Issue no. 5/2016 | Technology www.kpmg.com/in Accounting and Auditing Update IN THIS EDITION Impact of the new revenue standard on the technology sector p1 Conversation with Mr. Sanjay Puria p11 Key elements of business combinations – contingent consideration, intangible assets and goodwill p19 Share-based payments - key accounting developments p27 Financial Instruments p31 Operating segment p35 Enhanced responsibilities of the audit committee p37 The dilemma of tax exemption for SEZ p41 Base Erosion and Profit Shifting p45 Will GST address the expectations of technology service exporters? p51 Regulatory updates p53
Transcript
Issue no. 5/2016 | Technology
www.kpmg.com/in
Accounting andAuditing UpdateIN THIS EDITION
Impact of the new revenue standard on the technology sector p1
Conversation with Mr. Sanjay Puria p11
Key elements of business combinations – contingent consideration, intangible assets and goodwill p19
Partner and HeadAccounting Advisory Services KPMG in India
In continuance with our revamped series of the Accounting and Auditing Update, this edition focusses on the technology services sector.
The Ind AS (Indian Accounting Standards) are bringing about a paradigm shift in financial reporting which is going to potentially affect many key metrics of performance. This publication seeks to highlight the expected impact of Ind AS on various topics including how revenue recognition would be impacted for a typical technology services contract on adoption of Ind AS 115, Revenue From Contracts with Customers. Under business combinations accounting, the publication highlights the impact of accounting of contingent consideration, types of intangibles recognised in the technology services sector and differences in the approach of goodwill impairment under the current Indian GAAP, Ind AS and the U.S. GAAP. The Accounting and Auditing update also discusses accounting of share-based payments, financial instruments and segment reporting under Ind AS and their likely impact on the financial statements of companies in this sector.
The publication also carries an interview section where we speak to a CFO/finance director of a leading company from the sector and explore some key accounting and reporting, as well as topical matters relevant to the industry. This month’s issue features an interview with Mr. Sanjay Puria, Group Chief Financial Officer, WNS.
Certain entities in the technology services sector enjoy certain tax exemptions when they set-up their facilities in the special economic zones in India. These tax exemptions affect the computation of current and deferred taxes under Indian GAAP and Ind AS. Our article on this topic highlights the potential impact of such tax exemptions under the new reporting framework.
The sector is also affected by a number of global developments in the areas of direct and indirect tax. For example, the Organisation for Economic Co-operation and Development issued guidance on 15 key areas for identifying and curbing aggressive tax planning practices (Base Erosion and Profit Sharing) and altering the international tax system in a way that
it is coherent and consistent amongst countries. Our article summarises the impact of this guidance with a specific reference drawn to the technology services sector. Additionally, we summarise the expected impact of the Goods and Services Tax requirements on the sector.
Finally, apart from our regular round up of regulatory updates, this edition of the Accounting and Auditing Update provides a summary of the concept release by the U.S. Securities and Exchange Commission on enhanced responsibilities of the Audit Committee along with the Indian Exposure Draft on Auditing Standard 260, Communication with those charged with governance.
As always we would be delighted to receive any kind of feedback or inputs on the topics that we have covered.
OverviewThe importance of the technology sector as a critical driver of growth for the Indian economy cannot be overemphasised. The revenue generated from this sector is expected to exceed USD150 billion in in Financial Year (FY) 2015-161, making it one of the largest contributors to the Indian GDP and to employment. The explosive growth witnessed in the e-commerce industry in India over the past couple of years and the emphasis laid on e-governance, ‘Make in India’ as well as the ‘Start-up India’, are aiding the technology sector in India to assume a leading position, even within the domestic industry.
Historically, companies that operate in the technology services sector in India have been better aligned in terms of adoption of leading practices in accounting and reporting, governance, etc. Since this sector led the clutch of Indian companies that went public in developed markets such as the U.S., it necessitates compliance with higher accounting, reporting and governance norms. Additionally, many of the global multinational companies (MNCs) in the technology and consultancy sector have made India their second home, employing a huge workforce in their captive centers here, and bringing to the country some of the well-known practices from around the world.
The changes introduced by the Companies Act, 2013 and the adoption of Ind AS are developments that are expected to assist companies in the sector to align even more closely with leading practices in the accounting, reporting and governance arena.
Recent developments such as the proposed introduction of the Goods and Services Tax and the recently introduced Base Erosion and Profit Shifting Rules, Advance Pricing Agreement, etc. also seem to be in line with global practices in taxation that require companies to carefully review the impact of such legislation on their operations and prepare for a smooth transition/adoption.
1. NASSCOM publication ‘The Information Technology- Business Process Management sector in India – Strategic Review 2015’
In May 2014, the International Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) published their new joint standard on revenue recognition - IFRS 15 and FASB Topic 606 Revenue from Contracts with Customers, replacing the existing revenue guidance in both U.S. GAAP and IFRS.
The new standard moves away from the industry and transaction specific requirements under U.S. GAAP (which are also used by some IFRS preparers in the absence of specific IFRS guidance), and contains a single model that will be applied while accounting for contracts with customers across all industries, including real estate. Under current Indian GAAP, AS 7, Construction Contracts and AS 9, Revenue
Recognition and the Technical Guide on Revenue Recognition for Software provide guidance on revenue recognition. In India, Ind AS 115, Revenue from Contracts with Customers, is the standard on revenue recognition that is converged with IFRS 15.
Internationally, under the road map for implementation, the new standard is effective for annual periods beginning on or after 1 January 2018 for entities applying IFRS and for annual periods beginning on or after 15 December 2017 for public business entities and certain not-for-profit entities applying U.S. GAAP. Early adoption is permitted only under IFRS.
Ind AS 115 is currently applicable for periods beginning on or after 1 April 2016. The National Advisory Committee on Accounting Standards (NACAS)
has recommended to the Ministry of Corporate Affairs (MCA) that Ind AS 115 be deferred in line with IFRS 15. Consequently, on 24 September 2015, the Institute of Chartered Accountants of India has issued two exposure drafts on Ind AS 11, Construction Contracts and Ind AS 18, Revenue, which will form part of the suite of Ind AS standard available for adoption.
Five-step model
The core principle of the new standard is that revenue should be recognised when (or as) an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. To achieve the core principle, the new standard establishes a five step model that entities would need to apply to determine when to recognise revenue, and at what amount.
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Step 1Identify the contract
Step 2Identify performance obligations
Step 3Determine the transaction price
Step 4Allocate the transaction price
Step 5 Recognise revenue
Five step model Key requirements
Step 1 Contract is considered in scope if it is legally enforceable and certain other criteria such as collectability, commercial substance, rights and obligations are met.
Step 2 Performance obligation represents goods or services that are capable of being distinct and are distinct within the context of the contract.
Step 3 Transaction price is the consideration the company expects to receive under the contract. This should include an assessment of variable consideration, non-cash consideration, deferred payment terms and amounts payable to the customers.
Step 4 Allocate the transaction price to identified performance obligations in proportion to stand-alone selling prices computed based on observable prices or management estimates.
Step 5 Recognise revenue either at a point or over a period of time depending on when the customer obtains control of the transferred goods or services.
While the overall principles remain the same, the new standard is expected to have significant impact on the accounting of revenue by entities in the technology sector, specifically in view of the detailed guidance in steps 2 and on identifying separate components and allocating the transaction price.
What is in this for you?
This article analyses some of the frequent service offerings by companies in the technology sector and the impact of Ind AS 115 on accounting for such transactions.
Example: Accounting for contract revenue and costs under the new standard
Company X enters into a multi-year IT services contract with a customer to render transition, transformation, development and support services. The broad scope of the services are as below:
Transition – includes activities to transfer maintenance of all in-scope applications to company X’s governance and delivery model. Deliverables include documentation of existing processes and defining the new process that will be followed for service delivery during a steady state.
Transformation – involves activities pertaining to upgrading the customer’s legacy application platforms to the latest industry standards. This would entail implementation services, migration, developing interfaces and testing the end solution.
Development - involves building certain computer software (IP which would be owned by customer) to assist the customer in automating service desk functionalities and other manual processes.
Support – involves maintenance activities (including bug fixes) for all in-scope applications over the contract period of three years and adherence to prescribed Service Level Agreements (SLAs).
Under the terms of the contract, company X is also required to set up a near shore facility from which services would be rendered to the customer. In addition to the above mentioned payments, the customer is also required to pay an upfront fee of INR2,000,000, intended to compensate company X for the initial set up costs incurred by it to set up the near shore facility.
Company X has incurred costs amounting to INR800,000 to obtain the contract. Of this, INR500,000 pertains to sale commissions paid by the company to its sales personnel who were instrumental in securing the contract. Company X believes that these costs are capable of being recovered under the contract. The balance (INR300,000)
pertains to costs which would have been incurred irrespective of whether or not the contract was obtained.
Step 1
Identification of the contract with the customer
A contract exists if it is considered to be legally enforceable and certain other criteria discussed earlier are met. Legal enforceability may be either through oral or written arrangements, depending on the customary practice. In this example, company X has signed a contract for services which demonstrates legal enforceability. Hence, a contract is deemed to be in existence for the purposes of this standard.
Accounting for contract modifications
A contract modification may either be for a change in scope of services or price or both. Under the new standard, a contract modification is accounted for as a separate contract if distinct goods and services are added to the arrangement, and if those goods and services are priced at their stand-alone selling prices. Else, contract modifications are accounted for either prospectively or by a cumulative catch-up adjustment. No such guidance is provided explicitly in the existing standard on revenue recognition.
The charges under the contract for the services are as below:
Identification of performance obligationsThe new standard requires an entity to identify the performance obligations, i.e. the unit of account for revenue recognition. A promised good or service would qualify to be a performance obligation if both the below mentioned criteria are met:
If a promised service under the contract does not qualify to be a separate performance obligation, the entity would need to combine such services with other services until the
bundled arrangement qualifies to be a performance obligation.
Identification of a performance obligation requires significant management judgement and entails an assessment
of the promised goods and services under the contract (including implied and customary promises). Please see below for an indicative evaluation that company X could perform to identify performance obligations:
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Criteria Indicators
Capable of being distinct
• Sold by the entity separately to other customers
• Capable of being used by the customer independently in a manner that generates economic benefits
• Capable of being used in conjunction with other goods or services sold separately by the entity or other vendors
Distinct within the context of the contract
• The entity is not using the services as an input to deliver the output promised under the contract
• The services do not significantly modify or customise other services promised under the contract
• The customer has the ability to procure each service independently without significantly affecting the utility of other services promised under the contract
Performance obligation Points for evaluation
Transition services • Are the transition deliverables owned by the customer?
• Are they robust enough to enable a new service provider to gain an in-depth understanding of the customer’s IT environment?
Transformation services • What is the customer’s objective of availing such services? These could include reduction in capital assets, shift of operational responsibility. Are these objectives capable of being met even if other services are not rendered?
Transition, transformation, development and support services
• Does company X in the normal course of business render similar services on a standalone basis to customers?
• Is rendering of the service independent of the other services to be rendered under the scope of the contract?
• Is the customer capable of consuming the associated benefits of the service independent of other services under the contract?
Currently, limited guidance is available under IFRS to account for multiple deliverable contracts and these are accounted for by analogy to the test in IFRS Interpretations Committee (IFRIC) 18, Transfer of Assets from Customers. The interpretation provides two indicators (not exhaustive):
• the service has stand-alone value to the customer
• the fair value of the service can be measured reliably.
In contrast, Ind AS 115 provides comprehensive guidance on identifying performance obligations. In practice, this could result in goods or services being unbundled or bundled more frequently than under current practice.
Comparison with current U.S. GAAP
Criterion one (capable of being distinct) is similar, but not identical, to the stand-alone value criterion required under
current U.S. GAAP. The evaluation no longer depends entirely on whether the entity or another entity sells an identical or largely interchangeable good or service separately, or whether the delivered item can be resold by the customer, to support a conclusion that a good or service is distinct. Therefore, potentially more goods can qualify as distinct under criterion one than under current U.S. GAAP. However, an entity also has to evaluate criterion two.
Step 3
Determine the transaction priceTransaction price is the consideration company X expects to receive under the contract. This includes an estimate of the variable consideration and evaluation of embedded financing components, if any. Variable pricing is included in the transaction price only if it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the associated uncertainty is subsequently
resolved (a downward adjustment). Under this example, the transaction price is determined to be INR67 million (INR10 million + INR15 million + INR40 million + INR2 million).
Under the new standard, consideration is measured at the amount to which the entity expects to be entitled, rather than at fair value.
Step 4
Allocation of transaction priceThe standard requires that company X allocate the transaction price to each performance obligation in proportion to its stand-alone selling prices, i.e. the price at which company X would sell the promised service separately to a customer. See table below for an illustration of the methods used to determine the stand-alone selling prices.
Source: KPMG’s publication Issues in Depth – Revenue from Contracts with Customers September 2014
The best evidence of stand-alone selling price would be an observable price from stand-alone sales of that service to similarly situated customers. However,
considering that entities may face difficulties in determining the stand-alone selling prices of a performance obligation, the standard also describes
the following alternative estimation methods as possible approaches.
The residual approach is appropriate only if the stand-alone selling price of one or more goods or services is highly variable or uncertain, and observable stand-alone selling prices can be established for the other goods or services promised in the contract.
For the purposes of our example, transition, transformation, development and support could qualify to be separate performance obligations. Assessing whether transition service is distinct would require application of significant judgement. This evaluation would be complex and require assessment of the specific facts and circumstances that are relevant to a contract. Certain indicators may provide more compelling evidence to the separability analysis than
others in different scenarios or types of contracts. In addition, there are some instances where the relative strength of an indicator, in light of the specific facts and circumstances of that contract, may lead an entity to conclude that two or more promised goods or services are not separable from each other in the context of the contract. This may occur even if the other two indicators might suggest separation. The new standard provides illustrative examples highlighting the judgemental nature of this determination.
Assuming in this case, a detailed documentation of the transition process would be delivered under the contract and would not form part of a combined output. Additionally, in this case it is
assumed that the transition services would not significantly modify the other elements of the contract. The customer would be capable of consuming transformation, development and the support services, without obtaining the transition services.
To comply with the requirements of the standard, the transaction price has to be allocated to each of these performance obligations. Please see below for possible approaches that company X could take to determine stand-alone selling prices of the performance obligations under the contract:
Adjusted market assessment approach
Expected cost plus a margin approach
Residual approach (limited circumstances)
Evaluate the market in which goods or services are sold and estimate the price that customers in the market would be willing to pay
Forecast the expected costs of satisfying a performance obligation and then add an appropriate margin for that good or service
Subtract the sum of the observable stand-alone selling prices of other goods or services promised in the contract from the total transaction price
Performance obligation Evaluation Method
Transition Company X has sold similar transition services to other customers on a stand-alone basis.
Observable price
Transformation Company X has sold similar transformation services to other customers on a stand-alone basis.
Observable price
Development and support
• Company X has not sold similar services to other customers on a stand-alone basis.
• Adequate data is not available to determine market prices for such services.
Accordingly, in this example, all performance obligations are satisfied over a period of time. For each performance obligation that is satisfied over time, company X would need to
apply a single method of measuring progress towards the complete satisfaction of that performance obligation. The objective is to use a method that depicts the transfer of
control of the goods or services to the customer. To meet this objective, company X would need to select an appropriate output or input method.
Performance obligation Evaluation
Transition/transformation/development
Company X’s performance creates an asset (contract deliverables) that the customer controls as the asset is created. Accordingly, company X concludes that revenue from such services should be recognised over time.
Support The customer simultaneously receives and consumes the benefits of the output as company X performs related services. Accordingly, revenue from steady state services should also be recognised over time.
However, as a practical expedient, if the billing under the contract corresponds directly with the value to the customer, company X may recognise revenue based on amounts billed.
Comparison with current IFRS
Current IFRS is largely silent on the allocation of consideration to components of a transaction. However, recent IFRS interpretations include guidance on allocation for certain industries (such as IFRIC 13, Customer Loyalty Programmes and IFRIC 15, Agreements for the Construction of Real Estate).
The new standard introduces guidance applicable to all in-scope contracts with customers. It therefore enhances comparability and brings more rigour and discipline to the process of allocating the transaction price. With various estimation methods available to suit different circumstances, we expect that situations where companies are unable to determine the stand-alone selling price of their goods and services will be rare.
Comparison with current U.S. GAAP
The approach and methods available for establishing stand-alone selling prices provide more flexibility than what is currently available under U.S. GAAP. For example, using ‘observable selling prices’ under the new standard versus the current practice of establishing Vendor Specific Objective Evidence (VSOE).
Step 5
Recognise revenue As per the new standard, revenue may be recognised either at a point in time (when the customer obtains control over the promised service) or over a period of time (as the customer obtains control over the promised service). For the purposes of the standard, control refers to the customer’s ability to direct the use of and obtain necessary benefits from the asset, i.e. the promised services.
An entity would have to determine at contract inception whether it satisfies
the performance obligation over time or at a point in time. A performance obligation may be satisfied over time if any of the following criteria are met:
a. The customer simultaneously receives and consumes the benefits provided by the entity’s performances as the entity performs or
b. The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced or
c. The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to payment for performance completed to date.
