Brief- Accounting Standard 22 -Accounting for taxes on Income – provides for recognition and disclosure of deferred tax assets/liabilities. In view of the proposed reduction in corporate tax rates as announced in Budget 2015, is there a change in the method to be adopted by the corporates for the purpose of calculation of deferred tax assets/liabilities? 

Introduction- May 26, 2015 completes one year of the new government’s tenure at the centre. Riding on strong anti-incumbency factors prevalent then, Shri Narendra Modi ji led BJP stormed to power. Predictably the expectation levels were high among the business community for getting the “Indian growth story’ back on track. And so the usual pre-budget hype was heightened this year. Budget 2015, on its part did not disappoint. Among a slew of measures to prep up the economy, tax rates for domestic corporate was proposed to be reduced from the current 30% to 25% over the next 4 years. Swaminathan Aiyar, a reputed columnist, writing in the Economic times (dated 1st Mar, 2015), opined that the proposed reduction “was a bigger conceptual breakthrough than his (Finance Minister’s) big thrust in infrastructure, aimed at kickstarting economic growth in the country”.

AS-22 – An Overview

Before I start analyzing the impact of this announcement on the application of AS-22 (Accounting for taxes on Income), let me briefly give a conceptual overview of Deferred tax Assets/ Liabilities.

Deferred tax assets/liabilities are created whenever there is a timing difference between income(s)/expense(s) accounted for in the books and income(s)/expense(s) allowed for tax purposes. The important point to note is that over a period of time the income(s)/expense(s) accounted/allowed for in both the cases will even out or match. Hence the term, timing difference

The simplest example to illustrate this point would be Depreciation. While for companies depreciation has to be accounted for as per Schedule 2 of Companies Act, 2013 in their books, for the purposes of tax computation depreciation has to be provided for as per Income tax Act, 1961.

If, in the first year, depreciation provided in the books of accounts is higher than the depreciation allowable for tax purposes, the resultant taxable income and consequently the tax liability increases. Since accumulated depreciation for an asset, over a period of time, will remain more or less same howsoever computed, in the subsequent years depreciation expense is likely to be lower in the books compared to what is allowable for tax computation purposes. Essentially the company has paid more taxes in the first year which is likely to get adjusted in the following years. In this scenario the company has created a Deferred Tax Asset (DTA) in the first year which will reverse in the ensuing years. If the opposite happens (i.e. in the first year, dep. expense is lower in the books compared to that which is allowable for tax purposes), then the company has created a Deferred Tax Liability (DTL).

DTA DTL

Para 20, 21 & 22 of AS-22

Now let us pay attention to what paragraphs 20, 21 and 22 of AS-22 state. They are reproduced as such below.

“20. Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws.

21. 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.

22. Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. 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 announced tax rate and tax laws.” (Emphasis added)

Essentially AS-22 stipulates that while the provision for current taxes must be calculated using the current tax rates, deferred tax calculation should be based on future tax rates (i.e. enacted or substantively enacted rates). Let’s understand this with an illustration.

Illustration: X ltd has the following financials.

PARTICULARS Year1 Year2 Year3
EBITDA 200 200 200
Depreciation

(as per books)

30

 

30

 

30

 

Depreciation

(as per IT Act)

75

 

15

 

NIL

 

Current Tax rate 30% 30% 30%
Timing Difference (TD) 45 (75-30)

 

-15 (15-30)

 

-30 (0-30)
Cumulative TD 45 30 NIL
DTL (Cumm.)

 

13.5(45*30%)

 

9(13.5-(15*30%))

 

NIL

 In the above illustration, the corporate tax rate has been assumed to be same in each of the three years. If the rate of tax changes, it would be necessary for the enterprise to adjust the amount of deferred tax liability carried forward by applying the tax rate that has been enacted or substantively enacted by the balance sheet date.

Now let’s assume that the corporate tax rate is progressively reduced by 1% year-on-year so that the rate is as follows: Year 1-30%; Year 2-29%; Year 3-28%. The revised deferred tax calculation will be as below.

PARTICULARS Year1 Year2 Year3
EBITDA 200 200 200
Depreciation

(as per books)

30

 

30

 

30

 

Depreciation

(as per IT Act)

75

 

15

 

NIL

 

Corp Tax rate 30% 29% 28%
Timing Difference (TD) 45 (75-30)

 

-15 (15-30)

 

-30 (0-30)
Cumulative TD 45 30 NIL
Breakup of TD 45   15 (yr 2)

30 (yr3)

30 (yr 3) NIL
DTL (Cum.)

 

12.75 [(15*29%) + (30*28%)] 8.4 [12.75 – (15*29%)] NIL [8.4 – (30*28%)

Thus we can see that the amount recorded as DTL reduces from 13.5 Lakhs to 12.75 Lakhs in the first year and in from 9 Lakhs to 8.4 Lakhs in the second year.

Corporate tax rate cut proposed in Budget 2015

The critical issue to be looked at here is whether the Hon’ble FM Shri Arun Jaitley’s proposal given in the budget speech ‘to reduce the rate of Corporate Tax from 30% to 25% over the next 4 years’ can be taken as having a substantive effect of enactment as mentioned in Para 22. Well, the obvious answer is no because FM’s proposal is just that … a proposal. Ultimately the tax rate may or may not reduce in the subsequent years and is dependent on whole lot of other extraneous factors like the economic condition of the nation etc.

But let’s consider the following scenario. A big MNC with multi-crore balance sheet assets has an originating deferred tax asset in the year 2014-15 and it is expected to be reversed over a period of 5 years. A difference of 5% on DTA for such companies could well run into hundreds of lakhs. Now does the following of prudent concept not entail that the corporate has to recognize the DTA (which is reversible in future years) at appropriately lower amounts (since the tax rate is likely to be @25%).

Like so many other areas in accounting, this too does not have any easy answers. Certain interesting questions that arise are:

  • Para 15 of AS -22 states DTA is to be recognized when there’s reasonable certainty. In the above mentioned case, is there reasonable certainty to account for DTA?
  • Is true and fair presentation of Financial Statements affected by this?
  • Also if we have to account for the differential rates in future taxes, how do we do it? The proposed reduction is 5% over 4 years. So does it mean 1.25% reduction in tax rates per year?

Conclusion

Auditors of Listed Companies will be busy finalizing the accounts before the SEBI dealine of May 31st. They also need to pay attention to the issue raised in this article especially if any of them has huge DTA as on the Balance sheet date. Since AS-22 has clearly mentioned that at every balance sheet date the position must be reviewed and the carrying amount of DTA must be written off to the extent it is not reasonably certain that the amount will be recoverable.

(The views expressed herein are my personal interpretation of law. Reader’s discretion is required. Author takes no personal responsibility for any mistakes or omissions or misinterpretation of law).

N. Sai Sundar- SRO-0392946- CA Final student

More Under Income Tax

Posted Under

Category : Income Tax (27874)
Type : Articles (17584)
Tags : income tax law (15)

0 responses to “Proposed Corporate Tax rate cut in Budget 2015 and its Impact on AS-22”

  1. Pankaj Chopra says:

    Very good article. However this will be applicable once Govt. Announce exact rate to be changed in coming years.

Leave a Reply

Your email address will not be published. Required fields are marked *

Featured Posts