Budget 2017: The MAT Impact On Corporate Earnings
As India Inc is steering through the last quarter of the year, it is time to start preparing for closure of the current fiscal and plan ahead for the next. This year-end is also particularly important for the largest of Indian companies, as it’s the first year of reporting under the new IFRS converged Indian Accounting Standards (Ind AS). While the companies have reported three quarters under Ind AS, there was still one large uncertainty that they have been grappling with: what is the tax cost and the tax outflows associated with the transition to Ind AS?
The discussion and debate on the tax implications has been going on for a while, and part of the issue was settled when the CBDT issued Income Computation and Disclosure Standards (ICDS) to bring some parity to the way companies compute their taxable income irrespective of the accounting standards they use for their financial reporting. However, the issue of bringing the same horizontal equity for computation of Minimum Alternate Tax (MAT) wasn’t settled yet and so there were a lot of expectations from Budget 2017 to provide some certainty.
As expected, the budget has proposed detailed amendments to Section 115JB on how companies that report under Ind AS should compute book profits for MAT calculations. This addresses both the adjustments that are to be made to annual reported Ind AS profits as well as those relating to adjustments made to opening reserves on the date of transition to Ind AS.
Equitable Transition?
While there is clarity now, the objective of horizontal equity between companies following Ind AS and the old standards doesn’t seem to have been achieved for reasons discussed hereafter.
The proposals state that profit as per Ind AS will be the starting point for computation of MAT, with just one incremental adjustment relating to gains and losses on demergers.
This essentially means that a company that now moves from a historical cost-based accounting framework to a framework that uses fair values to a great extent, is likely to see lot more of fair value gains and losses reflected in its profit & loss account.
This when read with the budget proposals also means that these fair value gains, which are unrealised, will now be subject to MAT, resulting in potentially higher tax outflows although the underlying gains are unrealised, possibly notional and susceptible to reversal in a subsequent period.
To illustrate, say a company has a profit of Rs 100 crore as per old Indian GAAP and would have a MAT liability of Rs 20 crore. When the same company recasts its earnings under Ind AS, it posts a profit of Rs 150 crore, an increase of Rs 50 crore on account of recognition of certain fair value gains on some derivative contracts, investments in mutual funds and other equity investments, etc. By just moving from one accounting framework to another, the company’s MAT liability has gone up from Rs 20 crore to Rs 30 crore. And that is why there isn’t horizontal equity between companies.
This stems from the fact that the Companies Act, 2013 permits a company to distribute all its profits as dividend; so technically the company in the example above could distribute all its Rs 150 crore in a dividend even though a lot of it is represented by unrealised gains. However, the tax authorities seem to go by the principle that if profits can be distributed as dividend, they should be subject to MAT as well. So any changes to these proposals will need to go hand in hand with changes to the dividend distribution norms for companies under Ind AS.
Demergers Remain Tax Neutral
Unlike tax law, where demergers are tax neutral and are done at book values, under Ind AS, such transactions are generally done at fair values, with the resultant gain/loss being routed through the profit and loss statement and the corresponding distribution to shareholders being recorded at the fair values of the assets transferred.
The budget proposals provide that any such gain/loss on a demerger would be disregarded for MAT purposes, thereby taking away the uncertainty over the taxability of such gains.
Therefore, like before, demergers are expected to remain tax neutral from a MAT perspective as well.
However, a related change that the budget proposals have brought in is the accounting in the resulting company’s books. While under Ind AS, the resulting company may record the assets received at their fair values, they will need to revert to the original book values in the demerged company for MAT purposes, as per these proposals. This means that the resulting company would need to maintain parallel records for a reasonable period of time.
Adjustments For Items Recorded In OCI
Under Ind AS, there are certain items representing gains or losses or changes in values of assets and liabilities that are not routed through the profit and loss statement and instead routed through a statement of ‘Other Comprehensive Income’. The budget proposals suggest a sensible approach to tax such items with the general principle being to include these items in book profits in the year when they are realised or when they are reclassified to profit and loss statement, barring one exception on actuarial gains and losses on defined benefit plans, which are added to book profits each year.
First Time Adoption Adjustments Recorded In Opening Reserves
The budget proposals also suggest certain adjustments to be made in relation to the one time effect of transition to Ind AS. An analysis of 34 of the BSE 100 companies that published their balance sheets as per Ind AS as at March 31, 2016, shows that the net effect of the adjustments made to their net worth at that date is in excess of Rs 50,000 crore. Since these adjustments may or may not get routed through the profit and loss statement in subsequent periods, the budget proposals seek to provide a framework to subject these to MAT.
Many of the large items of Ind AS adjustments made on the transition date, including those relating to fair valuation or revaluation of fixed assets, will be considered in the computation of book profits only in the year when these assets are sold or disposed. This is quite sensible and the tax outflow will be aligned to the realisation of the underlying assets.
For the remaining adjustments, the proposals suggest that these be adjusted to book profits equally over a five year period, starting with the year of transition to Ind AS. As a result, there are still a few items such as fair valuation of mutual funds or equity investments, fair valuation of derivatives, lease accounting, including embedded leases, business combination accounting, etc. that are likely to get taxed upfront over a period of five years, even though the related gains/losses may not be realised within that period.
The Way Ahead
On the whole, the Central Board of Direct Taxes (CBDT) has considered a fairly practical approach to dealing with MAT computations for Ind AS companies. From a regulatory standpoint, the only one ask, but a fundamental one, is to bring in horizontal equity between Ind AS reporting companies and others, for which the CBDT and Ministry of Corporate Affairs would need to work closely. From a corporates standpoint, it is now time to reassess all their Ind AS accounting policy choices and transition date adjustments in light of the clarity on the tax implications and make the necessary changes before closing their annual accounts in March this year.
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.