SEMINAR ON

Income Computation and Disclosure Standards -

Analytical Study

10th August, 2015

At

Emami Conference Hall

6, Lyons Range, 3rd Floor, Unit-2

Kolkata -700 001

Organized by

ACAE Chartered Accountants Study Circle - EIRC

Income Computation and Disclosure Standards- Analytical Study

1.1Original and Need

The Apex Court in the case of J.K.Industries Ltd Vs UOI(2008) 297 ITR 176(SC) in a long judgement while considering the question as to “whether AS 22 entitled “accounting for taxes on income” in so far as it relates to deferred taxation is inconsistent with and ultra vires the provisions of the Companies Act,1956(“the Companies Act”) , the Income-tax Act,1961 (“the I.T.Act”) and the constitution of India, While rejecting the arguments of the appellants, the supreme court observed in a long judgement as follows:-a) Meaning and purpose of Accounting Standards(AS)

In its origin, AS is a policy statement or document framed by the Institute. AS establish rules relating to recognition, measurement and disclosures thereby ensuring that all enterprises that follow them are comparable and that their financial statements are true, fair and transparent. AS are based on a number of accounting principles. They seek to arrive at the true accounting income. One such principle is matching principle. The other is the fair value principle. The aim of the Institute is to go for a paradigm shift from the matching to the fair view principle.

The main object sought to be achieved by Accounting Standards which is now made mandatory is to see that accounting income is adopted as taxable income and not merely as the basis from which taxable income is to be computed. Thus if the rules by which inventories are to be valued are laid down in the Accounting Standards and are followed in the determination of Accounting Income, then tax laws doesn’t need to lay down the rules and the tax authorities do not need to examine the computation of the value of inventories and its effect on computation of income. Similarly if there is an Accounting Standard on depreciation which requires estimation of the useful life and prescribes the appropriate method for apportionment of the cost of fixed asset over their useful life , it is unnecessary for the tax laws to apply an artificial rule to decide the extent of allowance for depreciation.

Finally, the adoption of Accounting Standards and of accounting income as taxable income would avoid distortion of accounting income which is real income.

Under Section 211(3A) Accounting Standards framed by the National Advisory Committee on Accounting Standards constituted under Section 210A are now made mandatory. Every Company has to comply with the said standards. Similarly under Section 227(3)(d) every auditor has to certify whether the

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profit and loss account and balance sheet comply with the accounting standards referred to in Section 211(3C). Similarly, under section 211(1) the company accounts have to reflect a “true and fair” view of the state of affairs. Therefore the object behind insistence on compliance with the AS and “true and fair” accrual is the presentation of accounts in a manner which would reflect the true income/profit. In our view, the provisions of the Companies Act together with the rules framed by the Central Government constitute a complete scheme. Without the rules, the Companies Act cannot be implemented. The impugned rules framed under section 642 are a legitimate aid to construction of the Companies Act as contemporaneaexpositio. Many of the provisions of the Companies Act like computation of book profit, net profit etc cannot be put into operation without the rules.Para 79In our view, it is the statutory function given to the central government to frame Accounting Standards in consultation with the National Advisory Committee on Accounting Standards(NAC) under Section 211(3C). It is not necessary for the Central Government to adopt in every case the Accounting Standards issued by the Institute. Nothing prevents the Central Government from enacting its own Accounting Standards which may not be in consonance with the standards prescribed by the Institute. Similarly, nothing prevents the Central Government from adopting the standards issued by the Institute as is the case in the present matter.

This seems to be genesis of the matter. The accounting Standards which were so far working fine were done away with by the Central Government by enacting its own accounting Standards. There can be difference in the Accounting profit and taxable income of a Company because of the differences in reporting period and because of the fact that ICAI AS enabled an entity with flexibility of alternative accounting treatments which made it possible for a taxpayer to avoid payment of correct taxes by choosing a particular system.While accounting profit is computed based on the accounting standards, or generally accepted accounting policies(GAAP), the taxable income is calculated using the provisions of Income-tax Act,1961 and Rules and thus need was felt to standardise the alternatives in various standards so that the income for tax purposes can be computed precisely as per the Act.

Matching Concept of Accounting

Matching concept is a very significant concept of accounting. According to this concept income and expense must be recognised in the period to which they relate. In India Profit & Loss is computed with two different set of provisions one set is profit and loss as per the Companies Act, 2013(earlier it was Companies Act, 1956( and the second one is Profit & Loss as per Income-tax Act,1961. The root cause of difference between Income as per these two acts is different treatment given to some items of income and expenditure and transactions. Some of these items are as follows:-

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1. Treatment of Interest during Construction period2. Valuation of inventories3. Depreciation rates4. Accounting for changes in foreign exchange difference5. Accounting for investment6. Accounting for Impairment of assets7. Revenue recognition8. Deferred revenue expenditure9. Prepaid expenses- claimable under the Income-tax in one year as against

accounting where it can be claimed year to year- Recent Supreme Court judgement to give.Treatment of work-in-progress in case of construction companies.Morvi Industries ltd – 82 ITR 835(SC).Recognition of revenue pauses problem where in reality it may not be feasible to account the same as income and this causes the problem.

There can be other reasons also. Thus it has been seen that time and again courts have interpreted the accounting standards in different manner as far as their effect is to be given for the purposes of computation of Income under the Income-tax Act, 1961 and therefore the need for Income Computation and Disclosure Standards can be said to have arisen.

1.2 Income Computation and Disclosure Standards- Details of Introduction

Chapter XIV of the Income Tax Act, 1961 deals with the “Procedure for Assessment”. The provisions of Section 145 of the Income Tax Act, 1961 are contained in Chapter XIV as mentioned above.

As a matter of fact, Section 145 of the Income Tax Act, 1961 traces its history to the provisions of Section 13 of the Indian Income Tax Act, 1922, which read as follows:

“13. Method of accounting.—Income, profits and gains shall be computed, for the purposes of sections 10 11* and 12, in accordance with the method of accounting regularly employed by the assessee:Provided that, if no method of accounting has been regularly employed, or if the method employed is such that, in the opinion of the Income-tax Officer, the income, profits and gains cannot properly be deduced therefrom, then the computation shall be made upon such basis and in such manner as the Income-tax Officer may determine.”

The said section was incorporated as Section 145 in the new Act and the section had been divided into two sub–sections. Sub-section (1) covered the cases where the accounts were correct and complete. The first proviso empowered in case the method employed did not reveal proper income, an assessment on a different basis and manner thought fit by the Assessing Officer. Section 145 (2) dealt with situation where the accounts were not correct and complete, or where no method of accounting had been regularly employed by the assessee. In such cases, the Assessing Officer was empowered to make best judgment assessment in the manner provided in Section 144. The latter portion was not provided in the 1922 Act.

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Hence, after a series of amendments in Section 145 of the Income Tax Act, 1961, the Finance Act, 1995 (w.e.f. 1-4-1997) brought into existence a substituted section which read as follows:

“Method of accounting.

145.      (1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

(2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of assesses or in respect of any class of income.

(3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.

