Tax liability on taxable income: Clarification from CBDT is a must

Published: December 14, 2017 4:39 AM

Indian companies need to pay minimum alternate tax (MAT) on book profits in case their tax liability on taxable income is lower than MAT.

tax liability, how necessary is tax filing, cbdt clarification on incomeThis tax is levied on book profits computed in accordance with applicable Accounting Standards (AS). From FY17, the new Indian Accounting Standards (Ind-AS) are applicable to select companies for preparing financial statements. (Reuters)

By- Ashutosh Chaturvedi  

Indian companies need to pay minimum alternate tax (MAT) on book profits in case their tax liability on taxable income is lower than MAT. This tax is levied on book profits computed in accordance with applicable Accounting Standards (AS). From FY17, the new Indian Accounting Standards (Ind-AS) are applicable to select companies for preparing financial statements. Book profit based on Ind-AS is likely to be different from book profit under AS. The Finance Act, 2017, introduced certain amendments to Section 115JB of the Income-tax Act, 1961, for computation of book profits of Ind-AS companies. These provide additional adjustments to be made to book profits in the year of transition to new Ind-AS, leading to several ambiguities. Although, in a welcome step, CBDT provided clarifications, more needs to be done to address the issues relating to transition.

The new tax provisions in Section 115JB provide that adjustments made to Other Equity (OE) on the transition date need to be added to or reduced from book profits equally over five years. This has been provided without considering whether the adjustment is on account of balance sheet item or profit and loss (P&L) item. If adjustments are on account of P&L item, charging them to MAT over five years may be justified. But if they relate to balance sheet items, charging MAT is unwarranted as MAT is a tax on book profits and not on balance sheet items.

Let us take the example of an interest-free loan by a holding company to its subsidiary. As per Ind-AS, the current value of the loan is recognised as debt in the books of subsidiary company and the balance is regarded as equity contribution from the holding company and is credited to OE. This adjustment is not income, yet the new amendment provides it should suffer MAT as income, over the next five years, which is unfair. The same is true for such adjustments made to OE with respect to financial instruments such as CCD, RPS, NCD, etc. If an interest-free loan were provided by a holding company to its subsidiary after the transition date, this adjustment would not suffer MAT.

This matter has been aggravated by the CBDT clarification, which states that OE component of an interest-free loan should be considered as part of book profits, and taxed accordingly.

Ind-AS requires that any change in accounting policy should be effective retrospectively, even if Ind-AS became applicable from April 1, 2016. Relevant amended provisions of Section 115JB provide that even if adjustment in OE is on account of an income/expense item relating to earlier years, such an adjustment be taxed as part of book profits over five years. This results in retrospective taxation because this income/expense arises on items in earlier years but booked now, due to change in accounting policy, retrospectively. The taxation of such items should happen as and when the income is earned going forward, instead of trying to tax it as income of earlier years, as if Ind-AS were applicable even before April 1, 2016.

While Ind-AS are retrospective, taxation provisions should have only prospective effect. Finance minister Arun Jaitley, while presenting the FY15 Budget, had stated: “This government will not ordinarily bring about any change retrospectively, which creates a fresh liability.” But owing to the retrospectivity of Ind-AS, some companies may be required to pay MAT on income relating to earlier year, resulting in retrospective taxation.

Under Ind-AS, certain items of income and expenses are recorded in P&L statement, which do not represent real income or expense, but represent book entries due to fair value accounting. As these do not represent real income/expense, factoring them is not in line with basic intent of MAT provisions.

Let us take the example of a simple interest-free loan again. As per Ind-AS, only the current value of the amount lent is regarded as debt in the books of the borrower and lender. Subsequently, the borrower would be recording an interest expense and the lender a corresponding interest income every year. As per amendment in MAT provisions, this accounting entry for interest, although not representing real income/expense, would be considered for computing book profits. Such amendment will result in tax on notional income under MAT and should not be considered for MAT. Given these ambiguities, a clarification from CBDT to address these is a must until the law is amended.

(Inputs from Richa Singla, associate director, M&A Tax, PwC India)

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