The gross v. net presentation of taxes is very important for many companies as revenue is a key performance indicator. Further some companies have to pay licence fees or have a revenue sharing arrangement and hence the amount disclosed as revenue becomes critical. There is substantial accounting literature in Indian GAAP that deals with these issues, albeit in various context.
In the ‘Guidance Note on Terms used in Financial Statements’ of ICAI, the expression ‘sales turnover’ has been defined as: “The aggregate amount for which sales are effected or services rendered by an enterprise.” The term ‘gross turnover’ and ‘net turnover’ (or ‘gross sale’ and ‘net sales’) are sometimes used to distinguish the sale aggregate before and after deduction of returns and trade discounts”
The Guide to Company Audit issued by the Institute while discussing ‘sales’, states as follows:
“Total turnover, that is, the aggregate amount for which sales
are effected by the Company, giving the amount of sales in respect of each class of goods dealt with by the company and indicating the quantities of such sale for each class separately.
The term ‘turnover’ would mean the total sales after deducting therefrom goods returned, price adjustments, trade discount and cancellation of bills for the period of audit, if any. Adjustments which do not relate to turnover should not be made e.g., writing off bad debts, royalty, etc. Where excise duty is included in turnover, the corresponding amount should be distinctly shown as a debit item in the profit and loss account.”
The ‘Statement on the Amendments to Schedule VI to the Companies Act, 1956’ issued by the ICAI while discussing the disclosure requirement relating to ‘turnover’ states as follows:
“As regards the value of turnover, a question which may arise is with reference to various extra and ancillary charges. The invoices may involve various extra and ancillary charges such as those relating to packing, freight, forwarding, interest, commission, etc. It is suggested that ordinarily the value of turnover should be disclosed exclusive of such ancillary and extra charges, except in those cases where because of the accounting system followed by the company, separate demarcation of such charges is not possible from the accounts or where the company’s billing procedure involves a composite charge inclusive of various services rather than a separate charge for each service.
In the case of invoices containing composite charges, it would not ordinarily be proper to attempt a demarcation of ancillary charges on a proportionate or estimated basis. For example, if a company makes a composite charge to its customer, inclusive of freight and despatch, the charge so made should accordingly be treated as part of the turnover for purpose of this section. It would not be proper to reduce the value of the turnover with reference to the approximate value of the service relating to freight and despatch. On the other hand if the company makes a separate charge for freight and despatch and for other similar services, it would be quite proper to ignore such charges when computing the value of the turnover to be disclosed in the Profit and Loss Account. In other words, the disclosure may well be determined by reference to the company’s invoicing and accounting policy and may thereby vary from company to company. For reasons of consistency as far as possible, a company should adhere to the same basic policy from year to year and if there is any change in the policy the effect of that change may need to be disclosed if it is material, so that a comparison of the turnover figures from year to year does not become misleading.”
The Statement on the Companies (Auditors’ Report) Order 2003 issued by the Institute in April 2004, while discussing the term ‘turnover’ states as follows: The term ‘turnover’ has not been defined by the order. Part II of Schedule VI to the Act, however, defines the term ‘turnover’ as the aggregate amount for which sales are effected by the company. It may be noted that the ‘sales effected’ would include sale of goods as well as services rendered by the company. In an agency relationship, turnover is the amount of commission earned by the agent and not the aggregate amount for which sales are effected or services are rendered. The term ‘turnover’ is a commercial term and it should be construed in accordance with the method of accounting regularly employed by the company.
As per the ‘Guidance Note on Tax Audit’ — “The term turnover for the purposes of this clause may be interpreted to mean the aggregate amount for which sales are effected or services rendered by an enterprise. If sales tax and excise duty are included in the sale price, no adjustment in respect thereof should be made for considering the quantum of turnover. Trade discounts can be deducted from sales, but not the commission allowed to third parties. If, however the excise duty and/ or sales tax recovered are credited separately to excise duty or sales tax account (being separate accounts) and payments to the authority are debited in the same account, they would not be included in the turnover. However, sales of scrap shown separately under the heading ‘miscellaneous income’ will have to be included in turnover.”
