This article is taken from our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America. The articles in our bulletin are a part of our mission to become the ultimate ally in your success by keeping you informed about current events.
This busy season we will be dealing with several changes to the accounting and assurance standards. I would like to focus on changes to the financial instrument section in ASPE that relates to mandatorily redeemable shares issued in a tax planning arrangement (usually referred to as ROMRS).
Why focus on ROMRS? The answer is practical – the changes in ROMRS can potentially have a dramatic impact on the balance sheet which in turn can wreak havoc with our client’s bank covenants; not something that you want to find out about at the end of an audit engagement.
ROMRS amendments
So, what are the changes to the ROMRS rules that cause this drastic change in the balance sheet? A simple example will hopefully provide some insight. Imagine Segal Co. issued ROMRS many years ago to its shareholders. These preferred shares have a cost of $100 and a redemption amount of $5,000,000. Since they were issued, these shares would have sat benignly in the equity section at their cost of $100. With the upcoming amendments, however, these shares, unless they meet certain conditions, will now show up as liabilities at the REDEMPTION amount. You will now have a $5,000,000 liability with an offsetting equity amount of $4,999,900. Covenants related to debt-to-equity and current ratios will be decimated. We need to be prepared for these possibilities well in advance of busy season.
Exceptions to classification as a liability
As hinted to above, if certain conditions are met then these shares will not have to be reclassified as liabilities at the redemption amount. Specifically, all the following conditions must be met:
- The individual that received the ROMRS retains control of the Company before and after the transaction in which the ROMRS were issued,
- Only shares are exchanged, and
- There are no scheduled redemptions of the ROMRS in future years.
Transitional Relief
One might correctly conclude that for some clients where these transactions happened several years ago, this information might be very difficult to obtain. The Accounting Standards Board has acknowledged this and has provided some welcomed relief upon transition.
For ROMRS issued prior to January 1, 2018, the determination of whether they can be classified as equity is based on the following two criteria:
- The individual that received the ROMRS controls the Company at the date of initial application of the amended standard (for most December 31, 2021, year ends will be January 1, 2021), and
- There are no scheduled redemptions of the ROMRS.
This article hopefully provides a small glimpse into the upcoming changes in ROMRS. For a deeper dive, I would highly recommend the CPA Canada publication: “ASPE Briefing: Retractable or Mandatorily Redeemable Shares Issued in a Tax Planning Arrangement” (March 2019).
Written by Trevor Reef, CPA, CA, from Segal LLP. This document was written for our quarterly bulletin, Canadian Overview, published by Canadian member-firms of Moore North America.