study circle meeting icds i, ii and iv - · pdf fileicds applies only to taxpayers following...
TRANSCRIPT
CA Ravikant Kamath
17 August 2017
Study Circle Meeting
ICDS I, II and IV
Page 2 August 2017CTC Study Circle – ICDS I, II & IV
Contents
► ICDS – General principles
► ICDS I – Accounting Policies
► ICDS II – Valuation of Inventories
► ICDS IV – Revenue Recognition
Page 3
ICDS – General principles
Page 4 August 2017CTC Study Circle – ICDS I, II & IV
ICDS - General principles
► Broad principles which internally guided the Committee while formulating ICDS
are:
► Reduction of litigation
► Minimization of alternatives
► Certainty to issues
► ICDS applies from A.Y. 2017-18 (F.Y. 2016-17)
► ICDS applies only to taxpayers following mercantile method of accounting
► Applicable for two heads of income viz. ‘Profits & Gains of Business & Profession’ and
‘Income from other sources’
► Taxpayers who predominantly follow mercantile method but adopt cash method for
small/ insignificant streams of income may not be able to presume non-application of
ICDS1
► Non resident taxpayers may also have concern on computation of income of PE/branch
► Does not apply to Individuals and HUFs not liable to tax audit1 ICDS application to small streams recognized on cash basis will require fact based analysis and is litigation prone
Page 5 August 2017CTC Study Circle – ICDS I, II & IV
ICDS - General principles
► ICDS to be given effect in computation of taxable income (FAQ 1 of Circular No.
10/2017)
► No two sets of books required to be maintained as clarified by Preamble of each ICDS
► Practically, will necessitate maintenance of memorandum records (including changes in
ERP wherever necessary)
► Tax Audit Report (Form 3CD) amended to include ICDS disclosures (Refer
Notification No. 88/ 2016 dated 29 September 2016)
► Each ICDS has both ‘computation’ and ‘disclosure’ requirements
► Disclosure required in Tax Audit Report; not applicable if taxpayer is not liable for tax
audit (FAQ 25 of Circular)
► MAT will continue to be governed by books of account prepared as per applicable GAAP
(FAQ 6 of Circular)
Page 6 August 2017CTC Study Circle – ICDS I, II & IV
ICDS - General principles
► ICDS is based on pre-2016 ICAI AS subject to deviations/ carve-outs as
suggested by Committee
► IFRS / Ind-AS are notified to become effective from F.Y. 2016-17 in phased manner
► Differences of ICDS with Ind-AS will require independent evaluation (eg. BOT project,
Revaluation of PPE, Deferred revenue recognition for loyalty points or deferred
payment terms, Financial instruments, etc)
► Some ICAI AS revised w.e.f F.Y. 2016-17
► Revenue/ expense on which there is no ICDS will continue to be governed by AS/
Ind-AS
► E.g. ESOP cost
► Unlike ICAI AS, ICDS contains only main principles; no Explanations or
Illustrations provided
Page 7 August 2017CTC Study Circle – ICDS I, II & IV
ICDS – Principles of construction
► Provisions of the Income-tax Act, 1961 (ITA) to prevail in case of conflict with ICDS
► Undefined words/ expression take their meaning from ITA
► FAQ 2 states that ICDS shall apply to ‘transactional issues’ dealt therein for A.Y. 2017-18 onwards
over judicial pronouncements rendered in absence of authoritative guidance under the Act
► ICAI Technical Guidance classify judicial rulings in three categories (Para 15, pg 15-17)
► ICDS supporting specific amendments (s.2(24)(xviii), 36(1)(iii) & 36(1)(vii)) shall override earlier judicial precedents
► ICDS shall override judicial precedents based on extant GAAP
► But ICDS cannot override judicial precedents on basic principles of tax (eg. real income theory in context of
interest on NPAs)
Hierarchy of ICDS
– Specific statutory provisions (ITA)
– Income tax rules
– Real income theory
– Tax jurisprudence on above
– ICDS
– Commercial principles of accounting
Page 8
ICDS I – Accounting Policies
Page 9 August 2017CTC Study Circle – ICDS I, II & IV
Fundamental Accounting Assumptions and Materiality
