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Query No. 7
Subject:
Disclosure of income tax reimbursed by the
customers
in a power generating company.1
A. Facts of the Case
1. A company is engaged in generation of power, having 14 coal
based and 7 gas based generating stations located all over the
country. The power is supplied mainly to the distribution companies
of the State Electricity Boards. In the power sector, tariff for ‘sale
of energy’ is determined by the Central Electricity Regulatory
Commission (CERC) and the State Electricity Regulatory
Commission (SERC) for central and state utilities, respectively.
2. The querist has informed that the tariff for sale of energy of
the company is determined by CERC. CERC has notified by way
of Regulations in March 2004, the terms and conditions for the
determination of tariff applicable with effect from 1st April, 2004,
for a period of five years. As per the Regulation, tariff for sale of
energy in case of a thermal power generating station comprises
two components, namely, the recovery of annual capacity (fixed)
charges and energy (variable) charges, wherein :
(i) The annual capacity (fixed) charges consist of:
(a) Interest on loan capital;
(b) Depreciation including advance against depreciation;
(c) Return on equity;
(d) Operation and maintenance expenses; and
(e) Interest on working capital.
(ii) The energy (variable) charges consist of fuel cost.
3. The querist has further mentioned that the tariff regulations
have given a special dispensation for ‘tax on income’, which is as
follows:
“Tax on income:
(1) Tax on the income streams of the generating company
or the transmission licensee, as the case may be, from
its core business, shall be computed as an expense
and shall be recovered from the beneficiaries.
(2) Any under-recoveries or over-recoveries of tax on income
shall be adjusted every year on the basis of income-tax
assessment under the Income-tax Act, 1961, as certified
by the statutory auditors.
Provided that tax on any income stream other than the
core business shall not constitute a pass through
component in tariff and tax on such other income shall
be payable by the generating company or transmission
licensee, as the case may be.
Provided further that the generating station-wise profit
before tax in the case of the generating company and
the region-wise profit before tax in the case of the
transmission licensee as estimated for a year in advance
shall constitute the basis for distribution of the corporate
tax liability to all the generating stations and regions.
Provided further that the benefits of tax-holiday as
applicable in accordance with the provisions of the
Income-tax Act, 1961 shall be passed on to the
beneficiaries.
Provided further that in the absence of any other
equitable basis the credit for carry forward losses and
unabsorbed depreciation shall be given in the proportion
as provided in the second proviso to this regulation.
Provided further that income-tax allocated to the thermal
generation station shall be charged to the beneficiaries
in the same proportion as annual fixed charges, the
income-tax allocated to the hydro generating station shall
be charged to the beneficiaries in the same proportion
as annual capacity charges and in case of inter-state transmission, the sharing of income tax shall be in the
same proportion as annual transmission charges.”
4. According to the querist, income tax computed and paid in
each quarter is billed to the beneficiaries. Further, the querist has
informed that the company was hitherto disclosing the amount of
income tax recoverable from beneficiaries on the face of the profit
and loss account as under:
Provision for Current tax : xxxxxxxx
Less: Current tax recoverable xxxxxxxx
xxxxx
5. The querist has further mentioned that in line with the
provisions of the tariff regulations, income tax is a reimbursement
and is recoverable from the beneficiaries while the components of
tariff are accounted for as sales revenue.
6 The querist has drawn the attention of the Committee to the
‘Framework for the Preparation and Presentation of Financial
Statements’, issued by the Institute of Chartered Accountants of
India, which, inter alia, states that “the objective of financial
statements is to provide information about the financial position,
performance and cash flows of an enterprise that is useful to a
wide range of users in making economic decisions.” The Framework
sets out the following four principal qualitative characteristics that
underlie the preparation and presentation of financial statements
for external users:
(a) Understandability: An essential quality of the information
provided in financial statements is that it must be readily
understandable by users having a reasonable knowledge
of business, economic activities and accounting
(emphasis supplied by the querist).
(b) Relevance: Further, the financial statements should be
useful and the information provided must be relevant to
the users for making decisions. Information has the
quality of relevance when it influences the economic
decisions of users by helping them to evaluate the past,
present or future events or confirming, or correcting their past evaluations. The ability to make prediction
from financial statements is enhanced, however, by the
manner in which information on past transactions and
events is displayed (emphasis supplied by the querist).
(c) Reliability: The Framework further attaches the importance to the substance over form. If information is
to represent faithfully the transactions and other events
that it purports to represent, it is necessary that they
are accounted for and presented in accordance with
their substance and economic reality and not merely in
accordance with their legal form (emphasis supplied by
the querist).
(d) Comparability: Users must be able to compare the
financial statements of an enterprise through time in
order to identify trends in its financial position,
performance and cash flows. Users must also be able
to compare the financial statements of different
enterprises in order to evaluate their relative financial
position, performance and cash flows (emphasis supplied
by the querist).
