EY Tax Alert Indian tax administration issues clarifications to compute book profit for Minimum Alternate Tax (MAT) levy for Ind-AS companies

Transcription

1 26 July 2017 EY Tax Alert Indian tax administration issues clarifications to compute book profit for Minimum Alternate Tax (MAT) levy for Ind-AS companies 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. Executive summary This Tax Alert summarizes clarifications issued by the Central Board of Direct Taxes [1] (CBDT) vide its Circular No. 24/2017 dated 25 July 2017 (Circular) and Press Release dated 25 July 2017 (Press Release) on the Minimum Alternate Tax (MAT) framework introduced in the Indian Tax Laws (ITL) by the Finance Act, 2017 (FA 2017) for companies converged/converging to Indian Accounting Standards (Ind-AS) [2]. After the amendments made vide the FA 2017, various stakeholders made representations to the CBDT to clarify apprehensions on items giving rise to double taxation and/or hardships for the taxpayer companies. The CBDT referred these issues to the MAT Ind-AS Committee [3] (Committee) which had originally conceptualized the [1] The apex administrative body of direct taxes in India. [2] Converged form of International Financial Reporting Standards (IFRS) [3] Committee constituted by the CBDT that comprises senior officials from the Tax Authority and independent professionals.

2 MAT framework for companies converging to Ind- AS. The Committee, after duly considering these representations, recommended that the CBDT issue certain clarifications by way of frequently asked questions (FAQs) and also recommended supplemental amendments to the MAT provisions in the next Budget. The CBDT has accepted the Committee s recommendations regarding issuance of clarifications and has, accordingly, issued the Circular that clarifies 14 issues by way of FAQs. The CBDT has also issued the Press Release stating that the relevant parts of the Committee s recommendations containing supplemental amendments suggested by the Committee have been placed in the public domain for wider public consultation. Stakeholders may submit their comments/suggestions regarding the supplemental amendments recommended by the Committee to the CBDT by 11 August The clarifications contained in the Circular are mainly intended to clear the air on possible adjustments that may result in duplicated taxation and to relieve hardships for taxpayers. Background MAT provisions apply to a company and provide for taxation based on book profit. MAT is triggered when tax liability, computed at a specified percentage [4] of book profit, is higher than the 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 the Companies Act, 2013 and further adjusting it by upward and downward adjustments as specified under MAT provisions. Prior to the FA 2017, accounting standards formulated by the Institute of Chartered Accountants of India (ICAI) [5] and notified by the Ministry of Corporate Affairs (MCA) in 2006 (popularly known as IGAAP), formed the basis of preparation of P&L and, hence, MAT was levied on book profit as per IGAAP. Based on the Committee s recommendations, the FA 2017 amended the existing MAT provisions to provide a mechanism for computation of book profit for Ind-AS compliant companies. The amendments are effective from 1 April 2017 i.e., tax year Post FA 2017 amendments, various stakeholders made representations to the CBDT to clarify apprehensions on items giving rise to double taxation and/or hardships for the taxpayer companies. The CBDT referred these issues to the Committee. After duly considering these representations, the Committee recommended that the CBDT issue certain clarifications by way of FAQs and also recommended supplemental amendments to the MAT provisions in the next Budget. The CBDT has accepted the Committee s recommendations regarding issuance of clarifications and has, accordingly, issued the Circular that clarifies 14 issues by way of FAQs. The CBDT has also issued the Press Release stating that relevant parts of the Committee s recommendations containing supplemental amendments suggested by the Committee have been placed in the public domain for wider public consultation. Stakeholders may submit their comments/suggestions regarding the supplemental amendments recommended by the Committee to the CBDT by 11 August MAT framework for Ind-AS companies based on FA 2017 amendments Since MAT is levied on net profit as per P&L, while Ind-AS involves combined statement of P&L and Other Comprehensive Income (OCI) (which largely comprises fair value adjustments), the MAT framework for Ind-AS companies envisages pick up of OCI items at an appropriate point of time viz., either on reclassification to P&L or realization thereof. Furthermore, MAT framework also envisages separate adjustments for First Time Adoption (FTA) adjustments on transition to Ind-AS, which are directly made in Other Equity on the convergence date. The MAT adjustments ensure that FTA adjustments are also picked up for MAT at an appropriate point of time when they are reclassified to P&L or realized. Else, they form part of the residual transition amount to be amortised over five years starting from the first year of Ind-AS adoption (5-year amortisation rule). Thus, the MAT framework for Ind-AS companies is a combination of adjustments as per the existing MAT provisions (applicable to all companies) and new provisions (applicable only to Ind-AS companies). [4] Currently 18.5% plus applicable surcharge and cess. [5] Regulator of the accounting profession in India.

