Expert Advisory Committee

Query No. 5

Subject:

Accounting Treatment of Sales Tax Exemption.1

A. Facts of the Case

1. A small scale industrial unit is engaged in the manufacture of tea. On account of expansion of the unit satisfying certain conditions, sales-tax exemption has been granted to the unit for a period of 3 years from 31.3.1998 to 30.3.2001. The unit is entitled to claim a total exemption of Rs. 94.43 lakh on its sales spread over the above period of three years. As per the querist, the amount of the exemption is computed on the basis of additional investment in plant, machinery and building required for expansion. The querist has mentioned that as the exemption is granted in total, individual exemption for each asset cannot be ascertained.

2. The benefit of exemption is reflected in the higher average sales realisation. In other words, after getting the certificate of exemption, the unit has been able to charge a comparatively higher sales price for its product from the customers.

3. The querist has drawn the attention of the Committee to Accounting Standard (AS) 12, ‘Accounting for Government Grants’, issued by the Institute of Chartered Accountants of India. According to the querist, if the sales-tax exemption is treated as a government grant or assistance, in terms of the capital approach discussed in AS 12, it would be in the nature of promoters’ contribution as the exemption is given with reference to the total investment in the unit or by way of contribution towards its total capital outlay.

4. According to the querist, as per explanation 10 to section 43 of the Income-tax Act, 1961, any subsidy, grant or reimbursement received from a state government is not to be included in actual cost of an asset. The explanation provides where such subsidy or grant or reimbursement is of such nature that it cannot be directly relatable to the asset acquired, so much of the amount which bears to the total subsidy or reimbursement or grant the same proportion as such asset bears to all the assets in respect of or with reference to which the subsidy or grant or reimbursement is so received, shall not be included in the actual cost of the asset to the assessee.

B. Queries

5. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether, from the accounting point of view, the treatment of sales-tax exemption as a capital receipt is correct.

(b) In view of the benefit of exemption being reflected by way of a higher average sales realisation, and considering the exemption as a capital receipt, whether the unit can transfer the amount of exemption from sales account to capital reserve account by debiting sales and crediting capital reserve.

(d)Whether the sales-tax exemption is covered within the definition of subsidy, grant or reimbursement as per section 43 of the Income-tax Act, 1961. Whether the exemption is a capital receipt or a revenue receipt for the purposes of the Act.

(e) Whether the amount of sales-tax exemption is to be proportionately reduced from the cost of assets acquired for expansion.

(f) Whether the reduction from the cost of assets can be made on the basis of actual amount of exemption availed by the unit (even though the unit is entitled to a higher amount of exemption). If so, whether the unit has to make a reduction from the cost of assets every year since the eligible amount of exemption can be availed by the unit only over a period of three years.

C. Points Considered by the Committee

6. Accounting Standard (AS) 12, ‘Accounting for Government Grants’, defines government grants as “assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise”.

7. The Committee is of the view that sales-tax exemption available to the unit is not an assistance in cash or kind and is therefore not a government grant within the meaning of this term under AS 12. As such, AS 12 is not applicable to the exemption.

8. The Committee notes the following definition of the term ‘revenue’ as given in Accounting Standard (AS) 9, ‘Revenue Recognition’ :

“Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.”

9. The Committee is of the view that in terms of the above definition, the entire sale proceeds of the unit from the sale of the product constitute the revenue of the unit. It is immaterial whether these sale proceeds result from sales at normal prices or at higher-than-normal prices that the unit is able to charge due to sales-tax exemption.

10. Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, states that “financial statements should disclose all ‘material’ items, i.e., items the knowledge of which might influence the decisions of the user of the financial statements” (paragraph 17). Accordingly, the Committee is of the view that if the effect of the sales-tax exemption (in the form of higher average sales realisation) on the financial statements is material, the financial statements should contain adequate disclosures about the same.

11. The Committee takes note of the following definitions of the terms ‘reserve’ and ‘capital reserve’ as given in Part III of Schedule VI to the Companies Act, 1956.

“The expression ‘reserve’ shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability.”

“The expression ‘capital reserve’ shall not include any amount regarded as free for distribution through the profit and loss account; and the expression ‘revenue reserve’ shall mean any reserve other than a capital reserve.”

12. The ‘Guidance Note on Terms Used in Financial Statements’, issued by the Institute of Chartered Accountants of India, defines the expression ‘reserve’ as follows:

“The portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability. The reserves are primarily of two types: capital reserves and revenue reserves.”

From the above, it can be seen that reserves represent amounts appropriated by the management for a general or specific purpose. In determining the amounts to be transferred to various reserves, due consideration should be given to the applicable statutory, regulatory and contractual requirements. However, purely from an accounting point of view, there is no bar on a unit from transferring a part (or even the whole) of its profits to capital reserve or any other reserve.

13. Capital reserve, by definition, is not available for distribution as dividend.

14. The Committee does not express any opinion on the treatment of sales-tax exemption under the Income-tax Act as the matter involves merely an interpretation of a law.

D. Opinion

15. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 5:

(a) Sales-tax exemption cannot be accounted for separately as a capital receipt. The proceeds from the sale of the product (at higher-than-normal prices due to sales-tax exemption) would constitute the revenue of the unit.

(b) From an accounting point of view, the unit can transfer any part (or even the whole) of its profits to capital reserve or to any other reserve. (However, in making such a transfer, due consideration would need to be given to the applicable statutory, regulatory and contractual requirements.)

(d) The Committee does not express any opinion as to whether the sales-tax exemption is covered within the definition of subsidy, grant or reimbursement under section 43 of the Income-tax Act, 1961, nor does it express any opinion as to whether sales-tax exemption constitutes a capital receipt or a revenue receipt for the purposes of the said Act.

(e) The Committee does not express any opinion on this issue following what has been stated at (d) above.

(f) The Committee does not express any opinion on this issue following what has been stated at (d) above.

1Opinion finalised by the Committee on 22.4.2000.