Thursday, February 11, 2016

Adoption of Indian Accounting Standards (Ind AS) by Banks, Insurance Companies and NBFCs – Effects of Transition and Potential Hurdles

[The following guest post is contributed by Arka Saha, who is a 4th Year B.A.LL.B. (Hons) & Executive Student in CS (ICSI) at National Law University Odisha (NLU-O)]

To bring about systemic convergence of financial reporting standards in vogue in the case of Indian banking companies, Insurance companies and Non-banking Financial Companies with those recognised and accepted globally, the Indian Government posited the roadmap for the adoption of Indian Accounting Standards (Ind As) by these companies on the 18 January 2016.[1] As per the press release, scheduled commercial banks and insurance companies have to switch over to the Ind As, which are a set of accounting standards in concurrence with the International Financial Reporting Standards (IFRS) barring certain carve-outs,  promulgated by the Ministry of Corporate Affairs, from the period commencing from 1 April 2018. The nature of these standards mandate a paradigm shift in the financial reporting process for these companies and its adoption is likely to have a drastic impact on the company's financial statements.

Prevalent Accounting Standards and the Need for Change

The Indian GAAP or the Generally Accepted Accounting Principles area collection of pronouncements by various regulatory authorities in India pertaining to the mode of recognition, measurement and disclosure of data in the books of accounts of companies.Section 211(3C) of the Companies Act, 1956, introduced by the Companies (Amendment) Act, 1999, mandated compliance with Accounting Standards  that were recommended by the Indian Institute of Chartered Accountants of India (ICAI) and notified by the Central Government. These standards, were incorporated into legislation by the Companies (Accounting Standards) Rules, 2006 and made applicable to all companies vide Notification G.S.R. 739(E) dated 7 December 2006.  In 2011, the Revised Schedule VI to the Companies Act, which contained a new format for the preparation and presentation of financial statements as required under section 211 of the Act, and framed as per the existing standards notified by the 2006  rules, was issued by the Ministry of Corporate Affairs. The coming into force of the Companies Act 2013 saw the same standards of reporting and similar format being retained in Schedule III under section 129.

The accounting standards issued by the ICAI were made  applicable to banks by the sector regulator,  the Reserve Bank of India, vide circulars and guidelines and to Insurance companies by the Insurance Regulatory and Development Authority (IRDA) vide IRDA (Preparation of Financial Statements and Auditor's Report of the Insurance Companies) Regulations 2002. Banking companies, have to prepare their accounts as per the format contained in the third schedule to the Banking Regulation Act, 1949. The requirements stipulated in Schedule VI (and subsequently Schedule III of the Companies Act 2013) relating to profit and loss account and  the balance sheet of a company also apply to those of a banking company, unless inconsistent with the provisions of the Banking Regulation Act.  In summary, all kinds of companies are mandated by law to follow GAAP as set out by the ICAI and modified by sector regulators. It is pertinent at this juncture, to note that the Indian GAAP, being discordant with the IFRS, which are a set of internationally recognised and accepted accounting standards promulgated by the International Accounting Standards Board (IASB),[2]  has resulted in the lack of comparability of Indian companies with their international counterparts across various jurisdictions.

Adoption of IFRS confers various advantages over the GAAP, such as cost saving by multinationals, increased comparability between companies world-wide, increased access to foreign capital markets in jurisdictions wherein IFRS is mandatory for listing, improved consistency and transparency, and so on. These advantages of adopting the IFRS were recognised by the ICAI in October 2007, with it issuing a concept paper on convergence of accounting standards with the IFRS. The concept paper mooted the idea of adoption of IFRS by public interest entities such as public listed companies, banking companies and insurance companies on or after the financial year commencing from 1 April 2011. India further reiterated its ambition to converge extant accounting standards with the IFRS at the G20 summit in Pittsburgh in 2009 and subsequently, the Ministry of Corporate Affairs released a roadmap ended towards the convergence of the prevailing accounting standards with IFRS for companies, not being banking companies, insurance companies and NBFCs, in 2010. The roadmap, posited two separate sets of standards under Section 211(3C) of the Companies Act: one, the standards newly converged with the IFRS, which would be applicable to certain classes of companies from dates specified in the roadmap called Ind As, and second, the extant accounting standards, which would be applicable to unlisted entities  having a net worth of less than Rs. 500 crores or less, and small and medium companies.

