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April 1, 2017

INCOME COMPUTATION AND DISCLOSURE STANDARDS - (‘ICDS’) III, IV & X. April 1, 2017. Presentation by : Anjali Agrawal. What is ICDS?.

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April 1, 2017

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  1. INCOME COMPUTATION AND DISCLOSURE STANDARDS - (‘ICDS’)III, IV & X April 1, 2017 Presentation by : Anjali Agrawal

  2. What is ICDS? • Section 145(1) – Income chargeable under the heads “Profits and Gains from Business or Profession” or “Income from other Sources” – subject to 145(2) - as per method of accounting regularly followed • Section 145(2) – the Central Government has power to notify “ICDS” • CBDT vide Notification dated March 31, 2015 introduced 10 ICDS to be effective from April 1, 2015 and thus, the same was applicable from AY 2016-17 onwards • However, in January 2016, Income-tax Simplification Committee recommended deferment of ICDS

  3. What is ICDS? • On July 6, 2016 via press release application of ICDS postponed by one year – to apply from AY 2017-18 and onwards. • On September 29, 2016:, Revised ICDS notified effective from AY 2017-18 and Form 3CD was amended • Recently, on March 23, 2017, CBDT has issued certain clarifications by way of FAQs.

  4. List of Notified ICDS

  5. Applicability of ICDS • ICDS will apply to: • An assessee • Following mercantile system of accounting • Computing taxable income under the following heads of income: • Profit and gains of business or profession • Income from other sources • No Net worth or Turnover Criteria prescribed for applicability • However, Individuals and HUFs not subject to tax audit u/s. 44AB exempted • ICDS are mandatory in nature • Not for the purpose of maintenance of books of account • In case of conflict between ICDS and Act, the Act shall prevail

  6. Commercial Accounting principles- Basis for Taxable Profits • Prior to introduction of ICDS , the taxable profits were computed based on the commercial accounting principles subject to express provision of the Act. :- • Miss Dhun Dadabhai Kapadia v. CIT [(1967) 63 ITR 651(SC)] • CIT v. U.P. State Industrial Development Corporation [(1997) 225 ITR 703 (SC)] it was held that :- “for the purposes of ascertaining profits and gains the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statute” • Going Forward – for taxation purposes- profits to be computed as per commercial accounting principles as modified by provisions of ICDS

  7. Specimen for computing Taxable Income under ICDS framework * For any non compliance with ICDS appropriate disclosure should be made.

  8. Fundamental Issues • Can ICDS bring to charge any item which is not “income”? • In the event of inconsistency between ICDS and principle of “accrual” what would prevail? • Whether the decisions of the Supreme Court or a jurisdictional court interpreting the provisions of the Act would prevail over the ICDS, in case of any conflict?

  9. Scope of delegated legislation • Settled law that a notification cannot override the statute. This view is supported based on following decisions : • CIT v. Sirpur Paper Mills [(1999)(237 ITR 41)(SC)] • CIT v. TajMahal Hotels [(1971)(82 ITR 44)(SC)] • DurgaDassDevkiNandan Vs. ITO (200 Taxman 318)(HP) : • “It is settled law that the CBDT cannot issue a circular, which goes against the provisions of the Act. The CBDT can only clarify issues but cannot insert terms and conditions which are not part of the main statute;A delegate or person authorized to issue delegated legislation cannot virtually set at naught the provisions of the main statute.” • Preamble to every ICDS clearly states that in case of conflict between the provisions of the Act and the ICDS - the provisions of the Act shall prevail.

  10. ICDS III - CONSTRUCTION CONTRACTS Ω

  11. Retention Money • Retentions - • “amounts of progress billing which are not paid until satisfaction of conditions specified in the contract for the payment of such amounts or until defects have been rectified” • AS/Ind AS – • Silent on treatment of retention money. • It requires separate disclosure of retention money. • Recognition of revenue is based on PCM method, subject to ultimate recovery.

