ACCOUNTING FOR TAXES ON INCOME June 20, 2008

AGENDA  The old story  Deferred tax: mandatory recognition?  Losses and deferred taxation  Tax holidays  Tax losses under “Capital Gains”  Deferred tax and MAT  Deferred tax and amalgamations  Income statement Vs. balance sheet approach  Measurement  Disclosures  International GAAP

THE OLD STORY  ACCRUAL/MATCHING CONCEPTS  INTER PERIOD TAX ALLOCATION  TAXABLE Vs. ACCOUNTING INCOME  TIMING Vs. PERMANENT DIFFERENCES Contd…..

THE OLD STORY ….contd  GUIDANCE NOTE -Accounting for Taxes on Income -Effective Recommended: Tax Effect Accounting Method -Permitted: Taxes Payable Method -Withdrawn: effective Apr 2001  ACCOUNTING STANDARD -Accounting for Taxes on Income -Tax Effect Accounting Method -Effective Apr 2001

DEFERRED TAXATION: MANDATORY RECOGNITION?  ACCOUNTING STANDARD -Recognize DT for all timing differences -Consideration of prudence for DTA  BASIS -Concept of “Full Provision” and not “Partial Provision” Contd…..

DEFERRED TAXATION: MANDATORY RECOGNITION? Contd…  FULL PROVISION -Recognize tax effect of all transactions -Whether current or deferred tax  PARTIAL PROVISION -Excludes tax effect of timing differences which may not reverse for a considerable period Contd…..

DEFERRED TAXATION: MANDATORY RECOGNITION? Contd...  PARTIAL PROVISION -Involves subjective judgments Future time frame Future liability estimation Future profitability Future capital expenditure -Rejected internationally

LOSSES AND DEFERRED TAXATION a judgmental call  INDICATORS -History of recent losses -Existence of carried forward tax losses….  RECOGNITION -Recognize deferred tax assets if: Virtual certainty Supported by convincing evidence Contd…..

LOSSES AND DEFERRED TAXATION….contd a judgmental call  CONCEPT -Virtual certainty: an Indian concept x Forecast of performance? Convincing evidence: a matter of fact Not a matter of perception  CONCLUSION -Check existence of deferred tax liabilities -Recognize deferred tax assets: if supportable convincing evidence or only to the extent of deferred tax liabilities PRACTICALLY TOO RESTRICTIVE AT THE TIME OF REVERSAL, DTL WOULD LEAD TO TAXABLE INCOME

DEFERRED TAXATION AND TAX HOLIDAYS  TIMING DIFFERENCES REVERSING DURING TAX HOLIDAY -No recognition -Do not meet the criteria of asset/liability -Probably, will not be realized/settled  TIMING DIFFERENCES REVERSING AFTER TAX HOLIDAY -Recognize, when they originate Contd…..

DEFERRED TAXATION AND TAX HOLIDAYS contd…  DEDUCTION AVAILABLE (SAY U/S 80IA/IB) -Permanent difference  DIFFERENT TAX TREATMENT OF ITEMS -Timing difference  DURING TAX HOLIDAY -Current tax may be nil -Deferred tax exists (to reverse after tax holiday) DIFFERENCES WHICH ORIGINATE FIRST ARE CONSIDERED TO REVERSE FIRST

TAX LOSSES: “CAPITAL GAINS”  LOSSES UNDER THE HEAD CAPITAL GAINS -Timing difference: if not set off and carried forward -Normally not due to operating activities -Timing difference only for max. 8 years  BEING A CRRIED FORWARD LOSS -Consideration of prudence -Virtual certainty with convincing evidence, e.g., Sale of asset after balance sheet date Binding sale agreement Contd….. PRACTICALLY TOO RESTRICTIVE

TAX LOSSES: “CAPITAL GAINS” contd….  MEASUREMENT -Long term loss (requires long term gain) -Short term loss -Set off principles

DEFERRED TAX AND MAT  IF TAXES UNDER 115 JB -Measure DT at regular rates  IF REVERSALS EXPECTED IN PERIOD COVERED BY 115 JB -Measure DT at regular rates Contd…..

