ILLUSTRATION CLARIFYING MAT ADJUSTMENTS DUE TO IND AS. Example 1

Transcription

1 ILLUSTRATION CLARIFYING MAT ADJUSTMENTS DUE TO IND AS Example 1 The Company is covered under Phase 1.Its transition date is April 1, 2015.The year of Ind AS adoption is financial year and the comparative period is financial year On the transition date the company makes the following adjustments in the opening retained earnings. 1. The Company applies the fair value as deemed cost exemption and revalues the fixed assets from Rs 100 million to Rs 150 million.on a go forward basis the Company will apply the cost measurements basis for accounting purposes and the opening cost of fixed assets will be Rs 150 million under Ind AS. 2. The Company has investment in two subsidiaries, whose cost at April 1, 2015 is Rs 60 million (Subsidiary 1) and 70 million (Subsidiary 2).On the transition date the Company records the investments at fair value, Rs 80 million and Rs 85 million, respectively, which is the new deemed cost.on a go forward basis the investments will be recorded at the deemed cost.during the financial year, , the Company sells Subsidiary 1 at Rs 82 million. 3. The Company has investments in equity mutual funds.under Ind AS, investments in equity mutual funds are marked to market and the gains/losses are recognized in P&L.Under Indian GAAP, the book value of investments in the mutual funds is Rs 215 million.the fair value at transition date (1 April, 2015) is Rs 220 million and at the end of comparative period (31 March 2016) is Rs 225 million. 4. The fair value of the above equity mutual fund at end of 31 March 17 increased by Rs 7 million and at end of 31 March 18 decreased by Rs 3 million. Solution 1. The fair value uplift of fixed assets of Rs 50 million will be completely MAT neutral.for MAT purposes, the same will be ignored for computing future book depreciation, as well as gains/losses on sale or final disposal of the fixed assets. Please refer example 4 for detailed workings. 2. With respect to Subsidiary 2, there is a fair value uplift of Rs 15 million.the adjustment to retained earnings is completely MAT neutral vis-à-vis existing provisions. For the purpose of MAT, retained earnings adjustment of Rs 15 million shall be included in the book profit at the time of realisation of such investment. With respect to Subsidiary 1, there is a fair value uplift of Rs 20 million.however, it is sold in the comparative period.for the purpose of MAT, retained earnings adjustment of Rs 20 million as well as gain of Rs 2 million in the comparative period are completely ignored, since the same has already been realized in the comparative period, on which MAT was applied under Indian GAAP. 3. The fair value uplift on the mutual fund of Rs 5 million is to be included in the book profits for purposes of determining MAT equally over the next five years.however, firstly this needs to be trued up at 31 March 16.The trued up uplift is Rs 10 million.for the next five years, Rs 10 million would be equally spread, for determining book profits for MAT, in accordance with the Table below. Rs (million) Previous year Assessment year Amount to be added to book profits

