Synopsis:
Land acquisition now has become a crucial driver for development activities undertaken by Government and Private Sector. Central Government has proposed a combined bill on land acquisition and rehabilitation and resettlement which shall now also cover private sector. Hence it is all the more important to analyze various nuances involved in such kind of transactions. There are three types of cost involved in acquisition of land Direct compensation, future subsistence cost for displacement of livelihood of the families and community development and welfare activities in general. The author describes accounting, recognition , measurement treatment and taxation impact on such kind of costs.
Introduction
With the growing need to grow, various industrialists in developing nations like India step forward to invest in new manufacturing facilities. One of the key requisite for this activity is Land, on which the upcoming industries will be set up. Land acquisition is a crucial driver for various infrastructures projects and economic developmental activities undertaken by the Government as well as by Private sector.
Land acquisition refers to the compulsory acquisition of land by the government from the owner of land. In India it is governed under Land Acquisition Act, 1894. Land may be acquired for defence and national security; roads, railways, highways, and ports built by public as well as private sector enterprises; planned development; residential purposes for the poor and landless, etc. This Act did not include any rehabilitation or resettlement scheme or address any Social impact on such acquisition by Government. In 2003, the Central Government formulated the National Rehabilitation and Resettlement Policy, which was last updated in 2007. It provides for minimum rehabilitation and resettlement expenditure that has to be incurred by the Government machinery, though State Governments can provide for additional rehabilitation avenues. In order to facilitate the process of acquisition, many private enterprises have adopted to acquire the land through Government under the provisions of the Act.
Central Government has proposed a combined bill on Land Acquisition and Rehabilitation and Resettlement in the Parliament. The proposed bill requires all Private land acquisitions also to provide rehabilitation and resettlement to displaced people if the area of acquisition is over a certain limit.
As per the existing and proposed guidelines, there are three types of costs incurred while acquiring land:
a. Direct Compensation for the fair value of the piece of land;
b. Future subsistence cost for displacement of the livelihood of the families; and
c. Community development and welfare activities in general.
To take a practical view, following are the objectives and various cost components that are part of Jharkhand Rehabilitation and Resettlement policy – 2008:
Objectives of the Policy
1. to minimise displacement and to promote, as far as possible, non-displacing or least displacing alternatives;
2. to ensure adequate rehabilitation package and expeditious implementation of the rehabilitation process with the active participation of the affected families;
3. to ensure that special care is taken for protecting the rights of the weaker sections of society, especially members of the Scheduled Tribe and Scheduled Castes with concern and sensitivity;
4. to provide a better standard of living, making concerted efforts for providing sustainable income to the affected families;
5. to integrate rehabilitation concerns into the development planning and implementation process; and
6. where displacement is on account of land acquisition, to facilitate harmonious relationship between the requiring body and affected families through mutual cooperation.
Direct Compensation – Family specific
i. Piece of land for constructing house, free of cost
ii. Construct a permanent establishment for the displaced land owner
iii. One time financial assistance in case of the family wishes to relocate.
Future Subsistence – Family specific
i. Allowance for displacement of cattle and Employment to individuals from those family
ii. Employment to family members.
iii. If employment is not given or accepted by land owner, then regular income for sustaining life of the individual for a period of 25 to 30 years depending upon State Governments i.e. Bhatta.
iv. Percentage share in net profits of the company
Community/Infrastructure Development – General
i. Expenses on village infrastructure development such as roads, water and sewerage systems, drainage systems, education, skill development, etc.
ii. Construction of Residential colonies.
Recognition and measurement With respect to compensation cost, there is no ambiguity as it represents direct cost of acquisition based on fair market value of the piece of land.
It is Rehabilitation and Resettlement (R&R) expenditure where various practices have been observed in its recognition and measurement. Some attribute a nexus to acquisition of land and capitalise the entire expected outflow on this account. While some account the R&R cost as revenue expenditure, as and when incurred.
