Study Circle Meeting. ICDS I, II and IV. CA Ravikant Kamath 17 August 2017

Transcription

1 Study Circle Meeting ICDS I, II and IV CA Ravikant Kamath 17

2 Contents ICDS General principles ICDS I Accounting Policies ICDS II Valuation of Inventories ICDS IV Revenue Recognition Page 2 CTC Study Circle ICDS I, II & IV

3 ICDS General principles Page 3

4 ICDS - General principles Broad principles which internally guided the Committee while formulating ICDS are: Reduction of litigation Minimization of alternatives Certainty to issues ICDS applies from A.Y (F.Y ) ICDS applies only to taxpayers following mercantile method of accounting Applicable for two heads of income viz. Profits & Gains of Business & Profession and Income from other sources Taxpayers who predominantly follow mercantile method but adopt cash method for small/ insignificant streams of income may not be able to presume non-application of ICDS 1 Non resident taxpayers may also have concern on computation of income of PE/branch Does not apply to Individuals and HUFs not liable to tax audit 1 ICDS application to small streams recognized on cash basis will require fact based analysis and is litigation prone Page 4 CTC Study Circle ICDS I, II & IV

5 ICDS - General principles ICDS to be given effect in computation of taxable income (FAQ 1 of Circular No. 10/2017) No two sets of books required to be maintained as clarified by Preamble of each ICDS Practically, will necessitate maintenance of memorandum records (including changes in ERP wherever necessary) Tax Audit Report (Form 3CD) amended to include ICDS disclosures (Refer Notification No. 88/ 2016 dated 29 September 2016) Each ICDS has both computation and disclosure requirements Disclosure required in Tax Audit Report; not applicable if taxpayer is not liable for tax audit (FAQ 25 of Circular) MAT will continue to be governed by books of account prepared as per applicable GAAP (FAQ 6 of Circular) Page 5 CTC Study Circle ICDS I, II & IV

6 ICDS - General principles ICDS is based on pre-2016 ICAI AS subject to deviations/ carve-outs as suggested by Committee IFRS / Ind-AS are notified to become effective from F.Y in phased manner Differences of ICDS with Ind-AS will require independent evaluation (eg. BOT project, Revaluation of PPE, Deferred revenue recognition for loyalty points or deferred payment terms, Financial instruments, etc) Some ICAI AS revised w.e.f F.Y Revenue/ expense on which there is no ICDS will continue to be governed by AS/ Ind-AS E.g. ESOP cost Unlike ICAI AS, ICDS contains only main principles; no Explanations or Illustrations provided Page 6 CTC Study Circle ICDS I, II & IV

7 ICDS Principles of construction Provisions of the Income-tax Act, 1961 (ITA) to prevail in case of conflict with ICDS Undefined words/ expression take their meaning from ITA Hierarchy of ICDS Specific statutory provisions (ITA) Income tax rules Real income theory Tax jurisprudence on above ICDS Commercial principles of accounting FAQ 2 states that ICDS shall apply to transactional issues dealt therein for A.Y onwards over judicial pronouncements rendered in absence of authoritative guidance under the Act ICAI Technical Guidance classify judicial rulings in three categories (Para 15, pg 15-17) ICDS supporting specific amendments (s.2(24)(xviii), 36(1)(iii) & 36(1)(vii)) shall override earlier judicial precedents ICDS shall override judicial precedents based on extant GAAP But ICDS cannot override judicial precedents on basic principles of tax (eg. real income theory in context of interest on NPAs) Page 7 CTC Study Circle ICDS I, II & IV

8 ICDS I Accounting Policies Page 8

9 Fundamental Accounting Assumptions and Materiality Going concern, consistency and accrual are fundamental accounting assumptions disclosure required if any of the assumptions not followed Accrual of income takes place when there emerges a debt in favour of taxpayer which is enforceable in law [E.D. Sassoon & Co. Ltd. (26 ITR 27) (SC)] As per ICAI TG, ICDS does not alter or impinge upon supremacy of s.5 over s.145 (para 4.19, pg 35) S.145 permits cash method as a choice. Also, judicially, it is recognized that if no method is discernible, default choice is cash method Concept of materiality which was relevant in selecting and applying accounting policy omitted No likely significant tax impact, but possible litigation on small value items if Tax Authority insists on strict application of ICDS ICAI TG also states that omission of materiality is unlikely to impact income computation Page 9 CTC Study Circle ICDS I, II & IV