If one or more of these criteria are met, then company X would need to recognise revenue over time, using a method that depicts its performance i.e., the pattern of transfer of control of the service to the customer. If none of the criteria is met, control transfers to the customer at a point in time and company X would recognise revenue at that point in time.
Company X may determine that revenue may be recognised as follows:
Method Amount in INR Service
Output Based on direct measurement of the value to the customer of goods or services transferred to date, relative to the remaining goods or services promised under the contract
• Surveys of performance to date
• Appraisals of results achieved
• Milestones reached
• Time elapsed
Input Based on an entity’s efforts or inputs towards satisfying a performance obligation, relative to the total expected inputs to the satisfaction of that performance obligation
• Resources consumed
• Costs incurred
• Time elapsed
• Labor hours expended
• Machine hours used
Performance obligation Method used Stage of completion
determined using Remarks
Transition/ transformation/development
Input method Cost incurred Resources consumed/time elapsed is not considered for determining stage of completion as the cost differs over the service delivery period and consequently, the stage of completion would also differ.
Support Output method
Time lapsed Time lapsed is considered to be the best measure of stage of completion as the customer gets the same benefit through the service delivery period.
Comparison with current IFRS
Contracts for rendering of services are currently accounted for under the stage-of-completion method. The new standard is consistent with the stage-of-completion accounting, but introduces new criteria to determine when revenue should be recognised over time. Subtle differences in contract terms could result in different assessment outcomes and therefore significant differences in the timing of revenue recognition.
Comparison with current U.S. GAAP
Currently, revenue from service contracts is recognised under the proportional performance or straight-line method. Under the new standard, an entity currently applying these methods can continue to recognise revenue over time only if one or more of the three criteria are met. Unlike current industry and transaction specific guidance, the requirements in Step 5 of the model are not specific to certain services, but
rather are applied consistently to each performance obligation in a contract. Accordingly, on applying the new criteria, some entities may determine that revenue that is currently recognised at a point in time should be recognised over time, or vice versa.
Other issues: Contract costs
Under the new standard, an entity is required to capitalise certain costs incurred in obtaining a contract if specified criteria are met. Company X would need to account for costs of obtaining a contract as follows:
• If the costs incurred are direct incremental costs associated with obtaining the contract and if such costs are capable of being recovered in the future, they should be capitalised as an asset. Accordingly, INR500,000 of sales commission paid by the company X would need to be capitalised and amortised over the contract term consistent with the pattern in which services are rendered to customers.
• If the costs incurred would have been incurred regardless of whether or not the contract was obtained, they should be expensed in the period in which they are incurred unless they qualify to meet the definition of fulfillment costs. In the technology sector, costs incurred to submit a proposal, perform due diligence activities or feasibility studies and other expenses of a similar nature would not meet the requirements of costs of obtaining a contract and fulfillment costs. Accordingly, in our example, INR300,000 would be expensed in the period in which it is incurred.
Judgement would be required to assess which costs should be capitalised and for determination of the appropriate period and pattern of amortisation, e.g. whether the amortisation period should include the anticipated contracts with the same customer.
In many cases, service providers receive a non-refundable upfront fee as part of the contract. Such fee may pertain either towards services to be rendered under the contract or to compensate the entity for set up/administrative activities.
Non-refundable upfront fees pertaining to
Compensation for set up/administrative activitiesA promised service
Separate performance obligation Not a separate performance obligation
Recognise revenue as and when services are
rendered
Allocate to other identified performance obligations and recognise revenue as and
when services are rendered
However, a practical expedient allows an entity to expense as incurred, the incremental costs of obtaining a contract if the amortisation period of the asset would be a year or less.
Comparison with current IFRS
Currently there is no specific guidance on the accounting for the costs to obtain a contract. The IFRS Interpretations Committee discussed the treatment of selling costs and noted that only in limited circumstances direct and incremental recoverable costs to obtain a specifically identifiable contract with a customer would qualify for recognition as an intangible asset in the scope of IAS 38, Intangible Assets. The new standard
therefore brings clarity to this topic. It also introduces a new cost category – an asset arising from the capitalisation of the incremental costs to obtain a contract will be in the scope of the new standard, and not in the scope of IAS 38.
Comparison with U.S GAAP
Current guidance indicates that an entity can elect to capitalise direct and incremental contract acquisition costs in certain circumstances. Further, some entities capitalise a portion of an employee’s compensation relating to origination activities, which is not permitted under the new standard since they do not constitute incremental costs.
The upfront payment of INR2,000,000 in the current example is intended to compensate an administrative activity. Therefore it is allocated to other identified performance obligations based on relative fair value and recognised as and when services are rendered.
Comparison with current IFRS
Under the current standard, upfront payments are recognised as revenue when:
i. there is no significant uncertainty over its collection; and
ii. the entity has no further obligation to perform any continuing services
Accounting for non-refundable upfront fees is not expected to differ from the current standard. However, the period of amortisation under Ind AS 115 would consider whether or not the non-refundable fee provides a material right to the customer i.e., if the fee is significant enough that it would be likely to impact the customer’s decision on whether to renew a contract.
Comparison with current U.S. GAAP
Concluding whether a non-refundable upfront fee represents a payment for a promised service under the new standard may involve a similar analysis to that required under current SEC Staff guidance. When performing the analysis under the new standard as part of Step 2 above, the entity in required to consider the integration guidance. Such analysis may be different from current U.S. GAAP thereby leading to a change in identification of performance obligations.
Under current SEC Staff guidance, upfront fees are deferred and recognised over the expected period of performance, which can extend beyond the initial contract period and quite often, over the average customer relationship period. Under the new standard, the entity is required to assess if the upfront fee provides the customer with a material right, and if so, for how long. The upfront fees may then be deferred over such period. This could require companies to disregard the average customer relationship period thereby leading to a change in the period over which upfront fees are recognised as revenue.
Other areas of Impact
Other key areas of revenue, which would be impacted by Ind AS 115 are as below:
• Sale of licenses
Ind AS 115 distinguishes between licenses that represent the transfer of a right to use an entity’s intellectual property and licenses that represent the provision of access to an entity’s intellectual property over a period of time. Revenue from the former would be recognised at a point in time and for the latter, over a period of time.
• Post customer support services (PCS)
Ind AS 115 distinguishes between PCS that are technical support services and unspecified software upgrades. The former could constitute as a separate performance obligation and the latter does not.
• Principal vs agent considerations
Under current IFRS, an entity is a principal in the transaction when it has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. Under Ind AS 115, in order to assess whether the entity is a principal or agent, the entity considers whether it controls a promised good or service before the good or service is transferred to the customer.
Conclusion and next steps
Ind AS 115 could have a significant impact on the revenue recognition polices for companies in the technology sector. With implications on the timing of revenue recognition, contract costs and the extensive use of estimates and judgements in certain areas, amongst other factors, the new standard could have a significant bearing on revenues and margins. Companies will also need to carefully analyse the transition method that they want to adopt – from the full retrospective method, to the modified retrospective method to the cumulative effect method, the implications on retained earnings and future revenues and margins could be varied. There would also be extensive disclosure requirements which information systems will need to support.
Entities would need to carry out an extensive assessment of how their financial reporting, information systems, processes and controls are expected to be affected. They will need to engage with their investors and other stakeholders to establish expectations of how their key performance indicators or business practices may change as a result of the new standard. Planning in advance will therefore be key to help ensure a smooth transition to this new, transformational standard.
Q As per the Ind AS adoption road map, WNS would be adopting Ind AS from 1 April 2016, with date of transition being 1 April 2015. How are you addressing the related challenges? What learnings or insights are you developing as you gear up to meet these challenges?
WNS (Holdings) Limited (WNS Holdings) is the parent company of our Indian subsidiaries (collectively referred to as WNS). WNS Holdings is listed on the New York Stock Exchange (NYSE) and follows IFRS standards, as recommended by the International Accounting Standards Board (IASB). For us, the rollout journey of Ind AS began from December 2007, wherein the U.S. Securities and Exchange Commission (SEC) permitted foreign private issuers to file IFRS-compliant financial statements without reconciliation to U.S. GAAP
standards. WNS Holdings adopted IFRS standards and issued the first annual audited financial statements under IFRS, as recommended by IASB, in fiscal 2012. We were among the earliest adopters of IFRS, and our internal team implemented the IFRS practices. Most of the jurisdictions in which our subsidiaries operate had already migrated to IFRS as adopted by their respective country.
The Ministry of Corporate Affairs (MCA) in India issued a notification on the Companies (Indian Accounting Standards) Rules, 2015, along with 39 Indian accounting standards and an implementation road map. Our Indian subsidiaries will be adopting Ind AS from 1 April 2016.
In order to ensure that the transition to Ind AS is smooth, we chalked out a detailed project management approach with a three phased plan.
a. Phase 1 – Planning
• Performing gap analysis
• Make key management decisions and outline policies
• Develop conversion path and plan
b. Phase 2 – Development and preparation
• Draft policies and outline policies
• Identify changes to workflow, processes and standard operating procedures
c. Phase 3 – Roll out and implementation
• Preparing financial statement under Ind AS with an opening balance sheet and comparatives
The Ind AS convergence activity involves collaborated efforts from various stakeholders. We instituted a steering committee comprising of board members, which oversees progress and provides guidance to the core group, driving Ind AS implementation. As things stand, we are on course as per our internal Ind AS conversion timelines. Our journey to Ind AS convergence has been much simpler, as we were already conversant with IFRS.
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Q The Income Computation and Disclosure Standards (ICDS) have been notified and are applicable from Assessment Year 2016-17 onwards. The adoption of ICDS is expected to significantly alter the way companies compute their taxable income, as many of the concepts from existing Indian GAAP have been modified. This may also require changes to existing processes and
systems. What are the key implementation challenges of ICDS that you foresee? Do you believe that adequate implementation time and guidance has been provided by the government for ICDS?I believe that the very objective of introducing ICDS is to bring consistency in computation of income and reduce the potential for litigation. Although a separate set of books is not required, the ICDS are likely to have far-reaching practical implications. Enterprise Resource Planning (ERP) applications need to be customised to capture
and extract the necessary data. The confusion would further increase with Ind AS getting implemented next year. The applicability of ICDS may ideally have coincided with the implementation of Ind AS.
The objective of ICDS seems to bring forward revenues and defer recognition of expenses. There may be a strong possibility of the income being taxed twice – once under normal provisions of the Income Tax Act, 1961 and later under the Minimum Alternate Tax (MAT), when the income is recognised in the books.
Q The Companies Act, 2013 (2013 Act) has introduced reporting requirements on internal financial controls (IFC) to be followed by the company and that such internal controls are adequate and were operating effectively. How have you approached this area and what have been the key considerations relating to the implementation of reporting on IFC? How have you been able to leverage the framework implemented for SOX 404 reporting, including
the implementation of the Committee Of Sponsoring Organisations (COSO) 2013 framework?
We had implemented the COSO 1992 framework in the first year of our listing on the NYSE (2006). We have been reporting the management’s assessment on our internal control over financial reporting in our annual report (Form 20-F) since 31 March, 2008. In fiscal year 2015, WNS management assessed the effectiveness of the company’s internal control over financial reporting, based on the COSO 2013 framework.
The 2013 Act strongly emphasises on internal controls, and fixes the responsibility of overseeing it on the board. Since the COSO framework was already in place for WNS Holdings,
implementing, or rather extending the framework for the Indian entity, was easier. The process of implementing the controls began in 2006 and enhanced, as required, until the 2013 framework came into force. Indian entities had already set up the control components since 2006 for demonstrating efficient and effective internal financial controls in the following areas:
• Procedures to monitor adherence to policies
• Prevention and detection of frauds and errors
• Safeguarding of assets
• Accuracy and completeness of accounting records
• Timely preparation of reliable financial information.
Q Have there been other areas such as related party transaction approvals required under the 2013 Act that have been challenging to implement?
Since our Indian subsidiaries are private companies as per the 2013 Act, we are not impacted by the change in the legislation.
Q What has been your overall evaluation of the 2013 Act and are there any learnings on how such significant economic legislation should be implemented for the country?The 2013 Act is a result of several years of discussion on how to shape corporate law in India. The 2013 Act provides a stimulus to better govern
company affairs. We believe that the Act itself is very progressive in the areas of corporate governance, women directors, independent directors, Corporate Social Responsibility (CSR), rotation of auditors and audit partners and related party transactions. There are very few countries that have made audit partner/firm rotation compulsory. Similar is the case with women directors.
We believe that adequate transition time should be provided for corporates to fully understand and implement the provisions of the 2013 Act. Formal bodies
should be set up to collate problems and challenges faced by corporates in the implementation process, and the identified problems should be adequately addressed by MCA.
Q Goods and Services Tax (GST) is a path breaking business reform, and not just a tax reform for India. It is likely to trigger a major ‘business transformation’. Despite the recent setback in the winter session of the parliament, the general view is that GST will become a reality soon. Viewed from this perspective, how are you approaching this area and how are you framing your plans in order to achieve significant efficiencies of business and even yield a competitive edge in the market? Is GST expected to increase/decrease the overall tax flows for WNS?
GST is a path-breaking reform for India and, hopefully, will be a reality soon. This requires a major transformation of the taxation structure, and will likely expand the tax department’s responsibilities from traditional tax functions to broader areas, such as process, technology and data. We reviewed our sourcing arrangements, current processes and have laid down high level plans to be pro-actively prepared for this changeMost companies in the BPM/ITeS1 industry operate under the STPI /SEZ2 regime. The SEZ regime provides outright tax exemption on procurement of goods and services. If these benefits are not extended to the STPI units as well, there will be a high cash blockage under the new GST law due to anexpected increase in the tax rate. Similarly, CENVAT3 credit rules under the proposed GST should provide clarity on entitlement of service credit on key essential inputs such as rent-a-cab services, staff insurance services, and so on. As the BPM/ITes industry is people-centric, its business units suffer due to this
distortion. The proposed GST regime should allow seamless input credit on all input services. From a compliance perspective, the industry is presently taking advantage of a single central registration facility. It will face a higher compliance burden along with related costs, unless a similar facility is provided under the GST legislation also. The ease of doing business, with minimum compliances and cost, will go a long way in achieving business growth.
Q The government has introduced mandatory CSR requirements in the 2013 Act. The 2013 Act mandates companies to spend on social and environmental welfare, making India perhaps one of the very few companies in the world to have such a law and order. What were the key considerations and challenges your company faced implementing this law for the first time? Could you please elaborate the CSR programmes being undertaken by the company?
India became the first country to mandate CSR through statutory provisions, and joined the league of countries having mandatory guidelines for CSR spending and reporting. The final CSR rules got notified in February 2014 and became effective from 1 April 2014.
Much before it was mandated by the 2013 Act, CSR had been a part of WNS’ DNA. WNS Cares Foundation (WCF) was formed with an objective to give back to the society and create a strong foundation for sustainability initiatives.
Our mission is to ‘Educate, Empower and Enrich’ the underprivileged children and youth. Our core philosophy revolves around making a difference through education, and the power of one individual to make that difference. To ensure that our programmes are aligned to this mission and vision, they are specifically designed to be versatile, comprehensive and driven by the core objectives.
The programmes are:
• Impactful: WCF’s programmes are designed to create the right impact at the right stage, to help a child pursue higher education or be employment-ready
• Result-oriented: The aim is not just to reach a large number of students through strategic programmes, but also to ensure that the programmes help the children overcome the critical stages of their student life
• Strategic: WCF identifies and selects programmes keeping in mind the needs of underprivileged children, the importance of a holistic approach, the significance of facilitation of volunteering and the sensibilities of each location, among other aspects
• Strategic: WCF identifies and selects programmes keeping in mind the needs of underprivileged children, a holistic approach, facilitation of volunteering, and the sensibilities of each location, among other things.
1. Business Process Management/IT enabled Services
2. Software Technology Parks in India/Special Economic Zones
Q In the technology sector, the success of an organisation is dependent on hiring, training and retaining highly skilled IT professionals. Finding and competing for the world’s top talent can be tough, especially if the options are confined to a small geographic area. An added challenge is that the market continues to be highly competitive and thus attracting and retaining the tech professionals is becoming increasingly difficult. What are the steps/measures your
company has taken in this direction to retain the right people and manage the attrition rate?
Talent is heart of our business. We strive to provide best in class workplace environment to our talent. We at WNS have been focussing on a diverse range of people initiatives to engage with our multi-generational global workforce:
• Enriched role profiles, which promote exposure and new experience for employees on a continuous basis as part of structured talent development
• Work culture, which is positive, challenging, involved and promotes innovation and entrepreneurship, ‘giving space for employees to align their own goals and career needs with organisational goals’
• A structured and transparent talent identification and performance management process with high-level involvement from our leadership team
• Talent planning, job rotation and coaching to nurture capabilities for the next-level leadership roles (including global exposure and leadership nurturing).
In a bid to create a human resource pool equipped with the skill set to deal with emerging technologies including social, mobility, analytics and cloud, and business process management at WNS we have implemented various programmes including the one where WNS had partnered with NIIT University to start first-of-its kind MBA programme in big data analytics.
