The Ministry of Finance recently released the final report of the Accounting Standards Committee constituted by the Central Board of Direct Taxes. The report recommends notifying Tax Accounting Standards under the Income Tax Act to provide a framework for computation of taxable income, independent of the accounting standards issued by the Institute of Chartered Accountants of India. It also provides drafts of 14 TAS on varied topics.
While TAS seeks to provide certainty and clarity on computation of income, it may change tax practices in several areas and, consequently, have a material impact for many companies.
Impact on tax outflow
While the ICAI’s accounting standards have been used as a starting point for formulating TAS, there are modifications to conform with existing provisions, infuse certainty on issues subject to litigation and minimise accounting alternatives for consistency in computation of taxable profits. Some of these modifications would alter the computation of taxable profits and tax liability of companies. Select examples of such changes are:
The principle of ‘prudence’, which governs the determination of accounting profits, has been removed from the TAS framework. As a result, losses that are expected but not realised will not be available as deductions, except where specifically provided by TAS. This has significant implications in areas such as disallowance of mark-to-market losses on most derivatives and provisions for onerous (loss) contracts.
A company currently recognises income only when it is reasonable to expect collection at the time of sale. TAS does not contain this criteria. Therefore, companies may have to recognise income even when collection is uncertain due to the difficult financial situation of the customer. While companies can claim a bad debt deduction in such cases, it may be practically difficult in certain cases (for example, unbilled revenues).
Companies that provide services can currently recognise income on a proportionate basis or on completion of a contract. However, TAS mandates income recognition on a proportionate basis. Therefore, companies that have previously applied the completed contract method would need to recognise income earlier.
TAS will require companies to treat as income all grants that are not in relation to a depreciable fixed asset. Previously, some of these would have been considered capital receipts or reduced from the cost of the related non-depreciable asset such as land.
In addition to the impact on taxable income and tax outflow, TAS requires additional documentation or computation. These requirements include:
A lessor and lessee should have the same classification for a lease transaction and execute a joint confirmation for it. If not executed on time, the lessee would not be entitled to tax depreciation on a finance lease asset. Companies that have significant volumes of lease transactions would need to prepare accordingly.
The mechanism for calculating the general borrowing costs that need to be capitalised is significantly different from what is followed under the accounting standards. This calls for initial and recurring adjustments in companies with significant capital expenditure programmes.
TAS does not permit use of average exchange rates for translating foreign currency sales/ purchases unlike the corresponding accounting standards, and the exchange rate prevailing during each transaction is to be used. This may necessitate modifying the accounting processes and systems.
Implementation of Ind AS
TAS will remove a significant impediment to the adoption of IFRS converged standards (Ind AS), as companies now have to follow an independent framework for computation of taxable income regardless of what they use for financial statements. However, neither TAS nor the report address the Minimum Alternate Tax implications that may arise on implementation of Ind AS. This will likely be addressed with further progress in Ind AS implementation.
TAS represents a significant change in the computation of taxable income and will have varying impact on companies. However, there will be real benefit only if the principles of TAS are correctly interpreted and applied by tax and judicial authorities. Though it provides another opportunity to implement Ind AS in India, it is uncertain whether regulators will capitalise on this opportunity.
Jamil Khatri is Global Head of Accounting Advisory Services, KPMG in India