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Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 20

Subject: 

Creation of deferred tax assets on provision for doubtful debts,

loans and advances, earnest money deposit and security deposit.1

 

A. Facts of the Case

 

1.A company (hereinafter referred to as ‘the company’) is a State Government Undertaking whose 100% paid-up capital is held by the Government of Rajasthan. The company was incorporated as a Government company in the year 1979 under section 619 of the Companies Act, 1956. The main objective of the company (as per the objective clause of the MOA) is infrastructure development in the State of Rajasthan.  The company is executing construction of roads, bridges, bye-passes, buildings, tunnels and dams, etc.

 

2.The querist has stated that the company is not reflecting deferred tax on provision for doubtful debts, loans and advances, earnest money deposit and security deposits. During the course of audit of accounts of the company for the period ending on March 31, 2011, Accountant General, Rajasthan (hereinafter referred as ‘A.G. Rajasthan’) has expressed reservation with regard to not creating deferred tax asset (DTA) on provisions for debtors, loans and advances, earnest money deposits and security deposits which results in temporary timing differences. Provisions made on debtors, loans and advances, earnest money deposits and security deposits are not allowable deduction under the Income-tax Act, 1961, unless and until written-off in the books of account. AG Rajasthan was of the view that since the provision is capable of reversal in subsequent years, deferred tax needs to be created on such provisions in accordance with Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’. Accordingly, the same is not in line with AS 22.

 

3.The querist has also stated that the company has made these provisions at the insistence of the auditors, although management of the company, on the basis of past records of the company, had considered these debts/advances fully recoverable even at the time when these provisions had been made. The company has a complete official setup of a recovery cell which is responsible for recovering old balances. Considering the fact that all these balances pertain to Government Department, it is the considered view of the management that there could be procedural delays on account of Government rules and regulations and budgetary control but nevertheless these accounts are fully recoverable, and it is only a matter of time.

 

4. In view of the above, the management on its considered view, best judgment and prudence, does not feel it necessary to increase the reserve and surplus artificially by recognising deferred tax assets in the books of account. The company has also stated that as per paragraph 16 of AS 22, “While recognising the tax effect of timing differences, consideration of prudence cannot be ignored” (emphasis supplied by the querist). 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 certainty would normally be achieved by examining the past records of the enterprise and by making realistic estimates of profit for the future.

 

5. The company feels that the view taken by the AG Rajasthan is only a theoretical view which does not take into consideration, the practical aspects and the judgment of the company that all these dues of debtors, loans and advances, earnest money deposits and security deposits on which the provisions have been made are of the Government Department, where some delays could happen due to procedural delays but the amount will nevertheless be recovered. Relying on the view of the company, the statutory auditors have also endorsed and no DTA has been created in the books of account. The auditor’s report clearly states that the true and fair view of the company is not affected by non-creation of DTA, which in view of the past records and fact that the dues are government dues, is not in contravention of AS 22.

B.Query

6. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether it is non-compliance of AS 22 and generally accepted accounting principles (GAAPs) if DTA is not created based on the inputs as stated above in respect of virtual certainty of recoverability of debtors, loans and advances, earnest money deposit and security deposit.

or

Whether the management of the company and auditors will have to evaluate the probability and certainty of DTA realisation in view of the collection history, nature of dues, their probable recoverability and then determine whether the DTA can be accurately ascertained, measured and if the recovery is virtually certain, then whether there are requirements to create the DTA.

 

(i).If the treatment adopted by the company is correct, whether any further disclosure is called for in accounting policy/ notes to accounts.

(ii). If the treatment adopted by the company is not correct, an alternative method of accounting or disclosure thereof may be suggested.

C. Points considered by the Committee

7. The Committee notes that the basic issue raised by the querist relates to creation of DTA in respect of provisions for doubtful debts made in respect of debtors, loans and advances, earnest money deposits and security deposits. Accordingly, the Committee has considered only this issue and has not examined any other issue arising from the Facts of the Case, such as,  computation of deferred tax assets, etc. Further, the Committee wishes to point out that its opinion is expressed purely from accounting point of view.

 

8. The Committee notes that as per AS 22, the ‘timing differences’ are “the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods”. The Committee notes that creation of provisions for doubtful debts made in respect of debtors, loans and advances, earnest money deposits and security deposits gives rise to timing differences which have deferred tax implications.

 

9. The Committee notes that the debtors, loans and advances, earnest money deposits and security deposits in the extant case are of the nature of ‘receivables’ and the provisions for their non-recovery are covered by Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’). The Committee notes that the Standard requires a provision to be made in respect of receivables only when it is ‘probable’ that it has been impaired.  The Committee notes that an event is regarded as ‘probable’ if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not. Thus, creation of a provision requires application of judgement regarding recovery in the facts and circumstances of the case. The Committee notes from the Facts of the Case that the company has made provision in respect of the above-said receivables at the insistence of the auditors. Therefore, without going into the correctness of the judgement of the company and auditors, the Committee has presumed that the provision on receivables has been made in accordance with the requirements of AS 4. With regard to creation of deferred tax assets on such provisions, the Committee notes paragraphs 13, 15 and 16 of AS 22, notified under the Companies (Accounting Standards) Rules, 2006, which provide as below:

“13. Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-18.
…”

“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 certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future.”

 

10. From the above, the Committee notes that the term ‘prudence’ contained in paragraphs 15 and 16 of AS 22, has been used in relation to reasonable certainty regarding availability of sufficient future taxable income for realisation of deferred tax assets. The term ‘prudence’ has not been used in these paragraphs with reference to the realisability of the debts against which provision has been created, as argued by the querist in paragraph 4 above. Therefore, the Committee is of the view that deferred tax assets should be recognised as per AS 22 in respect of provisions for non-recoverability of debtors, loans and advances, earnest money deposits andsecurity deposits provided there is a reasonable certainty that sufficient future taxable income will be available.

 D.  Opinion

11.On the basis of the above, the Committee is of the following opinion, on the issues raised in paragraph 6 above:

 

(i) Presuming that provisions have been correctly created, as discussed in paragraph 9 above, it is non-compliance of AS 22 and GAAPs, if DTA is not recognised in respect of provisions against doubtful debts, loans and advances, earnest money deposits and security deposits, provided there is reasonable certainty of sufficient taxable income.

 

(ii). Since the treatment adopted by the company is not correct, answer to this question does not arise.

 

(iii). DTA should be recognised as per the provisions of AS 22 in respect of provision against doubtful debts, loans and advances, earnest money deposits and security deposits, as discussed in paragraphs 8 to 10 above and appropriate disclosures as per the requirements of AS 22 should be made.

 

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1Opinion finalised by the Committee on 26.12.2012 and 27.12.2012.