TFHPSA Working Group 2

1
TFHPSAWorking Group 2

• Capital injections / Superdividends /
  Reinvested earnings
• Philippe de Rougemont (Eurostat-C.3)
• drawing on presentations by T. Dobbs and B.
  Robinson, and by A. Harrison

2
Part I

• Presentation of the issue

3
In this discussion

• Superdividends refers to payments returning
  multi-year (operating) earnings to owners.
• Capital injections refers to payments covering
  multi-year (operating) losses
• Including against issuance of shares.

4
Guidance

• GFSM 2001 Government Finance Statistics Manual
  2001 IMF
• Manual on Government Deficit and Debt (MDD)
  interprets ESA 1995

5
Table 1
6
Table 1 continued
7
Table 2 Criteria
8
Table 2 Criteria continued
9
Table 3 Criteria end
10
Table 3
11
Table 4 - continued
12
Support I

• TFHPSA Questionnaire 17 responses 13 nationals
  (10 countries) 4 international
• Question on support of the approach of the
  paper Support 8, partly support 4, do not
  support 4
• Question on support to GSFM /MDD
• capital injection superdividend
• No 1 2
• Yes but not enough 6 7
• Yes to be in SNA 9 7
• Reinvested earnings defaults volatility of 1st
  estimate, source data issues, consistency

13
Support II

• TFHPSA in Washington (and Paris)
• Support reinvested earnings USA, AUS, IMF GFD,
  Eurostat
• Accounting? IPSASB
• Oppose reinvested earnings CAN, UNSD, ECB, FR,
  DE
• Japan?

14
Part II

• To summarize

15
3 Options

• 1 SNA unaltered
• 2 SNA amended for superdividends and interpreted
  for capital injection
• 3 Reinvested earnings

16
SNA unaltered

• Advantages
• No changes to concepts or practice
• Disadvantages
• Inconsistent with GFSM and MDD
• Capacity to game
• Asymmetry between superdividends and capital
  transfers (income)
• Lack of worldwide comparability of net
  lending/net borrowing

17
Support

• First choice small support
• Second choice small support

18
SNA amended for superdividends and interpreted
for capital injections
19
Advantages

• Symmetry between superdividends and capital
  injections (income)
• Consistent with GFSM and MDD
• Improves on SNA 1993, against gaming
• Currently implemented by some compilers

20
Disadvantages

• Not net worth neutral
• Asymmetry between superdividends and capital
  injections (net lending/net borrowing)
• Time of recording of the capital transfer not
  appropriate
• Still leaves noticeable wriggle room for
  manipulation of S.13 data (injections)
• Involve compilation difficulties
• To be applied to which transactions?

21
Support

• First choice - about half
• Second choice - most of the other half

22
Reinvested earnings
23
Advantages

• Net worth neutral
• Symmetry between superdividends and capital
  injections (income and net lending/net borrowing)
• Reduces gaming
• Comes closer to accounting (IPSAS/GAAP)

24
Disadvantages

• Requires changes to SNA (and supporting manuals)
• Allocates saving to government
• Imputation
• Consistency issue if not applied to all sectors
• Consistency with market valuation (?)
• Measurement issues

25
Support

• First choice - about half
• Second choice - small

26
Part III

• Reinvested earnings how does it work and what
  proposed threshold?

27
How does it work?

• Example
• Government owns a corporation that makes 15 of
  operating profits during the accounting period,
  and distributes 5 in dividends
• The corporations assets/liabilities generate,
  during that period, 3 of holding gains/losses (to
  be excluded from operating profits)
• The equity stakes in the company starts at 100.
  It closes at 113100153-5

28
How does it work? (2)
29
100 Threshold is suggested

• 100 is a lesser change in SNA
• 100 controlled entities are un-restrictively
  controlled
• transfer pricing notion of savings elusive.
  Slightly different concept from D.43 for S.2
  (influence and control)
• 100 public controlled provide most scope for
  gaming in fiscal
• 100 does not give rise to the question of the
  treatment of minority interest
• 100 may allow a recording of losses as subsidy,
  instead of negative property income

30
Capturing quasi-fiscal operations

• (1) Set a market/nonmarket rule to cover all loss
  making corporations
• (2) Record as expenditure the granting of
  guarantees, before the call
• (3) Accrue profits and losses in the account of
  the government

31
Part IV

• TFHPSA to AEG
• (1) Possible propositions of change
• (2) What preference

32
option A GFSM2001 / MDD

• Extend the quasicorporation treatment of
  superdividends to corporations
• Clarify capital transfer recording implemented
  when to cover past losses, even when shares are
  issued
• Clarify this also applies to quasicorporations
• Clarify capital injections can also be carried by
  way of debt assumption
• Change a reference in GFSM 2001 in case of public
  corporation
• Change ESA for references to units that
  disappeared, at least when public corporations

33
Option A cont. GFSM2001 / MDD

• To which equity links to apply the superdividend
  treatment?
• To all equity? Portfolio/Direct
• thresholds? 10, 50, 20, 10
• To all sectors?

