Good & Simple Tax-A Myth or Reality?

It has been two months since the Goods and Service Tax (GST) has been in operation. Termed as the biggest reform in Indirect Taxes, GST has been showcased by the Government as a Good and Simple Tax. No doubt, conceptually GST is the good tax. However, the implementation and the complexity in the Indian variant of GST as detailed below, does not make this law either good or simple. The GSTN portal has not been able to cope with the pressure of filing returns by business entities and dates for filing of returns have had to be extended multiple times.

1. Multiplicity of Rates

Multiplicity of rates goes against the concept of a good and simple tax. Five rates of tax, one special rate for Gold and cess for certain goods is going to result in classification disputes. This would increase the load on the already overburdened judiciary with unnecessary litigation. Across the world there is no country where five rates of GST / VAT are in effect. But as always, our Government believes in making laws which are complex and cumbersome. The rationale behind bucketing of goods and services under various rates was that the new rate would be in line with the aggregate rate of VAT & Excise being levied under the erstwhile law. While for some commodities this has been possible but for many goods and for services the rates of tax have increased thereby raising the cost for the ultimate consumer.

2. Dual GST

The very concept of a dual GST, wherein the supplier of goods and services has to determine whether he has to levy CGST, SGST or IGST goes against the basis of ‘One Nation One Tax’. The present form of GST is not ‘One Nation One Tax’. It is One Nation but 29 taxes, as each State has its own law and credit for tax paid in one State cannot be claimed as credit in the other State. If the intent were to keep the law simple then there should not have been Dual GST in the first place. The Supplier would deposit the GST collected and the allocation or bifurcation of tax between the Centre and States would be done at the level of the Government as opposed to what is being expected out of the taxpayers today. Also, the input CGST cannot be used to set off the output SGST and vice-versa.

3. Blockage of Credit

As long as any Goods or Service are used for the purpose of business, the entity paying for such Goods and Service should be permitted to claim input credit in respect of taxes paid on receipt of such goods or service. In various cases however, the Government has expressly denied allowance for the input credit. This goes against the concept of seamless credit which is fundamental to GST. Further, the Government has also clarified that CGST of one State cannot be set off as an input against the output liability of CGST of another State. While, there is no express prohibition in the Act, the view therefore taken by the Government on this matter is strange. As long as taxes have been paid anywhere in India by an entity that entity should be allowed to take credit of the taxes paid subject to the condition that the Goods and Services are used for the purpose of business.

4. Complex Returns

The law in its present form expects tax payers to file invoice wise details while filing the returns under GST which would then be matched at an invoice level against the inputs of that payer resulting in differences for the tax payer to sort out in a given period of time. Under the existing indirect tax laws there was no requirement of invoice wise matching of credits. This requirement is cumbersome and unnecessary. This is a mammoth task leading to huge compliance cost for companies. This is clear example of the Government not trusting its tax payers and trying to procedurally complicate the law instead of making it simple for the tax payers. The lower the tax rates, the simpler the compliance mechanism higher will be the compliance by the tax payers.

5. Blockage of working capital

Implementation of GST has resulted in huge blockage of working capital especially for start-up or small exporters where furnishing of bond or payment of tax is mandatory before exporting.

I sincerely hope that the Government considers all the above aspects and actually makes GST truly a good and simple tax in letter and spirt for the tax payers.


Composite Supply & Mixed Supply

As per section 2(27) of the CGST/SGST Act, “composite supply” means a supply made by a taxable person to a recipient comprising of two or more supplies of goods or services, or any combination thereof, which are naturally bundled and supplied in conjunction with each other in the ordinary course of business, one of which is a principal supply. To illustrate this consider purchase of a laptop. When you buy the laptop you get a bag alongwith the laptop. Therefore this becomes a composite supply wherein the supply of laptop is the principal supply and the bag is incidental to the principal supply.

On the other hand ‘mixed supply’ as per section 2(66) means two or more individual supplies of goods or services, or any combination thereof, made in conjunction with each other by a taxable person for single price where such supply does not constitute composite supply. For eg. A supply of a package consisting of canned foods, sweets, chocolates, cakes, dry fruits, aerated drink and fruit juices when supplied for a single price, is mixed supply. Each of these items can be supplied separately and is not dependent on any other.

“Composite supply” and “mixed supply” are mutually exclusive concepts. The answers to the following questions would help to distinguish between the two types of supplies:

(a) Are the supplies involving supply of different types of goods or services which are made for a single price ‘naturally bundled’ and supplied in conjunction with each other in the ordinary course of business.
(b) Are different supplies provided as a package in a single contract
(c) What is the intention of the parties

Every composite supply presupposes an existence of principal supply and therefore, a composite supply shall be deemed to be a supply of that principal supply. The end use test should also be applied to see which part would be the predominant supply and which would be an ancillary supply. For example: In a contract involving supply of software and customisation thereof, if the intention of the parties was to acquire a customised software, and the basic software without such customisation is of no use to the customer, then such contract can be said to be a naturally bundled contract.

