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AS 22 or Catch 22?

S. Rajaratnam on why Accounting Standard 22, on accounting for tax on income, has limited scope.

CONVENTIONALLY, income has been understood as operating profit, which the entrepreneur is entitled to before income-tax, and the tax treated as post-profit appropriation. Be it an entrepreneur or an investor, reward is judged with reference to the after- tax return, thus reckoning tax as a cost. Though an ascertainable cost, it is often a variable cost as it is `manageable'. Manageable because it can be reduced by exercising the options available under income-tax law, as in matters such as choice of busi ness, form of organisation (taxable entity), method of accounting (including valuation of inventories) and utilising incentives. As it is a cost with many variables, making a provision for tax is often a difficult task, especially where the volume of tra nsactions is significant.

AS 22 has limited scope: Provision for tax is the first step in accounting for income-tax. Such a provision has to be with reference to the liability which has already accrued or which could be ascertained with reference to the profits of the business. A ccounting for taxation has only a brief reference in standard texts. The Institute of Chartered Accountants of India has now issued Accounting Standard 22 -- `Accounting for tax on income'. The Standard, however, deals solely with tax deferment, expectin g the provision for taxes to be treated like any other provision.

In this sense, AS 22 serves only a limited purpose, confining itself to distribution of tax payments and benefits to the respective years by adopting the matching principle. This, after all, is the purpose of any provisioning in the accrual system of acc ounting.

On the march: AS 22 has now become mandatory and is effective in three stages -- for listed companies, from April 1, 2001; for all companies, April 1, 2002; and for other enterprises requiring certification, April 1, 2003. Accounting for income-tax has t o be finally done in the light of the generally accepted accounting principles (GAAPs).

Treatment of advance tax: Advance tax relates to the year of transaction, though the tax itself gets crystallised in the subsequent year. But a provision for tax is necessary because it is a certain liability, required to be made as a charge on profits g oing by the matching principle. It is ordinarily ascertainable notwithstanding the fact that there could be many imponderables owing to tax controversies which are thrust on taxpayers even if they wished to avoid them.

There may be liability for minimum alternate tax (MAT), where the tax liability is greater than the tax on statutory profits. So, it is necessary to compute advance tax or the tax payable with reference to both the criteria, as the greater one is require d to be provided for. With two High Courts taking contrary views, there is no doubt a controversy whether advance tax is payable at all for MAT liability. The Gauhati High Court, in Assam Bengal Carriers Ltd vs CIT (1999 239 ITR 862 Gauhati), held that a dvance tax is inevitable, while Karnataka High Court, in Kwality Biscuits Lts vs CIT (2000 243 ITR 519 Karnataka), ruled that it is not. There is a also a view that the latter decision, too, has no application for MAT. The controversy is: If advance tax has not been paid, should the provision include interest under Section 234B?

Proposed dividend: Another variable is proposed dividend, the tax on which is now leviable under Section 115-O of the I-T Act. The provision will depend on the extent of the proposed dividend to be distributed at the stage of presentation of accounts at the annual general meeting (AGM), liable to correction if the general meeting scales it down, which is possible.

TDS: Tax deduction at source (TDS) is another area which would need to be recognised. Where there is any failure with regard to TDS, it is bound to be made good along with interest for delay; a provision is, therefore, required for the same. In respect o f the various provisions relating to payments to non-residents -- as royalty, technical fees, accrued interest or any other payment -- tax becomes deductible, though payable next May, and a provision would be necessary.

Credit to the income-tax account and debit to the profit and loss (P&L) account by way of a provision have been recommended even in the early works such as Spicer and Pegler's Book Keeping and Accounts (chapter on `Accounting for taxation'). A similar tr eatment is advised in William Pickle's Accountancy.

Deferred tax: The concept of deferred tax, as one requiring adjustment of profit, has also been a matter of historical accounting. Spicer and Pegler refer to timing differences, whether permanent or otherwise, arising out of various situations, some of w hich are short/long term while others permanent. Short-term differences arise because of disallowances -- such as bad debts or accrued expenditure -- likely to be paid and allowed in the very next year.

Long-term differences, which are not permanent, may arise out of accelerated/differential depreciation amortised in the assessee's books at normal rate. Rollover relief, which is now recognised under the block scheme of depreciation, will also spread ove r amortisation to a longer period. Such temporary differences are described as timing differences in AS 22. Permanent differences arise in respect of capital expenditure on which depreciation is not admissible, or items such as entertainment expenditure which are disallowed.

