Statements of Accounting Standards (AS 22)

ACCOUNTING FOR TAXES ON INCOME

(In this Accounting Standard, the standard portions have been set in bold italic type. These
should be read in the context of the background material which has been set in normal type, and
in the context of the ‘Preface to the Statements of Accounting Standards’1)

Accounting Standard (AS) 22, ‘Accounting for Taxes on Income’, issued by the Council of the
Institute of Chartered Accountants of India, comes into effect in respect of accounting periods
commencing on or after 1-4-2001. It is mandatory in nature2 for:

(a) All the accounting periods commencing on or after 01.04.2001, in respect of the following:

i. Enterprises whose equity or debt securities are listed on a recognized stock exchange
in India and enterprises that are in the process of issuing equity or debt securities that will
be listed on a recognized stock exchange in India as evidenced by the board of directors’
resolution in this regard.

ii. All the enterprises of a group, if the parent presents consolidated financial statements
and the Accounting Standard is mandatory in nature in respect of any of the enterprises
of that group in terms of (i) above.

(b) All the accounting periods commencing on or after 01.04.2002, in respect of companies not
covered by (a) above.

(c) All the accounting periods commencing on or after 01.04.2003, in respect of all other
enterprises.

The Guidance Note on Accounting for Taxes on Income, issued by the Institute of Chartered
Accountants of India in 1991, stands withdrawn from 1.4.2001. The following is the text of the
Accounting Standard.

Objective

The objective of this Statement is to prescribe accounting treatment for taxes on income. Taxes
on income are one of the significant items in the statement of profit and loss of an enterprise. In
accordance with the matching concept, taxes on income are accrued in the same period as the
revenue and expenses to which they relate. Matching of such taxes against revenue for a period
poses special problems arising from the fact that in a number of cases, taxable income may be
significantly different from the accounting income. This divergence between taxable income and
accounting income arises due to two main reasons. Firstly, there are differences between items
of revenue and expenses as appearing in the statement of profit and loss and the items which are
considered as revenue, expenses or deductions for tax purposes. Secondly, there are differences
between the amount in respect of a particular item of revenue or expense as recognized in the
statement of profit and loss and the corresponding amount which is recognized for the
computation of taxable income.

Scope

1. This Statement should be applied in accounting for taxes on income. This includes the
determination of the amount of the expense or saving related to taxes on income in
respect of an accounting period and the disclosure of such an amount in the financial
statements.

2. For the purposes of this Statement, taxes on income include all domestic and foreign taxes
which are based on taxable income.

3. This Statement does not specify when, or how, an enterprise should account for taxes that are
payable on distribution of dividends and other distributions made by the enterprise.

Definitions

4. For the purpose of this Statement, the following terms are used with the meanings
specified:

Accounting income (loss) is the net profit or loss for a period, as reported in the statement
of profit and loss, before deducting income tax expense or adding income tax saving.

Taxable income (tax loss) is the amount of the income (loss) for a period, determined in
accordance with the tax laws, based upon which income tax payable (recoverable) is
determined.

Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or
credited to the statement of profit and loss for the period.

Current tax is the amount of income tax determined to be payable (recoverable) in respect
of the taxable income (tax loss) for a period.

Deferred tax is the tax effect of timing differences.

Timing differences are the differences between taxable income and accounting income for
a period that originate in one period and are capable of reversal in one or more
subsequent periods.

Permanent differences are the differences between taxable income and accounting
income for a period that originate in one period and do not reverse subsequently.

5. Taxable income is calculated in accordance with tax laws. In some circumstances, the
requirements of these laws to compute taxable income differ from the accounting policies applied
to determine accounting income. The effect of this difference is that the taxable income and
accounting income may not be the same.

6. The differences between taxable income and accounting income can be classified into
permanent differences and timing differences. Permanent differences are those differences
between taxable income and accounting income which originate in one period and do not reverse
subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow
only a part of an item of expenditure, the disallowed amount would result in a permanent
difference.

7. Timing differences are those differences between taxable income and accounting income for a
period that originate in one period and are capable of reversal in one or more subsequent
periods. Timing differences arise because the period in which some items of revenue and
expenses are included in taxable income do not coincide with the period in which such items of
revenue and expenses are included or considered in arriving at accounting income. For example,
machinery purchased for scientific research related to business is fully allowed as deduction in
the first year for tax purposes whereas the same would be charged to the statement of profit and
loss as depreciation over its useful life. The total depreciation charged on the machinery for
accounting purposes and the amount allowed as deduction for tax purposes will ultimately be the
same, but periods over which the depreciation is charged and the deduction is allowed will differ.
Another example of timing difference is a situation where, for the purpose of computing taxable
income, tax laws allow depreciation on the basis of the written down value method, whereas for
accounting purposes, straight line method is used. Some other examples of timing differences
arising under the Indian tax laws are given in Appendix 1.