► Going concern, consistency and accrual are fundamental accounting assumptions –
disclosure required if any of the assumptions not followed
► Accrual of income takes place when there emerges a debt in favour of taxpayer which is
enforceable in law [E.D. Sassoon & Co. Ltd. (26 ITR 27) (SC)]
► As per ICAI TG, ICDS does not alter or impinge upon supremacy of s.5 over s.145 (para 4.19,
pg 35)
► S.145 permits cash method as a choice. Also, judicially, it is recognized that if no method is
discernible, default choice is cash method
► Concept of ‘materiality’ which was relevant in selecting and applying accounting policy
omitted
► No likely significant tax impact, but possible litigation on small value items if Tax Authority
insists on strict application of ICDS
► ICAI TG also states that omission of ‘materiality’ is unlikely to impact income computation
Page 10 August 2017CTC Study Circle – ICDS I, II & IV
Prudence
Concept of ‘prudence’ is modified by ICDS
► Prior to ICDS, prudence understood to mean non-recognition of anticipated profits
but recognition of known liabilities and losses on best estimate basis (e.g. ICAI’s
guidance on derivatives in March 2008)
► As per Committee, prudence led to differential treatment for income and loss
► ICDS prohibits recognition of marked to market (MTM) or expected loss unless
permitted by any other ICDS
► MTM gain at par with MTM loss – Taxable only at the time of realization (FAQ 1 of
Circular)
► ICDS I covers derivatives not covered under ICDS VI /VIII (FAQ 10 of Circular)
Page 11 August 2017CTC Study Circle – ICDS I, II & IV
Prudence
► ‘Expected loss’ is different from actually incurred loss recognised on best estimate
basis (eg. loss by fire, theft, etc) or actuarially valued liabilities (eg. pension
obligation)
► ICDS prohibits deduction in respect of “expected loss” – but, does not impact actual loss
though may have been estimated on a scientific basis
Page 12 August 2017CTC Study Circle – ICDS I, II & IV
► Accounting policy shall be such to represent true and fair view of state of affairs and income of
the business, profession or vocation
► As per ICAI TG, ‘accounting policy’ should be read as ‘computation policy’ (para 3.6, pg 25)
► As per FAQ 1 of Circular, accounting policies are ‘fundamental’ in nature
► All significant accounting policies adopted by taxpayer need to be disclosed
► As per ICAI TG, ‘significant’ infers of such magnitude as may influence readers/users of financial statements (para
3.3, pg 25)
► Accounting policy can be changed for any ‘reasonable cause’
► ‘Reasonable cause’ is not defined in ICDS; an existing concept, to be governed by judicial precedents
(FAQ 9 of Circular)
► ‘Reasonable cause’ means a reason which appeals to a person of average intelligence and ordinary
prudence; probable cause (Refer, illustratively, Woodward Governor India (P) Ltd (Del) (253 ITR 745),
Azadi Bachao Andolan (Del) (252 ITR 471))
► Earlier, change permitted if required by statute; or for compliance with AS; or considered as
resulting in more appropriate presentation
Disclosure of ‘accounting policy’
Page 13 August 2017CTC Study Circle – ICDS I, II & IV
Change in Accounting Policy
► Upon change in accounting policy, disclosure required in the year of change if it
has material effect
► If no material effect in current year, disclosure also required in first year of material
impact.
► Enhanced disclosure requirement and compliance burden
► Default of sheer non disclosure unlikely to have any adverse impact on best
judgement assessment.
Page 14 August 2017CTC Study Circle – ICDS I, II & IV
Transitional Provision- ICDS-I
► Extract of transitional provision
“10. All contract or transaction existing on the 1st day of April, 2016 or
entered into on or after the 1st day of April, 2016 shall be dealt with in
accordance with the provisions of this standard after taking into account the
income, expense or loss, if any, recognised in respect of the said contract or
transaction for the previous year ending on or before the 31st March, 2016.”
