The US Tax Cuts and Jobs Act (the Act) aims to encourage economic growth and bring jobs and profits from overseas back to the country. It significantly changes the US income tax law. Entities will need to account for the effects of these changes in the period that including December 22, 2017, the enactment date of the Act. Accordingly, the companies which had December 2017 or later (e.g. March 31, 2018) as their year-end had to account for the impact immediately.
Considering that most of the Indian life sciences companies (LS companies) have significant presence and operations in the US (through their group companies), these changes are likely to have an impact on their financial statements and business practices. The LS companies applying Indian Accounting Standards (Ind AS) must apply the relevant guidance in Ind AS, in particular, Ind AS 12 Income Taxes and Ind AS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
The Act will have greatest accounting impact on the following areas for the life sciences companies:
1. Deferred and current tax accounting The Act has established a flat corporate income tax rate of 21 percent to replace previous rates that ranged from 15 percent to 35 percent. LS companies need to apply the new tax rate when calculating their deferred tax balances as of the enactment date and subsequent period end. Accordingly LS companies which have significant deferred tax asset as at the enactment date will have huge deferred tax charge (approximately 40 percent of their deferred tax assets) in their profit and loss account and vice versa would hold good in case LS companies have deferred tax liabilities as at the enactment date.
Non-calendar year-end entities need to calculate the blended tax rate at which they will be computing current tax. To compute the blended rate, an entity calculates the weighted average tax rate based on the ratio of days in the fiscal year prior to and after enactment. For example, LS companies with 31 March 2018 as their fiscal year end will have a blended rate of 31.55 percent.
2. Deduction limits for interest expense
The Act limits the deduction for net interest expense that exceeds 30% of the taxpayer’s adjusted taxable income (ATI) for that year. ATI is approximating earnings before interest, taxes, depreciation and amortisation and subsequently (i.e. beginning 2022) approximating earnings before interest and taxes. The Act permits an indefinite carryforward of any disallowed business interest.
Going forward, LS companies with interest limited under the new Act will have to assess the recoverability on any resulting deferred tax assets for interest carried forward.
3. Bonus depreciation
The Act specifies bonus depreciation claim on certain qualified property acquired and placed in service after 27 September 2017 and before 1 January 2024. For the first five-year period (through 2022), entities may deduct 100 percent of the cost of qualified property. During the period starting in 2023, the additional bonus depreciation is gradually phased out by 20 percent each year through 2027.
Hence LS companies need to carefully determine the appropriate rate to apply when calculating their deferred taxes and current taxes when claiming the bonus depreciation.
4. Unit of account
One of the key issues in the selection of accounting policies by preparers is deciding the level at which an entity should separately account for items (i.e., the ‘unit of account’). The unit of account should be determined based on a judgement as to which approach allows for the best possible estimate of the tax position and reduces the extent to which no reliable estimate can be made. In practice, entities should look at individual aspects of the tax changes as the unit of account.
The LS companies will need to be mindful of disclosures too, particularly those required by Ind AS 1 and Ind AS 12; such as amount of deferred tax expense (income) relating to changes in tax rates or the imposition of new taxes, explanation of changes in the applicable tax rate compared to the previous accounting period, judgements, information about the assumptions made and other estimates.
Accordingly for LS companies, who have their group entities in USA, financial reporting effects of the Act for the next financial reporting period (e.g. year ending 31 March 2018) may be complex. LS companies must use their judgement in providing sufficiently detailed quantitative and qualitative disclosures to enable users to understand the impact of the tax law changes on its financial position, financial performance and cash flow.
The author is Partner, Financial Accounting Advisory Services (FAAS), EY India. Views are his own.