The 10 Income Computation and Disclosure Standards (ICDS) which have been notified on 31st March 2015 u/s. 145(2) of the Income-tax Act, 1961 have significant implications on the computation of income for assessment years beginning from assessment year 2016-17.
Under the notification, these standards come into force from 1st April 2016, i.e. assessment year 2016-17, apply to all assessees following mercantile system of accounting, and are to be followed 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”. The notification also supercedes notification dated 25th January 1996 [which notified 2 Accounting Standards u/s 145(2) – Disclosure of Accounting Policies, and Disclosure of Prior Period and Extraordinary Items and Changes in Accounting Policies], except as regards such things done or omitted to be done before such supersession.
Background
Section 145, which deals with method of accounting, was substituted by the Finance Act, 1995, with effect from assessment year 1997-98. Sub-section (2) to this section, after this amendment, provided that the Central Government may notify in the Official Gazette from time to time accounting standards (“AS”) to be followed by any class of assessees or in respect of any class of income.
The provisions of sub-section (1) were made subject to the provisions of sub-section (2), whereby the income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” was to be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee, subject to the provisions of subsection (2).
Sub-section (3) provided that where the assessing officer was not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or AS notified under sub-section (2) had not been regularly followed by the assessee, the assessing officer could make an assessment in the manner provided in section 144 (i.e. a best judgement assessment).
In 1996, AS notified by ICAI were not mandatory for companies, but were mandatory for auditors auditing general purpose financial statements. On 29th January 1996, two AS (“IT-AS”) were notified by the CBDT, Disclosure of Accounting Policies, and Disclosure of Prior Period and Extraordinary Items and Changes in Accounting Policies.
In July 2002, the Government constituted a Committee for formulation of AS for notification u/s 145(2). In November 2003, this Committee recommended the notification of the AS issued by ICAI without any modification, since it would be impractical for a taxpayer to maintain two sets of books of account. It also recommended appropriate legislative amendments to the Act for preventing any revenue leakage due to the AS being notified by ICAI. These recommendations were not implemented.
With the imminent introduction of International Financial Reporting Standards (IFRS) in India in the form of Ind- AS, in December 2010, the Government constituted a Committee of Departmental Officers and professionals to suggest AS for notification u/s. 145(2). The terms of the Committee were as under:
i) to study the harmonisation of AS issued by the ICAI with the direct tax laws in India, and suggest AS which need to be adopted u/s. 145(2) of the Act along with the relevant modifications;
ii) to suggest method for determination of tax base (book profit) for the purpose of Minimum Alternate Tax (MAT) in case of companies migrating to IFRS (IND AS) in the initial year of adoption and thereafter; and
iii) to suggest appropriate amendments to the Act in view of transition to IFRS (IND AS) regime. This Committee submitted an interim report in August 2011. The recommendations of the Committee in such interim report were as under:
1. Separate AS should be notified u/s. 145(2), since the AS to be notified would have to be in harmony with the Act. The notified AS should provide specific rules, which would enable computation of income with certainty and clarity, and would also need elimination of alternatives, to the extent possible.
2. Since it would be burdensome for taxpayers to maintain 2 sets of books of account, the AS to be notified should apply only to computation of income, and books of account should not have to be maintained on the basis of such AS.
3. T o distinguish such AS from other AS, these AS should be called Tax Accounting Standards (“TAS ”).
4. S ince TAS were based on mercantile system of accounting, they should not apply to taxpayers following cash system of accounting.
5. S ince TAS are meant to be in harmony with the Act, in case of conflict, the provisions of the Act should prevail over TAS .
6. S ince the starting point for computation of taxable income was the profit as per the financial accounts, which are prepared on the basis of AS whose provisions may be different from TAS , a reconciliation between the income as per the financial statements and the income computed as per TAS should be presented.
In October 2011, drafts of 2 TAS – Construction Contracts and Government Grants – were released for public comment. In May 2012, drafts of another 6 TAS were released for public comment.
The Committee gave its final report in August 2012. It focused only on formulation of TAS harmonised with the provisions of the Act, since the position regarding the transition to Ind-AS was fluid and uncertain, and therefore even the impact of Ind-AS on book profits relevant for the purposes of MAT could not be ascertained.
