Aug 10 2015
The year 2015 has ushered in a new era for compliance service providers with the introduction of two sets of new standards issued by the Ministry of Corporate Affairs (MCA) & the Central Board of Direct Taxes (CBDT) respectively. The MCA notified the Companies (Indian Accounting Standards) Rules, 2015 in February 2015 laying down the roadmap for application of IFRS converged Indian Accounting standards (Ind - AS) along with the Ind - AS standards for application by companies other than Banking Companies, Insurance Companies and Non - Banking Finance Companies (NBFCs). The CBDT vide Notification no. 32/2015 dated 31 - 03 - 2015 has notified 10 Income Computation and Disclosure Standards (ICDS) effective from 01 - 04 - 2015, applicable from Assessment Year 2016 - 17 onwards to be followed by all the assessees, following the mercantile system of accounting. The Ind - AS roadmap provides for a phase wise implementation with Ind - AS up for voluntary adoption for FY 2015 - 16 and becoming mandatory for certain class of companies from FY 2016 - 17 onwards.
The International Accounting Standards Board (IASB) taking into account the considerable practical difficulties surrounding first - time application of IFRS, published IFRS - 1 First - time Adoption of International Financial Reporting Standards in order to assist preparers to overcome the practical difficulties in applying IFRS for the first time. Ind - AS 101 (First-time adoption of Indian Accounting Standards) is the standard corresponding to the revised IFRS - 1. Ind - AS 101 provides numerous mandatory exceptions and optional exemptions. Though Ind - AS 101 goes some way to reduce the burden of historical accounting information, it does not turn the transition process into a hassle free job. Even under Ind AS - 101, the transition will remain a complex and time consuming process for many entities, placing demand on areas such as staff training, data collection, and new or modified information system requirement. Another challenge relates to the exemptions available in preparing the transition date balance sheet. The biggest challenge, however, will be the alignment with various legislations including direct and indirect tax legislations or RBI guidelines on compliance with accounting standards. The standard includes both optional and mandatory exceptions and companies are required to make judgements and decisions about the options to apply in their first set of Ind - AS financial statements. In this article we shall be discussing the issues arising from convergence to Ind - AS and its impact from direct tax perspective.
Ind - AS and ICDS
Till recently, for the purpose of computation of taxes, the profits as per books was the starting point to which various adjustments were made for arriving at the taxable income. With the introduction of Ind - AS and its emphasis on fair value accounting, the book profits as per Ind - AS and the existing GAAP will be substantially different, which would have resulted in higher tax liability of Ind - AS adopters over Ind - AS non-adopters under the regular provisions of Income-tax Act.
However, with the timely introduction of ICDS by the CBDT, this challenge has been overcome as taxable income now will be computed as per ICDS ensuring uniformity in taxation irrespective of the accounting framework followed by an entity.
In case of ICDS, they are applicable for all categories of assessees for computation of income under Chapter IV - D and IV - F of the Income - tax Act, 1961, from AY 2016 - 17. Therefore, for the purpose of advance tax computation for the Financial Year 2015 - 16, those Company assessees who have voluntarily adopted Ind - AS will have to compute profits as per Ind - AS for the purpose of book profits and compute income as per ICDS for the purpose of Income -tax Act, 1961 to determine the taxable income under the provisions of the Act.
Ind - AS and Minimum Alternate Tax (MAT)
Coming to MAT, Sec. 115JB of the Income - tax Act, 1961 provides that the profit and loss account shall be prepared in accordance with Schedule - III of the Companies Act, 2013 (earlier Schedule VI of the Companies Act, 1956) and Sec. 129 of the Companies Act, 2013. Sec. 129 of the Companies Act, 2013 prescribes that the accounting standards notified under section 133 of the Companies Act have to be complied with while preparing the financial statements. Those Companies to which Ind - AS are applicable shall prepare the profit and loss account as per Ind - AS' and the remaining Companies shall continue to prepare their profit and loss account as per Companies (Accounting Standard) Rules, 2006.
With the introduction of ICDS, computation of taxable income under regular provisions of the Act has attained certainty and how the possible influence of Ind - AS on computation of taxable income is negated. However for the purpose of Sec. 115JB of the Income - tax Act, 1961, ICDS will not be applicable for computation of book profits as book profits will be computed under the regular accounting framework followed by the Companies. This could result in a situation where book profits as per Ind - AS would be higher over companies which are non Ind - AS adopters resulting in higher current tax outflows. The reason being that in comparison to the existing Indian GAAP, in case of Ind - AS there is an increased emphasis on fair value accounting principles which may be routed through profit and loss account (Fair Value through P&L - FVTPL) or as an item of other comprehensive incomes (Fair Value through Other Comprehensive Income - FVTOCI). Also the adjustments to book profits prescribed in Explanation 1 to Sec. 115JB for the ultimate levy of MAT are based on the existing Indian GAAP. Thus adopting Ind - AS for preparation of financial statements might result in higher profits due to the emphasis on fair value concept and changes in other Ind - AS's vis - a - vis existing Indian GAAP thereby resulting in potential higher current tax outflows due to levy of MAT.
