particular, the requirements of IFRS 10 – Consolidated Financial Statements – relating
to disposals of, or loss of control over, subsidiaries (see Chapter 7 at 3.2) and the
requirements of IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations – relating to disposal groups held for sale and discontinued operations
(see Chapter 4). The discussion in Chapter 7 at 3.7 and in Chapter 8 at 2.4.2 relating to
demergers (e.g. the spin-off of a subsidiary or business) may also be relevant.
Finally, any transaction between entities under common control is a related party
transaction under IAS 24, the requirements of which are dealt with in Chapter 35.
2
THE IFRS 3 SCOPE EXCLUSION
IFRS 3 establishes principles and requirements for how the acquirer accounts for a business
combination, which is defined as ‘a transaction or other event in which an acquirer obtains
control of one or more businesses’. [IFRS 3.1, Appendix A]. Identifying a business combination,
including the definition of a business, is discussed generally in Chapter 9 at 3.
However, IFRS 3 excludes from its scope ‘a combination of entities or businesses under
common control’. [IFRS 3.2(c)]. The application guidance of the standard provides further
guidance to determine when a business combination is regarded a business combination
under common control. [IFRS 3.B1-B4].
If the transaction is not a business combination in the first place, because the assets
acquired and liabilities assumed do not constitute a business as defined, it is accounted
for as an asset acquisition. [IFRS 3.3]. The accounting for acquisitions of (net) assets under
common control is discussed in Chapter 8 at 4.4.2.D.
2.1
Business combinations under common control
For the purpose of the scope exclusion, a business combination involving entities or
businesses under common control is ‘a business combination in which all of the
combining entities or businesses are ultimately controlled by the same party or parties
both before and after the business combination, and that control is not transitory’.
[IFRS 3.B1]. This will include transactions such as the transfer of subsidiaries or businesses
between entities within a group.
The extent of non-controlling interests in each of the combining entities before and
after the business combination is not relevant to determining whether the combination
involves entities under common control. [IFRS 3.B4]. This is because a partially-owned
subsidiary is nevertheless under the control of the parent entity. Therefore transactions
Business combinations under common control 711
involving partially-owned subsidiaries are also outside the scope of the standard.
Similarly, the fact that one of the combining entities is a subsidiary that has been
excluded from the consolidated financial statements of the group in accordance with
IFRS 10 is not relevant to determining whether a combination involves entities under
common control. [IFRS 3.B4]. This is because the parent entity controls the subsidiary
regardless of that fact.
2.1.1
Common control by an individual or group of individuals
The scope exclusion is not restricted to transactions between entities within a group. An
entity can be controlled by an individual or a group of individuals acting together under a
contractual arrangement. That individual or group of individuals may not be subject to
the financial reporting requirements of IFRSs. It is not necessary for combining entities
to be included as part of the same consolidated financial statements for a business
combination to be regarded as one involving entities under common control. [IFRS 3.B3].
Thus if a transaction involves entities controlled by the same individual, even if it results
in a new reporting group, the acquisition method would not always be applied.
A group of individuals controls an entity if, as a result of contractual arrangements, they
collectively have the power to govern its financial and operating policies so as to obtain
benefits from its activities. Therefore, a business combination is outside the scope of
IFRS 3 if the same group of individuals has ultimate collective power to control each of
the combining entities and that ultimate collective power is not transitory. [IFRS 3.B2].
The mere existence of a common ownership is not sufficient. For the scope exclusion
to apply to a group of individuals, there has to be a ‘contractual arrangement’ between
them such that they have control over the entities involved in the transaction. IFRS 3
does not indicate what form such an arrangement should take. However, in describing
a ‘joint arrangement’, IFRS 11 – Joint Arrangements – explains that ‘contractual
arrangements can be evidenced in several ways’ and that ‘an enforceable contractual
arrangement is often, but not always, in writing, usually in the form of a contract or
documented discussions between the parties’. [IFRS 11.B2]. This also implies that it is
possible for a contractual arrangement to be in non-written form. If it is not written,
great care needs to be taken with all of the facts and circumstances to determine
whether it is appropriate to exclude a transaction from the scope of IFRS 3.
One particular situation where there might be such an unwritten arrangement, is where
the individuals involved are members of the same family. In such situations, whether
common control exists between family members very much depends on the specific
facts and circumstances and requires judgement.