It recommended that of the 31 AS issued by ICAI, 7 AS did not need to be examined, since they did not relate to computation of income. Of the remaining 24 AS, 10 related to disclosure requirements, were not yet mandatory or were not required for computation of income. The Committee therefore provided drafts of 14 TAS . The Committee also recommended that TAS in respect of certain other areas be considered for notification – Share based payment, Revenue recognition by real estate developers, Service concession arrangements (example, Build Operate Transfer agreements), and Exploration for and evaluation of mineral resources.
In January 2015, the CBDT released the draft of 12 TAS (renamed as ICDS) for public comment. These did not include 2 TAS recommended by the Committee – Contingencies and Events Occurring After the Balance Sheet Date and Net Profit or Loss for the Period, Prior Period Items and changes in Accounting Policies.
Section 145 was amended by the Finance (No. 2) Act, 2014 with effect from 1st April 2015 (assessment year 2015-16), by substituting the term “income computation and disclosure standards” for the term “accounting standards” in sub-section (2). Similarly, sub-section (3) was amended to substitute the “not regular following of accounting standards” with “non-computation of income in accordance with the notified ICDS”.
Finally, in March 2015, the CBDT notified 10 ICDS as under:
ICDS I – Accounting Policies
ICDS II – Valuation of Inventories
ICDS III – Construction Contracts
ICDS IV – Revenue Recognition
ICDS V – Tangible Fixed Assets
ICDS VI – 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
The draft ICDS prepared by the Committee but not notified were those relating to Leases and Intangible Fixed Assets.
Applicability & Issues
The notified ICDS apply with effect from assessment year 2016-17, while section 145(2) was amended with effect from assessment year 2015-16. Therefore, for assessment year 2015-16, IT-AS would not apply, since the section provides for ICDS to be followed. Further, since ICDS were not notified till March 2015, ICDS were also not required to be followed for that year. Effectively, for assessment year 2015-16, neither IT-AS nor ICDS would apply. ICDS would apply only with effect from assessment year 2016-17.
ICDS would apply to all taxpayers following mercantile system of accounting, irrespective of the level of income. It would not apply to taxpayers following cash system of accounting. It would not apply only to taxpayers carrying on business, but even to other taxpayers, who may have income under the head “Income from Other Sources”. Effectively, since almost every taxpayer would have at least bank interest, which is taxable under the head “Income from Other Sources”, it would apply to most taxpayers. Further, most taxpayers choose to offer income for tax on an accrual basis, to facilitate matching of tax deducted at source (TDS) from their income with their claim for TDS credit as per their return of income.
Would it apply to taxpayers who do not maintain books of accounts? The provisions would certainly apply to all taxpayers who offer their income to tax under these 2 heads of income on a mercantile basis. Can a taxpayer choose to offer his income to tax on a cash basis, where books of account are not maintained, or is it to be presumed that his income has to be taxed on a mercantile or accrual basis in the absence of books of accounts?
In N. R. Sirker vs. CIT 111 ITR 281, the Gauhati High Court considered the issue and held as under:
“It can safely be assumed that ordinarily people keep accounts in cash system, that is to say, when certain sum is received, it is entered in his account and in the case of firms, etc., where regular method of accounting is adopted, sometimes accounts are kept in mercantile system. In the instant case it was not the case of the department that the assessee’s accounts were kept in mercantile system. On the other hand, the assessment orders showed that no proper accounts were kept. That being so it would not be justified to presume that the assessee kept his accounts in the mercantile system. Income-tax is normally paid on money actually received as income after deducting the allowable deductions. In the case of an assessee maintaining accounts in mercantile system, there was some variation, inasmuch as moneys receivable and payable were also shown as received and paid in the books. In order to apply this method, the proved or admitted position must be that the assessee keeps his accounts in mercantile system.”
Similarly, in Dr. N. K. Brahmachari vs. CIT 186 ITR 507, the Calcutta High Court held that unless and until it was found that the assessee maintained his accounts on accrual basis, income accrued but not received could not be taxed.
