BCAJ | Bombay Chartered Accountant Journal

Acquisition date v Appointed date

Acquisition
date v Appointed date

In India, merger and acquisition schemes that require a court/ tribunal
approval will have an appointed date, mentioned in the scheme, which is the
date from which the merger and acquisition is accounted. The scheme becomes effective when the court
order is passed and the order is filed with the Registrar of Companies. The appointed date is a very important date,
since from an income-tax legislation perspective, that is the date when the
amalgamation or acquisition accounting is done and the carry forward of any
business losses is allowed to the transferee.

The Indian GAAP accounting standards were also aligned to this
concept. AS-14, Accounting for Amalgamations, itself did not expressly contain any
discussion around the difference between the appointed date and effective
date. However, an EAC opinion required
the accounting of the combination from the appointed date mentioned in the
court scheme, once the court approval was received. From an income-tax perspective, the company
would need to file revised returns to reflect the combination from the
appointed date.

With the introduction of Ind AS, the Indian GAAP position is no longer
valid for companies that apply Ind AS.
As per paragraph 8 of Ind AS 103 Business
Combinations, the acquirer shall identify the acquisition date, which is
the date on which it obtains control of the acquiree.

An investor controls an investee when it is exposed, or has rights, to
variable returns from its involvement with the investee and has the ability to
affect those returns through its power over the investee. An investor shall consider all facts and
circumstances when assessing whether it controls an investee and the date of
obtaining control.

The date on which the acquirer
obtains control of the acquiree is generally the date on which the acquirer
legally transfers the consideration, acquires the assets and assumes the liabilities
of the acquiree—the closing date. However, the acquirer might obtain
control on a date that is either earlier or later than the closing date. For
example, the acquisition date precedes the closing date if a written agreement
provides that the acquirer obtains control of the acquiree on a date before the
closing date. An acquirer shall consider
all pertinent facts and circumstances in identifying the acquisition date.

Determination of acquisition date
under Ind AS may not always be straight-forward, particularly in a transaction
that involves a court scheme. Such court
schemes may involve common control transactions involving entities under common
control or acquisition that involves independent or non-related parties. Careful analysis of the facts and
circumstances and judgement would be necessary to determine the date of
acquisition.

When an independent party is
acquired, determining the acquisition date is important because at that date
the assets and liabilities are fair valued and goodwill and minority interest
is determined. From the acquisition date
the acquired entity results are included in the financial statements of the
acquirer.

Business combinations
involving entities or businesses under common control shall be accounted for
using the pooling of interests method. The pooling of interest method is carried
out as follows:

i. The
assets and liabilities of the combining entities are reflected at their
carrying amounts.
ii. No
adjustments are made to reflect fair values, or recognise any new assets or liabilities.
The only adjustments that are made are to harmonise accounting policies.

iii. The
financial information in the financial statements in respect of prior periods
should be restated as if the business combination had occurred from the
beginning of the preceding period in the financial statements, irrespective of
the actual date of the combination.

When a business
combination is effected after the balance sheet but before the approval of the
financial statements for issue by either party to the business combination,
disclosure is made in accordance with Ind AS 10 Events after the Reporting
Period, but the business combination is not incorporated in the financial
statements.

From an Ind AS perspective,
the business combination date in a common control transaction determines two
things:

i. The
year in which the combination is accounted.
Therefore, assuming the combination date is financial year 17-18, the
accounting will be done in the financial year 17-18. However, the financial information for the
financial year 16-17, will be restated as if the business combination had
occurred from the beginning of the financial year 16-17.
ii.
If
the business combination date falls after the balance sheet but before the
approval of the financial statements for issue by either party to the business
combination, disclosure is made in accordance with Ind AS 10 Events after
the Reporting Period, but the business combination is not incorporated in
the financial statements.

Agreements or court schemes may
provide a retrospective date of business combination. Irrespective of such date, the date for
business combination under Ind AS 103 is the date on which the control is
actually obtained. This may or may not
correspond to the date specified in the agreement or the appointed date in a
court scheme.

Some business
combinations cannot be finalized without a regulatory approval or a court
approval. An investor controls an investee when it is exposed,
or has rights, to variable returns from its involvement with the investee and
has the ability to affect those returns through its power over the
investee. It is necessary to consider
the nature of regulatory approval in each case, to determine the date when
control is passed.

To illustrate, consider a business
combination involving three telecom companies, under a court scheme. Though the court may approve the scheme, it
does not become effective till the transaction is approved by the Department of
Telecom (DOT)/ TRAI and the Competition Commission and the final order is filed
with ROC. In this scenario, the last of
the date of final approval from DOT/ TRAI and the Competition Commission may be
the acquisition date. Consider another business
combination, involving entities under common control. Essentially two 100% subsidiaries of the
parent are merging to form one company.
The shareholder of the companies, which is the parent company, has
approved the merger in the annual general meetings. There are no creditors and no minority
shareholders. No approval is required of
the Competition Commission or any other regulator, and there are no
complexities in the transaction.
Essentially in such circumstances, the court order may be deemed to be a
formality, and the date of shareholders resolution approving the combination
may be the date of business combination.

In a transaction between two
independent parties, the date the control passes is the date when the
unconditional offer is accepted. When
the agreement is subject to substantive preconditions, the date of acquisition
will be the date when the last of the substantive precondition is fulfilled.

The Madras High Court by way of its
order dated 6 June, 2016 in the case of Equitas
passed a very interesting order. In
the said case, the holding company had applied to the RBI for in-principle
approval to establish a Small Finance Bank (SFB). The RBI granted an in-principle approval
subject to the transfer of the two transferor companies into the transferee
company, prior to the commencement of the SFB business.

The Regional Director (RD) raised a
concern that the scheme did not mention an appointed date, and that the
appointed date was tied to the effective date.
Further, even the effective date was not mentioned and it was defined to
be the date immediately preceding the date of commencement of the SFB
business. The court observed that under
section 394 of the Companies Act such a leeway was provided to the
Company. Further, section 394 did not
fetter the court from delaying the date of actual amalgamation/merger. This judgement would provide a leeway to the
Company to file scheme of mergers/amalgamation with an appointed date/effective
date conditional upon happening or non-happening of certain events.

The two examples below explain how
the requirements of Ind AS and the court scheme can be aligned.

Acquisition of an
Independent Party

Company
A (Acquisitive) wants to acquire Company B (Willing). Acquisitive and Willing are involved in
running some business. The acquisition
requires several important formalities to be completed including the approval
of the court. One of the pre-condition
of the acquisition is the completion of all formalities and the receipt of
court approval. Acquisitive follows
the financial year. Acquisitive and
Willing enter into a binding agreement (subject to the above pre-condition) on
1 April 2016. The appointed date
mentioned in the court scheme is 1 April 2016. The formalities and the final court approval
for Willing to be subsumed in Acquisitive are received on 1 September 2016.

Under
Ind AS 103, the acquisition date is 1 September 2016. This is the date when Acquisitive will do a
fair value accounting and determine goodwill and minority interest. Acquisitive will fair value the assets and
liabilities of Willing at 1 September 2016.
Legally, for normal income tax computation, Acquisitive will consider
the profits of Willing for the full financial year 16-17. However, in Ind AS financial statements,
Acquisitive will not account for Willings profits from 1 April 2016 to 31
August 2016 as its own profits; rather the profits for that period would
increase the fair value of net assets of Willings and reduce the amount of goodwill
recognized by Acquisitive.

In
order to comply with the requirements of Ind AS, Acquisitive may consider the
following two options:

Acquisitive
relies on the Madras High Court judgement in Equitas. Consequently, the
appointed date and the effective date could be set out in the court scheme,
as the date when the court passes the final order approving the acquisition,
1 September 2016. The appointed date cannot be 1 April, 2016, because it
would not be in compliance with Ind AS.

Appointed
date for tax purposes and tax financial statements can be 1 April 2016.
However, the scheme should clearly provide that for accounting purposes in
Ind AS financial statements, date determined under Ind AS 103 will be used. In this fact pattern, the said date would
be 1 September, 2016. Some legal
luminaries have opined that it is possible to follow this path and that the
courts have an unfettered power to do so.

The
author believes that in general, the first alternative should be preferred as
it ensures consistency between tax and accounting treatment. Also, there will
be no need to file revised tax return for past periods or maintain two set of
financial statements, one for tax purposes and another for Ind AS purposes.

It
may be noted that for MAT purposes, the financial statements are required to
be in compliance with accounting standards.
Therefore, for MAT purposes the financial statements should be
prepared with 1 September 2016 as the date of acquisition. In other words, the Ind AS compliant
financial statements will be the relevant financial statements for the
purposes of MAT. From an income tax
computation perspective for the carry forward of losses or acquisition
accounting, the tax financial statements prepared with an appointed date 1
April, 2016 may be acceptable.

For
normal income tax computation purposes, legal merger is from 1 April 2016.
Profits from 1 April 16 to 31 August 16 has to be offered to tax in hands of Acquisitive
even though it reflects as goodwill in Acquisitives’ Ind AS financial
statements. Specific provisions of the Income tax Act will govern tax
treatment of items like tax WDV of assets, allowance of certain expenses on
actual payment basis, disallowance for TDS default, etc. Transition of
business loss/unabsorbed depreciation will be of amounts as determined till
31 March 16. Normal income tax computation is generally not impacted by
accounting treatment in Ind AS financial statements.

However,
if the court scheme contains any unusual adjustments that are not consistent
with tax policies, those may not be acceptable. For example, if the court scheme allows
derivative profits to be recognized by Acquisitive directly into reserves in
the tax financial statements, and the auditor has modified the audit report,
the derivative profits will be taxable under income-tax laws.

Business Combination
between Common Control Entities

Company
A (Acquisitive) and Company B (Willing) are in the business of manufacturing
and selling cement. Both Acquisitive
and Willing have a common parent. The combination
of Acquisitive and Willing requires several important formalities to be
completed such as approval from the competition commission, clearance from
minority shareholders and creditors, other regulatory approvals, and the
final approval of the court.
Acquisitive follows the financial year. Acquisitive and Willing enter into a
binding agreement on 1 April 2016, subject to completion of all
formalities. A resolution has been
passed by shareholders of both the companies, prior to that date, for
approving the transaction. The
appointed date mentioned in the court scheme is 1 April 2016. The formalities are completed and the final
court approval is received on 1 April 2017.

Under Ind AS 103, the combination
date is 1 April, 2017. This is the
date when Willing will merge into Acquisitive. The combination is accounted by Acquisitive
in the financial year 2017-18, using the pooling of interest method. However, the financial information of
Acquisitive for the financial year 16-17, will be restated as if the business
combination had occurred from the beginning of the financial year 16-17, ie
from 1 April 2016.

If the formalities are
completed and the final court approval is received on 1 April 2018, the
combination is accounted by Acquisitive in the financial year 2018-19.
However, the financial information of Acquisitive for the financial year 17-18,
will be restated as if the business combination had occurred from the beginning
of the financial year 17-18, ie from 1 April 2017.

In
order to comply with the requirements of Ind AS and ensure tax consistency as
discussed in previous example, Acquisitive would need to rely on the Madras
High Court judgement in Equitas. Essentially the appointed date and the
effective date could be set out in the court scheme, as the date when the
court passes the final order approving the combination transaction. The appointed date may not be 1 April,
2016, because it would not be in compliance with Ind AS.

However,
Acquisitive may consider an option whereby it prepares separate accounts for tax purposes with an appointed
date of 1 April, 2016. For MAT
purposes, Ind AS compliant financial statements will be the relevant
financial statements. These aspects
are discussed in the previous example.

Conclusion

The ICAI should
provide appropriate clarification on the above subject. However, in the meanwhile, the principles
established in this article may be used to ensure compliance with Ind AS and
also fulfill the requirements of section 394 of the Companies Act.

shailesh.kwebmaker

Impact on MAT from First Time Adoption (FTA) of Ind AS

The MAT Ind AS Committee (hereinafter referred to as ‘Committee’) on 18th March 2016 issued a draft report on the ‘Framework for computation of book profit for the purposes of levy of Minimum Alternate Tax (MAT) u/s. 115JB of the Income-tax Act 1961 for Indian Accounting Standards (lnd AS) compliant companies in the year of adoption and thereafter’. The Report was revised on 23rd July 2016 (hereinafter referred to as ‘Framework’). The Framework is a draft and is subject to public comments and final changes. Once the Framework is final, the same will have to be incorporated in the Income-tax Act, to make it effective.

This article discusses the issues and challenges on first time adoption (FTA ) of Ind AS and the consequences for companies that fall under MAT . Though the revised Framework is an improvement from the pre-revised draft, the provisions do not appear to be fair or reasonable, and will significantly hamper the ease of doing business. In addition, the environment is most likely to become very litigious and painful.

The accounting policies that an entity uses in its opening Ind AS balance sheet at the time of FTA may differ from those that it previously used in its Indian GAAP financial statements. An entity is required to record these adjustments directly in retained earnings/reserves at the date of transition to Ind AS. The Committee noted that several of these items would subsequently never be reclassified to the statement of P&L account or included in the computation of book profits.

Consider a company has a net worth of Rs 500 crore, and therefore falls under phase 1of Ind AS implementation. Its date of transition to Ind AS is 1 April, 2015; comparative period is financial year 2015-16, and first Ind AS reporting period is financial year 2016-17. The company is engaged in several businesses and makes the following seven transition decisions at 1 April, 2015 in order to comply with Ind AS.

1. The company’s accounting policy for fixed assets is cost less depreciation under Ind AS. However, as per option available in Ind AS 101 all fixed assets are stated at fair value at date of transition. The revalued amount is a deemed cost of fixed assets at 1 April, 2015. In other words, the company’s policy is not to use revaluation on a go forward basis as the accounting policy. The uplift on revaluation is recorded in retained earnings and will never be recycled to the P&L account.

2. In the stand-alone accounts the company has several investments in subsidiaries which under Indian GAAP are stated at cost less diminution other than temporary. Under Ind AS the company will continue to account them at cost less impairment. However, as per option available in Ind AS 101 the investments in subsidiaries are stated at fair value at date of transition. The fair value is the deemed cost of investments at 1 April, 2015. Subsequently, the investments in subsidiaries are not fair valued but tested only for impairment. The uplift on fair valuation is recorded in retained earnings and will never be recycled to the P&L account.

3. Under Indian GAAP, the company discloses assets under a service concession arrangement (SCA) as intangible assets at cost and which does not include construction margin. On date of transition, the company accounts for the intangible assets in accordance with Ind AS 11 (Appendix A), treating them as service concession assets. Consequently, under Ind AS 11 (Appendix A), the construction margin is also reflected in the value of the intangible asset.Therefore at transition date, the value of the intangible assets will be increased with a corresponding increase in retained earnings. The increase in retained earnings will never be recycled to the P&L account. However, the increase in the value of the intangible asset will be amortized in the future years.

4. At 31 March 2015, the Company has a lease equalization liability under Indian GAAP for an operating lease. Under Ind AS 17, the Company is required to charge operating lease payments in the P&L account without equalizing the lease payments, since those lease payments are indexed to inflation. Consequently on the transition date, the company reverses the lease equalization liability and takes the credit to retained earnings. The increase in retained earnings will never be recycled to the P&L account.