34
Option B Reinvested earnings

• Extend the reinvested earnings treatment that
  exist for direct foreign investment only to 100
  public owned corporations (and quasi corporation)

35
TFHPSA preference

• Slight preference for MDD/GFSM Option as
  those preferring reinvested earnings are more
  amenable to supporting this option than the
  reverse.

36
Some data

• See Excel file

37
(No Transcript)
38
Distribution of dividend of 10
Change net worth Income before remeasurement Remeasurement Total income
1993 SNA 0 10 -10 0
New SNA 0 0 0 0
Equity Method 0 ? ? 0
Cost Method 10 ? ? 10

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Earnings of profits (of 25)
Change net worth Income before remeasurement Remeasurement Total income
1993 SNA 25 0 25 25
New SNA 25 25 0 25
Equity Method 25 ? ? 25
Cost Method 0 0? 0? 0

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The Government Finance issue

• Capital injections should generally be expensed,
  even though they are always net worth neutral for
  the corporation in question and also for
  government
• Prudence cover past or future losses of public
  corporations, which are not accrued as expenses
  in the books of government
• Injections realized in a commercial context, with
  expectation of a reasonable return on investment,
  can be classified as transaction in equity
• Distributed dividends recorded for a period
  should not exceed the income of the period
• distributions of superdividends or lump sum
  payments should be classified as financial
  transactions (for the part in excess)
• otherwise governments would be able to manipulate
  the timing of their revenues, irrespective of the
  time of the underlying event (the profit accrued)

41
The Government Finance issue II

• In Europe the accounting treatment of GG
  Public corporations transactions the most
  contentious issue when EU Commission visits
  countries
• Railways
• Importance of issue largely depends on the
  definition of the market/non market (50 rule or
  100 rule)

42
Guidance

• SNA 1993 - ESA 1995
• Dividends / losses
• Quasi-corporations
• Reinvested earnings (RoW)
• Eurostats Manual on Deficit and Debt (MDD)
• Interpretation of ESA 1995, though not a legal
  act
• 40 of the MDD (of 243 pages) is dedicated to
  Part II Relations between the government and
  public enterprises
• GFSM 2001
• Compilation guide

43
Part II

• Superdividends / Capital injections

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Dividends (1)

• SNA - mixed message
• it encompasses all distribution of profits by
  whatever name they are called SNA 7.114
• the level of dividend is not unambiguously
  attributable to a particular earning period....
  SNA 3.99
• income is often defined as the maximum amount
  that a household, or other unit, can consume
  without reducing its real net worth SNA 8.15
• QC income that the owner of quasi-corporations
  withdraws from them is analogous to the income
  withdrawn from corporations by paying out
  dividends to their shareholder SNA 7.89
• QC amounts recorded under D.422 have to be
  explicitly identifiable (SNA 7.116) and will
  depend largely on the size of the
  entrepreneurial income (SNA 7.117)
• QC D.422 excludes withdrawal of funds realized
  by the sale or disposal of the quasi-corporations
  assets or of large amounts of accumulated of
  retained earnings or other reserves. SNA 7.118

45
Dividends (2)

• MDD II.1.2.1
• Dividends arise from the government ownership of
  the unit. They, apply to payments that are funded
  from the units income. Dividends do not apply to
  payments funded by asset sales, capital gains, or
  reserves accumulated over several years, even if
  they are called dividend.
• GFSM 2001
• Dividends are payments a corporation makes out
  of its current income, which is derived from its
  ongoing productive activities. A corporation may,
  however, smooth the dividends its pays from one
  period to the next so that in some periods it
  pays more in dividends than it earns from its
  productive activities. Such payments are still
  dividends. Distributions by corporations to
  shareholders of proceeds from privatization
  receipts and other sales of assets and large and
  exceptional one-off payments based on accumulated
  reserves or holding gains are withdrawals of
  equity rather than dividends. GFSM 5.87

