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1
Provisions of section 195- Certification and documentation
CA N. C. Hegde
January 2017
JB Nagar Study
Circle of WIRCIssues in ICDS, Disclosure in TAX Audit and Returns
J.B.Nagar CPE Study Circle
CA Jhankhana M. Thakkar
5 August 2017
.
Contents
2
Section Page
ICDS Overview 3 – 11
Issues 12
ICDS I – Accounting Policies 13 - 20
ICDS II - Valuation of Inventories 21 - 33
ICDS III - Construction Contracts 34 - 49
ICDS IV - Revenue Recognition 50 - 59
ICDS V - Tangible Fixed Assets 60- 72
ICDS VI - Effect of Changes in Foreign
Exchange Rates
73 - 85
ICDS VIII - Securities 86 - 91
ICDS IX - Borrowing Costs 92 - 104
Impact on Computation of total income 105 - 107
Disclosure in Tax audit report 108 – 110
Disclosure in Income-tax return forms 111 – 113
Questions & Answers 114
Background
March 2017
• CBDT has issued
Circular No. 10/2017 on 23 March 2017
to clarify specific issues
1995
S.145 of the
Act amended
to notify AS for
Taxpayer and income
Jan 1996
CG notified 2AS –
S.145(2) of the
Act
September 2016
Revised ICDS were notified on
29 Sept 2016 and the same is
effective from 1 April 2016
i.e.FY 2016-17
• Form 3CD amended
January 2015
• CBDT issued draft of 12 ICDS
• Draft ICDS kept open for comments and
suggestions
March 2015
CG notified 10 ICDS for taxpayers
following mercantile method of
accounting, w.e.f FY2015-16
4
Revised ICDS (Notification 88/2016 dtd 29 September 2016)
5
ICDS II
Valuation of Inventories
ICDS I
Accounting Policies
ICDS III
Construction Contracts
ICDS IV
Revenue Recognition
ICDS V
Tangible Fixed Assets
ICDS VII
Government Grants
ICDS VI
Effect of Changes in Foreign Exchange Rates
ICDS VIII
Securities
ICDS IX
Borrowing Costs
ICDS X
Provisions, Contingent Liabilities & Contingent
Assets
Draft ICDS
on Real
Estate
Transactions
Back ground
6
ICDS
• The Income Computation and Disclosure
Standards (ICDS) are applicable for
computation of taxable income under the
heads ‘Income from Business or Profession’
and ‘Income from Other Sources’ (and not for
the purpose of maintenance of books of
accounts)
• 10 ICDS have been notified to be effective
from 1 April 2016
• Takes legal force from section 145(1) of the Act.
• Non-compliance with ICDS could result into
best judgement assessment – Section 145(3)
of the Act
• ICDS is not for the purpose of maintenance of
books of accounts
AS / IndAS
• The Ministry of Corporate Affairs (MCA) has
officially notified the Companies (Indian
Accounting Standards) Rules, 2015 (‘the Rules’)
in the Gazette of (Ind AS) applicable to certain
class of companies and set out the dates of
applicability.
• The Ind AS will be mandatorily applicable in
phases for following companies (including their
holding, subsidiary, joint venture or associate
companies)
- w.e.f financial year 2016-17 : companies net
worth > INR 500 crore
- w.e.f financial year 2017-18: companies with
listed debts/equity (listed in/outside India) with
net worth< INR 500 Crore and other companies
with net worth exceeding INR 250 Crore
• For the financial year 2015-16, the current
Accounting Standards will continue
Changes in accounting as well as income computation standards in FY 2016-17 –
Combined impact to be understood for harmonious implementation of new norms
Key Features of ICDS
7
• Effective Date of ICDS is 1 April 2016 i.e. FY 2016-17 & AY 2017-18
• ICDS applicable to all Assesses (other than an individual or an HUF to whom
tax audit u/s. 44AB is not applicable)following mercantile system of accounting
• No Net Worth or Turnover or any other criteria prescribed for applicability.
• Entity need not to maintain separate Books of accounts for ICDS.
• ICDS are only for computation of Income under the head “Profit and gains of
business or profession” or “Income from other sources”.
• ICDS is meant for normal computation of income not for Minimum Alternate Tax
(MAT)
• In the case of conflict between the provisions of the Income-tax Act, 1961(‘the
Act’) and ICDS, the provisions of the Act shall prevail to that extent.
• It is to be noted that non-compliance of ICDS gives power to the Tax Authority
to assess income on “best judgement” basis as per section 145(3) of the Act. It
may have potential penalty implications too.
Applicability
8
Circular No. 10/2017 dated 23 March 2017 clarifies that ICDS will apply to:
• Assessees under presumptive tax schemes – FAQ 3
• Companies adopting Ind-AS – FAQ 5
• AMT computation, but will not apply to MAT computation – FAQ 6
• Assessees in Finance, Insurance & Power sectors – FAQ 7
• Real estate developers, Build-Operate-Transfer projects, Leases – FAQ 12
Applies to all assessees following the
mercantile system of accounting, except
for individuals, HUF who are not covered
under the tax audit provisions
ICDS and AS/IndAS (Accounting Standards)
Can accounting taxation principles be harmonised ?
9
ICDS Accounting Standards
Disallow certain losses
Recognize revenue earlier
Recognises all possible
Losses
Recognise revenue only
when certain
Principles of “Prudence
and “Materiality” absent
in ICDS
ICDS and Accounting Standards harmonization – to be a factor of Industry and
government experience in implementation of these standards
ICDS and corresponding Accounting Standards
10
No. ICDS Accounting
Standard
(AS)
Ind AS
I Accounting policies AS 1 & 5 IND AS 8
II Valuation of Inventories AS – 2 IND AS 2
III Construction Contracts AS – 7 IND AS 115
IV Revenue Recognition AS – 9 IND AS 115
V Tangible fixed assets AS – 10 IND AS 16
VI Effects of changes in foreign exchange rates AS – 11 IND AS 21
VII Recognition of Government Grants AS – 12 IND AS 20
VIII Securities AS – 13/AS - 30 IND AS 109
IX Borrowing costs AS – 16 IND AS 23
X Provisions, Contingent Liabilities & Contingent
Assets
AS – 29 IND AS 37
Where no specific treatment of an element of income/expense/asset/liability is prescribed under the
Act or ICDS, the existing accounting framework (including guidance notes and other authoritative
pronouncements of ICAI) applicable to the entity will apply
General Clarifications vide Circular No. 10/2017 dated 23 March 2017
11
FAQ Clarification
1 ICDS do not apply to maintenance of books of account and for
preparation of financial statements
(the above is also clarified in the Preamble of each ICDS)
2 W.e.f AY 2017-18, ICDS shall prevail over judicial precedents on the
issues dealt therein
14 Specific provisions of Income-tax Rules, 1962 shall prevail over ICDS
25 Disclosures required under ICDS are to be made in the ITR Form and
Form 3CD, no separate disclosure requirement for persons not liable
to tax audit
• ICDS recognizes three accounting concepts
− going concern
− consistency
− Accrual
• Accounting policies must be chosen to represent true and fair view of state of
affairs and income
• Treatment of transactions will be governed by their substance and not legal
form
• Accounting policy can be changed if there is reasonable cause to do so
• Mark-to-market or expected loss shall not be recognized unless provided by
other ICDS
ICDS I – Accounting policies
14
• This ICDS is not merely a disclosure standard but it requires income
computation standard to factor in elements of this standard viz accrual, going
concern and consistency. Therefore, the term accounting policies should be
read as “computation policies”
• The definition of “accrual” under a standard should not alter the understanding
of accrual under Section 5.The principle laid down by the Hyderabad Tribunal in
case of DCIT v Nagarajuna Investment Trust Limited (1998) 65 ITD 17 has
been affirmed by the Andhra Pradesh High Court in case of DCIT vs Chakra
Financial Services (350 ITR 396) that the provisions of Section 145 cannot
override Section 5 of the Act. Section 145 determines mode of computing the
taxable income, it does not affect the scope of taxable income.
