Understanding Section 145(2) of the Income Tax Act and its Importance for Taxpayers

March 13, 2023

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Section 145(2) of the Income Tax Act, 1961, deals with the method of accounting to be followed by a taxpayer while computing their income chargeable to tax under the head ‘Profits and Gains of Business or Profession.’ The section empowers the Central Board of Direct Taxes (CBDT) to notify the accounting standards (AS) that need to be followed by the taxpayers.

In simpler terms, Section 145(2) provides a framework for taxpayers to maintain their books of accounts and prepare their financial statements according to the accounting standards notified by the CBDT. This ensures uniformity and consistency in the financial reporting practices of different taxpayers and makes it easier for the tax authorities to verify and scrutinize the financial statements.

The CBDT has notified ten accounting standards under Section 145(2) that are mandatory for taxpayers to follow. These accounting standards cover various aspects of financial reporting, such as revenue recognition, inventory valuation, depreciation, accounting for investments, and provisions and contingencies. The purpose of these accounting standards is to ensure that the financial statements prepared by the taxpayers reflect a true and fair view of their financial position and performance.

Taxpayers are required to maintain their books of accounts and prepare their financial statements in accordance with the notified accounting standards. However, if a taxpayer is unable to follow a particular accounting standard due to the nature of their business or any other valid reason, they can seek the permission of the tax authorities to use an alternative method of accounting. The tax authorities may allow such alternative method of accounting if they are satisfied that it would reflect the true and fair view of the taxpayer’s financial position and performance.

Non-compliance with Section 145(2) can attract penalties and interest under the Income Tax Act. Therefore, it is essential for taxpayers to maintain their books of accounts and prepare their financial statements in accordance with the notified accounting standards.

Section 145(2) of the Income Tax Act, 1961, deals with the method of accounting to be followed by taxpayers while computing their income chargeable to tax under the head ‘Profits and Gains of Business or Profession.’ The section provides a framework for taxpayers to maintain their books of accounts and prepare their financial statements in accordance with the accounting standards notified by the Central Board of Direct Taxes (CBDT).

Table of Contents

Accounting Standards notified by CBDT

The accounting standards notified by CBDT are as follows:

Accounting Standard

AS 1 – Disclosure of Accounting Policies
AS 2 – Valuation of Inventories
AS 3 – Cash Flow Statements
AS 4 – Contingencies and Events Occurring After the Balance Sheet Date
AS 5 – Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies
AS 6 – Depreciation Accounting
AS 7 – Construction Contracts
AS 8 – Revenue Recognition
AS 9 – Accounting for Fixed Assets
AS 10 – The Effects of Changes in Foreign Exchange Rates Compliance with Accounting Standards

Taxpayers are required to maintain their books of accounts and prepare their financial statements in accordance with the notified accounting standards. This ensures that the financial statements prepared by taxpayers reflect a true and fair view of their financial position and performance. Non-compliance with Section 145(2) can attract penalties and interest under the Income Tax Act. Therefore, it is essential for taxpayers to comply with the notified accounting standards.

Alternative Method of Accounting

If a taxpayer is unable to follow a particular accounting standard due to the nature of their business or any other valid reason, they can seek the permission of the tax authorities to use an alternative method of accounting. The tax authorities may allow such alternative method of accounting if they are satisfied that it would reflect the true and fair view of the taxpayer’s financial position and performance.

Penalties for Non-Compliance

Non-compliance with Section 145(2) can attract penalties and interest under the Income Tax Act. If a taxpayer fails to maintain books of accounts or fails to comply with the accounting standards notified by the CBDT, they can be penalized with a penalty of up to Rs. 25,000. Further, if a taxpayer fails to maintain books of accounts for a period of six years or more, they can be penalized with a penalty of up to Rs. 1,50,000.

Conclusion

Section 145(2) of the Income Tax Act, 1961, provides a framework for taxpayers to maintain their books of accounts and prepare their financial statements in accordance with the accounting standards notified by the CBDT. Compliance with the accounting standards is essential to ensure that the financial statements prepared by taxpayers reflect a true and fair view of their financial position and performance. Taxpayers should seek the permission of the tax authorities if they are unable to follow a particular accounting standard due to the nature of their business or any other valid reason. Non-compliance with Section 145(2) can attract penalties and interest under the Income Tax Act.

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Frequently asked questions (FAQs) related to Section 145(2) of the Income Tax Act:

What is Section 145(2) of the Income Tax Act?
Section 145(2) of the Income Tax Act, 1961, deals with the method of accounting to be followed by taxpayers while computing their income chargeable to tax under the head ‘Profits and Gains of Business or Profession.’

What are the accounting standards notified by the CBDT under Section 145(2)?
The CBDT has notified ten accounting standards under Section 145(2) that are mandatory for taxpayers to follow. These accounting standards cover various aspects of financial reporting, such as revenue recognition, inventory valuation, depreciation, accounting for investments, and provisions and contingencies.

Are taxpayers required to comply with the accounting standards notified by the CBDT?
Yes, taxpayers are required to maintain their books of accounts and prepare their financial statements in accordance with the notified accounting standards. Non-compliance with Section 145(2) can attract penalties and interest under the Income Tax Act.

Can taxpayers use an alternative method of accounting if they are unable to follow a particular accounting standard?
If a taxpayer is unable to follow a particular accounting standard due to the nature of their business or any other valid reason, they can seek the permission of the tax authorities to use an alternative method of accounting. The tax authorities may allow such alternative method of accounting be penalized with a penalty of up to Rs. 1,50,000.

How can taxpayers ensure compliance with Section 145(2)?
Taxpayers can ensure compliance with Section 145(2) by maintaining their books of accounts and preparing their financial statements in accordance with the accounting standards notified by the CBDT. They should also seek the permission of the tax authorities if they are unable to follow a particular accounting standard due to the nature of their business or any other valid reason. Regular monitoring of their financial reporting processes and seeking professional guidance can also help taxpayers ensure compliance with Section 145(2).

Are there any exemptions for small taxpayers?
Small taxpayers with a turnover of up to Rs. 2 crores can opt for the presumptive taxation scheme under Section 44AD of the Income Tax Act. Under this scheme, taxpayers are not required to maintain regular books of accounts or comply with the accounting standards notified by the CBDT. However, taxpayers opting for this scheme must declare their income at a prescribed rate, and their income is deemed to be 8% of their turnover or gross receipts.