Deferred Tax on Assets Held for Use vs Sale Under Ind AS

1. Query

Omega Energy Limited (hereinafter referred to as “the Company”) owns a power generation plant, including a critical turbine with a carrying amount of Rs. 120 crore as at the end of the reporting period. For tax purposes, the written-down value of the turbine is Rs. 70 crore, resulting in a significant temporary difference.

Under the applicable tax framework, the manner of recovery of the asset gives rise to materially different tax consequences. If the turbine is used over its remaining useful life, the benefits are realised through tax depreciation, and the applicable tax rate is 25%. However, if the turbine is sold, the resulting gain is subject to a capital gains tax rate of 15%, and the tax base is recomputed without allowing certain deductions that are otherwise available under the use model.

Historically, the Company has always intended to recover the asset through use. However, during the current year, the Company entered into a non-binding arrangement with a third party for a potential sale of the turbine as part of a broader restructuring plan. While management believes that the sale is probable, the transaction is contingent upon regulatory approvals and financing arrangements, which are yet to be finalised. At the same time, the turbine continues to be actively used in operations, and no formal plan for its disposal has been approved by the Board.

Given these circumstances, the Company is facing uncertainty in determining the appropriate manner of recovery for the purpose of measuring deferred tax. Specifically, the Company seeks guidance on whether the deferred tax liability should be measured based on recovery through use, recovery through sale, or some form of probability-weighted approach considering both possible outcomes.

2. Relevant Provisions

Ind AS 12 – Income Taxes

Para 51 of Ind AS 12

The measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities.

Para 51A of Ind AS 12

In some jurisdictions, the manner in which an entity recovers (settles) the carrying amount of an asset (liability) may affect either or both of:

(a) the tax rate applicable when the entity recovers (settles) the carrying amount of the asset (liability); and

(b) the tax base of the asset (liability).

In such cases, an entity measures deferred tax liabilities and deferred tax assets using the tax rate and the tax base that are consistent with the expected manner of recovery or settlement.

3. Analysis

The core issue in this case lies in determining the “expected manner of recovery” of the turbine at the end of the reporting period. Paragraph 51 does not permit a mechanical or purely hypothetical assessment; instead, it requires management to exercise judgment based on the facts and circumstances that exist at the reporting date.

Although the Company has initiated discussions for a potential sale, the arrangement remains non-binding and is subject to significant uncertainties, including regulatory approvals and financing. Further, there is no formal commitment or approved plan to dispose of the asset, and the turbine continues to be used in the Company’s operations.

In this context, the expectation of recovery through sale does not yet appear to have sufficient certainty or substance to override the existing pattern of recovery through use. The standard emphasises the manner in which the entity “expects” to recover the asset, implying a realistic and supportable expectation rather thanmere possibility.

Paragraph 51A becomes particularly relevant because the tax consequences differ significantly depending on whether the asset is used or sold. This makes it critical to identify a single, most likely manner of recovery, as the standard does not envisage the use of probability-weighted or blended tax rates. Instead, the deferred tax liability must be measured using the tax rate and tax base corresponding to the expected mode of recovery.

Accordingly, unless and until the Company has sufficient evidence to demonstrate that recovery through sale is the expected outcome, such as a binding agreement, Board approval, or a high degree of certainty regarding completion, the deferred tax liability should continue to be measured based on recovery through use.