De-FACTO Control - Ind-As/ IFRS

It is a general presumption that if an entity holds 50% or more voting rights of another entity then it can be further evaluated for assessing if any Control (for consolidation purposes) exists over the investee. However Ind-As -110 "Consolidated Financial Statements" para B 41-42 defines situation where even an entity holds less than 50% of the voting rights of another entity, it can still have a current ability to direct the relevant activities of the investee. This concept is widely known as "De-facto control" (as used in IASB issued IFRS-10 whereas in Indian version of Ind-As-110 does not use this word however provisions are almost same as per IFRS standard). Unlike in current Indian accounting system there is no such concept.

As per Ind-As 110 the situation has been defined in the standard as below -

The investor’s voting rights

Para -B41 "An investor with less than a majority of the voting rights has rights that are sufficient to give it power when the investor has the practical ability to direct the relevant activities Unilaterally".

Para- B42 "When assessing whether an investor’s voting rights are sufficient to give it power, an investor considers all facts and circumstances, including:

(a) the size of the investor’s holding of voting rights relative to the size and dispersion of holdings of the other vote holders, noting that:

(i) the more voting rights an investor holds, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

(ii) the more voting rights an investor holds relative to other vote holders, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

(iii) the more parties that would need to act together to outvote the investor, the more likely the investor is to have existing rights that give it the current ability to direct the relevant activities;

Para 10- "An investor has power over an investee when the investor has existing rights that give it the current ability to direct the relevant activities, ice the activities that significantly affect the investee’s returns".

Let’s discuss this concept by taking an example:

"Company A" holds 40% voting shares of "Company B" and rest 60% of Voting shares are being hold by individual investors in very large numbers.

Now we will look into this concept in a very crisp and practical manner which can provide glimpse of the concept to understand this in a better way –

1. We have a situation where standard says that an entity will have power over other entity when it has current ability (refer Para 10 above) to direct the "relevant activities" (as defined in Ind-As 103-"Business Combinations")  of an investee which essentially means that existing rights which can in substance direct these relevant activities to conclude as power.

2. In such type of situations, assuming that other 60% shareholders widely spread and each of such shareholder are holding very small number of shares individually and  does not get into the process of voting collectively to vote out the decisions of Company A which holds 40% of the voting rights, then it can be an indication that Company A (which holds 40%) can have power over the investee.

3. The past meeting records/ attendances/ quorums would provide substance about the fact mentioned above and one has to see if the decisions are being taken by Company A itself as other shareholders has not voted in full or not voted collectively against the Company A, then one can draw a conclusion that Company A which holds 40% of voting share has current ability to direct the relevant activities of the Investee.

4. Standard states that while making such type of analysis related to "de facto", One has to carefully examine if there are any contractual arrangements/ agreements  between shareholders which gives Company A (in our example) the power to vote in all activities without being interfered by other small investors (in the examples 60% small investors) then one can draw a conclusion that because of this agreement even Company A holds less than 50% of voting rights, it still has current ability to direct relevant activities of the Company B and control exits.

5. The standard uses the word "current ability" to direct the investee's relevant activities which means that in case of our example above, suppose rest 60% is being hold by ONE individual investor but he/ she usually act as passive, then we simply cannot conclude that because of the rest 60% shareholder (held by One shareholder) does not use its vote in past meetings and all decisions are being taken by Company A (holding 40% shares) then Company A has power over Company B because this individual shareholder is having "CURRENT ABILITY" and we cannot just conclude because he is acting passively.

Based on the guidelines above provides overall idea/ approach for a reader about the possibility of having control over an investee even voting rights are being held by less than 50%. However. there has to be careful assessment of all contractual arrangements between shareholders and /or all potential (e.g. call/put options etc) voting rights together with past history of meetings compositions while taking decisions over control.

It is highly judgmental area and requires regular updates/ re-assessment in case any situations changes. One has to look into all related facts and patterns before concluding this type of assessment based on this concept. Reader is requested not to take this article as any kind of advice and should evaluate all relevant factors of each individual cases separately.

The author can also be reached at anujagarwalsin@gmail.com

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CA Anuj Agrawal 
on 17 February 2017
Published in Accounts
Views : 981
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