The transition to the new Indian Accounting Standards (Ind AS) continues to be a taxing affair for Indian companies. The Central Board of Direct Taxes (CBDT) issued a circular on July 25, 2017, providing further guidance and clarifications on the computation of book profit for payment of Minimum Alternate Tax (MAT) for companies that follow Ind AS.
This circular comes almost a month after all listed companies have announced their first annual results in accordance with the new Indian Accounting Standards (Ind AS), and a few months after the Income Tax Act, 1961 was amended vide Finance Bill, 2017 to deal with computation of MAT for companies reporting under Ind AS. However, late is certainly better than never, and this guidance is still timely as most companies are yet to file their first tax return after their transition to the Ind AS framework.
MAT and its interplay with Ind AS transition have been subjects of great debate and resulted in the formation of the MAT-Ind AS Committee, whose report formed the basis for the MAT-related amendments in the Finance Bill, 2017. However, the final draft of the Bill wasn’t entirely in line with either the Committee report or the memorandum to the Finance Bill, which led to numerous questions and representations being made to the CBDT seeking clarity on some of these inconsistencies as well as certain unintentional unintended consequences of those amendments. This ultimately prompted the CBDT to issue FAQs.
The circular essentially deals with two key areas – first, the determination of the ‘transition amount’ as defined in the Act, and second, the adjustments, if any, to be made to the Ind-AS profit, in computing book profit on an ongoing basis. Transition amount refers to the adjustments made to the reserves on the convergence date in relation to the transition to Ind AS.
In each of the above areas, the guidance emanating from these FAQs can be further grouped into two categories - one which provides clarificatory and procedural guidance on the existing provisions of the Act and the second which prescribes certain additional requirements over and above what is stated in the Act. On the whole, while these changes are welcome, it does raise the question of the validity of some of these changes and whether these can be challenged subsequently, in particular areas where it goes beyond what is stated in the Act.
In some ways, the situation is not very different to what was witnessed just a couple of years back when the new Companies Act was being rolled out.
Numerous circulars were issued to ease the implementation, some of which were seen as seeking to override the provisions of the law itself. We may have a similar situation here where certain parts of this circular may be seen as overriding the provisions of the Act.
Computation Of Transition Amount
The Finance Act, 2017, has introduced a definition of ‘transition amount’, clearly articulating how it is to be calculated and the specific adjustments that need to be included in arriving at that amount. The correct determination of the transition amount is highly pertinent as one-fifth of this amount is added to the book profit over five years starting with the year of convergence.
However, the circular seeks to make certain additional adjustments to the transition amount over and above what was envisaged in the Act. The circular essentially seeks to exclude certain items that shouldn’t have been included in the transition amount, such as proposed dividend, deferred taxes, reclassification between equity accounts, etc., as the intent of the law may not have been to subject such items to MAT. Some of these items are also excluded when computing book profits under the current MAT provisions.
While there may be a sound rationale for requiring these additional adjustments, as they seek to deal with some of the unintended consequences of how the Finance Bill was drafted, it raises the question of whether a CBDT circular can provide enough legal sanctity to these changes.
Some of these changes could be seen as being detrimental to the interest of the taxpayer, such as the adjustments relating to the diminution in the value of certain assets or the interest cost recorded on preference shares that have been classified as a liability under Ind AS. The table below provides a list of the adjustments as originally envisaged in the Act and also the additional adjustments that are now required as per this circular.
These changes are not just clarifying the current provisions of the Act, but making fairly substantive changes to the formula and could lead to potential litigation as well.
The circular also provides clarity on how companies that follow the calendar year for statutory financial reporting would compute their transition amount for tax reporting, and the need to use a split period approach, whereby in the year of transition, 9 months would be prepared using the old accounting standards and the balance 3 months would use Ind AS.
Ongoing Computation Of Book Profit
On the manner of computation of book profits on an ongoing basis for companies covered under Ind AS, the memorandum to the Finance Bill specifically states “No further adjustments to the net profits before other comprehensive income of Ind AS compliant companies, other than those already specified under Section 115 JB of the Act shall be made.” However, the circular now seeks to make certain adjustments to be reported net profits for the purpose of computation of book profits for levy of MAT.
One of the adjustments discussed in the circular relates to dividend/interest on preference shares (including dividend distribution tax). As per the adjustments already specified under Section 115 JB of the Act, the book profit shall be increased by the amount or amounts of dividends paid or proposed. While the intent of Circular may be to clarify that any dividend paid or proposed on preference shares should be added back while computing book profits, the use of the words ‘dividend/interest’ may now lead to a position that the entire interest recorded in the profit and loss statement on account of these preference shares be added back.
It is important to note that the accounting under Ind AS for interest on preference shares is done using the ‘effective interest rate method’, which would result in the interest cost recorded each year as different from the dividends paid or payable on those instruments in those years.
Therefore, the adjustment of the total interest recorded on the preference share would tantamount to making further adjustments to the net profits over and above those already specified under the Act.
While the circular only refers to adding back the dividend or interest on preference shares, the same principles may very well get extended by the tax authorities to similar instruments that have dividend or interest payments attached and are accounted in the Ind AS financial statements as liability instruments. Further, there may be preference shares on which there is no dividend payable, but for which an interest cost is recorded in the books (to account for the redemption premium, etc.). On such instruments, under the provisions of the Act, no adjustment is required to be made, whereas the tax authorities may take a different position pursuant to the provisions of this circular.
One can rationalise that the attempt of the CBDT was to provide clarity to tax payers and to extend the principles within the existing Section 115 JB to the way the transition amount is computed. However, in doing so through this circular, it appears that some of the changes go beyond what was originally stated in the law.
This, in turn, could provide grounds to the tax authorities for opening up a number of other adjustments, which have not been currently envisaged in the circular, by using a similar principle.
A simpler approach could have been to amend the Act to require that adjustments using principles similar to those specified in 115 JB for computation of book profit would apply to the computation of the transition amount as well.
If the intent of the circular was to provide clarity and certainty to companies, there is still some way to go before companies can rest easy after all the arduous effort in transitioning to Ind AS.
Sai Venkateshwaran is a partner and head of accounting advisory services at KPMG in India.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.