Query No. 27

Subject:           Accounting treatment of dividend received on own shares held under trust.[1]

A.        Facts of the Case

1.         A public sector undertaking (hereinafter referred to as ‘the company’), registered under the Companies Act, 1956, is engaged in refining and marketing of petroleum products. The company mainly imports crude oil and after refining it through its various refineries across India, sells the finished petroleum products and after further processing, sells the petrochemicals throughout the country.

2.         The company had acquired two companies (referred to as ‘amalgamating companies’) in May 2007 and March 2009 respectively. The querist has informed that before acquisition, both the amalgamating companies were subsidiaries of the company and upon merger, the shares of the company which were issued for its holding in amalgamating companies as per swap ratio (herein after referred as ‘trust shares’) were transferred to trusts formed for this purpose. The company was the sole beneficiary for the income of trust. In the year 2011-12, both the trusts were merged and named as ‘Shares Trust’. These shares can be disposed off by the trust under the approval of the company by sale in open market. The querist has separately clarified that at the time of acquisition, the actual cost of the shares of amalgamating companies was treated as the cost of trust shares issued to the trusts in exchange of shares of erstwhile amalgamating companies. Further, Pooling of Interest method was adopted at the time of merger of both the companies.

3.         The querist has stated that the trust is a separate legal entity having the tax status of its own. The amount of dividend paid by the company to the trust is received by trust in its bank account and afterwards, the trust transfers the income to the company. The transaction is recorded as receipt and payment in the financial statements of the trust. In income tax return also, the dividend received by trust is shown as income and exemption is claimed under sub-section 34 of section 10 of the Income-tax Act, 1961. The company also pays dividend tax on the dividend declared in relation to the shares held by the trust as in case of the other shares.

4.         The querist has informed that the present accounting and disclosure followed by the company is as below:

Shares held under Trust

Presently, the shares held under the trust are shown under ‘Other Current Assets’ as ‘Receivables from Shares Trust’ at cost (representing original cost of acquisition of shares in erstwhile companies). At each reporting date, the company tends to mark to market the value of these shares by creating a provision through the statement of profit and loss for the current period. 

Income from Trust Shares

The querist has informed that as the company is the sole beneficiary of the income of trust, the dividend income from shares held under the shares trust is accounted for as dividend income under ‘Other Income’ in the year in which the right to receive dividend is established, i.e., when the dividend is approved by the shareholders in general meeting.

5.         The querist has further informed that the company has decided to review the present accounting treatment followed in respect of the trust shares as well as the income from these shares and during the course of discussion with the statutory auditors, different views emerged on the subject accounting treatment.  Thus, the company has decided to review the transaction in its entirety to follow the best practice in line with the accounting framework.  The querist has stated that the following accounting areas have been identified for review in relation to the transaction:

(a) Shares held under Trust 

Accounting for shares held under the trust as ‘Other Assets’ should be reviewed for disclosure of the same as ‘Investments’. Further, once these shares are classified as investments, whether the same can be treated as long term/current investment based on the intention of the company to dispose (cancel/sale) these shares in line with the provisions of Accounting Standard (AS) 13, ‘Accounting for Investments’. In this regard, the querist has separately clarified that the trust shares held by the company may be disposed off at the best possible opportunity, although, there is no intention either documented or otherwise for disposal of the same within 12 months as of today.

Alternatively, it may also be evaluated whether the shares held by the trust are to be shown as deduction from the share capital of the company and the difference between the face value of shares and acquisition cost/mark-to-market value may be treated as ‘Investment’ or ‘Other Assets’.

(b) Income from Trust Shares 

Whether the income from trust shares is to be accounted for as income (dividend or otherwise) through the statement of profit and loss or the same is to be treated as an item of appropriation (as the income is from own shares), i.e., to be added back to the balance of statement of profit and loss at the time of appropriation.

Also, whether the income from trust shares is to be accounted for in the year in which the dividend is proposed by the board of directors or in the next year when the same is approved by shareholders and right to receive is established.

(c) Consideration of Trust Shares while calculating Earnings Per Share (EPS) and Share Capital

Whether shares held by the trust should also be adjusted while calculating weighted average number of equity shares for the purpose of calculating basic and/or diluted earnings per share (EPS) as the sole beneficiary of these shares is the company only. If these shares are to be excluded for calculating basic EPS, then whether the same are also to be excluded for calculating diluted EPS as these shares may be considered dilutive.

 

6.         The querist has stated that there is no statutory provision available regarding accounting for trust shares and income therefrom except guidance in Accounting Standard (AS) 9, Revenue Recognition, on timing of recognising the dividend income which is reproduced below:

“8.4     Dividends from investments in shares are not recognised in the statement of profit and loss until a right to receive payment is established.”

