FOR PRIOR PERIOD ITEMS REVENUE SHOULD CONSIDER GROUND REALITIES AND WORK OBJECTIVELY WITH RESULT ORIENTATION IN MIND TO AVOID COSTLY, WASTEFUL LITIGATION Honorable FM and CBDT are requested to issue guidelines.

[CA DEV KUMAR KOTHARI]

Prior period expenses:

Prior period expenses means expenses which pertains to any period prior to commencement of accounting period for which accounts are prepared. Such expenses are usually of immediately preceding accounting period and sometimes can be of a period many year prior to current period. For example, in case of accounts for financial year  from 01042018 to 31032019 , if any expenses are pertaining to a period before 01042018 that is up to 31032018  which is debited in P & L account such expenses shall be called prior period expenses. There is requirement to disclose such items, and usually auditors insist to disclose even if accrual took place during the accounting period and the amount is not material. In view of author, if accrual take place during accounting period and amount is not material, then such disclosure is undesirable. Author suggests that in case of IPP the informative note should also be given about reasons thereof and that the same accrued or settled during the year.

Prior period income:

Similarly there are found some items being income relating to prior period in some accounts.

Why prior period expenses or income (Items Pertaining to prior periods (IPP):

In many of accounts we find that there are some prior period expenses or incomes. These are collectively called IPP (items pertaining to previous periods). IPP can occur due to several reasons, some of important reasons are:

1. Accounts are to be prepared on conservative basis. Reasonable estimates are permissible and are made and accordingly accounted for and later on  in factual ascertainment there can be some difference. The difference, when accounted for in next year results into IPP.
2. In some situations even reasonable estimates are deferred to a proper time when more accuracy can be achieved, this can lead to IPP in subsequent year.
3. Accounts are finalized in a limited period of time and some bills, claims are not received or these are not settled due to disputes or differences. Therefore, expenses of previous year were not accounted for and debited in earlier year and are debited when claims are received or settled.
4. In respect of some of incomes due to disputes if there is any contingency, the income is not accounted for and the same is accounted for on settlement and/ or when there is reasonable certainty.
5. Now found an IPP was not considered as accrued (with reasonable certainty) in earlier year. Because at that time it could  be called unascertained or contingent income or expenditure leading to qualification  or clarificatory notes and additions in income.

Many IPP are accrued during the year when accounted for:

We find that many of IPP are accounted for in current year, because the same was not accounted for due to some known or un-known reasons or contingencies. If an expenditure is accounted for where there is uncertainty, it will not be allowed by the AO. If an uncertain income is accounted for it will go against conservative and prudence rules. 

An IPP is accounted for, means that the same was not accounted for in earlier year and has been accounted for in current year due to some reasons and such accounting is well recognized.

IPP is a periodic matter and make no difference for revenue over a period of time:

IPP is a matter concerning periods of more than one year. An expenditure which is allowable was not claimed in year to which it relates due to some reason, is accounted for and claimed in current year. There is only difference of year. For the revenue, in overall context of volume of revenue such IPP hardly have any impact on revenue.  

Generally difference is of one year. And totality of IPP for incomes and expenses can, over a period of time is likely to neutralize impact.

IPP are not significant or material amounts:

In context of most of accounts of companies and other assesses total IPP are not significant – these may be minuscule.

For such miniscule items and that too which have no impact over two accounting periods there should not be disputes.

There should not be dispute by revenue:

There should not be dispute by revenue for insignificant amount and particularly for IPP because if and IPP is disallowed in present year and is not allowed in year to which it relates, then over a period of time ( more  than one year) income will not be correctly ascertained.

However, revenue authorities are in habit of raising disputes even for small sums. If an income relating to prior period is disclosed, tax authorities can take steps for reassessment of income of prior year to which the income relates.

 When assesse has disclosed the income in current year, due to some reasons, it should be accepted income of that year and attempts should not be made to reassessed income of year to which such income related. This is experienced that major part of reassessment may ultimately turn fruitless.

When any IPP being expenses are debited, tax authorities try to disallow the same in normal computation and also in computation of book profit. Tax authorities also ignore that the expenditure was not claimed and allowed in earlier year and that the amount is very small. If an expenditure of earlier year is claimed, means that assesse had disclosed higher income in earlier year and might have paid higher tax.     

Search with prior period items on this website:

On search ” with prior period items” , in Income Tax  section  author found results pages  1 to 20  and  6247 Records. All these are related with disputes about IPP.

On further analysis, Results for Supreme Court shows 142 records. For High Courts 1701 records and for Tribunal 4350 records are found. Some records will be  for AAR and other authorities. On sample reading of case laws, It can be said that in most of cases attempt of tax authorities was meaningless.

This shows that disputes are raised and pursued on items which are insignificant in amount and have only impact of taxability or allow ability in current year or some earlier year.

Once it is found that expenses are not claimed twice there should not be dispute. If an expenditure is disallowed in current year due to relating to earlier year, then it should be allowed in earlier year. This only creates complications without any meaningful gain for the revenue in overall context.

 Circular for guidance of tax authorities is desirable:

In view of above, for IPP guidance should be issued to accept the same as income or expenditure of the account in which it is accounted for.

For small sums (depending on size of operations of assesse) tax authorities should not make adjustments for IPP and there need not be enquiry also when accounts are audited.

 Exceptions   should be provided only for huge amounts, if it is designed to reduce tax liability hugely.

A general guidance can be that there should not be exceptional enquiry and  variation in assessed income if total IPP on net basis does not exceed Rs. Five lakh or 0.5% of turnover, whichever is higher.

The honorable Finance Minister and the CBDT are requested to consider objectivity and result orientation in tax administration and to issue necessary guidelines.

Discussions to this article

[Ganeshan Kalyani]

The concept of materiality is there in accounts. In accounting to err is accountant and to forgive is to auditor SUBJECT to the condition that the amount is meager, minuscule. If demand notice is received at the demand involved is less then even though the ground for the demand is not acceptable , the tax payer prefer to accept it because the cost of litigation is much more than the demand account. In Mumbai, I took 40 minutes to cover 12kms by road and by train only 20 minutes. Even though people here has four wheeler they prefer to train beacuse it saves time and energy. Similarly, as the author is highlighting the importance of the time of the authority who should not invest much time where the return is low.

[Ganeshan Kalyani]

The concept of materiality is there in accounts. In accounting, to err is the accountant and to forgive is the auditor, SUBJECT to the condition that the amount is meagre, minuscule. If demand notice is received and the ground for the demand is not acceptable to the tax payer then also he prefers to accept it rather than appealing, because the cost of litigation is more than the demand account. In Mumbai, I took 40 minutes to cover 12kms by road and by train only 20 minutes. Even though people here have four wheeler but they prefer train to travel beacuse it saves time and energy. Same way the authority should not invest much time where the return is low.