Historically, enterprises have computed taxable income applying profits as per the financial statements as the starting point and making additions or deductions thereto, as required by the Income-tax Act. 1961 (I-T Act) for the purposes of annual income tax liability and tax return. However, with the recent notification of Indian Accounting Standards (Ind-AS), two accounting frameworks shall now co-exist in the country. Most companies follow the existing Generally Accepted Accounting Principles (GAAP), while certain other companies will be following Ind-AS. As a result, there is no level playing field from the tax perspective.
Therefore, to provide a uniform basis for computation of taxable income, the Central Board of Direct Taxes (CBDT) has notified 10 Income Computation and Disclosure Standards (ICDS) for compliance by all taxpayers following mercantile system of accounting. ICDS shall apply effective from FY16 onwards on the computation of business profits and income from other sources from tax angle.
Adoption of ICDS could markedly alter the way the industry computes taxable income, as certain concepts in the existing accounting standards have been modified. In case of conflict between the provisions of the I-T Act and the notified ICDS, the provisions of the Act shall prevail. Non-compliance with ICDS could lead to best judgment assessment by the assessing officer. Items not specifically covered by any ICDS (such as intangibles, leases, etc) will continue to be governed by AS and existing provisions of the Act.
Some of the significant impact areas for the industry are discussed below:
No concept of prudence and materiality
Prudence and materiality are two fundamental accounting assumptions. While AS provides for such assumptions, ICDS does not recognise these concepts. It also does not recognise expected or marked-to-market loss for tax purposes. This, in fact, dilutes the fundamental accounting considerations recognised by the commercial world all along.
It does not permit change in accounting policies unless there is a reasonable cause. The term “reasonable cause” is not defined; hence, it will be based on the discretion of the tax authorities.
Minimum Alternate Tax (MAT)
Recognition of income or postponement of deductibility of expenses in any year arising out of ICDS may result in MAT liability in that year as compared to recognition for accounting purposes in the subsequent years. This will result in double taxation of the same income. This is certainly not fair and just.
Construction contracts
ICDS mandatorily requires to apply percentage of completion method but do not recognise expected losses on the construction contracts. For instance, as on March 31, 2015, if an entity booked expected losses on contract as per AS-7, then the entire loss will be disallowed and allowed only on percentage completion method basis. Further, retention money is included as part of contract revenue, which is against the principle laid down in AS-7.
While AS-7 lays down specific conditions for estimation of the outcome of a construction contract, ICDS III simply refers to early stages of a contract, and that does not extend beyond 25%.
Borrowing costs
There are significant deviations of ICDS IX from AS on borrowing costs in respect of capitalisation of costs, resulting in different costs capitalised for accounting and tax purposes.
One of the critical differences is the criterion of substantial period of time for classifying any asset as qualifying asset.
As per the AS, the substantial period of time for regarding qualifying assets being tangible and intangible assets as well as inventory is 12 months. While the ICDS retains the substantial period condition of 12 months for inventory, there is no period prescribed in the context of tangible and intangible assets. Thus, ICDS requires capitalisation of borrowing costs for other tangible and intangible assets even if they do not require 12 months for completion. This would result in higher borrowing cost being capitalised for tax purposes, which in turn would defer the claim of the taxpayer who would have otherwise claimed a deduction of such borrowing costs upfront as revenue expenditure against income of business or profession.
Provisions and contingent liabilities
As per AS 29, provision is recorded when outflow of resources embodying economic benefits required to settle an obligation is ‘probable’ in occurrence. As per normal accounting parlance, the word ‘probable’ may be understood as an incident whose probability of occurrence is more than 50%, whereas ICDS holds that such provision is to be recorded when outflow of economic resources required to settle an obligation is ‘reasonably certain’. The term ‘reasonably certain’ is not defined in ICDS. However, it appears to carry a lesser threshold than the term ‘probable’.
Recognition of a provision as per ICDS would act like a double-edged sword for an assessee. The tax payer would be eager to take deduction of an expenditure whose incurrence is reasonably certain, although it may not have been debited to the income and expense statement. While the tax officer would certainly pore over it through a lens, non-consideration of such expenditure may be questioned in withholding tax assessment.
In this backdrop, following the introduction of ICDS, Indian enterprises need to gear up. The taxable income might now be visibly de-linked from the accounting income as both will be computed under different set of standards and principles. As a first step, companies should carry out an impact assessment. This would provide clarity on the impact on taxable income and extent of changes in the system and processes to compute taxable income in each period in an efficient manner.
Goyal is managing director and Kaur, senior manager, Protiviti India
