We hope you will consider our representation favourably. Thanking You, For Bombay Chartered Accountants Society,

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1 5th December 2012 Director (Tax Policy & Legislation)-III Central Board of Direct Taxes, Room No.147-G, North Block, New Delhi Dear Sir / Madam Sub: and suggestions on the Final Report of the Committee constituted for formulating Accounting Standards Please find enclosed herewith and suggestions on the Final Report of the Committee constituted for formulating Accounting Standards for the purposes of notification under section 145(2) of the Income-tax Act, We hope you will consider our representation favourably. Thanking You, For Bombay Chartered Accountants Society, Deepak R. Shah President Gautam S. Nayak Chairman, Taxation Committee

2 on Final Report of Accounting Standards Committee The Committee constituted for formulating accounting standards for notification under section 145(2) of the Income Tax Act, 1961 has submitted its final report. We give below our comments and suggestions on the recommendations of the committee. General 1. It is submitted that there is absolutely no need for notifying a different set of Tax Accounting Standards (TAS) for the purpose of computing income under the provisions of the Income-tax Act. Though phased introduction of Ind-AS would mean that some taxpayers would be following Ind-AS while others would be following AS notified under the Company Rules, even today the position is that corporates are following Accounting Standards notified under the Company Rules, while noncorporates are following Accounting Standards issued by ICAI. Each set of taxpayers may be permitted to compute their taxable income as per the relevant accounting standards applicable to each of them. 2. One of the stated purposes of TAS is to harmonise the accounting standards issued by ICAI with the direct tax laws in India. It is submitted that the accounting standards are already in harmony with the provisions of the direct tax laws in India, since the commencement of computation of business profits, is from the profit as per the profit and loss account. The deviations from the accounting standards are in relation to specific allowances and disallowances provided for under the Income Tax Act. If the desire is really to harmonise the two, then it is the Income Tax Act which really needs to be amended to remove such artificial allowances and disallowances from the profits declared in the accounts prepared in accordance with accounting standards, and not have TAS which increases the number of differences between the profits as per accounts and the taxable income. 3. TAS are now meant to be the basis of computation of taxable income by a mere notification. This will open the door to amendments in the law without requiring amendments in the Act, and thereby the executive will be encroaching on the powers of the legislature. This would also amount to excessive delegation of authority. 4. It needs to be kept in mind that accounting standards have to follow commercial reality. Having accounting standards which are completely at variance with the commercial reality, such as TAS, will cause untold hardship to businesses. 5. From the recommendations of the Committee, it appears that the provisions of TAS are being utilised to overcome the ratio of various judgments, which were in favour of taxpayers, without having to take recourse to make amendments in the law, rather than for any harmonisation or to handle the transition to Ind-AS. 1

3 The recommendations of the Committee are therefore not in accordance with its terms of reference. It is suggested that rather than having TAS which indirectly effect such amendments in the law, the law itself should be amended to overcome the ratio of those judgments, wherever it is thought that the law needs to be otherwise. 6. TAS will give rise to an enormous amount of litigation, as issues are likely to arise as to the meaning of various provisions of TAS. It is therefore suggested that there is no need for separate TAS, and amendments to the law would serve the purpose far better. 7. If at all TAS is to be introduced, all the TAS should not be introduced simultaneously. TAS should be introduced in a phased manner, over a few years, making it applicable first only to large companies, which have the wherewithal to implement TAS. Thereafter, applicability to other taxpayers may be considered, after taking into account the experience of implementation of TAS by large companies. 8. There are various disclosure requirements in various TAS. If accounts are not required to be drawn up in accordance with TAS, the question of any disclosure should not arise, particularly as there is currently no scope for any disclosures in the return of income. The disclosure requirements should therefore be deleted from TAS. 9. The notification No 9949 dated 25 th January 1996 notifying the earlier two accounting standards under section 145(2) had clarified that those accounting standards applied only to taxpayers following the mercantile system of accounting. The interim draft of TAS also had such clarification. Such clarification is missing in the present draft, and needs to be rectified by clarifying that TAS do not apply to taxpayers following the cash method of accounting. 10. It is accepted internationally that small and medium enterprises should not have to follow the same complex accounting standards as those required for large companies, and there are therefore different and simpler accounting standards for such entities, besides exemption from certain standards. It is suggested that small and medium enterprises should be exempted from TAS as well, as they do not have the infrastructure or expertise to handle complex adjustments required by TAS. 11. It needs to be clarified that not following of TAS should not result in rejection of books of account under section 145(3), but result only in adjustment to the total income. Section 145(3) needs to be amended accordingly. 2

