CARO 2020 clauses 3 explained: this guide covers what it means, who it applies to, the step-by-step process, documents required, fees, due dates and penalties in India — so you can stay compliant with confidence and avoid costly mistakes.
These five clauses cover very different ground: Nidhi company ratios, related party approvals and disclosures, the internal audit system, non-cash deals with directors and RBI registration. This article explains how the ICAI Guidance Note says the auditor should approach each clause.
It is explained from the ICAI Guidance Note on the Companies (Auditor's Report) Order, 2020 (Revised 2022 Edition, July 2022). CARO 2020 applies to audits of financial years commencing on or after 1 April 2021. Later amendments to the Order, Schedule III and the laws named should be checked. Where the GN refers to RBI directions, use RBI's directions as in force.
Clause 3(xii) applies only to a Nidhi company. Clause 3(xiii) asks whether related party transactions comply with sections 177 and 188 and are disclosed. Clause 3(xiv) asks whether the internal audit system is commensurate with the business and whether the auditor considered the internal audit reports. Clause 3(xv) reports non-cash dealings with directors and section 192, and clause 3(xvi) covers NBFC and core investment company registration.
The Order's wording is in the live clause xi to xvi explainer. Related party approvals and registrations are a regular topic for compliance advisory. The preceding clauses are in our fraud and fund-raising article.
Clause 3(xii): Nidhi companies (paragraph 73)
The clause applies to a company incorporated as a Nidhi, or declared one under the older Act. It asks three things: whether the ratio of net owned funds to deposits meets 1:20, whether ten per cent unencumbered term deposits are held as the Nidhi Rules require, and whether there was any default in paying interest on or repaying deposits.
- Net owned funds are the paid-up equity capital and distributable reserves in the last audited balance sheet, reduced by accumulated losses and intangible assets, excluding preference share proceeds. Deposit liability is the total of fixed, recurring and savings deposits from members.
- Procedure: verify management's computation of net owned funds and deposit liability; examine Form NDH-3, the half-yearly return; test the term deposit holding; tie the interest and repayment schedule to books and deposit terms.
- Defaults: report all defaults existing at year end and those made good during the year, with nature, amount, period and number of persons affected. A dispute with a depositor is decided on the existing terms, with a brief note of the dispute.
- Shortfalls: report the shortfall in the ratio with the actual ratio, and any shortfall in the term deposit holding.
See our rule posts on net owned funds and deposits and forms NDH-1 to NDH-5.
Clause 3(xiii): related parties (paragraph 74)
The auditor reports (i) whether all related party transactions comply with sections 177 and 188 where applicable and (ii) whether disclosures required by the applicable accounting standard are in the financial statements.
Section 188 as the GN reads it: it applies to all classes of companies, including private companies. Shareholder approval is not required for transactions between a holding company and its wholly owned subsidiary whose accounts are consolidated, and neither Board nor shareholder approval is needed for ordinary-course, arm's-length transactions. The covered transaction types are sales and purchases of goods, property dealings, leases, services, agents, office or place of profit, and underwriting. Section 177 requires audit committee approval where the committee exists. See section 188 and section 177.
Ordinary course and arm's length are matters of judgement. The GN's indicators are: within the objects, usual or unusual, frequent, at arm's length, a business purpose, similar dealings with third parties, and size. For sole suppliers, compare list prices and trade terms; the company should hold documentary proof of arm's length pricing. SA 550 gives further guidance on unusual transactions and arm's length assertions.
Procedures: get representations from management and, where suitable, those charged with governance on related parties and completeness; read board and audit committee minutes; match the section 189 register with directors' Form MBP-1 disclosures; check accounting standard disclosures. Report non-compliance with sections 177 and 188 and with disclosure rules separately, with relationship, nature, amount and remarks.
Clause 3(xiv): internal audit (paragraphs 75 and 76)
(a) System commensurate with size and nature. Section 138 makes an internal audit system mandatory for listed companies and for unlisted companies crossing its thresholds for turnover, borrowings, paid-up capital or deposits; check the section as in force. Listing status is judged at the balance sheet date. The internal auditor may be an individual, firm or body corporate, a chartered or cost accountant or other professional the Board decides, and need not be an employee. The auditor evaluates:
| Factor | What the GN looks at |
|---|---|
| Size of the function | Nature of business, locations, how decentralised controls are |
| Qualifications | A qualified head and enough staff; for external agencies, competence, objectivity and independence |
| Reporting line | The higher the reporting level, the greater the independence; Board or audit committee |
| Scope and help | Scope set by the audit committee or Board with the internal auditor; IT or technical support where needed |
| Follow-up | Deficiencies reported must be corrected |
| Evidence | Internal audit reports and Board and audit committee minutes |
For companies outside section 138, still enquire and report the position. If the system is not commensurate for a company that must have one, tell the audit committee or Board and report.
