Clause 13 of Tax Audit – Points to be reported -Difference between ICDS Vs Accounting Standards

ICDS were issued and implemented w.e.f FY 2016-17 by the Government of India in exercise of the power conferred to it under 145(2) of Income Tax Act, 1961. In order to ensure adequate compliance, Form 3CD was amended by insertion of  Clause 13 for the Tax Auditor to verify the compliance. Clause 13 (d) to (f) contains reporting related to ICDS.

Clause 13(d) to (e) are reproduced for reference –

13(d) – Whether any adjustment is required to be made in profit & loss for complying with the provisions of income computation and disclosure standards notified under 145(2)?

13(e) – If answer to 13(d) is affirmative , give details of such adjustments

13(f) – Disclosure as per ICDS

There are only few differences between the Accounting standards and ICDS that have significant monetary impact. Below article is an extract of ICAI Guidance Note on Income Computation and Disclosure Standards covering such differences. We have tried to cover only important aspects that requires attention while verifying compliance with ICDS. Para numbers in the article are the same as presented in ICAI GN.

ICDS 1 – Accounting Policies

  1. Accounting policies adopted by a person shall be such so as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose,

(i) the treatment and presentation of transactions and events shall  be governed by their substance and not merely by the legal form;  and 

(ii) marked to market loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other Income Computation and Disclosure Standard.

The second consideration clarifies that marked to market loss or an expected loss shall  not be recognised unless the recognition of such loss is in accordance with the provisions of any other ICDS. The reason for such treatment can be inferred from the explanation provided by Accounting Standard Committee (while introducing Tax Accounting Standards) in its final report of August 2012.

The relevant extract is as under:

“Based on the concept of prudence, AS-1 precludes recognition of anticipated profit and requires recognition of expected losses. Since this amounts to differential treatment for recognition of income and losses, the TAS (AP) provides that expected losses or mark-to-market  losses shall not be recognised unless permitted by any other TAS.”

6.5. The Committee was of the opinion that since anticipated profits are not recognised, expected or mark-to-market losses also should not be allowed as a deduction. The objective is to bring parity between treatment of income and expenses/ losses

The ICDS specifically excludes (i) MTM losses and (ii) Expected losses not covered by another ICDS. Thus, reduction in the value of stock-in-trade, which is governed by ICDS II, can be claimed as a deduction against business income.

The Supreme Court in the case of CIT v Woodward Governor India (P) Ltd. (2009) 312 ITR 254 (SC) held that loss arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes was allowable as a deduction under section 37 of the Act.

Question 8: Para 4(ii) of ICDS-I provides that Market to Market (MTM)  loss or an expected loss shall not be 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.

 Any change in an accounting policy which has a material effect shall be disclosed. The amount by which any item is affected by such change shall also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect for the current previous year but which is reasonably expected to have a material effect in later previous years, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted and also in the previous year in which such change has material effect for the first time.  

Accounting Standard 1 stipulates that if a change is made in the accounting policies which has no material effect for the current period but which are reasonably expected to have a material effect in later periods, the fact of such change shall be appropriately disclosed in the periods in which the change is adopted. The same language had been adopted in IT-AS 1 notified under section 145(2). Both these standards do not mandate disclosure in the year in which such change has material effect for the first time. This ICDS deviates from the disclosure norms from these two standards. It provides for disclosure of such change in two years namely, the year in which change is adopted and when it takes effect for the first time.

ICDS II – Valuation of Inventories –

The Standard does not apply to the following:

  • Work-in-progress of a construction contract or a contract for service directly related to a construction contract. Such work-in-progress is covered by ICDS III relating to Construction Contracts.

 It may be noted that items of inventory that have not been used in the construction work and have not become part of work-in-progress of the contract will come within the scope of this ICDS and should be included as part of the inventory to be valued as per the requirements of this ICDS.  

  • Securities held as stock in trade which are dealt with by ICDS VIII relating to Securities. However, ICDS VIII does not deal with securities held by mutual funds, venture capital funds, banks, public financial institutions formed under a Central Act or a State Act or entities declared as public financial institutions under the Companies Act, 1956 or the Companies Act, 2013. Consequently, valuation of securities held as stock-in-trade by entities referred above i.e. mutual funds, venture funds, financial institutions will be governed by ICDS II.