10 Prudence Concept of prudence is modified by ICDS Prior to ICDS, prudence understood to mean non-recognition of anticipated profits but recognition of known liabilities and losses on best estimate basis (e.g. ICAI s guidance on derivatives in March 2008) As per Committee, prudence led to differential treatment for income and loss ICDS prohibits recognition of marked to market (MTM) or expected loss unless permitted by any other ICDS MTM gain at par with MTM loss Taxable only at the time of realization (FAQ 1 of Circular) ICDS I covers derivatives not covered under ICDS VI /VIII (FAQ 10 of Circular) Page 10 CTC Study Circle ICDS I, II & IV

11 Prudence Expected loss is different from actually incurred loss recognised on best estimate basis (eg. loss by fire, theft, etc) or actuarially valued liabilities (eg. pension obligation) ICDS prohibits deduction in respect of expected loss but, does not impact actual loss though may have been estimated on a scientific basis Page 11 CTC Study Circle ICDS I, II & IV

12 Disclosure of accounting policy Accounting policy shall be such to represent true and fair view of state of affairs and income of the business, profession or vocation As per ICAI TG, accounting policy should be read as computation policy (para 3.6, pg 25) As per FAQ 1 of Circular, accounting policies are fundamental in nature All significant accounting policies adopted by taxpayer need to be disclosed As per ICAI TG, significant infers of such magnitude as may influence readers/users of financial statements (para 3.3, pg 25) Accounting policy can be changed for any reasonable cause Reasonable cause is not defined in ICDS; an existing concept, to be governed by judicial precedents (FAQ 9 of Circular) Reasonable cause means a reason which appeals to a person of average intelligence and ordinary prudence; probable cause (Refer, illustratively, Woodward Governor India (P) Ltd (Del) (253 ITR 745), Azadi Bachao Andolan (Del) (252 ITR 471)) Earlier, change permitted if required by statute; or for compliance with AS; or considered as resulting in more appropriate presentation Page 12 CTC Study Circle ICDS I, II & IV

13 Change in Accounting Policy Upon change in accounting policy, disclosure required in the year of change if it has material effect If no material effect in current year, disclosure also required in first year of material impact. Enhanced disclosure requirement and compliance burden Default of sheer non disclosure unlikely to have any adverse impact on best judgement assessment. Page 13 CTC Study Circle ICDS I, II & IV

14 Transitional Provision- ICDS-I Extract of transitional provision 10. All contract or transaction existing on the 1st day of April, 2016 or entered into on or after the 1st day of April, 2016 shall be dealt with in accordance with the provisions of this standard after taking into account the income, expense or loss, if any, recognised in respect of the said contract or transaction for the previous year ending on or before the 31st March, ICDS I does not permit recognition of MTM losses or expected losses unless permitted by other ICDS Transitional provisions arguably does not require reversal of MTM losses recognised in earlier years (Refer ICAI TG para 8.2, page 38) Page 14 CTC Study Circle ICDS I, II & IV

15 Case study Modifying Prudence ICo Facts MTM recognition of gain/loss on derivative (Interest Rate Swaps) for hedging purposes (not covered by ICDS VI on Foreign Exchange Rates) Commercial Impact Higher interest cost MTM gain on derivative Net commercial income (Rs. 1 Cr) Rs. 1 Cr NIL ICo has entered into derivative contract with bank for hedging exposure to fluctuating interest rate risk on loan having floating rate interest Derivative contract is in compliance with RBI Guidelines ICo is able to demonstrate that loss/gain on derivative offsets corresponding gain/loss on underlying interest outflow on loan Page 15 CTC Study Circle ICDS I, II & IV

