Query No. 6                    

Subject:           Accounting treatment for amalgamation of wholly owned subsidiary. 1

A.         Facts of the Case

1.         A company is listed on the stock exchanges in India and is in the business of providing services. The company has finalised a scheme of arrangement to reorganise its group structure wherein three wholly owned subsidiaries, namely A Ltd., B Ltd. and C Ltd. (hereinafter also referred to as the amalgamating companies) will be amalgamated with the company. The scheme requires fair valuation of all assets and liabilities of the amalgamating companies. The fair value of assets will be assessed by an independent valuer and the fair valuation report will be used as a basis to determine value at which the assets and liabilities will be recognised in the books of amalgamated company. Brief nature of business operations of amalgamating companies is as follows:

A Limited: - Company A is engaged in the business of making investment into the shares and securities of its group                                companies /body corporates.

 

B Limited: - Company B was set up to be engaged in the business of online services. Currently, there are no business                         operations in this company, however, it intends to carry out the business as per the object clause of the                         company.

 

C Limited: - Company C is presently engaged in the business of providing services to corporate customers.

2.        The querist has stated that as per the Scheme:

(1) Accounting for the amalgamation and treatment of goodwill or reserves, if any, in the books of amalgamated company shall be in accordance with the provisions of the Accounting Standard (AS) 14, ‘Accounting for Amalgamations' and Generally Accepted Accounting Principles (GAAPs) in India.

 

(2) With effect from the Appointed Date, amalgamated company shall record all the assets and liabilities, including any intangible assets, pertaining to the amalgamating companies transferred to and vested in amalgamated company pursuant to the Scheme, at their fair value.

 

(3) The inter-company balances between amalgamating companies and amalgamated company, if any, including any shares held by amalgamated company in amalgamating companies shall stand cancelled.

 

(4) An amount corresponding to the value of net assets transferred to amalgamated company, after making adjustment as mentioned in 3 above, shall be credited to ‘Capital Reserve Account’ (in case of excess of assets over liabilities) or debited to ‘Goodwill Account’ (in case of excess of liabilities over assets), as the case may be, in the financial statements of amalgamated company.

3.         Nature of amalgamation as per AS 14

The querist has further stated that in Indian GAAPs, accounting for amalgamations of companies is governed by a specific standard, i.e., AS 14, notified under the Companies (Accounting Standards) Rules, 2006. As per paragraph 7 of the AS 14, there are two methods of accounting for amalgamations: (a) the pooling of interests method; and (b) the purchase method. As per paragraph 8 of AS 14, the pooling of interests method can be applied only where amalgamation meets the criteria referred to in paragraph 3(e) for an amalgamation in the nature of merger. In this regard, paragraph 5 of AS 14, inter alia, states that "An amalgamation is classified as an ‘amalgamation in the nature of merger' when all the conditions listed in paragraph 3(e) are satisfied”. Further, as per paragraph 3(f) of AS 14, “Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified in sub­paragraph (e) above.”

4.         An assessment of the Scheme vis-a-vis the conditions in paragraph 3(e) for classifying the amalgamation as ‘in the nature of merger’ has been made by the querist as under:

(i) All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company:

 

This condition is satisfied - As per the Scheme, all the assets and liabilities of all the transferor companies shall become the assets and liabilities of the transferee company.

 

(ii) Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation:

 

This condition is satisfied since the transferor companies are 100% owned by the transferee.

 

(iii) The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares:

 

The transferor is a wholly owned subsidiary. Hence this clause is not applicable in the present case.

 

(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company:

 

This condition is also satisfied - The businesses of companies A, B and C are intended to be carried by amalgamated company.

 

(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies:

 

As per the Scheme, the assets and liabilities of the transferor company will be recognised by the transferee company at fair values based on a valuation report of an independent valuer. Thus, this condition is not met.

According to the querist, since all the conditions of paragraph 3(e) are not met, the amalgamation qualifies as an amalgamation in the nature of purchase.

5.    The querist has further stated that at a group level, there is no change of control. However, this does not necessarily imply that the transferred net assets should be recognised at carrying value as per the books of the transferor company. Indian GAAPs give primacy to the legal entity concept. At a legal entity level, there has been a transfer of net assets. Even internationally, there is no specific enunciation regarding the accounting of the transferred assets and liabilities in case of a common control business combination. Where the transaction qualifies as a business combination within the meaning of International Financial Reporting Standard (IFRS) 3, ‘Business Combinations', issued by the International Accounting Standards Board and involves entities under common control, by practice, the following accounting treatment applies:

• In consolidated financial statements, the acquirer in a business combination under common control applies either book value basis or IFRS 3 (fair value).
• In its separate financial statements, the acquirer uses one of the following approaches

— Book value accounting

— Fair value accounting

— Exchange amount accounting (however, this basis is not appropriate in transactions in which no consideration, or nominal consideration, has been transferred).

Thus, the practice is diverse with companies using fair value as well as book value for recognition of assets and liabilities transferred.

6.    In this regard, reference has also been made by the querist to the following discussion in AS 14:

"5.     An amalgamation is classified as an ‘amalgamation in the nature of merger’ when all the conditions listed in paragraph 3(e) are satisfied. There are, however, differing views regarding the nature of any further conditions that may apply. Some believe that, in addition to an exchange of equity shares, it is necessary that the shareholders of the transferor company obtain a substantial share in the transferee company even to the extent that it should not be possible to identify any one party as dominant therein. This belief is based in part on the view that the exchange of control of one company for an insignificant share in a larger company does not amount to a mutual sharing of risks and benefits.