Further, ICDS VIII does not deal with securities held by a person engaged in the business of insurance, as well. As per para 3(1)(b) of ICDS VIII, the term Securities’ shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956, other than derivatives. Considering that the definition of securities contained in ICDS VIII specifically excludes derivatives, if an assessee holds derivatives as a part of his inventory, <strong>provisions of ICDS II shall apply</strong>. However, if the derivatives are not held as part of inventory, then such derivatives shall not be governed by the provisions of ICDS II. The definition of the termSecurities’ in para 3(1)(b) of ICDS VIII specifically includes share of a company in which public are not substantially interested. Accordingly, provisions of ICDS II shall not apply to shares of a company in which public are not substantially interested even if these are held as inventory.

  1. Cost of inventories shall comprise of all costs of purchase, costs of services, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.”

5.1. ‘Cost of inventories’ is defined in para 4 of the ICDS. Accordingly,`Cost of inventories shall comprise of all costs of purchase, costs of services, cost of conversion and other costs incurred in bringing the inventories to their present location and condition.’

5.2. The definition of cost of inventories under the ICDS includes cost of services unlike para 6 of the Revised AS 2 which does not cover cost of services. Work in progress in case of service providers is not inventory, as discussed in para 7 below. Further, in case services have been used in manufacture, production or processing of goods, cost of such services will form part of inventory as part of cost of conversion. 

The costs of purchase shall consist of purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates and other similar items shall be deducted in determining the costs of purchase.”

6.1. It may be noted that under the provisions of para 7 of the Revised AS 2, duties and taxes that are subsequently recoverable from the taxing authorities are excluded while arriving at the cost of purchase. Ind AS 2 also provides for exclusion of duties and taxes that are subsequently recoverable from the taxing authorities while arriving at the cost of purchase. ICDS II differs from Revised AS 2, as well as Ind AS 2 in this respect. The ICDS prescribes inclusive method’ while the Accounting Standards prescribeexclusive method’.

6.2. Section 145A of the Act provides that 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.

6.3. Thus, even prior to the ICDS becoming applicable, under the provisions of section 145A, purchases, sales and inventory were required to be valued by including therein the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee. It was therefore necessary to make adjustments to comply with the provisions of section 145A.

One may refer para 23 of the Guidance Note on Tax Audit under section 44AB of the Income-tax Act, 1961 issued by the ICAI. Paras 23.7 to 23.24 deal with deviations from the method of valuation prescribed under section 145A and the effect thereof on the profit or loss to be reported under clause 14(b) of Form 3CD. These sub-paras explain the adjustments to be made to comply with the provisions of section 145A and the procedure for the adjustments to be carried out in case of both, trading and manufacturing concerns.

Costs of services shall consist of labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads.”

7.1. Where services have been utilised in manufacture, production or processing of goods, as stated in para 5.2 above, cost of such services will form part of inventory as part of cost of conversion, under this para.

The issue that one needs to consider is whether a service provider has to value his inventory under this ICDS

Para 2(1)(a)(i) of ICDS III relating to Construction Contracts includes within the scope of the term `construction contract’ a contract for rendering of services which are directly related to the construction of an asset. In such a case provisions of ICDS III will become applicable. Further, para 6 of the ICDS IV relating to Revenue Recognition provides that subject to paragraph 7 of that ICDS, revenue from rendering of services shall be recognised by the percentage completion method. It further provides that requirements of ICDS III relating to Construction Contracts will apply mutatis mutandis. 

7.4. It also provides that when services are provided by an indeterminate number of acts over a specific period of time, revenue may be recognised on a straight-line basis over the specific period. This is a practical way of recognising the revenue from services where earnings are generally evenly spread over the period of service contract.

7.5. Para 7 of ICDS IV provides that revenue from service contracts with duration of not more than ninety days may be recognised when the rendering of services under that contract is completed or substantially completed.