2 4. The upward fair valuation in the mutual fund of Rs 7 million for the year 16-17, will be included in the Ind AS book profits and MAT profits as well.the downward fair valuation of Rs 3 million will be included as loss in the Ind AS book profits.however, in accordance with the requirements of 115 JB, the same will be added back to the Ind AS book profits, for purposes of calculating MAT book profits. Example 2: Equity investment in subsidiaries, associates and joint ventures The table below sets out the broad impact on MAT under different Ind AS accounting policy choices with respect to accounting for equity investments in subsidiaries, associates and joint ventures.these provisions will apply to equity investments in the stand-alone financial statements of the parent/investor. Indian GAAP accounting policy At cost less other than temporary diminution in value Ind AS accounting policy choices At cost less impairment 1. Use fair value on TD as deemed cost At cost less impairment 3. Use Indian GAAP carrying amount as deemed cost FVTPL 5. Measure investment at fair value on TD and at each reporting date 6. TD impact in RE &year on year (YOY) impact in P&L FVTOCI 10. Measure investment at fair value on TD and at each reporting date 11. Recognise difference in a separate reserve, say, FVTOCI reserve MAT consequences 2. Corresponding impact in RE. However, it is MAT neutral 4. No transition impact in RE 7. TD impact after true up adjustment to be included in book profit over 5 years 8. YOY fair value gains/ losses will have yearly MAT impact 9. Fair value losses may be excluded from book profit due to section 115JB 12. It is MAT neutral on TD and after 13. To be Included in book profit only on realisation/ transfer/ disposal of investment Example 3: Investments measured at FVTPL Ind AS requires Fair Value through Profit & Loss (FVTPL) accounting for investments in most mutual fund units, equity investments held for trading, and investments in convertible instruments.investments in mutual funds such as fixed maturity plans (FMP) may be eligible for amortized cost accounting. All investments in convertible instruments are fair valued irrespective of whether those instruments are issued by subsidiary, associate, joint venture or any other company.ind AS also allows as a matter of accounting policy choice FVTPL accounting for all equity investments subject to certain conditions. The table below explains how fair value changes are recognised in RE/ P&L and their MAT impact. Amounts in INR Date Cost Fair Retained P&L MAT impact value earnings 1 April INR 70 to be included in MAT equally over 5 years, i.e., INR 31 March per year from to It may be noted that the RE impact of INR 50 is trued up at 31 March March To be included in MAT computation for the year March (25) Downward fair valuation to be added back as per section 115JB. 31 March INR 35 gain to be offset against downward valuation of INR 25 disallowed in previous year. Thus, INR 10 to be included

3 Example 4: Use of Fair value as deemed cost for PPE on TD in MAT book profits for the year The Company has used the fair value as deemed cost exemption for PPE on TD. The cost of the asset is INR 100 and the fair value is INR 150 on TD.The RE adjustment at TD of INR 50 is trued up for the period The trued up RE adjustment of INR 45 is MAT neutral.for sake of simplicity it is assumed that the assets useful life is ten years, residual value is nil and the depreciation method followed is the SLM method. At 31 March 2019 the asset is sold at INR 110. For the purposes of MAT book profits, the Ind AS P&L is completely ignored.for purposes of MAT book profits the following will apply: (a) (b) The trued up adjustment of INR 45 is MAT neutral On a go forward basis, depreciation of INR 10 is deductible (c) Profit on sale of asset to be included in MAT book profits is INR 50 (110-60) Amounts in INR Date/ year-ended Cost IndAS RE IndASP MAT Book adjustment &L profit MAT impact 1 April Fair valuation effect as trued up for depreciation is INR 45 (135-90).This is MAT neutral. It will be considered only at the time of disposal 31 March (15) (10) No depreciation is allowed on fair value portion 31 March (15) (10) for determining MAT book profits. 31 March (15) (10) 31 March (15) (10) 110) Profit on sale Fair value portion will be ignored for determining book profit on sale of assets. Thus, gain on sale would be INR 50 (110-60). Revaluation may not be MAT neutral The response provided above is based on the intention of the MAT committee to make PPE revaluation MAT neutral. However, a question is being raised as to whether PPE revaluation is indeed MAT neutral. A very technical reading of the Finance Act would lead to INR 65 being included in book profits for determining MAT in The profit on sale is INR 20 and, there shall be addition of INR 45 being the trued up transitional adjustment which is not subjected to MAT in F.Y , adding to INR 65. The author believes that this is unintentional since the Explanatory Memorandum clearly spells out the intent that only INR 50 should be included in book profits for determining MAT. CBDT should provide appropriate clarification on the matter. Example 5: Redeemable preference shares In the following brief fact pattern, the table explains the MAT consequences on TD and after TD. The Company has issued preference shares which are mandatorily redeemable and are outstanding at the TD Fixed premium is payable on redemption Redemption date is a few years afterind AS implementation

