Accounting and Taxation issues of Micro Finance Institutions.
- WHAT IS MICRO FINANCE?
The term Micro Finance is of comparatively recent origin. The concept was popularized by the Nobel Prize winner Mr. Mohammed Yunus of
- ORGANISATIONAL STRUCTURE
Most of the MFI’s operating in
Yet another MFI’s are functioning purely as commercial organizations and they have no claim that they are involved in charities. Most of them are registered as Non Banking Financial Companies (NBFC) which are strictly regulated by the Reserve Bank Of India(RBI). There are Local Area Banks (LAB) also. These are known as For-profit micro finance organizations.
- FROM WHERE FUNDS COME?
There are mainly two sources for meeting the funding requirements of the MFI’s.
A) External sources like promoters contribution, equity capital including investment by private equity fund agencies/ venture capitalists etc. The MFI’s get funds through External commercial debts, grants from various national and international organizations, corporate donors, High Networth Individulal (HNI) donors, promotional funds from SIDBI and NABARD etc. Apart from the above the retained earnings from operations are also sources of funds.
B) Internal Sources like income from operations and investment income etc. Ultimately the efficiency of an MFI is decided on the basis of its operational efficiency and its ability to generate sufficient income on a self sustainable basis. In the case of some MFI’s income may flow through fee collected from training etc.
- STATUTE DRIVEN ACCOUNTING PRACTICES
As already indicated there are different organizational structures adopted by the MFI’s. So the laws and legal formalities applicable to them would also differ. For eg MFI’s registered under Section 25 of the Companies act are governed by that law whereas cooperative societies are governed by the cooperative societies act etc. Some trusts registered under the Indian trust act and others prepare and present the accounts according to their whims and fancies since such laws do not contain provisions relating to accounts. In such cases there is no uniformity in the matter of adoption of accounting practices and thus naturally such organizations prepare accounts according to their own needs and adopt their own practices. Therefore it can be noticed that the accounts prepared and presented are largely statute driven.
- FINANCIAL REPORTING
It may be noted that accounts are prepared and presented for the purpose of meeting various needs. There exist various interest groups who require different kinds of information from the accounts of the organization. For eg the Income Tax Department may be most interested in the calculation of net profit and the classification of expenditure as revenue or capital, since only revenue expenditure are allowed as deduction. They are also interested in the information relating to donations and whether it is corpus donation or not since corpus donations do not form part of income taxable. Like wise donors may be interested in the figures relating to utilization of their donation and how effectively it was spent. Bankers and other debt providers may be interested in the information relating to interest coverage vis- a -vis the net profit and the efficiency of repayment etc. Thus the financial accounts preparation and reporting has to be fine tuned in such a way as to satisfy to the maximum extent possible the requirements of the users of the financial reports.
- USERS OF FINANCIAL REPORTS
The following are some of the users who are interested in the financial reports of the MFI’s.
1. The donors 2. Grantors 3.Creditors 4.Owners 5.Employees 6.Directors and Trustees 7. Beneficiaries 8.Financial Analysts 9.Government 10.Economists 11. Sociologists 12.Financial press 13.General public 14. Government agencies etc. On a look at the varieties of users it will be clear that each of them carry different interests and the kind of information they require varies. Needless to say the financial reports should be understandable, timely, relevant, reliable and comparable for its effective use by its users.
7. METHODS OF ACCOUNTING
It is a matter of common knowledge that there are two methods of accounting generally followed by the organizations including the MFI’s. They are Cash system of accounting and Accrual system of accounting. A hybrid of the above two systems are also followed. In the case of cash system of accounting transactions are recorded when the relative cash receipts are actually received or when the expenses are actually paid out. Accrual system of accounting on the other hand would record transactions as when the right to receive the revenue arises or the liability to pay the expenditure is incurred. It is pertinent to note that under the Companies Act 1956 vide Section 209(3)(b) it is mandatory to follow the accrual system of accounting. It is to be noted that Section 145 of the Income Tax Act allows a person to follow either of the two methods. But accrual basis of accounting would be preferable since the same is more scientific and conceptually superior to cash system. Thus the MFI’s are free to choose the method as may be found suitable to them except in the case of MFI’s which are companies where it is compulsory to follow accrual system.
8. APPLICABILITY OF ACOUNTING STANDARDS
Accounting standards are designed to apply to the general purpose financial statements and other financial reporting which are subject to the attest function of the members of the Institute of Chartered Accountants of India (ICAI). The ICAI is of the opinion that micro finance activities are of a commercial nature even though the objectives may be charitable or non- profit. Thus the various accounting standards issued by the ICAI are applicable to such MFI’s and the same would help maintaining the uniformity in the presentation of accounts.. Even where the same is not applicable still it is recommended that the standards may be followed. As such Accounting Standards (AS) 1 to AS 7 and AS9 to AS31 shall be applicable to MFI’s.
9. FORMAT OF PROFIT AND LOSS ACCOUNT (INCOME AND EXPENDITURE ACCOUNT).
The Income of MFI’s can be broadly classified into two groups as stated below.
A) Income from Financial Services and
B) Other Income.
A) Income from Financial Services would include interest on loan, fees and service charges like training fee, loan processing fee, application fee etc, insurance commission and technical and consultancy fees.
B) Other Income would include grants received from various government and private institutions, interest on investments and miscellaneous income.
10. FORMAT OF THE BALANCE SHEET
The Balance sheet of an MFI may be drawn up in the manner described below.
A) Sources of Funds divided into broad 3 categories as Shareholders funds , Loan Funds and Deferred Tax liability. Shareholders funds may be further divided into share capital or general capital fund and Reserves and surplus. Loan Funds may be classified as secured and unsecured. Those liabilities which fall due with in a short period say one year may be shown as current liabilities.
B) Application of Funds divided into categories viz Fixed assets, Loans and Advances, Investments, Current assets net of Current liabilities and Miscellaneous items including Deferred Tax Assets.
11. TAXATION ISSUES
As already stated many of the MFI’s are functioning as Not-for- profit organizations and thus claim exemption under the Income tax act as organizations for charitable purposes. For this, the MFI’s are required to get themselves registered under Section 12A of the said Act. If so the organizations shall be prima facie eligible for exemption from income tax. The claim is based on the ground that the main objectives sought to be achieved through micro finance activities are poverty alleviation and empowerment of rural poor especially women. But, of late, the Income tax department is taking the view that such organizations are not eligible for tax exemption since they are mere money lending agencies and are purely commercial organizations. To add to the existing fire Income tax Act has been amended in 2009 to say that those organizations whose objectives are advancement of any objects of general public utility shall not be eligible for tax exemption if the it involves carrying on activities in the nature of trade commerce or business etc. Another issue is relating to non availability of deductions towards bad debts which is a very normal incident in this area of activities, though NBFC’ s are required to make provision for the same as per Reserve Bank guidelines.
The paper deals in brief with the accounting and taxation issues of micro finance organizations. It is not at all exhaustive in nature. So many issues are left out for want of time and space. The scope of the paper was also one of the factors taken into consideration. Anyway, much needs to be done to improve the overall preparation and presentation of financial information relating to micro finance institutions. The government is also considering the introduction of a separate legislation to control and regulate the functioning of these institutions. Let us hope for the best to emerge in the coming years.
SIVADAS CHETTOOR B.COM FCA LL.M