Accountin g Standard ( AS ) 22 347 Accounting for T axes on Incom e Contents OBJECTIVE SCOPE Paragraphs 1-3 DEFINITIONS 4-8 RECOGNITION 9-19 Re-assessment of Unrecognised Deferred Tax Assets 19 MEASUREMENT 20-26 Review of Deferred Tax Assets 26 PRESENTATION AND DISCLOSURE 27-32 TRANSITIONAL PROVISIONS 33-34 ILLUST R A TIONS 318 AS 22 (issued 2001) Accounting Standard (AS) 22 Accounting for T axes on Incom e (Thi s A ccountin g S tanda r d include s p aragraph s s et in bold i t alic typ e and plain type, which have equal authority. Paragraphs in bold italic typ e indicate the main principles. This Accounting Standard should be read i n the context of its objective and the General Instructions contained in part A of the Annexure to the Notification.) Objective The objective of this Standard is to prescribe accounting treatment for taxes o n income. Taxes on income is one of the significant items in the statement o f p rofit and loss of an enterprise. In accordance with the matchin g concept, taxes on income are accrued in the same period as the revenue an d expenses to which they relate. Matching of such taxes against revenue for a perio d p oses special problems arising from the fact that in a number of cases, taxabl e income may be significantly different from the accounting income. Thi s divergence between taxable income and accounting income arises due t o two main reasons. Firstly, there are differences between items of revenu e and expenses as appearing in the statement of profit and loss and the item s which are considered as revenue, expenses or deductions for tax purposes . Secondly, there are differences between the amount in respect of a particula r item of revenue or expense as recognised in the statement of profit and loss an d Scope 1. This Standard should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or savin g related to taxes on income in respect of an accounting period and th e disclosure of such an amount in the financial statements. 2. Fo r the purposes of this Standard, taxes on income include all domesti c and foreign taxes which are based on taxable income. 3. This Standard does not specify when, or ho w , an enterprise shoul d account for taxes that are payable on distribution of dividends and othe r distributions made b y the enterprise. Definitions A ccounting for Taxes on Income 349 4 . F o r the p urpose o f this S tandard , the f ollowin g terms a r e used with the meanings specified: 4.1 Accountin g income (loss) i s the ne t p ro fi t o r loss f o r a p eriod , a s reported in the statement of profit and loss, before deducting incom e tax expense or adding income tax saving. 4.2 T axable income ( t ax loss) i stheamoun t o f the income (loss) f o r a period, determined in accordance with the tax laws, based upon whic h income tax payable (recoverable) is determined. 4.3 T a x expense ( t a x savin g ) i sthea gg re g ate o f curren t ta x and de f erre d tax charged or credited to the statement of profit and loss for th e period. 4.4 Current ta x i s the amoun t o f income ta x determined t obe p a y able (recoverable) in respect of the taxable income (tax loss) for a period. 4.5 D e f erred t a x i s the t a x e f f ec t o f timin g d i f f erences. 4.6 Timin g d i f f erences a r ethedi f f erences between taxab l e income and accounting income for a period that originate in one period and ar e capable of reversal in one or more subsequent periods. 4.7 P ermanen t di f f erences a r ethed i f f erences between t axab l eincome and accounting income for a period that originate in one period an d do not reverse subsequently. 5. T axable income is calculate d in accordance with tax laws. In some circumstances, the requirements of these laws to compute taxable incom e differ from the accounting policies applied to determine accounting income . The effect of this difference is that the taxable income and accounting incom e may not be the same. 6. The differences b etween taxable income an d accounting income can b e classified into permanent differences and timing differences. Permanen t differences are those differences between taxable income and accountin g income which originate in one period and do not reverse subsequently. Fo r instance, if for the purpose of computing taxable income, the tax laws allo w only a part of an item of expenditure, the disallowed amount would result i n a permanent difference. 