8. Unabsorbed depreciation and carry forward of losses which can be set-off against future
taxable income are also considered as timing differences and result in deferred tax assets,
subject to consideration of prudence (see paragraphs 15-18).

Recognition

9. Tax expense for the period, comprising current tax and deferred tax, should be included
in the determination of the net profit or loss for the period.

10. Taxes on income are considered to be an expense incurred by the enterprise in earning
income and are accrued in the same period as the revenue and expenses to which they relate.
Such matching may result into timing differences. The tax effects of timing differences are
included in the tax expense in the statement of profit and loss and as deferred tax assets (subject
to the consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, in
the balance sheet.

11. An example of tax effect of a timing difference that results in a deferred tax asset is an
expense provided in the statement of profit and loss but not allowed as a deduction under Section
43B of the Income-tax Act, 1961. This timing difference will reverse when the deduction of that
expense is allowed under Section 43B in subsequent year(s). An example of tax effect of a timing
difference resulting in a deferred tax liability is the higher charge of depreciation allowable under
the Income-tax Act, 1961, compared to the depreciation provided in the statement of profit and
loss. In subsequent years, the differential will reverse when comparatively lower depreciation will
be allowed for tax purposes.

12. Permanent differences do not result in deferred tax assets or deferred tax liabilities.

13. Deferred tax should be recognized for all the timing differences, subject to the
consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-
18.

14. This Statement requires recognition of deferred tax for all the timing differences. This is based
on the principle that the financial statements for a period should recognize the tax effect, whether
current or deferred, of all the transactions occurring in that period.

15. Except in the situations stated in paragraph 17, deferred tax assets should be
recognized and carried forward only to the extent that there is a reasonable certainty that
sufficient future taxable income will be available against which such deferred tax assets
can be realized.

16. While recognizing the tax effect of timing differences, consideration of prudence cannot be
ignored. Therefore, deferred tax assets are recognized and carried forward only to the extent that
there is a reasonable certainty of their realization. This reasonable level of certainty would
normally be achieved by examining the past record of the enterprise and by making realistic
estimates of profits for the future 17. Where an enterprise has unabsorbed depreciation or
carry forward of losses under tax laws, deferred tax assets should be recognized only to
the extent that there is virtual certainty supported by convincing evidence that sufficient
future taxable income will be available against which such deferred tax assets can be
realized.

18. The existence of unabsorbed depreciation or carry forward of losses under tax laws is strong
evidence that future taxable income may not be available. Therefore, when an enterprise has a
history of recent losses, the enterprise recognizes deferred tax assets only to the extent that it
has timing differences the reversal of which will result in sufficient income or there is other
convincing evidence that sufficient taxable income will be available against which such deferred
tax assets can be realized. In such circumstances, the nature of the evidence supporting its
recognition is disclosed.

Re-assessment of Unrecognized Deferred Tax Assets

19. At each balance sheet date, an enterprise re-assesses unrecognized deferred tax assets. The
enterprise recognizes previously unrecognized deferred tax assets to the extent that it has
become reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18),
that sufficient future taxable income will be available against which such deferred tax assets can
be realized. For example, an improvement in trading conditions may make it reasonably certain
that the enterprise will be able to generate sufficient taxable income in the future.

Measurement

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.

23. When different tax rates apply to different levels of taxable income, deferred tax assets and
liabilities are measured using average rates.

24. Deferred tax assets and liabilities should not be discounted to their present value.

25. The reliable determination of deferred tax assets and liabilities on a discounted basis requires
detailed scheduling of the timing of the reversal of each timing difference. In a number of cases
such scheduling is impracticable or highly complex. Therefore, it is inappropriate to require
discounting of deferred tax assets and liabilities. To permit, but not to require, discounting would
result in deferred tax assets and liabilities which would not be comparable between enterprises.
Therefore, this Statement does not require or permit the discounting of deferred tax assets and
liabilities.

Review of Deferred Tax Assets

26. The carrying amount of deferred tax assets should be reviewed at each balance sheet
date. An enterprise should write-down the carrying amount of a deferred tax asset to the
extent that it is no longer reasonably certain or virtually certain, as the case may be (see
paragraphs 15 to 18), that sufficient future taxable income will be available against which
deferred tax asset can be realised. Any such write-down may be reversed to the extent
that it becomes reasonably certain or virtually certain, as the case may be (see paragraphs
15 to 18), that sufficient future taxable income will be available.
Presentation and Disclosure

27. An enterprise should offset assets and liabilities representing current tax if the
enterprise:

(a) has a legally enforceable right to set off the recognised amounts; and

(b) intends to settle the asset and the liability on a net basis.