5. The Company has a cash flow hedge reserve at 31 March 2015 under Indian GAAP, which meets all hedge accounting requirements under Ind AS. In accordance with Ind AS 101, the Company is required to maintain the cash flow hedge reserve, and recycle the same to the P&L account, in accordance with the principles of Ind AS 109.

6. The Company has a foreign branch and a positive foreign currency translation reserve (FCTR) in Indian GAAP stand alone accounts at 31 March 2015. In accordance with Ind AS 101, it restates the FCTR to zero on 1 April, 2015 – the date of transition. Consequently the corresponding effect is taken to retained earnings. The increase in retained earnings will never be recycled to the P&L account.

7. In addition to investments in subsidiaries the company has investments in unquoted securities that are held long term for strategic reasons, but which are neither, subsidiaries, associates or joint ventures. The Company designates these investments as FVOCI (Fair Value through Other Comprehensive Income). As per this accounting policy choice, the fair value changes are permanently recorded in reserves (not retained earnings) and are never recycled to the P&L account.

As per the Framework, the MAT implication for the above seven FTA items is given below, along with the author’s recommendation of the changes required and grounds for such recommendations.

The FTA adjustments made at 1 April, 2015 are to be appropriately dealt with to determine the book profits for MAT purposes. The big question is – Is it included in the book profits over three years starting from the comparative period, ie, financial year 2015-16 or in the year of FTA, ie, financial year 2016-17? Though the intent of the government may have been to include the adjustments in the book profits for 2015-16, it is no longer practically feasible to do so. It is most likely that the adjustments would be included to determine the book profits starting from the financial year 2016-17. Hopefully that clarity will come in the forthcoming budget, as this requirement would require an amendment to the Act. This is again an unpleasant outcome, given that companies would be paying advance taxes without the knowledge of the final law on this subject.

Conclusion
Companies need to make careful choices of FTA options to minimize a negative MAT impact. They can make those choices up till financial statements for year ended 31 March 2017 are finalized. However, changes in those choices will cause significant fluctuations in 2016- 17 quarterly results. For example, a company decides to carry forward fixed assets at previous GAAP carrying value as a transition choice to avoid any MAT liability on fair value uplift. Subsequently, in the last quarter, the budget clarifies that the fair value uplift on fixed assets will be completely tax neutral from MAT perspective. Because of the clarity, the Company prefers to fair value the fixed assets from the transition date instead of carrying them at previous GAAP carrying value. This would mean that the lower depreciation charge in the earlier quarters and the comparative period will have to be adjusted, thereby resulting in significant change in the reported numbers in the last quarter.

As a bold step, the Government may consider simplifying the MAT provision, and lower the MAT rates. Alternatively, AMT (Alternate Minimum Tax) regime applicable to noncorporate assesses and which is highly successful may be introduced for corporate assesses. However, given the time constraint it is generally understood, that the Government may not explore these choices.

shailesh.kwebmaker

Can a Company have two functional currencies?

Query
Can a Company have two functional currencies for its two autonomous divisions? Travel & Logistics Ltd (TL or the Company) an Indian registered company has two independent business divisions, namely, hotel division which runs hotels in India and shipping division which runs global shipping operations. TL assessed the functional currency of the hotel division as rupee (INR) and shipping division as US $. It may be noted that substantial income and expense of the shipping division is in US $. If the shipping division was housed in a separate company, its functional currency would be US $.

In which currency, TL will prepare its Ind AS financial statements? Will it be (a) INR (b) US $ or (c) INR for hotel division and US $ for shipping division?

Response
A similar issue was discussed by the Ind AS Transition Facilitation Group (ITFG). The view of the ITFG and the Author’s view are expressed below.

View of ITFG
As per paragraph 8 of Ind AS 21, The Effects of Changes in Foreign Exchange Rates, functional currency is the currency of the primary economic environment in which the entity operates.

Further, paragraph 17 of Ind AS 21 states that: “In preparing financial statements, each entity – whether a stand-alone entity, an entity with foreign operations (such as a parent) or a foreign operation (such as a subsidiary or branch)—determines its functional currency in accordance with paragraphs 9–14 of Ind AS 21.”

Paragraphs 9-14 of Ind AS 21, elaborate the factors that need to be considered by an entity while determining its functional currency.

In view of the above, it is concluded that functional currency needs to be identified at the entity level, considering the economic environment in which the entity operates, and not at the level of a business or a division. Accordingly, if after applying paragraphs 9-14 of Ind AS 21, the Company concludes that its functional currency is USD at the entity level, then it shall prepare its financial statements as per USD.

Though not stated, the obvious extension of this interpretation is that if the Company concludes that its functional currency is INR at the entity level, then it shall prepare its financial statements as per INR.

Authors view
Under Ind AS 21, foreign operations are defined as “Foreign operation is an entity that is a subsidiary, associate, joint arrangement or branch of a reporting entity, the activities of which are based or conducted in a country or currency other than those of the reporting entity.”

It is interesting to note that the activities of the branch may be conducted in a different country or in the same country but in a different currency. Ind AS 21 uses the term ‘branch’ to describe an operation within a legal entity that may have a different functional currency from the entity itself. It does not describe a branch, in the classical sense, such as a Company in Mumbai has a branch in Chennai.

An entity may have an operation, eg a division that operates in a different currency environment from the rest of the entity. Though this may not be a branch in a classical sense, it would be a branch for the purposes of Ind AS 21, provided the operation of that division represents a sufficiently autonomous business unit.

Therefore in the given fact pattern, the entity will apply functional currency US $ for shipping division and INR for hotel division. This interpretation would not be challenged if the shipping division was registered as a separate company in India or as a separate branch abroad. Therefore it does not make any logical sense to challenge this view just because it is housed in one entity and is called a ‘division’ rather than a ‘branch’. Besides given the way the term branch is used in the Ind AS 21 context, the shipping division and hotel division should be evaluated separately for the purposes of determining the functional currency.

To state the entity’s Ind AS financial statements in the presentation currency, the results and financial position of its operations having different functional currencies will be included using the translation method set out in paragraph 38-43 of Ind AS 21. The entity shall translate: (a) assets and liabilities at the closing rate; (b) income and expenses at period average exchange rates; and all resulting exchange differences shall be recognised in other comprehensive income.

Conclusion
In view of the discussion and arguments provided above, the ITFG may reconsider its view on the above matter. In any case, the ITFG views are only recommendatory and are not binding.

shailesh.kwebmaker

Adjustment of Debenture Premium against Securities Premium in Ind AS

Background

On April 1, 2011 a company issued zero coupon Nonconvertible debentures (NCDs) of INR 100 payable on 31 March, 2021 at a premium amount of INR 116 which provides an 8% IRR to the holder of the instrument. At the time of issuance of the NCDs, Companies Act, 1956 (1956 Act) applied. At current date, the provisions of the Companies Act, 2013 (2013 Act) have become applicable to the company.

The Company is covered under phase 1 of Ind AS roadmap notified under the Companies (Indian Accounting Standards) Rules, 2015 (as amended) and needs to start applying Ind AS from financial year beginning on or after 1 April 2016 with comparatives for the year ended 31 March 2016. Its date of transition to Ind AS will be 1 April 2015.

Section 78 of the 1956 Act ‘Application of premiums received on issue of securities’ states as below: “

(2) The securities premium account may, notwithstanding anything in s/s. (1), be applied by the company:

(a) In paying up unissued securities of the company to be issued to members of the company as fully paid bonus securities;

(b) In writing off the preliminary expenses of the company;

(c) In writing off the expenses of, or commission paid or discount allowed on, any issue of securities or debentures of the company; or

(d) In providing for the premium payable on the redemption of any redeemable preference securities or of any debentures of the company.”

Position taken by the Company under Indian GAAP For all periods including upto financial year ended 31 March 2016, the company is preparing its financial statements in accordance with Indian GAAP. With regard to Indian GAAP, the Companies (Accounting Standards) Rules, 2006, state as below:

“Accounting Standards, which are prescribed, are intended to be in conformity with the provisions of applicable laws. However, if due to subsequent amendments in the law, a particular accounting standard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements shall be prepared in conformity with such law.”

The Company adjusted the entire premium payable on redemption i.e. INR 116 against the securities premium, in the year of issuance of NCDs, i.e. in year ended 31 March 2012. A corresponding premium liability of INR 116 was created.

From 1 April 2014, section 78 of the 1956 Act has been replaced by section 52 of the 2013 Act. Section 52 states as below: “

(2) Notwithstanding anything contained in s/s. (1), the securities premium account may be applied by the company—

(a) Towards the issue of unissued shares of the company to the members of the company as fully paid bonus shares;

(b) In writing off the preliminary expenses of the company;

(c) In writing off the expenses of, or the commission paid or discount allowed on, any issue of shares or debentures of the company

(d) In providing for the premium payable on the redemption of any redeemable preference shares or of any debentures of the company; or

(e) For the purchase of its own shares or other securities u/s. 68.

(3) The securities premium account may, notwithstanding anything contained in subsections (1) and (2), be applied by such class of companies, as may be prescribed and whose financial statement comply with the accounting standards prescribed for such class of companies u/s. 133,—

(a) In paying up unissued equity shares of the company to be issued to members of the company as fully paid bonus shares; or

(b) In writing off the expenses of or the commission paid or discount allowed on any issue of equity shares of the company; or

Based on the above, under the 2013 Act, on a go forward basis, Ind AS companies cannot charge debenture redemption premium against securities premium account. However, the word ‘and’ in section 52(3) also highlighted above lends itself to another technical argument. One could read the provision as restricting the use of securities premium only when two conditions are fulfilled, ie, (a) the class of companies are prescribed and (b) that class of companies are those that comply with accounting standards under section 133. Since no class of companies are yet notified u/s. 52(3), the restriction on use of securities premium will not apply.

Query under Ind AS

Under Ind AS 109 Financial Instruments, NCD liability is measured at amortised cost. The application of this principle implies that premium liability is accrued over the life of NCDs using the amortized cost method under effective interest method and debiting profit and Loss (P&L). In accordance with Ind AS 101 First Time Adoption of Ind AS, an entity is required to apply Ind AS retrospectively while preparing its first Ind AS financial statements except for cases where Ind AS 101 provides specific exemptions/ exceptions. Ind AS 101 does not contain any exemption/ exception with regard to the application of effective interest rate accounting for financial assets or liabilities.

The amortized cost under Ind AS on transition date at 1 April 2015 will be INR 136 (original cost of INR 100 and premium accrued of INR 36). On a go forward basis also premium will be accrued at an IRR of 8% and the same will be charged to the P&L a/c.

Whether the Company needs to reverse premium payable on redemption of NC Ds previously charged to the securities premium INR 80 (INR 116 – INR 36). Consequently, will the debenture premium of INR 80 be charged to future Ind AS P&L using the effective interest method?

Author’s Response

The author makes the following key arguments to support non-reversal of premium payable on redemption of NCDs previously charged to securities premium:

1. With regard to Ind AS, the Companies (Indian Accounting Standards) Rules, 2015 states as follow: “Indian Accounting Standards, which are specified, are intended to be in conformity with the provisions of applicable laws. However, if due to subsequent amendments in the law, a particular Indian Accounting Standard is found to be not in conformity with such law, the provisions of the said law shall prevail and the financial statements shall be prepared in conformity with such law.”

In light of the underlined wordings, the intention of Ind AS rules should not be construed as requiring reversals of actions done in accordance with the applicable laws.

2. Ind ASs have been notified under the Companies (Indian Accounting Standards) Rules, 2015, which is a subordinate legislation. It cannot override provisions of the main legislation. The action of the company in debiting its securities premium account in the relevant financial year was in accordance with the provision of section 78 of the 1956 Act. As per section 6 of the General Clause (GC) Act, the repeal of an enactment will not affect anything validly done under the repealed enactment. Hence, to the extent that any acts are validly done under any repealed provision of the 1956 Act, such action will not be affected upon corresponding provision of the 2013 Act becoming applicable. Therefore the application of the 2013 Act does not impact position taken in the past.

3. While section 78 of the 1956 Act allows premium on redemption to be adjusted against the Securities Premium, it does not prescribe the timing of such adjustment. Hence, it is permissible to make upfront adjustment for the premium at any time during the tenure of the debentures. The Company adjusted the entire debenture premium of INR 116 against the securities premium account in year ended 31 March 2012 is in accordance with the law and completely justified.

4. The financial statements for the year ended 31 March 2012 were approved by the shareholders. On the basis of the shareholders’ approval and the extant law, the securities premium was utilised. Section 78 of the 1956 Act/ section 52 of the 2013 Act contain specific requirement concerning creation as well as utilisation of the securities premium. Once the company has charged premium payable on redemption, it effectively tantamount to utilisation of the securities premium. One may argue that once utilised, in accordance with the extant provisions of the main law the premium cannot be brought back to life merely because of an accounting requirement contained in a subordinate legislation.

5. The 2013 Act only recognizes premium received on shares as balances that may be credited to securities premium account. In the present case the securities premium account has already been reduced by the full debenture premium amount. Therefore credit back to the securities premium account pursuant to any reversal is not permitted under the 2013 Act.

6. As discussed earlier in the article one view is that debenture redemption premium can be adjusted against securities premium account in accordance with section 52(3) because no notification as required u/s. 52(3) has yet been issued. If this interpretation is taken, then Ind AS companies will be allowed to use securities premium account to adjust debenture premium till such time a notification is issued by the MCA.

Conclusion

The transition from Indian GAAP to Ind AS will not impact actions previously taken by the company under other provisions of the Act (section 78 of the 1956 Act in this case). The Company can carry forward the Indian GAAP accounting (done in accordance with a law) in Ind AS financial statements. The Company need not reverse premium payable on redemption of NCDs previously charged to the securities premium INR 80 (INR 116 – INR 36). Consequently, the debenture premium of INR 80 will not be charged to future Ind AS P&L. The Company should make appropriate disclosures as required by the applicable Ind AS and governing laws in the financial statements.

It may be noted that the author’s view in this article is not consistent with the clarifications provided by the Ind AS Transition Facilitation Group (ITFG). However, it may be noted that the views of the ITFG are not those of the ICAI and are not binding on the members of ICAI.

shailesh.kwebmaker

IND AS ROAD MAP – CORPORATE vs. NBFC

One of the key issues with the Ind AS roadmap is the alignment of implementation dates between NBFC companies and non NBFC companies. For example, phase 1 non NBFC companies go live on Ind-AS from 1-4-2016, with a transition date of 1-4-2015. The first Ind AS financial year will be 2016-17. In the case of NBFC, phase 1 companies will go live on Ind-AS from 1-4-2018, with a transition date of 1-4-2017. The first Ind AS financial year will be 2018-19. In the case of NBFC company, early adoption of Ind AS is prohibited. This poses a unique challenge to a consolidated group that has an NBFC company and a non NBFC company. Consider the diagram below.

When the NBFC is on the top of the structure, the problem is very acute. In this case, the non NBFC companies below the NBFC Parent company (M Co, T Co & S Co) will prepare Ind AS for financial year 2016-17 as they are in phase 1. For 2016-17, the NBFC Parent will prepare stand-alone and CFS under Indian GAAP, since it is prohibited from early adopting Ind AS. For purposes of consolidation by the NBFC Parent; M Co, T Co & S Co will have to continue preparing their accounts under Indian GAA P as well. Therefore M Co, T Co & S Co will end up preparing accounts both under Indian GAAP & Ind AS, which will be a huge burden.

