As defined by International Financial Reporting Standards, Romanian Accounting Standards and German Accounting Standards
Participations and related parties are sometimes misinterpreted as to what they include in scope and there is not always a clear correspondence of the terms from one language to the other. Moreover, in Romania, The Fiscal Code brings also a definition of the term, obviously for fiscal purposes and this definition does not match perfectly any of the accounting terms.
In principle, the International Financial Reporting Standards (“IFRS”), the Romanian Accounting Standards and German Accounting Standards are harmonized and they refer to the following instances.
On one hand there are relations between two entities where one entity has participations in the other and the ability to control or significantly influence it. Depending on the percentage held from the voting rights or on the capacity to control, an entity may have subsidiaries, associates or may enter in a joint arrangement. German Commercial Code (Handelsgesetzbuch – “HGB”) namely HGB §271 generally defines participations and associates and establishes a 20% threshold for the equity participations. The same 20% threshold is indicated by the Ministry of Public Finance Order no 1802/2014 (“OMFP 1802”) for participations.
Romanian accounting standards, namely OMFP 1802 define a subsidiary as an entity that is controlled by the mother company. German Accounting Standard no 4 (DRS 4) gives the same exact definition and contains details as to determining control. In principle the mother company controls the subsidiary if it holds more than half the voting rights or if it has the power to govern the financial and operational policies of the subsidiary or if it assumes the majority of the risks and obtains the majority of the rewards of an entity created to accomplish a narrow and well defined objective (special purpose entity). IFRS 10 defines a subsidiary as an entity that is controlled by another entity and defines the control as being determined on one side by the power over the investee and on the other by the relationship between power and the obtaining a return from its participation (right to variable returns from its involvement with the investee and the ability to use power to affect the amount of the investor’s return).
As per Romanian Accounting Standards, the associates are entities in which the investor has a participation; additionally the investor has also a significant influence over the financial and operational policies of the associate. A participation is considered to be held if the investor holds a minimum 20% of the voting rights. The 20% threshold is also relevant to the ability to have significant influence, according to conform OMFP 1802. Section 89 of the OMFP 1802 brings additional details regarding significant influence which basically replicates the International Standards. German Accounting Standard no 8 (DRS 8) considers that associates are those entities in which the group has significant influence and that are neither subsidiaries nor joint ventures of one of the group entities. A 20% participation is considered to indicate significant influence; additionally the same indications listed by IAS 28 imply existence of significant influence.
From the international standards perspective, IAS 28 gives the definition of the associates as being the entities over which the investor has significant influence. Holding 20% of the voting rights is the first indication for significant influence. Additionally significant influence exists when the investor has a representation on the board of directors, when the investor participates in policy – making processes, including those related to dividends, when there are material transactions between the entity and its investor, when there is interchange of managerial personnel or when the investor provides essential technical information.
Jointly controlled entities
Jointly controlled entities are not defined by OMFP 1802, but they are mentioned section 5 - Financial non current assets. Section 810 brings additional details related to joint control; joint control exists only when consensus is required for deciding on relevant activities.
German Accounting Standard no 9 (GAS 9 ) defines joint ventures (Gemeinschaftsunternehmen) as being those jointly controlled by one of the entities included in the consolidated financial statements and by one or several other entities which do not belong to the group. Joint control must actually exist and it implies the consent of all venturers on strategic business decisions, on capital investments and financing.
Joint arrangements are defined by IFRS 11 as those oh which two or more parties have joint control. Joint control is the contractually agreed sharing of control of an arrangement which exists only when decisions about relevant activities require the unanimous consent of the parties sharing control. The standard differentiates between joint operations and joint ventures. This distinction is not made in the Romanian or German accounting rules.
Finally, there can exist a less tight relationship between entities, although they could still influence one another. Related parties include such instances. The Romanian accounting rules and the German Accounting Standards do not bring own definitions for related parties, but both accept and utilize the IFRS’ definition. Actually IAS 24 provides the definition of the related parties.