Q The impact of disruptive trends such as cloud computing, mobility, robotics and analytics have transformed the IT services and BPM industry. Implementing new technologies in business solutions has become imperative for service providers. The future of the Indian IT services and BPM
sector will largely be impacted by the digital initiatives of the service providers and requirements of the customers. What strategies has the group adopted to counter such technology risks? WNS has consistently provided our clients with sustainable and scalable business models leveraging our domain expertise, actionable insights, technology-enabled solutions and global delivery platforms. WNS does not view the ‘disruptive’ trends in our industry
as a risk, but as an opportunity. With the focus shifting from traditional to disruptive we have made investments in next generation technologies including social, mobility, robotics and analytics to build solutions that can deliver tangible values. We provide our clients with a commitment to not only reduce costs via productivity improvements, but also improve their competitive positioning through developing deeper capabilities and competencies, operational excellence and innovative business delivery models.
Q There have been severe movement in most foreign currencies impacting the technology sector. The global financial position continues to remain volatile and this is expected to continue in the medium term as well. Additionally, there is an
added complexity of the cross-currency movements, particularly in the European currencies. How has the company strategised its treasury related risks? Currency volatility is a business reality. Due to our global presence, we are exposed to multiple currencies as our clients and delivery centres are spread across the globe. We manage
our currency risk through a systematic hedging programme. We have an internal hedging policy, whereby the hedges are executed in a step-up process for rolling 24 months through forwards and options. The policy-driven approach and a right mix of instruments play a key role in effectively mitigating the risk and supporting business operations.
Q Privacy issues at technology firms are anything but private. Data breaches (involving customer’s private information) and their associated costs of remediation and liability, as well as their toll on reputation, can and do make headlines. Complicating matters in this area is the patchwork of privacy laws and regulations that only grows as new threats and security needs are identified. Your company could be materially and adversely affected if adequate steps are not taken to protect the intellectual property (IP) of the company or if the services offered by the company are found to infringe on the IP of others. What are your views on this and what are the steps undertaken by you to protect your as well as your client’s IP?At WNS, we recognised the importance of data security, privacy and intellectual property protection at a very early stage. Our philosophy towards data security is that we do not view security and privacy just as matters of compliance, but as core business differentiators and enablers. We have, therefore, made security and privacy integral parts of our business service offerings. We are
an information-centric organisation that provide services to our clientele, and have exposure to sensitive and regulated information in addition to third-party intellectual properties. We continually work towards maturing our data protection programmes, so that not only can we act as a compliant partner, but also as an extended enterprise for our clients.
We run privacy and security programmes under our overall risk management function. Being a matter of strategic importance to us, we regularly track developments in these areas. Our security programmes get certified under ISO 27001 and Payment Card Industry Data Security Standard (PCI DSS), and are independently audited as part of enterprise-wide SSAE (Statement on Standards for Attestation Engagements) 16 SOC (Service Organisation Controls Report) 1 and SOC 2 Type II audits.
Our programmes incorporate best practices, obtained from global standards, regulations and industry knowledge. The implementation is supported by organisation-wide information security and data privacy policies, function-specific privacy policies (e.g. HIPAA (Health Insurance Portability and Accountability Act of 1996) privacy policy for healthcare business functions), detailed associated procedures and various technical and administrative data protection safeguards. While working for our clients, we ensure that we
agree upon legally binding contractual arrangements for matters pertaining to information security and intellectual property. We also employ a trusted and trained workforce for our clients and work with them on suitability of controls for adequate protection of their data and intellectual property. In addition, we have implemented risk assessment and audit programmes, which focus on assessment of exposure of sensitive information, identification of various associated security risks and performing audits (including contractual compliance, operational security and privacy audits). We also bring forth identified risks and audit improvement areas during governance discussions with our clients to ensure greater transparency and obtain a mutually agreeable resolution.
Over the years, our information security efforts have been lauded by the industry, and we have won multiple awards for security implementation. In the field of privacy too, our efforts have been recognised by the industry. One of our risk management leaders has been a Runner-up for the DSCI (Data Security Council of India) privacy leader of the year 2015 award and, as an organisation, we have been declared as Runner-up in the DSCI Excellence award in the ‘Privacy Implementation - BPM Large’ category. Coming from DSCI, a leading and focal body of data protection in India, these awards bear testimony to our commitment to data protection.
Q Currently, the WNS group comprises a complex structure of wholly owned subsidiaries and step up subsidiaries. The company’s growth strategy involves gaining new clients and expanding service offerings, both organically and through strategic acquisitions and partnership
ventures. What are the key challenges related with such strategic initiatives and how the accounting and reporting framework supports business during such acquisitions? WNS is present in multiple geographies and has grown both organically and inorganically over the last few years. One of the key criteria of successful acquisition is successful integration. All the acquisitions have been integrated successfully within WNS as we have
a robust integration process. For an acquisition or strategic deals finance team is involved very early from diligence stage and we ensure that the acquired companies accounting policies, processes, controls, best practices and ERP systems are integrated within first 60 days. By following this process, we have ensured full compliance with the processes and polices of the company.
Q WNS India subsidiary is the primary operating subsidiary of the group. A substantial portion of the assets and employees are located in India. Enactment of new tax legislations in India can have adverse impact on the operations of the group. In the past, the company has enjoyed various tax exemptions with respect to profits earned from export of revenue from operating units registered under the STPI. The SEZ
legislation has been criticised on economic grounds by the International Monetary Fund (IMF) and other non-government organisations. The company is exposed to the continuing uncertainty as to the governmental and regulatory approvals required to establish operations in the SEZs or to qualify for the tax benefits. What are your views on this and how would this affect the growth of the technology companies in India?
The government is trying to provide a predictable tax regime, but the industry still requires clarity on the future of SEZ/similar tax benefits in India. There have been constant changes to the SEZ regulations, starting from the applicability of MAT and the proposed unlikely extension beyond March 2017 for setting up a new SEZ. We strongly feel that the government should continue with SEZ benefits, or introduce similar benefits so that BPM companies can remain competitive in the market.
Q The government of India has issued guidelines on General Anti Avoidance Rule (GAAR) which is currently expected to be effective from 1 April 2017. It is intended to curb sophisticated tax avoidance. Under the GAAR, a business arrangement will be deemed an ‘impermissible avoidance arrangement’ if the main
purpose of the arrangement is to obtain tax benefits. While the full implications of the GAAR may be unclear, what are your views on this and will this adversely affect the growth of the technology companies in India? In recent times, tax legislation in India has been at the centre of controversies, and is cited as one of the predominant apprehensions by foreign investors for doing business in India. One of the
reasons for the uncertainty in the tax environment is the introduction of GAAR in the domestic tax law. Although there can be a considerable debate about the need for a statutory GAAR, considering the potential uncertainty that it could create in an already difficult business environment, there can be no objection to the intent of preventing tax avoidance. However, care should be taken to ensure that the attempt to do so does not drive away legitimate businesses. Given the environment, it seems clear that we are moving slowly, but surely, towards more substantial legitimate tax planning.
Q The Organisation for Economic Co-operation and Development (OECD) has recently issued a final package of reports in connection with its action plan to address Base Erosion and Profit Shifting (BEPS), as well as plan for follow-up work and a timetable for implementation. While the prescribed threshold limit for Company by Company (CbyC) reporting is on a higher scale, Indian companies covered under the threshold limit are expected to start providing information under CbyC Reporting for transactions pertaining to financial year 2016-17. Some of the challenges that companies may face are the low level of awareness on how the BEPS measures will impact their business operations and the need for increased compliance,
sharing of information with other countries, fiscal to calendar year mismatch and reconciliation. What in your view are the benefits and other practical challenges companies in India would face in implementing BEPS?India is supporting the proposed two-tier documentation suggested in the CbyC reporting. This move may impose a higher compliance burden on companies, but would ultimately benefit the taxpayer as it would reduce the number of tax audits. The CbyC Report is to be filed by the parent entity of a multinational group, in its country of tax residency. The CbyC Report should then be shared, through an automatic exchange of information, within the jurisdictions in which the multinational group operates. In terms of consistency, the OECD recommends that countries use their best efforts to use the CbyC template and not request more or less information than is currently proposed under that template. The final version of the recommended template requires companies to
report revenue, profit before income tax, income taxes paid and accrued, total employment, capital, retained earnings and tangible assets in each tax jurisdiction. Individual countries can, however, modify the template to require additional information. Unfortunately, companies will have to wait until each country implements these new rules to determine the information that will be required in each country. This means that companies have to make sure that they devote the right amount of time and resources to CbyC reporting. Before the first year of CbyC reporting begins, companies should make sure that they have a clear and consistent message around the information that they will place in the template, knowing that there will be leakage risks, inconsistency and improper use by jurisdictions. As a result, companies need to update their existing systems and reporting procedures in order to gather and analyse the data that will be reported in the CbyC Report. There is no guidance on what happens when there are no tax treaty procedures to address the improper use of the information.
Q What are the new learning initiatives that the company is planning to take as capacity building initiatives in order to equip its finance department/internal auditors/stakeholders/Board of Directors to build their knowledge base in the area of finance?Our finance team is organised into disparate functions, namely Business Finance, Corporate Controllership, Finance Planning and Analysis, Treasury, Pricing and Tax. WNS finance professionals come from finance, accounting, economics, mathematics, business finance, tax, analytics and engineering backgrounds.
At WNS, we employ a wide range of training and development approaches to keep our talent enriched with knowledge and latest updates, which includes:
• Cross-training/cross-skilling: Involving geographies, Business Units (BU), Strategic, Planning and Core IFRS Team in training programmes, wherein the team is cross-trained on different subjects within the functions
• Knowledge sharing
– Organising regular in-house training sessions conducted by external consultants
– Conducting a Friday session wherein team members are encouraged to talk about the latest amendments within their domain e.g. taxation, treasury, and so on.
• Job enrichment
– Encouraging job rotation within team, across locations and geography and functional domains
– Encouraging teams to share best practices from their respective domains and location
– Encouraging and supporting team members with Continuing Professional Education (e.g. IFRS diploma, Certified Financial Analyst (CFA), etc.)
• Knowledge management through a web portal, where all the study papers/accounting notes are hosted.
Note: The views and opinions expressed herein are those of the interviewee and do not necessarily represent the views and opinions of KPMG in India.
Last several years have been characterised by high merger and acquisition (M&A) activity with business combinations offering companies a way of increasing and stabilising their earnings. These M&A transactions are done with significant benefits in mind, leading to businesses being sold at higher prices. Along with the benefits and opportunities, these business acquisitions could also present risks. With the objective to address the uncertainty about the valuation being based on aggressive projections for the target company, acquirers may structure the payout of purchase consideration into two components: upfront payout and payout linked to future earnings/events. The part of consideration linked to future earnings/events is termed as ‘contingent consideration’.
Further, many companies may have recognised high values of intangible assets such as customer relationships, technology, brands and goodwill in their balance sheets. Moreover, in certain situations, the percentage allocation of the purchase price to goodwill could be over 50 per cent. This indicates that goodwill and intangible assets form a major part of the balance sheet of the companies, thus, the need to closely evaluate the initial accounting of goodwill on acquisition, identification of triggers for impairment and its subsequent measurement.
Technical guidance
Under existing Indian GAAP, there is no comprehensive guidance that addresses accounting for business combinations and the current accounting is driven by the form of the transaction, i.e. legal merger, share acquisition, business division acquisition, etc. which results in varied results based on the form of acquisition. AS 14, Accounting for Amalgamations applies only to amalgamations. i.e., when acquiree loses its existence, and AS 10, Accounting for Fixed Assets applies when a business is acquired without its legal entity. AS 21, Consolidated Financial Statements, AS 23, Accounting for Investments in Associates in Consolidated Financial Statements and AS 27, Financial Reporting of Interests in Joint Ventures, apply to subsidiaries, associates and joint ventures, respectively with no guidance other than presenting the goodwill/capital reserve for the differential of the
cost to the parent of its investment in a subsidiary/associate/jointly controlled entity over the parent’s portion of equity of the subsidiary/associate/jointly controlled entity, at the date on which investment is made.
With respect to contingent consideration, para 41 of AS 14 requires that where the scheme of amalgamation provides for an adjustment to the consideration contingent on one or more future events, the amount of the additional payment should be included in the consideration if payment is probable and a reasonable estimate of the amount can be made. In all other cases, the adjustment should be recognised as soon as the amount is determinable. As a result, goodwill would get adjusted for actual payout of contingent consideration.
Ind AS 103, Business Combinations, tries to bridge the gap between existing Indian GAAP with no comprehensive guidance to internationally followed standards under IFRS and U.S. GAAP.
This article aims to deal with the accounting of three key elements of a business combination transaction with reference to Ind AS 103 and these are contingent consideration, intangible assets and goodwill. This article also highlights the difference on these three topics with IFRS and U.S. GAAP, wherever applicable.
Contingent consideration
Contingent consideration is an obligation of the acquirer to transfer additional assets or equity interests to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. Contingent consideration may also include an acquirer’s right to the return of previously transferred consideration if certain conditions are met - e.g. a repayment to the acquirer of consideration transferred to the former owners of an acquired business is required if that business does not meet financial or operating targets that were specified in the acquisition agreements.
Contingent consideration may include the transfer of additional cash, the issue of additional debt or equity securities, or the distribution of other consideration on resolution of contingencies based on post-combination earnings, post-
combination security prices or other factors.
Some examples of contingent consideration include the following1:
Contingent consideration based on earnings: Consideration may be contingent on maintaining or achieving specified earnings levels in future periods. An acquirer may be required to issue additional shares of its common shares to the former shareholders of the acquiree if earnings of the acquiree reach a certain level for a specified period.
Contingent consideration based on components of earnings: Consideration could be contingent on components of earnings such as revenue growth, cost containment, or EBITDA2. An acquirer may be required to pay additional consideration to the acquiree’s previous owners based on the number of units or amount of sales of specified products sold by the acquirer for a specified period following the acquisition date.
Contingent consideration that represents a guarantee of security price: Contingent consideration is sometimes issued to guarantee the price of securities issued by the acquirer in an acquisition. This type of guarantee is generally in the form of an agreement by the acquirer to issue additional shares, cash, or other consideration if the market (fair) value of the acquirer’s securities issued to the former shareholders of the acquiree does not reach the guaranteed value by a specified date or maintain the guaranteed value for a stipulated period of time.
Redeemable preferred shares and put options: A guarantee of the value of shares issued as consideration in a business combination may be embedded in the securities, i.e., the shares unconditionally issued at the date of acquisition are puttable for the guaranteed value at the option of the holder (i.e. the holder may demand cash in exchange for the shares). Alternatively, in addition to the shares issued to effect the combination, an acquirer could issue put options that give the holder the right to return the shares to the acquirer for the guaranteed value.
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1. KPMG’s publication: Accounting for business combinations and noncontrolling interests, January 2012
2. Earning Before Interest, Taxes, Depreciation and Amortisation
Contingent consideration is measured at fair value on the date of acquisition and considered as part of consideration transferred.
Subsequent changes in the fair value of the contingent consideration that result from additional information about facts and circumstances that existed at the date of acquisition that the acquirer obtains during the measurement period are measurement-period adjustments; therefore, the acquisition accounting is adjusted.
The accounting for changes in the fair value of contingent consideration after the date of acquisition, other than measurement-period adjustments, depends on whether the contingent consideration would be classified as an equity, an asset or a liability. Ind AS 103 requires an obligation to pay contingent consideration to be classified as a liability or equity on the basis of the definitions
of a financial liability and an equity instrument under Ind AS 32, Financial Instruments: Presentation.
Contingent consideration classified as equity is not remeasured and its subsequent settlement is accounted for within equity.
Contingent consideration classified as an asset or a liability would need to be re-measured to fair value at each reporting date until the contingency is settled, with changes in fair value recognised in the statement of profit and loss.
Payments to employees who are former owners of an acquiree
In a business combination an acquirer may enter into an arrangement for contingent payments to employees or selling shareholders of the acquiree. The accounting for such arrangements depends on whether they represent contingent consideration issued in the business combination and are included in
the accounting for the acquisition, or are separate transactions and are accounted for in accordance with other relevant Ind AS.
Acquirer at the date of acquisition would have to assess whether any portion of a contingent consideration arrangement is in exchange for elements other than the acquired business (e.g., compensation for future service). Although these payments typically are negotiated as part of an acquisition, a different accounting treatment could be required if the payments are made to former shareholders who become employees of the combined business. Depending on the terms of the arrangement, the payment may be more appropriately accounted for separately from the business combination as compensation expense for post-combination services than as consideration transferred for a business acquisition.
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Appendix B of Ind AS 103 includes the following factors for consideration in order to determine whether contingent payments to employees or selling shareholders are part of the business combination or a separate transaction
Factors Indicates towards contingent consideration Indicates towards compensation
Continuing employment Contingent payments not affected by employment termination
Contingent payments are automatically forfeited if employment terminates
Duration of continuing employment Shorter than the contingent payment period Coincides with or is longer than the
contingent payment period
Level of remuneration Remuneration other than contingent payments is at reasonable level
Remuneration other than contingent payments is not at reasonable level
Incremental payments to employees
Non-employee selling shareholder receives similar contingent payments on per share basis
Non-employee selling shareholder receives lower contingent payments on per share basis
Number of shares owned Selling shareholders remaining as employees own only a small portion of shares
Selling shareholders remaining as employees own substantially all shares (in substance profit sharing)
Linkage to valuation Payment formula linked to the valuation approach (i.e. to bridge the valuation gap)
Payment formula consistent with other profit sharing arrangements
Formula for determining consideration
Contingent payment is based on valuation formula such as earnings multiples
All the above factors should be evaluated to determine whether the arrangement represents additional consideration for the acquired company or compensation for post-combination services. In such situations, the determination of the appropriate accounting treatment will requires the exercise of judgement based on the particular facts and circumstances.
