Analysis of some issues with ICDS

Analysis of some issues with ICDS, in detail with case studies.

Background:

On 31^st March, 2015, the Central Government has notified 10 Income Computation and Disclosure Standards (‘ICDS’) which are effective from 1^st April, 2015.

ICDS are applicable to all taxpayers, following mercantile system of accounting, for computation of income chargeable under the head “Profits and gains of business or profession” and “Income from other sources”. In case of conflict between the provisions/ of the Act and ICDS, the provisions of the Act shall prevail to that extent.

1.) ICDS on Accounting Policies

ICDS provides that expected losses or mark to market(MTM) losses shall not be recognized unless permitted by any other ICDS. Prior to ICDS, the same was allowable for tax purpose also under the Income-tax Act, 1961. However, ICDS is silent on MTM gain.

Impact:

Assesse has incurred MTM loss in Futures transactions during the FY 2015-16 as below.

Currency Future: Rs. 1 crore/-
Interest Rate Future: Rs. 10 lakhs/-

The said loss will not be allowed as a deduction for FY 2015-16.

2.) ICDS on Revenue Recognition

Revenue from service transactions are recognized as per the percentage completion method or by the completed service contract method. However, ICDS requires the same to be recognized as per the percentage completion method only.

Impact:

In case of revenue recognition from service transactions, an option of full completion method shall not be available for income tax purposes.

3.) ICDS on the Effects of Changes in Foreign Exchange Rates

a) As per AS-11, revenue non-monetary items (like, inventory, current investments, etc.) which are carried at fair value or other similar valuation denominated in a foreign currency are reported using the closing rate. However, ICDS requires the same to be converted into reporting currency using the exchange rate on transaction date.

Impact:

The difference in exchange rate between the transaction date & the valuation date will be treated as income/loss.
In other words, inventory value shall be unaffected from the exchange rate fluctuations till the time it is disposed off i.e. sold or used.
This would require creation of Deferred Tax Liability (DTL) or Deferred Tax Asset (DTA) as per “AS 22 – Accounting for taxes on Income” as accounting entry will be as per AS – 11.

b) For accounting purpose, exchange differences due to capital monetary items (not relating to imported assets) are recognized in P&L A/c. An option of capitalization as per Para 46 & 46A of AS 11 is also available. For the tax purpose, Section 43A of Income Tax Act, 1961 would not apply since it applies only if it relates to the imported assets. Therefore, such FE differences are not recognized for tax purposes i.e. gain is not taxable, loss is not deductible/ allowable.

However, ICDS requires the same to be recognized as income or loss i.e. taxable/allowable in computing taxable income.

Impact:

Such exchange differences would not be non-cognizable anymore.
However, w.e.f. 1st April, 2015, such losses would be available as a deduction and the gain would be taxable.
Also refer note given below the point no. (c)

c) Forward exchange contract for the capital account transaction.

The impact has been illustrated using the following example.

On 01-01-16, XYZ Ltd. borrowed loan from USA to purchase asset, payment to be made $ 100,000 on 30-06-16. On 01-01-16 itself it entered into a forward exchange contract to mitigate the risks associated with changes in exchange rates. The company follows Para 46A for accounting purpose. The exchange rates (Rs. per US $) are as below:

Period	01-01-16	31-03-16	30-06-16
Spot Rate	60	63	65
Forward rate (for six months)	62
Forward rate (for three months)		64

Borrowings used for the purpose other than the import of asset i.e. bought asset from domestic market.

(Rs. In Lakhs)

Particulars	F.Y. 2015-16			F.Y. 2016-17
	Accounting Purpose	Income-tax purpose		Accounting Purpose	Income-tax purpose
	Accounting Purpose	Pre-ICDS	Post-ICDS	Accounting Purpose	Pre-ICDS	Post-ICDS

Premium	1 [62-60]/2 (capitalized as per Para 46A over period of contract)	Nil (Non-cognizable for the tax purpose)	*(1) [62-60]/2 (deducted from Net Profit as per books to arrive at PGBP)	1 [62-60]/2 (capitalized as per Para 46A over period of contract)	Nil (Non-cognizable for the tax purpose)	*(1) [62-60]/2 (deducted from Net Profit as per books to arrive at PGBP)
Forward Exchange Gain	(3) [63-60] (reduced from value of asset as per Para 46A)	Nil (Non-cognizable for the tax purpose)	*3 [63-60] (Added to Net Profit as per books to arrive at PGBP)	(2) [65-63] (reduced from value of asset as per Para 46A)	Nil (Non-cognizable for the tax purpose)	*2 [65-63] (Added to Net Profit as per books to arrive at PGBP)
Loss due to increase in Liability	3 [63-60] (capitalized as per Para 46A)	Nil (Non-cognizable for the tax purpose)	*(3) [63-60] (deducted from Net Profit as per books to arrive at PGBP)	2 [65-63] (capitalized as per Para 46A)	Nil (Non-cognizable for the tax purpose)	*(2) [65-63] (deducted from Net Profit as per books to arrive at PGBP)

* Note:To the extent, ICDS suggests revenue treatment of exchange fluctuations on capital account, it is in conflict with the provisions of the Act and settled position by the Supreme Court in the case of TISCO-(1998) 231 ITR 285 (SC). However, the Tax Department may not challenge treatment as per ICDS.