If a contract of supply falls under the category of a mixed supply then a mixed supply shall be deemed to be a supply of that particular supply which attracts higher rate of tax. In some cases involving composite supply of goods as well as services, it may be difficult to identify whether the principal supply is a supply of goods or supply of services, as in such cases both the elements may be equally predominant. In such cases, legislature by a deeming fiction has decided whether such supplies shall be treated as ‘supply of goods’ or ‘supply of services’. Such cases are enumerated in Schedule II of the CGST/SGST Acts.

Goods and Service Tax – A New Beginning

Considered to be the biggest tax reform in the Country, the implementation of Goods and Service Tax Law (GST) is now a reality. The date of its implementation though has been postponed but all contentious issues have been sorted out by the GST Council. There is a paradigm shift in the basis of taxation under GST. The taxation moves from collecting tax at the point of origin to a destination based consumption tax. GST is a dual tax i.e. Central GST/State GST (CGST/SGCT) and Integrated GST (IGST). The fundamental basis of levy of GST is ‘Supply’. If there is an intra State supply of goods and/or services then a CGST and SGST would be charged, whereas if there is an inter State supply of goods and/or services then IGST would be charged.


Section 2(57) of CGST/SGST Acts defines “intra-state supply of goods” to mean supply of goods in the course of intra-state trade or commerce in terms of Section 4(1) of IGST Act. Section 2(58) of CGST/SGST Act defines “intra-state supply of services” to mean supply of services in the course of intra-state trade or commerce in terms of Section 4(2) of IGST Act. Thus, what constitutes an intra-state trade or commerce is contained in Section 4, of the IGST Act.


Two factors namely (i) the location of the supplier and (ii) the place of supply will determine whether the supply is intra-state or interstate. If both are in the same State, then it will be intra-state supply. If both are in different States, then it will be an interstate supply. Supply, in the course of import into territory of India, shall be deemed to be an inter-state supply. Similarly supply of goods / services when the supplier is located in India and the place of supply is outside India (i.e. exports), shall be deemed to be an interstate supply. Besides, import and exports, supply of goods/service to or by a SEZ developer or a SEZ unit, shall also be deemed to be an inter-state supply.



As per section Section 3(1)(a) of the CGST/SGST Law, “Supply” includes all forms of supply of goods and services such as sale, transfer, barter, exchange, license, rental, lease or disposal, made or agreed to be made for a consideration, by a person, in the course or furtherance of business. The said section makes importation of service for a consideration a supply whether or not such importation is under ordinary course of business.


In the context of transaction involving goods, supply would mean alienation (temporary or otherwise) of goods by one person and possession/custody thereof by another person. In the context of service, it means carrying out an activity by one person and enjoyment of deliverables of such activities by other person. From the above, it would be clear that there has to be contract for ‘supply’ between ‘two distinct persons’, consensus-ad-idem as to the ‘identity of goods or services’ and ‘consideration’ identified with the supply. Further, the transaction should be in the course or furtherance of business or commerce. This fourth condition is to be examined from the perspective of the person making the supply. Hence, even if the person receiving a supply is not a business entity such supplies would still attract GST.


In the subsequent posts various aspects of Supply would be covered in greater detail.

Income Declaration Scheme, 2016

The Income Declaration Scheme, 2016 (referred to here as ‘the Scheme’) is contained in the Finance Act, 2016, which received the assent of the President on 14th of May 2016.The Scheme provides an opportunity to persons to declare their undisclosed income and pay tax thereon at the rate of 30% of such undisclosed income, surcharge at the rate of 25% of such tax and penalty at the rate of 25% of such tax, totaling in all to 45% of such undisclosed income. The aforesaid payment of taxes, surcharge and penalty shall not be refundable under any circumstances. It has been clarified vide CBDT Circular No. 24/2016 dated 27th June 2016, that in case of part payment, the entire declaration made under the aforesaid scheme shall be invalid.

The Scheme has been brought into effect from 1st June 2016 and is available to every person, whether resident or non-resident. The Scheme is applicable in respect of undisclosed income of any financial year upto FY 2015-16.

Meaning of Undisclosed Income: Undisclosed income means any income or income in the form of investment in any asset located in India and acquired from income chargeable to tax in India under the Income-tax Act, 1961 (the Act), for which the declarant had either failed to furnish a return under section 139 of the Act or failed to disclose such income in its return or such income had escaped assessment. Where the undisclosed income is in the form of investment in any asset located in India, the fair market value (FMV) of such asset as computed in accordance with Rule 3(1) of Income Declaration Scheme Rules, 2016 (Rules) shall be deemed to be the undisclosed income. Where the investment in any asset is partly from an income which has been assessed to tax prior to AY 2017-18, the FMV of the asset, determined in accordance with Rule 3(2) of the Income Declaration Scheme Rules, 2016, shall be reduced by an amount which bears to the value of the asset as on 1st June 2016, the same proportion as the assessed income bears to the total cost of the asset (i.e., FMV as on 1.6.2016 X Assessed Income / Total cost of asset)

