The Hindu Business Line : Quizzing around deferred tax

I CO. LTD, an infrastructure development company, commenced its operations in the financial year (FY) 2002-03 and installed computer system worth Rs 90 lakh in the very first week of 2002-03. The company is eligible for getting deduction of profit under Section 80-IA.

The board of directors of the company, on the basis of the technological evaluation, decided to provide depreciation on the computer system at 33.33 per cent on straight-line method in accounts. Compute deferred tax liability as per AS-22 read along with ASI-3.

Explanation and solution: According to a DCA clarification, a company can provide depreciation on the assets or category of assets as it may deem fit at a rate (based on bona fide technological evaluation) which is higher than the rate provided in Schedule XIV to the Companies Act, 1956. Hence, the company is within its rights to provide depreciation at 33.33 per cent on SLM, which is higher than the 16.21 per cent provided in Schedule XIV.

According to Section 80-IA of the Income-Tax Act, the company is entitled to get 100 per cent deduction of the profit for the first 10 consecutive years. Accordingly, as per paragraph 7 of ASI-3, depreciation is a timing difference.

Further, according to the paragraph 9 of the said ASI, deferred tax assets/liabilities for timing differences which reverse after the tax-holiday period is recognised in the period in which these differences originate because these can be realised/paid after the expiry of the tax-holiday period by payment of lesser or higher amount of tax after the tax-holiday period because of reversal of timing differences.

If depreciation is calculated under accounting and I-T, it can be found that the entire cost of computer is charged off as per the accounting policy within the first three years and depreciation of Rs 89,99,070 is charged off within 10 years, that is, within the tax-holiday period, leaving a balance of Rs 930 to be charged off as depreciation after the holiday period.

Under accounting, there is no balance after the third year. In other words, deferred tax for timing difference to the tune of Rs 89,99,070 originates during the tax holiday period and also reverse within the period. Only Rs 930 remains under I-T, for which, benefit after holiday period will be available by way of payment of lesser tax.

This benefit will not reverse and, as such, no provision for deferred tax liability need be created in the accounts. The question of deferred tax would have been there if there had been some balance left under accounting as well after the tax-day holiday period.

ii) Z Pvt Ltd, having its registered office at Mumbai (rented) and plant at Pune (leasshold premises), acquired a piece of land for Rs 6,00,000 near Kolkata in the financial year 1995-96 for constructing a new factory. Owing to political turmoil in the area, it could not construct any factory and was forced to sell the land for Rs 5,50,000 during the financial year 2002-03. In the said financial year the company made a profit of Rs 3,00,000 lakh, which includes profit on sale (date of sale, February 26, 2003) of shares of TK Ltd (a listed company) amounting to Rs 25,000 but does not include loss on sale of land.

The shares were acquired in December 2002. The rates of tax are 35 per cent (normal) and 20 per cent for long-term capital gain. The company owns securities of Rs 40,000 (cost price), the market value of which on March 31, 2003, is Rs 50,000. Show deferred tax asset and liability with necessary explanation.

Explanation and solution: Accounting loss arising from the sale of land is Rs 50,000 (Rs 5,50,000 - Rs 6,00,000). The net accounting profit after considering the loss will be Rs 2,50,000 (Rs 3,00,000 - Rs 50,000).

Loss under the head long-term capital gain from sale of land:

Sale price of land — Rs 5,50,000

Less: Indexed cost of acquisition

Cost x cost of inflation index (2002-03)

Cost of inflation index (1995-96)

Rs 6,00,000 x 447 / 2,819,54,448

Loss under the head capital gain — Rs 4,04,448

According to paragraph 7 of ASI-4, "Where an enterprise's statement of profit and loss includes an item of loss, which is considered a `loss' under the capital gains as per the provisions of the Act, the loss is a timing difference, to the extent the same is not set-off in the current year, because this loss can be allowed to be set-off against income arising under the head capital gains in future, subject to the provisions of the Act, and to that extent the amount of income under that head will not be taxable in future year even though the said income would be included in the determination of the accounting income of that year."

This loss under capital gain relating to long-term capital assets cannot be set off against profit and gains from business or capital gain arising from sale of shares being short-term capital assets. The aforesaid loss can only be carried forward for eight assessment years and set off only against gain arising from long-term capital assets. Hence, there arises a timing difference with respect to the said loss.

The tax rate for long-term capital gain is 20 per cent. Thus a saving in tax leading to creation of deferred tax asset on March 31, 2003, will amount to Rs 80,890 (20 per cent of Rs 4,04,448). But will the deferred tax asset of Rs 80,890 be subjected to `virtual certainty test'? According to ASI-4, loss under the head capital gain is not covered by paragraphs 17 and 18 of AS-22.

iii) For AY 2000-01, the assessing officer (AO) disallowed `travelling expenses' to the tune of Rs 20,000 in an assessment under Section 143(3) and completed on March 31, 2003. The company does not want to dispute the disallowance in appeal. The tax pursuant to disallowance was paid in April 2003. What will be the treatment, assuming the tax rate to be 35 per cent?

Solution: The liability for tax on account of disallowance of travelling expenses, amounting to 35 per cent of Rs 20,000 = Rs 7,000, shall be simply provided for in the accounts as current tax expenses on March 31, 2003.

The profit and loss account of 2002-03 will be debited for Rs 7,000 with a corresponding credit to provision for current tax, as the liability crystallises on March 31, 2003, upon passing of the order by the AO.

(Edited extracts from A Practical Guide to Deferred Tax Problems. Book Courtesy: Kamal Law House, Kolkata.)

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