Accounting Policy excerpt from NTPC Limited Consolidated Financial Statements 2009
“Based on the opinions of the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI) received during the year, in respect of land in possession of the company, provision of Rs. 3,197 million has been made towards expenditure on resettlement & rehabilitation activities including the amount payable to the project affected persons (PAPs) towards land for land option, resettlement grant or other grants, providing community facilities and compensatory afforestation, greenbelt development & loss of environmental value etc. based on the Rehabilitation Action Plan (RAP) of the Company or as per the agreement with/demand letters/directions of the local authorities and the same is included in the cost of land”.
Accounting Policy excerpt from NTPC Limited Consolidated Financial Statements 2012
“Fixed assets: Deposits, payments/liabilities made provisionally towards compensation, rehabilitation and other expenses relatable to land in possession are treated as cost of land.”
Accounting Policy excerpt from Coal India Limited Annual Report 2012
“Land: Value of Land includes cost of acquisition and Cash rehabilitation expenses and resettlement cost incurred for concerned displaced persons. Other expenditure incurred on acquisition of land viz. compensation in lieu of employment, etc are, however, treated as revenue expenditure.”
Looking at the compensation structure in acquisition of land, it seems to be similar to acquisition of Spectrum, which requires initial license fee and regular revenue share to the government with minimum committed every year.
In fact, the analogy also holds good in case of acquisitions of definite life assets such as Mine, Coal or an Oil Block. In these cases, since the assets are not in ready to use condition at the first instance. Government allots them at nominal value with limit on its capital exploration expenditure, as seen in case of Oil& Gas exploration. Once the asset is ready to use, there is a regular fee/royalty/revenue share based on production on an annual basis till the useful resource is depleted.
This analogy is drawn on following counts:
i. Both, the assets, ie Spectrum in specific, as well as Land, have indefinite useful life.
ii. The compensation for both types of asset acquisition is split into 3 categories
iii)immediate compensation at the time of acquisition to secure right to use the asset and
– sustaining expenditure, in case of spectrum, it is on usage of spectrum over its life and in case of land it is R&R expenditure i.e. subsistence cost for every subsequent year’s livelihood.
– The utilisation of natural resource also requires certain rehabilitation expenditure such as mine rehabilitation, maintenance of flaura & fauna of the place and other environmental obligations on sustaining basis.
Let us understand the facets of concerns and issues involved in measurement and recognition for accounting of various components of such rehabilitation and resettlement cost.
Recognition and Measurement:
From the accounting perspective, the following two issues arise with regard to the R&R expenditure:
i) The timing of the creation of the provision for R&R expenditure; and
ii) The corresponding debit in respect of the provision, i.e., whether the same should be capitalised or recognised as an expense in the statement of profit and loss.
There is no specific literature for the given case except from the Technical guide on Accounting for Special Economic Zones (SEZs) Development Activities.
It states that “in accordance with the above principles of recognition of provision as enunciated in AS 29, the provision for R & R expenditure should be created and accounted for as follows:
(i) In respect of the R&R expenditure which arises on the acquisition of land as the lump-sum or annuity payment to be made by a Developer to the land seller, provision should be created at the time of the acquisition of the land itself. This is because the Developer has present obligation in this regard at the time of the acquisition of the land itself and the other two criteria for recognition are normally met at that point of time. The amount in respect of the provision should be capitalised as a part of the cost of the land. Similarly, provision should be created at the time of acquisition of land in respect of the other R&R expenditure with regard to which the Developer has a present obligation which cannot be avoided by the Developer by a future action.
Such expenditure should also be capitalised as part of the cost of land.
(ii) Where a provision is not related to any asset, to be recognised as the asset of the Developer, for example, R&R incurred with respect to those assets which will not be recognised by the Developer because he would not be the owner of these assets as these will be transferred to the local area administrators, for example, village panchayats, the same should be recognised in the statement of profit and loss when the provision in this regard is made.
(iii)The R&R expenses, which are revenue in nature, e.g., revenue expenditure in respect of Education and Health Programmes, should be recognised in the statement of profit and loss for the period in which the criteria for making the provision in this regard are met.
