Phoenix Legal Northern India Regional Council, ICAI Seminar on Income Computation and Disclosure Standards Aseem Chawla Pranshu Goel aseem.chawla@phoenixlegal.in April 15, 2017 New Delhi
Evolvement: Notable Developments The CBDT notified 2 IT-AS viz. (i) Disclosure of Accounting Polices and Prior Period & Extra Ordinary items and changes in accounting standards January, 1996 Finance Act, 1995 The committee formulated draft 14 Tax Accounting Standards (TAS) and submitted its report. December, 2010 The concept of Accounting Standards was introduced for the first time under Income Tax Act by amending section 145 of the Act. August, 2012 The CBDT Constituted a Committee to harmonize Accounting Standards (AS) issued by ICAI with Income Tax Act and suggest amendments. 2
Evolvement: Notable Developments (Contd ) The CBDTvide its Notification no. 86/2016 rescinded the ICDS issued vide notification no. 32 /2015 and issued revised ICDS on 29 September 2016 effective from AY 2017-18 September, 2016 March, 2015 Post seeking public comments on drafts of TAS, the CBDT issued 10 ICDSs vide notification No. 32/ 2015 dated March, 31, 2015 u/s 145(2) of the Act. Effective from AY 2016-17 March, 2017 CBDT has issued Clarifications on ICDS, vide Circular No. 10/2017 dated March 23, 2017 3
Income Computation and Disclosure Standard: An Overview Objectives of the Accounting Standard Committee constituted vide Order No.134/48/2010- SO (TPL) dated 20thDecember 2010 a) To study the harmonization of Accounting Standards issued by ICAI with the direct tax laws in India, and suggest Accounting Standards which need to be adopted under section 145(2) along with the relevant modifications; b) To suggest method for determination of tax base (book profit) for the purpose of Minimum Alternate Tax ( MAT ) in case of companies migrating to IFRS in the initial year of adoption and thereafter; and c) To suggest appropriate amendments to the Act in view of transition to Ind-AS regime Principles adhered to by the Accounting Standard Committee: a) Reduction of litigation; b) Minimization of alternatives; and c) Certainty to issues. 4
ICDS: An Overview (Contd ) Section 145 of the Income Tax Act, 1961 ( Act ), mandates computation of Business Income & Income from other sources, in accordance with accounting policy regularly followed. Mercantile or Cash basis of accounting is permitted. Need felt by Central Board of Direct Taxes ( CBDT ) to harmonize Indian Accounting Standards issued by Institute of Chartered Accountants of India ( ICAI ) with income tax framework for effective tax compliance. Income Computation and Disclosure Standards notified to be followed by all the assessees (other than Individuals or HUF who are not required to get their accounts audited in terms of provisions of Section 44AB of the Act), following the mercantile system of accounting for computing Profits and Gains from Business and Profession & Income from Other Sources. Not Applicable for assessees following cash system of accounting. As the ICDS were framed taking into consideration AS issued by the ICAI significant departures exist between ICDS and Indian AS ( Ind AS ). 5
ICDS: An Overview (Contd ) If the scheme of ICDS is in conflict with the provisions of the Income Tax Act, provisions of the Act ought to prevail. ICDS does not mandate maintenance of separate books of accounts according to the provisions of ICDS. However if there is difference between the scheme of ICDS and the accounting policies and standards on basis of which the books of accounts are maintained, the difference to be adjusted in the Computation of Income. Creation of huge deferred tax assets in initial years of implementation. ICDS would have the effect of increasing the scope of taxation; upfront recognition of revenue for tax purposes. Though, ICDS does not focus on maintenance of separate books of accounts convergent with ICDS, the same is practically difficult and complex re-conciliations would necesiate. 6
ICDS: An Overview (Contd ) Parameters of level of turnover, net-worth etc not applicable No minimum threshold Applicable where mercantile system is followed Tax payers following cash system of accounting not required to comply with ICDS Provisions of Act shall prevail No separate books of accounts In case of conflict, Act with apply Complex calculations / adjustments required 7