7. The querist has referred to an earlier opinion on the subject,
‘Disclosure of recovery of income tax from customers’, given by
the Expert Advisory Committee (published in Compendium of
Opinions, Volume XXI, Query No. 11). The querist has contended
that the disclosure of ‘turnover’ and ‘tax recoverable from customers’
by power sector companies need to be re-looked in the light of the
above principal qualitative characteristics of the financial statements.
In case the income tax reimbursed by the beneficiaries is included
in the ‘Turnover’ of the company, disclosure of the same will not
be in the spirit of the presentation of financial statements for external
users as has been brought out in the Framework. The querist
provides the following reasons to support this contention:
(a) As per the present tariff regulations, the company cannot
retain any tax savings on account of tax planning or tax
holidays available u/s 80 IA of the Income-tax Act, 1961,
which is normally not the case in other industries. Due
to such different norms of the industry, the income tax provision in the books and recovery thereof from the
beneficiaries depends on the rate of income tax and the
tax concessions enjoyed by the company. The incidence
of income tax may be substantially lower during certain
accounting periods due to tax holidays available to the
company on account of new capacity addition.
(b) The most commonly used ratios to ascertain the
performance of the company are Gross Margin, Net
Margin, EBITDA, Asset–turnover ratios etc., and all of
them are related to sales (or the top line). Along with
these ratios, the trend ratios and trend lines will also be
vitiated, in case the tax recoverable is included in the
turnover. This being a factor beyond the control of the
company, the ratios related to turnover will not portray
the true performance of the company and its
management.
(c) The comparison with other enterprises in the same sector
will also not give a correct picture since the tax holidays
available to a company would depend on the growth
trajectory specific to each company and accordingly,
the tax provisions will be different for different companies.
Due to this, the ratios related to the turnover will not be
comparable as they will not reflect the operational
performance correctly.
8. The querist has mentioned that the above referred opinion of
the Committee draws strength from the definition of the term
‘revenue’ given in Accounting Standard (AS) 9, ‘Revenue
Recognition’, wherein revenue has been defined, inter alia, as
below:
“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.”
Further, according to the querist, as per paragraph 92 of the
Framework, the procedure normally adopted in practice for recognising income is that the revenue should be earned. The
querist has contended that no element of earning is involved as
far as income tax reimbursed by the beneficiaries is concerned.
Neither any effort is involved nor is any revenue generating asset
used for earning the same.
9. The querist has also drawn the attention of the Committee to
Accounting Standards Interpretation (ASI) 14 (revised), ‘Disclosure
of Revenue from Sales Transactions’, issued by the Institute of
Chartered Accountants of India, which deals with disclosure of
turnover in the following manner :
Turnover (Gross) xxx
Less: Excise Duty xxx
Turnover (Net) xxx
The querist has stated that as per ASI 14 (revised), the amount of
excise duty is to be shown as deduction from turnover and the
basis for such conclusion is that the financial analysts and other
users of the financial statements require the information related to
turnover gross of excise duty as well as net of excise duty for
meaningful understanding of financial statements. From the
aforesaid, the querist has concluded that this disclosure of turnover
and presentation thereof has significance for companies in the
manufacturing sector, where excise duty is a key component of
turnover, on which the company does not have any control, as the
rates are determined by the State. This indicates that every industry
could have very specific items/ components of turnover, which
would demand appropriate disclosure in financial statements (emphasis supplied by the querist). As per the querist, while issuing
ASI 14 (revised), the Institute of Chartered Accountants of India
has recognised and appreciated that the disclosure requirements
could be industry specific, and accordingly, the querist has drawn
the attention of the Expert Advisory Committee to this aspect while
reviewing the extant opinion.
10. The querist reiterates that tariff regulations in the power sector
require a specific treatment for income tax provisions on the
generation business of the company. Therefore, for better
understanding of the financial statements of the power generating companies, if a parallel is drawn, the presentation of income tax
recoverable from beneficiaries as a line item as referred to in
paragraph 4 above may be in order and the inclusion of the income
tax in the turnover may not be an appropriate presentation
considering the peculiarity of the power industry. Further, the querist
contends that in order to give a true and fair view of the position of
the company’s performance and cash flow statement, it would be
prudent to present income tax reimbursed by the beneficiaries
separately so that the users of the financial statements have a fair
idea about the total income tax payable by the company on the
non-generation income and the part which is recoverable from the
beneficiaries and the net income tax liability.
B. Query
11. Based on the above, the querist has requested the Expert
Advisory Committee to review its earlier opinion on the subject,
‘Disclosure of recovery of income tax from customers’ (published
in Compendium of Opinions, Volume XXI, Query No. 11,) keeping
in view the regulatory environment of the power sector.
