With the new accounting standards for tax purposes coming into force from the first quarter of this fiscal year, companies have found their flexibility to defer tax outgo curtailed, in what could impact Corporate India’s investment capacity.
As the industry is still to fathom the full impact of the new norms, many firms are paying a little extra advance tax in Q1 to avoid any interest liability from a possible shortfall in payment. Companies can adjust any shortfall in the Q1 payment in subsequent instalments but would have to incur an interest cost of 1% per month and hence many businesses have paid a bit extra as a buffer, said industry sources.
The Income Computation and Disclosure Standards (ICDS), which are compulsorily to be followed in computing corporate tax liability, prescribes accelerated recognition of revenue and delayed reporting of certain expenses. These norms also seek to bring uniformity in how tax liability is calculated, irrespective of the accounting standards used by businesses to prepare profit and loss account for shareholders. Under ICDS, firms are also denied the multiple options they so far had under the Companies Act on how to treat revenue from certain transactions.
According to tax experts, businesses have found in their initial assessment of ICDS that the accounting positions they need to follow in many areas are significantly different from their tax returns for previous years. These include compulsory recognition of revenue in construction projects as soon as 25% of the work is done, not recognising anticipated losses when economics change half way through a project for reasons like cost escalation and the compulsory recognition in taxable income any currency translation gains or losses from foreign operations.
“In a construction project for example, if two years down the line, input costs are going in an unanticipated direction, making it a loss making project, ICDS will not permit immediate recognition of the anticipated losses, unlike GAAP which prescribes its immediate recognition as an expense under Accounting standard 7,” explained Sai Venkateshwaran, Partner and Head, Accounting Advisory Services, KPMG in India. This could impact any long term contract across sectors, if the underlying economics undergo a change.
ICDS requirements would make the taxable profit reported in the corporate tax return significantly different from what is reported to investors and shareholders in the annual financial statements as required under the Companies Act.
As per the company law, businesses have to prepare books going by notified accounting standards—the Generally Accepted Accounting Principles (GAAP), which, as a matter of prudence, allow recognition of anticipated losses but not anticipated gains. GAAP also allow businesses to ignore certain accounting requirements, say the prescribed depreciation rate for a very cheap asset, if its impact on profit and loss account is not material. These two flexibilities are not allowed under the ICDS.
ICDS will prevail over not just GAAP, but also over the new set of accounting rules called Ind AS which large companies with net worth above Rs 500 crores and their arms will have to follow to prepare their books under Companies Act from April 1, 2016. These standards that comply with International Financial Reporting Standards (IFRS) followed in more than 100 countries allow mark to market valuation of assets and liabilities, which is not allowed in ICDS as taxation is based on historical cost of assets. Capital gains for example is the gap between cost of purchase and the sale price. Present market value of an asset is not relevant unless it is sold, when the real taxable gain (or loss) arises.
In essence, ICDS prescribes accelerated recognition of revenue and delayed recognition of certain expenses, uniformity in accounting norms for taxation irrespective of whether GAAP or Ind AS is used to prepare book of accounts and no multiple options to recognise certain transactions as allowed in GAAP.
As a result, construction firms and real estate companies cannot wait till they complete a project to recognize their revenue under ICDS. As soon as 25% of the project is complete, they have to start showing revenue in proportion to the construction achieved. This threshold will bring uniformity as real estate companies now start recognizing revenue at different stages, some when 20% of construction is complete, some at 30% and others later.
Also, the new tax accounting system allows expected losses to be shown only in proportion to the work completed, not immediately and in full as in GAAP. Contract costs are to be spread across the period when they are to be incurred, not immediately. Ind As on the other hand only lays down broad principles of recognition.
ICDS also mandates recognition of government grants as income from the date of receipt over the period when the costs that are being reimbursed by the state are to be incurred even if any attached conditions cannot be met. Under GAAP, such recognition as income is not required if the attached conditions are unlikely to be met. ICDS does not allow recognition of marked to market loss or an expected loss except where it is specifically provided for.
ICDS mandates that even if there is uncertainty in collection, businesses have to recognise revenue from the various contracts they enter into. This is not required under GAAP or Ind AS. ICDS also require businesses with foreign branches to recognise currency conversion gains and losses for calculating the taxable income rather than showing them in the balance sheet.
“If corporate houses do not plan in advance for recognition of taxable income for any year based on ICDS, then advance tax payment for that year may fall short at the end of the year, leading to interest liability on such short payment,” said Nidhi Goyal, Managing Director, tax and regulatory services, Protiviti India.
Businesses expect more clarity on the new tax accounting standards. “Since some of the concepts in ICDS seem to be at variance with certain judicial pronouncements on Income Tax Act provisions, clarifications or FAQs from the finance ministry would be greatly appreciated,” said Venkateshwaran.