This article was also published in BCA Journal Feb 2014 issue. https://www.bcasonline.org/articles/artin.asp?1125
Executive
Summary:
Land
acquisition in India is one of the critical components for any new industry to
come up in rural India. The acquisition process not only considers the cost of
land but also considers the socio economic impacts of such acquisition, which
triggered rehabilitation and resettlement measures to be undertaken by
acquiring entity. Let us touch upon the accounting and tax implications of the
expenditure incurred by entities towards Rehabilitation and Resettlement
(R&R) of displaced land owners. This Article brings out the debate on
provision and accounting of the said R&R expenditure, by referring relevant
guidance note, opinion, industry applications and drawing analogy cum
inferences from similar asset sharing models such as Spectrum, summarizing the various
thought points that arise for choosing the logical and substantive approach for
recognition, measurement and accounting of R&R expenditure.
Introduction
With the growing need to grow, various industrialists in developing nations like India step forward to invest in new manufacturing facilities. One of the key requisite for this activity is Land, on which the upcoming industries will be set up. Land acquisition is a crucial driver for various infrastructures projects and economic developmental activities undertaken by the Government as well as by Private sector.
In India land
acquisition was governed under Land Acquisition Act, 1894. Land may be acquired
for defense and national security; roads, railways, highways, and ports built
by public as well as private sector enterprises; planned development; residential
purposes for the poor and landless, etc. This Act did not include any
rehabilitation or resettlement scheme or address any consequential Social
impact on such acquisition by Government. In 2003, the Central Government formulated the
National Rehabilitation and Resettlement Policy, which was last updated in
2007. It provides for minimum rehabilitation and resettlement expenditure that
has to be incurred by the Government machinery, though State Governments can
provide for additional rehabilitation avenues. In order to facilitate the
process of acquisition, many private enterprises have adopted to acquire the
land through Government under the provisions of the Act.
Central Government in
2013 approved a combined bill on Land Acquisition and Rehabilitation and
Resettlement in the Parliament. The new law now requires all Private land
acquisitions to provide rehabilitation and resettlement to displaced people if
the area of acquisition is over a certain limit.
As per the
guidelines, we can broadly identify the costs incurred while acquiring land
into following two categories:
a. Direct
Compensation for the fair value of the piece of land and;
b. Rehabilitation
and Resettlement.
Rehabilitation and
Resettlement (R&R) cost can further catgorised as follows:
i.
Future subsistence cost for displacement of
the livelihood of the families; and
ii.
Community development and welfare
activities in general.
To
take an instance of State Policy and its accounting implications, following are
the objectives of Jharkhand Rehabilitation and Resettlement policy – 2008:
Objectives of the
Policy
1.
to
minimise displacement and to promote, as far as possible, non-displacing or
least displacing alternatives;
2.
to ensure
adequate rehabilitation package and expeditious implementation of the
rehabilitation process with the active participation of the affected families;
3.
to ensure
that special care is taken for protecting the rights of the weaker sections of society,
especially members of the Scheduled Tribe and Scheduled Castes with concern and
sensitivity;
4.
to provide
a better standard of living, making concerted efforts for providing sustainable income to the affected families;
5.
to
integrate rehabilitation concerns into the development planning and
implementation process; and
6.
where
displacement is on account of land acquisition, to facilitate harmonious relationship
between the requiring body and affected families through mutual cooperation.
The
various cost elements during acquisition of land can be allocated to the above
three categories based on its nature, as follows:
Direct Compensation
i.
Piece of land for constructing house, free
of cost
ii.
Construct a permanent establishment for the
displaced land owner
iii.
One time financial assistance in case of
the family wishes to relocate.
Future Subsistence
i.
Allowance for displacement of cattle and Employment
to individuals from those family
ii.
Employment to family members.
iii.
If employment is not given or accepted by
land owner, then regular income for sustaining life of the individual for a
period of 25 to 30 years depending upon State Governments i.e. Bhatta.
iv.
Percentage share in net profits of the
company
i.
Expenses on village infrastructure
development such as roads, water and sewerage systems, drainage systems,
education, skill development, etc.
ii.
Construction of Residential colonies.
Accounting Application in Industry
With respect to ‘Direct
Compensation Cost’, there is no debate as it represents direct cost of
acquisition based on fair market value of the piece of land and hence should be
capitalised as cost of Land.
It is R&R
expenditure where mixed practices have been observed in its recognition and
measurement. NTPC in their accounting policy has attributed a nexus to
acquisition of land and capitalise the entire expected outflow on this account
under cost of Land, while Coal India accounted the R&R cost as revenue
expenditure, as and when incurred.