  12. Retention Money • Judicial View – • More than 6 High Courts have held that retention money doesn’t accrue during the performance of contract based on the principle of ‘accrual’ • For instance: • CIT vs. Simplex Concrete Piles India Pvt. Ltd. (179 ITR 8) (Cal HC); • CIT vs. East Coast Constructions & Industries Ltd. (283 ITR 297)(Mad HC); • CIT vs. Associated Cables Pvt. Ltd. (286 ITR 596)(Bom HC); • CIT vs. P&C Constructions Pvt Ltd (318 ITR 113)(Mad HC)]. • Committee Report – • To overcome unintended meaning given by judicial pronouncements.

  13. Retention Money • ICDS – • Contract revenue defined to include the initial amount of revenue agreed in the contract, including retentions. • Further, contract revenue is to be recognized by reference to the stage of completion of contract activity. • FAQ of CBDT • Retention money, being part of overall contract revenue, shall be recognized as revenue subject to reasonable certainty of its ultimate collection condition contained in para 9 of ICDS – III. (Q 11)

  14. Whether Retentions is taxable on PCM basis under ICDS • Possible view – • ICDS cannot override the concept of accrual u/s. 5 • ‘Accrual’ of income is dealt u/s. 4 and 5 of the IT Act. • ICDS is only a computational provision • A computational provision cannot bring to tax something which is not income accrued u/s 5. • Under ICDS I itself, ‘accrual’ is regarded as one of the fundamental accounting assumptions • ICDS only defines Contract Revenue to include “Retention Money”. Recognition criteria is still the same i.e. when there is reasonable certainty of its ultimate collection.

  15. Expected Loss • Expected Loss: • Total contract costs exceed total contract revenue • AS/Ind AS– • Expected loss is allowed – prudence • Committee Report – • To remove differential treatment between income and losses. • ICDS III is silent on treatment of Expected Loss

  16. Expected Loss • ICDSI - • Principle of ‘prudence’ not regarded as one of the principles for selecting accounting policy • Expected loss shall not be recognised unless such recognition is in accordance with any other ICDS • ICDS X- • Unlike AS 29, ICDS X does not allow creation of provision for ‘onerous contracts’

  17. Expected Loss • Judicial Pronouncements – • Courts have allowed deduction for expected losses on construction contract considering commercially accepted accounting principles. See: • CIT vs. Triveni Engineering & Industries Ltd. (336 ITR 374) (Delhi HC); • CIT vs. Advance Construction Co. Pvt. Ltd. (275 ITR 30) (Gujarat HC); • MazagonDock Ltd. v. Jt. CIT (29 SOT 356)(Mum); • Jacobs Engineering India (P.) Ltd. ( 14 taxmann.com 186)(MumT); • ITD Cementation India Ltd (36 taxmann.com 74) (MumT).

  18. Whether Expected Loss an allowable deduction after ICDS • Possible view – • Prima facie, such loss won’t be allowed, since today’s legal position was based on the accounting treatment; • However, if it is concluded that ICDS – I is a legislative misfire, then relying on commercial accounting principle the loss should be allowed. • Whether provision for expense can be made or not under ICDS X has to be analyzed on case to case basis.

  19. Implication of non-allowance of expected loss • Example :- • Expected loss in the 1st year of a 3 year contract is Rs. 300. • Actual Loss on completion of the contract in the third year is Rs. 240. • It can be observed that, without any actual income there would be taxable income u/s. 115JB, for wrong estimation of loss even though no deduction is allowable for same.

  20. Limit for Early Stage of Contract • Treatment during early stage of contract- • If during early stage of contract, the outcome of the contract cannot be estimated reliably, both AS and ICDS require that the contract revenue is recognised only to the extent of costs incurred. • AS/Ind AS– • The AS do not provide for any criteria on what is the early stage of a contract. Hence, under AS, where the outcome cannot be estimated reliably, no profits may be recorded even if say, 50% of project is already completed.

  21. Limit for Early Stage of Contract • GN on accounting for Real Estate Transactions: • Rebuttable presumption for completion of early stage: • All critical approvals necessary for commencement of the project have been obtained. • When the stage of completion of the project reaches a reasonable level of development i.e. 25 % of the construction and development costs • At least 25% of the saleable project area is secured by contracts or agreements with buyers. • At least 10% of the contract consideration are realised at the reporting date and it is reasonable to expect that the parties to such contracts will comply with the payment terms as defined in the contracts. • Committee Report – • To avoid ambiguity and litigation

  22. Limit for Early Stage of Contract • ICDS – • The foregoing treatment is allowed only till 25% of stage of completion is achieved. • Possible view – • It appears to be good move on part of legislature to specify limit. • However, method of computing 25% limit has not been provided. • In case of uncertainty, one can still postpone recognition; • Further, tax department would be more interested in combining and segmenting of contract.

  23. Treatment of Incidental Income under ICDS • AS/Ind AS – • Allows reduction of any incidental income from the contract costs. • Committee Report – • It is judicially settled that pre-construction income is not reduced from cost of construction. • ICDS – • Allows reduction of incidental income other than interest, dividend or capital gains.

  24. Treatment of incidental income under ICDS • Judicial Pronouncements – • When the income is inextricably linked to acquisition of asset, the income shall reduce the cost of asset. Such income is capital in nature and cannot be taxed. (CIT v. Bokaro Steel Ltd. 236 ITR 315 (SC)) • In following HC decisions, interest income inextricably linked to a project has been held to be capital in nature: • CIT vs. Jaypee DSC Ventures Ltd. (17 taxmann.com) (Del) • Karnal Co-operative Sugar Mills Ltd. vs CIT (233 ITR 531) (P & H) • Phoenix Lamps India Ltd. vs. CIT (50 taxmann.com 320)(All) • Koshika Telecom Ltd. vs. CIT (287 ITR 479) (Del) • Indian Oil Panipat Power Consortium Ltd. v. ITO [2009] 315 ITR 255 (Del.) • NTPC Sail Power Company (P.) Ltd. v. CIT [2012](25 taxmann.com )(Del) • PCIT v. Facor Power Ltd. [2016] 66 taxmann.com 178 (Delhi).

  25. Whether incidental income is taxable under ICDS • Possible view – • It is arguable that since the Committee has suggested the said change in ICDS on the basis that the issue is judicially settled, the said change would apply only in the context of such investments and activities, which are not directly relatable to construction contracts. • ICDS, being a computational provision cannot bring to tax something, which is not regarded as ‘income’ under the provisions of the Act. • The same can be effected only through amendment in the Act as was done in the case of government grants. • Besides, this ICDS wont apply to assessees who are setting up their own plants/buildings.

  26. Transitional provisions of ICDS III • Contract revenue and contract costs associated with uncompleted construction contract as on March 31, 2016 shall be recognized based on the method regularly followed by the person prior to the previous year beginning on the 1st day of April, 2016. • Hence, ICDS would not effect the tax treatment of contracts which are already in progress as on March 31, 2016. • Applicable even to transition provisions of ICDS IV relating to service contracts.

  27. ICDS IV – REVENUE RECOGNITION

  28. Recognition of revenue from Sale of Goods • No change in criteria for recognition of revenue from sale of goods in AS – 9 and ICDS. • The key criteria is that the significant risks and rewards in the goods are transferred. • The recognition criteria under Ind AS 18 is also similar (though more detailed). However, under Ind AS, the revenue is required to be measured at ‘fair value’. • Eg. In case of deferred consideration, Ind AS requires the sales consideration to be recognised at the discounted value of the consideration and the difference between the fair value and the nominal value is to be recognised as interest income.

  29. Recognition of revenue from Service Transactions • AS 9 – • Permits both the methods of revenue recognition. • Ind AS 18: • Permits on PCM basis for recognition of revenue from service transactions • Committee Report – • To reduce litigation and alternatives, only PCM is recommended • ICDS – • Permits only PCM, except where the duration of the contracts is < 90 days.

  30. Recognition of income from Service Transactions • Judicial Pronouncements – • As both the methods are permitted in commercial accounting principle, hence any method can be followed. • Bilahari Investment (P.) Ltd. (299 ITR 1) (SC): Service provider - follow completed contract method • Possible view – • The terms used in the standards are ‘revenue recognition’ not income recognition. However, in case of Lohia Machine (152 ITR 308), Supreme Court has upheld the power of rule making authority restrict the manner of computation to any one of the possible methods.

  31. Implication of following CPM method in Books • Possibility of MAT liability: • Say, service contract will take 3 years for execution and expected profit is Rs. 300. • TDS Mismatch: • ICDS does not require raising of a bill - if the transaction is covered by TDS then complication will increase, as the tax would be deducted in the year in which the bill is raised

  32. Recognition of Interest Income • AS 9 – • Interest income may be recognized on time basis. Usually, discount or premium on debt securities held is treated as though it were accruing over the period to maturity. • Ind AS 18 – • Interest shall be recognised using the effective interest method as set out in Ind AS 109. • ICDS – • Interest shall accrue on the time basis determined by the amount outstanding and the rate applicable, except in case of Interest on refund of any tax, duty or cess, which will taxed on receipt basis.

  33. Recognition of Interest Income • Q – where a instrument provides coupon date, whether interest would still be taxable on time basis?? • Judicial Pronouncements – • Right to receive - E.D. Sassoon & Co. Ltd. v. CIT (26 ITR 27) (SC) • Interest income to accrue on coupon date - DIT v. Credit Suisse First Boston (Cyprus) Ltd (351 ITR 323)(Bom.) • Possible view – • ICDS cannot override the concept of accrual u/s. 5, as explained by the courts.

  34. Recognition of interest income from NPAs • AS 9/ Ind AS 18 – • Interest income may be recognisedwhen no significant uncertainty as to measurability or collectability exists • Committee Report – • Due to specific provision of bad debt in the Act, revenue recognition should not be postponed. • ICDS – • Interest ‘shall’ be recognised on time basis. No clause requiring postponement of recognition of interest in case of uncertainty.

  35. Recognition of interest income from NPAs • FAQ of CBDT – • ‘As a principle, interest accrues on time basis and royalty accrues on the basis of contractual terms. Subsequent non-recovery in either cases can be claimed as deduction in view of the amendment to section 36(1)(vii). Further, the provision of the Act (eg. Section 43D) shall prevail over the provisions of the ICDS.’ (Q 13) • Provision of the Act – • Section 43D: Interest income from NPAs of Scheduled Banks, Cooperative Banks, etc. is taxable in the year in which it is credited to the P&L A/c or the year of receipt, whichever is earlier. • Provision not applicable to NBFCs.

  36. Recognition of interest income from NPAs • Judicial Pronouncements – • Real Income theory – • Shoorji Vallabhdas & Co. (46 TR 144) (SC): No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a "hypothetical income", which does not materialise. ; • Godhra Electricity (225 ITR 746) (SC), • State Bank of Travancore v. CIT (158 ITR 102) (SC)

  37. Recognition of interest income from NPAs • CIT v. Motor Credit Co. (P) Ltd. (127 ITR 572)(Mad)[SLP dismissed by SC in (149 ITR (Statutes) 93]. Where no income has resulted, it cannot be said that the income has accrued merely on the ground that the assessee has been following the mercantile system of accounting • Principle of accrual – • CIT vs. VasisthChayVyapar Ltd. (196 Taxman169)(Delhi), • CIT vs. India Equipment Leasing Ltd (293 ITR 350)(Mad), etc. • DIT vs. Brahamputra Capital Financial Services Ltd. (12 taxmann.com 387)(Delhi).   • CIT vs. Elgi Finance Ltd (293 ITR 357)(Mad).

  38. Recognition of interest income from NPAs • Possible view – • ICDS is a delegated legislation, cannot bring to tax something which has been held to be not ‘income’; • Besides it cannot override the concept of ‘accrual’ u/s. 5; • The explanation of CBDT does not hold good in case of ‘IOS’; • Recognition of interest on NPAs for NBFCs is governed by section 45Q of the RBI Act, which override any other law in India. Therefore, arguable that it overrides section 145 of the Act.

  39. Impact of ICDS IV on recognition of export incentive • AS 9– • Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. • ICDS – • Para 5 – where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim for export incentives, revenue recognition in respect of such claim shall be postponed to the extent of uncertainty involved.

  40. Impact of ICDS IV on recognition of export incentive • Judicial Pronouncement – • Income to be recognised when there is corresponding third party liability to pay • See CIT v. Excel Industries Ltd. (358 ITR 295) (SC) • Possible view – • ICDS cannot override the concept of accrual as explained by the courts. • Additional argument can be taken that export incentive is outside the scope of the ICDS - EAC Vol26, Q 32.

  41. Impact of ICDS IV on treatment of Finance Lease • AS/Ind AS – • A separate AS is prescribed for accounting of leases • Committee Report – • Recommended a separate ICDS on leases, which has not been notified yet. • ICDS IV – • Excludes revenue recognition of items specifically dealt by other ICDS.

  42. Impact of ICDS IV on treatment of Finance Lease • FAQ of CBDT: • At present there is no specific ICDS notified for leases. Therefore, relevant provisions of the Act and ICDS shall apply to these transactions, as may be applicable. (Q 12) • Possible view – • Scope of ICDS – IV is limited to sales of goods, rendering of services and use of resources by others yielding Interest, Royalties or Dividends. • Hence a view may be taken that lease rentals are outside the purview of ICDS – IV.

  43. Applicability to presumptive taxation • ICDS: • Applicable to all assessees following mercantile system of accounting, for the purposes of computation of income chargeable under the head “BI” or “IOS”. • FAQ by CBDT • ‘ICDS is applicable to specified persons having income chargeable under the head BI or IOS. Therefore, the relevant provisions of ICDS shall also apply to the persons computing income under the relevant presumptive taxation scheme. For example, for computing presumptive income for a partnership firm under section 44AD of the Act, the provisions of ICDS on Construction Contract or Revenue recognition shall apply for determining the receipts or turnover, as the case may be. (Q 3)

  44. Applicability to presumptive taxation • Possible View: • Section 145 applies only to assessee following a system of accounting. U/s. 44AA, assessee opting for presumptive taxation is not required to maintain books • ICDS are applicable for computation of ‘income’ not ‘gross turnover/receipts’ referred in section 44AD, etc. • The presumptive provisions being non-obstante provisions, would override section 145, including the ICDS.

  45. Applicability to presumptive taxation • Possible view (cont.) • ICDS itself provides in case of conflict, provisions of Act would override. • Unlike old ICDS, preamble to revised ICDS provides for specific exclusion to individuals/HUFs not liable for tax audit u/s. 44AB. Assessees opting for presumptive taxation are neither required to maintain books nor get it audited. Hence, ICDS clearly not applicable for individuals and HUFs opting for presumptive taxation. • In case of other assessees too, if they determine the gross receipt on cash basis and not mercantile basis, ICDS would not apply since it applies to assessees following mercantile system of accounting.

  46. Applicability to income taxable on gross basis • FAQ of CBDT- • The provisions of ICDS shall apply for computation of income which are liable to tax on gross basis like interest, royalty and fees for technical services for non-residents u/s. 115A of the Act for arriving at the amount chargeable to tax. (Q 14) • Section 115A provides for rate of taxation for non-resident assessees. TDS is deducted on this income under the Act at the time of credit or payment, whichever is earlier. • Generally therefore, the point of taxation of these types of income is at the time the income is credited or paid by the Indian resident.

  47. Applicability to income taxable on gross basis • In case of a service provider receiving income as FTS, who raises the invoice on completion of the contract (on which TDS is deducted), due to foregoing clarification would now be required to offer income on PCM basis. This is unintended consequence, which would also create practical difficulty.

  48. Applicability of ICDS to Real Estate Developers • Accounting standard – 1985 – Scope :- “This Statement deals with accounting for construction contracts in the financial statements of enterprises undertaking such contracts (hereafter referred to as 'contractors'). The Statement also applies to enterprises undertaking construction activities of the type dealt with in this Statement not as contractors but on their own account as a venture of a commercial nature where the enterprise has entered into agreements for sale.” • Accounting standard – 2002 – Scope :- “This Standard should be applied in accounting for construction contracts in the financial statements of contractors.”

  49. Applicability of ICDS to Real Estate Developers • IndAS 11 – Scope: “This Standard shall be applied in accounting for construction contracts in the financial statements of contractors.” • ICDS – Scope :- “This Income Computation and Disclosure Standard should be applied in determination of income for a construction contract of a contractor.”

  50. Applicability of ICDS to Real Estate Developers • Committee Report – “the Committee recommends that TAS covering the following areas may also be considered for notification under the Act: . . . (iii) Revenue recognition by real estate developers” • FAQ Issued by CBDT: “At present there is no specific ICDS notified for real estate developers, BOT projects and leases. Therefore, relevant provisions of the Act and ICDS shall apply to these transactions as may be applicable.”(Q 12)

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