In CIT vs. Vimla D. Sonwane 212 ITR 489, the Bombay High Court considered a case where the assesse did not maintain regular books of accounts and did not follow mercantile system of accounting. The Bombay High Court held in that case:
“Option regarding adoption of system of accounting is with the assessee and not with the Income-tax Department. The assessee is indeed free even to follow different methods of accounting for income from different sources in an appropriate case. The department cannot compel the assessee to adopt the mercantile system of accounting. As a matter of fact, it was not adopted.”
In Whitworth Park Coal Co. Ltd. vs. IRC [1960] 40 ITR 517, the House of Lords laid down that where no method of accounting had been regularly employed, a non-trader cannot be assessed, (in the Indian context, u/s. 56 under the head ‘Income from other sources’) in respect of money which he has not received. The House of Lords observed:
“…The word ‘income’ appears to me to be the crucial word, and it is not easy to say what it means. The word is not defined in the Act and I do not think that it can be defined. There are two different currents of authority. It appears to me to be quite settled that in computing a trader’s income account must be taken of trading debts which have not yet been received by the trader. The price of goods sold or services rendered is included in the year’s profit and loss account although that price has not yet been paid. One reason may be that the price has already been earned and that it would give a false picture to put the cost of producing the goods or rendering the services into his accounts as an outgoing but to put nothing against that until the price has been paid. Good accounting practice may require some exceptions, I do not know, but the general principle has long been recognised. And if in the end the price is not paid it can be written off in a subsequent year as a bad debt.
But the position of an ordinary individual who has no trade or profession is quite different. He does not make up a profit and loss account. Sums paid to him are his income, perhaps subject to some deductions, and it would be a great hardship to require him to pay tax on sums owing to him but of which he cannot yet obtain payment. Moreover, for him there is nothing corresponding to a trader writing off bad debts in a subsequent year, except perhaps the right to get back tax which he has paid in error.” (p. 533)
“The case has often arisen of a trader being required to pay tax on something which he has not yet received and may never receive, but we were informed that there is no reported case where a non-trader has had to do this whereas there are at least three cases to the opposite effect—Lambe v. IRC [1934] 2 ITR 494, Dewar v. IRC 1935 5 Tax LR 536 and Grey v. Tiley [1932] 16 Tax Cas. 414, and I would also refer to what was said by Lord Wrenbury in St. Lucia Usines & Estates Co. Ltd. v. St. Lucia ( Colonial Treasurer) [1924] AC 508 (PC). I certainly think that it would be wrong to hold now for the first time that a non-trader to whom money is owing but who has not yet received it must bring it into his income-tax return and pay tax on it. And for this purpose I think that the company must be treated as a non-trader, because the Butterley’s case [1957] AC 32 makes it clear that these payments are not trading receipts.” (p. 533)
Therefore, for income falling under the head “Income from other sources”, it is clear that in the absence of books of accounts, and where the assessee has not exercised any option, the income would be taxable on a cash basis.
It is well settled that the method of accounting is vis-a-vis each source of income, since computation of income is first to be done for each source of income, and then aggregated under each head of income. An assessee can choose to follow one method of accounting for some sources of income, and another method of accounting for other sources of income. In J. K. Bankers vs. CIT 94 ITR
107 (All), the assessee was following mercantile system of accounting in respect of interest on loans in respect of its moneylending business, and offered lease rent earned by it to tax on a cash basis under the head “Income from Other Sources”. The Allahabad High Court held that an assessee could choose to follow a different method of accounting in respect of its moneylending business and in respect of lease rent. Similarly, in CIT vs. Smt. Vimla D. Sonwane 212 ITR 489, the Bombay High Court held that “The assessee is indeed free even to follow different methods of accounting for income from different sources in an appropriate case”.
Where an assessee follows cash method of accounting for certain sources of income and mercantile system of accounting for others, ICDS would apply only to those sources of income, where mercantile system of accounting is followed and would not apply to those sources of income, where cash method of accounting is followed. For instance, an assessee may have a manufacturing business, and a separate commission agency business. He may be following mercantile system of accounting for his manufacturing business, and a cash method of accounting for his commission agency business. ICDS would then apply only to the manufacturing business, and not to the commission agency business.
