Section 145A: How to Calculate the Value of Inventories for Taxation

Section 145 of the Income Tax Act deals with the processes and standards of accounting for business owners and professionals. It allows an assessee to follow one of the following accounting systems — cash system or mercantile system as per ICDS (Income Computation and Disclosure Standards). On April 1 1999, the Government of India introduced Section 145A of the Income Tax Act to bring in a new accounting method for some instances.

Section 145A tells us about the valuation of goods/inventories for determining income from a business or a profession. Read along to know more about how this accounting system works.

What is Section 145A of the Income Tax Act?

The Finance Act, 2018 replaced earlier sections with Section 145A and Section 145B to bring certainty regarding the applications of ICDS. It substituted the old Section 145A from April 1, 2017.

Section 145A determines your taxable income under ‘Profits and gains from business and profession’ and ‘Income from other sources‘. It states that regardless of the provisions of Section 145, valuation of purchase or sale of inventory and goods under income from business/profession will be determined at:

A lower cost or NRV (net realisable value), which is calculated as per computation and disclosure rules of Section 145(2)
The valuation of goods/services and inventory would be further adjusted to include any taxes, cess or duty (This consists of any fees paid/incurred to bring goods/services to their location as of the day of valuation.)
Valuation of listed or unlisted securities not quoted on recognised stock exchanges is done at the actual costs as per ICDS u/s 145(2).
According to Section 145A of the Income Tax Act, you need to value other securities at a lower actual cost or NRV in accordance with ICDS.
Scheduled commercial banks and public financial institutions need to disclose their inventories in accordance with ICDS and RBI guidelines.

Understanding the Valuation of Inventories under the IT Act

Under the Income Tax Act, assessees need to maintain books of accounts. Section 145 of the IT Act states the accounting standards which they need to follow for income from business, profession or other sources. There are two modes of accounting you can follow in recording your income, assets, and liabilities:

Cash method: In this, you record the transactions in books of accounts for inflow or outflow of cash. It is a simple method of accounting but has low accuracy and is not recognised by the Companies Act.
Mercantile method: In this method, you record transactions when you accrue income or expenses. It does not depend on whether you have received cash on the day of the transaction. This method though more complex is highly accurate and recognised by the Companies Act.

Income Computation Standards as per ICDS

As per Section 145A of the Income Tax Act, assesses need to follow the Income Computation and Disclosure Standards for valuation of inventory or securities. The Central Government, through its powers u/s 145(2), notifies the applicability of ICDS.

ICDS is applicable to all taxpayers who have taxable income from businesses, professions or other sources. They are applicable for taxpayers who follow the mercantile system of accounting and need their accounts audited u/s 44AB. Non-corporate taxpayers computing income under the presumptive taxation scheme must also follow it.

This accounting standard states that taxpayers have to disclose accounting policies as well as the total amount of inventories in financial statements. Moreover, they have to value inventories at actual cost or NRV, whichever is lower.

Also read: What Is Section 45 Of Income Tax: Assessment, Calculation And How Capital Gains Are Taxed

What Is Net Realisation Value and Actual Cost of Inventories/Securities?

Net Realisation Value (NRV) is the estimated selling price of an asset upon the realisation of its sale. The estimated costs of completion and expenses necessary for this sale are deducted from the selling price.

As per Section 145A of the Income Tax Act, assessees must value inventories and listed securities at NRV or actual price, whichever is lower. Cost of inventories includes expenses for purchases, services, conversion and other costs to bring it to current conditions. The actual cost of inventories also consists of the purchase price, including duties, taxes, freight charges, and other expenses directly contributing to the acquisition.

Note that the Interest and borrowing costs are not included unless for recognition of interest. Furthermore, trade discounts and rebates are reduced to determine the cost of purchase.

The following costs are included in the actual cost of securities:

Its purchase price
Acquisition costs, including tax, duty, cess, brokerage, and other fees
When you acquire security in exchange for another security, its fair value price
The fair value price of security acquired by exchange of another asset

Final Word

Section 145A of the Income Tax Act states how to evaluate various types of inventories and securities to calculate your taxable income. You need to calculate the actual cost or NRV as per the provisions of ICDS and subsections of Section 145. You will want to consider various costs like taxes, duties, cess, purchase price, labour cost, conversion cost, etc., for calculating actual costs or NRV.

FAQs on Section 145A

Q1. What is the mercantile system of accounting?

Ans. In the mercantile system or accrual basis of accounting, you record transactions when they arise. It involves recording all earnings in books of accounts when you earn them. This system is useful for calculating salaries, capital gains and income from properties.

Q2. What is the purpose of Income Computation and Disclosure Standards in India?

Ans. ICDS refers to guidelines that the Indian Government issues for taxpayers to calculate their taxable income. Their purpose is to promote uniform accounting standards in India and ensure that income computation is in line with tax provisions. Taxpayers who have income under the head ‘PGBP’ or ‘other sources’ and those opting for presumptive taxation must follow these standards.

Q3. What are some of the key features of ICDS?

These are some of the key features of ICDS:
a) It is applicable to all taxpayers
b) ICDS is meant only for the computation of income
c) It is not applicable for computing Minimum Alternate Tax (MAT)
d) If there is a conflict between the provisions of IT Act and ICDS, the IT Act will prevail.
e) It does not provide explanations/illustrations like AS.

Q4. What happens when an Assessing Officer is not satisfied with your accounting?

Ans. Section 145(3) covers situations in which your accounts may not be complete/correct, or you have employed the wrong accounting methods. In this case, the AO can make an assessment based on his/her preferred method as per the provisions of Section 144. If you do not maintain a regular mode of accounting, the AO will employ the method used last year.

Q5. What are the provisions of Section 145B of the Income Tax Act?

Ans. Section 145B states that regardless of the provisions of Section 145, interest received on compensation/enhanced compensation will be deemed taxable for the previous year. Section 145B(2) stipulates that any claim for escalation of price for contracts and exports incentives will be the income of the PY when you realise its certainty. Subsection (3) states that income from grants, subsidies or reimbursements will be deemed taxable in the PY (previous year) of receiving them.

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