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TMI BlogAccounting for Taxes on IncomeX X X X Extracts X X X X X X X X Extracts X X X X ..... tween items of revenue and expenses as appearing in the statement of profit and loss and the items which are considered as revenue, expenses or deductions for tax purposes. Secondly, there are differences between the amount in respect of a particular item of revenue or expense as recognised in the statement of profit and loss and the corresponding amount which is recognised for the computation of taxable income. Scope 1. This Standard should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or saving related to taxes on income in respect of an accounting period and the disclosure of such an amount in the financial statements. 2. For the purposes of this Standard, taxes on income include all domestic and foreign taxes which are based on taxable income. 3. This Standard does not specify when, or how, an enterprise should account for taxes that are payable on distribution of dividends and other distributions made by the enterprise. Definitions 4. For the purpose of this Standard, the following terms are used with the meanings specified: 4.1 Accounting income (loss) is the net profit or loss for a period, as reported in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machinery for accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed will differ. Another example of timing difference is a situation where, for the purpose of computing taxable income, tax laws allow depreciation on the basis of the written down value method, whereas for accounting purposes, straight line method is used. Some other examples of timing differences arising under the Indian tax laws are given in Illustration 1. 8. Unabsorbed depreciation and carry forward of losses which can be set-off against future taxable income are also considered as timing differences and result in deferred tax assets, subject to consideration of prudence (see paragraphs 15-18). Recognition 9. Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. 10. Taxes on income are considered to be an expense incurred by the enterprise in earning income and are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... own in paragraphs 15 to 18. (c) For the above purposes, the timing differences which originate first are considered to reverse first. The application of the above explanation is illustrated in the Illustration attached to the Standard. 14. This Standard requires recognition of deferred tax for all the timing differences. This is based on the principle that the financial statements for a period should recognise the tax effect, whether current or deferred, of all the transactions occurring in that period. 15. Except in the situations stated in paragraph 17, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised. 16. While recognising the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y, in respect of such 'loss', deferred tax asset is recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head 'Capital gains' against which the loss can be se-off as per the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would depend on the facts and circumstances of each case. The examples of situations in which the test of virtual certainty, supported by convincing evidence, for the purposes of the recognition of deferred tax asset in respect of loss arising under the head 'Capital gains' is normally fulfilled, are sale of an asset giving rise to capital gain (eligible to set-off the capital loss as per the provisions of the Act) after the balance sheet date but before the financial statements are approved, and binding sale agreement which will give rise to capital gain (eligible to set-off the capital loss as per the provisions of the Act). (c) In case where there is a difference between the amounts of 'loss' recognised for accounting purposes and tax purposes because of cost indexa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the current period would reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the current period, tax effect of which is required to be recognised under AS 22, is measured using the regular tax rates and not the tax rate under section 115JB of the Act. 22. Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities are measured using such announced tax rate and tax laws. 23. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using average rates. 24. Deferred tax assets and liabilities should not be discounted to their present value. 25. The reliable determination of deferred tax assets and liabilities on a discounted basis requires detailed scheduling of the timing of the reversal of each timing difference. In a number of cases such scheduling is impracticable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... head 'Investment's and deferred tax liabilities (net of the deferred tax assets, in any, in accordance with paragraph 29) is disclosed on the face of the balance sheet separately after the head 'Unsecured Loans'. 31. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts. 32. 