimate buyer existed and not to ITC Global
The profits from tobacco sales were adjusted against outstanding receivables in respect to the sales of cigarettes to Russia. These adjustments resulted in incorrect accounting entries and there was no approval for write-off of the debts from the board.