Background of ICDS

The Central Government had notified ten Income Computation and Disclosure Standards (‘ICDS’) to be applicable from assessment year (AY) 2016-17 for the purpose of computation of income under the head ‘profits and gains from business or profession’ and ‘income from other sources’.

Post receipt of widespread representations and concerns from various stakeholders, the Government had deferred the applicability of ICDS by one year and re-notified the amended ICDS to be applicable from AY 2017-18.

The preamble to the ICDS clarified that in case of a conflict between the ICDS and the provisions of the Act, the provisions of the Act shall prevail to that extent. The Delhi High Court in the case of Chamber of Tax Consultants [TS-6173-HC-2017(DELHI)-O] raised doubts on the constitutional validity of ICDS and reaffirmed that the ICDS provisions cannot overrule the provisions of the Income-tax Act, 1961 (‘the Act’), the Income-tax Rules and the judicial precedents interpreting the provisions of the Act. Further, the High Court substantially diluted various provisions of ICDS which were contrary to judicial precedents.

It was expected that the Government may consider abolishing the ICDS provisions which created burden for taxpayers to prepare detailed reconciliations and also has a significant potential for disputes and litigations.

The Finance Bill 2018 however proposes to introduce various provisions under the Act to bring certainty on the issue of applicability of ICDS with retrospective effect from AY 2017-18.

Key proposals in the Finance Bill 2018

1. Marked to Market Losses (ICDS I)

As per ICDS I, marked to market losses (MTM) loss or an expected loss shall not be recognised while computing business income unless such loss is recognised in accordance with the provisions of other ICDS.

The Finance Bill proposes to amend Section 36 of the Act to provide that deduction in respect of any marked to market loss or other expected loss computed in accordance with the provisions of ICDS shall be allowed as a deduction.

Corresponding amendment is proposed to be made in Section 40A to provide that no deduction or allowance shall be allowed in respect of any MTM loss or other expected loss except those allowable under Section 36(1)(xviii) of the Act.

2. Foreign exchange fluctuation gains or loss (ICDS VI)

ICDS VI provides for giving effect to the changes in foreign exchange rates on the closing date and recognise the loss or gain.

The Finance Bill proposes to insert a new Section 43AA in the Act relating to taxation of foreign exchange fluctuation. The proposes new section provides that any gain or loss arising on account of any changes in foreign exchange rates and computed in accordance with ICDS shall be treated as income or loss, as the case may be.

Further, it was proposed that for the purpose of calculating gains or loss, foreign currency transaction includes:

a. Monetary items and non-monetary items.

b. Translation of financials statements of foreign operations.

c. Forward exchange contracts.

d. Foreign currency translation reserves.

3. Construction Contracts (ICDS III)

Paragraph 10(a) of ICDS III states that retention money would be a part of the contract and the same has to be assessed to tax based on ‘proportion computation method’. This is contrary to certain decisions wherein it was held that the retention money does not accrue to the tax payer unless and until the defect liability period is over and it is certified that no liability is attached further. Taxing the amount, the receipt of which is uncertain / conditional, is contrary to the settled position.

The Finance Bill however proposes to recognise the treatment in ICDS III as valid by inserting a new Section 43CB which provides that profits and gains of a construction contract or a contract for providing service shall be determined on the basis of ‘percentage of completion method’ in accordance with ICDS. Further, for this purpose the contract revenue shall include retention money and the contract costs shall not be reduced by any incidental income in the nature of interest, dividends or capital gains.

Further, it was proposed that Section 43CB of the Act shall not be applicable in the following cases:

a. In the case of a contract for providing services with the duration less than 90 days, income shall be determined on the basis of project completion method.

b. In case of a contract for providing services involving indeterminate number of acts over a specific period of time, income from such contract shall be determined on the basis of a straight line method.

4. Valuation of inventory (ICDS II read with ICDS VIII)

The Finance Bill proposes to amend Section 145A of the Act to provide that for the purpose of determining business income:

a. the valuation of inventory shall be made at lower of actual cost or net realisable value in accordance with ICDS.

b. the valuation of purchase and sale of goods or services and of inventory shall be adjusted to include the amount of any tax, duty, cess or fee actually paid or incurred to bring the goods or services to the place of its location and condition as on the date of valuation.

c. inventory of unlisted or unquoted securities shall be valued at actual cost initially recognised in accordance with ICDS.

d. Inventory of listed securities shall be valued at cost or net realisable value whichever is lower and for this purpose, the comparison shall be done category-wise.

5. Revenue Recognition (ICDS IV read with ICDS VII)

The Finance Bill proposes to introduce a new Section 145B of the Act to provide the following:

a. interest received on compensation or on enhance compensation shall be deemed to be the income of the year of receipt.

b. claims for escalation of price in a contract or export incentives shall be deemed to be the income of the year in which reasonable certainty about its realisation exists.

c. subsidy, grant, cash incentives, duty drawbacks etc as defined in Section 2(24)(xviii) is taxable in the year of receipt, if not charged to tax in any of the earlier previous years.

Our Comments

The ICDS proposal in the Finance Bill 2018 have been made to the Act to lend authenticity to the disputed provisions which were struck down as ultra vires the Act by the Hon’ble Delhi High Court (supra) and thereby removing the contradictions between the Act and the provisions of ICDS.

The proposed amendments, however, would have far reaching implications on the computation of total income. For example, the method of computation of contract revenue and contract costs will have a huge bearing on the construction industry and the provisions of the ICDS are different from the settled judicial precedents. By modifying the mode of computation, the Government has queered the pitch for the industry participants by forcing them to adopt different methods of revenue and cost recognition for computation of total income for tax purposes and for their regular reporting commitments.

It is also pertinent to note that the Central Government has not addressed all the points raised by the Delhi High Court in its judgement. For example, we note that the point related to the accounting concept of ‘prudence’ which was done away under ICDS I (Accounting Policies) and highlighted by the Delhi High Court has not been addressed in the proposals contained in the Finance Bill 2018.

To succinctly put, the Central Government through the Finance Bill 2018, has addressed the issues relating to the constitutional validity of the ICDS by making them a part of the Act itself. However, the concerns of the taxpayers have not been fully addressed leading to increase in the compliance burden on the industry.