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India Inc - Are we ready for the metamorphosis?

Posted in Finance Articles, Total Reads: 1452 , Published on December 26, 2013

Apart from the repo rates, rising cost of capital, inflation, depreciating rupee and current account deficit the corporates are worried about a host of changes which is going to transform the entire accounting and taxation system. Yes, you are right!!! I am talking about

1. IFRS (also known as IND-AS)

2. GST (Goods and Service Tax)

3. DTC (Direct tax code)

4. Companies Bill

India Inc. is facing its biggest challenge which is to reconcile all the above mentioned rules which are serving different purposes into one coherent strategy for the business. It is imperative to ensure the rules are compatible in order to harmonise them and avoid any clamour at a later stage.

Image Courtesy: ddpavumba, freedigitalphotos.net

What are they?

• IFRS- These are accounting principles accepted by more than 100 countries in the world which provides a better representation of accounts in terms of transparency, accuracy and reliability. India has committed in the G-20 summit to apply IFRS in the converged form, i.e. applying similar standards but with the name of IND-AS. This will replace all the 32 accounting standards which is currently followed and issued by ICAI. The full implementation will not be achieved any time before 2014-15.

Complying with IND-AS will impact the way in which financial statements are prepared and ratios are calculated. Manipulating losses by dumping it to associates and subsidiaries will no longer be possible. It will facilitate cross- border raising and lending of capital and acquisitions.

However, the perceived benefits from IFRS adoption are based on the experience of IFRS compliant countries in a period of mild economic conditions. The current decline in market confidence in India and overseas coupled with tougher economic conditions may present significant challenges to Indian companies.

IFRS requires application of fair value principles in certain situations and this would result in significant differences from financial information currently presented, especially relating to financial instruments and business combinations. Given the current economic scenario, this could result in significant volatility in reported earnings and key performance measures like EPS and P/E ratios. Indian companies will have to build awareness amongst investors and analysts to explain the reasons for this volatility in order to improve understanding, and increase transparency and reliability of their financial statements.

This situation is worsened by the lack of availability of professionals with adequate valuation skills, to assist Indian corporates in arriving at reliable fair value estimates. This is a significant resource constraint that could impact comparability of financial statements and render some of the benefits of IFRS adoption ineffective.

• GST- This will replace excise duty, service tax at the Central level and VAT at state level, besides cess, surcharges and local taxes. GST structure in India proposes dual structure- Central GST and State GST. It will lead to revenue gain for the Centre through widening of the dealer base by capturing value addition in the distributive trade and increased compliance. GST is an improvement over the existing system of VAT and service tax as it helps in eliminating the cascading effect of CENVAT and Service Tax. The date for implementation of GST was 1st April, 2013.

The positive impact of GST will be the elimination of cascading effect which in turn will bring down the prices of goods and hence inflation. Lesser paperwork with lower working capital requirements will give more relief to industry, trade, agriculture and more consumers. However, sharp differences continue to exist between states regarding the contours of GST. Substantial amount of taxes remain outside the GST ambit, especially the one’s levied by municipal corporations like octroi, entertainment tax etc.

• DTC- In an effort to address India’s tax legislations that has caused much concerns for the domestic and foreign business, the DTC was scheduled to be implemented in 2012 by replacing the Income Tax Act, 1961.

One aim of the new tax code is to provide a system which takes into account the increase in cross-border mergers and acquisitions undertaken by Indian companies over the last few years. In addition, while lowering corporate tax rates, the DTC aims to remove the administrative burden on foreign companies and investors for whom the country is now a leading target for investment. By implementing the new code, the Government of India also intends to streamline and simplify legislation, as well as iron out many ambiguities in the current system. Perhaps the provisions of DTC will address the issues of Black Money and Tax Evasion as well. An increase in the income tax threshold for exemption and no levy of surcharge and cess will be benefiting the individual tax payers.

• Companies Bill- It was first introduced in the year 2008 in Lok Sabha to address the issues of Corporate Governance and Accountability and replace the Companies Act, 1956. The bill has been passed by the Lok Sabha in December, 2012. The bill is based on three major principles of transparency, accountability and responsibility. It strives to provide certain basic principles for various aspects of internal governance of corporate entities and a framework for their regulation with protection of the rights of minority stakeholders, responsible self-regulation with disclosures and accountability. The new Bill has consolidated many sections of the previous Act and appears to be relatively lean, with 470 clauses and 7 schedules as against 658 sections and 15 schedules in the existing Companies Act, 1956. Another Important provision is making CSR mandatory for companies exceeding a specified networth or profit.

Learning from some of the recent scandals, the Bill seeks to prohibit making contributions to trusts that are not for bona fide reasons and also needs unqualified approvals of the board and public financial institutions to give large loans to affiliates, etc. These measures seek to fill in some gaps that were exploited by companies in the past.

To conclude, laws need to reflect societal and economic changes and should not merely be drafted to mitigate events and scams that have happened in the recent past. Some argue that having no law is better than having laws that cannot be enforced. We have seen in the past that laws have been inefficient in preventing erosion of wealth from the economy. IFRS, DTC and GST have different implementation challenges; the implementation of all of these at the same time may be a bit tough for some of the corporates. The various changes taking shape in the regulatory environment would soon become law in the coming years. Though, this would make life for India Inc very complicated these compliances would encourage good business practices and governance. Companies are aware of the upcoming changes in regulatory scenario, but they are unaware of the shape, size or format applicable for them. The biggest challenge faced by the corporates would be lack of adequate resources, synchronizing the present set targets with the changes happening, identifying the impact of these new laws, identifying the cost and the time required. By the time India Inc becomes aware of these impacts, these changes would have taken the corporates by surprise. The new laws are far better and comprehensive than the existing ones and implementation of the same in a phased manner can attract a lot of investments from abroad. One hopes that the outcome is unequivocally a boost for India Inc.

This article has been authored by Prateek Didwania from IIM Kozhikode

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