ICDS: a move towards simplification or a new challenge?

In order to minimize alternative tax treatments and bring certainty in reporting taxable income, the Central Government (CG) has recently notified the following 10 Income Computation and Disclosure Standards (ICDS), w.e.f., 1 April 2015 for implementation:

I. Accounting policies
II. Valuation of inventories
III. Construction contracts
IV. Revenue recognition
V. Tangible fixed assets
VI. Effects of changes in foreign exchange rates
VII. Government grants
VIII. Securities
IX. Borrowing cost
X. Provisions, contingent liabilities and contingent assets

The ICDS will prevail over the existing Accounting Standards (AS) for tax payers, and in case of inconsistency between the ICDS and the Income tax Act, 1961 (the Act), the Act shall prevail. However, the interplay between ICDS and well-settled positions by the courts will be an interesting area to watch. The due date to pay the first instalment of advance tax for FY15–16 is fast approaching. Therefore, it is vital to immediately analyze the impact of ICDS, since taxpayers will have to factor in the same while paying the advance tax and reporting quarterly tax provision.

Applicability of ICDS
ICDS is applicable to all taxpayers following the mercantile method of accounting for computation of income from profits and gains from business and profession and income from other sources from FY15–16 onwards. Currently, there is no threshold of income/turnover/net worth for triggering the applicability of ICDS.

Accounting system
The preamble of each ICDS clarifies that separate books of account are not required to be maintained. However, with respect to the divergence between ICDS and AS, an entity may need to make amendments to its systems/ERP/processes to maintain relevant information and audit trail for tax audit purposes. The key areas to watch while applying ICDS are captured in ensuing paragraphs.

Concept of prudence modified
ICDS modifies the concept of prudence, leading to accelerated taxation, either on account of
preponement of income or postponement of loss or delayed allowance of expense. The said timing difference could have a significant impact on cash flow and minimum alternate tax (MAT) mismatch.

Construction contracts
It mandates the recognition of revenue on a percentage of completion method (POCM) basis vis-à-vis alternatives provided by AS-7. It has also prescribed a threshold of 25% to start recognizing revenues under the contract.
Moreover, AS-7 requires a provision to be made for the expected losses immediately. However, according to ICDS, losses incurred on a contract will be allowed only in proportion to the stage of completion. Future or anticipated losses will not be allowed. The said deviation may have a significant impact on the taxpayer. Taxpayers could end up paying tax on income which is larger than their real commercial income.

Foreign exchange fluctuations
AS-11 requires capital monetary items not related to imported assets such as foreign currency borrowings, loans or advances, bank deposits awaiting capital use, etc., to be recognized in the profit and loss account. According to the current tax position, for all capital items, the taxpayers could argue that the exchange gain or loss, being capital in nature is not taxable. However, ICDS requires all such gains/losses to be recognized in the profit and loss account on mark-to-market basis.
According to AS-11, all mark-to-market gains or losses on forward exchange contracts are to be recognized in the Profit and Loss account. According to ICDS, gains or losses on forward contracts/foreign currency options for trading, speculation, firm commitments, etc., (other than hedging contracts) are to be recognized in income computation only on settlement basis. This may have a significant impact on the banks and MAT mismatch.

Government grants
Currently, AS-12 provides that a grant shall be recognized only if there is conclusive evidence that conditions attached to the grant have been or will be fulfilled. Mere receipt of grant is not sufficient. In contrast, ICDS prohibits postponing the recognition of a grant beyond the date of actual receipt. This, prima facie, is likely to lead to accelerated recognition on receipt basis.
Furthermore, the courts have held that a grant is to be treated on the basis of the purpose or motive for which it is granted. However, ICDS does not recognize this. To align ICDS with the Act, the Finance Act, 2015 amends the definition of “income” to include any assistance in the form of subsidy, grants, etc., provided by the government or any authority in cash or kind. Accordingly, most subsidies/grants received from the government/authority irrespective of their nature, i.e., capital or revenue is likely to become the income of the recipient, chargeable to tax.

Borrowing costs
ICDS regards all tangible and intangible assets as “qualifying assets” on which the interest on borrowing is to be capitalized. In contrast, AS 16 requires capitalization of interest, only if the qualifying asset takes substantial time to be ready for use/sale. In case of inventory, the capitalization of interest is to be made only if it takes 12 months or more to bring them into saleable condition.

Provisions, contingent liabilities and contingent assets
ICDS requires contingent assets to be recognized on the basis of reasonable certainty v. virtual certainty according to AS-29. Under accounting, the term “reasonable certainty” is generally understood as that the event is more likely to occur than not, i.e., probability of occurrence is more than 50%.
However, the term “reasonable certainty” has neither been defined in the ICDS, the Act or Income-tax Rules. It appears to carry a lower threshold than the term “virtual certainty.” Suppose a company has claims for compensation pending before the courts. If there is reasonable certainty of winning but not “virtual” certainty, the same would be recognized for tax purposes, even though not recognized in the books. This would lead to accelerated recognition of income for tax purpose, which may eventually be found to be irrecoverable. Furthermore, it may not be recognized in the books of accounts till the threshold of certainty is very high. In order to provide relief to the taxpayers, the Finance Act, 2015 provides that such amount taxed according to ICDS but not recognized in the books should be allowed as bad debt in the tax year in which it becomes irrecoverable, and it shall be deemed as if such debt has been written off as irrecoverable in the accounts for this purpose.

Non-compliance of ICDS
Non compliance could lead to severe consequences, such as best judgement assessment by the tax officer. Therefore, it is pertinent to analyze the impact and comply with ICDS quickly, as advance tax computation will require its adoption before 15 June 2015 for corporates. The purpose of ICDS is to bring consistency of approach and reduce the current quantum of litigation due to varying treatments for tax computation purposes. However, in light of the issues highlighted above, one needs to watch this space very carefully. We can expect thing to turn interesting as the interplay between ICDS, the Act and the principles laid down by the courts while interpreting the Act is likely to throw up new areas for evaluation and consequent determination as we move ahead with implementation.

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