CA NIHAR JAMBUSARIA [email protected] [email protected] Income Computation And Disclosure Standards (ICDS)

CA NIHAR JAMBUSARIA

[email protected]

[email protected]

Income Computation And Disclosure Standards (ICDS)

Contents

• Background

• General principles

• ICDS V - Tangible fixed assets

• ICDS VI - Foreign exchange fluctuations

• ICDS X – Provisions, Contingent liabilities and Contingent assets

Background

Section 145(1) of the Income-tax Act, 1961 (Act) stipulates that the method of accounting for computation of income under the heads “Profits and gains of business or profession” and “Income from other sources” can either be cash or mercantile system of accounting.

Section 145(2) of the Act states that the Central Government may notify the accounting standards to be followed by any class of assesses or in respect of any class of income.

Accordingly, two tax accounting standards had been notified until now:

1. Disclosure of accounting policies

2. Disclosure of prior period and extraordinary items and changes in accounting policies

Background

Finance Act, 2014 amended section 145(2) of the Act to substitute “accounting standards” with “income computation and disclosure standards” (ICDS).

The CBDT constituted the Accounting Standards Committee which had earlier issued draft 14 Tax Accounting Standards in 2012. On the basis of the suggestions and comments received from the stakeholders, CBDT had revised and issued 12 draft ICDS for public comments.

On 31st March, 2015, the Central Government has notified 10 our of the 12 draft ICDS which shall be effective from 1st April, 2015.

The introduction of ICDS may significantly alter the way companies compute their taxable income.

General principles

ICDS are applicable for computation of income chargeable under the head “profits and gains of business or profession” and “income from other sources” and not for maintaining books of accounts.

ICDS applies to all taxpayers

In case of conflict between the provisions of the Act and ICDS, the provisions of the Act shall prevail to that extent.

o What if in case of conflict between HC / SC rulings and ICDS?o The risk of best judgment assessment u/s 144 if positions adopted as

per ICDS which is contrary to rulings.

ICDS applies only to taxpayers following mercantile system of accounting.

Tangible Fixed Assets

AS- 10 ICDS It applies to tangible fixed assets

as well as goodwill It applies to only tangible fixed

assets. Cost of fixed asset comprises its

purchase price, non refundable taxes and any directly attributable cost of bringing the asset to its working condition for its intended use.

It has similar definition to AS 10 but the words used are actual cost as compared to cost in AS -10.

Impact:The Act provides for the definition of the term ‘actual cost’ and it is again repeated in the ICDS but it does not modify the concept of actual cost. However when there is conflict in interpreting the abovementioned term under ICDS and Act, the Act will prevail over ICDS. Such a narrow definition in ICDS might encourage the taxpayer to contend that expenditure on acquisition which is not part of actual cost should be deductible as revenue instead of capitalising.

AS- 10 ICDS

AS 10 read with guidance note on Machinery for Spares provides for charge to P/L, however spares to specific asset should be capitalised and shall form part of that Asset .

It provides that machinery spares which can be used only in connection with an item of tangible fixed asset and their use is expected to be irregular, shall be capitalized.

Impact:ICDS specifies that machinery spares dedicated to a tangible fixed asset should be capitalized, it does not provide any further guidance on subsequent treatment that whether it will form part of the block of the asset. However, in absence of such clarification spares would form part of the block and once the principal asset is put to use, the spares shall qualify for the depreciation at the same rate.

Assets acquired against non-monetary consideration

AS- 10 ICDS When a fixed asset is acquired in

exchange or in part exchange for another asset, the cost of acquired asset should be recorded either at FMV or NBV of asset given up, adjusted for any balancing payment or receipt of cash or other consideration.

When a tangible fixed asset is acquired in exchange for other asset, the fair value of the tangible fixed asset so acquired shall be its actual cost

Fixed asset acquired in exchange for shares or other securities in the enterprise should be recorded at its FMV, or the FMV of the securities issued, whichever is more clearly evident.

When a tangible fixed asset is acquired in exchange for shares or other securities, the fair value of the tangible fixed asset so acquired shall be its actual cost.

Usual Practice: Concept of cost should normally relate to what is given up.