3 FAQs as per the Circular to address issues in computation of book profit under Ind-AS Parity in MAT treatment of marked-to-market (MTM) gains and losses on financial instruments fair valued through P&L (FAQ 1): Under Ind-AS, the P&L may comprise MTM gains or losses on various financial instruments fair valued through P&L (FVTPL financial instruments). The existing MAT provisions disallow provision for diminution in the value of any asset. This may result in MTM loss debited to P&L getting disallowed, but MTM gain credited to P&L getting taxed under MAT. In order to provide parity in the MAT treatment for MTM gains and losses on FVTPL financial instruments, the Circular clarifies that while MTM gain shall continue to be taxed under MAT, MTM loss shall not be subjected to upward adjustment as provision for diminution in the value of any asset and, thus, will be allowed as deduction for MAT purposes. But, this concession is restricted to FVTPL financial instruments and not to any other assets. Also, gains and losses on financial instruments recognized through OCI shall continue to be governed by specific adjustments of the FA Start point for book profit computation (FAQ 2): There was a drafting lacuna in the FA 2017 amendment, which referred to the start point of MAT computation as statement of profit and loss which includes both P&L and OCI. A literal interpretation thereof could have resulted in unintended duplicated taxation of OCI items. The Circular clarifies that the start point for MAT computation shall be net profit (before OCI), which avoids duplicated taxation of OCI items. Reference date for calculating the transition amount (FAQ 3): The Circular clarifies that the FTA adjustments made at the start of the opening date of the first year of Ind-AS adoption shall be considered for calculating the transition amount. For example, if a company adopts Ind-AS from financial year (FY) , the FTA adjustments made at the start of business on 1 April 2016 (or, equivalently, closure of business on 31 March 2016) shall be considered for calculating the transition amount for tax year and thereafter. Reversal of proposed dividend for preceding FY (reported under IGAAP) not subject to MAT (FAQ 4): Under IGAAP, provision is made for dividend proposed by the Board of Directors even if approved in the Annual General Meeting (AGM) held in the subsequent FY. As per the Circular, under the IGAAP regime, such provision was not allowed as a deduction due to upward adjustment in the existing MAT provisions for dividends paid or proposed [6]. Under Ind-AS, provision for dividend is made only when it becomes payable post approval in the AGM. In the first Ind-AS year, provision for proposed dividend of the preceding FY (whose financial statements are prepared under IGAAP) is reversed by credit to Retained Earnings as FTA adjustment. On a literal reading, such credit forms part of the transition amount and is subject to taxation over a period of five years. This leads to double taxation as the provision for proposed dividend created under IGAAP is not deductible, but reversal thereof under Ind-AS is subject to MAT. The Circular resolves such difficulty by clarifying that reversal of proposed dividend shall not form part of the transition amount and, hence, shall not be subject to MAT taxation under the 5-year amortisation rule. Deferred tax adjustments on FTA ignored in MAT (FAQ 5): As per the existing MAT provisions, deferred tax adjustments to P&L are neither allowed as deduction nor taxed as part of book profit. Thus, book profit is computed by ignoring deferred tax impact. Along the lines of a mention in the Explanatory Memorandum to Finance Bill, 2017, the Circular clarifies that deferred tax adjustments recorded on FTA shall also be ignored in a similar manner while calculating the transition amount and, hence, shall not be considered in the 5-year amortisation rule. FTA adjustments relating to provision for diminution in value of asset to be excluded for the 5-year amortisation rule (FAQ 6): The existing MAT provisions require upward adjustment for provision for diminution in the value of any asset if debited to P&L. On FTA, the company may recognize provision for diminution in value of asset by adjusting Retained Earnings [7], which, as per literal reading, forms part of the transition amount and is deductible under the 5-year amortisation rule. The Circular states that such FTA adjustment relating to provision for diminution in the value of any asset shall be ignored in calculating the transition amount and, hence, shall not be deductible under the 5-year amortisation rule. However, such restriction shall not apply to FTA adjustment relating to MTM loss on FVTPL financial instruments (covered by FAQ 1). [6] The upward adjustment was relevant prior to revision of Schedule VI of the Companies Act, 1956 in 2011 when appropriations (including for dividends paid or proposed) were shown on the face of the P&L. [7] For e.g., on FTA, the company may provide for expected credit loss that may not have been created under IGAAP.

