Enquiry:

This is with reference to the subject matter where it has been observed that the companies are following different accounting practices as follows:

(a) No amortization of the interest free loan;
(b) Amortization of the interest free loan and accounting for the amortized gain in Profit & Loss Account (P&L); and
(c) Amortization of the interest free loan and accounting for the amortized gain in Equity.

2. In this connection, it has been noticed that when the amortized gain is credited to P&L, as per the requirements of International Accounting Standard (IAS) 39 “Financial Instruments: Recognition and Measurement”, the tax authorities are treating the said income as taxable. This is one of the reasons that the companies are reluctant to follow the treatment of carrying the interest free loan on amortized cost as required under lAS 39.

3. Secondly, it has also been observed that the amortized gain is being accounted for within the equity rather than treated as income in the P&L. In this regard, your valuable opinion is solicited whether the aforesaid treatment is in line with the requirements of the lASs.

4. With regard to Para 2 above, you are requested to take up the matter with the Federal Board of Revenue on the issue of taxability of amortized gain under intimation to us, in order to streamline the accounting treatment and / or taxable issues of the subject matter.

5. Moreover with regard to Para 3 above, you are requested to confirm whether the treatment of accounting the amortized gain in equity is a valid treatment under the lASs.

Opinion:

The Committee considered your enquiry and its views are as follows:

The fair value of inter-company loans usually need to be estimated and the difference between fair value and loan amount then needs to be accounted for.

Where the loan is from a parent to a subsidiary, it would be inappropriate to recognise a gain or loss for the discount or premium; in substance this is an additional contribution by the parent (or a return of capital/distribution by the subsidiary). Contributions from and distributions to “equity participants” do not meet the basic definition of income or expenses (refer Framework para 70). In this case, the difference between the loan amount and the fair value (discount or premium) should be recorded as:

o an investment in the parent’s financial statements (as a component of the overall investment in the subsidiary);
o a component of equity in the subsidiary’s financial statements.

Subsequently, the loan should be measured at amortised cost, using the effective interest method. This involves “unwinding” the discount such that, at repayment, the carrying value of the loan equals the amount to be repaid. The unwinding of the discount should be reported as interest income or expense.

Where the loan is between group entities other than a parent and subsidiary, the discount or premium may meet the definition of income or expense depending on whether or not, in substance, the transaction is carried out at the direction of the parent. In this case, the Committee would like to refer its Selected Opinion No. 1.9 ‘Measurement of Interest Free (Low Interest Rate Loans Received/ Advanced By Companies’ of Volume XII which addresses your issue.

With regard to take up this issue with the Federal Board of Revenue (FBR), the Committee is of the view that accounting treatment of amortization of interest free loan is clear in IAS 39. If the Commission has identified the taxability issues in certain companies then the Committee suggests interested parties to take up the matter directly with the FBR.

(February 11, 2015)