ICDS: An Overview (Contd ) Considering a situation where a judicial pronouncement interprets a provision of the Act whether overriding such pronouncement would end up being in conflict with the provision of the Act. The scheme of the Act provides that total income shall include income accruing or arising during the year. In this regard, Hon ble Supreme Court in the cases of Godhra Electricity Co. Ltd v. CIT (1997) 225 ITR 746 (SC),etc and Delhi High Court in Saraswati Insurance Co. Ltd v. CIT (2001) 252 ITR 430 (DELHI) have held that a) The accrual of any income is to be determined in light of the terms of a contract under which such income arises, and b) a mere accounting entry or the following of the mercantile system of accounting is not conclusive of the accrual of income etc. which are required to be fulfilled before an income can be said to have accrued or arisen under the Act. Thus, where ICDS prescribes for revenue recognition in contradiction with these principles, whether the jurisprudence in such cases read with basic fundamental provisions of recognition of income under the the Act would be overridden by ICDS or not. 8
Income Computation and Disclosure Standard- Framework S.No Income Computation and Disclosure Standards AS IND AS I Accounting Policies AS-1 1/8 II Valuation of Inventories AS-2 2 III Construction Contracts AS-7 115 IV Revenue Recognition AS-9 115 V Tangible Fixed Assets AS-10 16 VI The Effect of Changes in Foreign Exchange Rates AS-11 21 VII Government Grants AS-12 20 VIII Securities AS-13 32/109 IX Borrowing Cost AS-16 23 X Provisions, Contingent Liabilities and Contingent Assets AS-29 37 9
ICDS I: Accounting Policies Supersedes IT-AS 1 issued by CBDT in 1996. Fundamental accounting assumptions of Going Concern, Consistency and Accrual remains in vogue; The major considerations governing selection and application of accounting policies are prudence, substance over form and materiality. This ICDS does not consider prudence and materiality as the major consideration in selection and application of accounting policies; Changes in accounting policy permitted only if there is a reasonable cause, whereas AS/ Ind AS framework permits the same when there is a more appropriate presentation of the financial statements, or if other law / AS requires such change 10
ICDS I Accounting Policies: Key Highlights Any change in an accounting policy which has a material effect along with the amount by which any item is affected should be disclosed Where such amount is not ascertainable, wholly or in part, the fact be indicated and If any fundamental accounting assumption not followed, the fact shall be disclosed. The concept of materiality is absent from this ICDS and if the ICDS are applied in a strict manner, there may be tax impact on low value items. For instance, under post ICDS regime, even small and non-material assets may need to be capitalized. Due to absence of concept of prudence, the loss will only be allowed on actual basis. Further, if the expected loss is recognized as per AS in books of accounts, the same shall be disallowed at the time of making provision and in turn be allowed only on actual basis in the income computation which will lead to timing difference and creation of deferred tax asset. 11
Comparative analysis ICDS I & AS-1, Ind AS-1/8 The table describes some of the key differences between ICDS I, Indian GAAP (including the provisions of Schedule III to the Companies Act, 2013, where considered necessary) and Ind AS. Particulars ICDS I AS Framework Ind AS Framework Accounting Policies, Changes in Accounting Estimates and Errors Accounting Policies AS 1 Disclosure of Accounting Policies AS 5 Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies Ind AS 1-Presentation of Financial Statements Ind AS 8-Accounting Policies, Changes in Accounting Estimates and Errors 12
Comparative analysis ICDS I & AS-1, Ind AS-1/8 (Contd ) Topic ICDS I AS Framework Ind AS Framework Consideration in selection of accounting policies To represent a true and fair view of the state of affairs and income of the business, profession or vocation. The treatment and presentation of transactions and events shall be governed vis-à-vis substance and not merely by the legal form. The major considerations governing the selection and application of accounting policies are:- a. Prudence b. Substance over Form c. Materiality Selection and Application of accounting policies depends upon different IND AS covering different transactions, events or conditions. 13
Comparative analysis ICDS I & AS-1, Ind AS-1/8 (Contd ) Topic ICDS I AS Framework Ind AS Framework Changes in accounting policies Changes in accounting policy will not be done unless for a reasonable cause. However, reasonable cause is not defined. The guidance for the same shall be taken from judicial precedents. Changes in accounting policies be made only if it is required by statute, for compliance with an AS or for a more appropriate presentation of the financial statements on a prospective basis (unless transitional provisions, if any, of an accounting standard require otherwise) together with a disclosure of the impact of the same, if material. Requires retrospective application of changes in accounting policies by adjusting the opening balance of each affected component of equity or the earliest prior period presented and the other comparative amounts for each period presented as if the new accounting policy had always been applied. 14
