Accounting Standard 22 — Accounting for Taxes on Income
By Riya Vyas
In a normal business circumstances, while finalizing on Financials, the Company’s taxable income may be significantly different from accounting income posing problem in matching of taxes against revenue for a given period. Accounting standard 22 provides an understanding for accounting of taxes that arises due to difference in taxable income and accounting income.
Taxable income is calculated in accordance with tax laws. In some circumstances, the law requires computation of taxable income differently. There are some adjustments made to the accounting income to arrive at taxable income.
Accounting income is determined based on accounting policies as per the requirement of the law.
The effect of this difference is that the taxable income and accounting income may not be the same. This in turn fluctuates the tax payable year on year. To overcome this difference and to unify the tax payable over years, Deferred tax asset (DTA)/ Deferred tax liability (DTL) is created.
The differences between taxable income and accounting income can be classified into –
· Permanent differences: Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference.
· Timing differences: Timing differences are those differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. For example, machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life.
Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period. Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period. Deferred tax is the tax effect of timing differences.
List of items that can create timing differences:
1. Expenses debited in the statement of profit and loss for accounting purposes but allowed for tax purposes in subsequent years, e.g.
a. Expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess, fees, etc.) accrued in the statement of profit and loss on mercantile basis but allowed for tax purposes in subsequent years on payment basis.
b. Payments to non-residents accrued in the statement of profit and loss on mercantile basis, but disallowed for tax purposes under section 40(a)(i) and allowed for tax purposes in subsequent years when relevant tax is deducted or paid.
c. Provisions made in the statement of profit and loss in anticipation of liabilities where the relevant liabilities are allowed in subsequent years when they crystallize.
2. Expenses amortized in the books over a period of years but are allowed for tax purposes wholly in the first year (e.g. Advertisement expenses to introduce a product, etc. treated as deferred revenue expenditure in the books) or if amortization for tax purposes is over a longer or shorter period (e.g. preliminary expenses under section 35D, expenses incurred for amalgamation under section 35DD, prospecting expenses under section 35E).
3. Where book and tax depreciation differ. This could arise due to:
a. Differences in depreciation rates.
b. Differences in method of depreciation e.g. SLM or WDV.
c. Differences in composition of actual cost of assets.
4. Income credited to the statement of profit and loss but taxed only in subsequent years e.g. conversion of capital assets into stock in trade.
5. If for any reason the recognition of income is spread over a number of years in the accounts but the income is fully taxed in the year of receipt.
For easy understanding,
When Taxable income>Accounting income, create Deferred Tax Asset
When Taxable income<Accounting income, create Deferred Tax Liability
Deferred Tax in various different scenarios:
DTA/DTL in case of tax holidays:
The deferred tax in respect of timing differences which reverse during the tax holiday period is not recognized to the extent the enterprise’s gross total income is subject to the deduction during the tax holiday period as per the requirements of sections 80-IA/80IB of the Income-tax Act, 1961 (‘Act’). Deferred tax in respect of timing differences which reverse after the tax holiday period is recognized in the year in which the timing differences originate.
DTA/DTL in case of unabsorbed losses/depreciation:
When there are unabsorbed losses and depreciation to be carried forward, deferred tax asset should be recognized only to the extent that there is virtual certainty, supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realized.
Virtual certainty refers to the extent of certainty, which, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact.
DTA/DTL in case of MAT provisions:
In a period in which a company pays tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the period, tax effect of which is required to be recognized under this Standard, is measured using the regular tax rates and not the tax rate under section 115JB of the Act. The same logic applies when the deferred tax assets and liabilities are reversing in the tax period which is taxable under section 115JB.
Other relevant points for DTA/DTL:
Deferred taxes and liabilities should not be discounted to their present value.
The carrying amount of deferred tax assets should be reviewed at each balance sheet date. An enterprise should write-down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain, that sufficient future taxable income will be available against which deferred tax asset can be realized.
Transitional Provisions:
On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognize, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Standard as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets. The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the beginning.
Presentation and Disclosure:
1. An enterprise should offset assets and liabilities representing current tax if the enterprise:
a. Has a legally enforceable right to set off the recognized amounts; and
b. Intends to settle the asset and the liability on a net basis.
2. Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period. Deferred tax assets and liabilities should be disclosed under a separate heading in the balance sheet of the enterprise, separately from current assets and current liabilities.
3. Deferred tax assets is disclosed on the face of the balance sheet separately after the head ‘Investments’ and deferred tax liabilities is disclosed on the face of the balance sheet separately after the head ‘Unsecured Loans’.
4. The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws.
Illustration
A company, ABC Ltd., prepares its accounts annually on 31st March. On 1st April, 2015, it purchases a machine at a cost of Rs. 1,50,000. The machine has a useful life of three years and an expected scrap value of zero. Although it is eligible for a 100% first year depreciation allowance for tax purposes, the straight-line method is considered appropriate for accounting purposes. ABC Ltd. has profits before depreciation and taxes of Rs. 2,00,000 each year and the corporate tax rate is 40 per cent each year.
The purchase of machine at a cost of Rs. 1,50,000 in 2019 gives rise to a tax saving of Rs. 60,000. If the cost of the machine is spread over three years of its life for accounting purposes, the amount of the tax saving should also be spread over the same period as shown below:
Statement of Profit and Loss
(For the 3 years ending 31st March 2015, 2016 and 2017)
Note to readers:
Information in this blog is intended to provide only a general outline of the subjects covered It should not be regarded as comprehensive or sufficient for making decisions, nor should it be used in place of professional advice.
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