ICDS-III provides accounting standards for construction contracts that must be followed for income tax purposes. Key aspects of ICDS-III include: 1) Contractors must use the percentage of completion method to recognize revenue and expenses over time based on the stage of completion, rather than the completed contract method. 2) Retention money is considered contract revenue under ICDS-III, conflicting with some court precedents. 3) Compliance may be difficult for non-corporate contractors accustomed to the completed contract method.

1. CONSTRUCTION CONTRACTS AND ICDS
K. Vaitheeswaran
Advocate
vaithilegal@gmail.com
Background
Section 145(2) of the Income Tax Act was amended by Finance (No.2) Act,
2014 in order to provide that the Central Government may notify from time to
time Income Computation and Disclosure Standards to be followed by any class
of assessees or in respect of any class of income.
Income Computation and Disclosure Standards (ICDS)
The Central Government has notified ICDS vide Notification No.SO.892(E)
dated 31.03.2015 and the standards will have to be followed by all assessees
following the mercantile system of accounting for computation of income under
the heads ‘profits and gains of business or profession’ or ‘income from other
sources’. Currently, the Government has notified 10 Income Computation and
Disclosure Standards which are effective from 01.04.2015 and applicable from
assessment year 2016-2017.
Construction Contracts
ICDS-III is applicable to determination of income for a construction contract of
a contractor. The key features of this standard are given below:-
(i) Contract revenue and contract costs associated with the construction
contract should be recognized as revenue and expenses respectively by
reference to the stage of completion of the contract activity at the
reporting date. ICDS thus refers to percentage of completion method
(POCM). Completed contract method is no longer relevant.
(ii) The stages of completion of contract has to be determined with reference
to
(a) Cost incurred for work performed upto the reporting date as they
bear to the estimated total contract costs; or
(b) Surveys of work performed; or

2. (c) Completion of a physical proportion of the contract work.
(iii) Progress payments and advances received from customers are not
determinative of the stage of completion of the contract.
(iv) Contract revenue shall be recognized when there is reasonable certainty
of its ultimate collection. This is in one sense a relief.
(v) Contract revenue shall comprise of
• Initial amount of revenue agreed in the contract including retentions;
• Variations in contract work, claims and incentive payments to the
extent are probable that it will result in revenue and to the extent it can
be reliably measured.
(vi) During the early stages of a contract where the outcome of the contract
cannot be estimated reliably, contract revenue is recognized only to the
extent of costs incurred. The early stage of contract shall not extend
beyond 25% of the stage of completion.
(vii) Where contract revenue that is already recognized as income is
subsequently written-off in the books of accounts as uncollectable, the
same shall be recognized as an expense and not as an adjustment of the
amount of contract revenue.
Key Issues
(i) Retention money. AS-7 which deals with construction contract is silent
with reference to retention money but under ICDS-III, retention money is
also considered as contract revenue. Without an amendment to the
Income Tax Act, ICDS attempts to nullify the decisions of the Bombay
High Court in the case of Associated Cables; Calcutta High Court in the
case of Simplex Concrete Pipes; and the Madras High Court in the case
of P&C Constructions / East Coast Constructions. The crux of these
decisions was to the effect that retention money is contingent upon
satisfactory completion of contract work. Therefore, it would not amount
to income in the year in which the amount is retained. The principles laid
down in these decisions and the concept of real income will now have to
be debated once again in the light of ICDS.

3. (ii) Compliance. There would be practical difficulties in complying with
ICDS as it is applicable to all tax payers following mercantile system of
accounting for the purpose of taxable income under ‘business or
profession’ or ‘other sources’. Non-corporates such as partnership, sole
proprietors, LLPs who had been following completion contract method
would now have to mandatorily follow percentage of completion method.
(iii) Anticipated losses. The Delhi High Court in the case of CIT Vs. Triveni
Engineering & Industries Ltd. (2011) 336 ITR 374 had held that where
completed method of accounting is followed which is consistent with the
accounting standards, provision for anticipated losses is justified. There
is no provision in ICDS for recognizing anticipated losses. This is
clearly in conflict with the concept of prudence. In ICDS only actual
losses would be allowed on percentage of completion basis.
(iv) Existing contracts. Para 22 of ICDS-III provides that contract revenue
and contract costs associated with construction contracts which
commenced on or before 31.03.2015 but not completed by the said date
shall be recognized as revenue and costs respectively in accordance with
this standard. The amount of contract revenue, contract costs or expected
loss if any recognized for the said contract for any previous year
commencing on or before 01.04.2014 shall be taken into account for
recognizing revenue and costs for the said contract for the previous year
commencing from 01.04.2015 and subsequent previous year. This is
likely to have a significant impact on assessees following completed
contract method since they would now be required to compute taxable
income for all contracts for the Assessment Year 2016-2017 (Financial
year 2015-2016). In the year of transition there could be an early
recognition of income based on the stage of completion.
(v) Incidental income. AS-7 allows income such as interest, dividend,
capital gain earned during the pre-construction stages to be reduced from
the cost of construction. ICDS provides that contract costs shall be
reduced by incidental income not being in the nature of interest,
dividends or capital gains that is not included in contract revenue.