IntroductionIn 2011 the IASB published proposals to exempt investment entities from the consolidation requirements in IFRS 10. Following consultation and extensive further discussion these have now been finalised. In the original exposure draft, the various criteria that would have had to have been met in order to qualify as an investment entity were detailed, complex and restrictive, largely in an effort to prevent possible misuse. The definition of an investment entity has been reworked and simplified and in its final form the exemption should go a long way towards removing the consolidation burden for many investment entities that find themselves controlling portfolio investees.

Overview of the exemption provisionsIn their final form the provisions continue to revolve around the definition of an investment entity. The key features are that:

• toqualify,aninvestmententitymustmeetthreecriteria,areduction from the six proposed in the original exposure draft. This revised approach allows for less prescription and greater use of judgement in determining investment entity status. The amendment also includes detailed guidance in determining whether the criteria are met

• aninvestmententityisrequiredtoaccountforsubsidiariesat fair value through profit or loss rather than consolidating them

• theexistingIAS28exemptionpermittinginvestmentsinassociates to be measured at fair value through profit or loss is being retained in its current form. This is an about-turn from the original proposals

• additionaldisclosurerequirementsareintroducedwithinIFRS 12.

Definition of an investment entityThe six criteria which were originally proposed have been reconfigured such that an investment entity is defined having regard to the three key criteria which relate most directly to the entity’s business model. An investment entity is one which:− obtains funds from investors for the purpose of providing

them with investment management services− invests funds solely for returns from capital appreciation

and/or investment income, and− measures and evaluates the performance of substantially all

of its investments on a fair value basis.The remainder of the criteria from the original exposure draft are now described as “typical characteristics” of an investment entity. An investment entity typically has:− multiple investments− multiple investors− investors which are not related parties of the entity− owners with equity interests.

These four characteristics have to be considered in making the investment entity assessment but as they focus more on the entity’s form and structure, the absence of any of these does not necessarily prevent an entity from having investment entity status. Entities failing to exhibit one or more of the characteristics would have to justify why they consider that they meet the definition and this would require to be disclosed.

Investment company technical releaseIASB finalises exemption from consolidation for investment entities

November 2012

It is perhaps worth emphasising that although the final published provisions give scope for the exercise of greater judgement, the assessment and the resulting exemption remains at the level of the entity as had been originally proposed. Thus the exemption is based fundamentally on the nature of the entity which is holding the subsidiary rather than by reference to individual holdings on an investment by investment basis.

The accountingSo far as subsidiaries are concerned, as noted above, an investment entity is required to account for these at fair value through profit or loss rather than consolidating them. This is a requirement and is not a matter of accounting policy choice. There is however one key exception to this requirement not to consolidate and that is where the investment entity has a subsidiary which provides investment related services or activities. Such subsidiaries would have to be consolidated, and this requirement will need to be considered carefully by investment companies particularly having regard to subsidiaries providing (for example) investment advice, management or administration or carrying out dealing activities.

Withregardtoassociates,IAS28hasforsometimehad a measurement option which permits venture capital organisations and funds to measure associates at fair value through profit or loss rather than equity accounting them. Whilst the exposure draft had proposed to remove this and link the exemption to investment entity status, the IASB has ultimatelydecidedtoleavethefairvalueoptioninIAS28unchanged.ThisiswelcomeastheexistingIAS28exemptionhas worked well in practice.

Disclosure requirementsIFRS 12 ‘Disclosure of Interests in Other Entities’ is a recently published disclosure standard designed to sit alongside IFRS 10. This combines the disclosure requirements for subsidiaries, associates and other arrangements into one standard and requires greater transparency on borderline consolidation decisions. In finalising the investment entity exemption, the IASB has added a number of additional disclosures to IFRS 12 which investment entities will be required to make regarding their status and their interests in subsidiaries. These include:

• significantjudgementsandassumptionsmadeinassessinginvestment entity status

• explanationswheretypicalcharacteristicsarenotmet• detailsandeffectofanychangeininvestmententitystatus• name,countryofincorporationand%interestin

subsidiaries• anysignificantrestrictionsontheabilityofsubsidiariesto

transfer funds• detailsregardingcontractualornon-contractualsupport

for subsidiaries.

The original investment entity exposure draft had proposed a number of additional disclosures designed to enable investors to evaluate the entity’s investment activities – primarily entity level performance information. These disclosures have not been implemented.

First year implementationThe amendments introducing the investment entity exemption are effective from 1 January 2014. The implementation in the EU of the IASB’s new suite of consolidation standards comprising IFRS 10, 11 and 12 is likely to be deferred until the same date, but the EU will in addition have to consider the extent of adoption of the investment entity amendments. Only once all of this has been approved for adoption by the EU would the exemption become available for early adoption, assuming of course that the EU permit early adoption in this instance.

Unless it is impractical to identify the fair value of investments in prior periods, which would seem unlikely in an investment trust context, then the investment entity exemption will be applied retrospectively when implemented for the first time.

Julian BartlettT 020 7865 2327E julian.bartlett@uk.gt.com

Marcus SwalesT 020 7865 2320E marcus.swales@uk.gt.com

Alastair RobertsonT 020 7865 2275E alastair.robertson@uk.gt.com

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Contact usIf you would like to discuss any of the matters raised in this release further, please contact one of our investment trust specialists listed below.

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ConclusionGiven the controversy which has surrounded this area of debate over an extended period of years, the fact that the IASB has managed to issue an exemption in final form is a notable landmark. It appears to significantly advance the level of general acceptance of the argument that trading entities and investment entities are not the same and that there can be some fundamental differences in terms of the accounting information demanded by their respective investors.

Any investment companies wishing to benefit from the exemption now that it is in final form will need to examine

the requirements closely to confirm whether they meet these having regard to their specific circumstances and will need to keep an eye on the EU adoption process. Careful consideration will also need to be given to the stipulation that certain subsidiaries providing investment related services will fall outside of the exemption.

At this stage the exemption applies only in relation to IFRS. So far as UK GAAP is concerned an exemption in some shape or form remains on the agenda and the details of this will become clearer when the replacement UK accounting standards are published, hopefully early in 2013.