When a NBFC is below a non NBFC company, the NBFC will prepare Indian GAAP accounts for standalone purposes and to enable non NBFC parent to prepare Ind AS CFS, the NBFC will also prepare Ind AS accounts. In the above diagram, the NBFC subsidiary will prepare Indian GAAP stand-alone financial statements since it is prohibited from early adopting Ind AS. However to enable M Co to prepare Ind AS CFS, the NBFC subsidiary will also need to provide Ind AS numbers to M Co.

Conclusion
A group that has NBFC and non NBFC companies will bear a huge burden of preparing financial statements under both Indian GAAP and Ind AS. RBI/ MCA can remove this burden by allowing NBFCs, particularly those that are not systemically important to early adopt Ind AS.

In the author’s opinion, in such an instance, NBFC should have the option of earlier adoption of Indian AS. A clarification will avoid confusion and duplication.

shailesh.kwebmaker

Questions on GST

Issue 1: Should
the revenue be presented gross or net of GST under Ind AS?

Paragraph 8 of Ind AS 18 Revenue states as below:

“Revenue includes only the gross
inflows of economic benefits received and receivable by the entity on its own
account. Amounts collected on behalf of third parties such as sales taxes,
goods and services taxes and value added taxes are not economic benefits which
flow to the entity and do not result in increases in equity.”

An entity collects GST on behalf of the government and not on its own
account. Hence, it should be excluded from revenue, i.e., revenue should be net
of GST. This view is consistent with the guidance given in the Guidance note on
Ind AS Schedule III issued by ICAI and will apply irrespective of pricing
arrangement with customers, say, fixed prices inclusive or exclusive of GST. It
may be noted that GST net presentation does not impact the presentation of
excise collected from customers and paid to the government for periods till 30^th
June 2017. Excise duty will be included in revenue and presented as an expense
in accordance with Ind AS principles.

Issue 2: How
should a company treat the GST paid on raw material/ finished goods inventory
purchased and available as GST input tax credit? Should it be included in
valuation of inventory at the quarter/ year-end?

Paragraph 11 of Ind AS 2 Inventories states as below for
refundable taxes:

“The costs of purchase of inventories
comprise the purchase price, import duties and other taxes (other than those
subsequently recoverable by the entity from the taxing authorities), and
transport, handling and other costs directly attributable to the acquisition of
finished goods, materials and services.”

Thus, only those taxes are included as costs of inventory which are not
subsequently recoverable by the company from taxation authorities. Since
GST paid on raw material/ finished goods inventory purchased is available for
set-off against the GST payable on sales or is refundable, it is in the nature
of taxes recoverable from taxation authorities. Accordingly, input tax paid
should not be included in the costs of purchase, to the extent
utilisable/refundable.

On similar lines, Ind AS 16 Property, Plant and Equipment (PPE)
requires that the cost of an item of PPE comprises – purchase price, including
import duties and non-refundable purchase taxes, after deducting trade
discounts and rebates (emphasis added). Hence, similar accounting will
apply to the GST Input Credit available on purchase of items of PPE. To the
extent not utilisable/refundable, the same may be included in cost of goods
sold, inventory or PPE as the case may be.

Issue 3: How is
GST paid on inter-branch transfers accounted for? It is assumed that sales
depots have obtained requisite registration and other documents. Hence, they
will be able to obtain full credit for GST paid on supply of goods.

For reasons already mentioned (refer issue 2), the valuation of
inventory at the branches should not include GST. The GST paid on branch
transfer of inventory should be reflected under an appropriate account such as
“GST Input Tax Credit (GITC) Receivable Account.”

Issue 4: As on
30^th June 2017, the factory is holding substantial stock of
inventory on which no excise duty is paid, since those were not cleared from
the factory. How should the company value such inventory and the input tax
credit (ITC) on the inputs for manufacturing the inventory?

1. Since excise duty is not payable on such inventory (as per
notification of CBEC), no provision for excise duty is required. Consequently,
the inventory valuation will not include excise duty.

2. After 30^th June, the Company will pay GST on supply.

3. The ITC credit on procurement for manufacturing the inventory will
be recorded as GST Input Tax Credit (GITC) Receivable Account, provided the
Company has adequate documentation and is reasonably certain of receiving the
ITC.

Issue 5: As on
30^thJune 2017, the sales depot of the entity is holding substantial
stock of inventory on which excise duty was paid, since those goods were
cleared from the factory. How should the company value such inventory and the
excise duty paid? The Company is entitled to ITC subject to submission of
proper documents. The Company has sufficient documentation available.

Paragraph 11 of Ind AS 2 Inventories states as below for
refundable taxes:

Since the tax is a recoverable tax, inventory lying at the depot should
be valued at net of excise duty paid to the extent the company will be able to
receive ITC. The corresponding ITC should be reflected under the other
appropriate account such as “GST Input Tax Credit (GITC) Receivable Account.”

Issue 6: After
initial recognition, how should the “GST Input Tax Credit (GITC) Receivable
Account” be treated in the financial statements?

Balances in the GITC Receivable Account, pertaining to both inputs and
PPE, should be reviewed at the end of each reporting period. If it is found
that the balances or a portion thereof are not likely to be used in the normal
course of business or not refundable (even in inverted duty structure), then,
notwithstanding the right to carry forward such excess credit under GST Law,
the non-useable excess credit should be adjusted in the financial statements.
The irrecoverable input credit should generally be added to COGS or inventory
or PPE, as applicable.

In some cases, it may so happen that the company is not able to avail
input credit for reasons such as: it has not got proper registration, not
maintained proper documentation or not filed proper returns or the vendor has
not uploaded credit. In such cases, GST Input Credit disallowance is in the
nature of expense for the company. The same should be written off to P&L
immediately.

It may be noted that GITC is not a financial
instrument; hence Ind
AS 109 Financial Instruments is not applicable. Though impairment rules
of Ind AS 109 do not apply, the impairment rules of Ind AS 36 Impairment
of Assets will apply. Therefore, GITC that may not be recovered or
recovered after significant time period should be impaired for
non-recoverability and time value of money under Ind AS 36.

Issue 7: How should
a company present the “GITC Receivable Account” in the balance sheet?

The GITC Receivable Account represents an amount receivable due to
statutory right and against contractual right. Hence, it is a non-financial
asset and should be presented as such in the balance sheet.

The amount should be classified as current and non-current asset
depending upon the classification criteria as laid down under paragraph 66 of
the Ind AS 1 Presentation of Financial Statements and Ind AS compliant
Schedule III, viz., the following criteria. Particularly, the criteria at (a)
and (c) will be more critical.

‘An entity shall classify an asset as current when:

(a) It expects to realise the asset, or intends to sell or consume it,
in its normal operating cycle,

(b) It holds the asset primarily for the purpose of trading,

(d) The asset is cash or a cash equivalent (as defined in Ind AS 7 Statement
of Cash Flows) unless the asset is restricted from being exchanged or used
to settle a liability for at least twelve months after the reporting period.

An entity shall classify all other assets as non-current.’

Issue 8: Under
the GST regime, dealers may face losses on their inventory at 30^th
June; for example, ITC benefit may not be available with respect to certain
local taxes or cess. To compensate dealers for the losses, the manufacturing
company has decided to provide cash compensation to dealers. How should the
company treat such compensation to dealers, particularly whether it should be
reduced from revenue or shown as an expense?

Paragraphs 9 and 10 of Ind AS 18 provide as below:

“9. Revenue shall be measured at the
fair value of the consideration received or receivable.

10. The amount of revenue arising on a
transaction is usually determined by agreement between the entity and the buyer
or user of the asset. It is measured at the fair value of the consideration
received or receivable taking into account the amount of any trade discounts
and volume rebates allowed by the entity.”

Paragraph 18 of Ind AS 18 states as below:

“18. Revenue is recognised only when it
is probable that the economic benefits associated with the transaction will
flow to the entity. In some cases, this may not be probable until the
consideration is received or until an uncertainty is removed. For example, it
may be uncertain that a foreign governmental authority will grant permission to
remit the consideration from a sale in a foreign country. When the permission
is granted, the uncertainty is removed and revenue is recognised. However, when
an uncertainty arises about the collectability of an amount already included in
revenue, the uncollectible amount or the amount in respect of which recovery
has ceased to be probable is recognised as an expense, rather than as an
adjustment of the amount of revenue originally recognised.”

Based on the above, the following two views seem possible under Ind AS
18:

(a) The cash compensation paid to dealer is effectively a cash incentive
paid by the company. This reduces consideration received/ receivable for sale
of goods and fair value thereof. Consequently, it should be reduced from
revenue since Ind AS 18 requires revenue to be recognised at fair value. This
would also be the view under Ind AS 115 Revenue from Contracts with
Customers, which requires any cash compensation paid to customer or
customer’s customer to be reduced from revenue.

(b) The circumstances for compensation arising from the extraordinary
situation did not prevail at inception, when the original sale agreement was
signed between parties. At the time of recognition, there was no uncertainty
regarding the revenue receivable. Nor the company had any explicit/ implicit
obligation to provide cash compensation. Rather, the company has decided to
provide cash compensation to the dealer in exceptional circumstances arising
purely after recognition of the original sale transaction. This expense was
incurred to maintain harmony and good relationship with dealers and is not
reflective of the fair value of the revenue. The compensation should be seen as
a distinct activity from the original revenue. Thus, it can be presented as an expense rather than
reduction from revenue.

The author believes that from an Ind AS 18 perspective, both the views
are acceptable.

Issue 9:
Consider that a company has entered into contract for supply of goods for INR
10,000 plus GST @ 18%, i.e., total invoice amount of INR 11,800. The sale
agreement involves deferred payment at the end of the 18^th month. It
is a ‘zero percent’ financing arrangement. The management has determined that
the present value of sale consideration including GST amount discounted at
market rate of interest is INR 9,900. How will the company reflect this
transaction in the financial statements?

Though the company will recover the amount from the customer at a later
date, it needs to pay the GST immediately to the government. Consequently, the
company will pass the following entry to recognise sale/ supply of goods:

Debit
Receivable from customer

(discounted
amount) INR 9,900

Credit Sale of goods INR 8,100

Credit GST payable INR 1,800

Going forward, interest on receivable from customer will be recognised
using market rate of interest, i.e., the rate used for original discounting.

Issue 10:
Consider that the company has entered into fixed price construction contract
which includes all taxes at the rates prevailing when the agreement was signed.
No variation is allowed due to change in indirect tax rates. Due to
applicability of GST, the taxes applicable on the company have increased. How
should the company reflect such impact in its financial statements?

GST is pass through on the company, i.e., the company
collects GST on behalf of the government. Hence, revenue should be net of GST
Payable to the government, irrespective of the
fact that the company has signed
an all-inclusive contract with its
customers. Consequently, the increase in tax rate due to the GST
applicability which cannot be absorbed by customer will reduce overall
construction revenue/margins. The company should reflect such reduction as
change in estimate while determining construction revenue/margins to be
recognised based on Ind AS 11 Construction Contracts principles. The
company will make Ind AS 8 Accounting Policies, Changes in Accounting
Estimates and Errors disclosures related to change in estimate. If due
to increase in the GST rate, the overall contract has become loss making, Ind
AS 11 would require an expected loss on the construction contract to be
recognised as an expense.

Issue 11: How
does the introduction of GST impact indirect tax incentive schemes such as
advance authorisation/ EPCG schemes and various export promotion schemes under
the foreign trade policy (FTP)? How should these schemes be accounted for under
Ind AS and GST regime?

At the time of writing this article, the status of indirect tax
incentive schemes under the GST regime is not very clear. It is expected that
the Government will introduce appropriate changes in the law/ foreign trade
policy to clarify these impact.

Based on non-authoritative FAQs issued by the Finance Ministry, the
following applies:

– As
the GST Law stands today, while the exporters will continue to get the benefit
of BCD (Basic Custom Duty) exemption, the Integrated GST (IGST) that has
replaced CVD (Countervailing duty) and SAD (Special Additional Duty) is not
exempt. This would mean the importer will have to pay IGST and claim refund or
utilise it against output liability, if any. Midterm review of the Foreign
Trade Policy is likely to align FTP with GST. Representation has been made to
allow IGST exemption in case of Advance Authorisation, EPCG and other such
benefits. IGST paid would be presented as GITC Receivable Account.

– The benefit of Merchandise Exports from India
Scheme (MEIS) and Service Exports from India Scheme (SEIS) for its utilisation
against procurement tax (earlier Central excise and Service tax) is no longer
available under GST. However, they may be utilised to pay basic custom duty or
additional duties of customs not covered under GST.

Therefore, MEIS and SEIS scripts at 30^th June, may be
usable. The entity will have to evaluate the extent to which it can be used.
Since the scripts are also transferable, the possibility of utilisation is
high. To the extent it cannot be used, or refund is not available, the same
will have to be written off.

– There
is no clarity in respect of State incentives or Package schemes and the
Area-based exemptions made available to industry, which had made investment in
the state. Fact remains that under GST, the exemption could be only by way of
refund or utilisation of tax credit after paying tax. For example, in a State,
the entity may be entitled to sales tax exemption for a certain number of
years. Under GST, the entity will have to pay GST, and claim refund of SGST
from the State Government. The entity will have to evaluate the extent to which
they will be able to receive refund; to the extent refund is not available,
impairment would be required.

This is an area where the companies should maintain a close watch.
Further clarity on this matter will emerge in the near future.

The author believes that accounting impact on such incentive schemes can
be analysed in detail only after clarity from the Government. In the interim,
the related principles in Ind AS 20 Accounting for Government Grants and
Disclosure of Government Assistance will continue to apply to these
schemes.

If the government does not provide incentive schemes which were
previously available to the company, then this may indicate an impairment of
assets/ onerous contracts. Consequently, it is imperative that the companies
evaluate the impact of applying Ind AS 36 Impairment of Assets and Ind
AS 37 Provisions, Contingent Liabilities and Contingent Assets carefully.

Issue 12: At
the time of dispatch of goods, a company raises an invoice and incurs GST
liability. Does that automatically result in revenue recognition under Ind AS?

Under Ind AS 18, revenue from the sale of goods shall be recognised when
all the following conditions have been satisfied:

(a) the entity has
transferred to the buyer the significant risks and rewards of ownership of the
goods;

(b) the entity retains
neither the continuing managerial involvement to the degree usually associated
with ownership nor the effective control over the goods sold;

(d) it is probable that the
economic benefits associated with the transaction will flow to the entity; and

(e) the costs incurred or
to be incurred in respect of the transaction can be measured reliably.

It may so happen that an
invoice is raised and GST liability is incurred, but because the above conditions are not fulfilled,
revenue cannot be recognised under Ind AS.

shailesh.kwebmaker

Business Combinations of Entities under Common Control

Background

Appendix C, Business
Combinations of Entities under Common Control of Ind AS 103, Business
Combinations, deals with accounting of common control business
combinations. The assets and liabilities of the combining entities in a common
control business transaction are reflected at their carrying amounts. This is
commonly known as “The pooling of interest method”. Paragraph 9 of Appendix C is reproduced
below.

