India Tax Insights – eighth edition
Corporate India and Ind-AS implementation: a tax apprehension
Sunil Kapadia, Partner – Tax & Regulatory Services, EY India
Transition from Indian GAAP (IGAAP) to Indian Accounting Standards (Ind-AS) is a historic and landmark change, pursuant to India’s commitment to G20 in the 2009 summit. India is converging to International Financial Reporting Standards (IFRS) in a phased manner, beginning 1 April 2016/2017 (excluding scheduled commercial banks, insurance companies and non-banking financial companies)* as follows:
|Phase I (from 1 April 2016)||Phase II (from 1 April 2017)|
|All listed and unlisted companies having net worth > INR500 crore||All listed companies not covered in Phase I and unlisted companies having net worth > INR250 crore|
|Holding companies, subsidiaries and joint venture or associate companies of these companies||Holding companies, subsidiaries and joint venture or associate companies of these companies|
* Roadmap for the implementation of Ind-AS in a phased manner laid down with effect from 1 April 2018/2019.
Ind-AS: as an accounting concept
The adoption of Ind-AS would mean significant changes in the preparation and presentation of financial statements. Under Indian Generally Accepted Accounting Principles (IGAAP), companies prepare a single profit and loss (P&L) account, whereas under Ind-AS P&L is divided into two sections: P&L and other comprehensive income (OCI), which appears below P&L. The aggregate result of P&L and OCI is reflected as total comprehensive income (TCI), which is carried to the balance sheet.
The illustrative list of assets to be reported at fair value on transition to Ind-AS and annually after the transition is summarized in the table below:
|Category of asset||On transition||Annually|
Property, plant and equipment, and equity share of subsidiaries, associates and JVs
|Equity shares (other than of subsidiaries, associates and JVs) held as investment/stock in trade||Mandatory||Mandatory|
When a company adopts Ind-AS for the first time, it has to make changes to its policies used in its IGAAP financial statements. The transitional impact of such adjustments is recorded in retained earnings (or, if appropriate, another category of equity) except for certain adjustments such as acquired intangibles and impairment, which is adjusted against goodwill.
Under Ind-AS, certain fair valuation gains/losses reported in OCI are directly transferred to specific reserves in the balance sheet annually, without routing them through P&L. For example, fair valuation gain on property, plant and equipment (PPE) is credited to the revaluation reserve account and fair valuation of non-trading equity investments is credited to the fair valuation through other comprehensive income (FVOCI) reserve account. For certain items, the fair valuation difference captured on a year-on-year basis in the OCI account may subsequently get re-classified to the P&L account; for others, it may be transferred directly to retained earnings in the year of retirement or disposal of the revalued asset. For instance, the balance lying in the FVOCI reserve account on the disposal of a debt instrument is transferred to the P&L account, whereas the revaluation difference on PPE is not reclassified to the P&L account on disposal but transferred directly to the retained earnings account.
Forward-looking corporate houses and multinational companies have already started analyzing the accounting implications that may arise on the first-time adoption of Ind-AS; however, from a tax perspective, there is lack of qualitative guidance from the CBDT or the Government.
The key illustrative differences between IGAAP and Ind-AS are summarized in Annexure 1.
IND-AS application: impact on calculation of book profits and normal taxable income
It is widely expected that the transition to Ind-AS will raise certain questions and challenges while computing normal tax liability as also while determining book profit, not only in the year of first time adoption of Ind-AS, but also on an ongoing basis. Therefore, it is imperative for CBDT to step forth and provide comprehensive guidance on the treatment of various Ind-AS items both under the normal provisions of the act and for computing book profit.
As far as minimum alternate tax (MAT) implications are concerned, CBDT had constituted a committee in December 2010 (reconstituted in June 2015) to suggest a framework for computing book profit for the levy of MAT for companies adopting Ind-AS. The committee noted that the act provides for several upward and downward adjustments while computing book profit and it seeks to adopt distributable profits before tax as the base for computing MAT. The committee also consulted the Ministry of Corporate Affairs (MCA) to understand the scope of distributable profits under the Ind-AS regime, considering the implicit relationship between the base for distributable profits and book profit for MAT. After MCA’s clarifications, the committee suggested a three-pronged approach for the levy of MAT on the basis of book profit as per the Ind-AS income statement, summarized as under:
- The starting point for the computation of book profit would be profit as reported in the P&L account — i.e., the P&L account under Ind-AS, excluding OCI. Such profit will be subjected to upward and downward adjustments as existing under the current MAT regime. If any adjustments are prescribed in the future for the computation of managerial remuneration/dividend by the MCA, similar adjustments would be made while computing book profit.
