CBDT Committee recommends MAT framework for Ind-AS companies

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1 2 May 2016 EY Tax Alert CBDT Committee recommends MAT framework for Ind-AS companies Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. This Tax Alert discusses framework recommended by a Committee set up by Central Board of Direct Taxes (CBDT), the apex administrative body of direct taxes in India, inter alia, for making amendments to the Indian Tax Laws (ITL) for the purpose of levy of book profit based Minimum Alternate Tax (MAT) on companies required to prepare financial statements as per framework of new Indian Accounting Standards (Ind-AS) which are converged form of International Financial Reporting Standards (IFRS). With Ministry of Corporate Affairs (MCA) notifying roll out of Ind-AS in a phased manner from financial year commencing on or after 1 April 2016, the Committee (called Accounting Standards Committee) was directed on 8 June 2015 to suggest framework for MAT in view of transition to Ind-AS. On review of provisions of the ITL and Companies Act, 2013 (CA 2013), the Committee noted that (a) that there was an implicit relationship between distributable profit (i.e. profit before tax available for appropriation and distribution as dividend) and tax base for levy of MAT under CA 2013; (b) dividend may be allowed to be paid from past realised profits or from current year s profits even if unrealized. Accordingly, the Committee approached MCA for clarifications of scope of free reserves and determination of distributable profit under CA 2013 in Ind-AS regime since fair valuation is pervasive under Ind-AS. MCA clarified that distributable profit for the purposes of determining ceiling on managerial remuneration and dividend distribution under Ind-AS regime will exclude items

2 included in Other Comprehensive Income (OCI) section of income statement under Ind- AS. Based thereon, the Committee has suggested a three-pronged approach for levy of MAT on the basis of book profit as per Ind-AS income statement. The three-pronged approach may be summarized as follows:- 1. Ind-AS requires a combined statement of Profit & Loss (P&L) and OCI. Since OCI largely comprises fair valuation differences, MAT pick up should be from the P&L and not from Total Comprehensive Income (which represents aggregate of P&L and OCI). The profit as per P&L can be subjected to upward and downward adjustments which already exist in current MAT provisions. 2. Although, MAT pick up should be from P&L, items included in OCI should also be picked up for MAT levy at an appropriate point of time. Illustratively, revaluation surplus/gain can be picked for MAT at the time of realization /disposal/retirement of the asset or investment. 3. On first time adoption of Ind-AS, items which are directly transferred to Retained Earnings and are not reclassified to P&L in future should be picked up for MAT in the first year of Ind-AS adoption. Continuing with its recent trend of consultative approach, the CBDT has published Committee s Report and sought issues/points requiring further clarifications/guidance from stakeholders and general public by 10 May Background MAT provisions apply to a company and provide for taxation based on book profit. MAT is triggered when tax liability, computed at specified percentage [1] of book profit is higher than tax liability under normal computation. The book profit is computed by adopting the net profit as per P&L, prepared in compliance with the relevant provisions of CA 2013 and further adjusting it by upward and downward adjustments as specified under MAT provisions. Hitherto, accounting standards formulated by Institute of Chartered Accountants of India (ICAI) [2] and notified by MCA in 2006 (popularly known as IGAAP) formed basis of preparation of P&L and hence MAT is levied on book profit as per IGAAP. While presenting Union Budget for , the Finance Minister announced that Government will implement Ind-AS from a date to be notified. The Finance Minister also announced that standards for computing tax liability (known as Income Computation & Disclosure Standards or ICDS) shall be notified separately. Pursuant to Budget announcement, on 16 February 2015, MCA notified the Companies (Indian Accounting Standards) Rules, 2015 comprising Ind- AS to be implemented in phased manner [3] from tax year onwards for companies meeting specified net worth and group relationship criteria. [1] Currently 18.5% plus applicable surcharge and cess [2] Regulator of accounting profession in India [3] The road map did not cover banking, insurance and nonbanking finance companies at that point of time but subsequently, MCA issued a Press Release on 18 January 2016 to announce roadmap for scheduled commercial banks (excluding regional rural banks), insurance and non-banking finance companies (based on net worth criteria and group relationship) starting from 1 April 2018 onwards.