Further, the definition of “inventories” as per paragraph 2(1)(a) does not include work-in-progress of a service provider. It only includes materials or supplies to be consumed in the rendering of services, and not even material actually consumed.

7.7. Considering this, in case of service providers ICDS II will not have application and value of service not fully rendered need not be computed under this ICDS.

Para 8 of Ind AS 2 provides that in the case of a service provider, inventories include the costs of the service for which the entity has not yet recognised the related revenue. Further para 19 of the Ind AS 2 provides for measurement of inventory of service providers taking into account labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads . In case under Ind AS 2 if inventory of service provider has been valued, appropriate adjustment will have to be made while computing the total income.(Not relevant now – To be confirmed)

9.2. Where finished or intermediate product is chargeable to excise duty, the cost of inventory should include the excise duty whether or not it has been actually paid on the date as of which valuation is made. In this respect a reference may be made to the Guidance Note on Accounting Treatment for Excise Duty issued by the ICAI.

 

ICDS – III – Construction Contracts  –

This ICDS is not applicable to real estate developers.

“2(1) The following terms are used in this Income Computation and Disclosure Standard with the meanings specified: 

(a) “Construction contract” is a contract specifically negotiated for the construction of an asset or a combination of assets  that are closely interrelated or interdependent in terms of their design, technology and function or their ultimate purpose or use and includes: 

(i) contract for the rendering of services which are directly related to the construction of the asset, for example, those for the services of project managers and architects; 

(ii) contract for destruction or restoration of assets, and the restoration of the environment following the demolition of assets. 

“9. Contract revenue shall be recognised when there is reasonable certainty of its ultimate collection. 

Contract revenue shall comprise of:

(a) the initial amount of revenue agreed in the contract, including retentions; and 

(b) variations in contract work, claims and incentive payments:

 (i) to the extent that it is probable that they will result in revenue; and 

(ii) they are capable of being reliably measured.

Para 9 stipulates that contract revenue is to be recognized when there is a reasonable certainty of its ultimate collection. Para 21 of AS 7 recommends that contract revenue should be recognized if the outcome of a construction contract can be estimated reliably. The TAS Committee in its final report published during August 2012 addressing the reason for this difference, observed “As per AS-7, contract revenues are recognized if it is possible to reliably measure the outcome of a contract. This issue being subjective in nature has resulted in litigation and postponement of tax liability. Therefore, this condition is removed.”

The expression ‘reasonable certainty’ would, accordingly mean that the contractor should recognize contract revenues only if there is no doubt about collection of such revenues. 

6.4 Under the income tax regime, business receipts are assessable in the year in which the same accrue to the assessee [Section 5 read with section 145(1)]. The concept of ‘accrual’ postulates crystallization of a right in favour of the assessee to receive the income. An income accrues when the payer acknowledges a debt in his favour. In CIT v Excel Industries Ltd (2013) 358 ITR 295 (SC), the Supreme Court after referring to various decisions laid down the following three tests to determine the accrual of income [Para 27 of the decision]. 

(i) Whether the income accrued to the assessee is real or hypothetical;

(ii) Whether there is a corresponding liability of the other party to pay the amount;

(iii) Whether there is a realistic probability of realisation of the amounts by the assessee.

6.5 The stipulation of Para 9 of this ICDS reiterates the third test mentioned above. Mere satisfaction of the same would not, however, amount to accrual of income. For accrual of income under section 5 of the Act, all the three tests outlined above would have to be satisfied. Also, there has to be a corresponding liability on the other party to pay the amount. As the provisions of section 5 prevail over ICDS, the contract revenue should be recognized on satisfaction of the test of accrual and not merely on the basis of reasonable certainty of collection of contract revenue. 

6.6 Para 10 of the ICDS enumerates the components of contract revenue. Clause (a) of Para 10 states that contract revenue shall comprise of initial amount of revenues agreed in the contract including retentions. The ICDS however stipulates that the retention monies are part of the contract revenue.

In applying the percentage of completion method (discussed infra), the income recognition should factor retention amounts also as contract revenue. Whether retention monies accrue before satisfaction of conditions stipulated, remains debatable in the light of the legal understanding of ‘accrual’ under section 5.