4 Indian GAAP accounting Ind AS accounting MAT consequences Preference shares are Preference shares are On TD, Equity is reclassified classified as equity classified as liability as liability. Premium paid is treated as distribution and charged to RE or securities premium.there is no charge under Indian GAAP uptill the TD, since the premium will be paid a few years later Premium is treated as interest expense and charged to P&L on an effective interest rate (EIR) basis On TD, liability is measured at amortized cost (i.e., issue price + accrued interest/ premium using EIR) On TD, liability is increased by amortization amount with a corresponding debit to RE RE impact after true up adjustment will reduce book profits equally over next five years On a go forward basis, interest expenses recognized in P&L is MAT deductible Example 6: Debentures redeemable at premium In the following brief fact pattern, the table explains the MAT consequences on TD and after TD. The Company has issued 0% Redeemable Debentures which are outstanding on the TD.There is no annual interest charge Debentures are redeemable at 10% p.a. Redemption date is a few years after TD In the table below, two scenarios are considered.in Scenario 1, the entire debenture premium has been already accounted for under Indian GAAP upfront.in Scenario 2, no premium has been accounted for under Indian GAAP. Indian GAAP accounting Day 1 Debit Securities Premium Credit Debenture liability Full premium liability accrued upfront Ind AS Transition date accounting Debit Debenture liability Credit Securities Premium (Reversal of excess liability) MAT implications Scenario 1 Scenario 2 No entry as premium on redemption was proposed to be charged to securities premium at end. Debit Retained earning Credit Debenture liability (Recognition of liability at amortized cost) Adjustment to securities premium is MAT neutral. Amount debited to retained earnings after true up However, interest charged to P&L during theadjustment will be MAT deductible over 5 years. comparative period will be MAT deductible equally over 5 years. In Scenario 1, the full premium liability is accounted for under Indian GAAP on issuance of the debentures.on TD, debenture liability will be recognized at amortized cost on an EIR basis.therefore excess debenture liability on TD will be reversed by crediting securities premium account.it may be noted that any adjustment on TD to capital reserve account or securities premium account is MAT neutral. In Scenario 2, no entry was passed with respect to the premium under Indian GAAP as the Company s policy was to account for such premium at the time of redemption of debentures.therefore on TD, debenture liability will be increased under Ind AS to reflect the amortization effect on an EIR basis.the corresponding debit adjustment to RE, after true up effect, will be MAT deductible equally over next five years.

5 In both Scenario 1 and 2, on a go forward basis, redemption premium recognized as interest in Ind AS P&L on an EIR basis is MAT deductible. Point to note There may be a number of situations, which could lead to a debit or credit to securities premium with a contra effect to retained earnings. In such cases, since two accounts in the reserves caption are affected, the author believes that it should be neutral from MAT perspective. Example 7: Zero Coupon Optionally Convertible Redeemable Preference Shares (OCRPS) The brief fact pattern is as follows: The Company has issued 0% OCRPS, which are outstanding at the TD The holder has an option to redeem or convert into a fixed number of equity shares Under Ind AS, the OCRPS will be treated as a compound financial instrument, and will be split into a liability and an equity component.the equity components represents the option of the holder to convert the OCRPS into a fixed number of equity shares in the future The table below sets out the accounting under Indian GAAP and Ind AS and the MAT consequences on TD and after. Indian GAAP accounting Ind AS accounting MAT consequences OCRPS are classified ason initial recognition/ date of Debatable whether equity component equity issuance, preference shares will be split into liability and equity component of compound financial instrument will be considered for MAT computation over 5 years (discussed earlier in this article) Interest on liability amount is recognized using EIR Equity component is not remeasured Past interest on liability component uptill the TD after true up will be adjusted to RE and will reduce book profits over 5 years On a go forward basis, interest expense on liability component recognized in P&L is MAT deductible Assume the OCRPS amount is INR 100, and the split accounting results in liability of INR 60 and equity of INR 40.As OCRPS was issued prior to TD, the liability amount will have to be increased for the amortization effect on EIR basis with a corresponding charge to RE. Interest after TD is charged to Ind AS P&L. On TD, there are two adjustments; namely an equity credit of INR 40 and past interest debit of INR 12 (see below).equity component of compound financial instruments was meant to be MAT neutral under the Finance Bill.However, that neutrality was removed in the Finance Act Therefore this is a slightly contentious issue.one may argue that equity component on TD is MAT neutral on the following grounds: (a) (b) Equity component is MAT neutral on an ongoing basis and hence the same rule should apply for equity component on TD Equity component represents an option to the investors to buy equity shares and hence is not a P&L or RE credit item With respect to INR 20 (RE debit of INR 12 on TD, and true up effect of INR 8), the same will equally

