ICDS 1 Accounting Polices

ICDS 1 Accounting Polices

Presentation Outline Background Applicability of ICDS ICDS I Accounting Policies Disclosure requirement of ICDS I ICDS I vs AS 1 Examples, Relevant case laws FAQ Significant impact ICDS Road Map

Background The Central Board of Direct Taxes (CBDT) has issued a notification on 29 September 2016 stating that the ICDS will come into effect from 1 April 2016 and shall accordingly apply for assessment year 2017-18 onwards ICDS have been notified by the Government as per powers granted under section 145(2) of the Income-tax Act, 1961 (Act) The notified ICDS shall supersede the existing accounting standards (AS) notified by CBDT on 25 January 1996 (existing tax AS) Accounting standard I relating to disclosure of accounting policies Accounting standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies ICDS applies to all taxpayers following accrual system of accounting for the purpose of computation of income under the heads of profits and gains of business / profession and income from other sources except individuals/hufs who are not required to get their accounts audited under section 44AB ICDS is not for the purpose of maintenance of books of accounts Applies from AY 2017-18 onwards Supersedes the earlier notified Accounting Standard for tax

Applicability of ICDS v ICDS applies to all taxpayers except individual and HUF who are not covered under the tax audit provisions. v ICDS are applicable for computation of income chargeable under the head profits and gains of business or profession and income from other sources and not for maintaining books of accounts. v ICDS applies only to taxpayers following mercantile system of accounting. Object of ICDS is to ensure consistency and clarity in computation of taxable income

ICDS I Accounting Policies ICDS-I deals with the selection of accounting policies to be adopted by enterprises and the considerations to be followed in selecting and changing such accounting policies while computation of taxable income under the heads Profit & Gains from Business or Profession and Income from Other Sources. Unlike AS-1, ICDS-I is applicable to all assessees (corporate and non-corporate) following the mercantile system of accounting. ICDS-I would now supersede the erstwhile Accounting Standard I [ AS(IT) 1 ] notified by the CG under section 145 of the Act relating to disclosure of accounting policies. ICDS-I also advocates the fundamental accounting assumptions of Going Concern, Consistency and Accrual as provided under AS 1 for the preparation of financial statements.

ICDS I Accounting Policies ICDS recognizes three accounting concepts going concern, consistency and accrual Materiality and prudence are absent as considerations for selection of accounting policies Accounting policy can be changed only if there is reasonable cause to do so Mark-to-market (MTM) or expected loss shall not be recognized unless provided by other ICDS (inventory valuation, securities valuation, foreign exchange differences) silent on MTM gain Recognition of taxable income at an earlier point in time as compared to book profits

ICDS I Accounting Policies Accounting Policies: Accounting principles and method of applying To represent true and fair view of state of affairs of income The treatment of transaction will be governed by their substance and not legal form Concept of Prudence: Mark-to-market or expected loss shall not be recognized unless provided by other ICDS. The losses that arise on actual settlement are only to be realised for the purpose of computation. Treatment of mark to market unrealised gain treatment has not been defined. Exceptions to mark to market losses: ICDS II- Accounting the inventory on the last date of financial year at cost or NRV whichever is lower. ICDS VI- Recognizing the exchange difference on conversion of monetary items according to closing rate on the last day of the financial year.

ICDS I Accounting Policies Fundamental Accounting Assumptions Going Concern The entity will continue its operations for the foreseeable future Consistency Accounting polices are consistent from period to period Accrual Revenues and costs are recognized as they are earned & incurred

ICDS I Accounting Policies Disclosure requirement Disclose all the significant accounting policies. Change in Accounting Policy Material effect to be disclosed. The item affected by the change of policy, shall be disclosed to the extent ascertainable. If the change in accounting policy has no material effect for the current PY but will have effect in the subsequent PY s, the change of policy shall be disclosed in the year of adoption along with the year on which such change will have an material effect for the first time. Presently, as provided for in AS-1, the accounting policies followed by entities form part of the financial statements which is usually submitted to the revenue authorities. ICDS-I does not however provide for where such disclosures are required to be made. It is awaited to see if the income-tax return forms or the tax audit report forms etc. would be amended to facilitate the same.

ICDS I vs AS 1 Unlike AS-1, ICDS-I does not provide for prudence and materiality as basic considerations to be followed in the selection of accounting policies. This is to ensure precise computation of the total income. The erstwhile AS (IT) 1 had provided for these concepts as the major considerations governing the selection of accounting policies. Accordingly, considerable time and cost may be involved in making trivial adjustments to net profit as per books of account to arrive at the total income asauthorities may insist on strict application of ICDS even on immaterial items. For eg: If an entity is following a policy of expensing immaterial items of assets purchased rather than capitalizing the same for accounts and tax purposes, the same may be questioned. Further, in the absence of recognition of prudence as a basic consideration to be followed, any accounting provision for anticipated losses made by entities could also be questioned and disallowed.

ICDS I vs AS 1 Materiality No concept of materiality in ICDS unlike, AS-1. No likely significant tax impact In absence of materiality concept, considerable time and cost will be involved making trivial adjustments in net profit as per books of accounts to arrive at PGBP since authorities may insist on strict application of ICDS even on small value items.

