New accounting regime for taxation from finmin soon
July, 25th 2011
A key hurdle to implementing International Financial Reporting Standards (IFRS) in India is set to be removed. The finance ministry, which flatly refused to endorse IFRS for taxation purposes, has now started work on developing a new set of indigenous accounting standards, which would be capable of accurately estimating the tax liability of India Inc. The new India-specific standard will be marked by its flexibility to suit different types of businesses. It will also reconcile the Direct Taxes Code which would replace the Income Tax Act once Parliament approves it with the IFRS.
The finance ministry move would mean that IFRS and the new standards for taxation would co-exist and companies could achieve compliance with both with relative ease. The larger companies will be the first to adopt IFRS.
The finance ministry had earlier expressed the fear that IFRS-compliant financial statements would allow a greater degree of volatility in the profits of companies, and could go against the ministrys interests of ensuring a steady tax revenue flow.
The new standards for taxation purposes would seek to clearly define the heads of expenditure and liabilities to avoid any under-reporting of profits. These would be notified by the ministry after the finalisation of the draft currently under preparation. The draft will soon be put in public domain along with a discussion paper.
According to official sources, the proposed Indian accounting standards for taxation would be totally delinked from the existing Indian GAAP (generally accepted accounting principles) and the soon-to-be adopted IndAS, the Indian variant of IFRS. Unlike the Indian GAAP, IndAS is considered to be a truer reflection of a companys financial health since it is based on fair valuations of assets. For instance, once IFRS (IndAS) is adopted, Indian firms would be required to disclose the actual market value of an asset in their financial statements determined by an independent valuer as opposed to recording the historical cost of the asset which has been followed till date under Indian GAAP.
According to an official working on the draft of the new standards for computing the tax liability of a company, the government would come out with as many as 30 different variants or systems of these standards, which would be industry-specific in nature.
Companies will be free to choose a system closest to its business of operation. We are in the final stages of completing the rough draft for the new standards, the official said. He added that the final draft would then be sent to the Prime Ministers Office for approval before it is notified.
It is expected that of the 30 industry-specific standards for taxation purposes, five would be ready over next couple of months. All the 30 systems would eventually be notified in phases to give enough time to the industry to shift its accounting to the new system as they also do prepare accounts under IFRS.
Since the corporate affairs ministry laid out a road map for IFRS convergence last year, the finance ministry has been wary of using the new standards for taxation purposes. In an interview with FE, the former revenue secretary Sunil Mitra had categorically said that his department would not recognise IFRS for taxation purposes since it could lead to under-reporting of profits, severely impacting tax collections.
The finance ministry also fears that since IndAS seeks to reflect the actual market value of an asset any fluctuation in its value could prevent a steady tax revenue flow. Since taxation is based on the actual transaction between two parties where an asset gains significance only if it is bought or sold, the concept of notional gain or loss might not always be in conformity with the accepted principles of taxation in the country. For instance, if the asset prices go up, then firms would be required to pay capital gains tax even if the asset is not actually sold. The reverse is also equally possible whereby a company purposely chooses to reflect a lower tax liability once its asset prices goes down, despite them not actually incurring a loss in a transaction.
Similarly under Indian GAAP, redeemable preference share is treated as share capital, whereas IFRS treats it as debt. Thus, the dividend paid on preference share is an interest liability, which is deducted from taxable income under IFRS. However, Indian GAAP does not permit this tax protection as dividend is treated as an appropriation (a way of utilising profits.) In the new standards that we are developing, tax liability would be clearly defined. This would avoid any possible litigation and also avoid under-reporting of profits, the government source added. He added that the new standards would also reconcile the differences between the DTC, which is now before a parliamentary standing committee, and IFRS.
Responding to the development, former finance minister Yashwant Sinha told FE that having a new set of accounting standards for taxation purposes is the correct move. He, however, cautioned against coming out with multiple systems, since it could create confusion. Indigenisation (of a new standard for taxation) is fine but it must be simple, he added. Leading companies and IFRS experts welcomed the move. Ravi Sud, chief financial officer at the countrys largest two-wheeler maker Hero Honda said: This is a good step by the government and we welcome it. If taxation is based on fair value, then you land up taxing notional income and losses. It would not be desirable. CFO of a leading manufacturing company, on condition of anonymity, said that if the government does not want Indian firms to follow the GAAP for taxation purposes, a new set of standards which are easy and clear to understand must be brought out.
Founding director of Delhi-based Thought Arbitrage Research Institute Kaushik Dutta said that since filing financial statements in IFRS format is meant for investors, it cannot be used for taxation purposes. Partner and national leader (IFRS Services) at Ernst & Young Dolphy DSousa said that since the finance ministry would issue its own standards for taxation it could perhaps be an indication of IFRS being adopted sooner. According to the roadmap prepared by MCA, top Indian corporate houses in the Sensex and Nifty were required to converge to IFRS by April 1, 2011. However, owing to finance ministrys opposition and its lack of clarity on taxation the final notification has been indefinitely delayed.