ICDS I – Accounting policies
15
ICDS I – Accounting policies
16
ICAI Accounting Standards
(AS)
ICDS
Change in
accounting
policy
should be made only if it is
required by statute,
accounting standard or if
such change will result in
more appropriate
presentation of financial
statements
shall not be changed without any
reasonable cause
Prudence profits are recognized only
when realized. Provision is
made for all known
liabilities and losses even
though the amount cannot
be determined with
certainty
"marked to market loss" or an
"expected loss" shall not be
recognized unless the recognition
of such loss is in accordance with
the provisions of any other ICDS
Materiality should disclose all
"material“ items
-
ICDS I – Accounting policies
17
This standard mandates the principle of substance over form. The financial
information should represent the substance of an economic phenomenon
rather than merely its legal form
• In case of Finance lease, the asset and depreciation is recorded in the
books of lessee. The Supreme Court in case of ICDS Ltd vs CIT(2013)
350 ITR 627 held that the owner of the asset had used it for its business
and was thus entitled to depreciation under Section 32 of the Act. Having
regard to this decision, the lease rent would be taxable as income and
lessor will be entitled for depreciation.
Key considerations
ICDS I : Accounting Policies
An accounting policy shall not be changed without reasonable cause
What does ‘reasonable cause’ mean in this regard?
Analysis:
• There are no judicial precedents on ‘reasonable cause’ in relation to change in accounting policy
• Normally, AO can change method of accounting:
− when he has ascertained the method of accounting followed by the assessee in the past is erroneous and
− when change in method of accounting is warranted on the ground that profit is being underestimated under the impugned method of accounting
− Based on below judicial precedents, assessee can change accounting policy if the same is bonafide and is followed in subsequent years as well
• Gujarat HC case of Atul Products Ltd. [125 TAXMAN 727]
• Andhra Pradesh HC case of Mopeds (India) [38 TAXMAN 123]
• Calcutta HC case of Snow White Food Products Co. Ltd. [141 ITR 847]
• Calcutta HC case of Reform Flour Mills (P.) Ltd. [114 ITR 227]
18
Key considerations
ICDS I : Accounting Policies
Marked to market loss or an expected loss shall not be recognized unless the
recognition of such loss is in accordance with the provisions of any other ICDS
Current Practice:
• Loss suffered due to exchange difference as on balance sheet date relating to revenue account is
allowable expenditure u/s 37(1) of the Act
Proposed Practice:
• Mark-to-market loss on derivatives held as stock-in-trade shall be allowed as a business loss -
• MTM gains not to be recognized unless they are in accordance with any other ICDS(Circular 10/2017)
19
Adjustments provided in other ICDS Adjustments not provided in other
ICDS
Inventory Valuation- ICDS II Local Hedging contracts for
Commodities
Exchange Difference- ICDS VI Interest rate swaps
Securities Valuation – ICDS VIII Others??
Adjustment for MTM difference relating to inventory, exchange difference, securities held as
stock-in-trade is provided under ICDS – in line with existing judicial precedents
Disclosure requirements
ICDS I : Accounting Policies
• Any change in accounting policy which has material impact shall be disclosed
• Amount should be quantified to the extent ascertainable
• Where the amount is not ascertainable, wholly or in part, such fact shall be
indicated
• Change having material effect on later previous years also to be disclosed.
20
ICDS is applicable to valuation of inventories except:-
• WIP arising from construction contracts
• WIP dealt by other ICDS
• Shares, debentures and other financial instruments held as stock in trade and
dealt by other ICDS
• Inventories of livestock, agriculture and forest products, mineral oil, ores and
gases to the extent that they are measured at NRV
• Machinery spares used in connection with tangible fixed assets
22
ICDS II : Valuation of Inventories
Scope
ICDS II – Inventories
23
ICAI Accounting
Standards (AS)
ICDS
Techniques for the
measurement of the
cost of the inventories
techniques such as the
standard cost method or
retail method may be used if
the results approximate to the
actual cost
Standard Cost method or retail method is
allowed provided the results approximate
the actual cost
Change in method of
valuation
may be changed if it is
considered that the change
would result in a more
appropriate presentation
shall not be changed without a reasonable
cause
Dissolution of
partnership firm or AOP
or BOI
- Inventory on the date of dissolution of
partnership firm or AOP or BOI shall be valued
at the net realizable value [ALA Firm vs CIT
189 ITR 285(SC) v Sakthi Trading Co vs CIT
250 ITR 871 (SC)]
Inventory – Costs of
services ,
service providers
work-in-progress of service
provider excluded
Work in progress of service provider excluded
however, cost of service utilized in
manufacture, production or processing of
goods shall form part of the inventory
Highlights
ICDS II : Valuation of Inventories
• Inventories shall be valued at cost or net realizable value (NRV), whichever is lower*
• Following valuation methods have been identified –
− First-in First-out,
− weighted average cost and
− retail method ‘
− Standard costing
As per AS 2 Standard costing and retail method may be used for convenience if results approximate the actual cost
• Specific identification of cost is required for goods that are not interchangeable
• Method of valuation of inventory, once adopted in any tax year, cannot be changed without a reasonable cause
• Interest and other borrowing cost shall not be included in the cost of inventories, unless they meet the criteria for recognition of interest as a component of the cost as specified in the ICDS on borrowing costs i.e. direct / indirect attribution basis
• Value of opening inventory shall be the value of inventory as on the close of the immediately preceding previous year
Inventory shall be valued at NRV on the date of dissolution of partnership firm / AOP/ BOI, whether business is discontinued or not 24
Key Considerations
ICDS II : Valuation of inventories
25
As
pe
cts
• Standard costing method and retail costing is allowed – provided the results approximate the actual cost
• No change in valuation allowed without reasonable cause
Valuation method
• Inventory to be recorded at Net Realizable Value
Dissolution of partnership
• Opening inventory to be same as closing inventory of previous year
Valuation of opening stock
• Purchase price includes duties and taxes whether or not subsequently recoverable.
• In line with 145A of the Act
Cost of Purchases
Recording of Inventory- Goods and Services
ICDS II : Valuation of Inventories
26
Profit and Loss account shall reflect closing inventory of services
for all business and impact Profits
Topic ICDS AS
Inventories –
Valuation
ICDS II relating to valuation of
inventories
AS 2 – Valuation of Inventories
Of goods Cost of purchase
Add: Cost of services
Add: Costs of conversion
and other costs
XXX
XXX
XXX
_______
XXX
Costs of purchase
Add: Costs of
conversion and
other costs
XXX
XXX
______
XXX
Of Services Cost of Labour
Add: Other costs of
personnel directly
engaged in providing
the service
Add: Attributable
overheads.
XXX
XXX
XXX
_____
XXX
Not prescribed
Case Study-1
ICDS II : Valuation of Inventories
Valuation of opening inventory vis-a-vis closing inventory of preceding financial year:
• For financial year 2015-16, closing stock of A Ltd. has been valued using Standard Costing Method.
From financial year 2016-17 onwards, A Ltd. changed its method for valuation of closing stock to First-
in-First-out method at the time of valuation of closing stock.
27
FY 2015-16
Opening Stock
Closing Stock
FY 2016-17
15 Lakh10 Lakh
A Ltd.
15 Lakh 25 Lakh
Issue:
Can the AO adjust the opening stock of the year?
Case Study-1
ICDS II : Valuation of Inventories
Analysis:
• As per ICDS II, value of opening inventory shall be the inventory of the business as on the
close of the immediately preceding previous year. Relevant extract of ICDS has been
reproduced below:
Para 22 of ICDS II :
“The value of inventory as on the beginning of the previous year shall be:
the cost of inventory available, if any, on the day of the commencement of the business when
the business has commenced during the previous year; and
the value of the inventory of the business as on the close of the immediately preceding
previous year, in any other case”
• There have been cases where the AO attempts to change the opening stock of the year, if
the method of accounting for the valuation of closing stock is changed.