Assets acquired for a consolidated price

AS- 10 ICDS

Para 15.3 says that when several assets are purchased for consolidated price, the consideration is apportioned on fair basis as determined by competent valuers.

When several assets are purchased for a consolidated price, the consideration shall be apportioned to the various assets on a fair basis.

Impact: In absence of determination by registered valuers in ICDS words “fair basis” becomes subjective and might be prone to litigation.

Misc.

Depreciation on a tangible fixed asset and income arising on transfer of a tangible fixed asset shall be computed in accordance with the provisions of the Act.

The requirement of maintenance of ICDS specific tangible fixed asset register as proposed earlier has been done away with.

The Effects of Changes in Foreign Exchange Rates

Revenue monetary items (like trade receivables, payables, bank balance, etc.)

AS- 11 ICDS

Reported using the closing rate Exchange difference recognised in

P&L A/c Allowed under the Act also.

Converted into reporting currency by applying the closing rate

Recognised as income or expense subject to provisions of Rule 115

Impact: No change in tax position

Revenue non-monetary items (like inventory)

AS- 11 ICDS Impact Which are carried in

terms of historical cost denominated in a FC - Reported using the exchange rate at the date of the transaction

Converted into reporting currency using the exchange rate at the date of the transaction.

No exchange difference would arise under both

No change in the position

Which are carried at fair value or other similar valuation denominated in a FC - Reported using the exchange rates that existed when the values were determined i.e. closing rate.

Converted into reporting currency using the exchange rate at the date of the transaction.

No exchange difference would arise as per ICDS. Hence, the FE gain/loss as per the books of accounts will have to be reduced/ added back respectively while computing the taxable income.

Revenue non-monetary items (like inventory)

The impact of this deviation by ICDS from the provisions of AS may be understood with the help of following illustration:

Particulars Amount in Forex

Exchange Rate

Value

Cost $100 55 as on date of acquisition

Rs.5,500

NRV $50 60 closing rate i.e. at B/S date

Rs.3,000

Valuation at lower of cost or NRV ($100 or $50) i.e. $50

As per AS 11 Rs.3,000 (50*60)

As per ICDS Rs.2,750 (50*55)

Applicability of AS 22

This will result into creation of Deferred Tax Liability (DTL) as per AS 22 “Accounting for Taxes on Income”

DTL will be created on difference of valuation of Inventory as per Taxation and as per Books of accounts

= Rs. 3000 – Rs. 2750 = Rs. 250 * Applicable Tax Rate

When stock will be sold, in that year it will result into reversal of DTL.

Applicability of Ind AS 12 and Ind AS 21

• Those companies which are voluntarily complying with the Ind AS for accounting periods beginning on or after 1st April, 2015 for them its applicability is explained. Even otherwise for the purpose of providing comparatives statement companies need to comply with Ind AS from financial year 2015-16.

• In Ind AS 12 “Income Taxes” Balance Sheet approach is followed which focuses on “Temporary Difference” whereas in AS 22 Profit & Loss Statement approach is followed which focuses on “Timing Difference”.

• According to Ind AS 21 “The effect of changes in foreign exchange rates” Non-monetary items carried at fair value, Rate as of date of fair value determination will be considered

• Temporary differences are differences between the carrying amount of an asset or liability in the balance sheet and its tax base. So effect will remain same under Ind AS 12 also and DTL (According to Ind AS parlance “Taxable temporary differences”) will be created.

Capital monetary items – Relating to Imported assets

AS- 11 ICDS Requires recognition in P&L A/c. Option of capitalization u/s 211(3C) of

companies Act, 1956 as per which (Para 46 & 46A) exchange differences arising in case of long-term foreign currency monetary items shall be either adjusted to capital asset or accumulated in FCMITDA.

Requires recognition in P&L A/c subject to provisions of Section 43A.

No Para 46 & 46A exists.

Impact: Presently, Section 43A permits capitalization on payment basis of

exchange differences relating to asset acquired from a country outside India.

Hence, there would be no change in the tax position.

Capital monetary items – Not relating to Imported assets

AS- 11 ICDS Requires recognition in P&L A/c. Option of capitalization u/s 211(3C) of

companies Act, 1956 as per which (Para 46 & 46A) exchange differences arising in case of long-term foreign currency monetary items shall be either adjusted to capital asset or accumulated in FCMITDA.

Requires recognition in P&L A/c subject to provisions of Section 43A.

No Para 46 & 46A exists.

Impact: Section 43A does not apply since it applies only if it relates to the

imported assets. Presently, such FE differences are not recognized for tax purposes

i.e. gain is not taxable, loss is not deductible/ allowable.

Capital monetary items – Not relating to Imported assets

Judicial precedents

Section 43A of the Act was introduced by the Finance (No. 2) Act, 1967 with effect from 1st April, 1967.

In the case Tata Iron & Steel [TISCO - (1998) 231 ITR 285 (SC)] for the case relating to AY 1960-61 and AY 1961-62 (When Section 43A was not introduced), Supreme Court had held that cost of an asset and cost of raising money for purchase of asset are two different and independent transactions and events subsequent to acquisition of assets cannot change price paid for it. Therefore, fluctuations in foreign exchange rate while repaying instalments of foreign loan raised to acquire asset cannot alter actual cost of assets for computing depreciation.

Capital monetary items – Not relating to Imported assets

Hence, given that the provisions of Section 43A requiring foreign exchange gain/loss to be adjusted with the cost of the assets, apply only with respect to imported assets, the case of indigenous assets will continue to be governed by the ratio of the Tata Iron & Steel’s decision.

Gains arising on deposits (in foreign currency) are capital receipt as the deposits were in essence loan/capital and not a trading receipt - Shell Company of China Ltd. [22 ITR 1 (CA)]

If the foreign currency is held as a capital asset or as fixed capital, profit or loss to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, would be of capital nature. - Sutlej Cotton Mills Ltd., [(1979) 116 ITR 1 (SC)]

Capital monetary items – Not relating to Imported assets

Conclusion

Since ICDS requires recognition in P&L A/c subject to provisions of Section 43A and Section 43A applies only if it relates to imported assets, a controversy may arise, whether such exchange fluctuation gain or loss on capital monetary items (not relating to imported assets) would be allowable as an income or expense as per ICDS or not.

May be considered as non-cognizable for tax purposes based on its Capital nature.

It is also arguable that judicial settled position would remain unchanged as the Act shall prevail in case of conflicts with ICDS.

Foreign operationsAS - 11 ICDS

Foreign Operation is a subsidiary, associate, joint venture or branch of the reporting enterprise, the activities of which are based or conducted in a country other than the country of the reporting enterprise.

“Foreign operations of a person” is a branch, by whatever name called, of that person, the activities of which are based or conducted in a country other than India.

Impact: The definition of foreign operations given under ICDS does not include a subsidiary, associate or joint venture of the reporting enterprise. Hence, the tax positions will remain the same in the case of foreign operations being a subsidiary, associate or joint venture of the person

Integral operations – No change in tax positions

Non-integral foreign operationsAS - 11 ICDS

Exchange Differences arising on translating monetary items of non-integral foreign operations shall be transferred to “Foreign Currency Translation Reserve”(FCTR).

Exchange Differences arising on translating of assets and liabilities both monetary and non monetary of non integral foreign operations shall be recognised as “income or expense” in that previous year.

Impact: FE differences arising from the translation of the financials on MTM

basis will have to be considered in Computation of Income Statement. Capital and revenue items are not distinguished in ICDS. MTM to be

recognised even on tangible fixed assets. Recognition of the amount lying in the FCTR on 31st March, 2015. In case of change of foreign operations from integral to non-integral

and vice-versa, no adjustment is required for the foreign exchange difference, since unlike AS, no FCTR is maintained under ICDS.

AS 22 Applicability

DTL or DTA will be created as the case may be due to the above difference.

E.g. Suppose Exchange Differences arising on translating financial statements of non-integral foreign operations results into FE income.

This will result into creation of DTA subject to condition of AS 22 i.e. consideration of prudence and virtual certainty as to sufficiency of future taxable income in case of unabsorbed depreciation or carry forward of losses under tax laws.

On disposal of Net Investment in Non Integral Operation, according to AS 11 the balance in FCTR will be recognized as income which will result into reversal of DTA.

