Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.9       Query

 

Treatment of Development Rebate Reserve of an acquired companyon its becoming free after the acquisition and the treatment of preacquisition profits accruing and arising after acquisition

 

1.The Government of India acquired a company ‘X’ Ltd., which was carrying on the business of exploration, production, marketing and distribution of oil through an Acquisition Act passed on 29th September, 1981. In exercise of the powers vested in the Central Government under the provisions of the Act, assets and liabilities of ‘X’ Ltd., to the extent they related to production, marketing, and distribution of oil were vested in the Government Company ‘Y’ Ltd., with effect from 14th October, 1981. The purchase consideration was settled by the Government by making a cash payment to the shareholders of ‘X’ Ltd. as per Section 5 of the Acquisition Act.

 

2.‘Y’ Ltd. incorporated the value of assets and liabilities, including Rs. 15.82 lakhs on accounts of Development Rebate Reserve of ‘X’ Ltd., in its accounts for the year 1981-82. ‘Y’ Ltd. merged the aforesaid amount of Development Rebate Reserve with its own Development Rebate Reserve Account.

 

3.An amount of Rs. 11.39 lakhs in 1981-82 and Rs. 1.16 lakhs in 1982-83 was transferred from Development Rebate Reserve Account out of Rs. 15.82 lakhs carried over from ‘X’ Ltd., to General Reserve Account, after it became free from the conditions laid down under Section 34(3a) of the Income-tax Act, 1961.

 

4.The Government issued orders on 31st July, 1982, allowing additional margins, with effect from 1st April, 1981, to the oil industry including ‘X’ Ltd. As a result of which an amount of Rs. 105.25 lakhs accrued to ‘Y’ Ltd., on account of ‘X’ Ltd., for the period between 1st April, 1981 to 13th October, 1981, i.e., period prior to its acquisition. The company treated it as revenue income while finalising the accounts for 1981-82, on the ground that it came into existence for the first time to ‘Y’ Ltd., only on 31st July, 1982- much after the date of take-over.

 

5.The aforesaid treatments in respect of Development Rebate Reserve and the additional margins related to pre-acquisition period have been agreed to by the statutory auditors of ‘Y’ Ltd. This treatment has also been supported by the solicitors of the company. However, the company has now been advised that:

 

i)          the balance of Development Rebate Reserve of erstwhile ‘X’ Ltd. should be shown distinctly and not merged with its own Development Rebate Reserve:

 

ii)         the transfers from Development Rebate Reserve should have been made to a Capital Reserve when it became free from the provisions of Income-tax Act instead of to General Reserve; and

 

iii)         the additional margins received for the pre-acquisition period in respect of ‘X’ Ltd. should be  treated as ‘Capital Reserve’ and not as income of the period in which they have arisen.

 

6. ‘Y’ Ltd. has argued that the aforesaid treatments are in accordance with the terms of section 7(1) of the Acquisition Act which confers on the ‘Y’ Ltd the, the same rights, and interest in respect of any property which ‘X’ Ltd. held immediately before the date of the acquisition. ‘X’ Ltd. had a right to transfer the money from its Development Rebate Reserve to General Reserve after it became free from the conditions prescribed in Section 34(3a) of the Income–tax Act. This right of ‘X’ Ltd. had been vested with ‘Y’ Ltd. in terms of the above section, and therefore, has been exercised accordingly. The company has argued further that had it carried the amount to capital reserve, it would have deprived the share-holders their right under the aforesaid section 7(1), read with section 9(1) of the Acquisition Act to use the amount to be declared as dividend which existed with ‘X’ Ltd. The said sections are reproduced below:

 

“7.(1)  Every right or interest in respect of any property in India (including a right under any lease or under any right of tenancy or any right under any arrangement to secure any premises for any purpose), which a specified company held, immediately before the appointed day, shall, notwithstanding anything contained in any other law or in any agreement or instrument relating to such right or interest, vest in, and be held by, the Central Government on and after that day on the same terms and conditions on which the specified company would have held it, if no negotiations had taken place for the acquisition by the Central Government of the  undertakings in India of the specified company or, as the case may be, if this act had not been passed.

 

9.(1)  Notwithstanding anything contained in sections 5, 6 and 7, the Central Government may, subject to such terms and conditions as it may think fit to impose, direct, by notification, that the right, title and interest and the liabilities of each specified company in relation to its undertakings in India which have vested in that Government under section 5 shall, instead of continuing to vest in the Central Government vest in one or more Government companies either on the date of the notification or on such earlier or later date (not being a date earlier than the appointed day) as may be specified in the notification.”

