Direct vs. Indirect Tax in India: Part 3 – Revenue Recognition – Expenditure

Further, as per explanations provided u/s 37 viz. explanation 1 & 3, any expenditure which is an offence or is prohibited by law is specifically disallowed.

If the Taxpayer is following a mercantile system of accounting, then he would be allowed to claim that such expenditure is deductible by provisions of the Act.

Further, if TDS is deductible and not deducted by the taxpayer, then disallowance u/s 40(a)(i)/(ia) triggers. Disallowance @ 30% is applicable in the case of Resident payees and 100% in the case of Non-resident Assessees.

Further, if Tax Audit u/s 44AB is applicable, then the tax Auditor of the enterprises is duty-bound to report such lapse in his Tax Audit report i.e. Form 3CD and reporting appropriate observation and remarks in Form 3CA/3CB.

Further, if such disallowance as reported in the Tax Audit Report is not disallowed while determining total income u/s 28 of the Income Tax Act, 1961, then Return of Income filed by the Taxpayer u/s 139 will be termed as defective returns and consequently, ramifications of such defective returns shall apply following the provisions of the ITA.

Further, provisions of reversals or Reavailment of ITC similar to Rule 37 and Rule 37A as discussed under the Indirect Tax Regime, do not exist under the ITA as per my understanding.

Further, ITC needs to be reversed as per Rule 37/37A of CGST Rules, 2017 by the taxable persons.  Taxable person is expected to comply such reversals while discharging his GST obligations as per the provisions of the Act and Rules, if not discharged, then, interest u/s 50 of the CGST Act, 2017 would be payable.

If reversals under Rule 37 and 37A are applicable and if not reversed, then, such ITC can be recovered by following the provisions of Section 73/74/74A as the case may be.

The rule provisions are reproduced below for reference:

Rule 37 – Reversal of input tax credit in the case of non-payment of consideration

(1)  A registered person, who has availed of input tax credit on any inward supply of goods or services or both, other than the supplies on which tax is payable on reverse charge basis, but fails to pay to the supplier thereof, the amount towards the value of such supply, whether wholly or partly,] along with the tax payable thereon, within the time limit specified in the second proviso to sub-section (2) of section 16, shall pay or reverse an amount equal to the input tax credit availed in respect of such supply, proportionate to the amount not paid to the supplier, along with interest payable thereon under section 50, while furnishing the return in FORM GSTR-3B for the tax period immediately following the period of one hundred and eighty days from the date of the issue of the invoice

Provided that the value of supplies made without consideration as specified in Schedule I of the said Act shall be deemed to have been paid for the purposes of the second proviso to sub-section (2) of section 16:

Provided further that the value of supplies on account of any amount added in accordance with the provisions of clause (b) of sub-section (2) of section 15 shall be deemed to have been paid for the purposes of the second proviso to sub-section (2) of section 16.

(2) Where the said registered person subsequently makes the payment of the amount towards the value of such supply along with tax payable thereon to the supplier thereof, he shall be entitled to re-avail the input tax credit referred to in sub-rule (1).

(3) ^{……………………………….}

(4) The time limit specified in sub-section (4) of section 16 shall not apply to a claim for re-availing of any credit, in accordance with the provisions of the Act or the provisions of this Chapter, that had been reversed earlier.

Such reversal provisions are unique to GST Acts and Rules framed thereunder.

Rule 37A – Reversal of input tax credit in the case of non-payment of tax by the supplier and re-availment thereof.

Where input tax credit has been availed by a registered person in the return in FORM GSTR-3B for a tax period in respect of such invoice or debit note, the details of which have been furnished by the supplier in the statement of outward supplies in FORM GSTR-1 ^69b [ , as amended in FORM GSTR-1A if any, ] or using the invoice furnishing facility, but the return in FORM GSTR-3B for the tax period corresponding to the said statement of outward supplies has not been furnished by such supplier till the 30th day of September following the end of financial year in which the input tax credit in respect of such invoice or debit note has been availed, the said amount of input tax credit shall be reversed by the said registered person, while furnishing a return in FORM GSTR-3B on or before the 30th day of November following the end of such financial year:

Provided that where the said amount of input tax credit is not reversed by the registered person in a return in FORM GSTR-3B on or before the 30th day of November following the end of such financial year during which such input tax credit has been availed, such amount shall be payable by the said person along with interest thereon under section 50:

Provided further that where the said supplier subsequently furnishes the return in FORM GSTR-3B for the said tax period, the said registered person may re-avail the amount of such credit in the return in FORM GSTR-3B for a tax period thereafter.

However, as per accounting standards, whole expenditures are to be recognized as expenses in the year of occurrence in the audited financial statements.

However, if such expenditure is incurred to expand a business after registration under GST laws, then an ITC claim would be admissible.

Any expenses incurred must be recognised as expenses in the profit and loss account as per the applicable Accounting Standards (AS) or Indian Accounting Standards (Ind AS) and shall be claimed as deductible under the provisions of the ITA.

Readers should not misconstrue the concept of Prepaid Expenses, Advances for future supplies, and Provisions when interpreting Deferred Revenue Expenditure. These concepts are extensively defined under GAAP, AS, or Ind AS and are periodically updated to ensure accurate reporting based on the relevant period to which such transactions apply. Their purpose is to ensure a true and fair representation of net profits and financial position in the interest of all stakeholders.

Deferred Revenue Expenditure is often seen as an artificially created concept used to inflate an enterprise’s reported profits or losses, while the underlying reality may be different.

To my limited understanding, nothing should be reported as Deferred Revenue Expenditure in an enterprise’s financial statements to present a true and fair view of its business operations.