4 Chapter 3 Approach (1)(i) To avoid the requirement of maintaining two sets of books of account by the taxpayer, the Committee recommends that the accounting standards notified under the Act should be made applicable only to the computation of taxable income and a taxpayer should not be required to maintain books of account on the basis of accounting standards to be notified under the Act. While such recommendation of not having to maintain separate books of account under TAS is laudable in theory, it is practically unworkable. The proposed Tax Accounting Standards (TAS) would result in wide variance between the figures as per the books of accounts and the figures for taxation purposes. Many of the recommended TAS would require maintenance of separate books of accounts in order to ensure that the computation is correct and proper. For example, TAS (AP) removes the concept of materiality. Therefore, the expenditure debited in the books of accounts would be different from the expenditure claimed for tax purposes. In order to ensure that the valuation of stock under TAS (VI) takes into account all such expenditure claimed under TAS only, and not expenditure debited in the books of accounts, it would be necessary to maintain separate books of accounts under TAS. Similarly, in the case of TAS (CC), the requirement of expenses being capable of measured reliably is not a condition as it is under AS 7. There are various other deviations in the case of TAS (CC) from AS 7, which cannot effectively be computed properly without maintaining books of accounts in accordance with TAS. This would place an enormous compliance burden on all businesses, which are already suffering from excessive compliance requirements necessitating substantial expenditure and whose profitability is already under severe pressure on account of the global slowdown. This additional compliance burden will further reduce the competitiveness of Indian business. (5) For ensuring compliance with the provisions of TAS by the taxpayer, the Committee recommends appropriate modification in the return of income. For tax audit cases, the Form 3CD should also be modified so that a tax auditor is required to certify that the computation of taxable income is made in accordance with the provisions of TAS. The requirement of having a tax auditor certify that the computation of income is in accordance with TAS would add significantly to the costs of tax audit for taxpayers. 3

5 Further, currently the basis of the tax audit report is the books of account and the final accounts prepared from such books, which final accounts are certified or identified by the tax auditor. Since computation of income is not part of the books of account, it would not be possible for a tax auditor to certify that such computation is in accordance with TAS. It would also be too onerous and an impossible obligation for an auditor to certify compliance with all TAS. Currently, an auditor expresses a true and fair view on the accounts, which are based on accounting standards, because it is impossible to express a true and correct view in respect of accounts. Given the fact that TAS does not recognize the concept of materiality, the auditor would have to certify compliance with each and every clause of TAS, which is an impossibility. Chapter 4 Harmonisation of Accounting Standards AS 14 Accounting for Amalgamations The Committee also recommends that suitable amendments be made to the Act to provide certainty on the issue of allowability of depreciation on goodwill arising on amalgamation. The Supreme Court, in the case of CIT v Smifs Securities Ltd 348 ITR 302, has already provided certainty on the issue, by holding that depreciation is allowable on such goodwill. There is therefore no need for any further certainty on the issue. Annexure-D Tax Accounting Standards [TAS] Specific Standards TAS (AP) Accounting Policies 2(c) Accrual refers to the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the previous year to which they relate. If TAS is not to be followed in maintenance of books of accounts, the question of recording such revenues and costs does not arise. 4

6 5.2.1.ii [Of Chapter5] AS-1 recognises the concept of materiality for selection of accounting policies. Since the Act does not recognise the concept of materiality for the purpose of computation of taxable income, the same has not been incorporated in the TAS (AP). Removal of the concept of materiality would result in substantial, impossible and non-productive work of determining adjustment of minor and trivial amounts, the compliance cost of which would far exceed the likely revenue from such adjustments. Besides, any such adjustments would be nullified in the subsequent year, and would ultimately be revenue neutral. 5(i) The treatment and presentation of transactions and events shall be governed by their substance and not merely by the legal form. When TAS is not to be followed in maintenance of books of account, the question of presentation of a transaction or event should not arise. Also, it would be impossible to look at the substance of each and every transaction. The meaning of substance could also be subjective. Tax laws need to be specifically amended to provide for cases where substance is to be seen, rather than the form. For instance, would redeemable preference shares be regarded as borrowing for tax purposes, and dividend thereon be allowed as a deduction in computing taxable income? Would a holding company and its wholly owned subsidiary have to file consolidated tax returns? 5(ii) 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 Tax Accounting Standard. The purpose seems to be to incorporate Instruction No. 3 of 2010 dated in respect of forex derivatives in the TAS. However, it is so widely worded that its scope is not restricted only to marked to market loss from foreign exchange derivative transactions. The words marked to market loss or expected loss are also not defined expressly in the TAS. 5

