Background

The Ministry of Corporate Affairs (MCA), through its notification on 16 February 2015, issued the Indian Accounting Standards (Ind AS), which are converged with the International Financial Reporting Standards (IFRS). The MCA also issued an implementation road map for companies mandating the adoption of Ind AS in a phased manner with the first phase commencing on or after 1 April 2016 for all companies with a net worth of INR500 crore or more (along with their holding, subsidiary, joint venture or associate companies).

New development

Considering the practical difficulties being faced by companies while implementing Ind AS, the Accounting Standards Board (ASB) of the Institute of Chartered Accountants of India (ICAI), on 3 November 2016 issued certain clarifications in the form of Frequently Asked Questions (FAQs) on the following topics:

• Elaboration of terms ‘infrequent number of sales’ or insignificant in value’ used in Ind AS 109

Issue

Paragraph 4.1.1(a) of Ind AS 109, Financial Instruments requires an entity to classify financial assets on the basis of an entity’s business model for managing the financial assets.

Ind AS 109 provides guidance to determine if the business model of an entity is to hold financial assets to collect contractual cash flows (‘held to collect’ business model). In order to determine the business model, it is necessary to consider the following:

a) Frequency of sales,

b) Value and timing of sales in prior periods, 

c) Reasons for sales, and

d) Expectations about future sales activity. 

The application guidance of Ind AS 109 states that sales of assets before maturity may be consistent with a ‘held to collect’ business model if those sales are infrequent (even if significant in value) or insignificant in value both individually and in aggregate (even if frequent). This is reiterated in the
Basis of Conclusions to IFRS 9, Financial Instruments, which provides an example of a situation where a change in the regulatory treatment of a particular type of financial asset may cause an entity to undertake a significant rebalancing of its portfolio in a reporting period. Such an instance is considered consistent with a ‘held to collect’ business
model.

 However, neither the terms ‘infrequent number of sales’ or ‘insignificant in value’ have been defined nor any threshold for value or number has been specified in the standard. The ASB considered the following issues:

i) Interpretation of terms ‘infrequent number of sales’ or ‘insignificant in value’ and indicative rebuttable thresholds for sales that are more than insignificant in value.

ii) Relation between the terms ‘immaterial’ and ‘insignificant’.

Response

Interpretation of infrequent number of sales or insignificant in value

 

The guidance given in Ind AS 109 indicates that  determining an entity’s business model involves significant judgement.
Accordingly, the ASB has clarified that no rule of thumb in terms of indicative percentage can be provided to determine ‘infrequent number of sales’ or ‘insignificant in value’, since it may not be applicable in all cases considering the differing quantum, configuration and nature of financial assets
in different entities. 

An entity’s management may, therefore, exercise judgement in determining the situations in which sales of financial assets
occurring before the maturity date may not be considered inconsistent with the ‘held to collect’ business model. In doing so, it may specify certain guiding criteria - for example, sale of a security initially rated as AAA and subsequently rated as BB may not be considered inconsistent with the entity’s
business model as the intent is for the entity to rebalance its portfolio rather than waiting till the maturity date.

Relation between ‘immaterial’ and ‘insignificant’

With regard to relation between terms ‘immaterial’ and ‘insignificant’, the ASB clarified that the term ‘materiality’ is already present in Ind AS which also does not lay down any criteria based on indicative fixed percentages. The term ‘insignificant’ has not been defined andcan be interpreted to mean ‘less than material’ or almost ‘negligible’.

• Presentation of dividend and Dividend Distribution Tax (DDT) under Ind AS

Issue

Ind AS 32, Financial Instruments: Presentation requires an issuer to
classify financial instruments as a financial liability or an equity instruments based on their contractual terms. Instruments that have features of both, a liability and an equity instrument, are classified as compound financial instruments under Ind AS 32.

The ASB considered the presentation requirements for dividend and dividend distribution tax on financial instruments classified as equity or as compound instruments by the issuer. 

Response

Dividend

As per paragraph 35 of Ind AS 32, ‘interest, dividends, losses and gains relating to a financial instrument or a component that is a financial liability shall be recognised as income or expense in profit or loss. Distributions to holders of an equity instrument shall be recognised by the entity directly inequity.’

