Under the new accounting rules, banks will have to add foreign exchange gains to their taxable income in the current year
The new accounting rules for computing taxable income of firms being implemented from the current fiscal could lead to substantial one-time additional tax liabilities for many leading banks and companies with foreign branches.
As per the Income Computation and Disclosure Standards (ICDS), entities with foreign branches need to recognise in their profit and loss account the impact of any change in exchange rate between a transaction date and the last date of the respective financial year. As a result of this, many banks, including State Bank of India and ICICI Bank, may have huge gains to be recognised as income in rupee terms as most assets held by their foreign branches were acquired over the last several years when rupee was much stronger against the dollar. Since 2015-16 is the first year of adoption of ICDS, the banks will have to add these foreign exchange gains to their taxable income in the current year, sources said.
SBI, for example, has over Rs 6,172 crore of exchange rate gains on FCTR as on March 31, 2015 which may get added to its taxable income under ICDS. That is compared to the R19,314 crore the public sector lender reported as profit before tax last fiscal.
ICICI Bank, similarly, has over Rs 2,027 crore on FCTR, compared to the R15,820-crore profits before taxes it reported for the last fiscal. Other banks have smaller amounts in FCTR. Canara Bank has R196 crore and HDFC Bank has just Rs 39 crore in this account.
Experts said the impact of ICDS on tax outflows for banks might be adverse or favourable depending on market factors. “ICDS visibly delinks the accounting profits and taxable profits of businesses. It might lead to a significant impact on tax outflows for companies and banks that have derivatives exposure and that organise foreign operations through branches,” said Rahul Chowdhary, associate director – accounting advisory services, KPMG.
ICDS demands showing as taxable income any exchange rate gains on ‘monetary items’ like cash held in foreign currency, receivables and liabilities of the foreign branch converted to rupee at the year-end exchange rate.
Similarly, exchange rate losses will be treated as expenses to be deducted from the taxable income. This is a major change from the current tax treatment of these gains and losses disclosed under the head ‘Foreign Currency Translation Reserve’ (FCTR) in the balance sheet and not adjusted in the income statement until their disposal.
Since Indian banks, including SBI, ICICI Bank and HDFC Bank, conduct foreign operations as branches and not as subsidiaries or joint ventures, the norms are applicable to them. Although banks have to follow RBI’s accounting rules on different assets depending on their purpose and nature, they have to comply with the tax department’s rules as far as taxation is concerned.
Experts said the tax department may do well to bring more clarity on the transition provisions of ICDS, which was meant to bring parity on accounting policies followed by companies for tax purposes rather than as one yielding extra revenue. “The notification of ICDS was imperative to ensure smooth implementation of Ind AS (IFRS-compliant accounting standards), and therefore should have maintained a tax neutral position. Unfortunately ICDS are not tax neutral vis-à-vis the current Indian GAAP and tax practices currently followed and may give rise to litigation,” said Dolphy D’Souza, partner in Indian member firm of EY Global.
He said that in the case of non-integral foreign operations, e.g., non-integral foreign branches, it is not absolutely clear whether the opening accumulated FCTR, which could be a gain or loss, will be ignored or recognised in the first transition year 2015-16. “Since the amounts involved will be huge, particularly for many banks, the interpretation of this transitional provision will have a huge impact for those who have not already considered the same in their tax computation in past years. The quality of drafting leaves a lot of scope for litigation,” said D’Souza.
From the next fiscal, ICDS, however, would bring parity in tax treatment of companies using different accounting standards for computing book profits as is required under the Companies Act. Large companies with network of Rs 500 crore and their associates would be adopting a new set of standards called Ind AS, which is compliant with International Financial Reporting Standards (IFRS) that is based on mark to market valuation of assets and liabilities. The others would continue to follow the more conservative Indian GAAP, which as a matter of prudence, recommends recognising anticipated losses, but not gains in their books. ICDS, on the other hand, seeks early recognition of revenue in many areas compared to existing tax practices.
Pangs of change
* ICDS augurs extra tax burden this year for banks and companies with foreign branches
* New rules prescribe income adjustments based on exchange rate movements
* SBI, ICICI Bank among banks whose taxable income could see a huge increase
* Experts seek more clarity in transition provisions, say ICDS not tax neutral
* ICDS meant to bring tax parity despite differences in corporate accounting choices