Tax Audit Reporting issues with reference to ICDS. CA Kalpesh Katira 3 September 2017

Transcription

1 Tax Audit Reporting issues with reference to ICDS CA Kalpesh Katira 3 September 2017

2 Table of contents ICDS in brief Disclosures Tax Audit reporting issues 2

3 ICDS in brief

4 Introduction Fi a e A t, 99 e po e ed the Ce t al Go e e t CG to otif Ta A ou ti g Sta da ds TAS ide se tio of the I o e-ta A t, 9 A t Jan 1995 the CG otified t o TAS s o pa a le to ICAI AS-1 and AS-5 Jan 1996 CG Constituted a committee (2002 Committee) for formulation of TAS July 2002 The Committee suggested: Adoption of ICAI AS without modification Nov 2003 Suitable amendments to be made in the Act to prevent revenue leakage 4

5 Introduction Dec 2010 Oct 2012 July 2014 January CG constituted new Committee to study harmonization of ICAI AS with the Income-tax Act and suggest Tax standards Based on final report submitted by Committee in August 2012, CG published drafts of 14 standards for public comments Section 145(2) amended vide Finance Act, 2014 to replace the term A ou ti g Sta da d ith the te I o e Co putatio a d Dis losu e Sta da ds ICDS 12 draft ICDS released for public comments (including intent of transition FY )

6 Introduction 10 ICDS notified for taxpayers following mercantile method of accounting, effective from FY (AY ) March 2015 April 2016 July 2016 September 2016 CBDT notified new Income-tax return forms applicable from FY (AY ) onwards containing a separate schedule on ICDS to capture effect of each ICDS on profits CBDT defers the applicability of ICDS to FY (AY ) vide its press release dated July 06, 2016 considering the recommendations by expert committee 10 ICDS re-notified effective from FY (AY ) Old ICDS notification rescinded - vide Notification 86/2016 Prescribed relevant amendment to the format of the tax audit report vide Notification 88/2016 Clause 13(d) to Clause 13(f) Circular No. 10/2017 dated 23 March 2017 issued which includes various FAQ March

7 Applicability & Issues Revised ICDS apply with effect from assessment year , while section 145(2) was amended with effect from assessment year and also notification dated 31 March, 2015 superseded notification dated 25th January, Therefore, for assessment years and , earlier AS notified under section 145(2) would not apply, since the said section provides for ICDS to be followed. Further, since ICDS notified are applicable only from assessment year , ICDS are also not required to be followed for the above two years. Effectively, therefore, for assessment years and , neither AS nor ICDS would apply. ICDS would apply only with effect from assessment year

8 Scope ICDS ICDS I Accounting Policies Relevant AS AS-1 and AS-5 ICDS 2 - Valuation of Inventories AS-2 ICDS 3 - Construction Contracts AS-7 ICDS 4 - Revenue Recognition AS-9 ICDS 5 - Tangible fixed assets AS-10 ICDS 6 - Effects of changes in foreign exchange rates AS-11 ICDS 7 - Government Grants AS-12 ICDS 8 Securities AS-13 ICDS 9 - Borrowing costs AS-16 ICDS 10 - Provisions, Contingent Liabilities & Assets AS-29 8

9 Scope 9

10 Example Mr X is a trader. He has asked you whether ICDS is applicable to him for FY or not. Kindly advise him. Facts are as under. Case A - his turnover in was FY Rs.3.5 cr while turnover in FY was Rs.30 lakhs Case B - his turnover in FY was Rs 80 lakhs, while in FY it increased to Rs.3 cr. (Note: Ignore section Presumptive Taxation for the time being) 10

11 Scope The ICDS have been issued for computation of income chargeable under the head Income from Business and Profession and Income from Other Sources. Assessee having income from two business, one from manufacturing business and other from commission agency business. For manufacturing business, mercantile system is followed and commission business, cash system is followed. Is ICDS applicable for both business or either of them? Different methods of accounting for different sources of income J. K. Bankers v. CIT 94 ITR 107 (All.) CIT v Smt Vimla D Sonwane ITR 489 (Bom.) CIT v VTC Leasing & Finance Ltd ITR 514 (Raj) 11

12 Scope Can assessee change the method of accounting from mercantile to cash system of accounting? An accounting method is different from an accounting policy. A change in accounting method itself does not amount to a change in accounting policy, but is a change in the method itself. Therefore, para 5 of ICDS I, which deals with change in accounting policy, and the requirement of reasonable cause for such change, would not apply. In the context of section 145, various courts have held that an assessee is entitled to change the method of accounting, if such change is bona fide. If such method of accounting is a permissible method and is regularly followed thereafter, the change of method cannot be rejected. Molmould Corporation v CIT ITR 789 (Bom) CIT v Carborandum Universal Limited ITR 759 (Mad). 12

13 Scope ICDS are to be applied only for computation of income and not for the purpose of maintenance of books of accounts. No disclosure to be made in financial statements FAQ 25 clarifies as under. Net effect on the income due to application of ICDS is to be disclosed in the Return of income. The disclosures required under ICDS shall be made in the tax audit report in Form 3CD. However, there shall not be any separate disclosure requirements for persons who are not liable to tax audit 13

14 Scope Assessee covered by presumptive tax scheme viz. section 44AD, 44AE, 44ADA, 44B, 44BB, 44BBA, etc. ICDS applicable to assessee covered by above presumptive sections FAQ 3 clarifies as under. ICDS is applicable to specified persons having income chargeable under the head `Profits and gains of business or profession or `Income from other sources. Therefore, the relevant provisions of ICDS shall also apply to the persons computing income under the relevant presumptive taxation scheme. For example, for computing presumptive income of a partnership firm under section 44AD of the Act, the provisions of ICDS on Construction Contract or Revenue recognition shall apply for determining the receipts or turnover, as the case may be. 14

15 Scope Applicability to non-residents If income of non-resident is taxable on gross basis, ICDS will apply. If provisions of DTAA are claimed, it will override all provisions of the Act including section 145(2) and ICDS notified thereunder. FAQ 14 clarifies as under. Yes, the provisions of ICDS shall also apply for computation of these incomes on gross basis for arriving at the amount chargeable to tax. Retention money whether to be included as income of non-resident architecturer? 15

16 Scope In case of conflict between the Act and the ICDS, provisions of the Act will prevail over the ICDS. FAQ 2 clarifies as under. The ICDS have been notified after due deliberation and after examining judicial views for bringing certainty on the issues covered by it. Certain judicial pronouncements were pronounced in the absence of authoritative guidance on these issues under the Act for computing Income under the head Profits and gains of business or profession or Income from other sources. Since certainty is now provided by notifying ICDS under section 145(2), the provisions of ICDS shall be applicable to the transactional issues dealt therein in relation to assessment year and subsequent assessment years. Ratio of SC rulings vs. ICDS provisions If SC ruling is based on generally accepted accounting principles and courts have interpreted law on the basis of such principles, such decisions will now be subject to the provisions of ICDS. If SC ruling has interpreted provisions of the Act, such ruling may continue to override ICDS. 16