3 Ind-AS is applicable to both standalone and consolidated financial statements. Companies not meeting the specified net worth and group relationship criteria have option to voluntarily adopt Ind-AS or continue with IGAAP. Earlier, much prior to announcement of final roadmap to Ind-AS convergence, the CBDT had constituted a Committee in December 2010, comprising officials of Tax Authority and independent professionals to formulate ICDS [4] and also suggest amendments to MAT in view of transition to Ind-AS regime. With clarity in roadmap for Ind-AS, the CBDT reconstituted the Committee on 8 June 2015 to suggest framework to compute book profit, which constitutes tax base for MAT levy, for companies converging to Ind-AS. The Committee submitted its report on 18 March 2016 post consultation with MCA. In its present report, the Committee has clarified that its deliberation on examining Ind-AS/ICAI Guidance Notes for the purpose of identifying the areas where additional ICDS need to be notified are not complete. Committee s findings on relationship between distributable profit under CA 2013 and book profit for MAT levy requiring MCA consultation As MAT provides for several upward and downward adjustments including set off of brought forward losses / unabsorbed depreciation, MAT seeks to adopt realized profits before tax as tax base for MAT. Accordingly, there is an implicit relation between distributable profit for declaration of dividend under the CA 2013 and book profit for levying MAT. However, fair value accounting is predominant in Ind-AS and current year s profit as also OCI may include sizeable amount of notional/unrealized gain. CA 2013 appears to permit payment of dividend from current year s profits or from free reserves (in case of inadequacy of current year s profits). The definition of free reserves excludes unrealized/notional gains arising on fair valuation or revaluation of assets and liabilities. But, CA 2013 appears to permit payment of dividend out of current year s profits without adjustment in respect of notional/unrealized gains. Also, for the purposes of determining ceiling limit for managerial remuneration also, CA 2013 requires exclusion of impact of fair valuation of assets and liabilities. Consultation with MCA [4] Pursuant to Committee s recommendations, CBDT notified 10 ICDS on 31 March 2015 for compliance by all taxpayers following mercantile system of accounting for computing normal tax liability under the heads Profits and gains of business or profession or Income from other sources. In view of differing requirements in CA 2013 for treatment of unrealized/notional gain/losses, the Committee consulted MCA to understand scope of distributable profit under Ind- AS regime. The MCA vide its Office Memorandum dated 11 January 2016 clarified that distributable profit for both managerial remuneration and dividends shall exclude

4 items included in OCI which represent notional/unrealized gains. The MCA also provided a list of 9 items that are included in OCI (Refer Annexure A). It also recommended that same principle may be extended for reckoning book profit for MAT purposes. Committee s recommendations for MAT levy under Ind-AS regime MAT pick up for OCI items not routed through P&L at stage of realization OCI includes certain items which remain permanently recorded in reserves and never get reclassified to P&L and consequently do not get included in MAT computation. These should be included in book profit at an appropriate point of time. Illustratively list of such items with recommended MAT treatment is as follows: Post MCA s clarification, the Committee further deliberated and suggested three pronged approach for levy of MAT on the basis of book profit as per Ind-AS income statement viz. MAT pick up under Ind-AS vis-à-vis current year s P&L a/c (excluding OCI); MAT pick up for OCI items not routed through P&L at stage of realization; MAT impact on first time adoption of Ind-AS. Changes in revaluation surplus [5] on Property, Plant and Equipment and Intangible Assets to be included in book profit at the time of realization or disposal or retirement of such assets. Gains and losses from investments in equity instruments designated at fair value through OCI [6] to be included in book profit at the time of realization Re-measurements of defined benefit plans [7] to be included in book profit every year as the re-measurements gains and losses arise; MAT pick up under Ind-AS vis-à-vis current year s P&L a/c (excluding OCI) Since OCI largely comprises fair valuation differences, MAT pick up should be from P&L by excluding OCI items. The profit as per P&L can be subjected to upward and downward adjustments which already exist in current MAT provisions. However, if MCA prescribes any additional adjustments to P&L for determining distributable profits under CA 2013, the same may be prescribed for MAT also. MAT impact on first time adoption of Ind-AS On date of transition to Ind-AS, the company may make transitional adjustments to align existing IGAAP accounting policies with Ind-AS. These are generally recorded directly in Retained Earnings or Reserves. Several of these items never get subsequently classified to P&L and, hence, are not included in MAT computation. [5] Arising out of revaluation of Property, Plant and Equipment under Ind-AS 16 titled Property, Plant and Equipment and revaluation of Intangible Assets under Ind-AS 38 titled Intangible Assets [6] Under Ind-AS 109 titled Financial Instruments [7] Under Ind-AS 19 titled Employee Benefits