Accounting Policy excerpt from NTPC Limited
Consolidated Financial Statements 2009
“Based
on the opinions of the Expert Advisory Committee (EAC) of the Institute of
Chartered Accountants of India (ICAI) received during the year, in respect of
land in possession of the company, provision of Rs.3,197 million has been made
towards expenditure on resettlement & rehabilitation activities including
the amount payable to the project affected persons (PAPs) towards land for land
option, resettlement grant or other grants, providing community facilities and
compensatory afforestation, greenbelt development & loss of environmental
value etc. based on the Rehabilitation Action Plan (RAP) of the Company or as
per the agreement with/demand letters/directions of the local authorities and
the same is included in the cost of land”.
Accounting Policy excerpt from NTPC Limited
Consolidated Financial Statements 2012
“Fixed
assets: Deposits, payments/liabilities made provisionally towards compensation,
rehabilitation and other expenses relatable to land in possession are treated
as cost of land.”
Accounting Policy excerpt from Coal India
Limited Annual Report 2012
“Land:
Value of Land includes cost of acquisition and Cash rehabilitation expenses and
resettlement cost incurred for concerned displaced persons. Other expenditure
incurred on acquisition of land viz. compensation in liu of employment, etc
are, however, treated as revenue expenditure.”
Looking
closer at the compensation structure in acquisition of land, it seems to be similar
to acquisition of Spectrum which is an
indefinite resource just like Land, which requires initial license fee (Direct
Compensation) and regular revenue (Future Subsistence) share to the government
with minimum committed every year.
In fact, the above analogy
also holds good in case of acquisition of definite life assets such as Ore mines,
Coal or an Oil Block. In these cases, since the assets are not in ready to use
condition at the first instance. Government allots them at nominal value with
limit on its capital exploration expenditure, as seen in case of Oil& Gas
block allocations. Once the asset is ready to use, there is a regular fee /
royalty / revenue share based on production on an annual basis till the useful
resource is depleted.
This analogy is
drawn on following counts:
i.
Both, the assets, i.e. Spectrum in specific,
as well as Land, have indefinite useful life.
ii. The compensation
for both types of asset acquisitions can broadly be split into following
categories:
-
immediate compensation at the time of
acquisition to secure right to use the asset and
-
sustaining expenditure, in case of
spectrum, it is on usage of spectrum over its life and in case of land it is
R&R expenditure i.e. subsistence cost for every subsequent year’s
livelihood.
Let us understand the
facets of concerns and issues involved in measurement and recognition for
accounting of various components of such rehabilitation and resettlement cost.
Recognition and Measurement for R&R expenditure:
From the accounting perspective, the following two
issues arise with regard to the R&R expenditure:
i)
The timing of
the creation of the provision for R&R expenditure; and
ii)
The
corresponding debit in respect of the provision, i.e., whether the same should
be capitalised or recognised as an expense in the statement of profit and loss.
There is no specific
literature to refer except the Technical guide on Accounting for Special
Economic Zones (SEZs) Development Activities.
It states that “in accordance with the principles
of recognition of provision as enunciated in AS 29, the provision for R & R
expenditure should be created and accounted for as follows:
(i)
In respect of
the R&R expenditure which arises on the acquisition of land as the lump-sum
or annuity payment to be made by a Developer to the land seller, provision
should be created at the time of the acquisition of the land itself. This is because the Developer has present
obligation in this regard at the time of the acquisition of the land itself and
the other two criteria for recognition are normally met at that point of time. The amount in respect of the provision
should be capitalised as a part of the cost of the land. Similarly, provision
should be created at the time of acquisition of land in respect of the other
R&R expenditure with regard to which the Developer has a present obligation
which cannot be avoided by the Developer by a future action. Such expenditure should also be capitalised as part
of the cost of land.
(ii)
Where a
provision is not related to any asset, to be recognised as the asset of the
Developer, for example, R&R incurred with respect to those assets which
will not be recognised by the Developer because he would not be the owner of
these assets as these will be transferred to the local area administrators, for
example, village panchayats, the same should be recognised in the statement of
profit and loss when the provision in this regard is made.
(iii)
The R&R
expenses, which are revenue in nature, e.g., revenue expenditure in respect of
Education and Health Programmes, should be recognised in the statement of
profit and loss for the period in which the criteria for making the provision
in this regard are met.