16 Case study Modifying Prudence ( contd) Income/Loss Amount ICAI 2008 GN ICAI 2015 GN Ind-AS ICDS I Higher (1 Cr) Recognise as Recognise as Recognise as Recognise as interest cost per AS-16 per AS-16 per effective per ICDS IX interest rate MTM Gain 1 Cr Ignore MTM Recognise Recognise Ignore MTM on IRS Gain MTM gain/loss MTM gain/loss Recognise gain/loss Recognise in MTM Loss year of realisation Net income NIL (1 Cr) NIL NIL (1 Cr) Page 16 CTC Study Circle ICDS I, II & IV

17 ICDS II - Valuation of inventory Page 17

18 Valuation of inventory tangible assets Includes assets Held for sale in the ordinary course of business In the process of production for such sale In the form of materials or supplies to be consumed in the production process or in the rendering of services Valuation at lower of cost or NRV Akin to ICAI AS-2, ICDS permits FIFO, weighted average, specific identification, standard cost or retail method If taxpayer adopts standard cost method, ICDS requires disclosure confirming that standard cost approximates actual cost Will include unconsumed items for construction contract at year end (Refer ICAI TG, para 2.2(a), page 40) Specific provisions of s.145a may override anything to contrary in ICDS Page 18 CTC Study Circle ICDS I, II & IV

19 Valuation of inventory service WIP Definition of inventory is ambiguous on inclusion of service inventory within its scope Cost of inventories includes cost of services and para 6 of ICDS II defines cost of services as labor and other direct personnel cost and attributable overheads Revised ICDS has deleted reference to service providers As per ICAI TG ICDS-II is not applicable to service inventory (para 7, pg 46) ICDS II include derivatives held as inventory but not covered by ICDS VI/VIII (para 2.4, pg 41) Page 19 CTC Study Circle ICDS I, II & IV

20 Valuation of inventory S.145A overrides provisions of s. 145 r.w. ICDS 145A. Notwithstanding anything to the contrary contained in section 145, (a) the valuation of purchase and sale of goods and inventory for the purposes of determining the income chargeable under the head "Profits and gains of business or profession" shall be (i) in accordance with the method of accounting regularly employed by the assessee; and (ii) further adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods to the place of its location and condition as on the date of valuation. Explanation. For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment; (b).. S.145A does not apply to service inventory* * CIT v Knight Frank (India) Pvt. Ltd. (2016) (242 Taxman 313) (Bom HC) Page 20 CTC Study Circle ICDS I, II & IV

21 Valuation of inventory In case of newly commenced business, cost of inventory on day of commencement of business shall be opening inventory In case of conversion of capital asset into stock-in-trade for commencing business, FMV as on date of conversion is cost to the business (ICAI TG, para 13.4, pg 57-58) If business is commenced by acquiring a running business from another, consideration paid (whether slump price or itemised value) constitutes cost to the business of opening inventory No specific guidance about basis of determination of cost to business of firm where partners contribute assets as stock-in-trade S.45(3) does not apply Value credited in books may arguably constitute the cost? Valuation of opening inventory to be the same as closing inventory in preceding year regardless of change in method of valuation of closing inventory Page 21 CTC Study Circle ICDS I, II & IV

22 Valuation of inventory On dissolution of firm, AOP or BOI, inventory to be valued at NRV regardless of whether business is discontinued In ALA Firms (189 ITR 285)(SC), SC upheld valuation at NRV since business was discontinued on dissolution Whether SC ruling in Shakthi Trading s case (250 ITR 871) where SC upheld lower of cost or NRV considering that business was continued post dissolution may no more apply? In Shakti Trading s case (supra), ALA Firms (supra) was held not applicable as business was continued on a going concern basis upon takeover Method of valuation once adopted shall not be changed without reasonable cause Courts have permitted bonafide change where changed method is as per GAAP and followed regularly thereafter (e.g. from cost to lower of cost or NRV) Page 22 CTC Study Circle ICDS I, II & IV

23 Treatment of general machinery spares as per revised AS-2/ 10 and ICDS II/ V Revised ICAI AS-2/ 10 ICDS II and V Treated as Property, Plant & Equipment (PPE) if useful life > 12 m Else, treated as Inventory Treated as inventory, irrespective of useful life Charged to revenue as and when consumed Illustration X Co purchased general machinery spares with useful life > 12 m on 15 th April 2016 Book treatment as per revised ICAI AS-2/10 PPE to be depreciated over useful life Tax treatment Alternative 1 Depreciate over useful life as per books Alternative 2 Treat it as inventory as per ICDS II/V Issue How does s.145a impact conclusion? Page 23 CTC Study Circle ICDS I, II & IV

