Draft TAS: Legislating For Revenue Protection

By: Kanwal Gupta, Director, Deloitte Haskins & Sells

The CBDT had constituted an Accounting Standards Committee ('the Committee') to suggest Tax Accounting Standards ('TAS') to be issued under Section 145(2) of the Income-tax Act, 1961 ('the Act'). The Committee was mandated to study the harmonization of Accounting Standards ('AS') issued by The Institute of Chartered Accountants of India ('ICAI') with the direct tax laws in India, the method for determination of book profit for Minimum Alternate Tax ('MAT') purposes and in case of companies migrating to IFRS appropriate amendments to the Act in view of transition to Indian Accounting Standards (Ind-AS) regime.

The Committee has identified certain issues that may arise at the time of notification of TAS under the Act and has accordingly made recommendations, namely that to avoid maintenance of two separate books of accounts by the taxpayer, TAS would apply only to computation of taxable income and that appropriate amendments be made in the Act as Section 145(2) applies to computation of taxable income and not applicable to maintenance of books of accounts. Further TAS is to be made applicable to all taxpayers. Further the provisions of the Act shall prevail in case of a conflict with provisions of TAS and for compliance with TAS may be ensured by way of appropriate modifications in the return of income and Form 3CD (wherein the tax auditor will be required to certify compliance of computation of taxable income with TAS).

Accordingly the Committee examined all the thirty-one AS and observed that seventeen of those either relate to disclosure requirements or have been adequately dealt within the Act and hence need not be notified. In respect of the balance AS, the committee has recommended some modifications. Outlined below are some of the key changes to the AS issued by ICAI which may result in far reaching tax impacts.

1. TAS (AP) - AS 1 - Disclosure of Accounting policies

In contrast to AS1 which precludes recognition of anticipated profit, but requires recognition of mark to market losses, TAS (AP) provides that in the selection or change of accounting policies, mark to market losses or an expected loss shall not be recognized unless permitted by any other TAS. Further TAS (FE) provides that the mark to market unrealized gain or loss in respect of forward exchange contracts entered into for trading or speculation purposes shall be realized only on settlement.

The recommended change could significantly impact the tax liability where such transactions are a normal feature. The tax impact in the initial year could be substantial followed with timing differences to be recognized and reversed on a year to year basis. In respect of profits of a PE, the same may result in the PE paying tax in the earlier years, with a possibility of corresponding benefit not being available in the subsequent years due to closure of the operations in India.

2. TAS (VI) - AS2 - Valuation of inventories.

A significant change as compared to AS 2 on valuation of inventories is in respect of inclusion under TAS (VI) is the concept of valuation of services and recognition of the same in computing the income.  TAS (VI) provides that cost of services in the case of a service provider shall consist of the labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads. Such inventory would be valued at cost.

Considering that around 60 to 65 per cent of the GDP is contributed by the services sector this change could significantly impact the services sector. Each service sector would be required to evaluate the impact considering the operations and the method of accounting being followed. Though the Committee recommended that TAS would apply only to computation of taxable income, it is highly unlikely in this scenario as assesses would be required to make major changes to their accounting systems to record, maintain and compute the valuation for services.

Considering that tax holidays have been eased out, it could significantly impact the taxability of export of services. Even in respect of tax holiday, where the condition of remitting the funds for claiming the benefit is to be met, such valuation of the services where the income may not result in the flow of funds within the stipulated time frame could lead to distortions. Non-residents having rendering services in India could also be impacted significantly.

3. TAS (CC) - AS 7 - Construction Contracts

Significant departure from AS 7 in respect of construction contract accounting relate to

• Amounts not receivable on account of uncertainty of realisability would be written off in line with the provisions of bad debts as against the reversal in the revenue account under AS 7.
• Cost of contracts would include borrowing costs in contrast to AS & which does not provide for such an allocation.
• Interest, dividend and capital gains would not be reduced from cost of construction as compared to AS 7 which provides that the costs may be reduced by any incidental income that is not included as contract revenue.
• Losses incurred would be allowed only in proportion to the stage of completion and that future anticipated losses would be allowed only actual incurrence.
• Revenue would be recognised once the contract crosses 25% of the stage of completion.

Considering the above proposed changes to the accounting of income/ expenses in respect of construction contracts, it seems that the situation could lead to dichotomy within the provisions themselves. For e.g. depreciation in respect of assets is considered as costs of construction, however the gains from the transfer of such assets would not be considered in reducing the costs. Further borrowing costs are to be included, but interest income would not be allowed to reduce the costs of construction.

In respect of losses being allowed on a proportionate basis to the stage of completion and anticipated losses not being allowed could result in complexities and challenges in computing the income and the tax thereon.

4. TAS (GG) - AS12 - Government Grants

In contrast to AS12, it is recommended that Government grants would be recognised as revenue or reduced from the costs of the assets, based on the purpose for which the grant/subsidy was given. Correspondingly it has been provided that where the grant is refundable the cost of the assets would be increased and depreciation would be allowed on the revised cost prospectively. Further it has been provided that recognition of the grant shall not be postponed beyond the date of actual receipt.

The change seems to derecognise the principle that grants could be in the nature of a capital receipt and not directly relatable to an asset. Further, in case of addition to the value of asset arising out a refund of the grant, the same does not provide for allowance of the additional depreciation on such amount which would have been allowed in the year the asset was put to use.

5. TAS (LS) - AS19 - Leases

AS 19 provided that the classification of operating/ finance lease could result in the lessor/ lessee accounting for it differently. It is being provided under TAS (LS) that based on a joint confirmation by the lessor and lessee would provide the consistent treatment in the respective accounts of the contracting parties. It has been further provided that depreciation in respect of a finance lease would be allowed to the lessee even though the lessor is the owner.

Though it may be considered as a measure to reduce distortions, it could lead to complications in terms of structuring the lease arrangement, issues arising out of ownership etc. Further, it not clear as to how the provisions would be made applicable in case of cross border transactions.