7 There could be various other situations, which may be interpreted as marked to market loss or expected loss, such as valuation of investments, loss incurred due to fire or fraud, etc. The provision for marked to market loss or expected loss should apply only in respect of derivatives transactions and not to any other transactions. 2(1)(a) Inventories are assets: TAS (VI) Valuation of Inventories (iii) in the form of materials or supplies to be consumed in the production process or in the rendering of services. The TAS proposes to include service providers also within its ambit, unlike AS-2 which did not cover service providers. Most professional service providers follow cash method of accounting. Accounting for inventory would be contrary to the cash method of accounting followed by them. It needs to be clarified that this provision would not apply to professional service providers, or service providers following cash method of accounting. None It needs to be kept in mind that valuation of inventory is a commercial concept, which is carried out as an interim measure to break up the income into different accounting periods. Any changes in inventory valuation have an opposite and equal effect in the next accounting period. There is therefore no need to have a separate tax treatment for valuation of inventory, which is different from that followed for accounting purposes. Given the fact that such valuation is tax neutral, the amount of effort required for computing inventory on a separate basis would add to administration costs without any corresponding benefit. It is therefore suggested that there should be no separate TAS for valuation of inventory. 6

8 None The TAS has eliminated Standard Cost as a method of valuation of inventory with a view to reduce litigation and alternatives. However, there has been hardly any litigation on account of an entity following Standard Cost method of valuation of inventory. Standard cost method is being widely used by most large taxpayers. It is a well recognised method. Many large entities also use ERP like SAP. In such cases it will be next to impossible without incurring unreasonable cost to value inventory on Standard Cost basis for books of account and value the same again on either FIFO basis or Weighted Average basis for TAS. Standard Cost method should be a permitted alternative under TAS. TAS(PP) Prior Period Expense 3 (2) Prior period expense shall not be considered as allowable deduction in the previous year in which it is recorded unless the person proves that such expense accrued during the said previous year. The condition for allowability contained in subparagraph (2) can never be satisfied since, by definition in para 3(1), prior period expense is an error or omission, and therefore cannot have accrued in the previous year. The portion beginning with unless and ending with the said previous year is accordingly meaningless, and should be deleted. 7

9 TAS(CC) Construction Contracts 2(1)(d) Retentions are amounts of progress billings which are not paid until the satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified. 9. Contract revenue shall comprise of: (a) the initial amount of revenue agreed in the contract, including retentions; Retentions can never be income, because the right to receive such amounts comes into existence only after fulfilment of the specified conditions. It is therefore suggested that retentions should not be treated as part of contract revenue. Further, if retentions are not released but are adjusted, due to the fact that the specified conditions are not met and if retention is regarded as contract revenue under TAS, subsequent non-realisation cannot be claimed as a deduction, since such retentions would not appear in the books of account and cannot be written off in the books of account. 13. Contract costs include the costs attributable to a contract for the period from the date of securing the contract to the final completion of the contract. Costs that are incurred in securing the contract are also included as part of the contract costs, provided (a) they can be separately identified; and (b) it is probable that the contract shall be obtained. There could be litigation as to whether costs can be separately identified or not, and whether there is a probability or not that the contract shall be obtained. It is suggested that costs incurred in obtaining the contract should therefore be allowed as a deduction in the period in which they are incurred. 15. Contract revenue and contract costs associated with the construction contract should be recognised as revenue and expenses respectively by reference to the stage of completion of the contract activity at the reporting date. 8

10 16. The recognition of revenue and expenses by reference to the stage of completion of a contract is referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed. 17. The stage of completion of a contract shall be determined with reference to: (a) the proportion that contract costs incurred for work performed up to the reporting date bear to the estimated total contract costs; or.. Under the percentage of completion method, revenue is recognized depending upon stage of completion which in turn is determined with reference to costs incurred. Therefore, the question of recognizing costs incurred by reference to stage of completion of the contract activity at the reporting date, as is mentioned in para 15, does not arise and should be deleted. 17. The stage of completion of a contract shall be determined with reference to: (a) the proportion that contract costs incurred for work performed up to the reporting date bear to the estimated total contract costs; or (b) surveys of work performed; or (c) completion of a physical proportion of the contract work. Para 17 of TAS provides for 3 methods of determining stage of completion. Controversies are likely to arise in case the assessee determines the stage of completion by one method and the AO wants to determine the same by another method. The different methods followed may lead to different stages of completion resulting in different amounts to be recognized as contract revenues. The TAS should expressly provide that it shall be the choice of the assessee to follow any one of the above methods. TAS(RR) Revenue Recognition 4. Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim for escalation of price and export incentives, revenue recognition in respect of such claim shall be postponed to the extent of uncertainty involved. 9