4 Reclassification of share application money pending allotment to Other Equity on FTA (FAQ 7): On FTA, share application money pending allotment, that is not refundable by the company, may be reclassified to Other Equity. On a literal reading of the MAT provisions, the reclassification to Other Equity forms part of the transition amount and can get taxed under the 5-year amortisation rule. The Circular clarifies that such reclassification on FTA shall not form part of the transition amount and, hence, shall not be taxable under MAT. Dividend on preference shares not deductible in MAT (FAQ 8): The existing MAT provisions provide for add-back of dividends paid or proposed if debited to P&L. Under Ind-AS, preference shares may get classified as financial liability and dividend thereon may be debited to Ind-AS P&L as finance cost. The Circular clarifies that such dividend on preference shares (including dividend distribution tax thereon) shall be added back in MAT, whether shown as dividend or finance cost. The Circular further states that such add-back shall apply even for FTA adjustment as part of the transition amount. FTA adjustment of Equity Component of Compound Financial Instruments, interest-free loan etc. (FAQ 9): On the principles of substanceover-form and time value of money, Ind-AS may require certain financial instruments issued like non-convertible debentures issued or interestfree loans borrowed to be split between Equity Component and Liability Component at inception i.e., on the date of issuance of the instrument. The Equity Component is included in the Other Equity schedule in the Ind-AS Balance Sheet. If such instrument has been issued before the date of transition to Ind-AS, such split will be made on retrospective basis as part of FTA adjustment. The Circular states that the amount credited as Equity Component on FTA will be included in the transition amount. Consequently, it will be taxable under the 5-year amortisation rule. Relieving double taxation in MAT for revaluation of Property, Plant and Equipment (PPE) under Ind-AS (FAQ 10): On FTA, the company has the option to adopt the Revaluation Model for PPE and record the difference in Revaluation Surplus to be adjusted for fair valuation changes on yearon-year (Y-O-Y) through OCI. As another option, the company may treat fair value as on the transition date [8] as Deemed Cost and record the difference in Retained Earnings without any further fair valuation adjustment on Y-O-Y basis. [8] Which is one year prior to the convergence date. The MAT framework for Ind-AS companies ensures that there is no immediate MAT implication of such revaluation, but the gain/loss in the year of disposal of the asset shall be computed for MAT purposes by ignoring such revaluation. The existing MAT provisions ensure that no depreciation is allowed on the revaluation component. There is an ambiguity in the MAT framework on computation of gain/loss in the year of disposal by ignoring revaluation in terms of which, on a literal reading, there could be double taxation of depreciation related to revaluation which is not allowed as deduction. The Circular resolves such difficulty by clarifying that book profit of the year of disposal of the revalued asset shall be increased or decreased (as the case may be) by Revaluation Surplus after adjusting depreciation on revaluation. The illustration given in the Circular is at Annexure A. Taxability of notional construction profit/loss in respect of service concession agreement (SCA) under Ind-AS (FAQ 11): Ind-AS requires recognition of notional construction profit on SCA (popularly called as build-operate-transfer (BOT) projects) as part of Intangible Asset or Financial Instrument. The Circular clarifies that such notional construction profit shall be included in the MAT computation, whether as part of FTA in the transition amount or on an ongoing basis. FTA adjustments resulting into wipe-off of accumulated losses as per IGAAP Balance Sheet (FAQ 12): The existing MAT provisions allow reduction from the current year s book profit of the earlier years book losses to the extent of lower of loss brought forward (excluding depreciation) or unabsorbed depreciation, as appearing in the books of account. Due to fair valuation adjustments on FTA, it may so happen that accumulated losses, as appearing in IGAAP Balance Sheet, may get wiped off under Ind-AS. If tax year is first Ind-AS reporting period, the Circular clarifies that reduction of losses from book profit of tax year shall be based on figures as appearing in IGAAP books of account on 31 March For subsequent tax years, the reduction shall be based on figures as appearing in Ind-AS books of account. Reclassification of Capital Reserve or Securities Premium Reserve to Retained Earnings or Other Reserves on FTA (FAQ 13): The Circular states that, on FTA, the company may reclassify Capital Reserve or Securities Premium Reserve to Retained Earnings or Other Reserves and viceversa. The Circular states that such reclassification shall not be included in the transition amount and, hence, not chargeable to MAT. The Circular further states that even after such reclassification, the amount of Revaluation Reserve shall continue to be considered as Revaluation Reserve for the purposes of computation of book profit and shall also include transfer to any other reserves by whatever name

