ICDS is not meant for passing entries in the books of accounts or preparing financial statements. Its scope is restricted to computation of total income. Taxpayers are required to prepare financial statements as per Generally Accepted Accounting Policies applicable to them. For example, companies are required to maintain books of account and prepare financial statements as per requirements of Companies Act 2013. ICDS 1 does not apply to such taxpayers except Para 4(ii) and paras 6 to 10. ICDS 1 applies to those taxpayers (like individuals , HUF, Partnership firms and LLPs) who prepare financial statements pursuant to section 44AA and 44AB of the Act i.e. for the limited purpose of computation of total income under the Act.
Sections 44AD, 44AE, 44ADA , 44BB , 44BBA etc. deals with a situation where assessee is engaged in business and provides special mechanism for computing income under the Head “Profits & Gains from business” in terms of special deeming provisions for income and deductions. Preamble to each ICDS specifies that in case of a conflict between the provisions of the Act and ICDS, and then the provisions of the Act will prevail. Also, such assessee are not required to maintain any books of accounts and follow any method of accounting, the provisions of section 145(1) does not apply to such assessee and ICDS are notified under section 145 of the Act. Hence, ICDS shall not apply to taxpayers covered by presumptive scheme of taxation like section 44AD, 44AE, 44ADA, 44B, 44BB, 44BBA, etc. Further, for the purposes of proper and efficient administration of ICDS, it is also clarified that ICDS shall not apply to Individuals, HUFs, partnership firms and LLPs who are not required to get their accounts audited under section 44AB of the Act.
In case of conflict between ICDS and other Income Tax Rules, specific Income Tax Rules, 1962 shall prevail.
ICDS will apply for computation of taxable income under the head Profit & Gains of Business under the Income Tax Act. This is irrespective of the accounting standards i.e. either Accounting Standards or Ind-AS.
The computation of book profit for MAT purpose will be as per the existing provisions of the Income Tax Act.
Minimum Alternate Tax under section 115JB of the Act is computed on ‘book profit’ of companies for which start point is net profit as per Profit and Loss Account prepared under Companies Act and which further is subjected to specified upward and downward adjustments. ICDS shall not impact computation of such ‘book profit’ since ICDS is applicable to computation of income under normal provisions of the Act. However, Alternative Minimum Tax under section 115JC of the Act is computed on the basis of total income computed under normal provisions of the Act subject to addition of specified tax incentives. Hence, ICDS shall apply to computation of total income which forms start point for such computation of Alternative Minimum Tax.
It is hereby clarified that ICDS is meant for computation of total income under Income Tax Act 1961 and not for the purpose of maintenance of books of accounts. Taxpayers like Banks, nonbanking financial institutions, insurance companies, power sector, telecom sector, etc. will continue to follow accounting guidelines by its Regulators for maintenance of books of accounts &preparation of financial statements. Further, it is also clarified that ICDS does consider that certain taxpayers may be governed by sector specific guidelines. For example, ICDS VIII relating to securities does not apply to securities held by mutual funds, venture capital funds, banks and public financial institutions. Similarly, ICDS X excludes contingent provisions, contingent liabilities and contingent assets arising in insurance business from contracts with policyholders. Further, there are specific provisions in the Act like sections 42, 43D, 44, Chapter XII-G, etc. which govern taxation of taxpayers governed by sector specific regulations. Therefore, such sector specific taxpayers like Banks, non-banking financial institutions, insurance companies, power sector, telecom sector, etc. will be required to compute taxable income as per ICDS and by sector specific provisions of Income Tax Act,1961 which shall override anything contained contrary in ICDS. However, if there are any specific concerns on application of ICDS, the relevant issues may be forwarded to CBDT through the respective sector regulator for clarification.
