Understanding Section 145A: GST and Closing Stock Valuation

Introduction

For businesses, accurately reporting income and complying with tax regulations is essential. One area that often creates confusion is the valuation of closing stock under Section 145A of the Income Tax Act, particularly with the introduction of GST. This blog explores the provisions of Section 145A, how it impacts closing stock valuation, and the differences it creates between financial and tax accounting, supported by practical examples.

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What is Section 145A?

Section 145A overrides the general provisions of Section 145 of the Income Tax Act. It mandates that while computing income under the heads of business or profession, taxpayers must include the following:

1. Taxes, duties, and other levies in the valuation of purchases, sales, and inventory.
2. Valuation of closing stock should include GST, even though it may be recoverable as Input Tax Credit (ITC).

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Financial Accounting vs. Tax Accounting

Financial Accounting (AS/Ind AS):

• Under Accounting Standards (AS) or Ind AS, GST is treated as a recoverable tax. Hence:
  • Purchases are recorded excluding GST.
  • Sales are recorded excluding GST, with GST collected treated as a liability.
  • Closing stock is valued excluding GST.

Tax Accounting (Section 145A):

• For tax purposes, Section 145A requires the inclusion of GST in the valuation of purchases and closing stock. This creates a temporary timing difference between financial books and taxable income.

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Impact of Section 145A with an Example

Scenario 1: Excluding GST in Purchases and Sales (Financial Accounting)

• Purchases: ₹1,00,000 + ₹18,000 (GST) = ₹1,18,000 (for tax purposes, ₹1,00,000 for financial books).
• Sales: ₹1,50,000 (excluding GST).
• Closing Stock: ₹40,000 (excluding GST).

Financial Books (AS/Ind AS):

Particulars	Amount (₹)
Purchases (Excl. GST)	1,00,000
Sales (Excl. GST)	1,50,000
Closing Stock (Excl. GST)	40,000
Cost of Goods Sold (COGS)	1,00,000 – 40,000 = 60,000
Net Profit	1,50,000 – 60,000 = 90,000

Tax Books (Section 145A):

Particulars	Amount (₹)
Purchases (Incl. GST)	1,18,000
Sales (Excl. GST)	1,50,000
Closing Stock (Incl. GST)	40,000 + 7,200 = 47,200
Cost of Goods Sold (COGS)	1,18,000 – 47,200 = 70,800
Net Profit	1,50,000 – 70,800 = 79,200

Profit Difference:

• Financial Books: ₹90,000
• Tax Books: ₹79,200
• Difference in Profit: ₹10,800 (higher taxable income due to GST in closing stock).

Scenario 2: Including GST in Purchases, Sales, and Closing Stock

• Purchases: ₹1,18,000 (including GST).
• Sales: ₹1,77,000 (₹1,50,000 + ₹27,000 GST).
• Closing Stock: ₹47,200 (₹40,000 + ₹7,200 GST).

Books (Including GST):

Particulars	Amount (₹)	Amount (₹)
To Opening Stock	–
To Purchases	1,18,000
To Gross Profit c/d	59,200
Total		2,24,400
By Sales		1,77,000
By Closing Stock		47,200
Total		2,24,400

Observations:

• The Gross Profit remains the same because GST inflates both purchases and closing stock proportionately, and sales include GST.
• There is no impact on profit when all figures are inclusive of GST.

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Why Include GST in Closing Stock?

1. Economic Reality: GST paid on purchases is part of the total cost incurred to acquire goods until it is recovered via ITC.
2. Matching Principle: Including GST in closing stock ensures that the cost of goods matches the revenue earned during the year, aligning tax computations with actual costs.

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Reporting and Compliance

To ensure compliance with Section 145A, businesses must:

1. Include GST in the valuation of closing stock for tax purposes, even if excluded in financial books.
2. Report the adjustments in the Tax Audit Report (Form 3CD) under Clause 13(b).
3. Prepare for potential cash flow impacts due to higher taxable income in the current year.

Failure to comply can lead to:

• Adjustments during tax assessments.
• Additional tax liability, penalties, and interest.
• Increased scrutiny during audits.

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Temporary Timing Difference

The higher valuation of closing stock due to GST creates a timing difference:

• The inflated closing stock (including GST) at the end of the year becomes the opening stock for the subsequent year.
• This results in higher costs (COGS) in the following year, reducing taxable income for that year.
• Over time, the effect balances out.

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Conclusion

Section 145A ensures that taxes like GST are appropriately reflected in taxable income computations. While it may create temporary differences between financial and tax accounting, these differences align with the matching principle and ensure consistent tax treatment.

Businesses should carefully adhere to these provisions to avoid disputes with the Income Tax Department and ensure accurate income reporting. Proper disclosure of adjustments under Section 145A in the tax audit report is critical for compliance and transparency.