Accounting for Taxes on Income :
What is the Object of this standard?
In number of cases, the accounting income is different from taxable income that is profit as per Profit & Loss account is different compared to Income calculated in Statement of Total Income for calculating tax liability. The reasons are as follows:
1. There are some items which are debited in profit and loss account which are not allowed as expenses as per Income Tax Act for calculating tax liability. For e.g. We have debited Rs.60,000 as payment to contractor but we have not deducted tax on it, so the result is it will get added back in Statement of Total Income that is not allowed as expenses u/s 40(a)(ia).
2. There are some expenses which are wholly debited in Profit and loss account but are allowed as expenses in part or amortized over some years. For e.g. Preliminary expenses are entirely debited to the Profit & Loss account but as per section 35D of Income Tax Act are spread over time for deduction that is not entirely allowed in the year in which it is incurred.
Above differences are of two types.
1. Timing Difference
2. Permanent Difference
To calculate and recognising such difference in Financial Statment is an object of this standard.
What is Timing Difference?
Difference between taxable income and income as per Profit & Loss account which is time being in nature and will get reversed in subsequent period. For e.g. as discussed above preliminary expenses u/s 35D is debited entirely in P& L but is allowed entirely in specific number of years, that is it is amortised over number of years but finally it is allowed but in parts in every years, say 5 years. So Rs.100 (preliminary expenses) debited entirely in P&L but is allowed in 5 equal installments for 5 years that is Rs.20 every year. At the end of 5 years, entire Rs.100 is allowed.
What is Permanent Difference?
Difference between taxable income and income as per P&L which is permanent in nature and will not get reversed in subsequent years.
In short, Taxable income is calculated in accordance with the tax laws. In some circumstances, the requirements of these laws to compute taxable income differ from the accounting policies applied to determine income as per P&L.
Permanent difference does not result in deferred tax asset or liability.
Give an example of Timing Difference and explain it in detail.
Depreciation method followed in books is SLM in which equal amount of depreciation is charged to P&L. For e.g. Cost of Asset is Rs.10,000/-. Useful life of asset is 10 years. So the amount of depreciation to be charged every year is Rs.1,000/- (10,000 / 10). At the end of 10th year, the book value of asset will be nil.
Depreciation method followed for tax purpose is WDV. Under this method, the amount of depreciation is decreasing every year. Say for e.g. the rate is 10% and the cost of asset is Rs.10,000/-. Now, for first year depreciation is Rs.1,000/- (10,000 x 10%). Now, the written down value is Rs.9,000 (10,000 – 1,000). Next year 10% of 9,000 is depreciation that is Rs.900/- and the WDV is 8,100/- (9000 – 900). The book value of the asset will be Nil after some years.
Now, the depreciation for second year under accounting policies (SLM) will be Rs.1,000/- while as per income tax calculation (WDV) is Rs.900, this difference is due to depreciation is timing difference. At the end of useful life of the asset the depreciation is equal to cost but year wise amounts are different under both system. This is a timing difference.
What is the meaning of Deferred Tax Asset?
Deferred Tax Asset arises when the income as per Income tax Act is higher than the income as per Profit & Loss account. Therefore, tax to be paid is more due to higher income as per Income Tax Act but actual income as per Profit & Loss account is less. If one has considered income as per Profit & Loss for tax liability calculation than the tax payable will be less. This difference of tax liability due to difference in income as per Profit & Loss account and income as per Income Tax Act is Deferred Tax Asset.
What is the meaning of Deferred Tax Liability?
Deferred Tax Liability arises when the income as per Income tax Act is lower than the income as per Profit & Loss account. Therefore, tax to be paid is less due to lower income as per Income Tax Act but actual income as per Profit & Loss account is more. If one has considered income as per Profit & Loss for tax liability calculation than the tax payable will be higher. This difference of tax liability due to difference in income as per Profit & Loss account and income as per Income Tax Act is Deferred Tax Liability.
How to measure the deferred tax asset and liability?.
Deferred tax assets and liabilities should be measured using the tax rates and tax laws prevailing at the time of balance sheet date.
Deferred tax should be measured using the regular tax rated for companies even if company pays tax u/s 115JB (MAT).
What is the requirement of this standard?
This accounting standard requires recognition of deferred tax for all timing differences. This is based on the principle that the financial statement for a period should recognize the tax effect, whether current or deferred, of all the transactions during the year.
When deferred tax asset / liability should be recognized?
Whenever the income as per Income Tax asset is lesser than the income as per Profit & Loss Account, the deferred tax liability should be calculated and recognized in financial statement. But for recognizing deferred tax asset, there is a condition given in the standard. Deferred tax asset should be recognized and carried forward only if there is certainty that there will be sufficient future taxable income (higher income as per Income Tax Act compared to Profit & Loss account) against which such deferred tax asset can be realized.
In short there should be certainty that in future, there will be enough of deferred tax liability will arise so against which the current deferred tax asset will be adjusted.
How to make disclosure / presentation of deferred tax asset / liability in financial statement?
Deferred tax asset or liability should be distinguished from assets and liabilities representing current tax for the period.
Deferred tax asset and liability should be disclosed under a separate heading in the balance sheet separately from the current assets and current liabilities.
Deferred tax asset or deferred tax liability is a timing difference shown in P&L. the other effect is in balance Sheet
In Balance Sheet: Deferred tax asset should be disclosed separately after the head ‘Investments’ and deferred tax liability should be disclosed separately after the head ‘Unsecured Loans’.
In Notes to Accounts: The break up of deferred tax assets and liabilities into major components should be disclosed in notes to accounts.
Some more examples of Timing Differences.
· Disallowance u/s 43B of Income Tax Act – Expenditure of nature mentioned in section 43B )e.g. taxes, duties, cess, fees, etc.) accrued in P& L on mercantile basis but allowed for tax purpose in subsequent years on payment basis.
· Disallowance u/s 40(a)(ia) – payment to resident / non-resident accrued in P & L on mercantile basis but allowed for tax purpose u/s 40(a)(ia) when tax is deducted and paid to the Government.
· Provision made in P & L in anticipation of liability that is in advance by forecasting liability, where the relevant liabilities are allowed in subsequent years when they are crystallized that is when they actually arises with definite amount. (provision for expenses)
· Expenses amortised in the books over a period of years but are allowed for tax purpose wholly in the first year.
· Amortisation for tax purpose is over a longer or shorter period like Preliminary expenses (Section 35D)
· Income credited to Profit & Loss account but treated only in subsequent years. E.g. conversion of capital asset into stock –in-trade but gain calculated in the year in which stock is sold.
CA Shreya Sanghvi