Income Computation and Disclosure Standard IX relating to Borrowing costs

Page 2 Agenda Income Computation and Disclosure Standard IX relating to borrowing costs ► Scope and Recognition principle Definition Capitalisation methodology Transitional Provisions and Disclosure Key takeaways

Page 3 Scope and Recognition principle This Income Computation and Disclosure Standard deals with treatment of borrowing costs. Income Computation and Disclosure Standard IX relating to borrowing costs Recognition This ICDS does not deal with the actual or imputed cost of owners’ equity and preference share capital. Entity should capitalize borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset Core recognition principle Other borrowing costs shall be recognised in accordance with the provisions of the Income Tax Act For the purposes of this standard, “capitalisation” in the context of inventory shall means addition of borrowing cost to the cost of inventory

Page 4 Alignment of tax provisions with ICDS Income Computation and Disclosure Standard IX relating to borrowing costs Current tax positionICDS (tax guidance) ► In order to resolve the existing anomaly in interest capitalization ‘i.e. interest to be capitalized only if it relates to extension of business’. Finance Act 2015 had amended the provisions under the Act and has removed the phrase “for extension of existing business or profession”. ► The erstwhile provision under the Act [section 36(1)(iii)] provided that interest paid in respect of capital borrowed for acquisition of asset for extension of existing business or profession shall be disallowed (from the period of borrowing of capital till the date of put to use of assets) ► Aligning with the Act, provisions of ICDS does not limit on capitalization of borrowing cost for extension of existing business or profession only

Page 5 Agenda Income Computation and Disclosure Standard IX relating to borrowing costs Scope and Recognition principle ► Definition Capitalisation methodology Transitional Provisions and Disclosure Key takeaways

Page 6 Definition Income Computation and Disclosure Standard IX relating to borrowing costs Borrowing Costs ► These are interest and other costs incurred by a person w.r.t borrowed funds and include: ► commitment charges ► amortised amount of discounts or premiums ► amortised amount of ancillary costs incurred to arrange the borrowings ► finance charges w.r.t assets acquired under finance leases or other arrangements of similar nature. Qualifying Assets ► These are: ► tangible assets which include land, building, machinery, plant or furniture. ► intangible assets which include know-how, patents, copyrights, trade marks, licences etc. ► inventories that require a period of twelve months or more to bring them to a saleable condition.

Page 7 Key differences- Qualifying assets definition Income Computation and Disclosure Standard IX relating to borrowing costs IssueICDS IXIGAAP (AS 16)Ind AS 23 Qualifying AssetsAll assets regardless of the time are covered. Inventories requiring a period of twelve months or more to bring them to a saleable condition are covered. It covers assets which take substantial period of time to get ready for its intended use or sale. Ordinarily, period of 12 months is usually considered as substantial period of time, however not mandatory. Similar to AS 16 i.e. cover assets that necessarily takes a substantial period of time to get ready for its intended use or sale However, there is no mention that 12 months period ordinarily could be considered as substantial period of time.

Page 8 Case Study - Qualifying Assets for capitalisation Income Computation and Disclosure Standard IX relating to borrowing costs Facts: ► ICo is engaged in manufacturing business ► It desires to replace its IT infrastructure at its Head office with new IT infrastructure system at total cost of $1 Mn ► ICo places order with vendor on 1 st April 2015 and pays advance ► Vendor supplies and installs all the computers by 31 August 2015 (i.e., within five months) ► ICo pays balance amount to vendor on 31 August 2015 ► Ico has made specific borrowing from bank for the project. The payments to Vendors are made out of borrowed funds IT Infrastructure ICoBank Vendor of computers Specific borrowing Acquisition and installation completed in five months Payment from borrowed funds

Page 9 Case Study - Qualifying Assets for capitalisation Income Computation and Disclosure Standard IX relating to borrowing costs Tax treatment pre ICDS and amendment in Act Indian company claim full deduction of interest u/s 36(1)(iii) Arguably, interest not required to be capitalized in absence of ‘extension of business’ Tax treatment post ICDS and amendment in Act ICDS regards all fixed assets as ‘qualifying assets’ warranting capitalisation of interest regardless of‘ substantial period’ for being ready to use as a precondition ICDS will, therefore, require ICo to capitalise interest from the date of specific borrowing even if pending utilisation, the funds may have been kept in short term income yielding investment ICo can not claim that there is absence of ‘extension to business’ post amendment under the Act Income earned from short term deployment of specific borrowed funds is to be offered to tax on gross basis Book Treatment as per ICAI AS – 16 The IT infrastructure is not a ‘qualifying asset’ (as it does not take substantial period (≥ 1 year as a benchmark rule) to be ready for use). AS-16, therefore, does not require capitalisation of interest in present case Pre ICDS Post ICDS

