Query No. 23

Subject:

Disclosure of interest on shortfall in payment of advance

income-tax in the financial statements. ¹

A. Facts of the Case

1. A company is a premier electronics company under the Ministry of Defence, Government of India, having its shares listed at the major stock exchanges in India. The turnover of the company for the year 2005-06 was Rs. 3,536 crore.

2. The querist has stated that as per an earlier opinion issued by the Expert Advisory Committee (published in the Compendium of Opinions, Volume XXIV, Query No.21), the interest payable under section 234B and section 234C of the Income-tax Act, 1961, should not be considered as a part of tax expense. The Opinion further states that this may, however, be separately provided for in accordance with the requirements of Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the Institute of Chartered Accountants of India. As per the querist, the Opinion of the Expert Advisory Committee does not indicate as to where the interest expenditure under section 234B and section 234C should be disclosed in the profit and loss account, i.e., whether as a part of ‘interest costs’, or as a separate item above the line (i.e., before profit before tax (PBT)), or whether it can be included in ‘other expenses’.

3. The querist has stated that the company has been including this amount as a part of tax expense in the profit and loss account after profit before tax and indicating the same as part of ‘Provision for Income-tax’ and grouping the same under the head ‘Provisions’ in the balance sheet. The company is of the view that the interest in question does not fall under the purview of AS 29 since AS 29 defines a provision as “a liability which can be measured ‘only by using a substantial degree of estimation’.” As per the querist, calculation of interest on the shortfall of advance income tax does not call for a substantial degree of estimation.

4. According to the querist, interest costs generally reflect the efficiency or otherwise with which an organisation is able to meet its financing requirements. The expenditure on interest under section 234B and section 234C does not reflect the above. On the other hand, this amount is to be paid to the income tax department at predetermined rates of interest, irrespective of the position of the funds availability with the company. Moreover, this interest amount is not in the nature of ‘borrowing costs’ as defined under Accounting Standard (AS) 16, ‘Borrowing Costs’, issued by the Institute of Chartered Accountants of India. The querist has stated that the company is of the view that the ‘interest cost under section 234B and section 234C’ reflects the efficiency or otherwise with which the company is able to estimate its taxable income, and hence, should ideally form part of the ‘tax expense’. If required, a separate disclosure can be made of the element of interest cost included in the ‘tax expense’, in the same manner as the current tax and deferred tax expense/income in the schedules to the profit and loss account. The liability aspect of the same can be shown under the head ‘Provisions’ in the balance sheet as a part of ‘Provision for Income-tax’.

B. Query

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

(i) Whether the accounting treatment adopted by the company, i.e., accounting for the interest under section 234B and section 234C of the Income-tax Act, 1961, as part of tax expense in the profit and loss account, disclosing the interest amount in the Schedule on ‘Provision for Taxation’ and grouping the same (Provision for Taxation) as part of ‘Provisions’ in the balance sheet, is in order.

(ii) If not, what should be the treatment/disclosure to be made in the profit and loss account and the balance sheet for the same.

C. Points considered by the Committee

6. The Committee notes that section 234B and section 234C of the Income-tax Act, 1961, appear under ‘Part F – Interest Chargeable in Certain Cases’ of Chapter XVII – ‘Collection and Recovery of Tax’. The Committee further notes that the sections prescribe payment of interest where advance tax is not paid in accordance with the requirements of the said sections. The Committee thereby concludes that the nature of income-tax is different from that of interest chargeable under these sections even though the levy of interest is automatic. In this context, the Committee notes the definition of the term ‘tax’ as per section 2(43) of the Income-tax Act, 1961, as reproduced below:

“ “tax” in relation to the assessment year commencing on the 1st day of April, 1965, and any subsequent assessment year means income-tax chargeable under the provisions of this Act, and in relation to any other assessment year income-tax and super-tax chargeable under the provisions of this Act prior to the aforesaid date and in relation to the assessment year commencing on the 1st day of April, 2006, and any subsequent assessment year includes the fringe benefit tax payable under section 115WA”.

On the basis of the above, the Committee is of the view that interest chargeable under section 234B and section 234C cannot be considered as ‘income-tax’ within the meaning of the provisions of the Income-tax Act, since the said sections do not deal with computation of income-tax but deal with payment of interest on the lower amount paid as advance tax in specified cases. The Committee notes that the above conclusion had also been drawn in the earlier opinion issued by the Expert Advisory Committee (mentioned in paragraph 2 above). The Committee feels that the said interest can be viewed as of the nature of interest since it is paid as a compensation for the amount used by the assessee which, otherwise would have been paid by him to the Government as income-tax.

7. The Committee further notes that the earlier opinion of the Committee did not deal in detail with the aspect of disclosure of the interest under section 234B and section 234C of the Income- tax Act, 1961, in the profit and loss account since the matter was not specifically raised by the querist in that query. The opinion of the Committee stated that a provision for such interest should be made separately as per the requirements of AS 29 provided the company considers the payment of interest probable on the date of the balance sheet and the amount of interest can be estimated reliably, presuming that a substantial degree of estimation would be required. The Committee is of the view that even in case the calculation of the interest under section 234B and section 234C of the Income-tax Act, 1961, does not call for a substantial degree of estimation as argued by the querist, it could still not be considered as ‘income-tax’. The Committee is of the view that in case the amount of such interest is certain, it would then be considered as a crystallised ‘liability’, as defined in paragraph 10 of AS 29 and paragraph 49 of the Framework for the Preparation and Presentation of Financial Statements, issued by the Institute of Chartered Accountants of India, as below:

“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”

8. On the basis of the above, the Committee is of the view that a crystallised liability should be recognised as an expense in the profit and loss account. Accordingly, the interest under section 234B and section 234C of the Income-tax Act, 1961, is required to be recognised as an expense in the profit and loss account, even if it is a crystallised liability and substantial degree of estimation is not involved in its estimation.

9. As regards the disclosure of the expense on account of interest under section 234B and section 234C in the profit and loss account, the Committee notes the provisions of Part II of Schedule VI to the Companies Act, 1956, as reproduced below:

          “2. The profit and loss account –

(a) shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account; and

(b) shall disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature.”

From the above, the Committee is of the view that the interest in question should be disclosed as a separate sub-item under the head ‘interest’ with a proper disclosure of its nature or as a separate line item in the profit and loss account. It can be clubbed with other items, if any, under the head ‘interest and penalties’, in case it meets the requirements of paragraph 3(x)(i) of Part II of Schedule VI to the Companies Act, 1956, as reproduced below:

                 “(i) Miscellaneous expenses:

Provided that any item under which the expenses exceed 1 per cent of the total revenue of the company or Rs.5,000, whichever is higher, shall be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and shall not be combined with any other item to be shown under ‘Miscellaneous expenses’.”

10. With respect to disclosure in the balance sheet, the Committee is of the view that the interest expense under section 234B and section 234C, under the circumstances of the query, is a ‘current liability’ and should be disclosed accordingly. Such interest expense cannot be disclosed as a ‘provision for income-tax’.

D. Opinion

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

(i) No, the treatment given by the company is not correct.

(ii) If the interest in question is a crystallised liability and no substantial degree of estimation is required for estimation of interest under section 234B and section 234C of the Income-tax Act, 1961, the same should be accrued and recognised as an expense in the profit and loss account and disclosed as discussed in paragraphs 8 and 9 above. The liability for such interest should be disclosed in the balance sheet under the head ‘Current Liabilities’ (and not as a ‘provision’).

¹ Opinion finalised by the Committee on 18.9.2006