28
After introduction of the ICDS, does the AO have the liberty to change the value of
opening stock, if the closing stock is revalued?
Case Study-2
ICDS II : Valuation of Inventories
Valuation of inventory at the time of dissolution of partnership firm / AOP/ BOI,
whether business discontinued or not
• For financial year 2016-17, M/s A & Co is in the process of dissolution. Details of inventory
at the time of dissolution is mentioned below:
Issue:
• Can inventory be valued at cost at the time of dissolution?
29
FY 2016-17
Cost of Inventory = 10 crore
Net Realizable Value of Inventory = 20 crore
Case Study-2
ICDS II : Valuation of Inventories
Analysis:
• As per ICDS II, Inventory shall be valued at NRV on the date of dissolution of partnership
firm / AOP/ BOI, whether business discontinued or not
30
Post adoption of the ICDS, does the assessee have the option of valuing inventory
at cost at the time of dissolution of partnership firm / AOP/ BOI, whether business
discontinued or not?
Case Study-3
ICDS II : Valuation of Inventories
Valuation of inventory in case of conversion of capital asset into Stock in trade
Issue:
• If an assessee converts capital asset into stock-in-trade and commences his
business during the year . How will the inventory be valued
31
Case Study-3
ICDS II : Valuation of Inventories
Analysis:
• Under Section 2(47)(iv) of the Act such conversion is to be treated as transfer and under
Section 45(2) of the Act capital gain is computed taking the fair value of the asset on the
date of conversion as full value of the consideration. The Supreme Court in case of CIT vs
Bai Shirnbai K. Kooka 46 ITR 86(SC) held that for computing the trading profit the fair
market value of the asset on the date of conversion into stock-in-trade is cost to the
business. Considering the decision of Supreme court ,the fair market value of the asset on
the date of conversion shall be regarded as cost of the invemtory, although ICDS I
provides that the cost of inventory available has to be taken as the value of the inventory
as on the beginning
32
• The accounting policies adopted in measuring inventories including the cost
formulae used and
• The carrying amount of inventories and its classification
33
ICDS II : Valuation of Inventories
Disclosure requirements
• Revenue (including retentions) and costs (i.e. direct cost, allocated cost,
borrowing cost as per specific ICDS and other cost specifically chargeable to
customer) from construction contracts shall be recognized by reference to the
stage of completion of the contract
• The Delhi High Court in Tirath Ram Ahuja (P.) Ltd vs CIT (1976)[103 ITR 15]
(affirmed by Supreme Court (1990) [186 ITR 428] has affirmed that in the case
of contract, the profits can be estimated on the basis of receipts in each year
and need not wait till the completion of contract. AS 7 issued by the ICAI
mentions that revenue should be recognized only on Percentage Completion
Method(POCM). However, ICDS specifically mentions Percentage of
Completion Method(POCM)
• During the early stages of a contract, where the outcome of the contract cannot
be estimated reliably, contract revenue must be recognized only to the extent of
costs incurred. The early stage of a contract shall not extend beyond 25% of the
stage of completion
• Contract revenue to be recognized only when there is reasonable certainty of
its ultimate collection. Contract revenue once recognized cannot be reversed
but needs to be written off as expenses
ICDS III– Construction contracts
35
Significant deviations
• Retention money to be included in the sales turnover
• Interest/ dividend and capital gains need to be recognized as income separately
and cannot be reduced from contract costs
• Does not allow provision for foreseeable losses for tax purposes which is in line
with non-allowability of expected losses as provided in ICDS-1
ICDS III– Construction contracts
36
Where a contract covers a number of assets, the construction of each asset
should be treated as separate construction:
- Separate proposals have been submitted for each asset
- Each asset has been subject to separate negotiation
- Cost and revenues of each asset can be identified
A number of contracts whether with a single customer or with several customers
shall be treated as a single construction contract when:
- The group of contracts is negotiated as a single package
- The contracts are so closely interrelated that they are in fact part of a single
project
- The contracts are performed concurrently or in a continuous sequence
ICDS III – Construction ContractsCombining and Segmenting Construction Contracts
37
ICDS III– Construction contracts
38
ICAI Accounting Standards
(AS)
ICDS
Retention money - shall be recognized on basis
of percentage of completion
method
Pre-construction
interest income,
dividend income &
capital gains
Any income earned on the
temporary investment of
those borrowings is
deducted from the
borrowing costs incurred
(AS-16 borrowing cost)
shall not be reduced from the
contract costs but shall be
treated and taxed as income in
accordance with the applicable
provisions of the Act
Recognition of
losses including
probable/expected
losses
fully and not in proportion to
the percentage of
completion
shall not be allowed unless
such losses are actually
incurred. The losses incurred
shall be allowed only in
proportion to the stage of
completion
ICDS III – Construction Contract
Impact
Can upfront provision of expected loss be made based on following Supreme Court cases?
• Metal Box Co. of India Ltd. V. Their Workmen
• Rotork Controls India (P.) Ltd. [180 TAXMAN 422]
Year 1 Books ICDS
Revenue 100 x 30% 30 30
Less: Cost incurred during the year (40) (40)
Less: Provision for expected loss on construction contracts (30) NIL
Net profit (40) (10)
Year 2 Books ICDS
Revenue 100 x 70% 70 70
Less: Cost incurred during the year (60) (90)
Net profit 10 (20)
Recognition of taxable income at an earlier point in time as compared to book profits
Illustration: disallowance of expected loss• Contract revenue – 100
• Contract cost originally estimated – 80
• Revised probable estimated contract cost – 130
• Cost incurred during year 1 – 40
• Percentage of completion at end of year 1 – ~30% (40 of 130)
• Cost incurred during year 2 – 90
• Percentage of completion at end of year 2 – 100%
39
Key Considerations
ICDS III - Construction contracts
40
Retention money
ICDS possibly
militates against
the basic principle
that revenue
accrues only when
assesse gets the
right to receive /
amount becomes
payable
Early stage of
contract
• Revenue only to
the extent of
costs
recognized
• Early stage of
contract cannot
be > 25% of the
contract
completion
stage in order to
prohibit
deferment of
revenue
recognition
Expected loss
Recognized in
proportion of work
completed
Asp
ects
Adjustment of
contract revenue
Contract variations,
claims and
incentives included
in the contract
revenue only to the
extent it is
probable that they
will result in
revenue
ICDS III – Construction Contracts
41
Contract Revenue
• Contract Revenue = Initial amount of agreed revenue + retentions + (variations in contract work + claims + incentive payments)*
*only if capable of being reliably measured and only to the extent that will result in revenue
• If contract revenue recognized in earlier years is subsequently written off – the same shall be recorded as an expense
Contract Costs
• Contract Costs = Direct expenses + attributable to the contract + costsspecifically chargeable to the customer + allocated borrowings in termswith ICDS IX - Borrowing Costs
• Costs incurred from the date of securing the contract till the finalcompletion of the contract
• Costs incurred in advance – to be recorded as an asset as recoverablefrom customers
ICDS III – Construction Contracts
42
Borrowing costs allocable in terms of ICDS IX – Borrowing Costs
Clarifications vide Circular dated 23 March 2017
If there are specific provisions in the Act for disallowance of a portion of theborrowing costs, e.g. 14A, 43B, etc., only that portion of the borrowing cost shall becapitalized which is otherwise allowable as a deduction under the Act
Particulars Cost to be capitalized
If funds are specifically borrowed Actual borrowing cost incurred
If general borrowings are utilized Borrowing costs on general borrowings
x
(Average cost of qualifying asset /
Average of total assets excluding assets
funded out of specific borrowings)
Case Study-1
ICDS III : Construction Contracts
Retention money
• A Ltd. entered into a contract with B Ltd at an agreed contract revenue of INR 100 crore. As per the
terms of the contract, an amount of INR 10 crore is to be retained by B Ltd. and would be paid after
fulfillment of certain conditions mentioned in the contract.
Issue:
ICDS provides that contract revenue shall include retention money
Is retention money required to be included in the value of Contract Revenue?
43
FY 2015-16
Contract Revenue = INR 100 crore
Retention Money = INR 10 crore
Case Study-1
ICDS III : Construction Contracts
Analysis:
• Income can be held to accrue only when assessee acquires right to receive that income(Section
5 of the Act)
• Retention money may not accrue to the assessee if assessee had certain obligations which
were linked to the retention payment and right to receive crystalises only on the performance of
the obligation.
• ICDS provides that contract revenue shall include retention money.
• ICDS also states that revenue shall be recognised when there is reasonable certainty of its
ultimate collection
• Income can be held to accrue only when assessee acquires right to receive that income – SC
cases of Ashokbhai [56 ITR 42], Shrivastava [57 ITR 624] ,Excel Industries(2013)(358 ITR 259)
• Retention money could not be said to be accrued to the assesse if assessee had no right to
receive the same till the completion of work or does not become payable as per the terms of the
contract.
• The following decisions also support this contention:
⁻ Calcutta HC case of Simplex Concrete Piles India (P) Ltd [79 CTR 71]
⁻ Madras HC case of P & C Constructions (P.) Ltd. [318 ITR 113]
44
When it can be said that there is reasonable certainty of ultimate collection ?
Case Study-2
ICDS III : Construction Contracts
Allowability of Expected Loss:
• A Ltd. entered into a contract with B Ltd at a agreed contract revenue of INR 100 crore. At
the end of the financial year, 60% of the contract was complete and an expected loss of
INR 5 crore was determined by A Ltd.
Issue:
• How is the expected loss on contract required to be recognized in the books of accounts?
45
FY 2015-16
Contract Revenue = INR 100 crore
% Completion of Contract = 60%
Expected Loss = INR 5 crore
Case Study-2
ICDS III : Construction Contracts
Analysis
Expected loss on Contract – ICDS and Accounting Standards
‒ Para 17 of ICDS III:
“The recognition of revenue and expenses by reference to the stage of completion of a contract is referred to as the percentage of completion method. Under this method, contract revenue is matched with the contract costs incurred in reaching the stage of completion, resulting in the reporting of revenue, expenses and profit which can be attributed to the proportion of work completed”
‒ AS-7 on ‘Construction Contracts:
“When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately”.
Current Practice‒ AS-7 provides that expected loss be recognized immediately as an expense, if it is probable
that the total contract costs would exceed total contract revenue
Practice under the ICDS regime:
‒ Expected losses from the contract has to be recognized in proportion to percentage completion
46
Whether expected loss can be claimed as an expense, post introduction of the ICDS?
Case study-3
ICDS III : Construction Contracts
Early stage of a contract:
• For financial year 2016-17, A Ltd. entered into a contract with B Ltd at a agreed contract
revenue of Rs. 100 crore. At the end of the financial year, assuming contract has been
completed as per the following percentages:
• 25%
• 30%
Issue:
• At what stage, is revenue to be recognised?
47
Case study-3
ICDS III : Construction Contracts
Analysis:
• AS does not specify a percentage at which early stage of the contract can be considered
to have reached.
• Generally, industry practice is to record profits post 25% stage of completion.
• Certain companies may not record profits up to 30%
• Para 20 of ICDS III:
“During the early stages of a contract, where the outcome of the contract cannot be
estimated reliably contract revenue is recognised only to the extent of costs incurred. The
early stage of a contract shall not extend beyond 25% of the stage of completion.”
• ICDS has specifically provided that early stage of a contract shall not extend beyond 25%
of the stage of completion and profits of a contract are required to be booked, once the
contract reaches the stage of 25%.
48
Is it mandatory to book profits post completion of 25%?
Does reasonable certainty of completion of the contract need to be examined?
Disclosure requirements
ICDS III : Construction Contracts
• Contract revenue recognized and method used to determine the stage of
completion
• In case of contracts in progress:-
‒ amount of cost incurred and recognized profits less recognized losses upto
the reporting date
‒ amount of advance received
‒ amount of retention
Further, as per revised ICDS
“ The transitional provisions in revised ICDS- III provide that the contract
revenue and contract costs, with respect to construction contracts which
commenced but were not completed on or before 31 March 2016, shall be
continued to be recognized in accordance with the method regularly
followed for such contracts before 1 April 2016.
49
• Revenue from sale of goods shall be recognized when all significant risks and
rewards of ownership are transferred and when there is a reasonable certainty of
collection. Claims for escalation of price and export incentives can be postponed
to the extent of uncertainty involved
• Revenue from service transactions –
Revenue from service transactions will be recognized as per percentage
completion method and ICDS on ‘Construction contracts’ will apply except
‘Completed service contract method’, permissible under AS-9 (current Indian
accounting standard followed for maintaining books of accounts), is not
available to a taxpayer.
Exceptions to the above are:
‒ Where services are provided by an indeterminate number of acts over a
specific period of time, revenue may be recognized on a straight line basis
over the specific period.
- Where service contracts have duration of not more than 90 days, revenue
may be recognized when the rendering of services under that contract is
completed or substantially completed
ICDS IV– Revenue Recognition
51
• Interest will be recognised on time basis except interest on refund of any tax,
duty or cess shall be deemed to be the income of the previous year in which
such interest is received.
• Dividend income as per provisions of the Act and royalty income as per terms of
the relevant agreement
• Discount or premium on debt securities held should be accrued over the period
to maturity
• The condition of reasonable certainty of ultimate collection is not laid down for
taxation of interest, royalty and dividend. Interest accrues on time basis and
royalty accrues on basis of contractual terms. Subsequent non recovery can be
claimed as a deduction under Section 36(1)(vii) (FAQ- Circular 10/2017)
Significant deviations
• Percentage completion method to be followed for recognition of revenue for
service providers
ICDS IV– Revenue Recognition
52
ICDS IV– Revenue Recognition
53
ICAI Accounting
Standards (AS)
ICDS
Revenue
recognition
from service
contracts
both the "proportionate
completion method" and
"completed service
contract method" for
recognition of revenue
from service
transactions
shall only be recognized by
following the "percentage
completion method".
Requirements of TAS for
Construction Contracts to apply
mutatis mutandis for recognition of
revenue and associated expenses
for a service transaction
exceptions are as per slide no. 52
Key Considerations
ICDS IV - Revenue recognition
54
Sale of goods /
services
Revenue
recognition on
transfer of
significant risks and
rewards of
ownership to the
buyer for sale of
goods
Revenue
recognition in cases
of obligation of free
/ discounted goods
/ services – ICDS
IV silent – ought to
be governed by
IndAS 18
Price escalations
and export
incentives
Postponement on
account of inability
to assess ultimate
collection in context
of escalations and
export incentives is
specifically
provided for
Discount /
premium on debt
securities
Recognized over
the period to
maturity rather than
receipt
Asp
ects
Royalty
Recognized based
on agreement
subject to
‘substance over
form’
Key considerations
ICDS IV : Revenue Recognition
Sale of goods:
Para 3 of ICDS IV :
“In a transaction involving the sale of goods, the revenue shall be recognized when the
seller of goods has [transferred to the buyer the property in the goods for a price] or
[all significant risks and rewards of ownership have been transferred to the buyer] and
[the seller retains no effective control of the goods] transferred to a degree usually associated
with ownership. In a situation, where transfer of property in goods does not coincide with the
transfer of significant risks and rewards of ownership, revenue in such a situation shall be
recognized at the time of transfer of significant risks and rewards of ownership to the buyer”
55
When the date of transfer of significant risks and rewards are different from the date of the
transfer of title to the goods, can revenue from sale of goods be recognized?
Key considerations
ICDS IV : Revenue Recognition
Royalty – Substance over Form?
Para 3 of ICDS IV :
“Royalties shall accrue in accordance with the terms of the relevant agreement and shall be
recognised on that basis unless, having regard to the substance of the transaction, it is more
appropriate to recognise revenue on some other systematic and rational basis”
56
Can authorities alter recognition of royalty based on substance of agreement and not
the terms of agreement?
