Income Tax · Form 145

Form 145 — Method of Accounting — cash or mercantile, declared correctly.

Form 145 compliance under Section 145 of the Income Tax Act — correct declaration of method of accounting for business and professional income, and transition guidance by Chartered Accountants in Mumbai.

Section 145 of the Income Tax Act governs the method of accounting that a taxpayer must use for computing income from business or profession. Every business and professional taxpayer must follow either the mercantile system of accounting (also called the accrual system, where income and expenses are recognised when they are earned or incurred, not when cash changes hands) or the cash system (where income and expenses are recognised when actually received or paid). Form 145 is the declaration through which a taxpayer communicates this method to the Income Tax Department.

The choice of accounting method has direct implications for tax liability in any given year. Under the mercantile system, income accrued but not yet received is taxable in the year of accrual; under the cash system, only income actually received in the year is taxable. The Income Tax Act requires that once a method is adopted, it must be consistently followed. A change in method requires prior approval or appropriate disclosure, and any change that results in income being omitted is not permissible.

NDS Advisors assists business owners, professionals, and firms with Form 145 compliance — reviewing the method of accounting actually followed, ensuring consistency with the method declared in prior year returns, advising on the implications of a switch in accounting method, and integrating the Section 145 declaration correctly into the ITR preparation process. We also advise on the Income Computation and Disclosure Standards (ICDS) notified under Section 145(2), which modify the application of the accounting method for certain items.

Our Form 145 — Method of Accounting Services

Method of Accounting Review

Assessment of whether the taxpayer's books are maintained on cash or mercantile basis — and verification that the method declared matches the books.

Section 145 Declaration in ITR

Correct disclosure of the method of accounting in the ITR — Schedule BP for business income and professional income schedules.

ICDS Compliance — 10 Standards

Review and application of all ten Income Computation and Disclosure Standards (ICDS I to X) notified under Section 145(2) for business taxpayers.

Change of Accounting Method Advisory

Guidance on implications of switching from cash to mercantile or vice versa — income recognition in the transition year, AO approval, and disclosure requirements.

Opening Stock & Valuation

ICDS II compliance for valuation of inventories — cost or net realisable value, and consistency of valuation method across years.

Revenue Recognition (ICDS IV)

Application of ICDS IV on revenue recognition — percentage of completion for service contracts, construction contracts, and long-term agreements.

Prior Period Items & Errors

Treatment of prior period income and expenses under ICDS — no prior period adjustments permissible; only prospective correction is allowed.

Tax Audit Integration

Integration of Section 145 compliance into the Form 3CD tax audit report — Clauses 12 and 13 specifically address accounting method and ICDS compliance.

Our Process

Books Review

Review the taxpayer's books of accounts to determine the actual method of accounting followed.

ICDS Checklist

Apply the 10 ICDS standards to the financial data; identify any adjustments required for tax computation.

ITR Schedule Integration

Declare the method of accounting in the correct ITR schedule; make ICDS adjustments in Schedule OI and Schedule BP.

Tax Audit Clause Reporting

Report method of accounting in Form 3CD Clause 12; ICDS adjustments in Clause 13; inventory valuation in Clause 14.

Documentation

Retain ICDS working papers and method of accounting declaration as part of the tax audit file for potential assessment reference.

Why It Matters

✓Correct method of accounting declared in ITR

✓ICDS adjustments computed and disclosed in Schedule OI

✓Accounting method consistent with prior year returns

✓Change of method — proper disclosure and no income omission

✓Revenue recognition compliant with ICDS IV

✓Inventory valuation consistent with ICDS II

✓Tax audit clauses 12 and 13 correctly completed

✓No Section 145(3) best judgment assessment risk

Frequently Asked Questions

Section 145 requires that income from business or profession must be computed according to the method of accounting regularly employed by the taxpayer — either cash or mercantile. Sub-section 145(2) empowers the Central Government to notify Income Computation and Disclosure Standards (ICDS), which override accounting standards in certain cases for income tax computation.

Under the cash system, income is taxable only when it is actually received, and expenses are deductible only when actually paid. Under the mercantile (accrual) system, income is taxable when it is earned (even if not yet received) and expenses are deductible when they are incurred (even if not yet paid). Most businesses follow the mercantile system; professionals often follow the cash system.

ICDS are 10 standards notified by the Central Government under Section 145(2) that govern how certain items — including revenue recognition, inventory valuation, construction contracts, government grants, and foreign exchange — are treated for income tax computation. ICDS override accounting standards (AS/Ind AS) for tax purposes and must be applied when computing business income in ITR.

A taxpayer can change the method of accounting, but the change must be bona fide, consistently applied going forward, and must not result in any income escaping taxation in the transition year. Any change must be disclosed in the ITR and in the Form 3CD (Clause 12). The Assessing Officer can reject the change if it is designed to defer or omit income.

If the Assessing Officer is not satisfied with the correctness of the accounts or the method of accounting, or if ICDS standards have not been complied with, Section 145(3) empowers the AO to make a best judgment assessment — computing income on the basis of the AO's own estimate rather than the taxpayer's books. Proper Section 145 and ICDS compliance avoids this risk.

Method of accounting — declared, documented, defended.

Our Chartered Accountants ensure your Section 145 declaration is correct, your ICDS adjustments are applied, and your tax audit clauses are accurately completed.