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IND-AS: Income Computation & Disclosure Standards

Published on Mon, Apr 06,2015 | 19:21, Updated at Mon, Apr 06 at 19:21Source : 

By: Dolphy D’Souza, Partner,  India member firm of EY Global

The Indian Accounting Standards (Ind AS), the Indian version of International Financial Reporting Standards, will have significant impact on financial statements for many entities.  Ind AS’s are meant to primarily serve the needs of investors and hence are not suitable for the purposes of tax computation.  A clear need was felt for tax accounting standards that would guide the computation of taxable income.

The Central Government (CG) constituted a Committee in December 2010, to draft Income Computation and Disclosure Standards (ICDS).  Section 145 of the Indian Income tax Act bestows the power to the CG to notify ICDS to be followed by specified class of taxpayers or in respect of specified class of income.

In August 2012, the Committee provided drafts of 14 standards which were released for public comments by the CG. After revisions,  the CG has now notified 10 ICDS effective from the current tax year itself (viz. tax year 2015-16) for compliance by all taxpayers following mercantile system of accounting for the purposes of computation of income chargeable to income tax under the head “Profits and gains of business or profession” or “Income from other sources”.

Earlier, the CG had notified two standards in 1996 viz., (a.) Accounting Standard I, relating to disclosure of accounting policies. (b.) Accounting Standard II, relating to disclosure of prior period and extraordinary items and changes in accounting policies. They now stand superseded. These standards were largely comparable to the current AS corresponding to AS 1 & AS 5.  

ICDS are meant for the normal tax computation.  Thus, as things stand now, ICDS has no impact on minimum alternate tax (MAT) for corporate taxpayers which will continue to be based on “book profit” determined under current AS or Ind AS, as the case may be.

ICDS shall apply to all taxpayers whether corporate or otherwise.  Further, there is no income or turnover criterion for applicability of ICDS. An entity need not maintain books of accounts to compute income under ICDS.  However, if the differences between ICDS and Ind AS/current AS as the case may be are several, an entity may need to evolve a more sophisticated system of tracking them as against doing it manually on an excel spread sheet.  It is possible that the current tax audit requirements will be enhanced to require auditors to report on the correctness of tax computation under ICDS.  Noncompliance of ICDS gives power to the Tax Authority to assess income on “best judgement” basis and also levy penalty on additions to returned income.

List of ICDS

Following is the list of 10 ICDS notified w.e.f. 1 April 2015:

1.    ICDS I relating to accounting policies
2.    ICDS II relating to valuation of inventories
3.    ICDS III relating to construction contracts
4.    ICDS IV relating to revenue recognition
5.    ICDS V relating to tangible fixed assets
6.    ICDS VI relating to the effects of changes in foreign exchange rates
7.    ICDS VII relating to government grants
8.    ICDS VIII relating to securities
9.    ICDS IX relating to borrowing costs
10.    ICDS X relating to provisions, contingent liabilities and contingent assets

Key differences between ICDS and current AS

A few key differences between ICDS and current AS are given below:

•    ICDS I prohibits recognition of expected losses or mark-to-market losses unless permitted by any other ICDS.
•    During the early stages of a contract, where the outcome of the construction contract cannot be estimated reliably contract revenue is recognised only to the extent of costs incurred. This requirement is contained both in AS 7 and ICDS III.  However, unlike AS 7, ICDS III states that the early stage of a contract shall not extend beyond 25 % of the stage of completion.
•    AS 7 requires a provision to be made for the expected losses on onerous construction contract immediately on signing the contract.  Under ICDS III, losses incurred on a contract shall be allowed only in proportion to the stage of completion. Future or anticipated losses shall not be allowed, unless such losses are actually incurred.
•    Under AS 9 revenue from service transactions is recognized by following “percentage completion method” or “completed contract method”. Under ICDS IV only percentage of completion method is permitted.
•    Under AS 11, all mark-to-market gains or losses on forward exchange or similar contracts entered into for trading or speculation contracts shall be recognized in P&L.  In contrast, ICDS VI requires gains or losses to be recognized in income computation only on settlement.
•    Under AS 11, exchange differences on a non-integral foreign operation are not recognized in the P&L, but accumulated in a foreign currency translation reserve.  Such a foreign currency translation reserve is recycled to the P&L when the non-integral operation is disposed.   Under ICDS VI, exchange differences on non-integral foreign operations shall also be included in the computation of income.  
•    Under AS 12, government grants in the nature of promoter’s contribution are equated to capital and hence are included in capital reserves in the balance sheet.  Under ICDS VII government grants should either be treated as revenue receipt or should be reduced from the cost of fixed assets based on the purpose for which such grant or subsidy is given.
•    Under AS 12 recognition of government grants shall be postponed even beyond the actual date of receipt when it is probable that conditions attached to the grant may not be fulfilled and the grant may have to be refunded to the government.  Under ICDS VII, recognition of Government grants shall not be postponed beyond the date of actual receipt.
•    Under AS 16 in the case of borrowings in foreign currency, borrowing costs include exchange differences to the extent they are treated as an adjustment to the interest cost.  Under ICDS IX borrowing cost will not include exchange differences arising from foreign currency borrowings.
•    AS 16 requires the fulfillment of the criterion “substantial period of time” for treating an asset as qualifying asset for the purposes of capitalization of borrowing costs.  ICDS IX retains substantial period condition (i.e. 12 months) only for qualifying assets in the nature of inventory but not for fixed assets and intangible assets. Therefore, ICDS requires capitalisation of borrowing costs for tangible and intangible assets even when they are completed in a short period.
•    Under ICDS IX, capitalisation of specific borrowing cost shall commence from date of borrowing.  Under AS 16, borrowing cost is capitalized from the date of borrowing provided the construction of the asset has started.
•    Unlike AS 16, income on temporary investments of borrowed funds cannot be reduced from borrowing costs eligible for capitalization in ICDS IX.
•    Unlike AS 16, requirement to suspend capitalization of borrowing costs during interruption of active construction of asset is removed in ICDS IX.
•    Under ICDS X a contingent asset is recognized when the realization of related income is “reasonably certain”.  Under AS 29 the criterion is “virtual certainty”.