6 reduce book profits over the next 5 years, starting from Amounts in INR Date Item Liability Equity IndASP&L RE Adjusted Original amount Past interest (12) Total (12) Interest 8 - (8) - Total (8) (12) Interest 10 - (10) - An interesting point to note MAT impact Debatable whether equity component of compound financial instrument will be considered for MAT over 5 years. INR 20 (12+8) TD impact after true up to be reduced from book profit equally over next 5 years Interest charged to P&L (INR 10) is MAT deductible. On transitional adjustment to Equity Component of Compound Financial Instruments, there could be difference between 0% Optionally Convertible Preference Shares (OCPS) and 0% Compulsorily Convertible Preference Shares (CCPS). In OCPS, if the company pays MAT over 5 years on INR 40 (in the above example), it will also get deduction by way of interest debit to P&L on the liability amount over future periods. Hence, the tax burden arising from MAT may be offset. If in the above example, the instrument was not OCPS but CCPS, the whole ofinr 100 will get classified as Equity component and there will be no interest charge in future periods. This can lead to potential double taxation. One may argue that because such a treatment leads to double taxation, is not equitable and not fair, the Equity amount of INR 100 should not be included in book profits for determining MAT. Other questions that may arise in case of 0% CCPS are (a) CCPS s are not compound financial instruments, and therefore one may argue that on TD, the equity component will not be included in book profits over next five years (b) CCPS may have been classified as equity even under Indian GAAP, in which case, there is no reclassification from liability to equity in Ind AS. Consequently, this is not an adjustment at TD and hence will not be included in book profits. These matters are highly debatable. Example 8: Financial Guarantee (FG) Given by Parent on Behalf of Subsidiary A bank gives a loan to a Subsidiary at competitive interest rates on the basis of a FG provided by the Parent of the Subsidiary.The bank can recover the loan from the Parent if the Subsidiary does not pay.under Indian GAAP, the Parent disclosed the FG as a contingent liability.under Ind AS, the parent would record the investment made in the subsidiary and the FG obligation at fair value.subsequently, assuming the Subsidiary is able to repay the loan to the bank, the Parent would amortize the FG obligation and the corresponding credit is taken to the P&L.The accounting entries in the books of the Parent are set out below.the FG is given prior to the TD, and is outstanding on the TD.In the entries below, the FG amortization upto the TD, is INR 15. Parent Accounting Amount in INR Indian GAAP No separate accounting Disclosure as contingent liability Ind AS accounting Debit Credit On issue of a new guarantee Investment In Subsidiary 75 FG Obligation 75 Period Prior to TD