An arrangement under which contingent payments are automatically forfeited if employment terminates would be compensation for post-combination services. Although this requirement is included within a group of indicators to assist in identifying amounts that are part of consideration transferred, the language in the standard is plain and rules out an alternative interpretation; this has been confirmed by the International Accounting Standards Board’s (IASB’s) IFRS Interpretations Committee.Therefore, this is the case even if an evaluation of some, or even all, of the other indicators suggests that the payments would otherwise be considered to be additional consideration
transferred in exchange for the acquiree; and even if the relevant employee is entitled to remuneration at rates comparable with those earned by people in similar roles.
Concept of goodwill and intangible assets
Intangible assets
As per Ind AS 38, Intangible Assets, ‘an intangible asset is an identifiable non-monetary asset without physical substance’. Further, an asset is identifiable if either it is separable or it arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
Initial recognition and measurement of intangible assets
All identifiable intangible assets acquired in a business combination are recognised separately from goodwill and are initially measured at their acquisition date fair
values. In general, an intangible asset is recognised only if it meets the asset recognition criteria i.e. it is probable that the expected future economic benefits attributable to the asset would flow to the entity, and its cost can be measured reliably. For identifiable intangible assets acquired in a business combination, these recognition criteria are always considered to be satisfied.
For recognition of an intangible asset in a business combination, the first step is to identify the intangible asset, which requires an understanding of the key characteristics and value drivers within an industry and its sector. The various type of intangible assets which can be identified during a business combination in case of technology companies can be illustrated as follows (taking essence from Ind AS 103):
Category of intangible assets Type of intangible assets
Technology related a) Computer softwareb) Patented/unpatented technologyc) Databases
Contract related a) Licenses, royalties and standstill agreementsb) Lease agreementsc) Right to use
Customer related a) Customer contractsb) Customer relationshipsc) Non contractual customer relationshipsd) Customer lists
Marketing related a) Trademarks and trade-namesb) Internet domain namec) Non – compete agreements
The second step is selection of an appropriate valuation methodology and making important assumptions which is expected to directly affect the fair value of the intangibles identified. The valuation approach and methods used for calculating the fair value of these intangible assets can be based on the following techniques:
Intangible assets can be categorised based on their useful lives, as follows:
• Intangible assets with definite useful lives- such intangible assets primarily derive the essence from the economic, contractual and legal factors affecting the useful life of the assets.
• Intangible assets with indefinite useful lives – Indefinite does not mean infinite, it means that there is no foreseeable limit to the period over which the asset is expected to generate net cash inflows for the entity. (Example: broadcasting
license, trademark or airline route which is renewable for indefinite period and cost of renewals in not significant, etc.)
• Intangible assets not yet available for use – such intangible assets are under development.
Goodwill
Goodwill is the excess price paid for the business acquired over the fair value of the business.
‘Goodwill’ is an asset representing the future economic benefits arising from
other assets acquired in a business combination that are not individually identified and separately recognised. An intangible asset acquired in a business combination that meets neither the separability criterion nor the contractual-legal criterion at the date of acquisition is subsumed into goodwill. Similarly, any value attributable to items that do not qualify as assets at the date of acquisition is subsumed into goodwill. In light of the technology sector, these could be attributable to assembled workforce, expected synergies, etc.
Goodwill recognised during business combination is measured as follows:
Market approach Income approach Cost approach
Market price in active market
Analogy method
Discounted cash flow method
Incremental cash flow method
Excess earning method
Relief from royalty method
Reproduction cost method
Replacement cost method
Cost of business combination (Purchase consideration)
Value of goodwill
Excess price is attributable to some intangigle benefits derived, which either are unidentifiable or cannot be valued
Purchase price allocable to identified assets and liabilities
Fair value of intangible assets identified and acquired
Fair value step up of assets and liabilities acquired
Book value of assets and liabilities acquired
Balancing figure attributable to unidentified intangible assets and benefits
Fair value of intangible assets
Fair value of assets acquired and liabilities assumed
Subsequent accounting for goodwill and intangible assets
As per the existing Indian GAAP, the goodwill arising out of amalgamations is to be amortised on a systematic basis over its useful life which in no case should exceed a period of five years (AS 14) and also is to be annually tested for impairment (AS 28, Impairment of Assets). Further with respect to goodwill arising on consolidation of subsidiaries, associates and joint ventures, in the absence of specific guidance, other than temporary diminution in the value of investment, is reflected as impairment of goodwill in consolidated financial
statements prepared in accordance with AS 21, Consolidated Financial Statements. As per Ind AS, goodwill is not amortised and is only tested for impairment.
With respect to intangible assets having finite useful lives, the same are amortised over their useful lives and these are tested for impairment if indicators of impairment exists. Indefinite lived intangible assets and intangible assets not yet available for use are not amortised and are tested for impairment on an annual basis or more frequently if indicators exist.
Impairment testing of goodwill
Goodwill is tested for impairment either annually or more frequently, basis some triggering factors/indicators. Goodwill individually is not capable to generate cash flows, thus its impairment testing is done by testing the fair value of the group of assets to which it belongs. The smallest/lowest group of assets to which goodwill can be allocated is called cash generating unit (CGU) under Ind AS 36, Impairment of Assets. Impairment evaluation of goodwill gives rise to following GAAP differences (as summarised in the table below).
*As per U.S. GAAP, impairment testing is done at a reporting unit level, where a reporting unit is an operating segment or one level below it (known as component of an operating segment). A component would be a reporting unit, if it constitutes a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. Accordingly, goodwill impairment may be determined on a different basis under Ind AS and U.S. GAAP.
Point of Difference Indian GAAP Ind AS IFRS US GAAP
Testing basis indicators vs annual testing
It is tested for impairment if any indicator exists.
Goodwill is to be tested for impairment annually or earlier if any indicator exists. Annual testing is required and there is no option to conclude basis qualitative testing.
Goodwill is to be tested for impairment annually or earlier if any indicator exists. Annual testing is required and there is no option to conclude basis qualitative testing.
Entities have the option to first assess qualitative factors to determine whether it is necessary to perform the goodwill impairment test.
Level of testing CGU CGU CGU Reporting unit *
Allocation of impairment loss
First to goodwill of CGU and then proportionately to the remaining assets in the CGU.
First to goodwill of CGU and then proportionately to the remaining assets in the CGU.
First to goodwill of CGU and then proportionately to the remaining assets in the CGU.
Implied fair value of goodwill of the reporting unit is calculated and is compared with the carrying value of goodwill to arrive at the amount of impairment of goodwill.
Goodwill impairment loss is irreversible once recognised.
Recognition and presentation of goodwill impairment loss
The impairment loss is recognised in the statement of profit and loss and disclosures are given with respect to the following:
• Description of the facts and circumstances leading to the impairment.
• The amount of the impairment loss and the method of determining the fair value/recoverable value of the associated reporting unit/CGU (whether based on quoted market prices, prices of comparable businesses, a present value or other valuation technique, or a combination thereof).
• Details of the goodwill impairment analysis for each reporting unit/CGU, including how reporting units/CGU are identified, how assets, liabilities and goodwill are allocated to reporting units/CGU, and how the fair value/recoverable amount of the each reporting unit/CGU was estimated.
• Details of the company’s analysis of events that occurred since the latest annual goodwill impairment assessment and whether those events suggest that the fair value/recoverable value of goodwill is less than its carrying amount.
Impairment testing of intangibles
For impairment testing of intangible assets under Ind AS, the entity is required to assess at each reporting date, whether any indicators exist for impairment, if there are any, then the entity is required to compute the recoverable amount of such asset and compare the same with the carrying value of the intangible asset. In the event where the carrying value exceed the recoverable amount, the same is recognised as an impairment loss. In case the intangible asset is not capable of generating cash flow individually, it is tested for impairment as part of CGU.
Unlike Ind AS, under U.S. GAAP, a two-step approach is followed. First step is the qualitative testing followed by a recoverability test where impairment is indicated only if the undiscounted cash flows from the intangible asset are less than its carrying amount. In case of such an event, step two is carried out, which requires an entity to determine the fair value of the intangible asset and recognise an impairment loss if the carrying amount of that asset exceeds its fair value. In case the intangible asset is not capable of generating cash flow individually, it is tested for impairment as part of group of assets.
With respect to indefinite lived intangible assets and intangible assets yet not in use, as per Ind AS these are subject to a single step assessment that reduces the carrying value to fair value. Such an assessment is performed on an annual basis or more frequently if indicators exist.
Reversal of intangible impairment loss
As per Ind AS, if the estimates used to determine an asset’s or CGU’s recoverable amount have improved since the last impairment loss was recognised, the impairment loss that was last recognised for that asset, is reversed. Unlike Ind AS, under U.S. GAAP, the reversal of previously recognised impairment loss for definite lived intangible assets is not allowed.
Recognition and presentation of intangible impairment loss
The recognition and disclosure requirements for intangible impairment loss are similar to that of goodwill impairment.
As per the 2015 Employee Stock Options Plans (ESOP) survey report of KPMG in India, the Information Communication and Entertainment (ICE) sector dominates the share-based compensation space followed by financial services, manufacturing and consumer goods sectors. The survey indicates that companies consider share-based compensation as an incentive tool which enhances productivity and motivates employees’ interest in the company’s overall performance. In our experience, many Indian companies with overseas operations are increasingly awarding equity incentives to attract and retain talent. Similarly, employees of India operations of multinational companies are also granted share-based awards of parent companies. The feeling of ownership encourages employees to have long-term career aspirations in the organisation. Once companies are able to address key aspects, such as dilution of share capital and facilitating exit mechanism (in case of unlisted companies), share-based compensation could yield the desired result that it has been implemented for.
In October 2014, Securities and Exchange Board of India (SEBI) issued revised guidelines for accounting of ESOP, aligning the accounting treatment with the guidance note issued by Institute of Chartered Accountants of India (ICAI). Erstwhile SEBI guidelines prescribed accounting for listed companies, whereas unlisted companies followed the guidance note issued by ICAI. In February 2015, the Ministry of Corporate Affairs (MCA) notified the new IFRS converged Indian Accounting Standards (Ind AS). Consequently, the Ind AS 102, Share-based Payment, which is consistent with IFRS 2, Share-based Payment would be applicable to companies as per the convergence road map specified by the MCA.
As highlighted in the survey report, the recent trends of multi-fold deals of management buy-outs and overall buoyancy in the stock market, coupled with certain regulatory changes (new SEBI ESOP guidelines, Corporate Law provisions and implementation of Ind AS) have been the drivers for many companies to re-consider share-based compensation plan for amendments to align with the regulatory changes and restructure for effectively realising the compensation plan objectives.
Accounting for employee share-based payments is a complex reporting area, be it under existing Indian Generally Accepted Accounting Principles (GAAP), international reporting frameworks such as U.S. Generally Accepted Accounting Principles (US GAAP), IFRS or Ind AS. In many cases, cost related to share-based payments is material to the financial statements and is also important for investors to understand the present and future capital structures and related rights and obligations. The complexity on accounting arises due to nature of awards, conditions attached (market, performance, service or others) to the awards, need for fair valuation, impact on earnings, disclosures and multiple current and proposed accounting rules.
IFRS converged Ind AS 102 has brought in following key additional guidance coupled with some significant differences with guidance note issued by ICAI which may pose challenges for share-based compensation accounting:
Scope Share-based payments to non-employees
Under existing Indian GAAP, para 22 of AS 10, Accounting for Fixed Assets, requires a fixed asset acquired in exchange for shares to be recorded at its fair market value or the fair market value of the shares issued, whichever is more clearly evident. With respect to other goods and services, there is no guidance on recognising the cost of providing such benefits to vendors in lieu of goods or services received. Guidance note on share-based payments also does not include share-based payment arrangements with non-employees in its scope. In the absence of sufficient guidance, companies are following different accounting policies including no-charge for such transactions.
Converging with IFRS, Ind AS 102 extends the scope of share-based payments accounting to include share-based payments to non-employees. Thus, on transition to Ind AS, companies would have to account for share-based transactions with non-employees in accordance with Ind AS 102.
Although, recognition requirements are similar for share-based payment transactions with employees and share-based payment transactions with non-employees, the measurement requirements differ in many respects.
Equity-settled share-based payment transactions with non-employees are generally measured at the fair value of the goods or services received (direct measurement), rather than at the fair value of the equity instruments granted at the time that the goods or services are received. If, in rare cases, the fair value of the goods or services received cannot be measured reliably, then the goods or services received are measured with reference to the fair value of the equity instruments granted (indirect measurement).
When the fair value of the identifiable goods or services appears to be less than the fair value of the equity instruments granted, measurement of both the goods/services received and the equity instruments granted may be necessary in order to measure the value of any unidentifiable goods or services received. For both direct and indirect measurement, goods or services are measured when they are received.
Goods or services received in cash-settled share-based payment transactions with non-employees are recognised when they are received. Goods or services received and the liability incurred in a cash-settled share-based payment award with non-employees are generally measured at the fair value of the liability. The liability is re-measured at the end of each reporting period and at the date of settlement.
Measurement Intrinsic value method rarely available
The guidance note on accounting for share based payments recognises that there are two methods of accounting for employee share-based payments, viz., the fair value method and the intrinsic value method and permits as an alternative the intrinsic value method with fair value disclosures. Further, it also allows considering volatility of unlisted company to be considered zero for measurement of fair value of share-based awards.
Ind AS 102 only permits fair value method for measuring the share-based payment transactions (with permission of intrinsic value only in rare circumstances). Further, it does not provide exception to use volatility as zero in a fair valuation model for measuring the fair value of share-based awards.
In India, unlisted companies opt for intrinsic value method primarily on the ground of uncertainty about future market price. However, as share-based payment transactions form part of the consideration to be paid to counterparty and it seems reasonable to presume that the entity’s management would consider the value of awards to satisfy itself that appropriate consideration is paid to counterparty. Under Ind AS 102, uncertainty about the future market price as a reason for not being able to measure the fair value reliably, may not meet the condition of rare circumstances for using intrinsic value method.
Recognition Straight-lined attribution not permissible in certain cases
Consistent with the guidance note, Ind AS 102 requires recognition of share-based payment transactions with employees over the vesting period. In case the options/shares granted under an employee stock option plan do not vest on one date but have graded vesting schedule, total plan should be segregated into different groups, depending upon the vesting dates. Each of such groups would be having a different vesting period and expected life and, therefore, each
vesting date should be considered as a separate option grant and evaluated and accounted for accordingly. For example, suppose an employee is granted 100 options which will vest at 25 options per year at the end of the third, fourth, fifth and sixth years. In such a case, each tranche of 25 options would be evaluated and accounted for separately. However, guidance note on accounting for share-based payments also permits an alternative accounting treatment for attribution period in case the option/ shares are granted under graded vesting plan with only service conditions. In such a case, an entity has an option to recognise the share-based compensation cost on a straight-line basis over the requisite service period for the entire award (i.e. over the requisite service period of the last separately vesting potion of the award). This alternative accounting treatment would be available with the condition that the amount of compensation cost recognised at any date is at least equal to the portion of the grant-date value of the award that is vested at that date. Ind AS 102 does not allow alternate accounting treatment of straight line basis.
Accordingly, under Ind AS, costs with respect to awards granted with graded vesting will have to be recognised on an accelerated basis only. For graded vested awards that being recognised on straight-line basis currently under Indian GAAP, the accelerated basis under Ind AS is expected to result in reporting higher expense upon the adoption of Ind AS.
Accounting for group share-based compensation plan
In India, though the guidance note requires subsidiaries to account for share-based payments awarded by parent to its employees, divergent practice is followed ranging from no recognition to following guidance under IFRS. Subsidiaries at times do not account for share-based awards issued to its employees by its parent entity, on the ground that clear-cut guidance is not available and it does not have any settlement obligation. Ind AS 102 provides specific guidance on accounting for group share-based awards.
The following flowchart provide a snapshot of requirements for determining whether a share-based payment transaction involving different entities is a group-share based payment as covered in Ind AS 102.
Are the receiving entity (entity receiving goods and services) and the reference entity (entity whose equity instrument is referenced for share-based arrangement) in the same group from the perspective
of ultimate parent?
Is the settling entity (entity which has the obligation to
settle the share based payment transaction) part of the ultimate
parent group?
Yes
No
No No
Yes
Yes Yes
No No
Is the settling entity a shareholder?
Is the transaction clearly for a purpose other than payment for
goods or services supplied to the entity?
Is the transaction clearly for a purpose other than payment for
goods or services supplied to the the entity?