ICDS VIII: Securities Income Computation and Disclosure Standard VIII on Securities is divided into two Parts. Part A deals with securities held as stock in trade. Part B of ICDS VIII deals with the securities held by a scheduled bank or public financial institutions under a Central or State Act or so declared under Companies Act, 1956 or Companies Act, 2013. Application ICDS applies to all taxpayers (other than Individual or HUF who is not required to get his accounts audited) following accrual system of accounting for the purpose of computation of income under the heads profits and gains from business/ profession or income from other sources. Income Computation and Disclosure Standard VIII (ICDS 8) relating to Securities is applicable from the Assessment Year 2017-18 (corresponding to AS-13 issued by the ICAI) 15
ICDS VIII- Securities Part A: Securities held as Stock in trade Part A of Income Computation and Disclosure Standard -8 on Securities deals with securities held as stock-in-trade and not as Investment. Part A provides for initial measurement and subsequent measurement of securities elucidated in subsequent slides. Application Part A of Income Computation and Disclosure Standard does not deal with: (a) the framework or policy for recognition of interest and dividends on securities which are covered by the Income Computation and Disclosure Standard on revenue recognition; (b) securities held by a person engaged in the business of insurance; (c) securities held by mutual funds, venture capital funds, banks and public financial institutions formed under a Central or a State Act or so declared under the Companies Act, 1956 (1 of 1956) or the Companies Act, 2013 (18 of 2013). 16
ICDS VIII: Securities Part A- Initial Measurement On acquisition of a security, the same shall be recognized at the actual cost incurred for such acquisition. The actual cost of a security shall comprise of its purchase price and include acquisition charges such as brokerage, fees, tax, duty or cess. Where a security is acquired in exchange for other securities, the fair value of the security so acquired shall be its actual cost. Where a security is acquired in exchange for another asset, the fair value of the security so acquired shall be its actual cost. Where unpaid interest has accrued before the acquisition of an interest-bearing security and is included in the price paid for the security, the subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; the pre-acquisition portion of the interest is deducted from the actual cost. 17
ICDS VIII: Securities Part A- Subsequent Measurement At the end of any previous year, securities held as stock-in-trade shall be valued at actual cost initially recognized or net realizable value at the end of that previous year, whichever is lower. Such comparison of actual cost initially recognized and net realizable value shall be done category wise and not for each individual security (bucket approach). For this purpose, securities shall be classified into the following categories, namely:- (a) shares; (b) debt securities; (c) convertible securities; and (d) any other securities not covered above. 18
ICDS VIII: Securities Part A- Subsequent Measurement (Contd ) The value of securities held as stock-in-trade of a business as on the beginning of the previous year shall be: (a) the cost of securities available, if any, on the day of the commencement of the business when the business has commenced during the previous year; and (b) the value of the securities of the business as on the close of the immediately preceding previous year, in any other case. Further, at the end of any previous year, securities not listed on a recognized stock exchange; or listed but not quoted on a recognized stock exchange with regularity from time to time, shall be valued at actual cost initially recognized. Where the actual cost initially recognized cannot be ascertained by reference to specific identification, the cost of such security shall be determined on the basis of first-in-first-out method or weighted average cost formula. 19
ICDS VIII- Securities Part B: Securities held by Scheduled Bank Part B of Income Computation and Disclosure Standard deals with securities held by a scheduled bank or public financial institutions formed under a Central or a State Act or so declared under the Companies Act, 1956 (1 of 1956) or the Companies Act, 2013 (18 of 2013). Classification, Recognition and Measurement of Securities Securities shall be classified, recognised and measured in accordance with the extant guidelines issued by the Reserve Bank of India in this regard and any claim for deduction in excess of the said guidelines shall not be taken into account. To this extent, the provisions of Income Computation and Disclosure Standard VI Changes in foreign exchange rates relating to forward exchange contracts would not apply. 20
