TMI BlogAccounting for Taxes on IncomeX X X X Extracts X X X X X X X X Extracts X X X X ..... , there are differences between items of revenue and expenses as appearing in the statement of profit and loss and the items which are considered as revenue, expenses or deductions for tax purposes. Secondly, there are differences between the amount in respect of a particular item of revenue or expense as recognised in the statement of profit and loss and the corresponding amount which is recognised for the computation of taxable income. Scope 1. This Standard should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or saving related to taxes on income in respect of an accounting period and the disclosure of such an amount in the financial statements. 2. For the purposes of this Standard, taxes on income include all domestic and foreign taxes which are based on taxable income. 3. This Standard does not specify when, or how, an enterprise should account for taxes that are payable on distribution of dividends and other distributions made by the enterprise. Definitions 4. For the purpose of this Standard, the following terms are used with the meanings specified: 4.1 Accounting income (loss) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation 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 will differ. Another example of timing difference is a situation where, for the purpose of computing taxable income, tax laws allow depreciation on the basis of the written down value method, whereas for accounting purposes, straight line method is used. Some other examples of timing differences arising under the Indian tax laws are given in Illustration 1. 8. Unabsorbed depreciation and carry forward of losses which can be set- off against future taxable income are also considered as timing differences and result in deferred tax assets, subject to consideration of prudence (see paragraphs 15-18). Recognition 9. Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... udence as laid down in paragraphs 15 to 18. (c) For the above purposes, the timing differences which originate first are considered to reverse first. The application of the above explanation is illustrated in the Illustration attached to the Standard. 14. This Standard requires recognition of deferred tax for all the timing differences. This is based on the principle that the financial statements for a period should recognise the tax effect, whether current or deferred, of all the transactions occurring in that period. 15. Except in the situations stated in paragraph 17, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable income will be available against which such deferred tax assets can be realised. 16. While recognising the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of c ertainty would normally be achieved by examining the past record of the enterprise a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of prudence. Accordingly, in respect of such loss , deferred tax asset is recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head Capital gains against which the loss can be set-off as per the provisions of the Income-tax Act, 1961. Whether the test of virtual certainty is fulfilled or not would depend on the facts and circumstances of each case. The examples of situations in which the test of virtual certainty, supported by convincing evidence, for the purposes of the recognition of deferred tax asset in respect of loss arising under the head Capital gains is normally fulfilled, are sale of an asset giving rise to capital gain (eligible to set-off the capital loss as per the provisions of the Income-tax Act, 1961) after the balance sheet date but before the financial statements are approved, and binding sale agreement which will give rise to capital gain (eligible to set-off the capital loss as per the provisions of the Income-tax Act, 1961). (c) In cases where there is a difference between the amounts of recognised for accounting purpos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion 115JB of the Income-tax Act, 1961. (c) In case an enterprise expects that the timing differences arising in the current period would reverse in a period in which it may pay tax under section 115JB of the Income-tax Act, 1961, the deferred tax assets and liabilities in respect of timing differences arising during the current period, tax effect of which is required to be recognised under AS 22, is measured using the regular tax rates and not the tax rate under section 115JB of the Income-tax Act, 1961. 22. Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities 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. Deferred tax assets and liabilities should not be discounted to their present value. 25. The reliable determination of deferred tax assets and liabilit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ly from current assets and current liabilities. 31. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts. 32. The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax laws. Transitional Provisions 27 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 the revenue reserves, subject to the consideration of prudence in case of deferred tax assets (see paragraphs 15- 18). The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the beginning. 34. For the purpose of determining accumulated deferred tax in the period in which this Standard is applied for the first time, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t basis. b) Payments to non-residents accrued in the statement of profit and loss on mercantile basis, but disallowed for tax purposes under section 40(a)(i) and allowed for tax purposes in subsequent years when relevant tax is deducted or paid. c) Provisions made in the statement of profit and loss in anticipation of liabilities where the relevant liabilities are allowed in subsequent years when they crystallize. 2. Expenses amortized in the books over a period of years but are allowed for tax purposes wholly in the first year (e.g. substantial advertisement expenses to introduce a product, etc. treated as deferred revenue expenditure in the books) or if amortization for tax purposes is over a longer or shorter period (e.g. preliminary expenses under section 35D, expenses incurred for amalgamation under section 35DD, prospecting expenses under section 35E). 3. Where book and 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 for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 50 Profit before taxes 150 150 150 Less: Tax expense Current tax 0.40 (200 150) 20 0.40 (200) 80 80 Deferred tax Tax effect of timing differences originating during the year 0.40 (150 50) 40 Tax effect of timing differences reversing during the year 0.40 (0 50) (20) (20) Tax expense 60 60 60 after tax 90 90 90 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Dr. 20,000 To Profit and Loss A/c 20,000 (Being the deferred tax liability adjusted for reversing timing difference of Rs. 50,000) Year 20x3 Profit and Loss A/c Dr. 80,000 To Current tax A/c 80,000 (Being the amount of taxes payable for the year 20x3 provided for) Deferred tax A/c Dr. 20,000 To Profit and Loss A/c 20,000 (Being the deferred tax liability adjusted for reversing timing difference of Rs. 50,000) In year 20x1, the balance of deferred tax account i.e., Rs. 40,000 would be shown separately from the current tax payable for the year in terms of paragraph 30 of the Standard. In Year 20x2, the balance of deferred tax account would be Rs. 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 60 Less: Current tax - - (4) Deferred tax: Tax effect of timing differences originating during the year 40 Tax effect of timing differences reversing during the year (20) (20) Profit (loss) after tax effect (60) 30 36 Illustration 4 Note: The purpose of this illustration is to assist in clarifying the meaning of the explanation to paragraph 13 of the Standard. Facts: 1. The income before depreciation and tax of an enterprise for 15 years is Rs. 1000 lakhs per year, both as per the books of account and for income-tax purposes. 2. The enterprise is subject to 100 percent tax-holiday for the first 10 years under section 80-IA. Tax rate is assumed to be 30 percent. 3. At the beginning of year 1, the enterprise has purchased one machine for Rs. 1500 lakhs. Residual value is assumed to be n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Between accounting income and taxable income (3-6) Permanent Difference (deduction pursuant to section 80-IA) Timing Difference(due to different amounts of depreciation for accounting purposes and tax purposes) (O= Originating and R=Reversing ) 1 1000 900 625 625 Nil 900 625 275 (O) 2 1000 900 719 719 Nil 900 719 181 (O) 3 1000 900 789 789 Nil 900 789 111 (O) 4 1000 900 842 842 Nil 900 842 58 (O) 5 1000 900 881 881 Nil 900 881 19(O) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... down value of the machinery of Rs. 19 lakhs would be eligible to be allowed as depreciation. 2. As per the Standard, deferred tax on timing differences which reverse during the tax holiday period should not be recognised. For this purpose, timing differences which originate first are considered to reverse first. Therefore, the reversal of timing difference of Rs. 228 lakhs during the tax holiday period, would be considered to be out of the timing difference which originated in year 1. The rest of the timing difference originating in year 1 and timing differences originating in years 2 to 5 would be considered to be reversing after the tax holiday period. Therefore, in year 1, deferred tax would be recognised on the timing difference of Rs. 47 lakhs (Rs. 275 lakhs - Rs. 228 lakhs) which would reverse after the tax holiday period. Similar computations would be made for the subsequent years. The deferred tax assets/liabilities to be recognised during different years would be computed as per the following Table. Table 3 Computation of current tax and deferred tax (Amounts in Rs. lakhs) Year Current tax (Taxable Income x 30%) ..... X X X X Extracts X X X X X X X X Extracts X X X X
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