The querist is of the view that in view of the above provisions of AS 9, the income can be recognised only when the right to receive dividend is established, i.e., on approval of dividend by shareholders in the general meeting.

The querist has drawn the attention of the Committee to the following provisions of Accounting Standard (AS) 20, ‘Earnings Per Share’, for the purpose of calculating weighted average number of equity shares outstanding during the period:

“18.     Equity shares issued as part of the consideration in an amalgamation in the nature of purchase are included in the weighted average number of shares as of the date of the acquisition because the transferee incorporates the results of the operations of the transferor into its statement of profit and loss as from the date of acquisition. Equity shares issued during the reporting period as part of the consideration in an amalgamation in the nature of merger are included in the calculation of the weighted average number of shares from the beginning of the reporting period because the financial statements of the combined enterprise for the reporting period are prepared as if the combined entity had existed from the beginning of the reporting period. …”

In view of the querist, as per the above provisions of AS 20, the shares held by trust, being issued as part of consideration in the amalgamation, are to be considered for the purpose of calculating EPS. The querist has stated that nothing is available in the accounting standard which guides for exclusion of the equity shares held by the trust whose beneficiary is the company only for the calculation of EPS.

7.         The querist has further stated that as there is no statutory provision regarding accounting for trust shares and income therefrom, the querist has analysed the practice followed by some other companies on accounting for such shares and related dividend income, which is summarised in the table below:

As per the querist, as can be seen from above, there are varied practices across companies with respect to subject issue.

8.         The querist has further stated that as the company is the sole beneficiary of the trust, it may be argued that in the standalone financial statements of the company, the share capital of the company should be presented only in respect of shares held by the outsiders, i.e., after deducting the face value of the shares held by the trust. However, in that case, the question that needs to be determined is of the treatment of the difference between present book value of these shares in the books of the company and their face value, as raised in paragraph 10 (e) below.

9.         In the context of consolidated financial statements, the querist has stated that the trust, being an entity wholly owned and controlled by the company, can be considered as a group entity for the purpose of consolidated financial statements wherein adjustments can be made from share capital of consolidated entity for holdings of subsidiary in parent company as per the provisions of Accounting Standard (AS) 21, ‘Consolidated Financial Statements’.

B.        Query

10.       The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)        Whether the disclosure of trust shares as under ‘Other Current Assets’ is in order. If not, how the same should be disclosed in the standalone financial statements?

(b)        Whether the accounting treatment followed in respect of income on trust shares by treating it as dividend income is in order. If not, how the same should be accounted for in the standalone financial statements?

(c)        Whether the timing of accounting for income from trust currently followed by the company, i.e., when the right to receive is established is in order. If not, when the same should be accounted for in the light of related statutory provisions?

(d)       Whether the equity shares held by the trust should be deducted while calculating weighted average number of shares for the purpose of basic or dilutive EPS in the standalone financial statements of the company. If yes, for which EPS?

(e)        Whether the trust shares can be presented as deduction from share capital in standalone financial statements of the company. If yes, how the difference between face value and acquisition price/mark-to-market value is to be accounted for?

(f)        Whether the trust can be treated as group entity for consolidation as per AS 21. If yes, how the trust shares and income therefrom shall be accounted in this case under standalone financial statements and consolidated financial statements of the company?

C.        Points considered by the Committee

11.       The Committee notes that, as per the querist, before acquisition, the company had held some of the shares of amalgamating companies and, upon merger, the shares of the company which were issued towards its shareholding in amalgamating companies were transferred to trusts formed for this purpose. The Committee has examined this matter purely from accounting point of view and, accordingly, has not evaluated the compliance or otherwise of this matter with the applicable laws and regulations since as per Rule 2 of the Advisory Service Rules of the Committee, the Committee does not answer issues that involve only interpretation of enactments. Similarly, the Committee has not evaluated any tax implications of the acquisition and the subsequent accounting thereof.

12.       The Committee notes that in the present case, the trusts (later on merged as one trust) had been established for the primary purpose of holding the shares of the company which were allotted to the trusts in lieu of the shares of the amalgamating companies held by the company pursuant to the trust deeds and respective schemes of amalgamation. As a result of this, while all the net assets of the amalgamating companies had been incorporated in the stand-alone financial statements of the company pursuant to the respective schemes of amalgamation, the investments in the amalgamating companies held by the company prior to the amalgamation continued in its stand-alone financial statements in the form of amount recoverable from trusts (with subsequent provisions towards decline in the market value of shares). The Committee notes that, if the company had cancelled the shares held by it in the amalgamating companies (considering these shares as consideration given up), the extant situation would not have arisen and, to that extent, lesser number of the shares of the company would have been issued as a part of amalgamation. The Committee also notes that as per the trust deed, the trusts have been established for the exclusive benefit of the company for the purpose of, inter alia, holding the shares of the company exclusively on behalf of and for the benefit of the company. Therefore, the trust is holding these shares merely as a legal owner although the beneficial owner is the company.