Time limit for declaration and making payment:

  • The scheme shall remain in force for a period of 4 months from 01.06.2016 to 30.09.2016 for filing of declarations. CBDT has, in this regard, clarified vide circular no. 27/2016 dated 14th July 2016 that a revised declaration can also be filed on or before 30.9.2016 provided the undisclosed income in the revised declaration is not less than the undisclosed income declared originally.
  • Payment towards taxes, surcharge and penalty must be made latest by 30.11.2016.
  • A declaration under the Scheme shall be made in Form 1 and shall be furnished either (a) electronically under digital signature or (b) electronically under electronic verification or (c) manually in print form to the concerned Principal CIT/ CIT. After such declaration has been furnished, the jurisdictional principal CIT/ CIT will issue an acknowledgement in Form 2 to the declarant within 15 days from the end of the month in which the declaration under Form 1 is made. The declarant shall not be liable for any adverse consequences under the Scheme in respect of any income which has been duly declared but has been found ineligible for declaration. However, such information may be used under the provisions of the Act. The declarant shall furnish proof of payment made in respect of tax, surcharge and penalty to the jurisdictional Principal CIT/CIT in Form 3 after which the said authority shall issue a certificate in Form 4 within 15 days of submission of proof of payment by the declarant.

Declaration is not eligible in the following cases:

  • For those assessment years in respect of which notices have been issued under section 142(1) or 143(2) or 148 or 153A or 153C of the Act and served on the declarant on or before 31st May 2016, or
  • Where a search or survey has been conducted and the time for issuance of notice under the relevant provisions of the Act has not expired. However, he can make a declaration in respect of undisclosed income of any other previous year, or
  • For those assessment years for which the proceeding is pending with the Settlement Commission
  • Cases covered under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015, or
  • Persons notified under Special Court Act, 1992, or
  • Cases covered under Indian Penal Code, the Narcotic Drugs and Psychotropic Substances Act, 1985, the Unlawful Activities (Prevention) Act, 1967 and the Prevention of Corruption Act, 1988

Consequences/ Effect of valid declaration as per clarifications by CBDT:

  • The amount of undisclosed income declared by the declarant shall not be included in his total income under the Income-tax Act for any assessment year. Further, the value of the asset declared by the declarant shall not be chargeable to Wealth-tax for any assessment year or years.
  • The contents of the declaration shall not be admissible in evidence against the declarant in any penalty or prosecution proceedings under the Act and the Wealth Tax Act, 1957.
  • Immunity from Benami Transactions (Prohibition) Act, 1988 shall be available in respect of the assets disclosed in the declarations subject to the condition that benamidar shall transfer to the declarant or his legal representative the asset in respect of which the declaration of undisclosed income is made on or before 30th September, 2017.
  • Declaration of undisclosed income will not affect the finality of completed assessments.
  • Under normal circumstances, the capital gain is computed by deducting cost of acquisition from sale price. However, when the asset which is disclosed under the scheme is sold, since the asset will be taxed at its fair market value, the cost of acquisition for the purpose of capital gains shall be the fair market value as on 01.06.2016 and the period of holding shall start from the said date (i.e. the date of determination of fair market value for the purpose of the scheme).
  • It has been clarified by the CBDT that it is not mandatory to file the valuation report, along with the declaration, of the undisclosed income represented in the form of investment in asset. However, while filing the declaration on the e-filing website, a facility for uploading the document will be available.
  • In case of amalgamation or conversion of a company to LLP, the declaration is to be made in the name of the amalgamated company or LLP, as the case may be, for the year in which the amalgamation or conversion takes place.
  • The CBDT, vide circular no. 25/2016 dated 30.6.2016, has clarified that the department will not make any enquiry in respect of the source of income, payment of tax, surcharge and penalty. However, this created a doubt as to whether the payment of tax, surcharge and penalty can be made out of the undisclosed income, thereby bringing down the effective rate of tax, surcharge and penalty to around 31%. The CBDT, vide circular no. 27/2016 dated 14.7.2016, has clarified that if a person declares Rs. 100 Lakhs as undisclosed income and pays tax, surcharge, penalty of Rs. 45 Lakhs out of his other undisclosed income, he will not get immunity under the Scheme in respect of undisclosed income of Rs. 45 Lakhs which has been utilized towards payment of tax, surcharge and penalty. Immunity will be granted if the person declares the entire Rs. 145 Lakhs as undisclosed income and pays tax, surcharge and penalty @ 45% amounting to Rs. 62.25 Lakhs.

Deeming provisions under the Scheme

Section 197(c) of the Scheme provides that

A careful reading of the same would show that the aforesaid provision of the Scheme goes beyond the provisions of section 149 of the Act. At present a notice for re-assessment cannot be issued beyond 6 years of the end of any assessment year. By virtue of this deeming fiction any income of any preceding previous year shall deemed be to the income of the year in which a notice under the aforesaid sections is issued. For eg. if the undisclosed income pertains to financial year 2001-02 for which no declaration is filed under this Scheme and particulars of such income become available to the tax department in financial year 2017-18. Under, the normal provisions of the Act, this undisclosed income would not be taxed but considering the wording of section 197(c) of the Scheme such undisclosed income can be taxed in any year in which a notice is sent.