AS-7 is silent about treatment of accrual of income in respect of the retention money. There are some judicial pronouncements holding that the retention money is not deemed to have accrued for tax purposes. To overcome this unintended meaning, the TAS (CC) specifically provides that the retention money shall accrue to the person for computing revenue based on the percentage of completion method.”

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 condition contained in para 9 of ICDS-III on Construction contracts.

6.9 Despite the recommendation of the TAS Committee and the clarification contained in the Circular referred above, one would have to ascertain whether the test of accrual under section 5 of the Act would be satisfied. This is because, section 5 being a part of the Act would prevail over ICDS in case there is any conflict between the two. It may be noted that the definition of ‘accrual’ in Para 2(c) of ICDS I is for the purposes of section 145(2). A similar definition already existed in AS I issued under section 145(2) vide Notification No. 9949, dated 25-1-1996. It was nobody’s contention that the said definition altered the understanding of accrual under section 5. The definition of accrual in ICDS I being in a similar setting , should not assume a different meaning or purpose. 

6.16 This ICDS does not cover the second situation envisaged in section 36(1)(vii) viz., where contract revenue not recorded in the books of account, but offered to tax as per ICDS, turns bad. An assessee cannot write-off a debt which was not recorded in the books of account but offered to tax. In such a case, Para 11 of the ICDS cannot be invoked to claim deduction of uncollectible amounts as the same cannot be written-off in the books of account. To illustrate, retention amount is generally recognized in the books of account when the right to receive the same is established. However as per the ICDS, retention amount is to be recognized as contract revenue for tax purposes in proportion to the stage of completion. purposes in proportion to the stage of completion. The assessee having paid tax on the whole or a part of the retention monies would not be in a position to claim deduction towards the uncollectable retention amount as the condition of writing off the bad debts in the books of account would not be satisfied. The deduction under such a situation would, however, be available by virtue of second proviso to section 36(1)(vii). As per the said proviso, bad-debts could be claimed as deduction without a write off in books of account. The condition precedent is that the amount of debt or part thereof has been taken into account in computing the income of the assessee of the previous year in which the amount of such debt or part thereof becomes irrecoverable or of an earlier previous year.

 

ICDS IV – Revenue –

It may be noted that Ind AS 18 -Revenue provides that revenue should be recognised at fair value of the consideration received or receivable. Accordingly, it provides that where the seller has extended interest free credit or credit at low rate of interest and when the arrangement effectively constitutes a financing transaction, the fair value of the consideration is determined by discounting all future receipts using an imputed rate of interest. The difference between the stated consideration and the fair value arrived at by discounting is recognised as interest income (Refer paras 9 to 11 of Ind AS 18 – Revenue). This ICDS does not recognise discounting of consideration. Hence, while computing total income, the revenue should be considered/recognised without discounting.

Further, para 13 of Ind AS 18 – Revenue provides that in certain circumstances, it is necessary to apply the recognition criteria to the separately identifiable components of a single transaction. Similarly, Ind AS 18 – Revenue provides that the recognition criteria are applied to two or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. This may not always be appropriate while applying the provisions of this ICDS depending upon the facts. Considering this, revenue recognised under Ind AS 18 – Revenue should be adjusted wherever necessary to comply with the provisions of the ICDS.

In a transaction involving the sale of goods, the revenue shall be recognised when the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership. In a situation, where transfer of property in goods does not coincide with the transfer of significant risks and rewards of ownership, revenue in such a situation shall be recognised at the time of transfer of significant risks and rewards of ownership to the buyer.  Revenue shall be recognised when there is reasonable certainty of its ultimate collection.

The two cumulative criteria for recognising revenue from sale of goods are:

The seller has transferred the property in the goods to the buyer for a price or significant risks and rewards associated with the ownership of the goods have been transferred to the buyer and the seller has not retained effective control over the goods transferred. Control contemplated here is control that an owner usually has over the goods.

Revenue recognition under IND AS 115 is dealt in 5 steps . The same has to be compared with the two criteria mentioned above and appropriate adjustments shall be made.