7 FG Obligation 15 P&L 15 On TD To keep things simple, let us consider, the Parent decides to use Indian GAAP carrying value of investment as the deemed cost.in other words, on TD the investment in subsidiary of INR 75 is written off.therefore INR 75 will be debited to RE on TD.With respect to FG obligation, it is recorded on TD.However, there is an amortization of INR 15 prior to the TD, resulting in RE credit of INR 15.Thus, Net RE debit INR 60 will reduce MAT book profits equally over next 5 years. After TD On a go forward basis, FG obligation released to P&L will result in a higher MAT book profit. Example 9: Accounting by Subsidiary of Interest Free Loan from Parent Under Indian GAAP an interest free loan from Parent was accounted by the Subsidiary at face value.under Ind AS the Subsidiary accounts for such loan at fair value.to the extent of the interest free element, the Subsidiary records a capital contribution from the Parent.On TD, assume that an interest free loan was outstanding.below the journal entries are provided for the effect prior to TD and after. Accounting by Subsidiary Amount in INR Subsidiary accounting Debit Credit On receipt on loan Bank 100 Loan from Parent 70 Capital contribution 30 Periods prior to TD Interest expense 16 Loan from parent 16 Periods after TD Interest expense 14 Loan from parent Bank 14 On repayment date Loan from parent 100 Bank 100 On TD From the subsidiary s perspective After TD Capital contribution (capital reserve) is MAT neutral RE Adjustment on TD i.e. RE debit of 16 will reduce book profits over next 5 years after true up adjustment On a go forward basis, interest expense recognized by the Subsidiary in P&L will be MAT deductible Example10: Accounting by Lessee for FinanceLeases Embedded in Service Contracts

8 Under Indian GAAP leases embedded in service contracts (for example, an exclusive power purchase agreement) were accounted by lessees as a service contract rather than as a lease.under Ind AS such leases need to be identified separately and accounted for as such. If the arrangement results in a finance lease, such arrangements are recorded in the financial statements, by capitalizing the asset and recording a corresponding finance lease liability of equal amounts.in the example below, the lease entered into prior to TD is outstanding at TD.At TD, the asset and the corresponding finance liability will not be equal amounts because the depreciation on the asset is not equal to the amortization of the finance lease obligation. This results in a RE Debit Adjustment at TD ofinr 44 (assumed) which after true up adjustment will reduce MAT book profits equally over next 5 years. Balance Sheet (New lease) Ind AS Indian GAAP Assets Leasehold Power Plant Equity and Liabilities Finance lease obligation Transitiondate (past leases) Balance Sheet Ind AS Assets Leasehold 304 Power Plant Equity and Liabilities RE adjustment (44) Finance lease 348 obligation Example 11: Service concession arrangement (SCA) The accounting for a SCA under Indian GAAP and Ind AS is very different.under Indian GAAP, the operator typically records the investment in the SCA (e.g., a toll road) as a fixed asset/ intangible asset at cost.under Ind AS, it is argued that the operator has provided a toll road to the government, against which it has received a right to collect toll over the service concession period.the transaction is recorded as an exchange at fair value.consequently, under Ind AS, the value of the intangible asset is the cost incurred for building the toll road plus the construction margin. Balance sheet Ind AS Year Intangible asset Gross block Amortisation Net block Amount INR Indian GAAP Year Fixed asset Gross block Depreciation Net block Please refer to the tables above, and assume the Company is in Phase 1.

9 At TD It may be noted that: RE adjustment at TD after true up adjustment will increase book profits over 5 years The RE adjustment at 1 April, 2015 is INR 200 ( ) This adjustment will need to be trued up for RE adjustment at 1 April True-up amortization for (50) Net increase 150 RE credit of INR 150 will increase book profits equally over 5 years; i.e., INR 30 each year starting from After TD On a go forward basis, the book profits as determined under Ind AS will be subjected to MAT.Consequently, the entity will be allowed deduction for higher amortisation of intangible asset while computing book profit. In the case of new SCA, the construction margins will also be included in Ind AS P&L and also for determining book profits for MAT purposes. Example 12: Parent ESOP Consider the following brief fact pattern with respect to an Indian Subsidiary. Foreign Parent awards its ESOP to employees of Indian subsidiary ESOPs are outstanding at TD and will vest after TD Under Indian GAAP No accounting is required in the financial statements of subsidiary Ind AS Accounting in Subsidiary Debit ESOP Expense Credit Contribution from Parent (Capital reserve) At TD, since the Subsidiary has not recorded ESOP expense under Indian GAAP in the past, it will at TD, pass the following entry Debit RE Credit Contribution from Parent (Capital reserve) RE Adjustment as at TD after true up adjustment will reduce book profits equally over 5 years.however, adjustment to capital reserve at TD is MAT neutral. PROVISION FOR MAT LIABILITY ON TD ADJUSTMENTS Query As explained above, the Finance Act 2017 requires FTA adjustments in specific cases to be included in determining book profits under section 115 JB equally over a period of 5 years.for such adjustments that are not MAT neutral and have a MAT impact over a period of 5 years, would a provision for MAT liability or a credit for MAT asset be required on TD under Ind AS 12 Income Taxes? Response As a first step a company determines its income tax liability based on normal income tax provisions.however, this is subject to the provisions of section 115 JB of the Income tax Act, which requires a company to pay at least a minimum tax on the basis of the book profits as determined under Indian GAAP or Ind AS as applicable.if a company pays higher tax during any financial year due to

