Webcast on Non - Compliance of Accounting Standard

AS – 22 Accounting For Taxes on Income

Deficiencies observed : at a glance

23%

22%

22%

11%

22%

AS 22 - Accounting for Taxes on Income

Para 13 - Recognition

Para 17 - Regarding virtual certainty

Para 31 - Break up of DTA/DTL

Para 32 - Nature of evidance of DTA

Others

1.Offsetting of DTA and DTL in

Consolidated Financial Statement

Case:

A company having several subsidiaries, disclosed Net Deferred Tax Asset in the Consolidated Balance Sheet.

Principle:Paragraph 29 of AS 22

Observation:

It was noted that as per aforesaid principle deferred tax liabilities and deferred tax assetscan be set off against each other, only when the enterprise has legal enforceable right to setthem off against each other. It was noted that in the given case, Net Deferred Tax Assets(DTA) reported in the Consolidated Balance Sheet has been determined by adjustingDeferred Tax Asset (DTA) of one enterprise against Deferred Tax Liabilities (DTL) ofanother enterprises. It was viewed that there is no legal enforceable right to set off DTAof one enterprise against DTL of another enterprise.

2.Offsetting of DTA and DTL in Standalone

Financial Statements

Case:

In the Balance Sheet of a company, both the Deferred Tax Liabilities and Deferred Tax Assets have been shown separately on the face of the Balance Sheet.

Principle:

Paragraph 29 of AS 22

Observation:

An enterprise is required to disclose on the face of the Balance Sheet either the ‘Deferred

Tax Assets’ or the ‘Deferred Tax Liabilities’ after setting-off the two balance against each

other. However, it has been noted that both the ‘Deferred Tax Assets’ and ‘Deferred Tax

Liabilities’ have been shown separately on the face of the Balance Sheet. In other words, the

‘Deferred Tax Assets’ and ‘Deferred Tax Liabilities’ have not been set-off against each other for

their presentation in the Balance Sheet as required by paragraph 29 of AS 22.

3.

Presentation of Deferred Tax Liability(DTL) and Deferred

Tax Asset (DTA) on the face of Balance Sheet

Case:In the Annual Report of certain companies, Deferred Tax Liability (DTL) had been presented in the following manner on the face of the Balance Sheet: • As part of Loan Fund• As part of Note on Provision• After Shareholders Fund• After the head ‘Net Current Asset’ as a deduction from ‘Application of Funds’

And in some case, Deferred Tax Asset (DTA) had been presented in the following manner on the face of the Balance Sheet:• As part of Current Assets• After the head ‘Net Current Asset’

Principle:

Explanation to Paragraph 30 of AS 22

Observation:As per above stated principle, DTL should be disclosed separately after the head ‘unsecured loans’ andDTA should be disclosed separately after the head ‘Investments’ on the face of Balance Sheet.Accordingly, the presentation of DTA and DTL in all these cases is not in line with the requirement ofparagraph 30 of AS 22.

4.Non-disclosure of major components of

DTA and DTL

Case: Certain companies have disclosed the break-up only for deferred tax assets and deferred tax liabilities that have been recognized in Statement of Profit and Loss.

Principle:Paragraph 31 of AS 22

Observation:

It was noted from the aforesaid paragraph that it requires the break-up of deferred tax

assets and deferred tax liabilities balances. It was viewed that the term ‘balances’ signify

that break up of DTA and DTL as shown in the Balance Sheet is to be disclosed rather

than the amount expensed in the Statement of Profit and Loss. However, the companies

have disclosed the break up of only the deferred tax liability/ assets that has been

created during the year rather than providing the break-up of entire balance being

carried forward in the Balance Sheet from one period to another period.

5.Non-recognition of DTA and DTL in

case of losses

Principle:Paragraph 13 of AS 22 and Question 9 (ii) of Background Material for Seminars on Accounting Standard

(AS) 22, Accounting for Taxes on Income

Case :In the Annual Report of a company, the note relating to provision for taxation read as follows:

‘In the absence of book/ tax profits and consequent impact of the timing differences on the same, provisionfor deferred taxes and current income tax has not been made.’ It was further noted from the note on fixedassets that the depreciation has been provided during the year.