Depreciated Value/ Written Down Value (WDV) of Asset

	Accounting Purpose	Income-tax purpose
	Accounting Purpose	Pre-ICDS	Post-ICDS
F.Y. 2015-16	Rs. 60,00,000 Add: Rs. 3,00,000 Less: Rs. 3,00,000 Add: Rs. 1,00,000 Balance: Rs. 61,00,000	Rs. 60,00,000 Balance: Rs. 60,00,000	Rs. 60,00,000 Balance: Rs. 60,00,000
F.Y. 2016-17	Add: Rs. 2,00,000 Less: Rs. 2,00,000 Add: Rs. 1,00,000 Balance: Rs. 62,00,000	Balance: Rs. 60,00,000	Balance: Rs. 60,00,000

For detailed analysis please refer annexure.

d) Hedging in foreign currency risk of a firm commitment or a highly probable forecast transaction

ICDS requires recognition of premium, discount or exchange difference on contracts for hedging of the foreign currency risk of a firm commitment or a highly probable forecast transaction on settlement basis. Here, firm commitment does not include assets and liabilities existing at the end of the previous year.

However, AS-11 requires the premium or discount arising at the inception of a forward exchange contract to be amortized as expense or income over the life of the contract and FE differences to be recognized as income or expense in the previous year in which the exchange rates change. Any profit or loss arising on cancellation or renewal to be recognized as income or expense for the previous year.

Impact:

In case of hedging of a firm commitment or a highly probable forecast transaction, exchange difference shall be recognized on settlement basis.

4.) ICDS on ‘Borrowing cost’

As per AS-16, Land is not a qualifying asset. However, ICDS on ‘Borrowing cost’ includes ‘Land’ in the definition of a qualifying asset.

Impact:

The borrowing cost pertaining to the ‘Land’ which is not put to use will be capitalized for tax purposes. “Land” is a non-depreciable asset. Hence, the depreciation on the capitalized borrowing cost would not be available.

When the land is sold deduction for cost of the land and the borrowing cost capitalized will be allowed as deduction.

Annexure

Accounting entries for forward exchange contract

Rs. In Lakhs

Date	Particulars	Debit	Credit
01-01-2016	Bank A/c Dr.	60
	To Foreign Currency Loan A/c		60
	(Being entry passed for taking the foreign currency loan i.e. $100000*Rs/$60)
01-01-2016	Asset A/c Dr.	60
	To Bank A/c		60
	(Being asset purchased)
01-01-2016	Foreign currency receivable A/c Dr.	60
	Deferred Premium A/c Dr.	2
	To Amount payable to bank A/c		62
	(Being entry passed for entering into forward exchange contract)
31-03-2016	Premium A/c Dr.	1
	To Deferred Premium A/c		1
	(Being entry passed for amortization of proportionate premium on forward exchange contract for three months)
31-03-2016	Foreign Exchange Loss A/c Dr.	3
	To Foreign Currency Loan A/c		3
	(Being entry passed for booking exchange loss on foreign currency loan at the balance sheet date (63-60)*1 lakh $)
31-03-2016	Foreign currency receivable A/c Dr.	3
	To Foreign exchange gain A/c		3
	(Being entry passed for booking of exchange gain on forward exchange contract (63-60)*1 lakh $)
31-03-2016	Asset A/c Dr.	1
	To Premium A/c		1
	(Being premium capitalized as per Para 46A of AS 11 over period of contract)
31-03-2016	Asset A/c Dr.	3
	To Foreign Exchange Loss A/c		3
	(Being loss capitalized as per Para 46A)
31-03-2016	Foreign exchange gain A/c Dr.	3
	To Asset A/c		3
	(Being gain deducted from asset as per Para 46A)
30-06-2016	Premium A/c Dr.	1
	To Deferred Premium A/c		1
	(Being entry passed for amortisation of proportionate premium on forward exchange contract for three months)
30-06-2016	Foreign Exchange Loss A/c Dr.	2
	To Foreign Currency Loan A/c		2
	(Being entry passed for booking exchange loss on foreign currency loan at the balance sheet date (65-63)*1 lakh $)
30-06-2016	Foreign currency receivable A/c Dr.	2
	To Foreign exchange gain A/c		2
	(Being entry passed for booking of exchange gain on forward exchange contract (65-63)*1 lakh $)
30-06-2016	Amount payable to bank A/c Dr.	62
	To Bank A/c		62
	(Being entry passed for amount paid to bank for the settlement of forward exchange contract)
30-06-2016	Foreign Currency Loan A/c Dr.	65
	To Foreign currency receivable A/c		65
	(Being entry passed for closing of asset and liability account)
31-03-2017	Asset A/c Dr.	1
	To Premium A/c		1
	(Being premium capitalized as per Para 46A of AS 11 over period of contract)
31-03-2017	Asset A/c Dr.	2
	To Foreign Exchange Loss A/c		2
	(Being loss capitalized as per Para 46A)
31-03-2017	Foreign exchange gain A/c Dr.	2
	To Asset A/c		2
	(Being gain deducted from asset as per Para 46A)