5 MAT treatment for such items may be as follows: The adjustments which get directly recorded in reserves but would be subsequently reclassified to P&L [8] should be included in book profit of the year of reclassification to P&L. The adjustments which get recorded in OCI but would never be subsequently reclassified to P&L [9] should be included in book profit as provided under caption MAT pick up for OCI items not routed through P&L at stage of realization" above. All other adjustments which get recorded in Retained Earnings and which would never subsequently get reclassified to P&L should be included in book profit in the year of first time adoption of Ind-AS. Comments MAT when originally introduced in 1987 was meant to make companies which declare dividends to shareholders based on book profit but pay NIL or negligible amount of tax by availing different tax incentives, pay a minimum amount of tax based on book profit. It is a complete code in itself and adopts net profit as per P&L as start point for computation subject to specified upward and downward adjustments. Since fair value accounting is pervasive under Ind-AS, there was concern for corporate taxpayers that existing MAT provisions, if not amended, will require payment of tax on notional/unrealized gains credited to income statement. The Committee s report addresses this concern partly to the extent it recommends that fair value adjustments forming part of OCI / reserves should be subjected to MAT levy when such fair valuation differences are actually realized. While this approach is a balanced approach, the amendments which may be made to MAT provisions to achieve the intended object may make the provisions extremely complex and run counter to Government policy objective of promoting ease of doing business. Furthermore, as regards fair valuation differences which in terms of Ind-AS forms part of P&L [10], one will need to wait for MCA clarification for their exclusion from distributable profit based on which additional adjustments may be prescribed in MAT computation. [8] This would generally apply to OCI items appearing as part of comparative previous years figures for F.Y in first Ind- AS financial statements for F.Y [9] This would generally apply to OCI items appearing as part of comparative previous years figures for F.Y in first Ind- AS financial statements for F.Y [10] For instance, equity instruments held for trading need to be fair valued on balance sheet date which may bring unrealized fair value appreciation in P&L and hence subjected to MAT

6 The recommendation to levy MAT on adjustments transferred to Retained Earnings on first time adoption of Ind-AS (and not required to be subsequently reclassified to P&L) may create hardships for taxpayers. On principles, it appears to be inconsistent with basis of levy of MAT on distributable profit as adopted by the Committee for other recommendations. MCA s clarification that OCI items shall be excluded for the purpose of computing distributable profit for determining managerial remuneration and dividend payment, although given in the context of MAT, will be equally relevant from corporate law perspective. It is important for corporates to carefully consider impact of above recommendations on their potential MAT liability on Ind-AS accounts and point out issues/ points requiring further clarifications/guidance by 10 May 2016.

7 Annexure A Items included in OCI as clarified by MCA vide its Office Memorandum dated 11 January 2016 Sr. No. Nature of OCI item Reference of relevant Ind-AS 1. Changes in revaluation surplus Ind-AS 16 - Property, Plant and Equipment and Ind- AS 38 - Intangible Assets 2. Re-measurements of defined benefit plans Ind-AS 19 - Employee Benefits 3. Gain and losses arising from translating the financial statements of a foreign operation Ind-AS 21 - The Effects of Changes in Foreign Exchange Rates 4. Gains and losses from investments in equity instruments designated at fair value Ind-AS Financial Instruments 5. Gains and losses on financial assets measured at fair value 6. The effective portion of gains and losses on hedging instruments in a cash flow hedge and the gains and losses on hedging instruments that hedge investments in equity instruments measured at fair value through other comprehensive income in accordance with paragraph of Ind-AS For particular liabilities designated as at fair value through profit or loss. the amount of the change in fair value that is attributable to changes in the liability' s credit risk 8. Changes in the value of the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value (Chapter 6 of Ind-AS 109) 9. Changes in the value of the forward elements of forward contracts when separating the forward element and spot element of a forward contract and designating as the hedging instrument only the changes in the spot element and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument (Chapter 6 of Ind-AS 109)

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