The Firm

Show Timings:

Friday: 10.30 pm, Saturday: 11.30 am

Sunday: 9:30am & 11.00pm


ICDS & Interest Deduction

Published on Wed, May 20,2015 | 18:55, Updated at Wed, May 20 at 18:55Source : 

By: Keyur Shah, Tax Partner, EY

The Income-tax Act, 1961 (IT Act) allows interest paid on capital borrowed as a deduction in computing the total taxable income of a tax payer under the head Profits and gains of business or profession. The Finance Act, 2003 introduced provisions to restrict the allowance of the interest expenditure in situations where the borrowed capital is used for acquisition of an asset for extension of existing business (whether capitalised in the books of accounts or not). In such cases, the interest relatable to the period from the date of borrowing till date of asset is put to use is not tax deductible in computing the income from business or profession of a tax payer. Such interest is required to be capitalised from a tax standpoint i.e. added to the cost of acquisition of the capital asset.

Section 145 of the IT Act has accorded powers to the Central Government to notify Income Computation and Disclosure Standards (ICDS) to be followed by any class of taxpayers or in respect of any class of income.  

The Government of India notified ICDS on 31 March 2015, effective from tax year 2015-16 onwards, to be complied by all taxpayers following mercantile method of accounting while computing income under the head Profits and gains of business or profession or Income from other sources.  ICDS IX provides for capitalization of borrowing costs in respect of qualifying assets. Qualifying assets are defined to mean tangible assets, intangible assets and inventories which take more than 12 months to become saleable.

Importantly, the condition ‘for extension of existing business or profession’ (contained in the provisions of the IT Act) in relation to acquisition of an asset for the purposes of capitalizing borrowing costs does not find place in ICDS IX. This resulted in a dichotomy between the provisions of the income-tax laws and ICDS. With a view to align the provisions of the income-tax laws with the ICDS, the Finance Bill 2015 (as amended and passed by the both houses of Parliament) has sought to omit the condition ‘for extension of existing business or profession’ in respect of acquisition of an asset for disallowance of borrowing cost from computing the total business income of assessees. Thus, this amendment widens the asset base in respect of which borrowing costs would be capitalized and hence, results in deferral of the revenue expense claim of tax payers (as the same would now be claimed as depreciation expense on the asset).

It may be noteworthy that there are significant deviations of ICDS IX from Accounting Standard 16 (AS-16) on Borrowing Costs, issued by the Institute of Chartered Accountants of India in respect of capitalization of costs which would result in different borrowing costs being capitalized for accounting and tax purposes.  

One of the critical differences is the criterion of substantial period of time for classifying any asset as qualifying asset. As per AS-16, the substantial period of time for regarding qualifying assets being tangible and intangible assets as well as inventory is 12 months. While the ICDS retains the substantial period condition of 12 months for inventory, there is no period prescribed in the context of tangible and intangible assets. Thus, ICDS requires capitalization of borrowing costs for other tangible and intangible assets even if they do not require 12 months for completion.  

As per the ICDS IX, borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalized as part of the cost of that asset. To the extent funds are borrowed specifically for the purpose of acquisition, construction or production of a qualifying asset, the amount of borrowing cost to be capitalized would be the actual borrowing costs during the period the funds are so borrowed. On the other hand, in case of general borrowings, a normative pro-ration formula is provided for capitalizing borrowing costs having regard to borrowing cost on general borrowings and the total assets of the tax payer. Due to this pro-rata method of calculation, the amount of deduction for borrowing costs is expected to be lower.

Further, the capitalization of specific borrowing costs would commence from date of borrowing whereas AS-16 requires cumulative fulfillment of three conditions i.e. incurrence of capital expenditure, incurrence of borrowing costs and preparatory activities being in progress. Hence, it is virtually certain that the borrowing costs to be capitalized for tax purposes would be higher than those as per AS-16.

To conclude, the deviations from the accounting standards as well as the amendments made to the IT Act are likely to result in higher borrowing costs being capitalized for tax purposes, going forward which would defer the claim of the tax payer who would have otherwise claimed a deduction of such borrowing costs upfront as a revenue expenditure against income of business or profession. Further, this would entail separate sets of books being maintained for accounting and tax purposes which is likely to increase compliance costs.

(Azeem Bundeally, senior tax professional, EY contributed to the article)

(Views expressed are personal)


Copyright © Ltd. All rights reserved. Reproduction of news articles, photos, videos or any other content in whole or in part in any form or medium without express written permission of is prohibited.