Computation of book profits by Ind AS compliant companies for levy of MAT

1) Introduction

The provisions of Section 115JB provide for levy of MAT on basis of "book profits", i.e., the profit disclosed in profit and loss account prepared in accordance with provisions of The Companies Act. Ind AS compliant companies shall be required to bifurcate theirProfit or Loss account into

following two parts -

(i)		Net profit or loss for the year;
(ii)		Net Other Comprehensive Income.

Now question arises whether 'Net other comprehensive income' should be considered for computation of book profit under Section 115JB? On June 8, 2015, the CBDT had constituted a committee to,inter alia, suggest the framework for computation of book profit for the purpose of levy of MAT on the Ind AS compliant companies in the year of adoption and thereafter.

Now the committee has submitted its report after having consultation with MCA. Recommendations of committee and other related terms have been discussed in this article in the form of Q&As.

2) What is IND-AS

India has adopted the IFRS converged IND-AS with a view to enhance the acceptability and transparency for the financial statements of Indian corporates. These IND-AS can be applied voluntarily in preparation of financial statements from April 1, 2015 and have to be applied mandatorily from April 1, 2016 by certain entities.

3) Format of Financial Statements

With adoption of IND-AS, the format of financial statements shall undergo various changes which can be either change in the nomenclature of any item or their accounting treatment. One of themajor changes that shall happen in the format of financial statements after adoption of IND-AS includeseparate disclosure of "other comprehensive income" in the Statement of profit or loss.

4) What is 'Other Comprehensive Income'

The IND-AS promotes the concept of Fair Value Accounting where assets shall be valued at fair value.'Other comprehensive income'includes, inter-alia, the financial impact arising from reinstatement of underlying assets in accordance with principle of Fair Value Accounting.

To avoid the distribution of the revaluation profits to the shareholders by way of dividend or to the managers as managerial remuneration, the net profits are adjusted with 'Net OCIs'.

OCIs include the following items, which shall be excluded for the purpose of arriving at distributable profits:

(a)		Changes in revaluation surplus;
(b)		Re-measurements of defined benefit plans;
(c)		Gains and losses arising from translating the financial statements of a foreign operation;
(d)		Gains and losses from investments in equity instruments designated at fair value;
(e)		Gains and losses on financial assets measured at fair value;
(f)		The effective portion of gains and losses on hedging instruments in a cash flow hedge and the gains and losses on hedging instruments that hedge investments in equity instruments measured at fair value;
(g)		For particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability's credit risk;
(h)		Changes in the value of the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value;
(i)		Changes in the value of the forward elements of forward contracts when separating the forward elements and spot elements of a forward contract and designating as the hedging instrument only the changes in the spot element, and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument.

Due to the concept of OCIs two profits arise - Profit before tax and before OCIs adjustment and Profit before tax but after OCIs adjustment.

5) MAT Computation

For computation of Minimum Alternative Tax ('MAT'), the book profit is to be calculated after making certain adjustments in the net profit as appearing in the profit and loss account. The book profit shall be calculated as per following mechanism before and after implementation of IND-AS:

Before IND-AS	After IND-AS
Profit before Tax	Profit before Tax (including Net OCIs)
Add: Adjustment allowed under Section 115JB	Less: Net other comprehensive income
Less: Adjustment allowed under Section 115JB	Add: Adjustment allowed under section 115JB
	Less: Adjustment allowed under section 115JB
Book Profit	Book Profit

6) Why Net OCIs are excluded

The 'Lohia Committee' constituted on MAT and IND-AS has recommended that no further adjustments are required to be made to the net profits (excluding net other comprehensive income) of IND-AS compliant companies other than those already specified under Section 115JB.

In other words, the committee recommends that since the distributable profits (available for distribution of dividend or managerial remuneration) exclude net comprehensive income, it should also be excluded from the book profit for computation of MAT.

7) Are Net OCIs always excluded from Book Profit ?

Net OCIs are the outcome of reinstatement of specified assets (immovable property, figures appearing in financial statements of foreign subsidiaries, etc.) at their fair value or other adjustments. These Net OCIs are capable of reversal in subsequent period and, on reversal, reclassified into profit & loss account.

Thus, Net OCIs are proposed to be excluded from the calculation of Book Profit till these items are not reclassified into profit & loss account.

However, the committee recommended adjustment for following items of Net OCIs which are permanently recorded in reserves and are never reclassified into the Statement of Profit and Loss:

(a)		Changes in Revaluation Surplus(IND-AS 16 and IND-AS 38) as it is currently included in book profits at the time of realization/ disposal/ retirement of Asset.
(b)		Re-measurement of Defined Benefit Plan(IND-AS 19), which should be included in the Book profits on annual basis when the gains or losses arise.
(c)		Gains and losses from investments in equity instruments designated at fair value (IND-AS 109), which should be included in book profits at the time of realization.

