The much-touted global accounting system based on the International Financial Reporting Standards (IFRS) is not acceptable to the Indian taxman. For the purposes of taxation, companies will have to continue with the historical system of accounting because IFRS allows significant under-reporting of profits, revenue secretary Sunil Mitra told FE. He asserted that the revenue department would not notify IFRS as a system of accounting for taxation purpose.

The official, however, added the revenue department wont have any objection to firms keeping their accounts in the IFRS system also, for the benefit of investors. As per the corporate affairs ministrys schedule, a section of Indian Inc comprising the Nifty and Sensex companies were supposed to converge their opening balance sheets with IFRS by April 1, 2011. The ministry has failed to implement the schedule, owing to the finance ministrys ambivalence to the proposal, and also resistance from many leading companies. This is for the first time the finance ministry has come on record against the IFRS.

The IFRS system of accounting captures a more realistic picture of a companys financial health than the conservative Indian GAAP (generally accepted accounting principles). The main virtue of IFRS is that it requires companies to show the actual market value of assets instead of their cost of purchase, which would help investors and shareholders get a better idea of the fair value of the firms investments. The GAAP is largely based on historical costing and prudence. It does not have standards for business combinations (M&As) and derivatives.

The IFRS system is followed in more than 100 countries including the EU nations, Canada and Australia. The US has its own GAAP for domestic companies while foreign companies listed on the country's stock exchanges are allowed to furnish IFRS-compliant accounts. It is our conscious decision not to accept IFRS system for tax purposes. And we are not alone here; most countries in the world have followed this approach. Even the US does not have IFRS for tax purposes, Mitra said.

Our system is not ready yet to accept the IFRS system as a recognised system for income-tax purposes, he said. When you switch over from a historical costing system to a market value system, you can assign valuations which can lead to significant under-reporting of profits. This could lead to under-reporting of corporate income, Mitra said.

Unlike the investors and shareholders, the tax department is not concerned about the fair value gains or losses. It is interested in only the profits realised by the firm. There is no reason to delay the IFRS adoption citing concerns over taxation.

Investors and shareholders would benefit from IFRS-based accounting system. If the tax department wants to continue with Indian GAAP, so be it, said Dolphy D'Souza, partner and national leader, IFRS services, Ernst & Young.

The concern is that frequent reassessment of assets and liabilities based on fluctuating market value would raise problems in taxation, which is based on the cost of purchasing the asset. The tax authorities have serious concerns over the sentiment-driven volatility integral to fair valuation of assets and liabilities, which could lead to under-reporting of income.

For the purpose of taxation, the market value of an asset becomes meaningful only when it is sold or bought. Adoption of fair valuation of assets for preparing financial statements would lead to a situation where companies may be asked to pay tax on gains or appreciation of assets even if they are not sold. Similarly, companies can show a lower tax liability when asset prices go down, even if they have not actually incurred that loss in a transaction.

The corporate affairs ministry was supposed to ensure that Indian accounting standards are fully convergent with the IFRS. The ministry had notified 35 IFRS-compliant accounting standards (Ind-AS) on February 25, 2011. It has issued a revised schedule VI under the Companies Act, which is applicable from April 1, 2011. The ministry has now lobbed the ball in the finance ministrys court by saying that Ind-AS will be implemented after various issues including tax-related issues are resolved.

With the finance ministry not notifying the IFRS system, it has created confusion among companies that were preparing to adopt the new set of accounting standards from the beginning of the financial year. They do not know which set of accounting standards (AS or Ind-AS) will now be applicable in the preparation and presentation of financial statements.

The companies are faced with a problem because for taxation they have to prepare accounts as per the Indian GAAP, and the IFRS profit numbers will be very different from the profit numbers on India GAAP.

Convergence with IFRS is expected to help Indian companies in an increasingly globalised world. Now that over 100 countries have already adopted the system, corporate India's overseas acquisitions would be facilitated by the adoption of IFRS. It would also come handy in the efforts of homegrown firms to float companies in foreign countries, and get listed on exchanges abroad.

Source: http://www.financialexpress.com/news/ifrs-system-not-conducive-for-taxation-purposes-says-mitra/772775/1