Background

Schedule II to the Companies Act, 2013 (Schedule II) specifies the manner in which useful lives of assets are determined for the purpose of computing depreciation. On 31 March 2014, the Ministry of Corporate Affairs (MCA) issued a notification (G.S.R. 237(E)) amending Schedule II. This amendment specified that for determining the useful lives of intangible assets,

‘the provisions of the accounting standard applicable for the time being in force shall apply, except in the case of intangible assets (toll roads) created under ‘Build, Operate and Transfer’, ‘Build, Own, Operate and Transfer or any other form of public-private partnership route in case of road projects.’

For such ‘toll road’ intangible assets, the amendment permitted companies to apply revenue-based amortisation, based on the proportion of actual revenue for the year as compared to the total projected revenue from the intangible asset during the concession period.

However, Ind AS 38, Intangible Assets specifies that an amortisation method based on revenue generated by an activity that includes the use of an intangible asset, is presumed to be inappropriate, except in very limited circumstances. In order to transition to Ind AS, Ind AS 101, First time adoption of Indian Accounting Standards permits companies to apply a previously used amortisation method for such toll-road intangibles only to assets existing at the beginning of the first year of adoption of Ind AS (i.e. 1 April 2016 for companies that are within the first phase of the Ind AS implementation road map). For intangible assets recognised subsequently, Ind AS 38 applies.

The Ind AS Transition Facilitation Group (ITFG) noted the inconsistency between the guidance in Schedule II and in Ind AS. In its third bulletin (ITFG Bulletin 3) issued on 2 July 2016, the ITFG opined that the principles of Ind AS 38 should be followed for all service concession arrangements including toll roads that are recognised once Ind AS becomes applicable to an entity, based on a harmonious reading of the Companies Act (2013) and Ind AS. Consequently, companies that transition to Ind AS should not apply revenue-based amortisation methods to toll road intangibles recognised after the beginning of the first year of adoption of Ind AS.

New development

The MCA, on 17 November 2016, issued a notification (G.S.R. 1075(E)) amending Schedule II and replacing a part of the provision relating to intangible assets as follows:

“For intangible assets, the relevant Indian Accounting Standards (Ind AS) shall apply. Where a company is not required to comply with Ind AS, it shall comply with relevant Accounting Standards under Companies (Accounting Standards) Rules, 2006 (AS). Except in the case of intangible assets (toll roads) created under ‘Build, Operate and Transfer’, ‘Build, Own, Operate and Transfer or any other form of public-private partnership route in case of road projects.”

Our comments

Companies transitioning to Ind AS

We consider that the amendment above is intended to clarify that the relevant provisions of Ind AS (i.e. Ind AS 38) would apply to companies that are transitioning to Ind AS. They would therefore be unable to apply the revenue-based amortisation method to toll road related intangible assets that are recognised after the beginning of the first year of adoption of Ind AS. This is also consistent with transition provisions of Ind AS 101 for the ‘toll road’ related intangible assets i.e. an option is available to use ‘previously used amortisation method’ only to such intangible assets existing at the beginning of the first year of adoption of Ind AS. The ITFG opinion re-confirmed this position and this amendment is now expected to resolve the inconsistency between Schedule II and Ind AS.

The toll road companies that followed revenue-based amortisation method in the past that resulted in a lower amount of amortisation in the initial years of a new toll road project are likely to have an adverse effect on the reported profits under Ind AS during those initial years.

Further, a plain reading of the amendment could give an impression that the exception for using revenue based amortisation for toll road related intangible assets is extended to companies that are implementing Ind AS. This could effectively result in a ‘carve out’ from the provisions of Ind AS 38, which generally does not permit revenue-based amortisation methods for intangible assets. A revenue based amortisation method is also inconsistent with international practice for similar transactions in accordance with International Accounting Standard (IAS) 38, Intangible Assets.
Therefore, MCA may consider issuing further clarification on the intent and interpretation of this amendment as applicable to companies that are required to comply with Ind AS.

Companies that continue to follow AS

Companies that continue to follow AS are permitted to continue applying the exception in Schedule II and use a revenue-based amortisation method for their toll road intangibles.

To access the text of the MCA notification, please click here.