Background The Indian Accounting Standards (Ind AS), the
Indian version of International Financial Reporting Standards, will have
significant impact on financial statements for many entities. Ind AS’s
are meant to primarily serve the needs of investors and hence are not
suitable for the purposes of tax computation. A clear need was felt for
tax accounting standards that would guide the computation of taxable
income.
The Central Government (CG) constituted a Committee in
December 2010, to draft Income Computation and Disclosure Standards
(ICDS). Section 145 of the Indian Income tax Act bestows the power to
the CG to notify ICDS to be followed by specified class of taxpayers or
in respect of specified class of income.
In August 2012, the
Committee provided drafts of 14 standards which were released for public
comments by the CG. After revisions, the CG has notified 10 ICDS
effective from the current tax year itself (viz. tax year 2015- 16) for
compliance by all taxpayers following mercantile system of accounting
for the purposes of computation of income chargeable to income tax under
the head “Profits and gains of business or profession” or “Income from
other sources”.
Earlier, the CG had notified two standards in
1996 viz., (a.) Accounting Standard I, relating to disclosure of
accounting policies. (b.) Accounting Standard II, relating to disclosure
of prior period and extraordinary items and changes in accounting
policies. They now stand superseded. These standards were largely
comparable to the current AS corresponding to AS 1 & AS 5.
ICDS
are meant for the normal tax computation. Thus, as things stand now,
ICDS has no impact on minimum alternate tax (MAT ) for corporate
taxpayers which will continue to be based on “book profit” determined
under current AS or Ind AS, as the case may be.
ICDS shall apply
to all taxpayers, whether corporate or otherwise. Further, there is no
income or turnover criterion for applicability of ICDS. An entity need
not maintain books of accounts to compute income under ICDS. However, if
the differences between ICDS and Ind AS/current AS as the case may be,
are several, an entity may need to evolve a more sophisticated system of
tracking them as against doing it manually on an excel spreadsheet. It
is possible that the current tax audit requirements will be enhanced to
require auditors to report on the correctness of tax computation under
ICDS. Non-compliance of ICDS gives power to the Tax Authority to assess
income on “best judgement” basis and also levy penalty on additions to
returned income.
List of ICDS
Following is the list of 10 ICDS notified w.e.f. April 1,2015:
1. ICDS I relating to accounting policies
2. ICDS II relating to valuation of inventories
3. ICDS III relating to construction contracts
4. ICDS IV relating to revenue recognition
5. ICDS V relating to tangible fixed assets
6. ICDS VI relating to the effects of changes in foreign exchange rates
7. ICDS VII relating to government grants
8. ICDS VIII relating to securities
9. ICDS IX relating to borrowing costs
10. ICDS X relating to provisions, contingent liabilities and contingent assets
KEY differences between icds and current as A few key differences between ICDS and current AS are given below:
ICDS I prohibits recognition of expected losses or markto- market losses unless permitted by any other ICDS.
During
the early stages of a contract, where the outcome of the construction
contract cannot be estimated reliably, contract revenue is recognised
only to the extent of costs incurred. This requirement is contained both
in AS 7 and ICDS III. However, unlike AS 7, ICDS III states that the
early stage of a contract shall not extend beyond 25 % of the stage of
completion.
AS 7 requires a provision to be made for the
expected losses on onerous construction contract immediately on signing
the contract. Under ICDS III, losses incurred on a contract shall be
allowed only in proportion to the stage of completion. Future or
anticipated losses shall not be allowed, unless such losses are actually
incurred.
Under AS 9, revenue from service transactions is
recognised by following “percentage completion method” or “completed
contract method”. Under ICDS IV, only percentage of completion method is
permitted.
Under AS 11, all mark-to-market gains or losses on
forward exchange or similar contracts entered into for trading or
speculation contracts shall be recognised in P&L. In contrast, ICDS
VI requires gains or losses to be recognised in income computation only
on settlement.
Under AS 11, exchange differences on a
non-integral foreign operation are not recognised in the P&L, but
accumulated in a foreign currency translation reserve. Such a foreign
currency translation reserve is recycled to the P&L when the
non-integral operation is disposed. Under ICDS VI, exchange differences
on non-integral foreign operations shall also be included in the
computation of income.
Under AS 12, government grants in the
nature of promoter’s contribution are equated to capital and hence are
included in capital reserves in the balance sheet. Under ICDS VII,
government grants should either be treated as revenue receipt or should
be reduced from the cost of fixed assets based on the purpose for which
such grant or subsidy is given.
Under AS 12, recognition of
government grants shall be postponed even beyond the actual date of
receipt when it is probable that conditions attached to the grant may
not be fulfilled and the grant may have to be refunded to the
government. Under ICDS VII, recognition of Government grants shall not
be postponed beyond the date of actual receipt.
Under AS 16, in
the case of borrowings in foreign currency, borrowing costs include
exchange differences to the extent they are treated as an adjustment to
the interest cost. Under ICDS IX, borrowing cost will not include
exchange differences arising from foreign currency borrowings.
AS
16 requires the fulfilment of the criterion “substantial period of
time” for treating an asset as qualifying asset for the purposes of
capitalisation of borrowing costs. ICDS IX retains substantial period
condition (i.e. 12 months) only for qualifying assets in the nature of
inventory but not for fixed assets and intangible assets. Therefore,
ICDS requires capitalisation of borrowing costs for tangible and
intangible assets even when they are completed in a short period.
