Expert Advisory Committee

Query No. 25

Subject:

Recognition of duty credit entitlement under ‘Served from India Scheme’. ¹

A. Facts of the Case

1. A multinational company has the main object, as per the Memorandum of Association and as approved by Foreign Investment Promotion Board (FIPB), to carry on the business of research and development of products, processes, systems, investigation and experiments on drugs, pharmaceuticals and chemicals of any nature and kind whatsoever and production of bulk pharmaceuticals and chemicals.

2. The objective of process research and development is to design practical, efficient, environmentally responsible and economically viable chemical synthesis for existing bulk pharmaceuticals and chemicals.

3. The company undertakes process research and development work on existing bulk pharmaceuticals and chemicals identified by group companies and works exclusively for the group companies. For providing the services to its group companies, the company earns income in foreign exchange.

4. As the company earns foreign exchange from its activities, it is eligible to avail the benefits under the “Served from India Scheme” (hereinafter referred to as ‘the Scheme’) as provided under the Foreign Trade Policy 2004-2009. The querist has stated that as per the Scheme, the company received a license dated January 15, 2006, granting a duty credit entitlement of Rs. 50,00,000 for use in the import of capital goods including spares, office equipment and professional equipment, office furniture and consumables, related to the main line of business of the applicant. The license issued under the Scheme is valid for a period of 24 months from the date of issue.

5. According to the querist, as per the Scheme, the Indian Customs Assessing Officer, based on the assessable value, arrives at the import duty payable and adjusts the said import duty against the license amount. In effect, the company is provided the said benefit as part of the Scheme (emphasis supplied by the querist).

6. During the financial year 2005-06, the company has utilised the duty credit entitlement of Rs. 10,00,000 towards the import of capital equipments, Rs. 3,00,000 towards the import of spares and Rs. 2,00,000 towards the import of consumables. The following accounting entries were passed in the books of the company for the financial year 2005-06:

(being the amount of duty entitlement utilised)

B. Query

7. Under the given facts and circumstances of the case, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the amount of duty credit entitlement is required to be accounted for as income in the books of account as per the applicable Accounting Standards, Guidance Notes, Opinions, etc.

(ii) Whether the value of fixed assets/spares/consumables is to be increased by the value of duty credit entitlement utilised as per the applicable Accounting Standards, Guidance Notes, Opinions, etc.

(iii) If the value of fixed assets is to be increased by the value of duty credit entitlement utilised, then whether it will be allowed to claim depreciation on such addition.

(iv) In case the duty credit entitlement is required to be recognised as income, whether the same is to be recognised in the year of export of services, receipt of license or at the time of actual utilisation of such credit or some other event.

C. Points considered by the Committee

8. The Committee notes that the basic issues raised in the query relate to recognition of benefit under the ‘Served from India Scheme’, i.e., how should this benefit be recognised in the books of account and whether this benefit should be recognised at the time of export of services, or on receipt of license, or at the time of actual utilisation of such credit. The Committee has, therefore, considered only these issues and has not touched upon any other issue arising from the Facts of the Case.

9. The Committee notes that even though the benefit received under the Scheme does not strictly fall within the definition of the term ‘revenue’, as defined under Accounting Standard (AS) 9, ‘Revenue Recognition’, such credit is of the nature of revenue and accordingly, the principles enunciated under AS 9 would be applicable in the present case. In this context, as far as timing of recognition of duty credit is concerned, the Committee notes paragraph 9.1 of AS 9, which states as follows:

“9.1 Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.”

10. The Committee further notes from the Served from India Scheme that the duty credit entitlement under the Scheme shall be non-transferable. It signifies that there are certain uncertainties associated with the utilisation of duty credit entitlement since if this credit is not utilised within the specified time period, i.e., 24 months, the credit shall lapse. Hence, keeping in view the above-mentioned recognition principle of AS 9, the Committee is of the view that the credit under the Scheme should be recognised only at the time when and to the extent there is no significant uncertainty as to its measurability and ultimate realisation, i.e., utilisation of the credit under the Scheme. The assessment of the level of uncertainty is a matter of judgement based on the facts and circumstances of each case on considering factors, such as, utilisation of duty credit within the specified period as evidenced by the existence of a binding contract for purchase of allowable capital goods including spares, office equipment and professional equipment, office furniture and consumables against which the duty credit can be utilised; the expected cost of purchase of the imported allowable specified goods vis-à -vis the cost thereof in the domestic market; etc. Events occurring between the balance sheet date and the date on which the financial statements are approved by the Board of Directors, may remove the uncertainty about the utilisation of the duty credit, e.g., imports are made after the balance sheet date but before the approval of the financial statements by the Board of Directors, against which the duty credit has been utilised. The Committee is, therefore, of the view that it is not necessary that uncertainty regarding measurement and utilisation of duty credit is removed only on actual utilisation of the credit, i.e., at the time when the import of specified goods is made.

11. As far as the question regarding how this duty credit entitlement should be recognised in the books of account is concerned, the Committee notes from the entries passed by the company as indicated in paragraph 6 above that the company has increased the value of fixed assets, spares, consumables, etc. with the amount of duty credit utilised. It appears that at the time of purchase of these items, the company is recording these at the cost incurred net of duty. In this regard, the Committee notes paragraph 9.1 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, and paragraphs 6 and 7 of Accounting Standard (AS) 2, ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, which state as follows:

AS 10

“9.1 The cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price. Examples of directly attributable costs are:

(i) site preparation;

(ii) initial delivery and handling costs;

(iii) installation cost, such as special foundations for plant; and

(iv) professional fees, for example fees of architects and engineers.

The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar factors.”

AS 2

“6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.”

From the above, the Committee is of the view that the cost of purchase of fixed assets, consumables, spares, etc. should be recorded at their full value inclusive of the import duties payable thereon whether by way of payment in cash or whether by way of utilisation of duty credit, with a view to provide the fairest possible approximation to the costs incurred in bringing these items to their present location and working condition. Hence, the question of separately increasing the value of fixed assets, consumables, etc. by the duty amount does not arise, as is being presumably done by the company. Further, the Committee is of the view that as mentioned in paragraph 10 above, when and to the extent the significant uncertainty as to measurability and ultimate realisation of the duty credit is removed, the company should recognise the duty credit entitlement as its ‘other income’ by debiting the ‘duty credit entitlement account’ and crediting the profit and loss account and further, at the time of purchase of fixed assets, spares, consumables, etc., such credit entitlement is adjusted against the duty payable on the import thereof.

D. Opinion

12. On the basis of the above, the Committee is of the following opinion on issues raised in paragraph 7 above:

(i) The benefit of duty credit entitlement should be recognised as ‘other income’ at the time and to the extent there is no significant uncertainty as to its measurability and ultimate realisation as discussed hereinbefore.

(ii) The value of fixed assets/spares/consumables should be inclusive of the duty payable whether by way of payment in cash or by way of utilisation of duty credit entitlement. Hence, there is no question of increasing the value of fixed assets/spares/consumables separately by the amount of duty credit entitlement utilised, as discussed in paragraph 11 above.

(iii) The cost of the fixed asset (inclusive of duty payable whether by way of payment in cash or by way of utilisation of duty credit entitlement) is eligible for depreciation.

(iv) The duty credit should be recognised when and to the extent there is no significant uncertainty about the measurability and ultimate realisation of the duty credit available under the ‘Served from India Scheme’, after considering the factors such as those indicated in paragraph 10 above.

¹Opinion finalised by the Committee on 17.1.2007