Well, the ramp was crowded enough already - we had the Accounting standards applicable to such companies as are not covered by Indian Accounting standards, IFRSs for companies with international exposure, US GAAPs for companies with Nasdaq listing, and now we have one more baby on the ramp - accounting standards for tax purposes.
It is not that tax accounting standards are new. Pursuant to sec 145 of the Income Tax Act, the CBDT had earlier come with two Accounting Standards relating to disclosure of accounting policies and disclosure of prior period and extraordinary items and changes in accounting policies. The reason for introduction of these accounting standards was that there is flexibility in the standards issued by the ICAI which makes it possible for an assessee to avoid the payment of correct taxes by following a particular system. Hence, it was decided to standardize one or more of the alternatives in various standards so that income for tax purpose can be computed precisely and objectively.
Initially, a committee was formed by Central Government in July 2002 for formulation of Accounting Standards under the IT Act. However, the committee, after understanding the impracticality in maintaining two sets of books, one as per Accounting standards and other as per TAS, recommended that the Accounting standards issued by ICAI should be notified under the Act without any modifications and the Act should be accordingly amended to prevent any scope for tax evasion by adopting the Accounting standards as it is. However, these recommendations were not implemented because of several reasons – one among others was the continuous revision of the Accounting Standards by ICAI requiring simultaneous amendments in the Act.
Though the provisions of the Income Tax Act, 1961 govern the computation of taxable Profits, the Act currently does not comprehensively specify accounting standards that should be followed for this purpose.
Even though the Finance Act, 1995 empowered the Central Government to notify such accounting standards, only two accounting standards on disclosure of accounting policies; and disclosure of prior period and extraordinary items and changes in accounting policies have been notified till date.
In the absence of such notified accounting standards under the Act, companies generally compute their taxable income following the same accounting principles and policies followed for the preparation of financial statements, subject to specific provisions of the Act and after considering various judicial pronouncements.
Over the last several years, the Institute of Chartered Accountants of India (ICAI) has issued several accounting standards and pronouncements, many of which have been notified by the Ministry of Corporate Affairs (MCA). Additionally, as a part of the convergence with International Financial Reporting Standards (IFRS), the MCA has placed thirty five converged standards (Indian Accounting standard) on its website.
In the absence of notification of accounting standards under the Act, in practice, uncertainty and litigation continues on various accounting related issues where the views of the tax authorities are not consistent with the provisions of the accounting standards and pronouncements of the ICAI or the MCA.
Further, in the absence of clarity around the tax impact of the transition to Indian Accounting standard, the MCA is yet to notify the final implementation dates for adoption of Indian Accounting standard.
Accounting Standards Committee (constituted by the CBDT)
With the above background, in December 2010, the CBDT constituted an Accounting Standard Committee (the Committee) comprising of officers from the Income Tax department and other professionals. The terms of reference of this Committee are as follows:
1) To study the harmonization of Accounting Standards issued by the ICAI with the direct tax laws in India, and suggest Accounting Standards which need to be adopted under section 145(2) of the Act along with the relevant modifications;
2) To suggest method for determination of tax base (book profit) for the purpose of Minimum Alternate Tax (MAT) in case of companies migrating to IFRS (Indian Accounting standard) in the initial year of adoption and thereafter; and
3) To suggest appropriate amendments to the Act in view of transition to IFRS (Indian Accounting standard) regime.
On 17 October 2011, based on the recommendation of the Committee, the Ministry of Finance issued a discussion paper on Tax Accounting Standards. This paper discusses the key recommendations of the Committee on point (I) above.
