[Submitted by CA. Sachin Gupta,
May 19, 2008
This AS deals with the accounting treatment for taxes on income. The main object of this AS is to match taxes of specified period against revenue and expense of such period in accordance with the matching concept.
Concept of this AS is to classify the difference between taxable income and accounting income into permanent differences and timing differences. It goes on to identify the tax credits/ carry forwards depending upon the temporary differences identified and then accordingly recognizing the deferred tax assets or liabilities as the case may be in the books of accounts, based on the general prudence. The deferred tax assets should be recognized wherever some positive evidence that in future some taxable income would arise. It should be reviewed from year to year basis so as to exclude those for which there is no evidence left that any future income would arise. While calculating the deferred tax assets / liabilities the tax rates should be applied according to the tax laws applicable on the balance sheet date.
In the today's scenario this AS is a need of the organizations to match their taxes and with their revenue and to present the true & fair picture of their accounts that's way this AS is mandatory for all organizations.
The differences between taxable income and accounting income can be classified into permanent differences and timing differences.
Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference.
Timing differences are those 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. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income
Deferred tax should be recognized for all the timing differences like (list is illustrative):
- Expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess, fees, etc.) accrued in the statement of profit and loss on mercantile basis but allowed for tax purposes in the subsequent years on payment basis.
- Payment of expenditure to residents accrued in the statement of profit and loss on mercantile basis but for tax purpose disallowed under section 40(a)(ia) for not deducting or depositing the TDS in the prescribed time and allowed for tax purposes in the year in which relevant tax is deducted or paid
- Payment to non-residents accrued in the statement of profit and loss on mercantile basis but disallowed for tax purposes under section 40(a)(i) and allowed for tax purposes in the subsequent years when relevant tax is deducted or paid.
- Provisions made in the statement of profit and loss in the anticipation of liabilities where the relevant liabilities are allowed in the subsequent years when they crystallize.
- Some kind of expenditures which are amortized in the books over a period of years but are allowed for tax purposes wholly in the first year or over a longer or shorter period like expenditure under section 35D, 35DD, 35E etc.).
- Difference in the depreciation as per books and as per tax. This difference could be arisen due to difference in the rates, method, cost or method of calculation.
- If recognition of income is spread over a number of years in the accounts but the income fully taxed in the year of receipts.
- Income credited to statement of profit and loss but taxed only in subsequent years e.g. conversion of capital assets into stock in trade.
- Provision of gratuity and leave encashment credited to profit and loss account should be recognised as DTA and reversed when the company will pay, DTA would be reversible.
- Where a deduction is allowed in one year for tax purposes on the basis of a deposit made under a permitted deposit scheme (e.g. deposit under section 33AB or section 33ABA) and expenditure out of withdrawal from such deposit is debited in the statement of profit and loss in the subsequent years.
- Diminution in the value of investment as per Accounting Standard-13 recognized in the profit and loss account is also a timing difference and it is capable of reversible when the investment is sold. Rate of tax depends upon the nature of investment if the investment is current/short term so the normal rate should be applied for the DTA and if investment is permanent/long term so rate of capital gain i.e. 20% should be applied.
- According to ASI 4, loss debited to profit and loss account which can be set off in future for taxation purposes, only against the income arising under the head capital gain, so that loss becomes the timing difference and DTA should be recognized accordingly.
- Unabsorbed depreciation and carry forward of losses which can be set-off against future taxable income are also considered as timing differences and result in deferred tax assets
Except in the situations stated in point no. 12, deferred tax assets should be recognised 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. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future.
In case of point no. 12, 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 (as per ASI-9, it refers to the extent of certainty and it can't be based merely on forecasts of performance such as business plans. Determination of virtual certainty is a matter of judgement and will have to be evaluated on a case to case basis. Evidence is a matter of fact and it should be supported by convincing evidence. To be convincing, the evidence should be available at the reporting date in a concrete form) that sufficient future taxable income will be available against which such deferred tax assets can be realised.
Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities are measured using such announcement tax rates and tax laws.
According to the ASI-6, normal rate of tax should be used whether company pays tax under section 115JB of Income tax Act or with any special rate.
When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using average rates.
Deferred tax assets and liabilities should not be discounted to their present value.
