1. Introduction
Fair value accounting has become a key aspect of financial reporting under Ind AS, especially for investments in listed equity shares and other financial instruments. The introduction of Ind AS 12 (Income Taxes) and Ind AS 109 (Financial Instruments) has brought significant changes in the way companies recognize deferred tax liabilities (DTL) and deferred tax assets (DTA) on fair value gains and losses.
With the reintroduction of tax on long-term capital gains (LTCG) on listed equity shares under Section 112A of the Income Tax Act, companies face a crucial question:
- Should deferred tax be created on fair value changes of listed equity shares?
- How should these changes be accounted for in financial statements under Ind AS 12?
This article provides a detailed professional analysis of these questions, backed by practical scenarios and examples.
2. Understanding Ind AS 12 and Section 112A
A. Ind AS 12 – Deferred Tax Accounting
Ind AS 12 prescribes the accounting treatment for income taxes, including the recognition of deferred tax assets (DTA) and deferred tax liabilities (DTL) on temporary differences arising between the carrying amount of assets and liabilities in financial statements and their tax base.
Key principles under Ind AS 12:
- DTL is recognized when the carrying amount of an asset exceeds its tax base (i.e., taxable temporary difference).
- DTA is recognized when the tax base of an asset exceeds its carrying amount (i.e., deductible temporary difference).
- Deferred tax is recognized on fair value changes of investments classified under Fair Value Through Profit or Loss (FVTPL) or Fair Value Through Other Comprehensive Income (FVOCI).
B. Section 112A – LTCG on Listed Equity Shares
As per Section 112A of the Income Tax Act, long-term capital gains (LTCG) exceeding ₹1 lakh from listed equity shares are taxable at 10% without indexation benefit.
Key tax provisions under Section 112A:
- LTCG tax applies only on actual sale or disposal of shares.
- Unrealized fair value gains or losses are not taxable until realization.
- Companies may need to assess deferred tax implications if fair value adjustments impact financial statements.
3. Should Deferred Tax Be Created on Fair Value Gains/Losses of Listed Equity Shares?
The recognition of DTL or DTA on fair value changes of investments depends on how they are classified under Ind AS 109:
A. Fair Value Through Profit or Loss (FVTPL) Investments
- Under FVTPL, fair value gains/losses are recorded directly in the Profit & Loss statement at each reporting period.
- Since these gains/losses affect the taxable income when realized, deferred tax should be recognized on these fair value changes.
- DTL is created for unrealized fair value gains, as these will be taxable upon realization.
- DTA is created for unrealized fair value losses, as they will be deductible when realized.
Example 1: DTL on Fair Value Gains
ABC Ltd. holds ₹5 crore worth of listed shares under FVTPL. At year-end, the fair value increases to ₹6 crore, leading to an unrealized gain of ₹1 crore.
- As per Ind AS 109, the gain of ₹1 crore is recognized in the P&L statement.
- Deferred tax liability (DTL) of ₹10 lakh (10% of ₹1 crore) should be recognized under Ind AS 12 since this gain will be taxable under Section 112A upon realization.
Example 2: DTA on Fair Value Losses
XYZ Ltd. holds ₹8 crore of listed shares under FVTPL, but at year-end, their value drops to ₹7 crore, creating an unrealized loss of ₹1 crore.
- As per Ind AS 109, this loss is recorded in the P&L.
- If XYZ Ltd. expects to set off future capital gains, a DTA of ₹10 lakh (10% of ₹1 crore) can be created, provided it meets the recoverability criteria under Ind AS 12.
B. Fair Value Through Other Comprehensive Income (FVOCI) Investments
- Under FVOCI, fair value gains/losses are recorded in Other Comprehensive Income (OCI) instead of P&L.
- Section 112A allows exemption for LTCG on shares acquired before 31st Jan 2018 (grandfathering rule) but taxes future gains on disposal.
- Since Ind AS 12 prohibits DTL/DTA recognition on FVOCI equity investments, no deferred tax is recognized.
Example 3: No Deferred Tax on FVOCI Shares
PQR Ltd. holds ₹10 crore of listed equity shares under FVOCI. The fair value rises to ₹12 crore, creating a ₹2 crore unrealized gain.
- No DTL is recorded, as these gains are not taxable until realized and Ind AS 12 prohibits deferred tax recognition on FVOCI equities.
- When the shares are actually sold, the gain will be taxable under Section 112A.
4. Practical Scenarios: Revenue vs. Capital Approach
Scenario 1: Listed Equity Shares Held as Treasury Investments (Trading Portfolio – FVTPL)
A stockbroking firm holds shares in FVTPL as part of its trading operations.
- Fair value gains/losses impact the firm’s P&L statement.
- Deferred tax should be recognized on unrealized gains/losses, as these are taxable upon realization.
Conclusion: Recognize DTL on gains and DTA on losses.
Scenario 2: Strategic Investment in Another Company (Long-Term Investment – FVOCI)
A company holds shares in another listed company for strategic purposes (classified as FVOCI).
- Unrealized gains/losses are recorded in OCI.
- Ind AS 12 prohibits deferred tax recognition for FVOCI equities.
Conclusion: No deferred tax is created on FVOCI investments.
5. Key Considerations for Accountants & Tax Professionals
Understand the Investment Classification:
- Use FVTPL for trading portfolios → Recognize DTL/DTA.
- Use FVOCI for long-term investments → No deferred tax recognition.
Assess Taxable Temporary Differences Properly:
- Recognize DTL for unrealized fair value gains that will be taxable later.
- Recognize DTA for fair value losses only if future taxable gains exist.
Align Ind AS 12 with Section 112A Compliance:
- Track LTCG exemptions and grandfathering provisions under Section 112A.
- Ensure proper disclosure of deferred tax adjustments in financial statements.
6. Conclusion
The taxation of fair value changes in investments under Ind AS 12 and Section 112A requires careful analysis of:
- Investment classification under Ind AS 109 – FVTPL vs. FVOCI.
- Recognition of Deferred Tax – DTL for FVTPL gains, DTA for FVTPL losses, no deferred tax for FVOCI.
- Long-term tax impact – Ensuring proper compliance with capital gains tax laws.
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