IMPACT OF ORDINANCE DATED 20th SEPTEMBER, 2019

The tax ordinance of
September, 2019 has made significant changes in the income-tax provisions and
the income-tax rates.

Prior to
this, existing domestic companies were liable to tax at the basic rate of
either 25% or 30%. The effective tax rate ranged from 26% to 34.94% after
considering surcharge of 7% / 12% and health and education cess of 4%.

The tax rate of 25% was
applicable to two types of domestic companies, viz., (a) those having turnover
or gross receipts not exceeding Rs. 400 crores in tax year 2017-18; and (b) new
domestic manufacturing companies set up and registered on or after 1^st
March, 2016 fulfilling specified conditions.

With
effect from the tax year 2019-20, domestic companies shall have an option to
pay income tax at the rate of 22% plus 10% surcharge and 4% cess, taking the
effective tax rate (ETR) to 25.17%, subject to the condition that they will not
avail specified tax exemptions or incentives under the ITA. Such an option,
once exercised, cannot be subsequently withdrawn. Companies exercising such option will not be required to pay Minimum Alternate Tax (MAT).

Domestic companies claiming
any tax exemptions or incentives shall also be eligible to exercise such an
option after the expiry of the tax incentive period.

Subsequently, the CBDT has
clarified that domestic companies opting for the 22% concessional tax rate
(CTR) will not be allowed to set off the following while computing the total
income and their tax liability:

(i) Brought forward ‘losses’
on account of additional depreciation arising in any tax year prior to opting
for the 22% CTR;

(ii) Brought forward credit of
taxes paid under MAT provisions of the Indian Tax Law (ITL) in any tax years
prior to opting for the 22% CTR in view of inapplicability of MAT provisions to
a domestic company which opts for the 22% CTR.

Further, the CBDT clarified
that in the absence of any time-line for exercising of option to claim 22% CTR,
the domestic company, if it so desires may opt for the 22% CTR after it has
exhausted the accumulated MAT credit and unabsorbed additional depreciation by
being governed by the regular taxation regime existing under the ITL prior to
the ordinance.

The comparative effective tax
rates before and after exercise of the option are as follows:

There are numerous tax issues
relating to the recent ordinance. From an accounting perspective, it converges
to a few important questions. These are discussed below and are equally
applicable to AS (Indian GAAP) as well as Ind AS.

Question

Does the ordinance have any
effect on the 31^st March, 2019 financial statements (which were yet
to be issued at the time the ordinance was announced)?

Response

The ordinance was not an
enactment / substantive enactment at the balance sheet date, i.e. 31^st
March, 2019. Consequently, the tax charge and deferred taxes are based on the
pre-ordinance rates / income tax provisions. However, it is a subsequent event
which needs the disclosure below in the notes to accounts. This disclosure may
need suitable modification to the fact pattern. For example, the impact
quantification may not be appropriate / required where the impact cannot be
estimated with reasonable certainty or is not material.

Pursuant to the Taxation Laws
(Amendment) Ordinance, 2019 (Ordinance) issued subsequent to the balance sheet
date, the tax rates have changed with effect from 1^st April, 2019
and the company plans to pay tax at the revised rates. If those changes were
announced on or before reporting date, deferred tax asset (or / and deferred
tax liability) would have been reduced by xxxx. The tax charge or (credit) for
the year would have been increased / (decreased) by xxxx.

Question

The company currently has MAT
credit and unabsorbed depreciation. It is currently evaluating the tax position
and has not decided whether it should adopt new rates now or later. How should
the matter be dealt with in the quarter ended September, 2019 interim results?

Response

The ordinance is an abiding
law that came into force in September, 2019. Accordingly, the impact on tax
expenses based on the option elected by the company needs to be considered in
the September quarter financial results. Merely stating that the company is in
the process of evaluating the impact will not comply with Ind AS / AS
requirements. It is also possible that a decision made in the September, 2019
quarter may change at the year-end. The impact of change on the tax expense
will constitute a change in the accounting estimate which will have to be
properly explained both under Ind AS and AS.