The Acquirer has present obligation in this regard at the time of the acquisition of the land itself, there is high probability of outflow of resources to settle the obligation and a reliable estimate can be made at that point of time. These are essentially the three criteria with regard to the timing of the creation of the provision, Accounting Standard (AS) 29, Provisions, Contingent Liabilities and Contingent Assets.”
The Technical guide as referred above, requires all direct and indirect expenditure i.e. Compensation as well as subsistence cost, to be capitalised with the Cost of Land. For Community related expenditure, it however suggests to recognise a separate asset if the expenditure is incurred for creation of a capital asset ie roads, hospitals, buildings, etc and charge to income statement if the expenditure is for health programs and other such Corporate social responsibility measures, as and when incurred.
It is to note that all the three types of expenditure (ie direct compensation of fair value, subsistence cost and community development) is incurred only for acquiring the Land and hence there is direct nexus of such expenditure with the asset in balance sheet. It is within the direct framework of AS 10 Fixed assets to capitalise direct compensation cost to Cost of land, however, capitalising future subsistence expenditure to cost of Land seems to be little unreasonable.
Expert advisory Opinion:
Provision towards resettlement and rehabilitation schemes (Compendium of Opinions — Vol. XXVIII)
The querist had sought an opinion on recognition and measurement of expenditure incurred/to be incurred while acquiring land of project purposes.
The Committee opined as follows:
(a)In respect of the estimated amount payable to the land oustees in respect of ‘Land for Land’, re-habilitation/ resettlement grants, subsistence grant/ self-resettlement grant, a provision, on the basis of best estimate of the expenditure required to settle the obligation, should be made on the acquisition of land from the project affected persons.
(b) In respect of infrastructural measures, a provision on the basis of best estimate of the expenditure re-quired to settle the obligation, should be made on the acquisition of land from the project affected persons.
The recognition criteria for provision is dependent on an Obligating event. The committee has considered the acquisition of Land as the obligating event for recognising a provision for future subsistence cost as well as Community development/Infrastructure related cost.
Looking at the larger picture, following aspect may be evaluated for considering the substance, while applying the recognition and measurement principles for R&R expenditure:
In a growing economy which has natural resources and tribal population residing in interior rural India, setting up a manufacturing plant requires following five major partners:
1. Businessmen, i.e., Promoter with equity and vi-sion;
2. Banks to support the additional capital;
3. Government to allow use of the country’s re-sources (some having definite and some indefi-nite life)
4. People who own a perpetual/indefinite life asset, i.e., Land; and last but not the least
5. Environment/nature itself.
Establishment of any project in backward rural areas is possible only if it benefits all. Government Policy plays a crucial role in combining and serving the interest of all parties and executing the project.
While Promoters with equity investment earn profits from an ongoing business, Lenders earn their share of profit in terms of fixed service cost since they part their money only for short period.
Government initially recovers a fair value of the natural resource but since some of them have in-definite life, it also charges on-going basis, a share in its profits as in case of spectrum usage in Telecom i.e. Revenue Share, Revenue share in Oil & Gas and Royalty in case of mines.
Similar to Government, people who have been living and earning their livelihood also possess and own an asset with indefinite life. In order to obtain their consent, a similar policy is followed wherein they initially get the fair value of their asset and continue to earn the share of business profits for their balance life.
Their contribution to the business is more than Lenders as they have a right to share the profits in a fixed form like “Bhatta” or Share in profits till plant operation, in perpetuity as per the regulations promulgated by the State Governments. This partnership with people promises a regular income to the owner of land which is similar to the revenue share in case of Spectrum Usage, Revenue share and Royalty.
In the above presented partnership, the cost of acquisition as well as future expenditure obligations is known, but then there is no need to create a provision/capitalisation on Day 1 for the Promoter for his future share of profits, for the lender/banker for its committed interest service, Government for its future estimated royalties based on estimated business cashflows, then why should there be a provision and capitalization (in land) of future subsistence cost in case of displaced landowners !!.
Excerpts from AS 29: Provisions, Contingent Liabili-ties and Contingent assets
14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation.