In March 2010, the Ministry of Corporate Affairs issued a roadmap for the convergence of accounting standards for Banking Companies, Insurance Companies and NBFCs. The Ministry of Corporate Affairs, in 2011, placed 35 Ind ASs, converged with the IFRS on its website, but without an implementation date. Consequently, the companies covered under the initial roadmap of 2010 did not implement the same. The same accounting standards continued to be in force for companies with the enactment and subsequent notification of the Companies Act 2013.[3]

Subsequently, four more Ind ASs were recommended by the ICAI. In 2015, these accounting standards were notified by the Ministry of Corporate Affairs under the Companies (Indian Accounting Standards) Rules 2015, under section 133 of the Companies Act, 2013. The rules laid down the roadmap pertaining to the adoption of Ind ASs by companies, but chose to leave out Banking companies, Insurance Companies and NBFCs outside its purview. The predominant reason for the late proposed adoption of Ind As by banks, insurance companies and NBFCs was the non finalisation of IFRS 9, pertaining to financial instruments, which was later issued by the IASB in July 2014.

The Recent Measures

The roadmap for implementation of Ind As by scheduled commercial banks and insurance companies notified vide a press release dated 18 January 2016 requires all scheduled commercial banks (barring Regional Rural Banks) , All-India Term Lending Refinancing institutions like EXIM Bank, NABARD, SIDBI  and NHB, and insurance companies, to prepare Ind-As based financial statements for the financial year commencing 1 April 2018 with comparatives for periods ending 31 March 2018. Further, regardless of the requirement under the roadmap for Ind-As adoption by companies, the holding company, a Joint Venture Company, subsidiaries and associate companies of a scheduled commercial bank (excluding RRBs) will have to implement Ind-As and prepare financial statements based on these standards for accounting periods starting from 1 April 2018, with comparatives for periods ending 31 March 2018.

The implementation of Ind-As by NBFCs, as per the notification is to be carried out in two phases, with phase 1, including NBFCs with a net-worth of over Rs. 500 crores and their holding companies, subsidiaries, Joint Venture companies and associate companies, and commencing from the accounting period starting 1 April 2018, with comparatives for periods ending 31 March 2018.  NBFCs covered under phase -II of implementation of Ind-As are those having a net-worth of more than 250 crores and less than 500 crores, NBFCs whose debt securities or equity is listed or is to be listed in a recognised stock exchange either in India or abroad having net worth of less than Rs. 500 crores. These NBFCs  have to present Ind-As compliant financial statements from the accounting periods commencing 1 April 2019, with comaparatives for periods ending 31 March 2019. The requirement of implementation of Ind-As under this phase extends to holding companies of the NBFCs included in phase II, their subsidiaries, associate companies and Joint Venture companies.  The press release further prohibits scheduled commercial banks, NBFCs and insurance companies who do not fall under the roadmap presented from adopting Ind-As voluntarily in order to encourage a structured and phased transition to the new standards. However, these companies are not prohibited from providing to their parent companies  or investor companies Ind-As compliant financial statements, if such parent company is mandated under law to prepare consolidated financial statements compliant with Ind-As.

It is pertinent to note that for the companies covered in the roadmap, Ind-As is to be applicable to both individual and consolidated financial statements. The notification also specifically excludes Urban Cooperative Banks (UCBs) and Regional Rural banks (RRBs) from Ind-As implementation.

Effects of Transition

For a company moving from the GAAP to Ind-As, requirements of Ind-As 101 have to complied with, of which the primary requirement is the retrospective application of Ind-As, barring certain optional and mandatory exceptions to retrospective application. It is pertinent to note that adjustments arising from the initial application of Ind-As are to be adjusted against the opening retained earnings of the first period and is thus likely to negatively impact the retention ratio of implementing entities.

