Income computation and disclosure standards (ICDS)

Income Computation And Disclosure Standards (ICDS) RAO & KUMAR Chartered Accountants Contents 1) 2) 3) 4) 5) 6) 7) 8) 9) 10) 11) 12) 13) 14) Background General principles Key Areas of Impact Hierarchy of Act, ICDSs and ASs ICDS I: Accounting Policies ICDS II: Valuation of Inventories ICDS III: Construction Contracts ICDS IV: Revenue Recognition ICDS V: Tangible Fixed Assets ICDS VI: The effects of changes in foreign exchange rates ICDS VII: Government Grants ICDS VIII: Securities ICDS IX: Borrowing Costs ICDS X: Provisions, Contingent liabilities and Contingent assets Background of ICDS…    Section 145(1) of the Income-tax Act, 1961 (Act) stipulates that the method of accounting for computation of income under the heads “Profits and gains of business or profession” and “Income from other sources” can either be cash or mercantile system of accounting Section 145(2) of the Act states that the Central Government may notify the accounting standards to be followed by any class of assesses or in respect of any class of income Accordingly, two tax accounting standards had been notified until now: Disclosure of accounting policies Disclosure of prior period and extraordinary items and changes in accounting policies Background of ICDS…  Finance Act, 2014 amended section 145(2) of the Act to substitute “accounting standards” with “income computation and disclosure standards” (ICDS)  The CBDT has vide notification no: 32/2015 [F.No 134/48/2010 – TPL/SO 892(E) notified 10 ICDS effective from 01.04.2015 and shall accordingly apply to the A.Y 2016-17 and for estimating Advance tax Liability due during F.Y 2015-16 and all subsequent years  Non-Compliance of ICDS may result in Best Judgement Assessment by tax authorities and may lead to protracted Litigation General principles   Applicable to all tax payers (Corporate and Non-corporate) following mercantile system of accounting including non-resident tax payers   In case of conflict between the provisions of the Act and ICDS, the provisions of the Act shall prevail to that extent ICDS applies to income computed under the head “profits and gains of business or profession” and “income from other sources” and not for maintaining books of accounts No impact on computation of book profits for the purpose of MAT The Provisions of sec-115 JB(1) shall continue to apply Key Areas of Impact…  Expected Losses/Mark to Market losses will not be recognized unless permitted by specific ICDS Not Clarity w.r.t MTM Gains  New formula for capitalization of Borrowing Costs is introduced  Applicable for all open Construction Contracts as at 31.03.2015  All Service contracts shall be valued at POC for Revenue Recognition Hierarchy of Act, ICDSs and ASs  Income Tax Act, 1961  Income Tax Rules, 1962  Income Computation and Disclosure Standards – (Ultra-vires Sec-145)  Accounting Standards Accounting Policies • • • No concept of materiality in ICDS unlike, AS-1 No likely significant tax impact In absence of materiality concept, considerable time and cost will be involved making trivial adjustments in net profit as per books of accounts to arrive at PGBP since authorities may insist on strict application of ICDS even on small value items Materiality • • Based upon the concept of ‘prudence’, AS-1 precludes recognition of anticipated profits and requires recognition of expected losses • However, ICDS is silent on MTM gain However, ICDS provides that expected losses or mark to market losses shall not be recognized unless permitted by any other ICDS to avoid differential treatment for recognition of income and losses Prudence Borrowing Costs AS - 16 Borrowing costs include exchange differences arising from foreign currency ICDS Borrowing costs not include exchange differences borrowings to the extent they are an adjustment to interest costs • Qualifying Asset is an asset that takes substantial period of time to get ready for its intended use or sale • Qualifying Assets mean: o o o Tangible Assets – land, plant, etc Intangible Assets – patents, licenses, etc Inventories – that require 12 months or more to bring them to saleable condition • ICDS includes ‘land’ also in the definition of qualifying assets, unlike AS-16 As per ICDS, the borrowing cost in respect of land shall be capitalized The depreciation shall not be allowed on the same since the land is a non-depreciable asset However, the capitalized cost shall form part of a cost of asset while calculating Income from Capital Gain in respect of that land Borrowing Costs AS - 16 • ICDS Commencement of Capitalisation: The date of fulfilment of three conditions viz incurrence of capex, incurrence of borrowing costs and preparatory activities are in progress a) Specific borrowings – Date on which funds were borrowed b) General borrowings – Date on which funds were utilised Impact: The capitalisation period starts early under the ICDS as compared to AS-16 Borrowing Costs AS - 16 • Method of Capitalisation:  Specific Borrowings: ICDS  Specific Borrowings: Actual borrowing costs incurred on the borrowing during the period less any income Actual borrowing costs incurred