350 AS 2 2 7. T iming differences a r e those differences b etween taxable income an d accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. Timing differences aris e because the period in which some items of revenue and expenses ar e included in taxable income do not coincide with the period in which suc h items of revenue and expenses are included or considered in arriving at accounting income. For example, machinery purchased for scientifi c research related to business is fully allowed as deduction in the first yea r for tax purposes whereas the same would be charged to the statement o f p rofit and loss as depreciation over its useful life. The total depreciatio n charged on the machinery for accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed wil l differ. Another example of timing difference is a situation where, for th e p urpose of computing taxable income, tax laws allow depreciation on th e basis of the written down value method, whereas for accounting purposes , straight line method is used. Some other examples of timing difference s arising under the Indian tax laws are given in Illustration I. 8. Unabsorbe d depreciation an d car r yforwar d of losses which can b e set- off against future taxable income are also considered as timing difference s and result in deferred tax assets, subject to consideration of prudence (se e p aragraphs 15-18). Reco g nition 9. Tax expense for the period, comprising current tax and deferred tax , s hou l d be included in the determination of the net profit or loss for th e p eriod. 10. T axes on income are considered to b e an expense incurred b y th e enterprise in earning income and are accrued in the same period as the revenu e and expenses to which they relate. Such matching may result into timin g differences. The tax effects of timing differences are included in the ta x expense in the statement of profit and loss and as deferred tax assets (subject to the consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, in the balance sheet. 11. An example of tax effect of a timing difference that resul t s in a deferre d tax asset is an expense provided in the statement of profit and loss but no t allowed as a deduction under Section 43B of the Income-tax Act, 1961. Thi s A ccounting for Taxes on Income 351 timing difference will reverse when the deduction of that expense is allowe d under Section 43B in subsequent year(s). An example of tax effect of a timing difference resulting in a deferred tax liability is the higher charge o f depreciation allowable under the Income-tax Act, 1961, compared to th e depreciation provided in the statement of profit and loss. In subsequen t years, the differential will reverse when comparatively lower depreciatio n will be allowed for tax purposes. 12. Permanent differences do not result in deferre d tax assets o r deferre d tax liabilities. 13 . D e f erred t ax shou l d be reco g nised f or a l l the timin g d i f f erences, s ub j ect to the consideration of prudence in respect of deferred tax asset s as se t ou t i n p ara g ra p hs 15-18. E x p lanation: (a) The de f erred t ax i n respect o f timin g d i f f erences which reverse during the tax holiday period is not recognised to the extent th e enterprise’s gross total income is subject to the deduction durin g the tax holiday period as per the requirements of sections 80-IA/80 - IB of the Income-tax Act, 1961 (hereinafter referred to as the ‘Act’). In case of sections 10A/10B of the Act (covered under Chapter I I I of the Act dealing with incomes which do not form part of tota l income), the deferred tax in respect of timing differences whic h reverse during the tax holiday period is not recognised to the exten t deduction from the total income of an enterprise is allowed durin g the tax holiday period as per the provisions of the said sections. (b) D e f erred t a x i n respec t o f timin g d i f f erences which reverse a f te r the tax holiday period is recognised in the year in which the timin g differences originate. However, recognition of deferred tax assets i s subject to the consideration of prudence as laid down in p ara g raph s 15 to 18. (c) F o r the above p urposes , the timin g d i f f erences which ori g inate f irs t are considered to reverse first. The application o f the above explanation is illustrated in th e I llustration attached to the Standard. 352 AS 2 2 14. This Standar d requires recognition of defer r e d tax fo r all the timin g differences. This is based on the principle that the financial statements fo r a period should recognise the tax effect, whether current or deferred, of al l the transactions occurring in that period. 15 . E xcep t i n th e situations stated i n p ara g raph 17 , de f erred ta x asset s s hou l d be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be availabl e against which such deferred tax assets can be realised. 16. While recognising the tax effect of timing differences, consideratio n of prudence cannot be ignored. Therefore, deferred tax assets are recognise d and carried forward only to the extent that there is a reasonable certainty o f their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by makin g realistic estimates of profits for the future. 