Intensive Study Group on Ind-AS of The Chamber of Tax Consultant

Intensive Study Group on Ind-AS of The Chamber of Tax Consultant Indian Accounting Standard(Ind AS) 12 Income Taxes CA Pankaj Tiwari C N K & Associates LLP December 13,2017

Today s Agenda: Objective & Scope Some Important "New Definition" & "New Concepts" Interesting aspects Presentation & Disclosure 9 Step theory approach Practical Challenges Case Studies Ind-AS impact on ICDS Ind-AS impact on MAT 2

Some Facts: 3

Objective & Scope 4

Objective & Scope: (Para 1 to Para 4) CURRENT TAX Incomes taxes payable/ recoverable in respect of the current period s taxable profit/ loss DEFERRED TAX Income taxes payable / recoverable in respect of future periods Income Tax 5

New -Definitions & Concepts 6

Definition & Concepts: (Para 5 to Para 9) Accounting Profit- "As per books of accounts- General Purpose Financial Statement". Taxable Profit- Profit/(Loss) determined in accordance with rules on which income taxes are payable/(recoverable). Temporary Difference-are differences between carrying amount of an asset or liability in the balance sheet & its tax base. Taxable temporary differences Deductible temporary differences No Timing & Permanent Tax Base- of an asset or liability is the amount attributed to that assets or liability for tax purpose. Tax Base of an asset Tax Base of an liability 7

Did you get it?- Tax base of an assets 8 Situations A machine cost INR 100. For tax purposes, depreciation of INR 30 has already been deducted in the current and prior periods and the remaining cost will be deductible in future periods, either as depreciation or through a deduction on disposal. Revenue generated by using the machine is taxable, any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes. Interest receivable has a carrying amount of INR 100. The related interest revenue will be taxed on a cash basis. Trade receivables have a carrying amount of INR 100. The related revenue has already been included in taxable profit (tax loss). Inventory of INR 100 in the balance sheet will be recovered in the next period through transfer to cost of sales. Tax Base INR 70 NIL INR 100 INR 100

Did you get it?- Tax base of a liability Situations Current liabilities include accrued expenses with a carrying amount of INR 100. The related expense will be deducted for tax purposes on a cash basis. Current liabilities include interest revenue received in advance, with a carrying amount of INR 100. The related interest revenue was taxed on a cash basis. Current liabilities include accrued expenses with a carrying amount of INR 100. The related expense has already been deducted for tax purposes. Current liabilities include accrued fines and penalties with a carrying amount of INR 100. Fines and penalties are not deductible for tax purposes. Tax Base Nil Nil INR 100 INR 100 9

Temporary Differences: (Para 15 to Para 31) TAXABLE TEMPORARY DIFFERENCES gives rise to taxable amounts. Temporary Differences Deferred Tax liability shall be recognised for all taxable temporary differences. 10

Temporary Differences: (Para 15 to Para 31) DEDUCTIBLE TEMPORARY DIFFERENCES gives rise to future tax deductible amounts. Temporary Differences Deferred Tax assets shall be recognised for all deductible temporary differences. 11

Did you get it?- Temporary Differences Situations TD A machine has cost INR 200 and now has a net book value of INR 150. For tax purposes, the cumulative depreciation (i.e. total tax allowances to date) is INR 110. An entity recognises a liability of INR 100 for product warranty costs. For tax purposes, the warranty costs are deductible only when claims are made. An entity has taken out a foreign currency loan of $ 100 that is recorded at INR 6,250. At the reporting date, the carrying amount of the loan is INR 5,750. The unrealised exchange gain of INR 500 is included in profit or loss, but will be taxable when the gain is realised on repayment of the loan. Provision for doubtful debts was made in accounting books for INR 200 but the same will be allowed for tax purpose only when debts will be written off. (60) DTL 100 DTA (500) DTL 200 DTA 12

Effect in the Financial Statements: Deferred Tax effect:- Account for deferred tax consequences of transaction in same way that it account for transactions themselves. Situation Normal Principle Transactions recognised in OCI Transaction recognised in equity Effect Income Statement OCI Equity Check the following: Situations Temporary difference due to depreciation A change in carrying amount arising from the revaluation of PPE Effects P & L OCI 13

14 Interesting aspects

Unused tax losses & Unused tax credits: (Para 34 to Para 37) DTA is recognised for unused losses and unused tax credits to the extent it is probable that future taxable profits will be available against which the unused tax losses and unused tax credits can be utilised. Probable- not defined in Ind AS 12, factors to consider: Existence of sufficient taxable temporary differences. Taxable profit before UTL or UTC expires. Identified causes unlikely to recur. Re-assess the unrecognised DTA on each reporting date. Requirement under Ind AS 12 relaxed but has not become easy. ("Virtual Certainity") Situation where DTA under Ind AS 12 but not under AS-22. 15