 

6.     Others believe that the substance of an amalgamation in the nature of merger is evidenced by meeting certain criteria regarding the relationship of the parties, such as the former independence of the amalgamating companies, the manner of their amalgamation, the absence of planned transactions that would undermine the effect of the amalgamation, and the continuing participation by the management of the transferor company in the management of the transferee company after the amalgamation.”

(Emphasis supplied by the querist.)

As per the querist, as is evident from the above, the standard setter had considered whether additional conditions (such as, no transfer of control, the absence of planned transactions that would undermine the effect of the amalgamation, the continuing participation by the management of the transferor company in the management of the transferee company after the amalgamation) are required for classifying an amalgamation to be in the nature of merger. However, no such conditions have been prescribed in paragraph 3(e) which defines amalgamation in the nature of merger and which requires only the 5 specified criteria therein to be met. Accordingly, it would not be appropriate to apply additional considerations other than those specified in paragraph 3(e) for determining the nature of amalgamation. Thus, since all of the five conditions are not met, the additional considerations would not be relevant and the amalgamation cannot be classified as an amalgamation in the nature of merger.

7.    The querist has also stated that the transaction should be viewed as per the currently applicable notified standards in India, i.e., AS 14. This would be so, even if the relevant Ind-AS (which are yet to be notified) states otherwise. AS 14 is a notified Standard and it has to be followed. AS 14 clearly lays down that if any one or more of the five conditions listed in paragraph 3(e) is not satisfied, "an amalgamation should be considered to be an amalgamation in the nature of purchase”. In case the amalgamation is classified to be in the nature of merger to be accounted for using pooling of interest method, it would be in non-compliance of AS 14 since the conditions prescribed by the Standard for amalgamation in the nature of merger are not met. AS 14 does not preclude the use of fair value in an amalgamation within the group; the value at which assets and liabilities are being incorporated is relevant only for assessing the classification of amalgamation.

8.    The matter also needs to be considered from the perspective of the objectives that the Scheme seeks to achieve, i.e.,

•  Prioritize resource allocation amongst businesses
•  Realign business operations

The reorganisation will remove inefficiencies and combine similar business interest into one corporate entity, resulting in economies of scale, operational synergies, simplification, efficient administration, improved allocation of capital, etc.

B.    Query

9.    On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether application of purchase method under the Scheme of arrangement in the present case is in compliance with AS 14 and Generally Accepted Accounting Principles in India.

C.    Points considered by the Committee

10.    The Committee notes that the basic issue raised by the querist relates to whether the ‘purchase method', as per the principles of AS 14 can be applied in the extant case or not. Accordingly, the Committee has considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, accounting for inter-company balances between amalgamating companies and amalgamated company, if any, including the shares held by amalgamated company in amalgamating companies and consequent adjustment to reserves or goodwill in the books of the amalgamated company pursuant to amalgamation, recording of assets and liabilities of the amalgamating companies at fair value in the books of amalgamated company, etc. Further, the opinion expressed hereinafter is purely from accounting perspective and not from legal perspective involving interpretation of various legal enactments.

11.    With regard to the issue of application of method as per AS 14 in the extant case, viz., the pooling of interests method or the purchase method, the Committee is of the view that the application of any method of amalgamation depends on the type of amalgamation, viz., whether it is amalgamation in the nature of merger or it is in the nature of purchase. In this regard, the Committee notes paragraphs 3(e) and 3(f) of AS 14, notified under the Companies (Accounting Standards), Rules, 2006 as follows:

“3(e) Amalgamation in the nature of merger is an amalgamation which satisfies all the following conditions.

(i)    All the assets and liabilities of the transferor company become, after amalgamation, the assets and liabilities of the transferee company.

 

(ii)    Shareholders holding not less than 90% of the face value of the equity shares of the transferor company (other than the equity shares already held therein, immediately before the amalgamation, by the transferee company or its subsidiaries or their nominees) become equity shareholders of the transferee company by virtue of the amalgamation.

 

(iii)    The consideration for the amalgamation receivable by those equity shareholders of the transferor company who agree to become equity shareholders of the transferee company is discharged by the transferee company wholly by the issue of equity shares in the transferee company, except that cash may be paid in respect of any fractional shares.

 

(iv) The business of the transferor company is intended to be carried on, after the amalgamation, by the transferee company.

 

(v) No adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies.

3 (f) Amalgamation in the nature of purchase is an amalgamation which does not satisfy any one or more of the conditions specified in sub-paragraph (e) above."

The Committee notes from the above that as per paragraph 3(f) of AS 14, an amalgamation is an ‘amalgamation in the nature of purchase’ when all or any of the conditions listed in paragraph 3 (e) above are not satisfied. The Committee notes from the Facts of the Case that as per the Scheme of amalgamation in the extant case, "amalgamated company shall record all the assets and liabilities pertaining to amalgamating companies transferred to and vested in amalgamated company pursuant to the Scheme at their fair value". Thus, condition (v) of paragraph 3(e) of AS 14  relating to "no adjustment is intended to be made to the book values of the assets and liabilities of the transferor company when they are incorporated in the financial statements of the transferee company except to ensure uniformity of accounting policies" is not satisfied. Accordingly, the Committee is of the view that in the extant case, the definition of 'amalgamation in the nature of purchase’ as per paragraph 3 (f) of AS 14 reproduced above is met, and therefore, the company should apply ‘purchase method’ in  the   extant case as per the requirements of AS 14.

D.    Opinion

12.    On the basis of the above, the Committee is of the opinion that the application of purchase method in the extant case would be in compliance with AS 14 and GAAPs in India, as discussed in paragraph 11 above.

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1 Opinion finalised by the Committee on 3.6.2015.