In Part I of the two article series author had analysed the impact created on computation of deferred tax i.e. timing or permanent difference keeping the remaining nine ICDS in the backdrop, six of which are dealt with in Part I, namely, valuation of inventory, construction contracts, revenue recognition, fixed assets, foreign currency translation and accounting for Government grants.

1. Securities

Accounting treatment of securities on its purchase, subsequent measurement and disposal are dealt by AS 13 – Investments, such treatment for computation of Taxable income and when the securities are held as stock in trade is dealt by ICDS 8.

Both these standards have areas in common; they have divergent view on following aspects:

• Exchange of one security for another security

While AS 13 and ICDS 8 are similar in most of the postulates regarding accounting for securities, there are divergent views on treatment to be adopted for exchange of securities. In accordance with AS 13, fair value of security foregone or security acquired whichever is more clearly evident shall be taken as value for accounting. ICDS on the other hand provides that fair value of the security acquired shall be the actual cost of acquisition.

Although this does not create a direct deferred tax impact, the real challenge will be on sale of the security as it will result in two different gains, one for books of account and another for computation of taxable income. The difference in gain is permanent in nature and would be having impact only on effective tax rate reconciliation.

• Subsequent measurement on class of security

Both ICDS 8 and AS 13 accept the concept of valuation of security eitherat cost or NRV whichever is lower. However, ICDS 8 departs itself from AS 13 on the factor whether such exercise of determining cost or NRV should be done on global basis or on individual basis. ICDS advocates global basis considering the class of securities similar to the concept of block of asset followed for depreciation whereas AS 13 mandates the securities are to be measured on individual basis.

Following table depict the valuation with more clarity.

Secondly under ICDS, \subsequent measurement of ‘Unlisted’ or ‘Listed but rarely quoted securities’ shall be carried only at cost whereas for books of account we are required to make an estimate of NRV and compare the same with cost to determine whichever is lower. These differences on valuations would carve way to deferred tax impact being temporary in nature.

2.       Borrowings Cost

Philosophy of capitalizing interest with the value of asset for which loan has been obtained is vide recognized both in accounting standard and in taxation regime. ICDS 9 is adding few elements to the existing provisions of the act towards interest capitalization.

ICDS 9 has significant departure from AS 16 as detailed below:

•  Substantial period of time

Both ICDS 9 and AS 16 accept the concept that only qualifying assets are eligible for borrowing cost capitalization.

AS 16 creates a condition on eligibility of an asset to be treated as qualifying asset. It states only when an asset takes substantial period of time in its installation / deployment or making available for its intended use, it can be treated as qualifying asset. ICDS 9 on the other hand lay this condition only in respect of Inventories and not for Fixed assets.

On account of the above, borrowing cost will be capitalized in respect of a fixed asset even if it does not take substantial period of time for installation or put to use under ICDS and such interest will be claimed as expenditure in books of account.

• Point of Capitalization

AS 16 provides for three conditions being

      i.            Incurring of expenditure on the asset
     ii.            Incurring of borrowing cost and
     iii.            Activities that are required to put the asset into intended use are complete;

Only on completion of above laid conditions capitalization of Interest shall be commenced.

ICDS 9 mandates commencement of capitalization from date of borrowing even if above conditions are not met.

• Income earned by temporary investment of borrowed funds

In business scenario, although funds are borrowed for fixed asset or inventories, time lag between application and receipt of funds would result in temporary investment of borrowed funds thereby resulting in income. AS 16 on treatment of such income, provides that, it shall be reduced from borrowing cost and the resultant shall be capitalized along with assets. ICDS 9 on the other hand provides that, income shall not be reduced from borrowing cost; the same shall be assessed as income in accordance with the provisions of the act.

• Capitalization of General borrowing cost

There are situations where borrowings are not meant for a particular asset but used for acquisition of multiple assets. AS 16 visualizing this scenario provides that in case funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs to be capitalized shall be determined by applying a capitalization rate. This capitalization rate should be the weighted average of the borrowing costs other than borrowings made specifically for the purpose of obtaining a qualifying asset and it further provides that the amount of capitalization cannot be higher than the actual amount of borrowing cost.

ICDS 9 also envisages such requirement, but has provided its own formula for capitalization as against the concept provided by AS 16.  The formula under ICDS 9 is

A x B/C Where:

A = Borrowing costs incurred during the year other than borrowings directly relatable to specific purposes

B = i. The average of costs of qualifying asset in the balance sheet on the first and the last day of the year;

Ii in case the qualifying asset does not appear in the balance sheet on the first day or both on the first day and the last day of the year, half of the cost of qualifying asset;

iii in case the qualifying asset does not appear in the balance sheet on the last day of year, the average of the costs of qualifying asset as appearing in the balance sheet of a person on the first day of the year and on the date of put to use other than those qualifying assets which are directly funded out of specific borrowings;

C = the average of the amount of total assets in the balance sheet on the first day and the last day of the year, other than those assets which are directly funded out of specific borrowings;

These four differences pointed above will have its impact in following two outlooks,

a. Amount of interest expenditure for books of account and for computation of taxable income

The entire interest cost will be treated as expenditure in books of account and interest corresponding to period after the asset is put to use will only be allowed as expenditure for the purpose of computation of taxable income.

b. Difference in capitalized value of fixed asset between books of account and computation of taxable income.

Amount of interest capitalized for compliance under ICDS will be different from amount of interest capitalized under AS 16 and thereby making the value of block of asset different from the corresponding fixed asset valuation adopted for books of account.

Point ‘a’ detailed above will result in permanent difference as differential amount of interest will never be allowed as deduction for the purpose of computation of taxable income and point ‘b’ will be resulting in temporary difference on account of distinct WDV values.

3. Provisions Contingent assets and liability

Accounting standard 29 endow that provisions shall be recognized as expenditure in books of account when it is probable there will be an outflow of economic resources on account of past events.  ICDS 10 dealing with the corresponding concept mandates that, it shall be recognized only on reasonable certainty. This distinction would be resulting in timing difference when provisions which do not satisfy the test of reasonable certainty although probable will be allowed as deduction in computation of taxable income only in the year of attaining reasonable certainty.

For the sake of brevity, the entire discussion is tabulated and provided in Table contained in Annexure 2.

Précis

Introduction of ICDS with the connotation of proviso(s) will have wider parlance and implications. It’s not out of place to mention that interplay taxation and accounting standard is always a fertile area of complications and the help of accountants shall always be of pertinent both for taxman and tax payers. The standards discussed above are of no difference which require in depth understanding, interpretation and application.

References

(i)           Notification on Income computation and disclosure standard issued by CBDT – on 31.03.2015

(ii)          Accounting standards issued by Institute of Chartered Accountants of India.