“9 The pooling of interest method is considered to involve
the following:

(i) The assets and liabilities of the combining entities
are reflected at their carrying amounts.

(ii) No adjustments are made to reflect fair values, or
recognise any new assets or liabilities. The only adjustments that are made are
to harmonise accounting policies.

(iii) ………… “

Issue

An interesting question arises on
the application of the pooling of interest method. The question is whether
the carrying amount of assets and liabilities of the combining entities should
be reflected as per the books of the entities transferred/merged or the
ultimate parent. The standard requires reflecting the business combination
under common control at carrying value of the combining entities. However the
standard is silent about whether the carrying amounts should be those as
reflected in the standalone financial statements of the combining entities or
those as reflected in the consolidated financial statements (CFS) of the parent
or the ultimate parent.

Consider a basic fact pattern. A Ltd. is the parent company
of two subsidiaries, viz., B Ltd. & C Ltd. Consider the following two
Scenarios.

Scenario 1: B Ltd. merges with C Ltd.

Scenario 2: B Ltd. merges with A Ltd.

The question is raised from the perspective of how C Ltd. in
Scenario 1 and A Ltd in Scenario 2 will prepare their post combination
standalone financial statements.

It
may be noted that as far as A Ltd / parent’s CFS is concerned; the merger will
have absolutely no effect. This is because all intra-group transactions should
be eliminated in preparing CFS in accordance with Ind AS 110. The legal merger
of a subsidiary with the parent or legal merger of fellow subsidiaries is an
intra-group transaction and accordingly, will have to be eliminated in the CFS
of the parent or the ultimate parent.

Response

A similar question was raised to
the Ind AS Transition Facilitation Group (ITFG). In responding to the query,
the ITFG made a distinction between Scenario 1 and Scenario 2. The ITFG’s view
is given below.

Scenario 1

Assets and liabilities of
the combining entities are reflected at their carrying amounts. Accordingly, in
the separate financial statements of C Ltd., the carrying values of the assets
and liabilities as appearing in the standalone financial statements of the
entities being combined i.e B Ltd. & C Ltd. shall be recognised.

Scenario 2

In this case, since B Ltd. is merging with A Ltd.
(i.e. parent) nothing has changed and the transaction only means that the
assets, liabilities and reserves of B Ltd. which were appearing in the CFS of
Group A immediately before the merger would now be a part of the separate
financial statements of A Ltd. Accordingly, it would be appropriate to
recognise the carrying value of the assets, liabilities and reserves pertaining
to B Ltd. as appearing in the CFS of A Ltd. Separate financial statements to
the extent of this common control transaction shall be considered as a
continuation of the consolidated group.

Author’s View

The
ITFG has made a distinction between Scenario 1 and Scenario 2. In Scenario 1,
since the parent is not a party to the combination, the standalone financial
statements of C will combine carrying value of assets and liabilities of B and
C as appearing in their standalone financial statements. In Scenario 2, since
the parent is a party to the combination, A Ltd./ the parent’s post combination
financial statements will combine carrying values of A and carrying value of B
as appearing in A’s CFS. In other words, in Scenario 2, the accounting for the
combination is accounted as if, A had acquired B, and merged it with itself
from the very inception.

The logic of two different
approaches for accounting common control business combination based on whether
the parent is a party to the business combination is not absolutely clear.
Further, the logic does not emanate from a reading of the standard. In both
Scenario’s, business under common control are merging. Since the standard is
not clear on which carrying values to be used, the author believes that in both
Scenarios, there should be a clear accounting policy choice of either using
standalone carrying values or those that are reflected in the CFS of the parent
or ultimate parent.

The continuation of the
consolidation group approach should be an accounting policy choice and should
not be made conditional to the parent being a party to the business
combination. Globally under IFRS too,
either methods are acceptable, irrespective of whether a parent is party to the
business combination. Giving up the shares for the underlying assets is
essentially a change in perspective of the parent of its investment, from a
‘direct equity interest’ to ‘the reported results and net assets.’ Hence, the
values recognised in the CFS becomes the cost of these assets for the parent.

If the author’s approach is
considered, other relevant questions as detailed below, and not addressed by
ITFG, may not need any further clarification:

– In Scenario 2, B Ltd does not merge with A
Ltd, but A Ltd. merges with B Ltd.

– In Scenario 2, it is not absolutely clear
whether it is mandatory to use the carrying values of B Ltd as appearing in the
CFS of A or there is a choice to use the carrying values of B Ltd. as appearing
in the standalone financial statements of B Ltd.

The ITFG may provide appropriate clarification.

shailesh.kwebmaker

Goodwill In Common Control Transactions Under Ind AS Whether Capital Reserve Can Be Negative?

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 1^st
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.

shailesh.kwebmaker

Impact of Ind AS on Demerger Transactions

Demerger
is a business reorganisation where one or more business unit is hived off into
a separate entity. There could be a number of reasons why a demerger is done;
for example, to unlock the value in a business, to focus on a particular
business or to seek external participation in the transferor or resulting
company. It involves separation of business, unlike an amalgamation, which
entails consolidation or merger of businesses.

Demerger
is generally achieved through a scheme of compromise or arrangement in a court
process u/s. 391 to 394 of the Companies act, 1956. The demerged company
(transfer or company, referred to as TCO in this article) transfers a business
unit on a going concern basis to a resulting company (transferee company
referred to as RCO in this article).

In
order to become a tax neutral or tax compliant scheme, the demerger should be
compliant with section 2(19AA) of the income-tax act, which, inter alia,
requires that the demerger should be pursuant to a scheme u/s. 391 to 394 of
the Companies act, 1956 and that the
transfer of assets and liabilities should take place at the book values of the
transferor company by ignoring revaluation, if
any. The tax neutrality provisions
provide neutrality to all parties
concerned, viz., the transferor company, the transferee company and the
shareholders of the transferor and transferee company. From the transferor
company perspective, there will be no capital gains on the transfer. Further
there will be no deemed divided nor dividend distribution tax with respect to
the distribution to the shareholders. The shareholders of the transferor
company too will not have to bear the incidence of capital gains tax.

Appendix
a Distribution of Non-cash Assets to Owners of Ind AS 10 Events after the
Reporting Period deals with accounting for distribution of assets other than
cash (non cash assets) as dividends to its owners (shareholders) acting in
their capacity as owners. The appendix applies to the non-reciprocal
distributions of non-cash assets (e.g. items of property, plant and equipment,
intangible assets, businesses as defined in Ind AS 103, ownership interests in
another entity or disposal groups as defined in Ind AS 105) by an entity to its
owners acting in their capacity as owners. The appendix addresses only the
accounting by the entity that makes a non-cash asset distribution, not the
accounting by recipients.

The appendix
does not apply
to a distribution
of a non-cash asset
that is ultimately
controlled by the same party or parties before and after
the distribution. This exclusion applies to the separate, individual and
consolidated financial statements of an entity that makes the distribution. A
group of individuals shall be regarded as controlling an entity when, as a
result of contractual arrangements, they collectively have the power to govern
its financial and operating policies so as to obtain benefits from its
activities, and that ultimate collective power is not transitory.
therefore, for a distribution to be
outside the scope of this appendix on the basis that the same parties control
the asset both before and after the distribution, a group of individual
shareholders receiving the distribution must
have, as a
result of contractual
arrangements, such ultimate collective power over the entity making the
distribution.

The
Appendix does not apply when an entity distributes some of its ownership
interests in a subsidiary but retains control of the subsidiary. The entity
making a distribution that results in the entity recognising a non-controlling
interest in its subsidiary accounts for the distribution in accordance with Ind
AS 110.

When
an entity declares a distribution and has an obligation to distribute the
assets concerned to its owners, it must recognise a liability for the dividend
payable. Consequently, this appendix addresses the following issues:

(a)
When should the entity recognise the dividend payable?

(b)
How should an entity measure the dividend payable?

(c)
When an entity settles the dividend payable, how should it account for any
difference between the carrying amount of the assets distributed and the
carrying amount of the dividend payable?

When to Recognise a Dividend Payable

The
liability to pay a dividend shall be recognised when the dividend is
appropriately authorised and is no longer at the discretion of the entity,
which is the date:

(a) When declaration of the dividend, e.g. by
management or the board of directors, is approved by the relevant authority,
e.g. the shareholders, if the jurisdiction requires such approval, or

(b) When the dividend is declared, e.g. by
management or the board of directors, if the jurisdiction does not require
further approval.

Since
the demerger is to be approved by the court, a question may emerge as to
whether the dividend liability is accounted when the demerger is approved by
the shareholders or when finally approved by the court. If the court approval
is substantive and not a mere formality, then the dividend liability shall be
recorded when the final court approval is received. If the court approval is
treated as a mere formality, then dividend liability should be recognized on
approval from shareholders. Under the indian jurisdiction, the court order
would generally be treated as substantive and determine the acquisition date.
However, this issue is not very relevant for the purposes of this article.

Measurement
of a Dividend Payable

An
entity shall measure a liability to distribute non-cash assets as a dividend to
its owners at the fair value of the assets to be distributed. At the end of
each reporting period and at the date of settlement, the entity shall review
and adjust the carrying amount of the dividend payable, with any changes in the
carrying amount of the dividend payable recognised in equity as adjustments to
the amount of the distribution.

Accounting For Any Difference between the Carrying Amount of
the Assets Distributed and the Carrying Amount of the Dividend Payable when an
Entity Settles the Dividend Payable

When
an entity settles the dividend payable, it shall recognise the difference, if
any, between the carrying amount of the assets distributed and the carrying
amount of the dividend payable in profit or loss.

Example: Non – Cash Asset Distributed To Shareholders

TCO
is an Ind-AS and a listed company. TCO has two divisions, hardware
manufacturing and software. TCO is professionally managed and has a widely
dispersed shareholding. There is no group of shareholders that controls TCO.
TCO’s accounting period ends at 31st march 2017. On 29th march 2017, the
shareholders of TCO approve a non-cash dividend in the form of demerger of the
hardware division. The hardware division will be hived off into a resultant
company (RCO). The shareholders of TCO shall become the shareholders of RCO in
the same proportion. The court approves the demerger scheme on 20th July 2017,
and the demerger is executed.

In
TCO’s separate financial statements at 29th march 2017 and 31st march
2017, the net assets of the hardware division, is carried
at INR 250. The fair value of the hardware division
at 29th march and 31st march 2017
is INR 350. The fair value increases to INR 400 when the non-cash asset is distributed
on 20th July 2017. For simplicity, it is
assumed that there is no change in the carrying amount of the net assets of the
hardware division from 29th march 2017 to 20th july 2017.

In
this example, for illustration purposes only, we have assumed that the court
order is a mere formality1 and hence the dividend liability is recognised on
approval of the demerger by the shareholders. On that basis, the dividend is a
liability in the books of TCO when the annual financial statements are prepared
as at 31st march 2017. At 31st march 2017 TCO would record a dividend liability
of INR 350 with a corresponding debit to its equity. In TCO’s separate
financial statements, the net assets in hardware division of INR 250 are
classified as held for distribution to owners. When the non-cash asset is
distributed on 20th July 2017, the fair value has increased by INR 50. At that
date, TCO shall record an additional dividend liability of INR 50 with a
corresponding debit to equity.

The
non-cash asset is distributed on 20th July 2017 at which point the fair value
of the division is INR 400. The difference between the carrying amount of the
net assets distributed (INR 250) and the liability (INR 400) which is INR 150,
is recognised as a gain in profit or loss of TCO.

———————————————————————————————-

1 Under the Indian Jurisdiction, the court
order would generally be treated as substantive and determine the acquisition
date.

The
above example included the following assumptions:

1. TCO is an Ind-AS and a listed company. TCO
needs to provide an auditor’s certificate of compliance with Ind AS, in order
for the court to approve the demerger scheme. Effectively, this means that TCO needs to comply with
Ind-AS standards. RCO is the resulting
company.

2. TCO and RCO are not controlled by the same
party or parties before and after the demerger.

TCO
needs to address the following challenges from an income-tax angle
arising from the above demerger scheme:

1. TCO is a listed company and hence should
comply with the accounting standards in a court scheme, as per SEBI
requirements. If TCO was a non-listed entity, to which Ind AS was applicable,
SEBI requirements for providing an
auditor’s certificate with respect to Ind AS compliance would not apply.
Therefore, if TCO is a non-listed entity, there is a possibility, not to comply
with Ind AS to account for the demerger. However, additional consequence may
have to be examined, such as, the registrar of Companies, enforcing compliance
with Ind AS or auditors providing a matter of emphasis in the audit report.

2.
Under Ind AS the transfer of the non-cash asset is recorded at
fair value and
the resultant gain/loss is taken to the P&l. Would this be considered as a revaluation and
hence not meet the condition of section 2(19AA)? one
view is that TCO records a gain/loss on distribution of the assets,
which is not the same as revaluation of assets in the books of TCO. Therefore
with respect to this matter it may be argued that section 2(19AA) is not
violated.

3. On the other hand, if it is concluded that
the scheme is not in compliance with section 2(19AA), there could be an issue
of dividend distribution tax (DDT) on the distribution of non-cash assets.
arguments against this possibility would
be (a) Companies act 2013, prohibits any dividend distribution in kind – hence
the demerger cannot be treated as dividend for income- tax purposes also (b)
the legal form of the transaction as a ‘demerger’ cannot be disregarded.

4. Fair valuation is at the core of Ind AS. TCO
may have used the fair value option to determine the deemed cost at the
transition date to Ind AS for certain assets such as PPE or investments.
Alternatively, TCO may have used fair value option as a regular basis of
accounting for certain assets, where such a basis is allowed/ required. Fair
valuation may have resulted in an upwards or downwards adjustment. When TCO has
used such fair valuation under Ind AS, compliance with the condition u/s. 2(19AA)
to consummate the demerger transaction at book value will become challenging.

5. In our example, TCO records a profit of INR
150 on the distribution of non-cash assets. Whilst this would not be taxable
from a normal income tax computation perspective, if TCO is under mat, this credit would be counted
for the purposes of determining the profits for MAT purposes.

From
the perspective of RCO, the following aspects need to be considered:

1. Under Ind AS, from an RCO perspective, this
would be treated as a business restructuring transaction. RCO will have to
account for the assets and liabilities at book value, because under Ind AS, a
change in the geography of assets, arising from the restructuring, does not on
its own result in accounting for the exchange at fair value. The difference
between the fair value of shares issued by RCO to the shareholders and the book
value of assets and liabilities received from TCO will be debited to equity.
Assuming the fair value of shares issued by RCO to the shareholders is INR 445;
the amount to be debited to equity would be INR 195 (INR 445 – INR 250).

2. In other words, RCO will not be able to
create a goodwill for INR 195, and hence will not be able to derive any tax
benefits from goodwill.

Conclusion

It does
not appear fair
that Ind AS
should result in an unintended consequence for TCO with
respect to demerger schemes under
the income-tax act.
At the same time, it is not appropriate to try and meddle with Ind AS
and create more differences between IASB IFRS and Ind AS. The finance ministry and the Income-tax authorities
should move into swift action to resolve these issues by making suitable
changes in the income-tax act. If this is not done, the restructuring of
businesses will be hampered. Consequently, all this will have a negative impact
on the indian economy in the long run.

shailesh.kwebmaker

Accounting For Loss of Control in Subsidiary

Issue

Consider the following example.
Parent (P) sells wholly owned Subsidiary (S) to Associate (A). The structure before and after sale is given
below.

