1. Income Computation & Disclosure Standards (ICDS)
Ameya Kunte – Taxsutra
5th August 2017

2. Agenda Evolution of ICDS Important ICDS Concepts CBDT’s FAQs
ICAI Technical Guide
Impact of ICDS on rulings
ICDS to presumptive taxation…and more
Analysis of ICDS 1, 2 and 10

3. Evolution of ICDS

4. ICDS – Background
Section 145 of the Income Tax Act, 1961 gives power to Government to notify accounting standards to be followed by any class of taxpayers or in respect of any class of income
Two prescribed tax accounting standards notified since 1996
Disclosure of Accounting Policies and
Disclosure of Prior Period and Extraordinary Items and Changes in Accounting Policies
December 2010 – Government committee to study harmonization AS with IT Act and
To suggest method for addressing MAT issue in transitional year of convergence to IFRS
To suggest appropriate amendments to the ITA in view of transition to Ind-AS regime

5. 2012 Draft TAS Report August 2012 – 14 draft standards announced
Suitable amendments to IT Act to provide certainty on the following issues:
Depreciation on goodwill arising on amalgamation.
Allowability of the provision made for the payment of pension on retirement or termination of an employee.
Separate Tax Accounting Standards covering the areas not covered by ICAI AS
Share-based payment.
Revenue recognition by real estate developers.
Service concession arrangements (e.g., BOT agreements).
Exploration for and evaluation of mineral resources.

6. ICDS Background
10 Notified ICDS
ICDS I - Accounting Policies
ICDS VI - Foreign exchange fluctuations
ICDS II - Valuation of inventory
ICDS VII - Government grants
ICDS III - Construction Contracts
ICDS VIII - Securities
ICDS IV - Revenue recognition
ICDS IX - Borrowing Cost
ICDS V - Tangible fixed assets
ICDS X – Provisions, Contingent liabilities and Contingent assets
March 2015 – 10 ICDS notified by the Government applicable from FY
No ICDS on:
Leases
Intangible assets
Events occurring after the End of Tax Year
Prior Period Expense

7. Revised ICDS from AY
September, 2016: Earlier notification dated March 31, 2015 rescinded
CBDT issued new notification for 10 ICDS, to be applicable from AY
Changes introduced in 7 of the 10 ICDS in the revised notification
No changes in ICDS 1 (Accounting Policies), ICDS 7 (Government grants) and ICDS 10 (Provisions, contingent liabilities and contingent assets)
CBDT vide Circular No. 10 of 2017 has clarified vexed issues in ICDS notified u/s 145(2) by issuing 25 clarifications in the form of FAQs. 

8. Important ICDS Concepts

9. ICDS – Key Aspects
ICDS apply to all taxpayers following mercantile accounting system
ICDS is applicable for computation of income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” and not for the purpose of maintenance of books of accounts.
FAQ 1 : CBDT clarifies that ICDS is not meant for maintenance of books of account or preparing financial statements (which is required to be done as per requirements of Companies Act 2013) and ICDS is to be applied only for computation of income.
ICDA applicable to trusts reporting business income (Para 14.6 of ICAI Guidance Note)
Taxpayer following cash and mercantile system for different sources of income permissible – ICDS to apply only where mercantile system is followed (ICAI Guide Para 7.7)

10. ICDS – Key Aspects Income Tax Act to prevail where ICDS is in conflict
The risk of best judgment assessment u/s 144 if positions adopted as per ICDS which is contrary to rulings.
For various purposes other than computation of income under two heads of income, provisions of ICDS would not apply.
For instance, ICDS would not apply for determining the time of credit of income for deduction of tax at source. (Para 14.1)
However, in some cases, the ICDSs may indirectly apply to the applicability aspect of the TDS. (Para 14.4)

11. ICDS & Tax Rulings ICDS and Tax Rulings
FAQ 2 : The ICDS have been notified after due deliberation and after examining judicial views for bringing certainty on the issues covered by it. Certain judicial pronouncements were pronounced in the absence of authoritative guidance on these issues under the Act for computing Income under the head “Profits and gains of business or profession” or Income from other sources. Since certainty is now provided by notifying ICDS under section 145(2), the provisions of ICDS shall be applicable to the transactional issues dealt therein in relation to assessment year and subsequent assessment years.

