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The Income Computation and Disclosure Standards (ICDS) that improved the country's ranking (by the World Bank) over 50 notches in ease of paying taxes are an accounting standard for the purpose of income tax. It advances some income and postpones some expenses to arrive at the profitability of companies.
Earlier, tax accounting was done on a conservative basis, to recognise income as and when it arose. For instance, a company engaged in construction activity was allowed to show income from a contract after a point when the construction had reached a specified level. Say, after four years. This is called the completed contract method.
However, the tax department felt companies were manipulating their books to show lower or a fit. Companies, on the other hand, used to say they were preparing their accounts on the basis of latest standards.
To address this, the Central Board of Direct Taxes (CBDT) came out with its own accounting standard -- ICDS-- for tax purposes. Implemented from April 1, 2016.
Under ICDS, profits have to recognised once 25 per cent of the completion stage is achieved in construction contracts. This is called percentage of completion method.
Also, interest payment by companies were allowed full deduction from income tax under the previous standards. However, a certain portion of the borrowings taken for acquisition, construction or production of an asset is taken under the capital account that is not allowed deduction, according to ICDS.
However, there would be no capitalisation of borrowing cost related to general borrowings where none of the asset has required a period of 12 months or more for its acquisition, construction or production, says Neeru Ahuja of consultancy Deloitte.
ICDS does not recognise expected losses or mark-to-market (revaluing at current values) losses unless specifically provided for by it. This is in sharp divergence with earlier accounting standards, which allowed recognition of expected losses. An earlier CBDT committee had recommended doing away with mark-to-market losses as well, since the accounting standard amounts to differential treatment for recognition of income and losses.
ICDS is silent on the prudence aspect. Prudence is a key accounting principle to ensure assets and income are not overstated and liabilities and expenses not understated. For instance, a company might provide for bad and doubtful debts based on prudence, due to a doubt regarding non-realisation of sales already booked in earlier years. This is not allowed as deduction by ICDS.
The World Bank also based its ranking on the parameter of ease of paying taxes due to the use of modern Enterprise Resource Planning (ERP) software. Ahuja of Deloitte says, "The government has committed itself to using technology for simplifying the tax procedures. The rankings given by the World Bank is recognition to this effort."