IAS24 provides that a party is related to another if:
a) directly, or indirectly through one or more intermediaries, the party:
- controls, is controlled by, or is under common control with, the entity (this includes parents, subsidiaries and fellow subsidiaries);
- has an interest in the entity that gives it significant influence over the entity; or
- has joint control over the entity;
b) the party is an associate (as defined in IAS 28 Investments in Associates) of the entity;
c) the party is a joint venture in which the entity is a venturer (see IAS 31 Interests in Joint Ventures);
d) the party is a member of the key management personnel of the entity or its parent;
e) the party is a close member of the family of any individual referred to in (a) or (d);
f) the party is an entity that is controlled, jointly controlled or significantly influenced by, or for which significant voting power in such entity resides with, directly or indirectly, any individual referred to in (d) or (e); or
g) the party is a post-employment benefit plan for the benefit of employees of the entity, or of any entity that is a related party of the entity.
If an entity had transactions with a related party, than it shall disclose the nature of the related party relationship as well as information about the transactions and outstanding balances with that related party. Such disclosure provides an understanding of the potential effect of the relationship on the entity’s financial statements.
In OMFP 1802’ Definitions the related parties are defined by reference to IFRS. Actual definition is given in article 474 and 475 of the same Order. Related parties fall under one of the following instances:
- An individual or a close family member of that individual is related to the reporting entity if that individual:
- Controls or jointly controls the reporting entity;
- Has significant influence on the reporting entity, or
- Is part of the entity’s key management or part of the mother company’s key management.
- An entity is related to the reporting entity if it meets any of the following conditions:
- The entity and the reporting entity belong to the same group (hence each of the mother company, subsidiaries of the group is related to the others);
- An entity is an associate or a jointly controlled entity of the other entity (or an associate or a jointly controlled entity of a member of the group to which the other entity belongs);
- Both entities are jointly controlled entities of the same third party;
- An entity is a jointly controlled entity of a third party and the other entity is an associate of the third party;
- The entity is a post-employment benefits plan for the benefit of employees of the reporting entity or of a related party of the reporting entity. Should the reporting entity be itself a benefits plan, the sponsoring employers are also related to the reporting entity;
- The entity is controlled or jointly controlled by an individual as defined above;
- An individual as defined above significantly influences the entity or is a key management member (or a mother company’s key management member);
- The entity or any member of the group to which it belongs supplies management services to the reporting entity or to the reporting entity’s mother company.
German Commercial Code defines the related parties as being an individual or an entity which:
- controls, directly or indirectly
- is controlled directly or indirectly
- owns a participation in the reporting entity and thus has a significant influence
- jointly controls the entity
- is an associate of the reporting entity
- is a partner in a joint venture
- is a key management member for the entity or for its mother company
- is a close family member of an individual indicated above
- is a post-employment benefit plan of the reporting entity.
We can thus understand that related parties represent the broadest concept, including different types of participations with different levels of control AND including additionally individuals that can influence the reporting entity or entities that are not a participation, irrespective of whether a participation exists, as long as influence can be exerted.
Depending on the types of participations as identified above, different accounting methods apply when preparing consolidated accounts. For the related parties there are only disclosure requirements in the notes to the financial statements, individual or consolidated statements.
OMF 1802 brings a change in the accounting method applied for jointly controlled entities that are included in consolidated accounts. Previously the proportional consolidation was used, while OMF 1802 requests applying the equity method.
From the point of view of the Romanian Fiscal Code, only the affiliation between two entities is relevant. The definition of the affiliated parties as per Fiscal Code does not match exactly any of the categories presented above. According to Fiscal Code, two persons are affiliated whether the relation between them falls in one of the following instances:
a) an physical person is affiliated to another physical person if they are spouses or up to third degree relatives;
b) an physical person is affiliated to a legal person if the legal person owns directly or indirectly at least 25% of the value / number of the participations or voting rights of the legal person or if he/she actually controls the legal person;
c) a legal person (reporting entity) is affiliated to another legal person if the second owns directly or indirectly at least 25% of the value / number of the participations or voting rights of the legal person (reporting entity) or if it actually controls the legal person;
d) a legal person (reporting entity) is affiliated to another legal person if it owns directly or indirectly at least 25% of the value / number of the participations or voting rights of the second legal person or if it actually controls that legal person;
As you may notice, the definition of the affiliated person as per Fiscal Code is wider than the definition as per Romanian accounting standards. From the fiscal point of view affiliated persons include entities defined as associates or as related parties by the accounting standards.
Transfer prices apply to the transactions between affiliated persons. For these transactions the Romanian entities must prepare and present a transfer pricing file.