12. ICDS & Tax Rulings – ICAI Technical Guide (Para 15)
Category 1
3 specific amendments by the Finance Act, 2015, to ensure that the provisions of the Act are in line with the provisions of ICDS. Eg subsidy or bad debts
ICDS read along with the amended Act, would override the earlier judicial rulings.
Category 2
Judicial rulings which are based on the relevant GAAP
These judicial rulings would now have to be considered as being subject to the requirements of ICDS,
Category 3
Courts have laid down basic principles of taxation
Such rulings continue to apply and override ICDS.
See next slide…

13. ICDS & Tax Rulings View from ICAI Technical Guide on ICDS:
15.6 For instance, various judicial rulings have propounded the real income theory. The Delhi High Court, in the case of CIT v Vasisth Chay Vyapar Ltd. [2011] 330 ITR 440 (Delhi) has held, based on the real income theory, that interest accrued on non- performing assets of non-banking financial companies cannot be taxed until such time as such interest is actually received. Would the contrary provisions of ICDS IV on revenue recognition change the position? It would appear that the ruling will still continue to hold good even after the introduction of ICDS.

14. Imp ICDS FAQs
FAQ 3 : . ICDS shall also apply to the persons computing income under the relevant presumptive taxation scheme (eg Sec 44AD, 44AE, 44ADA, 44B, 44BB, 44BBA).
Example – partnership firm computing income under presumptive basis will need to apply ICDS on revenue recognition for determining receipts/turnover.
FAQ 4 : In a case of conflict between provisions of Income Tax Rules and ICDS, provisions of Rules (eg rules 9A, 9B dealing with film distributors), which deal with specific circumstances, shall prevail.
FAQ 5 : ICDS shall also apply to companies preparing its accounts under IND-AS. 
FAQ 14: ICDS provisions would apply to computation of income on gross basis (e.g. interest, royalty etc.) u/s 115A.

15. Imp ICDS FAQs
FAQ 6 : ICDS shall not apply to computation of Minimum Alternate Tax (MAT) under section 115JB of the Act. CBDT however added that the provisions of ICDS shall apply for computation of AMT u/s 115JC (as it is computed on adjusted total income which is derived by making specified adjustments to total income computed as per the regular provisions of the Act).
FAQ 7 : General provisions of ICDS shall apply to all persons (including for example -  Banks, Non-banking financial institutions, Insurance companies, Power sector) unless there are sector specific provisions contained in the ICDS or the Act.
FAQ 25 : Disclosures required under ICDS shall be made in the tax audit report in Form 3CD and no separate disclosures are required for persons not liable to tax audit.

16. Important Developments
FAQ 6 CBDT released draft ICDS on "Real Estate Transactions" for public consultation – ICDS not finalized yet.
Changes in draft ICDS vis-a-vis ICAI Guidance Note proposed in five areas viz. definition of project & project cost, revenue recognition, application of percentage of completion method (POCM) for real estate projects and transferable development rights (TDRs)
Draft ICDS proposes doing away with the condition of obtaining all 'critical approvals' for revenue recognition in view of the newly enacted RERA
Chamber of Tax Consultants (‘CTC’) has filed writ petition before Delhi HC challenging constitutional validity of ICDS 
Hearing scheduled on Aug 28

17. Analysis of ICDS
ICDS 1, 2 and 10

18. ICDS 1 – Accounting Policies
Prescription under ICDS 1 – Para 4 - Accounting policies adopted by a person shall be such so as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose,
(i) the treatment and presentation of transactions and events shall be governed by their substance and not merely by the legal form; and
(ii) marked to market loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other Income Computation and Disclosure Standard.
ICAI Technical Guide: The term “accounting policies” in ICDS I should be read as “computation policies”. (Para 3.6)

19. ICDS I - Accounting Policies
Concept of ‘prudence’ modified and concept of ‘materiality’ removed
Expert Committee stated that “concept of materiality not recognised by the Income Tax Act”
ICDS prohibits marked to market or expected loss recognition
Exceptions - marked to market forex loss on monetary items, inventory valuation etc.
ICDS silent on MTM gains
FAQ 8 : Principles as contained in ICDS-I relating to marked to market (‘MTM’) losses or an expected loss shall apply mutatis mutandis to MTM gains or an expected profit.
No likely significant tax impact - In absence of materiality concept