Case Study-1: A newly set-up entity (New Co.) incurred significant losses in the first three years of operations due to reasons such as advertising and initial set-up related costs, significant borrowing costs and lower level of activity in the first two years of operations. Over the years, there has been a significant increase in the operations of New Co. and its advertisement cost has stabilised to a normal level. Further, it has raised new capital during the year and repaid its major borrowing. The cumulative effect of all the events is that the New Co. has started earning profits from the fourth year. It is expected to make substantial profits in the next three years that may absorb the entire accumulated tax loss of the entity. However, the nature of the business is such that it does not have any binding orders. What will be your opinion in light of Ind AS-12? 16

Case Study-2: A battery manufacturer (Battery Co.), who had incurred tax losses in the past, enters into an exclusive sales agreement with a car manufacturer (Car Co.). According to the agreement, all the cars manufactured by Car Co. will only use batteries manufactured by Battery Co. Though Car Co. has not guaranteed any minimum off-take, there is significant demand for its cars in the market. Please advise whether Battery Co. can recognise deferred tax assets under AS-22 & under Ind AS-12? 17

Investment in Group companies: (Para 39 to Para 45) Accounted at Cost when the parent or investor acquires such an Investment (i.e. Carrying amount of Investment)- in SFS. CFS- investment is recorded as follows: Subsidiary- line by line consolidation. Associates- Equity Method of Accounting. JV's- Proportionate Consolidation. Carrying value and its tax base- temporary differences due to existence of undistributed profits. DTL should be recognised for all taxable temporary differences except following: Investor is able to control the timing of reversal of temporary difference and It is probable the difference will not reverse in future. 18

Case Study-3: On 1 st April 2014, ABC Ltd acquired 100% shares of XYZ Ltd for INR 4,373 crores. By 31 st March, 2015, XYZ Ltd had made profits of INR 5 crores, which remain undistributed. Based on the tax legislation in India, the tax base investment in XYZ Ltd is its original cost. Assume the dividend distribution tax rate applicable is 15%. Analysis: A taxable temporary difference of INR 5 therefore exists between the carrying value of the investment in XYZ at the reporting date of INR 4,378 (INR 4,373 + INR 5) and its tax base of INR 4,373. Since a parent, by definition, controls a subsidiary, it will be able to control the reversal of this temporary difference, for example - through control of the dividend policy of the subsidiary. Therefore, deferred tax on such temporary difference is generally not provided unless it is probable that the temporary will reverse in the foreseeable future. 19

Case Study-5: ABC Ltd. acquired 50% of the shares in PQR Ltd. on 1 st January 2014 for INR 1000 crores. By 31 st March, 2015 PQR Ltd. had made profits of INR 50 crores (ABC Ltd.'s share), which remained undistributed. Based on the tax legislation in India, the tax base of the investment in PQR Ltd. is its original cost. Assume the dividend distribution tax rate applicable is 15%. Analysis: A taxable temporary difference of INR 50 therefore exists between the carrying value of the investment in PQR at the reporting date of INR 1,050 (INR 1,000 + INR 50) and its tax base of INR 1,000. As ABC Ltd. does not completely control PQR Ltd. it is not in a position to control the dividend policy of PQR Ltd. As a result, it cannot control the reversal of this temporary difference and deferred tax is provided on temporary differences arising on investments in joint venture. (50*15%). 20

Case Study-6: XYZ Ltd. has issued Zero-coupon convertible bonds at INR 1000 during the FY 2017-18. The transaction cost for such issue is approx. INR 50. The tenure of the said bond is for 3 years at the end of which the same will mature and amount will be repaid to the holder of such instrument. The effective interest rate works out to 10%. The company is expected to earn profit of INR 300 each year for next three years. Assume the tax rate of 40%. At what price the bond should be accounted in the books of accounts at the time of issue? Whether any impact of transaction costs on the effective rate of interest needs to be considered? Compute the deferred tax liability to be recognised in the books of XYZ Ltd. for period of next three years. 21

Case Study-7: ABC Ltd. has issued 100 10% redeemable preference shares of INR 10 each as on April 1,2016. The transaction cost for such issue is approx. INR 50. These preference shares are redeemable at par after two years. The effective interest rate works out to 12.22%. The company is expected to earn profits of INR 300 each year for next three years. Assume the tax rate of 40%. Pass the necessary journal entries in the books of accounts of ABC Ltd. at the time of issue, accrual of finance cost and at the time of redemption of these shares. Compute the deferred tax liability to be recognised in the books of ABc Ltd. for period of next three years. 22

