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Section 145 of the Income Tax Act,1961

Narendra Kumar

| Updated: Mar 08, 2019 | Category: Income Tax, Taxation

Section 145

Section 145 of the Income Act, 1961 deals with the process of standards which the following persons are required to follow when it comes to non-compliances to accounting standards.

In this topic we will discuss the following contents:

Overview of Section 145
Method of Accounting
What is Section 145?
What is Section 145A?
What is Section 145B?

Overview of Section 145

Income chargeable under the head “Profits & Gains from Business & Profession” or “Income from Other Sources” shall be computed in accordance with the method of accounting to be followed by the assessee.

Provided that in the case where the accounts maintained are correct but the method employed by the assessee is not proper in such a case in the opinion of the Assessing officer in such a case the income cannot be properly deducted therefrom. However, in such a case the computation shall be done in such manner as the Assessing officer may think fit.

Method of Accounting

Method of Accounting is a simple process of recording income, expenses, assets and liabilities of every business on the basis of certain standards which is known as a method of accounting. There are two methods of accounting:

  • Cash method:

In cash method of accounting, transactions in the books of accounts where there is inflow or outflow of cash. In simple words cash what comes in and cash what goes out.

For Example:

Mr. Rahul has sold 100 tube lights to Mr. Ram at Rs.15000/- on 13th April 2018 but he had made the payment on 15th July 2018. In spite of Cash received on 13th July 2018 but the entry in the books of accounts will be entered on 15th July 2018 as and when the cash is received.

Benefits:

  1. It is a simple method of accounting.
  2. This method is not recognized by the Companies Act.
  3. The income statement under this method depicts lower income
  4. The matching concept is not applicable.
  5. There are outflows and inflows of cash.
  6. The degree of accuracy in the cash method is very low.
  • Mercantile Method:

In the mercantile method of accounting, transactions in the books of accounts are recorded at the time when the income or expenses accrue. It does not depend on whether cash is received or not.

Mr. Rahul has sold 100 tube lights to Mr. Ram at Rs.15000/- on 13th April 2018 but he had made the payment on 15th July 2018. In spite of Cash received on 13th July 2018 but the entry in the books of accounts will be entered on 13th April 2018. It does not depend on whether cash is received or not and recorded on the day when transactions take place.

Benefits:

  1. This is a complex method of accounting.
  2. This method is recognized by the Companies Act.
  3. The income statement under this method depicts higher income.
  4. Matching Concept is applicable.
  5. There is a concept of revenue earned and expenses incurred.
  6. The degree of accuracy id high

While following the Mercantile method of accounting the assessee has to follow the following set of standards:

ICDS I: Accounting Policies

ICDS II: Valuation of Inventory

ICDS III: Construction Contracts

ICDS IV: Revenue Recognition

ICDS V: Tangible Fixed Assets

ICDS VI: Effects of changes in foreign exchange rates

ICDS VII: Government Grants

ICDS VIII: Securities

ICDS IX: Borrowing Costs

ICDS X: provisions, Contingent Liabilities, and Contingent Assets

Read our article:What are the Income Tax Laws for Startups in India

What is Section 145?

Section 145 of the Income Tax Act, which basically deals with the method of accounting to be, followed which is divided into 3 subsections:

  • Section 145(1):

Section 145(1) deals with the provides that Income under the head “Profits & Gains from Business & Profession” or Income from Other Sources shall be either cash or mercantile system of accounting to be regularly employed by the assessee paying taxes. However, some assessee follows the combined method of accounting. cash and mercantile method of accounting. This method is normally not allowed. They have to either use cash or mercantile method.

Provision 1 of Section 145 states that when accounts are correct and complete but the method of accounting deployed does not compute accurate income, in that case, income will be computed by the assessing officer with regard to accounting method of his preference.

Provision 2 of Section 145 states that where the assessee has no regular method of accounting the income in such a case will be calculated as per the method of account deployed in the last financial year

Provision 3 of Section 145 states that any interest in security that an individual receives has not been charged in the earlier years that does not mean that he will not be charged for that this year.