Subject to Para 7, revenue from service transactions shall be recognised by the percentage completion method. Under this method, revenue from service transactions is matched with the service transactions costs incurred in reaching the stage of completion, resulting in the determination of revenue, expenses and profit which can be attributed to the proportion of work completed. Income Computation and Disclosure Standard on construction contract also requires the recognition of revenue on this basis. The requirements of that Standard shall mutatis mutandis apply to the recognition of revenue and the associated expenses for a service transaction.

However, when services are provided by an indeterminate number of acts over a specific period of time, revenue may be recognised on a straight line basis over the specific period.

  1. Revenue from service contracts with duration of not more than ninety days may be recognised when the rendering of services under that contract is completed or substantially completed.”

There may be cases where one may have to consider whether the transaction is a service transaction attracting provisions of recognition of revenue based on percentage of completion method. This will depend upon the facts and circumstances of the transaction. Often a transaction involves both, sale of goods and provision of service. In such a case, one will have to examine what is the predominant aspect of the transaction, whether consideration to be received for the transaction can be split into that for sale of goods and for provision of service, etc.

A reference may be made to the decision of the Bombay High Court in the case of DIT v Credit Suisse First Boston (Cyprus) Ltd. [2013] 351 ITR 323 (Bom). Considering this, based on facts and circumstances, where reasonable certainty of recovery of revenue is lacking, it will be appropriate to say that revenue has not accrued at all as contemplated under section 5.

6.4 One may however refer to the clarifications on ICDS contained in Circular no. 10/2017, dated 23rd March, 2017 issued by the CBDT. Question no. 13 and answer thereto are reproduced below:

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 Section 36 (1) (vii). Further, the provision of the Act (e.g. Section 43D) shall prevail over the provisions of ICDS. 

Debt Security –

6.9 A person may hold a debt security for a part of the previous year and may sell the debt security before interest on the same becomes payable in accordance with the terms of such security. He may still have to compute interest for the period during which he was holding the security, although he will not receive any interest. For harmonious construction, while computing the capital gain (or business income in case of a dealer in securities) on transfer of security, the consideration should be reduced by the amount of interest offered for taxation.

The moot question that needs to be considered is whether any part of the full value of consideration which is chargeable to capital gain under section 45 read with section 48, can be taxed as interest on account of provisions of this ICDS. It may be noted that ICDS do not apply for computation of capital gain. It is therefore possible to take a view that where the Act provides the mode of computation of capital gain under section 48 by taking the full value of consideration, no part of such consideration can be taxed as interest under the provisions of ICDS.

Further, where the terms of a debt security provide that interest becomes due on a particular day, say on 30th June and 31st December every year, can it be said that the assessee has acquired a right to receive any interest prior to such date. In this respect a reference may be made to the decision of the Bombay High Court in the case of DIT v Credit Suisse First Boston (Cyprus) Ltd. [2013] 351 ITR 323 (Bom). The Court held that interest accrued only on due dates and the right to receive the interest vested only on the due dates and cannot be said to have accrued on any date other than stipulated date. Considering this decision and also the provisions of section 48, a view can be taken that so far as interest on debt security is concerned, it will accrue only on the due dates specified in terms of the debt security and not on time basis.

ICDS V – Fixed Assets

2.3 Since intangible assets are excluded from the scope of this ICDS, for the purpose of computation of income, the treatment of intangible assets would be based on the normal provisions of the Act and accounting principles. 

While Para 2(1)(a) of this ICDS defines tangible fixed asset, under the Act as well as this ICDS, no monetary threshold is prescribed for any asset to be identified as a tangible fixed asset and therefore all purchases of tangible fixed assets are to be capitalised to their respective blocks of assets as per section 2(11) of the Act. Under AS 10 and Ind AS 16, with regard to purchase of insignificant items, it provides that it may be appropriate to aggregate the value of such items and, on the basis of judgement and materiality of the amount, decide to expense such items in its books. ICDS does not have the concept of materiality and therefore one will have to consider the principle of enduring benefit of the asset for the purpose of treating the particular item as tangible fixed asset. 

Stand-by equipment and servicing equipment are to be capitalised. Machinery spares shall be charged to the revenue as and when consumed. When such spares can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular, they shall be capitalised.”