AS 11 ICDS

Foreign Currency Translation Reserve (FCTR)

Treated as income for tax purpose

Applicability of Ind AS 12 and Ind AS 21

As per Ind AS 21, the exchange difference shall be recognized in “Other Comprehensive Income (OCI)”. It is a form of reserve forming part of equity.

So effect under Ind AS will also be same and results into creation of DTA (According to Ind AS parlance deductible temporary differences)

Comparison between AS 11 and Ind AS 21Particulars AS - 11 Ind AS 21

Exchange Difference on foreign operation

Exchange Differences arising on translating monetary items of non-integral foreign operations shall be transferred to Foreign Currency Translation Reserve” (FCTR).

Exchange Differences arising on translating monetary items of foreign operations shall be transferred to Other Comprehensive Income (OCI)

Functional currency

There is no concept of determining functional currency by the entities

Functional currency is defined as the currency in which it primarily generates and expends cash.

E.g. Entity A operates an oil refinery in Saudi Arabia having local currency as riyal. All of the entity's income is denominated and settled in US dollars. Accordingly, the functional currency of entity A is USD.

Cont.Particulars AS - 11 Ind AS 21 Initial

Recognition

A foreign currency transaction should be recorded in the reporting currency

Foreign currency transaction shall be recorded in functional currency

Use of a presentation currency other than the functional

currency

No such concept Exchange differences shall be recognized in other comprehensive incomeE.g. In case of an entity preparing financial statements in USD (functional currency), balance sheet amounts are translated into INR (presentation currency) at the closing rate and income statement items are translated into INR at average rates for the period. Any exchange differences arising from opening to closing rates, and average to closing rates, is recorded in other comprehensive income.

Forex derivatives – Forward exchange contractsPurpos

eAS - 11 ICDS Impact

Hedging – Capital account

Premium/discount is amortized over the life of contract.

Restated on MTM basis at year end and difference is recognized in P&L.

Profit/loss on cancellation or renewal is also recognized in P&L.

Same as AS – 11

Impact:As per the Act, FE difference is capitalized to imported asset on actual settlement, if it is related to imported asset. If not related to imported assets, exchange difference may give rise to capital gains but only on actual settlement and not on MTM basis. However, ICDS requires FE differences to be recognized as revenue income/ expense which is contrary to the judicial settled position under the Act.

Hedging –Revenue account

Same as above Same as above

No change in tax position in relation to contracts on revenue account

Impact of Hedging – Capital account Explained with the help of Following Illustration

On 01-01-16, XYZ Ltd. imported asset from USA on credit, payment to be made $ 100000 on 30-06-16. On 01-01-16 itself it entered into a forward exchange contract to mitigate the risks associated with changes in exchange rates. The exchange rates (Rs. per US $) are as belowPeriod 01-01-

1631-03-16 30-06-

16

Spot Rate 60 63 65

Forward rate (for six months) 62

Forward rate (for three months) 64

F.Y. AS 11 ICDS VI Section 43A of IT Act, 1961

Premium (Amortized over period of contract)

Forward Exchange Gain

Loss due to increase in Liability

Premium (Amortized over period of contract)

Forward Exchange Gain

Loss due to increase in Liability

15-16

(1) [62-60]/2

3 [63-60]

(3)* [63-60]

(1) [62-60]/2

3 [63-60]

Nil*

16-17

(1) [62-60]/2

2 [65-63]

(2)* [63-60]

(1) [62-60]/2

2 [65-63]

Nil*

5 [65-60] Capitalized

Rs. In Lakhs Cont.

The above differential treatment for loss will result into creation of DTA and then reversal of DTA due to depreciation difference because of capitalization. * The Loss due to increase in Liability recognized in Statement of Profit & Loss will have to be added back while computing Profit and Gain for Business and Profession as the same will be capitalized as per Section 43A of IT Act, 1961 and not allowed as deduction.

Forex derivatives – Forward exchange contracts

Purpose AS - 11 ICDSOthers (i.e. trading, speculation, firm commitment, highly probable forecast)

Marked to market at each balance sheet date and the gain or loss be recognised in the P&L a/c.

No amortization of premium/ discount.

Premium, discount or exchange difference on contracts be recognised at the time of settlement only.

Impact:SB ruling in Bank of Bahrain & Kuwait (41 SOT 290) which relied on SC ruling in Woodward Governor’s case supports MTM recognition. Contradiction would arise between the ICDS and settled position under the Act.