28. An enterprise will normally have a legally enforceable right to set off an asset and liability
representing current tax when they relate to income taxes levied under the same governing
taxation laws and the taxation laws permit the enterprise to make or receive a single net payment.

29. An enterprise should offset deferred tax assets and deferred tax liabilities if:

(a) the enterprise has a legally enforceable right to set off assets against liabilities
representing current tax; and

(b) the deferred tax assets and the deferred tax liabilities relate to taxes on income
levied by the same governing taxation laws.

30. Deferred tax assets and liabilities should be distinguished from assets and liabilities
representing current tax for the period. Deferred tax assets and liabilities should be
disclosed under a separate heading in the balance sheet of the enterprise, separately from
current assets and current liabilities.

31. The break-up of deferred tax assets and deferred tax liabilities into major components
of the respective balances should be disclosed in the notes to accounts.

32. The nature of the evidence supporting the recognition of deferred tax assets should be
disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under
tax laws.

Transitional Provisions

33. On the first occasion that the taxes on income are accounted for in accordance with
this Statement, the enterprise should recognise, in the financial statements, the deferred
tax balance that has accumulated prior to the adoption of this Statement as deferred tax
asset/liability with a corresponding credit/charge to the revenue reserves, subject to the
consideration of prudence in case of deferred tax assets (see paragraphs 15-18). The
amount so credited/charged to the revenue reserves should be the same as that which
would have resulted if this Statement had been in effect from the beginning.

34. For the purpose of determining accumulated deferred tax in the period in which this
Statement is applied for the first time, the opening balances of assets and liabilities for accounting
purposes and for tax purposes are compared and the differences, if any, are determined. The tax
effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if
these differences are timing differences. For example, in the year in which an enterprise adopts
this Statement, the opening balance of a fixed asset is Rs. 100 for accounting purposes and Rs.
60 for tax purposes. The difference is because the enterprise applies written down value method
of depreciation for calculating taxable income whereas for accounting purposes straight line
method is used. This difference will reverse in future when depreciation for tax purposes will be
lower as compared to the depreciation for accounting purposes. In the above case, assuming that
enacted tax rate for the year is 40% and that there are no other timing differences, deferred tax
liability of Rs. 16 [(Rs. 100 - Rs. 60) x 40%] would be recognised. Another example is an
expenditure that has already been written off for accounting purposes in the year of its incurrance
but is allowable for tax purposes over a period of time. In this case, the asset representing that
expenditure would have a balance only for tax purposes but not for accounting purposes. The
difference between balance of the asset for tax purposes and the balance (which is nil) for
accounting purposes would be a timing difference which will reverse in future when this
expenditure would be allowed for tax purposes. Therefore, a deferred tax asset would be
recognised in respect of this difference subject to the consideration of prudence (see paragraphs
15 - 18).

Appendix 1

Examples of Timing Differences

Note : This appendix is illustrative only and does not form part of the Accounting Standard. The
purpose of this appendix is to assist in clarifying the meaning of the Accounting Standard. The
sections mentioned hereunder are references to sections in the Income-tax Act, 1961, as
amended by the Finance Act, 2001.

1. Expenses debited in the statement of profit and loss for accounting purposes but allowed for
tax purposes in subsequent years, e.g.

a) Expenditure of the nature mentioned in section 43B (e.g. taxes, duty, cess, fees, etc.)
accrued in the statement of profit and loss on mercantile basis but allowed for tax
purposes in subsequent years on payment basis.

b) Payments to non-residents accrued in the statement of profit and loss on mercantile

c) Provisions made in the statement of profit and loss in anticipation of liabilities where
the relevant liabilities are allowed in subsequent years when they crystallize.

2. Expenses amortized in the books over a period of years but are allowed for tax purposes
wholly in the first year (e.g. substantial advertisement expenses to introduce a product, etc.
treated as deferred revenue expenditure in the books) or if amortization for tax purposes is over a
longer or shorter period (e.g. preliminary expenses under section 35D, expenses incurred for
amalgamation under section 35DD, prospecting expenses under section 35E).

3. Where book and tax depreciation differ. This could arise due to:

a) Differences in depreciation rates.

b) Differences in method of depreciation e.g. SLM or WDV.

c) Differences in method of calculation e.g. calculation of depreciation with reference to

4. Where a deduction is allowed in one year for tax purposes on the basis of a deposit made
under a permitted deposit scheme (e.g. tea development account scheme under section 33AB or
site restoration fund scheme under section 33ABA) and expenditure out of withdrawal from such
deposit is debited in the statement of profit and loss in subsequent years.

5. Income credited to the statement of profit and loss but taxed only in subsequent years e.g.
conversion of capital assets into stock in trade.

6. If for any reason the recognition of income is spread over a number of years in the accounts
but the income is fully taxed in the year of receipt.