13.       Considering the above background and the very objective for which trusts have been formed, as discussed above, the Committee is of the view that the amounts reflected as recoverable from trusts in the stand-alone financial statements of the company, represent its own shares, in substance, although in form the trust is a separate legal entity.

14.       The Committee also notes the definition of ‘investments’ from Accounting Standard (AS) 13, ‘Accounting for Investments’, notified under the Companies (Accounting Standards) Rules, 2006 , as below:

“3.1     Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals, for capital appreciation, or for other benefits to the investing enterprise. Assets held as stock-in-trade are not ‘investments’.”

The Committee notes that an essential requirement to consider an asset as an ‘investment’ is that the asset should be held for earning income, capital appreciation or for other benefits. The Committee notes that in the present case, the income in the form of dividend income or capital appreciation is from the company’s own shares and does not represent any incremental benefit to the company as such.

15.       In view of the above, considering the ‘substance over form’ principle, the Committee is of the view that the accounting for the shares issued to two trusts (later on merged as one trust) in lieu of shares held by the company in the amalgamating companies should portray the same picture as if no shares have been issued to these trusts since, the company cannot issue shares to itself. In substance, the company, as a part of amalgamation, had issued shares only to the minority shareholders of the amalgamating companies since rest of the shareholding of amalgamating companies was already owned by it. In view of this, the Committee is of the view that the shares of the company held by the trust should be presented as a deduction from the share capital to the extent of face value of these shares. The difference between the carrying amount of the ‘amounts recoverable from trusts’ (shown as other current assets) and the face value should be presented as an adjustment to different components of reserve and surplus as if no shares have been issued, as explained above. The company should give a suitable note in the notes to accounts to explain the nature of these deductions. 

16.       The Committee also notes the definition of ‘income’ as per the Framework for the Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India, as stated below:

“Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.” (Emphasis supplied by the Committee.)

In the current case, the receipt of dividend income from trust does not result in any increase in economic benefits resulting into an increase in equity, since, in substance, the company is receiving dividend income from its own shares. The company is first making a payment of dividend on the shares held by trust and then receiving back the same amount as dividend from the trust. Therefore, the recognition of dividend received from the trust as ‘other income’ is not appropriate. Consistent with the accounting treatment prescribed in paragraph 15 above, the dividend, to the extent it relates to the shares held by the trust, should be presented as a deduction from the dividend appropriated. Since, the dividend on own shares does not fulfill the definition of income, the requirements of AS 9, as stated by the querist, are not relevant.

17.       In line with the accounting treatment prescribed above, the company should exclude the shares held by trust from the calculation of earnings per share.

18.       Considering the accounting treatment prescribed in paragraphs 15-17 above, the Committee is of the view that the question of trust being a ‘group entity’ does not arise and, accordingly, the accounting treatment followed in stand-alone financial statements, should also be followed in the consolidated financial statements.

19.       The Committee is also of the view that while carrying out the accounting treatment, as specified in above paragraphs, the company should also follow the requirements of Accounting Standard (AS) 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies, notified under the Companies (Accounting Standards) Rules, 2006 with regard to prior period items.

D.        Opinion

20.       On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 10 above:

(a)        The shares of the company held by the trust should not be presented as under ‘Other Current Assets’. Instead, these should be presented as deduction from the share capital to the extent of face value of these shares, as discussed in paragraph 15 above.

(b)        Since, the dividend on own shares does not fulfill the definition of income, the   recognition of dividend received from the trust as ‘other income’ is not appropriate. The dividend to the extent it relates to the shares held by the trust, should be presented as a deduction from the dividend appropriated, as discussed   in paragraph 16 above.

(c)        In view of (b) above, answer to this question does not arise.

(d)       The equity shares held by trust should be excluded while calculating earnings per share, as discussed in paragraph 17 above.

(e)        The shares of the company held by the trust should be presented as deduction from the share capital to the extent of face value of these shares. The difference between the carrying amount of the ‘amounts recoverable from trusts’ (shown as other current assets) and the face value should be presented as an adjustment to different components of reserve and surplus as if no shares have been issued, as     explained in paragraph 15 above.   The company should also give a suitable note in the notes to accounts to explain the nature of these deductions.

(f)        Considering the accounting treatment prescribed in paragraphs 15-17 above, the question of treating the trust being a ‘group entity’ does not arise and, accordingly, the accounting treatment followed in stand-alone financia statements of the company should also be followed in its consolidated financial statements.

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