Difference between Accounting Standards (AS) and Ind–AS in regard to recognition of Deferred Asset (DTA ) in regard to unabsorbed losses and carry forward depreciation.
There is a difference in the virtual Certainty Principles in AS 22 and Ind AS 12 for recognition of DTA on unabsorbed losses and carry forward depreciation.
Accounting Standard – 22
AS 22 Accounting for Taxes on Income lays down the general criterion of “reasonable certainty” for the recognition of a deferred tax asset (DTA ). However, if an entity has unabsorbed depreciation or carry forward of tax losses, it needed to satisfy a much higher threshold of “virtual certainty supported by convincing evidence” to recognise DTA . Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence should be available at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence. Even subsequent opinions from the Expert Advisory Committee have emphasised the need for profitable binding orders for recognition of DTA .
Apparently, the “virtual certainty” criteria laid down in AS 22 for the recognition of DTA was difficult to implement because it required the existence of profitable binding orders. In many industries, the requirement for orders does not exist, and hence, it was difficult to demonstrate virtual certainty in those cases, despite the existence of other convincing evidence.
Ind AS – 12
The requirement in Ind AS 12 is somewhat relaxed when compared to the requirements in AS 22. Under Ind AS 12, when an entity has a history of recent losses, the entity recognises a deferred tax asset arising from unused tax losses or tax credits only to the extent that the entity has sufficient taxable temporary differences or there is convincing other evidence that sufficient taxable profit will be available against which the unused tax losses or unused tax credits can be utilised by the entity. An entity considers the following criteria in assessing the probability that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised:
a) whether the entity has sufficient taxable temporary differences relating to the same taxation authority and the same taxable entity, which will result in taxable amounts against which the unused tax losses or unused tax credits can be utilised before they expire;
b) whether it is probable that the entity will have taxable profits before the unused tax losses or unused tax credits expire;
c) whether the unused tax losses result from identifiable causes which are unlikely to recur; and
d) whether tax planning opportunities are available to the entity that will create taxable profit in the period in which the unused tax losses or unused tax credits can be utilised.
A deferred tax asset shall be recognised for the carryforward of unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilised. To the extent that it is not probable that taxable profit will be available against which the unused tax losses or unused tax credits can be utilised, the deferred tax asset is not recognised.
Differences
Whilst the requirement in Ind AS 12 are somewhat relaxed; it does not necessarily mean that it has become absolutely easy to recognise DTA on unabsorbed losses and carry forward depreciation. Nonetheless, there could be many situations where a DTA can be recognised under Ind AS 12 but not under AS 22. For example, in the scenarios below, DTA is not recognised under AS 22, but may be recognised under Ind AS 12.
a) A newly set-up entity (New Co.) incurred significant losses in the first three years of operations due to reasons such as advertising and initial setup related costs, significant borrowing costs and lower level of activity in the first two years of operations. Over the years, there has been a significant increase in the operations of New Co. and its advertisement cost has stabilised to a normal level. Further, it has raised new capital during the year and repaid its major borrowing. The cumulative effect of all the events is that the New Co. has started earning profits from the fourth year. It is expected to make substantial profits in the next three years that may absorb the entire accumulated tax loss of the entity. However, the nature of the business is such that it does not have any binding orders.
b) A battery manufacturer (Battery Co.), who had incurred tax losses in the past, enters into an exclusive sales agreement with a car manufacturer (Car Co.). According to the agreement, all the cars manufactured by Car Co. will only use batteries manufactured by Battery Co. Though Car Co. has not guaranteed any minimum off-take, there is significant demand for its cars in the market.
c) An oil exploration company may have discovered proven oil reserves, whose extraction will result in significant profits based on current and forward prices of oil.
The virtual certainty principle has a fatal flaw; since nothing in this world is virtually certain. Even profitable binding orders could be cancelled without receiving any penalty or the buyer/seller could end up getting bankrupt. The principle of convincing evidence under Ind-AS12 is not only fair, but is also practical to apply, compared to the “virtual certainty” principle under AS 22. The standard setters should immediately revise AS 22 and bring it in line with Ind-AS 12.