  • Section 145(2):

Section 145(2) deals with the provisions related to the accounting standards which are provided by Central Government from time to time in the official gazette. Following accounting standards are notified under section 145(2):

Accounting Standard I:

  • AS 1 deals with all significant accounting policies adopted in the preparation and presentation of Financial Statement.
  • Any changes in the accounting policy from the previous year or years earlier to that shall be disclosed. Also, the impact of the same on the financial statement should be disclosed.
  • Accounting Policies adopted by the assessee shall present a true and fair view stating the following:
  • Prudence: Provisions should be made for all known liabilities and losses even if the amount cannot be determined by certainty and represents only the best estimate on the basis of available information.
  • Substance over form: The accounting treatment and preparation of the financial statement have to be done on the basis of certain of the transactions and the vents should be governed by their substance not by their legal form.
  • Materiality: Financial statement should disclose all the material effects the knowledge of which can influence the decision of the user of the financial statement

Accounting Standard II:

  1. This AS II deals with the prior period items which are to be disclosed properly in the profit and loss account in the previous year together with the nature and amount and its impact on the profit and loss account.
  2. A Change in the accounting policy shall be made only if the adoption of different accounting policies is required by the statue or if the change would result in more appropriate preparation or presentation of financial statements by the assessee.
  3. Extraordinary items of the business during the previous year shall be disclosed in the profit and loss account as a part of taxable income, the nature and amount of such item should be disclosed separately with relevant significance and its effect on the operating results on the previous year.
  4. A change in account entry having a material effect on the previous year shall be quantified and disclosed. Also, any changes which reasonably expect to have a material effect in the years subsequent to the previous year have also to be disclosed.
  5. However, if any question arises with regards to change in accounting policy or change in accounting estimate such question shall be referred to the Board of Decision.
  • Section 145(3):

Section 145(3) provides that where the Assessing Officer is not satisfied with

  1. About the correctness or completeness of the accounts of the assessee.
  2. Where the method of accounting has been regularly followed by the assessee
  3. Income has not been computed by the standards notified.

If the Assessing Officer finds any of the discrepancies, he can reject the books of accounts on the following criteria:

  1. Improper accounting Method
  2. Non-Production of Accounts for verification
  3. Failure to produce records
  4. Defective Accounts
  5. No maintenance of Stock Register

After the rejection of the books of accounts due dissatisfaction with the correctness of the accounts produced by the assessee, the Assessing Officer must pass the judgment on the basis of best judgment as per section 145 of the Income Tax Act,1961[1].

What is Section 145A?

Method of Accounting in certain cases: Notwithstanding anything to the contrary as contained in Section 145 the valuation of purchase and sale of inventory under the head Income from Business & Profession shall be calculated in accordance with

  1. Method of accounting regularly employed by the assessee.
  2. Further adjusted to include any tax, duty or cess or fee by whatever name called actually paid or incurred by the assessee to bring the goods on the basis of place of its location and condition on the valuation date.
  • Section 145A determines that income chargeable under the head “Profits & Gains from Business & Profession.
  • The valuation of inventory shall be done at lower of actual cost or a net realizable value computed in accordance with the Income Computation and disclosure standard notified under subsection (2) of Section 145.
  • The valuation of sale and purchase of goods and services shall be adjusted to include any tax, duty, cess or fee actually paid or incurred by the assessee to bring the goods or service to the place of its location and its condition as on the date of valuation.
  • The Inventory being securities not listed on a recognized stock exchange or listed but not quoted on recognized stock exchange regularly from time to time shall be valued at an actual cost initially recognized in accordance with income computation and disclosure standards.
  • The inventory being securities other than those mentioned above shall be valued at lower of actual cost or net realizable value in accordance with income computation and disclosure standard notified under subsection (2) of Section 145.

What is Section 145B?

Section 145B is mainly divided into 3 subsections:

Section 145B (1):

Notwithstanding anything to the contradictory as contained in Section 145, interest or any compensation or any enhanced compensation received by the assessee as the case may be shall be deemed to be the income of the assessee in the previous year in which it is received.

Section 145B (2):

Any claim for escalation of price in a contract or export incentives shall be deemed to be the income of the assessee in the previous year in which it is received subject to realization. These schemes generate two types of income:

  1. Any claim for escalation of price in a contract
  2. Export Incentives.

Section 145B (3):

Any income from subsidy, grant or reimbursement shall be deemed to be the income for the previous year when it is received if the same is not chargeable to income tax in the previous year

Conclusion

In this article, we discussed the cash or mercantile method of accounting which is to be followed by the assessee for their income from business and profession and income from other sources. Central Government has the authority to make changes in the provisions of accounting standards. All the assesses should follow the changes and calculate the income as per the Income Tax Slab. The Assessing Officer has a right to assess the books of accounts and reject them on the basis of completeness or correctness of the books of accounts and pass judgment on the basis of best judgment.

After explaining the complete section, it is very tedious to maintain such books of accounts and maintaining this type of records can be confusing and abiding which will be difficult for the assessee to handle. We have a Tax Expert who can guide you through the entire process of maintaining books of accounts and filing your Income Tax Return. For more details visit Enterslice.

Read our article:Flashback 2018: 25 major influential Income Tax Judgments

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Narendra Kumar

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