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IFRS 3 — Mandatory purchase of non-controlling interests in a business combination obtaining control of listed entity

Date recorded:

In November 2012 the IFRS Interpretations Committee (the Interpretations Committee) discussed a request to address the accounting for mandatory purchases of non-controlling interests (NCI) in business combinations. The submission noted that IFRS 3 Business Combinations does not specifically address the accounting for a sequence of transactions that begins with an acquirer gaining control of an entity and is followed shortly thereafter by the acquisition of additional ownership interests as a result of a regulatory requirement that obliges the acquirer to offer to purchase the ownership interests of NCI shareholders.

At the meeting in November 2012 the Interpretations Committee discussed two issues:

  1. whether the initial acquisition of the controlling stake and the subsequent mandatory tender offer (MTO) should be treated as separate transactions or as a single acquisition (i.e. as linked transactions)
  2. whether a liability should be recognised for the MTO at the date that the acquirer obtains control of the acquiree.

On the first issue, the Interpretations Committee tentatively agreed, in the November 2012 meeting, that the initial acquisition of the controlling stake and the subsequent MTO should be treated as a single acquisition. It tentatively decided to propose that the guidance in IFRS 10 Consolidated Financial Statements on how to determine whether the disposal of a subsidiary achieved in stages should be accounted for as one or more transactions should also be applied to circumstances when the acquisition of a business is followed by successive purchases of additional interests in the acquiree. The Interpretations Committee tentatively decided to propose to the IASB that the Board amend IFRS 3 through Annual Improvements.

The Interpretations Committee also discussed the second issue in their November 2012 meeting. The Interpretations Committee noted that IAS 37 Provisions, Contingent Liabilities and Contingent Assets excludes from its scope contracts that are executory in nature and therefore concluded that no liability needs to be recognised for the MTO. The Interpretations Committee, in the November 2012 meeting, tentatively decided to recommend to the IASB not to amend IFRS 3 for this second issue.

In the March 2013 Interpretations Committee meeting the Staff noted that feedback had been received on the second tentative decision from the November 2012 meeting.  Some expressed the view that the Interpretation Committee’s rationale was unclear and others disagreed with the tentative conclusion.  Some noted that if MTOs were excluded from the scope of IAS 37 because they were executory contracts then how could they be excluded from the scope of IAS 32 because they were not contracts.

Other concerns were expressed that the Interpretation Committee’s tentative conclusion that a liability did not need to be recognised for an MTO was inconsistent with its tentative decision that the initial acquisition of the controlling stake and the subsequent MTO be treated as a single acquisition.  They argued that if the transactions are linked then the occurrence of the second transaction is dependent upon the occurrence of the first transaction.  Hence the obligation to purchase the NCI shareholders’ shares is generated by the acquisition of the controlling stake and should be reflected in the financial statements as a liability.

The Staff noted, among others, that others concerns expressed were:

  1. If a liability was not recognised, the entity’s financial statements would not reflect the acquirer’s unconditional obligation to pay cash (or deliver another financial asset) in exchange for the NCI shareholders’ shares.
  2. The Interpretation Committee’s tentative conclusion on MTOs was inconsistent with the accounting for put options written on non-controlling interests (NCI puts).
  3. The requirement to make an offer to NCI shareholders that arises from an MTO effectively creates an NCI put and hence would meet the definition of a liability under IAS 32.  The Staff argued that it might be suggested that since the put option arising from an MTO is not the result of a contractual obligation but rather is the result of a legal/statutory obligation, it would not meet the definition of a liability in IAS 32. However they noted that the legal obligation has an impact on the contractual relationship between the shareholder and the reporting entity and is therefore no different from any other put option on NCI.  The Staff noted that this was consistent with paragraph 5 of IFRIC 2 which states that an entity must consider all of the terms and conditions of a financial instrument in determining its classification as a financial liability or equity and this would include local laws and regulations.
  4. An MTO meets the definition of a liability in paragraph 4.4(b) of the Conceptual Framework for Financial Reporting and hence should be reflected in an entity’s financial statements.

The Staff noted that in light of these comments they had performed additional analysis as to whether a liability should be recognised for an MTO.  The Staff noted to the Interpretations Committee that they considered that a liability should be recognised for an MTO at the date that an acquirer obtains control of an acquiree.  The Staff agreed that such an arrangement met the definition of a liability in the Conceptual Framework and it would be misleading to investors to omit this liability from the financial statements.  The Staff also were of the view that the MTO should be accounted for in accordance with the requirements for financial instruments (IAS 32 and 39 or IFRS 9) and noted that they thought that the MTO described in the submission was similar to an NCI put (the entity had a present unconditional obligation to purchase the shares held by the NCI shareholders.  The Staff acknowledged that the form of an MTO was different from that of an NCI put as with an NCI put the parties have will enter into a bilateral contract which was not the case with an MTO.  However the Staff thought that the substance of the arrangements was the same and hence should be accounted for the same.