8) Reversals of Net OCIs

(a)		Changes in Revaluation Surplus in case of revaluation of fixed assets
		As per IND-AS 16, 'Property, Plant and Equipment', on revaluation, the amount of increase in carrying amount of tangible fixed asset is recognised as other comprehensive income and accumulated as 'revaluation surplus', whereas, any decrease in the carrying amount of tangible asset is debited to statement of profit and loss.
		Subsequent increase in carrying amount of such tangible asset shall be recognised in profit or loss to the extent of decrease in carrying amount of same asset recognized in earlier years in the profit or loss.In case of decrease, amount of decrease to the extent of credit balance existing in revaluation surplus (because of upward revaluation during previous years) in respect of same asset should be recognised as OCI.
		IND-AS 38, 'Intangible Assets' provides similar principles in case of revaluation of intangible assets.
		The Committee recommends the same treatment of such revaluation surplus as provided in Explanation 1(j) to Section 115JB, i.e., inclusion of revaluation surplus in the book profit in the year of retirement or disposal of asset.
(b)		Re-measurement of defined benefit plans
		Re-measurement of defined benefits plans comprises of:

■		Actuarial gains or losses;
■		Return on plan assets; and
■		Change in effect of asset ceiling (change in present value of any economic benefits available in form of refunds from plan or reductions in future contributions to the plan).

		As per IND-AS 19, 'Employee Benefits' re-measurement of defined benefit plans shall be recognised in other comprehensive income which shall not be reclassified to profit or loss in any subsequent period.
		Since re-measurement of defined benefit plans is never re-classified to statement of profit or loss, the Lohia Committee recommended that such Net OCIs arising should be included in the book profits on annual basis when the gains or losses arise.
(c)		Gains or losses arising from translating the financial statements of a foreign operations
		At the time of consolidation of results and financial position of foreign operation with Indian entity, any exchange difference arising on monetary items forming part of the reporting entity's net investment in the foreign operation shall be recognised in other comprehensive income in the combined financial statement. Such exchange difference is reclassified to profit or loss on disposal of the net investment in the foreign operation.
		The amount of Net OCIs shall form part of Book profit for computation of MAT only in the year of re-classification into profit or loss.
(d)		Gains and losses from investments in equity instruments designated at fair value
		As per IND-AS 109, an entity has an option to recognize the changes in the fair value of an investment in an equity instrument that is neither held for trading nor contingent consideration recognised by an acquirer (the entity) in a business combination. Any gains or losses arising on such type of investment should also be recognised as other comprehensive income and does not require reclassification to profit or loss.
		The Committee recommended that such Net OCIs should be included in the book profit for computation of MAT at the time of realization.
(e)		Gains and losses on financial assets measured at fair value
		A financial asset shall be measured at fair value through other comprehensive income if following conditions are met:

■		the financial asset is held for the purpose of collecting contractual cash flows and selling the financial asset; and
■		the contractual terms of the financial asset give rise to cash flows, on specified dates, that include payments of principal and interest.

		Gains or losses on such financial asset are treated as other comprehensive income. When the financial asset is de-recognised form the books the cumulative gain or loss previously recognised in other comprehensive income is reclassified from equity to profit or loss.
		Such Net OCIs are recommended to be included in the book profit for computation of MAT only at the time of re-classification into statement of profit or loss.
(f)		Gains and losses on hedging instruments
		As per IND-AS 109, in case of cash flow hedge, the portion of the gain or loss that is offset by the change in the cash flow hedge reserve on the hedging instrument shall be recognised in other comprehensive income. In this case the amount recognised in other comprehensive income shall be reclassified to profit or loss in subsequent periods.
		Further, in case of fair value hedge, the gain or loss on hedging instrument should be treated as other comprehensive income, if the hedging instrument hedges an equity instrument for which an entity has elected, in specified cases, to present changes in fair value in other comprehensive income. These should not be reclassified to profit or loss in subsequent periods.
		Such Net OCIs are recommended to be included in the book profit for computation of MAT only at the time of re-classification into statement of profit or loss.
(g)		For particular liabilities designated as at fair value through profit or loss, the amount of the change in fair value that is attributable to changes in the liability's credit risk
		IND-AS 109 provides that the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability shall be presented in other comprehensive income. This amount also shall not be reclassified to profit or loss in subsequent periods.But if this treatment of changes in the fair value of the financial liability that is attributable to change in the credit risk of that liability it would create or enlarge an accounting mismatch in profit or loss, then such gains should be recognised in the profit or loss account.
(h)		Changes in the time value of options when separating the intrinsic value and time value of an option contract and designating as the hedging instrument only the changes in the intrinsic value
		While separating the intrinsic value and time value of an option contract and designating it as the hedging instrument only the changes in the intrinsic value, the changes in the value of the time value of options shall be recognised in other comprehensive income. Such amount of changes shall be reclassified to profit or loss when the hedged expected future cash flows affect profit or loss.
		Such Net OCIs are recommended to be included in the book profit for computation of MAT only at the time of re-classification into statement of profit or loss.
(i)		Changes in the value of the forward elements of forward contracts when separating the forward element and spot element of a forward contract and designating as the hedging instrument only the changes in the spot element, and changes in the value of the foreign currency basis spread of a financial instrument when excluding it from the designation of that financial instrument as the hedging instrument
		At the time of separating forward element and spot element of a forward contract and designating it as the hedging instrument only the changes in the spot element, any changes in the value of forward element shall be recognised in other comprehensive income. This amount shall be reclassified to profit or loss when the hedged expected future cash flows affect profit or loss.
		Such Net OCIs are recommended to be included in the book profit for computation of MAT only at the time of re-classification into statement of profit or loss.