Modernisation of accounting Law and reform of the CNC - 05/01/2012
On 20 December 2011, the Draft Law No 6376 was published, reforming the Commission des normes comptables (CNC – Accounting Standards Commission) and amending various provisions relating to companies’ accounting and annual accounts and to the consolidated accounts of certain types of companies.
The purpose of this Draft Law is to introduce two key changes:
1. The optional scope of the principle of “substance over form”
The Draft Law introduces the optional scope of the so-called “substance over form” principle, as permitted by the 4th Directive 78/660/EEC. In the absence of clear rules and a consistent interpretation of the concept of substance over form, this option feature is certainly desirable, it being understood that regardless of whether they apply this concept, companies clearly remain bound by the principle of true and fair view of the annual financial statements.
2. Revised procedures governing the use of the fair value method
a) Limiting the fair value option for other asset categories
While, in theory, the Law of 10 December 2010 made it possible to measure all categories of assets other than financial instruments at their fair value, the Draft Law limits the use of fair value measurements. Article 64(sexies) states that such a fair value measurement is only possible if it is authorised by IFRS (such as investment real estate in accordance with IAS 40).
If a company chooses to measure certain assets other than financial instruments at fair value, disclosures with content similar to that required for financial instruments measured at fair value will henceforth be required concerning the assumptions made in determining fair value, the variations relating thereto and the risks linked to the non-recovery of this value.
b) Introducing a new requirement: accounting for deferred tax liabilities
Another point worth emphasising is the introduction of the requirement to recognise deferred tax liabilities, i.e. taxes that are recognised in the current financial year but will only fall due during a subsequent tax year, for companies making use of the fair value option referred to in Section 7 bis of the Law. This requirement applies “where applicable”, i.e. provided that the gain relating to the fair value recognition of an asset or due liability is taxable when it is realised.
c) Tax implications of procedures governing the use of the fair value method
Naturally, the use of fair value accounting has tax implications. This is important, as Luxembourg tax law is closely linked to accounting law pursuant to Article 40 of the Luxembourg law on income tax (LIR), which lays down the principle of linking the tax balance sheet to the commercial balance sheet.
If fair value accounting is used, the Draft Law provides for the requirement to recognise deferred tax liabilities. This requirement is logical and necessary, as measuring an asset or liability at its fair value so that unrealised gains or losses can be recognised entails a de facto increase in a company’s net assets.
Even if the comments on the Draft Law indicate that it is “understood” that unrealised income and gains will “generally” be taxed only when they are realised, it will be necessary to amend the tax legislation if we are to ensure the fiscal neutrality of the use of fair value.
Indeed, combining Articles 18 and 40 of the LIR, i.e. the calculation of taxable profit as the difference between net assets invested at the end of the financial year and net assets invested at the beginning, and the principle of linking the tax balance sheet to the commercial balance sheet will automatically entail taxing unrealised income.
Without anticipating the position of the Luxembourg tax authorities, and unless tax legislation is amended, either by changing the rules for calculating taxable profit in order to deduct or ignore unrealised profits or by making the filing of Lux Gaap accounts mandatory for tax purposes (based on the principle of valuation at historic cost), the use of fair value accounting could result in the immediate taxation of unrealised profits, thereby creating a cash flow problem relating to tax payments.
d) Calculation of distributable reserves when performing fair value measurements or if IFRS has been adopted
The aim of the reform of the Laws of 10 August 1915 on commercial companies and 19 December 2002 on the Commercial and Companies Register, accounting and annual accounts is to allow flexible but fair accounting while offering companies the option of the fair value measurement method.
The optional nature of this method requires that companies that use it do not find themselves at an advantage over other companies in terms of the distribution of available dividends, and that the use of fair value accounting should not be used specifically to increase a company’s distribution capacity by including profits that may have been booked but are as yet unrealised.
The new concept, enshrined in the Draft Law, is based on two principles: the first is to authorise the distribution of realised and substantially-realised profits (or reserves). The second is to allocate unrealised profits to a non-distributable reserve.
The provisions covering the distribution of unrealised profits and reserves (Article 72 ter) apply to companies that prepare their accounts in accordance with IFRS, and also to companies that prepare their annual accounts under Lux Gaap and exercise the fair value options. The principle of non-distribution of any unrealised or substantially-realised item that would increase a company’s equity capital, either by posting it directly in equity or through the income statement, is thus introduced.
Companies should therefore be able to isolate – with a view to allocating profits and calculating distributable reserves – unrealised gains recognised in the income statement for the year or directly in equity, as well as the resulting tax implications.
This reform does not apply to credit institutions or insurance and reinsurance companies, or to investment companies such as open-ended investment companies (SICAV), closed-ended investment companies (SICAF), venture capital companies (SICAR) or Specialised Investment Funds (SIF).