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. Transitional Provisions 33. On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognise, 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 (see paragraphs 15-18). 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uty, 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. substantial 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) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Current tax 0.40 (200 - 150) 20 0.40 (200) 80 80 Deferred tax Tax effect of timing differences originating during the year 0.40 (150 - 50) 40 Tax effect of timing differences reversing during the year 0.40 (0 - 50) (20) (20) Tax expense 60 60 60 Profit after tax 90 90 90 Net timing differences 100 50 0 Deferred tax liability 40 20 0 In 20x1, the amount of depreciation allowed for tax purposes exceeds the amount of depreciation charged for accounting purposes by ₹ 1,00,000 and, therefore, taxable income is lower than the accounting income. This gives rise to a deferred tax liability of ₹ 40,000. In 20x2 and 20x3, accounting income is lower than taxable income because the amount of depreciation charged for accounting purposes exceeds the amount of depreciation allowed for tax purposes by ₹ 50,000 each year. Accordingly, deferred tax liability is reduced by ₹ 20,000 each in both the years. As may be seen, tax expense is based on the accounting income of each period. In 20x1, the profit and loss account is debited and deferred tax liability account is credited with the amount of tax on the originating timing difference of ͅ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0) = ₹ 17,500 31st March, 20x3 = 0.38 (Zero) = Rs. Zero Accordingly, the amount debited/(credited) to the profit and loss account (with corresponding credit or debit to deferred tax liability) for each year would be as under: 31st March, 20x1 Debit = ₹ 40,000 31st March, 20x2 (Credit) = Rs. (22,500) 31st March, 20x3 (Credit) = Rs. (17,500) Illustration 3 A company, ABC Ltd., prepares its accounts annually on 31st March. The company has incurred a loss of ₹ 1,00,000 in the year 20x1 and made profits of ₹ 50,000 and 60,000 in year 20x2 and year 20x3 respectively. It is assumed that under the tax laws, loss can be carried forward for 8 years and tax rate is 40% and at the end of year 20x1, it was virtually certain, supported by convincing evidence, that the company would have sufficient taxable income in the future years against which unabsorbed depreciation and carry forward of losses can be set-off. It is also assumed that there is no difference between taxable income and accounting income except that set-off of loss is allowed in years 20 x 2 and 20 x 3 for tax purposes. Statement of Profit and Loss (for the three years ending 31st March, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fferent amounts of depreciation for accounting purposes and tax (O=Originating and R=Reversing) 1 1000 900 625 625 Nil 900 625 275 (O) 2 1000 900 719 719 Nil 900 719 181 (O) 3 1000 900 789 789 Nil 900 789 111 (O) 4 1000 900 842 842 Nil 900 842 58 (O) 5 1000 900 881 881 Nil 900 881 19 (O) 6 1000 900 911 911 Nil 900 911 11 (R) 7 1000 900 933 933 Nil 900 933 33 (R) 8 1000 900 950 950 Nil 900 950 50 (R) 9 1000 900 962 962 Nil 900 962 62 (R) 10 1000 900 972 972 Nil 900 972 72 (R) 11 1000 900 979 Nil 979 -79 Nil 79 (R) 12 1000 900 984 Nil 984 -84 Nil 84 (R) 13 1000 900 988 Nil 988 -88 Nil 88 (R) 14 1000 900 991 Nil 991 -91 Nil 91 (R) 15 1000 900 993 Nil 993 -93 Nil 74 (R) 19 (O) Notes: 1. Timing differences originating during the tax holiday period are ₹ 644 lakhs, out of which ₹ 228 lakhs are reversing during the tax holiday period and ₹ 416 lakhs are reversing after the tax holiday period. Timing difference of ₹ 19 lakhs is originating in the 15th year which would reverse in subsequent year when for accounting purposes depreci ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... --------- Notes:- [1] No deferred tax is recognised since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognised at their origination. [2] No deferred tax is recognised since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognised at their origination. [3] No deferred tax is recognised since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognised at their origination. [4] No deferred tax is recognised since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognised at their origination. [5] No deferred tax is recognised since in respect of timing differences reversing during the tax holiday period, no deferred tax was recognised at their origination. [6] Deferred tax asset of ₹ 6 lakhs would be recognised at the end of year 15 subject to consideration of prudence as per AS 22. If it is so recognised, the said deferred tax asset would be realised in subsequent periods when for tax purposes depreciation would be allowed but for accounting purposes no depreciation would be recognis ..... X X X X Extracts X X X X X X X X Extracts X X X X
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