► ICDS I does not permit recognition of MTM losses or expected losses unless
permitted by other ICDS
► Transitional provisions arguably does not require reversal of MTM losses recognised in
earlier years (Refer ICAI TG para 8.2, page 38)
Page 15 August 2017CTC Study Circle – ICDS I, II & IV
Case study – Modifying ‘Prudence’
MTM recognition of gain/loss on derivative (Interest Rate
Swaps) for hedging purposes (not covered by ICDS VI on Foreign Exchange Rates)
ICo Facts
► ICo has entered into derivative contract
with bank for hedging exposure to
fluctuating interest rate risk on loan having
floating rate interest
► Derivative contract is in compliance with
RBI Guidelines
► ICo is able to demonstrate that loss/gain
on derivative offsets corresponding
gain/loss on underlying interest outflow on
loan
Commercial Impact
Higher interest
cost
(Rs. 1 Cr)
MTM gain on
derivative
Rs. 1 Cr
Net commercial
income
NIL
Page 16 August 2017CTC Study Circle – ICDS I, II & IV
Case study – Modifying ‘Prudence’ (…contd)
Income/Loss Amount ICAI 2008 GN ICAI 2015 GN Ind-AS ICDS I
Higher
interest cost
(1 Cr) Recognise as
per AS-16
Recognise as
per AS-16
Recognise as
per effective
interest rate
Recognise as
per ICDS IX
MTM Gain
on IRS
1 Cr Ignore MTM
Gain
Recognise
MTM Loss
Recognise
MTM gain/loss
Recognise
MTM
gain/loss
Ignore MTM
gain/loss
Recognise in
year of
realisation
Net income NIL (1 Cr) NIL NIL (1 Cr)
Page 17
ICDS II - Valuation of inventory
Page 18 August 2017CTC Study Circle – ICDS I, II & IV
Valuation of inventory – tangible assets
► Includes assets
► Held for sale in the ordinary course of business
► In the process of production for such sale
► In the form of materials or supplies to be consumed in the production process or in the
rendering of services
► Valuation at lower of cost or NRV
► Akin to ICAI AS-2, ICDS permits FIFO, weighted average, specific identification,
standard cost or retail method
► If taxpayer adopts standard cost method, ICDS requires disclosure confirming that
standard cost approximates actual cost
► Will include unconsumed items for construction contract at year end (Refer ICAI TG, para
2.2(a), page 40)
Specific provisions of s.145A may override anything to contrary in ICDS
Page 19 August 2017CTC Study Circle – ICDS I, II & IV
Valuation of inventory – service WIP
► Definition of ‘inventory’ is ambiguous on inclusion of service inventory within its scope
► Cost of inventories includes cost of services and para 6 of ICDS II defines “cost of
services” as labor and other direct personnel cost and attributable overheads
► Revised ICDS has deleted reference to ‘service providers’
► As per ICAI TG
► ICDS-II is not applicable to service inventory (para 7, pg 46)
► ICDS II include derivatives held as inventory but not covered by ICDS VI/VIII (para
2.4, pg 41)
Page 20 August 2017CTC Study Circle – ICDS I, II & IV
Valuation of inventory
► S.145A overrides provisions of s. 145 r.w. ICDS
“145A. Notwithstanding anything to the contrary contained in section 145,—
(a) the valuation of purchase and sale of goods and inventory for the purposes of
determining the income chargeable under the head "Profits and gains of business or
profession" shall be—
(i) in accordance with the method of accounting regularly employed by the
assessee; and
(ii) further adjusted to include the amount of any tax, duty, cess or fee (by whatever
name called) actually paid or incurred by the assessee to bring the goods to the place
of its location and condition as on the date of valuation.
Explanation.—For the purposes of this section, any tax, duty, cess or fee (by whatever
name called) under any law for the time being in force, shall include all such payment
notwithstanding any right arising as a consequence to such payment;
(b)…..”
* CIT v Knight Frank (India) Pvt. Ltd. (2016) (242 Taxman 313) (Bom HC)
S.145A does not apply to service inventory*
Page 21 August 2017CTC Study Circle – ICDS I, II & IV
Valuation of inventory
► In case of newly commenced business, cost of inventory on day of
commencement of business shall be opening inventory
► In case of conversion of capital asset into stock-in-trade for commencing business, FMV
as on date of conversion is cost to the business (ICAI TG, para 13.4, pg 57-58)
► If business is commenced by acquiring a running business from another, consideration
paid (whether slump price or itemised value) constitutes cost to the business of opening
inventory
► No specific guidance about basis of determination of cost to business of firm
where partners contribute assets as stock-in-trade
► S.45(3) does not apply
► Value credited in books may arguably constitute the cost?
► Valuation of opening inventory to be the same as closing inventory in preceding
year – regardless of change in method of valuation of closing inventory
Page 22 August 2017CTC Study Circle – ICDS I, II & IV
Valuation of inventory
► On dissolution of firm, AOP or BOI, inventory to be valued at NRV regardless of
whether business is discontinued
► In ALA Firms (189 ITR 285)(SC), SC upheld valuation at NRV since business was
discontinued on dissolution
► Whether SC ruling in Shakthi Trading’s case (250 ITR 871) where SC upheld lower of
cost or NRV considering that business was continued post dissolution may no more
apply ?
► In Shakti Trading’s case (supra), ALA Firms (supra) was held not applicable as business was
continued on a going concern basis upon takeover
► Method of valuation once adopted shall not be changed without reasonable
cause
► Courts have permitted bonafide change where changed method is as per GAAP and
followed regularly thereafter (e.g. from cost to lower of cost or NRV)
Page 23 August 2017CTC Study Circle – ICDS I, II & IV
Treatment of general machinery spares as per revised AS-2/ 10 and ICDS II/ V
Revised ICAI
AS-2/ 10
Treated as Property, Plant & Equipment (PPE) if
useful life > 12 m
Else, treated as Inventory
ICDS II and V Treated as inventory, irrespective of useful life
Charged to revenue as and when consumed
Illustration
X Co purchased general machinery spares with useful life > 12 m on 15th April 2016
Book treatment as per
revised ICAI AS-2/10
PPE to be depreciated over useful life
Tax treatment Alternative 1 – Depreciate over useful life as per books
Alternative 2 – Treat it as inventory as per ICDS II/V
Issue How does s.145A impact conclusion?
Page 24 August 2017CTC Study Circle – ICDS I, II & IV
Transitional Provision- ICDS-II
► Extract of transitional provision
“25. Interest and other borrowing costs, which do not meet the criteria for recognition
of interest as a component of the cost as per para 11, but included in the cost of the
opening inventory as on the 1st day of April, 2016, shall be taken into account for
determining cost of such inventory for valuation as on the close of the previous year
beginning on or after 1st day of April, 2016 if such inventory continue to remain part of
inventory as on the close of the previous year beginning on or after 1st day of April,
2016.”
