Company finances at risk due to perpetual bonds being reclassified as debt in 2020, PwC Thailand warns

Stocks and Financial Services Press Releases Monday October 21, 2019 16:18
Bangkok--21 Oct--PwC Thailand

PwC Thailand has warned about changes in the way financial instruments are classified under the new Thai Accounting Standards (TAS 32). This standard may result in perpetual bonds being reclassified from equity to liabilities in financial statements.

This may increase the debt-to-equity ratio (D/E ratio) for issuers, potentially leading to a breach of debt covenants, and ultimately prompting banks to call in all outstanding loans.

As of 30 September 2019, there were eight listed companies in Thailand with perpetual bonds worth THB80 billion in outstanding principal. Reclassification may cause short term volatility in share prices and affect the overall capital market. While relief from reclassification for a certain period is possible, it is not guaranteed.

At PwC Thailand's Symposium 2019, Chanchai Chaiprasit, Assurance Leader and partner at PwC Thailand, spoke on the topic of 'Connecting the dots: Managing corporate challenges in 2020 and beyond'.
"All businesses will face challenges as we dive deeper into the digital era, catch up with new technologies and abide by rules and regulations that follow them," said Chanchai.

Several new accounting standards and principles will come into effect in 2020, including TFRS 9, TAS 32 and TFRIC 23. These new requirements will affect how listed companies report their finances. In TAS 32, a financial instrument presentation standard, areas that were once ambiguous are addressed with much more clarity. Changes in perpetual bond classification may worsen key financial ratios such as the D/E ratio.

This may result in liquidity issues and might also lead to higher finance costs as it indicates higher credit risk.

Perpetual bonds have two key features. Firstly, there are no repayments of principal so the holder has no right to redeem the bonds. The right to redeem lies with the issuer. Secondly, although there's a clear interest payment schedule, the issuer has the right to defer those payments indefinitely.

Most perpetual bonds trigger the principal and/or interest settlement provisions in extraordinary circumstances such as liquidation, bankruptcy, rehabilitation and going into absolute receivership.

TAS 32 provides clear guidance on the classification of debt and equity, highlighting control as the key consideration. Where the entity cannot control the situation that triggers repayments (such as where cumulative deficits result in an equity balance of less than 50% of registered share capital), the bonds are classified as a liability.

Given that rehabilitation and absolute receivership would lead to a settlement provision of the bonds, the instrument is then considered to have a contractual obligation to repay, and so it becomes a liability. If the issuer can defer settlements indefinitely, apart from repayments upon voluntary liquidation or forced liquidation (i.e. bankruptcy by court order), the bond is classified as equity.

Perpetual bonds satisfy the need for capital while mitigating high D/E ratios and higher credit risks without borrowing or increasing share capital, making it attractive to many businesses.

There are two ways to handle the new requirements imposed by TAS 32. The issuer can either revise the term of perpetual bonds or redeem and reissue new perpetual bonds. Either way will be costly and time consuming. As TAS 32 comes into effect on 1 January 2020, many may also find that time is insufficient.

"Navigating through the changes in TAS 32 may prove tricky for those who have issued and still have outstanding perpetual bonds.

"While reclassification is impending, the final verdict on whether issued and outstanding bonds may be relieved from reclassification for a certain period, has yet to be announced by the Federation of Accounting Professions. We'll have to wait and see, and this will have an effect on higher D/E ratio in those listed entities. It might trigger breaches in debt covenants resulting in the right to call in all outstanding bank loans immediately. This will temporarily affect share prices," said Chanchai.

On another note, new reporting standard TFRIC 23, which resonates with the United States' FIN 48, addresses income tax uncertainty. This standard requires entities to recognise provision or liability arising from income tax uncertainties and report them in financial statements. Conventionally, companies estimate deductible expenses and income tax liabilities on the assumption that they have a certain obligation to pay taxes. Any unclear or incorrect tax treatments are left out of financial statements.

In the past, a common practice was to recognise that income tax relating to those unclear items would be finalised post-inspection if the Revenue Department required any clarification. This requirement may affect the financial position and performance of many companies in the short and long term.

"All businesses must assess all uncertain tax items to determine any tax obligations. The assessment should be based on facts, rules and regulations to determine if and how much you'll need to pay in taxes. When it's deemed more likely (50% or higher) that you have an obligation to pay and can reliably estimate the amount, present that amount as income tax expense and related liabilities at the time they arise. Work with the assumption that the Revenue Department has full visibility of your transactions and put this to practice at all times, even if not inspected," added Chanchai.

As companies navigate the increasingly complex nature of business transactions, keep in mind that the Thailand Revenue Code and the Financial Reporting Standards are based on different sets of principles.

This disparity, combined with the lack of clarity, guidance and interpretation from the tax authorities, means management needs to make its best estimations to comply with both standards. A good understanding of tax laws and their interpretation would enable companies to best mitigate the risk and take an appropriate position when doing tax returns.

Businesses to keep an eye on 5G, cloud computing and ICO
Keeping up with accounting regulations is one thing but to have an edge in the increasingly competitive business sector requires being up-to-date with emerging technologies.

Technological leaders around the world are on their toes as the 5G and cloud computing races continue to unfold. When used to its full capacity, 5G will introduce Thailand to state-of-the-art connectivity that will allow for projects such as smart cities and eHealth.

Cloud computing technologies at full functionality will surpass traditional hardware and software, ushering in a new era of light-speed data processing, unlimited storage, and limitless businesses.

"Leaders have to quickly assess if and how these technologies benefit their businesses. When considering implementing these technologies, they should do so in conjunction with enhancing cybersecurity and human resource capabilities. The ASEAN region will increasingly be targeted by cybercriminals as internet penetration continues to rise," said Chanchai.

In the funding arena, an Initial Coin Offering (ICO), is a crowdfunding method that has been gaining popularity over the past few years.

At the moment, there aren't any specific accounting standards to deal with emerging asset types such as cryptocurrencies. Chanchai said it would take time for financial reporting standards and regulations to develop and catch up. If and when this asset class truly establishes itself, financial reporting standards with greater clarity and detail will follow.

PwC Thailand must obtain approval from the global PwC network before providing auditing services for issuers or holders of cryptographic assets. However, our global network, well- experienced in cryptographic activities' risk management, monitoring and other related operations, is ready to provide consultations along with auditing or assurance services.

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