Form 145 — Method of Accounting Declaration

Q: What is the difference between cash basis and mercantile basis of accounting?

Cash basis: income and expenses recognised when cash is received or paid. Mercantile (accrual) basis: income recognised when it accrues or becomes due; expenses when they accrue. Most businesses use mercantile basis. ICDS applies to mercantile basis taxpayers.

Q: What are Income Computation and Disclosure Standards (ICDS)?

10 standards notified under Section 145(2) prescribing income computation for tax purposes — overriding accounting standards. Applicable to all mercantile-basis taxpayers. Cover accounting policies, inventory, construction contracts, revenue, fixed assets, foreign exchange, government grants, securities, borrowing costs, and provisions.

Q: Can a taxpayer change the method of accounting during a financial year?

Yes, but the change must be bona fide and disclosed to the Assessing Officer with financial impact. AO can reject accounts if the change is not genuine or designed to defer income recognition.

Q: Which taxpayers are required to comply with ICDS?

All taxpayers computing income from business/profession or other sources on the mercantile basis — individuals, HUFs, companies, firms, LLPs. Not applicable to cash-basis taxpayers or income under salary, house property, or capital gains heads.

Q: What is the consequence of not following ICDS or not disclosing ICDS adjustments?

AO can make best judgment assessment under Section 145(3) — disregarding books of accounts and computing income based on available information. This can result in significant additions to income and consequential tax, interest, and penalty demands.

Declaration Under Section 145 of the Income Tax Act — Choosing Between Cash and Mercantile Method of Accounting

Section 145 of the Income Tax Act, 1961 governs the method of accounting to be followed by taxpayers computing income under the heads "Profits and Gains of Business or Profession" and "Income from Other Sources." Every taxpayer carrying on business or profession must either follow the cash basis of accounting or the mercantile (accrual) basis of accounting — and must follow it consistently.

Form 145 — more correctly referenced as a declaration under Section 145 — is filed to declare the method of accounting adopted by a taxpayer. The Assessing Officer can reject accounts maintained on a basis not regularly employed or not in accordance with Income Computation and Disclosure Standards (ICDS) notified under Section 145(2). Our Form 145 and ICDS compliance services ensure that taxpayers' accounts are maintained and disclosed correctly. This connects with our income tax and income tax audit services.

Our Form 145 and Section 145 Compliance Services

Method of Accounting Review

Reviewing the taxpayer's current method of accounting — cash or mercantile — and ensuring it is consistently applied across all income heads and financial years.

ICDS Compliance Review

Reviewing the taxpayer's accounts and adjustments required under the 10 Income Computation and Disclosure Standards (ICDS) notified by the government under Section 145(2).

ICDS Disclosure in ITR

Preparing the mandatory ICDS disclosure in Schedule ICDS of the income tax return — required for all taxpayers computing business or professional income under mercantile basis.

Method Change Advisory

Advising on the implications and process for changing the method of accounting — a change requires disclosure to the Assessing Officer and may result in transitional adjustments in the year of change.

Accounting Policy Documentation

Documenting the taxpayer's accounting policies — revenue recognition, depreciation method, inventory valuation, and other significant policies — consistent with ICDS and the chosen accounting method.

Tax Audit ICDS Reporting (Form 3CD)

Ensuring correct disclosure of ICDS adjustments in the tax audit report (Form 3CD) — Clause 13 of Form 3CD specifically requires disclosure of the method of accounting and any changes therein.

Key Facts About Section 145 and ICDS

Under Section 145, income under "Profits and Gains of Business or Profession" must be computed on either cash or mercantile basis — hybrid methods are not permitted
The government has notified 10 Income Computation and Disclosure Standards (ICDS) under Section 145(2) applicable to all taxpayers following the mercantile basis
ICDS override accounting standards (Ind AS / AS) for tax purposes — resulting in temporary differences between book profit and taxable income
All ICDS adjustments must be disclosed in Schedule ICDS of the income tax return
Tax audit report Form 3CD Clause 13 requires disclosure of method of accounting and ICDS adjustments
Failure to follow ICDS or failure to disclose ICDS adjustments can result in best judgment assessment by the Assessing Officer
The 10 ICDS cover: accounting policies, valuation of inventories, construction contracts, revenue recognition, tangible fixed assets, effects of changes in foreign exchange rates, government grants, securities, borrowing costs, and provisions/contingencies

Frequently Asked Questions

What is the difference between cash basis and mercantile basis of accounting?

Under the cash basis of accounting, income is recognised when cash is actually received and expenses are recognised when cash is actually paid — regardless of when the right to receive or obligation to pay arose. Under the mercantile (accrual) basis, income is recognised when it accrues or becomes due — even if not received in cash — and expenses are recognised when they accrue or become due, even if not yet paid. Most businesses maintain accounts on the mercantile basis. The cash basis is more common among small traders and certain professionals.

What are Income Computation and Disclosure Standards (ICDS)?

ICDS are 10 standards notified by the Central Government under Section 145(2) that prescribe how income is to be computed for income tax purposes — overriding accounting standards (AS or Ind AS) to the extent they conflict. ICDS apply to all taxpayers computing income from business or profession or other sources using the mercantile basis of accounting. They cover accounting policies, inventory valuation, construction contracts, revenue recognition, fixed assets, foreign exchange, government grants, securities, borrowing costs, and provisions. ICDS adjustments create differences between book profit and taxable income that must be disclosed in Schedule ICDS of the ITR.

Can a taxpayer change the method of accounting during a financial year?

A taxpayer can change their method of accounting, but the change must be bona fide and consistently applied. If a taxpayer changes the method of accounting during the year, they must disclose the change and its financial impact to the Assessing Officer. The Assessing Officer has the power to reject accounts if the change is not genuine or if it has been made to reduce tax liability without commercial justification. A change from mercantile to cash basis is particularly scrutinised as it may result in deferral of income recognition.

Which taxpayers are required to comply with ICDS?

ICDS applies to all taxpayers — whether individual, HUF, company, firm, or LLP — who compute income under "Profits and Gains of Business or Profession" or "Income from Other Sources" using the mercantile basis of accounting. ICDS does not apply to taxpayers computing income on cash basis, or to those computing income under other heads (salary, house property, capital gains). All mercantile-basis business taxpayers must disclose ICDS adjustments in Schedule ICDS, even if the adjustments are nil.

What is the consequence of not following ICDS or not disclosing ICDS adjustments?

If a taxpayer fails to maintain accounts in accordance with ICDS or fails to disclose required information under ICDS in the return, the Assessing Officer can make a best judgment assessment under Section 145(3) — disregarding the books of accounts and computing income on the basis of any information available. This can result in significant additions to income and consequential tax, interest, and penalty demands. The tax audit report (Form 3CD Clause 13) also requires disclosure of ICDS adjustments, and errors can attract scrutiny during assessments.

ICDS Compliance and Form 145 — Done Right

Method of accounting review, ICDS adjustment computation, Schedule ICDS preparation, and tax audit disclosure.