DEFERRED TAX AND MAT contd… WHY NOT USE MAT RATE?  CONCEPT OF FULL PROVISION METHOD -Measure all timing differences -Avoid substantial assumptions: Timing differences that may not reverse for a long period Future time frame Future liability estimation Future profitability Future capital expenditure

DEFERRED TAX AND AMALGAMATIONS  ACCOUNTING STANDARD 14  NO SPECIFIC GUIDANCE ON DT Contd…..

 ALLOCATION OF CONSIDERATION -Basis fair value  VALUATION FOR TAXATION -No change (base as applicable to transferor)  FAIR VALUE ALLOCATION -Akin to revaluation for taxation -Constitute permanent difference INCOME STATEMENT APPROACH DEFERRED TAX AND AMALGAMATIONS contd… Contd…..

(A) AMALGAMATION IN THE NATURE OF PURCHASE BASIS FAIR VALUES  ALLOCATION OF CONSIDERATION: BASIS FAIR VALUES -treatment at the time of amalgamation? -in first annual accounts after amalgamation? -in subsequent periods? ASSUMPTION: BENEFIT OF DTA IS IN BUILT IN PURCHASE CONSIDERATION DEFERRED TAX AND AMALGAMATIONS contd… When DTA not recognized by transferor Contd…..

(B) AMALGAMATION IN THE NATURE OF PURCHASE BASIS BOOK VALUES  ALLOCATION OF CONSIDERATION: BASIS BOOK VALUES -treatment at the time of amalgamation? -in first annual accounts after amalgamation? -in subsequent periods? ASSUMPTION: BENEFIT OF DTA IS IN BUILT IN PURCHASE CONSIDERATION DEFERRED TAX AND AMALGAMATIONS contd… When DTA not recognized by transferor Contd…..

(C) AMALGAMATION IN THE NATURE OF MERGER BOOK VALUES  ASSETS AND LIABILITIES AT BOOK VALUES -treatment at the time of amalgamation? -in first annual accounts after amalgamation? -in subsequent periods? ASSUMPTION: MERGED ENTITIES CONTINUING SINCE BEGINNING DEFERRED TAX AND AMALGAMATIONS contd… When DTA not recognized by transferor

 “BLOCK OF ASSETS” CONCEPT -Depreciation on WDV of block -Reduction of sale proceeds from block -Results in timing difference  REVALUATION: THRU BALANCE SHEET -Additional depreciation from revaluation reserve -Results in timing difference  IFRS AND US GAAP -Balance sheet approach INCOME STATEMENT Vs. BALANCE SHEET APPROACH

 TAX RATES -“Enacted” or “substantively enacted” -Announcements by the Govt may lead to substantive effect  AVERAGE RATE -If different tax rates for different income levels MEASUREMENT Contd…..

 DISCOUNTING TO PRESENT VALUE -Neither required nor permitted -Reliable determination of reversal: Subjective Impracticable Complex -if permitted but not required: May lose comparability MEASUREMENT contd….

 SCHEDULE VI PART I -Balance sheet format -As near thereto as circumstances admit -Flow not entirely on liquidity basis  DISCLOSE SEPARATELY FROM CURRENT ASSETS/LIABILITIES DISCLOSURES Contd…..

 DEFERRED TAX ASSETS -Normally more liquid compared to fixed assets/investments -Less liquid compared to current assets -Show after investments  DEFERRED TAX LIABILITIES -Show after unsecured loans  DISCLOSE COMPONENTS DISCLOSURES contd…

 APPROACH -Income statement: focus timing differences -Balance sheet: focus temporary differences -Certain differences may be “temporary” but not “timing” Say revaluation of fixed assets INTERNATIONAL GAAP IFRS/US: BALANCE SHEET APPROACH INDIA: INCOME STATEMENT APPROACH Contd…..

 LEVEL OF CERTAINTY -Reasonable/virtual certainty -Probable -More likely than not INTERNATIONAL GAAP contd…  LEVEL OF CERTAINTY -Reasonable/virtual certainty INDIA -Probable IFRS -More likely than not USA

AGENDA  Background and the old story  Deferred tax: mandatory recognition?  Losses and deferred taxation  Tax holidays  Tax losses under “Capital Gains”  Deferred tax and MAT  Deferred tax and amalgamations  Income statement Vs. balance sheet approach  Measurement  Disclosures  International GAAP (a broad view)

THANK YOU FOR YOUR KIND ATTENTION

PRESENTOR: Kaushal Kishore PHONE: