Determining the constituents of the formula and its application in practical situations has thrown up various interpretational issues
The government has repeatedly expressed its intention to reduce tax litigation and bring in certainty in the tax regime. With an aim to increase consistency in computation and reporting of taxable income and reducing litigation, 10 ICDS (Income Computation and Disclosure Standards) were notified dealing with different aspects of tax accounting and were made applicable from FY16. However, subsequent to ICDS notification, representations were made by corporate and professional associations requesting for clarifications regarding certain provisions to ensure unambiguous implementation. The government also responded by constituting an expert committee to address the concerns of the taxpayers and dispel doubts surrounding implementation of ICDS. At the same time, it has also announced deferment of ICDS by one year to FY17.
One of the ICDS which has been troubling the taxpayers with various interpretational issues and requires attention is ICDS-9 relating to treatment of borrowing costs. The ICDS seeks to clarify the tax treatment of borrowing costs, i.e., whether they are to be capitalised to the cost of qualifying assets (including inventory) or be allowed as a deduction while computing the taxable profits. While the treatment of costs related to borrowings utilised specifically in relation to qualifying assets (specific borrowings) is in line with the accounting standards (AS), the criterion for constituting a qualifying asset under ICDS is different from AS, which poses a significant challenge to tax payers. To explain, an asset which takes 10 days time to get ready for its intended use may not be a qualifying asset under AS, which provides for a minimum time of 12 months for such qualification, however, it would be considered as a qualifying asset under ICDS as there is no time limit prescribed.
Moreover, a specific formula has been prescribed for determining the amount of costs related to general business borrowings which are to be capitalised to the cost of qualifying assets. Determining the constituents of this prescribed formula and its application in practical situations has thrown up various interpretational issues which may be looked into and clarified by the government.
Calculation of average value of total assets and average cost of qualifying assets
The prescribed formula seeks to apportion the general borrowing costs to the costs of qualifying assets, in proportion to the value of total assets. To determine the value of total assets and qualifying assets, the formula provides for exclusion of those assets which are funded out of specific borrowings. While the logic and intent appears to be reasonable, treatment for assets which were partly acquired out of specific borrowings is not clear, i.e., whether to be excluded completely or only to the extent funded out of specific borrowings. To explain, assume that an asset costing Rs 1,000 was acquired using specific borrowing to the tune of R500 and balance from general borrowings. As per the formula, assets funded out of specific borrowings are to be excluded from the calculations. Hence, the complete asset value of Rs 1,000 is to be excluded or asset value, to the extended funded out of specific borrowings of R500 is to be excluded is a doubt which needs to be clarified.
Though the plain reading of the ICDS provisions hint that complete asset value of R1,000 is to be excluded, but this may not be logical as it would mean that the general borrowing cost would not get apportioned to that part of the asset which was not funded out of specific borrowings.
Calculation to be done with reference to block of assets or an individual asset
Another doubt that has been raised by the taxpayers, especially those having a large asset base, is the reference point of the prescribed formula, i.e.,whether the formula is to be applied individually to each and every qualifying asset or the same to be applied on the basis of block of assets under construction, which can then be apportioned to the individual assets forming part of the block.
While taxpayers having a large asset base advocate the block of assets approach, on account of the practical difficulties in performing an asset wise computation, the logic appears to be favouring an individual asset approach. The government may be expected to put this controversy to rest and suggest a uniform approach to be followed by all.
Considering the period of capitalisation
ICDS, on borrowing costs, specifically provides that capitalisation of general borrowing costs to the value of qualifying assets shall start from the date of utilisation of funds till such time the qualifying asset is put to use.
However, the formula prescribed for computing the amount of general borrowing costs to be capitalised averages out the general borrowing costs over the year and does not take into account the period of capitalisation, as specifically provided for in the ICDS.
Given the fact that ICDS provides for a period of capitalisation, it can only be assumed that the amounts arrived at by applying the formulae given in ICDS are the ‘eligible amounts’ and not the actual amounts to be capitalised. To arrive at the capitalised amount, the ‘eligible amount’ computed as per the formula is to be adjusted for the period of capitalisation.
Though the above appears to be the logical interpretation of the ICDS provisions, there is a need for specific clarification to be issued in this regard.
While the above are some of the clarifications that are required in respect of the ICDS relating to borrowing costs, other ICDS’ may warrant similar analysis from a practical application perspective to ensure that there are no gaps/ambiguity in the implementation of ICDS. The next step of providing clarification/revisions in ICDS should also be taken quickly so as to allow taxpayers adequate time to assess the impact of amended ICDS in detail, well in advance.
The author is partner-direct tax, PwC India.Views are personal