20. Double Whammy
Deferred Tax Asset (DTA) / Deferred Tax Liability (DTL) as the case may be as per AS 22 would arise.
Year
Loss
Anticipated Income
Computation
Remarks
Income Tax
Books of Accounts 1
Expected loss = (5000)
Anticipated Income = 1,000
1,000
(5,000)
Foreseeable loss is not allowed as deduction in Year 1 as per ICDS but anticipated profit is taxed and thus tax is required to be paid as per Normal Provisions on 1,000. 2
Actual loss = (5,000)
Actual Income = 1,000
As per ICDS, the actual loss will now be allowed in year 2 and actual gain will be regarded as income in accounts. However, MAT will apply and tax is required to be paid as per the provisions of MAT.

21. Transition Impact
Para 10 prescribes that all contracts or transactions entered into by the assessee on or after shall be in accordance with this ICDS. This recognition should be carried out after considering the income, expense or loss (if any) which have already been recognised on or before
Para 8.2 of ICAI Technical Guide :
Migration from income computation under IT-AS 1 to ICDS could result in change of accounting policies such as ‘non-recognition of MTM losses’. Such change however should not impact the recognition of the MTM losses of earlier year.
a view is possible that recognition of losses relating to earlier years should remain intact, and would not result in a reversal of loss during the transitional year due to the transitional provisions.

22. ICDS I - Accounting Policies
FAQ 10 - Derivatives which are not covered within the scope of ICDS – VI (which deal with accounting for derivative contracts such as forward contracts and other similar contracts), ICDS - I provisions would apply.
Examples – Commodity hedge

23. ICDS II - Valuation of inventory
Inventories shall be valued at cost or net realizable value, whichever is lower
ICDS II permits FIFO and Weighted Average Cost formula for inventory valuation
Retail method permitted in specified situations
ICDS now permits standard cost method for the purpose of inventory valuation
Method of valuation once adopted shall not be changed without reasonable cause
FAQ 9 : Under the Act, 'reasonable cause' is an existing concept and has evolved well over a period of time conferring desired flexibility to the tax payer in deserving cases.

24. ICDS II - Valuation of inventory
In case of newly commenced business, cost of inventory on day of commencement of business shall be opening inventory.
Valuation of opening inventory to be the same as closing inventory in preceding year – regardless of change in method of valuation of closing inventory.

25. ICDS II - Valuation of inventory
Inventories shall be valued at cost or net realizable value, whichever is lower
NRV = estimated selling price in the ordinary course of business less the estimated costs of completion and the  estimated  costs necessary to make the sale.
NRV to be determined item – by- item basis
Exclusions from application of ICDS
WIP arising under ‘construction contract’ including directly related service contract
Shares, debentures and other financial instruments held as stock-in-trade 
Producers’ inventories of livestock, agriculture and forest  products, mineral oils, ores & gases to the extent that they are measured at net realisable value; 
Machinery spares

26. ICDS II – Service contracts
AS- 2
ICDS
AS-2 does not include work in progress (WIP) arising in the ordinary course of business of service providers.
Specifies that it does not apply to WIP which is dealt with by other ICDS.
Cost of services – Para 6 of the recent ICDS notification:
The costs of services in the case of a service provider shall consist of labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads.
Inventories definition not been modified to cover WIP of service providers

27. ICDS II – Service contracts
Para 7.7. of ICAI Technical Guide:
Considering this, in case of service providers ICDS II will not have application and value of service not fully rendered need not be computed under this ICDS. This is also indicated by the scope of the ICDS, which excludes work-in-progress which is dealt with by other ICDS.

28. ICDS II – Opening inventory issues
Valuation – closing and opening conflict due to indirect taxes – Sec 145A
Opening service inventory on April 1, 2015
Cases of conversion of capital asset into stock-in-trade with intent to commence business may remain unaffected due to overriding provisions of Section 45(2) of the Act
Para 13.4 of ICAI Technical Guide – FMV on the date of conversion to be taken as inventory cost
If business is commenced with acquisition of running business on slump sale, price paid will be ‘cost’ of opening inventory

29. Sec 145A Method of accounting in certain cases.
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) interest received by an assessee on compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the year in which it is received.