Whether, this provision of the Scheme would stand the test of judicial scrutiny or not is a question but the reason for such a provision in the Scheme is clearly to give a message to all persons who have undisclosed income to take benefit of this Scheme.

ICDS III relating to Construction Contracts

Scope of ICDS
The said ICDS is based on Accounting Standard-7 (AS-7) on Construction Contracts notified by the Companies (Accounting Standard) Rules 2006. The ICDS has made significant changes in treatment of certain items of contract revenue which would have far reaching implications. This ICDS also seeks to override settled legal position on many aspects which are explained in detail in the subsequent paragraphs.

AS-7 does not deal with recognition of revenue by Real Estate Developers. However, there is separate Guidance Note on the same issued by the ICAI. The ICDS is silent on this aspect but the treatment provided for by the Guidance Note on this aspect is being accepted by the tax authorities. In my opinion as the ICDS is silent on this aspect, the accounting treatment prescribed by the Guidance note should continue to be followed for tax purposes as well.

Under AS-7, contract revenue is to be recognized if it is possible to reliably estimate the outcome of the contract. The criteria “if it is possible to reliably measure the outcome of a contract” has been omitted in the ICDS. This omission would result in taxing of the contract revenue earlier as compared to it being accounted for as income for accounting purposes.

Contract revenue and contract costs as per AS-7 are to be recognized as revenue or expenses by reference to the percentage of completion method (POCM) if the outcome of the contract can be estimated reliably. If it is not possible to do so, revenue should be recognized only to the extent of contract costs incurred. AS-7 does not provide for any threshold for determining the stage of completion. On the other hand, the ICDS takes a position whereby recognition of revenue cannot be postponed once the contract has reached 25% completion stage. If the contract has not reached the 25% completion stage, contract revenue would be equal to contract costs.

Another significant difference between AS-7 and ICDS is regarding accounting and taxation of Retention money. As per AS-7, retention money would be taxed when the right to receive is established. Under the ICDS, retention money is also taxed on POCM basis. This seeks to override settled legal position wherein it has been held that retention money can be taxed only when the right to receive the same is established.

Under AS-7, recognition of actual loss and forseeable loss is permitted. Under the ICDS, there is no provision for recognition of forseeable loss and actual loss would be allowed on POCM basis. The position taken by the ICDS again seeks to unsettle the settled legal position. Some of the cases where the judiciary had allowed deduction of anticipated losses are CIT vs. Triveni Engineering & Industries Ltd. (336 ITR 374) (Delhi HC), CIT vs. Advance Construction Co. Pvt. Ltd. (275 ITR 30) (Gujarat HC), Jacobs Engineering India Pvt. Ltd. (14 186) (Mumbai Tribunal). On account of non-allowbility of forseeable loss in Year 1 or preponing of revenue in year 1 as per the ICDS, a situation may arise which would lead to double taxation as in year 2 when the revenue is recognised for books of account, MAT would be applicable.

The ICDS provides that any pre-construction income in the nature of interest, dividends and capital gains shall not be reduced from the cost of construction. Accordingly, preconstruction income (like interest from advances given to sub-contractors, etc.) could get taxed as income in the year of accrual. AS-7 permits reduction of incidental income from the contract costs as long as the income is not in the nature of contract revenue. The authorities seem to have based their view on the decision of the Apex Court in the case of Tuticorin Alkali Chemicals and Fertilizers Ltd. v CIT 227 ITR 172 ignoring the subsequent decision of the Apex Court in the case of CIT v Bokaro Steel Ltd. 236 ITR 315.

As compared to other ICDS, the impact for taxpayers under this ICDS is significant. Apart from corporate tax payers who would be following the POCM method, there would be many tax payers in the category of partnerships and proprietorships where the completed contract method would be followed uptill now. The application of this ICDS would result in early taxation of income for such class of tax payers. Time will tell whether the stated objective of the ICDS i.e. to reduce litigation will be achieved with this ICDS

ICDS II relating to Valuation of Inventories


The said ICDS is based on Accounting Standard-2 (AS-2) on Valuation of Inventories notified by the Companies (Accounting Standard) Rules 2006. The ICDS however, has made some departures from the accounting treatment prescribed for preparation of financial statements. The intent behind the change seems to be to address certain matters which have been subject to litigation. As explained earlier in case of conflict between the provisions of Income-tax Act 1961 (the Act) and this ICDS, the provisions of the Act shall prevail.


Inventories under the ICDS is defined as assets-

  • held for sale in the ordinary course of business
  • in the process of production for such sale
  • in the form of materials or supplies to be consumed in the production process or in the rendering of services.

