Taxes under Ind AS Regime
“We have not yet completed the disclosure requirement of Effective Tax Rate” – said Mr. Arth, CFO of Peace Ltd. He continued saying, “I know how to deal with timing differences under previous GAAP. I have been preparing these notes for last few years. We have been using Income Tax computation and accounting profit to conclude disclosures under previous GAAP”. He paused for a second.
We all could sense his last-minute anxiety. Everyone around him was talking about Timing differences in previous GAAP and Temporary differences under Ind AS but no one was conclusively explaining him the exact difference between the two. We decided to tackle his anxiety by going right deep into the concept and explained him the basics of deferred taxes.
- AS 22 and Ind AS 12, both deal with recognition of deferred tax assets (DTA) and deferred tax liabilities (DTL).
- However, the two standards differ on two accounts:
- Approach for determining deferred tax assets and liabilities, and
- The basis of comparison, to compute the deferred tax asset or liability
In this blog, we have explained the nitty-gritties of these differences in AS 22 and Ind AS 12.
- First major differences between AS and Ind AS is the approach for determining deferred tax assets and liabilities. While AS 22 had an Income Statement based approach for computing deferred tax assets and liabilities, Ind AS 12 prescribes a Balance Sheet based approach.
So, what is the difference between the two approaches?
First, under AS 22, we computed deferred tax asset or deferred tax liability on the difference between ‘taxable income’ (computed as per Income-tax Act, 1961) and ‘accounting income’ (i.e. Profit/ Loss as per books of accounts). Under Ind AS 12, deferred tax asset or deferred tax liability is computed on the difference between the carrying amounts of assets and liabilities in the Balance Sheet and their ‘tax base’.
Let us understand the concept of ‘tax bases’ under Ind AS 12.
The tax base of an asset or liability is the amount attributed to that asset or liability for tax purposes.
- The tax base of an asset is the amount that will be deductible for tax purposes against any taxable economic benefits that will flow to an entity when it recovers the carrying amount of the asset. If those economic benefits will not be taxable, the tax base of the asset is equal to its carrying amount.
For example: A machine has cost of ₹100. For tax purposes, depreciation of ₹30 has already been deducted in the current and prior periods. The remaining cost of ₹70 will be deductible in future periods, either as depreciation, or through a deduction on disposal.
Revenue generated by using the machine is taxable. Any gain on disposal of the machine will be taxable and any loss on disposal will be deductible for tax purposes.
The tax base of the machine is ₹70.
- The tax base of a liability is its carrying amount, less any amount that will be deductible for tax purposes in respect of that liability in future periods. In the case of revenue which is received in advance, the tax base of the resulting liability is its carrying amount, less any amount of the revenue that will not be taxable in future periods.
For example: A loan payable has a carrying amount of ₹100. The repayment of the loan will have no tax consequences. The tax base of the loan is ₹100.
Another example is: Current liabilities include accrued expenses with a carrying amount of ₹100. The related expense has already been deducted for tax purposes. The tax base of the accrued expense is ₹100.
Second point of difference is, AS 22 analyzed ‘Permanent Difference’ and ‘Timing Difference’ whereas Ind AS 12 analyses ‘Temporary Differences’. Let us understand these concepts one by one.
- There are two types of differences between taxable income and accounting income as per AS 22:
- Timing Difference: The difference that originates in one period, and is capable of reversal in subsequent period(s). For example: Depreciation under companies act differs with depreciation/ additional depreciation under Income-tax Act, 1961
- Permanent Difference: The differences that originate in one period, and cannot be reversed in subsequent periods(s) example: Penalty for contravention of law is non-deductible under computation of tax profits, however, accounted as an expense under computation of accounting profits.
Please note that Accounting Profit is not equal to Book Profits. Book Profit is used for computation of Minimum Alternative Tax and Accounting Profit is used for calculation of Current Tax. Difference between tax profit and accounting profit comprises of either timing difference or permanent difference. On timing differences, we previously created deferred tax assets/ liabilities under AS 22.
Now, under Ind AS 12, there are temporary differences. There are two types of temporary differences.
- Taxable temporary difference: Differences that will result in taxable amounts while determining taxable profit (or loss) of future periods, when the carrying amount of the asset or liability is recovered or settled.
- Deductible temporary difference: Differences that will result in amounts that are deductible while computing taxable profit (or tax loss) of future periods, when the carrying amount of the asset or liability is recovered or settled.
- The carrying amount of any asset is recovered in form of economic benefits that flow to the entity in future tax periods. When the carrying amount of the asset exceeds its tax base, the amount of taxable economic benefits will exceed the amount that will be allowed as a deduction for tax purposes. This difference is a taxable temporary difference, and the obligation to pay resulting income taxes in future period(s) is a deferred tax liability.
Let us understand this with the help of an example.
An asset which cost ₹150 has a carrying amount of ₹100. Cumulative depreciation for tax purposes is ₹90 and tax rate is 25%.
The tax base of the asset is ₹60 (Cost of ₹150 less cumulative tax depreciation of ₹90). To recover the carrying amount of ₹100, the entity must earn taxable income of ₹100, but will only be able to deduct depreciation of ₹60. Consequently, the entity will only be able to deduct tax depreciation of ₹60. Consequently the entity will pay income taxes of ₹10. (₹40 x 25%) when it recovers the carrying amount of the asset. The difference between the carrying amount of ₹100 and the tax base of ₹60 is a taxable temporary difference of ₹40. Therefore, the entity recognises a deferred tax liability of ₹10 (₹40 x 25%) representing the income taxes that it will pay when it recovers the carrying amount of the asset.
The standard states that temporary differences may arise even on initial recognition of exampleThere are some difficult concepts under Ind AS 12. For asset. In such scenario, entity shall not recognise deferred tax liability.
Let us try to understand this complex concept with the help of an example.
An entity intends to use an asset, the cost of which is ₹1000, throughout its useful life of 5 years and dispose it of for residual value of nil. The tax rate is 40%. Depreciation of the asset is not deductible for tax purposes. On disposal, any capital gain would not be taxable and any capital loss would not be deductible.
As it recovers the carrying amount of the asset, the entity will earn taxable income of ₹1000 and pay tax of ₹400. The entity does not recognise the resulting deferred tax liability of ₹400 because it results from initial recognition of the asset.
In the following year, the carrying amount of the asset is ₹320. The entity does not recognise the deferred tax liability.
Mr. Arth was happy to have thought clarity on all the concepts. Ind AS Lab went one step ahead to offer him live examples of significant accounting policies and disclosures.
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