Presentation & Disclosure 23

Measurement: (Para 46 to Para 56) Current Tax Measured at the amount expected to be paid(recovered from) the taxation authorities, using the tax rates(and tax laws) that have been enacted or substantively enacted by the end of reporting period. Deferred Tax Measured at tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on the tax rates(and tax laws) that have been enacted or substantively enacted by the end of reporting period. DTA/DTL should not be discounted 24

Presentation: Major Component: Current tax expenses Prior period adjustment Deferred expense/income Reconciliation: Numerical reconciliation between tax expenses(income) & product of accounting profit multiplied by applicable tax rates. Numerical reconciliation between average effective tax rate and applicable tax rate. Amount & Expiry, if any of deductible temporary differences, unused losses for which no DTA recognised. Offsetting can be done subject to certain conditions as prescribed in Ind AS 12. 25

Practical Challenges: No exemption on first time adoption of Ind AS 12- any changes needed must be accounted retrospectively. Deferred Tax assessment in case of carried forward losses. Tax impact on Consolidation- unrealised inter-company profits. Accounting of Deferred tax is linked to recording of the item to which it relates to. Deferred Tax on special reserve u/s 36(1)(viii). DDT issue in Case of Consolidated Financial Statements. 26

9 Step Model: 1. Calculate current income tax 2. Determine Tax base 3. Calculate temporary differences 4. Identify Exceptions 5. Review deductible "TD"s and tax losses 6. Determine tax rate 7. Recognise deferred taxes 8. Presentation & Off setting 9. Disclosure 27

Case Study-8: A s Ltd. profit before tax according to Ind AS for Year 2016-17 is INR 100 and taxable profit for year 2016-17 is INR 104. The difference between these amounts arose as follows: On 1st November 2016, it acquired a machine for INR 120. Depreciation is charged on the machine on a monthly basis for accounting purposes. Under the tax laws, the machine will be depreciated for 6 months. The machine s useful life is 10 years according to Schedule II as well as for tax purposes. In the year 2016-17, expenses of INR 8 were incurred for charitable donations. These are not deductible for tax purposes. You are required to prepare necessary entries as at 31st March 2017, taking current and deferred tax into account. The tax rate is 25%. Also prepare the tax reconciliation in absolute numbers as well as the tax rate reconciliation. 28

Case Study: Analysis: Current tax = Taxable profit* Tax rate= 104*25%=26. Computation of Taxable Profit: Accounting profit = 100 + Donation not deductible 8 - Excess Depreciation 4 Total Taxable profit =104 Profit & loss A/c Debit 26 Current Tax Credit 26 Deferred tax: Machine s carrying amount according to Ind AS is 118 (120-2) Machine s carrying for Taxation purpose= 114(120-6) Deferred Tax Liability= 4*25%= 1 Profit & loss A/c Debit 1 Deferred Tax liability Credit 1 29

Case Study: Analysis: Tax reconciliation in absolute numbers: Profit before tax according to Ind AS 100 Applicable tax rate 25% Fictitious tax (at the applicable tax rate) 25 Expenses not deductible for tax purposes (8*25%) 2 (Current and deferred) tax expense 27 Tax rate reconciliation Applicable tax rate 25% Expenses not deductible for tax purposes 2% Average effective tax rate 27% 30

Case Study-9: A Ltd. has an unresolved tax dispute over whether a specific item should be deductible in determining the taxable profit for a specific period. A tax investigator did not accept this tax treatment but the entity appealed against this to the court. A Ltd. determines that it is not probable that the taxation authority will accept the tax treatment. The most likely amount is INR 100 cr. As management, what should be accounting treatment in the books of accounts and also while determining the current year s taxable profit? Analysis: Ind AS-12???????? 31

IFRIC-23-Uncertainty over Income Tax Treatments: How to determine the accounting tax position ( ATP ) when there is uncertainty over income tax treatment; Determine whether to consider each uncertain tax treatment separately or together with one or more other uncertain tax treatments; Acceptability of tax position by the Tax Authority Yes ATP same as used in ITR No ATP should reflect the effect of uncertainty Applicability- applies from reporting period beginning on or after January 1, 2019. 32

Different Framework for Computation of Taxes 33

Framework for Tax Computation : As per Income Tax Act,1961: Section 28- Primary income chargeable to tax under the head Profit and Gains from Business or Profession. Section 41- Other Income chargeable to tax not covered under Section 28. Section 32- Depreciation allowed on tangible assets including additional depreciation on certain assets. Section 36(1)(iii)- Interest on borrowed capital for business or profession or for capital assets. Section 37- any other expenditure not covered in any other Section incurred for purpose of business or profession. Other- Section 40, Section 43 etc. 34