17 Scope ICDS vs. Rules ICDS VI and FAQ 4 both clarifies that ICDS will be subject to the provisions of the Rules ICDS vs. Circulars / Press Release A Circular / Press Release merely clarifies the CBDT s view relating to a particular provision of law. Such a circular therefore, merely interprets the law as it is viewed by the CBDT. Also, it is well established that CBDT circulars are binding only on tax officers, and not on assessee. Circular / Press Release issued by CBDT prior to ICDS will no longer be valid. Applicability for MAT & AMT MAT : it is based on book profits and hence, not applicable AMT : it is computed on adjusted total income as per regular provisions of the Act; hence, applicable. 17

18 Scope It may be possible that a particular income is required to be recognised as per ICDS but has not been recognised in the books of account or a particular expense which is not deductible as per ICDS has been recognised in the books of account. Such deviations from the provisions of ICDS are required to be adjusted while computing the income under the heads Profits and gains of business or profession and Income from other sources. The income under these two heads shall necessarily be computed in accordance with the provisions of ICDS. A transitional provision entered in all the ICDS except for ICDS on Securities says that income, expenses, loss or provision existing or entered into 01/04/2016 are to be recognised as per ICDS, however the same, if any, recognised before 31/03/2016 shall be taken into account for recognising the same for the period commencing on 01/04/2016. The main purpose of this transitional provision is to avoid double taxation/ non taxation in the pre and post ICDS period. 18

19 FAQs Circular No. 10/2017 dated 23 March 2017 Question 8: Para 4(ii) of ICDS-I provides that Market to Market ( MTM) loss or an expected loss shall not he recognized unless the recognition is in accordance with the provisions of any other ICDS. Whether similar consideration applies to recognition of MTM gain or expected incomes? Answer: Same principle as contained in ICDS-I relating to MTM losses or an expected loss shall apply mutatis Mutandis to MTM gains or an expected profit. Question 11: Whether the recognition of retention money, receipt of which is contingent on the satisfaction of certain performance criterion is to be recognized as revenue on billing? Answer: Retention money, being part of overall contract revenue, shall be recognised as revenue subject to reasonable certainty of its ultimate collection contained in para 9 of ICDS-III on Construction contracts. 19

20 FAQs Circular No. 10/2017 dated 23 March 2017 Question 13: The condition of reasonable certainty of ultimate collection is not laid down for taxation of interest, royalty and dividend. Whether the taxpayer is obliged to account for such income even when the collection thereof is uncertain? Answer: As a principle, interest accrues on time basis and royalty accrues on the basis of contractual terms. Subsequent non recovery in either cases can be claimed as deduction in view of amendment to 5.36 (1) (vii). Further, the provision of the Act (e.g. Section 43D) shall prevail over the provisions of ICDS. 20

21 FAQs Circular No. 10/2017 dated 23 March 2017 Question 15: Para 8 of ICDS-V states expenditure incurred on commissioning of project, including expenditure incurred on test runs and experimental production shall be capitalized. It also states that expenditure incurred after the plant has begun commercial production i.e., production intended for sale or captive consumption shall be treated as revenue expenditure. What shall be the treatment of expense incurred after the conduct of test runs and experimental production but before commencement of commercial production? Answer: As clarified in Para 8 of ICDS-V, the expenditure incurred till the plant has begun commercial production, that is, production intended for sale or captive consumption, shall be treated as capital expenditure. 21

22 FAQs Circular No. 10/2017 dated 23 March 2017 Question 20: There are specific provisions in the Act read with Rules under which a portion of borrowing cost may get disallowed under sections like 14A, 43(1), 40(a)(i), 40(a)(ia), 40A(2)(b), etc of the Act. Whether borrowing costs to be capitalized under ICDS-IX should exclude portion of borrowing costs which gets disallowed under such specific provisions? Answer: Since specific provisions of the Act override the provisions of ICDS, it is clarified that borrowing costs to be considered for capitalization under ICDS IX shall exclude those borrowing costs which are disallowed under specific provisions of the Act. Capitalization of borrowing cost shall apply for that portion of the borrowing cost which is otherwise allowable as deduction under the Act. 22

23 FAQs Circular No. 10/2017 dated 23 March 2017 Question 24: Expenditure on most post-retirement benefits like provident fund, gratuity, etc. are covered by specific provisions. There are other post-retirement benefits offered by companies like medical benefits. Such benefits are covered by AS-15 for which no parallel ICDS has been notified. Whether provision for these liabilities are excluded from scope of ICDS X? Answer: It is clarified that provisioning for employee benefit which are otherwise covered by AS 15 shall continue to be governed by specific provisions of the Act and are not dealt with by ICDS-X. 23

24 Disclosures in Tax Audit

25 Tax Audit perspective CBDT Notifications no. 88/2016 dated 29 September 2016 Clause 13(d), (e) and (f) (d) Details of deviation, if any, in the method of accounting employed in the previous year from accounting standards prescribed under Section 145 and the effect thereof on the Profit or Loss stands deleted (d) Whether any adjustment is required to be made to the profits or loss for complying with the provisions of income computation and disclosure standards notified under section 145(2) Select Yes or No 25

26 Tax Audit perspective 26

27 Tax Audit Perspective 27

28 Tax Audit perspective 28

29 Tax Audit perspective Practical Aspect- the Auditor separately needs to upload Form 3CD through the utility as prescribed by the IT Dept-but the utility has space constraint- Each field in form 3CD utility of Dept against clause 13(f) accepts maximum of 500 character. As such, separate attachment/annexure for the same has to be given while uploading the Tax Audit Report. 29

30 Tax Audit perspective 30

31 Tax Audit perspective 31

32 Tax Audit perspective 32

33 Tax Audit perspective 33

34 Tax Audit perspective 34

35 Tax Audit perspective 35

36 Importance for Auditor Statutory Auditor Primary concerned with the accuracy and/or correctness of Provision for Taxation. (AS 22) May also effects Deferred Taxation May have impact on MAT CREDIT Receivable And likewise other consequential figures and disclosures gets affected (e.g. EPS) Tax Auditor Directly having a direct bearing on reporting requirement of 3CD- with special emphasis to clause 13(d) of 3CD. Clause 13(d) requires the Auditor to report; whether any adjustment is required to be made to the profits or loss of the entity 36

37 Consequences of non-compliance Non-compliance with the ICDS may invite Best Judgement Assessment u/s 144 of the Act, since provision of section 145(3) of the Act empower AO to do Best Judgement Assessment if AO is not satisfied about the correctness or completeness of accounts; or Method of accounting (cash or mercantile) not regularly followed; or Income not computed in accordance with ICDS 37

38 Summary Act Act will prevail and adjustments to be made in COI AS / Ind As Act will prevail and no effect of ICDS ICDS will prevail over AS / Ind AS; adjustments to be made in TAR and COI ICDS 38

39 ICDS I Accounting Policies

40 Concept of Materiality ICDS I has impliedly eliminated the concept of Materiality Erstwhile, Tax Accounting Standard I notified u/s 145(2) was aligned to ICAI AS- I and permitted Materiality as a consideration for selecting applying accounting policy Write off of printing and stationery expenses, spares and materials, etc. which are small value items cannot be ignored Possible litigation to capitalize small value items if Tax Authority insists on strict application of ICDS 40