Under
ICDS IX, capitalisation of specific borrowing cost shall commence from
the date of borrowing. Under AS 16, borrowing cost is capitalised from
the date of borrowing provided the construction of the asset has
started.
Unlike AS 16, income on temporary investments of
borrowed funds cannot be reduced from borrowing costs eligible for
capitalisation in ICDS IX.
Unlike AS 16, requirement to suspend
capitalisation of borrowing costs during interruption of active
construction of asset is removed in ICDS IX.
Under ICDS X, a
contingent asset is recognized when the realisation of related income is
“reasonably certain”. Under AS 29, the criterion is “virtual
certainty”.
Impact of ICDS
The notification of ICDS was imperative to ensure smooth implementation
of Ind AS, and therefore should have maintained a tax neutral position.
Unfortunately, ICDS are not tax neutral vis-à-vis the current Indian
GAAP and tax practices currently followed and may give rise to
litigation. For example, based on AS 7 Construction Contracts, the
current practice is to recognise any expected loss on a construction
contract as expense immediately. In contrast, ICDS will require expected
losses to be provided for using the percentage of completion method.
ICDS
I lays out the “accrual concept” as a fundamental accounting
assumption. The prohibition on recognising expected or mark-to-market
losses appears to be inconsistent with the accrual concept. Though
mark-tomarket losses are not allowed to be recognised, there is no
express prohibition on recognising mark-to-market gains. The ICDS
therefore appears to be one-sided, determined to maximie tax collection,
rather than routed in sound accounting principles. Matters such as
these are likely to create litigious situations despite the Supreme
Court decision in the Woodword Governor case where the status of ICDS is
upheld.
The preamble of the ICDS states that where there is
conflict between the provisions of the Income-tax Act, 1961 and ICDS,
the provisions of the Act shall prevail to that extent. Consider that a
company has claimed markto- market losses on derivatives as deductible
expenditure u/s. 37(1) of the Income-tax Act. Can the company argue that
this is a deductible expenditure under the Incometax Act (though the
matter may be sub judice) and hence should prevail over ICDS, which
prohibits mark-to-market losses to be considered as deductible
expenditure?
Under ICDS, exchange differences arising on the
settlement or on conversion of monetary items shall be recognised as
income or as expense. Consider that a company uses foreign currency loan
for procuring fixed asset locally. Now under ICDS, the exchange
difference on the foreign currency loan will be recognised in the
P&L A/c. Now consider the following decision in Sutlej Cotton Mills
Ltd. vs. CIT (116 ITR 1) (SC) “The Law may, therefore, now be taken to
be well settled that where profit or loss arises to an assessee on
account of appreciation or depreciation in the value of foreign currency
held by it, on conversion into another currency, such profit or loss
would ordinarily be trading profit or loss if the foreign currency is
held by the assessee on revenue account or as a trading asset or as part
of circulating capital embarked in the business. But, if on the other
hand, the foreign currency is held as a capital asset or as fixed
capital, such profit or loss would be of capital nature”. As per this
decision the exchange difference in our fact pattern will be
capitalised. However, under ICDS it will be recognised in the P&L
A/c. It is not absolutely clear whether the court decision or ICDS will
prevail in the given instance.
All ICDS (except ICDS VIII
relating to Securities) contain transitional provisions. These
transitional provisions are designed to avoid double jeopardy. For
example, if foreseeable loss on a contract is already recognised on a
contract at 31st March 2015, those losses will not be allowed as a
deduction again on a go forward basis using the percentage of completion
method. On the other hand, if only a portion of the loss was
recognised, the remaining foreseeable loss can be recognised using the
percentage of completion method. The detailed mechanism of how this will
work is not clear from the ICDS.
The transitional provisions
are not always absolutely clear. In the case of non-integral foreign
operations, e.g. non-integral foreign branches, ICDS requires
recognition of gains and losses in the P&L (tax computation), rather
than accumulating them in a foreign currency translation reserve. It is
not absolutely clear from the transitional provision whether the
opening accumulated foreign currency translation reserve, which could be
a gain or loss, will be ignored or recognised in the first transition
year 2015-16. Since the amounts involved will be huge, particularly for
many banks, the interpretation of this transitional provision will have a
huge impact for those who have not already considered the same in their
tax computation in the past years.
Some of the transitional
provisions are also expected to have a material unanticipated effect.
For example, the ICDS requires contingent assets to be recognised based
on reasonable certainty as compared to the existing norm of virtual
certainty. Consider a company has filed several claims, where there is
reasonable certainty that it would be awarded compensation. However, it
has never recognised such claims as income, since it did not meet the
virtual certainty test under AS 29. Under the transitional provision, it
will recognise all such claims in the first transition year 2015-16. If
the amounts involved are material, the tax outflow will be material in
the year 2015- 16. This could negatively impact companies that have
these claims. The interpretation of “reasonable certainty” and “virtual
certainty” would also come under huge stress and debate. This may well
be another potential area of uncertainty and litigation.
Overall,
the CG through CBDT will have to play a highly pro-active role to
provide clarity and minimise the potential areas of litigation. An
amendment of the Incometax Act would have been more appropriate rather
than a notification of the ICDS because the impact is expected to be
very high and all pervasive.
