Accounting and Taxation of IRD

Accounting and Taxation of IRD (Part 1)

• Accounting Treatment of Derivatives: The accounting treatment for derivatives is based on the following key principles:
  • All derivative contracts should be recognised on the balance sheet and measured at fair value.
  • If an entity decides not to use hedge accounting, it should account for its derivatives at fair value with changes in fair value being recognised in the statement of profit and loss.
  • If an entity decides to apply hedge accounting, it should be able to clearly identify its risk management objective, the risk that it is hedging, and how it will measure the derivative instrument if its risk management objective is being met.
• Disclosure Requirement: An entity should satisfy the broader disclosure requirements by describing its overall financial risk management objectives, including its approach towards managing financial risks.
• Taxation of ETIRD: Not explicitly covered in this part of the section, but will be discussed in subsequent parts.
• Key Principles of Hedge Accounting:
  • Fair Value Hedge Accounting Model: A fair value hedge seeks to offset the risk of changes in the fair value of an existing asset or liability or an unrecognised firm commitment.
  • Cash Flow Hedge Accounting Model: A cash flow hedge seeks to offset certain risks of the variability of cash flows in respect of an existing asset or liability or a highly probable forecast transaction.
  • Net Investment Hedging: An investor in a non-integral operation is exposed to changes in the carrying amount of the net assets of the foreign operation arising from the translation of those assets into the reporting currency of the investor.
• Presentation in Financial Statements:
  • Derivative assets and liabilities recognised on the balance sheet at fair value should be presented as current and non-current based on the classification of the hedged item or the settlement date/maturity dates of the derivative contracts.
  • Derivatives that are intended for trading or speculative purposes should be reflected as current assets and liabilities.
• Hedge Effectiveness: Hedge effectiveness is the degree to which changes in the fair value or cash flows of the hedged item that are attributable to a hedged risk are offset by changes in the fair value or cash flows of the hedging instrument.

Accounting and Taxation of IRD (Part 2)

• Definition of Derivatives: A derivative is a financial instrument or other contract with three characteristics: its value changes in response to a specified variable, it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts, and it is settled at a future date.
• Accounting Standard (AS) 30: Defined derivatives and was eventually withdrawn and replaced by Ind AS 109.
• Ind AS 109: Governs the accounting for derivatives, including classification and measurement of financial instruments, impairment of financial assets, hedge accounting, and derecognition of financial assets and liabilities.
• Key Principles for Derivatives under Ind AS 109:
  • Recognition and initial measurement: Derivatives are recognized on the balance sheet at fair value.
  • Default measurement (Fair Value Through Profit or Loss—FVTPL): Derivatives are measured at FVTPL, with gains or losses recognized immediately in the profit and loss.
  • Hedge accounting: Aligns gain and loss recognition on hedging instruments and hedged items to reduce income statement volatility.
  • Types of hedge accounting: Fair Value Hedge, Cash Flow Hedge, and Net Investment Hedge.
• Taxation of Exchange Traded Interest Rate Derivatives:
  • Gains or losses are taxable under the head 'Profits and Gains from Business or Profession' (PGBP).
  • Income from exchange traded derivatives is treated as non-speculative business income.
  • Losses can be set off against any normal business income.
  • Taxpayer is liable to pay Advance Tax if tax liability exceeds INR 10,000.
• Computation of Turnover:
  • Total of favourable and unfavourable differences is taken as turnover.
  • Premium received on sale of options is included in turnover.
  • Difference on reverse trades is also included in turnover.
• Applicability of Tax Audit:
  • Turnover up to Rs. 2 Cr: Tax Audit is applicable if profit is less than 6% of Trading Turnover or if taxpayer has opted out of presumptive taxation scheme.
  • Turnover between Rs. 2 Cr and Rs. 10 Cr: Tax Audit is not applicable.
  • Turnover more than Rs. 10 Cr: Tax Audit is applicable.
• Scheme of Taxation:
  • Normal scheme of taxation or presumptive scheme of taxation under Section 44AD.
  • Presumptive scheme: Profits are declared at 6% of turnover.
  • New tax regime under Section 115BAC: No Chapter VI-A deductions, no set off of brought forward business loss, and no carry forward of business loss.
• Set-off and Carry Forward of Losses:
  • Losses can be set off against income from other heads, except salary.
  • Unabsorbed loss can be carried forward up to 8 Assessment years.
  • Losses cannot be set off against business incomes if entity has opted for new tax regime.

Accounting and Taxation of IRD (Part 3)

• Income from Other Sources: This includes income that is not from a business or profession, or from salary, such as income from investments, rent, or other miscellaneous sources.
• Salary Income: This refers to the income earned by an individual from their employment, including wages, bonuses, and other benefits.
• Loss on Derivative Transactions:
  • Definition: A loss incurred from transactions involving derivative instruments, such as options, futures, or swaps, that are traded on a recognized stock exchange.
  • Details: Such losses can be carried forward for a period of 8 assessment years, as per the given options, the correct answer is d. 8.