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The Central Government is empowered under Section 145(2) of the Income-tax Act to notify accounting standards. However, only two standards relating to disclosures have been notified till date.
As a result, there is uncertainty and litigation over various issues where the tax authority’s views may not be consistent with the guidance in the Accounting Standards issued by the Institute of Chartered Accountants of India and the Ministry of Corporate Affairs.
To address some of these issues, the Central Board of Direct Taxes constituted the Accounting Standard Committee, whose final report last month was issued for public comment. The report also contains drafts of 14 Tax Accounting Standards. Some of the significant recommendations include:
Provisions of the Act would prevail over TAS when there is conflict between the two.
TAS would apply only to the computation of income and, thus, a taxpayer need not maintain separate books of account based on TAS.
TAS would apply to all taxpayers, and appropriate modifications would be made to return of income and tax audit forms.
The Act is to be amended to provide clarity on the treatment of goodwill depreciation arising from amalgamation, and on provision made for payment of pension in case of retirement or termination of services of an employee.
As TAS is based on the mercantile system of accounting, it will apply only to taxpayers who follow that system.
Though TAS is in harmony with the respective accounting standards, there are modifications that may significantly impact taxable income of several companies. Some key areas are discussed below.
Construction Contracts
TAS mandates use of percentage of completion method for revenue recognition. Accordingly, the completed contract method is no longer permitted.
Furthermore, if revenue recognition conditions are met under TAS, even uncertain revenue must be recognised in computation of income.
Revenue Recognition
Unlike AS-9, TAS does not require revenue to be measurable or collectible at the time of sale (there is an exception for price escalation claims and export incentives). As such, revenue will have to be recognised when other conditions of revenue recognition are met under TAS. A corresponding bad debt expense deduction can be claimed under the Act.
The committee has recommended a separate TAS for revenue recognition by real estate developers until such guidance is issued; diversity may continue in the manner in which real estate developers apply this TAS.
Forex rates
TAS provides that all gains or losses on forward exchange, or similar contracts entered into for trading or speculation, are to be recognised on settlement as opposed to mark-to-market.
Entities recognised foreign currency transactions at an average weekly or monthly rate when the exchange rate did not fluctuate significantly. TAS has removed this option, providing that all foreign currency transactions should be recognised at the exchange rate prevalent on the transaction date.
Furthermore, exchange differences on transactions that are not an integral part of the reporting enterprise should be recognised as income or expense, and not through the foreign currency translation reserve account as provided in AS-11.
Government Grants
Current accounting practices permit the capital approach of recording government grants, whereby these are recorded in the nature of promoter’s contribution or capital reserve. This is not permitted under TAS. Grants should be either reduced from the cost of the asset or recorded as income.
Borrowing Costs
TAS requires capitalisation of borrowing cost irrespective of the period of construction. The only exception is for inventories — TAS requires capitalisation of borrowing costs only for inventories that require more than 12 months for completion.
TAS provides that income from temporary deployment of specific borrowings is to be treated as income.
Further, under TAS, for loans borrowed specifically for acquisition of qualifying asset, capitalisation of borrowing costs commences from the borrowing date.
TAS provides an independent framework for computation of taxable profits, making the adaptation of accounting framework redundant. The committee has not commented on calculation of Minimum Alternate Tax.
The successful harmonisation of TAS with AS, and the achievement of objectives solely depend on how TAS is implemented by tax authorities and the judicial system.
(Hiten Kotak is Partner — M&A Tax and Jinesh Shah is Director, KPMG in India.)
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