The scope and effect of it have been elaborated by the department in Circular No. 717 dated 14th August, 1995. Paragraph number 44.1 of the circular read as follows:

“Methods of accounting and accounting standards for computing income

44.1 Section 145(1) of the Income-tax Act prior to its amendment by the Finance Act, 1995, provided for computation of income from business or profession or income from other sources in accordance with the method of accounting regularly employed by the assessee. Income is generally computed by following one of the three methods of accounting, namely, (i) cash or receipts basis, (ii) accrual or mercantile basis, and (iii) mixed or hybrid method which has elements of both the aforesaid methods. It was noticed that many assesses are following the hybrid method in a manner that does not reflect the correct income. The Finance Act, 1995, has amended section 145 of the Income-tax Act to provide that income chargeable under the head ‘Profits and gains of business or profession’ or ‘Income from other sources’ shall be computed only in accordance with either the cash or the mercantile system of accounting, regularly employed by an assessee. The first proviso to sub-section (1) of section 145 has been deleted.”

After the above mentioned amendments, today we finally have Section 145 of the Income Tax Act, 1961 as amended by the Section 52 of the Finance (No. 2) Act, 2014 (w.e.f. 01.04.2015) wherein the words “accounting standards” have been substituted by “income computation and disclosure standards”. The term “income computation and disclosure standards” was introduced in clause 50 of the Finance (No.2) Bill, 2014. Clause 50 of the Finance (No.2) Bill reads as follows:

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“Section 145 of the Act provides 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 the cash or mercantile system of accounting. The Finance Act, 1995 empowered the Central Government to notify Accounting Standards (AS) for any class of assesses or for any class of income. Since the introduction of these provisions, only two Accounting Standards relating to disclosure of accounting policies and disclosure of prior period and extraordinary items and changes in accounting policies have been notified.

The Central Government had constituted an Accounting Standard Committee vide Order dated 20thDecember, 2010 comprising of officials of the Tax authorities and professionals with the following terms of reference:

1. To study the harmonisation of the ICAI AS with the Indian Tax Laws and to suggest the accounting standards for tax compliance under the Income-tax Act, 1961 with suggestions for modifications

2. To suggest a method for determination of tax base for the purpose of computation of MAT in case of companies migrating to IND AS in the initial year of adoption and thereafter.

3. To suggest appropriate amendments to the Tax Laws in view of the transition to the IND AS.

The Committee has submitted its Final Report in August, 2012. The Committee recommended that the AS notified under the Act should be made applicable only to the computation of taxable income and a taxpayer should not be required to maintain books of account on the basis of AS notified under the Act. The Final Report of the Committee was placed in public domain for inviting comments from stakeholders and general public. After examining the comments/suggestions, the Committee inter alia recommended that the provisions of section 145 of the Act may be suitably amended to clarify that the notified AS are not meant for maintenance of books of account but are to be followed for computation of income.

In order to clarify that the standards notified under section 145(2) of the Act are to be followed for computation of income and disclosure of information by any class of assesses or for any class of income, it is proposed to provide that the Central Government may notify in the Official Gazette from time to time income computation and disclosure standards to be followed by any class of or in respect of any class of income. It is further proposed to provide that the Assessing Officer may make an assessment in the manner provided in section 144 of the Act, if the income has not been computed in accordance with the standards notified under section 145(2) of the Act.

This amendment will take effect from 1st April, 2015 and will, accordingly, apply in relation to the assessment year 2015-16 and subsequent assessment years.”

Earlier, Accounting Standard I and Accounting Standard II were notified under Section 145 (2) of the Income Tax Act, 1961 under NO. 9949 [F. NO. 132/7/95-TPL], DATED 25-1-1996.

Now we have a set of ten Income Computation and Disclosure Standards notified as on 31st March, 2015 by Notification no. 32/2015 F. No. 134/48/2010‐TPL.

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1.3 Difference between Accounting Standards (AS), Indian Accounting Standards (IndAS), Tax Accounting Standards (TAS) and Income Computation and Disclosure Standards (ICDS)

In exercise of the powers conferred by section 133 read with section 469 of the Companies Act, 2013 (18 of 2013) and sub-section 210A of the Companies Act, 1956 (1 of 1956), the Central Government, in consultation with the National Advisory Committee on Accounting Standards came up with a notification on the 16th of February, 2015. The notification announced the Companies (Indian Accounting Standards) Rules, 2015. These rules came into force on the 1st day of April, 2015.

In rule 4 of the Companies (Indian Accounting Standards) Rules, 2015, it has been clearly that the companies and their auditors mentioned in this rule shall mandatorily comply with IndAS for preparation of their financial statements and audit respectively. The companies mentioned in this rule are:

(i) any company may comply with the Indian Accounting Standards (Ind AS) for financial statements for accounting periods beginning on or after 1st April, 2015, with the comparatives for the periods ending on 31st March, 2015, or thereafter;

(ii) the following companies shall comply with the Indian Accounting Standards (Ind AS) for the accounting periods beginning on or after 1 st April, 2016, with the comparatives for the periods ending on 31st March, 2016, or thereafter, namely:-

(a) companies whose equity or debt securities are listed or are in the process of being listed on any stock exchange in India or outside India and having net worth of rupees five hundred crore or more;

(b) companies other than those covered by sub-clause (a) of clause (ii) of subrule (1) and having net worth of rupees five hundred crore or more;

(c) holding, subsidiary, joint venture or associate companies of companies covered by sub-clause (a) of clause (ii) of sub- rule (1) and sub-clause (b) of clause (ii) of sub- rule (1) as the case may be; and

(iii) the following companies shall comply with the Indian Accounting Standards (Ind AS) for the accounting periods beginning on or after 1 st April, 2017, with the comparatives for the periods ending on 31st March, 2017, or thereafter, namely:-

(a) companies whose equity or debt securities are listed or are in the process of being listed on any stock exchange in India or outside India and having net worth of less than rupees five hundred crore;

(b) companies other than those covered in clause (ii) of sub- rule (1) and sub clause (a) of clause (iii) of sub-rule (1), that is, unlisted companies having net worth of rupees two hundred and fifty crore or more but less than rupees five hundred crore.

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(c) holding, subsidiary, joint venture or associate companies of companies covered under sub-clause (a) of clause (iii) of sub- rule (1) and sub-clause (b) of clause (iii) of sub- rule (1), as the case may be:

Provided that nothing in this sub-rule, except clause (i), shall apply to companies whose securities are listed or are in the process of being listed on SME exchange as referred to in Chapter XB or on the Institutional Trading Platform without initial public offering in accordance with the provisions of Chapter XC of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009.”

Further, sub-rule 2 of Rule 2 of the Companies (Indian Accounting Standards) Rules, 2015 states that Accounting Standards as mentioned in the annexure to the Companies (Accounting Standards) Rules, 2006 shall be the Accounting Standards applicable to the companies other than the classes of companies specified in rule 4 (as given above). Hence, we can conclude that companies other than those mentioned in Rule 4 shall continue to apply the Accounting Standards notified in Companies (Accounting Standards) Rules, 2006.