Section 43B is a classic case of timing difference, both temporary and permanent. Interest payable to banks and financial institutions are examples of temporary difference deductible on payment, while delayed welfare dues do not get allowed at all, servi ng as an example of a permanent difference.

Tax deferral and company law: Paragraph 3(v) of Part II of the Schedule VI of the Companies Act, 1956 reads as follows:

``The amount of charge for Indian income-tax and other Indian taxation on profits, including, where practicable, with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where p racticable, between income-tax and other taxation.''

The provision for tax liability with reference to company law has been understood to be based upon tax laws and applicable rates, as there is no specific reference to credit for deferred tax benefit. The generally accepted view is that the disputed tax l iability, even if it had been imposed, need not be provided for if the dispute awaits adjudication with prospect of success; such a decision should necessarily be supported -- in the case of statutory liability -- by expert opinion with a note on account s. The same consideration may apply for anticipated liability in the light of the prevalent departmental view, on one hand, and the expert opinion, on the other.

Where a provision for tax has not been made but a larger liability arises on assessment, paragraph 13 of AS 5 would expect that it be disclosed as ``prior period and extraordinary items''. While T. P. Ghosh, in Accounting Standards and Corporate Accounti ng Practices (chapter on `Accounting for Income-tax'), points out that such additional liability, where it could not have been reasonably anticipated, cannot be treated as a prior-period item, as it arises in the current period though relating to an earl ier year and also in view of the definition in Paragraph 4 of AS 5. Such a conclusion follows even in the AS prescribed under Section 145 of the I-T Act.

Timing differences -- no precise guidelines: Treatment of deferred taxes has been the subject matter of treatises on accountancy, though not in accounting practice in India. Spicer and Pegler, in Book Keeping and Accounts, draws attention to the need for deferred tax to make the system more realistic, but there is no consensus about the manner in which it should be translated in accounting.

The reasons for the delayed recognition of deferred tax in accounting practice has been because the information on the future impact of such tax was always been uncertain. Fluctuating tax rates across the years, uncertainty of interpretation, unpredictab le market conditions, necessity of structural changes in business -- such as amalgamation, demerger or merely shuffling of shares (attracting Section 79), time limits for utilising set-offs with determined losses or depreciation lapses, are but some of t he variances which make any forecast extremely precarious. Dr Joel G. Siegel and others in GAAP, 2000 recommend recognition of a deferred tax asset only if there is more than 50 per cent probability of tax benefit in future. More than 50 per cent has to be ascertained with reference to the following factors:

``There has been a relatively consistent strong earnings history. Future earnings are assured. There is expected adequate future taxable income arising from the reversal of a temporary difference (deferred tax liability) to realise the benefit of the tax asset. Sound and prudent tax planning strategies are in place which would allow for the realisation of the deferred tax asset. The amount per books of asset value exceeds their tax bases sufficient to realise the deferred tax asset. Lucrative contracts exist. There is a significant sales backlog.''

In most cases, the presence of such factors in order to justify deferral would only be an academic exercise. It is for this that partial deferral was considered advisable in the Statement of Standard Accounting Practice 15.

Paragraph 15 of AS 22 itself recognises deferral ``only to the extent that there is reasonable certainty'' of realisation of future benefit. Hence, partial deferral is recognised by the Standard and the extent is left to be guided by ``consideration of p rudence'' by ``examining past records of the enterprise and by making realistic estimates of profits for the future.'' The guidelines for such amendment are too broad to be of much assistance. All the illustrations to the Standard assume full deferral.

If 50 per cent certainty, as recommended in American accounting texts, is to be observed, there will hardly be any case for deferral in erratic Indian conditions -- of fluctuating stock and foreign exchange values, and unstable political situation.

Full deferral approach is academic, while partial deferral approach can be objective. Pickles, while dealing with accounting for income-tax in Chapter 21 of Accountancy , advises that deferred benefit be determined in consultation with treatises on tax l aws -- that is, tax experts rather than accountants. It is a recognition of the complexities involved, which accounting standards cannot fully solve. Accounting -- Management Approach, by Shillinglaw, Gordon and Ronen, also point out the influence of rul es and regulations governing taxes on business income in respect of financial accounting for taxes.

(To be concluded)

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