► Transitional provision explicit only for interest component
► Overriding impact of s.145A on valuation of inventories needs to be considered before
application of ICDS II
Page 25
ICDS IV – Revenue Recognition
Page 26 August 2017CTC Study Circle – ICDS I, II & IV
POCM
Transfer of
property or
significant
risks &
rewards of
ownership to
buyer
As per contractual
terms, unless some
other systematic /
rational basis as
per substance of
transaction
Ordinarily, POCM
If contract duration <
90 days, permits
completed contract
method
If services by
indeterminate
number of acts,
permits straight line
method
Receipt
basis for
interest
on tax
refund
Time
basis for
other
Revenue recognition
criteria as per ICDS
Construction
contract
(including
services
directly related
to construction
like architect)
Sale of
goods
Rendering of services Interest Royalty (as defined
by ITA)
Broad Overview
As per ITA
Dividend
Page 27 August 2017CTC Study Circle – ICDS I, II & IV
Revenue recognition – Sale of goods
► Revenue from sale of goods recognised upon transfer of property or upon transfer
of significant risk/ rewards of ownership to buyer
► In case of timing mismatch between transfer of property vs. significant risks/ rewards;
revenue to be recognised on transfer of significant risks/ rewards
► No change in position for lessor in finance lease (ICAI TG, para 4.4, pg 89-90)
► Revenue to be recognised only if there is reasonable certainty of its ultimate
collection
► ICDS not materially different from AS-9
► ICDS is in line with current judicial thinking which aligns also with real income theory
► Reasonable certainty test is different from concept of accrual u/s. 5 of ITA (ICAI TG para
4.8, pg. 91)
Page 28 August 2017CTC Study Circle – ICDS I, II & IV
Revenue recognition – Rendering of services
► Distinction between sale of goods v. rendering of services should be based on
predominant aspect (ICAI TG, para 5.8, pg. 93)
► Revenue recognition criteria for services
► Real estate developer not covered by ICDS IV (FAQ 12 of Circular) – draft ICDS
published for public comments
Features of service Less than or equal to 90
days
More than 90 days
Service contract specifying
indeterminate number of acts
Taxpayer can follow completed
contract method
Taxpayer can follow Straight Line
Method
Service contract with specified
milestones
Taxpayer can follow completed
contract method
Taxpayer shall follow Percentage
of Completion Method
Page 29 August 2017CTC Study Circle – ICDS I, II & IV
Revenue recognition – Interest
► Interest income to be recognized on time basis (including discount or premium on securities)
► As per FAQ 13 of Circular, test of reasonable certainty of ultimate collection does not apply to interest
and royalty income; subsequent non-recovery can be claimed as deduction u/s. 36(1)(vii)
► Specific provisions of the Act (e.g. s. 43D, 145A) override ICDS
► As per settled legal position, interest income not taxable (unless contractually due) in absence of real
income
► Accrual and reasonable test certainty applicable to interest income (ICAI TG, para 6.5, pg. 95)
► Onus on taxpayer to prove that there is no reasonable certainty of realization
► Alternatively, taxpayers can claim bad debt deduction under second proviso to s.36(1)(vii)
► Broken period interest income on securities to be reduced in capital gains computation (FAQ 18 of
Circular)
► Taxation of interest/royalty in hands of NR on paid/ actual basis as per treaty and favourable judicial
decisions – remains unaffected by ICDS (ICAI TG, para 6.23, pg. 99)
► Interest on refund of any tax, duty or cess to be taxable on receipt basis
Page 30 August 2017CTC Study Circle – ICDS I, II & IV
Royalty income
► Royalty to be recognized in accordance with the terms of the relevant agreement
unless having regard to the substance of the transaction, it is more appropriate to
recognize it on some other systematic and rational basis.
► ‘Royalty’ definition to be borrowed from Exp 2 to 5 to s.9(1)(vi)
► Includes equipment royalty (excluding those covered by s.44BB)
► Includes services incidental to royalty transaction (ICAI TG, para 6.26, pg. 101)
► Beneficial provisions of applicable DTAA shall override ICDS (ICAI TG, para 6.23,
pg. 99)
Page 31 August 2017CTC Study Circle – ICDS I, II & IV
Revenue recognition – Applicability to special sectors
► Circular No. 10/2017
► Rules 9A, 9B (film production/distribution) shall override ICDS (FAQ 4)
► ICDS applicable to presumptive taxation schemes for determining turnover, receipts
(FAQ 3)
► Sector specific provisions in ITA shall override ICDS (FAQ 7) (eg. ICDS VIII – Securities
has special provisions for banks/FIs, Insurance governed by Schedule I of ITA)
► No specific ICDS for real estate developers, BOT projects and leases (FAQ 12)