The concept of ‘prudence’ precludes recognition of anticipated profit and requires recognition of expected losses. Since this amounts to differential treatment for recognition of income and losses, ICDS I provide that expected losses or mark-to-market losses shall not be recognised unless permitted by any other ICDS. This does not mean that incomes shall be taxed even if it has not accrued to the taxpayers. For example, ICDS IV provides that revenue shall be recognised only when there is reasonable certainty of ultimate collection. ICDS X also provides that contingent assets shall be recognised only when it becomes reasonably certain that inflow of economic benefit will arise. Further, it is also hereby clarified that ICDS does not override the provisions of section 4 and 5 of the Act. The Assessing Officers should consider well settled principles of ‘accrual’ of income based on binding judicial precedents before applying ICDS.
MTM profits or expected incomes shall also not be recognised unless warranted by any other ICDS.
Tax Accounting Standard I notified under Notification No. S.O. 69(E) dated 25 January 1996 permitted change in accounting policy due to change in statute or change for more appropriate presentation of financial statements. Those shall continue to be recognized under ICDS I. Further, taxpayer shall be permitted to change accounting policy for any other ‘reasonable cause’ which will depend upon facts and circumstances of each case.
ICDS IV read with ICDS III requires all service providers to recognise revenue on the basis of ‘Percentage of Completion Method’ (POCM). Under POCM, the work done till year end is recognised as revenue based on percentage of completion till that date. Hence, there is no requirement to value inventory of work in progress arising in ordinary course of business of service providers under ICDS II. As in case of ICAI AS-2, ICDS II shall apply to other items of inventories of service providers.
It is clarified that if the tax assessee has been following standard costing method on regular basis then tax payer may continue to follow the same.
The intent of transitional provisions of ICDS is to ensure that neither any income is doubly taxed nor any income escapes from taxation in view of implementation of ICDS. Accordingly, it is clarified that if a taxpayer has hitherto been following Completed contract method, he shall be required to recognize contract revenue, costs and profits as per Percentage of Completion Method from 1 April 2015. However, contract revenue, costs and profits for work done till 31 March 2015 shall be recognized in the year of completion of project as per erstwhile method. The taxpayer is not required to recognize entirety of profits/loss incurred on the contract till 31 March 2015 in F.Y. 2015- 16.
Similarly, if the taxpayer has already recognized foreseeable loss on entirety of the contract prior to 31 March 2015, Para 22 of ICDS III does not require reversal of such loss in F.Y. 2015-16. It merely requires recognition of incremental loss or profit based on percentage of work completed till 31 March 2016.
The relevant provisions of ICDS III worth noting are that ICDS III Para 6 prescribe Contract Revenue comprises of “Retention Money”. Para 1(c) defines “Retentions are amounts of progress billing which are not paid until satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified”. Para 4 provides Contract Revenue shall be recognized when there is reasonable certainty of its ultimate collection. Therefore, like contract revenue, retention money should be included as part of contract revenue only on satisfaction of performance criterion i.e. on reasonable certainty of ultimate collection.
The Accounting Standards Committee has recommended that separate ICDS should be notified for real estate development activity, BOT projects and Leases. A draft ICDS on Leases was also published for public comments but not finally notified. Hence, pending notification of specific ICDS to deal with these revenue items, they shall continue to be governed by existing tax laws. It is clarified that ICDS III and ICDS IV do not apply to these business activities.
Para 5 ICDS IV provides where ability to access the ultimate collection with reasonable certainty is lacking at time of raising any claim for escalation of price and export incentive, revenue recognition in respect of such claim shall be postpones. Whereas AS 9 Para 9.2 provides similar provision for “interest etc.” also apart from claim for escalation of price and export incentive. To harmonize the ICDS with settled principle laid down at ED Sasson& Co. Ltd 26 ITR 27 (SC) &Godhra Electricity Co. Ltd 225 ITR 746 (SC) which provides unless there is established right to receive income, no tax shall be received it is Para 9 of ICDS III provides that revenue should be recognized when there is reasonable certainty of its ultimate collection. Hence, if revenue can be earned only if a particular milestone is Para 9 of ICDS III provides that revenue should be recognized when there is reasonable certainty of its ultimate collection. Hence, if revenue can be earned only if a particular milestone is clarified that similar to AS 9 Para 9.2 the conditions of Para 5 ICDS IV shall be also applicable to income from interest, royalty and dividend
ICDS is applicable to those sources of incomes which are assessable on net basis and does not apply to incomes liable to tax on gross/presumptive basis. This is because specific provisions of the Act shall prevail over ICDS.