4.2 Both AS 10 and Ind AS 16 provide that spare parts, stand-by equipment and servicing equipment are to be recognised as assets if they meet the definition of Property, Plant and Equipment. Otherwise, they are classified as inventory. An item of Property, Plant and Equipment shall be recognised as asset, if and only if, it is probable that future economic benefits associated with the item will flow to the entity and the cost can be measured reliably. 

4.3 In cases where, under the tests laid down under AS 10 and Ind AS 16, stand-by equipment, servicing equipment or spares are classified as inventory, but as per this ICDS, these are required to be recognised as tangible assets and necessary adjustment will have to be done in computing the income. In such situations, the amount expended on stand-by equipment, servicing equipment and spares which has been debited to the profit and loss account will have to be reduced from the expenditure to be claimed in computing the taxable income and added to the appropriate block of assets, with corresponding depreciation claim. 

4.4 In this regard reference may be made to the Explanation to section 30 as well as Explanantion to section 31 of the Act which provide that capital expenditure will not be allowed as current repairs.

4.5 Useful reference in the above context may be made to the following

judicial pronouncements

CIT v Sri Mangayarkarasi Mills (P.) Ltd. [2009] 315 ITR 114 (SC)

CIT v Saravana Spinning Mills (P.) Ltd. [2007] 293 ITR 201 (SC)

Surinder Madan v ACIT [2014] 364 ITR 461 (Del)

CIT v H.P. Global Soft Ltd. [2012] 349 ITR 462 (Kar)

Cost of asset –

Both AS 10 and Ind AS 16 define elements of cost in an identical manner and contain several examples of costs that are includible or excludible in the determination of cost of assets. Under both the Accounting Standards, cost includes the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located. However, under this ICDS, in the components of cost such estimated costs of dismantling and removing the item and restoring the site are not included. Such expenditure cannot be considered as expenditure directly attributable in making the asset ready for its intended use. Accordingly, if such expenses have been considered as part of the cost of the fixed asset in the books of account, these may be reviewed and adjustment should be made while computing the total income, by excluding such expenditure from the cost of the fixed asset and arriving at the amount to be included in the block of assets.

“6. The cost of a tangible fixed asset may undergo changes subsequent to its acquisition or construction on account of 

(i) price adjustment, changes in duties or similar factors; or

(ii) exchange fluctuation as specified in Income Computation and Disclosure Standard on the effects of changes in foreign exchange rates.”

5.6 Para 6 of the ICDS contemplates that the cost of a tangible fixed asset may undergo changes subsequent to its acquisition on account of price adjustments, changes in duties etc. or exchange fluctuation. 

5.7 Both AS 10 and Ind AS 16 mandate that the cost of an item of property, plant and equipment should be recognised as an asset only if it is probable that future economic benefits associated with the item will flow to the enterprise and further, such costs can be measured reliably. Under ICDS V, this condition is absent and therefore, the initial recognition of the asset and subsequent addition to the cost due to factors referred above would be made to the cost of the asset regardless of the pre-condition that economic benefits will flow to the enterprise. While computing the total income, to the extent of any expense that is debited to the profit and loss account which, under para 6 of this ICDS, is required to be added to the cost of the asset, this should be reduced from the expenditure in the profit and loss account and added to the written down value of the relevant block of assets.

ICDS VI – Effect of changes in Forex Earnings –

 

ICDS IX – Borrowing Cost-

2.(1) The following terms are used in this Income Computation and

Disclosure Standard with the meanings specified:

(a) “Borrowing costs” are interest and other costs incurred by a person in connection with the borrowing of funds and include:

(i) commitment charges on borrowings;

(ii) amortised amount of discounts or premiums relating to borrowings;

(iii) amortised amount of ancillary costs incurred in connection with the arrangement of borrowings;

(iv) finance charges in respect of assets acquired under finance leases or under other similar arrangements.