Question

On transition to Ind AS 115 /
Ind AS 116, the transition adjustment along with deferred tax impact was
recognised in equity. Where should the subsequent changes in deferred taxes due
to the ordinance be recognised?

Response

The subsequent changes to
deferred tax impact is taken to P&L and not to equity even if the earlier
deferred tax was charged or credited to equity; for example, deferred tax
impact taken to equity on transitioning to Ind AS 115 / 116 or transitioning to
Ind AS under Ind AS 101. In the author’s view, the fact that deferred tax was
charged / credited to opening equity does not mean that subsequent changes in
the deferred tax asset or liability (for example, as a result of change in tax
rates) will also be recognised in equity. Rather, management needs to determine
(using the entity’s new accounting policy) where the items on which the
deferred tax arose would have been recognised if the new policy had applied in
the earlier periods (backward tracing). Therefore, if Ind AS 115 / 116 was
always applicable, the adjustment made to equity on transition would have ended
up in the P&L. Consequently, the subsequent changes in deferred tax due to
change in tax rates should also be taken to the P&L account.

Question

With
respect to 31^st March, 2020 accounts, whether the full tax impact is
considered in the September, 2019 quarter or spread over the three remaining
quarters, namely, September, 2019; December, 2019; and March, 2020?

Response

Due to the change in tax rates
/ provisions, there may be a substantial adjustment to the DTA / DTL balance.
For example, a company may be availing tax incentives due to which huge amounts
of DTA / DTL may have got accumulated. If the company decides to fall in the
new regime of taxation, a significant amount of DTA / DTL will need to be
adjusted. The impact of the adjustment has to be taken to the P&L and
cannot be deferred beyond the financial year in which the change occurs. There
are two acceptable approaches, viz., considering the full impact in the
September quarter, and the alternative approach of spreading it over the three
quarters. The reason for two acceptable approaches is as follows:

In determining the effective
average annual tax rate as required by Ind AS 34, it is necessary to estimate closing
deferred-tax balances at the end of the year because deferred tax is a
component of the estimated total tax charge for the year. This conflicts with
Ind AS 12 which requires deferred tax to be measured at enacted or
substantially enacted tax rates. It is therefore not clear as to when in the
annual period the impact of remeasuring closing deferred tax balances for a
change in tax rate is recognised. Consequently, two practices have emerged to
determine the tax charge for the interim period:

(a)   The estimated tax rate does not include the impact of remeasuring
closing deferred tax balances at the end of the year. It is not included in the
estimated ‘effective’ average annual tax rate. Consistent with the treatment of
tax credit granted in a one-off event, an entity may recognise the effect of
the change immediately in the interim period in which the change occurs
(Approach 1).

(b)   The estimated rate includes the impact of
remeasuring closing deferred tax balances at the end of the year. In this
approach the effect of a change in the tax rate is spread over the remaining
interim periods via an adjustment to the estimated annual effective income tax
rate (Approach 2).

It’s an accounting policy
choice to be followed consistently. The example below explains the two
approaches:

Example: Impact of change
in tax rate on tax charge / (credit) in the interim period

Company X’s applicable tax
rate in first quarter (June, 2019) was 40%. In the second quarter (September,
2019) the tax rate was changed retrospectively from 1^st April, 2019
to 25%. Opening temporary difference on which deferred tax asset was created is
Rs. 40,000, which is expected to reverse after three years.

Approach
1 – Adjust the impact of change in tax rate in the quarter in which change occurs

Approach
2 – Adjust the impact of change in tax rate over the period of remaining
quarters (the impact cannot be carried forward beyond the end of the financial year)

²Reversal of excess provision made in 1^st
quarter, i.e., 50,000*15% = 7,500 and reversal of opening deferred tax asset
created at higher rate, i.e., 40,000*15% = 6,000, i.e., 1,500 over the next
three quarters in the ratio of book profits (40000:40000:30000) minus
non-deductible temporary difference (zero in this fact pattern).

CONCLUSION

The author believes that both
views discussed above are based on sound arguments and are equally acceptable.