Income Computationand Disclosure Standards (ICDS)

The Finance Act, 1995 empowered the Central Government to notify the Accounting Standards to be followed for computing the income under the head “Profits and Gains of Business or Profession” or “Income from Other Sources”. The intention in framing the standards under the Income Tax Act is to compute the income precisely and objectively. In 1996, two Accounting Standards relating to ‘Disclosure of Accounting Policies’ and ‘Disclosure of prior period and extraordinary items and Change in accounting policies were notified.

Prolonged discussions, dialogues and debate over the issue of notification of Accounting Standards and its harmonization with Income Tax Laws have taken place and several committees have been formed. Finally, on March 31st 2015 i.e. after two decades, 10 Income Computation & Disclosure Standards (‘ICDS’) - new avatar of Tax Accounting Standard notified by the CBDT. Issuance of ICDS on selected issues and non inclusion of other topics covered by Account-ing Standard issued by ICAI may be because some of them relate to ‘disclosure’ requirement, while some other contain matter that are adequately dealt with the Income Tax Laws.

It is beyond doubt that these standards will change the way Income will be computed and will materially impact the Tax computation from assessment year 2016-17 i.e. first year of its implementation. How the Income Tax Authorities and specially those at lower part of the echelon will take this will be crucial and hope the bedrock principles – ‘reduction of litigation’ and ‘certainty to issues’ adhered at the time of drafting will also be kept in mind equally at its implemen-tation and application.

Foreword...

Soumen Adak & Manish ShethNational Leader - Tax and Regulatory Services

A. B a c k g r o u n d

1.0 The Central Board of Direct Taxes (‘CBDT’) vide Notification No. 33/2015 dated 31-03-2015 has notified 10 Income Computation and Disclosure Standards (‘ICDS’) effective from 01-04-2015, applicable from Assessment Year 2016-17 onwards.

2.0 Brief background of introduction of ICDS is as under :-

Sec. 145(2) of Income Tax Act, 1961 (‘the Act’) empowers the Central Government to notify* Accounting Standards (‘AS’) to be followed by any class of assessees or in respect of any class of income.

In 2010, CBDT constituted a Committee to suggest standards for the purposes of notification u/s 145(2) of the Act.

In 2011, the Committee submitted its Report and recommended ‘Tax Accounting Standards’ (‘TAS’) instead of notifying AS issued by the ICAI.

In Jan 2015, the CBDT placed revised draft of 12 ICDS (earlier referred to as TAS) in public domain for comments & suggestions.

Finally, In exercise of the powers conferred by Sec. 145(2) CBDT, vide Notification No. 33/2015 dated 31-03-2015 has notified 10 ICDS effective from 01-04-2015 (ICDS on Leases and Intangible asset not notified)

* Only two accounting standards were notified i.e. AS – 1 ‘Disclosure of Accounting Policies’ and AS - 5 ‘Disclosure of Prior Period items & Extraordinary items and Changes in Accounting Policies’.

Thereafter, draft TAS was placed in public domain for comments & suggestions.

In 2012, the Committee submitted its final report to CBDT with 14 draft TAS.

1.0 ICDS have been issued for the purpose of computation of income chargeable under the head “Profit and Gains of Business or Profession (‘PGBP’)” or “Income from Other Sources (‘IOS’)” and not for the purpose of maintenance of books of accounts. ICDS are to be followed by all the assessees following the mercantile system of accounting.

2.0 In case of conflict between the Act and ICDS, provisions of the Act shall prevail to that extent.

B. S c o p e

The term ‘reasonable cause’ has not been defined under ICDS. Hence the same may be subject matter of dispute.

C. Summary of significant deviations of ICDS from AS issued by ICAI

1.0 ICDS I relating to Accounting Policies

The significant deviations from AS - 1 (Disclosure of Accounting Policies) are as under:-

2.0 ICDS II relating to Valuation of Inventories

The significant deviations from AS-2 (Valuation of Inventories) are as under:-

Observations

Many companies follow standard costing method to measure cost of inventories. Non- inclusion of said method in ICDS will cause undue hardship to such companies as they have to value inventories separately for Income Tax purpose.

In this ICDS also the term ‘reasonable cause’ has not been defined. Hence the same may be subject matter of dispute.

Observations

3.0 Transitional provisions have been inserted in all ICDS except ICDS on Securities. Income, expense, loss or provision existing or entered into on or after 01-04-2015 are to be recognized as per ICDS. However Income, expense, loss or provision, if any, recognized before 31-03-2015 shall be taken into account for recognizing the same for the period commencing on 01-04-2015 to avoid double taxation/non-taxation in pre and post ICDS period.

• Marked to Market Loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other ICDS.

• Accounting policies shall not be changed without reasonable cause.

• Unlike AS-2, Standard Costing method has not been prescribed to measure cost.

• ICDS provides for valuation of inventories in the case of service provider. Inventories in the case of service providers are materials or supplies to be consumed in rendering of services.

• Method of valuation of inventory once adopted cannot be changed, unless there is reason-able cause for doing so.