A starting point could be the definition in IAS 24 of ‘close members of the family of a
person’ as ‘those family members who may be expected to influence, or be influenced
by, that person in their dealings with the entity and include:
(a) that person’s children and spouse or domestic partner;
(b) children of that person’s spouse or domestic partner; and
(c) dependants of that person or that person’s spouse or domestic partner.’ [IAS 24.9].
If the individuals concerned are ‘close members of the family’ as defined in IAS 24
(see Chapter 35 at 2.2.1), then it is possible that they will act collectively, and the scope
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exclusion in IFRS 3 may apply. This could be the case where one family member may
effectively control the voting of a dependent family member (e.g. scenario (a) in
Example 10.1 below). It is also possible that a highly influential parent may be able to
ensure that adult family members act collectively (e.g. scenario (b) in Example 10.1
below). In this case there would need to be clear evidence that the family influence has
resulted in a pattern of collective family decisions. However, common control is
unlikely to exist where the family members are adult siblings (e.g. scenario (c) in
Example 10.1 below), as such individuals are more likely to act independently. We
believe that there should be a presumption that common control does not exist between
non-close family members and sufficient evidence that they act collectively, rather than
independently, would need to exist to overcome this conclusion.
In all such situations involving family members, whenever there is sufficient evidence
that the family members (irrespective
of the family relationship) have acted
independently, then the scope exclusion for business combinations under common
control does not apply.
Example 10.1: Common control involving individuals
Entity A has three shareholders, Mr X, Mr Y and Mr Z. Mr X and Mr Y are family members who each hold
a 30% interest in Entity A. Mr X and Mr Y also each hold a 30% interest in Entity B. There is no written
contractual arrangement between Mr X and Mr Y requiring them to act collectively as shareholders in
Entity A and Entity B. Both Entity A and Entity B are businesses as defined in IFRS 3.
Mr Z
Mr X
Mr Y
Mr W
40 %
30 %
30 %
30 %
30 %
40 %
Entity A
Entity B
If Entity A acquires 100% of Entity B, is this a business combination under common control and therefore
outside the scope of IFRS 3 when the nature of the family relationship is:
(a) Mr X is the father and Mr Y is his young dependent son; or
(b) Mr X is a patriarchal father and – because of his highly influential standing – his adult son Mr Y has
traditionally followed his father’s decisions; or
(c) Mr X and Mr Y are adult siblings?
Whether common control exists between family members very much depends on the facts and circumstances,
as often there will not be any written agreement between family members. However, the influence that
normally arises within relationships between ‘close members of the family’ as defined in IAS 24 means that
it is possible that they will act collectively, such that there is common control. If so, the business combination
would be outside the scope of IFRS 3.
Scenario (a)
The business combination may be outside the scope of IFRS 3. The father, Mr X, may effectively control the
voting of his dependent son, Mr Y, by acting on his behalf and thus vote the entire 60% combined holding
collectively. However, if there is evidence that Mr X and Mr Y are acting independently (e.g. by voting
differently at shareholder or board meetings), the scope exclusion would not apply since these close family
members have not been acting collectively to control the entities.
Business combinations under common control 713
Scenario (b)
The business combination may be outside the scope of IFRS 3. A highly influential parent may be able to
ensure that adult family members act collectively. However, there would need to be clear evidence that the
family influence has resulted in a pattern of collective family decisions. If there is any evidence that Mr X
and Mr Y are acting independently (e.g. by voting differently at shareholder or board meetings), the scope
exclusion would not apply since the parent and adult family member have not been acting collectively to
control the entities.
Scenario (c)
Common control is unlikely to exist, and therefore the business combination would be in scope of IFRS 3.
In this scenario where Mr X and Mr Y are adult siblings (and not considered close family members
otherwise), it is less likely that an unwritten arrangement will exist. Where family members are not ‘close’,
they are less likely to have influence over each other and more likely to act independently. Accordingly, there
is a presumption that common control does not exist between non-close family members and sufficient
evidence that they act collectively, rather than independently, would be needed to overcome this conclusion.
If in Example 10.1 above, Mr X and Mr Y had been unrelated, then, in the absence of a
written agreement, consideration would need to be given to all of the facts and
circumstances to determine whether it is appropriate to exclude the transaction from the
scope of IFRS 3. In our view, there would need to be very strong evidence of them acting
together to control both entities in a collective manner, in order to demonstrate that an
unwritten contractual arrangement really exists, and that such control is not transitory.
