The Finance Bill 2017 sets out the requirement of determining how Ind AS will impact Minimum Alternate Tax (MAT) on first time adoption (FTA) and on an ongoing basis. This article discusses a few issues with respect to MAT implications on FTA.
FINANCE BILL 2017 PROVISIONS ON MAT IMPACT ON FTA OF Ind-AS
The broad provisions are set out below:
1. Ind AS adjustments in reserves/ retained earnings (RE) are included in 115 JB book profit equally over 5 years beginning from the year of Ind AS adoption, except:
– Other Comprehensive Income (OCI) items recyclable to P&L are included in book profits, when those are recycled to P&L
– Adjustments to capital reserve, securities premium and equity component of compound financial instruments are excluded from book profit
– Use of fair value as deemed cost exemption for PPE/ Intangible Asset will be MAT neutral
• To be ignored for computing book profit
• Depreciation is computed ignoring the amount of fair value adjustment
• Gains/ losses on transfer/realisation/disposal/ retirement are computed ignoring fair value adjustment (as per Memorandum to the Finance Bill)
– Gains/losses on investments in equity instruments classified as fair value through other comprehensive income (FVTOCI) will be included in
book profit on realisation/disposal/transfer of
investment
– Use of fair value as deemed cost exemption for investments in subsidiaries, associates and joint ventures will be MAT neutral. Gains/ losses to be included in book profit on realisation/disposal/ transfer of investment
– Use of option to make Indian GAAP Foreign Currency Translation Reserve (FCTR) Zero will be MAT neutral
• To be included in book profit at the time of disposal of foreign operation.
2. FTA adjustments made at transition date (TD) are trued up for any changes upto the end of the comparative year. For example, for a phase 1 Company the TD will be 1 April 2015. The FTA adjustments on 1st April 2015 will be trued up for any changes upto the end of the comparative year end, i.e., 31st March 2016. This is illustrated below.
3. Consider a company that has only one adjustment at TD. The investments in mutual fund were measured at cost less impairment (assume INR 100) on an ongoing basis under Indian GAAP. On TD the company will have to measure the investments in mutual funds at fair value (assume INR 180). At 1st April, 2015, the company has included the fair value uplift INR 80 in RE. At 31st March, 2016, the fair value of the mutual fund was INR 240. For purposes of section 115 JB book profits, the company will include INR 28 each year for the next 5 years (INR 140 in aggregate), starting from the financial year 2016-17.
MAT IMPACT ON FTA OF Ind-AS
On the TD to Ind AS, the company makes adjustments to align Indian GAAP accounting policies with Ind AS. The impact of these items may end up in different adjustments being made. An asset or liability is recorded or derecognised or measured differently and the corresponding impact is directly adjusted in either:
(a) RE or reserves
(b) Another asset or liability
(c) OCI
(d) Capital reserve
(e) Equity
(I) Corresponding Adjustment made to RE or Reserves
Some examples of adjustment in this category and the corresponding impact on MAT are as follows:
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Adjustments
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Impact on MAT
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Property, Plant
and Equipment (PPE) or Intangible Assets is fair valued on TD, as the new
deemed cost under Ind AS. The
corresponding impact is recorded in RE on the TD
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This is MAT
neutral.
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Investment in
subsidiaries, associates and joint ventures is fair valued on TD, as the new
deemed cost under Ind AS. The
corresponding impact is recorded in RE on the TD
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This is MAT
neutral.
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The amount of
deferred tax asset or liability (DTA/DTL) is changed due to TD adjustments of
various assets and liabilities. The corresponding debit or credit impact is
recorded in RE on the TD
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While the
Memorandum to Finance Bill states that it should be MAT neutral, the text of
the Finance Bill 2017 does not contain any such clause.
Hence, based on the text of the Finance Bill 2017, one may argue that for
purposes of determining book profits the debit or credit adjustment in RE
after true-up impact will be recognized over 5 years.
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Receivables are
provided for based on Expected Credit Loss (ECL). The corresponding debit
impact is recorded in RE on the TD
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For purposes of
determining book profits the debit adjustment in RE after true-up impact will
be recognized over 5 years.