► ICAI Technical Guidance
► Logically ICDS would not apply to taxpayers governed by presumptive taxation schemes
(ICAI TG, para 9.3, pg 10)
► ICDS not applicable to Insurance companies (para 10, pg 11)
Page 32 August 2017CTC Study Circle – ICDS I, II & IV
Applicability of ICDS to taxpayers governed by presumptive tax provisions
► As per FAQ 3 &14 of Circular, ICDS applies even to taxpayers opting for
presumptive tax provisions for determining “receipt” or “turnover” and also for
computation of income on gross basis u/s 115A
Incomes taxed on gross basis
u/s.115A
■ S.115A merely prescribes rate
of tax and quantifies tax
lability after income is
computed
■ Thus, income covered by
S.115A necessarily gets
subjected to ICDS
Presumptive sections like s.44B/ BBA/
BBB specify presumptive tax base as
amount paid/ payable or received/
deemed to be received
■ These presumptive tax provisions
are self-contained and complete
code in itself
■ Thus, taxation cannot be as per
ICDS
Presumptive sections like
s.44AD/ ADA do not define
gross receipt/ turnover
■ Taxpayers governed by
s.44AD/ ADA not liable to
tax audit
■ Thus, individual and HUF
continue to remain outside
the ICDS net
■ However, if taxpayers opt out of presumptive provision and offer lower
income, they are governed by normal tax provisions and also liable for
tax audit. ICDS will also apply in that case
Page 33 August 2017CTC Study Circle – ICDS I, II & IV
Transitional Provision - ICDS IV
► Extract of transitional provision
“11. The transitional provisions of Income Computation and Disclosure Standard on
construction contract shall mutatis mutandis apply to the recognition of revenue and the
associated costs for a service transaction undertaken on or before the 31st day of March,
2016 but not completed by the said date.
12. Revenue for a transaction, other than a service transaction referred to in Para 10,
undertaken on or before the 31st day of March, 2016 but not completed by the said date
shall be recognised in accordance with the provisions of this standard for the previous year
commencing on the 1st day of April, 2016 and subsequent previous year. The amount of
revenue, if any, recognised for the said transaction for any previous year commencing on
or before the 1st day of April, 2015 shall be taken into account for recognising revenue for
the said transaction for the previous year commencing on the 1st day of April, 2016 and
subsequent previous years.”
► ICDS III ‘grandfathers’ construction/service contracts commenced prior to 1 April 2016
► No grandfathering for other revenue streams – to be recognized as per ICDS after considering revenue already recognized in earlier years
Page 34 August 2017CTC Study Circle – ICDS I, II & IV
Disclosure requirements
► Taxpayer needs to make following disclosures:
► In case of sale of goods, unrecognized revenue amount due to lack of
reasonable certainty of its ultimate collection and nature of uncertainty
► In case of service contracts, similar disclosure requirements as under ICDS III
► Arguably, no disclosure requirements for :-
► grandfathered service contracts (ICAI TG, para 11.1, pg 84)
► Service contracts < 90 days (ICAI TG, para 8.4, pg 104)
Page 35 August 2017CTC Study Circle – ICDS I, II & IV
Case study – Recognition of ‘service’ revenue
Facts
► ICo is engaged in providing management
consulting services and it undertakes numerous
assignments which typically last over 3-4 years
► Invoices are raised as per milestones agreed in
service contracts
► Services rendered till balance sheet date but not
invoiced are not recognized either as ‘unbilled
revenue’ or as ‘inventory’
ICo
(Project Management Consulting)
Customers
Service contracts
Issues Position for books of
account
ICDS
impact
► Non-recognition of
unbilled revenue
No reasonable certainty
of receipt
?
► Non-recognition of
service inventory
AS-2 does not cover
service WIP
?
Thank you !“This Presentation is intended to provide certain general information existing as at the time of
production. This Presentation does not purport to identify all the issues or developments. This
presentation should neither be regarded as comprehensive nor sufficient for the purposes of decision-
making. The presenter does not take any responsibility for accuracy of contents. The presenter does
not undertake any legal liability for any of the contents in this presentation. The information provided is
not, nor is it intended to be an advice on any matter and should not be relied on as such. Professional
advice should be sought before taking action on any of the information contained in it. Without prior
permission of the presenter, this document may not be quoted in whole or in part or otherwise.”