Key recommendations of the committee
1) The Accounting Standards issued by the ICAI cannot be notified without modifications as the requirements prescribed by these standards are not necessarily consistent with other specific provisions of the Act. The accounting standards to be notified under the Act should provide specific rules, which would enable computation of income with certainty and clarity. Further, such notified accounting standards should eliminate alternatives to ensure horizontal equity and uniformity. Accordingly, separate accounting standards should be notified under Section 145(2) of the Act. These separate accounting standards should be termed as ‘Tax Accounting Standards (TAS)’ to distinguish them from accounting standards issued by the ICAI or notified by the MCA;
2) TAS should be made applicable only to the computation of taxable income and a taxpayer should not be required to maintain separate books of account on the basis of TAS;
3) A reconciliation between the income as per the financial statements and the income as computed per the TAS should be required;
4) Since the TAS are based on the mercantile system of accounting, the TAS should be applicable to only taxpayers who follow the mercantile system for tax purposes; and
5) Since the TAS is intended to be in harmony with the provisions of the Act, it should be expressly provided in the TAS, that in case of conflict, the provisions of the Act shall prevail over the TAS.
If the recommendations in the discussion paper are eventually accepted and incorporated into the Act, taxable income would be computed based on provisions of the TAS irrespective of the accounting standards followed for the preparation of the financial statements.
This would partially address the issue relating to the impact of transition of Indian Accounting standard on taxation, as taxes payable (other than MAT) would be computed based on TAS irrespective of whether a company follows the currently applicable accounting standards or Indian Accounting standard.
Further, though taxpayers will not be required to maintain separate books of account per the TAS, they would need to maintain and present reconciliation between the profits per the financial statements and per the provisions of TAS.
Tax Accounting Standards on Construction Contracts and Government Grants
Tax Accounting for Construction Contracts
Though the TAS is substantially based on Accounting Standard 7, Construction Contracts (AS 7), there are some significant modifications to AS 7, which require consideration:
1) The TAS mandates the use of the percentage of completion method for revenue recognition on construction contracts. Accordingly, use of completed contract method may no longer be permitted for tax purposes;
2) Even though the TAS permits non-recognition of margins during the early stages of a contract, it prohibits such deferral if the stage of completion exceeds twenty five percent;
3) Unlike AS 7, the TAS does not provide for recognition of expected losses on onerous construction contracts; and
4) The TAS precludes any incidental income in the nature of interest, dividend or capital gains from being reduced from the contract cost. However, incidental income, other than interest, dividend or capital gains can be reduced from the costs, if such income is not a part of the contract revenue.
Further, as the TAS is based on AS 7, the new concepts in Indian Accounting standard that may impact accounting for construction contracts (for example, discounting of retention receivables) have not been incorporated into the TAS. Accordingly, companies that transition to Indian Accounting standard may need to make certain additional adjustments to comply with the TAS.
Tax Accounting for Government Grants
1) Though the TAS is based on Accounting Standard 12, Accounting for Government Grants (AS 12), there are some fundamental modifications to AS 12, which require consideration:
2) The TAS does not permit the capital approach for recording government grants. Accordingly, the current practice of recording grants in the nature of promoters’ contribution or grants related to non-depreciable assets, directly in shareholders’ funds as a capital reserve will not be permitted under the TAS;
3) Under the TAS, all grants will either be reduced from the cost of the asset; or recorded over a period as income; or recorded as income immediately; depending on the nature of the grant; and
4)Unlike AS 12, the TAS provides that the initial recognition of the grant cannot be postponed beyond the date of actual receipt. AS 12 specifically provides that mere receipt of a grant is not necessarily conclusive evidence that conditions related to the grant will be fulfilled. Further, as the TAS is derived from AS 12, the new concepts in Indian Accounting standard that impact accounting for government grants (for example, recognition of nonmonetary grants at fair value) have not been incorporated into the TAS. Accordingly, companies that transition to Indian Accounting standard may need to make certain additional adjustments to comply with the TAS.
The proposal to issue separate TAS will represent a significant change for taxpayers. Tax payers would need to evaluate the requirements of the draft TAS proposed from time to time, and determine the specific areas of impact.
The recommendations in the current Discussion Paper will partially address one of the key stated bottlenecks for implementation of Indian Accounting standard, by requiring computation of taxable income using a uniform basis. It is likely that recommendation by the Committee on points (ii) and (iii) of their terms of reference will further facilitate the adoption of Indian Accounting standard in India.