11 The TAS does not allow postponement of recognition of revenue (other than claims for price escalation and export incentives) in a case where the ability to assess the ultimate collection with reasonable certainty is lacking. This is clearly against the principle of accrual, where there has to be reasonable certainty of receipt for an income to have accrued; and also against the principle of prudence. This is also against the commercial reality of business, whereby an amount which is unlikely to be realized, is not treated as income. Furthermore, in such cases, the assessee may not be able to make a claim for bad debts, since bad debts are now allowable only in the year in which they are written off in the accounts of the assessee and in the instant case, no write off would be effected in the books of account of the assessee. It is therefore suggested that the requirement of reasonable certainty of ultimate collection should be the basis for revenue recognition for all types of income. 5. Revenue from service transactions shall be recognised by the percentage completion method. The TAS states that revenue from service transactions shall be recognised by the percentage completion method, as against AS 9 whereby the revenue from service transactions is recognised either by the proportionate completion method or by the completed service contract method. It is suggested that, in view of complications that may be involved in computing revenue as per the percentage completion method, especially in the case of persons having large number of small independent service contracts, an option may be kept open to the assesses to recognise the revenue from service transactions by the completed service contract method. This is at best a timing issue and as it is for bigger contracts covered by the TAS on Construction contracts, the percentage completion method is mandatory. If at all the percentage completion method is to be mandated, the same should be so mandated only where the total income of the assessee, or the contract value, exceeds a certain threshold, or for long duration contracts, in order to avoid computational hardships. Professionals and other service providers following cash method of accounting should be excluded from the requirement of following the percentage of completion method. 10

12 TAS(FA) Tangible Fixed Assets 19. The record of tangible fixed assets shall be maintained in the tangible fixed asset register containing the following details:.. Currently, there is no statutory requirement of maintaining a fixed assets register by non-corporate entities. Many non-corporate entities may not be able to prepare such a register in the absence of details of Fixed Assets acquired in the past. Further, this does not serve any purpose, since the Income Tax Act does not recognize the individual identity of assets, but treats them as a block of assets. This requirement should be dispensed with, as it would unnecessarily add to compliance costs of small businesses. Further, as clarified, TAS is not required to be followed in maintenance of books of account. That being the position, how is it possible to maintain fixed assets register under TAS, since fixed assets register is also a book of account? TAS(FE) Effects of Changes in Foreign Exchange Rates 9. The financial statements of an integral foreign operation shall be translated using the principles and procedures in paragraphs 4 to 7 as if the transactions of the foreign operation had been those of the person himself. 10. (1) In translating the financial statements of a non-integral foreign operation for a previous year, the person shall apply the following: (a) the assets and liabilities, both monetary and non-monetary, of the nonintegral foreign operation shall be translated at the closing rate; (b) income and expense items of the non-integral foreign operation shall be translated at exchange rates at the dates of the transactions; and (c) all resulting exchange differences shall be recognised as income or as expenses in that previous year. 11

13 In most cases, it would be impossible to convert each and every income and expenditure transaction of an integral or non-integral foreign operation into rupees by applying the daily rates. It needs to be kept in mind that the accounts are maintained by the branch, and not by the Head Office, and this will involve an enormous amount of work of conversion, which may take weeks, if not months, in many cases, adding tremendously to compliance costs. It is suggested that where there are no significant fluctuations in exchange rates, adoption of periodical rates, such as a weekly rate or a monthly rate should be permitted, as permitted under AS (5) Premium, discount or exchange difference on contracts that are intended for trading or speculation purposes, or that are entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction shall be recognised at the time of settlement. that `marked to market gains or losses will be recognised only on settlement should be eliminated. This only increases divergences between books of account kept on recognised accounting principles. If at all, such provision should be restricted to contracts intended for trading or speculative purposes, and not to contracts to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction. TAS(GG) Government Grants 6. Where the Government grant relates to a non-depreciable asset or assets of a person requiring fulfillment of certain obligations, the grant shall be recognized as income over the same period over which the cost of meeting such obligations is charged to income. 12

