Ind AS – Common Control Business Combinations

With rapid globalisation and India playing a significant role in contributing to the fast-paced global economy, a dire need for more transparency and accountability on the part of Indian business houses towards their stakeholders worldwide has arisen. To ensure that these organisations meet international standards of accounting practices, the Ministry of Corporate Affairs, vide Notification dated 16 February 2015, notified new accounting standards, to be known as Indian Accounting Standards (Ind AS), the applicability of which has been carried out in a phased manner.

Ind AS 103 “Business Combinations” deals with the accounting for business combinations in standalone as well as consolidated financial statements. A set of assets acquired and liabilities assumed are typically regarded as a business if they can together run independently as a going concern (i.e. it consists of inputs and processes applied to those inputs, which has the ability to create an output). If they do not constitute business, the same shall be accounted as an asset acquisition.

Ind AS 103 vis-à-vis AS 14

Ind AS 103 provides guidance for accounting in the books of the acquirer in relation to recognition and measurement of assets, liabilities, any non-controlling interest acquired, any goodwill, and disclosure requirements. Its scope is much wider than AS-14 “Accounting for Amalgamations”.

With the evolution of time, the types of restructuring undertaken by companies have also evolved. Since AS-14 does not address the accounting needs in case of such transactions, Ind AS 103 has been introduced to cover a wider range of transactions (including slump sale, demergers, etc.) to bring uniformity between the industry practices and accounting treatments.

Ind AS 103 specifically provides for fair valuation of assets, liabilities and even non-controlling interest, which was earlier described as minority interest and valued at the amount of equity attributable to minority shareholders. One exception to such valuation is Common Control Business Combinations where the items are recorded at their carrying value (covered in detail below).

A key difference between Ind AS 103 and AS 14 is that any Goodwill arising out of Business Combinations is tested for impairment annually instead of being amortised over five years. Ind AS 103 has also introduced new terms and concepts such as reverse acquisitions, bargain purchase and recording of contingent considerations, among others.

Ind AS – Common Control transactions

One of the most essential elements covered in this Standard is the manner of accounting in a common control transaction. Before we discuss the accounting procedure, it is crucial to understand the meaning of terms “control” and “common control”.

Ind AS 103 has defined common control business combination as a business combination in which all the combining entities or business are ultimately controlled by the same person/ persons both before and after the combination and such control is not transitory in nature. It further states that a company may be said to be under the control of another entity or an individual or a group of them where they exercise the right to govern its financial statements and operating policies arising out of contractual agreement(s) so as to obtain benefits from its activities.

Interestingly, Ind AS 103 does not prescribe any threshold limit from a shareholding perspective to determine control in the entity. Instead, it has laid down few aspects such as decision making powers, board composition and contractual rights to determine control. Therefore, this brings in an element of subjectivity in determining where control lies.

Ind AS 110 Consolidated Financial Statements states that where an entity (say, “A”) has power over the other entity (say, “B”), has the rights to variable returns from its involvement with B and the ability to use its power to affect the returns of B, then it may be said that Entity A controls Entity B.

Given this, the extent of applicability of common control is wide and simultaneously demands more clarity in respect of definition of control.

• For example, we may consider a case where a lender, who does not hold any equity interest in the company, has entered into a contract as per which the company cannot enter into any major contracts or undertake any restructuring with any third party without the prior consent of the lender. In such a case, where the lender has agreed for a merger transaction with an entity in which it holds, say 80% equity interest, would such a transaction be referred to as a common control business combination?
• Another case can be mulled over where a company is merging with another company belonging to the same group, and both the entities have common lender or group of lenders having same rights and power as in the previous example. In such an instance, who would be said to have control in the merging entity, the lender(s) or the parent entity?

Accounting treatment under common control transactions under Ind AS 103

Ind AS 103 prescribes application of pooling of interest method to account for common control business combinations. Under this method:

• All identified assets and liabilities will be accounted at their carrying amounts, i.e. no adjustment would be made to reflect their fair values unlike in case of non-common control business combinations.
• Balance of retained earnings in the books of acquiree entity shall be merged with that of the acquirer entity, and identity of the reserves shall be preserved.
• Any difference, whether positive or negative, shall be adjusted against the capital reserves (or “Amalgamation Adjustment Deficit Account” in some cases).
• Hence, no goodwill can be recorded in books under common control transactions under Ind AS 103.

Conclusion

To conclude, given that a substantial number of restructuring transactions occur, it becomes critical for entities involved to evaluate various aspects such as control, acquisition date, and common control to determine the accounting treatment. Further, given that under the Companies Act, an Auditor’s Certificate is required for all the entities undertaking such restructuring, it is imperative to establish a clear and consistent understanding of the accounting implications.

Undoubtedly, Ind AS 103 has brought about a radical change in the manner of accounting and presentation to reflect a truer picture of companies’ financial statements. Nonetheless, many aspects continue to need clarity. One such welcome change in bridging the gap between Ind AS and other regulations has been the amendment to the Income tax Act, where the definition of demerger (which mandated book-value transfers), has been amended to allow companies to record assets/ liabilities at fair value under Ind AS 103 in case of non-common control demergers. Taking more such steps towards clearing the ambiguity between allied laws and regulations would make doing business in India easier and less cumbersome.

Author:  Aditya Narwekar – Partner, M&A Tax, PwC India and Jaisri S – Director, M&A Tax, PwC India

The views expressed in this article are personal to the author.

This article includes inputs from Nilay Mukesh Mehta – Manager, M&A Tax PwC India and Priya Shah – Associate, M&A Tax PwC India.