Background
White
Goods Ltd. (WGL) and Electronic Items Ltd. (EIL) are companies under common
control. WGL is in phase 1 of Ind AS. Its transition date (TD) is 1st
April, 2015, comparative year is 2015-16, and first year of Ind AS is 2016-17.
The last statutory accounts under Indian GAAP was 2015-16; which will be a
comparative year under Ind AS.
In the last year of Indian GAAP
and comparative year of Ind-AS; i.e., 2015-16, WGL acquired through a slump
sale the business of EIL and paid a cash consideration. The acquisition was by
way of a slump sale and did not require any court approval.
WGL applied AS 10 Accounting
for Fixed Assets to record for the slump sale under Indian GAAP.
Consequently, the excess of consideration over the fair value of assets and
liabilities taken over was recorded as goodwill. For simplicity, let’s assume,
the fair value of the net assets was equal to the book value of the net assets
taken over.
For purposes of Ind AS, WGL
chooses to restate the business combination in accordance with Ind AS 103.
Appendix C, Business Combinations of Entities under Common Control of Ind AS
103, Business Combinations would apply. In accordance with the said
standard, this would be accounted as a business combination under common
control and consequently WGL would record the assets and liabilities at their
book values and will not record any goodwill.
Issue
Paragraph 12 of Appendix C
(referred to above), requires the following treatment to account for difference
between the consideration amount and the book value of the net assets taken
over.
“The
identity of the reserves shall be preserved and shall appear in the financial
statements of the transferee in the same form in which they appeared in the
financial statements of the transferor. Thus, for example, the General Reserve
of the transferor entity becomes the General Reserve of the transferee, the
Capital Reserve of the transferor becomes the Capital Reserve of the transferee
and the Revaluation Reserve of the transferor becomes the Revaluation Reserve
of the transferee. As a result of preserving the identity, reserves which are
available for distribution as dividend before the business combination would
also be available for distribution as dividend after the business combination.
The difference, if any, between the amounts recorded as share capital issued
plus any additional consideration in the form of cash or other assets and the
amount of share capital of the transferor shall be transferred to capital
reserve and should be presented separately from other capital reserves with
disclosure of its nature and purpose in the notes.”
In Ind AS financial statements,
can the goodwill recognised under Indian GAAP be adjusted against retained
earnings/other equity or whether the goodwill has to be presented as a negative
capital reserve?
The above question becomes very
important because of section 115JB (2C). In accordance with section 115JB (2C),
the book profits of the year of convergence and each of the following four
previous years, shall be further increased or decreased, as the case may be, by
one-fifth of the transition amount adjustments. Explanation (iii) defines
“transition amount” as the amount or the aggregate of the amounts adjusted in
the other equity (excluding capital reserve and securities premium reserve) on
the convergence date. Consequently, Ind AS transitional adjustments in retained
earnings/other equity are included in book profit for determining MAT liability
equally over 5 years beginning from the year of Ind AS adoption. Transitional
adjustments to capital reserve and securities premium are excluded from book
profit.
Author’s View
The following two assumptions
appear implicit in Paragraph 12 referred to above.
– Paragraph 12
envisages a situation where two companies are merging, and in order to preserve
the identity of the reserves, the difference between the share capital issued
plus other consideration and the share capital of the transferor is recorded as
an adjustment to capital reserves.
– Paragraph 12
envisages a situation where the consideration is lower than the book value of
the acquired assets and consequently it results in a capital reserve, which is
a positive amount.
In the fact pattern under
discussion, neither of the above two assumptions apply. Consequently the amount
recorded as goodwill under Indian GAAP, can only be eliminated as an adjustment
to retained earnings/other equity under Ind-AS, rather than presented as a
negative capital reserve amount. In the author ‘s view, any reserve under the
standards can only be a positive number. Therefore, it would be more
appropriate to eliminate the goodwill against retained earnings/other equity.
The above treatment will have a
positive income-tax implication. The goodwill debited to retained
earnings/other equity under Ind AS will provide a five year straight line
deduction for the determination of book profits for MAT purposes. This
deduction is not available if the goodwill was debited to capital reserves.
Further, since the goodwill was recorded under Indian GAAP statutory accounts,
the benefit of depreciation going forward would be available for purposes of
normal income tax computations, subject to fulfilment of other conditions.
If the Company had continued to be
in the Indian GAAP regime, it would have amortised goodwill and have lower book
profits for MAT purposes. The Company would also receive the benefit of normal
income tax deduction on account of goodwill depreciation.
Since the Ind AS outcome is the
same as would have been the case if the Company would have continued under
Indian GAAP, it does not provide any undue tax advantage to the Company.
Conclusion
Capital reserve cannot be a
negative number. Consequently, goodwill will be eliminated against retained
earnings/other equity. This could be an acceptable view and will ensure income
tax neutrality between Indian GAAP and Ind AS treatment of goodwill.
Proposed Amendment
The MAT Committee has recommended
an amendment to 115JB [2A]. If the section is amended, it will change the way
book profits are determined under Ind AS on a go forward basis (not
transitional amounts). As per this amendment, items debited or credited to
other equity will be included in determination of book profits barring certain
exceptions. One of the exceptions is capital reserve in respect of business
combination of entities under common control.
In the author’s opinion, capital reserve cannot
be a negative number. Therefore, in a slump sale if the consideration paid is
greater than net assets, the excess will be debited to retained earnings. Since
the amount is not debited to capital reserves, it will not be covered by the
above exception, and should be allowed as a deduction of book profits for the
purposes of MAT in that year.
