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Qualification in question

R. G. Rajan

R. G. Rajan on differences of opinion in deferred tax accounting

ACCOUNTING Standard 22 — Accounting for taxes on income — became mandatory in respect of accounting periods commencing on or after April 1, 2001, for all enterprises whose equity or debt securities are listed on a recognised stock exchange in India and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange. With regard to banks, the RBI issued circular dated May 29, 2002, stating that compliance with ASs 17, 18, 21 and 22 is optional only for the financial year ending March 31, 2002. However, most of the banks had completed the annual accounts prior to the issue of the circular.

While most of banks computed the accumulated deferred tax liability and charged the same against revenue reserve as laid down in para 33 of the Standard, disclosures by Union Bank of India (UBI) and Syndicate Bank were quite unique and merit attention:

"The bank has written to authorities seeking clarification on applicability and modalities of AS 17 and AS 22 issued by the ICAI. AS 17 and AS 22 have not been compiled with during the current year. The impact on profit due to non-compliance with AS 22 has not been ascertained." (UBI)

"On a review of the position as on March 31, 2002, regarding accounting for taxes for income under AS-22, on the basis of prudence, the deferred tax asset is not being considered." (Syndicate Bank)

As regards UBI, qualification by the auditors was straightforward. However, the following qualification by four of the six central statutory auditors of Syndicate Bank appears a bit strange:

"The accounting treatment of deferred tax followed by the bank, which is not in consonance with the AS-22... result in non-provision of Rs 97.67 crore on account of deferred tax liability on the profit of the year."

Bank's reply to the qualification: "The bank has complied with AS-22 issued by the ICAI for the year 2001-2002. As on March 31, 2002, the bank had net deferred tax asset which, as a matter of prudence, has not been recognised. Four out of six statutory auditors have mentioned in their report that the accounting treatment of the deferred tax liability by the bank is not in consonance with AS-22... The bank, however, does not agree with their views. Besides, the other two central statutory auditors also do not agree to the above observation. Further, the bank has obtained opinions from tax consultants and an accounting firm, which also confirm that the bank's stand is right and there is no deferred tax liability on the part of the bank as on March 31, 2002. The RBI has also clarified that the matter is still under their examination and by the working group constituted by them. Accordingly, the bank is of the firm view that the provision of Rs 97.67 crore, as suggested by the four of the six central statutory auditors, is not required in accordance with the provisions of AS-22."

To comply with the Standard, the computation of deferred tax liability (DTL) or deferred tax asset (DTA) should be based on timing differences. In the current year, being the first occasion of implementation, it is further necessary to compute the accumulated DTL/DTA, as the case may be, as per para 34 and recognise the same accordingly. The AS allows the recognition of DTA subject to prudence and certainty as per paras 15 to 18.

Computation of DTL/DTA for the current year requires the following information: i) depreciation as per books as well as the Income-Tax Act for the current year; ii) allowances and disallowances as per the I-T Act; iii) unabsorbed depreciation and carried forward losses, if any, under the I-T Act; and iv) Opening WDV as per books and the I-T Act.

The information required as per the I-T Act is not a part of the published report. Hence, the issue: Is it possible to ascertain the factual position?

From the note given by the bank, the position is one of DTA and the same has not been provided. Hence, the logical conclusion is that the bank should have had accumulated unabsorbed losses and depreciation as per the I-T Act. Further, as the note indicates DTA on review of the position, the losses continue to remain unabsorbed at the year-end as well.

Though the information under the I-T Act is not available, one can still analyse the past record of the bank and come to some conclusions.

The introduction of prudential norms resulted in huge losses continuously for three years (from 1993 to1996) amounting to Rs 1,061 crore [(1993-94 (Rs 670 crore), 1994-95 (Rs 299 crore) and 1995-96 (Rs 92 crore)] .On March 31, 1999, the Government approved the reduction of capital, whereby, the entire accumulated loss of Rs 943 crore as on March 31, 1998, was set off against the capital of Rs 1,290 crore, thereby reducing the capital to Rs 347 crore. Subsequently, the bank recorded a cumulative profit of Rs 593 crores during the three years ending March 31, 1999, March 31, 2000 and March 31, 2001. Since the capital reduction is purely an accounting matter, from the view point of I-T Act, the bank would still have a carried forward loss of Rs 350 crore (Rs 943 crore minus Rs 593 crore) as on March 31, 2001. The bank recorded a profit of Rs 251 crore during 2001-2002. Hence, it is clear that as on March 31, 2002, there could still be unabsorbed carried forward losses. Perhaps, even after considering the current year timing difference the position could be still that of DTA from the balance-sheet point of view. In these circumstances, it appears that the bank's note is justified.

The bank, in the alternative, could have recognised the DTA in the books. As per para 8 of the Standard, 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, subject to prudence. Prudence involves a degree of caution in the exercise of the judgment needed in making the estimates required under conditions of uncertainty. Since the position is one of DTA, the bank must have chosen this as the basis in not recognising the same. Further, it is not a compulsion as per the Standard to recognise the DTA.

Qualification by auditors

When the bank has specifically stated the position as that of a DTA, how is it that the auditors quantified a DTL and went on to qualify the same?

The auditors' qualification includes a quantification of a DTL of Rs 97.67 crore on the profit of the year, the basis of which has been questioned by the bank. Deferred tax is the tax effect of timing differences. Therefore, the timing difference originating in the current year, as per the auditors, should have been Rs 273.58 crore (DTL (97.67) / current tax rate @ 35.7 per cent). The bank has reported a profit of Rs 250.55 crore after providing Rs 22.50 crore towards income-tax (page 54 of the published report). Hence, the accounting income for the purpose of the Standard equals Rs 273.05 crore, which almost coincides with the timing difference of Rs 273.58 crore as computed by the auditors. The logical conclusion, therefore, is that the taxable income is zero. Further, the tax provision of Rs 22.5 crore indicates it is towards minimum alternate tax. This also leads to the conclusion that the bank should have had carried forward losses.

As per the Standard, 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. Thus, the emphasis is on "a period". Appendix 1 of the Standard illustrates the various situations leading to timing differences: expenses debited in the statement of profit and loss for accounting purposes but allowed for tax purposes in subsequent years (Sections 43B, 40(a), and so on); expenses amortised in the books over a period of years but allowed for tax purposes wholly in the first year, or if amortisation for tax purposes is over a longer or shorter period (Sections 35D, 35DD and 35E); and where book and tax depreciation differ.

The important question is whether the timing difference of Rs 273.58 crore corresponds to 2001-2002. Analysing the bank's note, it is seen that there are carried forward losses. Therefore, it appears that the auditors have computed the DTL of Rs 97.67 crore by taking into consideration the carried forward losses originated in different periods prior to 2001-2002 and which are being reversed in the current period. Hence, it can be easily concluded that the timing difference of Rs 273.58 crore did not originate in 2001-2002.

Thus, it is clear that there is a conflict between the contentions of the bank and the auditors with respect to DTA and DTL. The factual position seems to be that of a DTA rather than a DTL. The auditors should have clearly spelt this aspect in their report. Perhaps, it would have been more prudent on the part of the auditors to give a disclaimer rather than a qualification with quantification.

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