- Adjustments recorded in reserves/OCI/retained earnings to be dealt as under:
|Adjustments recorded under||Taxed under MAT in the year of|
|Reserves but subsequently reclassified to P&L||Reclassification to P&L|
|OCI||Disposal/realization/retirement in case of PPE or on re-measurement in case of defined benefits|
|Retained earnings||First time adoption of Ind-AS|
These suggested recommendations will require modifications in the law for practical implementation. The committee’s recommendation for upfront levy of MAT on first-time adoption of Ind-AS for items recorded in retained earnings is harsh, unjust and unacceptable. It is also inconsistent with other recommendations to defer the levy of MAT on adjustments routed through OCI/reserves as explained above. Thus, it would be more appropriate to defer the levy of MAT to the year of realization.
While computing normal tax liability, regardless of the treatment under Ind-AS, items of revenue/expense will still need to be dealt with according to the specific provisions of the Income-tax Act, 1961. For example:
- Tax depreciation will not be admissible on amounts representing fair valuation or revaluation. Intangible assets with indefinite useful life will be depreciated for tax purposes at 25% on WDV basis, even if under Ind-AS they are not depreciable but are tested for impairment qua each asset test.
- Upward and downward fair valuation is of no consequence, and capital gain in respect of a capital asset will accrue when there is a transfer of a capital asset, and not before.
- Regardless of the accounting treatment in the books, capital expenditure that is deductible according to specific sections – for example, 35(2AB): expenditure incurred on in-house research and development facility – will continue to be tax-deductible.
Interplay between Ind-AS and ICDS1 (certain illustrative items)
- Ind-AS requires the recognition of exchange fluctuation differences on an MTM basis for derivatives contracts. ICDS does not permit the recognition of MTM loss or expected loss unless permitted by other ICDS. Hence, MTM derivative losses or expected future losses on contracts may not be permitted to be recognized for tax purposes even if recognized under Ind-AS.
- Under Ind-AS, the net present value (NPV) of the cost to be incurred at the end of the lease period for the restoration of premises is required to be capitalized to the cost of the equipment. However, ICDS V does not envisage such an amount to be part of the cost of equipment for the grant of depreciation or additional depreciation, etc.
- Ind-AS requires revenue reduction for future obligations, expected returns etc. It also requires the deferment of recognition of revenue to that extent. ICDS IV does not envisage the recognition of expected sales returns after the balance sheet date or the treatment of loyalty points as deferred revenue income. Hence, issues will arise around whether the revenue for tax purpose will need to be increased to the extent of actual sales or amount received/receivable.
The impact of taxes can be substantial because of fair value basis accounting and substance over form principles enshrined under Ind-AS. Care should be taken to legislate provisions/clarifications that notional gains are not taxed till actually realized. Further, the recognition of unrealized gains on financial instruments, non-amortization of goodwill and recognition of actuarial losses on defined benefit obligations in other comprehensive income are some examples that might potentially increase Ind-AS–reported accounting profits and therefore the MAT liability.
In light of these uncertainties that may have to be faced by Ind-AS–compliant companies, CBDT will have to play a highly proactive role to provide clarity and minimize potential areas of tax litigation.
Annexure 1: illustrative differences between IGAAP and Ind-AS
|Particulars||Under IGAAP||Under Ind-AS|
|Revenue recognition: sale of goods|| || |
| Mandatorily redeemable preference shares on which fixed dividend is mandatorily payable |
| They are treated as part of share capital, akin to equity. |
| They would be treated as liability, and the dividend paid would be reflected as one of the components of finance cost. |
|Intangible assets||There is no concept of indefinite useful life. IGAAP contains a rebuttable presumption that such assets have a useful life of 10 years.||An intangible asset can have an indefinite useful life. Accordingly, such assets are required to be tested only for impairment and not amortization.|
|PPE|| || |
|Major repairs and overhaul expenditure||Companies Act 2013 mandates componentization accounting from FY 2015–16 onward. However, because of lack of clear guidance on the issue, companies may have applied component accounting differently.||They are capitalized as replacement cost if the Ind-AS 16 criteria for capitalization are met.|
|Employee stock options||Cost is accounted either through the fair value method or the intrinsic value method. The intrinsic method does not factor in option and time value when determining compensation cost.||Accounting will have to be re-measured using the fair value method, generally resulting in increased charge for ESOP costs.|
|Determination of lease||It provides no guidance for such arrangements.||The substance of arrangements is important. For example, service contracts such as power purchase contracts, waste management contracts and outsourcing contracts may have to be accounted for as leases if the use of the specific asset is essential to the operations and certain prescribed conditions are satisfied.|
- The Central Government vide a press release dated 6 July 2016 has deferred the applicability of ICDS provisions from FY2105–16 to FY2016–17 .