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    Overview Of Income Computation & Disclosure Standard (ICDS)- III On Construction Contract

    Brief about ICDS:

    The Finance Act (No.2) 2014 provides in Section 145(2)that the Central Government may notify in the Official Gazette from time to time Income Computation and Disclosure Standards(ICDS) to be followed by any class of assessee or in respect of any class of income.

    In exercise of the powers conferred by Section 145(2) of the Income Tax Act, 1961 the Central Government has notified ICDS vide notification dated 31-3-2015. These notified ICDS are required to be followed by all assessee's following the mercantile system of accounting for the purpose of computation of income chargeable to income-tax under the head "Profits and Gains of Business or Profession" or "Income from Other Sources". ICDS is not applicable for assessee who are not required to maintain books of accounts as per the Income Tax Act, 1961.

    In case of any conflict between The Income Tax Act, 1961 & ICDS, the provisions of the Act will be prevail.

    Words and expressions used and not defined in ICDS but defined in the Act shall have the meaning respectively assigned to them in the Act.

    ICDS-III:

    ICDS-III shall be applied separately to each construction contract. However, where ever it is necessary, ICDS-III should be applied to the separately identifiable components of a Single Contract (Segmentation of Contract) or to a group of contracts (Combination of Contracts) to reflect the substance of a contract or group of contracts.

    When a contract covers a number of assets, the construction of each asset should be treated as a separate construction contract when separate proposals have been submitted for each asset and each asset is subject to separate negotiation. It provides that contractor and customer able to accept or reject that part of contract relating to each asset and cost and revenue of each asset can be identified, such contracts should be treated as separate construction contract.

    Where a contract provide for the construction of an additional asset at the option of the customer or is amended to include the construction of an additional asset, the construction of additional asset should be treated as a separate construction contract when the asset differs significantly in design, technology or function from the asset or assets covered by the original contractor the price of the asset is negotiated without having regard to the original contract price.

    A group of contracts should be treated as a single construction contract when the group contracts is negotiated as a single package and contracts are so closely interrelated that they are part of single project with an overall profit margin. These contracts are performed concurrently or in a continuous sequence.

     

    Contract for the purpose of this standard includes the following:

    1. Construction of an asset or combination of assets
    2. Contract for rendering services which are directly related to (i) above.
    • Contracts of demolition or destruction of assets in connection to (i) above.

    Note:- Taxpayer's who compute their taxable income on presumptive basis i.e 44AD etc are not required to maintain books of accounts for tax purposes if they claim their income in accordance with the provisions of section (i.e., 8% in case of 44AD). As a result ICDS may not be applicable as they are not following mercantile system of accounting.

    Contract revenue: It shall be recognized when there is a reasonable ground of certainty for collection of amount which includes the following:

     

    agreed price of the contract;

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    Retentions;

    Claims;

    Incentives;

    Variations such as escalation clause.

     

    Only when measured reliably.

    If any amount, in any year during the period of contract was written off due to uncertainty in collection, the same should be SHOWN AS AN EXPENSE, not by way of adjusting to contract revenue. (Finance Act,

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    2015- Section 36(1)(vii))

    Contract costs: Shall include the following:

    1. Costs which are directly related and attributed to contract;
    2. Other costs specifically charged under T&C of contracts;
    • Allocated BORROWED COSTS as per ICDS on BORROWED COSTS.

    These costs will be reduced by incidental income(Income which is supplementary to the costs), if any. But, income or revenue shall not comprise, if it is in the nature of:

    Interest;

    Dividend;

    Capital gains.

    Those costs* which are spent for securing a contract shall also be recognized if:

    1. They are separately identified;
    2. If it is more likely than not to secure a contract. (Probable).

    *If those costs are recognized as an expense in that particular year when they were incurred, then they are not included in contract costs when it is obtained.

    Contract costs related to future activity shall be recognized as an asset by showing as the amount due from customer.

    Contract costs exclude the following:

    1. Costs related to future activity;
    2. Payments to sub – contractors as an advance for work to be done.

    Recognition of contract costs & revenue: Shall be recognized by way of stage of completion of contract. Stage of completion of contract: Shall be determined by any of the following ways:

    1. Cost to cost method;
    2. Survey method;
    • Valuation through valuer - physical proportion of work done.

    Change in estimates: For cost to cost method – Cumulative cost is to be applied. If any change in estimates on a reasonable ground, that estimates are to be used for determining the percentage of completion of contract.

    Transitional pro visions: Contract costs & revenue which are commenced on or before 31st March, 2015 but not completed by the said date, shall be recognized as per this ICDS. The amount of contract revenue, contract costs or expected loss if any, recognised for the said contract for any previous year commencing on or before 01/04/2014 shall be taken into consideration for recognising revenue and cost of the said contract for the previous year commencing 01/04/2015.

    Disclosure requirements as per this standard:

    Type of contract;

    Contract revenue & costs recognized for the respective period; Method used for determining stage of completion of contract; The amount of advances received;

    The amount of retentions;

    Some Issues:‑

    Recognition of Retention Money:- AS-7 is silent on treatment of retention money. Various Judicial

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    pronouncements held that retention money accrues only at the time of completion of conditions attached as per the relevant contract. To nullify these judgements ICDS provides for recognition of retention money on Percentage of Completion Method basis. However, this is contrary to the concept of prudence and hence will not recorded in the books of accounts.

    If subsequently the amount is not recoverable, taxpayer can't claim this amount as bad debt since the amount is not recorded in the books. To claim non recovery of debt as bad debt it should have been written off in the books of accounts. Since debt was not recorded in the books the question of written off doesn't arise.

    To overcome this difficulty Finance Act, 2015 amended section 36(1)(vii) by inserting second proviso with effect from AY 2016-17. It provides that if debt or part thereof has been offered as income in compliance with ICDS and the debt or part becomes irrecoverable it would be allowed as a bad debt deeming that such debt or part thereof been written off as irrecoverable in accounts.

    Initial Period of Recognition of Revenue:- AS-7 provides that revenue shall not be recognized during the early stages of contract. What is meant by “early stage” is not clearly defined. To provide certainty ICDS provides that contract revenue and contract cost should not be recognised till the contract reaches 25% stage of completion.

    Recognition of Expected Losses:‑

    ICDS provides that expected losses from the contract are allowed to be recognised as per percentage of completion method. This is contrary to the concept of prudence. Also it would conflict with the provisions of section 28 which provides for allowances of losses in computing the business income. As per AS-7 expected losses to be recognised in full.

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