Framework for Tax Computation : As per Income Computation & Disclosure Standard: 10 ICDSs notified vide notification 87/2016 dated 29 th September, 2016 Notified ICDSs applicable from AY 2017-18: 35 ICDS ICDS-I ICDS-II ICDS-III ICDS-IV ICDS-V ICDS-VI ICDS-VII ICDS VIII ICDS-IX ICDS-X Relating To Accounting Policies Valuation of Inventories Construction Contract Revenue Recognition Tangible Fixed Assets Changes in Foreign exchange rates Government Grants Securities Borrowing Cost Provisions, Contingent Liabilities and Contingent Assets

Key ICDS Impact Areas: Items of Adjustment Revenue on deferred payment basis Impact Ind AS- bifurcate the revenue between sale of Goods/services and interest ICDS- no such concept under ICDS (Q.5 of CBDT Clarification) Impact on Taxes Total revenue offered for tax in 1 st year itself Revenue from Composite/ Bundled Transactions Ind AS- bifurcate the revenue and recognised over a period of contract as and when the services are performed Total revenue offered for tax in 1 st year itself 36 ICDS- no such provision of splitting the consideration and it will be taxable in the year of sale itself along with provision for warranty if applicable

Key ICDS Impact Areas: 37 Items of Adjustment Revenue from Service Contract Impact Ind AS- based on the % of completion method as prescribed under Ind AS-18 ICDS- compulsory % of completion once 25% stage of completion reached Ind AS- Full Loss in the year of estimation ICDS- Proportionate loss on a year on year basis Ind AS- % of completion for all the contracts ICDS- No % of completion for less than 90 days contract Impact on Taxes Total revenue offered for tax in 1 st year itself

Key ICDS Impact Areas: Items of Adjustment Purchase of goods on deferred settlement basis Impact Ind AS- interest element in such contract need to be recognised as finance cost over the period of financing ICDS- No such practice under ICDS and will be considered as Purchase Impact on Taxes Lower tax due to higher purchase cost Fixed Assets purchased on deferred settlement period Ind AS- charged to the Statement of P & L over a period on financing ICDS- actual cost need to be capitailised as per ICDS-IV Lower tax due to higher depreciation as per IT 38

Key ICDS Impact Areas: Items of Adjustment Interest free loans to Subsidiary Impact Ind AS- Notional interest needs to be recognised as per Ind AS 109. ICDS- No such treatment and the same needs to be ignored for the purpose of computation of taxable income. Borrowing Cost Ind AS - Capitalisation only for Qualifying Assets, up to the date the asset is ready for intended use, reduction of income from investment. Impact on Taxes Lower tax due to higher purchase cost May result higher or lower tax 39 ICDS - r.w. Sec.36(1)(iii)- for all the fixed assets, up to the date of put to use, no practice of reducing the income from interest cost.

Key ICDS Impact Areas: Items of Adjustment Financial Assets- Held for Trading Impact Ind AS- Held for Trading need to be fair valued at the end of the Financial Year. ICDS- actual cost or NRV whichever is lower, category wise valuation rather than script wise. Impact on Taxes May result in higher or lower taxes Cost of Dismantling Ind AS- cost of dismantling will be added to cost of assets at the time of initial recognition. May result higher or lower tax 40

Case Study-10: ABC Ltd. a listed company engaged in the development of sports infrastructure on PPP model with Government of Gujarat. The company has incurred huge capital expenditure on the project and has capitailised the same as Sports infrastructure as per AS-10 (Revised) on PPE. The company held an event in the current financial year to test the operational functionality of the infrastructure and has incurred huge expenses and nominal revenue from the same. The same has been adjusted as part of trial run cost of the project as per para 18(e) of AS- 10 Revised. In the Statement of P & L, the company does not have any revenue from operation since the company has not started the commercial operations other than some miscellaneous income. The tax auditor is of the view that the income can t be adjusted against the cost of trial run and the same need to be offered for tax in the current year as per ICDS-V. Whether the contention of the auditor is correct? 41

Case Study-11: XYZ Pvt. Ltd. having net worth of INR 100 cr. as on March 31,2016. The company has sold its one of the strategic investment in the year FY 2016-17 for INR 700 cr. resulting in gain of INR 650 cr. The said gain has resulted in a huge book profit of the company in the current financial year and huge cash outflow in the form of taxes under Section 115JB. This investment was an equity investment in an overseas company which was not a subsidiary company. The company requested you to suggest a suitable way for tax planning of the proposed tax cash outflow of the company as per the provisions of Section 115JB as applicable to the company. 42