17 . Whe r e an enterprise has unabsorbed depreciation o r carr y f orwar d of losses under tax laws, deferred tax assets should be recognised only t o the extent that there is virtual certainty supported by convincing evidenc e that sufficient future taxable income will be available against whic h s uch de f erred tax assets can be realised. E x p lanation: 1 . D etermination o f virtua l ce r t aint y tha t su f f icien t f uture t axable incom e will be available is a matter of judgement based on convincing evidenc e and will have to be evaluated on a case to case basis. Virtual certaint y refers to the extent of certainty, which, for all practical purposes, ca n be considered certain. Virtual certainty cannot be based merely o n forecasts of performance such as business plans. Virtual certainty i s not a matter of perception and is to be supported by convincin g evidence. Evidence is a matter of fact. To be convincing, the evidenc e should be available at the reporting date in a concrete form, f o r example, a profitable binding export order, cancellation of which wil l result in payment of heavy damages by the defaulting party. On th e other hand, a projection of the future profits made by an enterpris e based on the future capital expenditures or future restructuring etc. , submitted even to an outside agency, e.g., to a credit agency f o r obtaining loans and accepted by that agency cannot, in isolation, b e considered as convincing evidence. A ccounting for Taxes on Income 353 2(a) As p er the relevan t p rovisions o f the I ncome-ta x Act, 1961 (hereina f te r referred to as the ‘Act’), the ‘loss’ arising under the head ‘Capita l gains’ can be carried forward and set-off in future years, only a g ains t the income arising under that head as per the requirements of th e Act. (b) Whe r e an enterprise ’ ss t atemen t o f p ro fi t and loss includes an item o f ‘loss’which can be set-off in future for taxation purposes, only against the income arising under the head ‘Capital gains’ as per th e requirements of the Act, that item is a timing difference to the exten t it is not set-off in the current year and is allowed to be set-off a g ains t the income arising under the head ‘Capital gains’ in subsequen t years subject to the provisions of the Act. In respect of such ‘loss’, deferred tax asset is recognised and carried forward subject to th e consideration of prudence. Accordingly, in respect of such ‘loss’, deferred tax asset is recognised and carried forward only to the exten t that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the hea d ‘Capital gains’ against which the loss can be set-off as per th e provisions of the Act. Whether the test of virtual certainty is f ul f ille d or not would depend on the facts and circumstances of each case. Th e examples of situations in which the test of virtual certainty, supporte d by convincing evidence, for the purposes of the recognition of de f erre d tax asset in respect of loss arising under the head ‘Capital gains’ i s normally fulfilled, are sale of an asset giving rise to capital g ain (eligible to set-off the capital loss as per the provisions of the Act) afte r the balance sheet date but before the financial statements ar e approved, and binding sale agreement which will give rise to capita l gain (eligible to set-off the capital loss as per the provisions of th e Act). (c) I n cases where there is a di f f erence between the amounts o f ‘loss’ recognised for accounting purposes and tax purposes becaus e of cost indexation under the Act in respect of long-term capital assets, the deferred tax asset is recognised and carried forward (sub j ec t to the consideration of prudence) on the amount which can b e carried forward and set-off in future years as per the provisions of th e Act. 18. The existence of unabsorbe d depreciation o r car r yforwa r d of losse s under tax laws is strong evidence that future taxable income may not be available. Therefore, when an enterprise has a history of recent losses, th e 354 AS 2 2 enterprise recognises deferre d tax assets only to the extent that it has timin g differences the reversal of which will result in sufficient income or there i s other convincing evidence that sufficient taxable income will be availabl e against which such deferred tax assets can be realised. In such circumstances , the nature of the evidence supporting its recognition is disclosed. Re-assessment of Unreco g nised Deferred Tax Assets 19. At each balance sheet date, an enterprise re-assesses unrecognise d deferred tax assets. The enterprise recognises previously unrecognise d deferred tax assets to the extent that it has become reasonably certain o r virtually certain, as the case may be (see paragraphs 15 to 18), that sufficien t future