The Acquirer has present obligation in this regard
at the time of the acquisition of the land itself, there is high probability of
outflow of resources to settle the obligation and a reliable estimate can be
made at that point of time. These are essentially the three criteria with
regard to the timing of the creation of the provision, Accounting Standard (AS)
29, Provisions, Contingent Liabilities and
Contingent Assets.”
The
Technical guide as referred above, requires all direct and indirect expenditure
i.e. Compensation as well as subsistence cost, to be capitalized with the cost
of Land. For Community related expenditure, it however suggests to
recognize a separate asset if the expenditure is incurred for creation of a
capital asset i.e. roads, hospitals, buildings, etc and charge to income
statement if the expenditure is for health programs and other such Corporate
social responsibility measures, as and when incurred.
It
is to note that all the three types of expenditure (i.e. direct compensation of
fair value, subsistence cost and community development) is incurred only for
acquiring the Land and hence there is direct nexus of such expenditure with the
asset in balance sheet, however,
capitalizing future subsistence expenditure to cost of Land seems to be debatable.
Expert advisory
Opinion:
Provision towards resettlement and rehabilitation schemes (Compendium of
Opinions — Vol. XXVIII)
The querist had sought an opinion on recognition
and measurement of expenditure incurred / to be incurred while acquiring land
of project purposes.
The Committee
opined as follows:
(a)In respect of
the estimated amount payable to the land oustees in respect of ‘Land for Land’,
rehabilitation/ resettlement grants, subsistence grant/self-resettlement grant,
a provision, on the basis of best estimate of the expenditure required to
settle the obligation, should be made on the acquisition of land from the
project affected persons.
(b) In respect
of infrastructural measures, a provision on the basis of best estimate of the
expenditure required to settle the obligation, should be made on the
acquisition of land from the project affected persons.
The recognition criterion for provision is dependent on an Obligating
event. The committee has considered the acquisition of Land as the
obligating event for recognizing a provision for future subsistence cost as
well as Community development / Infrastructure related cost.
Looking at the
larger picture, following aspect may be evaluated for considering the substance,
while applying the recognition and measurement principles for R&R
expenditure:
In a growing
economy which has natural resources and tribal population residing in interior
rural India, setting up a manufacturing plant requires following five major
partners:
1.
Businessmen, i.e., Promoter
with equity and vision;
2.
Banks to support the additional
capital;
3.
Government to allow use of the
country’s resources (some having definite and some indefinite life)
4.
People who own a perpetual /
indefinite life asset, i.e., Land; and last but not the least
5.
Environment / nature itself.
Establishment of any
project in backward rural areas is possible only if it benefits all. Government
Policy plays a crucial role in combining and serving the interest of all parties
and executing the project.
While Promoters
with equity investment earn profits from an on-going business, banks earn their
share of profit in terms of fixed service cost since they part their money only
for a shorter period.
Government initially recovers a fair value of the natural resource but
since some of them have indefinite life, it also charges on-going basis, a share
in its profits as in case of spectrum usage in Telecom i.e. Revenue Share.
Similar to Government, People who have been living and earning their
lively hood also possess and own an asset with indefinite life. In order to
obtain their consent, a similar policy is followed wherein they initially get
the fair value of their asset and continue to earn the share of business
profits for their balance life.
Their contribution to the business is more than Bankers, as they have a
right to share the profits in a fixed form like “Bhatta” or Share in profits till
plant operation, in perpetuity as per the regulations promulgated by the State
Governments. This partnership with people promises a regular income to the
owner of land which is similar to the revenue share in case of Spectrum Usage,
Revenue share and Royalty.
In the above depicted
partnerships, the cost of acquisition as well as future expenditure obligations
is known, but then there is no need for an enterprise to create a provision /
capitalization on Day 1 for the Promoter for his future share of profits, for
the lender / banker for its committed interest service, Government for its
future estimated royalties based on estimated business cashflows, then why
should there be a provision and capitalization (in land) of future subsistence
cost in case of displaced landowners !
Excerpts
from AS 29: Provisions, Contingent Liabilities and Contingent assets
14. A provision should
be recognised when:
(a) an enterprise has a
present obligation as a result of a past event;
(b) it is probable that
an outflow of resources embodying economic benefits will be required to settle
the obligation; and
(c) a reliable estimate
can be made of the amount of the obligation.
It is probable that
the obligation will lead to outflow of resources but reliable estimate may not
be done for cases that require sharing of future profits. The future estimates
are though available with the Company as they are shared with various analysts,
it may not be completely reliable, though contrary view exists.