 

7.The opinion of Expert Advisory Committee has been sought on the following issues arising from the above as to whether:

 

(i)         the balance of the Development Rebate Reserve of the undertaking of ‘X’ Ltd. has been correctly shown along with balances of the Development Rebate Reserve of ‘Y’ Ltd. during the years 1981-82 and 1982-83 instead of showing distinctly and separately in the balance sheet as now advised;

 

(ii)        the transfers from the Development Rebate Reserve Account to the General Reserve Account have been carried out by ‘Y’ Ltd. as per normal accounting practices in terms of the rights vested in it as per section 7(1) read with section 9(1) of the Acquisition Act instead of showing them as capital reserve account;

 

(iii)       the profits which accrued to ‘Y’ Ltd. for transactions of the undertaking of ‘X’ Ltd. after the acquisition i.e., 14.10.81 for the period prior to 14-10-1981 have been taken correctly as revenue income instead of treating them as Capital Reserve.

 

Opinion                                                                                                                       April 30, 1984

 

1.The Committee notes that the Research Committee of the Institute of Chartered Accountants of India has issued a ‘Guidance Note on Accounting Treatment of Reserves in Amalgamations’. The Committee also notes that as per para 9(a) of the Guidance Note, only the treatment of reserves in respect of those amalgamations, which arise “pursuant to a Court Order under Section 394 of the Companies Act, 1956 or pursuant to a Government Notification under Section 396 of the said Act”, are covered by this Guidance Note. The Committee is therefore, of the view that the treatment of Development Rebate Reserve of a company taken over by the Government, which is subsequently vested in a Government Company, is not covered by the said Guidance Note.

 

2.The Committee is also of the view that Section 7(1) and 9(1) of the Acquisition Act, reproduced in para 6 above, are not relevant for the purpose of accounting treatment of Development Rebate Reserve of ‘X’ Ltd., on its becoming free from the requirements of Section 34(3a) of the Income-tax Act, in the hands of ‘Y’ Ltd., since the said sections primarily deal with those contractual rights and liabilities of the transferor company which are related to only property etc.

 

3.In view of the above, the Committee decided that the matter should be considered on the basis of the prevailing accounting principles and practices.

 

4.According to the prevailing accounting principles and practices, in the case of take-overs, the aggregate of the ‘consideration and the amount of liabilities taken over are deducted from the book value of the net assets of the transferor company (or in the case of revaluation the revalued amount). If the result of the computation is positive the same is credited to capital reserve and if the result is negative, the same is debited to goodwill. It may be noted that the preacquisition profits and reserves, including the revenue reserves are not-deducted from the net assets. In other words the amount of the reserves of the transferor company either increases the amount of capital reserve or it reduces the amount of goodwill, whatever may be the case. In view of this, the Committee feels that the Development Rebate Reserve of the transferor company is capital in nature, even though, it has been shown as Development Rebate Reserve in the Balance Sheet of the Transferee Company in order to enable it to continue to avail of the Income-tax relief. Because of the capital nature of the Development Rebate Reserve so transferred, the Committee is of the view that it should not be merged with the Development Rebate Reserve of ‘Y’ Ltd. but should be disclosed separately, with appropriate disclosure of its nature, in the balance sheet of ‘Y’ Ltd. The Committee is further of the view that when the Development Rebate Reserve becomes free from the conditions laid down in Section 34(a) of the Income-tax Act, it does not lose its capital nature and therefore should be transferred to Capital Reserve and not to General Reserve.

 

5.With regard to the amount of Rs. 105.25 lakhs as additional margins on oil for the pre-acquisition period in respect of ‘X’ Ltd., the Committee is of the view that it should be treated as the revenue income of ‘Y’ Ltd., since it accrued only after the acquisition of ‘X’ Ltd.

 

6.On the basis of the above consideration, the opinion of the Committee, on the issues raised by the company, is as follows:

 

(i)         The balance of Development Rebate Reserve of erstwhile ‘X’ Ltd. should have been shown distinctly and not merged with the Development Rebate Reserve of ‘Y’ Ltd., for the year 1981-82 and 1982-83.

 

(ii)        The transfers from Development Rebate Reserve should have been made to a Capital Reserve Account when it became free from the requirements of the Income-tax Act, and not to General Reserve, as per normal accounting practice in this regard.

 

(iii)       The profits which accrued to ‘Y’ Ltd., for transactions of the undertaking of ‘X’ Ltd. after the acquisition i.e. for the period prior to 14-10-81 have been correctly treated as revenue income instead of transferring them to a Capital Reserve Account.

 

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