41 Concept of Prudence ICDS I does not allow Mark to Market ( MTM ) losses and Expected Losses to be recognized unless specifically permitted by any other ICDS (e.g. MTM forex loss on monetary items covered under ICDS VI, inventory valuation loss covered under ICDS II and III.) As per Accounting Standard ( AS ) 1 Disclosure of Accounting Policies, the concept of Prudence means Income to be recognized on realization and not anticipation All known liabilities and losses to be recognized on estimation even though the amount cannot be determined with certainty ICDS I is silent on treatment of MTM gain Items affected Impact on Tax Position Pre ICDS Post ICDS MTM Loss/Gain MTM Loss can be claimed as deduction MTM gain not taxable MTM Loss not allowable MTM gain not taxable Expected Loss Allowed where there is a reasonable certainty of its incurrence Treated as crystallized liability when outflow of economic resource in settlement of present obligation is anticipated with reasonable accuracy Examples of crystallized liability are loss on onerous contracts Specifically not allowed Will ICDS overrule the judicial precedents which have held that expected losses are crystallized liability and hence should be allowed? 41

42 Change in Accounting Policy As per ICDS I, accounting policy shall not be changed without reasonable cause Term reasonable cause has not been defined in the ICDS reasonable cause would generally mean having sound judgment, fair and sensible, based on good sense, as much as is appropriate or fair, moderate. Items affected Any change in accounting policy which will affect the profits of the business such as : Change in valuation of inventories from FIFO to Weighted average or vice- versa; Change in revenue recognition policy especially for real estate developers Impact on Tax Position Pre ICDS Post ICDS As per AS 2, notified under section 145(2) of the Act, a change in Accounting policy should be made only if: Required by Statue; and Result in more appropriate preparation and presentation of the financial statement Test of reasonable needs to be satisfied. Following are the illustrative examples of reasonable cause: To represent true and fair view To meet statutory requirement More appropriate preparation and presentation of financial statement Reasonable person considers just and acceptable under normal circumstances Commercial or business need which will result into appropriate and fair presentation of transaction 42

43 ICDS I Disclosure All significant accounting policies. Changes in accounting policy which has material effect including amount to the extent ascertainable. If change in accounting policy to have material effect in later years, then disclosure to be made in year of adoption as well as in 1st year of material effect. Disclosure accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of item. If fundamental accounting assumptions not followed, then disclose. 43

44 ICDS I Practical Aspect Disclosure: May refer accounting policy mentioned in notes to accounts as similar with AS. To give effect of disallowances/deductions such as MTM gain/loss, expected loss, etc in ITR and Form 3CD. To keep track of change in accounting policies having material effect in later year. 44

45 Case Study - Prudence Q. X Ltd buys a three month futures contract on the stock exchange in February 2017 which entitles him to receive 100 shares of ABC Industries at price of INR 350 per share. Contract will expire in April As on 31 March 2017 there could be following two scenario Scenario 1 - Price of shares is INR 340 Therefore : X Ltd incurs a notional loss of INR 1,000 [100 shares multiplied by difference of INR 10 (i.e. INR 350 less INR 340) per share] Scenario 2 - Price of shares is INR 360 Therefore : X Ltd incurs a notional gain of INR 1,000 [100 shares multiplied by difference of INR 10 (i.e. INR 360 less INR 350) per share] 45

46 ICDS II Valuation of Inventories

47 ICDS II Valuation of Inventories Topic Indian GAAP (AS 2) ICDS II Valuation of Inventories To be valued excluding recoverable duties and taxes To be valued including recoverable duties and taxes Already in Section 145A Allocation of fixed Overhead Permissible based on both normal and actual level of production. Actual level of production shall be used only when it approximates to normal capacity. Dissolution of partnership firm Inventory to be valued at NRV only if the the business is discontinued. Inventory to be valued at NRV notwithstanding the business is discontinued or not. Change in method of Valuation Change in method constitutes a change in accounting policy and is permitted based on the criteria for change in accounting policies. Method cannot be changed without reasonable cause. 47

48 ICDS II Valuation of Inventories Topic Indian GAAP (AS 2) ICDS II Cost of inventory Does not include : osts of se i es duties a d ta es su se ue tl recoverable from tax authorities I te est / othe o o i g osts Includes : osts of se i es duties a d ta es e e if subsequently recoverable from tax authorities I te est / othe o o i g costs (if meets recognition criteria a per ICDS-IX) 48

49 Issues Issue 1 Valuation of inventory for service industry No clarity? ICDS II or ICDS IV to apply? Issue 2 Section 145A of the Act overrides Section 145 (ICDS) of the Act Section 145A states that stock valuation to be done as per method of accounting regularly followed Taxpayers regularly including Distribution cost in inventory Can this be continued post ICDS relying on Section 145A? 49

50 Position Pre and Post ICDS Pre ICDS No concept of valuation for services Judicial precedents both sides - opening stock could / could not be adjusted in case of change in method of valuation of closing stock Judi ial p e ede ts pe itted bonafide change of method if it is as per AS and regularly followed Post ICDS Services to be valued at lower of Cost or NRV Value of Opening stock to be same as the value of closing stock of the immediate preceding year - Tax impact in the year of change of inventory valuation Contrary to section 45(2) for opening inventory of newly commenced business No change permitted without reasonable cause Reasonable cause not defined could create ambiguity 50

51 Valuation of Inventories in case of Dissolution of Firm According to ICDS II, in case of dissolution of a partnership firm or association of person or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at the Net Realizable Value. This is unfair particularly as there is no specific provision for allowing such NRV as the cost to the successor of the business. Also this is contrary to law settled by Apex court in the case of Sakthi Trading Co. v. CIT ITR 871 If on dissolution of the firm the business is not discontinued, then, the ordinary principle of commercial accounting permitting valuation of stock-in-trade at Cost or Net Realizable value whichever is lower will apply. 51

52 Illustrative- ICDS II related Clause 13(e) ICDS II impact Valuation of Inventories Increase in Profit (Rs) Decrease in Profit (Rs) Net Impact (Rs ) Remarks 200, ,000 0 Being the component of VAt, Cenvat Credit etc considering inclusive method. But having no impact on the Net Profit of the Concern. 52

53 Disclosures clause 13(f) Accounting policies adopted in measuring inventories including the cost formulae used. May refer accounting policy mentioned in notes to accounts as both are similar. Where Standard Costing has been used as a measurement of cost, details of such inventories and a confirmation of the fact that standard cost approximates the actual cost; The total carrying amount of inventories and its classification appropriate to a person. RMS Components, WIP, FG, Stores and Spares, Loose Tools For carrying amount and classification may refer notes to Balance Sheet. 53

54 ICDS III Construction Contract

55 Differences between AS & ICDS Contract Cost AS 7 ICDS Contract cost as per AS 7 includes: Direct cost related to the contract Cost attributable to contract activity in general and can be allocated to the contract Cost specifically charged to the customers under the terms of the contract Apart from the costs includible as per AS 7, the following costs also forms part of Contract Cost Allocated borrowing costs in accordance with the ICDS on Borrowing Costs 55

56 Differences between AS & ICDS Recognition of Contract Revenue AS 7 ICDS Contract revenue is to be recognised only if it is possible to reliably estimate the outcome of the contract. Contract revenue is to be recognised when there is reasonable certainty of its ultimate collection. Revenue recognition under ICDS may be pre-poned as compared to AS 7 56

