The MAT Ind AS Committee (hereinafter referred to as ‘Committee’) on 18th March 2016 issued a draft report on the ‘Framework for computation of book profit for the purposes of levy of Minimum Alternate Tax (MAT) u/s. 115JB of the Income-tax Act 1961 for Indian Accounting Standards (lnd AS) compliant companies in the year of adoption and thereafter’. The Report was revised on 23rd July 2016 (hereinafter referred to as ‘Framework’). The Framework is a draft and is subject to public comments and final changes. Once the Framework is final, the same will have to be incorporated in the Income-tax Act, to make it effective.
This article discusses the issues and challenges on first time adoption (FTA ) of Ind AS and the consequences for companies that fall under MAT . Though the revised Framework is an improvement from the pre-revised draft, the provisions do not appear to be fair or reasonable, and will significantly hamper the ease of doing business. In addition, the environment is most likely to become very litigious and painful.
The accounting policies that an entity uses in its opening Ind AS balance sheet at the time of FTA may differ from those that it previously used in its Indian GAAP financial statements. An entity is required to record these adjustments directly in retained earnings/reserves at the date of transition to Ind AS. The Committee noted that several of these items would subsequently never be reclassified to the statement of P&L account or included in the computation of book profits.
Consider a company has a net worth of Rs 500 crore, and therefore falls under phase 1of Ind AS implementation. Its date of transition to Ind AS is 1 April, 2015; comparative period is financial year 2015-16, and first Ind AS reporting period is financial year 2016-17. The company is engaged in several businesses and makes the following seven transition decisions at 1 April, 2015 in order to comply with Ind AS.
1. The company’s accounting policy for fixed assets is cost less depreciation under Ind AS. However, as per option available in Ind AS 101 all fixed assets are stated at fair value at date of transition. The revalued amount is a deemed cost of fixed assets at 1 April, 2015. In other words, the company’s policy is not to use revaluation on a go forward basis as the accounting policy. The uplift on revaluation is recorded in retained earnings and will never be recycled to the P&L account.
2. In the stand-alone accounts the company has several investments in subsidiaries which under Indian GAAP are stated at cost less diminution other than temporary. Under Ind AS the company will continue to account them at cost less impairment. However, as per option available in Ind AS 101 the investments in subsidiaries are stated at fair value at date of transition. The fair value is the deemed cost of investments at 1 April, 2015. Subsequently, the investments in subsidiaries are not fair valued but tested only for impairment. The uplift on fair valuation is recorded in retained earnings and will never be recycled to the P&L account.
3. Under Indian GAAP, the company discloses assets under a service concession arrangement (SCA) as intangible assets at cost and which does not include construction margin. On date of transition, the company accounts for the intangible assets in accordance with Ind AS 11 (Appendix A), treating them as service concession assets. Consequently, under Ind AS 11 (Appendix A), the construction margin is also reflected in the value of the intangible asset.Therefore at transition date, the value of the intangible assets will be increased with a corresponding increase in retained earnings. The increase in retained earnings will never be recycled to the P&L account. However, the increase in the value of the intangible asset will be amortized in the future years.
4. At 31 March 2015, the Company has a lease equalization liability under Indian GAAP for an operating lease. Under Ind AS 17, the Company is required to charge operating lease payments in the P&L account without equalizing the lease payments, since those lease payments are indexed to inflation. Consequently on the transition date, the company reverses the lease equalization liability and takes the credit to retained earnings. The increase in retained earnings will never be recycled to the P&L account.
5. The Company has a cash flow hedge reserve at 31 March 2015 under Indian GAAP, which meets all hedge accounting requirements under Ind AS. In accordance with Ind AS 101, the Company is required to maintain the cash flow hedge reserve, and recycle the same to the P&L account, in accordance with the principles of Ind AS 109.
6. The Company has a foreign branch and a positive foreign currency translation reserve (FCTR) in Indian GAAP stand alone accounts at 31 March 2015. In accordance with Ind AS 101, it restates the FCTR to zero on 1 April, 2015 – the date of transition. Consequently the corresponding effect is taken to retained earnings. The increase in retained earnings will never be recycled to the P&L account.
7. In addition to investments in subsidiaries the company has investments in unquoted securities that are held long term for strategic reasons, but which are neither, subsidiaries, associates or joint ventures. The Company designates these investments as FVOCI (Fair Value through Other Comprehensive Income). As per this accounting policy choice, the fair value changes are permanently recorded in reserves (not retained earnings) and are never recycled to the P&L account.
As per the Framework, the MAT implication for the above seven FTA items is given below, along with the author’s recommendation of the changes required and grounds for such recommendations.
The FTA adjustments made at 1 April, 2015 are to be appropriately dealt with to determine the book profits for MAT purposes. The big question is – Is it included in the book profits over three years starting from the comparative period, ie, financial year 2015-16 or in the year of FTA, ie, financial year 2016-17? Though the intent of the government may have been to include the adjustments in the book profits for 2015-16, it is no longer practically feasible to do so. It is most likely that the adjustments would be included to determine the book profits starting from the financial year 2016-17. Hopefully that clarity will come in the forthcoming budget, as this requirement would require an amendment to the Act. This is again an unpleasant outcome, given that companies would be paying advance taxes without the knowledge of the final law on this subject.
Conclusion
Companies need to make careful choices of FTA options to minimize a negative MAT impact. They can make those choices up till financial statements for year ended 31 March 2017 are finalized. However, changes in those choices will cause significant fluctuations in 2016- 17 quarterly results. For example, a company decides to carry forward fixed assets at previous GAAP carrying value as a transition choice to avoid any MAT liability on fair value uplift. Subsequently, in the last quarter, the budget clarifies that the fair value uplift on fixed assets will be completely tax neutral from MAT perspective. Because of the clarity, the Company prefers to fair value the fixed assets from the transition date instead of carrying them at previous GAAP carrying value. This would mean that the lower depreciation charge in the earlier quarters and the comparative period will have to be adjusted, thereby resulting in significant change in the reported numbers in the last quarter.
As a bold step, the Government may consider simplifying the MAT provision, and lower the MAT rates. Alternatively, AMT (Alternate Minimum Tax) regime applicable to noncorporate assesses and which is highly successful may be introduced for corporate assesses. However, given the time constraint it is generally understood, that the Government may not explore these choices.