Appendix 2

Note : This appendix is illustrative only and does not form part of the Accounting Standard. The
purpose of this appendix is to illustrate the application of the Accounting Standard. Extracts from
statement of profit and loss are provided to show the effects of the transactions described below.

Illustration 1

A company, ABC Ltd., prepares its accounts annually on 31st March. On 1st April, 20x1, it
purchases a machine at a cost of Rs. 1,50,000. The machine has a useful life of three years and
an expected scrap value of zero. Although it is eligible for a 100% first year depreciation
allowance for tax purposes, the straight-line method is considered appropriate for accounting
purposes. ABC Ltd. has profits before depreciation and taxes of Rs. 2,00,000 each year and the
corporate tax rate is 40 per cent each year.

The purchase of machine at a cost of Rs. 1,50,000 in 20x1 gives rise to a tax saving of Rs.
60,000. If the cost of the machine is spread over three years of its life for accounting purposes,
the amount of the tax saving should also be spread over the same period as shown below:

Statement of Profit and Loss

(for the three years ending 31st March, 20x1, 20x2, 20x3)

(Rupees in thousands)
20x1 20x2 20x3
Profit before depreciation and taxes 200 200 200
Less: Depreciation for accounting purposes 50 50 50
Profit before taxes 150 150 150
Less: Tax expense
Current tax
0.40 (200 - 150) 20
0.40 (200) 80 80
Deferred tax
Tax effect of timing differences originating during the year 40
0.40 (150 - 50)
Tax effect of timing differences reversing during the year (20) (20)
0.40 (0 - 50)
Tax expense 60 60 60
Profit after tax 90 90 90
Net timing differences 100 50 0
Deferred tax liability 40 20 0

In 20x1, the amount of depreciation allowed for tax purposes exceeds the amount of depreciation
charged for accounting purposes by Rs. 1,00,000 and, therefore, taxable income is lower than the
accounting income. This gives rise to a deferred tax liability of Rs. 40,000. In 20x2 and 20x3,
accounting income is lower than taxable income because the amount of depreciation charged for
accounting purposes exceeds the amount of depreciation allowed for tax purposes by Rs. 50,000
each year. Accordingly, deferred tax liability is reduced by Rs. 20,000 each in both the years. As
may be seen, tax expense is based on the accounting income of each period.

In 20x1, the profit and loss account is debited and deferred tax liability account is credited with
the amount of tax on the originating timing difference of Rs. 1,00,000 while in each of the
following two years, deferred tax liability account is debited and profit and loss account is credited
with the amount of tax on the reversing timing difference of Rs. 50,000.

The following Journal entries will be passed:

Year 20x1

Profit and Loss A/c Dr. 20,000

To Current tax A/c 20,000

(Being the amount of taxes payable for the year 20x1 provided for)

Profit and Loss A/c Dr. 40,000

To Deferred tax A/c 40,000

(Being the deferred tax liability created for originating timing difference of Rs. 1,00,000)

Year 20x2

Profit and Loss A/c Dr. 80,000

To Current tax A/c 80,000

(Being the amount of taxes payable for the year 20x2 provided for)

Deferred tax A/c Dr. 20,000

To Profit and Loss A/c 20,000

(Being the deferred tax liability adjusted for reversing timing difference of Rs. 50,000)

Year 20x3

Profit and Loss A/c Dr. 80,000

(Being the amount of taxes payable for the year 20x3 provided for)

Deferred tax A/c Dr. 20,000

To Profit and Loss A/c 20,000

(Being the deferred tax liability adjusted for reversing timing difference of Rs. 50,000)

In year 20x1, the balance of deferred tax account i.e., Rs. 40,000 would be shown separately
from the current tax payable for the year in terms of paragraph 30 of the Statement. In Year 20x2,
the balance of deferred tax account would be Rs. 20,000 and be shown separately from the
current tax payable for the year as in year 20x1. In Year 20x3, the balance of deferred tax liability
account would be nil.

Illustration 2

In the above illustration, the corporate tax rate has been assumed to be same in each of the three
years. If the rate of tax changes, it would be necessary for the enterprise to adjust the amount of
deferred tax liability carried forward by applying the tax rate that has been enacted or
substantively enacted by the balance sheet date on accumulated timing differences at the end of
the accounting year (see paragraphs 21 and 22). For example, if in Illustration 1, the
substantively enacted tax rates for 20x1, 20x2 and 20x3 are 40%, 35% and 38% respectively, the
amount of deferred tax liability would be computed as follows:

The deferred tax liability carried forward each year would appear in the balance sheet as under:

31st March, 20x1 = 0.40 (1,00,000) = Rs. 40,000

Accordingly, the amount debited/(credited) to the profit and loss account (with corresponding
credit or debit to deferred tax liability) for each year would be as under:

31st March, 20x1 Debit = Rs. 40,000