Income Tax 2025

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Method of accounting. ​

276(1) ​

Income chargeable under the head “Profits and gains of business or profession” or “Income from other sources” shall, subject to the provisions of sub-section (2), be computed as per either cash or mercantile system of accounting regularly employed by the assessee.

276(2) ​

The Central Government may notify income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income.

276(3) ​

The Assessing Officer may make an assessment in the manner provided in section 271, where––

  • (a) he is not satisfied about the correctness or completeness of the accounts of the assessee;
  • (b) the method of accounting provided in sub-section (1) has not been regularly followed by the assessee; or
  • (c) income has not been computed as per the standards notified under sub-section (2)
Explanation

Section Summary: ​

This section of the income tax law governs the method of accounting that taxpayers must use to compute income under the heads "Profits and gains of business or profession" and "Income from other sources." It allows taxpayers to choose between the cash system or the mercantile system of accounting, provided it is consistently applied. Additionally, the Central Government has the authority to prescribe specific income computation and disclosure standards for certain taxpayers or types of income. If the Assessing Officer finds issues with the taxpayer's accounting method or compliance with notified standards, they can assess income under Section 271.

Key Changes: ​

  1. Flexibility in Accounting Methods: Taxpayers can continue to use either the cash or mercantile system of accounting, as long as it is consistently applied.
  2. Central Government's Authority: The government can now notify specific income computation and disclosure standards for certain taxpayers or income types, which must be followed.
  3. Assessing Officer's Discretion: The Assessing Officer has the power to reassess income if the taxpayer's accounts are incomplete, incorrect, or if the accounting method is not consistently followed.

Practical Implications: ​

  1. For Taxpayers:
    • Taxpayers must ensure they consistently apply their chosen accounting method (cash or mercantile) to avoid reassessment.
    • If the Central Government notifies specific standards, affected taxpayers must comply with those standards for income computation and disclosure.
  2. For Businesses:
    • Businesses must maintain accurate and complete records to avoid scrutiny from the Assessing Officer.
    • Compliance with notified standards may require additional documentation or adjustments to accounting practices.
  3. For Compliance Processes:
    • Taxpayers must be prepared to justify their accounting methods and ensure alignment with any notified standards.
    • Non-compliance could lead to reassessment under Section 271, potentially resulting in higher tax liabilities or penalties.

Critical Concepts: ​

  1. Cash System of Accounting: Income and expenses are recorded only when cash is received or paid.
  2. Mercantile System of Accounting: Income and expenses are recorded when they are earned or incurred, regardless of when cash is received or paid.
  3. Income Computation and Disclosure Standards (ICDS): Specific standards notified by the Central Government for computing income and making disclosures, which override general accounting practices.
  4. Section 271: This section allows the Assessing Officer to make a best judgment assessment if the taxpayer's records are incomplete, incorrect, or non-compliant.

Compliance Steps: ​

  1. Choose an Accounting Method: Decide whether to use the cash or mercantile system and apply it consistently.
  2. Maintain Accurate Records: Ensure all income and expenses are recorded correctly and completely.
  3. Follow Notified Standards: If applicable, comply with any income computation and disclosure standards notified by the Central Government.
  4. Prepare for Scrutiny: Be ready to provide documentation and justification for your accounting method and income computation if questioned by the Assessing Officer.

Examples: ​

  1. Cash System Example: A freelance consultant records income only when clients pay their invoices and expenses only when they pay their bills. If they receive payment in March 2024 for work done in December 2023, the income is recorded in March 2024.
  2. Mercantile System Example: A manufacturing company records income when goods are shipped to customers, even if payment is received later. Similarly, expenses are recorded when bills are received, not when they are paid.
  3. Non-Compliance Example: A business switches between cash and mercantile systems without consistency. The Assessing Officer may reassess their income under Section 271, potentially leading to higher tax liabilities.

This section ensures clarity and consistency in income computation while giving the government flexibility to set specific standards for certain taxpayers or income types.