14 Such a grant is of a capital nature, and cannot therefore be recognized as income at all. The character of a receipt cannot be changed from capital to revenue, through a mere provision of a TAS. 4(2) Recognition of Government grant shall not be postponed beyond the date of actual receipt. 6. Where the Government grant relates to a non-depreciable asset or assets of a person requiring fulfillment of certain obligations, the grant shall be recognized as income over the same period over which the cost of meeting such obligations is charged to income. The above two provisions are contradictory to each other, in that, one requires accounting for the grant on receipt, while the other permits spreading over of the grant over the period of fulfillment of obligations. TAS(BC) Borrowing Costs 2(1)(b) qualifying asset means: (i) land, building, machinery, plant or furniture, being tangible assets; (ii) know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets; (iii) inventories that require a period of twelve months or more to bring them to a saleable condition. Under AS-16, Qualifying Asset is defined to mean an asset that necessarily takes a substantial period of time to get ready for intended use or sale. Substantial period of time is taken to be generally twelve months. Under TAS (BC), all tangible fixed assets and intangible assets are Qualifying Assets. The condition of twelve months to bring the asset to saleable condition is restricted only to items of inventory. 13

15 As a result, borrowing costs will have to be capitalised even when there is a short interval between time when funds are borrowed and the asset is put to use. Where the entity has borrowed generally, borrowing costs will have to be capitalised in nearly all cases. This will only complicate the workings and also lead to litigation on account of quantum to be capitalised. This is also contrary to the proviso to s.36(1)(iii), where interest paid for acquisition of an asset only for extension of existing business or profession is not treated as a revenue expenditure. 3. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset. TAS (BC) contemplates capitalisation of borrowing cost to land as well. This will lead to substantial litigation on difference in view regarding the point of time when land is put to use. Will capitalisation cease once construction work commences on the land acquired for setting up a project or will it continue till the construction is complete? If some portion of the land is vacant for future expansion, will capitalisation of borrowing costs continue till expansion project is taken up? It is suggested that borrowing costs relating to purchase of land should not be capitalised to the cost of the land. 6. To the extent the funds borrowed generally and utilised for the purposes of acquisition of a qualifying asset, the amount of borrowing costs to be capitalised shall be computed in accordance with the following formula namely :- Paragraph (iv) of the Final Report states that AS-16 provides that judgement should be used for determining whether general borrowings have been utilised to fund Qualifying Assets. For this reason, the Final Report provides for a specific formula. The formula comes into play only in cases where there are generally borrowed funds and these have been utilised for the purposes of acquisition of a qualifying asset. Accordingly, even under TAS, judgement will have to be used for determining whether borrowed funds have been utilised for acquisition of assets. 14

16 The formula prescribed by paragraph 6 of TAS for computing the amount to be capitalised in respect of generally borrowed funds is irrational. It does not take into account the period between the time when funds are borrowed and the asset is put to use (point of time of cessation of capitalisation), and would therefore often give absurd results. It is therefore suggested that the requirement of capitalization of general purpose borrowings should not be introduced. It is also contrary to the provisions of section 36(1)(iii). None Paragraph (v) of the Final Report states that to align with judicial precedents, provision regarding income on temporary investments of funds borrowed has been removed from TAS. During construction period, borrowed funds are utilised for making deposit as margin money, advance to contractors. Such interest earned goes to reduce the amount of interest paid. It is only the net interest paid which should be capitalized. This aspect should be incorporated in TAS. TAS(IA) Intangible Assets 10. When an intangible asset is acquired in exchange for shares or other securities the asset shall be recorded at its fair value or the fair value of the securities issued, whichever is lower. 13. When an intangible asset is acquired in exchange for another asset, its actual cost shall be recorded at its fair value or the fair value of the asset given up, whichever is lower. [Refer Chapter 7, para 7.1.1] It is true that throughout all the TAS, wherever there is an exchange of asset for another asset or securities, lower of the fair market value of the asset acquired and securities or asset given up is adopted. However, in case of an intangible asset, it is difficult to ascertain the fair market value where there is exchange. 15

17 Consequentially, it would be difficult to arrive at value which is lower. This would only increase litigation. TAS(PC) s, Contingent Liabilities & Contingent Assets 11. Contingent assets are assessed continually and when it becomes reasonably certain that inflow of economic benefit will arise, the asset and related income are recognised in the previous year in which the change occurs. By recognizing contingent assets on reasonable certainty in tax computation, but not in books of account, on subsequent non-realisability of such asset, the taxpayer will never get a deduction for write off of such amount, since no entry for such asset is passed in the books of account on account of the fact that there was no virtual certainty when it was recognized for tax purposes. *** 16