JOSHI AND KARANDIKAR CHARTERED ACCOUNTANTS

AS 22 - ACCOUNTING FOR TAXES ON INCOME

BY-MALAVIKA MULAY

- URMILA BAPAT

Accounting Standard - 22

• AS has become mandatory for entities falling under all levels (categorised by ICAI)

• Supersedes the earlier Guidance Note issued by ICAI in 1991

• Became mandatory in phased manner

Applicability of AS 22 (For All Levels - I / II/ III)

Companies listed and in the process of listing in India - including Group companies.

01.04.2001

In respect of other companies not covered above. 01.04.2002

In respect of all other enterprises. 01.04.2006

Issued by council of Institute of Chartered Accountants of India

Comes into force on or after 01-04-2001

Need for AS – 22….• Practical issues in proper accounting taxes

• AS 22 - NOT a theoretical standard but a practical one.

• We need to understand the exact application of the standard initially

• ONLY experts who have practiced for years can command the application of the same

Two types of income• ACCOUTING INCOME • TAXABLE INCOME

• Based upon– Companies Act,1956– Accounting Concepts– Accounting Principles– Accounting Standards

• Based uponTHE ONLY AND ONLY

– INCOME TAX ACT 1961

OR AS PER ANY OTHER TAX LAWAS WELL AS(FOREIGN LAWS)

• Profit before tax determined as per accounting framework

• Taxable profit tax determined as per tax law

As the name suggests

To prescribe accounting treatment for taxesTaxes on Income one of the significant matter

MATCHING CONCEPT

The standard is based on the ‘Matching concept’ of accounting.

Taxes are accrued in the same period related to revenue/expenses

But in many cases, taxable income ≠ accounting income

OBJECTIVE

REASONS

1.Difference between items of Revenue and Expenses as per Profit And loss Account and those considered for tax purposes.

2.Difference between amount of expenditure considered differently in two cases.

3.Timing Differences

This creates some issues, dealt in AS 22

NOTE - SCOPE• APPLICABLE FOR DOMESTIC TAXES AS WELL AS

FOREIGN TAXES• It includes

• determination of the expense/saving related to taxes on income

• disclosure of the same in the financial statements.

Exclusions

Statement does not specify when, or how, an enterprise should account for taxes that are payable on

• distribution of dividends and • other distributions made by the enterprise.

SIMPLE DEFINITIONS

• Tax expense = aggregate of current tax and deferred tax.

• Current tax = tax payable in respect of the taxable income of the current period.

• Deferred tax = tax effect of timing differences.

What are timing differences?

Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods.

Best Example – Depreciation, Section 43B

Deferred Tax Liability

• Accounting Income > Taxable Income• Temporary differences will result taxable amount in future

years• Example:

Deferred Tax Asset

• Accounting Income < Taxable Income• Temporary differences will result deductible amount in future years

• Example:

Timing difference• Difference in net block of fixed assets between tax and

accounts - • Difference in Depreciation due to

• Different rates / methods• Pro rata treatment Vs. 180 days (in I year)• Up to Rs. 5000 assets write off under Companies Act

• Sale Proceeds Cr. to Block of Asset as per IT Act Vs. Profit / Loss on sale of FA’s recognized in P&L A/c

• Purchase of Scientific Research Assets [35(2)]

• Expenses Dr. to P & L A/c on accrual basis but allowed on actual payment. • Payments made without TDS, but disallowed for tax purposes u/s 40(a)(i) / (ia) and

allowed when relevant tax is deducted & paid subsequently• Expenditure U/s 43B of Income Tax Act• Provision for Gratuity u/s 40A(7)• Provisions made in the P&L A/c in anticipation of liabilities – allowed when liabilities

crystallize

• Provision for doubtful debts / advance

• Provision for warranties

• Preliminary expenses written off fully when incurred (U/s 35D)

• Expenses amortized in books of account over a period of years but a shorter or longer period is allowable for tax purposes

• Miscellaneous Expenditure

• VRS

Expenses debited in Statement of Profit and Loss Account but that shall never be allowed as expense under IT ActE g. Penalties paid

Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.

Permanent Difference

Permanent differences do not result in deferred tax assets or deferred tax liabilities.

FOR EXAMPLE• Amortization of goodwill considered as disallowable

expense• Personal expenditure disallowed by tax authorities• Penalty (Not being compensatory)• Payments disallowed U/s 40(A)(3) • Donations disallowed U/s 80G• Remuneration to partners disallowed U/s 40(b)• Scientific research expenditure.(only weighted element)• Exemptions u/s 10/10A/10B• Deductions U/s 80IA / IB / IC • Financial Lease - Circular No. 2 (dtd. 9th Feb 2001 – post

AS 19 tax position)• Additional Depreciation • on Revaluation

RECOGNITION

Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period.

CONCEPTS-TRUE AND FAIR VIEW - B/S-MATCHING CONCEPT-PRUDENCE

OBVIOUSLY

Deferred tax should be recognized for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets.

