Enquiry:
SL needs your technical advice regarding existence of control over an associated company PL and consolidation of financial Statement.
Both the companies have common Chief Executive Officer (CEO). The information regarding the associated company is as below.
(1) SL holds 49.24% shares of PL.
(2) Number of directors on behalf of SL on the board of PL are three out of seven directors.
PL does not meet the definition of a subsidiary company for SL as per section 3 of the Company Ordinance 1984. Majority of the Directors are not representing SL, and the decisions are made by majority of the Board.
Your technical advice is sought, whether the accounts of SL will be consolidated with the accounts of PL (an unquoted Limited Company) for publication or SL will show its investment in PL on equity Basis.
Opinion:
The Committee would like to draw your attention to the following paragraphs of IFRS 10 ‘Consolidated Financial Statements’:
6. An investor controls an investee when it is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee.
7. Thus, an investor controls an investee if and only if the investor has all the following:
(a) power over the investee (see paragraphs 10–14);
(b) exposure, or rights, to variable returns from its involvement with the investee (see paragraphs 15 and 16); and
(c) the ability to use its power over the investee to affect the amount of the investor’s returns (see paragraphs 17 and 18).
B18 In some circumstances it may be difficult to determine whether an investor’s rights are sufficient to give it power over an investee. In such cases, to enable the assessment of power to be made, the investor shall consider evidence of whether it has the practical ability to direct the relevant activities unilaterally. Consideration is given, but is not limited, to the following, which, when considered together with its rights and the indicators in paragraphs B19 and B20, may provide evidence that the investor’s rights are sufficient to give it power over the investee:
(a) The investor can, without having the contractual right to do so, appoint or approve the investee’s key management personnel who have the ability to direct the relevant activities.
(b) The investor can, without having the contractual right to do so, direct the investee to enter into, or can veto any changes to, significant transactions for the benefit of the investor.
(c) The investor can dominate either the nominations process for electing members of the investee’s governing body or the obtaining of proxies from other holders of voting rights.
(d) The investee’s key management personnel are related parties of the investor (for example, the chief executive officer of the investee and the chief executive officer of the investor are the same person).
(e) The majority of the members of the investee’s governing body are related parties of the investor.
B38 An investor can have power even if it holds less than a majority of the voting rights of an investee. An investor can have power with less than a majority of the voting rights of an investee, for example, through:
(a) a contractual arrangement between the investor and other vote holders (see paragraph B39);
(b) rights arising from other contractual arrangements (see paragraph B40);
(c) the investor’s voting rights (see paragraphs B41–B45);
(d) potential voting rights (see paragraphs B47–B50); or
(e) a combination of (a)–(d).
IFRS 10 explicitly includes the concept of ‘de facto’ control, where an investor with less than a majority of voting rights has power over an investee. The primary focus of the analysis under IFRS 10 remains on whether an investor has sufficient voting rights to give that investor the practical ability to direct the relevant activities. This involves an assessment of the size of its holding of voting rights relative to the size and dispersion of holdings of the other vote holders. An investor therefore needs to consider the indicators given in B42:
B42 When assessing whether an investor’s voting rights are sufficient to give it power, an investor considers all facts and circumstances including:
(a) the size of the investor’s holding of voting rights relative to the size and dispersion of holdings of the other vote holders noting that:
(i) the more voting rights an investor holds, the more likely the investor is to have existing rights that give it the current ability to direct relevant activities;
(ii) the more voting rights an investor holds relative to other vote holders, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;
(iii) the more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;
(b) potential voting rights held by the investor, other vote holders or other parties (see paragraph B47-B50)
(c) rights arising from contractual arrangements (see paragraph B40)
(d) any additional facts and circumstances that indicate the investor has, or does not have, the current ability to direct the relevant activities at the time that decisions need to be made, including voting patterns at previous shareholders’ meetings.
The Committee would like to draw your attention to following additional facts and circumstances to consider which includes:
• Voting patterns at previous shareholders’ meetings
• Whether the investor has the practical ability to direct the relevant activities unilaterally (e.g., the investee and the investor have the same key management)
• Whether the investor has a special relationship with the investee (e.g., the investee depends on the investor to fund a significant part of its operations)
• Whether the investor has a large exposure to variable returns (which may be an indicator that the investor had an incentive to obtain rights sufficient to give it power)
There is an important distinction to be drawn about voting patterns. IFRS 10 makes it clear that the focus is on the number of vote holders that have participated in the past and the absolute proportion of voting rights that have historically been exercised. It is not on whether other vote holders have voted in the same way as the investor.
If the criteria set out below are met, it may be clear that that the investor has power over the investee, and no further analysis is needed (refer example 4 of the standard):
• Direction of relevant activities is determined by majority vote
• The investor holds significantly more voting rights than any other vote holder or organised group of vote holders
• Other shareholdings are widely dispersed (IFRS 10.B43/B44).
In other situations the guidance above is not conclusive and further analysis of additional facts and circumstances is required. The fewer voting rights the investor holds, and the fewer parties that would need to act together to outvote the investor, the more reliance is placed on additional facts and circumstances to assess whether the investor’s rights are sufficient to give it power (IFRS 10.B45). An Investor has no power if additional facts and circumstances still do not provide a clear answer (IFRS 10.B46).
Additional facts and circumstances also need to be analysed which include indicators of a special relationship with the investee, which suggest more than a passive interest and voting patterns. As noted above, when voting patterns of previous shareholders meetings are analysed, the standard requires only the number of other shareholders that attended (to calculate the majority of votes required to unilaterally
make decision) to be considered, but not their voting patterns. Examples 5 to 8 from the standard illustrate how additional rights, and voting patterns, are taken into consideration.
Conclusion:
In the light of above, an investor can control an investee with less than the majority of voting rights. The Committee considers that common directorship is not a conclusive factor for determining control. Other factors like contractual arrangements and circumstances discussed above may also require judgment and need to be considered carefully.
Based on all the information provided to us, including the shareholder’s agreement, the Committee concludes that:
1. SL does not directly or indirectly controls, beneficially owns or holds more than fifty per cent of PL voting.
2. Group A comprising SL, APL and their subsidiaries has power under shareholders’ agreement to appoint four directors out of seven (including chief executive). Under the same shareholders’ agreement, the rights of board of directors have significantly been reduced from the usual statutory rights and even most of the ordinary matters to be decided by the general meeting with a majority of at least 2/3rd, with other annual matters requiring approval of the general meeting with 85% voting. This shows that most significant decisions that affect the business cannot be taken without a greater majority.
3. While SL is entitled to variable returns, prima facie it does not have the power over the investee in a host of key matters. Accordingly, based on the information and facts available the Committee is of the view that PL is not the subsidiary of SL.
(May 16, 2016)