Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
CA Bhawna Grover Manager - Research and Advisory, Taxmann
CA Prajwal Jha Associate - Research and Advisory, Taxmann
Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
CA Bhawna Grover Manager - Research and Advisory, Taxmann
CA Prajwal Jha Associate - Research and Advisory, Taxmann
Contents 1.
Introduction
5
2.
Accounting Treatment of Dividend on Redeemable Preference Shares Classified as a Financial Liability
5
Deferred Tax Liability on Freehold Land proposed to be sold through a Slump Sale
6
Conclusion
8
3. 4.
1.
Introduction
The transition from previous GAAP to Ind AS can result in significant changes not only in recognition and measurement but also in the presentation and timing of recognition of certain items in the financial statements. The impact is particularly relevant where the accounting treatment under previous GAAP was based on a different underlying principle from that prescribed under Ind AS. The case studies in the article examine selected transition issues relating to: a)
accounting for dividends on redeemable preference shares classified as financial liabilities
b)
recognition of deferred tax liability on freehold land proposed to be disposed of through a slump sale
These cases illustrate how the application of specific requirements of Ind AS may result either in a change in accounting treatment from the previous treatment under the Ind AS framework.
2.
Accounting Treatment of Dividend on Redeemable Preference Shares Classified as a Financial Liability
2.1
Understanding the Issue
The classification of preference shares under Ind AS can have a significant bearing on the subsequent accounting for the return payable to the holders. While preference shares may be described as an equity instrument in legal or commercial terms, their contractual terms and the substance of the arrangement determine whether they are classified as equity or a financial liability under Ind AS 32, Financial Instruments: Presentation. This classification becomes particularly relevant where the instrument is redeemable and carries a contractual obligation to make payments to its holders. Once the instrument is classified as a financial liability, the related return is no longer considered merely as a distribution of profit. The case therefore examines how the classification of redeemable preference shares under Ind AS affects the accounting for the related dividend/return.
2.2 Facts Aster India has issued redeemable preference shares to its investors. Although the instrument is legally described as preference shares, the terms attached to the instrument require the company to redeem the preference shares and provide for payment of dividend/return to the holders. On transition to Ind AS, the company examined the contractual terms of the preference shares in accordance with Ind AS 32. Based on the terms of the instrument, the redeemable preference shares were determined to meet the definition of a financial liability rather than equity. The company had a reporting period ending before the date on which the dividend was formally declared. The dividend on the redeemable preference shares was declared after
Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
5
the end of the reporting period. The issue before the company was whether the dividend should nevertheless be accrued in the financial statements for the year ended before the date of declaration, considering that the preference shares had already been classified as a financial liability. The question is therefore not merely whether the amount is legally described as a “dividend”, but whether the contractual terms of the instrument create an obligation that requires recognition of the related return in the financial statements.
2.3 Analysis Under Ind AS 32, classification of a financial instrument is based on the substance of the contractual arrangement. Where redeemable preference shares meet the definition of a financial liability, they are not treated as equity merely because they are legally called preference shares. Once classified as a financial liability, the instrument is subsequently accounted for in accordance with the applicable requirements of Ind AS 109, Financial Instruments. Where the instrument is measured at amortised cost, the related return is considered as part of the effective interest calculation. Accordingly, where the return is contractually determined under the terms of the instrument, the accounting is driven by the contractual obligation existing at the reporting date, rather than merely by the date on which the dividend is formally declared.
2.4 Conclusion Under the previous GAAP, preference shares could have been presented as equity depending upon their classification under the applicable previous GAAP requirements, and the dividend could consequently have been regarded as a distribution to equity holders. Under Ind AS, the contractual terms of the redeemable preference shares are examined under Ind AS 32. Where those terms result in classification as a financial liability, the related return is accounted for as a financial cost in accordance with Ind AS 109, rather than as a distribution of profit. Accordingly, the transition to Ind AS can result in a fundamental change in accounting: an amount that may previously have been viewed as a dividend/distribution on equity is treated, under Ind AS, as a return on a financial liability where the contractual terms require such classification.
3.