From the above definition of ‘inventories’, it would be clear that the ICDS requires measurement of inventory even in case of service providers. This aspect is not covered under AS-2. The ICDS further provides that the method of valuation for service providers would also be cost or NRV whichever is lower, which is the prescribed method for all other types of inventories.

NRV is defined as the estimated selling price in the ordinary course of business less estimated costs of completion and the estimated costs necessary to make the sale. This definition is similar to the definition given in AS-2.


As stated hereinabove, the ICDS adopts the accepted accounting measurement criteria for Inventories i.e. cost for NRV whichever is lower. Changes have however been made in the definition of costs. AS-2 defines the costs of purchase as consisting of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.

The ICDS has modified the said definition inasmuch as words “other than those subsequently recoverable by the enterprise from the taxing authorities” has been deleted. This implies that cost of purchase would necessarily include the element of duty for which cenvat credit is available. For accounting purposes a company is required to follow the exclusive method of accounting wherein taxes which are recovered subsequently are not included as cost of purchase. This ICDS however seems to follow the inclusive method of accounting. The ICAI in its Guidance Note on Tax Audit has taken a view that the adjustments envisaged by section 145A of the Act will not have any impact on the trading account of the assessee. In other words both under exclusive method of accounting and inclusive method of accounting, the gross profit in the trading account will remain the same. The view taken by the Guidance Note has also been affirmed by a Mumbai ITAT judgment in the case of Raj Petro Speciality Pvt. Ltd. vs ACIT (2013) 34 76.

In respect of valuation of services, the ICDS provides that the cost of services should include the cost of labour and other costs of personnel directly engaged in providing the service including supervisory personnel and attributable overheads. This could lead to a difficult situation as it may not be possible to prescribe value for certain type of service revenues. For example, commission income.

Value of opening inventory

The ICDS specifically provides guidance on value of inventory as on the beginning of the previous year so as to put to rest litigation on this aspect. The ICDS provides that the value of opening inventory shall be –

  • the cost of inventory available, if any, on the day of the commencement of the business when the business has commenced during the previous year, and
  • the value of inventory as on the close of the immediately preceding previous year in any other case.

Thus, if during the course of assessment proceeding the value of inventory is increased by the Assessing Officer then the said amount would have to be taken as the value of opening inventory in the subsequent assessment year. The guidance provided on this aspect would certainly help in reducing litigation.

Change of method of valuation of inventory

The method of valuation of inventories once adopted by a person in any previous year shall not be changed without reasonable cause. What constitutes ‘reasonable cause’ has not been defined. According to AS 5, Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies a change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate presentation of the financial statements of the enterprise. This should be used as a guiding principle to determine “reasonable cause”.

Valuation of inventory in place of dissolution

The ICDS provides that in case of dissolution of a partnership firm, or AOP or a BOI notwithstanding whether business in discontinued or not, the inventory on the date of dissolution shall be valued at the net realisable value. This decision adopted by the ICDS seems to overrule the decision of Hon’ble Supreme Court in the case of Sakthi Trading Co. vs. CIT (2001) 118 Taxman 301 (SC).

The Hon’ble Supreme Court in the said case had held that where a firm got dissolved due to death of a partner and business was reconstituted and continued without any interruption with the remaining partners, the closing stock was to be valued at cost or market price, whichever was lower, and not at market value. The ICDS overrules this decision by providing that in all cases of dissolution of partnerships, the inventory shall be valued at NRV on the date of dissolution.


ICDS II has tried to provide guidance on a few aspects which would certainly reduce litigation but the requirement to follow the inclusive method of accounting is not correct. This unnecessarily requires the taxpayer to make complex reconciliations which goes against the intent of the Government to make the law simple.


ICDS-1 relating to Accounting Policies

This Standard corresponds to AS-1 as notified by the Companies (Accounting Standard) Rules 2006 and provides that ‘All significant accounting policies adopted by a person shall be disclosed’. Accounting policies in the ICDS are defined as ‘accounting policies refer to the specific accounting principles and the methods of applying those principles adopted by a person.


Though the ICDS mandates the disclosure of significant accounting policies but it is silent where such disclosure has to be made. It seems that the income tax return forms are likely to be revised again to deal with the disclosure aspects of the accounting policies. Apart from the disclosure of all significant accounting policies the ICDS provides for the following:

  • Any change in an accounting policy which has a material effect shall be disclosed. The amount by which any item is affected by such change shall also be disclosed to the extent ascertainable. Where such amount is not ascertainable, wholly or in part, the fact shall be indicated. If a change is made in the accounting policies which has no material effect for the current previous year but which is reasonable expected to have a material effect in the later previous years, the fact of such change shall be appropriately disclosed in the previous year in which the change is adopted and also in the previous year in which such change has material effect for the first time.
  • Disclosure of accounting policies or of changes therein cannot remedy a wrong or inappropriate treatment of the item.
  • If the fundamental accounting assumptions of Going Concern, Consistency and Accrual are followed, specific disclosure is not required. If a fundamental accounting assumption is not followed, the said fact has to be disclosed.