ICDS I vs AS 1 Prudence Based upon the concept of prudence, AS-1 precludes recognition of anticipated profits and requires recognition of expected losses. However, ICDS provides that expected losses or mark to market losses shall not be recognized unless permitted by any other ICDS to avoid differential treatment for recognition of income and losses. However, ICDS is silent on MTM gain. In the absence of prudence as a fundamental assumption, there could be several situations which could result in earlier recognition of income or gains or later recognition of expenses as compared to that under AS. E.g. provision for warranty expenses on sales made. An ambiguity would arise on deductibility of losses which are not covered in any specific ICDS. E.g. Currently no specific proposed ICDS dealing with MTM loss on derivatives.

Example Year Loss Anticipated Income Computation Income Tax Books of Accounts Remarks 1 Expected loss = (5000) Anticipated Income = 1,000 1,000 (5,000) Foreseeable loss is not allowed as deduction in Year 1 as per ICDS but anticipated profit is taxed and thus tax is required to be paid as per Normal Provisions on 1,000. 2 Actual loss = (5,000) Actual Income = 1,000 (5,000) 1,000 As per ICDS, the actual loss will now be allowed in year 2 and actual gain will be regarded as income in accounts. However, MAT will apply and tax is required to be paid as per the provisions of MAT.

Relevant Case Laws ICDS-I states that an accounting policy shall not be changed without a reasonable cause. However the judicial pronouncements suggest no specific need for a reasonable cause as under: Change in accounting policy isn't allowed if there is nothing on record to indicate that the change is intended to be followed regularly in future by the assessee Snow White Food Products Co. Ltd. v. CIT [1983] 141 ITR 847 (Cal.) An assessee can change the method of accounting unilaterally in respect of a source of income - Reform Flour Mills (P.) Ltd. v. CIT [1978] 114 ITR 227 (Cal.) Where it was found that the change adopted by the assessee was for bona fide purpose and was not actuated by consideration to reduce income for income-tax purposes, the revenue had no right to interfere with the change in the method of valuation of inventory - CIT v. Mopeds India Ltd. [1988] 38 Taxman 123 (AP) Loss incurred on account of evaluation of contract on last date of accounting period, (before date of maturity of forward contract) is an allowable deduction - Dy. CIT (International Taxation) v. Bank of Bahrain & Kuwait [2010] 41 SOT 290 (Mum.)(SB) The losses incurred by assessee due to revaluation of an un-materialized oil exchange contract were allowable as deductions - Addl. DIT (IT) v. British Bank of Middle East [2011] 44 SOT 109 (Mum.)(URO)

Relevant Case Laws Possible losses from unsettled contracts could not be allowed as deductions - CIT v. Indian Overseas Bank [1984] 19 Taxman 542 (Mad.) Just because anticipated profits are not assessed to tax, it would not follow as a corollary thereto that anticipated losses cannot be allowed as deductions in computation of business income - ABN Amro Securities India (P.) Ltd. v. ITO [2011] 15 taxmann.com 177 (Mum.) It was held that any profit arising on account of revaluation of forward contract on the last day of accounting period has to be treated as an income of the assessee - Addl. DIT(IT) v. Development Bank of Singapore [2011] 12 taxmann.com 35 (Mum.)(URO) Mark-to-market loss on derivatives held as stock-in-trade shall be allowed as business loss - Deputy CIT v. Kotak Mahindra [2013] 35 taxmann.com 225 (Mumbai - Trib.) Forex loss computed at the end of the financial year on derivatives contract entered for hedging currency related risk had to be allowed as revenue expenditure - Reliance Industries Limited v. CIT (LTU) [2013] 40 taxmann.com 431 (Mumbai - Trib.) Booking of expected loss, might be warranted in terms of Accounting Standards, but for tax purposes, only expenses incurred or losses suffered could be allowed - EDAC Engineering Ltd. v. Deputy CIT [2013] 30 taxmann.com 355 (Chennai - Trib.)

FAQ Impact on the Act? Preamble in case of conflict, Act prevails Force of ICDS as a notification Is ICDS mandatory? If not followed income can be recomputed u/s 145(3) Prospective or retrospective? Prospective Impact on ongoing transactions Does ICDS also apply for computation of book profits under Minimum Alternate Taxes ( MAT )? No. The computation of book profits for the purposes of MAT would continue to be governed by the provisions of section 115JB of the Act. The provisions of ICDS would not be applicable for computation of book profits under MAT therefore.

Significant impact on tax computation 1. Marked to market Due to the non reorganization of prudence the marked to market losses are not to be considered for tax computation purpose The anticipated losses on account of existing obligation as on 31st March, determinable with reasonable accuracy, being in the nature of expenditure/accrued liability have to be taken into account while preparing financial statements as held in Bharat earth movers vs CIT [2000] 245 ITR 428 (SC) shall stand deviated. 2. Materiality Small and immaterial assets are to be capitalized for the purpose of computation of precise taxable income 3. Restriction on change in accounting policies As the term reasonable cause has not been defined, it would involve exercise of judgement by the assesse and the tax authorities, which may give rise to litigation

ICDS Road Map 4 3 2 Implementation Review of agreements 1 Strategy formulation Align as per ICDS Qualitative impact Current tax position Existing tax litigation Quantitative impact Impact assessment on current tax, effective tax, deferred tax, and MAT Divergence between tax profits and distributable profits

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