5 called or capitalized. If companies follow accounting year other than 1 April to 31 March (FAQ 14): A company which does not follow accounting year of April to March may encounter a situation where, in the first year of Ind-AS adoption, the taxable period for MAT purposes is partly covered by IGAAP and partly by Ind-AS. For e.g., a company following the calendar year as its accounting year for which 2017 becomes the first year of Ind-AS adoption, the tax year will comprise the first nine months under IGAAP and the next three months under Ind- AS. The existing MAT provisions require such company to prepare separate P&L for tax year from April 2016 to March 2017 and while preparing such separate P&L, the company shall adopt same accounting policies, accounting standards and method and rates for calculating depreciation which have been adopted for preparing the statutory P&L for the accounting year or part of such accounting year falling within the relevant tax year. The Circular states that, having regard to the above provision, the company will be required to follow IGAAP for the pre-convergence period and Ind-AS for the balance period. Accordingly, for MAT purposes, the company will be required to prepare P&L under IGAAP for the first nine months and under Ind-AS for the next three months. The transition amount will be calculated with reference to 1 January unwinding of discount. The Committee has specifically acknowledged that while debit/credit to Ind-AS P&L would affect the book profit computation, the corresponding adjustment in Other Equity post the convergence date may not be captured in book profit computation in the absence of a specific amendment. Therefore, the Committee has recommended amendment of the MAT provisions on a retroactive basis from tax year onwards to adjust the book profit under Ind-AS by all amounts or aggregate of the amounts credited/debited during the tax year to any item of Other Equity. This, as per the Committee, will bring provisions at par with the similar treatment provided for adjustments to Other Equity as part of FTA. However, the Committee has recommended that the following adjustments to Other Equity shall not be included in book profit: P&L for the tax year as per statement of profit and loss transferred to Other Equity. Items relating to OCI. Share application money pending allotment. Money received against share warrants. Capital Reserve in respect of Business Combinations of entities under common control as per Appendix C of Ind-AS 103. Securities Premium Reserve collected in cash and cash equivalent. Press Release inviting stakeholders comments/suggestions on the Committee s recommendation to introduce supplemental amendment to levy MAT on adjustments in Other Equity post convergence to Ind-AS, retroactively from tax year The relevant part of the Committee s recommendation states that certain related party transactions (for e.g., interest free loans/advances, purchase of assets at a discount or a premium) at lower or higher than fair value are accounted for at fair value under Ind-AS, with corresponding adjustments to Other Equity. Subsequently, when the assets acquired are either depreciated or sold, the fair value adopted at the time of acquisition of such assets is considered for calculating depreciation or profit/loss on sale, as the case may be, in MAT. Similarly, when loans/advances are received or given at a concessional rate of interest under Ind-AS, there would be similar adjustment to equity and corresponding impact on the Ind-AS P&L during the tenure of such loans/advances due to