57 Differences between AS & ICDS When outcome cannot be estimated reliably AS 7 ICDS As stated earlier, contract revenue and contract cost can be recognised by the Point of Completion Method (POCM) if the outcome can be reliably estimated. It provides that during the early stage of a contract where the outcome cannot be estimated reliably, contract revenue is to be recognised only to the extent of costs incurred. If outcome cannot be estimated reliably, contract revenue should be recognised only to the extent of contract cost incurred of which recovery is probable. AS 7 does not lay down any % limit for recognition of profit. The early stage of a contract shall not extend beyond 25% of the stage of completion. Under ICDS profit recognition should start once 25% stage is completed. 57

58 Differences between AS & ICDS Retention Money AS 7 ICDS Contract revenue comprises of the following initial amount of revenue agreed in the contract; and Variations in contract work, claims and incentive payments: to the extent that it is probable that they will result in revenue; and they are capable of being reliably measured Contract revenue 7 comprises of the following initial amount of revenue agreed in the contract, including retentions; and Variations in contract work, claims and incentive payments: to the extent that it is probable that they will result in revenue; and they are capable of being reliably measured AS defi ed te s su h as a iatio i o t a t o k, lai s a d i e ti e pa e ts 58

59 Differences between AS & ICDS Retention Money Various judicial precedents have held that retention money accrues to the contractor only when there is a right to receive such income, which generally accrues only at a later point of time upon completion of the attached conditions as per relevant contract. CIT v. Simplex Concrete Tiles India Pvt. Ltd. 179 ITR 8 (Cal.) CIT v. East Coast Constructions & Industries Ltd. 283 ITR 297 (Mad.) CIT v. Associated Cables Pvt. Ltd. 286 ITR 596 (Bom.) CIT v. P & C Constructions Pvt. Ltd. 318 ITR 113 (Mad.) To the extent of taxing retention money, the provisions of ICDS are in conflict with the basic concept of real income theory under the Act based on which, even under mercantile system of accounting, income accrues in the hands of a taxpayer only when there is an unconditional right to receive such income. 59

60 Differences between AS & ICDS Retention Money The concept of real income theory was upheld by the SC in the following cases. E. D. Sassoon & Co. Ltd. v. CIT 26 ITR 27 Godhra Electricity Co. Ltd. v. CIT ITR 746 Whether the turnover threshold limit for tax audit purposes will include retention money. 60

61 Case Study Pre-ICDS : Recognition of Contract Revenue Particulars Year 1 Year 2 Year 3 Year 4 Contract Revenue Stage of Completion 25% 50% 75% 100% Contract Revenue Recognised Nil* *No revenue is recognised in Year 1 since contractor recognizes revenue only when stage of completion is 30% Post-ICDS : Recognition of Contract Revenue Particulars Year 1 Year 2 Year 3 Year 4 Contract Revenue Stage of Completion 25% 50% 75% 100% Contract Revenue Recognised In the instant case, it is assumed that construction contractor recognizes contract revenue only on completion of 30% of the contract in its books of Account Under Pre-ICDS, the contractor follows similar policy for recognizing revenue for the tax purpose. Under Post-ICDS, it is mandatory to recognize contract revenue on completion of 25% of the contract. Retention Money - Nil 61

62 Case Study 62

63 Differences between AS & ICDS 63

64 Differences between AS & ICDS Incidental Income AS 7 ICDS Any incidental income viz. income from sale of surplus material and disposal of plant and equipment at the end of the contract, not forming part of the contract revenue, shall be deducted while computing construction cost as per AS 7. As per ICDS III contract cost shall be reduced by any incidental income, not being in the nature of interest, dividends or capital gains. Thus, those interest, dividends or capital gains will be taxed in accordance with the applicable provisions of the Act. - Based on SC decision in the case of Tuticorin Alkali Chemicals & Fertilizers Ltd. 227 ITR 172 that interest income from surplus funds is taxable as revenue receipt. - Later, SC in the case of CIT v. Bokaro Steel Ltd. 236 ITR 315 held that interest income from advance given to contractor is to be reduced from cost of plant since it is inextricably linked to the setting up of plant 64

65 Differences between AS & ICDS Recognition of Expected Loss AS 7 ICDS AS 7 permits recognition of any expected loss immediately irrespective of the commencement or the stage of completion of contract. ICDS III, on the contrary does not permit recognition of expected loss. Further, ICDS I on Accounting Policies also does not permit recognition of expected / foreseeable losses. In other words, expected loss is allowed only when it is actually incurred. Recognition of expected loss was upheld by various courts CIT v. Triveni Engineering & Industries Ltd. 336 ITR 374 (Del) CIT v. Advance Construction Co. P. L. 275 ITR 30 (Guj) Jacobs Engineering India Pvt. Ltd. 14 taxmann.com 186 (Mum.) 65

66 Case Study Details pertaining to a two year construction contract project : Contract revenue Rs.100 Contract cost originally estimated Rs.80 Revised probable estimated contract cost Rs.130 Actual Cost incurred during year 1 Rs.40 Percentage of completion at end of year 1 30% approx. (40 of 130) Other unrelated income earned in year 1 and year 2 Rs.35 Actual Cost incurred during year 2 Rs.90 Percentage of completion at end of year 2 100% Other unrelated income in year 2 Rs.35 Required: Identify and analyse the impact of Expected loss pre and post ICDS 66

67 Case Study 67

68 Differences between AS & ICDS Recognition of Actual Loss AS 7 ICDS AS 7 permits recognition of actual loss fully upfront. ICDS allows recognition of actual loss on POCM basis. - Section 28 allows actual loss in the year of incurrence - ICDS allows actual loss on POCM basis - Conflict between ICDS and section 28 68

69 Illustrative ICDS III Clause 13(e) ICDS III impact Increase in Profit (Rs) Decrease in Profit (Rs) Net Impact (Rs) Remarks Construction Contracts 3,500,000 NIL 3,500,000 Retention Money not considered as Revenue earlier, hereby considered on POCM as per ICDS Rs.5 L Expected Losses recognized in PL as per AS 7 but not allowed as per ICDS III- Rs.30L 69

70 ICDS III Disclosure The amount of revenue from contract/service recognised in the period. The method used to determine the stage of completion of contracts/service work in progress. For contracts/service in progress at the reporting date : Amount of costs incurred and recognised profits (less recognised losses) upto the reporting date; Amount of advances received; and Amount of retentions. 70

71 Illustrative ICDS III Clause 13(f) disclosure related Name of ICDS III. Construction Contracts Disclosure Refer Significant Accounting Policy mentioned at Note/ Schedule No to Financial Statements. For amount of contract revenue recognized in the revenue for the Period refer Note of P&L. For Contracts in progress: (refer Annexure for details) 71

72 ICDS IV Revenue Recognition

73 Recognition. summary Income Recognition Sale of goods When all significant risks and rewards of ownership are transferred Revenue to be recognized when there is reasonable certainty of its ultimate collection Rendering of services As per percentage completion method Exceptions Service contract of less than 90 days CCM allowed Service contract of indeterminate activities SLM allowed Interest On time basis- Accrual Royalty As per the terms of the relevant agreement (unless substance of transaction warrants some other basis) Dividend In accordance with the provisions of the Act Discount / premium on debt To be accrued over the period of maturity securities held Con ept of reasona le ertainty not appli a le to interest, royalty and dividend 73

