In income tax compliance, the method of accounting and the timing of income recognition are critical to determining taxable income. To ensure uniformity and reduce ambiguity in tax treatment, the Income Tax Act, 1961, lays down specific provisions under Sections 145, 145A, and 145B.

These sections not only define the acceptable methods of accounting (cash or mercantile) but also guide how to handle taxes, duties, inventory, and various types of income like interest, compensation, and subsidies.

Method of Accounting

🔸 What It Covers

This section governs how income under two heads is computed:

• Profits and gains of business or profession
• Income from other sources

🔸 Permissible Methods

1. Cash Basis – Income and expenses are recognized when actually received or paid.
2. Mercantile Basis – Income and expenses are recognized when they accrue, irrespective of actual receipt/payment.

🔸 Conditions to Follow

• The method must be consistently followed every year.
• Must comply with ICDS (Income Computation and Disclosure Standards) notified under Section 145(2).
• Assessing Officer may reject books under Section 144 if books are found incomplete, incorrect, or inconsistent with ICDS.

Method of Accounting in Certain Cases

Section 145A supplements Section 145 by specifying valuation rules for inventory and the inclusion of certain indirect taxes.

🔸 Key Provisions

1. Valuation of Inventory:

Inventory must be valued at cost or net realizable value (NRV), whichever is lower.

The valuation must include:

1. • • Any duty, cess, or tax (e.g., GST, excise) paid or incurred to bring the goods to their current location and condition.
2. Income from Sale of Goods or Services:

The value shall include any tax, duty, cess, or fee, even if the same is not credited to the P&L account (e.g., GST collected but not yet paid).

1. Other Incomes:

For certain incomes such as interest, royalty, or fees for technical services, if tax is deducted at source (TDS), then the income shall be deemed to be accrued and taxable in the year in which it is recorded in the books.

Taxability of Certain Income

Section 145B provides clarity on the timing of taxation of certain income items like compensation, interest, and subsidy.

🔸 Key Provisions

1. 145B(1) – Compensation on Business Termination:

Any compensation or payment due to modification/termination of a business contract is taxable in the year it is received.

Even if it relates to a different accounting period.

1. 145B(2) – Interest on Compensation/Enhanced Compensation:

Taxable in the year of receipt, regardless of the method of accounting.

Example: Interest on land acquisition compensation from the government.

1. 145B(3) – Subsidy or Grant:

Income in the nature of subsidy, grant, or reimbursement (not deducted from cost) shall be taxed in the year it is received, if not charged to P&L earlier.