Loan to U.S. Subsidiary without Agreement
Issue/Query:
What will be the accounting treatment of loan given to US subsidiary. No agreement but the management says it is non-current. So, if it is non-current then forex gains will not be taxable and if shown as current it will be taxable
Response:
The loan given to US Subsidiary is, in substance, a net investment in foreign operation, assuming that the functional currency of the parent is Indian Rupees, and the functional currency of US subsidiary is US Dollars.
The loan shall be measured at fair value through profit or loss and classified as non-current.
Exchange differences arising from the loan shall be recognised in profit or loss in separate financial statements of the parent company and in other comprehensive income in consolidated financial statements of the group.
Basis for Response:
Paragraph 15 of Ind AS 21 The Effects of Changes in Foreign Exchange Rates states as under:
“An entity may have a monetary item that is receivable from or payable to a foreign operation. An item for which settlement is neither planned nor likely in the foreseeable future is, in substance, a part of the entity’s net investment in that foreign operation and is accounted for in accordance with paragraphs 32 and 33. Such monetary items may include long-term receivables or loans. They do not include trade receivables or trade payables.”
The settlement of the loan as stated by the querist is neither planned nor likely in the foreseeable future. Therefore, such loan is accounted as net investment in foreign operation. Paragraph 32 of Ind AS 21 states as under:
“Exchange difference arising on a monetary item that forms part of a reporting entity’s net investment in a foreign operation (see paragraph 15) shall be recognised in profit or loss in the separate financial statements of the reporting entity or the individual financial statements of the foreign operation. as appropriate. In the financial statements that include the foreign operation and the reporting entity (eg consolidated financial statements when the foreign operation is a subsidiary), such exchange differences shall be recognised initially in other comprehensive income and reclassified from equity to profit or loss on disposal of the net investment in accordance with paragraph 48.”
Therefore, the exchange differences arising on the loan shall be recognised in profit or loss in separate financial statements of the lender parent and in other comprehensive income in the consolidated financial statements of the group.
Paragraph 4.1.2 of Ind AS 109, Financial Instruments, states as follows:
“A financial asset shall be measured at amortised cost if both of the following conditions are met:
(a) the financial asset is held within a business model whose objective is to hold financial assets in order to collect contractual cash flows and
(b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.
Paragraphs B4.1.1 - B4.1.26 provide guidance on how to apply these conditions.”
Paragraph 4.1.2A of Ind AS 109 states as follows:
“A financial asset shall be measured at fair value through other comprehensive income if both of the following conditions are met:
(a) the financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets and
(b) the contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.
Paragraphs B4.1.1 - B4.1.26 provide guidance on how to apply these conditions.”
Paragraph 4.1.4 of Ind AS 109 states as follows:
“A financial asset shall be measured at fair value through profit or loss unless it is measured at amortised cost in accordance with paragraph 4.1.2 or at fair value through other comprehensive income in accordance with paragraph 4.1.2A. However an entity may make an irrevocable election at initial recognition for particular investments in equity instruments that would otherwise be measured at fair value through profit or loss to present subsequent changes in fair value in other comprehensive income (see paragraphs 5.7.5–5.7.6).”
The settlement of the loan is neither planned nor likely in future. Therefore, the terms of the contract do not give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. Therefore, in accordance with paragraph 4.1.4 of Ind AS 109, such a financial asset is classified and subsequently measured at fair value through profit or loss.
Paragraph 66 of Ind AS 1 Presentation of Financial Statements states as under:
“An entity shall classify an asset as current when:
It expects to realise the asset, or intends to sell or consume it, in its normal operating cycle;
It holds the asset primarily for the purpose of trading;
It expects to realise the asset within twelve months after the reporting period; or
The asset is a cash or cash equivalent (as defined in Ind AS 7) unless the asset is restricted from being exchanged or used to settle a liability for at least twelve months after the reporting period.
An entity shall classify all other assets as non-current.”
As the management does not expect to realise the loan within twelve months after the reporting period, the loan shall be classified as non-current.