The transaction is a group share-based payment settled by a group
entity
The transaction is a group share-based payment settled by an
external shareholder
The transaction is not a share-based payment in the scope of
A share-based payment transaction is classified from the perspective of each reporting entity rather than by making a single classification determination at the level of consolidated financial statements of the group. Classification of the share-based payment transaction depends on the nature of the award
granted and whether the entity has an obligation to settle the transaction. If the entity has either an obligation to settle in its own equity instruments or no obligation to settle at all, then the transaction is accounted as equity settled. A settling entity, that is not the receiving entity, classifies a share-based
payment transaction as equity-settled if it settles it in its own equity instruments; otherwise, it classifies the transaction as cash-settled.
Following table summarises the classification principles:
Example: Entity A grants share-based payment awards to the employees of subsidiary B. The shared-based payment awards would be settled in the equity instruments of B.
The classification of this award in the separate financial statements of the entity A and entity B, and the consolidated financial statements of entity A can be as follows:
• Separate financial statements of the entity A: Since entity A has an obligation to settle the share-based payment award and it will not by issuing its own equity instruments. It would be classified as cash-settled in the separate financial statements of entity A as the shares of entity B (investment in entity B) are ‘assets’ in the separate financial statements of entity A.
• Separate financial statements of the entity B: The transaction would be share-based payment transaction in the scope of Ind AS 102 as entity B would receive the services of the employees. Since entity B does
not have an obligation to settle the share-based payment award, it would classify the share-based payment transaction as equity-settled in its financial statements.
• Consolidated financial statement of the entity A: Since entity A has an obligation to settle the share-based payment transaction in equity shares of the group, it would classify the share-based transaction as an equity-settled in its consolidated financial statements.
Plan administered through a trust
As per the erstwhile Securities and Exchange Board of India (SEBI) Employee Stock Option Scheme (ESOS) and Employee Stock Purchase Scheme (ESPS) Guidelines, 1999, in case of share-based awards administered through a trust, the financial statements of the company would be prepared as if the company itself is administering the awards. Thus, listed companies in India were preparing its separate and consolidated financial statements incorporating the financial statements of employee share-based payment trust.
In October 2014, SEBI issued revised guidelines for accounting of the employee stock option plans (ESOP), aligning the accounting treatment with the guidance note issued by the ICAI. The guidance note prescribes that
since the trust administers the plan on behalf of the entity, it is recommended that irrespective of the arrangement for issuance of the shares under the employee share-based payment plan, the entity should recognise in its separate financial statements the expense on account of services received from the employees. However, the guidance note does not permit merging the financial statements of the trust with that of the entity for preparing the separate financial statements (as envisaged in the erstwhile SEBI guidelines). Further, the guidance note prohibits consolidating such trust for consolidated financial statements of the company prepared in accordance with AS 21, Consolidated Financial Statements.
Ind AS 102 does not provide any specific guidance for accounting of entity’s shares held by an employee share-based payment trust and funding arrangements between an entity and the trust. For the consolidated financial statements of an entity administering employee share-based payment through a trust, share-based payment trust would be evaluated for consolidation based on the parameters prescribed in the Ind AS 110, Consolidated Financial Statements. For separate financial statements of the entity, the ICAI may have to clarify whether the employee share-based payment trust would be treated as a branch/an agent of the entity or as a separate stand-alone entity.
Nature of the awardOwn equity instruments Cash or other assets
Many of the technology companies have invested significant amount of funds in financial instruments such as investment in debt instruments, mutual funds, etc. Under the current Indian GAAP, financial instruments are generally accounted under AS 13, Accounting for Investments and/or AS 30 Financial Instruments: Recognition and Measurement (which is currently not mandatory). Ind AS 109, Financial Instruments is expected to have a significant impact on the technology sector due to the new concepts it introduces. In this article, we aim to highlight some of the key concepts and the corresponding current requirement.
Under Ind AS 109, financial assets are classified into the following types, each requiring application of a different recognition and measurement principle, as set out below.
a. A financial asset at amortised cost, wherein the objective is to hold these financial assets to collect the contractual cash flows on specified dates. Generally, investments which are held to maturity such as investment in corporate bonds and corporate deposits, investment in fixed deposits with banks, etc. would be classified under this category.
b. A financial asset at fair value through other comprehensive income, wherein the objective is to collect contractual cash flows and sell these financial assets. The contractual terms of the financial asset gives rise on specified dates to cash flows that are solely payment of principal and interest on the principal amount outstanding. Generally, financial assets such as investment in mutual funds, quoted debt securities, etc. may be classified under this category.
c. A financial asset at fair value through profit or loss includes financial assets that are held-for-trading. Held-for-trading investments are those investments which are held for the purpose of earning short-term profit. Generally, investment in quoted mutual funds or equity shares, etc. would be classified under this category.
Financial liabilities are generally classified at amortised cost (for example, bonds issued at fair value and redeemable at a premium on redemption date) except for the following types:
a. Financial liabilities at fair value through profit and loss - Generally, derivative instruments (forward or future contracts which are not hedging instruments) would be classified under this category.
b. Financial liabilities that arise when a transfer of a financial asset does not qualify for de-recognition or when the continuing involvement approach applies.
c. Financial guarantee contracts - Under these contracts, the issuer is required to make specific payments to the holder of the instrument if the specified debtor fails to make payment when due under the terms of the contract. Generally, letter of credit, credit default contract etc. issued by an entity would be classified under this category. An example would be an overseas holding company that issues a financial guarantee on behalf of its subsidiary for the debt taken from a bank in its local country.
d. Commitments to provide a loan at a below-market interest rate - Generally, loan commitments by a financial institution to body corporate would be classified under this category.
e. Contingent consideration recognised by the acquirer in a business combination transaction.
Generally speaking, in the technology sector, financial liabilities at amortised cost and at fair value through profit and loss are expected to be commonly encountered in many companies. Also, considering that technology companies are involved in business acquisitions, financial liabilities on account of contingent consideration recognised by the acquirer in a business combination may be relevant in certain situations. Ind AS requires the contingent consideration to be measured at fair value with changes recognised in the statement of profit and loss.
Under the current Indian GAAP, financial assets or financial liability are initially recognised at cost which includes the transaction cost. Under Ind AS 109, initial measurement for financial assets or financial liability is at fair value plus or minus, transaction costs which are directly attributable to the purchase of financial assets or issue of financial liabilities. Accordingly, financial assets which include interest free lease rent deposits or lease rent deposits at lower rate of interest (either to group companies or third parties) will have to be recognised at fair value at inception under Ind AS 109 which was carried at historical cost under current Indian GAAP. Similarly, interest free loans taken from group companies or interest free loans (or below market interest rate loan) taken from suppliers or vendors, would have to be recognised at fair value at inception under Ind AS 109.
Under the current Indian GAAP, after initial recognition, financial assets are carried at cost except where the financial assets are classified as current investments (recognised at lower of cost or fair value). Under Ind AS 109, there is specific guidance on subsequent measurement principles depending upon initial classification of financial assets or financial liabilities. Financial assets or financial liabilities that are carried at fair value through profit and loss account and those carried at fair value through other comprehensive income, are subsequently measured at fair value at the balance sheet date while financial assets and financial liabilities carried at amortised cost would be measured at amortised cost using effective rate of interest.
One of the key changes on subsequent recognition of financial assets or liabilities under Ind AS 109 is a gain which would be recognised in the statement of profit and loss or equity, depending upon the classification and measurement principles of financial instrument whereas, under the current Indian GAAP, gain on financial asset as of balance sheet date is not recognised in the statement of profit and loss (as it is carried at cost).
Also, under the current Indian GAAP, there is limited guidance on reclassifications between categories of financial instruments such as when an investment is reclassified from current to long-term and vice versa. Transfers are made at a lower of cost or fair value. Under Ind AS, an entity would reclassify its financial assets only when the entity changes its business model of managing its financial assets. An entity would not reclassify any financial liability. There is specific guidance under Ind AS 109 that are required to be applied if such a re-classification of financial assets is contemplated. Reclassification of financial assets would be applied prospectively and gains or loss (including impairment gain or loss) previously recognised would not be restated. For example, reclassification of financial asset by an entity from amortised cost category into the fair value through other comprehensive income category would be measured at its fair value on the reclassification date and any difference on the reclassification date in the previously recognised amortised cost and fair value is recognised in other comprehensive income.
Under current Indian GAAP, financial assets are generally de-recognised on legal transfer of ownership or title. Under Ind AS, an entity would derecognise the financial asset only when the entity ceases the right to receive the contractual cash flows from the financial asset and would derecognise the financial liability only when the obligation towards the liability is discharged or cancelled or expired.
Ind AS 109 has introduced the concept of ‘expected credit loss model’ for the impairment test for all categories of financial instruments. Under this model, an entity would assess, at the end of each reporting period, whether a financial asset, or group of financial assets, is impaired. The entity would recognise impairment as the difference between the expected credit losses from the financial asset and the carrying amount. Under the new concept of recognition of impairment losses based on ‘expected losses’, an entity would need to develop appropriate forecast models that take into account past data and expectations of economic variables in the future. Under the existing Indian GAAP, there is not much guidance on methodology for determining the impairment of financial instruments.
Application of Ind AS 109 is expected to result in significant change in the way an entity would measure and recognise financial instruments in its financial statements. It is expected that companies would spend significant amount of time in determining ‘fair values’ at each balance sheet date.
Additionally, Ind AS 109 is set to introduce sweeping changes in the disclosures made by companies. Some of these may entail significant time and effort of the top management. We would recommend that companies complete their evaluation of the impact of this Ind AS and the steps to enable accurate and timely reporting before the Ind AS standards become effective for their companies.
Under the current Indian GAAP, AS 17, Segment Reporting deals with the presentation of business operations into business segments (generally based on related products and services) and geographical segments (generally based on the operating geographies). Under Ind AS 108, Operating Segments, (business segments and geographical segments) are identified based on how the management (i.e. Chief Operating Decision Maker (CODM)) reviews/makes decisions, allocate resources to the segments and assess their performance. This article aims to highlight a few key changes under the new Ind AS.
The objective of Ind AS 108 is to identify an ‘operating segment’ for reporting purpose which will be called a ‘reporting segment’ based on ‘management approach’ i.e. how a CODM of a company regularly reviews the Management Information System (MIS)/internally generated reports for making decisions. A CODM may be Chief Executive Officer, Chief Operating Officer or an Executive Director but not the business unit head. This is also expected to align the segment information presented in the financial statements of the company to the segment information discussed in the Management Discussion and Analysis (MD&A), analyst calls and information displayed on a company’s website.
Under Ind AS 108, if the MIS has separate components and that information is reviewed by the CODM for performance reviews and resource allocation, each such component may qualify as a separate segment requiring segment related disclosures in financial statements. Under the current AS 17, a business segment is defined as ‘a distinguishable component of an enterprise that is engaged in providing an individual product or service or a group of related products or services and that is subject to risks and returns that are different from those of other business segments’. Nature of risks and returns of an entity govern whether its primary segment reporting format would be business segments or geographical segments.
Operating segment also includes business activities for which a company is yet to earn revenues - for example, start-up operations of e-commerce companies, if relevant information is reviewed by the CODM.
The illustrative list of economic characteristics based on which a CODM reviews the MIS is as follows:
a. the nature of the products and services e.g. software products (lisense sale, software-as-service), software solutions (customisation, implementation, maintenance) and business process outsourcing solutions.
b. the nature of the production processes e.g. development, maintenance, consulting.
c. the type or class of customer for their products and services e.g. banking, insurance, automobiles, healthcare, retail.
d. the methods used to distribute their products or provide their services e.g. onsite, offshore, cloud, software-as-service.
Under Ind AS, aggregation of one or more operating segments into a single reportable segment is permitted (but not required) when certain conditions are met, the principal condition being that the operating segments should have similar economic characteristics. Under AS 17, the aggregation of operating segments into a single reporting segment can be done if the segments do not have significant differing risks and returns. It also states that, while there may be dissimilarities with respect to one or several of the factors in the definition of business segment, such as nature of product and service, nature of production process, type of customer, method of distribution and nature of regulatory environment, the products and services included in a single business segment are expected to be similar with respect to a majority of the factors.
Companies need to disclose interest revenue and interest expense for each reportable segment separately unless a majority of the segment’s revenues are from interest and the CODM relies primarily on net interest revenue: this would require an allocation of interest expense on borrowing for general purpose to identified segments. Under the AS 17, interest expense including interest incurred on advances or loans from other segments is not considered as part of segment expense, and, therefore, not allocated to reporting segment.
An entity would also need to provide information about its major customers e.g. identity of customer, amount of revenue earned during the period and the segment to which it belongs. Major customer/s is/are the party with whom external transaction amounts to 10 per cent or more of an entity’s revenues. For the purposes of Ind AS, a group of entities known to a reporting entity to be under common control shall be considered a single customer.
Ind AS 108 also states that if an entity changes the structure of its internal organisation that causes the composition of its reportable segments to change, the corresponding information for earlier periods, including interim periods, should be restated unless the information is not available and the cost to develop it would be excessive.
Following are additional disclosures required under Ind AS 108 as compared to AS 17:
• Factors used to identify the company’s reportable segments, including the basis of an organisation.
• Differences in basis of measurement used for reporting segment information vs entity’s financial information.
• Disclose information the way CODM evaluates the financial performance of its operating segments e.g. revenue growth, operating income, return on capital employed, etc.
• Reconciliation of segment information to entity information for material items e.g. revenue, profit and loss, etc.
• Disclose information with regard to operating geographies, revenues from customers and non-current assets based on where the country it is domiciled.
In summary, Ind AS 108 requires companies to review the MIS that is produced for review by the CODM for performance assessment/resource allocation and align such information with segment categories identified for financial reporting purpose. Considering that segment identification would now significantly depend on how the CODM reviews the segment, we suggest that companies review their current processes for CODM identification as it may have an effect on the way the operating segments are reported in the financial statements.
Enhanced responsibilities of the audit committeeThis article aims to:
– Provide an overview of the concept release and our views on this topic, along with its inter-play with the exposure draft on the revised SA 260, Communication with those charged with governance.
This article aims to summarise the concept release on ‘Possible Revisions to Audit Committee Disclosures’ released by the Securities and Exchange Commission (SEC) on 1 July 2015. This concept release depicts the thought process of the regulator and the direction in which governance is headed.
Currently, an audit committee is responsible for the appointment, compensation, retention and oversight of the work of any registered public accounting firm engaged for the purpose of preparing or issuing an audit report or performing other audit, review or attestation services for the issuer, and the independent auditor reports directly to the audit committee. In addition, the audit committee has ultimate authority to, and is responsible for, resolving disagreements between a management and its auditor regarding financial reporting.
Disclosure requirements for the audit committee report are contained in Item 407 of Regulation S-K. The disclosure is only required in the proxy or information statement relating to a registrant’s annual meeting where directors are elected or chosen by written consents. An audit committee is required to make certain statements related to its responsibilities for overseeing financial reporting, internal control, and the audit. These statements include that the audit committee has:
• Reviewed and discussed the audited financial statements with the management
• Discussed with the independent auditor the matters required by AU Section 380, Communication with Audit Committees
• Received the required written communications from the independent accountant concerning independence and has discussed with the independent accountant his or her independence, and
• Recommended to the board of directors that the audited financial statements be included in the company’s annual report on Form 10-K or 20-F.
The above requirements are principally contained in Item 407 of Regulation S-K, which have not changed substantively since 1999. Hence, the SEC is seeking comments on the audit committee reporting requirement. From the perspective of Indian requirements, the exposure draft (ED) on Auditing Standard 260 (Revised) refers to several communications between the auditor and the audit committee which highlights the fact that the Indian requirements are moving towards the concepts highlighted in the above concept release. We will discuss briefly this interplay in the article.
While current audit committee reporting requirements provide information about the role of the audit committee with respect to its oversight of the auditor, these disclosures do not describe how the audit committee executes its responsibilities. On 1 July 2015, the SEC published a concept release to invite public input on possible changes to its audit committee disclosure requirements. The concept release is not a proposed rule, instead, it seeks feedback that SEC would consider when deciding whether rulemaking on this topic would be appropriate. Hence, the concept release proposes to build an additional disclosure about the audit committee oversight of the independent auditor by informing investors about the oversight process and to provide investors with relevant information that more transparently conveys the oversight responsibilities performed by the audit committee relative to an issuer’s auditor.
The concept release has sought feedback on 11 new disclosure topics that would focus on the audit committee’s oversight of the audit and the auditor relationship, and whether changes to the disclosure requirements would enhance the usefulness of the disclosures for investors. The potential topics are categorised into three groups namely:
• Audit committee’s oversight of the auditor
• Audit committee’s process to appoint or retain the auditor
• Qualifications of the audit firm and certain engagement team members.
Audit committee’s oversight of the auditor
• Additional information regarding communications between the audit committee and the auditor
• Frequency of meetings between the audit committee and the auditor
• Discussions about the auditor’s internal quality review and the most recent Public Company Accounting Oversight Board (PCAOB) inspection report 2015,
• How the audit committee assesses, promotes, and reinforces the auditor’s objectivity and professional skepticism.
The ED on Auditing Standard 260 (Revised) requires communicating significant risks identified by the auditor to those charged with governance which may assist them in fulfilling their responsibility to oversee the financial reporting process.
Audit committee’s process to appoint or retain the auditor
• How the audit committee assessed the auditor (including the auditor’s independence, objectivity and audit quality) and its rationale for selecting or retaining the auditor?
• Whether the audit committee sought proposals for the independent audit and, if so, the process the committee undertook and the factors it considered in selecting the auditor?