Deferred Tax Liability on Freehold Land proposed to be sold through a Slump Sale
3.1
Understanding the Issue
The recognition of deferred tax in respect of an asset depends not merely on the difference between its accounting carrying amount and the corresponding tax amount, but also on how the entity expects to recover the carrying amount of that asset. This becomes particularly relevant in the case of freehold land, where the tax consequences may differ depending upon whether the land is sold individually or transferred as part of a slump sale. The case therefore examines whether the proposed slump sale of freehold land gives
6
Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
rise to a taxable or deductible temporary difference under Ind AS 12, Income Taxes and consequently, whether any deferred tax asset or deferred tax liability is required to be recognised.
3.2 Facts Radiant Limited owns freehold land which is recognised as an asset in its financial statements. The company is considering disposal of the land, but the proposed transaction is not an individual sale of the land. Instead, the land is expected to be transferred as part of a slump sale. The manner in which the company expects to recover the carrying amount of the land is relevant for determining its tax consequences. The company therefore needs to determine whether the carrying amount of the land and its tax base will give rise to a temporary difference under Ind AS 12. The issue is whether Radiant Limited is required to recognise a deferred tax asset or deferred tax liability in respect of the freehold land merely because the accounting carrying amount of the land may differ from its tax-related amount. The specific issue becomes relevant because the tax consequences of a slump sale are different from those applicable where individual assets are sold separately. Further, the indexation benefit is not available in the case of a slump sale under the relevant provisions of the Income-tax Act, 1961.
3.3 Analysis Paragraph 5 of Ind AS 12, defines a taxable temporary difference and a deductible temporary difference by reference to the difference between the carrying amount of an asset or liability and its tax base. The determination therefore requires the entity to consider how the carrying amount of the asset will be recovered. In the present case, the land is expected to be recovered through a slump sale. Since, the indexation benefit is not available in the aforesaid transaction, the tax base of the land is the same as its carrying amount. Consequently, there is no difference between the carrying amount and tax base that would give rise to a temporary difference.
3.4 Conclusion Under the previous GAAP, deferred tax accounting was based on the requirements applicable to timing differences under the previous framework. Under Ind AS 12, the analysis is based on the concept of temporary differences and requires consideration of the manner in which the carrying amount of an asset is expected to be recovered. In the present case, since the land is expected to be disposed of through a slump sale, and the tax base is considered to be equal to its carrying amount, no temporary difference arises. Accordingly, there is no deferred tax asset or deferred tax liability to be recognised in respect of the land on the facts of this case.
Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
7
The case demonstrates an important difference in approach under Ind AS 12: the deferred tax analysis is not based merely on comparing accounting and tax figures in isolation; the expected manner of recovery of the asset is an important consideration in determining the tax base.
4. Conclusion First-time adoption of Ind AS is not merely an exercise of converting financial statements from previous GAAP to a new set of accounting standards. It requires an entity to revisit the substance of transactions, contractual rights and obligations, measurement bases and the manner in which assets and liabilities are expected to be recovered or settled. The case studies discussed in this article demonstrate how these considerations can materially influence accounting on transition. The case relating to redeemable preference shares illustrates the importance of classification based on the contractual substance of a financial instrument. An instrument that may have been viewed as equity under previous GAAP can, on applying Ind AS 32, meet the definition of a financial liability, resulting in a corresponding change in the accounting for the return on such instrument. Similarly, the case concerning freehold land proposed to be disposed of through a slump sale highlights the importance of determining the manner in which an asset is expected to be recovered while applying Ind AS 12. The deferred tax analysis under Ind AS is based on temporary differences and requires careful consideration of the relevant tax base and expected manner of recovery. The transition exercise should therefore be viewed as an opportunity to undertake a substantive reassessment of accounting policies and balances, rather than as a mechanical restatement of figures. A careful understanding of the facts, contractual terms, applicable exemptions and interaction between Ind AS 101 and other Ind AS is essential for arriving at an appropriate and supportable transition position.
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Practical Insights on Ind AS and SAs Understanding the Transition provision for Financial Instruments and Deferred Tax with Case Studies
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