What Will Constitute A Service Concession Arrangement?

Fact pattern

As per an arrangement with the Civil Aviation Department (CAD), Airport Co Ltd (ACO) shall construct an airport and provide Aeronautical & Non-Aeronautical Services. The Aeronautical services are regulated by the CAD, but Non-Aeronautical services are unregulated.

Aeronautical services (“Regulated activity”) include:

a)  Provision of flight operation assistance and crew support systems

b)  Ensuring the safe and secure operation of the Airport, excluding national security interest

c)  Movement and parking of aircraft and control facilities

d)  Cleaning, heating, lighting and air conditioning of public areas

e)  Customs and immigration halls

f)   Flight information and public-address systems

g)  X-Ray service for carry on and checked-in luggage

h)  VIP / special lounges

i)   Aerodrome control services

j)   Arrivals concourses and meeting areas

k)  Baggage systems including outbound and reclaim

Non-Aeronautical Services (“Unregulated activity”) include:

a)  Aircraft cleaning services

b)  Duty free sales

c)  Airline Lounges

d)  Hotels and Motels

e)  Car Park rentals

f)   Bank/ ATMs

g)  Telecom

h)  Advertisement

i)   Parking

j)   Flight kitchen

k)  Land and space

l)   Ground handling 

–   ACO shall recover charges for aeronautical services as determined or regulated by CAD under an agreed mechanism i.e. “price cap mechanism” which is substantive in nature. Thus, income from aeronautical services is considered as Regulated income.

–   ACO is free to fix the charges for Non-Aeronautical Services, thus income earned on this account is unregulated.  

–   ACO has subcontracted/outsourced certain specialised non-aeronautical services to separate entities i.e. joint ventures (between ACO and those specialised service providers e.g. Duty free, parking and IT equipment operations) and for certain services like shops, pharmacy, restaurant etc. directly to third parties. ACO earns revenue share from these entities/concessionaires. ACO, being the airport operator, continues to remain responsible for all the activities at the Airport including the ones sub-contracted.

Revenue from Aeronautical and Non-aeronautical services

–   To achieve the overall purpose CAD allows non-aeronautical services, and that too at an unregulated price to make the airport project as a whole viable for the government, users and the operator. In light of the non-aeronautical services, the government seeks to make the user charges for aeronautical services affordable to the users (public).

–   ACO estimates that over the entire concession period, total non-aeronautical revenue (unregulated) will be very significant and even greater than the aeronautical revenue (regulated).

Is this arrangement a service concession arrangement (“SCA”) under Ind-AS?

–   Appendix A to Ind AS 11 (“Appendix A”) contains provisions regarding what constitutes a service concession arrangement (“SCA”) and accounting for the same.

–  As per Para 5 of Appendix A an arrangement is a SCA if:

–    The grantor controls or regulates what services the operator must provide with the infrastructure, to whom it must provide them, and at what price; and

–  the grantor controls—through ownership, beneficial entitlement or otherwise—any significant residual interest in the infrastructure at the end of the term of the arrangement

–   Para AG7 of Application Guidance on Appendix A deals with scenario where the use of infrastructure is partly regulated and partly un-regulated and provides guidance on the application of control assessment principles as enunciated in Para 5 above in such scenarios.

–   It provides:

(a) Any infrastructure that is physically separable and capable of being operated independently and meets the definition of a cash-generating unit (CGU) as defined in Ind AS 36 shall be analysed separately if it is used wholly for unregulated purposes. For example, this might apply to a private wing of a hospital, where the remainder of the hospital is used by the grantor to treat public patients. 

(b) when purely ancillary activities (such as a hospital shop) are unregulated, the control tests shall be applied as if those services did not exist, because in cases in which the grantor controls the services in the manner described in paragraph 5 of Appendix A, the existence of ancillary activities does not detract from the grantor’s control of the infrastructure. 

Author’s Analysis

  The condition with regard to control over the price of service that is provided using the infrastructure asset is an important condition. If CAD does not control the price of the services, the infrastructure asset will not be subjected to SCA accounting.

–  Para AG7 (a) discussed above requires regulated activity and non-regulated activity to be accounted separately if the separability test is met. In the above case, the infrastructure i.e. Airport premises is being used both for regulated services (aeronautical) and for providing unregulated services (non-aeronautical). There is no distinct or separate infrastructure for providing regulated and unregulated services. The regulated and unregulated services are highly dependent on each other, and do not constitute separate CGU’s, thus failing the separability test. The aeronautical and non-aeronautical services are substantially interdependent and cannot be offered in isolation e.g. operations like Duty free, IT services, foods and shops and Hotel around airport etc. are dependent upon the passenger traffic generated by the aeronautical activities. The sustainability of aeronautical and non-aeronautical services gets significantly impacted by non-existence of the other. Thus, in the given fact pattern, control test as enunciated above (Para 5 of Appendix A) needs to be applied on the infrastructure as a whole.

–   Para AG7 (b) requires purely ancillary activities that are unregulated to be ignored, and the control test should be applied as if those services did not exist. Therefore, if the unregulated services are interpreted to be purely ancillary, and control test is applied on that basis, CAD would have control over the infrastructure and consequently SCA accounting would apply for the operator. However, in the given fact pattern, the unregulated activities are very significant and not “purely ancillary”.

–   Appendix A does not define the term “purely ancillary”, however, in normal parlance it is understood to be an ‘activity that provides necessary support to the main activity of an organisation. Some of the synonyms for the term “ancillary” include, additional, auxiliary, supporting, helping, assisting, extra, supplementary, supplemental, accessory, contributory, attendant, incidental, less important, etc. One may argue that a user needs an airport to travel from Point A to Point B. Seen from this perspective, the unregulated activity is ancillary because it is only supporting the main activity of air travel. However, if seen from the perspective of importance, the unregulated activity is very important and should not be seen as ancillary and certainly not as “purely ancillary”. This is because the unregulated activity drives the airport feasibility, and is therefore very important from the perspective of the public (users), government and the operator. Besides in the given fact pattern, the unregulated income is very significant and estimated to exceed regulated income over the concession period.

–  As discussed above since the separability test is not met, the regulated and unregulated activity and the related infrastructure cannot be accounted for separately.

     Further, the unregulated activity is not purely ancillary and hence cannot be ignored. Thus in the fact pattern, the condition as mentioned above in para 5 that grantor control or regulates the prices for services should be analysed considering the entire infrastructure. This control criterion is not met for the entire airport, and hence this is not a SCA.

–   Also, Appendix A does not deal with a situation where the separability test is not met and the unregulated activity is not purely ancillary. Consequently, one could argue that it is scoped out of Appendix A, and should be accounted as Property, plant and equipment (PPE). On the other hand, one may argue that since neither Ind AS 16 nor Appendix A prescribes any accounting in these situations, one may voluntarily decide to apply Appendix A. Therefore the author believes that there would be an accounting policy choice, which when selected, should be consistently applied.

Whilst this discussion has been made in the context of modern airports which have significant unregulated activity, it may be applied by analogy to several other SCA which entail significant unregulated activity and revenue.  In most cases, careful analysis would be required to determine if the arrangement is a SCA or not.