Query No. 11

Subject:           

Disclosure of recovery of income tax from customers. ¹

A. Facts of the Case

1. A company is engaged in generation of power which is supplied to various  Electricity  Boards.  The  company  collects  its  revenue  from the sale of power to Electricity Boards on the basis of terms and conditions laid  down  by  the  Tariff  Regulatory Authority  and  the  tariff  agreement between the company and the Electricity Boards.

2. According  to  the  querist,  one  of  the  terms  and  conditions  of  the Tariff Regulatory Authority and the tariff agreement is that the income tax relating to the power generating schemes will be reimbursed by the Electricity  Boards  on  quarterly  basis  before  the  payment  of  advance income  tax.  As  per  the  accounting  policy  of  the  company,  the reimbursement of tax is netted against the tax provision and disclosed in the profit and loss account of the company as below:

Income tax       xxxx.xx

Less: Recoverable from Electricity Boards         xxxx.xx xxxx.xx

3. The  auditors  of  the  company  drew  attention  of  the  shareholders regarding such disclosure as follows:

“Income-tax recoverable from Electricity Boards is netted off against provision for taxation of the year which, in our opinion, forms part of the gross revenue.”

4.  According to the querist, the rate fixed as per the bulk power supply agreement between the Electricity Boards and the company is cost-based with pre-tax return. The income tax payable on the power-generating and mining units is reimbursed as per clause 6 of the tariff agreement with the Electricity Boards, which provides as follows:

“6 INCOME TAX

6.1 Tax  liability,  if  any,  on  the  following income  streams  of  the company shall be borne by the recipients.

(i) Generation of power from Power Station II (Stage I) and Power Station II (Stage II).

 

(ii) Mining  of  lignite  from  Mine  II  for  the  purpose  of generation of power from Power Station II (Stage I) and Power Station II (Stage II).

 

(iii) The  amount  of  grossed  up  tax  that  is  payable  by  the company under the income streams mentioned at items (i) and (ii).

6.2       The total tax liability of the recipients shall however be:

(a) the  tax  payable  on  the  return  on  equity  and  internal resources relating to Mine II and Power Station II adopted in the tariff calculations and the grossed up tax thereon or

 

(b) the actual tax assessed for the above streams, whichever is less.

6.3. The income tax allocated to the recipients shall be in proportion to their energy drawals during the year to which the income tax pertains.

  6.4. The  company  shall  estimate  its  liability  for  income  tax  that will fall due for payment as advance tax every quarter and also the  income and  tax  relating to Mine  II and  Power Station  II and  the  tax  recoverable  from  the  recipients  and  allocate  it among  the  recipients  in  the  combined  ratio  of  allocation  of capacity  of  Power  Station  II  (Stage  I)  and  Power  Station  II (Stage II) indicated in para 1.1. The company shall claim the advance tax liability allocated to the recipients by presenting a statement specifying the date on which the advance payment is  due  and  the  amount  thereof.  The  recipients  shall  pay  the amount specified in the statement as payable by them at least three days prior to the due date for payment of advance tax in respect  of  each  quarter  as  prescribed  under  the  Income-tax th Act, viz.,  15th June,  15th September,  15 December and  15th March, failing which the recipient concerned shall pay interest on the  amount so delayed,  computed in accordance  with the provisions of the Income-tax Act.

6.5. After  finalisation  of  return  of  income  and  again  after  tax assessment of the income for any financial year, the excess or shortfall in the advance tax collected from the recipients shall be  adjusted  in  the  claim  for  advance  tax  for  the  subsequent quarters. Certificates from the statutory auditors of the company regarding the allocation of the returned/assessed income and tax for the above income streams of the company and among the recipients shall be furnished to the recipients.”

5. According to the querist, the government notification provides with regard to the tariff of power generating companies that the income tax of the companies is to be computed as an expense at actuals. Hence, it is a reimbursement of an expenditure only and it has to be netted off against expenses of income tax only and not accounted for as an income.

6. The querist has contended that the quantum of reimbursement is not directly linked to the quantum of power sold as there is a maximum limit of reimbursement subject to actual tax assessed for power generating and mining units, and also it is reimbursable quarterly before the payment of advance income tax. Hence, it could not be included in the income.

7.  The querist has also informed that another public sector undertaking in the same sector which is a pioneer in the power generating industry, is also following the same accounting policy for disclosure of income-tax reimbursement made by Electricity Boards.

B. Query

8. The querist has sought the opinion of the Expert Advisory Committee as to whether the netting off of reimbursement of income tax against the income tax provision in the profit and loss account is in order.

C. Points considered by the Committee

9. The Committee notes that Accounting Standard (AS) 9, ‘Revenue Recognition’, defines revenue as “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”.  The Committee  further  notes  that  the  ‘Guidance  Note  on  Terms  Used  in Financial Statements’, issued by the Institute of Chartered Accountants of India, apart from the aforesaid definition of ‘revenue’, also states that revenue  excludes  amounts  collected  on  behalf  of  a  third  party  such  as certain taxes (paragraph 14.06).

10. The Committee is of the view that the taxes such as sales tax and entertainment  tax  are  collected  on  behalf  of  a  third  party,  viz.,  the government and, accordingly, such taxes are excluded from revenue. The intention of the corresponding legislation is to recover such taxes from customers.  In  other  words,  the  enterprise  is  a  conduit  through  which government collects these taxes from the customers.

11. The  Committee  notes  that  the  income  tax,  being a  direct-tax,  is  a charge on the enterprise’s income and has to be borne by the enterprise itself. In case the burden on account of income tax is passed on to the customers,  it  is  in  the  form  of  recovery  of  any  other  expense  of  the enterprise  in  the  form of  a  consideration  to  sell  its  products  or  render services and, therefore, the recovery of income-tax from the customers should  form part  of  gross  inflow  on  account  of  sale  of  the  product  or rendering of services.

D. Opinion

12. On  the  basis  of  the  above,  the  Committee  is  of  the  opinion  that netting off of recovery of income tax from Electricity Boards against the income tax provision is not in order. The said recovery should form part of the revenue of the company.

¹Opinion finalised by the Committee on 14.4.2001.