6 Comments The clarifications through the Circular will be welcomed by the industry since they allay apprehensions of double taxation under the Ind-AS-MAT framework. Clarifications on deductibility of MTM loss on FVTPL financial instruments, non-taxation of reversal of proposed dividend of the preceding year, ignoring deferred tax adjustments, non-taxation of share application money or reclassification of reserves, etc., are favorable to taxpayers. However, there would be concerns due to the clarification on the exclusion of provision for bad and doubtful debts from the transition amount which may never, in the future, become deductible in computation of book profit. Also, the clarification to include equity component of liabilities like non-convertible debentures or interestfree loans in the transition amount, coupled with the proposed retroactive amendment to statutory provisions for inclusion of adjustments thereof in Other Equity post the convergence date, may cause concerns. This clarification, coupled with the proposed retroactive amendment, may create unintended taxation of adjustments to Other Equity, both at the time of convergence and Y-O-Y in respect of pure capital receipts of subscription amounts received for issuance of zero coupon compulsorily convertible debentures or zero coupon compulsorily convertible preference shares. This will also be contrary to the Committee s rationale behind the proposed amendment that correction is needed in respect of certain items for which debit/credit to Ind-AS P&L impacts book profit but corresponding adjustment in Other Equity post the convergence date is not considered in MAT computation. For taxpayers following accounting year different from April to March, the clarification that MAT shall be computed in the first year of Ind-AS convergence on a combined P&L of IGAAP for certain period and Ind-AS for the balance period will raise practical and legal challenges for taxpayers and their auditors. The unique circumstance has no precedent and may create its own set of challenges on compliance. It is well settled that a benevolent circular is binding on the Tax Authority even if it deviates from the correct legal position. On the other hand, a circular which is adverse to the taxpayer and deviates from the correct legal position is not binding on the taxpayer. The taxpayers that have converged to Ind-AS and those that are likely to converge in the future will need to critically evaluate the impact on MAT liability in light of the statutory framework, as also the administrative clarifications. Consistent with the recent consultative approach adopted by the CBDT, it has requested stakeholders to provide comments/suggestions on the recommendations of the Committee to amend the statutory provisions on retroactive basis to deal with credit/debit to Other Equity arising Y- O-Y. Stakeholders may take up the opportunity to raise concerns on the proposed amendment, as also on any other aspect which creates double or unintended taxation under Ind-AS in respect of MAT provisions.

7 Annexure A Illustration for MAT treatment of FTA revaluation of PPE under Ind-AS (FAQ 10): Particulars IGAAP Ind-AS (considering revaluation on PPE) Revaluation and corresponding depreciation Written-down Value (WDV)/Deemed Cost [9] as on 1 April 2015 ( transition date for accounting purposes) 10% for FY (preceding FY for which comparatives are presented as per Ind-AS) WDV as on 1 April 2016 (convergence date i.e., first day of first Ind-AS reporting period) (10) (100) (90) [10] 10% for FY (9) (90) (81) WDV as on 1 April Sale value as on 1 April 2017 (sale of revalued asset in FY ) Profit on sale credited to P&L of FY As per the Circular, upward adjustment in book profit of FY of revaluation amount after adjustment of depreciation on revaluation (Refer Note Below) Profit considered for MAT levy as per the Circular Note: On a literal reading of the FA 2017 amendment and in the absence of a clarification, upward adjustment in book profit of FY can be the amount adjusted in Other Equity on the convergence date of 810, without adjusting the depreciation on revaluation of 81 for FY that was disallowed in MAT. [9] Deemed Cost refers to one-time fair valuation of asset on the transition date, which is then treated as cost in future years. [10] This is the amount adjusted to Other Equity on the convergence date i.e., 1 April 2016.

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