Considerations in the Selection and Change of Accounting Policies

The ICDS provides that accounting policies adopted by a person shall not be changed without reasonable cause and should be such so as to represent a true and fair view of the state of affairs and income of the business, profession or vocation. For this purpose,

  • the treatment and presentation of transactions and events shall be governed by their substance and not merely by the legal form; and
  • marked to market loss or an expected loss shall not be recognised unless the recognition of such loss is in accordance with the provisions of any other ICDS.

The ICDS does not define the expression ‘true and fair’. However, the concept of ‘true and fair’ is very well understood in the context of Financial Statements wherein an auditor has to report on the true and fair view of the state of affairs of the balance sheet as at a particular date and on the profit/loss as per the statement of Profit & Loss for the year. The concept of materiality is embedded in the concept of ‘true and fair’. Income which is disclosed in the return of income is supposed to be the correct income and that is the reason why the tax audit report requires the tax auditor to certify that the disclosures in Form 3CD which enables the Assessing Officer to compute the income are true and correct. Therefore, how can the income of the business be true and fair is not understood. Does that mean that now materiality would play an important role in computing the income? If that is the case then there is an apparent contradiction in the ICDS as the ICDS does not recognise ‘Materiality’ as a basis for ‘Consideration and Selection’ of accounting policies but requires that income disclosed should be true and fair.

The position adopted under the ICDS regarding the non-recognition of marked to market loss and expected loss is also not correct. Once the accrual basis of accounting is accepted then to carve out exceptions for non-recognition of certain items is not the correct approach. This tantamounts to introduction of cash basis of accounting for certain items of expenditure/loss and actually leads to a hybrid method of accounting which is expressly prohibited under section 145 of the Act.

Going forward, taxpayers and professionals can look forward to a more comprehensive Form 3CD and income tax return form so as to capture all the requirements of the ICDS. It is hoped that the new forms are notified soon so that sufficient time is given to comply with the same.

Income Computation and Disclosure Standards

On 31.03.2015, the CBDT notified 10 Income Computation and Disclosure Standards (ICDS). These have been notified u/s 145(2) of the Income-tax Act,1961 (the Act) and have to be followed by assessees following the mercantile/accrual system of accounting for the purposes of computation of income under the head ‘Business or Profession’ and ‘Income from Other Sources’. Compliance with ICDS is mandatory w.e.f. the current financial year i.e. FY 2015-16. Though the ICDS were notified almost a year back but the level of preparedness of the assessees seems to be low. Whatever the reasons, time is ticking on and very soon we will be at the end of the financial year and post the end of the financial year the compliance with the ICDS would become more cumbersome. This post gives a broad overview of the ICDS. My subsequent posts would deal with each ICDS separately. The ICDS that have been issued are:

1 Accounting policies 1 1 8
2 Valuation of Inventories 2 2 2
3 Construction Contracts 3 7 11
4 Revenue Recognition 4 9 18
5 Tangible Fixed Assets 5 10 16
6 Effect of changes in Foreign Exchange Rates 6 11 21
7 Government Grants 7 12 20
8 Securities 8 13 32/39
9 Borrowing costs 9 16 23
10 Provisions, Contingent Liabilities and Contingent Assets 10 29 37

It has been clarified by the CBDT that separate books of account are not required to be maintained for compliance with the ICDS but adjustments would have to be made while computing the taxable income. This therefore implies that ICDS would have no impact on computation of books profits u/s 115JB of the Act. If adjustments have not been made by the assessee while computing the income under the normal provisions of the Act, the Assessing Officer can call for information in this respect and make adjustments and in the absence of receipt of information from the assessee resort to proceedings u/s 144 of the Act.

It is pertinent to note that in all ICDS it has been stated that in case of conflict between the Act and ICDS, the provisions of the Act would prevail. Though, this is the correct legal position but in the first place it should have been ensured that there is complete harmony between the provision of the Act and the ICDS in terms of computation of income. This would only accentuate confusion and complexity.

Implementation of ICDS itself is against the concept of ease of doing business and should never have been issued in the first place. If the revenue authorities would actually have been serious about ease of doing business then all Accounting Standards notified under the Companies Act should have been made applicable to computation of taxable income as opposed to issuance of a new set of Standards. Criticism will not change reality; ICDS are here to stay. It is better to take steps for its compliance today rather than wait for the time of making the final computation of income.

Analysis of the term ‘Fee for Technical Services’

What constitutes ‘fee for technical services’ has always been a vexed question? The correct characterization of the payment is important inasmuch as the withholding tax implications would vary depending upon if the payment were to constitute ‘fee for technical service’ or not. If the payment gets covered under ‘fee for technical services’ then section 194J of the Act or section 195 of the Act would get attracted depending upon the residential status of the payee. However, if the payment is merely contractual in nature without there being an element of ‘technical services’ then section 194C of the Act would get invoked. Failure to deduct tax at source at the appropriate rates has other ramifications and therefore it is important to characterize the nature of the payment correctly.