C. Points considered by the Committee
12. The Committee notes the definition of the term ‘revenue’ as
defined in Accounting Standard (AS) 9, ‘Revenue Recognition’,
which, inter alia, states as follows:
“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.”
13. The Committee notes that in the power sector, power is sold
at tariff determined as per the tariff regulations, whereby tariff for
sale comprises annual capacity (fixed) charges and energy
(variable) charges. In addition to this, owing to the peculiar nature
of the power sector, the tariff regulations include a special provision to separately allow for recovery of income tax from the customers. Thus, it can be said that the consideration received by the company
for the sale of electricity includes several components and income
tax recovered from the customers is one of them. The Committee
is of the view that though income tax expense which is reimbursed
by the customers is determined in a manner different from that of
the tariff charged and the amount of income tax keeps varying due
to the changing circumstances faced by the company, it is
nevertheless arising as a result of sale of electricity to the
customers, and accordingly, as per the definition of the term
‘revenue’ reproduced above, it is a part of the ‘charges made to
the customers for goods supplied and services rendered’ and hence
is revenue. The Committee is also of the view that what is revenue
as per AS 9, does not depend upon the manner of determination
of quantum of payment by the customer, what is of essence is the
consideration receivable in lieu of sale of goods or rendering of
services. The fact that some element of expense is not factored in
the determination of rate because of its varying nature, as in the
case of income-tax expense, and, therefore, is separately
recovered, does not change its inherent nature.
14. The Committee notes from the Facts of the Case that the
querist has referred to the qualitative characteristics given in the
Framework issued by the Institute and has contended that the
suggested accounting treatment as per the earlier opinion of the
Committee on ‘Disclosure of recovery of income tax from
customers’, whereby recovery of income tax is considered to be
revenue, is not in line with these qualitative characteristics. In this
context, the Committee notes that the Framework issued by the
Institute lays down broad principles with regard to the preparation
and presentation of financial statements and it is the individual
Accounting Standards which prescribe specific accounting
treatments which have to be followed. In this context, the Committee
notes paragraph 2 of the ‘Framework for the Preparation and
Presentation of Financial Statements’, which states as follows:
“2. This Framework is not an Accounting Standard and
hence does not define standards for any particular
measurement or disclosure issue. Nothing in this Framework
overrides any specific Accounting Standard.”
On the basis of the above, the Committee is of the view that once
the requirements of an Accounting Standard are satisfied, if there
is any perceived conflict between the said requirements and the
Framework, the former prevails. The Committee is of the view that
once it is agreed, as discussed in paragraph 13 above that the
recovery of income tax is a part of revenue, it is not necessary to
examine the qualitative characteristics as described in the
Framework for the purpose of determining its treatment.
15. The Committee also notes paragraph 92 of the Framework,
referred to by the querist in paragraph 8 above, which states as
follows:
“92. The procedures normally adopted in practice for
recognising income, for example, the requirement that revenue
should be earned, are applications of the recognition criteria
in this Framework. Such procedures are generally directed at
restricting the recognition as income to those items that can
be measured reliably and have a sufficient degree of certainty.”
16. The Committee notes from the above that the requirement
with regard to earning of revenue is in the context of the timing of
recognition of revenue and not in the context of what comprises
revenue. For example, revenue is said to be earned when in case
of sale of goods, all the significant risks and rewards of ownership
of the goods are transferred; it does not lay down what constitutes
the consideration for sale of goods. Accordingly, the querist’s
argument with regard to earning of the income tax which is
recovered from the customers is not relevant.
17. The Committee notes that the querist has contended that one
reason for not considering recovery of income tax as revenue is
that doing so would hamper various performance ratios of the
company. In this regard, the Committee is of the view that
performance indicators/ratios do not determine what is proper
accounting in accordance with the Accounting Standards.
18. The Committee notes ASI 14 (revised) simply deals with the
issue/manner of the disclosure of excise duty in the presentation
of revenue from sales transactions (turnover) in the profit and loss
account and the suggested disclosure does not imply that excise duty is not a part of revenue (turnover). Further, the Committee
notes that though the issue in question also deals with disclosure
of income tax recovered from the customers of a power generating
company, the main concern is to ascertain its nature. Hence, the
Committee is of the view that to draw a parallel with the disclosure
treatment given in ASI 14 is inappropriate.
D. Opinion
19. Based on the above, the Committee is of the view that the
earlier opinion issued by the Committee on a similar subject
‘Disclosure of recovery of income tax from customers’ (published
in Compendium of Opinions, Volume XXI, Query No. 11) is correct,
i.e., the recovery of income tax from the customers should form
part of the revenue of the company.
1Opinion finalised by the Committee on 30.4.2008
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