Key considerations
ICDS IV : Revenue Recognition
Discount / premium on debt securities
Para 7 of ICDS IV :
Interest shall accrue on the time basis determined by the amount outstanding and the rate
applicable. Discount or premium on debt securities held is treated as though it were accruing
over the period to maturity
57
Can discount or premium on all debt securities be chargeable as interest over period
of maturity?
Case Study
ICDS IV : Revenue Recognition
Recognition of revenue from service transactions
• For financial year 2016-17, A Ltd. entered into an agreement with B Ltd. for rendering of
services at an agreed contract price of 100 Cr.. At the end of the financial year, 70% of the
services have been duly rendered to B Ltd. and the balance services would be rendered
in the next financial year.
Issue:
• How is the revenue from service transaction to be recognized
58
FY 2015-16
Contract Revenue = 100 crore
% of services rendered = 70%
Disclosure requirements
ICDS IV : Revenue Recognition
Following disclosures shall be made in respect of revenue recognition:
a) In a transaction involving sale of good, total amount of claim raised for escalation of price
and export incentives not recognised as revenue during the previous year along with
nature of uncertainty about such claims
b) the amount of revenue from service transactions recognised as revenue during the
previous year; and
c) the methods used to determine the stage of completion of service transactions in
progress
d) for service transactions in progress at the end of previous year:
i. amount of costs incurred and recognized profits (less recognized losses) upto end of
previous year;
ii. the amount of advances received; and
iii. the amount of retentions
59
• Scope
- ICDS V deals with the treatment of tangible fixed assets
• Definitions
- “Tangible fixed asset” is an asset being land, building, machinery, plant or
furniture held with the intention of being used for the purpose of producing or
providing goods or services and is not held for sale in the normal course of
business.
−“Fair value” of an asset is the amount for which that asset could be exchanged
between knowledgeable, willing parties in an arm’s length transaction.
ICDS V– Tangible Fixed Assets
Scope and definitions
61
• Any tangible asset which is covered by the definition
• Stand-by equipment and servicing equipment are to be capitalized
• Generally, machinery spares are charged to revenue as and when consumed;
however, such spares are capitalised in the following cases:
- they are used only in connection with an item of tangible fixed asset; and
- their use is expected to be irregular
ICDS V– Tangible Fixed Assets
Identification of tangible fixed assets
62
• Tangible fixed asset shall be recorded at actual cost including purchase price,
taxes (excluding those that are recoverable) and other directly attributable
expenditure for making the asset ready for its intended use. Trade discounts and
rebates shall be deducted.
• The cost of the asset may undergo changes subsequent to its acquisition or
construction on account of:
- Price adjustments of the asset, changes in duties or similar factors
- Foreign exchange fluctuation –this will be governed by ICDS VI (effects of
changes of foreign exchange rates)
• Administration and general overheads shall be excluded from actual cost if not
relating to specific asset; however, expenses which are specifically attributable to
construction of a project or acquisition of a fixed asset or bringing it to its working
condition should be included as part of the cost of the project or the asset
• Expenditure on start-up and commissioning of a project shall be capitalized, while
expenditure post commencement of commercial production shall be expensed.
Expenditure incurred on test runs and experimental production should be
capitalised
ICDS V– Tangible Fixed Assets
Components of actual cost of fixed assets
63
• Actual cost of Self-constructed assets
− Same principles discussed for acquired assets would apply to compute actual
cost of self-constructed assets; costs attributable to construction activity in
general and can be allocated to the specific tangible fixed asset can also be
included in the actual cost
− Internal profits shall be eliminated in arriving at such costs
• Non-monetary consideration
- Tangible asset shall be recorded at its fair value if acquired for non-monetary
consideration i.e. in exchange for another asset or shares or other securities
• Valuation of tangible fixed assets in special cases
- The proportion in the actual cost, accumulated depreciation and written down
value of jointly owned tangible fixed assets should be grouped together with
other similar fully owned tangible fixed assets
- Consolidated price for acquiring group of assets shall be apportioned on fair
basis
ICDS V– Tangible Fixed Assets
Actual cost of fixed assets in different scenarios
64
• Improvements and repairs
- An expenditure that increases the future benefits from the existing asset
beyond its previously assessed standard of performance is added to its actual
cost; for example, an expenditure that results in an increase in the capacity of
a machine would be capitalized
- If an addition or extension to an existing asset is capital in nature and
becomes an integral part of the existing asset, it should be added to the actual
cost of the asset; however, if it has a separate identity and is capable of being
used after the existing asset is disposed it, it shall be treated as a separate
asset
• Depreciation
- Depreciation will be as per the Act
• Transfers
- Income on transfer of the tangible fixed asset should be computed as per the
Act i.e. the sections governing capital gains
ICDS V– Tangible Fixed AssetsImprovements and repairs, depreciation and transfers
65
• If the acquisition or construction of a tangible fixed asset commenced before 31
March 2016 but was not completed by that date, its actual cost will be recorded
in accordance with ICDS V
• With respect to assets for which actual cost was recognised for the previous
year commencing on or before 1 April 2015 (i.e. FY 2015-16 and earlier), the
same actual cost will be considered for FY 2016-17 and later as well
ICDS V– Tangible Fixed AssetsTransitional Provisions
66
• Description of asset or block of assets;
• Rate of depreciation;
• Actual cost or written down value, as the case may be;
• Additions or deductions during the year with dates; in the case of any addition of
an asset, date put to use; including adjustments on account of:
− Central Value Added Tax credit claimed and allowed under the CENVAT Credit
Rules, 2004;
− Change in rate of exchange of currency;
− Subsidy or grant or reimbursement, by whatever name called;
• Depreciation allowable; and
• Written down value at the end of year.
ICDS V– Tangible Fixed AssetsDisclosures
67
Question no. 15
Para 8 of ICDS-V states expenditure incurred in commissioning of project,
including expenditure incurred on test runs and experimental production shall be
capitalised. It also stated that expenditure incurred after the plant has begun
commercial production i.e., production intended for sale or captive consumption
shall be treated as revenue expenditure. What shall be the treatment of expense
incurred after the conduct of test runs and experimental production but before
commencement of commercial production?
Answer: As clarified in Para 8 of ICDS-V, the expenditure incurred till the plant has
begun commercial production, that is, production intended for sale or captive
consumption, shall be treated as capital expenditure
ICDS V– Tangible Fixed AssetsRelevant FAQs as per CBDT’s circular no. 10 of 2017
68
Key Issues
ICDS V : Tangible Fixed Assets
• Capitalisation of trial run cost
Para 8 -The expenditure incurred on start-up and commissioning of the project, including the
expenditure incurred on test runs and experimental production, shall be capitalised; the
expenditure incurred after the plant has begun commercial production, that is, production
intended for sale or captive consumption, shall be treated as revenue expenditure
AS-10 on Tangible Assets –Same as above; further, it provides that if the interval between
the date a project is ready to commence commercial production and the date at which
commercial production actually begins is prolonged, all expenses incurred during this period
are charged as revenue expense; however, the expenditure incurred during this period is
also sometimes treated as deferred revenue expenditure to be amortised over a period not
exceeding 3 to 5 years after the commencement of commercial production
69
Construction / acquisition of asset
Trial run –ready to use
Commercial production
Capitalise as
per ICDS
Revenue expense as
per ICDS
Capitalise or
Expense?
• Whether capitalisation of trial run expenditure is in line with current practice?
- Expenditure incurred on trial runs should be capitalised -Gujarat HC case of
Saurashtra Cement [127 ITR 47], Delhi HC case of Food Specialities[136 ITR
203], Bombay HC case of G T Industries (203 ITR 538)
- ICDS is in line with above decisions
• Question no. 15 of CBDT’s FAQs covers this issue with the question ‘what shall
be the treatment of expense incurred after the conduct of test runs and
experimental production but before commencement of commercial production?’