In the case of Skycell Communication vs. Dy. CIT [2001] 251 ITR 53 (Madras), the Hon’ble Madras High Court held that “technical service referred to in section 9(1) contemplates rendering of service to the payer of the fee. Mere collection of a fee for use of a standard facility provided to all those who are willing to pay for it does not amount to the fee having been received for technical services. The fact that the telephone service provider has installed sophisticated technical equipment in the exchange to ensure connectivity to the subscriber does not on that score make it a provision of technical service to the subscriber.”

In the case of CIT vs. Bharti Cellular Ltd. [2009] 319 ITR 139 (Delhi), the Hon’ble Court while adjudicating whether fee for interconnection between networks is ‘fee for technical service’ held that “in the Explanation the expression “fee for technical services” means any consideration for rendering of any “managerial, technical or consultancy services”. The word “technical” is preceded by the word “management” and succeeded by the word “consultancy”. Since the express “technical services” is in doubt and is unclear, the rule of noscitur a sociis is clearly applicable. This would mean that the word “technical” would take colour from the words “managerial” and “consultancy”, between which it is sandwiched. Both the words “managerial” and “consultancy” involve a human element. And, both, managerial service and consultancy service, are provided by humans. Consequently, applying the rule of noscitur a sociis, the word “technical” in Explanation 2 to section 9(1)(vii) would also have to be construed as involving a human element.”

In a recent case of CIT vs. Delhi Transco Ltd. [2016] 380 ITR 398 (Delhi), the issue for adjudication before the Hon’ble Court was whether payment of wheeling charges paid by the assessee to Powergrid Corporation India Ltd. were in the nature of ‘fee for technical services’. The Hon’ble Court referred to the above mentioned decisions and also relied upon evidence of experts wherein it was observed by the Hon’ble Court that the transmission of electricity was a technical service but the technical service provided was not to the purchaser of electricity but in operating or maintaining the various equipment and transmission of lines. Accordingly, the Hon’ble Court reiterated that human intervention in provision of service is a sine qua non for characterization of a service as a technical service.

Thus one of the tests which is laid down by the Courts in order to decide whether a particular payment qualifies as technical service or not is the presence of human intervention in the service. Though this is an important principle which should be borne in mind to decide the nature of the payment, however this is not the only test to conclude whether the payment is in the nature of fee for technical service or not.

Place of Effective Management (POEM)-New Rules for determining residential status

Section 6(3) of the Income-tax Act, 1961 (the Act), prior to its amendment by the Finance Act, 2015, provided that a company is said to be resident in India in any previous year, if it is an Indian company or if during that year, the control and management of its affairs is situated wholly in India. Vide Finance Act 2015 the existing provisions of section 6(3) of the Income-tax Act, 1961 were amended to provide that a company is said to be resident in India in any previous year, if-

(i) it is an Indian company; or
(ii) its place of effective management in that year is in India .

Explanation to the aforesaid section defines “place of effective management” to mean a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance, made.

The CBDT has recently issued draft guidelines to determine the POEM of a company. These guidelines provide process and guidance for determination of POEM of companies—both that are engaged in active business outside India and those that are not, factors which, by itself would not lead to a conclusion that POEM of a company is situated in India and process to be followed by an Assessing Officer in case of a finding that a company incorporated outside India is resident in India due to its POEM being in India.

Broad principles

  • Determination of the POEM will depend upon the facts and circumstances of a given case
  • The POEM concept is one of substance over form.
  • An entity may have more than one place of management, but it can have only one place of effective management at any point of time.
  • Like “residence” is to be determined for each year, POEM will also be required to be determined on year to year basis.
  • The process of determination of POEM would be primarily based on the fact as to whether or not the company is engaged in active business outside India.
  • Concept of passive income1 introduced to determine POEM.Companies engaged in active business outside IndiaThe place of effective management in case of a company engaged in active business2 outside India shall be presumed to be outside India if the majority meetings of the board of directors of the company are held outside India. However, if on the basis of facts and circumstances it is established that the Board of directors of the company are standing aside and not exercising their powers of management and such powers are being exercised by either the holding company or any other person (s) resident in India, then the place of effective management shall be considered to be in India. For the purpose of determining whether the company is engaged in active business outside India the average of the data of the previous year and two years prior to that shall be taken into account. In case the company has been in existence for a shorter period, then data of such period shall be considered.

    1 “Passive income” of a company shall be aggregate of ,-
    (i) income from the transactions where both the purchase and sale of goods is from / to its associated enterprises; and
    (ii) income by way of royalty, dividend, capital gains, interest or rental income;

    2 A company shall be said to be engaged in “active business outside India” if the passive income is not more than 50% of its total income and ,-
    (i) less than 50% of its total assets are situated in India; and
    (ii) less than 50% of total number of employees are situated in India or are resident in India; and

    (iii) the payroll expenses incurred on such employees is less than 50% of its total payroll expenditure ;

Companies not engaged in active business outside India

In cases of companies other than those that are engaged in active        business outside India the determination of POEM is proposed to be a two stage process , namely:-
(i) First stage would be identification or ascertaining the person or persons who actually make the key management and commercial decision for conduct of the company’s business as a whole.