Comparative Statement of P & L: IGAAP Amt. Ind AS Amt. Revenue from Operations xxxx Revenue from Operations xxxx Expenses (xxxx) Expenses (xxxx) Profit before Tax xxxx Profit before Tax xxxx Less: Taxes xxxx Less: Taxes xxxx Profit After Tax xxxx Profit after Tax xxxx OCI a) Items that will not be reclassified to P&L b) Items that will be reclassified to P&L Total Comprehensive Income xxxx xxxx xxxx 43

Framework for Tax Computation : Computation of Book Profit for Ind AS Compliant Companies: Profit / (Loss) as per Statement of Profit & Loss Increased / Decreased by Adjustments as per Section 115JB(2A) Adjustments as per sub-section (2A) of Section 115JB (a) Increased by all amounts credited to OCI in the Statement of P&L under the head "Items that will not be re-classified to profit or loss (b) Decreased by all amounts debited to OCI in the Statement of P&L under the head "Items that will not be re-classified to profit or loss (c)increased by amounts or aggregate of the amounts debited to the Statement of Profit & Loss on distribution of non-cash assets to shareholders in demerger in accordance with Appendix A of the Indian Accounting Standards 10 Decreased by amounts or aggregate of the amounts credited to the Statement of Profit & Loss on distribution of non-cash assets to shareholders in demerger in accordance with Appendix A of the Indian Accounting Standards 10 44

Ind AS Adjustment impacting MAT Computation: Other Comprehensive Income Re-classified to P & L Never be reclassified Year of reclassification In the same year 45

Key Impact Areas: Items of Adjustment Property, Plant & Equipment Investments (not held for trading) Ind AS impact PPE to be recognised at Fair Value and difference between Fair Value and Cost to be recognised in Retained Earnings Investments to be recognised at Fair Value through OCI and difference between Fair Value and Cost to be recognised in Retained Earnings Investments to be recognised at Fair Value through P&L and difference between Fair Value and Cost to be recognised in Profit & Loss Impact on MAT Difference to be ignored and included only at time of disposal Difference to be ignored and included only at time of disposal Increase in book profit resulting in increase in MAT. Whether loss is MAT deductible?? 46

Key Impact Areas: Items of Adjustment Long term employee benefit plans Government grant received for purchasing specific asset Government grant in nature of promoter contribution Ind AS impact Gain or loss on change in actuarial assumption instead of charging to income statement is to be charged to reserves thereby increasing book profit Grant should be recognized as income over the period which bears the cost of meeting the obligation instead of reducing the same from asset Grant should be recognized as income over the period which bears the cost of meeting the obligation instead of transferring to capital reserve Impact on MAT Increase / Decrease in book profit resulting in MAT impact Increase in book profit along with increase in depreciation cost Increase in book profit resulting in increase in MAT 47

Key Impact Areas: Items of Adjustment Sale of vehicle along with free service and warranties Exchange fluctuation on Long term foreign currency monetary assets Borrowing Cost - General Borrowing Ind AS impact Instead of recognizing revenue upfront, all service revenues to be recognized separately at the time of performance Instead of capitalizing to the value of asset, the exchange fluctuation is charged to income statement. Capitalization of Interest on working capital loan instead of routing through P&L Impact on MAT Since revenue is deferred, MAT liability will also be deferred It reduces asset value as well as book profit thereby reducing the MAT profit Deferment of interest cost due to capitalization to asset. Increase in Initial tax outflow. 48

Key Impact Areas: Items of Adjustment Translation difference in Foreign Operations Deferred Tax Any other item Ind AS impact Recognised in OCI Adjustment recorded in Reserves & Surplus on FTA FTA adjustment in Retained Earnings Subsequent Years recognised in OCI Impact on MAT Difference to be ignored and included only at time of disposal To be ignored FTA to be added / reduced in book profit over period of 5 years Subsequent years increase / decrease in book profit resulting in MAT impact 49

Case Study-12: ABC Ltd. is in the process of demerger of one of its division to XYZ Ltd. For a proposed consideration of INR 1000. Both these companies are listed and need to comply Ind AS w.e.f. April 1, 2017. Both these companies are not related to each other. The company has requested you to suggest the possible tax implication on account of this demerger in the following areas: Whether both these companies are required to comply with the Appendix A to Ind AS-10 which deal with the Non-cash distribution of Assets to owners? If the answer to the above is yes, how the companies will comply with the conditions as laid down in Section 2(19AA) of Income Tax Act,1961? 50

51 Thank You