• Policies for an annual shareholder vote on the selection of the auditor, and the audit committee’s consideration of the voting results.
Qualifications of the audit firm and certain engagement team members
• Disclosures of certain individuals on the engagement team (e.g. naming the engagement partner)
• Audit committee input in selecting the engagement partner
• The number of years the auditor has served as the company’s independent auditor, and
• Information relating to other firms involved in the audit.
Our viewsWe welcome the efforts of SEC to simplify disclosure so that investors have effective and efficient access to the information they need for their investing and voting decisions. We also have concerns on the standardisation approach for the additional disclosures which could lead to information overload, become a matter of legal compliance or result in boiler plate disclosures of limited value to financial statement users. From the firm’s perspective on some of the unintended consequences that could result from a mandated prescriptive approach to audit committee disclosure of oversight activities, for example:
• The candor of the audit committee discussions which is critical to developing and validating an effective audit strategy if disclosed, may reveal proprietary information about the issuer or the audit methodology.
• Disclosure of the substance of the conversations with the auditor such as overall audit strategy, scope of the audit, significant risks identified, locations to be visited by the auditor, results of the audit and how the audit committee considered the same may be difficult to describe in a manner which would be meaningful to financial statement users.
• Confidentiality of non-public PCAOB inspection results could be undermined if information provided to audit committee members about such results is disclosed.
• Simple metrics (e.g. frequency of private meetings with the auditors, number of years in the industry, experience of the partner, etc.) may not correlate to the effectiveness of the audit committee’s oversight nor audit quality and, therefore, may not be a decision useful to the investors.
Audit committees, besides providing an oversight on the role of the external auditor, are currently involved in the oversight of the financial reporting process of the company, reviewing compliances with laws and regulations, reviewing the work of internal auditors, oversight of the overall risk management, etc. The concept release focusses on the role of the audit committee in relation to the independent auditors and disclosures in that respect without taking cognisance of the other activities of the audit committee which helps ensure reliable financial reporting.
We believe that the SEC should allow the audit committees to continue performing its current role and include customised discussions on how they discharge their oversight responsibilities rather than issuing prescriptive minimum disclosures.
Section 10AA of the Indian Income Tax Act, 1961 (IT Act) outlays the provisions for tax deductions in respect of companies operating in a ‘Special Economic Zone’ (SEZ). This article aims to discuss the practical challenges and accounting issues in respect of tax exemption available to companies under Section 10AA of the IT Act
Brief description of Section 10AA of the IT Act.
Certain tax laws in India have been written to encourage growth in the economy e.g. for the manufacturing sector (Section 80-IC of the IT Act), and for the exports sector (Section 10AA of the IT Act).
Section 10AA of the IT Act encourages entities to operate out of specified areas e.g. SEZs when they render export services. Such entities get a deduction based on ‘eligible profit’ and ‘eligible turnover’ as defined under the IT Act from their taxable income.
Provisions of Section 10AA of the IT Act:
1. Subject to the provisions of this Section, in computing the total income of an assessee, being an entrepreneur as referred to in clause (j) of Section 2 of the Special Economic Zones Act 2005 (SEZ Act), from his/her Unit, who begins to manufacture or produce articles or things or provide any services during the previous year relevant to any assessment year commencing on or after the 1 April 2006, a deduction of:
i. 100 per cent of profits and gains derived from the export, of such articles or things or from services for a period of five consecutive Assessment Years (AY) beginning with the AY relevant to the previous year (PY) in which the unit begins to manufacture or produce such articles or things or provide services, as the case may be, and 50 per cent of such profits and gains for further five assessment years and thereafter;
ii. for the next five consecutive assessment years, so much of the amount not exceeding 50 per cent of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the ‘Special Economic Zone Re-investment Reserve Account’) to be created and utilised for the purposes of the business of the assessee in the manner laid down in Sub-section (2)
2. The deduction under clause (ii) of sub-section (1) shall be allowed only if the following conditions are fulfilled, namely:
a. the amount credited to the Special Economic Zone Re-investment Reserve Account is to be utilised
i. for the purposes of acquiring machinery or plant which is first put to use before the expiry of a period of three years following the previous year in which the reserve was created; and
ii. until the acquisition of the machinery or plant as aforesaid, for the purposes of the business of the undertaking other than for distribution by way of dividends or profits or for remittance outside India as profits or for the creation of any asset outside India;
Based on the above guidance, an entity can claim deduction as follows:
• 100 per cent of the profits of the SEZ unit for the initial five years from the year of commencement.
• 50 per cent of the profits of the SEZ unit for five years beginning from the sixth year since the operations of the SEZ had commenced, and
• 50 per cent of the profits of the SEZ unit for an additional five years beginning from the eleventh year since the operations of the SEZ had commenced, provided the above mentioned criteria of creation of a specified reserve and investment in plant and machinery within a period of three years are met.
SEZs were first set-up in India in the financial year 2005-06 (effective 1 April 2005). Accordingly, for those companies which moved early in the SEZs are in their eleventh year of SEZ operations in the year ending 31 March 2016. It is important to note that Section 10AA was essentially included in the IT Act as a tax holiday/exemption. The first 10 years of the tax holiday/exemption do not have any substantive conditions attached (e.g. creation of reserve and utilisation of such reserve for the purchase of eligible plant and machinery as mentioned above) to claim the deduction. However, the last five years require the assesse to comply with conditions as explained in detail above.
Further, in a typical Investment Tax Credit (ITC), the tax allowance/benefit from the government flows through in the year in which certain investments are made whereas in this particular scenario, the tax benefit is provided in the year in which profits are generated, subject to the company meeting certain conditions in the future.
This requirement from the eleventh year poses the following important issues:
• Whether the deduction can be claimed in the books in the year when the entity credits the sum into the special reserve (i.e., in year 11), or the deduction is to be claimed as an when the entity purchases eligible assets i.e. plant and machinery (from year 12 to year 14)
• Deferred tax implication on the amount of reserve created
• Whether the amount of deduction claimed has to be debited separately to the statement of profit and loss from a presentation perspective in the books of accounts maintained as per Indian GAAP and IFRS i.e., whether the transfer to reserve is a debit to the statement of the profit and loss (i.e. expense) or is an appropriation of profits (i.e. transfer from reserves and surplus to the specified reserve account).
The above mentioned issues are discussed in the subsequent sections in this article.
Accounting treatment of the deduction in the books of accounts
Under IFRS, the accounting of the tax benefit in this case depends on the accounting standard that governs it. IAS 12, Income taxes discusses tax benefits in the nature of an ITC could be either in the scope of IAS 20 Accounting for Government Grants and Disclosure of Government Assistance or in the scope of IAS 12 . Under Indian GAAP, AS 22, Accounting for Taxes on Income deals with this topic.
The definition of government grant as per IAS 20 suggests that the amount of tax incentive is independent of the amount of taxable profit or tax liability of the assessee.
Under Section 10AA of the IT Act, the amount of deduction is a fraction (upto 50 per cent of the profit of the undertaking) of the taxable profits and there are no ‘substantive conditions relating to the operating activity of the assessee (e.g. minimum profit threshold, number of employees, etc.)’, one can conclude that the IAS 20 may not be applicable while accounting for deduction under Section 10AA.
Application of IAS 12 would be more appropriate when the economic substance of an ITC is akin to a tax allowance.
For the question in hand, since the deduction is claimed on a specific expense (final permissibility of the deduction is based on expenditure in eligible plant and machinery) applying IAS 12 to account for the ITC therefore, would be appropriate.
From the tax books perspective, based on reading of the Section it appears that the deduction would be available in the year in which the specified reserve is created. However, for the purpose of accounting for this deduction in the accounting books, there are two possible views to record the tax deduction in the books of accounts:
View IRecord the ITC in the year when the amount transferred to the specified reserve is actually spent
An entity would be entitled to claim the deduction when the amount is actually spent, since investment tax credit requires the entity to fulfil all the conditions attached to claim the deduction (i.e. transfer the amount of benefit claimed to a specified reserve and spend such money to purchase eligible assets within a period of three years).
The definition of current tax as per IAS 12 is as follows:
‘Current tax is the amount of income taxes payable (recoverable) in respect of the taxable profit (tax loss) for a period.’
Accordingly, based on the above definition, since current tax represents income tax payable/recoverable on the taxable profit of an entity, the current tax expense should be recorded after considering the benefit taken as per tax in the year of creation of specified reserve.
However, since the investment tax credit requires the entity to actually spend the money to claim the benefit, the entity may exercise either of the following approaches to neutralise the current tax benefit recorded until the money is actually spent:
• Deferred tax liability - Applying the principles of IFRS, there is no temporary difference between tax book and accounting in this case i.e., there is no difference in the accounting and tax base of any particular asset/liability. However, since there is a difference in the accounting profit and tax profit because of difference in the timing of claiming the benefit (i.e. benefit is claimed in tax when the specified
reserve is created and benefit is recorded in the accounting books when the money is actually spent), a deferred tax liability should be created in the accounting books and reversed upon actual spending.
• Current tax charge - The entity can record a current tax liability in the accounting books at the time of creation of the specified reserve and record a current tax benefit at the time when the money is actually spent on plant and equipment.
View IIRecord the deduction in accounting books and tax books at the same time i.e., in the year the reserve is created
In this case a deferred tax liability would not be created.
As many technology sector entities are going to be dealing with this issue for the first time, the practice is expected to emerge in this area, due care and judgement should be exercised in evaluating this issue.
Deferred tax implication on the amount of reserve createdIf View I in the point above is adopted, companies may have to record a deferred tax liability on amounts that are transferred to the specified reserve and remain ‘not spent’ as at the end of the financial year.
It is useful to discuss the opinion of the Expert Advisory Committee of the ICAI (volume 24, query 14) in the context of creation of deferred tax liability on special reserve created under section 36(1)(viii) of the IT Act since it relates to the situation of a reserve created as per Section 10AA of the IT Act.
Relevant extracts of the opinion is quoted below:
‘the committee is of the opinion that the company is required to create deferred tax liability on the special reserve created and maintained under Section 36(1)(viii) of the Income-tax Act, 1961, irrespective of the fact that the withdrawal of the reserve may or may not happen since the company is capable to withdraw the reserve resulting into reversal of the difference between accounting income and taxable income (i.e. the timing difference).’
Accordingly, the entity would be required to create a deferred tax liability on the amounts that will be transferred to the SEZ reserve, since they are capable of being withdrawn or utilised for the purpose other than those specified.
Presentation in the financial statementsFrom a presentation perspective under the Indian GAAP and IFRS financial statements, even though the IT Act reads as ‘the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is
to be allowed and credited to a reserve account (to be called the “Special Economic Zone Re-investment Reserve Account”)’, it does not mean that in the accounting books an amount should be debited to the statement of profit
and loss . Under Indian GAAP and IFRS accounting books, this reserve would be treated as an appropriation of profits like any other reserve disclosed in the financial statements like capital reserve, hedging reserve, etc.
Besides the matters discussed above, there are certain other issues that entities might need to deliberate which could have an impact on the accounting for the tax benefit in the books:
1. Whether the investment in plant and machinery made during the eleventh year (year of tax deduction) is eligible for the satisfaction of the investment requirement or does the investment made in plant and machinery in years 12 to 14 (three years from the end of the year of tax deduction) only would be eligible for deduction.
2. Whether the required investment in plant and machinery is to be incurred specifically for the SEZ unit that is claiming the deduction or all such investment made by the entity in any of the (other) units is also eligible?.
The matter of accounting for the tax deduction in years 11 – 15 is a challenging topic for the entities. An entity should exercise due care and judgement in evaluating these issues and therefore, provide detailed disclosure of its position and explain the accounting rationale for the approach adopted.
On 5 October 2015, the Organisation for Economic Co-operation and Development (OECD) issued a final package of reports in connection with its Action Plan (the OECD guidance) to address BEPS, as well as a plan for follow-up work and a timetable for implementation. The OECD’s BEPS Action Plan, which was launched in July 2013, and endorsed by the G20, includes 15 key areas for identifying and curbing aggressive tax planning practices, and altering the international tax system in a way that it is coherent and consistent among countries. Many countries have already adopted or are poised to adopt changes to their international tax systems based on the OECD recommendations. While implementation and timing will vary across borders, this final OECD guidance marks a crucial shift from the recommendation and consultation phase of BEPS to implementation in the nature of administrative and legislative changes.
The action plan identified 15 actions along three key pillars, which are as follows:
i. introducing coherence in the domestic rules that affect cross-border activities,
ii. reinforcing substance requirements in the existing international standards, and
iii. improving transparency as well as certainty.
The 15 point action plan is as below.
Action 1: Address the tax challenges raised by the Digital Economy (DE)
Action 2: Neutralise the effects of hybrid mismatch arrangements
Action 3: Design effective controlled foreign company rules
Action 4: Limit base erosion via interest deductions and other financial payments
Action 5: Counter harmful tax practices more effectively, taking into account transparency and substance
Action 6: Prevent treaty abuse
Action 7: Prevent the artificial avoidance of Permanent Establishment (PE) status
Action 8 to 10: Develop rules to prevent BEPS by moving intangibles among group members; develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to group members; develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties
Action 11: Establish methodologies to collect and analyse data on BEPS and the actions to address it
Action 12: Require taxpayers to disclose their aggressive tax planning arrangements
Action 13: Transfer pricing documentation and Country by Country (CbyC) reporting
Action 14: Make dispute resolution mechanisms more effective
Action 15: Develop a multilateral instrument.
Key impact areas
Globalisation of the world economy has resulted in Multinational Enterprises (MNEs) shifting from country specific business models to global models where sometimes important functions are housed in low-tax jurisdictions. The technology sector has several types of transaction and business models which may need to be revisited in order to align to the forthcoming changes to the domestic and international tax regulations.
For example, an Intellectual Property (IP) being registered in an entity in a low-tax jurisdiction even though developing, enhancing, maintaining, protecting and exploiting (DEMPE) functions of the IP are performed by another entity in a different jurisdiction. The group may allocate revenue to the legal owner of the IP, which may be an entity in whose name the IP is registered in a lower tax jurion such revenues. Such a model may need to be relooked at to align with the changes that may happen with the implementation of Action 5 mentioned above.
In this article we look at some of the key impact areas on the technology sector from Actions 1, 8 to 10 and 13.
Develop rules to prevent BEPS by (Action 8) moving intangibles among group members; (Action 9) transfer risks among, or allocate excessive capital to group members and (Action 10) engage in transactions which would not, or would only very rarely, occur between third parties. The OECD guidance in these action points takes the form of amendments to various chapters of the OECD Transfer Pricing (TP) Guidelines for Multinational Enterprises and Tax Administrations.
The OECD guidance covers, among others, three key aspects that may be related to the technology sector such as,
• Addressee the capacity to assume and control risk, the relationship between contractual arrangements and conduct, as well as the return for low functioning or ‘cash box’ companies.
• Clarify the definition of intangibles and Hard To Value Intangibles (HTVI), it also discusses ownership
of intangibles and transactions involving development, enhancement, maintenance, protection and exploitation (DEPME) of intangibles.
• Provide guidance regarding intra-group services transactions and an elective simplified method or safe harbor for low value-adding intra-group services.
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Our observation
The above guidelines could impact technology sector entities in their business models and structures, location of intangibles vis-à-vis the benefits and the transfer pricing documentation.
In order to increase the chances of success, it is imperative for MNEs to align their contractual terms with the conduct. For example, technical assistance may have been granted, synergies may have been created through deliberate concerted actions, or know-how may have been provided through seconded employees or otherwise. These relations may not have been recognised by the MNE, may not be reflected in the pricing of other connected transactions, may not have been formalised in written contracts, and may not appear as entries in the accounting systems. Where the transaction has not been formalised, all aspects would need to be deduced from available evidence of the conduct of the parties, including what functions are actually performed, what assets are actually used, and what risks are actually assumed by each of the parties.
Action 1
Addressing the BEPS/tax challenges raised by the DE
The DE presents some key features that may exacerbate BEPS concerns – mobility (intangibles, users, and business functions), reliance on data, network effects, multi-sided business models, monopoly, and volatility. The OECD guidance on the DE asserts that DE business models facilitate the artificial shifting of income, avoidance of direct tax nexus, and the avoidance of Value Added Tax (VAT). The OECD guidance
also concludes that the work under the other BEPS actions addresses much of the DE BEPS concern, but also sets out additional measures countries may consider.
MNEs also operate through physical facilities located in market jurisdictions (e.g., e-commerce warehouses and computer server locations to address latency concerns). It is expected that the impact of introducing Action 7 and revised transfer pricing guidance (Actions 8-10) is equipped to address the issues
faced in the DE regime. Coupled with a broader definition of taxable nexus, these guidelines are expected to subject a greater share of DE profits to market country taxation. The guidance states that the character of many forms of DE income, including cloud computing, is not addressed in the existing commentary to the OECD Model Treaty (royalties, technical services, or business profits).