The earliest accounting period for which the entities included in the roadmap have to prepare Ind-As compliant financial statements is 1 April 2018. However, due to the requirement of having a comparable equivalent balance sheet, Ind-As compliant accounts have to be constructed from the period beginning 1 April 2017.The author is of the opinion that the requirement to prepare Ind-As compliant comparatives shall give the companies who have to prepare them mandatorily from 1 April 2017 very little time for the same, given the lack of skilled professionals conversant with the nitty-gritties of these converged accounting standards.

The gravest impact on Indian banks could be due to the adoption of Ind-As 109. In a time when banks in India are stressed due to the rising gross NPAs and weak assets, the adoption of Ind-As 109, which proposes a paradigm shift in the accounting model for impairment is tricky, to say the least. Indian banks traditionally, as per the extant international standard IAS 39, require loan loss provisions to be made upon the impairment taking place. This model has come to be widely criticised, and in pursuance of rectifying it, Ind-As 109, which is based on IFRS 9, adopts an “expected credit loss” framework.[4] Under this framework, an entity is mandated to set its expected credit loss arising out of a financial asset on the basis of “reasonable and supportable information that is available without undue costs or effort. These include historical, current and forecast information. [5]

The adoption of Ind-As 109 thus gives rise to three separate conundrums, one pertaining to capital requirement, and the other pertaining to associated costs of implementation and the third one pertaining to lack of consistence and objectivity. The Expected Credit Loss Model, juxtaposed to the Incurred Credit Loss model currently being followed, by virtue of relying on notions of risk of default, will require higher provisioning for loss, which is an expense, thus affecting the opening balance of retained earnings, and capital.  Pertaining to the second conundrum, it is pertinent to note that the Expected Credit Loss Model is “data intensive and necessitates fairly sophisticated credit modelling skills”[6] raising costs of implementation.

Thirdly, Under the Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances (IRACP), which Indian banks have to mandatorily follow, provisioning requirements are based on an objective criteria, as opposed to the subjective criterion followed under Ind-As 109. Under the extant norms, provisioning requirements come into play as per the '90 day rule', whereas under Ind – As 109, provisioning is largely dependent on management judgement. Thus, the objectivity of an RBI mandated criteria and consistency among banks is lost with adoption of Ind As 109.

Conclusion

The author is of the opinion that the adoption of Ind-As, focused towards bringing accounting in India in convergence with global standards under the IFRS, is a welcome step in spite of all the transient issues plaguing first time adoption. It is pertinent to note that India has chosen to converge its accounting standards with the IFRS as against complete adoption, with certain carve-outs. The presence of these carve-outs however, will take away some benefits of converging with the IFRS, such as listing of securities in capital markets abroad, that require IFRS compliance. It will also be interesting to see how the adoption of Ind-As affects M&A activities of banks, with more NPAs now set to be provisioned for, a move ultimately reflecting poorly on the health of such banking companies.

- Arka Saha


[1]    Roadmap drawn-up for implementation of Indian Accounting Standards (Ind AS) converged with International Financial Reporting Standards (IFRS) for Scheduled Commercial Banks (Excluding Rrbs), Insurers/Insurance Companies and Non-Banking Financial Companies (NBFC’s) , Press Information Bureau , Ministry of Corporate Affairs, Government of India, 18 January 2016  available at http://pib.nic.in/newsite/PrintRelease.aspx?relid=134578.
[2]    IFRS are a set of standards, frameworks and interpretations required for the preparation of Financial Statements. The term used herein includes the International Accounting Standards issued by the International Accounting Standards Committee (IASC) – the predecessor to the International Accounting Standards Board (IASB) and all interpretations. Presently, the IFRS consists of International Accounting Standards, International Financial Reporting Standards, Standard Interpretations, and the International Financial Reporting Interpretations.
[3]     General Circular No. 15/2013, available at http://www.mca.gov.in/Ministry/pdf/General_Circular_15_2013.pdf.pdf
[4]    5.5.1, Indian Accounting Standard (Ind AS) 109, available at www.mca.gov.in/Ministry/pdf/INDAS109.pdf
[5]    5.5.11, Indian Accounting Standard (Ind AS) 109
[6]    Report of the Working Group on Implementation of Ind AS by Banks in India, Reserve Bank of India, 2015

