The year ending 31 March, 2017, witnessed many companies preparing their financial statements as per the Indian Accounting Standards (‘Ind-AS’) for the first time. Ind-AS is a set of accounting standards that converge with the International Financial Reporting Standards (‘IFRS’) and require companies to adopt fair value accounting. The first time adoption of Ind-AS requires financial statements to be recast in accordance with the fair value principle, and any adjustment arising from transition to Ind-AS is recorded in retained earnings/ Other Equity without routing it through the statement of profit and loss.
There is a significant change in the manner in which instruments, which are convertible into a fixed number of equity shares, are accounted for under Ind-AS. These instruments, also referred to as compound financial instruments (‘CFI’), have elements of both financial liability and equity embedded in them. Ind-AS requires the issuer to separately recognize both these components in its financial statements as financial liability and equity. On first time adoption, the equity component is further split into (i) the original equity component and (ii) retained earnings, the latter representing the cumulative interest accreted on the liability component. Both these components are reflected under the head ‘Other Equity’ in the balance sheet.
Considering that book profits under Ind-AS will be different from those as per the existing Generally Accepted Accounting Principles (‘I-GAAP’), the Finance Act, 2017, has amended the provisions for the computation of the Minimum Alternate Tax (‘MAT’) to prescribe certain adjustments that should be made to the book profits, both in the year of transition and going forward, for the purposes of paying MAT.
As per the amended MAT provisions, the transition adjustments shall be apportioned over a period of five years for the purposes of paying MAT. The term ‘transition amount’ has been defined under the law as the aggregate of the adjustments in Other Equity (excluding the capital reserve and securities premium reserve) with certain specified exclusions.
In the case of CFIs, on transition, both portions of the equity component, the original equity and the cumulative interest adjusted through retained earnings, are reflected as Other Equity. Going by the plain reading of the MAT provisions, a possible interpretation could be that MAT is payable on the entire amount credited to Other Equity. While payment of MAT on the adjustment to equity on account of interest seems reasonable, payment of MAT on the original equity component recorded on the convergence date appears unreasonable.
Historically, MAT is never payable on capital infusions, and the amount credited towards original equity represents the equity element embedded in a CFI. In fact, if a CFI is issued post Ind-AS, the amount that would be recognized as original equity on such infusion will not be subject to MAT. Therefore, to have a MAT liability arising on the amount of the original equity component of CFI credited to Other Equity in the year of transition seems absurd.
The intention of the legislature to not levy MAT on capital infusions is evident from the fact that the capital reserves and securities premium are specifically excluded from the computation of the transition amount.
Moreover, the Memorandum to the Finance Bill, 2017, provides that the amount adjusted in ‘Reserves and Surplus’ is to be considered as a ‘transition amount’ for payment of MAT over the next five years. However, the language was replaced with ‘Other Equity’ in the fine print of the Finance Bill.
Thus, it appears that the lawmakers did not intend to include the original equity component of a compound financial instrument for payment of MAT. However, use of the term ‘Other Equity’ in the provisions may result in unwarranted litigations. It is therefore advisable that the Central Board of Direct Taxes (‘CBDT’) proactively clarifies its position and removes any ambiguity on this account.
Views expressed are personal to the author. Article includes inputs from Richa Singla – Associate Director – M&A Tax, PwC India and Priya Jain – Assistant Manager – M&A Tax, PwC India