In P’s CFS, the carrying amount of
the net assets of S at the date of the sale is INR 10,000. For simplicity, assume S has no accumulated
balance of OCI. The fair value of S and the selling price is INR 18,000, which
is the consideration received by P in cash. P recognises a profit of INR 8,000
on the sale of S in CFS.

The next step is to determine how
much of this profit of INR 8,000 is required to be eliminated on
consolidation. Essentially, there are
two approaches, which are explained below.

Ind AS 110 Approach

Paragraph 25 of Ind AS 110 –
Consolidated Financial Statements states as follows:

If a parent loses control of a
subsidiary, the parent:

a) Derecognises the assets and
liabilities of the former subsidiary from the consolidated balance sheet.

b) Recognises any investment
retained in the former subsidiary at its fair value when control is lost and
subsequently accounts for it and for any amounts owed by or to the former
subsidiary in accordance with relevant Ind ASs. That fair value shall be
regarded as the fair value on initial recognition of a financial asset in
accordance with Ind AS 109 or, when appropriate, the cost on initial
recognition of an investment in an associate or joint venture.

c) Recognises the gain or loss associated
with the loss of control attributable to the former controlling interest.

If P applies the Ind AS 110
approach, then it recognizes the full profit on the sale of S. The amount
included in the carrying amount of A for the sale of S in P’s CFS is INR 4,500
(18,000 x 25%)

Ind AS 28 Approach

Paragraph 28 of Ind AS 28 – Investments
in Associates and Joint Ventures states as follows:

Gains and losses resulting from
‘upstream’ and ‘downstream’ transactions between an entity (including its
consolidated subsidiaries) and its associate or joint venture are recognised in
the entity’s financial statements only to the extent of unrelated investors’
interests in the associate or joint venture. ‘Upstream’ transactions are, for
example, sales of assets from an associate or a joint venture to the investor.
‘Downstream’ transactions are, for example, sales or contributions of assets
from the investor to its associate or its joint venture. The investor’s share
in the associate’s or joint venture’s gains or losses resulting from these
transactions is eliminated.

If P applies the Ind AS 28
approach, then it eliminates 25% of the profit recognised on the sale of S
against the carrying amount of the investment in A. The amount included in the
carrying amount of A for the sale of S in P’s CFS is INR 2,500 [(18,000 x 25%)
– (8000 x 25%)]

P records the following entries in
its CFS for the transaction and the subsequent elimination

Debit

Credit

Cash

Net assets of S

Gain on sale ( P & L)

(To recognise sale of S)

18,000

10,000

8,000

Gain on sale (P & L) 8000 x 25%

Investment in associate

(To recognise elimination of 25% of profit on sale of $

2,000

The
amount included in the carrying amount of A for the net assets of S in P’s
consolidated financial statements, after elimination. is INR 2,500 (18,000 x
25% – 2,000). This equals to the carrying amount of the net assets of S in P’s
CFS before the sale, which was INR 2,500 (10,000 x 25%).

Author’s view

Both approaches discussed above
are acceptable, as both are supported by the respective standards.

In September 2014, the IASB issued
amendments to IFRS 10 and IAS 28: Sale or Contribution of Assets between an
Investor and its Associate or Joint Venture. The amendments address the
conflict between the requirements of IAS 28 and IFRS 10 Consolidated
Financial Statements regarding non-monetary contributions in exchange for
an interest in an equity-method investee.

The September 2014 amendments are
designed to address this conflict and eliminate the inconsistency; by requiring
different treatments for the sale or contribution of assets that constitute a
business and of those that do not.

When a non-monetary asset that
does not constitute a business as defined in IFRS 3 Business Combinations,
is contributed to an associate or a joint venture in exchange for an equity
interest in that associate or joint venture:

– The
transaction should be accounted for in accordance with IAS28.28, except when
the contribution lacks commercial substance; and

– Unrealised
gains and losses should be eliminated against the investment accounted for
using the equity method and should not be presented as deferred gains or losses
in the entity’s CFS in which investments are accounted for using the equity
method.

The gain or loss resulting from a
downstream transaction involving assets that constitute a business, as defined
in IFRS 3, between an entity and its associate or joint venture is recognised
in full in the investor’s CFS.

However, the IASB identified
several practical challenges with the implementation of the amendments. Consequently, the IASB has issued a proposal
to defer the effective date of the September 2014 amendments pending
finalisation of a larger research project on the equity method of accounting.

Conclusion

Till such time the IASB takes a final decision,
and is followed up by appropriate amendments in Ind AS’s, both approaches
discussed above with respect to elimination of profits on sale of subsidiary to
the associate are acceptable under Ind AS.

shailesh.kwebmaker

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.

Author is of the view that either the Institute
or the National Financial Reporting Authority should issue guidance to avoid
use of alteration accounting.

shailesh.kwebmaker

Deferred Tax under Ind AS On Exchange Differences Capitalised

Background

Under Indian GAAP, Para 46A of AS
11 The Effects of Changes in Foreign Exchange Rates, allowed an option
to companies to capitalise exchange differences arising on borrowings for
acquisition of fixed assets. The exchange differences arising on reporting of
long-term foreign currency monetary items at rates different from those at
which they were initially recorded during the period, or reported in previous
financial statements, insofar as they related to the acquisition of a
depreciable capital asset, can be added to or deducted from the cost of the
asset and shall be depreciated over the balance life of the asset.

Paragraph D13AA of Ind AS 101 First
Time Adoption of Ind AS provides an option on first time adoption of Ind
AS, to continue with the above accounting. A first-time adopter may continue
the policy adopted for accounting for exchange differences arising from
translation of long-term foreign currency monetary items recognised in the
financial statements for the period ending immediately before the beginning of
the first Ind AS financial reporting.

Paragraph 15 of Ind-AS 12 Income
Taxes states as follows: A deferred tax liability shall be recognised for
all taxable temporary differences, except to the extent that the deferred tax
liability arises from:

a) the initial recognition of
goodwill; or

b) the initial recognition of an
asset or liability in a transaction which:

i. is not a business combination;
and

ii. at the time of the transaction,
affects neither accounting profit nor taxable
profit (tax loss).

The exchange differences on
foreign currency borrowings used to purchase assets indigenously are not
allowed as deduction under the Income-tax Act either by way of depreciation or
otherwise. Under Income Tax Act, such expenditure is treated as capital
expenditure. Section 43A of the Income-tax Act contains special provision to
provide for depreciation allowance to the assessee in respect of imported
capital assets whose actual cost is affected by the changes in the exchange
rate. However, section 43A does not allow similar benefit for assets purchased
indigenously out of foreign exchange borrowings.

Issue

A company chooses to continue with
the option of capitalising exchange differences. On first time adoption of Ind
AS and thereafter, whether the Company should create deferred taxes on the
exchange differences capitalised?

Author’s Response

Paragraph 15 requires that no
deferred taxes are recognised on temporary differences that arise on initial
recognition of an asset or liability, which neither affects accounting profit
nor taxable profit. This is commonly referred to as ‘Initial recognition
exception (IRE).’ When IRE applies, deferred taxes are neither recognised
initially nor subsequently as the carrying amount of the asset is depreciated
or impaired.

There is no precise guidance in
the standards on this issue. Based on the above requirements of Ind AS, the
following two views need to be examined:

View 1: IRE exception does not apply and deferred tax needs to
be recognised

– IRE applies
only at the time of initial recognition of an asset or liability. In this case,
difference between tax base and carrying amount is arising subsequent to
initial recognition of the asset. Hence, IRE does not apply and deferred tax
needs to be recognised on amount of exchange differences capitalised (both
increases and decreases) to the asset in this manner. The corresponding
adjustment is made to P&L. With regard to exchange difference arising
before the transition date, adjustment is made to retained earnings. The
reversal of deferred tax will be recognised in P&L as the exchange
difference is depreciated.

– Since
exchange differences do not have an identity independent of the underlying
asset, IRE will not apply (since it is not a new asset) and deferred tax will
need to be created on temporary differences attributable to exchange difference
adjustments.

– An analogy
can be drawn to revaluation reserve (an item that too does not have an identity
independent of the underlying asset) on which Ind AS 12 specifically requires
creation of deferred taxes. A deferred tax liability is created on the
revaluation of fixed asset. Subsequently, the depreciation on the revalued
portion is debited to P&L. Recoupment out of revaluation reserve is not permitted
under Ind AS. As and when depreciation on revaluation is debited to P&L,
the deferred tax liability is debited and a tax credit is taken to P&L.

– An analogy
can also be drawn from land indexation benefit. A temporary difference is
created between book value and tax value of land, because of indexation
benefits allowed under the Income-tax Act for land. On such indexation amounts,
a deferred tax asset is created subject to the probability criterion being met.

– View 1 is
also supported by the fact that the additional capitaliation is not reflected
as a separate asset in the accounting records of the Company (for example, the
fixed asset register).

View 2: IRE exception applies and deferred taxes need not be
recognised

– When the
company adjusts exchange differences to the carrying amount of the asset, the
entry passed is Debit Asset, Credit Borrowings – that affects neither taxable
profit nor accounting profit. One may argue that each addition to the cost of
asset is in substance a new asset. This requires IRE to be applied at the time
of each capitalisation (which may include increase to the fixed assets due to
exchange loss or decreases to the fixed assets if there is exchange gain).
Consequently, IRE applies and no deferred tax should be recognised on difference
between the carrying amount and the tax base of the asset arising due to
capitalisation of exchange differences. The reversal of this portion of
exchange differences will also have no impact.

– Support for
view 2 can be drawn from the requirement of paragraph 46A to depreciate each
period’s capitalisation over the remaining useful life of the underlying asset.
In other words, the additional capitalisation is treated as a separate item to
be depreciated over the remaining useful life of the asset. If it was treated
as the original asset itself, there would be a need to provide for depreciation
on a catch up basis, as if the exchange difference capitalisation had happened
immediately on purchase of the asset.

– View 2 can
also be articulated differently.
Assuming that the capitalisation requirements were slightly tweaked to
require the exchange difference to be capitalised each time as a separate
intangible item, the IRE exception would certainly apply in that case.

Conclusion

Considering the above discussions, the author
believes that View 1 is more credible.

shailesh.kwebmaker

Impact on Mat from First Time Adoption (FTA) Of Ind As

As the book profit based on Ind AS
compliant financial statement is likely to be different from the book profit
based on existing Indian GAAP, the Central Board of Direct Taxes (CBDT)
constituted a committee in June, 2015 for suggesting the framework for
computation of minimum alternate tax (MAT) liability u/s. 115JB for Ind AS
compliant companies in the year of adoption and thereafter. The Committee
submitted first interim report on 18^th March, 2016 which was placed
in public domain by the CBDT for wider public consultations. The Committee
submitted the second interim report on 5^th August, 2016 which was
also placed in public domain. The comments/ suggestions received in respect of
the first and second interim report were examined by the Committee. After
taking into account all the suggestions/comments received, the Committee
submitted its final report on 22^nd December, 2016. Based on the
final recommendation of the committee, the Finance Bill, 2017 prescribes
framework for levy of MAT on Ind-AS companies.

Reference Year for FTA adjustments

Among other matters, the reference
year for FTA adjustments is clarified in the proposed final provisions. In the
first year of adoption of Ind AS, the companies would prepare Ind AS financial
statement for reporting year with a comparative financial statement for
immediately preceding year. As per Ind AS 101, a company would make all Ind AS
adjustments on the opening date of the comparative financial year. The entity
is also required to present an equity reconciliation between previous Indian
GAAP and Ind AS amounts, both on the opening date of preceding year as well as
on the closing date of the preceding year. It is proposed that for the purposes
of computation of book profits of the year of adoption and the proposed
adjustments, the amounts adjusted as of the opening date of the first year of
adoption shall be considered. For example, companies which adopt Ind AS with
effect from 1^st April 2016 are required to prepare their financial
statements for the year 2016-17 as per requirements of Ind AS. Such companies
are also required to prepare an opening balance sheet as of 1^stApril
2015 and restate the financial statements for the comparative period 2015-16.
In such a case, the first time adoption adjustments as of 31^st March
2016 shall be considered for computation of MAT liability for previous year
2016-17 (Assessment year 2017-18) and thereafter. Further, in this case, the
period of five years proposed above shall be previous years 2016-17, 2017-18,
2018-19, 2019-20 and 2020-21.

The above provisions are slightly
confusing because, the FTA adjustments are made at 1^stApril 2015,
whereas the final provisions allude to FTA adjustments at 31 March 2016 to be
considered for computation of MAT. Does that mean that the FTA adjustments made
at 1^st April, 2015 are trued up for any changes upto the end of the
comparative year, i.e, 31^stMarch 2016?

This article provides
clarification on how this provision needs to be interpreted.

Impact of Ind AS FTA Adjustments on MAT

The accounting policies that an
entity uses in its opening Ind AS balance sheet at the time of FTA may differ
from those that it previously used in its Indian GAAP financial statements. An
entity is required to record these adjustments directly in retained
earnings/reserves at the date of transition to Ind AS. The Committee noted that
several of these items would subsequently never be reclassified to the
statement of P&L or included in the computation of book profits.

The final provisions on MAT for
FTA adjustments in Ind AS retained earnings on the opening balance sheet date
that are subsequently never reclassified to the statement of P&L are
summarised below. It may be noted that those adjustments recorded in other
comprehensive income and which would subsequently be reclassified to the profit
and loss, shall be included in book profits in the year in which these are
reclassified to the profit and loss.

Items

The point of time it will be
included in book profits

Changes in revaluation surplus of Property, Plant or Equipment
(PPE) and Intangible assets (Ind AS 16 and Ind AS 38). An entity may use fair
value in its opening Ind AS Balance Sheet as deemed cost for an item of PPE
or an intangible asset as mentioned in paragraphs D5 and D7 of Ind AS 101.

This item is completely kept MAT neutral based on the existing
principles for computation of book profits u/s. 115JB of the Act. It provides that in case of revaluation of
assets, any impact on account of such revaluation shall be ignored for the
purposes of computation of book profits.

Therefore changes in revaluation surplus will be included in
book profits at the time of realisation/ disposal/ retirement or otherwise
transfer of the asset. Consequently, depreciation shall be computed ignoring
the amount of aforesaid retained earnings adjustment. Similarly, gain/loss on realisation/
disposal/ retirement of such assets shall be computed ignoring the aforesaid
retained earnings adjustment.

Investments in subsidiaries,
joint ventures and associates at fair value as deemed cost

An entity may use fair value in its opening Ind AS Balance Sheet
as deemed cost for investment in a subsidiary, joint venture or associate in
its separate financial statements as mentioned in paragraph D15 of Ind AS
101. In such cases retained earnings adjustment shall be included in the book
profit at the time of realisation of such investment.

Therefore this item is also completely kept MAT neutral from the
perspective of existing treatment.