POCM is prescribed to remove alternative between completed contract method and POCM available under ICAI AS-9 and to bring uniformity in computation of total income of all taxpayers. It is not intended to increase compliance burden for taxpayers in case of short duration contracts. Hence, for a proper and efficient administration of ICDS and as a measure to remove any hardships for taxpayers, it is directed that Assessing Officers shall examine compliance of POCM only for long duration service contracts which are expected to exceed one year duration. Service contracts which are not expected to last for more than a year shall be recognized as per accepted method of accounting regularly employed under section 145.
Para 9 of ICDS III provides that revenue should be recognized when there is reasonable certainty of its ultimate collection. Hence, if revenue can be earned only if a particular milestone is achieved (e.g. success fee model), ICDS IV read with ICDS III does not require recognition of such revenue until the milestone is achieved. Where taxpayers adopt POCM under ICAI AS-9 and recognize revenue as per specific criteria representing percentage of work completed till year end, such basis shall be ordinarily acceptable for the purposes of ICDS IV. Such basis for determining stage of completion may include ‘time’ or SLM basis in certain circumstances where such basis represents the most appropriate criteria for revenue recognition like AMC contracts. The method of recognition of revenue as illustrated in Appendix to ICAI AS-9 for different types of service contracts are consonant with ICDS IV. It is also clarified that it is only where taxpayers follow Completed Service Method in their books as per ICAI AS-9 that ICDS IV will require them to adopt POCM for tax purposes.
A taxpayer is free to choose the method of determining stage of completion from three alternatives provided in ICDS III and such choice will be binding on the Tax Authority unless, in the opinion of the Assessing Officer, such method does not result in reflection of correct income of the taxpayer. However, with a view to reduce litigation and provide certainty to taxpayers, it is clarified that Assessing Officer shall take prior approval of jurisdictional CIT/PCIT before rejecting method adopted by the taxpayer and also provide the taxpayer a reasonable opportunity of being heard and raise its objections. The Assessing Officer shall consider the objections raised by the taxpayer and pass a speaking order on the same before proceeding with the assessment.
It is also clarified that if the taxpayer has been following POCM as per ICAI AS-9 for recognition of service contracts prior to notification of ICDS which has been accepted in past concluded assessments and there is no pending litigation on correctness of method as on 1 April 2015, the Assessing Officer shall not dispute the method of accounting adopted by the taxpayer unless the Assessing Officer proves that there was fraud or misrepresentation of facts by the taxpayer.
AS 10 provides option to treat such expenditure either as deferred revenue expenditure to be spread over 3 to 5 years or as revenue expenditure to be fully written off in year of incurrence. Since, the Act does not recognize the concept of deferred revenue expenditure; post-trial run expenditure shall be allowable in full in year of incurrence. This is also buttressed by the ratio of judgment reported at NTPC Ltd 357 ITR 253 (DEL) wherein it has been held that assessee was entitled to Depreciation in respect of capital construction equipment which was not used by contractor but ready for use. This principle is also supported by the provision of section 3 of the income tax act where the expenditure is allowed once the business is setup. Hence, the expenditure incurred after the trial run should be allowed as revenue expenditure.
ICDS VI and Para 4(ii) of ICDS I do not apply to banks and authorized dealers which offer derivative products to their constituents under guidelines prescribed by RBI. ICDS VI and Para 4(ii) of ICDS I apply to the constituents which enter into such contracts with the banks and authorized dealers.
ICDS permits exchange loss on monetary items to be recognised as an expense and exchange gain as income based on closing rate subject to sections 43A and Rule 115. ‘Monetary items’ are money held and assets to be received or liabilities to be paid in fixed or determinable amounts of money, e.g. receivables, payables. Section 43A covers exchange difference relating to foreign exchange liability or borrowing for acquisition of an imported asset. The similar treatment should also be followed for the assets acquired from India. This will align with the accepted principal of law that the loss / gain on capital item is neither deductible nor taxable.