In India, the convergence of GAAP (generally accepted accounting principles) with International Financial Reporting Standard (IFRS) will pose various challenges on the tax and regulatory front which companies, investors and regulators will have to grapple with. In substance, for IFRS to become a reality in India by 2011, significant changes in the regulatory framework will be required.
Let us take the example of fair-value gains and losses recognized each year in the income statement for securities held for trading. Under Indian tax laws, these will be liable to tax only on eventual sale; therefore, it will result in the creation of a deferred tax asset or liability on the books. In the absence of any specific tax laws dealing with such fair-value gains and losses, it may be possible for companies to adjust fair-value losses against their taxable income, while gains would get deferred. Tax authorities have to clarify how unrealized fair-value gains and losses will be treated for tax purposes.
It is also not clear how tax authorities will treat adjustments in the values of financial assets or liabilities due to market-linked interest rates and discounting to net present values if these are long-term in nature. Under IFRS, the financial results will reflect the substance of the transaction. Take, for example, the IFRS provision on “Determining whether an arrangement contains a lease” or another on “Service Concession Arrangements”. These will have significant impact on the revenue recognition, operating profits and state of affairs of dedicated vendors and operators and infrastructure companies. It will be interesting to see how tax authorities react to these new concepts—for instance, will construction revenue recognized under an IFRS provision during the construction phase of a public infrastructure asset be liable to taxes? Similarly, one will also need to examine implications that will arise in areas of value added tax (VAT) and service tax, wherever revenue or cost of goods and services is impacted by IFRS.
Also Read Navin Agrawal’s earlier columns
Take another example—a tea or coffee plantation. Under the current accounting standard on “agriculture”, changes in the fair value of a plantation will have to be recognized each year in the income statement. In India, agricultural income is exempt from tax, but tea and coffee plantations have to pay tax on a certain portion of their total income which is deemed to be non-agricultural, or business, income. Plantation companies will need clarity from tax authorities as to how such fair-value gains or losses will be divided between agricultural and business income, and how these would be treated for tax purposes.
One important aspect about IFRS is that it will not recognize any legal override, unlike the present Indian GAAP scenario. At present, most of the financial statement presentation requirements are driven by the Companies Act, 1956. Similarly, managerial remuneration is determined with reference to the limits laid down in the Act. Under IFRS, this may get challenged since the remuneration might get restricted and will, therefore, be at variance with the contracted terms and not a right benchmark with other global players.
One section of the Companies Act allows securities premium accounts to be used for various purposes including expenses incurred for issue of fresh capital or for premium payable on redemption of debentures and bonds. However, these will be treated as expenses or interest costs under IFRS and be charged to the income statement. Another example is when courts sanction a scheme of arrangement or merger. Currently, the accounting treatment outlined in the approved scheme will prevail over accounting standards, but this will not hold water any more under IFRS.
The Companies Act will require a major overhaul, as will various other statutes such as the Insurance Regulatory Development Authority Act, the Securities and Exchange Board of India (Sebi) Act and the Reserve Bank of India Act.
It is unlikely that all regulatory authorities will accept the primacy of IFRS. There are bound to be certain exceptions and limitations and in those areas, there will be a legal override, as has been the experience worldwide in various non-European countries and in Europe for some banking companies. However, these legal overrides will distort the true application of IFRS principles and will, therefore, defeat the basic objective and benefit of convergence. It would be in the interest of India, if all the regulatory authorities concerned can work in conjunction with the Institute of Chartered Accountants of India, Sebi and the ministry of finance to bring about the required changes to support the implementation of IFRS in India—in its true spirit.
India will move to IFRS starting 2011. Navin Agrawal is a director with Ernst & Young India Pvt. Ltd. This is the fourth of a series that analyses the impact of IFRS on industries and regulatory issues pertaining to its convergence with Indian GAAP.
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