Wednesday, February 10, 2016

Retrospective Amendments to the Payment Of Bonus Act

[The following post is contributed by Bhushan Shah  from Mansukhlal Hiralal & Company]

The Payment of Bonus Act, 1965 (“Bonus Act”) requires the payment of compulsory bonus to certain employees of an establishment which employs 20 or more persons. The erstwhile provisions of the Bonus Act provided for payment of bonus to the employees drawing a salary not exceeding Rs 10,000/- per month and who has worked for not less than 30 days in an accounting year. Further, the erstwhile provisions of the Bonus Act provided that in the event the wage/salary of an employee exceeds Rs 3,500/- and Rs 500/- per month then, the bonus shall be calculated on the salary as being Rs 3,500/-.

Amendment

The Payment of Bonus (Amendment) Act, 2015 (“Amendment Act”) received Presidential assent on 31 December 2015. The Amendment Act provides for major changes in the eligibility limit and calculation of bonus of the employees under the Bonus Act.

Increase in Eligibility Limit: The Amendment Act has widened the scope and eligibility of payment of bonus to employees from the earlier drawn salary of Rs 10,000/- to Rs 21,000/- now.

Calculation of Bonus:  Further for the purpose of calculating bonus, the salary limit which was earlier Rs 3,500/- has now been revised to Rs 7,000/-. 

Retrospective Amendment: This Amendment Act is made applicable retrospectively from 1 April 2014. However, Kerala High Court has stayed the retrospective applicability of the Amendment Act. Vide an interim order, the Kerela High Court has held that the Amendment Act shall be applicable prospectively from 2015-16.

Comments

The Amendment Act is a positive move by the Government as it revises the limits for payment of bonus commensurate with the realities of today’s economic scenario. However, the Amendment Act should have been made applicable prospectively as retrospective application of the Amendment Act has caused unrest amongst employers and has given rise to unnecessary litigation.

- Bhushan Shah 


FDI in Marketplace Model – New Proposal for E-commerce

[The following guest post is contributed by Ananya Banerjee, a 5th Year Student of University of Calcutta, Department of Law]

Press Trust of India has reported on February 9, 2016 that the government is considering permitting 100% FDI in the marketplace model of e-commerce to attract more foreign investments. It was already expected that the Government would soon come up with a proper definition of ‘marketplace’ to effectively regulate the companies carrying on e-commerce through this model.

With several regulations addressing the marketplace, the point of confusion was as to which type of business would constitute a marketplace. In addition to that, the existing regulations do not adequately cover the ever evolving and fast growing e-commerce sector of India. Although, the Consolidated FDI Policy of 2015, as amended from time to time, does not allow foreign investment in e-commerce, the industry giants like Flipkart, Snapdeal, Amazon etc. have found a way to avoid this hurdle and have designed their business structure in a manner similar to that of Alibaba, the famous e-commerce company of China which provides an online marketplace for sellers.

Presently, there are no restrictions on FDI in such a marketplace model as the FDI Policy does not even include anything relating specifically to the marketplace model, although it allows 100% FDI in B2B e-commerce activities under the automatic route. In effect, these companies do not provide marketplace only, they also provide inventory services, delivery services and other related services, in a way that carefully avoids direct B2C e-commerce, yet enables these companies to attract foreign investment.

The Union Government is taking several policy reviews to change the economic scenario of the country, and in addition to policies like ‘make in India’, ‘Startup India’ the Government has also liberalized the FDI Policy to a great extent. With a view to further extending the effect of liberalization and to attracting more foreign investment, the Government is now considering allowing 100% FDI in marketplace model. This step by the Government only means that it will not only come up with regulations relating to e-commerce, but it would also define the term ‘marketplace’ so that the e-commerce companies are aptly regulated by these laws.
The effect and extent of the proposed review would be clear only when the proposal by the Department of Industrial Policy and Promotions is passed.