74 Transitional Provisions In case of Services The transitional provisions of Income Computation and Disclosure Standard on construction contract shall mutatis mutandis apply to the recognition of revenue and the associated costs for a service transaction undertaken on or before the 31st day of March, 2016 but not completed by the said date i.e- Service Transaction before ICDS not applicable to such cases In case of Others Revenue for a transaction, other than a service transaction referred to in Para 11, undertaken on or before the 31st day of March, 2016 but not completed by the said date shall be recognised in accordance with the provisions of this standard for the previous year commencing on the 1st day of April, 2016 and subsequent previous year. The amount of revenue, if any, recognised for the said transaction for any previous year commencing on or before the 1st day of April, 2015 shall be taken into account for recognising revenue for the said transaction for the previous year commencing on the 1st day of April, 2016and subsequent previous years. i.e.other Cases- ICDS will be APPLICABLE- irrespective of dates Subject to adjustment of recognition made earlier, if any 74

75 Case Study Percentage Completion Method Facts A obtains and executes a service contract with B Billing milestone at completion of 75% of work At the end of Year 1, A has completed 50% of the work By the end of Year 2, A has completed all the work and recognized revenue earned from the contract in its books Executes Service Contract B A Flow of revenue Table 1: Pre-ICDS (Contract Completion Method) Particulars Year 1 Year 2 Net Profit as per books - 1,000 Tax 30% Tax payable under 18.5% Total Tax liability 300 Table 2: Post-ICDS (Contract Completion Method) Particulars Net Profit as per books Year 1 Year 2-1,000 Net Profit under ICDS Tax 30% Tax payable under 18.5% Total Tax liability

76 Case Study Percentage Completion Method Mr. Kadar Khan, a professor, conducts a coaching class for CA Students. Since, the curriculum goes on for more than a year, therefore, he recognises revenue once the batch is over. i.e. after completion of the batch. In FY 16-17, 2 batches were conducted. One was carry forward batch started in the earlier year of which 20% work was completed upto The said batch was completed in FY to the extent of 80% and total revenue from the said batch was Rs.250,000/-. In respect of other batch, it was started in March 2017 and only 10% work was complete. Estimated revenue from the said batch was Rs.16,00,000/- Please advise. Revenue as per books? Revenue as per ICDS? 76

77 ICDS FAQs issued by CBDT on 23 March 2017 Question 13 : The condition of reasonable certainty of ultimate collection is not laid down for taxation of interest, royalty and dividend. Whether the taxpayer is obliged to account for such income even when the collection thereof is uncertain? As a principle, interest accrues on time basis and royalty accrues on the basis of contractual terms. Subsequent non-recovery in either cases can be claimed as deduction in view of amendment to S.36 (1) (vii). Further, the provision of the Act (e.g. Section 43D) shall prevail over the provisions of ICDS. What if offered to tax under the head income from other sources? 77

78 Interest recognition some issues By computing the interest as mandated by the ICDS, there is a likelihood of mismatch of tax deducted at source, since interest income will be computed and taxed in one assessment year, but certificate for tax deduction will be available in the subsequent year. It may also happen that before the interest becomes payable as per the terms of issue of the security, the holder of the security may sell the security. In such a case, interest may not have been booked as an expense by the issuer, and tax will not have been deducted by the issuer of the security. The assessee offering the income computed on the basis of this ICDS will not receive certificate for tax deducted at source. On the other hand, the purchaser of the security, who receives the certificate for tax deducted at source, would have held the security only for a part of the period covered by the TDS certificate. So, the person receiving the certificate for TDS will consider interest only for the period for which he held the security, while the TDS certificate will reflect interest for a longer period. 78

79 Interest recognition some issues At times, debt securities are issued at a discount and redeemed at par or issued at par and redeemed at a premium after the term of the security. In such cases, the debt security may or may not carry interest. The ICDS in para 8(3) requires that in such cases the discount or the premium is effectively treated as interest accruing over the period to maturity. The ICDS does not specify whether the accrual should be based on compound interest or simple interest. If interest is to be computed by compounding, at what `rests will it be compounded will it be compounded every quarter or every six months or on yearly basis? While the total revenue to be recognised over the term of the security will be the same, amount to be recognised from year to year will be different based on whether the calculation is done considering simple interest or compound interest and the method of compounding. Assessee may follow any reasonable method consistently for calculation of interest considering the facts and terms and conditions of the debt security. 79

80 ICDS FAQs issued by CBDT on 23 March 2017 Question 14 : Whether ICDS is applicable to revenues which are liable to tax on gross basis like interest, royalty and fees for technical services for non-residents under section 115A of the Act.? Yes, the provisions of ICDS shall also apply for computation of these incomes on gross basis for arriving at the amount chargeable to tax. Royalty / FTS taxable under the Tax Treaty only when amount actually paid 80

81 Royalty some issues The ICDS requires that royalties shall accrue in accordance with the terms of agreement between the parties and be recognised accordingly. However, the ICDS provides that, considering the substance of the transaction, if it is more appropriate to recognise royalties on other systematic and rational basis, then such other basis shall be adopted for recognising the royalties. If royalty is taxed under the provisions of any DTA, provisions of such DTA will prevail over the provisions of the Act and consequently, provisions of the ICDS will not apply. 81

82 Illustrative- ICDS IV related Clause 13(e) ICDS IV impact Increase in Profit Decrease in (Rs.) Profit (Rs.) Revenue Recognition 50,500 NIL Net Impact 50,500 Remarks Service Contract exceeding 90 days has been recognized on completed contract basis in books, which now as per ICDS is recognised on Percentage Completion Method 82

83 ICDS IV- related disclosure checklist IV. Revenue Recognition 1. For transactions involving sale of good, total amount not recognised as revenue during the previous year due to lack of reasonably certainty of its ultimate collection along with nature of Uncertainty NIL or the amount as Applicable 2.the amount of revenue from service transactions recognised as revenue during the previous year Refer Note to Financial Statements 3. the method used to determine the stage of completion of service transactions in Progress Percentage Completion method 4. for service transactions in progress a. amount of costs incurred and recognised profits (less recognised losses) upto end of previous year b. the amount of advances received c. the amount of retentions Cost Rs.150,000/-, Profit Recognised Rs.5,000/Rs.60,000/NIL or the amount as Applicable 83

84 ICDS IV Practical Aspect Disclosure: Additional disclosure is to be made in line with AS 7/ICDS III. May consider including the disclosure in notes to account in line with AS 7. No effect on contracts/services which were in progress on If service contract beyond 90 days and recognised on completed contract method, need to adjust and disclosure as per ICDS. 84

85 ICDS V Tangible Fixed Assets

86 ICDS V Tangible Fixed Assets Topic AS 10 ICDS V Cost of asset when acquired for nonmonetary Consideration Cost of asset shall be either FMV of asset so acquired or FMV of asset/ share/ security given up, whichever is more clearly evident. FMV of the asset so acquired shall be its actual cost. Depreciation Depreciation based on the useful life of the assets To be guided by income tax provision and not by ICDS. Revaluation Assets can be revalued based on the guidelines of the AS. However, no specific guideline is there on frequency of revaluation. Not covered in ICDS. However, as per the Act only actual cost to be considered. Capitalisation of Recognised as asset, if they meet spare parts, stand- the criteria of PPE. by equipment and servicing equipment All stand-by/service equipment to e capitalised. Spares parts to be capitalised, if used for specific asset and use is irregular. 86

