Accounting for Taxes on Income in Interim Financial Results in the context of the Finance Bill, 2004

1.

The Hon'ble Finance Minister has introduced the Finance Bill, 2004, on 8th July 2004. The Bill proposes certain changes in the tax rates and tax laws including increase in the tax rate by levy of surcharge of two percent as additional surcharge to be called education cess on income-tax. Such proposals in the Finance Bill have an effect on the measurement of the tax expense including deferred tax expense and amounts of deferred tax liability and deferred tax assets.

2.

In this regard, an issue is being raised as to whether these proposals should be taken into consideration for accounting for taxes on income for preparation of the quarterly financial results for the quarter ending June 30, 2004.

Accounting Treatment

3.

In respect of the above issue, the following accounting treatment should be followed:

 

1. The proposals with regard to changes in tax rates and tax laws announced on July 8, 2004, should not be taken into consideration while accounting for taxes on income for the quarter ending 30th June, 2004. Therefore, the tax expense for the quarter ending 30th June, 2004, should be measured without taking into consideration the proposals with regard to changes in tax rates and tax laws announced on July 8, 2004. Similarly, the balance of the deferred tax liability/asset as on March 31, 2004, is not required to be remeasured (as per paragraph 21 of AS 22 reproduced in paragraph 4 (ii) below) in the context of such proposals.
   
    
2. In the quarterly financial results for the period ending 30th June, 2004, the disclosure of the fact of the proposed changes in the tax rates and tax laws, to the extent relevant in the enterprise's context should be made as per the requirement (relating to disclosure of material event or transactions subsequent to the end of the quarter) contained in Clause 41 of the Listing Agreement entered into between stock exchanges and listed enterprises, if the change in tax rates and tax laws is considered material in the context of the facts and circumstances of the enterprise

Reasons for prescribing the accounting treatment

4.

The above treatment has been decided on the following consideration:

 

1. Paragraph 27 of Accounting Standard (AS) 25, Interim Financial Reporting, provides as follows:
   
   "27. An enterprise should apply the same accounting policies in its interim financial statements as are applied in its annual financial statements, except for accounting policy changes made after the date of the most recent annual financial statements that are to be reflected in the next annual financial statements. However, the frequency of an enterprise's reporting (annual, half-yearly, or quarterly) should not affect the measurement of its annual results. To achieve that objective, measurements for interim reporting purposes should be made on a year-to-date basis."
   
   From the above, it may be noted that for the preparation of the quarterly financial results, the same accounting policies are applied as those in the annual financial statements.
   
    
2. With regard to accounting for taxes on income, paragraphs 20, 21 and 22 of AS 22, Accounting for Taxes on Income, provide as below:
   
   "20. Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws.
   
   21. 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.
   
   22. Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these circumstances, deferred tax assets and liabilities are measured using such announced tax rate and tax laws."
   
   From the above, it may be noted that for the purposes of the quarterly financial results, the applicable tax rates and tax laws (for the measurement of current tax) and enacted or substantively enacted tax rates and tax laws (for the measurement of deferred tax) by the reporting date of the relevant quarter are required to be taken for measurement of tax expense.
   
    
3. For the purposes of the quarter ending on June 30, 2004, the proposals with regard to changes in tax rates and tax laws are not considered as applicable, enacted or substantively enacted tax rates or tax laws, since the proposals are announced after the reporting date of the quarter. Further, the announcement of the proposals can not be considered as event which provide further evidence of conditions that existed at the reporting date in view of the requirements of the AS 4, Contingencies and Events Occurring After the Balance Sheet Date. Accordingly, the amounts of tax expense, assets or liabilities representing current tax, and deferred tax assets or liabilities, as on June 30, 2004, are not adjusted by the proposed changes in tax rates and tax laws announced on July 8, 2004.