Page 10 Key Differences- Borrowing costs- Foreign exchange adjustment Income Computation and Disclosure Standard IX relating to borrowing costs IssueICDS IXIGAAP (AS 16)Ind AS 23 Foreign exchange adjustments relating to interest costs- Exchange differences arising from foreign currency borrowings to the extent they are regarded as an adjustment to interest cost are not covered in borrowing cost under ICDS. Such exchange difference is to dealt as per ICDS VI- Effect of changes in foreign exchange rates. Covered as part of borrowing cost

Page 11 Agenda Income Computation and Disclosure Standard IX relating to borrowing costs Scope and Recognition principle Definition ► Capitalisation methodology Transitional Provisions and Disclosure Key takeaways

Page 12 Capitalisation Methodology Income Computation and Disclosure Standard IX relating to borrowing costs Specific Borrowings ► Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset shall be capitalised as part of the cost of that asset. ► Capitalisation of such costs shall COMMENCE from the date on which funds were borrowed. General Borrowings ► Borrowing costs related to the funds utilised for acquisition, construction or production of a qualifying asset, amount to be capitalised shall be computed using the pro-ration formula (A*B/C) ► Capitalisation of such costs shall COMMENCE from the date on which funds were utilised. Borrowings ► Capitalisation of such borrowing costs shall CEASE when: ► a qualifying asset or a part of it is put to use; ► all the substantial activities are completed to prepare Inventory or a part of inventory for its intended sale.

Page 13 Capitalization Methodology: General borrowings (A) = General purpose Borrowing cost (B) = Cost of qualifying assets Appearing on first and last dayAverage cost of qualifying asset as on first and last day Not appearing on last dayAverage cost of qualifying asset as on first day and date of put to use or completion, as the case may be Not appearing in Balance sheet on first day or both first and last day Half of cost of qualifying asset (C) =Average of total assets on the first and last day of the year (other than those directly funded) Income Computation and Disclosure Standard IX relating to borrowing costs Pro rata borrowing costs allocation based on formula A*B/C

Page 14 Key Differences- Capitalisation methodology Income Computation and Disclosure Standard IX relating to borrowing costs IssueICDS IXIGAAP (AS 16)Ind AS 23 Income from temporary investment – Specific borrowing The income from temporary investments of those borrowings is not reduced from the amount of borrowing costs incurred. Such income is reduced from borrowing costs eligible for capitalization. Similar to AS 16 Capitalisation of general borrowing cost Interest is calculated using pro-ration formula i.e., A*B/C (discussed later) Requires capitalisation by applying weighted average cost of borrowing to capex for the period during which asset is under development. Similar to AS 16 Commencement of capitalisation Specific borrowings: ► from the date on which funds were borrowed. General borrowings: ► from the date on which funds were utilized. When below conditions are met: ► Expenditure on qualified asset incurred. ► Borrowings costs incurred ► Activities to prepare asset for its intended use or sale is in progress. Similar to AS 16 Cessation of capitalisation Capitalisation should cease when: ► a qualifying asset or a part of it is put to use; ► Substantial activities completed to prepare Inventory or a part of inventory for its intended sale Capitalisation should cease when: ► all the substantial activities are completed to prepare a qualifying asset for its intended sale or use. Similar to AS 16 Suspension of capitalisation Not covered by ICDSDuring extended periods in which active development is interrupted. Similar to AS 16

Page 15 Case Study- Methodology of Capitalisation Income Computation and Disclosure Standard IX relating to borrowing costs Facts: ► ICo is engaged in manufacturing business ► ICo sets up new unit for manufacturing ► ICo unit admittedly represents extension of business ► The investment in new unit is financed from ► Specific term loans from financial institutions for plant and machinery ► Cash credit facility for working capital ► Unsecured loans from group companies ► The new unit is treated as qualifying asset under AS-16 and borrowing cost is capitalized in books as per capitalization norms provided under AS-16 ICo Group Companies Financial Institution Bank Qualifying asset (New unit) Unsecured Loan Term Loan Cash Credit