- According to the CBDT, the expenditure incurred till the plant has begun
commercial production, that is, production intended for sale or captive
consumption, shall be treated as capital expenditure; this would imply that
expense incurred after the conduct of test runs and experimental production
but before commencement of commercial production should be capitalised
ICDS V– Tangible Fixed AssetsCapitalisation of trial run cost
70
Issue AS-10 ICDS V
Applicability Applies for the purpose of preparation of
financial statements
Applies for computation of
income under the heads ‘profits
and gains of business or
profession’ and ‘capital gains’
Tangible fixed
asset acquired
in exchange of
another asset
Fixed asset acquired should be recorded at
the fair market value (FMV) or net book
value of asset given up adjusted for any
other consideration
FMV of the asset acquired may be referred
to if it is more clearly evident
Tangible asset shall be recorded
at its fair value
Tangible fixed
asset acquired
in exchange of
shares or other
securities
Fixed asset acquired should be recorded at
FMV of the asset acquired or shares or
securities given up, whichever is more
clearly evident
Tangible asset shall be recorded
at its fair value
Revaluation of
assets
Specifically deals with revaluation of assets Does not deal with revaluation of
assets
ICDS V– Tangible Fixed AssetsKey Issues – variation from accounting standard
71
• Proviso 2 to section 43(1) inserted by the Finance Act, 2017
− As per the above proviso, if any asset is acquired by a taxpayer by paying an
amount exceeding INR 10,000 to a person during a day by any mean other
than cheque or electronic clearing system of a bank, such payment will be
ignored for determining actual cost; accordingly, depreciation would not be
available under the Act
- This implies that even if a particular expense can be considered as actual cost
as per ICDS V, the above proviso would debar its inclusion in actual cost if it is
a cash payment exceeding INR 10,000 in a day to one person
ICDS V– Tangible Fixed AssetsInterplay between ICDS and Income-tax Act
72
Scope
ICDS VI : Changes in Foreign Exchange Rates
ICDS VI deals with :-
a)treatment of transactions in foreign currencies;
b)translating the financial statements of foreign operations;
c)treatment of foreign currency transactions in the nature of forward exchange contracts
74
• Reporting Currency
- India Operations
- Overseas branch v. overseas JV/subsidiary
• Foreign currency
• Foreign currency transactions
- Denominated in foreign currency and settlement in foreign currency
• Monetary v. non-monetary items
Definitions
ICDS VI – Foreign exchange
75
AS - 11 ICDS IND AS 21
Foreign currency
transaction –
Initial Recognition
Record at
Spot Rate
As on the date of transaction or at a weekly / monthly
average rate (if rates do not fluctuate significantly from
actual)
Same as
AS
Conversion at last
day of the
Previous Year
All forex
differences
are
recognised
in P&L
Monetary Items –
Conversion at closing rate and recognize exchange
difference in P&L (subject to sec 43A read with Rule 115)
Non-monetary items (except inventory) –
Convert at rate as on date of transaction, exchange
difference shall not be recognised (subject to the
provisions of sec. 43A r.w.Rule 115)
Inventory – which is non-monetary item and is carried at
net realisable value denominated in a foreign currency,
shall be reported using the exchange rate that existed
when such value was determined.
Same as
AS
Q. 16 of FAQ – Taxability of opening Balance of Foreign Currency Translation Reserve (FCTR) relating to
Non-integral foreign operation as on 1 April 2016, if any, recognised as per Accounting Standards (AS) 11
?
Ans – FCTR balance as on 1 April 2016 pertaining to exchange difference on monetary items for
non-integral operations, shall be recognised in the previous year relevant for the assessment year
to the extent not recognised in the income computation in the past.
ICDS VI – Foreign exchange
76
AS - 11 ICDS IND AS 21
Forward contract -
not intended for
trading or
speculation and
entered to
establish reporting
currency on
settlement
Same as per ICDS Premium/discount is
amortized over the life of
contract.
Restated on MTM basis at
year end and difference is
recognized in P&L.
Profit/loss on cancellation or
renewal is also recognized in
P&L
Forward exchange contract
accounting treatment is similar to
Derivative accounting.
Derivatives are measured at fair
value with change in fair value
recognized in profit or loss
unless they qualify as hedging
instruments in a cash flow hedge
or in a net investment hedge.
Forward contract -
(trading,
speculation, firm
commitment,
highly probable
forecast)
Marked to market at
each balance sheet
date and the gain or
loss be recognized
in the P&L a/c.
No amortization of
premium/ discount.
Premium, discount or
exchange difference on
contracts be recognized at
the time of settlement only.
Forward exchange contract
accounting treatment is similar to
Derivative accounting.
Derivatives are measured at fair
value with change in fair value
recognized in profit or loss
unless they qualify as hedging
instruments in a cash flow hedge
or in a net investment hedge.
Q. 10 of FAQ – Which ICDS would govern derivative instruments ?
Ans – ICDS VI (subject to para 3 of ICDS-VIII) provides guidance on accounting for derivative contracts
such as forward contracts and other similar contracts. For derivatives, not within the scope of ICDS-VI,
provisions of ICDS-I would apply.
Revenue related
Foreign Exchange
77
Trade receivables,
payables, working
capital loans,
foreign currency
bank balances,
etc
Accounting
Income Tax
AS
Ind AS – P&L
IT Act, 1961 -
P& L
ICDS – P&L
If part of
borrowing cost,
cost, inventories
is part of
qualifying asset
Otherwise, P&L
Monetary Items-
Exchange
difference to be
recognised as
income /
expense
Capital related
Foreign Exchange
78
Fixed assets and
related payables
and borrowings
Accounting
Income Tax
AS
Ind AS – P&L
IT Act, 1961 -
P& L
ICDS – P&L
If part of
borrowing cost,
cost, capitalised
if part of
qualifying asset
Otherwise, P&L
In case of opting
for para 46A,
capitalised
Imported –
Capitalised on
settlement
Domestic - P&L
Derivatives – Fair value hedges
Foreign Exchange
79
Forwards and
options
Accounting
Income Tax
AS
Ind AS
IT Act, 1961 -
ICDS – P&L
Initial cost such
as premium, etc.
is amortised
over period of
contract
Exchange
difference –
P&L
Dept stand – On
settlement basis
Premium, discount is to
be amortised over the
period of the contract
Exchange Difference –
P&L
Derivatives – Cash flow hedges
Foreign Exchange
80
Forwards and
options
Accounting
Income Tax
AS
Ind AS
IT Act, 1961 -
ICDS – P&L
AS 30 –
Reserves
Otherwise –
Recognise MTM
losses as
incurred, gains
on settlement
Reserves
Recognise premium,
discount & exchange
difference on
settlement
Dept stand – On
settlement basis
Foreign Exchange
Derivatives – Speculative/Trading
81
Forwards and
options
Accounting
Income Tax
AS
Ind AS
IT Act, 1961 -
ICDS – P&L
Recognise MTM
gains as losses
as incurred
Recognise
gainson
settlement
Recognise
MTM
losses/gains as
incurred
Recognise premium,
discount & exchange
difference on
settlement
Dept stand – On
settlement basis
ICDS VI – Effects of Changes in Foreign
Exchange Rates
IMPACT
Can foreign exchange gain / loss on loan for purchase of capital assets in India be treated as
income / expense?
• ICDS only refers to section 43A
• As per section 43A, exchange difference relating to acquisition of a foreign asset is adjusted to
the cost of the asset at the time of payment
• Section 43A is silent on Indian assets
Illustration: Impact of ICDS on loan borrowed for purchase of capital assets in India
Overseas
India
Capital
asset
Exchange difference on loan –
adjust to asset cost as per
section 43A on settlement of
loan
Loan in foreign
currency for
purchase of
assets
Exchange difference on loan – ICDS treats
difference as revenue income / expense at
year end or settlement, whichever is earlier
Indian
company
Capital
asset
Overseas
lender
1 2
3
82
Case Study
ICDS VI : Changes in Foreign Exchange Rates
Treatment of exchange difference relating to borrowings taken for acquiring Indian
assets
A Ltd. purchased a machinery worth Rs 10 crore against the funds borrowed from a foreign
source at 1% p.m.