Our observation
The guidelines do not propose a special tax regime for DE as existing BEPS measures on Controlled Foreign Companies (CFC), Permanent Establishment (PE) and transfer pricing are considered to be sufficient to address the same. The report encourages countries to tackle digital BEPS challenges unilaterally which may lead to inconsistency. The sector may be expected to see increased litigation over the characterisation of payments relating to new digital products and services - royalties, PE on account of accessibility of websites/presence of equipment/agents, etc. The OECD guidance also suggests taxing B2C supplies of both digital services and low-value e-commerce in the country of residence of the consumer, which will likely place a greater compliance burden on vendors in the global digital economy and potentially increase the cost to consumers.
The action point on intangibles brings out the concept of economic ownership, e.g. a distributor of software products who makes considerable efforts to promote the brand of the MNEs group legally owned by the parent or some other entity in low-tax jurisdiction will be considered as an economic owner and will be entitled to returns from such intangibles like brand, etc. The action point on risk re-characterisation states that if after delineating the functions performed , assets employed and risk assumed in a transactions if it appears that the actual conduct of the parties is different from the contractually agreed terms the transactions can be re-charaterised and returns be re-allocated based on actual conduct.
Action 13
Transfer pricing documentation and Country by Country (CbyC) reporting
The guidance recognises that enhancing transparency for tax administrations by providing them with adequate information to conduct transfer pricing risk assessments and examinations is an essential part of tackling the BEPS problem. Accordingly, the OECD recommended a three-tiered approach to transfer pricing documentation that includes preparing a master file, local file and CbyC report.
The master file is intended to provide a ‘blueprint’ containing standardised information relevant for the entire MNE group. MNEs would also need to focus on ensuring whether global TP documentation is consistent and tells the same story of the corporate group value chain as the local entities. MNEs may also be required to include specific references to their relevant analysis of risk, intangibles, profit attributions and financial transactions in the master file.
The local file provides additional detail on the operations and transactions relevant to that jurisdiction and the economic analyses of the intercompany transactions.
The CbyC report contains summary of data by jurisdiction including revenue, income, taxes, and indicators of economic activity. It also gives details of economic activity entity-wise in each jurisdiction.
The local file will need to be filed with the local tax jurisdictions. Many MNEs have already started preparing their master files and CbyC reports, given the additional time, effort and resources that these requirements are expected to take.
Our observation
One of the key impact areas on the technology sector entities is likely to be disclosure of sensitive and voluminous information. CbyC reporting is specifically important for Indian headquartered companies. MNEs would need to assess whether their internal accounting and Management Information Systems (MIS) are geared to gather the data required for reporting. Also, as described above, the OECD added several cross references in the final Actions 8 to10 report to Action 13. It is, therefore, critical for MNEs to present a coherent story starting with the contractual arrangements, the actual conduct of the parties and the write-ups related to those in the transfer pricing documentation.
CbyC reporting will be adopted by all countries that are members of OECD and also the G20 countries that includes India, the minimum thresholds for CbyC reporting by an MNE’s parent are (i) be required for MNE groups with annual consolidated group revenue of more than EUR750 million, (ii) will begin for MNE’s fiscal year beginning on or after 1 January 2016; (i.e. will be implemented in India from tax year beginning 1 April 2016) iii) will be filed by the ultimate parent company of the MNE in its jurisdiction (or by a surrogate parent entity); iv) is due one year after the fiscal year end of the parent company; and v) will be automatically exchanged by the parent company’s jurisdiction with all the jurisdictions where the MNE has operations.
As regards the Master file, there are no specified thresholds and Indian tax administration may seek to make it mandatory for even smaller MNEs, in order to gain insight into the MNEs global business structure. This information will provide the tax administration with the required first-hand information for conducting a detailed risk assessment and coming to a conclusion whether the MNE should be subjected to detailed audit.
Throughout the past several months, we have seen approximately 14 to 16 countries indicate their intent to adopt CbyC reporting, with Australia leading the way with a bill introduced in its Parliament. We expect to see many more countries implementing CbyC reporting in the coming months.
The technology sector companies are likely to be impacted by many of the above 15 action points depending on the nature of its business. However, MNEs are almost certain to witness significant changes in transfer pricing documentation and additional reporting requirements. It is imperative that the MNEs in the technology sector give additional consideration to the BEPS project developments to ensure they align with the requirements.
Further developments and India perspective
At the G20 forum held in Antalya, Turkey on 16 November 2015, the leaders committed to the implementation of the BEPS project. They also reaffirmed their commitment to implement automatic exchange of information latest by 2018.
India has been actively involved with the OECD in the BEPS initiative from the beginning. The prescribed threshold limit for CbyC Reporting, group revenues of Euro750 million which is approximately equivalent to INR5,250 crore seems to be on the higher side and is likely to impact a
few hundred Indian headquartered companies. Though one may think that India could lower this threshold, it may practically seem difficult to deviate from the global guidance as the OECD has suggested all participating countries to remain consistent. However the master file requirement may impact a bigger number of companies operating a subsidiaries or joint-ventures of MNE groups in India.
The Indian government would be expecting the Indian headquartered companies to start providing information under CbyC Reporting for transactions pertaining to financial year 2016-17, but there could be certain practical challenges such as sharing of such information with other countries and fiscal to calendar year mismatch and reconciliation. Also, the OECD will have to work along with countries on the mechanism to electronically access and share the information. MNEs will need to rethink how they view taxes in a post-BEPS world. Governments will have to think about how they balance their ambition to attract business activity through offering an attractive corporate tax regime against commitments under
the BEPS Plan which aims to keep a more level global playing field.
These developments warrant an immediate action by the board of directors/management/audit committee of companies to understand the implications and transparency requirements of BEPS.
The action plans issued to date conclude the discussion and recommendation phase and mark the start of the implementation and practical delivery phase. The next phase is expected to include a mandate for monitoring and supporting implementation.
The OECD has said that as part of the follow-up work after October 2015 it will complete the guidance on profits splits and financial transactions, provide implementation guidance on low value-adding services and HTVI, and will develop a transfer pricing toolkit for low income countries
Sources: KPMG’s Flash News – BEPS Action Plan 13 - Guidance on implementation of Transfer Pricing Documentation and Country-by-country reporting issued on 13 February 2015, KPMG’s Special report on BEPS issued in October/November 2015, KPMG’s Tax Flash News on BEPS Action Plans in Nutshell issued on 8 October 2015
The Constitutional Amendment Bill (the Bill) required to implement the most awaited indirect tax reform i.e. GST received approval of the Cabinet and Lower House (Lok Sabha), and the government hopes to pass the Bill in the Upper House (Rajya Sabha) in the latter half of the ensuing Budget Session in April – May 2016. Concurrently the Joint Committee of the Empowered Committee has issued reports on registration, refund, payment and returns processes. The Chief Economic Advisor’s (CEA) Report on the Revenue Neutral Rate and Structure of rates for the GST has also been published in December 2015.
While the government is putting in efforts to get the Bill passed so as to enable the introduction of GST soon, businesses are eagerly looking forward to this major indirect tax reform, as well.
This new indirect tax regime is expected to bring with it opportunities as well as challenges which businesses need to be aware of. We have discussed below a few important considerations for the technology service exporters – who have been contributing significantly by generating employment and getting foreign exchange into India.
• Possibility of increase in indirect tax rates: The rates of state-wise value added tax (VAT), excise duty and service tax are now at 12.50 - 14.50 per cent, 12.50 and 14.50 per cent respectively. As against these rates of indirect taxes on goods and services, the rates of Central GST (CGST) and State GST (SGST) proposed by the CEA are between 16.90 and 18.90 per cent. The Integrated GST (IGST) on imports and inter-state transactions are expected to attract the total of CGST and SGST, as IGST. This could significantly raise the payout towards such taxes and also increase the input tax credits of both goods and services in the hands of the technology service exporters.
• Possible increase in availability of credits/refunds: Currently, while CENVAT credit of excise duty and service tax is eligible for refund, VAT on the goods procured by the service exporters is mostly a cost. It is indeed a welcome move to see that going forward, IGST, CGST and SGST on all goods and services is expected to be eligible to the technology service exporters, as refund.
• Additional working capital requirements: Technology service exporters have been large importers
of services and IT and non-IT which would attract the incidence of IGST. This is likely to increase cash outflow until refunds are received by the units which have used such imported goods and services, towards the export of services. Consequently there could be additional stress on the working capital requirements of such companies.
• Additional administrative requirements: Presently, although technology service exporters operate from multiple locations across Indian states, under current regulations, they are allowed to have a single centralised registration covering all these locations. It is, therefore, administratively easier for the exporter to consolidate and claim CENVAT credits of all locations at the centralised office i.e. where accounts are maintained or from where billings are done. However, the dual GST (i.e. CGST and SGST) administrative mechanism would require each location to be registered separately in its respective state and adhere to compliance requirements and file refund claims in each of these states. Technology service exporters would therefore need to come to terms with this change and adapt themselves to come at par with the manufacturing and trading sector, which is used to being administered by various tax departments, across states and locations.
Wherever agreements for a variety of services (such as Master Service Agreements (MSAs)) are entered into with the centralised office of a technology service exporter, separate invoices may need to be raised for each state from where the services are rendered - based on interpretations of the place of provision of services rules. The state-wise offices of the technology service exporter may, therefore, need to raise state-wise export invoices and claim refunds of input IGST, CGST and SGST with the central and state GST offices respectively, in each of the states, which could be a significant change from the current practice.
• Automatic refunds: While the Joint Committee Report on GST Business Processes on refund process has stated that automatic refund may be sanctioned, it would need to be seen how efficiently such refunds are granted automatically by the state GST and central GST offices within indicated timelines.
• Inter-office services: If the centralised office of the technology service exporter requires its other offices to provide ancillary or support services, there needs to be a mechanism for transfer of the credits in each of the states to the centralised office. While the transfer of goods is comparatively easier to track, tracking and quantifying the provision of services between offices is going to be a challenge.
• Transition: There needs to be clear guidelines with respect to transitional credits lying in the books of account as on the date of introduction and whether the unutilised CENVAT credits of input services would be transitioned into the CGST credits and be available for refund going forward.
• Awaiting clarity on import duties: The technology service exporters operating from STPI/SEZ units currently enjoy exemption of import duties on imported goods. However, the treatment in GST regime is presently unclear.
• De-bonding of assets in the GST era: Lastly, the taxes that would be payable on subsequent de-bonding of the bonded assets in the SEZ and STPI Units in the GST regime, would need to be clarified, so that the technology service exporters can then decide their future plans.
While the technology service exporters are likely to have to restructure their internal business processes to suit the requirements under GST, the policy makers need to understand the business processes of technology service exporters and frame uniform procedures in the central and each of the state’s GST legislations. This would be an endeavour in the direction of improving our present rating on the ‘Ease of Doing Business’ index which, as reiterated by the Finance Minister in his Budget Speech in 2015, is one of the major areas of focus of this government.
Further, the state and central tax authorities and administrators need to adapt and accept the business processes willingly, so that such technology service exporters have a better experience which can truly make GST one of the biggest reforms, thereby attracting much more investment into the country.
Regulatory UpdatesThe MCA notifies sections in the Companies Act relating to reporting of offences involving fraud by auditors and an omnibus approval for related party transactions and issues through the corresponding rulesBackground
The Companies Act, 2013 (the 2013 Act) became largely effective from 1 April 2014. On 2 December 2014, the Union Cabinet introduced the Companies (Amendment) Bill, 2014 in the Parliament to make certain amendments to the 2013 Act. The amendment received the President’s assent on 25 May 2015 and was subsequently notified in the Official Gazette on 26 May 2015, and is called the Companies (Amendment) Act, 2015
(Amendment Act, 2015). Further, the Ministry of Corporate Affairs (MCA) on 29 May 2015 notified Section 1 to 12 and 15 to 23 of the Amendment Act, 2015.determining the impairment of financial instruments.
New developments
The MCA on 14 December 2015, notified Section 13 (reporting of an offence involving a fraud to the central government) and Section 14 (an omnibus approval for related party transactions) of the Amendment Act, 2015. The notification will be effective from the date of its publication in the Official Gazette i.e. 15 December 2015.
Further, the MCA through its notification dated 14 December 2015 also amended/inserted certain rules which are as follows:
Point of Difference Indian GAAP
Amended Rule 13 relating to reporting of frauds by auditors and other matters (the Companies (Audit and Auditors) Amendment Rules 2015).
The amendment specifies that an auditor would report a fraud of an amount of INR1 crore or above to the central government after following a specified process.
Inserted Rule 6A relating to omnibus approval for related party transactions on an annual basis (the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015).
An audit committee may provide an omnibus approval for related party transactions after following certain specified conditions.
Omitted Rule 10 relating to loan to directors, etc. under Section 185 of the 2013 Act (the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015).
Aligned rules with the Amendment Act, 2015.
Amended Rule 15 relating to contract or arrangement with a related party (the Companies (Meetings of Board and its Powers) Second Amendment Rules, 2015).
Aligned rules with the Amendment Act, 2015.
The following section aims to provide an overview of key amendments in the above mentioned rules.
Amendment in reporting of frauds by auditors and other matters (Rule 13)
Currently, the 2013 Act or the aforesaid rules do not provide any threshold for reporting of frauds by auditors.
Now, the amended Rule 13 provides that if an auditor of a company in the course of the performance of his/her duties as a statutory auditor, has a reason to believe that an offence of fraud, which involves or is expected to involve individually an amount of INR1 crore or above, is being or has been committed against the company by its officers or employees, the auditor should report the matter to the central government after ensuring the following process:
• The auditor should report the matter to the board or the audit committee (as the case may be) immediately but not later than two days of his/her knowledge of the fraud seeking their reply or observations within 45 days.
• On receipt of such a reply or observations from the board or the audit committee, the auditor should forward his/her report and the reply or observations of the board or the audit committee along with his/her comments (on such a reply or observations of the board or the audit committee) to the central government within 15 days from the date of receipt of such a reply or observations.
• In case the auditor fails to get any reply or observations from the board or the audit committee within the stipulated period of 45 days, he/she should forward his/her report to the central government along with a note containing the details of his/her report that was earlier forwarded to the board or the audit committee for which he/she has not received any reply or observations.
The report to the central government would be in the form of a statement as specified in Form ADT-4.
In the case of a fraud of less than INR1 crore, the auditor would report the matter to an audit committee or board (as the case may be) not later than two days of his knowledge of the fraud. Additionally, the details of such a
fraud reported to the audit committee or the board during the year, would be disclosed in the board’s report along with the following information:
• Nature of fraud with description
• Approximate amount involved
• Parties involved, if remedial action not taken
• Remedial action taken.
The provision of this rule would also apply to a Cost Auditor and a Secretarial Auditor during the performance of his/her duties under Section 148 and Section 204 respectively of the 2013 Act.
Amendments to the above Rule 13 would come into force from the date of publication in the Official Gazette i.e. 15 December 2015.
Amendment in reporting of frauds by auditors and other matters (Rule 13)
Currently, Regulation 23 of the newly effective SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations) provides that an audit committee may grant an omnibus approval for a related party transaction proposed to be entered into subject to certain conditions. Such an omnibus approval would be valid for a period not exceeding one year and would require fresh approvals after the expiry of one year. MCA with an intent to align with the Listing Regulations has amended the rules so that an audit committee would be empowered to provide omnibus approvals for related party transactions subject to certain conditions. The conditions specified by MCA are largely similar to the Listing Regulations.
Following are the conditions specified for an omnibus approval from an audit committee:
• The audit committee after obtaining an approval of the board of directors specify the criteria which should include:
a. Maximum value of the transactions, in aggregate, which can be allowed under the omnibus route in a year
b. The maximum value per transaction which can be allowed
c. Extent and manner of disclosures to be made to the audit committee at the time of seeking an omnibus approval
d. Review, at such intervals as the audit committee may deem fit, related party transaction entered into by the company pursuant to each omnibus approval made
e. Transactions which cannot be subject to the omnibus approval by the audit committee.
• The criteria which the audit committee should consider while specifying the criteria for making an omnibus approval are as follows:
a. Repetitiveness of the transactions (in the past or the future)
b. Justification for the need of an omnibus approval.
• The audit committee would satisfy itself on the need for omnibus approval for transactions of repetitive nature and that such an approval is in the interest of the company.
• The omnibus approval should contain or indicate information:
a. name of the related parties
b. nature and duration of the transaction
c. maximum amount of transaction that can be entered into
d. the indicative base price or current contracted price and the formula for variation in the price, if any
e. any other information relevant or important for the audit committee to take a decision on the proposed transaction.
In the situations where need for a related party transaction cannot be foreseen and aforesaid details are not available, an audit committee may make an omnibus approval for such transactions subject to their value not exceeding INR1 crore per transaction.
• Omnibus approval would not be valid for a period exceeding one financial year and would require a fresh approval after the expiry of such financial year.
• Omnibus approval would not be made for transactions in respect of selling or disposing of an undertaking of a company.
• Any other conditions as the audit committee may deem fit.
The amendments to the above rules will come into force from the date of their publication in the Official Gazette.
Omitted Rule 10 relating to loan to directors, etc. under Section 185 of the 2013 Act
The Amendment Act, 2015 had incorporated the exemptions from requirements of Section 185 from the Rules to the 2013 Act. The exemptions relate to:
• Loan, or guarantee/security (for a loan) by a holding company to its wholly-owned subsidiary
• Guarantee/security by holding company for loan by a bank or a financial institution to its subsidiary
The above transactions should be subject to relevant loans being utilised only for principal business activities of a subsidiary.