Cumulative translation differences

An entity may elect a choice whereby the cumulative translation
differences for all foreign operations are deemed to be zero at the date of
transition to Ind AS. Further, the gain or loss on a subsequent disposal of
any foreign operation shall exclude translation differences that arose before
the date of transition to Ind AS and shall include only the translation
differences after the date of transition.

In such cases, to ensure that such Cumulative translation
differences on the date of transition which have been transferred to retained
earnings, are taken into account, these shall be included in the book profits
at the time of disposal of foreign operations as mentioned in paragraph 48 of
Ind AS 21.

Therefore this item is also completely kept MAT neutral from the
perspective of existing treatment.

Any other item such as remeasurements of defined benefit plans,
decommissioning liability, asset retirement obligations, foreign exchange
capitalisation/ decapitalization, borrowing costs adjustments, etc

To be included in book
profits equally over a period of five years starting from the year of first
time adoption of Ind AS.

Section 115JB of the Act
already provides for adjustments on account of deferred tax and its
provision. Any deferred tax adjustments recorded in Reserves and Surplus on
account of transition to Ind AS shall also be ignored.

Examples clarifying how the MAT
adjustments will be made

The Company is in Phase 1. It’s
transition date is April 1, 2015. The year of Ind AS adoption is financial year
2016-17 and the comparative period is financial year 2015-16. On the transition
date the company makes the following adjustments in the opening retained
earnings.

1. The Company applies the fair
value as deemed cost exemption and revalues the fixed assets from Rs 100
million to Rs. 150 million. On a go forward basis the Company will apply the
cost measurements basis for accounting purposes and the opening cost of fixed
assets will be Rs.150 million under Ind AS.

2. The Company has investment in two
subsidiaries, whose cost at April 1,
2015 is Rs. 60 million (Subsidiary 1) and 70 million (Subsidiary 2). On the
transition date the Company records the investments at fair value, Rs. 80
million and Rs. 85 million, respectively, which is the new deemed cost. On a go
forward basis, the investments will be recorded at the deemed cost. During the
financial year, 2015-16, the Company sells Subsidiary 1 at Rs. 82 million.

3. The Company has investments in
equity mutual funds. Under Ind AS, investments in equity mutual funds are
marked to market and the gains/losses are recognized in P&L. Under Indian
GAAP, the book value of investments in the mutual funds is Rs. 215 million. The
fair value at transition date (1^st April, 2015) is Rs. 220 million
and at the end of comparative period (31^stMarch 2016) is Rs 225
million.

4. The fair value of the above
equity mutual fund at end of 31^stMarch 17 increased by Rs. 7
million and at end of 31^st March 18 decreased by Rs. 3 million.

Solution

1. The fair value uplift of fixed
assets of Rs. 50 million will be completely MAT neutral. For MAT purposes, the
same will be ignored for computing future book depreciation, as well as
gains/losses on sale or final disposal of the fixed assets.

2. With respect to Subsidiary 2, there
is a fair value uplift of Rs. 15 million. The adjustment to retained earnings
is completely MAT neutral vis-à-vis existing provisions. For the purpose
of MAT, retained earnings adjustment of Rs. 15 million shall be included in the
book profit at the time of realisation of such investment.

3. With respect to Subsidiary 1,
there is a fair value uplift of Rs. 20 million. However, it is sold in the
comparative period. For the purpose of MAT, retained earnings adjustment of Rs.
20 million as well as fair value uplift of Rs. 2 million in the comparative
period are completely ignored, since the same has already been realised in the
comparative period, on which MAT was applied under Indian GAAP.

4. The fair value uplift on the
mutual fund of Rs. 5 million is to be included in the book profits for purposes
of determining MAT over the next five years. However, firstly this needs to be
trued up at 31^st March ’16. The trued up uplift is Rs. 10 million. For the next five years, Rs. 10 million
would be equally spread, for determining book profits for MAT, in accordance
with the Table below.

Previous year

Assessment year

Amount to be added to book profits

Rs (million)

2016-17

2017-18

2018-19

2019-20

2020-21

2021-22

5. The upward fair
valuation in the mutual fund of Rs. 7 million for the year 16-17, will be
included in the Ind AS book profits and MAT profits as well. The downward fair
valuation of Rs. 3 million will be included as loss in the Ind AS book profits.
However, in accordance with the requirements of 115 JB, the same will be added
back to the Ind AS book profits, for purposes of calculating MAT book profits.
This results in a double whammy for companies.

shailesh.kwebmaker

Clarifications on Security Deposits And Key Management Personnel

Presentation of Security
Deposits

An
electricity distribution company collects security deposit at the time of issue
of electricity connection, which is refundable when the connection is
surrendered. The entity expects that most of the customers will not surrender
their connection. A question was raised to the Ind AS Transition Facilitation
Group (ITFG) whether such a security deposit shall be classified as a ‘current
liability’ or a ‘non-current liability’ in the books of the electricity
company?

The
ITFG at the first instance concluded that the security deposit should be
presented as current liability on the basis of Paragraph 69 of Ind AS 1,
Presentation of Financial Statement, which states as under:

“An
entity shall classify a liability as current when:

a) it
expects to settle the liability in its normal operating cycle;

b) it
holds the liability primarily for the purpose of trading;

c) the
liability is due to be settled within twelve months after the reporting period;
or

d) it
does not have an unconditional right to defer settlement of the liability for
at least twelve months after the reporting period”

The
ITFG opined “Although it is expected that most of the customers will not
surrender their connection and the deposit need not be refunded, but
surrendering of the connection is a condition that is not within the control of
the entity. Hence, the electricity company does not have a right to defer the
refund of deposit. The expectation of the company that it will not be settled
within 12 months is not relevant to classify the liability as a non-current
liability. Accordingly, the said security deposits should be classified as a
current liability in the books of the electricity company.”

However,
subsequently the ITFG withdrew the above guidance. Among other matters, the
ITFG stated that the concept of current and non-current classification already
existed under Indian GAAP and is not new to Ind AS. Hence, there is no need for
transition group guidance on the matter. Rather, the classification should be
based on Ind AS 1 and Ind AS compliant Schedule III principles. Some may argue
that by withdrawing the guidance, ITFG is permitting electricity companies to
present the security deposit as non-current. The supporters of this view
believe that in withdrawing the guidance, the ITFG must have focussed on the
substance of the arrangement, and the redemption pattern, which indicates that
the security deposit was non-current.

Author’s
View on some related matters

Pursuant
to the above change, electricity and similar companies, for example, a company
that provides gas connection or water supply, would classify security deposits
received from the customers as current or non-current liability based on
estimated redemption pattern. This view would generally apply in limited
circumstances such as in monopolistic or oligopolistic situations where choices
available to the consumer to change the service provider are highly limited.
This view should not apply by analogy in all cases. For example, in the case of
security deposit received by a consumer goods company from
retailers/distributors, the classification of security deposits would continue
to be current.

The
other question not addressed by the ITFG is whether the security deposits, once
presented as non-current needs to be discounted to its present value followed
by subsequent unwinding of the discount. One view is that discounting would be
required. On initial discounting, the security deposit would be stated at its
present value. The difference between the amount of security deposit received
and the present value will be treated as deferred income. The deferred income
will be credited to the P&L income, generally on a straight line basis to
reflect the true value of the goods or services provided to the customer. On
the other hand, the unwinding of the discounting will result in the security
deposit being reflected at its original value just before redemption. The
unwinding will be done on an effective interest rate method and the consequent
financial expense will be debited to P&L. The accounting will result in a
mis-match in the P&L as the deferred income is recognised on a straight
line basis whereas the financial expense is recognised on an effective interest
rate basis.

The
author’s view is that the new guidance (viz., non-current presentation of
deposit by electricity and similar companies) arising from withdrawal of old
ITFG view is relevant only for presentation in the balance sheet. Recognition
and measurement of security deposits, including those accepted by the
electricity and similar companies, would continue to be governed by Ind AS 109 Financial
Instruments principles. Consequently, the author believes that there is no
need to discount the security deposits.

WHETHER INDEPENDENT DIRECTORS ARE KEY MANAGEMENT
PERSONNEL?

Whether
independent directors should be considered as key management personnel (KMP)
under Ind AS 24 Related Party Disclosures?

Authors’
View

Ind
AS 24 defines the term ‘key management personnel’ as “the persons having
authority and responsibility for planning, directing and controlling the
activities of the entity directly or indirectly, including any director (whether
executive or otherwise) of that entity.”

Under
Indian GAAP, AS 18 Related Party Disclosures excludes non-executive
directors from the definition of KMP. However, under Ind AS, it is quite clear
that all directors whether Executive or Non-executive will generally be
considered as KMP. Furthermore, the Companies Act, 2013, prescribes very
onerous responsibilities for independent directors. These responsibilities
include taking executive responsibilities. This includes authority and
responsibility for planning, directing and controlling the activities of the
entity. Hence, independent directors are KMP under Ind AS 24.

ITFG may provide
appropriate guidance on this matter.

shailesh.kwebmaker

DEEMED COST EXEMPTION ON FIXED ASSETS AND INTANGIBLES

Introduction

The application of the deemed cost
exemption to fixed assets and intangible assets has led to peculiar issues and
challenges. Let us first consider the wording of the exemption followed by the
clarifications provided by the Ind AS Transition Facilitation Group (ITFG).

Paragraph D7AA of Ind AS 101

D7AA – Where there is no change in
its functional currency on the date of transition to Ind ASs, a first-time
adopter to Ind ASs may elect to continue with the carrying value for all of its
property, plant and equipment as recognised in the financial statements as at
the date of transition to Ind ASs, measured as per the previous GAAP and use
that as its deemed cost as at the date of transition after making necessary
adjustments for decommissioning liabilities. If an entity avails the option, no
further adjustments to the deemed cost of the property, plant and equipment so
determined in the opening balance sheet shall be made for transition
adjustments that might arise from the application of other Ind ASs. This option
can also be availed for intangible assets covered by Ind AS 38, Intangible
Assets and investment property covered by Ind AS 40 Investment Property.

Salient features of the exemption

1. The
entity can continue with the carrying amount under previous GAAP for all of its
fixed assets, investment property and intangible assets after making necessary
adjustment for decommissioning liabilities. The ITFG opined that if a first
time adopter chooses the D7AA option, then the option of applying this on
selective basis to some of the items of property, plant and equipment and using
fair value for others is not available.

2. The exemption is
available to an entity only where there is no change in the functional currency
on the date of transition to Ind AS.

3. No further adjustments to
the deemed cost so determined in the opening balance sheet shall be made for
transition adjustments that might arise from the application of other Ind ASs

4. The exemption is an
additional option under Ind AS. An entity may choose not to use this option,
and instead use other first time adoption options. For example, in the case of
fixed assets, an entity may choose to:

a. state retrospectively all
the fixed assets in accordance with Ind AS principles

b. selectively choose to
fair value some fixed assets and use Ind AS principles for other fixed assets.

ITFG Clarification Bulletin 3 – Issue 9

The Company has chosen to continue
with the carrying value for all of its property, plant and equipment as recognised
in the financial statements as at the date of transition to Ind AS, measured as
per the previous GAAP. The Company has recorded capital spares in its previous
GAAP financial statements as a part of inventory, which under Ind AS would
qualify to be classified as fixed assets. Would such a reclassification be
required under Ind AS? Would such a reclassification taint the deemed
cost exemption?

As per paragraph D7AA, once the
company chooses previous GAAP as deemed cost as provided in paragraph D7AA of Ind
AS 101, it is not allowed to adjust the carrying value of property, plant and
equipment for any adjustments other than decommissioning costs. In this case, a
question arises whether the company may capitalise spares as a part of
property, plant and equipment on the date of transition to Ind AS. It may be
noted deemed cost exemption as the previous GAAP is in respect of carrying
value of property, plant and equipment capitalised under previous GAAP on the
date of transition to Ind AS. The ITFG opined that this condition does not
prevent a company to recognise an asset whose recognition is required by Ind AS
on the date of transition. The ITFG opined that the Company should recognise
‘capital spares’ if they meet definition of PPE as on the date of transition,
in addition to continuing carrying value of PPE as per paragraph D7AA of Ind AS
101.

ITFG Clarification Bulletin 5 – Issue 4

The Company has chosen to continue
with the carrying value for all of its property, plant and equipment as
recognised in the financial statements as at the date of transition to Ind AS,
measured as per the previous GAAP. The company has previously taken a loan for
construction of fixed assets and paid processing fee thereon. The entire
processing fees on the loan were upfront capitalised as part of the relevant
fixed assets as per the previous GAAP. The loan needs to be accounted for as
per amortised cost method in accordance with Ind AS 109, Financial
Instruments. Whether the Company is required to adjust the carrying amount
of fixed assets as per the previous GAAP to reflect accounting treatment of
processing fees as per Ind AS 109?

When the option of deemed cost
exemption is availed for property, plant and equipment under paragraph D7AA of
Ind AS 101, no further adjustments to the deemed cost of the property, plant
and equipment shall be made for transition adjustments that might arise from
the application of other Ind AS. Thus, once the entity avails the exemption
provided in paragraph D7AA, it will be carrying forward the previous GAAP
carrying amount.

Paragraph 10 of Ind AS 101, inter
alia, provides that Ind AS will be applied in measuring all recognised
assets and liabilities except for mandatory exceptions and voluntary exemptions
other Ind AS. Processing fees is required to be deducted from loan amount to
arrive at the amortised cost as per the requirements of Ind AS 109. In view of
this, with respect to property, plant and equipment, the company shall continue
the carrying amount of PPE as per previous GAAP on the date of transition to
Ind AS since it has availed the deemed cost option provided in paragraph D7AA
of Ind AS 101 for PPE. In the given case, the Company need to apply the
requirements of Ind AS 109 retrospectively for loans outstanding on the date of
transition to Ind AS at amortised cost. The ITFG opined that the adjustments
related to the outstanding loans to bring these in conformity with Ind AS 109
shall be recognised in the retained earnings on the date of transition. Consequently,
the carrying value of PPE as per previous GAAP cannot be adjusted to reflect
accounting treatment of processing fees.

ITFG Clarification Bulletin 5 – Issue 5

The Company received government
grant to purchase a fixed asset prior to Ind AS transition date. The grant
received from the Government was deducted from the carrying amount of fixed
asset as permitted under previous GAAP, i.e. AS 12, Accounting for Government
Grants. The Company has chosen to continue with carrying value of property,
plant and equipment as per the previous GAAP as provided in paragraph D7AA of
Ind AS 101. As per Ind AS 20, Accounting for Government Grants and
Disclosure of Government Assistance, such a grant is required to be
accounted by setting up the grant as deferred income on the date of transition
and deducting the grant in arriving at the carrying amount of the asset is not
allowed.

In this situation, whether the
Company is required to add to the carrying amount of fixed assets as per
previous GAAP and reflect the addition as deferred income in accordance with
Ind AS 20?

The ITFG opined that when the
option of deemed cost exemption under paragraph D7AA is availed for property,
plant and equipment, no further adjustments to the deemed cost of the property,
plant and equipment shall be made for transition adjustments that might arise
from the application of other Ind AS. Accordingly, once an entity avails the
exemption provided in paragraph D7AA, it will have to be carry forward the
previous GAAP carrying amounts of PPE. Consequently, the company shall
recognise the asset related government grants outstanding on the transition
date as deferred income in accordance with the requirements of Ind AS 20, with
corresponding adjustment to retained earnings.