taxable income will be available against which such deferred ta x assets can be realised. For example, an improvement in trading condition s may make it reasonably certain that the enterprise will be able to generat e sufficient taxable income in the future. Measurement 20. Current tax should be measured at the amount expected to be p ai d to (recovered from) the taxation authorities, using the applicable tax rate s and tax laws. 21 . D e f erred ta x assets and liabilities should be measured usin g the ta x rates and tax laws that have been enacted or substantively enacted by th e balance sheet date. E x p lanation: (a) The p a y men t o f ta x unde r section 115 J B o f the I ncome-ta x Act, 1961 (hereinafter referred to as the ‘Act’) is a current tax for th e period. (b) I n a p eriod i n which a compan y p a y s t a x unde r section 1 15 J B o f th e Act, the deferred tax assets and liabilities in respect of timin g differences arising during the period, tax effect of which is require d to be recognised under this Standard, is measured using th e regular tax rates and not the tax rate under section 115JB of th e Act. (c) I n case an enterprise expec t stha t the timin g d i f f erences arisin g in the current period would reverse in a period in which it may p a y t a x unde r section 115 J B o f the Act , the de f erred t a x asse t s an d A ccounting for Taxes on Income 355 liabilities i n respec t o f timin g d i f f erences arisin g durin g the curren t p eriod, tax effect of which is required to be recognised under AS 22, is measured using the regular tax rates and not the tax rate unde r s ection 115JB of the Act. 22. Deferre d tax assets an d liabilities a r e usually measure d using the ta x rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effec t of actual enactment. In these circumstances, deferred tax assets and liabilitie s are measured using such announced tax rate and tax laws. 23. When different tax rates apply to different levels of taxable income , deferred tax assets and liabilities are measured using average rates. 24 . D e f erred ta x asse t s and liabilities shou l dno t be discounted t o thei r p resent value. 25. The reliable determination of deferred tax assets an d liabilities on a discounted basis requires detailed scheduling of the timing of the reversa l of each timing difference. In a number of cases such scheduling i s impracticable or highly complex. Therefore, it is inappropriate to requir e discounting of deferred tax assets and liabilities. To permit, but not to require , discounting would result in deferred tax assets and liabilities which woul d not be comparable between enterprises. Therefore, this Standard does no t require or permit the discounting of deferred tax assets and liabilities. Review of Deferred Tax Assets 26. The carrying amount of deferred tax assets should be reviewed a t each balance sheet date. An enterprise should write-down the carr y in g amount of a deferred tax asset to the extent that it is no longer reasonabl y certain or virtually certain, as the case may be (see paragraphs 15 to 18) , that sufficient future taxable income will be available against whic h deferred tax asset can be realised. Any such write-down may be reverse d to the extent that it becomes reasonably certain or virtually certain, as th e case may be (see paragraphs 15 to 18), that sufficient future taxable incom e will be available. Presentation and Disclosure 27. An enterprise should offset assets and liabilities representing current tax if the enterprise: 356 AS 2 2 (a) has a le g all y en f orceab l eri g h t t os e t o f f the reco g nis e damoun t s; and (b) intends t o settle th e asse t and the liabili t y on a ne t basis. 28. An enterprise will normally have a legally enforceable right to set of f an asset and liability representing current tax when they relate to incom e taxes levied under the same governing taxation laws and the taxation law s p ermit the enterprise to ma k eo r receiveasin g le net pa y ment. 29 . An enterprise shou l d o f f set de f erred tax asse t s and de f erred t a x liabilities if: (a) the en t erprise has a le g al l y en f orceable ri g h t t ose t o f f asse t s against liabilities representing current tax; and (b) the de f erred ta x asse t sandthede f erred ta x liabilities relate to taxes on income levied by the same governing taxation laws. 30. D e f erred ta x assets and liabilities should be distin g uished f rom assets and liabilities representing current tax for the period. Deferred tax asset s and liabilities should be disclosed under a separate heading in the balance s heet of the enterprise, separately from current assets and current liabilities. E x p lanation: D e f erred t a x ass e t s (ne t o f the de f erred t ax liabilities, i f an y , in accordance with paragraph 29) is disclosed on the face of the balance shee t s eparatel y a f ter the head ‘Investments’ and de f erred tax liabilities (net o f the deferred tax assets, if any, in accordance with paragraph 29) i s disclosed on the face of the balance sheet separately after the head ‘Unsecured Loans’. 