Ledger A/c Rs. In Lakhs

Debit Foreign Currency Loan A/c Credit

Date	Particulars	Amount	Date	Particulars	Amount
	To			By
31-03-2016	Balance c/f	63	01-01-2016	Bank A/c	60
			31-03-2016	Foreign Exchange Loss A/c	3
		63			63
	To			By
30-06-2016	Foreign currency receivable A/c	65	01-04-2016	Balance b/f	63
31-03-2017	Balance c/f	Nil	30-06-2016	Foreign Exchange Loss A/c	2
		65			65

Debit Foreign Currency Receivable A/c Credit

Date	Particulars	Amount	Date	Particulars	Amount
	To			By
01-01-2016	Amount payable to bank	60	31-03-2016	Balance c/f	63
31-03-2016	Foreign Exchange gain A/c	3
		63			63
	To			By
01-04-2016	Balance b/f	63	30-06-2016	Foreign Currency Loan A/c	65
30-06-2016	Foreign Exchange gain A/c	2	31-03-2017	Balance c/f	Nil
		65			65

Debit Asset A/c Credit

Date	Particulars	Amount	Date	Particulars	Amount
	To			By
01-01-2016	Bank A/c	60	31-03-2016	Foreign Exchange gain A/c	3
31-03-2016	Premium A/c	1	31-03-2016	Balance c/f	61
31-03-2016	Foreign Exchange Loss A/c	3
		64			64
	To			By
01-04-2016	Balance b/f	61	31-03-2017	Foreign Exchange gain A/c	2
31-03-2017	Premium A/c	1	31-03-2017	Balance c/f*	62
31-03-2017	Foreign Exchange Loss A/c	2
		64			64

*Depreciation not considered

Computation of Income Tax

For A.Y. 2016-17 Rs. In Lakhs

Net profit as per Profit & Loss A/c xxxxxxxx

Adjustment for Tax purpose:

Less: Premium (allowed as expense as per ICDS) (1)

Loss due to increase in Liability(allowed as expense as per ICDS) (3)

Add: Forward Exchange Gain(considered income as per ICDS)3

Profits & Gains from Business and Profession xxxxxxxx – (1)

For A.Y. 2017-18 Rs. In Lakhs

Net profit as per Profit & Loss A/c xxxxxxxx

Adjustment for Tax purpose:

Less: Premium (allowed as expense as per ICDS) (1)

Loss due to increase in Liability(allowed as expense as per ICDS) (2)

Add: Forward Exchange Gain(considered income as per ICDS)2

Profits & Gains from Business and Profession xxxxxxxx – (1)

Note:For calculating WDV of asset for tax purpose, premium on forward contract capitalized in books of accounts as per AS 11 for F.Y. 2015-16 & 2016-17 would be reduced from the depreciated value of asset.

Accounting Standard – 11

Sr. No.	Facts	Transaction	Accounting purpose	Income Tax purpose
Sr. No.	Facts	Transaction	Accounting purpose	Pre-ICDS	Post ICDS
1.	Loan taken in foreign currency and assets bought from the domestic market	Exchange differences due to capital monetary items	Capitalized on MTM basis.	Non-cognizable for the income-tax purpose, i.e. gain is not taxable, loss is not deductible/ allowable.	Allowable as revenue item (i.e. gain taxable& loss deductible) on MTM basis.
2.	Forward contract for the above loan transaction	Premium on Forward exchange contract	Capitalized over the period of contract.	Non-cognizable for the income-tax purpose, i.e. gain is not taxable, loss is not deductible/ allowable.	Allowable as revenue expenditure over the period of contract.
2.	Forward contract for the above loan transaction	Exchange differences due to forward contract.	Capitalized on MTM basis.	Non-cognizable for the income-tax purpose, i.e. gain is not taxable, loss is not deductible/ allowable.	Allowable as revenue item (i.e. gain taxable& loss deductible) on MTM basis.
4.	Capital advances, deposits and long term loans and advances to foreign entities.	Exchange differences on repayment	Charged to P&L on MTM basis.	Non-cognizable for the income-tax purpose, i.e. gain is not taxable, loss is not deductible/ allowable.	Allowable as revenue item (i.e. gain taxable& loss deductible) on MTM basis.

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