Query No. 46                   
Subject:           Classification of investments in subsidiary and other companies and bonds of infrastructure finance companies/banks as trade investment.[1]

A. Facts of the Case

                                   
1.         A public limited company (hereinafter referred to as the ‘company’) was registered under the Companies Act, 1956 in January 2006. The company was set up as a special purpose vehicle to provide long term infrastructure finance as per the Scheme for financing viable infrastructure projects (SIFTI) through a special purpose vehicle. The company was also registered as Non-Banking Financial Company (NBFC) - Infrastructure Finance company with the Reserve Bank of India on 9th September, 2013. The company provides long term financial assistance to infrastructure projects in the country. The entire paid up equity capital of the company of Rs. 3300 crore is held by the Government of India. The company provides infrastructure finance through direct lending, refinance and take out finance scheme(s) as per SIFTI. The company has also taken up pilot Credit Enhancement Scheme to provide guarantee for bonds issued by infrastructure project companies.

2.         The company has raised long term debt by way of loans from Life Insurance Corporation of India, National Small Saving Fund (NSSF) and privately placed and public issue of bonds listed in India, foreign currency loans from bilateral and multilateral institutions viz., Asian Development Bank, Kreditanstalt für Wiederaufbau and the World Bank. The borrowings of the company except those guaranteed by the Government of India (GOI) are secured by charge on the assets of the company. The resources of the company are held in the form of bank deposits or loans to infrastructure projects. Besides, the company also holds investments in subsidiary and other companies engaged in infrastructure sector viz., Delhi Mumbai Industrial Corridor Development Corporation Limited (DMICDC) and bonds of infrastructure finance companies (IFC)/banks as per the investment policy approved by the Board of Directors.

3.         The company holds entire paid up equity share capital in the following subsidiary companies:

• A Limited was incorporated with the Registrar of Companies of England and Wales at London in February 2008 under the UK Companies Act, 1985 to provide foreign currency lending to Indian companies implementing infrastructure projects in India, by way of co-financing by extending long term financing (minimum average maturity of 8.5 years for the purpose of import of plant and machinery) for such projects, solely for the capital expenditure outside India.

 

• B Limited was promoted by the company in February 2012 with the objective of providing project advisory services in the areas of project appraisal, debt syndications and project development services including feasibility studies, project structuring, financial structuring, and transaction advisory services. B Ltd. started its business operations in March 2012.

 

• C Limited, a public limited company, incorporated under the Companies Act, 1956 on 28th March, 2012, was established to act as Asset Management Company (AMC) of infrastructure debt funds (IDF) by way of mutual fund route. C Ltd. has also been granted the approval by the Securities and Exchange Board of India (SEBI) to act as the asset management company of the company – Mutual Fund (IDF).

 

• Besides, the Government of India (GOI) vide letter no. 19/08/2012-IF dated 4th January, 2013 conveyed in-principle approval for merger of Irrigation and Water Finance Corporation Limited (IWRFC) in the company. The Government has conveyed approval for making it a subsidiary of the company, vide letter no. 19/8/2012-IF-I, dated 13th December, 2013. The process of making IWRFC as subsidiary of the company and thereafter merger into the company is underway. The Board of Directors of the company in a meeting held on 11th August, 2014 decided to request the Government of India to consider the proposal to merge IWRFC into the company by-passing the step of making it as subsidiary of the company.

Background for classification of investments in subsidiary and other companies and bonds of infrastructure finance companies/banks as trade investment

4.         The company has been classifying the investments in subsidiary and other companies engaged in infrastructure, viz., DMICDC and bonds of IFC/banks as trade investments in line with the objective of the company to provide long term financing to infrastructure sector. The company has made these investments since it was not possible for the company to directly undertake business activities undertaken by the subsidiary companies and DMICDC. Further, the company also acquired and held investment in bonds of Non Banking Financial Companies -Infrastructure Finance Companies viz., Rural Electrification Corporation Limited (REC), Power Finance Corporation Limited (PFC), Indian Railway Finance Corporation Limited (IRFC). Accordingly, business activities of investee companies are considered as activities for promotion of trade of the company and investment in subsidiary companies and DMICDC are classified as trade investment. Likewise, investment in bonds of NBFC-IFCs and banks are also classified as trade investment. 

5.         The querist has stated that as per paragraph 8.7.2.1 of the Guidance Note on the Revised Schedule VI to the Companies Act, 1956, issued by the Institute of Chartered Accountants of India, the term ‘trade investment’ is normally understood as an investment made by a company in shares or debentures of another company, to promote the trade or business of the first company. However, Comptroller and Auditor General of India (CAG) which conducts supplementary audit of accounts of the company under section 619 (3) (b) of the Companies Act 1956, while conducting audit of accounts of company for the year ended 31st March, 2014 inter-alia commented that:

“Trade investment, as per the para 8.7.2.1 of the Guidance Note on the Revised Schedule VI to the Companies Act, 1956, is normally an investment made by a company in shares or debentures of another company, to promote the trade or business of the first company.  The investments shown as ‘trade investments’ are not in the nature of trade investments as tabulated below:

In view of the above, the said investments should be classified as Other Investments.”