Can a taxpayer opt to change his method of accounting from mercantile to cash basis, in order to prevent the applicability of ICDS? Under paragraph 5 of ICDS I, an accounting policy shall not be changed without reasonable cause. Under AS 5, such a change was permissible only if the adoption of a different accounting policy was required by statute or for compliance with an accounting standard or if it was considered that the change would result in a more appropriate presentation of the financial statements of the enterprise. Would a change in law amount to reasonable cause? If such a change is made from assessment year 2016-17, the year from which ICDS comes into effect, an assessee would need to demonstrate that such change was actuated by other commercial considerations, and not merely to bypass the provisions of ICDS.
Do ICDS apply to a taxpayer who is offering his income to tax under a presumptive tax scheme, such as section 44AD? Under the presumptive tax scheme, books of account are not relevant, since the income is computed on the basis of the presumptive tax rate laid down under the Act. It therefore does not involve computation of income on the basis of the method of accounting, or on the basis of adjustments to the accounts. Therefore, though there is no specific exclusion under the notification for taxpayers following under presumptive tax schemes from the purview of ICDS, logically, ICDS should not apply to such taxpayers. However, where the presumptive tax scheme involves computation of tax on the basis of gross receipts, turnover, etc., it is possible that the tax authorities may take a view that the ICDS on revenue recognition would apply to compute the gross receipts or turnover in such cases.
Would ICDS apply to non-residents? The provisions of ICDS apply to all taxpayers, irrespective of the concept of residence. However, where a non-resident taxpayer falls under a presumptive tax scheme, such as section 115A, on the same logic as that of presumptive tax schemes applicable to residents, the provisions of ICDS should not apply. Further, where a non-resident claims the benefit of a double taxation avoidance agreement (DTAA), by virtue of section 90(2), the provisions of the DTAA would prevail over the provisions of the Income-tax Act, including section 145(2) and ICDS notified thereunder. In other cases of incomes of non-residents, which do not fall under presumptive tax schemes or DTAA, the provisions of ICDS would apply.
It has been stated in each ICDS that the ICDS would not apply for the purpose of maintenance of books of accounts. While theoretically this may be the position, the question arises as to whether it is practicable or even possible to compute the income under ICDS without maintaining a parallel set of books of account, given the substantial differences between AS being followed in the books of accounts and ICDS. Most taxpayers would end up at least preparing a parallel profit and loss account and balance sheet, to ensure that ICDS and its consequences have been properly taken care of while making the adjustments.
Further, the Committee had recommended that a tax auditor is required to certify that the computation of taxable income is made in accordance with the provisions of ICDS. Before certification, a tax auditor would invariably require such parallel profit and loss account and balance sheet to be prepared, to ensure that all adjustments required on account of ICDS have been considered. This will result in substantial work for most businesses, and may even result in the requirement of parallel MIS, one for the purposes of regular accounts, and the other for the purposes of ICDS. One wonders whether the Committee really wanted to avoid the requirement of maintenance of 2 sets of books of account, as stated by it, or has taken into account the practical difficulties, given the complex and myriad adjustments it has suggested through ICDS.
An interesting issue arises in this context. Can an assessee maintain 2 separate books of accounts – one under the Companies Act or other applicable law on a mercantile system, and a parallel set of books of accounts for income tax purposes on a cash basis? If one looks at the provisions of section 145(1), it provides that income chargeable under these 2 heads of income shall be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. What is the meaning of the term “regularly employed”? Normally, the system of accounting adopted by the assesse in his books for his dealings with the outside world would be adopted for the purposes of computing the profit or loss for tax purposes also. The accounts are those maintained in the regular course of business. It may therefore be difficult for an assessee to maintain separate books of account with different system of accounting only for income tax purposes.
It may be noted that even after the introduction of ICDS, the computation still has to be in accordance with the method of accounting regularly employed by the assessee. Compliance with ICDS is an additional requirement. Therefore, the computation in accordance with the method of accounting is merely modified by the requirements of ICDS, and not substituted entirely.
Since ICDS is not applicable for the purposes of maintenance of books of account, one wonders as to what is the purpose and ambit of ICDS I on Accounting Policies. Since the purpose of ICDS is not to lay down accounting policies which are to be followed in the maintenance of the books of account, ICDS I should be regarded as merely a disclosure standard and not a computation standard. There are however certain provisions in ICDS I which relate to computation.
