Query No. 17 Subject: Application of paragraph 21 of AS 22. 1
1. A company is a public limited company listed with recognised stock exchanges, engaged in manufacturing of cementitious material on Pan India basis (hereinafter referred to as the ‘company'). The company follows calendar year. In Union Budget for the financial year 2015-16 presented on 28th February 2015, the Government has revised the surcharge on income tax from 5% to 10%, resulting in increase of effective ‘Corporate Tax' rate from 33.99% to 34.61%.
2. The querist has stated that as per Accounting Standard (AS) 22, ‘Accounting for Taxes on Income', companies are required to recognise deferred tax on its temporary difference between book income and taxable income as per prescribed rate. Paragraph 21 of AS 22 says “deferred tax should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date.” According to the querist, as per Accounting Standard, it is important to note that the enactment or substantive enactment should have taken place by the balance sheet date. Enactment is when a bill is passed by both houses and receives consent of the President. It is important to note that the enactment or substantive enactment should take place by the balance sheet date, for example, if an enterprise has a December year end, the Finance Bill presented subsequently in February is neither an enactment nor a substantive enactment because it did not occur by the balance sheet date.
3. The querist has stated that the company is in the process of finalisation of its quarterly accounts for the quarter ended March 2015. Its board meeting for consideration and approval of results is scheduled on 29th April 2015. In order to finalise quarterly results for March 2015, the company has to decide the meaning of the word used in AS 22, ‘substantive enactment'. What is ‘substantive enactment'? At which point of time, substantive enactment should be considered/triggered. Whether substantive enactment of the Finance Bill 2015 (Budget) took place on the balance sheet date.
4. The querist has explained various stages for approval of Finance Bill as follows:
Further, the querist has also mentioned various possible situations where substantive enactment of Finance Bill may be considered:
The querist has stated that in all above situations, it is assumed that the President’s assent will be certain.
5. According to the querist, the following approach, viz., conservative versus aggressive approach, should be considered while deciding on above question:
6. Accounting treatment of change in effective tax rate:
The querist has also raised a question that in case of change in effective tax rate, what treatment should be given to opening deferred tax position, viz., whether it should be taken to free reserves or to the statement of profit and loss. For example, Companies Act, 2013, has made changes and it has changed the way depreciation was charged till date. All the companies need to apply these changes retrospectively. Here option is given to take the impact of depreciation till last year either in the statement of profit and loss of current year or adjust the same in retained earnings.
B. Query
7. In the above background, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points considered by the Committee
8. The Committee notes that the basic issues raised by the querist relate to application of paragraph 21 of AS 22 in relation to meaning of ‘substantive enactment' in the context of corporate tax rate, for finalisation of quarterly accounts of the company for quarter ended March 2015 and accounting treatment for effect of change in effective tax rate. Accordingly, the Committee has considered only these issues and has not examined any other issue that may arise from the Facts of the Case, such as, impact of following calendar year as the accounting year, etc. Further, while expressing its opinion, the Committee is laying down the principles to be followed in cases where a revision in tax rates has been announced/introduced but the same has not yet been enacted.
9. The Committee notes from the Facts of the Case that the company follows calendar year as the accounting year for the purpose of preparation of financial statements. Further, in Union Budget for the financial year 2015-16 presented on 28th February 2015, the Government has revised the surcharge on income tax from 5% to 10%, resulting in increase of effective ‘Corporate Tax' rate from 33.99% to 34.61%. However, till finalisation of quarterly accounts of March 2015, the revision has not yet been enacted (e.g., President's assent has not yet been accorded). Accordingly, the issue that arises is whether in such situation, can such proposed revision in tax rates be considered as substantively enacted for recognition of deferred taxes as per AS 22. In this regard, the Committee notes the following requirements of AS 22, notified under the Companies (Accounting Standards) Rules, 2006, (hereinafter referred to as the ‘Rules') as follows:
From the above, the Committee notes that in case certain changes are proposed in tax rates, the term ‘substantively enacted' should be construed as the tax rate that has the substantive effect of actual enactment. In other words, the process of enactment is substantively complete. The Committee is of the view that whether the process of enactment is substantively complete is a matter of judgement, which should be determined considering the facts and circumstances and various factors, such as, whether or not the remaining stages of the enactment process in past have affected the outcome (i.e., enactment of surcharge in the extant case) and are likely to do so in the present situation, viz., the process remaining to be executed for enactment is more of a procedural formality and is not expected to affect the outcome, etc. For example, in most cases, a tax rate for the purposes of AS 22 is regarded as having been substantively enacted if the Bill containing such changed tax rate has been passed by the Lok Sabha and is awaiting passage through the Rajya Sabha and the President's assent. The Committee is also of the view that adequate and appropriate disclosures should be made regarding the tax rate adopted while recognising deferred tax assets and liabilities and the basis for such adoption in the notes to accounts.
10. With regard to accounting impact of changes in effective tax rates in the next reporting period resulting into any increase or decrease in the recognised deferred tax assets or liabilities, the Committee notes the requirements of Accounting Standard (AS) 25, ‘Interim Financial Reporting' and Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies', notified under the Rules, as reproduced below:
From the above, the Committee is of the view that the income tax rate applied in an interim period is an accounting estimate and effects of any change in such estimates resulting into income or expenses in another reporting period should be recognised in the statement of profit and loss. Further, paragraphs 16(d), 25 and 26 of AS 25 also requires disclosure in the interim financial report or financial statements (for final interim period in case separate financial report is not prepared for that period) of the nature and amount of changes in estimates of amounts reported in prior interim periods of the current financial year if such changes have material effects in the current interim period. In this regard, the Committee also wishes to point out that any adjustment to free reserves or retained earnings is possible only if there is any specific requirement in the accounting standard(s) or law to do so.
D. Opinion
11. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7 above:
___________ 1 Opinion finalised by the Committee on 1.2.2016.
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