As we are sailing across the revolution in Indian regulatory framework as evidenced by development in Companies Act, Ind-AS and Prospective Goods and service Tax meanwhile Central Board of Direct Tax has notified as per power conferred u/s 145(2) ten Income Computation and Disclosure Standards (ICDSs) to be followed by all assesses for any class of income to be considered while computing taxable income for Assessment Year starting from 1st April 2016. It has been notified as on 31.03.2015 vide notification no 32/2015 dated 31st March 2015 and are applicable on assesses having income under head “Profit and gain from business and profession” and “Profit under head Other Sources” following the mercantile system of accounting.
The notified ICDSs are similar to the Accounting Standards (ASs) issued by The Institute of Chartered Accountants of India apart from several deviations owing to the difference in the fundamental objectives on which these are framed. The Accounting Standards are framed in order to secure the interest of various stakeholder like shareholders, Govt. Authorities, Employees and others where as the ICDSs are framed to serve the interest of Income Tax department. ASs where has objective of true and fair accounting, the ICDSs focus on avoidance of Tax evasion. By the reason of these differences the ASs thrust on postponing the recognition of income and advancing the booking of expenses which is perfectly vice versa in case of ICDSs.
Further the notified ICDSs have also annulled various case laws pronounced in that respect and has triggered several amendments in Income tax Act, 1961 through Finance Act, 2015. Let’s have a look over the difference between ICDSs and ASs and other related aspects.
ICDS I: Accounting Policies (Similar to AS 1: Disclosure of accounting policy)
Accounting Standard 1 provides the basis on which the accounting policies should be selected by the management. However the ICDS I do not provide the basis of selection of accounting policies i.e. materiality, prudence and substance over form. Prudence concept propels the advancing the recognition of all known liabilities and defers the recognition of income whose realization is not certain. Thus in computation of Income tax as per ICDS I the prudence concept is required to be ignored. This is also supported by the various instructions set in other ICDSs like:
- As per ICDS VII, Government grants should be recognized not later than its actual receipt even the condition w.r.t to such grant has not met.
- As per ICDS IV, Reasonable certainty of ultimate collection is ignored for recognition of revenue through rendering of service and on use by others of enterprise’s resources to generate Rent, interest, royalty and dividend.
- As per ICDS III, Non recognition of expected loss from construction contract and provisioning for loss on onerous contract.
Sec 36(i)(vii) provides that for deduction of bad debt, the debt should be written of irrevocably in the books of account. As discussed above it may happen that income has been recognized in tax computation but has not been recognized in the books of accounts. In such case the requirement of section 36(vii) can’t be complied as writing off such income in book will not be practically possible. In order to reconcile the same amendment through Finance Act, 2015 has been made in sec 36(vii) that if the income has been offered to tax but has not been recognized in books of accounts, the same is deemed to have been recognized in the books for the purpose of se 36(vii)
Apart from above the ICDS I provide that there should be reasonable cause for change in accounting policy. The Reasonable cause has not been defined in the ICDS. But AS 5 (Net Profit or loss for the period, prior period Items and changes in accounting policy) provides change in accounting policy should be made in order to meet the applicable statue and requirement of accounting standard and for better presentation of financial statements.
ICDS II: Valuation of inventory (Similar to AS 2: Valuation of Inventories)
AS 2 provides the adoption of other valuation methods for valuation of inventory if it results the value approximating to actual valuation but ICDS II supports on valuation based on FIFO and Weighted average cost mechanism only. As a result the other method like standard costing is not acceptable by the ICDS II.
AS 2 provide the cost of purchase of inventory to include duties and taxes which are not subsequently recoverable from the taxing authorities but the ICDS II provide the cost of purchase of inventory to include all duties and taxes.
ICDS II require the inventory to be valued on NRV basis in case of dissolution of firm irrespective of whether business is continued or not. This provision has annulled the land mark Judgment of Shakti trading Co. where it held that inventory should be valued at cost where the business is continued by other partners in case of dissolution.
ICDS III: Construction Contracts (Similar to AS 7: Contraction Contracts)
AS 7 provide for the recognition of expected loss from the construction contracts immediately but ICDS III doesn’t have this provision. Thus by avoiding this provision in ICDS III, it has supported ignorance of prudence concept. As a result of this the loss will be recognized in proportion to recognition of revenue since revenue from the contraction contract is recognized on the base of percentage completion methods as per ICDS IV.
AS 7 requires the reduction in recognition of revenue in Construction contract by penalty if it occurs due to delay in contract or other reasons but ICDS has not this sort of provision. Thus as per ICDS full revenue to be recognized and the penalty should be recognized u/s 37(1) only of it is compensatory in nature or on base of other case laws pronounced in this respect till date.
ICDS IV: Revenue Recognition (Similar to AS 9: Revenue recognition)
AS 9 allows the recognition of revenue in service contract based on either percentage completion method or completed service contract method but ICDS IV lays down the method of proportionate completion method only for the recognition of revenue in service contract.
AS per ICDS IV reasonable assurance of ultimate collection of revenue is not a criterion for recognition of revenue in case of rendering of service or revenue from the use by others of enterprise’s resources by way of royalty, interest and dividend.