Issue:
• Can the exchange difference relating to borrowings taken for acquiring Indian assets be
treated as a revenue item?
83
FY 2016-17
Cost of Machinery = Rs. 10 crore
Interest incurred for the whole year in respect of foreign borrowings = Rs. 12 Lakh
Case Study
ICDS VI : Changes in Foreign Exchange Rates
Analysis
• Exchange difference on fixed assets
⁻ Para 6 of ICDS on ‘Tangible Fixed Assets’ :
The cost of a tangible fixed asset may undergo changes subsequent to its acquisition or
construction on account of (i) price adjustment, changes in duties or similar factors; or (ii)
exchange fluctuation as specified in ICDS on the effects of changes in foreign exchange rates
⁻ Para 5 of ICDS VI:
In respect of monetary items, exchange differences arising on the settlement thereof or on
conversion thereof at last day of the previous year shall be recognised as income or as
expense in that previous year.
⁻ Para 6 of ICDS VI
Initial recognition, conversion and recognition of exchange difference is subject to provisions of
section 43A or Rule 115 of the Act
• Current Practice
⁻ Amount payable due to foreign exchange difference on repayment of a loan is a capital
expenditure
84
Case Study
ICDS VI : Changes in Foreign Exchange Rates
Analysis
• As per section 43A, exchange difference relating to acquisition of a foreign asset is adjusted to
the cost of the asset at the time of payment
• Various HC judgements have held that higher amount payable due to foreign exchange
difference on repayment of a loan is a capital expenditure, not allowable as a deduction
• However, now ICDS permits exchange loss on monetary items to be recognised as an expense
and exchange gain as income
• Reliance can be place on recent decision of Pune Tribunal in case of Cooper Corporation Pvt
Ltd – 159 ITD 165 and Chennai Tribunal in case of Hyundai Motor India Limited – ITA
No.853/Chnny/2014 and 563/Chny/2015 wherein it has been held foreign exchange loss is
allowable under section 37(1) of the act.
• Further, ICDS on ‘Tangible Fixed Assets’ only states that adjustment to cost of tangible asset
may be adjusted for exchange difference but does not make the same mandatory.
85
Can the exchange difference relating to borrowings taken for
acquiring Indian assets be treated as a revenue item?
Scope
ICDS VIII: Securities
87
Scope
Securities held as stock in
trade
Part A
Securities held by a scheduled bank or
public financial institutions formed under
a Central or a State Act or so declared
under the Indian Companies Act
Part B
Securities shall be carried at actual cost (including purchase price, brokerage, cess, tax, etc.) or net
realizable value, whichever is lower at year-end. Unlisted / not regularly quoted securities will be
recognised at actual cost
88
• Comparison to be done category-wise and not on individual basis which has been also clarified in FAQ No. 19 – CBDT clarification dated 23 March 2017
• For this purpose, securities shall be classified as: shares, debt securities, convertible securities and any other
Comparison for cost vs Net realizable value
• Unpaid interest accrued before the acquisition of an interest-bearing security included in the price paid for the security – deducted from actual cost to the extent it pertains to pre-acquisition period
Pre-acquisition interest
ICDS VIII: SecuritiesSecurities held as stock-in-trade – Part A
•Where actual cost initially recognised cannot be ascertained by reference to specific identification, the cost of such security shall be determined as per First in First out method
First in First out method is permissible where actual cost is unascertainable
ICDS VIII – Securities
Impact
Security Cost NRV at
year end
Valuation
as per
books
Valuation as per ICDS
1 50 40 40 N.A.
2 70 60 60 N.A.
3 30 10 10 N.A.
4 60 90 60 N.A.
Total 210 200 170 200
ICDS
valuation
Itemised
valuation
Category-wise valuation
Category wise valuation of securities could lead to early taxation
Illustration: Valuation of securities as per category
89
Measurement of securities
90
ICDS VIII: SecuritiesCase Study - 1
Security Category Comments
Equities (listed) held as
stock in trade
Name of stock Actual cost NRV
ICDS VIII is applicable – Shares
will be valued at actual cost
initially recognized or net
realizable value, whichever is
lower, and the comparison shall
be done category-wise
Therefore, equities to be valued
at INR 3,250
ABC Co 500 1,050
XYZ Co 2,200 1,960
RNIP Co 350 350
BCD Co. 200 240
Total 3,250 3,600
Equities (unlisted) held
as stock in trade
Name of stock Actual cost NRV
ICDS VIII is applicable –
However, unlisted securities will
be valued at actual cost initially
recognized Therefore, equities
to be valued at INR 7,200
ABC Co 5,000 1,050
XYZ Co 2,200 1,960
Total 7,200 3,010
ICDS VIII: Securities
Securities held by Scheduled Bank or public financial institutions formed under a Central or a State Act or so declared under the Indian Companies ActDefinition –• Scheduled Bank shall have meaning assigned to it in clause (ii) of the Explanation to
section 36(1)(viia) of the Act• Securities shall have the meaning assigned to it in section 2(h) of the Securities Contract
(Regulation) Act, 1956 (42 of 1956) and shall include share of a company in which public are not substantially interested.
Classification, Recognition and Measurement – Para 3
• Securities shall be classified, recognised and measured in accordance with the extent
guidelines issued by the Reserve Bank of India in this regard and any claim for deduction
in excess of the said guidelines shall not be taken into account. To this extent, the
provisions of ICDS VI on the effect of changes in foreign exchange rates relating to
forward exchange contracts shall not apply
91
ICDS IX:
Borrowing Costs(Corresponds to AS 16 / IndAS 23)
It deals with treatment of borrowing costs however the actual or imputed
cost of owners‟ equity and preference share capital is not cover under ICDS
IX
92
ICDS IX- Borrowing Costs
Borrowing Costs are interest and other costs incurred by a person in connection with the borrowing
of funds
93
Includes
- Commitment charges
- Amortised amount of discounts or premiums
- Amortised amount of ancillary costs
- Finance charges in respect of assets acquired under finance lease
Excludes
- actual or imputed cost of owner’s equity and preference share capital
ICDS IX– Borrowing Costs
94
ICAI Accounting Standards (AS) ICDS
Qualifying asset Asset that necessarily takes a
substantial period of time to get
ready for its intended use or
sale (generally 12 months)
Assets that requires a period of 12months or more for its
acquisition, construction or production
- Land, building, machinery, plant or furniture, being
tangible assets
- Know-how, patents copyrights, trademarks, licenses,
franchises or any other business or commercial rights
of similar nature, being intangible assets;
- Inventories that require a period of 12months or more
to bring them to saleable condition
Capitalization of
specific
borrowing
Actual borrowing cost less any
income on the temporary
investment
Actual borrowing cost only. Investment income to offer for
tax.
(Tuticorin Alkali Chemicals and Fertilizers Ltd vs CIT 227
itr 172)
Capitalization of
general
borrowing
Apply capitalization rate to
expenditure on qualifying asset.
Capitalization rate = weighted
average cost of borrowing
Ratio of qualifying assets to total assets i.e. as per
prescribed formula in respect of general borrowings which
is other than specific borrowings
ICDS IX– Borrowing Costs
95
ICDS
Borrowing cost eligible
for capitalization
Specific borrowing – actual borrowing costs incurred
General borrowing – amount to be determined as per prescribed formula
Commencement of
capitalization
Specific borrowing – from the date on which funds were borrowed
General borrowing – from the date on which funds were utilised
Cessation of
capitalization
Tangible / intangible assets – when the asset is first put to use
Inventory – when substantially all activities necessary to prepare it for intended
sale are complete
ICDS IX : Borrowing Costs
Analysis
• Capitalization of general borrowings
Para 6 of ICDS - To the extent the funds are borrowed generally and utilised for the purposes of acquisition,
construction or production of a qualifying asset, the amount of borrowing costs to be capitalised shall be
computed in accordance with the following formula namely:
General borrowing cost X
• AS 16 on Borrowing Costs - To the extent that funds are borrowed generally and used for the purpose
of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation should be
determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate
should be the weighted average of the borrowing costs applicable to the borrowings of the enterprise that
are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a
qualifying asset. The amount of borrowing costs capitalised during a period should not exceed the
amount of borrowing costs incurred during that period
96
average cost of qualifying asset as appearing in the balance sheet on first and last day of the previous year
average of total assets appearing in the balance sheet on first and last day of the previous year (other than
those assets which are directly funded out of specific borrowings)
Calculation of interest expense in respect of general borrowings (refer formula of earlier slide)
ICDS IX – Borrowing costs
Impact
Particulars Amount (Rs.)