Impact of ICDS
The notification of ICDS was imperative to ensure smooth implementation of Ind AS, and therefore should have maintained a tax neutral position. Unfortunately ICDS are not tax neutral vis-à-vis the current Indian GAAP and tax practices currently followed and may give rise to litigation. For example, based on AS 7 Construction Contracts, the current practice is to recognise any expected loss on a construction contract as expense immediately. In contrast, ICDS will require expected losses to be provided for using the percentage of completion method.

ICDS I lays out the “accrual concept” as a fundamental accounting assumption.  The prohibition on recognizing expected or mark-to-market losses appears to be inconsistent with the accrual concept.  Though mark-to-market losses are not allowed to be recognized, there is no express prohibition on recognizing mark-to-market gains.  The ICDS therefore appear to be one sided, determined to maximize tax collection, rather than routed in sound accounting principles.  Matters such as these are likely to create litigious situations despite the Supreme Court decision in the Woodword Governor case where the status of ICDS is upheld.

The preamble of the ICDS states that where there is conflict between the provisions of the Income-tax Act, 1961 and ICDS, the provisions of the Act shall prevail to that extent.  Consider that a company has claimed mark-to-market losses on derivatives as deductible expenditure under section 37(1) of the Income-tax Act.  Can the company argue that this is a deductible expenditure under the Income-tax Act (though the matter may be sub judice) and hence should prevail over ICDS which prohibits mark-to-market losses to be considered as deductible expenditure?  

Consider that a company receives a government subsidy for non-depreciable asset. Hitherto, it was accepted that it is a capital receipt not falling within the definition of ‘income’ and did not impact business income computation. Can the company argue that such receipt cannot be taxed in absence of amendment to definition of ‘income’ and hence should prevail over ICDS which requires such receipt to be recognized as income over the period of meeting related obligations? These are untested areas, and could be litigated.

All ICDS (except ICDS VIII relating to Securities) contain transitional provisions.  These transitional provisions are designed to avoid double jeopardy.  For example, if foreseeable loss on a contract is already recognized on a contract at 31 March 2015, those losses will not be allowed as a deduction again on a go forward basis using the percentage of completion method.  On the other hand, if only a portion of the loss was recognized, the remaining foreseeable loss can be recognized using the percentage of completion method.  The detail mechanism of how this will work is not clear from the ICDS.

The transitional provisions are not always absolutely clear.  In the case of non-integral foreign operations, e.g., non-integral foreign branches, ICDS requires recognition of gains and losses in the P&L (tax computation), rather than accumulating them in a foreign currency translation reserve.  It is not absolutely clear from the transitional provision whether the opening accumulated foreign currency translation reserve, which could be a gain or loss, will be ignored or recognised in the first transition year 2015-16.  Since the amounts involved will be huge, particularly for many banks, the interpretation of this transitional provision will have a huge impact for those who have not already considered the same in their tax computation in past years.

Some of the transitional provisions are also expected to have a material unanticipated effect.  For example, the ICDS requires contingent assets to be recognized based on reasonable certainty as compared to the existing norm of virtual certainty.  Consider a company has filed several claims, where there is reasonable certainty that it would be awarded compensation.  However, it has never recognized such claims as income, since it did not meet the virtual certainty test under AS 29.  Under the transitional provision it will recognize all such claims in the first transition year 2015-16.  If the amounts involved are material, the tax outflow will be material in the year 2015-16.  This could negatively impact companies that have these claims.  The interpretation of “reasonable certainty” and “virtual certainty” would also come under huge stress and debate.   This may well be another potential area of uncertainty and litigation.

Overall, the CG through CBDT will have to play a highly pro-active role to provide clarity and minimize the potential areas of litigation.


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