Page 16 Case Study - Methodology of Capitalisation Income Computation and Disclosure Standard IX relating to borrowing costs Particular ICAI AS- 16 ICDS Specific BorrowingGeneral BorrowingSpecific Borrowing General Borrowing Commencement date of capitalisation Fulfilment of all three conditions viz. incurrence of capex, incurrence of borrowing costs and construction activity is in progress. From date of borrowing once borrowing is for fixed asset. Date of utilization of borrowed funds. Method of capitalisation Borrowing costs directly attributable to qualifying asset from date of fund deployment to date of asset being ready for use. Weighted average cost of borrowing applied to capex from date of capex to date of asset being ready for use Borrowing costs from date of borrowing till date of asset first put to use (Proviso to S.36(1)(iii)) ► Pro rata borrowing cost allocation as per normative formula ► Capitalisation triggered w,r,t 50% cost irrespective of whether the asset remains under construction for 1 or 364 days Whether capitalisation is suspended if unexpected interruption in project? YesNo

Page 17 Case Study - Illustrating impact of mismatch in capitalisation of specific borrowing cost Income Computation and Disclosure Standard IX relating to borrowing costs Financial Year Date of borrowing1 April 2015 Date of Capex1 Jan 2016 Amount of Capex1000 Amount borrowed1000 Interest rate p.a.12% Borrowing cost incurred120 Date of asset put to use1 Feb 2017 (i.e., beyond F.Y ) Particulars ( for year 15-16)AS-16ICDS Base amount for capitalisation1,000 Interest rate p.a.12% Period of capitalisation3 months (Jan 16- Mar 16) 12 months (Apr 15- Mar 16) Interest to be capitalized30120 Income from temporary investment Assuming, there is an interest income of Rs. 5 from temporary investment of Rs. 1,000. The borrowing cost to be capitalized under AS 16 and ICDS shall be as under. AS-16 ICDS 25=

Page 18 Case Study - Illustrating impact of mismatch in capitalisation of general borrowing cost Income Computation and Disclosure Standard IX relating to borrowing costs

Page 19 Case Study- Illustrating impact of mismatch in capitalisation of general borrowing cost Income Computation and Disclosure Standard IX relating to borrowing costs Consider following Balance Sheet extract: Balance Sheet Items Capitalisation base Basis A. Fixed Assets ► Assets under construction2,0005,0003,500 Average of Opening and closing ► Assets from opening CWIP put to use during the year 1 6,000 ► Assets acquired but not installed 1 50% of cost ► Assets acquired & put to use-20,00010,000 Subtotal of all qualifying assets8,00041,00024,500 (B) B. Other assets as per Balance Sheet (including current assets) 12,000 C. Total assets as per Balance Sheet20,00053,00036,500 (C) Average of Opening and closing

Page 20 Key Impact - others Income Computation and Disclosure Standard IX relating to borrowing costs IssueICDS IX Treatment of borrowings costs not eligible for Capitalisation These shall be recognised in accordance with the provisions of the Act. ► Post introduction of ICDS, the borrowing costs which would be not be considered for capitalization illustrated as under: ► If borrowing costs incurred in respect of non-qualifying assets viz current assets, inventories for less than 12 months etc; ► If borrowing costs incurred in respect of qualifying assets before commencement and after cessation of capitalization viz: ► In case of general borrowings, cost incurred before utilization of funds for qualifying assets; ► Borrowing costs incurred after the assets have been put to use ► These costs may be eligible for deduction as an expense under the provisions of the Act. However, post ICDS comparatively lower quantum of deduction would be available for such costs due to impact of enhanced capitalization post ICDS.

Page 21 Agenda Income Computation and Disclosure Standard IX relating to borrowing costs Scope and Recognition principle Definition Capitalisation methodology ► Transitional Provisions and Disclosure Key takeaways

Page 22 Transitional Provisions and Disclosures Income Computation and Disclosure Standard IX relating to borrowing costs ► Borrowing costs incurred on or after 1st April 2015, shall be capitalised for the previous year commencing on or after 1 st April 2015 as required by this standard. ► Any borrowing cost capitalised for the same borrowing on or before 31 st March 2015 shall also be taken in account. ► The accounting policy adopted for borr owing costs; and ► The amount of borrowing costs capitalise d during the previous year. Transitional Provisions Disclosures

Page 23 Agenda Income Computation and Disclosure Standard IX relating to borrowing costs Scope and Recognition principle Definition Capitalisation methodology Transitional Provisions and Disclosure ► Key takeaways

Page 24 Key takeaways! Income Computation and Disclosure Standard IX relating to borrowing costs ► Manufacturing concerns which regularly purchase assets may be impacted by the ICDS ► Now proper records have to maintained for purpose of capitalization of borrowing costs inspite of assets falling under the purview of ‘qualifying asset’ as per AS – 16 ► ICDS intends acceleration of capitalization of borrowing costs resulting in higher taxable income ► Formula impact

Page 25 Questions?

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