- Ananya Banerjee


Proposed Changes in Corporate Tax – A Brief Overview

[The following guest post is contributed by Ananya Banerjee, a 5th Year Student of University of Calcutta, Department of Law]

After the Budget Speech, 2015 of the Finance Minister, the Income Tax Department has come out with a phasing out plan under the Income Tax Act. In the Speech, the Minister indicated that the corporate tax burden will be reduced from 30% to 25% in the next four years. But, along with the reduction of tax burden, the Government will also gradually phase out exemptions and deductions available to both corporate and non-corporate tax payers. The proposed amendment is aimed at simplifying the tax laws and bringing transparency and clarity to the existing system.

Manner of Phasing Out

The Government has proposed to implement the changes by:

(i)        Phasing out profit linked, investment linked and area based deductions, for both corporate and non-corporate tax payers;

(ii)       Not extending the sunset dates provided in the Income Tax Act, and not modifying any provision having sunset date;

(iii)      Incentives that are provided without any terminal date shall have a sunset date of March 31, 2017, which would be provided for either commencing a certain activity or for claiming any benefit under the incentive;

(iv)      Weighted deductions will be no longer available from the start of financial year 2017-18.

Details of Phasing Out

Depreciation

Section 32 of the Income Tax Act lays down the details of depreciation available under the Act. In certain block of assets, such depreciation is allowed upto 100%. This ceiling is proposed to be brought down to 60% from the start of financial year 2017-18.

Deduction in Respect of Expenditure

While 100% deduction is provided for capital expenditure, other than expenditure on land, goodwill and financial assets, incurred by certain businesses specified under Section 35AD of the Act, certain other specified businesses enjoy 150% weighted deduction on such capital expenditure. It is proposed that from the start of financial year 2017-18, no such weighted deduction would be available.

Expenditure on Eligible Projects or Schemes

Section 35AC provides certain deductions for any expenditure by way of payment of any sum to a public sector company or a local authority or to an association or institution approved by the National Committee for carrying out any eligible project or scheme. It is proposed that no deduction under this Section shall be available from April 01, 2017.

Expenditure on Scientific Research

Section 35 of the Income Tax Act provides for deduction for expenditure incurred on scientific research. The provisions of this Section allow deduction for both capital and revenue expenditure as well as weighted deduction for donations made to certain notified institutions. It is proposed that the limit of deduction shall be restricted to 100% from the 2017-18 financial year and the 200% deduction available for companies engaged in the business of bio-technology or any business of manufacture or production of certain things notified under the Eleventh Schedule, would be reduced to 100% from the same financial year.

Expenditure on Other Projects

The weighted deductions available under Section 35CCC and 35CCD of the Act to the agricultural extension projects and skill development projects respectively, would also be reduced to a ceiling of 100% deduction.

Sunset Date

The tax incentives which do not have any sunset date (a terminal date) for commencing their activities, would be brought under a timeframe for which, April 01, 2017 is proposed to be the sunset date. It means, the deductions provided under several activities listed below, would have to commence their respective activities by the start of financial year 2017-18.

(i)        Development, operation and maintenance of infrastructure facility as provided under Section 80-IA of the Act;

(ii)       Development of Special Economic Zone (“SEZ”), provided under Section 80-IAB;

(iii)      Export of articles or things or services by a unit located in a SEZ, as provided under Section 10AA; and

(iv)      Commercial production of

(a)        Natural gas in blocks licensed under CBM-IV and NELP VIII, and

(b)       Mineral oil from blocks licensed under a contract awarded up to 31.03.2011, as provided under Section 80-IB of the Act.

Analysis

However, the Commerce Ministry, in its Budget recommendations, has rooted for the continuance of incentives and non-applicability of the sunset clause for SEZ sector stating that otherwise, export and employment generation would be adversely affected. In addition to the foregoing, according to industry experts, bringing SEZ under the purview of sunset clause, would also impact large-scale investments in this sector. With the already slowing down SEZ sector affected by the imposition of Minimum Alternate Tax and Dividend Distribution Tax, applying the sunset clause is expected to impact this sector even more harshly. In order to improve export situation, it is pertinent that the Finance Ministry look into this proposal once again.

The proposal made by the Finance Ministry was open for comments of the stakeholders and several other Ministries and industry experts have criticized various parts of this proposal. However, some of the provisions have also been welcomed. The extent and manner, in which this proposal would be implemented, would only be clear during the upcoming Budget.

- Ananya Banerjee