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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 ..... between 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he same would 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idered 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 c ertainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future. 17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... incing evidence, that sufficient future taxable income will be available under the head 'Capital gains' against which the loss can be set-off as per the provisions of the Income-tax Act, 1961. 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 Income-tax Act, 1961) 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 Income-tax Act, 1961). (c) In cases where there is a difference between the amounts of recognised for accounting purposes and tax purposes because of cost indexation under the Income-tax Act, 1961 in respect of long-term capital assets, the deferred tax asset is recognised and carried forward (subject ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act, 1961, 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 Income-tax Act, 1961. 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 or highly complex. Therefore, it is inappropriate to require discounting o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws. Transitional Provisions27 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 the beginning. 34. For the purpose of determining accumulated deferred tax in the period in which this Standard is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are compared and the differences, if any, are determined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences are timing differences. For example, in the ye ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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) Differences in method of calculation e.g. calculation of depreciation with reference to individual assets in the books but on block basis for tax purposes and calculation with reference to time in the books but on the basis of full or half depreciation under the block basis for tax purposes. d) Differences in composition of actual cost of assets. 4. Where a deduction is allowed in one year for tax purposes on the basis of a deposit made under a permitted deposit scheme (e.g. te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therefore, taxable income is lower than the accounting income. This gives rise to a deferred tax liability of Rs. 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 Rs. 50,000 each year. Accordingly, deferred tax liability is reduced by Rs. 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 Rs. 1,00,000 while in each of the following two years, deferred tax liability account is debited and profit and loss account is credited with the amount of tax on the reversing timing difference of Rs. 50,000. The following Journal entries will be passed: Year 20x1 Profit and Loss A/c Dr. 20,000 To Current tax A/c 20,000 (Being the amount of taxes payable for the year 20x1 provided for) Profit and Loss A/c Dr. 40,000 To Deferred tax A/c 40,000 (Being the deferred tax liability created for originating timing differenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 20x2 and 20x3 for tax purposes. Statement of Profit and Loss (for the three years ending 31st March, 20x1, 20x2, 20x3) (Rupees in thousands) 20x1 20x2 20x3 Profit (loss) (100) 50 60 Less: Current tax - - (4) Deferred tax: Tax effect of timing differences originating during the year 40 Tax effect of timing differences reversing during the year (20) (20) Profit (loss) after tax effect (60) 30 36 Illustration 4 Note: The purpose of this illustration is to assist in clarifying the meaning of the explanation to paragraph 13 of the Standard. Facts: 1. The income before depreciation and tax of an enterprise for 15 years is Rs. 1000 lakhs per year, both a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -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 Rs.644 lakhs, out of which Rs. 228 lakhs are reversing during the tax holiday period and Rs. 416 lakhs are reversing after the tax holiday period. Timing difference of Rs. 19 lakhs is originating in the 15th year which would reverse in subsequent years when for accounting purposes depreciation would be nil but for tax purposes the written down value of the machinery of Rs. 19 lakhs would be eligible to be allowed as depreciation. 2. As per the Standard, deferred tax on timing differences which reverse during the tax holiday period should not be recognised. For this purpose, timing differences which originate first are considered to reverse first. Therefore, the reversal of timing difference of Rs. 228 lakhs during the tax holiday period, would be considered to be out of the timing difference which originated in year 1. The rest of the timing difference originating in year 1 and timing differ ..... 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