Observation:It was viewed that deferred tax should be recognised for all the timing differences. The fact that there are

no tax profits or book profits, does not exempt the company from recognition of deferred taxes. Deferred

tax asset should be recognised based on principles of prudence as stated in the standard. However, as per

the clarification in response to Question 9 (ii) of BGM, it was viewed that deferred tax liability recognised

at the balance sheet date gives rise to future taxable income at the time of reversal. Hence, deferred tax

asset to the extent of deferred tax liability should be recognised. In the given case, it was viewed that

depreciation is giving rise to deferred tax liability. Hence, the company should have recognised DTL on

timing difference related to depreciation, and thereafter, DTA to the extent of DTL, should have been

recognized.

6.Incomplete Accounting Policy for Taxes

on Income

Case:A company having history of unabsorbed depreciation and carry forward business losses had recognised the deferred tax asset. The accounting policy of the company reads is as under:

“Deferred Tax Asset is recognised, subject to consideration of prudence, on timing differences, being difference between taxable and accounting income/ expenditure that originate in one period and are capable of reversal in one or more subsequent period(s). The management is of the opinion that sufficient future taxable income will be available against which, such deferred tax assets will be realised.”

Principle:

Paragraph 17 of AS 22

Observation:It was noted from the stated accounting policy that DTA was recognised subject to theconsideration of prudence. However, as per above stated requirement it should be recognised onthe basis of virtual certainty supported by convincing evidence that future taxable incomewould be available against which such deferred tax can be realised. Accordingly, the accountingpolicy for the recognition of DTA is not complete considering the requirements of paragraph 17 ofAS 22.

7.Virtual certainty is not supported by

convincing evidence

Principle: Explanation to paragraph 17 of AS 22

Case:

A company had unabsorbed depreciation and carry forward tax losses. Its accounting policy stated

that the “Deferred tax assets are recognised only if there is virtual certainty supported by

convincing evidence that such deferred tax assets can be realised against future taxable profits.”

However, under the Notes to the Accounts, it is stated that “based on the future profitability

projections, the Company is virtually certain that there would be sufficient taxable income in

future, to claim the above tax credit.”

Observation:It was noted that the deferred tax asset was recognised based on virtual certainty evident from

future profitability projections. As per the explanation to para 17 of AS 22, a projection of the

future profits made by an enterprise cannot, in isolation, be considered as convincing evidence. The

evidence, being a matter if fact, should be available at the reporting date in a concrete form, for

example, a profitable binding export order. Accordingly, recognition of DTA on the basis of

profitability projection, in the given case, is not in line with the requirements of AS 22.

8.Non-Disclosure of nature of

evidence supporting recognition of DTA

Case:

From the accounting policy, it was noted that deferred tax asset has been recognized only

to the extent of virtual certainty supported by convincing evidence. Further, from the note

providing the components of DTA and DTL, it was noted that the company had

unabsorbed depreciation and carry forward business losses against which DTA has been

recognized. However, the nature of evidence supporting the recognition of DTA was not

disclosed.

Principle:

Paragraph 32 of AS 22

Observation:As the company has unabsorbed depreciation and carry forward business losses undertax laws, the above-mentioned principle of AS 22 is applicable. However, the nature ofevidence, based on which such deferred tax assets (DTA) was recognised has not beendisclosed.

9. No DTL on Special Reserve created under

Section 36 (1) (viii) of the Income Tax Act, 1961

Case:From the Annual Report of a Housing Finance company, it was observed from the ‘Note on Reserves and Surplus’ and ‘Note on Deferred Tax’ that the company had made a transfer to “Special Reserve” created under section 36(1)(viii) of the Income Tax Act, 1961. However, the note on components of Deferred Tax Liabilities did not include the deferred tax liability arising on such transfer.

Principle:EAC opinion on Query No.18 of Compendium of Opinions, Vol. 26

Observation:

It was noted from the Statement of Profit and Loss that the current tax has been determinedconsidering the deduction available under Section 36(1)(viii) of Income Tax Act. However,neither the accounting policy states to have considered the aforesaid deduction nor thecomponents of DTA/ DTL reflects any DTL made with respect to the same. It was viewed that thecompany is required to create deferred tax liability on the special reserve created and maintainedunder section 36(1)(viii) of the Income-tax Act, 1961, irrespective of the fact that withdrawal ofthe reserve may or may not happen, since the company is capable to withdraw the reserveresulting into reversal of the difference between accounting income and taxable income (i.e.,timing difference).