46
Capital injections (1)

• 1993 SNA
• Transfers from government units to publicly or
  privately owned enterprises to cover large
  operating deficits accumulated over two or more
  years are recorded as other capital transfer
  (D.99). SNA 10.141
• Regular transfers paid to public corporations
  which are intended to compensate for persistent
  lossesi.e. negative operating surpluses
  (B.2)which they incur on their productive
  activities as a result of charging prices which
  are lower than their average cost of production
  as a matter of deliberate government economic and
  social policy, are recorded under D.319 Other
  subsidies on products. SNA 7.78c

47
Capital injections (2)

• MDD
• A capital injection made to cover expected future
  losses, as well as repetitive losses, should be
  recorded as capital transfer (D.9), even if
  shares (or equivalent) are issued. II.3.1.2.3.
• GFSM
• GFSM 6.60 Subsidies also include transfers to
  public corporations and quasi-corporations to
  compensate for losses they incur on their
  productive activities as a result of charging
  prices that are lower than their average costs of
  production as a matter of deliberate government
  economic and social policy. If such losses have
  been accumulated over two or more years, the
  payments are classified as miscellaneous other
  capital expense (2822).

48
Specific issues

• Central bank lumpsums
• MDD
• Debt assumption / cancellation
• ESA 1995 inconsistencies 3 cases not expensed
• Quasicorporations / Privatization / disappearing
  entity
• GFSM 2001 Appendix II inconsistencies
• Notion of effective claim
• 5 cases

49
SNA ambiguous reading of some government
operations

• Subsidies (D.3) to cover persistent losses
  incurred as a matter of deliberate government
  policy
• Tax (D.2) profits of fiscal monopolies
• Capital transfers (D.9) to cover post losses
• Current 1993 SNA
• reference in each case to transfers, to cover
  losses//of profits fiscal mono.//of QC income
• not in line with the accrual principle

50
Part III

• Assessment of the GFSM 2001 and MDD guidance

51
Assessment (1)

• MDD and GFSM 2001 usefully clarify 1993 SNA
• They extend the 1993 SNA quasicorporation
  treatment to other public corporations
• It has problems
• Implementation
• Conceptual

52
Assessment (2)

• Implementation
• Asymmetry
• superdividends not recognized as revenue but
  capital injections are expensed
• Misrepresentation of income over the long run
  (superdividend)
• Time of recording for capital injection is
  unsatisfactory
• Cherry picking
• Loopholes
• guarantees.

53
Assessment (3)

• Not in line with core 1993 SNA/GFSM 2001
  principles
• Dividends/injections are net worth neutral they
  do not meet the governments expense/revenue
  definition
• Dividends/injections time of recording does not
  respect the accrual principle. The time of event
  is the time of the profit / of the loss
• Income / revaluation delineation

54
Assessment (4) Principles own funds / net worth
neutrality

• Superdividends partial liquidation (more cash
  less equity)
• Dividend distribution gives rise to a fall on the
  market at time of distribution
• Value of shares present value of future
  dividends
• Capital injection less cash more equity
• So what moves the own funds? the profit / the
  loss (at time they occur/are announced)

55
Assessment (5) Is it quantitatively important?

• In the world massive cases of quasifiscal
  operations inequality of treatment
• Algeria over the past 10 years, debt assumption
  of 10-15 of GDP every 3 years
• Yemen losses are immediately covered by budget/
  most profits are immediately distributed
• In Europe
• On average, less severe cases (0.2-0.5 of GDP
  but in some countries up to 2 of GDP yearly)
  //. because of Eurostat MDD rules, most
  amounts are correctly recorded remains the
  issue of the time of recording
• EU targets can be impacted (EDP)
• Equality of treatment between countries

56
Part IV

• Accruing of losses/profits - Reinvested earnings

57
1993 SNA treatment of property income on FDI -
D.43

• DFI enterprise is subject to control or influence
  by a foreign direct investor the decision to
  retain some of its earnings within the enterprise
  must represent a conscious deliberate investment
  decision on the part of the foreign direct
  investor. SNA 7.121
• DFI Direct foreign investment enterprises
  encompass corporations where a foreign investor
  owns a sufficient stake to have effective voice
  in its management. SNA 7.119

58
D.43

• 1993 SNA recognizes income flow
• D.43  reinvested earnings on FDI 
• With a counterpart entry
• F.5 Shares and other equity

59
Importance of D.43 a European experience

• Governments contributions to Europe based on
  GNI/GNP (GNI Committee)
• Relevant measure of relative national
  income/revenue
• Reinvested earnings task force
• Compilation of EU/Euro area sector accounts
• Quarterly data task force
• Work on asymmetries, notably D.43/D.42

60
Possible proposal for the new SNA

• Extend the 1993 SNA treatment of reinvested
  earnings of FDI to earnings of public
  corporations / domestic direct investment links

61
Part V

• Advantages
• -
• Arguments

62
Advantages GFS (1)Improvement in fiscal data

• Boosts transparency (quasifiscal operations)
• Lowers manipulability
• Eliminates cherry picking and asymmetry
• Eliminates loopholes
• Captures the impact of fiscal policy on the
  economy correctly
• Time of recording issue (when the economy is
  stimulated)

63
Advantages conceptual (2)

• Solves the issue of superdividends and capital
  injections at a stroke they become financial
  transactions
• Implements accrual reporting
• Purifies the government expense/revenue
  definitions
• Improves the income / revaluation delineation
• Aligns with accounting practices (?)