ICDS VI: Effects of change in foreign exchange rates (Similar to AS 11: Effects of change in foreign exchange rates)
As per AS 11, the exchange differences arising on foreign exchange translation in case of non-integral foreign operation is required to be credited or debited as foreign exchange translation reserve but as per ICDS, the same is required to be recognized as income/loss in the year in which it arises.
ICDS VII: Government Grants (Similar to AS 12: Government Grants)
AS 7 requires government grant should be recognized as revenue when there is reasonable assurance that condition attached to grant will be complied and the grant will be received. However the ICDS VII also lays down the same conditions for recognition of revenue but it also provides that the recognition of revenue should not be postponed beyond the time it has received even if the condition attached to it has not met.
Government grant with respect to depreciable fixed assets as per AS 12 may be either reduced from the gross block or may be transferred to Profit and loss account in proportion to the grant included in deprecation on such depreciable fixed assets. However as per ICDS VII Government grant with respect to depreciable fixed asset always required to be reduced from the actual cost of depreciable fixed assets.
Government grants in respect of non depreciable fixed assets as per AS 12 are required to be credited to the capital reserve account. However the same is as per ICDS VII is required to be recognized as income over the period over which cost of meeting such obligation is charged.
The above discussed provisions have annulled the purpose rule that was established by several Case laws pronounced in this respect like Rasoi Ltd. According to this case, it is the purpose of subsidy which decides its taxability. If the subsidy is of capital nature or for expansion of business then it is capital receipt not chargeable to tax. Thus now even the subsidy is for capital purpose the same is exposed to taxability.
ICDS VIII: Securities (Similar To AS 13: Accounting for Investments but Dealt by AS 2: Valuation of Inventories)
If Securities are held as investment then it shall be treated under head of Capital gain. ICDS VIII is required to be complied if the securities are held as stock in trade which is dealt by AS 2 .The valuation of securities as per both AS 2 and ICDS VIII is done by taking lower of cost or net realizable value (NRV) whichever is lower. But as per AS 2 the comparison between cost and NRV should be done for each security separately but as per ICDS VIII, the same is done category wise.
As per ICDS the valuation of unquoted securities and securities which are listed but not quoted in recognized stock exchange should be valued at actual cost initially recognized. The same is not supported by AS 2 and required to be valued by taking lower of cost or NRV whichever is lower only.
ICDS VIII provides that where in case of interest bearing security, if the interest earned corresponds to the period before acquisition the same is required to be deducted from actual cost of the security. Such provision has not been provided in AS 2.
ICDS IX: Borrowing Cost (Similar to AS 16: Borrowing Costs)
Both AS and ICDS provides for the capitalization of interest cost in case of qualifying assets. Qualifying assets as per ICDS IX mean
- Land, building, machinery or furniture being tangible assets.
- Know-how, patents, copyrights, trade-marks, licenses, franchises or any other business or commercial rights of similar nature being tangible assets.
- Inventories that require a period of twelve months or more to bring them to a saleable condition
In case of (a) and (b) as per AS 16 these shall be qualifying asset if it requires substantial period of time to get ready for their intended use. Substantial period of time has not been defined in AS 16 but generally period of 12 months is regarded as substantial period of time for determining qualifying assets. Also in case of (c) AS 2 provides the same criteria for defining qualifying assets as provided in AS 16. Thus interest on borrowed fund for acquisition of fixed assets is required to be capitalized as per ICDS irrespective of the period it require to get ready for their intended use but as per AS the same is capitalized if fixed assets take substantial period of time to get ready for their intended use.
To give effect the above discussed requirement of capitalization of interest in case of fixed asset amendment has been introduced via Finance Act, 2015 in proviso to sec 36(i)(iii) that the interest expenses incurred for acquisition of capital asset upto put to use shall not be deducted u/s 36(i)(iii).
AS 16 require the income earned from the temporary investment of borrowed fund to be deducted from the interest expense incurred. Since ICDS doesn’t provide for this provision, the same is required to be recognized as income. This results in postponing recognition of expenses.
ICDS IX does not provide for the treatment of foreign exchange difference as interest in case interest cost on cross border loan is lower than the interest cost that ought to be incurred if loan has been taken from Indian lender as provided in Para 4(e) of AS 16.
ICDS X: Provisions, contingent liabilities and contingent Assets (Similar to AS 29: Provisions, Contingent Liabilities and Contingent Assets)
As per AS 29 provision is required to be made when there is probable that the outflow of resources is required to settle an obligation but as per ICDS IX the same is required to be recognized when there is reasonable certainty that outflow of resources is required to settle the obligation. ICDS X requires more cemented estimation in booking of provision in comparison of AS which requires the same only if there is probability.
As per AS 29 contingent assets and related income is not recognized but the same can be recognized if the flow of economic benefit is virtually certain. But as per ICDS, the same is recognized if the flow of economic benefit is reasonably certain. ICDS X is more lenient in recognition of income is comparison to AS 29 here.
Note: In case of any conflict between notified ICDSs and Income tax Act, 1961, the Act shall prevail over the ICDSs
Conclusion: CBDT, by issuing these standards, has taken step to rationalize accounting treatment of transactions for which Act is silent and the law has been driven through various pronounced case laws.