(b) Reports considered. The auditor considers internal audit reports before concluding the audit. If he uses internal audit work for audit purposes, SA 610 applies. The GN adds practical expectations: agree with management that reports reach the auditor in good time; meet the internal auditor; make sure observations with a financial impact are addressed; assess control deficiencies for the report on internal financial controls; ask for full reports, not summaries; and classify control gaps by severity. If reports are missing, late or inadequate, the clause should reflect that, and the effect on internal financial controls reporting should be considered.
Clause 3(xv): non-cash transactions (paragraph 77)
The first part asks whether the company had non-cash transactions with directors or connected persons; the section 192 compliance part arises only if the answer is yes. The GN notes that section 192 covers arrangements where the director (of the company, its holding, subsidiary or associate) or a connected person acquires assets from the company, or the company acquires assets from them, for consideration other than cash. Prior approval by a resolution in general meeting is needed, and also at the holding company if the director is a director there; the notice must state the particulars and the value by a registered valuer. Our section 192 explainer covers the Act.
The GN reads the key terms this way: non-cash means outside cash and cash equivalents under the cash flow standard; a deferred payment for an asset acquired in one year and settled in the next is not non-cash; court-approved mergers are not covered; and "connected person" is undefined, so the section 185 explanation of persons in whom a director is interested is the reference point.
Procedures: begin with a management representation, then corroborate from the MBP-1, MBP-2 and MBP-4 registers, PPE register movements and minutes. Ask about post-year-end intentions, since the section covers "is to acquire". Check the approval, the valuer's value in the notice and any holding company approval.
Clause 3(xvi): RBI registration (paragraphs 78 to 81)
| Clause | Question | GN approach |
|---|---|---|
| 3(xvi)(a) | Is registration under section 45-IA required, and obtained? | Test whether financial activity is the principal business using RBI's tests as in force; check required net owned funds; if not registered, document management's reasons; consider whether a breach is temporary and was told to the regulator |
| 3(xvi)(b) | Any NBFC or housing finance activity without a valid certificate? | Same procedures; take a representation and check whether a certificate was withdrawn, suspended or surrendered and business continued |
| 3(xvi)(c) | Is it a core investment company, and does it still meet the criteria (or exemption)? | Test the last audited balance sheet against RBI's CIC directions; check registration or application where required; for exempt CICs, check they do not access public funds or take contingent liabilities that end the exemption |
| 3(xvi)(d) | More than one CIC in the group? | List group companies as the directions define them; take a representation covering exempt and unregistered CICs; compare with the RBI list; report the number |
A non-compliance reported under clause 3(xvi) should also lead the auditor to consider an exception report to the RBI.
A worked example
Orion Credit Limited is a Nidhi with net owned funds of Rs 4 crore and deposits of Rs 90 crore. The ratio of 1:22.5 breaches 1:20, so the auditor reports the shortfall and actual ratio, and also ten per cent term deposits shortfall of Rs 60 lakh as at the balance sheet date, with no interest defaults.
Need help with related party and regulatory compliance?
Approvals, registers and registrations are far easier to settle during the year. TaxClue's compliance advisory team can review related party approvals, section 192 arrangements and regulatory registrations with you before the audit.
Key takeaways
- Clause 3(xii) is for Nidhi companies only and tests the 1:20 ratio, ten per cent term deposits and deposit defaults.
- Clause 3(xiii) combines Companies Act approvals and accounting standard disclosures.
- Internal audit has two limbs: the system itself, and whether the auditor considered its reports.
- Section 192 compliance is reported only if a non-cash transaction exists.
- Clause 3(xvi) depends on RBI's directions as in force.
Read next
- CARO 2020 clauses 3(xvii) to 3(xxi) in practice
- CARO 2020 clauses 3(x) and 3(xi) in practice
- SA 610: using the work of internal auditors
- Section 188: related party contracts
Disclaimer: Based on the Companies (Auditor's Report) Order, 2020 as explained in the ICAI Guidance Note on CARO 2020 (Revised 2022 Edition), as consulted on 3 October 2026. CARO applies to financial years commencing on or after 1 April 2021; later amendments to the Order, Schedule III and the laws referred to should be checked. This article is general information, not legal advice; check the official text before acting.