The Staff also highlighted that they thought the rights and obligations that arise from an MTO are inextricably linked to the share contracts that were held by the controlling and NCI shareholders.  They noted that the acquirer (by virtue of becoming the controlling shareholder) has an unconditional obligation to offer to purchase the shares held by the NCI shareholders and the other shareholders (by virtue of being NCI shareholders) have an unconditional right to sell their shares to the acquirer.  The Staff noted that while the MTO is a statutory requirement, the controlling and NCI shareholders were bound by that arrangement as a result of holding their respective ownership instruments.

The Staff asked the Interpretations Committee whether they agreed that a liability should be recognised for an MTO in a manner consistent with IAS 32 at the date that the acquirer obtains control of the acquiree.

One Committee member was still of the view that the tentative decision reached in the November 2012 Interpretations Committee meeting was still the correct decision and hence disagreed with the Staff.  This Committee member did not think that the MTO should be accounted for like an NCI put under IAS 32 and believed that there was no contractual obligation.  This Committee member believed that this was a linked transaction and hence the acquirer was obtaining control in one step rather than a two-step approach of obtaining control and then non-controlling interest separately.  This Committee member noted that in this situation his view was that the acquirer was acquiring assets and liabilities rather than non-controlling interests and IAS 39 (AG 35(b)) states that when there is firm commitment to acquire assets and liabilities (which this member thought was the case) then there would not be recognition of a liability at the date of the commitment but instead when one of the parties had performed under the agreement.  Hence, even if it was considered that there was a contractual obligation under IAS 39, a financial liability would not be recognised at the date that the acquirer obtained control of the acquiree as nothing had been performed under the executory contract yet.  This view was shared by some other Committee members.

Another Committee member also disagreed with the Staff conclusion.  She also disagreed that the MTO should be accounted for as an NCI put.  This Committee member stated that the Staff were removing the relevance as to whether there is or is not a contract in place in deciding whether there is a financial liability under IAS 32.  She noted that there had always been emphasis on the existence of a contract and the relevance of the terms of a contract to decide whether IAS 32 is applicable in recognising a financial liability.  This member noted expressed concern with the consequences of not sticking to this view.  This Committee member also expressed a view that she did not think that this situation was a linked transaction – she was of the view that there were two separate transactions.  This Committee member did not think that the IFRS 10 criteria for linked transactions were met and no liability should be recognised.  Another Committee member agreed with this view.  He did not agree with the analogy to IAS 32 based upon the fact that the MTO was not contractual where IAS 32 had always required the existence of a contractual obligation for recognition of a financial liability.  He thought that this was an executory contract and agreed with the conclusion in the November 2012 Committee meeting.  He noted that this would not be a liability under IAS 37 which excludes from its scope executory contracts.

Against the views of these Committee members one Committee member expressed the view that he considered that the MTO met the definition of a liability in the Conceptual Framework and agreed with the Staff.  He thought that the key debate to be had was which standard governs the recognition of the liability.  He considered, like the Staff, that the MTO was similar to an NCI put even though not contractual and hence a liability should be recognised.  Another Committee member also agreed with the view of the Staff.  He did not agree that because in the situation being discussed there was an enforced contract rather than a voluntary contract a liability should not be recognised.

Another Committee member agreed that the MTO was in substance the same as an NCI put and hence should be accounted consistent with NCI puts.

Another Committee member believed that the MTO was a liability that should be recognised.  She believed that the transaction was linked and hence the obligation to purchase the NCI shareholders’ shares was generated by the acquisition of the controlling stake.  She agreed that there was an obligation that met the definition of an obligation in the Conceptual Framework and hence should be recognised.

The Chair put a vote to the Interpretation Committee members as to whether they considered that there was a liability.  Eight Committee members tentatively supported the Staff recommendation that the MTO should be accounted for as a liability and six tentatively disagreed, instead seeing there to be an executory contract.  The Chair asked the Staff how to proceed in line with the Due Process Handbook.  The Staff noted that the original proposal was for an annual improvement that would be presented to the IASB.  It was noted that with an 8:6 split an annual improvement could not be presented to the IASB.  The Staff noted that the results of the discussion would be reported to the IASB and that there was an 8:6 vote expressed on the issue or recognising a liability for the MTO.  It would also be recommended to the IASB that this issue be grouped with other NCI issues and the post implementation review of IFRS 3.

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