• In case of dissolution of a partnership firm or Association of Persons (‘AOP’) or Body of Individuals (‘BOI’), value of inventories shall be the net realizable value on the date of dissolution.

3.0 ICDS III relating to construction contracts

The significant deviations from AS-7 (Construction Contracts) are as under:-

4.0 ICDS IV relating to Revenue Recognition

The significant deviations from AS-9 (Revenue Recognition) are as under:-

Presently, retention money is excluded in computing taxable income on the premise that the right to receive the retention money accrues only after the obligations under the contract are fulfilled and therefore it would not amount to income of the year in which the amount is retained. [Re: Simplex Concrete Piles (India) P. Ltd (1989) 179 ITR 8 (Cal) & CIT -vs.- East Coast Constructions and Ind Ltd (2006) 283 ITR 297 (Mad)]

Under ICDS regime, retention money is specifically included as part of contract revenue. However, the same may still be claimed as exclusion on the premise that retention money is that part of contract revenue where there is no reasonable certainty of its ultimate collection.

Henceforth, expected and foreseeable loss recognised in the books of accounts as per AS-7 on conservative basis shall not be allowed as deduction under ICDS on Accounting Policies. In terms of Para 4(ii) of the ICDS on Accounting Policies read with ICDS relating to Construction Contract, expected loss cannot be recognised.

Observations

• Contract revenue is to be recognized when there is reasonable certainty of its ultimate collection.

• Contract revenue shall comprise of (a) initial amount of revenue agreed in the contract including retentions and (b) variations in contract work, claims and incentive payments if it can be measured reliably.

• Contract revenue already recognized as income is to be written off as bad debt (and not as an adjustment of the amount of contract revenue) if the collection of that revenue later becomes uncollectible.

• Contract costs shall not be reduced by any incidental income being in the nature of interest, dividend and capital gains (that is not included in contract revenue). The same shall be separately chargeable to tax.

• In case of early stages of contract (i.e upto 25% of the stage of completion), where the outcome of the contract cannot be estimated reliably contract revenue is to be recognised only to the extent of cost incurred. In other words, when a contract crosses 25% of the completion stage, the revenue in respect of such contract shall be required to be recognised.

• Revenue from service contract only to be recognized on percentage completion method as against AS-9 (Revenue Recognition) where both ‘completed service contract method’ and ‘percentage completion method’ is permitted for recognition of revenue from service contract.

5.0 ICDS V relating to Tangible fixed assets

The significant deviations from AS-10 (Accounting for Fixed Assets) are as under:-

6.0 ICDS VI relating to Effects of change in Foreign Exchange Rate

The significant deviations from AS- 11 (The Effects of change in Foreign Exchange Rate) are as under:-

Many companies recognise revenue from service contract as per completed contract method. Non-inclusion of said method in ICDS will cause undue hardship to such companies as they have to separately compute revenue from service contract as per percentage completion method for Income Tax purpose.

Observations

As per ICDS and AS-10, any expenditure incurred which increases the useful life of an asset is required to be capitalised with the cost of said asset. Hence it can be inferred that any expenditure incurred in relation to any asset which does not increase useful life of the said asset, for e.g. expenditure for the purpose of preserving or maintaining an existing tangible fixed asset may be claimed as revenue expendi-ture.

Observations

Observations

• In case of acquisition of a tangible fixed asset in exchange for another asset, shares or other securities, the fair value of the tangible fixed asset so acquired shall be its actual cost.

• There is no concept of revaluation of asset in the ICDS. The same is in conformity with the provision of the Act wherein also the concept of revaluation of assets is not recognised.

• ICDS prescribes disclosure requirement similar to requirement of Tax Audit Report. Even the persons not subject to tax audit have to comply with such disclosure requirement.

• Paragraph 46A of AS-11 grants an option to recognize exchange difference arising on rein-statement of long term foreign currency monetary items under “Foreign Currency Mon-etary Item Translation Difference Account (FCMITDA)” and amortize the same over the balance period of such long term asset or liability whereas ICDS provides that profit/(Loss) arising at the year end on reinstatement of monetary items shall be recognised as income or expense.

• Marked to market gains or losses are unrealized in nature. All gains or losses on forward exchange or similar contracts entered into for trading or speculation contracts shall be recognized only on settlement.

• Disclosure requirements similar to construction contract have been prescribed for service contracts.

Many companies, in its books of accounts, amortizes the exchange difference arising on reinstatement of long terms foreign currency monetary items i.e. loans over the balance period of loan. As per ICDS, the

7.0 ICDS VII relating to Government Grants

The significant deviations from AS-12 (Government Grants) are as under:-

8.0 ICDS VII relating to Securities [held as Stock in trade]

Salient feature of the ICDS:

• Grant in respect of depreciable fixed assets is to be reduced from actual cost of such assets. This treatment is similar to Explanation 10 to Sec 43(1). However, AS – 12 (Government Grants) prescribes that the same may either be adjusted with the value of assets or recog-nised as income on reasonable basis over a period of time.