30. ICDS II – Valuation in dissolution cases
In case of dissolution of a partnership firm or association of person or body of individuals, notwithstanding whether business is discontinued or not, the inventory on the date of dissolution shall be valued at the net realizable value.
No specific provision for allowing such NRV as the cost to the successor of the business.
Also this is contrary to law settled by Apex court in the case of Sakthi Trading Co. v. CIT
Sakthi Trading (250 ITR 871) (SC) – Regular method of accounting to be followed, hence inventory to be valued at cost or NRV, which ever is lower

31. ICDS – Inventory and borrowing costs
ICDS IX – Qualifying asset for ‘Borrowing Cost’ capitalisation purposes include inventories
Inventories – that require 12 months or more to bring them to saleable condition
Capitalisation means addition of borrowing cost to the cost of inventory (para 4)
Cessation of capitalisation for inventory - when substantially all activities necessary to prepare it for its intended sale are complete
Construction of qualifying asset is completed in part and a completed part is capable of being used while construction continues for the other parts , capitalisation of borrowing costs shall cease in relation to a part , when substantially all the activities to prepare such part of inventory for its intended sale are complete.

32. ICDS X – Provisions, Contingent liabilities and Contingent assets
A provision should be recognized when
A person has a present obligation as a result of a past event;
It is “reasonably certain” that an outflow of resources embodying economic benefits will be required to settle the obligation; and
A reliable estimate can be made of the obligation amount.
ICDS - Para 12 – Amount of a provision cannot be discounted to its present value.
As per AS-29, provision is recognized when outflow of resources is “probable” and not when it is ‘reasonably certain’.
FAQ 25: Provisions of employee post retirement benefits which are otherwise covered by AS 15 (like provident fund, gratuity, etc.) shall continue to be covered by specific provisions of the Act and shall not be dealt with by ICDS - X.

33. Warranty provision deduction should be available under ICDS
ICDS X – Provisions
Provision for Warranty is allowed as an expenditure upholding the test of ‘probable’ warranty obligation in many judgments.
Rotork Controls India P. Ltd. (2009) 314 ITR 62 (SC)
“A provision to qualify for recognition, there must be a present obligation arising from past events, settlement of which is expected to result in an outflow of resources and in respect of which a reliable estimate of amount of obligation is possible.”
“If historical trend indicates that in past large number of sophisticated goods were being manufactured and defects existed in some of items manufactured and sold, then provision made for warranty in respect of army of such sophisticated goods would be entitled to deduction from gross receipts under section 37(1), provided data is systematically maintained by assessee.”
Warranty provision deduction should be available under ICDS

34. ICDS X – Obligations & onerous contracts
Provisions made on obligations recognized out of customary business practices or voluntary obligations may be disputed.
e.g. informal refunds policy to dissatisfied customers, employee welfare, etc.
Deduction for the accrued liabilities on onerous contracts in books will be allowed in a year in which liability to pay arises.
AS 29
ICDS
Obligations may be legally enforceable and may also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.
No specific guidance on meaning of ‘obligation’
Upfront recognition of liabilities under onerous contracts
Not applicable to “executory contracts”, but no clarity on onerous contracts

35. ICDS X –Contingent liabilities and assets
Contingent liability not to be recognized
Contingent asset must be assessed continually and if it becomes “reasonably certain” that inflow of economic benefit will arise, the asset and the income are recognized in previous year in which the change occurs.
As per AS-29, contingent asset is recognized when inflow of resources is “virtually certain” and not when it is ‘reasonably certain’

36. ICDS X – Transition
FAQ 23 - Paragraph 20 of ICDS X (Transitional Provision ) provides that all the provisions or assets and related income shall be recognized for the previous year commencing on or after April 1, 2016 in accordance with the provisions of ICDS X after taking into account the amount recognized, if any, for the same for any previous year ending on or before March 31, Explaining the intent of transitional provision CBDT stated that its aim is “that there is neither 'double taxation' of income due to application of ICDS nor there should be escape of any income due to application of ICDS from a particular date.”

37. Concluding comments Prescriptive approach
No harmony sought in Accounting and Tax
Delegated legislation on ICDS
Immediate cash flow impact
No likely impact on EPS due to deferred tax

38. Thank you Ameya Kunte Executive Editor and Co-founder - Taxsutra
Views are personal.