ICAI Issues Exposure Draft of the Guidance Note on Transfer of Capital Reserves

Background:

This update is prepared in connection with the Exposure Draft of ‘Guidance Note on Transfer of Capital Reserve’ issued by the ICAI on March 21, 2023. Various Indian Accounting Standards (IND AS) provide for creating capital reserves. However, no proper guidance on transfer of those capital reserves to other free reserves or retained earnings is provided under those standards. The guidance note sets out the principles for transfer of the capital reserves to the free reserves.

Creation of the Capital Reserves:

Below mentioned are some examples where the Ind AS provide for creation of the Capital Reserves:

Ind AS 103 – Business Combinations:

• During a bargain purchase where the fair value of the assets acquired exceeds the amount of consideration plus non-controlling interest, the resultant gain is transferred to the capital reserve.
• In case of common control business combination, where the combining parties are ultimately controlled by the same party both before and after the combination, the difference between the share capital of the transferor and the share capital issued plus additional consideration in the form of cash or other assets shall be transferred to capital reserve.

Ind AS 28 – Investment in Associates and Joint Ventures:

• Excess of the investor’s share of the net fair value of identifiable assets and liabilities of investee over the cost of investment is recognised under Capital Reserve in the period in which the investment is acquired.

Transfer of Capital Reserve

Under the exposure draft, two views have been put forward with regards to the transfer of the capital reserves to free reserves.

View – 1: Capital Reserves, bearing the nature of permanent capital of the company, should not be transferred to free reserves without prior approval of a regulatory body (such as National Company Law Tribunal) or
View – 2: Following two conditions must satisfy to effect such transfer:

The company must have realised the underlying amount. The appendix to the guidance note provide
guidance in respect of below mentioned cases where the realisation of the capital reserve is deemed to
have happened:

• Bargain Purchase gain, recognised as capital reserve arising out of bargain purchase due to fair valuation of the PPE, becomes realised as the assets are depreciated or sold.
• Bargain Purchase gain, recognised as capital reserve arising out of bargain purchase due to fair valuation of the investments not required to be depreciated, become realised as the investments are sold.
• Where capital reserve in the books of transferee, during a common control business combination, arises due to carrying value of the assets and liabilities is more than the face value of shares issued, it becomes realised when the assets are depreciated and charged-off to P&L.
• In case of capital reserve arising due to fair valuation of an interest free loan from a parent company to its subsidiary, the reserve gets realised when the interest is charged to the P&L or when the loan is repaid.

The amount is available for distribution as dividend or issue of bonus shares, as per the applicable laws
and regulations.

SW Remarks:
It is worth noting that the transfer of capital reserves is an acceptable position under Ind AS based on realisation, due to which the View – 2 seems to be more appropriate. Research Committee of the Institute of Chartered Accountants of India invites comments on any aspect of the Exposure Draft of the ‘Guidance Note on Transfer of Capital Reserve’, latest by 20th April, 2023 at research@icai.in.

Shivam Bansal, Audit Associate, SW India

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