Section 145 : Method of Accounting

Objective:

The method of accounting holds a vital role in the structured computation of income falling under the categories of

• "Profits and gains of business or profession" or
• "Income from other sources"

as defined by the Income-tax Act.

Effective from

Section 145 of the Income-tax Act mandates the application of a specific method of accounting for the computation of income under the mentioned heads. This provision became effective from the 1st day of April, 1997.

Permissible Method of Accounting:

The taxpayers choose between the cash and mercantile systems. Under the Income-tax Act, taxpayers have the discretion to adopt either of these methods for computing income under specific heads, such as "Profits and gains of business or profession" or "Income from other sources."

• Discretion for Taxpayers: Taxpayers are allowed to choose the accounting method that best aligns with their business operations and financial reporting preferences.
• Cash System: This method recognizes income when it is received and expenses when they are paid.
• Mercantile System: Also known as the accrual basis, this method recognizes income when it is earned and expenses when they are incurred, regardless of actual cash flow.

No role of Method of accounting if incomes are taxable under the head:

• Salaries
• House Property
• Capital Gains

Regulation of Income Computation and Disclosure Standards (ICDS) or Other under Section 145(2)

Section 145(2) of the Income Tax Act vests the Central Government with the authority to prescribe Income Computation and Disclosure Standards (ICDS) to be adhered to by assesses, specifically those employing the mercantile system of accounting. Notably, individuals and Hindu undivided households are exempt from the mandatory compliance stipulated in section 44AB, barring them from having their accounts subjected to scrutiny. The issuance of ICDS notifications must be periodically published in the Official Gazette.

Recent developments have witnessed the Central Government unveiling 10 new ICDS, effective from 2017-2018        .

ICDS  DEALS WITH

• Disclosure of Accounting Policy
• Valuation of Inventories
• Construction Contracts
• Revenue Recognition
• Tangible Fixed Assets
• Effects of Changes in Foreign Exchange Rates
• Government Grants
• Securities
• Borrowing Costs
• Provisions, Contingent Liabilities & Contingent Assets

Best Judgment Assessment under Section 144: Circumstances Triggering AO Intervention

Section 145(3) outlines three circumstances under which the Assessing Officer (AO) may choose to initiate and conclude the assessment using the approach detailed in Section 144(1), which involves the Best Judgment Assessment:

1. Inadequate Completeness or Correctness: If the Assessing Officer is dissatisfied with the completeness or correctness of the Books of Accounts and documents provided by the assessee.
2. Non-Adherence to Correct Accounting Procedure: If the assessee fails to follow the correct accounting procedure on a daily basis, the Assessing Officer may opt for the Best Judgment Assessment.
3. Non-Compliance with ICDS: If the Income Computation and Disclosure Standards (ICDS) notified by the Central Government under section 145(2) have not been adhered to by the assessee in the computation of income, the Assessing Officer may initiate the Best Judgment Assessment process.

AO's Authority to Reject Books in Case of Discrepancies

• If the accounts were not produced for authentication.
• If no records are produced.
• If the accounts were defective.
• If the stock register was not maintained.

In these situations, the Assessing Officer has the discretion to choose the Best Judgment Assessment approach as outlined in Section 144(1) of the Income Tax Act. •     If the method of accounting is improperly followed.

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