Total assets appearing in balance
sheet as on 31.3.17*1,000
Total tangible assets acquired
during year 2016-2017700
General borrowings 500
Interest on general borrowings 50
Specific borrowings 200
Interest on specific borrowings 20
Cost of assets constructed using
general borrowings 450
Cost of assets constructed using
specific borrowings 200
Under – construction assets value 300
Particulars ICDS AS 16
Capitalizati
on of
general
borrowing
cost
= 22.73
Working:
50 X [(700 - 200) / 2]
[(300+1000-200) / 2]
= 45 (450 X 10%)
Working:
Weighted
average
borrowing cost is
10% i.e. (50/500)
Capitalization of general borrowing cost under ICDS and AS differs
• Does not consist of under-construction assets at beginning or end
of the year
97
Case Study-1
ICDS IX : Borrowing Costs
Interest expense to be claimed as revenue deduction u/s 36(1)(iii) , if not falling under
proviso to the said section.
A Ltd. constructed a building worth Rs. 10 crore against the funds borrowed from a bank at 1% p.m.
Issue:
• Whether the interest expense can be claimed as revenue deduction u/s 36(1)(iii), if not falling
under proviso to the said section?
98
FY 2016-17
Cost of Building = Rs. 10 crore
Interest incurred = Rs. 12 Lakh
Case Study-1
ICDS IX : Borrowing Costs
Analysis
• Section 36(1)(iii) of Act:
The deductions provided for in the following clauses shall be allowed in respect of the matters
dealt with therein, in computing the income referred to in section 28 - the amount of the interest
paid in respect of capital borrowed for the purposes of the business or profession
Provided that any amount of the interest paid, in respect of capital borrowed for acquisition of an
asset for extension of existing business or profession* (whether capitalised in the books of
account or not); for any period beginning from the date on which the capital was borrowed for
acquisition of the asset till the date on which such asset was first put to use, shall not be allowed
as deduction.
* Deleted by Finance act 2015 to remove the differential treatment for availability of interest in
case of capital borrowed for purchase of asset for existing business and for extension of existing
business
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Case Study-1
ICDS IX : Borrowing Costs
Analysis
• Qualifying assets as per ICDS:
As per ICDS, Qualifying assets means
⁻ land, building, machinery, plant or furniture, being tangible assets;
⁻ know‐how, patents, copyrights, trade marks, licences, franchises or any other business or
commercial rights of similar nature, being intangible assets;
⁻ inventories that require a period of twelve months or more to bring them to a saleable
condition.
• Current Practice
⁻ Amount payable as interest and not falling under the proviso to Section 36(1)(iii) of Act is
claimed as revenue expense
100
ICDS IX : Borrowing Costs
Where qualifying asset as per AS 16 is not an asset for expansion of
business:
101
Particulars Profit and loss account
Tax claim under COI (Post
ICDS)
Borrowing cost Amount to be capitalised to the
cost of asset
Disallowed – amount to be
capitalised to the cost of asset
Income on temporary investment
of borrowed funds
To be netted off from borrowing
costs and capitalised
Will be taxed as income - No
netting off from the cost of asset
Depreciation Allowed on cost of asset which
includes borrowing cost
Allowed on cost of asset which
includes borrowing cost
ICDS IX – Borrowing costs
FAQs issued by CBDT on 23 March 2017
102
Question 20 :
There are specific provisions in the Act read with Rules under which a portion of
borrowing cost may get disallowed under sections like 14A, 43B, 40(a)(i), 40(a)(ia),
40A(2)(b) etc of the Act. Whether borrowing costs to be capitalized under ICDS-IX
should exclude portion of borrowing costs which gets disallowed under which
specific provisions ?
Ans: Since specific provisions of the Act override the provisions of ICDS, it is
clarified that borrowing costs to be considered for capitalization under ICDS IX
shall exclude those borrowing costs which are disallowed under specific provisions
of the Act. Capitalization of borrowing cost shall apply for that portion of the
borrowing cost which is otherwise allowable as deduction under the Act.
ICDS IX – Borrowing costs
FAQs issued by CBDT on 23 March 2017
103
Question 21 :
Whether bill discounting charges and other similar charges would fall under the definition of borrowing cost?
Ans: The definition of borrowing cost is an inclusive definition. Bill discounting charges and other similar charges are covered as borrowing cost.
Question 22 :
How to allocate borrowing costs relating to general borrowing as computed in accordance with formula provided under Para 6 of ICDS – IX to different qualifying assets?
Ans: The capitalization of general borrowing cost under ICDS-IX shall be done on asset-by-asset basis.
Disclosure requirements
ICDS IX : Borrowing Costs
The following disclosure shall be made in respect of borrowing costs:
a) the accounting policy adopted for borrowing costs;
b) the amount of borrowing costs capitalised during the previous year
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Computation of taxable Income – Impact of ICDS
106
Profits and Gains from Business or Profession Pre ICDS Post ICDS
Net profit as per profit and loss account XXX XXX
Add: - Disallowance as per Act XXX XXX
Depreciation as per companies Act XXX XXX
Provision for gratuity XXX XXX
Less: Allowance as per Act (XXX) (XXX)
Depreciation as per Income tax Act (XXX) (XXX)
Allowance u/s 43B of the Income tax Act (XXX) (XXX)
Net profit before tax XXX XXX
Add / less : Adjustment on account of ICDS NA XXX
Valuation of Inventory (Standard Costing effect) NA XXX
Construction contract (Provision for expected loss) NA (XXX)
Foreign Exchange fluctuations (Premium of forward
contracts) NA XXX
Net Profit before after tax (after considering impact of
ICDS)XXX XXX
Computation of taxable Income – Impact of ICDS
107
Income from other sources Pre ICDS Post ICDS
Income from other sources xxx xxx
Add/Less: Adjustment as per ICDS xxx xxx
Add/Less: Adjustment as per the provisions of the Act xxx xxx
Net Income from other sources xxx xxx
Disclosures in Form 3CD (Notification no. 88/2016 dated 29
September 2016) (1/2):
Clause 13(d) under Part-B:
(d) Whether any adjustment is required to be made to the profits or loss for complying with the
provisions of income computation and disclosure standards notified under section 145(2)
(e) If answer to (d) above is in the affirmative, give details of such adjustments:
Increase in
profit (Rs.)
Decrease in
profit (Rs.)
Net effect
(Rs.)
ICDS I Accounting Policies
ICDS II Valuation of Inventories
ICDS III Construction Contracts
ICDS IV Revenue Recognition
ICDS V Tangible Fixed Assets
ICDS VI Changes in Foreign Exchange rates
ICDS VII Government Grants
ICDS VIII Securities
ICDS IX Borrowing Costs
ICDS X Provisions, Contingent Liabilities and
Contingent Assets
Total
Disclosures in Form 3CD (Notification no. 88/2016 dated 29
September 2016) (2/2):
Clause 13(d) under Part-B (Contd..):
(f) Disclosure as per ICDS:
(i) ICDS I - Accounting Policies
(ii)ICDS II - Valuation of Inventories
(iii)ICDS III - Construction Contracts
(iv)ICDS IV - Revenue Recognition
(v)ICDS V - Tangible Fixed Assets
(vi)ICDS VII - Government Grants
(vii)ICDS IX - Borrowing Costs
(viii)ICDS X - Provisions, Contingent Liabilities and
Contingent Assets