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  Date:6th September 2010

 Compiled by: M Sathya Kumar  

Does DTC address IFRS issues?  

It is very evident from the recent activity of the Core Group constituted by the Ministry of Corporate Affairs for the convergence of Indian accounting standards with International Financial Reporting Standards (IFRS) that IFRS is more than a reality in India.

Come April 2011, all companies listed overseas, or that are part of either Nifty 50 or Sensex 30 and those whose net worth exceeds Rs 1,000 crore would have to convert their balance sheets as of April 1, 2011 in compliance with the notified accounting standards that are convergent with IFRS.

It is now a widely held view that in addition to accounting issues, transition to IFRS would trigger implications under various legislations, including direct tax laws.

However, the roadmap prepared by the Core Group only deals with required changes in the Companies Act. Similar guidance is awaited from other regulatory authorities, including the Central Board of Direct Taxes (CBDT).

Let us take the case of the direct tax legislation that is due for a major overhaul through the introduction of the Direct Taxes Code (DTC). Although the objective of the DTC is to simplify the prevailing direct tax legislation, it also seeks to make it more relevant to business today.

However, it seems that it has not taken into account the provisions of IFRS and fails to throw any light on the direct tax issues that are likely to arise when companies transition to the IFRS regime.

To illustrate, let's consider the year in which companies transition to IFRS for the first time. IFRS 1 prescribes that companies should recast their balance sheets in accordance with IFRS and that all adjustments resulting from the re-measurement should be made either to retained earnings or to a more appropriate component of equity. It may appear that there are no immediate tax consequences resulting from the first time adoption of IFRS (since this is below the line adjustment). However, there could still be tax issues as any change in retained earnings/equity as a result of the restatement would impact the valuation of the underlying business (say, as per NAV method), thereby impacting determination of its net worth for the purpose of computing capital gains arising on slump sale of such business in the future.

The DTC does not provide any clarifications regarding tax implications resulting from such re-statement of balance sheet in accordance with IFRS and how the same would be treated in the tax returns. Let's take the example of the UK where IFRS was introduced in 2005. The tax authorities issued detailed clarifications specifying the adjustments that would be taxed and also those that would be exempt. They also outlined that taxable adjustments should be spread over a ten-year period rather than in the year when the transition takes place.

MAT, another disconnect

Another disconnect between the DTC and the proposed transition to IFRS is the introduction of the draconian Minimum Alternate Tax (MAT) a gross asset tax in DTC. Under IFRS, assets such as investments and derivatives are fair valued with corresponding gains/losses recognised through the profit and loss statement. DTC prescribes the levy of MAT at 0.25 per cent of the value of assets for banking companies and 2 per cent for other companies. Accordingly, the measurement of prescribed assets at fair value under IFRS would have significant MAT implication.

Most would agree that the introduction of the new ‘asset based' MAT could not have been more untimely considering that the transition to the IFRS accounting regime had been on the anvil for a while. Also, the DTC has not sought to provide any clarification on whether gains/losses arising from re-statement of assets at fair value would be taxable or not.

Financial instruments

Another area that is likely to throw up more questions on tax is the recognition of financial instruments. Let us take the example of redeemable preference shares which, under the prevailing Indian GAAP, are treated on a par with equity shares. Under IFRS, however, redeemable preference shares are likely to be treated as a liability in the books of the issuing company.

Accordingly, the dividend on such preference shares is likely to be recorded as interest, post migration to IFRS. Here also, the DTC has failed to clarify whether such interest would be allowed as a deduction.

It is clear that the transition to IFRS was not kept in perspective while drafting the DTC.

Even the most basic issue of whether the tax authorities would accept the IFRS results for determination of the taxable income has not been addressed by the DTC.

On the other hand, the UK had made appropriate changes in its Tax Code to accept IFRS to calculate the taxable income.

The CBDT and the Institute of Chartered Accountants of India have constituted a joint study group to identify direct tax issues arising post convergence to IFRS.

Since the present direct tax laws do not address any tax implications likely to arise from IFRS transitions, we believe this could be a great opportunity for the Government to do so and provide clarifications on the same through appropriate amendments to the proposed DTC.

Article was earlier published in one of the reputed IFRS website by Mr. Jamil Khatri

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