AS 22 ACCOUNTING FOR TAXES ON INCOME

Meaning of Deferred Taxes

Deferred tax is a form of tax which has been Reduced in advance and can be subsequently carried forward or that will be payable in the future. The difference arising between accounting income and taxable income is known as deferred taxes. Tax effect of deferred taxes is considered only if they arise due to temporary differences. IAS 12 requires that a deferred tax liability or asset is recorded in respect of all taxable temporary differences that exist at the year-end.

Objective of Deferred Taxes

A tax on income is one of the most important items in an entity’s financial statement. Keeping the matching concept in mind, taxes on income accrue during the same period as revenue and expenses. However, in many cases, taxable income may differ from accounting income. These differences must be accounted for to give a fair view of the financial statements to the stakeholders and hence recognition criteria and accounting entries have been prescribed in IAS 12 for deferred taxes. These differences may arise due to two main reasons:

• Difference in revenue and expenses reflecting in P&L account considered as revenue, expense or deduction for tax purposes.

• Difference in amounts recorded as revenue or expenses in P&L account and that considered for taxation purposes. e.g., Rate of Depreciation differs as per Income Tax Act and Companies Act.

Important Terms related to Deferred Taxes

Listed below are a few important definitions necessary to understand the concept of deferred taxes:

1. Accounting income is the net profit before tax for a period, as reported in the profit and loss statement.
2. Taxable income is the income on which income tax is payable, computed by applying provisions of the Income Tax Act, 1961 & Rules.
3. Current Tax: Amount of Income tax determined to be paid / recoverable during a period.
4. Tax Expense: Aggregate of Current tax & Deferred tax charged to P&L account
5. Tax Savings: Aggregate of Current tax & Deferred tax credited to P&L account

COMPARISON BETWEEN ACCOUNTING PROFIT AND TAXABLE PROFIT

Permanent and Temporary Differences

Difference between taxable income and accounting income can be classified into Permanent difference and temporary difference.

1. Timing Difference

Timing differences are those differences between accounting income and taxable income which can be reversed in one or more subsequent periods. For example, Depreciation allowed as per WDV method for computing taxable income and as per SLM method for computing accounting income.

      2. Permanent Difference

Permanent differences are those differences between accounting income and taxable income which cannot be reversed any subsequent period. For example, Donation paid in cash is disallowed in computing taxable income whereas it is allowed as expenditure while computing accounting income.

 There can be differences between accounting income and taxable income because of the following reasons:
      1. Expenses debited in profit and loss statement, but disallowed as per Income Tax Act 1961, while                 computing taxable income

2. Provision for Bad/doubtful debts allowed while computing accounting income, but disallowed while computing taxable income
3. Charging depreciation using different rates as per Companies Act 2013 and Income Tax Act 1961
4. Any income recognized on an accrual basis in profit and loss statement but recognized on receipt basis in subsequent period for computing taxable income.
   In order to account for these kinds of differences, AS 22 needs to be applied.

When to apply AS 22 Accounting for Taxes on Income

AS 22 needs to be applied when there are timing differences between taxable income and accounting income. If taxable income is greater than accounting income, then it will result in deferred tax asset. And if accounting income is greater than taxable income, then it will result in deferred tax liability.

When the difference is resulting in deferred tax asset, then it should be recognized only when there is a reasonable certainty of its realization. The recognition of deferred tax asset should be to the extent of the reasonable certainty of the expected realization. The reasonable certainty can be determined by making the realistic estimates of future profits based on the examination of profits and loss statement of earlier periods.

Say, an entity has unabsorbed depreciation or carry forward of losses. In such a case, deferred tax asset should be recognized to the extent there is a virtual certainty supported by convincing evidence. Virtual certainty is a matter of judgment of convincing evidence, which should be available in a concrete form at a particular date.

How to apply AS 22 Accounting for Taxes on Income

The application of AS 22 can be explained with the help of examples:

Example of timing difference: 

Deferred tax Computation

Deferred Tax Asset & Deferred Tax Liability

Deferred Tax Asset (DTA)

Where the book profits in a year are less than taxable income, the excess tax paid today is known as Deferred Tax Asset. DTA is recognised only if there is future virtual certainty i.e. it is realized only when sufficient future taxable income can be reliably estimated.

Let us understand this with an example:

M/s Om Ltd which manufactures cars. The company assumes that the probability of a car being sent for warranty repairs is 1%. If M/s Om Ltd.’s revenue for financial year 2018 is Rs.22,00,000, then the following difference arises in the accounting income and taxable income.

Income as per Books of Account

Taxable Income 

The deferred tax asset based on the example above would be calculated as follows:
(Rs 6,60,000 – Rs 6,53,400) = Rs. 6,600

Deferred Tax Liability (DTL)

Where the book profits in a year are more than taxable income, the deficit tax paid today is known as Deferred Tax Liability (DTL). The provision of virtual certainty is not applicable while recording DTL.

Let us take an example of the same company M/s OM Ltd which manufactures cars. Assuming that a fixed asset costs Rs 60,000 will last for 3 years. They will account Rs 20,000 p.a. as depreciation in P&L accounts by using SLM as the method of calculating depreciation. However as per the taxation laws depreciation is calculated differently.

As shown above, the difference between the tax that the company should have paid on the basis of accounting and the tax that it actually paid shall amount to a deferred tax liability of Rs 3,000.

Effect on Minimum Alternate Tax (MAT)

As per section 115JB of the Income Tax Act, Minimum Alternate Tax(MAT) is required to be paid by a company if the tax payable calculated as per the provisions of the income tax act is less than 18.5% of the book profits. Book profit for this purpose is to be calculated as per the provisions of section 115JB.

There are controversies if deferred tax liability debited to P&L should be added to the book profit for MAT calculations. There are contrary views regarding this issue by Kolkata Tribunal in Balrampur Chini and Chennai Tribunal in Prime Textiles Ltd case.

Presentation of Deferred Taxes in Financial Statements

Profit and Loss Account

Journal entries:
1. Profit and loss account                                              Dr xxx
To Current tax Account xxx
(Being provision for current tax made)

2. Profit and loss account Dr xxx
   To Deferred Tax Account xxx
   (Being Deferred tax liability created)

Balance Sheet

Deferred tax asset and deferred tax liability should be netted off and should be disclosed in the balance sheet. DTA and DTL, both should not be disclosed simultaneously for the same period. Deferred taxes are disclosed as current assets/liabilities under a separate heading in the balance sheet.

Comparison between AS 22 and IND AS 12

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