Prior to the acquisition of Entity B by Entity A in Example 10.1 above, another question
is whether financial statements can be prepared under IFRS for a ‘reporting entity’ that
does not comprise a group under IFRS 10 (i.e. combined financial statements containing
such ‘sister’ companies). This issue is discussed in Chapter 6 at 2.2.6.
2.1.2 Transitory
control
IFRS 3 requires that common control is ‘not transitory’ as a condition for the scope
exclusion to apply. In contrast, if common control is only transitory, the business
combination is still within the scope of the standard. The condition was included when
IFRS 3 was first issued in 2004 to deal with concerns that business combinations
between parties acting at arm’s length could be structured through the use of ‘grooming’
transactions so that, for a brief period immediately before and after the combination,
the combining entities or businesses are under common control. In this way, it might
have been possible for combinations that would otherwise be accounted for in
accordance with IFRS 3 using the purchase method (now called acquisition method) to
be accounted for using some other method. [IFRS 3(2007).BC28]. Questions have been
raised, however, on the meaning of ‘transitory control’.
The Interpretations Committee was asked in 2006 whether a reorganisation involving
the formation of a new entity (Newco) to facilitate the sale of part of an organisation is
a business combination within the scope of IFRS 3. Some suggested that, because
control of Newco is transitory (i.e. it is subsequently sold), a combination involving that
Newco would be within the scope of the standard. The Interpretations Committee
however observed that paragraph 22 of IFRS 3 (now paragraph B18) states that when
an entity is formed to issue equity instruments to effect a business combination, one of
the combining entities that existed before the combination must be identified as the
acquirer. To be consistent, the Interpretations Committee noted that the question of
714 Chapter
10
whether the entities or businesses are under common control, applies to the combining
entities that existed before the combination (i.e. excluding the newly formed entity that
did not exist before). Accordingly, the Interpretations Committee decided not to add
this topic to its agenda.3 Although the issue was considered in the context of the original
IFRS 3, the comments remain valid as the relevant requirements in the standard are
substantially unchanged.
Therefore, whether or not a Newco is set up within an existing group to facilitate the
disposal of businesses is irrelevant as to whether or not common control is transitory.
However, does the fact that the reorganisation results in the parent of the existing group
losing control over those businesses, mean that common control is transitory?
In our view, the answer is ‘no’. An intention to sell the businesses or go to an IPO shortly
after the reorganisation does not, by itself, preclude the scope exclusion in IFRS 3 from
applying. The requirement ‘that control is not transitory’ is intended as an anti-
avoidance mechanism to prevent business combinations between parties acting at arm’s
length fro
m being structured through the use of ‘grooming’ transactions so that, for a
brief period immediately before and after the combination, the combining entities or
businesses are under common control. Whether or not common control is transitory
should be assessed by looking at the duration of control of the combining businesses in
the period both before and after the reorganisation – it is not limited to an assessment
of the duration of control only after the reorganisation.
Example 10.2: The meaning of ‘transitory’ common control
Entity A currently has two businesses (as defined in IFRS 3) operated through wholly-owned subsidiaries
Entity X and Entity Y. The group structure (ignoring other entities within the group) is as follows:
Entity A
Entity X
Entity Y
Entity A proposes to combine the two businesses (currently housed in two separate entities, Entity X and
Entity Y) into one entity and then spin-off the combined entity as part of an IPO. Both businesses have been
owned by Entity A for several years. The reorganisation will be structured such that Entity A will first
establish a new entity (Newco) and transfer its interests in Entity X and Entity Y to Newco, resulting in the
following group structure:
Entity A
Newco
Entity X
Entity Y
Newco will then be subject to an IPO, with the result that Entity A will lose control.
Business combinations under common control 715
If Newco were to prepare consolidated financial statements, would the reorganisation undertaken to facilitate
the disposal of Entity X and Entity Y be in the scope of IFRS 3? Or would the scope exclusion for business
combinations under common control apply?
The question of whether the entities or businesses are under common control applies to the combining entities
that existed before the combination, excluding the newly formed entity, i.e. Entity X and Entity Y. These are
clearly entities that have been under the common control of Entity A, and remain so after the transfer.
If Newco prepares consolidated financial statements without there being an intended IPO, the scope exclusion
would apply. However, as the purpose of the transaction was to facilitate the disposal of the businesses by
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 141
