ICDS: A possibly taxing reality
The Ministry of Finance has issued ten Income Computation and Disclosure Standards (ICDS), operationalising a new framework for computation of taxable income by all assesses in relation to their income under the heads “Profit and gains of business or profession” and “Income from Other Sources”. The Central Board of Direct Taxes (CBDT) notified these standards under Section 145(2) of the Income-tax Act, 1961 vide “Notification No. 33/2015 [F. No. 134/48/2010-TPL]/SO 892(E) dated 31 March 2015”. The notification of these standards comes as a follow up to the announcement made by the Finance Minister in his maiden budget speech in July 2014 of the intent to notify these standards.
Applicability and effective date
All assesses following the mercantile system of accounting will be required to adopt these standards for the purposes of computation of taxable income under the heads “Profit and gains of business or profession” and “Income from Other Sources”.
These standards are applicable for the previous year commencing from April 1, 2015, i.e., Assessment Year 2016-17 onwards. Therefore, these standards are already effective, and will have an immediate impact on companies, who will need to take this into account when paying their advance taxes for the first quarter of FY 15-16.
Need for ICDS
When the CBDT set up a committee in 2010 to look at the taxation related aspects of Ind-AS implementation, they also recognized it as an opportunity to address certain accounting issues that have been a subject matter of tax litigation due to either diversity in accounting practices or divergence in views between tax payers and tax authorities.
While globally different approaches have been adopted to deal with the tax issues arising from IFRS adoption, the CBDT has chosen to go down the path of prescribing a separate framework for computation of taxable income, which is independent of the financial reporting framework followed by the company. While one of the other approaches could have been considered for India, it may be too late to reopen the debate on the merits of each of those approaches, considering that time is of the essence for implementation of Ind-AS. With the notification of ICDS, there is certainty on the path that has been chosen by the CBDT; ICDS is now a reality that companies must embrace.
Facilitates Ind-AS adoption
The notification of these ICDS is quite timely and important, especially considering that the timelines for adoption of Ind AS (IFRS converged standards) have also been notified, which permits voluntary adoption for the financial year 2015-16. Providing a tax neutral framework for transition to Ind-AS was a prerequisite for smooth implementation of Ind-AS from this year. With the adoption of ICDS, irrespective of the whether the company reports its financial results as per Ind AS or the existing Indian accounting standards, they would compute their taxable income in accordance with ICDS, ensuring horizontal equity.
These standards were developed prior to the notification of Ind-AS and used the old Indian GAAP standards as a base, and included modifications to make them suitable for tax purposes. Now that Ind-AS has been notified, and most large companies would switch to Ind-AS reporting from the coming year, they could find significant differences between the principles used in ICDS and those in Ind-AS. As a result, the resultant computations of taxable income and net income as per financial statements could be vastly different.
Significant changes
The adoption of ICDS is expected to significantly alter the way companies compute their taxable income, as many of the concepts from existing Indian GAAP have been modified. These ICDS have also been developed with a view to minimising tax related disputes by bringing in greater consistency in the application of accounting principles governing the computation of income.
The ICDS in general do not have prudence as a fundamental assumption, and accordingly in several situations this would result in earlier recognition of income or gains or later recognition of expenses as compared to that under the accounting standards; this would potentially have a direct impact on the timing of tax related cash outflows.
Some of the key changes are briefly discussed below:
• No concept of prudence or materiality.
• Disallows recognition of expected losses or mark-to-market losses unless specifically permitted by any other ICDS.
• Does not permit accounting under the completed contract method, and proposes that only the percentage of completion method should be applied for recognition of revenue for all services or construction contracts.
• Does not define any minimum period for classification of an asset as a qualifying asset (with the exception of inventories) for capitalization of borrowing costs. As a result, borrowing cost may need to be capitalized even if an asset does not take substantial period of time to construct.
• New formula for capitalization of borrowing cost on general borrowings which involves allocating the total general borrowing cost incurred in the ratio of average cost of qualifying assets on the first day and last day of the previous year and the average cost of total assets on the first and last day of the previous year. Formulae appears to be ambiguous and may require further clarification.
• Requires accounting of all government grants either to be reduced from cost of assets or recognition as income over a period of time or recognition immediately, depending on the nature of grants.
• Premium, discount or exchange difference on contracts that are intended for trading or speculation purposes, or that are entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction should be recognised at the time of settlement.
• Exchange differences on translation of non-integral foreign operations to be recognized as an income or expense unlike the Indian GAAP.
• Requires recognition of contingent assets when the inflow of economic benefits is reasonably certain.
• Does not permit recognition of expected losses on onerous contracts.
As compared to the twelve draft standards that were issued for public comments in January 2015, the CBDT has notified only ten standards now; the standards on leases and intangible assets have not been notified. Also, these standards have not comprehensively addressed areas such as financial instruments, share based payments, etc. which are quite prevalent in today’s business environment.
The standards have generally excluded those topics where there is specific guidance under the income tax law. However, if there is a conflict between the provisions of the Income-tax Act, 1961 and ICDS, then the provisions of the Income-tax Act would prevail. The interplay between judicial precedents and the requirements of these standards need to be seen, and there could be several instances, where there are conflicting positions.
Transitional provisions
The overarching principles of the transitional provisions are that no income would escape taxation nor would it suffer double taxation as a result of the transition to this new framework. As per the transitional provisions, the assesses will be required to do a retrospective catch up at the date of transition in certain cases, whereas in certain other cases, the provisions apply only on a prospective basis.
Making it ‘business as usual’
Considering the extent of differences between Ind-AS and ICDS, most large corporates would need to consider the process and system changes that may be warranted to implement ICDS and maintain records as per these two sets of standards. Considering that the information computed using ICDS would be subject to audit through the tax audit process, it becomes all the more important for companies to maintain information in a manner that provides an audit trail.
Way forward
From a regulatory perspective, considering the magnitude of the changes involved, CBDT would also need to ensure that all its officers are now trained and educated on the new framework. This is important to ensure that there is a fair process of assessment, and the objective of minimizing tax disputes is met.
Another area that needs the regulators’ attention is Minimum Alternate Tax (MAT) provisions. Once Ind-AS comes in, some companies would be reporting on Ind-AS whereas others would be on old Indian GAAP; therefore, the accounting profits based on which MAT is to be calculated would need to be clarified, and may require consideration of suitable adjustments to Ind-AS accounting profit. CBDT would need to address this matter shortly.
From a corporate perspective, as a first step, companies should carry out an impact assessment. The impact assessment could provide clarity on both the extent of impact on taxable income, as well as the system and process changes that would be required to compute taxable income for each period in an efficient manner. A thorough impact assessment could then serve as a blue print and drive the plan for implementation.
ICDS is now a reality, and certainly a step in the right direction to enable smooth implementation of Ind-AS and reduce tax litigation in the medium term. As with any new framework, its implementation is expected to throw up challenges. With the extent of changes in financial, corporate and tax reporting regulations, corporates in India certainly have their task cut out for 2015.