An instance where profit would be higher under Ind - AS over existing Indian GAAP is in case of Ind - AS 19 Employee Benefits corresponding to the existing Indian GAAP AS - 15 Employee Benefits. In case of AS - 15 all actuarial gains and losses should be recognised immediately in the statement of profit and loss which could result in a lower book profit. Whereas, under Ind - AS 19, actuarial gains and losses representing changes in the present value of the defined benefit obligation resulting from experience adjustments and effects of changes in actuarial assumptions are recognised in equity through other comprehensive income and not reclassified to profit or loss in a subsequent period.
Ind - AS and Income - tax Act, 1961
Going forward with the adoption of Ind - AS the revenue numbers reported by the entity for Income - tax purposes and revenue as per books could be quite distinct. Revenue numbers for the purpose of Income - tax would be recognised as per ICDS - 3 (Construction Contracts) and ICDS - 4 (Revenue Recognition) which are similar to AS - 7 and AS - 9 of the existing Indian GAAP subject to a few differences between the ICDS and the AS under the existing Indian GAAP. Under Ind - AS revenue recognition is regulated as per Ind - AS 115 Revenue from Contracts with Customers and it subsumes both AS - 7 and AS - 9. Ind - AS 115 essentially entails five broad steps to account for revenue. The core principle of Ind - AS 115 being that an entity will recognize revenue when it transfers control over goods or services to customers with an amount that reflects the consideration to which the entity expects to be entitled in exchange for underlying performance obligations arising from the transaction. This will require entities to use more judgement and make more estimates than today's revenue standards.
There will be other instances of difference which will arise between Ind - AS and current accounting norms as Ind - AS seeks to record the transaction by its substance over its legal form. For example Ind - AS 32 (Financial Instruments - Presentation) requires the issuer of a financial instrument to classify the instrument as a liability or equity on initial recognition, in accordance with substance and the definitions of the terms of issue. The application of this principle requires certain instruments that have the form of equity to be classified as liability. Therefore, items like mandatorily redeemable preference shares will now be treated as a liability and fixed dividend payable on them will be treated as an interest expense. However, for Income - tax purposes it will still remain as dividend payments due to the operation of Sec. 2 (22) of the Income - tax Act, 1961.
Ind - AS 12 - Income taxes prescribes accounting for deferred tax liability or asset and follows the balance sheet approach over the income statement approach under the existing Indian GAAP.
Under Ind - AS 12 it is assumed that assets will be realised and liabilities will be settled at their carrying amounts. If the carrying amounts of assets and liabilities differ from their corresponding tax bases, future tax effects will result from reversals of such book and tax basis differences. Accordingly, deferred taxes will be recorded on the resultant temporary difference (as opposed to timing differences under the existing Indian GAAP). This approach under Ind - AS is broader and likely to result in deferred taxes on more items and also additional deferred taxes on some items.
Ind - AS and Prior Period items
Under the current Indian GAAP prior period items have to be disclosed separately in the financial statements of the period in which the error pertaining to a prior period is discovered. However under Ind - AS material prior period errors are to be corrected retrospectively by restating the comparative amounts for prior periods presented in which the error occurred or if the error occurred before the earliest period presented, by restating the opening balance sheet. Under income - tax, though the accounting standard dealing with prior period items issued u/s 145 is scrapped, a prior period item is not be included in the return but is required to be disclosed separately in Clause 27 (b) of Form 3CD . But to call it a prior period item for income-tax purpose, the ICDS should be kept in mind to decide as to which year the income and expenditure belongs and not based on the principles laid down in Ind-AS. The return for the year to which the income / expenditure belongs should be revised. If there is no time for revision of return and you are revising the accounts, it is preferable to intimate the AO so as to avoid penalty, reassessment.
Some of the issues are highlighted in the following paragraphs
Issue 1. The spirit of sub-para (1) of General instructions in Annexure to Companies (Indian Accounting Standards) Rules, 2015 is that if Ind-AS is contrary to provisions of applicable laws, the laws would prevail. Laws that are applicable in case of revenue recognition, inter alia, are Sale of Goods Act, Indian Contract Act, Transfer of Property Act. Is Ind-AS 115 contrary to these laws? Are the principles governing the quantum and timing of recognition of revenue same as that stipulated in these laws? Para 9(e) talks of probability of collection which is unaware of in the Sale of Goods Act and Indian Contract Act. Is the revenue recognized as per Ind-AS same as consideration as defined in Indian Contract Act? Fair value concept if alien to these laws [Income-tax Act cannot influence accounting and the vice versa is true].