24 Transitional Provision- ICDS-II Extract of transitional provision 25. Interest and other borrowing costs, which do not meet the criteria for recognition of interest as a component of the cost as per para 11, but included in the cost of the opening inventory as on the 1st day of April, 2016, shall be taken into account for determining cost of such inventory for valuation as on the close of the previous year beginning on or after 1st day of April, 2016 if such inventory continue to remain part of inventory as on the close of the previous year beginning on or after 1st day of April, Transitional provision explicit only for interest component Overriding impact of s.145a on valuation of inventories needs to be considered before application of ICDS II Page 24 CTC Study Circle ICDS I, II & IV

25 ICDS IV Revenue Recognition Page 25

26 Broad Overview Revenue recognition criteria as per ICDS Construction contract (including services directly related to construction like architect) POCM Sale of goods Transfer of property or significant risks & rewards of ownership to buyer Rendering of services Interest Royalty (as defined by ITA) Ordinarily, POCM If contract duration < 90 days, permits completed contract method If services by indeterminate number of acts, permits straight line method Receipt basis for interest on tax refund Time basis for other As per contractual terms, unless some other systematic / rational basis as per substance of transaction Dividend As per ITA Page 26 CTC Study Circle ICDS I, II & IV

27 Revenue recognition Sale of goods Revenue from sale of goods recognised upon transfer of property or upon transfer of significant risk/ rewards of ownership to buyer In case of timing mismatch between transfer of property vs. significant risks/ rewards; revenue to be recognised on transfer of significant risks/ rewards No change in position for lessor in finance lease (ICAI TG, para 4.4, pg 89-90) Revenue to be recognised only if there is reasonable certainty of its ultimate collection ICDS not materially different from AS-9 ICDS is in line with current judicial thinking which aligns also with real income theory Reasonable certainty test is different from concept of accrual u/s. 5 of ITA (ICAI TG para 4.8, pg. 91) Page 27 CTC Study Circle ICDS I, II & IV

28 Revenue recognition Rendering of services Distinction between sale of goods v. rendering of services should be based on predominant aspect (ICAI TG, para 5.8, pg. 93) Revenue recognition criteria for services Features of service Less than or equal to 90 days Service contract specifying Taxpayer can follow completed indeterminate number of acts contract method More than 90 days Taxpayer can follow Straight Line Method Service contract with specified milestones Taxpayer can follow completed contract method Taxpayer shall follow Percentage of Completion Method Real estate developer not covered by ICDS IV (FAQ 12 of Circular) draft ICDS published for public comments Page 28 CTC Study Circle ICDS I, II & IV

29 Revenue recognition Interest Interest income to be recognized on time basis (including discount or premium on securities) As per FAQ 13 of Circular, test of reasonable certainty of ultimate collection does not apply to interest and royalty income; subsequent non-recovery can be claimed as deduction u/s. 36(1)(vii) Specific provisions of the Act (e.g. s. 43D, 145A) override ICDS As per settled legal position, interest income not taxable (unless contractually due) in absence of real income Accrual and reasonable test certainty applicable to interest income (ICAI TG, para 6.5, pg. 95) Onus on taxpayer to prove that there is no reasonable certainty of realization Alternatively, taxpayers can claim bad debt deduction under second proviso to s.36(1)(vii) Broken period interest income on securities to be reduced in capital gains computation (FAQ 18 of Circular) Taxation of interest/royalty in hands of NR on paid/ actual basis as per treaty and favourable judicial decisions remains unaffected by ICDS (ICAI TG, para 6.23, pg. 99) Interest on refund of any tax, duty or cess to be taxable on receipt basis Page 29 CTC Study Circle ICDS I, II & IV

