Tax treatment of a group company... the option to convert into equity a loan

In response to the blog posting ‘Tax treatment of a group company which holds the convertible debt of another group company as an asset and accounts at fair value through profit and loss‘, reader Sundaresh Bhat asks:

“Is the option to convert into equity a loan, an investment under the definition of investment under IFRS? Request a one line answer to this question if possible.”

The one word answer is “No.” Apart from anything else, IFRS doesn’t define investment. However, it is a financial asset under IFRS definitions.

My thought process on getting to the answer is as follows:

• Given the original posting, one is considering here a holding of convertible debt, which is bifurcated under IFRS so that the option to convert is being accounted for separately.


• Post bifurcation, the option is a financial asset and a derivative within the IFRS definitions, and will be carried on the balance sheet at fair value as are derivatives generally.


• IFRS does not define the word investment.


• The bifurcated derivative must be placed somewhere on the balance sheet, and is an asset. It has the quality of a financial investment, but would not form part of an investment in a subsidiary, joint venture or associate.


• Companies normally distinguish current and non-current assets. In this case, the derivative has the same longevity profile as the underlying host contract, assuming that the option to convert subsists throughout the life of the loan. Accordingly, unless the company intends to convert in the near future, the asset is non-current.

Accordingly the most appropriate description for the derivative on the balance sheet and assuming that the carrying amount is large enough to merit separate identification it is likely to be as a non-current financial asset.

In any actual situation, the company should consider its facts and circumstances, and then discuss them with its auditors.

Mohammed Amin

Comments

[Geld Lening 30 Jul 2007 20:52:11]

Last week, the FASB issued a proposal that might get financial statement preparers on the right track in their pursuit of simplicity (and manufactured effectiveness). It’s "Statement 133 Implementation Issue No. E23".