Further, the future
obligations under Indian GAAP are recorded at its full value instead of using discounted
approach. In any case, if such costs are considered as part of capital costs,
the actual share in profit for every year will lead to adjustment to the cost
of asset, which the entity will have to keep a tab till the life of asset. It
is more cumbersome under IFRS, which requires use of present value principles
for making a provision.
As we have broadly categorized
various expenditure components of R&R cost into Compensation, Future
subsistence and Community Development.
The first category
that includes viz.cost of piece of land for constructing house, free of cost, construct
a permanent establishment for the displaced land owner, one time financial
assistance in case of the family wishes to relocate, satisfy all the three
criteria for provision under AS 29 and also has a direct established nexus for
acquisition of land. Thus a provision is made and amount is capitalized with
the cost of Land in case of payments to landowners.
Commitments for
schools, hospitals, etc be owned by the Company but for the benefit of people are
recognized as fixed assets as and when constructed, CSR activities are expensed
as and when incurred. Unfinished work is forms part of Commitments disclosure
in Balance Sheet.
It is
the cost that is in the nature of future subsistence that needs to be
recognized and measured with its substance rather than form. It is more of a
period cost for supporting the livelihood of the family.
Taxation
impact
Any cost
capitalized as part of land is a capital cost. There is no depreciation benefit
available to the Company, though the cost of land increases and the company can
avail higher cost at the time of sale of such land. However, it is to note that
the Company has not acquired the land for disposal; hence the cost incurred on
land is essentially a sunk cost which yields no tax benefit.
Considering the tax
perspective, the company sharing percentage profit every year with land owners,
will not be allowed to consider as revenue expenditure if the Company had to
provide for and capitalise the entire future profits along with the cost of
land.
No depreciation benefit and no direct allowable expense benefit is available in income tax computation for such cost. Thus entities will have to carefully determine its accounting policy.
Points
of relevance
a. The Land
is for a specific usage as per the policy of the respective State Government.
b. It can
be observed that the Future subsistence costs incurred by the Company are in
the nature of Corporate Social Responsibility (CSR) and moreso governed by
Statute.
c. Some
costs are not compensation for land but for future subsistence of displaced
people till the plant is in operation and have direct nexus with Operations of
the plant. For example, if the company is shut down, there will be no
employment. There is not profit and thus no share of profit.
d. Some are
in the nature of regular taxes levied by stature such as property taxes. In
case of R&R these are regular income to land owners in the form of Bhatta.
e. If the
landowner agrees for employment, the amount of salary is charged to the income
statement, but if he agrees for fixed income without employment, then it gets
linked towards cost of land and not for future right to use on annual basis
like property taxes. Does it mean that the fair value of land belonging to the
owner who opts for employment is lower and the one who doesn’t is higher!
f.
Payments made on account of future
subsistence, if capitalised with the cost of land, then it may not be allowed
as expenditure in income statement which is not the case with “Revenue share”
and “Royalty”.
g. Acquiring
the land and committing R&R is in substance similar to a Purchase order
issued by a company for future subsistence cost. It can form part of
commitments in Balance sheet till the obligating event is happens in future
periods.
Views that emerge
Immediate cost that
is compensating the landowners immediate needs to be capitalized with cost of
land.
Subsistence allowance
which is committed by the Company at the time of acquisition of land is a
binding commitment towards land owners. The Obligating event i.e. acquisition
of land only gives rise to a commitment for future and should be viewed as a
period cost charged to operations. Especially for clauses such as share of
profits, where even determination of profit may not be a reliable estimate,
though alternate view exists.
Similar to telecom
and hydrocarbon businesses, land acquisition also is regulated for specific usage
and regular subsistence cost based on earning. Hence recognizing the future subsistence
cost component in substance to be considered as part of income statement, as
one of the charges for the usage of asset. This would to be more in line with comparative
asset acquisitions (i.e. Spectrum, Mine, Oil& Gas) followed by enterprises and
also justifies its core substance. Unrecognised commitment can be disclosed as
off-balance sheet item under ‘Contractual Commitments’.
References:
- Jharkhand State Rehabilitation and Resettlement
Policy – 2008
- Land Acquisition, Rehabilitation and
Resettlement Act, 2013
- Technical Guide on Accounting for Special
Economic Zones (SEZs) Development Activities (2010)
- Expert Advisory opinion on Provision towards resettlement and
rehabilitation schemes (Compendium of Opinions — Vol. XXVIII)
- AS 29 Provisions, Contingent
Liabilities and Contingent Assets