87 Assets acquired against non monetary consideration AS- 10 ICDS V When a fixed asset is acquired in When a tangible fixed asset is exchange or in part exchange for acquired in exchange for other another asset, the cost of acquired asset, the fair value of the tangible asset should be recorded either at fixed asset so acquired shall be its FMV or NBV of asset given up, actual cost adjusted for any balancing payment or receipt of cash or other consideration. Fixed asset acquired in exchange When a tangible fixed asset is for shares or other securities in the acquired in exchange for shares or enterprise should be recorded at its other securities, the fair value of FMV, or the FMV of the securities the tangible fixed asset so acquired issued, whichever is more clearly shall be its actual cost. evident. 87

88 Asset acquired for a consolidated price & change of method AS- 10 ICDS V Para 15.3 says that when several When several assets are assets are purchased for purchased for a consolidated consolidated price, the price, the consideration shall be consideration is apportioned on fair apportioned to the various assets basis as determined by competent on a fair basis. valuers. Impact: In absence of determination by registered valuers in ICDS words fair basis becomes subjective and might be prone to litigation. It provides specific treatment in case of change of method of depreciation. It does not have any provision for change of method or revaluation as these do not have any relevance under the Income Tax Act

89 Dismantling / Restoration Costs IND AS-16 Cost of asset include initial estimate of dismantling cost/restoration cost of property, plant and equipment. (Para 16(c) of Ind AS16 Property, Plant and Equipment) Further, where the effect of time value of money is material, amount of provision should be present value of expenditures expected to be incurred. (Para 45 of Ind AS 37 -Provisions, Contingent Liabilities and Contingent Assets) Tax Perspective Provision for dismantling cost to be reduced from the cost of the asset to arrive at Actual Cost u/s. 43(1) of the income-tax Act, 1961 (Act). It is allowable as deduction in computing income of the PY in which dismantling cost is actually incurred. For Tax Audit, scrutiny of the Asset Account and Dismantling Cost Account required every year. 89

90 Liquidated Damages IND AS-16 Liquidated damages (not in the nature of loss of revenue) would be adjusted against the cost of assets. (Para 16 of Ind AS 16 Property, Plant and Equipment) Tax Perspective ICDS is silent as regards compensation in nature of loss of revenue. Based on Supreme Court decision in CIT v. Saurashtra Cement Limited (325 ITR 422), it would be possible to treat it as capital receipt. 90

91 Valuation in case of exchange of assets IND AS-16 In case asset is acquired in exchange of another asset (does not lack commercial substance and assets are reliably measurable), the cost of acquired asset should be recorded at fair value of asset given up or fair value of asset received, whichever is more clearly evident. (Para 24 & Para 27 of Ind AS 16 Property, Plant and Equipment) If the acquired asset is not measured at fair value, its cost is measured at carrying amount of the asset given up. (Para 24 of Ind AS 16 Property, Plant and Equipment) Tax Perspective As per ICDS, asset acquired in exchange for another asset has to be recognized on the basis of fair value of asset so acquired. Asset acquired in exchange for shares or other securities, fair value of asset so acquired 91

92 Inspection Charges Ind AS 16 Expenses incurred for major inspection at regular interval are capitalized in the cost of asset. Carrying value of previous inspection charges is derecognized from the cost of asset an discharged to P&L. (Para 14 of Ind AS 16 Property, Plant and Equipment) Tax Perspective ICDS is silent on this point. Inspection expenses does not increase the value of fixed assets and hence the same will not be permitted to be added to the cost. 92

93 Expenses incurred between trial run and production Ind AS 16 Recognition of costs in the carrying amount of an item of property, plant and equipment ceases when the item is in the location and condition necessary for it to be capable of operating in the manner intended by the management. Tax Perspective FAQ 15 of circular no. 10/2017 states that the expenditure incurred till the plant begun commercial production, that is, production intended for sale or captive consumption, shall be treated as capital expenditure. 93

94 Illustrative- ICDS V related dislcosure Clause 13(e) ICDS V impact Increase in Profit (Rs) Tangible Fixed Asset 30,000 Decrease in Profit (Rs) 40,000 Net Impact (Rs) -10,000 Remarks Depreciation as per Books-Co Act 2013Rs.40,000 while depreciation allowable as per Income Tax Act is Rs.30000/-. 94

95 ICDS V - Disclosure Description of asset or block of assets; Rate of depreciation; Actual cost or WDV, as the case may be; Additions or deductions during the year with dates; in the case of any addition of an asset, date put to use; including adjustments on account of a) CENVAT credit claimed and allowed under CENVAT Credit Rules, 2004; b) Change in rate of exchange of currency; c) Subsidy or grant or reimbursement, by whatever name called; Depreciation Allowable; and Written down value at the end of year. May refer to clause 18 of Form 3CD as both are same. To give effect of differential treatment of spare parts, stand-by equipment and servicing equipment in ITR and Form 3CD. 95

96 ICDS VI The Effects of Changes in Foreign Exchange Rates

97 Summary ICDS VI Foreign currency transaction shall be recorded initially at exchange rate as on the date of transaction or at a weekly / monthly average rate (if rates do not fluctuate significantly from actual) Exchange difference on monetary items at each year-end shall be recognized as income / expense. Cash, receivables and payables Non-monetary items- exchange gain or loss shall not be recognised Fixed Assets, inventories and investments in equity shares The above is made subject to section 43A and rule 115 of the Act Further, inventory carried at NRV shall be converted at exchange rate when such value was determined All exchange differences relating to integral/non-integral foreign operations will be done as mentioned above 97

98 Summary ICDS VI Premium / discount on certain forward exchange contracts shall be amortized over life of the contract and exchange differences /differences on renewal or cancellation will be recognized as income / expense ICDS prescribes that premium / discount / 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 should be recognized at the time of settlement. MTM adjustment on such contracts to be disallowed 98

99 ICDS VI Practical Aspect To adjust FCTR on translation of financial statement of non-integral foreign operation. To adjust MTM gain/loss on forward exchange contracts entered into for trading or speculation. To adjust foreign exchange difference capitalised as per AS. No disclosure requirement 99

100 ICDS VII Government grants

101 ICDS vs AS Topic ICDS-7 AS-12 Ind- AS 20 Recognition Recognition of grants not to be postponed beyond the date of actual receipt or fulfilment of conditions which ever is earlier Fulfillment of conditions Grant will be received AS-12 provide for postponement of government grant beyond the date of actual receipt where condition attached to the grant are not fulfilled Similar to AS Recognition -Depreciable asset Grant relating to a depreciable asset to be deducted from the cost/wdv of the asset and cannot be treated as deferred income. Grants for fixed assets are presented either by deducting from gross value of the asset or as deferred income. Grants related to assets including non-monetary grants at fair value, should be presented in balance sheet as deferred income. Recognition Nondepreciable asset to be recognised as income over the same period of the cost being charged to be credited to capital reserve 101