For example, the provision that accounting policies adopted shall be such was to represent a true and fair view of the state of affairs and income of the business, profession or vocation, and that for this purpose, the treatment and presentation of transaction and events shall be governed by their substance and not merely by their legal form, and 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, really relates to what accounting policies an assessee should follow in its books of account. This is inconsistent with the preamble to this ICDS, that it is not applicable for the purpose of maintenance of books of account. This is also ultra vires the powers available under the provisions of section 145(2), which provide for computation in accordance with notified ICDS, and no longer contain the power to notify accounting standards.
This anomaly possibly arose on account of the fact that the provisions of section 145(2) were modified only after the Committee provided the draft of the relevant ICDS. Possibly, such provisions of ICDS I may not be valid.
Each ICDS states that in the case of conflicts between the provisions of the Income-tax Act and the ICDS, the provisions of the Act would prevail to that extent. Such a provision is ostensibly to harmonise the provisions of the ICDS with the provisions of the Act. One wonders as to why the Committee did not take into account the various provisions of the Act while framing ICDS. While such a provision is helpful, it would lead to substantial litigation in cases where there is no express provision in the Act, but where courts have interpreted the provisions of the Act in a manner which is inconsistent with the provisions of the ICDS.
There have been 3 specific amendments made to the Income-tax Act by the Finance Act 2015, to ensure that the provisions of the Act are in line with the provisions of ICDS. These 3 provisions are as under:
1. The definition of “income” u/s. 2(24) has been amended by insertion of clause (xviii) to include assistance in the form of a subsidy or grant or cash incentive or duty drawback or favour or concession or reimbursement (by whatever name called) by the Central Government or a State Government or any authority or body or agency in cash or kind to the assessee, other than the subsidy or grant or reimbursement, which is taken into account for determination of the actual cost of the asset in accordance with the provisions of explanation 10 to clause (1) of section 43. This is to align it with the provisions of ICDS VII on Government Grants.
2. The provisions of the proviso to section 36(1)(iii) have been modified to delete the words “for extension of existing business or profession”, after the words “in respect of capital borrowed for acquisition of an asset”, to bring the section in line with ICDS IX on Borrowing Costs, whereby interest in respect of borrowings for all assets acquired, from the date of borrowing till the date of first put to use of the asset, is to be capitalised.
3. A second proviso has been inserted to section 36(1) (vii), to provide that where a debt has been taken into account in computing the income of an assessee for any year on the basis of ICDS without recording such debt in the books of accounts, then such debt would be deemed to have been written off in the year in which it becomes irrecoverable. This is to facilitate the claim for deduction of bad debts, where the debt has been recognised as income in accordance with ICDS, but has not been recognised in the books of accounts in accordance with AS.
Obviously, with the amendment of the Income-tax Act as well, the provisions of the ICDS in this regard read along with the amended Act, which may be contrary to earlier judicial rulings, would now apply.
There could be earlier judicial rulings which are based on the relevant provisions of the accounting standards, and where the court therefore interpreted the law on the basis of such accounting standards. These judicial rulings would now have to be considered as being subject to the requirements of ICDS, as the method of accounting is now subject to modification by the provisions of ICDS.
The third and last category of judicial rulings would be those where the courts have laid down certain basic principles while interpreting the tax law, in particular, the relevant provisions of the tax law. In such cases, such judicial rulings would override the provisions of ICDS, since such rulings have interpreted the provisions of the Act, which would prevail over ICDS.
For instance, various judicial rulings have propounded the real income theory. The Delhi High Court, in the case of CIT vs. Vashisht Chay Vyapar 330 ITR 440 has held, based on the real income theory, that interest accrued on non-performing assets of non-banking financial companies cannot be taxed until such time as such interest is actually received. Would the contrary provisions of ICDS IV on revenue recognition change the position? It would appear that the ruling will still continue to hold good even after the introduction of ICDS.
In case any of the provisions of ICDS is contrary to the Income Tax Rules, which one would prevail? The provisions of ICDS are silent in this regard. Given the fact that rules are a form of delegated legislation, while ICDS is in the form of a notification, which then becomes a part of the legislation, it would appear that the provisions of ICDS should prevail in such cases.