Forex derivatives – Other Other forex derivatives like, futures, interest rate swaps, etc. are

not covered by ICDS VI.

ICDS I on accounting policies provides that marked to market loss or an expected loss shall not be recognized unless the recognition of such loss is in accordance with the provisions of any other Income Computation and Disclosure Standard. .

Hence, in case of forex derivatives not covered by ICDS VI, ICDS I would apply.

Forward exchange contract includes foreign currency option contract also.

Provisions, Contingent Liabilities and Contingent Assets

Recognition of provisionsAS - 29 ICDS

Provisions shall be recognised if it is probable that outflow of economic resources will be required.

Provision is not discounted to NPV

Provisions shall be recognised if it is reasonably certain that outflow of economic resources will be required.

Provision is not discounted to NPV

Impact: The criteria for recognition of provisions on the basis of the test of

‘probable’ (i.e. more likely than not criteria) replaced with the requirement of ‘reasonably certain’.

In the absence of definition and scope of ‘reasonably certain’ criteria, an ambiguity would arise on assessment of ‘reasonably certain’ criteria.

In the Act, there is no specific provision for recognition of provisions. However, provisions are allowed based on accrued liabilities as per ordinary principles of commercial accounting.

Recognition of provisionsImpact:

Provision for Warranty is allowed as an expenditure upholding the test of ‘probable’ warranty obligation in the following judgments.

o Rotork Controls India P. Ltd. (2009) 314 ITR 62 (SC) (extract on next slide)

o Himalaya Machinery (P) Limited v DCIT 334 ITR 64o CIT vs. Luk India P. Ltd. 52 DTR 117.o Siemens Public communication Networks Limited v CITo CIT v Indian Transformer Limited. 270 ITR 259

Recognition of provisionsRotork Controls India (P.) Ltd. v. CIT [2009] 180 TAXMAN 422 (SC)

A provision to qualify for recognition, there must be a present obligation arising from past events, settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate of amount of obligation is possible.

If historical trend indicates that in past large number of sophisticated goods were being manufactured and defects existed in some of items manufactured and sold, then provision made for warranty in respect of army of such sophisticated goods would be entitled to deduction from gross receipts under section 37(1), provided data is systematically maintained by assessee.

Meaning of obligationAS 29 ICDS

Clarifies that obligations may be legally enforceable and may also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.

No specific guidance on meaning of ‘obligation’

Impact:

Provisions made on obligations recognized out of customary business practices or voluntary obligations may not be allowed. (e.g. informal refunds policy to dissatisfied customers, employee welfare, etc.)

Onerous executory contractsAS - 29 ICDS

AS-29 is not applicable to “executory contracts” except where contract is onerous.

Since “onerous contracts” are excluded from executory contracts, AS is applicable to onerous contracts.

Requires upfront recognition of liabilities under onerous contracts

It is not applicable to “executory contracts”.

However, here “onerous contracts” are not specifically excluded from executory contracts.

Impact:Deduction for the accrued liabilities on onerous contracts in books will be allowed in a year in which liability to pay arises.

Contingent assets & reimbursement claims

AS - 29 ICDS Contingent assets/

reimbursement claims are recognized if inflow of economic benefits/ reimbursement is “virtually certain”.

Contingent assets/ reimbursement claims to be recognized if inflow of economic benefits/ reimbursements is “reasonably certain”.

Impact: Revenue authorities may contend that ‘reasonably certain’ is a

lower threshold than ‘virtually certain’. It is not made clear whether transitional provision requires

recognition of all past accumulated contingent assets in F.Y. 2015-16.

Conclusion

All the ICDS, except ICDS on Securities, have incorporated transitional provisions according to which the provisions of ICDS may apply retrospectively in certain cases and prospectively in some other cases.

The ICDS should also entail appropriate modifications in the return of income and Form No. 3CD.

The ICDS seem to be based on the current AS issued by ICAI. However, listed companies are required to adopt IND AS from 1st April, 2016. Thus, the accounting policies for these companies under IND AS could be significantly different from ICDS.

Thus, providing clarity on the tax position in ICDS in alignment with the IND AS is also essential.

Thank You