Enterprises may find it difficult complying with AS 22
The crux of AS 22 is the creation of deferred tax liability or asset, as the case may be, with regard to the timing differences.
Accounting Standard (AS) 22 was issued by the Institute of Chartered Accountants of India in 2001. It is now mandatory for all limited companies. As for all other enterprises, it is mandatory for accounting periods commencing on or after April 1, 2006. The crux of the standards is creation of deferred tax liability or asset, as the case may be, with regard to the timing differences.
The main factor contributing to the timing differences is depreciation. Further, unabsorbed depreciation and carry-forward losses which can be set off against future taxable income also contribute. Application of the transitional provisions, as per Paragraphs 33 and 34 of the Standard, will not bring uniformity in terms of disclosure by these enterprises, as it is very likely that the provisions would be interpreted differently.
Paragraph 33 states: "On the first occasion that the taxes on income are accounted for in accordance with this Statement, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Statement as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets. The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Statement had been in effect from the beginning."
As per Paragraph 34, "For the purpose of determining accumulated deferred tax in the period in which this Statement is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are compared and the differences, if any, are determined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences are timing differences."
A collective reading of the two Paragraphs clearly indicates that for creating a credit/charge to the revenue reserves, the overall net position should result in either a deferred tax liability or a deferred tax asset. And for computing this net position, timing differences should be analysed individually. However, if the provisions are read independently, it appears that net position may not be the criterion and creation of a deferred tax liability becomes mandatory when timing differences have both deferred tax liability and deferred tax asset.
Consider the situation with respect to a partnership firm. A & B sharing profit equally contribute a total capital of Rs 100 and purchase a fixed asset costing Rs 100 on April 1, 2005. For the year ended March 31, 2006, the firm makes a loss of Rs 100 before depreciation. The depreciation rates, are 40 per cent as per the books, and 60 per cent as per the Income-Tax Act. With the tax rate of 30 per cent, the situation will be a net deferred tax asset of Rs 42.
Where the Standard is applied for the first time, the opening balances of assets and liabilities for accounting and tax purposes are compared and the differences are determined. If the differences are that of timing, the tax effect is recognised either as deferred tax asset or liability. Hence, as on April 1, 2006, the difference in the written-down value (WDV) is Rs 20, the unabsorbed depreciation will be Rs 60 and the carry-forward loss, Rs 100. Hence, the net result is a deferred tax asset of Rs 42, computed as follows:
Deferred taxasset, 30 per cent on unabsorbed depreciation of Rs 60 = Rs 18
Thirty per centof the carry-forward loss of Rs 100 = Rs 30
Deferred taxliability, 30 per cent of net opening difference of assets of Rs 20 = Rs 6.
Net overalldeferred tax asset: Rs 18 + Rs 30 - Rs 6 = Rs 42.
As stated earlier, if the provisions are viewed collectively many firms may not create the net deferred tax asset for the sake of prudence. However, if the provisions are considered independently, some of the firms might create the deferred tax liability of Rs 6, which will reverse in future accounting periods.
It is not clear whether the deferred tax liability is to be viewed independently, as creation of deferred tax liability is a must as per the Standard. This being the case, many concerns will find it difficult to comply as the applicability begins on April 1. Perhaps a simple solution in case of loss would be to adopt income-tax depreciation rates and not create deferred tax asset. However, one would welcome a clarification from the ICAI on this aspect along with the disclosure norms.
(The author is a Chennai-based chartered accountant.)