As per explanation to paragraph 10 of AS-9 Revenue Recognition, “The amount of revenue from sales transactions (turnover) should be disclosed in the following manner on the face of the statement of profit and loss:
Turnover (Gross) XX
Less: Excise Duty XX
Turnover (Net) XX
The amount of excise duty to be deducted from the turnover should be the total excise duty for the year except the excise duty related to the difference between the closing stock and opening stock. The excise duty related to the difference between the closing stock and opening stock should be recognized separately in the statement of profit and loss, with an explanatory note in the notes to accounts to explain the nature of the two amounts of excise duty.” AS-9 clearly sets out the requirement with respect to presentation of revenue and excise duty.
With respect to VAT the Guidance Note on Value Added Tax issued by ICAI states that “VAT is collected from the customers on behalf of the VAT authorities and, therefore, its collection from the customers is not an economic benefit for the enterprise and it does not result in any increase in the equity of the enterprise”. Accordingly, VAT should not be recorded as revenue of the enterprise. Correspondingly, the payment of VAT is also not treated as an expense. The Guidance Note on VAT further states, “Where the enterprise has not charged VAT separately but has made a composite charge, it should segregate the portion of sales which is attributable to tax and should credit the same to ‘VAT Payable Account’ at periodic intervals”. Currently most companies follow this guidance, though some entities have presented revenue gross of VAT and correspondingly treated VAT as an expense.
With respect to sales tax and service tax, the Guidance Note on revised Schedule VI states that such taxes are generally collected from the customer on behalf of the Government in majority of the cases. However, it adds that this may not hold true in all cases and it is possible that a company may be acting as principal rather than as an agent in collecting these taxes. Whether revenue should be presented gross or net of taxes should depend on whether the company is acting as a principal and hence responsible for paying tax on its own account or, whether it is acting as an agent i.e., simply collecting and paying tax on behalf of Government authorities. In the former case, revenue should also be grossed up for the tax billed to the customer and the tax payable should be shown as an expense. However, in cases, where a company collects tax only as an intermediary, revenue should be presented net of taxes. Strangely under the Guidance Note on revised Schedule VI, this concept of principal and agent is to be applied only with respect to sales tax and service tax, but not on excise duty which is covered under AS-9 and VAT which is covered by the GN on VAT.
Author’s view
Sellers of goods and services may enter into different arrangements with respect to indirect taxes. Some contracts clearly require the customer to pay the seller whatever tax is finally paid to the Government; in other words the seller acts as an agent between the Government and the customer. In other cases, the seller charges one all inclusive lump-sum amount for the entire sale contract including taxes.
The seller then pays to the Government whatever taxes are due, shouldering the risks of changes in tax rate or tax legislations. The tax burden on the seller would be the amount paid to the Government less any amount of input credit that is available to him. The tax burden could vary significantly under different scenarios, and this would determine the ultimate profit the seller makes on the lump- sum contract. In such cases, it could be said that the seller acts as a principal with respect to these taxes and hence should present revenue on a gross basis and the indirect tax as an expenditure. This example highlights a quagmire that companies have to face due to conflicting literature. On the one hand the guidance note on VAT requires a net presentation; whereas the guidance note on revised Schedule VI with respect to sales tax and service tax requires an assessment of principal and agent relationship which in this example would translate into a gross presentation.
The end result is that “what is good for the goose is not good for the gander” and absent a uniform principle for presentation of revenue and indirect taxes significant disparity in the disclosures would continue to arise in the future.
In the author’s view, the ICAI should commission a project to deal comprehensively with the presentation of various indirect taxes paid in India. Whether these taxes are presented gross or net, would depend on the nature of the indirect tax and the contractual arrangements between the seller and the buyer. It may be noted that under International Financial Reporting Standards, the evaluation of gross v. net presentation is done on the basis of principal agent relationship.