3.1 Secton 36(i)(iv) only refers to interest on capital borrowed. However, this ICDS has enlarged the scope and accordingly borrowing cost would include interest and other costs included in the definition in para 2(1)(a)

It needs to be noted that so far as discounts or premiums relating to borrowings, and ancillary costs incurred in connection with the arrangement of borrowings, only the amortised amount is to be considered as borrowing costs, and not the entire amount of discount, premium or ancillary costs. In effect, therefore, the ICDS covers only deferred expenditure for the purposes of capitalisation, if such expenditure is deferred.

The related issue which arises is whether the amortised amount is to be considered as amount amortised in the books of account, or amount amortised for income tax purposes. This question would arise where a particular interest expenditure may be amortised on a different basis in the books of account, and on a different basis in the income tax computation. The concept of amortisation is vis-à-vis accounts, and therefore the amortisation referred to in the definition of “borrowing costs” should be amortisation as per books of account.

3.7 This definition also recognises the finance element of finance lease charges as a borrowing cost, and therefore goes by the substance of a finance lease, rather than its form. This is in accordance with the requirement of an accounting policy following the substance rather than the form, as laid down in ICDS 1 – Accounting Policies. Therefore, this ICDS includes finance charges in respect of assets acquired under Finance lease or similar arrangements as borrowing cost.

Unlike AS 16 and IndAS 23, borrowing costs under this ICDS do not include exchange differences arising from foreign currency borrowings to the extent they are regarded as an adjustment to interest costs. ICDS VI deals with effects of changes in foreign exchange rates, and would therefore apply even to fluctuations in foreign exchange rates in respect of such interest.

Unlike AS 16 and Ind AS 23, where an asset that necessarily takes a substantial period of time to get ready for its intended use or sale alone is a qualifying asset, under ICDS IX, all tangible assets and intangible assets referred to in the definition, irrespective of the period of time to get ready for their intended use, are qualifying assets. It is only in the case of inventories that ICDS IX requires a qualifying period of at least twelve months, in order to fall within the definition of a qualifying asset.

Paragraph 3 requires capitalisation of borrowing costs that are directly attributable to acquisition, construction or production of a qualifying asset as part of the cost of that asset till the asset is put to use. The quantum of borrowing costs to be capitalised is to be determined in accordance with this ICDS. Explanation 8 to section 43(1) provides that borrowing costs incurred for acquisition of an asset, which are relatable to periods after the asset is put to use, cannot be capitalised as part of the cost of the asset.

4.2 Borrowing costs which are allowable as a deduction are not governed by this ICDS, but are governed either by section 36(1)(iii), or by section 57(iii), as the case may be

While section 36(1)(iii) provides that interest paid in respect of capital borrowed for the purposes of the business or profession is an allowable deduction, the proviso to this clause prohibits deduction only in respect of capital borrowed for acquisition of an asset till the date the asset is first put to use. The term “asset” used in this proviso, has to be construed as “capital asset”, given similar usage of the term in section 43(1), as well as section 43A. The proviso therefore applies only to capital assets acquired, and not to stock-in-trade. This has been confirmed by the Bombay High Court in the case of CIT v Lokhandwala Construction Industries (2003) 260 ITR 579 (Bom). Therefore, the provisions of the ICDS are in conflict with section 36(1)(iii). In such an event, in accordance with the ICDS, the provisions of section 36(1)(iii), being a part of the Act, would prevail over the provisions of the ICDS requiring capitalisation of interest on borrowings for the purpose of acquiring stock-in-trade which takes more than 12 months to be ready for sale.

Capitalisation of general borrowing – For the purposes of computation of capitalisation of general borrowing costs, not all tangible and intangible assets are qualifying assets, as is the case for capitalisation of specific borrowing costs, but only those assets which necessarily require a period of 12 months or more for its acquisition, construction or production. In other words, unless the qualifying asset (tangible and intangible asset) necessarily require a period of twelve months or more for its acquisition, construction or production, general borrowing is not required to be capitalised.

Formula for computation of general interest to be capitalised to the cost of the asset has to be vis-à-vis each qualifying asset, and not to be applied to the aggregate of all qualifying assets acquired during the year.

ICDS X – Provision, Contingent Liabilities & Contingent Asset –

The term ‘provision’ is also used in the context of items such as depreciation, impairment of assets and doubtful debts which are adjustments to the carrying amounts of assets and are not addressed in this Income Computation and Disclosure Standard.”

