IFRS convergence — a taxing issue!

India Inc. is at an inflection point with respect to the impending adoption of International Financial Reporting Standards (IFRS).

Companies are making a concerted effort to prepare for this transition. However, one issue that is currently being deliberated by companies and regulators is the taxation framework (both direct and indirect) applicable for corporates that follow the IFRS-converged standards.

One of the fundamental problems with recognising the IFRS framework for taxation effective April 1, 2011, arises due to the fact that not all companies will transition to IFRS from this date.

It may be difficult to justify how two Indian corporate entities are taxed differently for similar transactions just because they follow different accounting frameworks (Indian GAAP or IFRS-converged standards).

This is further accentuated due to the fact that IFRS will be rolled out in multiple phases and there will be companies within the same industry following different accounting frameworks.

The regulators need to take a view on whether financial statements prepared in accordance with the IFRS converged standards will be acceptable for both direct and indirect tax purposes, or whether companies will be required to maintain two sets of accounting records.

Indirect taxes

Under IFRS there are many occasions where timing of revenue recognition would not coincide with the invoice date, which is considered as a triggering event for levying indirect taxes.

Following are a few illustrative areas.

Under IFRS, revenue from sale of goods is recognised only once the effective control over the goods and risks and rewards is transferred to the buyer. This could result in difference in timing of revenue recognition in the books of accounts and the invoice date (generally based on transfer of legal title of the goods).

In cases where a sales agreement contains multiple components, IFRS requires each component to be accounted separately.

Further this segregation is required to be based on relative ‘fair values', which may be different from the split provided in the contract/invoice.

This could also result in difference in timing/amounts of revenue recognition per books and per the invoice.

This further gets accentuated as the type of applicable taxes may differ — sales tax is leviable on sale of goods and service tax is leviable on maintenance services.

Direct taxes

In case of direct taxation, the areas that need to be addressed include what will be the book profit which will be considered for the purpose of calculation of taxable income or minimum alternate tax (as per Indian GAAP or as per IFRS converged standards).

Considering the IFRS-converged standards would in turn require consideration of tax treatment for notional gains and losses included in the IFRS-converged accounts .

The transition to the IFRS-converged standards will also result in recognition of certain one-time adjustments which will be recorded in the reserves. The tax treatment of such one-time adjustments needs to be considered.

However, since this challenge is not unique to India, the regulators may consider the approach followed by other countries in addressing this situation. These approaches are briefly discussed below.

United Kingdom: The UK tax code was amended such that the tax computation can be prepared using IFRS accounts.

Suitable amendments were also carried out to prescribe that certain tax adjustments (such as those relating to the change in the fair market value of certain financial instruments) which arise on transition to IFRS be spread over a ten year period rather than fully recognised in the period in which the transition takes place.

Germany: The German tax laws do not accept IFRS accounts for tax purposes. Accordingly, there were no amendments made to the tax laws to accommodate IFRS accounts. This ensured a tax neutral transition for the regulators and for companies.

Luxembourg: The tax laws do not accept IFRS accounts for the preparation of tax computation. However, there is a mechanism whereby tax payers may enter into an advance agreement, in relation with the transition to IFRS, with the tax authorities. In such cases, the tax authorities examine the associated tax issues and prescribe the tax treatment of the adjustments and the period over which such adjustments could be spread.

In order to neutralise non-desired tax implications that may result from the change of accounting standards, a Bill has been proposed (not yet accepted) which suggests that unrealised gains remain excluded from the tax base, independently of whether they are recognised or not from an accounting point of view.

Given the complexity of tax laws in India and our phased convergence program, the German approach may be most suitable to ensure a smooth transition and ensure that India meets the convergence deadline of April 1, 2011.

Regulators and industry need to get to common ground on the above matters prior to April 1.

This is essential for a smooth transition to ensure that companies are well prepared to generate two sets of accounting records – one as per the IFRS converged standards (under the Companies Act and for reporting to shareholders) and second per Indian GAAP (for tax purposes).

(The authors are Executive Director and Director, KPMG, respectively)

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