Since ICDS is not applicable for the purpose of maintenance of books of account, it is clear that the provisions of ICDS would not apply to the computation of “book profits” for the purposes of minimum alternate tax under section 115JB.
In fact, most of the ICDS provisions would increase the gap between the taxable income and the book profits, instead of narrowing down the gap. In this context, one wonders whether a recent Telangana & Andhra Pradesh High Court decision would be of assistance. In the case of Nagarjuna Fertilizers & Chemicals Limited 373 ITR 252, the High Court held that where an item of income was taxed in an earlier year but was recorded in the books of account of the current year, on the principle that the same income could not be taxed twice, such income had to be excluded from the book profits of the current year.
Can one use the provisions of AS for interpreting ICDS, where the provisions of both are identical? If one compares the ICDS with the corresponding AS, one notices that the bold portion of the AS has been picked up and modified, and issued as ICDS. Where the provisions of the AS and ICDS are identical, one should therefore be able to take resort to the explanatory paragraphs forming part of the AS, though they do not form part of the ICDS, in order to interpret the ICDS.
Impact & Conclusion
One thing is certain – the provisions of ICDS will create far greater litigation, then what one is now witnessing. That would defeat the very purpose of ICDS of bringing in tax certainty and reduction of litigation. Does reduction of litigation mean introduction of complicated provisions which are unfair to taxpayers? Is there at least one provision in the ICDS which decides a disputed issue in favour of taxpayers?
Does the CBDT believe that what is accepted worldwide as income (profit determined in accordance with IFRS), is not the real income when it comes to taxation? Are the Indian tax authorities an exception to the rest of the world? ICDS does not increase taxes – it merely results in advancement of taxability of income to an earlier year, and postponement of allowability of expenditure to a later year. Is the need for advancement of tax revenues so pressing, that taxpayer convenience and compliance costs are brushed aside?
Looking at the requirements of ICDS, one cannot but help wonder as to whether ICDS has been merely brought in to overcome the impact of adverse judicial rulings, and not really with a view to facilitate transition to IndAS. What ought to have been done by amendments to the law is being sought to be implemented through ICDS.
Assessees would now have to cope with not only frequent changes to the law, but also with frequent changes to ICDS, given the unfinished agenda of 4 draft ICDS yet to be notified, and the further 4 recommended for notification by the Committee. One understands that the Committee is in the process of drafting further ICDS for notification.
One also understands that the CBDT is likely to issue FAQs to clarify various aspects of ICDS. One only hopes that such FAQs will not create further confusion, but would help clear the confusion created by the ICDS.
One wonders as to how such ICDS fits in with the Prime Minister’s promise to improve the ease of doing business. The additional compliance costs in order to comply with ICDS would far outweigh the advantages gained by the tax department by recovering taxes at an earlier stage. Would business be keen to expand or would persons be willing to set up new businesses, given the significant compliance costs? The country would certainly take a significant hit in the “Ease of Doing Business Survey” once ICDS is implemented.
Tax auditors will now be in an extremely difficult situation, if the recommendation relating to requirement of certification of computation of income in accordance with ICDS is implemented. So far, they merely had to certify the true and fair view of the accounts, and the correctness of the information provided in Form 3CD. They did not have to certify the correctness of the claims for various deductions. If an auditor would now have to certify the correctness of the computation of income, this would give rise to various issues as to how such certification could be carried out, particularly in cases where the issue was debatable.
Instead of taxpayers, tax auditors may bear the brunt of the income tax department’s actions in respect of claims for deduction or exemption made which, in the view of the income tax department, is not allowable. Would assessees be willing to remunerate tax auditors for such additional high risks which they would bear in certifying the computation of income? If such a requirement of certification of the computation of income were introduced, it is possible that many chartered accountants may no longer be willing to carry out tax audits.
The biggest beneficiaries of ICDS may be tax lawyers and chartered accountants, who will have to handle the resultant additional litigation. The biggest losers will be the taxpayers, due to additional compliance and litigation costs, and the country, due to loss of productive manhours, and the loss of potential growth in business.