102 Case Study I Excel Ltd reported the following figures FY Particulars Amt in lakhs Net Profit 100 lakhs Book Depreciation 10 lakhs Income Tax Depn 12 lakhs WDV of P&M (15% Depn rate) 80 lakhs Grant recvd on lakhs Grant pending to be received 30 lakhs Assume: condition/obligation attached to the grant is yet to be satisfied / complied.the Book Profit was also calculated at Rs.100 lakhs. Assume -Tax Rate 30%. & MAT 18.5% (ignore Surcharge and Cess) Show effect on Taxation post ICDS 102

103 Case Study I 103

104 Case Study II Excel Ltd reported the following figures FY Particulars Amt in lakhs Net Profit 100 lakhs Book Depreciation 10 lakhs Income Tax Depn 12 lakhs WDV of P&M 80 lakhs Grant recvd on lakhs- REVENUEN GRANT Grant pending to be received NIL Assume:condition/obligation attached to the grant is not yet complied.the Book Profit was also calculated at Rs 100 lakhs. Assume -Tax Rate 30%. & MAT 18.5% (ignore Surcharge and Cess) Show effect ontaxation post ICDS 104

105 Case Study II 105

106 Illustrative ICDS VII Clause 13(e) ICDS VII impact Increase in Profit (Rs) Decrease in Profit (Rs) Net Impact (Rs) Remarks Government Grants 23,000 NIL 23,000 Decrease In Depreciation since Fixed Asset Related grant treated as revenue Rs.3,000/Recognition of Govt. Grant on Receipt basis although reason attached for conditions not fulfilled as per Para 4 of ICDS VIIRs.20,000/- 106

107 Illustrative ICDS VII Clause 13(f) disclosure related Name of ICDS VII. Government Grants (attach annexure for disclosure) Disclosure By way of deduction from actual cost of the asset or assets or from the WDV of block of assets during the PY Nature and extent of Government grants recognised during PY Nature and extent of Government grants not recognised during PY along with reasons thereof; Nature and extent of Government grants recognised during PY as income; Not recognised during the PY as income and reasons thereof.. 107

108 ICDS VII Practical Aspect Disclosure requirement for grant not recognised is not there in AS 12. To give additional detail. To adjust, if grant treated as Owner s Fund/Capital Reserve in books. To adjust, if grant for depreciable assets charged to revenue in proportion. 108

109 ICDS VIII Securities

110 ICDS- VIII: Securities Covers only those securities held as stock- in- trade. Businesses to whom ICDS- 8 is applicable- Indicative list Stock brokers Traders NBFC s Specifically Excludes Recognition of interest and dividend on securities Securities in the business of insurance Securities of Mutual Fund, Venture Capital funds, Banks and Public financial institutions Fair value means Amount for which an asset could be exchanged between a knowledgeable, willing buyer and a k o ledgea le, illi g selle i a a s le gth t a sa tio. Securities means Securities as defined in section 2(h) of the Securities Contract (Regulation) Act, 1956, and excludes derivatives. 110

111 AS-13 vs. ICDS VIII Key Differences 111

112 ICDS- VIII: Securities- Subsequent Measurement At the end of previous year ListedActual cost vs. NRV Whichever Is lower Unlisted/list ed but not quoted - Actual cost Measurement for the following: Shares Debt Securities Convertible Securities Any other securities If cost cannot be specifically attributed to the listed securities could be measured on FIFO or Weighted Average basis 112

113 ICDS VIII Bucket Method Category Security Name Cost NRV Lower of Cost/NRV As per ICDS Shares ABC Shares DEF Shares GHI 1, Shares Total 2,300 2,400 2,100 Debt Securities JKL 800 1, Debt Securities MNO Debt Securities PQR 1, Debt Securities PQR 1, Debt Securities Total 2,400 2,100 1,900 2,100 4,700 4,500 4,000 4,400 Total Securities 2,

114 ICDS FAQs issued by CBDT on 23 March 2017 Question 18 : If the taxpayer sells a security on the 30th day of April, The interest payment dates are December and June. The actual date of receipt of interest is on the 30th day of June, 2017 but the interest on accrual basis has been accounted as income on the 31st day of March, Whether the taxpayer shall be permitted to claim deduction of such interest i.e. offered to tax but not received while computing the capital gain? Yes, the amount already taxed as interest income on accrual basis shall be taken into account for computation of income arising from such sale. Under which provisions of the Act? 114

115 ICDS VIII Practical Aspect To adjust the difference in valuation - category wise vis-à-vis individual script wise. Alternatively, one may value its inventories of securities in books of accounts as per bucket method (i.e. category wise) as no specific AS on the same. Consequently, no ICDS adjustment will arise. No disclosure requirement 115

116 Case Study Q.Mr. Investor regularly invests in the stocks market since He has a portfolio of nearly Rs.60 Lakhs mainly consisting of Index stocks and some of the active mid caps. He also prefers to invest through Initial Public issue. On notification of ICDS-VIII, he was concerned about its impact on his portfolio and taxable income. He has requested you to analyze ICDS-VIII and explain him the impact including the transitional provisions, if any. 116

117 Case Study Reason: He has held the securities in the form of Investment (and NOT Stock in Trade) hence the provision of ICDS VIII Securities are not applicable. Thereby no adjustment required. 117

118 ICDS IX Borrowing Cost

119 Differences between AS & ICDS Borrowing Cost AS 16 ICDS Borrowing costs may include: interest and commitment charges on bank borrowings and other shortterm and long-term borrowings; amortisation of discounts or premiums relating to borrowings; amortisation of ancillary costs incurred in connection with the arrangement of borrowings; finance charges in respect of assets acquired under finance leases or under other similar arrangements; and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs. Borrowing costs are interest and other costs incurred by a person in connection with the borrowing of funds and include: commitment charges on borrowings; amortised amount of discounts or premiums relating to borrowings; amortised amount of ancillary costs incurred in connection with the arrangement of borrowings. finance charges in respect of assets acquired under finance leases or under other similar arrangements 119

120 Differences between AS & ICDS Borrowing Cost Exclusion of exchange difference from the definition of borrowing cost under ICDS is in line with the provisions of section 43A. The provisions of section 43A requires exchange difference on borrowings made for import of fixed assets to be added / deducted from the block value of fixed assets. However, section 43A is not applicable in respect of locally acquired assets out of borrowings made in foreign currency. Accordingly, exchange difference arising on assets acquired in India may neither be eligible to be added to the cost of asset nor treated as borrowing cost and therefore, may not be capitalised. 120

121 Differences between AS & ICDS Qualifying Asset AS 16 ICDS Qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale. Qualifying asset means: Tangible assets land, building, machinery, plant or furniture Intangible assets know-how, patents, copyrights, licenses, etc. Inventories requires 12 months or more to bring them to a saleable condition. 121

122 Differences between AS & ICDS Qualifying Asset Unlike AS 16, ICDS IX includes land also in the definition of qualifying asset apart from other depreciable assets. Thus borrowing cost in respect of land shall be capitalised. Further, land being a non-depreciable asset, depreciation on the same will not be allowed. However, the capitalised cost shall form part of the cost of asset while calculating Income from Capital Gain at the time of sale of land. Under ICDS, recognition of borrowing cost with respect to the fixed assets is now not related to time frame (i.e. substantial period of time to get ready for its intended use). Fixed assets which are acquired off the shelf or readily would also be treated as qualifying assets and the proportionate borrowing costs upto the date when they are put to use should be capitalised. 122

