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Net investment in foreign operation

CA Sachin Rastogi (Audit/IFRS Manager) (338 Points)

28 June 2012

Holding Company H gives a long term project loan to its foreign subsidiary S bearing an interest rate of 10%. The settlement of loan is neither planned and nor likely to happen in near future as the subsidiary S’s project is in construction phase.

As per Para 32 of IAS 21- Can we classify this loan as a part of net investment in foreign operation

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2 Replies

Sanjay Chauhan (IFRS) (IFRS) (2714 Points)
Replied 29 June 2012

The inclusion of long-term loans and receivables as part of the net investment in the foreign operation is only permitted where settlement is neither planned nor likely to occur in the foreseeable future. In other words, the parent must regard them as permanent as equity. For example, a loan to a foreign entity that is repayable on demand may seem to be a short-term item, rather than part of capital. However, if there is demonstrably no intent or expectation to demand repayment (for example, the short-term loan is allowed to be continuously rolled over, whether or not the subsidiary is able to repay it), the loan has the same economic effect as a capital contribution. On the other hand, a long-term loan with a specified maturity (say 10 to 15 years) does not automatically qualify to be treated as being part of the net investment simply because it is of a long duration, unless management has expressed its intention to renew the note at maturity. The burden is on management to document its intention to renew by auditable evidence, such as board minutes. Otherwise, absent management's intention to renew, the note's maturity date implies that its settlement is planned in the foreseeable future.

CA Sachin Rastogi (Audit/IFRS Manager) (338 Points)
Replied 30 June 2012

Dear Sanjay

Thanks for replying. I fully agree to your comments as the net investment in foreign operations should have a character of equity i.e the intention is not to get its repayment during the life time of the company but instead only at the time of liquidation of the company. Even a settlement period should not be defined for such contribution as you cannot decide the repayment date of equity capital to the shareholders of the company.

In the above case, the loan is not repayable on demand and even its repayment is not defined in the loan agreement and the loan carries interest as well. I personally believe that in such a case you cannot consider this loan as net investment in foreign operation as you cannot earn interest on an equity contribution even though such contribution doesnt increase your shareholding in the subsidiary.

Would appreciate if you share your thoughts on this.