6.         The company’s reply on the above audit observation has been supplied by the querist for the perusal of the Committee. The statutory auditors of the company also agreed with the views of the company. According to the querist, the classification of investment by the company in subsidiary and other companies, viz., DMICDC and also in bonds of NBFC-IFC’s and banks is in line with the Guidance Note on the Revised Schedule VI to the Companies Act, 1956. The company, vide letter dated 4th July, 2014, has given assurance to the CAG that matter regarding classification of investments in subsidiary and other companies and bonds of NBFC infrastructure finance companies / banks as trade investments will be referred to the Expert Advisory Committee of the Institute of Chartered Accountants of India (ICAI) for opinion for appropriate treatment from the next financial year.

7.         Views of the company:

The company has been classifying investments in subsidiary companies, DMICDC and bonds of infrastructure finance companies/ banks as trade investment considering the following factors:

(a) Nature of operation – The objective of the company is providing long term financial assistance to infrastructure projects. Accordingly, the investments made in the infrastructure sector to promote the business of the company are classified as trade investment.

(b) Compliance with the Guidance Note on the Revised Schedule VI to the Companies Act, 1956 – Paragraph 8.7.2.1 of the Guidance Note reads as follows:

“The term trade investment is normally understood as an investment made by a company in shares or debentures of another company to promote the trade or business of the first company”.

B.        Query

8.         In view of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether it is appropriate for the company to classify the investments in subsidiary and other companies viz., DMICDC and bonds of NBFC infrastructure finance companies and banks as per its mandate as trade investment.

C.        Points considered by the Committee

9.         The Committee notes that the basic issue raised by the querist relates to classification of investments in subsidiary and other companies and bonds of NBFC infrastructure finance companies and banks as trade investments.  The Committee, has therefore, considered only this issue and has not considered any other issue that may arise from the Facts of the Case, such as accounting for various investments made by the company, accounting for merger of IWRFC into the company, consolidation of various subsidiaries in the consolidated financial statements, etc. Further, the opinion being expressed hereinafter is purely from the perspective of classification and disclosure as per the requirements of Schedule VI (revised) to the Companies Act, 1956 and not from any other perspective.

10.       With regard to classification of trade investments, the Committee notes that Note 6 (K) (i) of General Instructions for Preparation of Balance Sheet to Schedule VI (revised) to the Companies Act, 1956 states as follows:

“K.        Non-current investments
(i)   Non-current investments shall be classified as trade investments and other investments and further classified as:

(a) Investment property;
(b) Investments in Equity Instruments;
(c) Investments in preference shares;
(d) Investments in Government or trust securities;
(e) Investments in debentures or bonds;
(f) Investments in Mutual Funds;
(g) Investments in partnership firms;
(h) Other non-current investments (specify nature)

Under each classification, details shall be given of names of the bodies corporate (indicating separately whether such bodies are (i) subsidiaries, (ii) associates, (iii) joint ventures, or (iv) controlled special purpose entities) in whom investments have been made and the nature and extent of the investment so made in each such body corporate (showing separately investments which are partly-paid). In regard to investments in the capital of partnership firms, the names of the firms (with the names of all their partners, total capital and the shares of each partner) shall be given.” (Emphasis supplied by the Committee.)

Further, paragraph 8.7.2.1 of the Guidance Note on the Revised Schedule VI to the Companies Act, 1956, issued by the Institute of Chartered Accountants of India states as follows:

“8.7.2.1 Trade Investment

Note 6(K)(i) of Part I requires that non-current investments shall be classified as "trade investment" and "other investments". The term “trade investments” is defined neither in Revised Schedule VI nor in Accounting Standards.

The term "trade investment" is, however, normally understood as an investment made by a company in shares or debentures of another company, to promote the trade or business of the first company.”

From the above, the Committee notes that a trade investment is a non-current investment. Further, the Committee notes that trade investment can be in the form of equity instruments in subsidiaries, joint ventures, associates, etc. or debt instruments in the form of debentures and bonds, etc. Thus, the classification as trade investment does not depend upon the legal form; rather it depends upon the purpose/intent of such investment, viz., for promotion of the trade or business of the investing company. The Committee is of the view that whether the investment is made by the company to promote its trade or business should be determined from the actual facts and circumstances, which may be evidenced from the resolution of the Board of Directors, or the shareholders’ approval, minutes of the meetings of the Board of Directors or shareholders or any other approving authority, etc. The Committee is further of the view that the term, ‘to promote the trade or business’ can be commonly understood in relation to investments for protecting or enlarging the activities of the investing enterprise and accordingly, while determining the nature of investment, the type/nature of business of the investing and investee company and connection with the business of investee company should also be considered. Accordingly, the Committee is of the view that to determine which investments are trade investments in the extant case, the company should consider its own facts and circumstances keeping in view the various factors as discussed above, such as, whether the investment is non-current investment, the intent of the company while making investment viz., to promote its trade or business, the type/nature of the businesses of the investing and investee company, connection with the business of the investee company, etc.

D.        Opinion

11.       On the basis of the above, the Committee is of the view that appropriateness of classification of investment in subsidiary and other companies viz., DMICDC and bonds of NBFC infrastructure finance companies and banks as per its mandate as trade investment would depend upon the consideration in the facts and circumstances of the company considering various factors, as discussed in paragraph 10 above.

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[1]Opinion finalised by the Committee on 6.2.2015.