New accounting standards will reconfigure taxation
The fundamental contradiction between IndAS and taxation is that the latter is based on real income theory while the former is based on economic substance of transactions
The country is undergoing an overhaul under the present government at the Centre, and so are its corporate laws. The country’s tax regime has recently been subject to fresh measures, such as new Income Computation and Disclosure Standards, crackdown on black money and agreements for international information exchange. The stage is set to become more dramatic with the adoption of the new Indian Accounting Standards (IndAS) which bring in the concept of fair valuation and greater rigour on accounting for the substance of a transaction rather than its form. All listed companies (except those listed on the Small & Medium Enterprises Exchange) and unlisted companies with net worth exceeding R250 crore, including group companies, will be required to mandatorily adopt IndAS in a phased manner. NBFCs, insurance and banking companies are exempted from it though.
The striking features of IndAS are recording of transactions based on economic substance which could result in recognition of notional benefits/expenditures, deferral of revenue recognition, fair valuation of certain financial assets and liabilities resulting in unrealised gains and losses. Herein lies the most obvious contradiction between IndAS and taxation, since taxation is based on real income theory, i.e., income is taxed when right to receive payment arises and expense is allowed as a deduction when there is an ascertained liability to make payment. This will entail multiple adjustments to book profits to arrive at taxable income. The maintenance of separate tax books may also become a reality.
To give an example of the said contradiction, consider a case where a subsidiary company obtains a loan which has been guaranteed by its parent company. The parent does not receive any guarantee commission. However, IndAS requires the parent to initially recognise the fair value of the financial guarantee as deferred income with a corresponding increase in investment in the subsidiary. The fair value is then recognised as income over the period of the loan. From taxation perspective, transfer-pricing officers have sought to tax such commission. Recognising such guarantee commission as income in the books could tip the scales in favour of tax authorities—for other companies not covered by transfer-pricing, tax authorities may seek to tax such commission based on the accounting entries.
Another issue arises, in the case where the company is paying minimum alternate tax (MAT). Calculation of MAT is a straitjacketed formula with certain prescribed additions and exclusions to be made to book profits to arrive at taxable income. Among these prescribed adjustments, there is no adjustment to exclude from income such notional commission as discussed above. However, there is an adjustment which disallows expenses which are unascertained liabilities. Thus, notional income, as per IndAS, may form part of taxable income while notional expenses may get disallowed leading to higher taxable profits. Further, differences between recognition of income/expense in books and those considered for tax purpose as well as the difference in the timing of their recognition, could lead to the company frequently oscillating between MAT provisions and normal tax provisions.
There are many other examples of radical changes in the way accounting will be done under IndAS and which will have prima facie impact on tax liability of a company. If a debt restructuring exercise is done on substantially different terms than the original debt arrangement, the increase/decrease in the present value of cash flows on account of restructuring must be accounted for as loss/gain. From tax perspective, further evaluation will be required on whether such gain/loss is capital in nature and hence, not subject to tax. In the case of inventory and fixed assets purchased on deferred terms, the difference between the purchase price for normal credit terms and the amount paid must be recognised as interest expense over the period of the credit. One wonders whether the tax authorities will insist on fulfilling withholding tax obligations on such ‘interest expense’. This could have serious implications since non-fulfilment of withholding tax obligations leads to penalty and prosecution.
The impact of IndAS on tax liability of corporates is not straight forward—in some cases, there could be higher profits while in some others, profits could be lower. But it is certain that corporates will need to evaluate the considerable adjustments to be made to book profits to arrive at taxable income. It is imperative that the government issue guidelines/amendments in the Income-Tax Act on the interplay between IndAS and tax.
Jhaveri is partner, and Savla deputy manager, at Deloitte Haskins & Sells LLP