Further we see that, the Government had constituted a committee in July 2002 for formulation of Accounting Standards for the purpose of notification under the Income Tax Act. This Committee recommended for notification of the Accounting Standards issued by the ICAI without any modification along with consequentiallegislative amendments to the Act for preventing any revenue leakage.Subsequently, the CBDT constituted another Committee to harmonize the AccountingStandards issued by the ICAI with the provisions of the Act for the purposes of notification under theAct and also to suggest amendments to the Act necessitated by transition to IndAS/IFRS. The Committee recommended that the Accounting Standards to be notified under the Act may be termed as "Tax Accounting Standards" (TAS), to distinguish the same from the Accounting Standards issued by the ICAI. The Committee examined all the thirty one Accounting Standards issued by the ICAI and noted that some of the Accounting Standards issued by the ICAI relate to 'disclosure' requirement, whilst some other contain matter that are adequately dealt within the Act. In view of this, the Committee recommended that Tax Accounting Standards need not to be notified in respect of seventeen Accounting Standards issued by the ICAI. The Committee then formulated the drafts of Tax Accounting Standards on the issues covered by the rest of the fourteen Accounting Standards issued by the ICAI. After continuous review, the CBDT again came up with a set of twelve draft Income Computation and Disclosure Standards (TAS being renamed) on the 8th of January, 2015 which was open for public comments until 8th of February, 2015. Hence, finally on the 31st day of March, 2015, CBDT came up with notification no. 32/2015 [F. No. 134/48/2010 – TPL]/ SO 892(E) issuing ten Income Computation and Disclosure Standards (ICDS) listed as below:

Serial No.

ICDS No. Name of the standard

1 I Accounting Policies2 II Valuation of inventories3 III Construction contracts4 IV Revenue recognition

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5 V Tangible fixed assets6 VI Effects of changes in foreign exchange rates7 VII Government Grants8 VIII Securities9 IX Borrowing Costs10 X Provisions, contingent liabilities and

contingent assets

The chart below gives a detail of the Accounting Standards issued by the ICAI which were recommended for notification under the Act by the Committee and the ones which were not recommended.

Serial No.

AS No. Recommended - Topic AS No. Not Recommended -

Topic1 1 Disclosure of

Accounting Policies3 Cash Flow Statements

2 2 Valuation of Inventories

6 Depreciation Accounting

3 4 Contingencies and Events Occurring After the Balance Sheet Date

14 Accounting for Amalgamations

4 5 Net Profit or Loss for the Period, Prior Period Items and changes in AccountingPolicies

15 Employee Benefits

5 7 Construction Contracts 17 Segment Reporting6 9 Revenue Recognition 18 Related Party Disclosures7 10 Accounting for Fixed

Assets20 Earnings Per Share

8 11 The Effects of Changes in Foreign Exchange Rates

21 Consolidated Financial Statements

9 12 Accounting for Government Grants

22 Accounting for Taxes on Income

10 13 Accounting for Investments

23 Accounting for Investments in Associates in Consolidated finance Statements

11 16 Borrowing Costs 24 Discontinuing Operations12 19 Leases 25 Interim Financial

Reporting13 26 Intangible Assets 27 Financial Reporting of

Interests in Joint Ventures

14 29 Provisions, Contingent Liabilities and

28 Impairment of Assets

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Contingent Assets15 30 Financial Instruments :

Recognition and Measurement

16 31 Financial Instruments : Presentation

17 32 Financial Instruments : Disclosures

1.4 Key Features of ICDS

1) Effective Date of ICDS is 01st April, 2015 i.e. FY: 2015-16 & AY: 2016-17.

2) ICDS applicable to all assesses i.e. Corporate & Non Corporate Assesses.

3) No Net Worth or Turnover Criteria Prescribed for applicability.

4) ICDS is meant for giving clarity in certain contentious tax issues and disclosures thereof. It does not mandate requirement of separate books of accounts to be maintained.

5) In the case of conflict between the provisions of the Income‐tax Act, 1961 and Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent.

6) ICDS requires certain disclosures to be made. However, it is not prescribed as to how and where to disclose such items. It is thus expected that Tax audit report and Tax return format may further undergo significant changes to accommodate such disclosures.

1.5 A short detailed comparison between AS and ICDS has been stated below:

1. AS 1 and ICDS I: Accounting Policies

The AS specified that the primary consideration for selection of accounting policies by an enterprises is that the financial statements prepared and presented on the basis of such accounting policies should represent a true and fair view of the state of affairs of the enterprise as at the balance sheet date and of the profit or loss of the period ended on that date and criterion for selection in the Accounting Standard 1 was three fold:-a) Prudenceb) Substance over formc) Materiality

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However, ICDS does not recognizes the concept of prudence and rather only mentions about the disallowance of recognition of expected losses or marked to market losses unless specifically permitted by any other standard.It may be noted that currently no ICDS provides for dealing with mark to market losses on derivatives. Moreover, without prudence being recognised in ICDS, there is a likely hood that income may be recognised earlier than when it should have been or expenses may be delayed from recognised.In this regard, it may be noted that ICDS II provides for valuation of inventories at cost or lower of net realisable value, whichever is lower. ICDS has remained silent on the treatment of mark-to-market unrealized gains.As opposed to this, under the Indian AS, mark to market losses are provided in view of the concept of prudence. Expected losses are also provided in accordance with the relevant Indian GAAP standards. In this regard, the apex court judgement of Vazir Sultan Tobacco is relevant.

Also, a major concept – materiality has also been removed in the current ICDS I. In auditing materiality pertains to the largest number (threshold) of uncorrected errors, misstatements, or erroneous disclosures or omissions that exist in the financial statements and yet are not misleading. The auditor plans and executes an audit with a reasonable expectation of detecting material misstatements. Keeping the above in mind, ICDS I might cause implementation problems in the treatment of unadjusted audit differences which may need to be considered in computing the taxable income.

Another change which might slightly affect the tax authorities is that ICDS does not define the term “reasonable cause”. Hence, since it does not permit a change in the accounting policy without any reasonable cause, it might end up into litigations and thereafter judgments of the authorities. The present AS has been interpreted by several courts and have held certain fundamental principles underlying change of accounting policies. However, whether they will fit into the parameters of “reasonable cause” is to be seen in coming days and months and years.

The AS 1 specifies that all significant accounting policies adopted in the preparation and presentation of financial statement should be disclosed. The disclosure of the significant accounting policies as such should form part of the financial statements and the significant accounting policies should normally be disclosed at one place. However under the ICDS there is no such mandate as to the place of disclosure. It has also been specified that the disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item. Often it is seen that the accounting policies state that this is the policy adopted which is though consistently followed but not in accordance with the Accounting Standards issued by ICAI or now may be CBDT.

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AS 1 recognises that in the following areas different accounting policies may be adopted by different enterprises:a) Methods of depreciation, depletion and amortisationb) Treatment of expenditure during constructionc) Conversion or translation of foreign currency Loansd) Valuation of inventoriese) Treatment of goodwillf) Valuation of investmentsg) Recognition of profits on long term contractsh) Valuation of fixed assetsi) Treatment of contingent liabilities

Though the above list is not an exhaustive list and there can be other items too.

Important cases

1. [1959] 37 ITR 1 (SC) SUPREME COURT OF INDIACalcutta Co. Ltd.v.Commissioner of Income-tax

Section 28(i) , read with section 145 of the Income-tax Act, 1961 (Corresponding to section 10(1), read with section 13 of the Indian Income-tax Act, 1922) - Business deductions - Allowable as - Assessment year 1948-49 - Assessee dealt in land and property and carried on land developing business - It maintained its accounts in mercantile method - In relevant accounting period it sold certain plots and even though assessee received only a portion of sale price, it entered in credit side of its account books whole of sale price of plots - Under terms of side deeds assessee undertook to carryout developments within six months from date of sale - Accordingly, it estimated a sum as expenditure for developments to be carried out in respect of plots sold out during relevant year and debited said sum in its books of account as accrued liability - Department did not take any exception to said estimated expenditure in regard to quantum but disallowed assessee's claim for deduction of that sum by relying upon provisions of section 10(2) of 1922 Act - Whether estimated expenditure which had to be incurred by assessee in discharging a liability which it had already undertaken under terms of sale-deeds of lands in question was an accrued liability which according to mercantile system of accounting assessee was entitled to debit in its books of account for accounting year as against receipts which represented sale proceeds of said lands - Held, yes

2. AS 2 and ICDS II: Valuation of Inventories

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ICDS II specifies various categories of inventories which are not to be valued as per ICDS II and they are :-a) Work in progress arising under construction contract including

directly related to service contractwhich is dealt with by Income Computation and Disclosure standard on construction contracts.

b) Work in progress dealt with by any other ICDSc) Shares, debentures and other financial instruments held as stock in

trade which are dealt with by ICDS on securities.d) Producers inventories of livestock, agriculture and forest products,

mineral oils, ores and gases to the extent that they are measured at net realisable value.

e) Machinery spares, which can be used in conjunction with a tangible fixed asset and their use is expected to be irregular, shall be dealt with in accordance with ICDS on tangible fixed assets. In this regard, Accounting Standards Interpretation(ASI) 2 has been issued which deals with which machinery spares are covered under AS 2 and AS 10 and what should be the accounting for machinery spares under the respective standards.

The definition of inventory remains the same under both the standard. The cost of purchase under the ICDS includes duties and taxes even if

subsequently recoverable from taxing authorities. This is in line with the provisions of Section 145A of the Income-tax Act,1961. However, under the AS, the cost of purchase doesn’t include duties and taxes if subsequently recoverable from taxing authorities, though Section 145A overrides Section 145.

A major change which has been brought in the newly formulated ICDS is the removal of Standard cost method as a technique for the measurement of cost of inventories. This may cause a problem for the assessees valuing their inventories using standard cost method. They will have to now value their inventories using the retail method or any other method prescribed for the purpose of taxation. Companies Act, prescribes Standard Cost method under the maintenance of cost record rules.

ICDS provides that the inventory of a service provided is to be valued at cost or net realisable value whichever is lower and cost of services to consist of labour and costs of personnel directly engaged in providing the services including supervisory personnel and attributable overheads. Under the AS-2 which did not provide for valuation of work in progress arising in ordinary course for the service providers. This Chartered Accountants now have to value inventory of services provided and report the same which until now was not being done. Difficulty may arise where the changeability itself depend on success of the services.

ICDS II specifies that the value of the inventory of a business as on the beginning of a previous year shall be the cost of inventory available if any, on the day of commencement of the business when the business has

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commenced during the previous year. Under the AS-2 there is no specific mention about the opening inventory.In cases of conversion of capital assets into stock in trade, they having been specifically dealt with in Section 45(2) of the Act, there may not be any issues. If a partner takes over running business of Firm/LLP, then the value agreed with other partners for inter settlement shall be the cost to the partner.

Another major issue which might arise due the effective changes is the rise of litigations due to the unexplained term “reasonable cause”. ICDS II says that method of valuation of inventory shall not be changed without a reasonable cause. It has not given any description on the meaning of the phrase “reasonable cause” which shall again lead to the interruption of tax authorities for analyzing the reasonability of the change in method by any assessee. AS 2 specifies that the method of valuation of inventories may be changed if it is considered that the change would result in a more appropriate presentation.

ICDS II deals with valuation of inventory in case of certain dissolutions and says that in case of dissolution of a partnership firm or association of persons or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at net realisable value. There being no specific provision to allow such NRV as cost to the successor of the business, there may be difficulties. In this regard,the decision of the Apex Court in the case of ALA Firm 189 ITR 225(SC) in this regard may be referred to. Also the decision of the Apex Court in the case of Sakthi Trading Co Ltd Vs CIT (2001) 250 ITR 871 may be looked into. The existing AS 2 has no such mechanism because of the assumption of going concern.

Regarding interest and borrowing cost, Para 11 of the ICDS II states that interest and borrowing costs shall not be included in the cost of inventories , unless they meet the criteria for recognition of interest as a component of the cost as specified in ICDS on borrowing cost. In this regard, it may be noted that ICDS on borrowing costs defines qualifying asset interalia as “inventories that require a period of twelve months or more to bring them to a saleable condition and thus only these types of inventory is eligible for inclusion of borrowing cost in the inventory. However, in Para 25 of this ICDS dealing with transitional provisions it has been stated that the interest and borrowing costs, which do not meet the criteria for recognition of interest as a component of the cost as per para11 but included in the cot of opening inventory as on the 1st day of April, 2015 shall be taken into account for determining costs of such inventory for valuation as on the close of the previous year beginning on or after 1stday of April, 2015 if such inventory continue to remain part of inventory as on the close of the pervious year beginning on or after 1st

day of April, 2015. The disclosure requirement specifies that the accounting policies

adopted in measuring inventories including the cost formulae used and 14 | P a g e

the total carrying amount of inventories and its classification appropriate to a person.

Important Cases

1. [1991] 54 TAXMAN 499 (SC)SUPREME COURT OF INDIACommissioner of Income-tax v.British Paints India Ltd.

Section 145 of the Income - tax Act, 1961 - Method of accounting - Valuation of closing stock - Assessment years 1963-64 and 1964-65 - Assessee - company was engaged in business of manufacture and sale of paints - It had valued goods in process and finished products exclusively at cost of raw materials and totally excluding overhead expenditure, i.e., stock-in-trade was valued at 84.49 per cent representing actual cost of raw material and overhead charges representing 15.51 per cent of total cost had been excluded from assessee's valuation of stock - Whether ITO was justified in rejecting assessee's method of valuation and in holding that assessee's goods in process and Finished products were liable to be valued at 100 per cent of cost which included overhead expenditure and not at 84.49 per cent as claimed by assessee - Held, on facts, yes2. [1991] 55 TAXMAN 497 (SC)SUPREME COURT OF INDIAA.L.A.

Firmv.Commissioner of Income-tax

Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as - Assessment year 1961-62 - On dissolution of assessee-firm, its stock-in-trade was revalued and certain amount was shown as 'difference on revaluation' in the profit and loss account - Whether, having valued stock-in-trade at market price, partners of assessee could not contend that valuation should be on some other basis and, thus, such surplus on valuation was to be charged to tax as profits of firm - Held, yes

3. [2007] 161 TAXMAN 162 (SC)SUPREME COURT OF INDIACommissioner of Income-tax, Udaipur*v.Hindustan Zinc Ltd.

Section 145 of the Income-tax Act, 1961 - Method of accounting - Valuation of stock - Assessment year 1996-97 - Whether correct principle of accounting is to enter stock in books of account at cost unless value is required to be reduced by reason of fall in market value of goods below original cost - Held, yes - Whether therefore, goods should not be written down below cost price except where there is an actual or anticipated loss - Held, yes - Whether if fall in price is only such as it would reduce merely prospective profit, there would be no justification to discard initial valuation at cost - Held, yes - Assessee- company was engaged in business of producing zinc concentrate which was utilised by it captively - During assessment year 1996-97, certain stock of zinc concentrate got

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accumulated - Since domestic consumption of accumulated stock was not possible, assessee decided to export same - Assessee estimated/valued net realisable value of stock by adopting London Metallic Exchange Price which was lower than Weighted Average Cost (WAC) on 31-3-1996, by Rs. 27.08 crores, while in past, it had been valuing closing stock of zinc concentrate for captive consumption at WAC - Assessing Officer observed that auditors’ report indicated that if accounting policy of earlier years was to be followed, then in that event, profits would have increased by Rs. 27.08 crores and, accordingly, added back Rs. 27.08 crores to income of assessee - Whether on facts, assessee’s valuation could not be sustained - Held, yes

4. [2001] 118 TAXMAN 301 (SC)SUPREME COURT OF INDIASakthi Trading Co.v.Commissioner of Income-taxSection 145 of the Income-tax Act, 1961 - Method of accounting - Valuation of closing stock - Assessment year 1984-85 - Whether where on dissolution of assessee-firm because of death of one partner business is taken over by remaining partners without discontinuance of its business and value of closing stock on date of dissolution determined under regular method of accounting is accepted by partners in settlement of accounts for dissolution purposes, it is impermissible for Assessing Officer to substitute market value in respect of closing stock alone for purpose of determining income of firm up to date of dissolution - Held, yes

5. [1991] 55 TAXMAN 497 (SC) SUPREME COURT OF INDIA, A.L.A. Firv.Commissioner of Income-tax

Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as - Assessment year 1961-62 - On dissolution of assessee-firm, its stock-in-trade was revalued and certain amount was shown as 'difference on revaluation' in the profit and loss account - Whether, having valued stock-in-trade at market price, partners of assessee could not contend that valuation should be on some other basis and, thus, such surplus on valuation was to be charged to tax as profits of firm - Held, yes

3. AS 7 and ICDS III: Construction Contracts

AS 7 specifies that it doesn’t deal with Real Estate Developers for which there is a separate guidance note by ICAI. However, ICDS III doesn’t clarify this.

AS 7 provides for the recognition of losses including probable or expected losses to be recognized fully and not as an asset when it is

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probable that these costs are recoverable. ICDS C does not permit the recognition of expected losses on onerous contracts.

AS 7 provided that contract revenue to be recognised if it is possible to reliably estimate the outcome of a contract. However, ICDS III has omitted this criteria. ICDS III says that contract revenue shall comprise of:a) The initial amount of revenue agreed in the contract, including

retentions; andb) Variations in contract work, claims and incentive payments

I. To the extent that it is probable that they will result in revenue; and

II. They are capable of being reliably measured.

It is also specified that where contract revenue already recognised as income is subsequently written off in the books of accounts as uncollectible, the same shall be recognised as an expense and not as an adjustment of the amount of contract revenue.

AS 7 does not permit the recognition of revenue during the early stages of a contract but ICDS III provides for recognition of revenue only to the extent of cost incurred in the early stages of a contract where the outcome cannot be estimated reliably. Also, this early stage of contract shall not extend beyond 25% of the stage of completion.These changes will happen to affect the accounting of various entities because where earlier recognition of revenue not being allowed at all and now being allowed partially. Also, the disallowance of recognition of expected losses on onerous contracts will lead to accounting discrepancies among entities.

4. AS 9 and ICDS IV: Revenue Recognition

AS 9 doesn’t apply to Companies engaged in Insurance business. ICDS is silent on the same and

AS 9 permits the use of both percentage completion method and completed service contract method but ICDS IV permits only the use of percentage completion method. Although, completed contract method does not accurately reflect revenues, expenses and profits in the period in which they are incurred and earned, the tax advantages of this method were obvious – the deferral of tax liability of future years. This cannot be availed now due to the applicability of ICDS IV. Accounting entries shall also slightly change in the percentage completion method.

Another change which has taken place is AS 9 provides for the postponement of recognition of revenue in relation to any claim if the ability to assess the ultimate collection with reasonable certainty is lacking. ICDS IV provides that where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any

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claim for escalation of price and export incentives, revenue recognition in respect of such claim shall be postponed to the extent of uncertainty involved. With regard to this what people could do was postpone the recognition of revenue and thereby artificially reduce the amount of net profit after tax, reserves and surpluses of the year and the net current assets leading to an effect on taxes also but ICDS has limited the postponement only to escalation of price and export incentives.

Revenue from Service transactions shall be recognised by percentage completion method. Under this method, revenue from service transactions is matched with the service transaction costs incurred in reaching the stage of completion, resulting in the determination of revenuer, expenses and profits which can be attributed to the proportion of work completed. ICDS on construction contract also requires the recognition of revenue on this basis. The requirements of that standard shall mutatismutandis apply to the recognition of the revenue and the associated expenses for a service transaction.

Important cases 1. [2013] 38 taxmann.com 100 (SC)SUPREME COURT OF

INDIACommissioner of Income-taxv.Excel Industries Ltd.*

Section 28(iv) of the Income-tax Act, 1961 - Business income - Value of any benefit or perquisite, arising from business or exercise of profession [Advance license and duty entitlement pass book] - Whether until imports are actually made by assessee, benefits under advance license or under duty entitlement pass book represent only hypothetical income which cannot be brought to tax by applying provisions of section 28(iv) - Held, yes [Paras 20 & 21] [In favor of assessee]

2. [1999] 104 TAXMAN 547 (SC)SUPREME COURT OF INDIAUCO Bankv.Commissioner of Income-tax

Section 5, read with sections 119 and 145, of the Income-tax Act, 1961 - Income - Accrual of - Assessment year 1981-82 - Whether in view of CBDT circular, dated 9-10-1984, interest on a loan whose recovery is doubtful and which has not been recovered by assessee-bank for last three years but has been kept in a suspense account and has not been brought to profit and loss account of assessee, cannot be included in income of assessee - Held, yes - Whether CBDT circular dated 9-10-1984 is in conflict with provisions of section 145 - Held, no

Section 119 of the Income-tax Act, 1961 - Central Board of Direct Taxes - Power to issue circulars, etc. - Whether, since Board has considered it necessary to lay down a general test for deciding what is a doubtful debt in circular dated 9-10-1984 and directed that all ITOs should treat such amounts as not forming part of income of assessee

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until realised, this direction by way of a circular cannot be considered as travelling beyond powers of Board under section 119 and such a circular is binding under section 119 - Held, yes

3. [1971] 82 ITR 835 (SC)SUPREME COURT OF INDIAMorvi Industries Ltdv.Commissioner of Income-taxSection 37(1) , read with section 5 of the Income-tax Act, 1961 [Corresponding to section 10(2)(xv), read with section 4(1)(b)(ii), of the Indian Income-tax Act, 1922] – Business expenditure – Allowability of – Assessment years 1956-57 and 1957-58 – Assessee-company, being managing agent of its subsidiary company and maintaining its accounts on mercantile system, relinquished certain amounts representing fixed monthly officer allowance and commission on sales, payable to it by managed-company in view of heavy financial losses suffered by managed company – Amounts of commission were relinquished after they had become "due" but before they were "payable" in terms of managing agencies agreement – Tribunal held that relinquishment by assessee of its income after it had become due was of no effect and that relinquishment was not for benefit of assessee so as to allow assessee's claim for amounts relinquished as permissible deduction under section 10(2)(xv) of 1922 Act – Whether postponement of date of payment did not affect accrual of income, and fact that amount of income was not subsequently received by assessee would not also detract from or efface accrual of income – Held, yes – Whether since amounts of income for years in question were given up unilaterally by assessee after they had accrued to it, assessee-company could not escape liability to tax on those amounts – Held, yes – Whether since there was nothing to show that amounts were relinquished on grounds of commercial expediency or for advancing assessee's business interests, assessee was not entitled to claim deduction of said amounts as business expenditure under section 10(2)(xv) of 1922 Act – Held, yes

4. [1986] 24 TAXMAN 337 (SC)SUPREME COURT OF INDIAState Bank of Travancorev.Commissioner of Income-tax

Section 5, read with section 145, of the Income-tax Act, 1961 - Income - Accrual of -Assessee-bank, following mercantile system of accounting, charged interest on advances considered doubtful of recovery, called sticky advances by debiting concerned parties but, instead of carrying it to profit and loss account, credited it to separate account styled 'Interest suspense account' In its return assessee disclosed such interest separately and claimed that same was not taxable in its hands as income of concerned years - Whether in view of concept of real income, impugned interest, which had accrued to

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assessee, could be excluded from assessee's taxable income of concerned years - Held, no

5. [1997] 091 TAXMAN 351 (SC)SUPREME COURT OF INDIAGodhra Electricity Co. Ltd.v.Commissioner of Income-tax

Section 5 of the Income-tax Act, 1961 - Income - Accrual of - Assessment years 1969-70 to 1972-73 - Assessee-company a licensee to generate and supply electricity to its consumers, from 1963 enhanced tariff - Suit was filed by consumers which was decreed against assessee ultimately - Supreme Court decided dispute in favour of assessee-company in 1969 - During pendency of litigations assessee though accounting for enhanced tariff could not recover same and even after decisions in its favour in view of Government's advice assessee was prevented from realising amounts in question - Ultimately, company was taken over by Government and later transferred to Electricity Board - Whether in above circumstances, since assessee was not able to collect enhanced charges, necessary entries made in its books of account represented only hypothetical income and it could not be brought to tax as it did not represent income which had really accrued even though assessee-company was following mercantile system of accounting - Held, yes

5. AS 10 and ICDS V: Tangible Fixed Assets

ICDS V provides that “tangible fixed asset” is an asset being land, building, machinery, plant or furniture held with the intention of being used for the purpose of producing or providing goods or services and is not held for the sale in the normal course of business. The definition is same except that the AS 10 refers to the word “asset” as against the specific items of land, building, machinery, plant or furniture referred to in ICDS V. Moreover, the AS specifically says that the standard doesn’tdeal with the following items to which special consideration applies i.e., a) Forests, plantations and similar regenerative naturalresources;b) Wasting assets including mineral rights , expenditure on the

exploration for and extraction of mineral oil, natural gas and similar non regenerative resources;

c) Expenditure on real estate developmentd) Livestock

Though it has been specified in AS that expenditure on individual items of fixed assets used to develop or maintain the activities covered in (i) to (iv) above, but separable from those activities are to be accounted for in accordance with the AS 2.

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AS 10 applies to Good will but ICDS doesn’t

One difference which can be highlighted majorly is the value at which an asset shall be acquired in exchange for another fixed asset or shares or securities. AS 10 says to record the fixed asset at the fair value of the asset given or acquired whichever is more clearly evident while ICDS V says to record the asset acquired in exchange at the actual cost of the asset so acquired. This although may not cause difficulties in accounting but shall mandatorily lead to discrepancies in valuation of the fixed asset and thereby shall affect the balance sheet also.

There is no concept of revaluation of fixed assets under ICDS whereas the AS 2 provides for revaluation of the fixed assets.

ICDS V says that depreciation on tangible fixed asset shall be computed in accordance with the provisions of the Act and again specifies that income arising on transfer of a tangible fixed asset shall be computed in accordance with the provisions of the Act. AS 10 provides for guidance on retirements and disposals of the fixed assets.

ICDS V specifically provides that the following disclosures shall be made regarding the tangible fixed assets, namely:-a) Description of asset or blocks of assetsb) Rate of depreciationc) Actual cost or written down value, as the case may bed) Additions or deductions during the year with dates, in the case of any

addition of an asset, date put to use, including adjustment on account of--Central Value added tax credit claimed and allowed under the Cenvat Credit Rules, 2004-change in rate of currency-subsidy or grant or reimbursement, by whatever name called.

e) depreciation allowable

f) written down value at the end of the year.

The existing AS 10 has also disclosure requirement but not exactly in the above manner.

There is no mention regarding maintenance of ICDS specific FA register , which was though proposed earlier.

6. AS 11 and ICDS VI: Effects of Changes in foreign exchange rates

ICDS requires premium, discount or exchange differences on forward contracts that are intended for trading or speculation purposes, or that are entered into to hedge the foreign currency risk of a firm commitment of a highly probable forecast transaction to be recognized at the time of settlement. This is different from the recognition of gains and losses on

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mark to market basis or recognition of only losses in line with the principle of prudence. Due to this the recognition of losses stands delayed thereby leading to a rise in income and taxes because the settlement of the losses on foreign currency and forward contracts usually takes time.

AS 9 provides for accumulation of exchange differences arising from the translation of financial statements of non-integral foreign operations in a foreign currency translation reserve in a balance sheet while ICDS VI provides for recognition of such differences as income or expense. This implies that now since we have to route the exchange differences through the profit and loss account, taxes shall be levied on the same and the income shall be accordingly higher on a positive exchange difference and lower on a negative exchange difference.

Important Cases1. [1979] 116 ITR 1 (SC)SUPREME COURT OF INDIASutlej Cotton Mills

Ltd.v.Commissioner of Income-tax

Section 28(1) of the Income-tax Act, 1961 (Corresponding to section 10(1) of Indian Income-tax Act, 1922) – Business loss/ deductions – Allowable as - – Assessment years 1957-58 and 1959-60 – Assessee-company after remitting certain amounts from Pakistan where it was doing business in fabrics, claimed that it suffered business loss due to devaluation of Pakistani rupee – Revenue authorities rejected assessee’s claim – High Court also took view that it was not a business loss as it was caused by devaluation of rupee which was an act of state – Whether where profit or loss arises to an assessee on account of appreciation or depreciation in value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if foreign currency is held by assessee on revenue account or as a trading asset or as part of circulating capital embarked in business – Held, yes – Whether, however, if foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature – Held, yes – Whether therefore, matter was to be remanded to Tribunal to firstly determine as to whether amounts in question were held in Pakistan as capital asset or as trading asset – Held, yes

2. CIT Vs Woodward Governor India P Ltd (2009) 312 ITR 254(SC)3. ACIT Vs EleconEngg. Co Ltd (2010) 189 Taxman 83(SC)4. Oil & Natural Gas Corporation Ltd Vs CIT(2010) 322 ITR 180(SC)

7. AS 12 and ICDS VII: Government Grants

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A major difference which ICDS VII has brought in is the disallowance of the use of capital approach method for recording of government grants. Thus, with the effect of ICDS, grants cannot be anymore treated as a part of the shareholder’s funds. It has to be either treated as revenue receipt or reduced from the cost of the fixed asset depending on the purpose for which the grant or subsidy is given. Thus, the theory of recognizing government grants outside the profit and loss account merely because it represents an incentive provided by the government without related costs stands dismissed in the newly formulated ICDS.