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Fair value gains
on derivative assets were not recognized under Indian GAAP. On TD a derivative asset is created with a
corresponding impact on RE
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For purposes of
determining book profits the credit adjustment in RE after true-up impact
will be recognized over 5 years.
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With respect to
Service Concession Arrangements, the Intangible assets were recorded at cost
under Indian GAAP. Under Ind AS these
are recorded at fair value (cost plus margin). On TD, the amount of Intangible Assets will
be increased with a corresponding impact on RE.
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For purposes of
determining book profits the credit adjustment in RE after true-up impact
will be recognized over 5 years.
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Under Indian
GAAP, Investments in mutual fund is measured at cost. Under Ind AS at each reporting date it is
fair valued with gains/losses recognized in the P&L account. On TD, the
amount of Investments will be increased or decreased for fair value gains/losses
with a corresponding impact on RE.
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For purposes of
determining book profits the credit or debit adjustment in RE after true-up
impact will be recognized over 5 years.
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(II) Corresponding Adjustment made to another
Asset or Liability
Some examples of adjustment in this category and the corresponding
impact on MAT are as follows:
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Adjustments
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Impact on MAT
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(a) A
day before the TD the parent issues to a bank a financial guarantee (FG) on
behalf of its subsidiary. The parent
will not cross charge the subsidiary for the FG. On TD the parent will record a FG liability
(INR 100) and a corresponding investment in the subsidiary.
(b) Indian
GAAP book value of investment is INR 250.
The Company uses fair value of INR 400 as deemed cost on TD. The investment is sold after four years at
INR 700.
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(a) No
Impact on MAT since an asset and a liability is recorded with no
corresponding impact on RE or reserves. However, true-up impact will have to
be adjusted.
(b) The
fair value uplift of INR 50 (400-(250+100)) is MAT neutral. When the investment is sold, the profit of
INR 300 (700-400) + the fair value uplift INR 50, will be included in book
profits for MAT purposes.
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(a) Two
years before the TD the parent issues to a bank a FG on behalf of its
subsidiary for a 5 year period. The
parent will not cross charge the subsidiary for the FG. Under Ind AS, on the date of issue of the
FG the parent will record a FG liability and a corresponding investment in
the subsidiary. Assuming the
subsidiary is financially capable and the bank does not have to invoke the
FG, the FG would be amortized over a 5 year period with a corresponding
credit to the profit and loss. On TD,
the FG would be amortized for a two year period with a corresponding credit
to RE.
(b) Indian
GAAP investment value is INR 100.
Assume the FG liability on initial recognition is INR 20, and that the
entity uses previous GAAP carrying value (INR 100) on TD for investment.
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(a) For
purposes of determining book profits u/s 115 JB the credit adjustment in RE
on account of FG amortization after true-up impact will be recognized over 5
years.
(b) With
respect to investment, for purposes of determining book profit u/s 115 JB, RE
will be debited by INR 20 which after true up impact will be recognized over
5 years
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A day before the
TD the entity enters into a long term service arrangement, which has an
embedded lease. The entity is a lessee
and lease is finance lease. On TD the
entity will record an asset and a corresponding lease liability of equal
amount.
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No Impact on MAT
since an asset and a liability is recorded with no corresponding impact on RE
or reserves. However, true-up impact during the comparative period will be
recognized over 5 years.
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Two years before the TD the lessee entity enters into a 30 year long
term service arrangement, which has an embedded lease. The entity is a lessee
and lease is finance lease. Under Ind
AS the entity will record an asset and a corresponding lease liability of
equal amount on the date of entering into a lease arrangement. On TD the
amount of asset and lease liability recognized would not be equal because the
asset depreciation and the loan amortization will happen at different
amounts. Therefore on TD, there would
be a debit or credit adjustment to RE.
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For purposes of
determining book profits u/s 115 JB the debit or credit adjustment in RE
after true-up impact will be recognized over 5 years.
