CFM92457 - Debt Cap: the available amount: subsidiaries that are not consolidated

This guidance applies to worldwide group periods of account ending before or straddling 1 April 2017.

Subsidiaries not consolidated by a parent applying IFRS {#}

IFRS 10 was amended with effect from 1 January 2014 such that investment entities, as defined, should not consolidate their subsidiaries, unless the subsidiary’s main purpose is to provide services that relate to the investment entity’s investment activities. As a result the parent would not consolidate the subsidiary’s underlying assets, liabilities, income or expenses in its accounts but would instead measure its interest in the subsidiary as an investment at fair value. This accounting treatment needs to be addressed in the debt cap legislation because, in the absence of special provisions, the funding costs of such unconsolidated subsidiaries would be left out of account in computing the available amount and inappropriate disallowances could arise.

An ‘investment entity’ is defined at IFRS10.27. An investment entity is an entity that:

  • obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services;
  • commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income, or both; and
  • measures and evaluates the performance of substantially all of its investments on a fair value basis.

The underlying rationale behind these changes is that an investment entity holds investments for the sole purpose of capital appreciation, investment income (such as dividends, interest or rental income), or both. The most useful information for such an entity is provided by measuring all investments, including investments in subsidiaries, at fair value. Preparing consolidated financial statements for such entities could hinder users’ ability to assess their financial position and results. Removing the requirement to consolidate should also reduce the compliance burden on the investment entity.

IFRS 10.31 contains the requirement (as against an option) not to consolidate subsidiaries, unless the subsidiary’s main purpose is to provide services that relate to the investment entity’s investment activities. The effect may be that no subsidiaries at all are consolidated or that only those subsidiaries which perform a support function and therefore not held as investments should be consolidated; there is further detail in subsequent paragraphs of the standard and in application guidance.

Whilst the amendments to the standard were not mandatory until annual periods beginning on or after 1 January 2014, early adoption was permitted.

Subsidiaries not consolidated by a parent applying FRS102

FRS 102 is a new UK accounting standard. It is likely to apply to any UK-parent “large group” within the ambit of the debt cap that does not choose or be required to apply IFRS. FRS 102 applies for accounting periods beginning on or after 1 January 2015, with early adoption permitted.

FRS102-9.9 provides that subsidiaries are to be excluded from consolidation in two circumstances:

  • The first is where severe long-term restrictions substantially hinder the exercise of the rights of the parent over the assets or management of the subsidiary.
  • The second is where the interest in the subsidiary is held exclusively with a view to subsequent resale; and the subsidiary has not previously been consolidated in the consolidated financial statements prepared in accordance with FRS102. This can include subsidiaries held as part of an investment portfolio and is therefore similar to IFRS10.31. However there is no specific requirement for the parent to be an investment entity.

Cases where no subsidiaries are consolidated

If none of an investment entity’s subsidiaries are consolidated under IFRS, TIOPA10/S348(5A) provides that, where an investment entity is a debt cap ultimate parent, its single entity accounts as prepared under IFRS are to be treated as IFRS financial statements for debt cap purposes. Accordingly, they are then the financial statements of the worldwide group (TIOPA10/S346(2A)) and are used as the starting point for computing the available amount.

Similarly, it is also possible that under FRS102, no consolidated accounts are prepared for a debt cap ultimate parent because FR102-9.3(f) and 9.9 are in point. In that case, the single entity accounts of the parent are treated as financial statements of the worldwide group – TIOPA10/S346(2A).

It should be noted, however, that if an investment entity is also a collective investment scheme, or is a partnership, it cannot be a debt cap ultimate parent and its investee groups are likely to form a number of different worldwide debt cap groups – see CFM90270.