(ii) Second stage would be determination of place where these decisions are in fact being made.

The place where these management decisions are taken would be more important than the place where such decisions are implemented. For the purpose of determination of POEM it is the substance which would be conclusive rather than the form.

Other Guiding principles

Location of Board Meetings

(a) The location where a company’s board regularly meets and makes decisions may be the company’s place of effective management provided, the Board-
(i) retains and exercises its authority to govern the company; and
(ii) does, in substance, make the key management and commercial decisions necessary for the conduct of the company’s business as a whole.

The guidelines provide that mere formal holding of board meetings at a place would by itself not be conclusive for determination of POEM being located at that place. If the key decisions by the directors are
in fact being taken in a place other than the place where the formal meetings are held then such other place would be relevant for POEM. As an example this may be the case where the board meetings are held in a location distinct from the place where head office of the company is located or such location is unconnected with the place where the predominant activity of the company is being carried out. If a board has de facto delegated the authority to make the key management and commercial decisions for the company to the senior management or any other person including a shareholder and does nothing more than routinely ratifying the decisions that have been made, the company’s place of effective management will ordinarily be the place where these senior managers or the other person make those decisions.

Executive Committee

A company’s board may delegate some or all of its authority to one or more committees such as an executive committee consisting of key members of senior management. In these situations, the location where the members of the executive committee are based and where that committee develops and formulates the key strategies and policies for mere formal approval by the full board will often be considered to be the company’s place of effective management. The delegation of authority may be either de jure (by means of a formal resolution or Shareholder Agreement) or de facto (based upon the actual conduct of the board and the executive committee).


Location of Head Office

The location of a company’s head office3 will be a very important factor in the determination of the company’s place of effective management because it often represents the place where key company decisions are made. In this regard guidance has been provided to decide where the head office of the company is located:-


Location of Head Office

Company’s Senior Management and their support staff are based in a single location which is held out to the public as company’s principal place of business or headquarters

Such principal place of business or headquarters.

Company is more decentralized and hence, Senior Management operates from time to time at offices in various countries

Location where these senior managers:
· are primarily or predominantly based; or
· normally return to following travel to other locations; or
· meet when formulating or deciding key strategies and policies for the company as a whole.

Members of Senior Management operate from different locations on a more or less permanent basis and members participate in various meetings via telephone / video conference

Location, if any, where the highest level of management (e. g.: Managing Director and Financial Director) and their direct support staff is located

Where the Senior Management is so decentralised that it is not possible to determine company’s Head Office with a reasonable certainty

Location of the Head Office would not be much relevant in determining POEM

Other Secondary Factors

If the above factors do not lead to clear identification of POEM then the following secondary factors can be considered :-

(i) Place where main and substantial activity of the company is carried out; or (ii) Place where the accounting records of the company are kept.

3 “Head Office” of a company would be the place where the company’s senior management and their direct support staff are located or, if they are located at more than one location, the place where they are primarily or predominantly located. A company’s head office is not necessarily the same as the place where the majority of its employees work or where its board typically meets;


Factors which do not establish POEM by itself

Determination of POEM is to be based on all relevant facts related to the management and control of the company, and is not to be determined on the basis of isolated facts that by itself do not establish effective management, as illustrated by the following examples:

i. The fact that a foreign company is completely owned by an Indian company will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

ii. The fact that one or some of the Directors of a foreign company reside in India will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

iii. The fact of , local management being situated in India in respect of activities carried out by a foreign company in India will not , by itself, be conclusive evidence that the conditions for establishing POEM have been satisfied.

iv. The existence in India of support functions that are preparatory and auxiliary in character will not be conclusive evidence that the conditions for establishing POEM in India have been satisfied.

The draft guidelines provide that for determination of POEM no single principle will be decisive in itself. The above principles are not to be seen with reference to any particular moment in time rather activities performed over a period of time, during the previous year, need to be considered. In other words a “snapshot” approach is not to be adopted. Further, based on the facts and circumstances if it is determined that during the previous year the POEM is in India and also outside India then POEM shall be presumed to be in India if it has been mainly /predominantly in India. Further, in case the Assessing officer proposes to hold a company incorporated outside India, on the basis of its POEM, as being resident in India then any such finding shall be given by the Assessing officer after seeking prior approval of the Principal Commissioner or the Commissioner, as the case may be, in this regard. The Principal Commissioner or the Commissioner shall provide an opportunity of being heard to the company before deciding the matter.

The Key

The issuance of these guidelines is a welcome step as they would provide much needed clarity on determination of POEM of a company. Based on the inputs received it is hoped that the CBDT would provide more illustrations regrading determination of POEM. Further, it is also hoped that the activity of stewardship is adequately addressed in the final guidelines.