ICDS VIII: Securities CBDT Clarifications The clarification issued by the CBDT vide Circular No. 10/2017 dated March 23, 2017 with regard to ICDS VIII Part A provides for clarification on subsequent recognition of Securities valued category wise. CBDT clarified that the aggregate cost and net realizable value (NRV) of each category of security is compared and the lower of the two is to be taken as carrying value as per ICDS- VIII. No clarity provided on how to identify securities, whether held as stock-in-trade or as an investment. 21
ICDS VIII: Securities CBDT Clarifications (Contd ) Security Category Cost NRV Lower of Cost(LOC) or NRV ICDS Value A Share 100 75 75 B Share 120 150 120 C Share 140 120 120 D Share 200 190 190 Total 560 535 505 535 (LOC or NRV) E Debt Security 150 160 150 F Debt Security 105 90 90 G H Debt Security Debt Security 125 135 125 225 230 220 Securities Total Total 600 615 585 600 (LOC or NRV) 1160 1150 1090 1135 Subsequent recognition to be category wise and not on basis of individual security. 22
Comparative analysis ICDS VIII & AS-13, Ind AS- 109 The below table describes some of the key differences between ICDS VIII, AS framework and Ind AS framework Particulars ICDS VIII AS Framework Ind AS Framework Securities primary Literature Securities AS 13 Accounting for Investments Ind AS 109 Financial Instruments Recognition, measurement and classification of financial assets Securities Scope This ICDS deals with securities held as stockin-trade and securities held by banks and FIs Securities held as stock-intrade are outside the scope of AS 13. However, provisions of AS 13 relating to current investments are applicable with suitable modifications. Ind AS 109 includes requirements for recognising and measuring financial assets, financial liabilities and is broader in scope when compared with AS 13 and ICDS VIII. 23
Comparative analysis ICDS VIII & AS-13, Ind AS- 109 (Contd ) Particulars ICDS VIII AS Framework Ind AS Framework Securities general recognition principle Not covered by ICDS No guidance included An entity should recognise a financial asset or a financial liability in its balance sheet when, and only when, the entity becomes party to the contractual provisions of the instrument. A financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. 24
Comparative analysis ICDS VIII & AS-13, Ind AS- 109 (Contd ) Particulars ICDS VIII AS Framework Ind AS Framework Securities Part A Initial Measuremen t Acquisition at cost. Where acquired in exchange of other security or any other asset, to be recognised at fair value of the security so acquired Acquisition at cost. Investment is acquired by issuing shares or securities or in exchange of any other asset, to be recognised at fair value of the asset given or security issued. All financial instruments are initially measured at fair value plus or minus transaction cost that are directly attributable to acquisition or issue of financial asset or liability. 25
Comparative analysis ICDS VIII & AS-13, Ind AS- 109 (Contd ) Particulars ICDS VIII AS Framework Ind AS Framework Securities Part A Subsequent Measuremen t Unquoted shares at initial cost. Other than the above at cost or NRV w.e.l. Investment either Long Term or Current. Long-term investments are carried at cost less provision for diminution in value, which is other than temporary. Current investments are carried at lower of cost and fair value. All financial assets are classified as measured at amortised cost or measured at fair value. Bucket Approach Individual Approach 26
Way forward The revised ICDS framework is applicable from Assessment Year 2017-18 onwards and the same are mandatory to be followed by all assessees following mercantile system of accounting (except individual and HUF(s) not covered under tax audit provisions) Non-compliance of the said ICDS may result into best judgement assessment as per provisions of section 144 of the IT Act, 1961. The amendments in the revised ICDS have settled some of the implementation issues, however, there are still many gaps which needs clarification. It is evident that the ICDS framework will change the way Income will be computed and will materially impact the Tax computation. Whether the objective of reduction of litigation and certainty to issues are adhered and met with, when comes to the implementation and application of ICDS framework. 27
The Joy of Tax 28
NOTE: This presentation is for discussion and general guidance purposes, prepared on the basis of information available. It may not be used for any other purpose, or distributed to any other party, without seeking our prior written consent. No party should rely on this presentation without taking necessary prior professional advice 29