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(III) Corresponding Adjustment made to OCI
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Adjustments
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Impact on MAT
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The entity
applies hedge accounting under Indian GAAP, which is fully aligned with the
Ind AS principles. On that basis it
has recorded a cash flow hedge reserve in OCI. Under Ind AS it will continue with the
hedge accounting, therefore, the cash flow hedge reserve recorded under
Indian GAAP will be continued as it is.
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This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The cash flow hedge reserve will
be included in book profits u/s. 115 JB as and when the hedge reserve is
recycled to the P&L account.
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Adjustments
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Impact on MAT
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The Company has a
foreign branch. It recognizes a FCTR
on translation of foreign branch. The
Company chooses the FTA option of restating the FCTR to zero under Ind AS. Subsequently the FCTR is accumulated afresh
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This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The Indian GAAP FCTR and the
fresh accumulated Ind AS FCTR is recognized when the branch is finally
disposed off.
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Adjustments
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Impact on MAT
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The entity
applies hedge accounting under Indian GAAP, which is fully aligned with the
Ind AS principles. On that basis it
has recorded a cash flow hedge reserve in OCI. Under Ind AS it will continue with the
hedge accounting, therefore, the cash flow hedge reserve recorded under
Indian GAAP will be continued as it is.
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This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The cash flow hedge reserve will
be included in book profits u/s. 115 JB as and when the hedge reserve is
recycled to the P&L account.
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Adjustments
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Impact on MAT
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The Company has a
foreign branch. It recognizes a FCTR
on translation of foreign branch. The
Company chooses the FTA option of restating the FCTR to zero under Ind AS. Subsequently the FCTR is accumulated afresh
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This is MAT
neutral, i.e, the consequences under Indian GAAP and Ind AS will be the
same. The Indian GAAP FCTR and the
fresh accumulated Ind AS FCTR is recognized when the branch is finally
disposed off.
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(IV) Corresponding Adjustment made to Capital
Reserves
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Adjustments
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Impact on MAT
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Prior to the TD
the Company has applied acquisition accounting for a common control
transaction. The consideration paid
was lower than the fair value of assets and liabilities taken over. The difference was recorded as capital
reserves. The Company chooses to restate the accounting of the common control
transaction on the TD in accordance with Ind AS 103. Under Ind AS the assets and liabilities in
a common control transaction are recorded at book value, and the excess of
book values over the consideration is recorded as capital reserves. Whilst in both Indian GAAP and Ind AS, a
capital reserve is recorded, the amount of capital reserve recognized is
different.
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Any adjustment to
capital reserves is MAT neutral.
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Prior to the TD
the Company has applied acquisition accounting for a common control
transaction and recognized goodwill in accordance with Indian GAAP. The Company chooses to restate the
accounting of the common control transaction on the TD in accordance with Ind
AS 103. Under Ind AS common control
transaction does not lead to recognition of goodwill. The said amount is adjusted against RE.
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For purposes of
determining book profits u/s. 115 JB the debit adjustment in RE will be
recognized over 5 years.
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(V) Corresponding Adjustment made to Equity
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Adjustments
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Impact on MAT
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A day prior to
the TD the Company has issued a compound financial instrument that is
classified as liability under Indian GAAP.
On TD under Ind AS, the Company does split accounting and records the
instrument partly as a liability and partly an equity. The equity represents the option under the
instrument to convert to shares at a future date and at a fixed predetermined
ratio.
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Equity component
of compound financial instruments is MAT neutral.
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Two
years prior to the TD the Company has issued a compound financial instrument
that is classified as liability under Indian GAAP. On TD under Ind AS, the Company does split
accounting and records the instrument as a liability and an equity amount.
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The
equity component is MAT neutral.
However, subsequent to the issue of the compound financial instrument,
the liability would have under gone a change under Ind AS due to the
amortization effect. RE would be debited to the extent of the amortization
for the two year period prior to TD.
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Adjustments
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Impact on MAT
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The equity
represents the option under the instrument to convert to shares at the end of
5 years at a fixed predetermined ratio.
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The debit
adjustment to the RE after true-up impact, would be allocated over 5 years
for the purposes of determining book profits u/s 115 JB.