123 Differences between AS & ICDS Qualifying Asset This will lead to maintaining two sets of fixed assets registers i.e. one for financial accounts and another for ICDS to comply with tax provisions. In respect of inventories, minimum threshold prescribed is 12 months or more to be recognised as qualifying assets. In AS-16, no minimum period is prescribed for reckoning as qualifying asset. 123

124 Differences between AS & ICDS Method of Capitalisation Specific borrowings AS 16 ICDS Actual borrowing costs incurred on the borrowing during the period less any income from temporary investment of those borrowings. Actual borrowing costs incurred during the period on the funds borrowed. Income arising from temporary investment made out of borrowed funds would be treated as income and taxed accordingly in line with the decision of SC in the case of Tuticorin Alkali Chemicals (227 ITR 172) 124

125 Differences between AS & ICDS Method of Capitalisation General borrowings AS 16 ICDS Borrowing costs determined by applying capitalisation rate to the expenditure incurred on the asset. Amount of borrowing costs to be capitalised shall be computed with the following formula. The capitalisation rate is weighted average of borrowing costs applicable to the borrowings that are outstanding during the period other than specific borrowings for the purpose of obtaining qualifying asset. A*B C The amount of borrowing costs capitalised during a period should not exceed the amount of borrowing costs incurred during the period. 125

126 Differences between AS & ICDS Method of Capitalisation General borrowings In the formula mentioned for capitalisation of general borrowings under the ICDS A, B and C stand for: A = Borrowing costs incurred during previous year except directly relatable to the specific borrowings. B = a) Average cost of Qualifying Asset (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 on first and last day of the previous year. c) Average cost of QA as on first day of previous year and date of put to use or completion, if it does not appear in balance sheet on the last day of the previous year. Other than those QA which are directly funded out of specific borrowings 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. 126

127 Differences between AS & ICDS Method of Capitalisation General borrowings Formula given for borrowing cost eligible for capitalisation in case of general borrowing is very different from that provided in AS-16. For AS-16, the borrowing costs was relating to the actual period for which the borrowing was outstanding; whereas, ICDS IX considers the borrowings only on the first day and last day of the year. Formula given in ICDS is likely to give rise to different interpretation and thereby, leading to litigations as formula does not take into account the actual borrowings at different points of time. Relaxation from capitalisation requirement in case of general borrowing, capitalisation of qualifying asset is required only if the asset necessarily require a period of 12 months or more for its acquisition, construction or production. 127

128 Differences between AS & ICDS Commencement of Capitalisation AS 16 ICDS Capitalisation commences on the date of fulfilment of following three conditions: Incurrence of expenditure on acquisition, construction or production of qualifying asset; Incurrence of borrowing cost; and Activities necessary to prepare the assets for its intended use or sale are in progress. Commencement of capitalisation is as under. For specific borrowings from the date on which funds were borrowed For general borrowings from the date on which funds were utilised - Principle based approach vs. Rule based approach - Capitalisation under ICDS commences earlier than AS-16 - Capitalisation is linked to the continuing activity of construction / development - Formula may become redundant in case of general borrowing 128

129 Differences between AS & ICDS Cessation of Capitalisation AS 16 ICDS Capitalisation ceases when all the activities necessary to prepare the qualifying asset for its intended use or sale are substantially complete. Capitalisation ceases as under. Tangible and Intangible Assets when such asset is first put to use; and Inventory when substantially all activities necessary to prepare it for its intended sale are complete. If asset is ready to use but it has not been put to use, borrowing cost shall not be capitalised as per AS 16; however, capitalisation will continue under ICDS 129

130 Differences between AS & ICDS Commencement and Cessation of Capitalisation Substantially all activities are complete - asset ready to use Date of borrowing ICDS Specific Borrowing Incurrence of CAPEX Asset put to use ICDS General Borrowing AS

131 Differences between AS & ICDS Suspension of Capitalisation AS 16 ICDS Capitalisation is suspended during There is no provision regarding the extended periods in which active suspension of capitalisation of development of the asset is borrowing cost in ICDS IX. interrupted. -Inflated cost of qualifying asset due to suspension - Suspension may not lead to higher economic value of qualifying asset 131

132 Borrowing Cost Ind AS 23 For interest on loan under Ind AS 23- Borrowing cost is calculated as per effective interest method (i.e. amortization of processing charges etc. paid to bank will be amortized over a period of loan). Tax Perspective As per ICDS actual borrowing costs incurred shall be considered for the purposes of capitalization. Ancillary costs (amortized) shall form part of borrowing cost. 132

133 Temporary Use of Funds IND AS-23 Income earned from temporary investment of borrowed funds is deducted while capitalizing the borrowing cost. (Para 12 of Ind AS 23) Tax Perspective ICDS mandates that any income arising from temporary use of funds shall be charged to income tax under the head Income from Other Sources. The asset value will have to be shown at gross value only. The above position is in line with the Supreme Court decision in case of Tuticorin Alkali Chemicals & Fertilizers Ltd v. CIT (227 ITR 172) 133

134 Deemed Interest Ind AS 16 If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total payment is recognised as interest over the period of credit unless such interest is capialised in accordance with Ind AS 23 (Para 23 of Ind AS 16) Tax Perspective Usance interest is not in the nature of interest on borrowed funds and hence, will not be covered by provisions of section 36(1)(iii)of the Act It is entitled to deduction u/s. 37(1) of the Act Bombay Steam Navigation Co. Private Limited v. CIT (56 ITR 52) Supreme Court loan of money is debt but every debt does not involve a loan; Interest paid on capital borrowed for the purpose of business in context of section 36(1)(iii) means money and not any other asset purchased on credit 134

135 Case Study General Borrowing 135

136 Illustrative ICDS IX Clause 13(e) ICDS IX impact Increase in Profit (Rs) Decrease in Profit (Rs) Net Impact (Rs) Remarks Borrowing Cost 45,00,000 22,73,000 22,27,000 Interest component of Asset not falling under definition of qualifying asset as per AS 16 and thus charges to P&L but being capitalized to Cost of Asset in terms of ICDS IX. 136

137 ICDS IX - Disclosure Accounting policy adopted for borrowing costs. Amount of borrowing costs capitalised during the previous year. Name of ICDS Disclosure Refer Significant Accounting Policy mentioned at Note/ Schedule No to Financial Statements. IX. Borrowing Costs For amount of Borrowing Cost capitalized during the PY refer Note /Sch to Financial Statements. 137

138 ICDS IX Practical Aspect Disclosure same as AS hence may refer notes to Financial Statement. To adjust the differential interest treated/not treated as borrowing cost in AS. To adjust the foreign exchange difference treated as borrowing cost in AS subject to section 43A. 138

139 ICDS X Provisions, Contingent Liabilities and Contingent Assets

140 ICDS X Provisions, Contingent Liabilities and Contingent Assets Topic Indian GAAP (AS 29) ICDS X Recognition of provisions A provision shall be recognised when the following conditions are met: a) an enterprise has a present obligation as a result of a past event b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and c) a reliable estimate can be made of the amount of the obligation Similar to AS, except term 'reasonable certain' is being used in place 'probable'. Recognition of contingent assets Contingent assets are recognised if it becomes reasonably certain that an inflow of economic benefits will arise. Contingent assets are recognised if it has become virtually certain that an inflow of economic benefits will arise. 140

141 Case Study ICDS X 141