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April 2017

Accounting for MAT

By Dolphy D'Souza
Chartered Accountant
Reading Time 17 mins
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-ASOn 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 ReservesSome examples of adjustment in this category and the corresponding impact on MAT are as follows:

Adjustments

Impact on MAT

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

This is MAT neutral.

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

This is MAT neutral.

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

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.

Receivables are provided for based on Expected Credit Loss (ECL). The corresponding debit impact is recorded in RE on the TD

For purposes of determining book profits the debit adjustment in RE after true-up impact will be recognized over 5 years.

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

For purposes of determining book profits the credit adjustment in RE after true-up impact will be recognized over 5 years.

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.

For purposes of determining book profits the credit adjustment in RE after true-up impact will be recognized over 5 years.

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.

For purposes of determining book profits the credit or debit adjustment in RE after true-up impact will be recognized over 5 years.

(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:

Adjustments

Impact on MAT

(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.

(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.

 

(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.

(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

 

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.

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.

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.

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.

(III) Corresponding Adjustment made to OCI

Adjustments

Impact on MAT

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.

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.

Adjustments

Impact on MAT

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

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.

Adjustments

Impact on MAT

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.

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.

Adjustments

Impact on MAT

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

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.

(IV) Corresponding Adjustment made to Capital Reserves

Adjustments

Impact on MAT

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.

Any adjustment to capital reserves is MAT neutral.

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.

For purposes of determining book profits u/s. 115 JB the debit adjustment in RE will be recognized over 5 years.

(V)   Corresponding Adjustment made to Equity

Adjustments

Impact on MAT

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.

Equity component of compound financial instruments is MAT neutral.

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. 

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. 

Adjustments

Impact on MAT

The equity represents the option under the instrument to convert to shares at the end of 5 years at a fixed predetermined ratio.

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.

       QUESTIONAs 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?

RESPONSEAs 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.

EXAMPLEThe 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.

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