SKP Tax Alert
12 June 2015 | Volume 8 Issue 9
Income Computation and Disclosure Standards - A paradigm shift in computing taxable income

The Central Board of Direct Taxes (CBDT) has notified the Income Computation and Disclosure Standards (ICDS)[1] under section 145(2) of the Income Tax Act, 1961 (ITA). The ICDS, as the name suggests, are a set of directions issued by the CBDT to compute taxable income.

The ICDS have a number of subtle variations from the existing Accounting Standards (AS) issued by the Institute of Chartered Accountants of India (ICAI) and the Indian Accounting Standards (Ind-AS), notified by the Ministry of Corporate Affairs. ICDS also provide for substantive disclosures to be made by the taxpayer. The ICDS have a potential of resulting in advancement of taxable income or bringing certain additional items to tax.

The ICDS are effective from 1 April 2015 and will be applied for the first time while calculating the advance tax liability due on 15 June 2015. This alert highlights the list of ICDS issued and examines the salient features of the new regime of computing taxable income under ICDS.

Salient Features
  • ICDS are applicable to all taxpayers irrespective of legal status.
  • ICDS will apply only when the taxpayer follows the mercantile system of accounting. 
  • ICDS are applicable for computing income under the head 'Profits and Gains of Business or Profession' and 'Income from Other Sources' only.
  • ICDS will not affect the taxpayer's books of accounts. All the adjustments arising due to ICDS will have to be considered in the computation of taxable income.
  • ICDS are not applicable for computing 'book profits' under the Minimum Alternate Tax (MAT) provisions.
  • There are no minimum turnover or income criteria specified for the applicability of ICDS. Therefore, ICDS are applicable to taxpayers with small operations as well.
  • In case of a conflict between the ICDS and the ITA, the ITA shall prevail.
Comparison of ICDS with the current Accounting Standards and Ind-AS
Particulars ICDS No. AS Ind-AS
Accounting policies 1 1 8
Valuation of inventories 2 2 2
Construction contract 3 7 115
Revenue recognition 4 9 115
Tangible fixed assets 5 10 16
Effect of change in foreign currency 6 11 21
Government grants 7 12 20
Securities 8 13 32/109
Borrowing costs 9 16 23
Provisions, contingent liabilities, contingent assets 10 29 37

Are ICDS different from Accounting Standards?
The drafting style of ICDS is similar to the Accounting Standards. The ICDS contain provisions for recognition, measurement and disclosure. However, there are some differences between the ICDS and the Accounting Standards which are listed below:
  • Definitions of certain terms under the ICDS have subtle variations as compared to the definitions under Accounting Standards.
  • ICDS are silent about certain accounting treatments permitted under the Accounting Standards.
  • ICDS provide for certain additional requirements which do not feature in the Accounting Standards.
Issues arising from ICDS
The ICDS require taxpayers to re-look at their existing tax positions. Some of the issues that arise from the introduction and application of the ICDS are:
  • ICDS do not override the provisions of the ITA.  Hence, the question that arises is whether ICDS would prevail in case of a conflict between the requirements of the ICDS and a court judgment.
  • The concept of 'prudence' is absent in ICDS. Therefore, provisions for expected expenses or losses may not be deductible, whereas expected income could be charged to tax, though it is not recorded as revenue under the accounting principles.
  • The concept of 'materiality' is absent in ICDS. Hence, recording individual assets of smaller value as expenditure could become questionable.
  • ICDS provide for valuation of inventory for service providers, which is specifically excluded from AS 2. The inventory in such cases would include contracts in progress on the last day of the year but not those that have been completed. The valuation of inventory of services would prove to be cumbersome since the cost involved in rendering services is difficult to determine.
  • Revenue from construction contracts and service contracts must be recognised by a percentage completion method. This is likely to result in income being offered to tax in advance, as compared to the accounting principles.
  • Treatment of premium/discount on forward contracts will be governed by the provisions of ICDS, which appear to differ from existing court judgments.
  • All kinds of government grants would now become taxable, either upfront, or by way of reduced depreciation. This will overrule a series of court judgments on this matter.
  • Borrowing costs must be capitalised according to a special formula provided under the ICDS.  This formula is different from the concept of Weighted Average Cost of Borrowing specified under AS 16.  Also, all fixed assets are considered as 'Qualifying Assets'. Unlike AS 16, there is no requirement that the asset should take a substantial period of time to get ready for the intended use.
  • Several judicial precedents place significant emphasis on treatment for certain items under the generally accepted principles of accounting. With the introduction of ICDS, this emphasis is likely to reduce.
  • ICDS also provide for transitional provisions. These provisions deal with the treatment of items existing on 1 April 2015, when ICDS was enforced. The Transitional Provisions are not very clearly worded and leave room for alternative interpretation.
  • Since ICDS are not to be adopted for maintaining books of accounts, the disclosure requirements provided by ICDS may either be covered in the return of income and/or in the tax audit report. This would require additional time and effort from taxpayers and tax professionals.

[1] Notified vide Notification No. S.O. 892(E) 
What steps should a taxpayer take?
Although the ICDS would apply for computing and filing tax returns for financial year (FY) 2015-16, it would significantly alter the manner of computation of taxable income and its impact would be felt right from the computation of advance tax for FY 2015-16, the first instalment of which would be due on 15 June 2015.

Taxpayers should carry out a detailed analysis of the impact of the ICDS on their business operations and tax outflow. A conscious decision will have to be taken by the taxpayers about areas where the ICDS take a divergent view from Accounting Standards and the legal position under the ITA, including court judgments. The ICDS would also require maintenance of strong and robust documentation to support calculations made under its provisions. In addition, appropriate reconciliation will have to be maintained between the accounting profit and the taxable income.

The accounting system of the taxpayer will have to be geared to provide information required for applying the ICDS. SKP strongly recommends that taxpayers should study and apply the impact of ICDS at the earliest. Carrying out such an exercise at the end of the year may result in shortfalls in the payment of advance tax, thus attracting penal interest. Also, analysing the impact and maintenance of the required documentation at the end of the year could prove to be not only time consuming but also a costly affair.

SKP
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ABOUT THIS TAX ALERT
This SKP Tax Alert contains general information existing at the time of its preparation only. It is intended as a news update and is not intended to be comprehensive nor to provide specific accounting, business, financial, investment, legal, tax or other professional advice or opinion or services. This tax alert is not a substitute for such professional advice or services, and it should not be acted on or relied upon or used as a basis for any decision or action that may affect you or your business. Before making any decision or taking any action that may affect you or your business, you should consult a qualified professional adviser and also refer to the source pronouncement/documents on which this tax alert is based. It is also expressly clarified that this tax alert is not a solicitation or an invitation of any sort whatsoever or a source of advertising from SKP Group or any of its entities to create any adviser-client relationship.

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