31 . The break-u p o f de f erred ta x assets and de f erred ta x liabilities int o major components of the respective balances should be disclosed in th e notes to accounts. 32 . The natu r e o f the evidence supportin g the reco g nition o f de f erre d tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws. [...].. .Accounting for Taxes on Income 357 Transitional Provisions 33 On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Standard as deferred tax asset/liability with a corresponding credit/charge to... depreciation allowed for tax purposes exceeds the amount of depreciation charged for accounting purposes by Rs 1,00,000 and, therefore, taxable income is lower than the accounting income This gives rise to a deferred tax liability of Rs 40,000 In 20x2 and 20x3, accounting income is lower than taxable income because the amount of depreciation charged for accounting purposes exceeds the amount of depreciation... tax depreciation differ This could arise due to: a) Differences in depreciation rates b) Differences in method of depreciation e.g SLM or WDV c) Differences in method of calculation e.g calculation of depreciation with reference to individual assets in the books but on block basis Accounting for Taxes on Income 359 for tax purposes and calculation with reference to time in the books but on the basis... shown below: Statement of Profit and Loss (for the three years ending 31st March, 20x1, 20x2, 20x3) (Rupees in thousands) 20x1 20x2 20x3 Profit before depreciation and taxes 200 200 200 Less: Depreciation for accounting purposes 50 50 50 Profit before taxes 150 150 150 80 80 Less: Tax expense Current tax 0.40 (200 – 150) 0.40 (200) 20 Accounting for Taxes on Income 361 Deferred tax Tax effect of timing... subsequent years 5 Income credited to the statement of profit and loss but taxed only in subsequent years e.g conversion of capital assets into stock in trade 6 If for any reason the recognition of income is spread over a number of years in the accounts but the income is fully taxed in the year of receipt 360 AS 22 Illustration II Note: This illustration does not form part of the Accounting Standard Its... purchased one machine for Rs 1500 lakhs Residual value is assumed to be nil 4 For accounting purposes, the enterprise follows an accounting policy to provide depreciation on the machine over 15 years on straight-line basis 5 For tax purposes, the depreciation rate relevant to the machine is 25% on written down value basis The following computations will be made, ignoring the provisions of section 115JB... for tax purposes Therefore, a deferred tax asset would be recognised in respect of this difference subject to the consideration of prudence (see paragraphs 15 - 18) 358 AS 22 Illustration I Examples of Timing Differences Note: This illustration does not form part of the Accounting Standard The purpose of this illustration is to assist in clarifying the meaning of the Accounting Standard The sections... 60 for tax purposes The difference is because the enterprise applies written down value method of depreciation for calculating taxable income whereas for accounting purposes straight line method is used This difference will reverse in future when depreciation for tax purposes will be lower as compared to the depreciation for accounting purposes In the above case, assuming that enacted tax rate for. .. Computation of depreciation on the machine for accounting purposes and tax purposes (Amounts in Rs lakhs) Year Depreciation for accounting purposes Depreciation for tax purposes 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 100 100 100 100 100 100 100 100 100 100 100 100 100 100 100 375 281 211 158 119 89 67 50 38 28 21 16 12 9 7 At the end of the 15th year, the carrying amount of the machinery for accounting. .. whereas for tax purposes, the carrying amount is Rs 19 lakhs which is eligible to be allowed in subsequent years Table 2 Computation of Timing differences (Amounts in Rs lakhs) 1 2 Year Income before depreciation between for accounting purposes and tax purposes) 3 4 Accounting Gross Income after Total Difference and tax (both (deduction (after deducting depreciation under tax laws) 5 Deduction under . Notification.) Objective The objective of this Standard is to prescribe accounting treatment for taxes o n income. Taxes on income is one of the. shoul d account for taxes that are payable on distribution of dividends and othe r distributions made b y the enterprise. Definitions A ccounting for Taxes on Income