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Even though the Finance Act, 1995 empowered the Central Government to notify Tax Accounting Standards (TAS) for determining taxable income, only two inconsequential standards were notified in the Income-Tax Act – relating to disclosure of accounting policies and disclosure of prior period and extra-ordinary items and changes in accounting policies. Consequently, taxable income in India is determined on the basis of specific provisions of the Income-Tax Act, various judicial pronouncements, and Indian GAAP (followed in the preparation of financial statements).
One of the main hurdles for introduction of IFRS in India (known as Ind-AS) is that it would bring about a significant change, volatility and uncertainty in determining taxable income.
Therefore the need to prepare and notify TAS gained momentum and in December 2010, the CBDT constituted an accounting standard committee.
COMMITTEE'S RECOMMENDATION
Based on the recommendation of the Committee, the Ministry of Finance issued a discussion paper on TAS for comments. The committee recommends that TAS should be applicable for determining taxable income. Interestingly, the committee believes that it is not necessary to maintain two sets of books of accounts; one for tax purposes, and another to report to the shareholders under the Companies Act.
Rather a reconciliation between the income according to the financial statements prepared under the Companies Act and income computed according to the TAS would be required. As taxable income would be determined on the basis of TAS, it should not matter from a tax point of view, whether a company is following Indian GAAP or Ind-AS. This approach, if followed, would resolve the concern relating to transition to Ind-AS and its impact on taxable income.
As part of the discussion paper, two draft TAS standards have been issued. The TAS standard on Construction Contracts is based on current Indian GAAP standard AS-7, with significant modifications.
Firstly, unlike AS-7, TAS does not allow recognition of expected losses on onerous contracts. Secondly, even though the TAS permits non-recognition of margins during early stages of a contract, when outcome of a contract is not certain, it prohibits the deferral of margins if the stage of completion exceeds twenty five percent. These are big changes and will have a significant impact in the manner of determining taxable income.
SWITCHING OVER
Currently tax assesses are allowed an option to follow either completed contract method or percentage of completion method, provided the method is then followed on a consistent basis. TAS requires the percentage of completion method and prohibits the completed contract method. The TAS standards do not contain any transitional provisions, which make matters worse.
For example, how will a company that was following the completed contract method till date switch over to the percentage of completion method? In which year the opening unrecognised margins on outstanding contracts would be taxed? There is no clarity on these issues.
The second draft TAS standard issued is on Government Grants and is based on current Indian GAAP standard AS 12, with significant modifications. Under TAS, the initial recognition of grant income cannot be postponed beyond the date of actual receipt. Under AS 12 mere receipt of a grant is not necessarily conclusive evidence that conditions related to the grant will be fulfilled. Under AS 12 government grants of the nature of promoter's contribution is credited to capital reserves and treated as a part of the shareholders funds. Under TAS this is not permitted.
The TAS will pave the way for introduction of Ind-AS in India, but given the enormity of the exercise it is likely that the process will take a long time to conclude. The process of issuing TAS standards and maintaining them on a regular basis will be a very intensive and long drawn affair, and hence the Ministry of Finance would need to look at a robust and permanent network to support this endeavour. The issuance of the TAS standards should not be viewed as a goal in itself.
As these standards are principle based standards, it will have to be supported by an interpretation committee, similar to the Expert Advisory Committee of the ICAI. To achieve these objectives, the Income-Tax Act itself may need to be amended. The TAS is meant to delink the accounting standards used for reporting under Companies Act and those required for determining taxable income. Seen from this perspective, these should be tax neutral. On the contrary, TAS represents a significant change for tax payers, increasing the tax amount to be paid or advancing the timing of the tax liability. Therefore tax payers should carefully assess these standards and consider providing their comments to the government.
(The author is Partner and National Leader, Ernst & Young.)
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