RECOGNITION OF DEFERRED TAX ASSET

Should be recognized and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised.

Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised.

Deffered Tax Asset

Re-assessmentRIGHT

Re-viewDUTY

Relates to DTA Previously unrecognized

Relates to DTA Previously recognized

Re-assessment of unrealized deferred tax asset

AT EACH B/S DATE

DEFERRED TAX

A I > TI DEFERRED TAX LIABILITY

AI < TI DEFERRED TAX ASSET

INCOME AS PER TI, LOSS AS PER AI

DEFERRED TAX ASSET

AI PROFIT BUT LOSS AS PER MI (MAT is payable)

DEFERRED TAX LIABILITY (for the difference)

ASI 9 – Virtual Certainty Supported by Convincing Evidence

• Sufficient taxable income will be available is a matter of judgement – case to case basis

• Extent of certainty for all practical purposes, not mere forecasts

• Not a matter of perception but fact

• Evidence – reporting date

MEASUREMENTCurrent Tax Applicable tax rates and

laws

Deferred Tax Tax rates and laws as at B/S date (tax rate enacted or substantively enacted at BS date)

Different Tax rates DTA average rate

DISCOUNTING OF DTA/DTL AT PRESENT VALUE IS PROHIBITED

Presentation of DT Balance Sheet

• Shareholder’s Funds• Share applictn money

pending allotment• Non current liabilities

• (b) Deferred tax liability (net)

• Current liabilitiesTotal

• Non Current Assets• (c) Deffered Tax asset

(net)• Current AssetsTotal

PROFIT AND LOSS ACCOUNTI. INCOMEGross SalesLess: Excise DutyNet SalesOther Income

TOTAL - III. EXPENDITUREMaterial CostEmployees' Remuneration & BenefitsManufacturing ExpensesSelling, General & Administration ExpensesInterestDepreciation

TOTAL - IIIII. PROFIT BEFORE TAX (I-II)X. Provision for Tax Expense (1) Current Tax (2) Deferred TaxXI. Profit after Tax (III - IV)

PRESENTATION

DISCLOSURES• Break-up of major components of DTA / DTL to be

disclosed.

• DTA and DTL to be set off if permissible under tax laws but to be shown separately otherwise.

• Evidence supporting the recognition of DTA to be disclosed, if an enterprise has Unabsorbed Depreciation / Tax Losses to be carried forward.

TRANSITIONAL PROVISION

On the first occasion, the enterprise should recognize, the deferred tax balance that has accumulated prior to adoption of this statement as DTA/DTL with the corresponding credit/charge to the revenue reserves.

Non Corporate Entities : Capital Account

In the first year of AS

THERE ARE TWO APPROACHES

PROFIT AND LOSS APPROACH

EG.DEPRECIATION

BALANCE SHEET APPROACH

EG. WDV

Better approach could be B/S as there is less chance that we miss out any item

Financial Implication of Deferred Tax:

(1) Effect of Deferred tax on Income Tax

(2) Effect on Current Ratio

(3) Affects Net Worth – Thereby affecting - Limits under Companies Acceptance of Deposits Rules

- Eligibility to make investments - Determination of Sickness for BIFR purposes

(4) Affects Debt -Equity Ratio and TOL / TNW (Double edged sword)

(6) Affects Net Profit Ratio (PAT/Net Sales)

(7) Affects EPS

(8) Affects Dividend declaration - No specific reference in the Company Law on DT.(PBT loss V PAT Profit position – Impact on dividend and Audit report)

(9) Affects Capital Adequacy Norms in case of banks (Tier-I & Tier-II Capital) - Capital to Risk Weighted Assets Ratio (CRAR)

(10) Accounting for Taxes on Income in Interim Financial Reports as per AS-2

Accounting Standard Interpretations (ASI) relating to the AS:

1. ASI 3: Accounting for Taxes on Income in the situations of Tax Holiday U/S 80-IA and 80-IB of the Income-tax Act, 1961

2. ASI 5: Accounting for Taxes on Income in the situation of Tax Holiday U/S 10A and 10B of the Income-tax Act,1961

3. ASI 4: Losses under the head Capital Gains

4. ASI 6: Accounting for Taxes on Income in the context of S. 115JB of the Income-tax Act, 1961

Accounting Standard Interpretations (ASI) relating to the AS:

5. ASI 7: Disclosure of deferred tax assets and deferred tax liabilities in the balance sheet of a company

6. ASI 9: Virtual Certainty Supported by convincing evidence

7. ASI 11: Accounting for Taxes on Income in case of an Amalgamation

AS 22 – Conclusion

- Increases transparency

- Matching / accrual concept upheld

- Tax effect Accounting - ensures that Tax Charge in future accounting periods is not vitiated by Timing Differences

- Aligns our AS with global AS

THE BEGINNING