Enquiry:

We have encountered a technical issue at one of our client. There are two group companies of which one is public-unlisted, hereinafter referred as ‘First Company’, and the other is a private limited, hereinafter referred as ‘Second Company’. First Company has given loan to the Second Company and is charging interest on it under compliance of Section 208 of Companies Ordinance, 1984. The Second Company has no business operations at present and it also doesn’t have smooth financial cash flows which due to which it is sure that it will not be able pay back even the principal amount. Note also that the Second Company’s audit report is being issued with emphasis matter paragraph due to going concern issue. Therefore, we need ICAP’s assistance, whether we can reverse the interest accrued which seems to be dummy accrual in both of the companies and whether we can stop further accruals.

Furthermore, we also need to inquire that if we can classify the above mentioned loan as non-interest bearing payable at convenience of the First Company, then whether TR-32 is applicable on this financial instrument.

Opinion:

We would like to refer relevant clauses of section 208 of the Companies Ordinance, 1984 (the Ordinance):

“208. Investments in Associated companies and undertaking-

(1) Subject to sub-section (2A) a company shall not make any investment in any of its associated companies or associated undertakings except under the authority of a special resolution which shall indicate the nature period and amount of investment and terms and conditions attached thereto.

Provided that the return on investment in the form of loan shall not be less than the borrowing cost of investing company.

(2) No change in the nature of an investment or the terms and conditions attached thereto shall be made except under the authority of a special resolution.

(2A) The Commission may-

(a) by notification in the official Gazette, specify the class of companies or undertakings to which the restriction provided in sub-section (1) shall not apply; and

(b) through regulations made thereunder, specify such conditions and restrictions on the nature, period, amount of investment and terms and conditions attached thereto, and other ancillary matters, as it deems fit.”

Under section 208 of the Ordinance, the rate of return on loan should not be less than prevailing market rate of return on similar deposits or borrowing cost of the investing company. Further, section 208 of the Ordinance and clause 8 of the “Companies (Investment in Associated Companies or Associated Undertakings) Regulations, 2012” (the Regulations) explain that the terms and nature of the loan, and any subsequent change thereto shall be made with the authority of a special resolution of the investing company. However, section 208 and the Regulations do not permit provision of a non-interest bearing loan to the associated company, which is ultra-virus to law.

The impairment due to un-collectible status of financial assets is based on the entity’s assessment of receivables from the counterparties, and shall be dealt in accordance with the paragraph 58 of IAS 39 ‘Financial In¬stru¬ments: Recog¬ni¬tion and Mea¬sure¬ment’ (Volume 2009) and provisions of section 196 of the Ordinance.

In view of the above, the investing company shall consider the requirements of section 208 of the Ordinance to account for the interest on loan provided to the associated company.

(March 20, 2017)