64
Accounting practices reminder

• Consolidated financial statements
• Treatment of equity stakes in accounting
• Controlled entities (above 50) consolidate
• Associates (20 to 50) equity method
• Below 20 at historical cost
• Equity method
• Equity reestimated on basis of shareholder equity
• The profit of the investee is recognized,
  prorated, as profit of the investor
• Therefore dividend is not a revenue..

65
IPSASB draft ED

• How will the GGS IPSAS account for equity stakes
  of GGS?
• In controlled entity
• On a net equity basis equity method
• Dividend is not a revenue the accruing profit is
• Analogy limited as long as no Performance
  Reporting
• In associates
• What would be the treatment of capital
  injections?
• Would GGS reclassify superdividends?

66
Argument (1) Source data

• Difficulties of recording D.43 in balance of
  payment accuracy, reliability, timeliness issues
• However
• NSI have databases for sector accounts.
• Governments need keeping data on their
  corporations
• Treasury at the board of corporations (central
  government)
• Transparency issue for public finance
• MDD and GFSM 2001 also cumbersome
• Flexibility in practice for local gov.s corpor.
• Jeff Golland example for the UK
• Problem of the minority stakes (private)

67
Argument (1bis) GFS issue Volatility and 1st
estimates issue

• D.43 volatile?
• In principle not it is not the accounting
  profit/loss it is more the operating surplus
  will hence mostly reflect the business cycle
• Importance of quick/reliable estimates
• Example in Europe EDP data due by 1st March
• Profits can be 1st estimated based on business
  cycle
• Profit of the year or year t-1?

68
Argument (2) Symmetry of treatment

• AEG decided to keep D.43 for S.2
• If extension to S.13, then to all economy.
• But
• SNA encompasses sector specific rules
• FISIM assets recognition (durables)
• Should we also extend the agreed ad-hoc rules of
  MDD/GFSM to all units (superdividends/equity
  injection)?
• Question is the General Government sufficiently
  specific?
• Any further extension is the prerogative of the
  AEG

69
Argument (2cont) Symmetry of treatment

• Government change behavior on the basis of the
  way national accountant compile data
• treatment of associates. in IAS
• Government give away value (public corporation)
• Quasi-fiscal operations
• Reclassifying
• Rerouting

70
Argument (4) Savings issue

• Proposal will shift savings out of the corporate
  sector
• But is this so important?
• Some units have zero savings in SNA (pension
  funds, and also mutual funds under ESA)
• profits is before distribution Savings
  capacity to  self finance  out of income can
  be measured by D.43 itself
• Public corporations behave differently as private
  corporations (lack of savings do not restrain
  them)

71
Argument (5) Change in the definition of
income

• The proposal restricts the extension to direct
  investment stakes of government
• It is about control
• Change to income definition would be to question
  the recording of dividend as such
• In some respects the retreatment of
  superdividends as financial transactions changes
  also income (and possibly more)

72
The case for dividends as financial transactions
the Microsoft example

• Used to distribute no dividends
• Superdividends of 32 billion to be paid on
  December 4st (3 of monthly GDP)
• US households income for December 2004? (bill
  Gates ownership)
• US GNI for December 2004?
• The target price of option plans of staff will be
  reviewed (Board Decision)
• Is the fall in value on 4th December a volume
  change or a price change?

73
Argument (6)  An imputation 

• Better to limit imputations in the SNA
• Imputations are welcome when improving analytical
  relevance. Accrual recording imputations
• Arguably, this more a delineation of flows (split
  of a change in value between a price component
  and a volume component) than an imputation
• Signification of the artificial financial
  accounts entry?
• Similar to interest accrued the reinvestment on
  the instrument shows a gain in size, in volume

74
Argument (7) Public Sector is enough

• Public Sector GGS data have different purpose
• SNA emphasis on GGS because of the nature market
  / non market of the output/resources
• It does not prevent to account adequately for GGS

