The Hindu Business Line : Deferred has arrived

IT HAS been almost a year since India Inc. was thrust with Accounting Standard 22 — accounting for taxes on income — popularly called the deferred tax accounting standard. This is applicable for listed companies for accounting periods commencing on or after April 1, 2001.

The introduction of this standard was a sort of `baptism by fire' for the corporate sector, and the shoe started pinching as early as October 2001 when companies started publishing half-yearly accounts to satisfy the requirements of SEBI.

The standard was bound to be controversial as it directly intruded and made a dent on both accumulated reserves as at April 1, 2001, and reported profits for the period commencing April 1, 2001. Understandably, therefore, there was resistance notwithstanding the fact that what was sought to be achieved was only a correction of the situation of overstated reserves and profits of yesteryear and restate the figures to realistic levels in the current year.

The first evidence of acrimony between the corporate sector and the Institute of Chartered Accountants of India (ICAI) on this issue surfaced in December 2001 when the Association of Leasing and Financial Companies took up the matter before the Madras High Court, challenging the legality of the Standard. The court gave an interim order permitting the companies in question to publish half-yearly accounts under both options — that is, with and without deferred tax liability.

A few companies also gave various reasons — some of them quite far-fetched — as to why deferred tax liability would not be applicable to them. In short, some companies were trying to get around the Standard and explore loopholes to escape compliance.

At the heart of the problem is: How to bridge the wide gap between reported and taxable profits? AS 22 seeks to address this issue much to the chagrin of the corporate sector.

Applicable tax rate

Now, the corporate sector has to apply deferred tax liability for the first full year of accounts for the year ended March 31, 2002. The immediate challenge was to work out the timing difference on accumulated gap between book depreciation and income-tax depreciation.

The tax liability on this gap was to be provided out of accumulated reserves as at April 1, 2001. But companies had to first tackle the question of the rate at which the opening reserves liability should be provided. The operative portion of the standard reads thus:

"Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance-sheet date."

The corporate tax rate was changed in Budget 2001, where the effective tax rate was reduced to 35.7 per cent from the 39.55 per cent prevailing up to March 31, 2001. On March 31, 2001, the proposed new rate was not made law yet.

Therefore, the issue is whether the new rate can be taken as `substantively enacted' as at March 31, 2001? There have been cases in the past where tax rates proposed in the Finance Bill have undergone changes at the time of debate in Parliament.

The general view — as also that of the ICAI through its clarification of AS 22 — is that the rate proposed in the Finance Bill has to be the one adopted for passing entry as at April 1, 2001, 35.7 per cent, that is.

An allied question on this subject that comes up for discussion is that in any case the new rate will apply only from April 1, 2001, but the accumulated reserves will have to be disturbed as at March 31, 2001, which means that though the new rate has been proposed in the Bill, the erstwhile rate of 39.55 per cent has to be the one which is legally in force on March 31, 2001, when the reserves are disturbed.

Though the entry is passed on April 1, 2001, for the transitional provisions, the accumulated reserves is to be reckoned as at March 31, 2001, and the prevailing tax rate as at March 31, 2001, is 39.55 per cent. While this argument appears reasonable, the better approach is to adopt the rate proposed in the Finance Bill on the opening balance of reserves as adopted by companies and also as endorsed by the ICAI through its clarification.

Interim stay

Southern Petrochemicals Industries Corporation (SPIC) moved the Madras High Court challenging, inter alia, the retrospective application of AS 22. In the petition, the company pointed out the hardship that would be caused because of the Standard's requirement of providing for accumulated timing differences as at April 1, 2001.

In June 2002, the Madras High Court granted an interim injunction on the retrospective application of AS 22 as provided in clause 33 of the standard.

Accordingly, notice has been ordered to the Finance Ministry and the ICAI to file the counter. It will be interesting to watch the developments when the main petition comes up for hearing.

It is now clear that some of the companies are finding it difficult and, in a few cases, impossible to carve deferred tax liability out of accumulated reserves. Following the standard for the accounting period commencing April 1, 2001, appears acceptable though.

The prime objection is only on the correction sought to be made for the accumulated timing difference.

It is unfortunate that decisions on ASs are being dragged to High Courts, and Chennai seems to be a front-runner in this. The solution lies in not making the standard rigid once released.

Problems arising in the implementation phase need to be taken into account and the standard modified on an ongoing basis to facilitate smooth execution by the corporate sector.

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