The MCA has now omitted Rule 10.
The amendments to the above rules would come into force from the date of their publication in the Official Gazette.
Amended Rule 15 relating to a contract or arrangement with a related party
The Amendment Act, 2015 had amended Section 188, related party transactions to allow a company to approve certain related party transactions through a resolution instead of special resolution. However, similar amendments were not made to the rules. Now Rule 15(3) has been amended by substituting ‘resolution’ instead of ‘special resolution’ for the above mentioned transactions.
The amendments to the above rules would come into force from the date of their publication in the Official Gazette.
(Source: MCA notification dated 14 December 2015 and KPMG in India’s First Notes: MCA notifies sections in the Companies Act relating to reporting of offences involving fraud by auditors and an omnibus approval for related party transactions and issues the corresponding rules dated 24 December 2015)
The government announces a road map for Ind AS implementation by banks, insurers and NBFCsOn 18 January 2016, the Ministry of Corporate Affairs (MCA) issued a press release announcing a road map for implementation of Indian Accounting Standards (Ind AS) converged with International Financial Reporting Standards (IFRS) for Scheduled Commercial Banks (banks), Insurance Companies and Non-Banking Financial Companies (NBFCs).
This press release follows from the announcement by the Union Finance Minister in his budget speech in July 2014 on the convergence with IFRS, and requires adoption of Ind AS for accounting periods beginning from 1 April 2018 onwards for the above mentioned entities. It has been issued subsequent to consultations with the Reserve Bank of India (RBI), the Insurance Regulatory and Development Authority (IRDA) and the Pension Fund Regulatory and Development Authority (PFRDA).
Background
The MCA through its notification dated 16 February 2015 issued a road map for implementation of Ind AS by companies other than banking companies, insurance companies and NBFCs.
On 29 September 2015, RBI recommended a road map to MCA for implementation of Ind AS from 2018-19 onwards for banks and NBFCs. Further, in October 2015, RBI issued a report of its Working Group on implementation of Ind AS by banks in India. This provided recommendations on key areas with a focus on financial instruments, as well as formats for financial statements of banks under Ind AS.
Further, the IRDA, through its order on 17 November 2015 stated that the insurance sector in India would be converging with IFRS after the issuance of the revised IFRS 4, Insurance Contracts (IFRS 4) by the International Accounting Standards Board (IASB). Currently, IFRS 4 is being deliberated by IASB and a final standard is expected to be issued later this year. On 7 December 2015, IRDA also issued a Discussion Paper on Ind AS implementation in the insurance sector with key recommendations.
The MCA’s press release on 18 January 2016 now provides certainty and states that rules/notifications will be issued by MCA, RBI and IRDA in due course mandating the implementation of Ind AS.
Overview
Banks and insurers/insurance companies
From accounting periods beginning on or after 1 April 2018, following entities would prepare financial statements based on Ind AS (with comparatives for the periods ending on or after 31 March 2018):
• All-India Term Lending Refinancing Institutions, and
• Insurers/insurance companies.
Ind AS would be applicable to both consolidated and individual financial statements.
In addition, the holding, subsidiary, joint venture or associate companies of banks would also be required to prepare Ind AS financial statements for accounting periods beginning on or after 1 April 2018, notwithstanding the road map issued for companies by MCA in February 2015.
UCBs and RRBs will continue to comply with the existing accounting standards to present their financial statements.
NBFCs
NBFCs would be required to prepare financial statements based on Ind AS in two phases.
Phase I
For accounting periods beginning from 1 April 2018 onwards, with comparatives for the periods ending on or after 31 March 2018:
• NBFCs having a net worth of INR500 crore or more, and
• Their holding, subsidiary, joint venture or associate companies, other than those companies already covered under the road map for companies issued by MCA in February 2015.
For accounting periods beginning from 1 April 2019 onwards with comparatives for the periods ending on or after 31 March 2019:
• NBFCs whose equity and/or debt securities are listed or are in the process of listing on any stock exchange in India or outside India and having a net worth of less than INR500 crore.
• NBFCs that are unlisted companies, having a net worth of INR250 crore or more but less than INR500 crore
• Holding, subsidiary, joint venture or associate companies of the above class of companies, other than those already covered under the road map for companies issued by MCA in February 2015.
NBFCs with a net worth below INR250 crore and not covered in Phase I or II will continue to comply with the existing accounting standards.
Next steps
The press release is expected to be followed by the issuance of a formal notification/rules by MCA, RBI and IRDA. We expect that these will provide greater clarity on how the specified criteria should be applied to banks, insurance companies and NBFCs.
(Source: MCA Press Release dated 18 January 2016 and KPMG’s IFRS Notes on the government announces a road map for Ind AS implementation by banks, insurers and NBFCs dated 20 January 2016)
IRDA issued a discussion paper on convergence to Ind AS in the insurance sector Background
The Insurance Regulatory and Development Authority of India (IRDA) through its order dated 17 November 2015 stated that the insurance sector in India would be converging with IFRS after the issuance of the revised standard on insurance contracts i.e. IFRS 4, Insurance Contracts by the International Accounting Standards Board (IASB). Currently, IFRS 4 is being deliberated by the IASB and a final standard is expected to be issued in 2016. The IASB expects to allow an implementation period of approximately three years after the publication of the new insurance contracts standard.
Additionally, for entities whose predominant activity is issuing contracts within the scope of IFRS 4, IASB is evaluating a proposal to allow an optional temporary exemption from applying IFRS 9, Financial Instruments (effective date 1 January 2018).
In order to prepare the Indian insurance sector for convergence with Ind AS, IRDA has constituted an implementation group to lay down the road map for convergence.
New development
IRDA on 7 December 2015 issued a Discussion Paper (DP) on the convergence to Ind AS in the insurance sector. The Standing Committee on Accounting Issues (SCAI) of the IRDA has recommended a draft of the regulations on financial statements and auditors’ report which are compliant to Ind AS. The DP is open for comments.
Key highlights of the draft are as follows:
• It explains the applicability of the Ind AS issued under the Companies (Indian Accounting Standards) Rules 2015 to the ‘life insurance business’ as well as provides certain exceptions
• It explains the applicability of the Ind AS’s issued under the Companies (Indian Accounting Standards) Rules 2015 to ‘other than life insurance business’ and provides certain exceptions
• It allows revaluation of investment property acquired from policyholders funds only
• It requires enhanced disclosures
• It extends the applicability of the Regulations on branch offices of foreign reinsurers
• It requires presentation of the ‘preference share capital’ under the Schedule ‘Borrowings’.
The date of applicability of these recommendations along with any other recommendations of the implementation group on Ind AS would be notified in due course of time.
(Source: Discussion paper dated 7 December 2015 issued by the IRDA and KPMG in India’s IFRS Notes: IRDA issues a discussion paper on convergence to Ind AS in the insurance sector dated 14 December 2015)
Business Responsibility Report to now apply to top 500 equity listed entitiesBackground
The SEBI on 2 September 2015 notified the Securities and Exchange Board of India (SEBI) (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations). Regulation 34(2)(f) requires a Business Responsibility Report (BRR) for the top 100 listed entities based on market capitalisation (calculated as on 31 March every year). The BRR should describe the initiatives taken by such entities from an environmental, social and governance perspective, in the format as specified by SEBI from time to time Accordingly, SEBI through a circular dated 4 November 2015 has prescribed the format for a BRR to be submitted to the stock exchange. The Listing Regulations are applicable from 1 December 2015.
New development
On 22 December 2015, SEBI issued amendments to Listing Regulations which is called SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2015. The amendments extended the applicability of BRR to top 500 listed entities instead of top 100. The amendment provides that BRR should be submitted by top 500 equity listed entities based on market capitalisation (calculated as on 31 March every year).
The said amendment is to be effective from 1 April 2016.
(Source: SEBI (Listing Obligations and Disclosure Requirements) (Amendment) Regulations, 2015 dated 22 December 2015)
The Ministry of Law and Justice provides an Act called the Payment of Bonus Act, 1965 (the Act). The Act is intended to provide for the payment of bonus to persons employed in certain establishments on the basis of profits or on the basis of production or productivity and for matters connected therewith. It came into force from 25 September 1965. The Act has undergone several amendments. This Act extends to the entire country.
New development
On 7 December 2015 Ministry of State for Labour and Employment introduced the Payment of Bonus (Amendment) Bill, 2015. The Bill proposes amendments in the Payment of Bonus Act, 1965. Further on 31 December 2015 the bill received an assent of the president and is called the Payment of Bonus (Amendment) Act 2015.
The amended Act provides the following amendments to the principal Act:
• Employee eligible for bonus- The eligibility limit for applicability of the Act increased from INR10,000 per month to INR21,000 per month. The Amended Act states that every employee of an entity on which the principal Act is applicable having a salary or wage not exceeding INR21,000 per month will be covered under the purview of the Act and will be eligible for receiving bonus under the said Act. Earlier the limit for receiving bonus was INR10,000.
• Salary or wage ceiling for calculation of bonus – The Act provides that every employee will be paid bonus in proportion to his salary or wage. However, if the salary or wage of an employee exceeds INR3,500 per
month the bonus payable to such employee will be calculated as if his/her salary or wage were INR3,500 only. The amended act increased the limit for the purpose of calculation of bonus. It provides that the limit will be higher of
• salary or wage of INR7,000 per month (earlier limit: INR3,500 per month), or
• minimum wage for scheduled employment fixed by Government.
The Act will be applicable with retrospective effect from 1 April 2014.
(Source: The Payment of Bonus (Amendment) Act 1965 published in The Gazette of India on 1 January 2016)
The ICAI issues exposure drafts on ASThe Institute of Chartered Accountants of India (ICAI) is in the process of revising the existing Accounting Standards (ASs). The reasons for this are as follows:
The existing ASs which were notified under the Companies Act, 1956 under the Companies (Accounting Standards Rules) 2006 have to be notified afresh under Section 133 of the Companies Act, 2013.
MCA has requested the Accounting Standards Board of the ICAI to upgrade ASs, as notified under Companies (Accounting Standards) Rules, 2006, to bring them nearer to Indian Accounting Standards. Accordingly, the Accounting Standards Board, ICAI, initiated to upgrade these standards which will be applicable to all companies having net-worth less than INR250 crores including non-corporate entities.
AS 8, Accounting Policies, Changes in Accounting Estimates and Errors.
Issued on 25 November 2015 and comment pe-riod closed on 7 December 2015.
AS 2, Inventories Issued on 23 September 2015 and comment pe-riod closed on 7 October 2015.
AS 10, Events after the reporting period Issued on 23 September 2015 and comment pe-riod closed on 7 October 2015.
AS 20, Accounting for Government Grants Issued on 23 September 2015 and comment pe-riod closed on 7 October 2015.
AS 108, Segment Reporting Issued on 23 September 2015 and comment pe-riod closed on 7 October 2015.
Amendments in the transitional provisions of accounting standards
Certain existing Accounting Standards which were notified in 2006 contain ‘Transitional Provi-sions’. The objective of these ‘Transitional Provi-sions’ is to prescribe the accounting treatment when an AccountingStandard becomes applicable for the first time. Accordingly, in 2006, there was some justifica-tion to include these
‘transitional provisions’. As now the Accounting Standards are being notified afresh, so from the perspective of their re-notification, ‘Transitional Provisions’ are being reexamined. The ED of the Amendments in Transitional Provisions of Accounting Standards issued on 3 December 2015. Comment period closed on 14 December 2015.
AS 7, Statement of Cash Flows Aligned rules with the Amendment Act, 2015.
SEBI prescribed the procedure to deal with cases involving issue of securities to more than 49 upto 200 investorsBackground
The Companies Act, 1956 provides that any offer or allotment of securities will be considered as public issue if the number of offerees/allottees exceeds 49 persons in a financial year. The Companies Act, 2013 increased this cap from 49 persons to 200 persons. SEBI in its board meeting in Mumbai on 30 November 2015 approved the proposal wherein issuance of securities to more than 49 persons but up to 200 persons in
a financial year will be deemed as public issue and there will be no penal action if the company/promoter provide an option to investors to surrender the securities and get the refund amount at a price not less than the amount of subscription money paid along with 15 per cent interest.
New development
The SEBI through its circular dated 31 December 2015 provides that with respect to earlier cases (relating to period prior to 1 April 2014, pending with SEBI) involving issuance of securities to more than 49 persons but up to 200 persons in a financial year, the companies may avoid
penal action if they provide the investors with an option to surrender the securities and get the refund amount at a price not less than the amount of subscription money paid along with 15 per cent interest per annum thereon or such higher return as promised to investors.
The SEBI also prescribed the refund procedure which companies are required to follow to refund the amount to investors. Further, the companies are required to submit a certificate from an independent peer reviewed practicing Chartered Accountant certifying compliance of the SEBI circular.
(Source: SEBI circular CIR/CFD/DIL3/18/2015 dated 31 December 2015)
Following is a list of the EDs issued by the ICAI in the quarter ending 31 December 2015 inviting comments from public on the proposed changes:
EPFO removed five days grace period for PF contribution by employers Background
Employers Provident Fund Organisation (EPFO) requires every employer to deposit Provident Fund (PF) contributions and administrative charges within 15 days from the close of every month and also allowed a grace period of five days to deposit the PF to the authorities.
New development
The EPFO through its circular dated 8 January 2016 withdrew the concession of grace period of five days provided to the employers for depositing the PF contribution and other charges. The amendment is effective from February 2016 and employers are required to deposit contribution for the month of January 2016 by 15 February 2016.
(Source: EPFO Circular No. WSU/9(1)2013/Settlement/35031, dated 8 January 2016)
Accounting Standards Board of the ICAI constitutes Ind AS Transition Facilitation Group Background
On 16 February 2015, MCA issued the Companies (Indian Accounting Standards) Rules, 2015 (Rules) which laid down a road map for companies other than insurance companies, banking companies and Non-Banking Financial Companies (NBFCs) for implementation of Indian Accounting Standards (Ind AS) converged with International Financial Reporting Standards (IFRS). The MCA also notified 39 Ind AS standards together with the implementation of road map.
New development
Pursuant to the issuance of a road map for Ind AS implementation various issues related to the applicability of Ind AS/implementation under Companies (Indian Accounting Standards) Rules, 2015, are being raised by preparers, users and other stakeholders. The Accounting Standards Board of the ICAI constitutes Ind AS Transition Facilitation Group (ITFG) to address the issues raised by the stakeholders.
The ITFG will address the issues in the following manner:
• Issues which are matter of clarifications on the application/implementation of Ind AS
The group may directly provide the related clarification to the issues referred to it.
• Issues pertaining to interpretation of Ind AS
Interpretational issues with regard to Ind ASs requiring in-depth study and, thereafter, issuance of guidance or educational material may be referred by the group to the concerned board/committee of the ICAI.
The group invites issues pertaining to the Ind AS implementation and application of the Ind AS as well as the road map from preparers, users and other stakeholders. Issues may be submitted through an e-mail to the group.
(Source: EPFO Circular No. WSU/9(1)2013/Settlement/35031, dated 8 January 2016)
KPMG in India’s IFRS institute KPMG in India is pleased to re-launch its IFRS institute - a web-based platform, which seeks to act as a wide-ranging site for information and updates on IFRS implementation in India.The website provides information and resources to help board and audit committee members, executives, management, stakeholders and government representatives gain insight and access to thought leadership publications that are based on the evolving global financial reporting framework.
SEBI issues Frequently Asked Questions (FAQs) on certain provisions of the SEBI Listing Regulations, 2015
13 January 2016
Background
The Securities and Exchange Board of India (SEBI) on 2
September 2015 notified the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (Listing Regulations). The Listing Regulations consolidate detailed requirements covering listing obligations and disclosure requirements of various types of securities e.g. equity shares, debt securities, preference shares and Indian Depository Receipts (IDRs).
New developments
Several representations have been made by various stakeholders highlighting the issues arising from the implementation of the aforesaid regulations. Accordingly, based on the queries/comments received from the market participants, SEBI recently issued FAQs on certain provisions of the Listing Regulations which provide guidance/clarifications on various issues raised by stakeholders.
Our issue of First Notes provides an overview of the key clarifications/guidance provided in the FAQs issued by SEBI.
KPMG in India is pleased to present Voices on Reporting – a monthly series of knowledge sharing calls to discuss current and emerging
issues relating to financial reporting
In this month’s call, on 20 January 2015 we covered following topics:
• Overview of Ind AS 21, The Effects of Changes in Foreign Exchange Rates
• Key regulatory updates.
Missed an issue of Accounting and Auditing Update or First Notes?
IFRS NotesIASB issues a new accounting standard IFRS 16, Leases
15 January 2016
Background
The International Accounting Standards Board (IASB) on 13 January 2016, issued a new accounting standard, IFRS 16 Leases. At the simplest level, the accounting treatment of
leases by lessees would change fundamentally. For the first time, analysts can anticipate to see a company’s own assessment of its lease liabilities, which is calculated using a prescribed methodology that all companies reporting under IFRS will be required to follow.
The new standard is effective from 1 January 2019, early application is permitted (as long as the recently issued revenue standard, IFRS 15, Revenue from Contracts with Customers is also applied).
Our issue of IFRS notes provides an overview of requirements of new standard.
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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.