The definition of “contingent liability” is consistent with the definition of the term in both AS 29 as well as Ind AS 37. This definition assumes importance under ICDS X, given the fact that a contingent liability would not be an allowable deduction for the purposes of the computation of the income under the heads “Income from business or profession” and “income from other sources”, as held by the Supreme Court in the case of Indian Molasses Company (P) Ltd v CIT [1959]37 ITR 66(SC).

The main recognition provision is similar to that contained in AS 29. While AS 29 requires that it is probable that an outflow of resources would be required to settle the obligation [with a similar view, having been taken by the Supreme Court in the case of Rotork Controls (supra)], ICDS uses the terminology ‘probable event’ with reasonable certainty. In substance, the meaning of both the terminology would be same.. Ind AS 37, which has similar recognition provision, also requires that it is probable that an outflow of resources is required. However, under Ind AS 37, the present obligation could be legal or constructive.

Paragraph 8 significantly differs from the corresponding provisions contained in paragraph 21 of AS 29 and paragraph 22 of Ind AS 37. While the two Accounting Standards require that it should be virtually certain that the new law will be enacted for an obligation to arise, ICDS X requires that the law should be enacted for an obligation to arise.

The Supreme Court in relation to warranty provision in the case of Rotork Controls, had observed as under:

“Where there are a number of obligations (e.g. product warranties or similar contracts) the probability that an outflow will be required in settlement, is determined by considering the said obligations as a whole. In this connection, it may be noted that in the case of a manufacture and sale of one single item the provision for warranty could constitute a contingent liability not entitled to deduction under Section 37 of the said Act. However, when there is manufacture and sale of an army of items running into thousands of units of sophisticated goods, the past event of defects being detected in some of such items leads to a present obligation which results in an enterprise having no alternative to settling that obligation.”

The principle which emerges from these decisions is that if the historical trend indicates that large number of sophisticated goods were being manufactured in the past and in the past if the facts established show that defects existed in some of the items manufactured and sold then the provision made for warranty in respect of the army of such sophisticated goods would be entitled to deduction from the gross receipts under Section 37 of the 1961 Act. It would all depend on the data systematically maintained by the assessee.”

The Act contains specific provisions for dealing with certain expenditure. Allowability of such expenditure is governed by relevant sections, e.g. provision for contribution to provident fund, gratuity etc. Provision for expenses other than expenses governed by specific section in the Act will be governed by this ICDS.

Contingent Liabilities

“9. A person shall not recognise a contingent liability.”

5.1 This provision is identical to paragraph 26 of AS 29 and paragraph 27 of Ind AS 37. This provision is also consistent with the tax position that a contingent liability is not deductible in computing the total income.

Contingent Assets

“10. A person shall not recognise a contingent asset.

  1. Contingent assets are assessed continually and when it becomes reasonably certain that inflow of economic benefit will arise, the asset and related income are recognised in the previous year in which the change occurs.”

6.1 The requirement of not recognising a contingent asset is consistent with AS 29 and Ind AS 37. However, subsequent recognition of a contingent asset as an asset and its related income require a lesser degree of certainty under ICDS X, which requires reasonable certainty of inflow of economic benefits, as against the two Accounting Standards, both of which require virtual certainty of inflow of economic benefits. Therefore, under ICDS X, the recognition of a contingent asset as an asset with the corresponding income would be sooner than that under Accounting Standards.

Reimbursements

“14. Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement shall be recognised when it is reasonably certain that reimbursement will be received if the person settles the obligation. The amount recognised for the reimbursement shall not exceed the amount of the provision.

  1. Where a person is not liable for payment of costs in case the third party fails to pay, no provision shall be made for those costs.
  2. An obligation, for which a person is jointly and severally liable, is a contingent liability to the extent that it is expected that the obligation will be settled by the other parties.”

7.3 As opposed to the virtual certainty of receipt of reimbursement required by both Accounting Standards for recognition of reimbursements, ICDSX requires reasonable certainty. Therefore, under ICDSX, reimbursement would be required to be recognised once there is reasonable certainty.