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Applicability of accounting standards to income tax act

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Applicability of accounting standards to income tax act

  1. 1. Applicability of Accounting Standards to Income Tax Act, 1961 CA. Dhruv Seth ds@sethspro.com
  2. 2. Statutory Provisions Judicial Pronouncement Convergence of IT and AS
  3. 3. Statutory Provisions for application of Accounting Standards
  4. 4. Accounting Standard Authorities • Accounting Standards issued by erstwhile National Advisory Committee on Accounting Standards (NFRA under Companies Act, 2013) • Accounting Standards issued by ICAI. • Tax Accounting Standards (TAS) proposed by Accounting Standard Committee • Powers to Central Government U/s 145(2) of the IT Act, 1961 (NAS-1 and NAS-2 vis-a-viz AS1 and AS5) • International Financial Reporting Standards in India (Ind AS)
  5. 5. J.K. Industries Ltd. v. Union of India [2008] 297 ITR 176 (SC) Accounting Standards help in – • Codification of Accounting rules • Application of the fundamental rules • Reduce the subjectivity • Arrive at best possible estimate • Reduces the need for tax laws dependency upon artificial rules
  6. 6. Sec 133 of Companies Act, 2013 (Sec 211(3C) of the erstwhile act) 133. Central government to prescribe accounting standards The Central Government may prescribe the standards of accounting or any addendum thereto, as recommended by the Institute of Chartered Accountants of India, constituted under section 3 of the Chartered Accountants Act, 1949 (38 of 1949), in consultation with and after examination of the recommendations made by the National Financial Reporting Authority.
  7. 7. Sec 44AA of the IT Act, 1961 (2) Every person carrying on business or profession [not being a profession referred to in sub-section (1)] shall – (i.) …… (ii) …... (iii) ….. (iv) ….. keep and maintain such books of account and other documents as may enable the 52[Assessing] Officer to compute his total income in accordance with the provisions of this Act.
  8. 8. Sec 145 of the IT Act, 1961 Method of accounting. 145. (1) Income chargeable under the head "Profits and gains of business or profession" or "Income from other sources" shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee. (2) The Central Government may notify in the Official Gazette57 from time to time accounting standards to be followed by any class of assessees or in respect of any class of income. (3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) or accounting standards as notified under sub-section (2), have not been regularly followed by the assessee, the Assessing Officer may make an assessment in the manner provided in section 144.]
  9. 9. Notification No. SO 69(E), dated 25-1- 1996 for Notified Accounting Standards • Accounting Standard I relating to disclosure of accounting policies • Accounting standard II relating to disclosure of prior period and extraordinary items and changes in accounting policies
  10. 10. Judicial Pronouncement on applicability of Accounting Standards
  11. 11. Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 Supreme Court ". . . As the expression ‘actual cost’ has not been defined, it should, in our opinion, be construed in the sense which no commercial man would misunderstand. For this purpose it would be necessary to ascertain the connotation of the above expression in accordance with the normal rules of accountancy prevailing in commerce and industry. . . ."
  12. 12. [2003] 130 TAXMAN 179 (SC) Commissioner of Income-tax v. Indo Nippon Chemicals Co. Ltd. ". . . The High Court took the view that unless the Assessing Officer acted under circumstances indicated in section 145 of the Act, the Assessing Officer is bound to adopt the method of computation of income regularly employed by the assessee. However, if he comes to the conclusion that the method of accounting employed by the assessee makes it impossible to correctly compute the income, then the Assessing Officer is entitled to adopt any other suitable accounting method. We may add that, whatever method the Assessing Officer adopts, the method has to be consistent with the accepted principles of accountancy.. . . ."
  13. 13. Commissioner of Income-tax v. Woodward Governor India (P.) Ltd. [2007] 294 ITR 451 (DELHI) Section 5, read with section 145, of the Income-tax Act, 1961 - Income - Accrual of - Whether in determining whether there has, in fact, been accrual of liability or income, accountancy standards prescribed by ICAI would have to be followed and applied ? The judicially accepted position appeared to be that in determining whether there has, in fact, been accrual of liability or income, the accountancy standards prescribed by the ICAI would have to be followed and applied. [Para 16]
  14. 14. Prakash Leasing Ltd. v. Deputy Commissioner of Income-tax [2012] 23 taxmann.com 3 (Kar.) “When the Accounting Standard is now made the basis of maintaining the accounts for the purpose of income-tax, even if the Central Government has not notified in the Official Gazette the Accounting Standards, certainly the Accounting Standards prescribed by the Institute of Chartered Accountants have to be followed.”
  15. 15. CIT v. Virtual Soft Systems Ltd. 205 Taxman 257 (Delhi) [2012] observed that "the guidance notes reflect the best practices adopted by accountants the world over" and further, that "as long as there was a disclosure of the change in the accounting policy in the accounts which had a backing of a professional body such as ICAI, it could not be discarded by the A.O."
  16. 16. [2013] 36 taxmann.com 74 (Mumbai - Trib.) ACIT, Range -10(1) v. ITD Cementation India Ltd “It is a fact that AS-7 has not been notified by the Central Government. This does not mean that the assessee is precluded from following AS-7. A perusal of the provisions of section 145 show that accounting standards which have been notified by the Central Government have to be mandatorily followed by the assessee. But this does not mean that the assessee cannot follow the other accounting standards issued by ICAI. The accounting standards issued by ICAI cannot be brushed aside lightly. On the contrary, if an assessee is following the accounting standards issued by ICAI, it would give more credibility and authenticity to its account.”
  17. 17. Convergence of IT Act and Accounting Standards
  18. 18. AS-2 (Inventory) • IT gives more weightage to consistency while AS more to correct representation AS-4 (Contingencies) • AS requires provision. SC - expenditure dependent upon the future events is not allowable as deduction AS-4 (Prior Period) • Difference in appreciating what actually qualifies as a prior period item
  19. 19. AS-6; AS-10; AS-16 • Concept of Block of Asset • Deferred Revenue Expenses (AS-26) vis- a-viz Sec 35AB; 35ABB; 35D; 35DD; 35E • Interest on Temporary Investment • Only WDV under IT Act, 1961 AS-7 • Warranties and Contingences • Retention Money
  20. 20. AS-9 (Revenue Recognition) • Interest accrual a major grey area for NBFC and banks. • Export incentives AS-11 (Foreign Exchange) v. Sec 43A • Exchange fluctuation is to be adjusted in cost of assets only on payment basis, whereas for accounting purpose, the entire outstanding liability is adjusted.
  21. 21. AS-13 (Investments) • Permanent diminution to written off as per AS. Not allowed under IT AS-26 (Intangibles) • Non Compete fees for AS-26 is intangible and debatable in IT Act. AS-28 (Impairment of Asset) • Mandatory to apply AS-28 though provision not allowable under IT Act.

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