Further paragraph 36 of Ind AS 32 states that ‘the classification of a financial instrument as a financial liability or an equity instrument determines whether interest, dividends, losses and gains relating to the instrument are recognised as income or expense in the statement
of profit and loss. Thus, dividend payments on shares wholly recognised as liabilities are recognised as expenses in the same way as interest on a bond.’

Therefore, based on the above, the ASB has clarified that dividends on each category of financial instruments should be presented as follows:

a) Financial instrument classified as debt: Charge dividend/interest paid on it to the statement of profit and loss.

b) Financial instrument classified as equity: Recognise
dividend/interest paid on it in the statement of changes in equity.

c) Compound financial instrument: Charge dividend or interest allocated to debt portion to the statement of profit
and loss and recognise the portion of dividend or interest pertaining to equity in the statement of changes in equity.

Dividend distribution tax

The ASB is of the view that in India, the rate of income tax for a company on its taxable income does not change if the company distributes dividend. The DDT is a tax that is computed on the basis of the amount of dividend distributed to shareholders rather than based on the amount of profits earned and it arises at the point of time when profits are distributed.  In India, dividends are not taxable in the hands of shareholders as DDT is paid by the company that
paid the dividend.  According to ASB, had there been no DDT mechanism, dividend would have been taxable in the hands of recipients (though recently dividend exceeding specified limit has been made taxable).  

Therefore, with respect to the presentation of DDT, the ASB is of the view that the relevant guidance is in paragraph 61A of Ind AS 12, Income Taxes. Para 61A states that ‘current tax and deferred tax shall be recognised outside profit or loss if the tax relates to items that are recognised, in the same or a different period, outside profit or loss. Therefore, current tax and deferred tax that relates to items that are recognised, in the same or a different period:

a)  in other comprehensive income, shall be recognised in other comprehensive income.

b)  directly in equity, shall be recognised directly in equity.’

Accordingly, the ASB has clarified that the presentation of DDT paid on dividends should be consistent with the presentation of the transaction that creates those income tax consequences, as follows:

a) Dividend charged to statement of profit and loss: Charge DDT to the statement of profit and loss.

b) Dividend recognised in statement of changes in equity: Recognise DDT in the statement of changes in equity.

c) Dividend on compound financial instruments: Recognise the portion of DDT related to dividend/interest on the debt component in the statement of profit and loss and the portion of DDT related to the equity component in the
statement of changes in equity.

Our Comments

The FAQs issued by the ICAI are expected to assist companies as they transition to Ind AS by reducing diversity in practice and enabling a more consistent interpretation of Ind AS requirements. Companies should carefully consider the clarifications issued in their implementation efforts.

In addition, companies may consider the following aspects relating to the issues discussed above:

• Business model: The determination of the business model within which financial assets are held is a matter of fact based on the way in which the entity manages its business, and is not based on management’s intention. This involves an assessment of all relevant and objective evidence including:
  • How the performance of the business model is evaluated and reported to key management personnel
  • How the risks that affect the performance of the business model are managed, and
  • How are managers of the financial assets held within that business model are compensated.

Ind AS 109 allows for the use of judgement, including consideration of past sales and expectations about future sales, along with reasons for those sales and whether they reflect a change in the entity’s business model. The following are some of the factors that may be considered by management in developing its guiding criteria:

• The frequency and significance of sales activity that is considered integral or incidental to the business model, and
• Reasons for sales – for example, sales in response to an increase in the investment’s credit risk in accordance with a documented investment policy, or sales close to maturity may be consistent with a ‘held to collect’ business model.     

Infrequent number of sales and insignificant value: Ind AS 109 also considers a scenario where there are more than an infrequent number of sales made from a portfolio of financial assets and those sales are more than insignificant in value. It states that an increase in frequency or value of sales in a particular period is not necessarily inconsistent with an objective to hold financial assets to collect contractual cash flows if the reasons for the sales can be effectively explained.  There is no quantitative bright-line measure on what frequency or value of anticipated sales would prevent a single business model from meeting the held to collect criterion.

To access the text of the FAQ on elaboration of terms used in Ind AS 109, please click here.

To access the text of the FAQ regarding DDT, please click here.