during the from temporary investment of those borrowings period on the funds borrowed Impact: AS-16 requires income from temporary deployment of unutilised funds to be reduced from borrowing cost However, ICDS does not provide for the same The income from temporary deployment of unutilised funds from specific loans shall be taxable as Income from other sources under the ICDS Borrowing Costs AS - 16  General Borrowings: ICDS  General Borrowings: Costs determined by applying capitalisation rate to the expenditure incurred on Costs determined by following formula; the asset The rate is weighted average of borrowing costs applicable to the A* B borrowings during the period other than specific borrowings C Borrowing Costs In the formula given in ICDS for capitalisation of general borrowing costs A, B and C stands for: A = Borrowing costs incurred during previous year except on specific borrowings B =a)Average cost of QA appearing in balance sheet on first and last day of the previous year b)Half of the cost of QA, if it does not appear in balance sheet on the first day or both first and last day of the previous year c)Average cost of QA as on first day of previous year and date of completion, if it does not appear in balance sheet on the last day of the previous year C = Average of total assets, other than those funded by specific borrowings, as appearing in balance sheet as on first and last day of previous year * QA = Qualifying Assets other than those funded by specific borrowings Borrowing Costs AS - 16 • ICDS Suspension of Capitalisation: During extended periods in which active development of the asset is interrupted No provision regarding suspension of capitalisation of borrowing cost Impact: Borrowing cost incurred during the periods in which active development of the asset is interrupted can also be capitalised under the ICDS • Cessation of Capitalisation: When substantially all activities necessary to prepare the qualifying asset for its intended use or sale are complete a) Qualifying Asset – when such asset is first put to use b) Inventory – when substantially all activities necessary to prepare it for its intended sale are complete Date of borrowing Asset ready to use Asset purchased Asset put to use ICDS: Specific borrowings General borrowings AS-16 Capitalization period Provisions, Contingent Liabilities and Contingent Assets Recognition of provisions AS - 29  Provisions shall be recognised if it is probable that outflow of economic resources will be required  Provision is not discounted to NPV ICDS  Provisions shall be recognised if it is reasonably certain that outflow of economic resources will be required  Provision is not discounted to NPV Impact:  The criteria for recognition of provisions on the basis of the test of ‘probable’ (i.e more likely than not criteria) replaced with the requirement of ‘reasonably certain’   In the absence of definition and scope of ‘reasonably certain’ criteria, an ambiguity would arise on assessment of ‘reasonably certain’ criteria In the Act, there is no specific provision for recognition of provisions However, provisions are allowed based on accrued liabilities as per ordinary principles of commercial accounting Recognition of provisions Impact:  Provision for Warranty is allowed as an expenditure upholding the test of ‘probable’ warranty obligation in the following judgments o o o o o Rotork Controls India P Ltd (2009) 314 ITR 62 (SC) (extract on next slide) Himalaya Machinery (P) Limited v DCIT 334 ITR 64 CIT vs Luk India P Ltd 52 DTR 117 Siemens Public communication Networks Limited v CIT CIT v Indian Transformer Limited 270 ITR 259 Meaning of obligation AS 29  Clarifies that obligations may be legally enforceable and may also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner ICDS  No specific guidance on meaning of ‘obligation’ Impact:  Provisions made on obligations recognized out of customary business practices or voluntary obligations may not be allowed (e.g informal refunds policy to dissatisfied customers, employee welfare, etc.) Onerous executory contracts AS - 29  AS-29 is not applicable to “executory contracts” except where contract is onerous  Since “onerous contracts” are excluded from executory contracts, AS is ICDS  It is not applicable to “executory contracts”  However, here “onerous contracts” are not executory contracts applicable to onerous contracts  Requires upfront recognition of liabilities under onerous contracts Impact: Deduction for the accrued liabilities on onerous contracts in books will be allowed in a year in which liability to pay arises specifically excluded from Contingent assets & reimbursement claims AS - 29  Contingent assets/ reimbursement claims are recognized if inflow of economic benefits/ reimbursement is “virtually certain” ICDS  Contingent assets/ reimbursement claims to be recognized if inflow of economic benefits/ reimbursements is “reasonably certain” Impact:   Revenue authorities may contend that ‘reasonably certain’ is a lower threshold than ‘virtually certain’ It is not made clear whether transitional provision requires recognition of all past accumulated contingent assets in F.Y 2015-16 Conclusion    Certain Essential Definitions missing – Like – Reasonable Cause, Reasonable Certainty Where to make the disclosures required by the ICDS The ICDS seem to be based on the current AS issued by ICAI However, listed companies are required to adopt IND AS from st April, 2016 Thus, the accounting policies for these companies under IND AS could be significantly different from ICDS Thus, providing clarity on the tax position in ICDS in alignment with the IND AS is also essential Thank You [...]