ICDS VII mentions that recognition of government grants shall not be postponed beyond the date of actual receipt even though all the recognition conditions in accordance with the accounting standards are not met. This has been done in order to reduce litigations regarding the recognition criteria and also to provide certainty on the topic. Under the AS 12 it is provided that mere receipt of a grant is not necessarily a conclusive evidence that conditions attaching to the grant have been or will be fulfilled.

AS provides that Government Grant in the nature of promoters’ contribution (i.e.,they are given with reference to the total investments in an undertaking or by way of contribution towards its total capital outlay and no repayment is ordinarily expected, are credited directly to shareholders funds. There is no such mention in the ICDS.

Important cases1. [1997] 94 TAXMAN 368 (SC)SUPREME COURT OF

INDIASahneySteel & Press Works Ltd.v.Commissioner of Income-tax

Section 4 of the Income-tax Act, 1961 - Income - Assessable as - Assessment year 1974-75 - According to a notification issued by Government of Andhra Pradesh, certain facilities and incentives were to be given to new industrial undertakings which commenced production on or after 1-1-1969 with investment capital not exceeding 5 crores for five years from date of commencement - Production incentives were not available unless and until production had commenced - In terms of said notification assessee received refund of sales tax - Whether refund of sales tax was a revenue receipt - Held, yes

2. [2009] 185 TAXMAN 409 (SC)Mepco Industries Ltd. v.Commissioner of Income-taxSection 154 of the Income-tax Act, 1961 - Rectification of mistakes - Apparent from record - Assessment years 1993-94 and 1994-95 - Assessee, engaged in business of manufacture of potassium chlorate, received power subsidy for two years, which it initially offered as revenue receipt in its returns of income - However, thereafter, it sought revision of assessment orders contending that subsidy amount was a capital receipt and, hence, not liable to be taxed -

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Commissioner allowed revision petitions - Subsequently, in case of Sahney Steel & Press Works Ltd. v. CIT [1997] 228 ITR 253/ 94 Taxman 368 (SC), Supreme Court held that incentive subsidy admissible to that company was a revenue receipt and, hence, it was liable to be taxed under section 28 - Following said judgment, Commissioner passed order of rectification on ground that power tariff subsidy given to assessee was admissible only after commencement of production and, consequently, it constituted operational subsidies and not capital subsidies - Whether in each case one has to examine nature of subsidy and this exercise cannot be undertaken under section 154 - Held, yes - Whether, on facts, when Commissioner, while passing orders under section 264, had taken view that subsidy in question was a capital receipt not taxable under Act, he was justified in invoking section 154 and holding subsidy in question to be revenue in nature based on judgment of Supreme Court in case of Sahney Steel & Press Works Ltd. (supra) - Held, no

8. AS 13 and ICDS VIII:Accounting for Investments

This ICDS deals with securities held as stock in trade. Accounting Standard 13 (Accounting for Investments) deals with current

investments, long term investments and property but excludes shares, debentures or other securities which are held as stock in trade by any assessee. ICDS VIII (Securities) on the other hand deals only with securities held as stock in trade. Hence, since both the AS 13 and ICDS VIII deal with two totally irreconcilable topics, collation of both shall stand unjustified. ICDS VIII requires the comparison of cost and net realizable value for securities held as stock-in-trade to be assessed category wise and not for each individual security. ICDS VIII also quotes that securities that are not quoted or are quoted irregularly shall be valued at cost. This could represent a change in practice for some entities.

ICDS provides that cost shall be determined on FIFO basis. At the end of the previous year, securities held as stock in trade shall be

valued at actual cost initially recognised or net realisable value at the end of the previous year whichever is lower.

Securities are attached importance in a sense that ICDS 2 does not deal with securities and a specific standard has been provided for the securities.

Net realisable value is not defined in this Standard even though it is defined in the ICDS 2. There are bound to be disputes in this regard. Only fair value is defined as the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable willing seller in an arm’s length transaction.

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The major changes which have taken place in AS 16 with regard to ICDS IX is in the method of capitalization of borrowing costs. In AS 16 we are supposed to suspend the capitalization of borrowing costs during extended periods in which active development is interrupted while in that of ICDS IX, nothing about the same has been mentioned hence we assume that capitalization of borrowing costs should not be suspended even where active development of a capital asset is interrupted. Also, in AS 16, capitalization of borrowing cost is to be done only on incurrence of expenditure on qualifying asset, incurrence of borrowing cost and on activities that are necessary to prepare the asset for its intended use or sale while in ICDS IX it is mentioned to commence to capitalize the borrowing costs from the date on which the funds have been borrowed. There has also been some changes in the capitalization of general borrowings. These changes in the method and timing of capitalization can bring about some discrepancies in accounting.

Also, in AS 16, income from temporary investments was to be deducted from borrowing costs but in ICDS IX, no mention has been made about the same hence we assume it as non-deductible and thereby a taxable income.

Borrowing in AS 16 specifies that exchange difference arises from foreign currency borrowing to the extent that they are regarded as an adjustment to interest costs may be included in Borrowing cost. However these are not covered in ICDS IX.Hindustan Lever Ltdhas taken a loan of USD 10 Million on April 1, 2015, for a specific project @3% p.a., payable annually. On April 1, 2015 the exchange rate Rs. 60/USD. The exchange rate, as at March 31, 2016, is Rs. 46/USD. The corresponding amount could have been borrowed by HLL. in local currency @11% p.a. on April 1, 2015. In this case, AS 16 prescribed the calculation of difference attributable as interest.

Qualifying asset is defined in a simple manner in the AS 16 as an asset which takes substantial period of time to get ready for its intended use or sale. In this regard the ASI explains the meaning of the term “Substantial period of time”. The following assets ordinarily take 12 months or more to get ready for intended use or sale unless the contrary is proved by the enterprise:a) Assets that are constructed or otherwise produced for an enterprise’s

own use e.g. assets constructed under major capital expansions.b) Assets intended for sale or lease that are constructed or otherwise

produced as discrete projects for example ships or real estate developments.

In case of inventories, substantial period of time is considered to be involved where time is the major factor in bringing about a change in the

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condition of the inventory. For example, liquor is often required to be kept in store for more than 12 months for maturing.