10.Tax expense comprises of only current

Income Tax

Principle:Paragraph 4.3 of AS 22

Case:In the Annual Report of a company, the accounting policy on Income tax, reads as under:

‘Tax expense comprises of current income tax.”

Observation :

It was noted from the stated policy on income tax that tax expense comprises of only current

income tax. It was viewed that as per paragraph 4.3 of AS 22, tax expense is the aggregate of

current tax and deferred tax. Accordingly, such statement was viewed to be not in line with

the requirements of AS 22.

11.

Estimation of provision for income tax on the basis of

Income Tax Advices

Principle:

Paragraph 20 of AS 22

Case:In the Annual Report of a company, the accounting policy on Taxation reads as follows:

‘Provision for Taxation is ascertained on the basis of assessable profit computed in accordance with the Tax Advices, wherever considered necessary…’

Observation :

It was noted that provision for tax is estimated based on certain tax advices. It was viewed

that AS 22 prescribes to measure the tax at the amount expected to be paid to taxation

authority, using the applicable tax rates and tax laws. It does not prescribe to follow

Income Tax Advices which involve interpretation of income tax laws. Hence, estimating

provision on the basis of such advices cannot be considered to be in line with paragraph 20 of

AS 22.

12.Creating DTL on Provision for

Gratuity

Principle:

Paragraph 11 and 13 of AS 22

Case:From the Annual Report of a company, it was noted that the Deferred Tax Liability of a company, interalia, comprises of ‘Provision for Gratuity’. It indicates that DTL has been recognised against provision for gratuity.

Observation :

It was viewed that provision for gratuity is an expense which is provided every year in the

Statement of Profit and Loss based on services rendered by the employee, but it is not

allowed as a deduction, as per Section 43B of the Income-tax Act, 1961. Accordingly, it

would result in deferred tax asset only.

Accordingly, it was viewed that treating provision for gratuity as deferred tax liability is

incorrect.

13. DTA/ DTL on the items not routed

through Statement of Profit and Loss

Case: From the note on Reserve and Surplus given in the Annual Report of a company, it has been noted that Deferred Tax Asset has been accounted on Cash Flow Hedge Reserve and balance of cash flow hedge reserve is stated at net of deferred tax assets.

Principle:

Paragraphs 13 of AS 22 regarding recognition of ‘Deferred Tax’ and Paragraph 4.6 of AS 22 regarding

definition of ‘timing difference’

Observation:AS 22 stipulates recognition of deferred tax for only the timing differences, i.e., when there is a difference

in the taxable income and the accounting income for the period, which originate in one period and would

reverse in subsequent period. In the given case, gain or loss on cash flow hedge has directly been adjusted

into reserves and has not been routed through the Statement of Profit and Loss. It was viewed that such

balance would impact the Statement of Profit and Loss only when, hedged forecast transaction would

occur. So effectively, till the final transaction takes place neither the accounting income nor taxable

income will be affected. Hence, such adjustment cannot be considered to be giving rise to any timing

difference on which deferred tax should be recognised.

14.Regarding Accounting Policy on

MAT

Case: In the Annual Report of a company, the Accounting Policy on MAT reads as follows:

‘In accordance with the Guidance Note issued by Institute of Chartered Accountants of India, the Company recognises MAT Credit as an asset only to the extent the probability exists that the Company will become liable to pay normal Income Tax during the specified period as per provision of the Income Tax Act, 1961’.

Principle:

Paragraph 11 of “Guidance note on Accounting for Credit Available in respect of Minimum

Alternative Tax under the Income-tax Act, 1961”

Observation:In the given case, it was noted that MAT credit is recognised by the company as an asset on the

basis of degree of certainty (i.e. if it is more likely than not) that the company will become liable to

pay normal income tax, whereas as per the Guidance Note, it should be recognised only when

convincing evidence is available that the company will pay normal income tax. Accordingly, it

was viewed that the accounting policy to recognise MAT credit on the basis of probability is not in

line with the requirements of the Guidance Note.

Thank You