Salient feature of the ITFG responses

The ITFG has provided conflicting
responses. In the context of accounting for the government grants and
processing fees, the ITFG opined that the impact of accounting for government
grants and processing fees should be adjusted against retained earnings.
Consequently, the previous GAAP carrying amount of fixed assets should not be
tampered with in order to comply with the requirements of D7AA. On the other
hand, the ITFG in the context of reclassification between inventory and fixed
assets, opined that the reclassification was necessary, and that such
reclassification would not result in non-compliance of D7AA.

The author also feels that too much
focus has been put on complying with the technical requirement of D7AA rather
than on the substance and the spirit of the exemption. This has led to a very
absurd interpretation. For example, in the case of fixed asset related
government grants, the grant amount was deducted from fixed assets under Indian
GAAP. However, the ITFG requires an entity to ignore the same and recreate the
deferred income on grant by adjusting the retained earnings. In subsequent
years, the deferred income would be released to the P&L account under Ind
AS. This effectively means that the government grant gets accounted twice; once
under Indian GAAP by deducting the grant amount from fixed assets and again
under Ind AS through creation of deferred income on Ind AS transition date.
Similarly the ITFGs response in the case of processing fee results in its being
treated as borrowing cost twice – once under Indian GAAP and again under Ind
AS.

Practical issue not dealt with by ITFG

Whether D7AA exemption is available
to service concession arrangements (SCA)?

Paragraph D22 of Ind AS 101
requires an operator of SCA to apply SCA accounting retrospectively. If it is
not practical to apply SCA accounting retrospectively, then the operator may
use the previous GAAP carrying amounts as the carrying amount at that date.
Assuming that there is no change in functional currency, whether in addition to
the above exemption, D7AA option is available?

One argument is that since
paragraph D22 contains specific requirements for intangible assets recognised
in accordance with the standard, the transitional provisions in D22 will apply
to intangible assets arising under the SCA. For all other intangible assets,
exemption in paragraph D7AA may be used.

The second argument is that there
is nothing in paragraph D7AA to suggest that it does not apply to SCAs. Hence,
the company can apply exemption under paragraph D7AA to all intangible assets,
i.e., SCA related intangible assets as well as all other intangible assets
covered within the scope of Ind AS 38.

The application of second view will
give rise the following additional issues:

– While the company continues the same carrying
amount as under previous GAAP, it will need to reclassify those amounts based
on requirements of Ind AS. For e.g., toll road classified as PPE under Indian
GAAP will be reclassified as intangible or financial asset, as applicable, at
the Indian GAAP carrying amount.

– Accounting for premium payable by operator to
grantor (negative grant): Companies may have followed one of the following
treatment under Indian GAAP:

• Certain companies have
created liability at undiscounted amount.

• Certain companies have
not created liability for negative grant under Indian GAAP.

In both the above cases, the
related question would be when the financial liability amount is reflected as
per Ind AS 109, whether the corresponding adjustment should be made to retained
earnings or to the intangible asset. Some may even argue that the strict
requirements of D7AA means that no adjustment is made to the financial
liability amount and consequently the corresponding adjustment is also not
made.

Conclusion

There are numerous questions around
the practical application of D7AA. These issues were not probably conceived
when D7AA was hurriedly introduced in Ind AS 101. The drafting of D7AA has
resulted in numerous unanswered questions. The ITFG has also provided
conflicting guidance on the subject. Besides some of the recommendations, for
example, in the case of processing fees and government grant accounting are
counter-intuitive and are against the spirit and intention of the exemptions.
In light of the above, the author would recommend that a broader view may be
taken on this issue, and in light of the lack of clarity arising from a not so
clear drafting of D7AA, companies may be allowed more room for different
interpretations. _

shailesh.kwebmaker

Accounting for MAT

The Finance Bill 2017 sets out the requirement of determining how Ind AS will impact Minimum Alternate Tax (MAT) on first time adoption (FTA) and on an ongoing basis. This article discusses a few issues with respect to MAT implications on FTA.

FINANCE BILL 2017 PROVISIONS ON MAT IMPACT ON FTA OF Ind-AS

The broad provisions are set out below:

1. Ind AS adjustments in reserves/ retained earnings (RE) are included in 115 JB book profit equally over 5 years beginning from the year of Ind AS adoption, except:

– Other Comprehensive Income (OCI) items recyclable to P&L are included in book profits, when those are recycled to P&L

– Adjustments to capital reserve, securities premium and equity component of compound financial instruments are excluded from book profit

–   Use of fair value as deemed cost exemption for PPE/ Intangible Asset will be MAT neutral
•   To be ignored for computing book profit
•   Depreciation is computed ignoring the amount of fair value adjustment
•   Gains/ losses on transfer/realisation/disposal/ retirement are computed ignoring fair value adjustment (as per Memorandum to the Finance Bill)

– Gains/losses on investments in equity instruments classified as fair value through other comprehensive income (FVTOCI) will be included in
book profit on realisation/disposal/transfer of
investment
– Use of fair value as deemed cost exemption for investments in subsidiaries, associates and joint ventures will be MAT neutral. Gains/ losses to be included in book profit on realisation/disposal/ transfer of investment

– Use of option to make Indian GAAP Foreign Currency Translation Reserve (FCTR) Zero will be MAT neutral
• To be included in book profit at the time of disposal of foreign operation.

2. FTA adjustments made at transition date (TD) are trued up for any changes upto the end of the comparative year. For example, for a phase 1 Company the TD will be 1 April 2015. The FTA adjustments on 1st April 2015 will be trued up for any changes upto the end of the comparative year end, i.e., 31st March 2016. This is illustrated below.

3. Consider a company that has only one adjustment at TD. The investments in mutual fund were measured at cost less impairment (assume INR 100) on an ongoing basis under Indian GAAP. On TD the company will have to measure the investments in mutual funds at fair value (assume INR 180). At 1st April, 2015, the company has included the fair value uplift INR 80 in RE. At 31st March, 2016, the fair value of the mutual fund was INR 240. For purposes of section 115 JB book profits, the company will include INR 28 each year for the next 5 years (INR 140 in aggregate), starting from the financial year 2016-17.

MAT IMPACT ON FTA OF Ind-AS
On the TD to Ind AS, the company makes adjustments to align Indian GAAP accounting policies with Ind AS. The impact of these items may end up in different adjustments being made. An asset or liability is recorded or derecognised or measured differently and the corresponding impact is directly adjusted in either:
(a)   RE or reserves
(b)   Another asset or liability
(c)   OCI
(d)   Capital reserve
(e)   Equity

(I) Corresponding Adjustment made to RE or Reserves
Some examples of adjustment in this category and the corresponding impact on MAT are as follows:

Adjustments

Impact on MAT

Property, Plant
and Equipment (PPE) or Intangible Assets is fair valued on TD, as the new
deemed cost under Ind AS. The
corresponding impact is recorded in RE on the TD

This is MAT
neutral.

Investment in
subsidiaries, associates and joint ventures is fair valued on TD, as the new
deemed cost under Ind AS. The
corresponding impact is recorded in RE on the TD

This is MAT
neutral.

The amount of
deferred tax asset or liability (DTA/DTL) is changed due to TD adjustments of
various assets and liabilities. The corresponding debit or credit impact is
recorded in RE on the TD

While the
Memorandum to Finance Bill states that it should be MAT neutral, the text of
the Finance Bill 2017 does not contain any such clause.
Hence, based on the text of the Finance Bill 2017, one may argue that for
purposes of determining book profits the debit or credit adjustment in RE
after true-up impact will be recognized over 5 years.

Receivables are
provided for based on Expected Credit Loss (ECL). The corresponding debit
impact is recorded in RE on the TD

For purposes of
determining book profits the debit adjustment in RE after true-up impact will
be recognized over 5 years.

Fair value gains
on derivative assets were not recognized under Indian GAAP. On TD a derivative asset is created with a
corresponding impact on RE

For purposes of
determining book profits the credit adjustment in RE after true-up impact
will be recognized over 5 years.

With respect to
Service Concession Arrangements, the Intangible assets were recorded at cost
under Indian GAAP. Under Ind AS these
are recorded at fair value (cost plus margin). On TD, the amount of Intangible Assets will
be increased with a corresponding impact on RE.

For purposes of
determining book profits the credit adjustment in RE after true-up impact
will be recognized over 5 years.

Under Indian
GAAP, Investments in mutual fund is measured at cost. Under Ind AS at each reporting date it is
fair valued with gains/losses recognized in the P&L account. On TD, the
amount of Investments will be increased or decreased for fair value gains/losses
with a corresponding impact on RE.

For purposes of
determining book profits the credit or debit adjustment in RE after true-up
impact will be recognized over 5 years.

(II) Corresponding Adjustment made to another
Asset or Liability

Some examples of adjustment in this category and the corresponding
impact on MAT are as follows:

Adjustments

Impact on MAT

(a) A
day before the TD the parent issues to a bank a financial guarantee (FG) on
behalf of its subsidiary. The parent
will not cross charge the subsidiary for the FG. On TD the parent will record a FG liability
(INR 100) and a corresponding investment in the subsidiary.

(b) Indian
GAAP book value of investment is INR 250.
The Company uses fair value of INR 400 as deemed cost on TD. The investment is sold after four years at
INR 700.

(a) No
Impact on MAT since an asset and a liability is recorded with no
corresponding impact on RE or reserves. However, true-up impact will have to
be adjusted.

(b) The
fair value uplift of INR 50 (400-(250+100)) is MAT neutral. When the investment is sold, the profit of
INR 300 (700-400) + the fair value uplift INR 50, will be included in book
profits for MAT purposes.

(a) Two
years before the TD the parent issues to a bank a FG on behalf of its
subsidiary for a 5 year period. The
parent will not cross charge the subsidiary for the FG. Under Ind AS, on the date of issue of the
FG the parent will record a FG liability and a corresponding investment in
the subsidiary. Assuming the
subsidiary is financially capable and the bank does not have to invoke the
FG, the FG would be amortized over a 5 year period with a corresponding
credit to the profit and loss. On TD,
the FG would be amortized for a two year period with a corresponding credit
to RE.

(b) Indian
GAAP investment value is INR 100.
Assume the FG liability on initial recognition is INR 20, and that the
entity uses previous GAAP carrying value (INR 100) on TD for investment.

(a) For
purposes of determining book profits u/s 115 JB the credit adjustment in RE
on account of FG amortization after true-up impact will be recognized over 5
years.

(b) With
respect to investment, for purposes of determining book profit u/s 115 JB, RE
will be debited by INR 20 which after true up impact will be recognized over
5 years

A day before the
TD the entity enters into a long term service arrangement, which has an
embedded lease. The entity is a lessee
and lease is finance lease. On TD the
entity will record an asset and a corresponding lease liability of equal
amount.

No Impact on MAT
since an asset and a liability is recorded with no corresponding impact on RE
or reserves. However, true-up impact during the comparative period will be
recognized over 5 years.

Two years before the TD the lessee entity enters into a 30 year long
term service arrangement, which has an embedded lease. The entity is a lessee
and lease is finance lease. Under Ind
AS the entity will record an asset and a corresponding lease liability of
equal amount on the date of entering into a lease arrangement. On TD the
amount of asset and lease liability recognized would not be equal because the
asset depreciation and the loan amortization will happen at different
amounts. Therefore on TD, there would
be a debit or credit adjustment to RE.

For purposes of
determining book profits u/s 115 JB the debit or credit adjustment in RE
after true-up impact will be recognized over 5 years.

(III) Corresponding Adjustment made to OCI

Adjustments

Impact on MAT

The entity
applies hedge accounting under Indian GAAP, which is fully aligned with the
Ind AS principles. On that basis it
has recorded a cash flow hedge reserve in OCI. Under Ind AS it will continue with the
hedge accounting, therefore, the cash flow hedge reserve recorded under
Indian GAAP will be continued as it is.

This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The cash flow hedge reserve will
be included in book profits u/s. 115 JB as and when the hedge reserve is
recycled to the P&L account.

Adjustments

Impact on MAT

The Company has a
foreign branch. It recognizes a FCTR
on translation of foreign branch. The
Company chooses the FTA option of restating the FCTR to zero under Ind AS. Subsequently the FCTR is accumulated afresh

This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The Indian GAAP FCTR and the
fresh accumulated Ind AS FCTR is recognized when the branch is finally
disposed off.

Adjustments

Impact on MAT

Adjustments

Impact on MAT

(IV) Corresponding Adjustment made to Capital
Reserves

Adjustments

Impact on MAT

Prior to the TD
the Company has applied acquisition accounting for a common control
transaction. The consideration paid
was lower than the fair value of assets and liabilities taken over. The difference was recorded as capital
reserves. The Company chooses to restate the accounting of the common control
transaction on the TD in accordance with Ind AS 103. Under Ind AS the assets and liabilities in
a common control transaction are recorded at book value, and the excess of
book values over the consideration is recorded as capital reserves. Whilst in both Indian GAAP and Ind AS, a
capital reserve is recorded, the amount of capital reserve recognized is
different.

Any adjustment to
capital reserves is MAT neutral.

Prior to the TD
the Company has applied acquisition accounting for a common control
transaction and recognized goodwill in accordance with Indian GAAP. The Company chooses to restate the
accounting of the common control transaction on the TD in accordance with Ind
AS 103. Under Ind AS common control
transaction does not lead to recognition of goodwill. The said amount is adjusted against RE.

For purposes of
determining book profits u/s. 115 JB the debit adjustment in RE will be
recognized over 5 years.

(V) Corresponding Adjustment made to Equity

Adjustments

Impact on MAT

A day prior to
the TD the Company has issued a compound financial instrument that is
classified as liability under Indian GAAP.
On TD under Ind AS, the Company does split accounting and records the
instrument partly as a liability and partly an equity. The equity represents the option under the
instrument to convert to shares at a future date and at a fixed predetermined
ratio.

Equity component
of compound financial instruments is MAT neutral.

Two
years prior to the TD the Company has issued a compound financial instrument
that is classified as liability under Indian GAAP. On TD under Ind AS, the Company does split
accounting and records the instrument as a liability and an equity amount.

The
equity component is MAT neutral.
However, subsequent to the issue of the compound financial instrument,
the liability would have under gone a change under Ind AS due to the
amortization effect. RE would be debited to the extent of the amortization
for the two year period prior to TD.

Adjustments

Impact on MAT

The equity
represents the option under the instrument to convert to shares at the end of
5 years at a fixed predetermined ratio.

The debit
adjustment to the RE after true-up impact, would be allocated over 5 years
for the purposes of determining book profits u/s 115 JB.

QUESTION
As explained above, the Finance Bill 2017 requires FTA adjustments in specific cases to be included in determining book profits under section 115 JB over a period of 5 years. For such adjustments that are not MAT neutral and have a MAT impact over a period of 5 years, would a provision for MAT liability or a credit for MAT asset be required on TD under Ind AS 12 Income Taxes?

RESPONSE
As a first step a company determines it’s income tax liability based on normal income tax provisions. However, this is subject to the provisions of section 115 JB of the Income tax Act, which requires a company to pay atleast a minimum tax on the basis of the book profits as determined under Indian GAAP or Ind AS as applicable. If a company pays higher tax during any financial year due to applicability of MAT, the excess tax paid is carried forward for offset against tax payable in future years when the company will be paying normal income tax.