It is conceivable that the ultimate parent of a debt cap group might be a subsidiary of an investment entity and be relieved from the obligation to prepare consolidated accounts simply because it is a subsidiary and not because it is also is an investment entity (or its subsidiaries are excluded from consolidation under FRS 102). In this eventuality TIOPA10/S348(5A) is not in point and the group will need to follow the other provisions of S348 calculating the available amount as if it had prepared consolidated accounts, see CFM90460; the rules described below do not apply.

The approach taken in computing the available amount, differs according to whether expenses that are not disclosed on a line by line basis in the group’s accounts are expenses of UK group companies or other members of the group.

Financing expenses of unconsolidated subsidiaries that are subject to Corporation Tax

The accounting changes have reduced the compliance burden on investment entities. Accordingly it would be undesirable for the debt cap to re-impose the burden of preparing consolidated accounts as a method of dealing with unconsolidated subsidiaries. Accordingly the approach is, so far as possible, to use figures available from tax computations to make adjustments in computing the available amount. This also means that tax/accounting mismatches (see CFM92475) are eliminated.

As regards financing expenses of UK Group companies, the available amount, as derived from the worldwide group financial statements (which may be single entity accounts, in the circumstances described above), is increased by amounts meeting the following description, in TIOPA10/S332AA(2)(a)(i) and (2)(b):

  • Financing expense amounts of UK group companies (CFM90250) taken into account in computing the tested expense amount (CFM91020) or tested income amount (CFM91220); where
  • The amount would be taken into account in computing the available amount, but for the effect of IFRS10.27/31 or FRS102-9.9.

The amount to be added to the available amount is the amount taken into account for tax, avoiding the risk of a book/tax mismatch.

The reference to but for the effect of IFRS10.27 or FRS102-9.9 ensures that these amounts are external financing expenses directly incurred by unconsolidated UK group companies.

Financing expenses of unconsolidated subsidiaries that are not subject to Corporation Tax

The same approach cannot be used for members of the worldwide group that are not UK group companies, because there will not be a UK tax measure of the expense. Nonetheless, it is possible, for instance, that amounts will be borrowed from external lenders by unconsolidated non-UK group members and on-lent to the UK. It would be inappropriate to leave such external borrowing costs out of account in computing the available amount.

In this case, the measure of the external financing expense is the amount that would have been reflected in consolidated accounts, had the unconsolidated companies been consolidated. The rules do not require consideration of whether the funds borrowed externally were actually on-lent to the UK. Adopting this approach ensures consistency of treatment with the situation where all of a group’s subsidiaries are consolidated on a line by line basis.

Accordingly, as regards financing expenses of members of the group that are not UK group companies, the available amount, as derived from the worldwide group financial statements, is increased by amounts meeting the following description, in TIOPA10/S332AA(2)(a)(ii) and (2)(b):

  • Financing expense amounts of members of the worldwide group that are not UK group companies; and
  • Where the amount would be taken into account in computing the available amount, but for the effect of IFRS10.27/31 or FRS102-9.9.

This formulation takes account of the amount that would have been recognised in the consolidated financial statements of the group, but for the non-consolidation of the subsidiaries incurring the expense. The amounts are measured by reference to what would have been recognised in the accounts; it is not necessary to consider what amounts would have been taken into account under UK tax rules.

FRS 101: unlikely to be applied by a group to which the debt cap applies

FRS 101 (Reduced Disclosure Framework) is a new UK accounting standard that could be used only by certain parents that are themselves subsidiaries. Accordingly, it is only in unusual circumstances that it could be used by a large group to which the debt cap applies.

FRS 101 largely applies the recognition and measurement requirements of full (EU-adopted) IFRS but with reduced disclosure requirements. FRS 101 applies for accounting periods beginning on or after 1 January 2015, with early adoption permitted.

A qualifying entity for FRS 101 is a member of a group where the parent of that group prepares publicly available consolidated financial statements which are intended to give a true and fair view (of the assets, liabilities, financial position and profit or loss) and that member is included in the consolidation. FRS 101 cannot be used for consolidated accounts.

Gateway test

No changes have been made to the gateway test.