Analysing the above requirement of the standard, all the components of R&R costs arise on account of signing an agreement with the land owners for acquiring their land and hence at any subsequent reporting date, an enterprise has obligation on account of the past event i.e. signing the land acquisition contract. However, some of the expenses are arguably not the present obligation but are future obligations.
It is probable that the obligation will lead to out-flow of resources but reliable estimate may not be done for cases that require sharing of future profits. The future estimates are though available with the Company as they are shared with various analysts, it may not be completely reliable, though contrary view exists.
Further, the future obligations under Indian GAAP are recorded at its full value instead of using dis-counted approach. In any case, if such costs are considered as part of capital costs, the actual share in profit for every year will lead to adjustment to the cost of land, which the entity will have to keep a tab till the life of asset. It is more cumbersome under IFRS, which requires use of present value principles for making a provision.
As we have broadly categorised various expenditure components of R&R cost into Compensation, Future subsistence and Community Development.
The first category that includes viz..cost of piece of land for constructing house, free of cost, construct a permanent establishment for the displaced land owner, one time financial assistance in case of the family wishes to relocate, satisfy all the three criteria for provision under AS 29 and also has a direct established nexus for acquisition of land. Thus a provision is made and amount is capitalised with the cost of Land in case of payments to landowners.
Commitments for schools, hospitals, etc. be owned by the Company but for the benefit of people are recognised as fixed assets as and when constructed, CSR activities are expensed as and when incurred. Unfinished work forms part of Commitments disclosure in Balance Sheet.
It is the cost that is in the nature of future subsis-tence that needs to be recognised and measured with its substance rather than form.
Taxation impact
Any cost capitalised as part of land is a capital cost. There is no depreciation benefit available to the Company, though the cost of land increases and the company can avail higher cost at the time of sale of such land. However, it is to note that the Company has not acquired the land for disposal, hence the cost incurred on land is essentially a sunk cost which yields no tax benefit.
Considering the tax perspective, the company sharing percentage profit every year with land owners, will not be allowed to consider as a revenue expenditure if the Company had to provide for and capitalise the entire future profits along with the cost of land.
No depreciation benefit and no direct allowable ex-pense benefit is available in income tax computation for such cost. Thus entities will have to carefully determine its accounting policy.
Points of relevance
a. The Land is for a specific usage as per the policy of the State Government.
b. It can be observed that the Future subsistence costs are in the nature of Corporate Social Responsibility (CSR) which are incurred by the Company and moreso governed by Statute.
c. Some costs are not compensation for land but for future subsistence of displaced people till the plant is in operation and have direct nexus with Operations of the plant. For example, if the company is shut down, there will be no employment, if there is not profit, there is no share of profit.
d. Some are in the nature of regular taxes levied by stature such as property taxes. In case of R&R these are regular income to land owners in the form of Bhatta.
e. If the landowner agrees for employment, the amount of salary is charged to the income statement, but if he agrees for fixed income without employment, then it gets linked towards cost of land and not for future right to use on annual basis like property taxes.
f. Payments made on account of future subsistence, if capitalised with the cost of land, then it may not be allowed as expenditure in income statement which is not the case with “Revenue share” and “Royalty”.
g. Acquiring the land is in substance similar to a Purchase order issued by a company for future subsistence cost. Thus the obligating event is de-ferred to respective future period for provisioning.
Views that emerge
Immediate cost that is compensating the landowners immediate needs to be capitalised with cost of land.
Subsistence allowance which is committed by the Company at the time of acquisition of land is a binding commitment towards land owners. The Obligating event ie acquisition of land only gives rise to a commitment for future and should be viewed as a period cost charged to operations. Especially for clauses such as share of profits, where even determination of profit may not be a reliable estimate, though alternate view exists.
Similar to telecom and hydrocarbon businesses, land acquisition also is regulated for specific usage and regular subsistence cost based on earning. Hence recognising the future subsistence cost component in substance to be considered as part of income state-ment, as one of the charges for the usage of asset. This would to be more in line with comparative asset acquisitions (ie Spectrum, Mine, Oil & Gas) followed by enterprises and also justifies its core substance. Unrecognised commitment can be disclosed as off-balance sheet item under ‘Contractual Commitments’.