Any expenses incurred, on which ITC is paid on procurement, must comply with the terms, stipulations, and conditions specified in Sections 16 and 17 of the CGST Act, 2017. If ITC is not claimed within the time limit prescribed under Section 16(4), the claim faces significant challenges, especially in light of recent developments in the Invoice Management System (IMS).

The treatment provided under GAAP, AS, or Ind AS is completely irrelevant when determining the eligibility and claim of Input Tax Credit (ITC) under the provisions of the GST Acts

Ascertained liabilities and obligations are often referred to as contractual liabilities that are payable in future by the business enterprise. Still, they pertain to the accounting period for which the financial statements are drawn. To reflect on a true and fair view of operations and statement of affairs of the business enterprises, they are recognised as an expense following the principles of revenue and expenses(costs), and consequently, if any withholding taxes are required to be deducted because of ascertained liabilities and obligations basis documentation, it is done by the taxpayer because payer and payee are easily identifiable with respective PAN Numbers. E.g. Auditor’s Remuneration payable, Salaries payable, AMC Contract Charges etc.

As stated earlier in the article, TDS compliance is only procedural compliance; it doesn’t mandate the recognition of operations’ revenue unless all other terms and conditions are satisfied. Most of the TDS can be carried forward to claim an offset against the tax liabilities payable in the year in which such revenue is offered to tax by the taxpayer.

Usually, ascertained liabilities are tax-deductible in the year they are booked as expenses. In the future, they will be reversed by crediting the parties’ accounts based on the receipt of invoices for the underlying supply of services.

Whereas Unascertained Liabilities and Obligations refer to provisions created in the books of accounts based on the Management’s reasonable accounting estimates, but there is no adequate documentary support available to justify the deduction of TDS on such Unascertained liabilities and obligations because the Payee/Recipient is not identifiable. Thus, on such provisions, withholding taxes are not deducted at source by the payer. E.g., provision for gratuity, leave encashment and bonus, warranties, contingent liabilities (recorded in the books of accounts), and/or ad-hoc expense provisions.

Usually, Unascertained liabilities and Obligations are not tax-deductible in the year they are booked as expenses because they will undoubtedly be reversed.

The answer to the above question lies in the examination of Section 16 of the CGST Act, 2017 which provides that to claim ITC following conditions and stipulations needs to be satisfied:

1.    Person is in the possession of Tax Invoice issued u/s 31 of the CGST Act, 2017 viz. in case of the provisions, there is no tax invoice available for claiming the ITC as supplier won’t have reported the supplies in their GSTR 1 which are reflected in GSTR 2B of the Buyer/Recipient; thus, ITC shall not be claimed;

2.    Person should receive such goods or services or both viz. in case of the provisions, there is no receipt of goods or services both; thus, even on this count too, ITC shall not be claimed;

3.    The recipient of goods or services must ensure that taxes have been paid to the supplier, and the supplier has duly filed returns under the GST provisions. If neither the tax is paid nor the returns are filed, ITC shall not be claimed on this ground as well.

4.    ITC should be claimed within the time limits provided u/s 16(4) of the Act, viz. time limits specified u/s 16(4) don’t apply to provisions because the Buyer/recipient has not claimed any ITC considering reasons stated(supra).

5.    On the receipt of goods or services or both, duly supported by tax invoices, along with the supplier’s compliance in filing returns, and subject to compliance with all terms and conditions specified under Sections 16 and 17 of the CGST Act, 2017, the buyer/recipient is eligible to claim Input Tax Credit (ITC) as per the GST provisions.

6.    Whatever is stated above is pari materia applicable to unascertained liabilities and obligations.

Such expenditures may or may not be allowed when determining total income under section 28 of the ITA unless the prior-period adjustments expenses are related to the current year.

It is recommended that registered persons accurately disclose such information in their annual returns, FORM GSTR-9 and GSTR-9C, as permissible.

Readers, please monitor the developments in IMS to make appropriate decisions.

If the taxpayer has opted for a concessional tax regime applicable to corporate and non-corporate assessees, then no deduction under Section 80G is available for such CSR expenses either.

Thus, it can be said that the treatment of CSR expenses under the direct and indirect tax regimes is aligned.

Section 145A and ICDS II mandate adjustment to the determination of total income where the taxpayer follows the exclusive method of reporting taxes. Such adjustment is mandatorily reported in Income Tax Returns, Tax Audit Reports, and notes to accounts by Accounting Standards and Ind AS and even a Statutory auditor under the Companies Act is mandatorily required to report on the frequency of verification, variations in inventories reported to the bankers in CARO report etc.

Further, if the taxpayer imports goods, such transactions are examined to ensure they are executed at arm’s length prices, verified via EOI (Exchange of Information) and MAP (Mutual Agreement Procedure) under DTAA read with MLI. A further detailed probe may be initiated considering GAAR, SAAR, and/or Customs Valuation documents of cross-border transactions to rule out any possibility of BEPS (Base Erosion and Profit Sharing) I and II.

If transactions are executed transparently at arm’s length prices, they do not pose any technical challenges.

Many taxpayers adopt the Cost plus 10% valuation mechanism to mitigate litigation risks under the Act, considering the definition of Distinct Persons as provided under Explanation 1 to Section 15 (discussed supra).

Often, custom authorities issue Show Cause Notices (SCNs) for undervaluation of imports, based on risk parameters flagged in their systems. If such SCNs are issued under Section 73, and the taxpayer decides to pay the differential tax, ITC can be claimed under Section 16 of the CGST Act, 2017, as the time limits under Section 16(4) do not apply to imports. This ITC can be claimed via GSTR-3B.

Conversely, if the SCN is issued under Section 74 for the undervaluation of imports, such ITC shall not be eligible for a claim under the provisions of the GST Act.