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QUESTION
As explained above, the Finance Bill 2017 requires FTA adjustments in specific cases to be included in determining book profits under section 115 JB over a period of 5 years. For such adjustments that are not MAT neutral and have a MAT impact over a period of 5 years, would a provision for MAT liability or a credit for MAT asset be required on TD under Ind AS 12 Income Taxes?
RESPONSE
As a first step a company determines it’s income tax liability based on normal income tax provisions. However, this is subject to the provisions of section 115 JB of the Income tax Act, which requires a company to pay atleast a minimum tax on the basis of the book profits as determined under Indian GAAP or Ind AS as applicable. If a company pays higher tax during any financial year due to applicability of MAT, the excess tax paid is carried forward for offset against tax payable in future years when the company will be paying normal income tax.
As per the current Income-tax Act, the MAT credit can be carried forward for set-off for ten succeeding assessment years from the year in which MAT credit becomes allowable. The Finance Bill 2017 proposes that credit in respect of MAT paid u/s. 115JB can be carried forward upto fifteen succeeding assessment years. MAT is an additional tax payable to authorities based on the comparison of book profit and taxable profit for the year, albeit the company may be required to make certain adjustments (additions or deductions) to accounting profit for arriving at the 115 JB book profit.
For accounting purposes, the author believes that a MAT provision or a MAT asset should not be created on TD adjustments for the following reasons:
– The trigger for MAT is a higher book profit compared to a lower income computed under normal income tax computation provisions. The relationship between future book profits and income computed under normal income tax provisions will determine the MAT in future periods. Therefore MAT is like a current tax liability/asset that is accounted in each year. The possibility of the future book profits being higher or lower due to TD adjustments, is not a relevant factor for creating a MAT liability or MAT asset for TD adjustments. In other words, MAT is a current tax based on book profits in each year, and the liability for MAT arises only once the financial year commences. MAT is not triggered by FTA adjustments, though those are taken into consideration for determining MAT book profits for the relevant year.
– Absent tax holidays and few tax exempt income/ expenses, differences between the normal tax and the MAT are primarily due to deductible and taxable temporary differences. Those temporary differences result in deferred taxes being recognized on the basis that they will eventually reverse subject to application of prudence for recognition of DTA. Thus, the MAT is effectively a mechanism to bridge/ reduce gap between the carrying amount and tax base of assets and liabilities. On its own the MAT does not create any new differences. Since Ind AS 12 requires an entity to recognise DTA/ DTL for temporary differences between the carrying amount and tax base of assets and liabilities, it may be argued that MAT itself should not result in recognition of any new/ additional DTA/ DTL. Else, it may be tantamount to double counting. This is explained with the help of a small example.
EXAMPLE
The Company enjoys an accelerated depreciation under the Income-tax provisions, but charges lower depreciation for accounting purposes. This has resulted in the Company being subjected to MAT. The Company has created a DTL for the accelerated depreciation at normal income tax rates. The Company also records a MAT liability in the financial year.
On TD the Company records the fixed assets at Indian GAAP carrying value and also creates a provision for decommissioning liability of INR 100 with a corresponding adjustment to RE. For 115 JB book profits the RE adjustment will be spread over 5 years.
As a result of recording the decommissioning liability in Ind AS, the DTL amount will also correspondingly reduce on TD. It would be inappropriate to record a MAT asset on TD, for the RE credit of INR 100, since that would tantamount to double counting.
MAT is effectively a mechanism to bridge/ reduce gap between the carrying amount and tax base of assets and liabilities. On its own the MAT does not create any new differences. Since Ind AS 12 requires an entity to recognise DTA/ DTL for temporary differences between the carrying amount and tax base of assets and liabilities, it may be argued that MAT itself should not result in recognition of any new/ additional DTA/ DTL
Considering the above arguments, MAT payment is only an event of the relevant period, viz., the period during which MAT obligation arises under the Income-tax Act. Hence, it should be recognised in the relevant period and no upfront DTA/ DTL should be created towards amount to be adjusted in book profit of future years. The ICAI may issue appropriate guidance on the matter.