75
Argument (8) Creditors view

•  Reinvested earnings imposes the creditors view
  on the debtor 
• This is true for all property income on equity in
  SNA
• equity seen as a liability, by convention
• hence, dividend seen as a Use, by convention
• The appropriate variable (for for-profit
  entities) is profit before distribution

76
Argument (9) Consistency with market valuation

• Reinvested earnings is not consistent with
  market valuation
• Reinvested earnings delineates between an income
  flow and a revaluation flow (whatever the
  valuation rule of the asset)
• For a quasicorporation, revaluation those
  observable on the firms assets and on its other
  liabilities
• For other shares (quoted), revaluation results
  from changes in the market conditions of the
  share itself

77
Argument (10) Ownership versus economic unit

• Reinvested earnings departs from SNA with an
  emphasis on ownership versus economic units
• But, justified in case of government
• public sector / government delineation is based
  on the market/nonmarket criteria (fundamental
  economic behavior)
• accountability requires reporting all public
  sector
• reinvested earnings combines the two requirements

78
Arguments (11) A GFSM 2001 footnote

• Footnote 18 of chapter 5 of GFSM 2001
• Origin
• Treat income on direct investment same
• Hesitation to depart too radically from 1993 SNA
  
• GFSM experts position reinvested earnings
• Enhances transparency
• Reduces manipulability
• So GFSM 2001 will happily be changed if deemed to
  be acceptable in Reviewed SNA

79
Summary it is about control

• About control/influence
• Rational of the 1993 SNA FDI treatment
• Rational for equity method in accounting (see
  IPSAS 7)
• GFS government takes not-for-profit actions and
  may act via corporations
• Government is different from other sectors it
  gives away value

80
Summary Balance of arguments

• Enormous boost in transparency
• Some remaining counterarguments
• Decision to restrict to GGS is reasonable
• 100 ownership only is appealing But this is
  control that is the more fundamental criteria

81
Part VI

• Positions

82
AEG

• sympathy in principle
• Practical implementation
• Definition of income
• Is it acceptable to adopt such treatment for
  government only?

83
European Task Force

• Position of the EU Commission services (DGECFIN)
  supportive of D.43
• Position of the Task Force Chair (Eurostat)
  openness to extend D.43 to equity stakes at least
  for 100

84
Accounting?

• Three questions
• Would GGS be accounted for on equity method?
• If yes, what would be the split under performance
  reporting?
• If no, how would be accounted superdividends?
  Capital injections?

85
TFHPSA

• ..

86
Part VII

• Pending issues

87
What definition of profit?

• Definition of profit to accrue for D.43
• 1993 SNA B.2D.4r-D.4pD.7r-D.7p-D.5p
• Question of consumption of fixed capital
• Adaptation to government?
• Capital transfers/ Loans write offs (for public
  banks)
• B.8n, B.10.1, B.9?

88
Question of threshold

• No reinvested earnings
• 100 ownership (straightforward)
• 50 ownership (control established)
• 20 ownership (associates in accounting)
• 10 ownership (FDI 1993 SNA)
• 0 ownership (all equity)

89
Various SNA review options

      Sector Sector Sector
  RoW General Corporations
Ownership   Government  
100          
50        
10      ??  
0.1          

    Current SNA
    Possible extension (1) Possible extension (1)
  Possible extension (2) Possible extension (2)
2/2/2004 2305
90
Other technical issues

• Recording of losses (negative profits)
• Expense or negative revenue of the investor?
• Treatment of indirect profits
• follow the BOP expertise?

91
Extension to other sectors / equity

• To be decided by AEG (not GFS specific)
• Extension to other sectors
• ROW applied / households negligible / General
  Government suggested / remains
  financial-nonfinancial sectors delineation
• Extension to other equities
• Practice of share buybacks (USA)
• Anomaly of the revaluation account
• Notion of volume of instrument profit reinvested
  allows the enterprise to grow in size. Like wine
  ageing, it is not a price change but a volume
  change.

92
Part VIII

• Recommendations
• (tentative not mutually exclusive)

93
Recommendation 1

• Change SNA to drop the reference to transfers
• To cover losses....
• Of profits of fiscal monopolies
• For quasicorporations

94
Recommendation 2

• Interpret SNA on the notion of income, to limit
  dividends to operating income of the period
• Interpret SNA for expensing capital injections in
  all (most) cases
• Clarify the treatment of debt operations in a
  consistent way towards expensing
• Recognize weaknesses of this approach

95
Recommendation 3

• Adopt reinvestment earnings to GG holdings in
  public corporations/direct investment
• Recognize conceptual superiority
• Control/influence of the shareholder
• Accrual basis
• Look at useful thresholds
• Look at the definition of earnings