As per the current Income-tax Act, the MAT credit can be carried forward for set-off for ten succeeding assessment years from the year in which MAT credit becomes allowable. The Finance Bill 2017 proposes that credit in respect of MAT paid u/s. 115JB can be carried forward upto fifteen succeeding assessment years. MAT is an additional tax payable to authorities based on the comparison of book profit and taxable profit for the year, albeit the company may be required to make certain adjustments (additions or deductions) to accounting profit for arriving at the 115 JB book profit.

For accounting purposes, the author believes that a MAT provision or a MAT asset should not be created on TD adjustments for the following reasons:

– The trigger for MAT is a higher book profit compared to a lower income computed under normal income tax computation provisions. The relationship between future book profits and income computed under normal income tax provisions will determine the MAT in future periods. Therefore MAT is like a current tax liability/asset that is accounted in each year. The possibility of the future book profits being higher or lower due to TD adjustments, is not a relevant factor for creating a MAT liability or MAT asset for TD adjustments. In other words, MAT is a current tax based on book profits in each year, and the liability for MAT arises only once the financial year commences. MAT is not triggered by FTA adjustments, though those are taken into consideration for determining MAT book profits for the relevant year.

– Absent tax holidays and few tax exempt income/ expenses, differences between the normal tax and the MAT are primarily due to deductible and taxable temporary differences. Those temporary differences result in deferred taxes being recognized on the basis that they will eventually reverse subject to application of prudence for recognition of DTA. Thus, the MAT is effectively a mechanism to bridge/ reduce gap between the carrying amount and tax base of assets and liabilities. On its own the MAT does not create any new differences. Since Ind AS 12 requires an entity to recognise DTA/ DTL for temporary differences between the carrying amount and tax base of assets and liabilities, it may be argued that MAT itself should not result in recognition of any new/ additional DTA/ DTL. Else, it may be tantamount to double counting. This is explained with the help of a small example.

EXAMPLE
The Company enjoys an accelerated depreciation under the Income-tax provisions, but charges lower depreciation for accounting purposes. This has resulted in the Company being subjected to MAT. The Company has created a DTL for the accelerated depreciation at normal income tax rates. The Company also records a MAT liability in the financial year.

On TD the Company records the fixed assets at Indian GAAP carrying value and also creates a provision for decommissioning liability of INR 100 with a corresponding adjustment to RE. For 115 JB book profits the RE adjustment will be spread over 5 years.

As a result of recording the decommissioning liability in Ind AS, the DTL amount will also correspondingly reduce on TD. It would be inappropriate to record a MAT asset on TD, for the RE credit of INR 100, since that would tantamount to double counting.

MAT is effectively a mechanism to bridge/ reduce gap between the carrying amount and tax base of assets and liabilities. On its own the MAT does not create any new differences. Since Ind AS 12 requires an entity to recognise DTA/ DTL for temporary differences between the carrying amount and tax base of assets and liabilities, it may be argued that MAT itself should not result in recognition of any new/ additional DTA/ DTL

Considering the above arguments, MAT payment is only an event of the relevant period, viz., the period during which MAT obligation arises under the Income-tax Act. Hence, it should be recognised in the relevant period and no upfront DTA/ DTL should be created towards amount to be adjusted in book profit of future years. The ICAI may issue appropriate guidance on the matter.

shailesh.kwebmaker

GapS in GAAP — Accounting for Jointly Controlled Entities that have Minority Interest

Background:

Entities A, B and C have equal ownership (33.33%) in Entity D, which they all account for as an interest in an associate (commonly known as equity method). Now A and B, enter into an arrangement under which they will form a Newco (a newly formed shell company), in which they will each have a 50% interest in return for contributing their shares in Entity D. Consequently, after completion of the transaction, Newco has a 66.7% controlling interest in Entity D and, in its consolidated financial statements (CFS), will record minority interest for investor C’s interest in Entity D.

Entities A and B when exchanging their shares in Entity D for shares in Newco, also enter into a contract which results in them having joint control (as defined in AS-27 ‘Financial Reporting of Interests in Joint Ventures’) over Newco. A and B both apply proportionate consolidation for Jointly Controlled Entities (JCE) in the CFS.

Question:
In the CFS of A and B, should the proportionate consolidation be restricted to the effective interests (33.33%) that Entities A and B each have in Entity D, or to 50% of all line items in Newco’s financial statements (including the minority interest) ?

View 1:
Entities A and B will recognise only their effective interests (33.33%) in Entity D. Proponents of this view use the definition of proportionate consolidation to support the argument. As per AS-27 Proportionate consolidation “is a method of accounting and reporting whereby a venturer’s share of each of the assets, liabilities, income and expenses of a jointly controlled entity is reported as separate line items in the venturer’s financial statements.” This definition refers only to the venturer’s share of each of the assets, liabilities, income and expenses of a JCE, and that minority interest does not meet the definition of any of these items. Further, paragraph 30 of AS-27 may also support this view, “When reporting an interest in a jointly controlled entity in consolidated financial statements, it is essential that a venturer reflects the substance and economic reality of the arrangement, rather than the joint venture’s particular structure or form. In a jointly controlled entity, a venturer has control over its share of future economic benefits through its share of the assets and liabilities of the venture. This substance and economic reality is reflected in the consolidated financial statements of the venturer when the venturer reports its interests in the assets, liabilities, income and expenses of the jointly controlled entity by using proportionate consolidation.”

View 2:
Proponents of view 2 (50% proportionate consolidation) point out to paragraph 31 of AS-27 ‘. . . . Many of the procedures appropriate for the application of proportionate consolidation are similar to the procedures for the consolidation of investments in subsidiaries, which are set out in AS-21 Consolidated Financial Statements’. Therefore, it is considered that this results in a requirement for the inclusion of all line items, including those relating to minority interest, for the purposes of proportionate consolidation.

View 3:
Entities A and B have an accounting policy choice, as the accounting guidance is not definitive.

Author’s view:
If the formation of Newco has no substance other than to house the JV and to achieve a gross-up presentation in the CFS of Entity A and B that includes minority interest, then view 1 (33% consolidation) may be a more appropriate accounting treatment. If however, the Newco did have substance (for example, it may be planned to raise funds or list NewCo) then view 2 (50% consolidation) could be favorably argued. In other words, substance over form should prevail.

Nevertheless, this is an issue that ultimately the standard-setters should resolve.

levitra

shailesh.kwebmaker

GAPs in GAAP — Revenue — Gross vs. Net of Taxes

The gross v. net presentation of taxes is very important for many companies as revenue is a key performance indicator. Further some companies have to pay licence fees or have a revenue sharing arrangement and hence the amount disclosed as revenue becomes critical. There is substantial accounting literature in Indian GAAP that deals with these issues, albeit in various context.

In the ‘Guidance Note on Terms used in Financial Statements’ of ICAI, the expression ‘sales turnover’ has been defined as: “The aggregate amount for which sales are effected or services rendered by an enterprise.” The term ‘gross turnover’ and ‘net turnover’ (or ‘gross sale’ and ‘net sales’) are sometimes used to distinguish the sale aggregate before and after deduction of returns and trade discounts”

The Guide to Company Audit issued by the Institute while discussing ‘sales’, states as follows:

“Total turnover, that is, the aggregate amount for which sales

are effected by the Company, giving the amount of sales in respect of each class of goods dealt with by the company and indicating the quantities of such sale for each class separately.

The term ‘turnover’ would mean the total sales after deducting therefrom goods returned, price adjustments, trade discount and cancellation of bills for the period of audit, if any. Adjustments which do not relate to turnover should not be made e.g., writing off bad debts, royalty, etc. Where excise duty is included in turnover, the corresponding amount should be distinctly shown as a debit item in the profit and loss account.”

The ‘Statement on the Amendments to Schedule VI to the Companies Act, 1956’ issued by the ICAI while discussing the disclosure requirement relating to ‘turnover’ states as follows:

“As regards the value of turnover, a question which may arise is with reference to various extra and ancillary charges. The invoices may involve various extra and ancillary charges such as those relating to packing, freight, forwarding, interest, commission, etc. It is suggested that ordinarily the value of turnover should be disclosed exclusive of such ancillary and extra charges, except in those cases where because of the accounting system followed by the company, separate demarcation of such charges is not possible from the accounts or where the company’s billing procedure involves a composite charge inclusive of various services rather than a separate charge for each service.

In the case of invoices containing composite charges, it would not ordinarily be proper to attempt a demarcation of ancillary charges on a proportionate or estimated basis. For example, if a company makes a composite charge to its customer, inclusive of freight and despatch, the charge so made should accordingly be treated as part of the turnover for purpose of this section. It would not be proper to reduce the value of the turnover with reference to the approximate value of the service relating to freight and despatch. On the other hand if the company makes a separate charge for freight and despatch and for other similar services, it would be quite proper to ignore such charges when computing the value of the turnover to be disclosed in the Profit and Loss Account. In other words, the disclosure may well be determined by reference to the company’s invoicing and accounting policy and may thereby vary from company to company. For reasons of consistency as far as possible, a company should adhere to the same basic policy from year to year and if there is any change in the policy the effect of that change may need to be disclosed if it is material, so that a comparison of the turnover figures from year to year does not become misleading.”

The Statement on the Companies (Auditors’ Report) Order 2003 issued by the Institute in April 2004, while discussing the term ‘turnover’ states as follows: The term ‘turnover’ has not been defined by the order. Part II of Schedule VI to the Act, however, defines the term ‘turnover’ as the aggregate amount for which sales are effected by the company. It may be noted that the ‘sales effected’ would include sale of goods as well as services rendered by the company. In an agency relationship, turnover is the amount of commission earned by the agent and not the aggregate amount for which sales are effected or services are rendered. The term ‘turnover’ is a commercial term and it should be construed in accordance with the method of accounting regularly employed by the company.

As per the ‘Guidance Note on Tax Audit’ — “The term turnover for the purposes of this clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprise. If sales tax and excise duty are included in the sale price, no adjustment in respect thereof should be made for considering the quantum of turnover. Trade discounts can be deducted from sales, but not the commission allowed to third parties. If, however the excise duty and/ or sales tax recovered are credited separately to excise duty or sales tax account (being separate accounts) and payments to the authority are debited in the same account, they would not be included in the turnover. However, sales of scrap shown separately under the heading ‘miscellaneous income’ will have to be included in turnover.”

As per explanation to paragraph 10 of AS-9 Revenue Recognition, “The amount of revenue from sales transactions (turnover) should be disclosed in the following manner on the face of the statement of profit and loss:

Turnover (Gross)   XX
Less: Excise Duty   XX
Turnover (Net)   XX

The amount of excise duty to be deducted from the turnover should be the total excise duty for the year except the excise duty related to the difference between the closing stock and opening stock. The excise duty related to the difference between the closing stock and opening stock should be recognized separately in the statement of profit and loss, with an explanatory note in the notes to accounts to explain the nature of the two amounts of excise duty.” AS-9 clearly sets out the requirement with respect to presentation of revenue and excise duty.

With respect to VAT the Guidance Note on Value Added Tax issued by ICAI states that “VAT is collected from the customers on behalf of the VAT authorities and, therefore, its collection from the customers is not an economic benefit for the enterprise and it does not result in any increase in the equity of the enterprise”. Accordingly, VAT should not be recorded as revenue of the enterprise. Correspondingly, the payment of VAT is also not treated as an expense. The Guidance Note on VAT further states, “Where the enterprise has not charged VAT separately but has made a composite charge, it should segregate the portion of sales which is attributable to tax and should credit the same to ‘VAT Payable Account’ at periodic intervals”. Currently most companies follow this guidance, though some entities have presented revenue gross of VAT and correspondingly treated VAT as an expense.

With respect to sales tax and service tax, the Guidance Note on revised Schedule VI states that such taxes are generally collected from the customer on behalf of the Government in majority of the cases. However, it adds that this may not hold true in all cases and it is possible that a company may be acting as principal rather than as an agent in collecting these taxes. Whether revenue should be presented gross or net of taxes should depend on whether the company is acting as a principal and hence responsible for paying tax on its own account or, whether it is acting as an agent i.e., simply collecting and paying tax on behalf of Government authorities. In the former case, revenue should also be grossed up for the tax billed to the customer and the tax payable should be shown as an expense. However, in cases, where a company collects tax only as an intermediary, revenue should be presented net of taxes. Strangely under the Guidance Note on revised Schedule VI, this concept of principal and agent is to be applied only with respect to sales tax and service tax, but not on excise duty which is covered under AS-9 and VAT which is covered by the GN on VAT.

Author’s view

Sellers of goods and services may enter into different arrangements with respect to indirect taxes. Some contracts clearly require the customer to pay the seller whatever tax is finally paid to the Government; in other words the seller acts as an agent between the Government and the customer. In other cases, the seller charges one all inclusive lump-sum amount for the entire sale contract including taxes.

The seller then pays to the Government whatever taxes are due, shouldering the risks of changes in tax rate or tax legislations. The tax burden on the seller would be the amount paid to the Government less any amount of input credit that is available to him. The tax burden could vary significantly under different scenarios, and this would determine the ultimate profit the seller makes on the lump- sum contract. In such cases, it could be said that the seller acts as a principal with respect to these taxes and hence should present revenue on a gross basis and the indirect tax as an expenditure. This example highlights a quagmire that companies have to face due to conflicting literature. On the one hand the guidance note on VAT requires a net presentation; whereas the guidance note on revised Schedule VI with respect to sales tax and service tax requires an assessment of principal and agent relationship which in this example would translate into a gross presentation.

The end result is that “what is good for the goose is not good for the gander” and absent a uniform principle for presentation of revenue and indirect taxes significant disparity in the disclosures would continue to arise in the future.

In the author’s view, the ICAI should commission a project to deal comprehensively with the presentation of various indirect taxes paid in India. Whether these taxes are presented gross or net, would depend on the nature of the indirect tax and the contractual arrangements between the seller and the buyer. It may be noted that under International Financial Reporting Standards, the evaluation of gross v. net presentation is done on the basis of principal agent relationship.

Nirav Shah

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Category: Accounting Standards (GAPS IN GAAP)

Acquisition date v Appointed date

Impact on MAT from First Time Adoption (FTA) of Ind AS

Can a Company have two functional currencies?

Adjustment of Debenture Premium against Securities Premium in Ind AS

IND AS ROAD MAP – CORPORATE vs. NBFC

Questions on GST

Business Combinations of Entities under Common Control

Goodwill In Common Control Transactions Under Ind AS Whether Capital Reserve Can Be Negative?

Impact of Ind AS on Demerger Transactions

Accounting For Loss of Control in Subsidiary

What Will Constitute A Service Concession Arrangement?

Deferred Tax under Ind AS On Exchange Differences Capitalised

Impact on Mat from First Time Adoption (FTA) Of Ind As

Clarifications on Security Deposits And Key Management Personnel

DEEMED COST EXEMPTION ON FIXED ASSETS AND INTANGIBLES

Accounting for MAT

GapS in GAAP — Accounting for Jointly Controlled Entities that have Minority Interest

GAPs in GAAP — Revenue — Gross vs. Net of Taxes