Review of Deferred Tax Assets:
The carrying amount of deferred tax assets should be reviewed at each balance sheet date. An enterprise should write-down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain, as the case may be, that sufficient future taxable income will be available against which deferred tax asset can be realised. Any such write-down may be reversed to the extent that it becomes reasonably certain or virtually certain, as the case may be, that sufficient future taxable income will be available.
Some other aspects
1. Provision for tax holiday period
As per ASI-3 & 5, there is no need to recognize deferred tax in respect of timing difference which originates during the tax holiday period and reverse during the tax holiday period and gross taxable of income of enterprises is exempt during the tax holiday period as per the requirement of the Act.
If the timing difference which originates during the tax holiday period and reverse after the tax holiday period, so deferred tax should be recognized in the year in which the timing difference originate.
2. Recognition of DTA and DTL in the course of amalgamation
i.) Amalgamation in the nature of purchase
In this case the consideration for the amalgamation is allocated to the individual identifiable assets/ liabilities of the transferor enterprise on the basis of their fair values at the date of amalgamation as per AS 14, 'Accounting for Amalgamation' and the carrying amounts thereof for tax purposes continue to be the same as that for the transferor enterprise
On the basis of their fair values and the carrying amounts of assets and liabilities, the difference should be recognised as deferred tax for accounting purpose
ii.) Amalgamation in the nature of merger
In this case the transferee enterprise incorporates the assets/liabilities of the transferor enterprise at their existing carrying amounts as per AS 14 and the carrying amounts thereof for tax purposes continue to be the same as that for the transferor enterprise, so the amalgamation does not, in itself, give rise to any difference between the carrying amounts of assets/liabilities for accounting purposes and tax purposes and therefore no need to recognise any deferred tax asset/liability
iii.) Unabsorbed depreciation and carry forward of losses in course of amalgamation
If any deferred tax asset, including in respect of unabsorbed depreciation and carry forward of losses, was not recognised by the transferor enterprise, because the conditions relating to prudence of AS 22 were not satisfied, the transferee enterprise can recognise the same if the conditions relating to prudence as per AS 22 are satisfied.
3. Transitional Provisions
When this AS applies first time, so the enterprise should recognize the deferred tax that has accumulated prior to the adoption of this AS and adjust/charged with opening balance of the revenue reserves, subject to the consideration of prudence
Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period.
As per ASI-7, deferred tax assets and liabilities should be disclosed separately from current assets and current liabilities.
a) If deferred tax assets - It should be disclosed on the face of the balance sheet separately after the head "Investments".
b) If deferred tax liabilities - It should be disclosed on the face of the balance sheet separately after the head "Unsecured Loans".
An enterprise should offset deferred tax assets and deferred tax liabilities if the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts.
The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws.
Reporting requirements as per AS 22:
The Auditor's report is an essential component of usage for the users of the financial information, especially the regulatory bodies. For instance, if a company reports that its auditors have doubt about the realisability / recognition / disclosure of Deferred Tax Assets or Liabilities, regulatory bodies are likely to take that as a sign of non-compliance of AS and True and Fair books of Accounts
If an auditor, after analyzing the sufficient appropriate audit evidences, opined the non-compliance of AS-22 then he needs to ensure as to whether there is adequate disclosure in the financial statements about the non realisability / recognition of Deferred Tax Assets or Liabilities. If there is proper disclosure of the above mentioned facts in the financial information, then an auditor need not to qualify his report and mention such fact in his report by referring the corresponding note in the financial information. For instance, that company is incurring heavy losses from past few years and lack of virtual certainty for Deferred tax Assets and realisability in the foreseeable future than he shall include the following paragraph in his audit report:-
"We draw attention to Note no.___ in the financial statements. The Company is incurring heavy cash losses from the past years which have adversely affects the profitability of the company. These factors alongwith other factors as laid in Note__ raise doubt on the realisability of Deferred Tax Assets particularly in respect of unabsorbed losses & depreciation in forcible future."
However, if the auditor discovers that there is no adequate disclosure of the facts, than he needs to qualify his report in the following form
"The Company is incurring heavy cash losses from the past 5 years which have adversely affected the profitability of the company. There is no mention of these facts in the financial statements.
In our opinion, subject to the omission of the information dealt with in the preceding paragraph, the financial statements give true and fair view of the financial position of the company at march 31, 19X1 and the results of its operations for the year then ended."