... International Ltd vs Department of Income Tax [ITA No.4085/DEL/2011] which does not recognize retention money as income for tax purpose if there is no enforceable debt ICDS leads to deviation from the settled judicial position  Incidental Income Any incidental income, not included in the contract revenue, shall be deducted while Contract cost shall be reduced by any incidental income, not being in the nature... income, not being in the nature of interest, computing construction cost dividends or capital gains, that is not included in the contract revenue Therefore, those interest income, dividend income and capital gains shall be taxed as income in accordance with the applicable provisions of the Act Construction Contract AS-7  ICDS III Recognition of foreseeable losses It permits to recognise immediately... Recognition of incentive payments Incentive payment to be recognised only when (i) probability exists that specified Requires recognition under POCM if incentive reliably measurable and it is probable that it performance standards would be met or exceeded (Guidance para in ICAI AS, links probability will result in revenue In absence of further guidance, ambiguity may arise if the requirement to contract... are actual cost as and any directly attributable cost of bringing the asset to its working compared to cost in AS -10 condition for its intended use Impact: The Act provides for the definition of the term ‘actual cost’ and it is again repeated in the ICDS but it does not modify the concept of actual cost However when there is conflict in interpreting the abovementioned term under ICDS and Act, the Act... apportioned to the various assets on a fair valuers basis Impact: In absence of determination by registered valuers in ICDS words “fair basis” becomes subjective and might be prone to litigation Misc  Depreciation on a tangible fixed asset and income arising on transfer of a tangible fixed asset shall be computed in accordance with the provisions of the Act  The requirement of maintenance of ICDS specific... impact since service sector largely follows POCM or Cost plus method ICDS requires application of ICDS on construction contracts for recognition of revenue on mutatis mutandis basis • Threshold of 25% stage of completion for recognition of income • No recognition of the foreseeable losses on a contract However, AS-7 permits immediate recognition of the foreseeable losses on a contract regardless of commencement... Specifies that it does not apply to WIP which is dealt with by other ICDS Valuation of service inventory to be the lower of cost or NRV Cost to include labor and other costs of personnel directly engaged in providing services including supervisory personnel and attributable overheads Difficulty would arise in case of services whose chargeability depends on the success of the service Valuation of inventories... with guidance note on Machinery for Spares provides for charge to P/L, however spares to specific asset should be capitalised and shall form part of that Asset ICDS  It provides that machinery spares which can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular, shall be capitalized Impact: ICDS specifies that machinery spares dedicated to a tangible... acquisition of running business on slump sale, price paid will be ‘cost’ of opening inventory Value of opening inventory • • ICDS does not permit standard cost method for the purpose of inventory valuation The same will have an impact on taxpayers following standard cost method for valuation of inventory for accounting purpose, who will need to adopt FIFO or weighted average cost formula for tax purposes... Conclusion  Since ICDS requires recognition in P&L A/c subject to provisions of Section 43A and Section 43A applies only if it relates to imported assets, a controversy may arise, whether such exchange fluctuation gain or loss on capital monetary items (not relating to imported assets) would be allowable as an income or expense as per ICDS or not  May be considered as non-cognizable for tax purposes ... Hierarchy of Act, ICDSs and ASs  Income Tax Act, 1961  Income Tax Rules, 1962  Income Computation and Disclosure Standards – (Ultra-vires Sec-145)  Accounting Standards Accounting Policies... 2014 amended section 145(2) of the Act to substitute “accounting standards with income computation and disclosure standards (ICDS)  The CBDT has vide notification no: 32/2015 [F.No 134/48/2010... of any class of income Accordingly, two tax accounting standards had been notified until now: Disclosure of accounting policies Disclosure of prior period and extraordinary items and changes in