ICDS however, says that qualifying asset means

a) Land, building, machinery, plant or furniture being tangible assets.b) Know-how , patents, copy rights, trade marks, licences , franchises or

any other business or commercial rights of similar nature, being intangible assets.

c) Inventories that require a period of 12 monthor more to bring them to a saleable condition.

Thus, as per ICDS all assets other than inventories (excluding inventories as given hereinabove) are considered for capitalisation of borrowing costs. Until now , the Act required that capitalisation of borrowing cost only when there was an extension of business. This condition of extension is now removed by the Finance Act, 2015. Thus iCDS is now in line with the Act

Important Cases1. [1975] 98 ITR 167 (SC)SUPREME COURT OF INDIAChallapalli Sugars

Ltd.V.Commissioner of Income-tax

Section 43(1) , read with section 32 of the Income-tax Act, 1961 (Corresponding to section 12B(1) of the Indian Income-tax Act, 1922) – Actual cost – Whether for purpose of deduction on account of depreciation and development rebate, interest paid before commencement of production on amount borrowed for acquisition and installation of plant and machinery can be considered to be part of actual cost of assets to assessee - Held, yes

2. [1997] 93 TAXMAN 502 (SC)SUPREME COURT OF INDIATuticorin Alkali Chemicals &Fertilizers Ltd.v.Commissioner of Income-tax

Section 56 of the Income-tax Act, 1961 - Income from other sources - Chargeable as - Assessment year 1980-81 - Whether interest earned on short-term investment of funds borrowed for setting-up of factory during construction of factory before commencement of business-has to be assessed as income from other sources and it cannot be said that interest income is not taxable on ground that it would go to reduce interest on borrowed amount which would be capitalised - Held, yes

3. [1999] 102 TAXMAN 94 (SC)SUPREME COURT OF INDIACommissioner of Income-taxv.Bokaro Steel Ltd.

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Section 28(i) of the Income-tax Act, 1961 - Business income - Chargeable as - Assessment years 1965-66 to 1971-72 - Assessee-company was in process of constructing and erecting its plant and had not started any business during relevant assessment years - It received certain amounts through (i) rent charged by assessee from its contractors for housing workers and staff employed by contractor for construction work of assessee, (ii) hire charges for plant and machinery given to contractors for use in construction work of assessee, (iii) interest from advances made to contractors for purpose of facilitating work of construction, and (iv) royalty for excavation and use of stones lying on assessee’s land for construction work - First three receipts had been adjusted against charges payable to contractors and, thus, had gone to reduce cost of construction - Whether first three receipts being intrinsically connected with construction of assessee’s plant, would be capital receipt and not income of assessee from any independent source - Held, yes - Whether similarly royalty received for stone excavated from assessee’s land would go to reduce cost of plant and could not be taxed as income - Held, yes

4. [2008] 167 TAXMAN 206 (SC)SUPREME COURT OF INDIADeputy Commissioner of Income-taxv.Core Health Care Ltd.*

Section 36(1)(iii) , read with Explanation 8 to section 43(1), of the Income-tax Act, 1961 - Interest on borrowed capital - Assessment year 1992-93 - Whether proviso inserted in section 36(1)(iii) with effect from 1-4-2004 has to be read as prospectively - Held, yes - Whether what section 36(1)(iii) emphasises on is user of capital and not user of asset which comes into existence as a result of borrowed capital, unlike section 37(1) which expressly excludes an expense of a capital nature - Held, yes - Whether Legislature has, therefore, made no distinction in section 36(1)(iii) between ‘capital borrowed for a revenue purpose’ and ‘capital borrowed for a capital purpose’ and an assessee is entitled to claim interest paid on borrowed capital provided that capital is used for business purpose irrespective of what may be result of using such borrowed capital - Held, yes - Whether Explanation 8 to section 43 as well as concept of determination of ‘actual cost’ have no application to section 36(1)(iii) as this section does not incorporate concept of depreciation - Held, yes - Assessee had a running business of manufacturing and selling of intravenous solutions - It installed new machineries on which production was not started during relevant year - Assessee claimed deduction of interest on borrowings made for purchasing these machineries - Whether assessee’s claim was to be allowed - Held, yes

10. AS 29 and ICDS X: Provisions, Contingent Liabilities and Contingent assets

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ICDS X specifically says that the standard deals with provisions, contingent liabilities and contingent assts, except thosea) Resulting from financial instrumentsb) Resulting from executory contractsc) Arising in insurance business from contracts with policyholders; andd) Covered by another ICDS

An important point to be noted is that the ICDS provides that the term provision is also used in the context of items such as depreciation, impairment of assets and doubtful debts which are adjustments to the carrying amounts of assets and are not addressed in this ICDS. Thus, the issues relating to the provisions of bad and doubtful debts which have been held to be not eligible for being deducted while computing book profit are sought to be taken care of by this exception.

Unlike the existing AS 29, ICDS X requires the recognition of provisions only if it is reasonably certain that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation.The phrase “reasonably certain” has not been defined. As against this, AS 29 uses the word “Probable” . This might cause a certain delay in the recognition of provisions although not much.

The definition of the term Present obligation also uses the phrase “reasonably certain” as against “Probable” used in AS 29.

AS 29 clarifies that “obligation” may be legally enforceable and may arise from normal commercial business practice or to act in a desirable business atmosphere. However, the ICDS does not define the term “obligation”. Thus, provisions made in order to follow normal business practices arising out of good customer relationship may not be allowed. Take the example of MNCs who are generally in the forefront in this.

Contingent Assets and reimbursement claims are recognised if inflow of economic benefits/ reimbursement is “virtually certain” as against “reasonably certain”. The term “reasonably certain” has not been defined and thus prone to disputes.

Important judgement.1. Rotork Controls India P Ltd (2009) 314 ITR 62(SC)

Section 37(1) of the Income-tax Act, 1961 - Business expenditure - Allowability of - Assessment years 1991-92 to 1994-95 - Whether for 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 - Held, yes - Whether 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

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army of such sophisticated goods would be entitled to deduction from gross receipts under section 37(1), provided data is systematically maintained by assessee - Held, yes

1.5 ICDS and MAT Computation

1. In case of MAT income- even though accounts are prepared as per AS- you are assuming that to be correct for the purposes of payment of taxes. In the case of MAT you are assuming that the accounts must be prepared as per the Accounting Standards where as for normal computation you would not be doing so. Levying tax on book profit which is determined as per the AS and again asking companies to restate the accounts using ICDS appears to be a tedious task. May be the coming budget will see changes in the provisions relating to MAT by including ICDS in Section 115JB and 115JC dealing with MAT and AMT.

1.6 Some other Cases in relation to the Computation vis-à-vis accounting Standards

a) Taparia Tools Ltd (2015) 55 taxmann.com 361(SC)b) Madras Industrial Investment Corporation Ltd Vs CIT(1997) 225 ITR

102(SC)

Thanking You,

CA Ramesh Kumar Patodiaramesh.patodia@rkrr.in

Disclaimer: The analysis in this booklet is solely for information purposes. We are not offering it as a legal, accounting or other professional service advice. While best efforts have been made in this preparation, we assume no liabilities of any kind with respect to the accuracy or completeness of the contents, and specifically disclaim from any loss caused, is alleged to have been caused directly or indirectly by the information contained herein. Readers are advised not to take expert opinion.

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