The Companies ((Indian Accounting Standards) Rules, 2015 have been made by the Central Government in exercise of the powers conferred by section 133 read with section 469 of the Companies Act, 2013 (18 of 2013) and sub-section (1) of section 210A of the Companies Act, 1956 (1 of 1956), which provide that if a particular Indian Accounting Standard is found to be not in conformity with any applicable law, the provisions of such law will prevail. Even if such subordinate legislation does not state so, only such law will prevail.
A rule is not only required to be made in conformity with the provisions of the Act where under it is made, but the same must be in conformity with the provisions of any other Act, as a subordinate legislation cannot be violative of any plenary legislation made by the Parliament or the State Legislature - Kerala Samsthana Chethu Thozhilali Union v. State of Kerala [AIR 2006 SC 3480].
Issue 2: Section 145(1) states that income shall be computed under the heads PGBP or IOS based on method of accounting regularly followed by the assessee. Ind-AS are meant for preparation of financial statements though they are coined as Accounting Standards [interestingly, globally the standards are referred to as reporting standards Eg; IFRS and not as accounting standards]. If ICDS does not provide for a particular aspect, one should necessarily go by the method of accounting regularly followed. So does it mean that Ind-AS would not trouble the assessee?
Income for income-tax purposes is to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments (plenary or subordinate legislation). This is where Section 145(2) of the Income-tax Act, 1961 comes into play. Under that section, the 13Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, in exercise of powers conferred by section 133 read with section 469 of the Companies Act, 2013 (18 of 2013) and sub-section (1) of section 210A of the Companies Act, 1956 (1 of 1956) the Companies ((Indian Accounting Standards) Rules, 2015 have been made by the Central Government. In other words, ordinary principles of commercial accounting which are to be followed consistently by the assessees have been superseded or modified by Legislative intervention. But for such intervention or in cases falling under Section 145(3) of the Income-tax Act, 1961, the method of accounting undertaken by an assessee continuously is supreme - CIT v. Woodward Governor India P Ltd. [312 ITR 254 SC].
Issue 3: Is the concept of real income given a go by? The concept of real income should prevail for income-tax purpose. This cannot be given a go by, especially, in respect of section 115IB. One cannot read section 115JB pedantically to by-pass the concept of real income. Concept of fair value is alien to income-tax.
The concept of real income is a well-accepted one and must be applied in appropriate cases but with circumspection and must not be called in aid to defeat the fundamental principles of income-tax as developed. An acceptable formula of co-relating the notion of real income in conjunction with the method of accounting for the purpose of computation of income for the purpose of taxation is difficult to evolve. Besides, any straight-jacket formula is bound to create problems in its application to every situation. It must depend upon the facts and circumstances of each case. It would be difficult and improper to extend the concept of real income to all cases depending upon the ipse dixit of the assessee which would then become a value judgment only. What has really accrued to the assessee has to be found out and what has accrued must be considered from the point of view of real income taking the probability or improbability of realisation in a realistic manner and dovetailing of these factors together, but once the accrual takes place on the conduct of the parties subsequent to the year of closing, an income which has accrued cannot be made 'no income'. Once the accrual takes place and income accrues, the same cannot be defeated by any theory of real income - State Bank of Travancore v. CIT [1986 AIR SC 757].
Issue 4: Can companies who have to compulsorily follow Ind-AS challenge MAT provisions on ground of discrimination? [profits in case of companies who have to follow Ind-AS and profits in case of other companies would vary largely]
The principles which will have to be borne in mind by the court when it is called upon to adjudge the constitutionality of any particular law attacked as discriminatory and violative of the equal protection of the laws have been laid down in Sri Ram Krishna Dalmia v. Sri Justice S.R. Tendolkar [1958 AIR SC 538] and restated in re Special Courts Bill [AIR 1979 SC 478].
The concept of MAT is based on book profits (tax base), which are generally aligned to distributable profits as computed under the Companies Act, 1956. Section 115JB of the Income-tax Act refers to Companies Act, 1956. In the absence of clarity on amendments to the Companies Act, 1956 relating to the impact of the transition to Ind-AS on the computation of distributable profits; the corresponding impact on computation of MAT under the Income-tax Act, 1961 cannot be determined with certainty.
In view of the above, it would be premature to impugn the constitutionality of s.115JB of the Income-tax Act, 1961 on the ground of discrimination under Article 14 of the Constitution.
With the introduction of two new sets of standards, these are exciting times for professionals. Through this article your author has tried to shed some light on the potential challenges ahead. As with any new law with the passing of time our understanding will become stronger, any creases will be ironed out through legislative/regulatory amendments or judicial interpretations. Presently ICAI has released an exposure draft on format of financial statements compliant with Ind - AS and Schedule III, however the Ministry of Corporate Affairs is yet to notify the same. For now it is time for us professionals to huddle together to gain better understanding of these standards by stopping to hit the snooze button and attend that early morning study circle meeting before office hours where our bonds will be strengthened and our understanding enhanced, in order to create value to the client and ensure a smooth transition.
(The author acknowledges valuable contribution from Ms Geetha Penkatoka)