10 applicability of MAT, the excess tax paid is carried forward for offset against tax payable in future years when the company will be paying normal income tax. The Income-tax Act earlier allowed that the MAT credit can be carried forward for set-off for ten succeeding assessment years from the year in which MAT credit becomes allowable. The Finance Act 2017 has extended this period. The amended Act states that credit in respect of MAT paid under section 115JB can be carried forward upto fifteen succeeding assessment years.mat is an additional tax payable to authorities based on the comparison of book profit and taxable profit for the year, albeit the company may be required to make certain adjustments (additions or deductions) to accounting profit for arriving at the 115 JB book profit. For accounting purposes, the author believes that a MAT provision or a MAT asset should not be created on TD adjustments for the following reasons: The trigger for MAT is a higher book profit compared to a lower income computed under normal income tax computation provisions.the relationship between future book profits and income computed under normal income tax provisions will determine the MAT in future periods.therefore MAT is like a current tax liability/asset that is accounted in each year.the possibility of the future book profits being higher or lower due to TD adjustments, is not a relevant factor for creating a MAT liability or MAT asset for TD adjustments.in other words, MAT is a current tax based on book profits in each year, and the liability for MAT arises only once the financial year commences.mat is not triggered by FTA adjustments, though those are taken into consideration for determining MAT book profits for the relevant year. Absent tax holidays and few tax exempt income/ expenses, differences between the normal tax and the MAT are primarily due to deductible and taxable temporary differences. Those temporary differences result in deferred taxes being recognized on the basis that they will eventually reverse subject to application of prudence for recognition of DTA. Thus, the MAT is effectively a mechanism to bridge/ reduce gap between the carrying amount and tax base of assets and liabilities. On its own the MAT does not create any new differences. Since Ind AS 12 requires an entity to recognise DTA/ DTL for temporary differences between the carrying amount and tax base of assets and liabilities, it may be argued that MAT itself should not result in recognition of any new/ additional DTA/ DTL.Else, it may tantamount to double counting.this is explained with the help of a small example. Example The Company enjoys an accelerated depreciation under the Income-tax provisions, but charges lower depreciation for accounting purposes.this has resulted in the Company being subjected to MAT.The Company has created a DTL for the accelerated depreciation at normal income tax rates.the Company also records a MAT liability in the financial year. On TD the Company records the fixed assets at Indian GAAP carrying value. The company also recognises certain provisions/ liabilities of INR 100 required under Ind AS with a corresponding adjustment to RE. For 115 JB book profits the RE adjustment will be spread equally over 5 years. As a result of recording the provision/ liability in Ind AS, the net DTL amount will also correspondingly reduce on TD.It would be inappropriate to record a MAT asset on TD, for the RE credit of INR 100, since that would tantamount to double counting. Considering the above arguments, MAT payment is only an event of the relevant period, viz., the period during which MAT obligation arises under the Income-tax Act. Hence, it should be recognised in the relevant period and no upfront DTA/ DTL should be created towards amount to be adjusted in book profit of future years.the ICAI may issue appropriate guidance on the matter.