30 Royalty income Royalty to be recognized in accordance with the terms of the relevant agreement unless having regard to the substance of the transaction, it is more appropriate to recognize it on some other systematic and rational basis. Royalty definition to be borrowed from Exp 2 to 5 to s.9(1)(vi) Includes equipment royalty (excluding those covered by s.44bb) Includes services incidental to royalty transaction (ICAI TG, para 6.26, pg. 101) Beneficial provisions of applicable DTAA shall override ICDS (ICAI TG, para 6.23, pg. 99) Page 30 CTC Study Circle ICDS I, II & IV

31 Revenue recognition Applicability to special sectors Circular No. 10/2017 Rules 9A, 9B (film production/distribution) shall override ICDS (FAQ 4) ICDS applicable to presumptive taxation schemes for determining turnover, receipts (FAQ 3) Sector specific provisions in ITA shall override ICDS (FAQ 7) (eg. ICDS VIII Securities has special provisions for banks/fis, Insurance governed by Schedule I of ITA) No specific ICDS for real estate developers, BOT projects and leases (FAQ 12) ICAI Technical Guidance Logically ICDS would not apply to taxpayers governed by presumptive taxation schemes (ICAI TG, para 9.3, pg 10) ICDS not applicable to Insurance companies (para 10, pg 11) Page 31 CTC Study Circle ICDS I, II & IV

32 Applicability of ICDS to taxpayers governed by presumptive tax provisions As per FAQ 3 &14 of Circular, ICDS applies even to taxpayers opting for presumptive tax provisions for determining receipt or turnover and also for computation of income on gross basis u/s 115A Presumptive sections like s.44b/ BBA/ BBB specify presumptive tax base as amount paid/ payable or received/ deemed to be received These presumptive tax provisions are self-contained and complete code in itself Thus, taxation cannot be as per ICDS Presumptive sections like s.44ad/ ADA do not define gross receipt/ turnover Taxpayers governed by s.44ad/ ADA not liable to tax audit Thus, individual and HUF continue to remain outside the ICDS net Incomes taxed on gross basis u/s.115a S.115A merely prescribes rate of tax and quantifies tax lability after income is computed Thus, income covered by S.115A necessarily gets subjected to ICDS However, if taxpayers opt out of presumptive provision and offer lower income, they are governed by normal tax provisions and also liable for tax audit. ICDS will also apply in that case Page 32 CTC Study Circle ICDS I, II & IV

33 Transitional Provision - ICDS IV Extract of transitional provision 11. 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. 12. Revenue for a transaction, other than a service transaction referred to in Para 10, 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, 2016 and subsequent previous years. ICDS III grandfathers construction/service contracts commenced prior to 1 April 2016 No grandfathering for other revenue streams to be recognized as per ICDS after considering revenue already recognized in earlier years Page 33 CTC Study Circle ICDS I, II & IV

34 Disclosure requirements Taxpayer needs to make following disclosures: In case of sale of goods, unrecognized revenue amount due to lack of reasonable certainty of its ultimate collection and nature of uncertainty In case of service contracts, similar disclosure requirements as under ICDS III Arguably, no disclosure requirements for :- grandfathered service contracts (ICAI TG, para 11.1, pg 84) Service contracts < 90 days (ICAI TG, para 8.4, pg 104) Page 34 CTC Study Circle ICDS I, II & IV

35 Case study Recognition of service revenue Facts ICo is engaged in providing management consulting services and it undertakes numerous assignments which typically last over 3-4 years ICo (Project Management Consulting) Customers Invoices are raised as per milestones agreed in service contracts Services rendered till balance sheet date but not Service contracts invoiced are not recognized either as unbilled revenue or as inventory Issues Position for books of ICDS account impact Non-recognition of No reasonable certainty? unbilled revenue of receipt Non-recognition of AS-2 does not cover? service inventory service WIP Page 35 CTC Study Circle ICDS I, II & IV

36 Thank you! This Presentation is intended to provide certain general information existing as at the time of production. This Presentation does not purport to identify all the issues or developments. This presentation should neither be regarded as comprehensive nor sufficient for the purposes of decisionmaking. The presenter does not take any responsibility for accuracy of contents. The presenter does not undertake any legal liability for any of the contents in this presentation. The information provided is not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional advice should be sought before taking action on any of the information contained in it. Without prior permission of the presenter, this document may not be quoted in whole or in part or otherwise.