• Additional disclosures are required to be made for each previous year which inter-alia includes nature & extent of grants reduced from the block of asset, grants not reduced from the block of assets with reasons & grants not recognised as income with reasons.

• This ICDS deals with securities held as stock-in-trade and not for securities held as invest-ment.

ObservationsICDS deals with subsidies granted with intention to compensate cost of assets or revenue expenditure incurred by the assessee. It does not deal with the subsidy granted for setting up an industry in backward area and generation of employment. Hence the same may continued to be claimed as capital in nature and not liable to tax even though it is credited to P&L A/c. Disclosure in this regard is also required to be given along with aforesaid additional disclosures mentioned herein above.

aforesaid exchange difference shall be allowed/ taxable as deduction/income respectively in the year of reinstatement.

On combined reading of ICDS on’ Accounting Policies’ and ‘The effect of Changes in foreign exchange rates’ it could be seen that only Marked to Market Loss arising on reinstatement of trading, speculation, firm commitment or highly probable forecast transaction shall not be allowed as deduction. As such, Marked to Market Profit/(loss) in respect of forward exchange contracts other than those entered into for trading or speculative purpose or firm commitment or highly probable forecast transaction shall be recog-nised as income or expense.

Also, similarly Marked to Market profit/(Loss) in respect of monetary items i.e. foreign currency loans made or received, purchase or sale of goods whose price is denominated in foreign currency etc. shall be recognised as income or expense.

Further, Marked to Market Profit/(loss) in respect of non-monetary items i.e. fixed assets shall not be recognised as income or expense. The treatment of the same shall be in accordance with Sec 43A of the Act.

Premium or discount on forward exchange contracts shall be recognised as income or expenses on amorti-sation basis over the life of the contract.

9.0 ICDS IX relating to Borrowing Costs

The significant deviations from AS- 16 (Borrowing Costs) are as under:-

10.0 ICDS X relating to Provisions, Contingent Liabilities & Contingent Assets

The significant deviations from AS-29 (Provisions, Contingent Liabilities & Contingent Assets) are as under:-

ObservationsICDS provides for capitalization of borrowing cost attributable to acquisition, construction or production of assets. The same is line with Sec. 36(1)(iii) of the Act, which provides that interest pertaining to the period from the date on which the capital was borrowed till the date on which such asset was first put to use should not be allowed as revenue expenditure.

• Where a security is acquired in exchange for another security, cost shall be fair value of the security acquired.

• Securities listed on a recognized stock exchange shall be valued at actual cost as initially recognized or net realizable value, whichever is lower.

• Securities not listed on a recognized stock exchange shall be valued at actual cost as initially recognized.

• This ICDS deals with borrowing cost other than relating to exchange differences arising from foreign currency borrowings. The same will be treated in terms of ICDS on ‘The Effect of Changes in Foreign Exchange Rate’.

• Borrowing Cost in respect of borrowings partly used for acquisition of the qualifying asset to be capitalized in accordance with the following formula:

(A)* (B)/(C)

• AS-29 requires the recognition of a provision when it is ‘probable’ that there will be outflow of resource. However, under ICDS provision is to be recognized when there is ‘reasonable certainty’ (more likely than not) for the outflow of resources.

• Unlike AS -16, suspension of capitalization of borrowing cost is not covered in the ICDS.

(A) Borrowing cost except directly relatable to specific purpose

(B) Average cost of qualifying asset at the first day and last day of the previous year and

(C) Average cost of asset at the first day and last day of the previous year.

Careful examination of the ICDS issued by CBDT & AS issued by ICAI, leads us to the following important inferences :

• The introduction of ICDS may significantly alter the way the companies compute their taxable income, irrespective of whether the company reports its financial results as per Ind AS or exist-ing AS.

• Though there is no requirement under the Act to maintain separate books of accounts for tax purposes, the effect of implementation of ICDS is expected to be pervasive on the taxpayers as these would require system and process in place to capture the relevant information required by ICDS. Accordingly, this would put an additional compliance burden on the tax payer.

• ICDS is not an extension of the Act rather it is a part of the Act which accords the treatment in respect of issues covered therein viz foreign exchange fluctuations, construction contract, tangible fixed assets etc. Hence, ICDS only meant to supplement the present Income Tax Act.

• The rationale behind issuing ICDS is to lessen the uncertainty of alternative accounting treat-ment due to flexibility offered by AS & also to reduce litigation that crops up when the stand taken by I.T. Authorities is not in alignment with the AS. However, to what extent ICDS shall be applied in right spirit, especially by the lower income tax authorities needs to be seen.

• ICDS shall not be applicable to computation of book profit u/s 115JB of the Act.

• Each ICDS requires disclosures in respect of various items dealt in the said standard. However, ICDS is silent about as to where such disclosure has to be given. Therefore, it is likely that appropriate changes will be made to include in the Tax Audit Report and Income Tax return to capture such disclosures.

• The ICDS are applicable w.e.f 01-04-2015 & hence advance tax for current financial year & thereafter needs to be computed based on ICDS.

E. I n f e r e n c e s

D i s c l a i m e r

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