Section 145 of the Income-tax Act: Method of Accounting and ICDS

Section 145 governs the accounting method used to compute taxable income from business or profession and from other sources. It recognises cash and mercantile accounting, provides for notified Income Computation and Disclosure Standards (ICDS), and permits a best judgment assessment when statutory conditions are met.

What does Section 145 mean?

The method of accounting is the consistently adopted basis on which income and expenses are recognised for tax computation. Section 145 applies specifically to income taxable under the heads Profits and gains of business or profession and Income from other sources. Separate statutory rules govern other income heads, and specific deeming or computation provisions can override the general accounting method.

Section 145 explained, subsection by subsection

Section 145(1): Cash or mercantile method

Income under the two specified heads must be computed using either the cash system or the mercantile system regularly employed by the assessee, subject to Section 145(2). Regular use matters: arbitrary switching to obtain a tax advantage may invite scrutiny.

Section 145(2): Notified standards

The Central Government may notify Income Computation and Disclosure Standards (ICDS) for specified classes of taxpayers or income. These standards govern tax computation and do not, by themselves, replace the accounting framework used for preparing financial statements.

Section 145(3): Rejection of accounts and assessment

The Assessing Officer may proceed to assessment in the manner provided by Section 144 if the officer is not satisfied with the correctness or completeness of accounts, if the method permitted under Section 145(1) has not been regularly followed, or if income has not been computed according to the notified standards. A reasoned assessment must consider relevant material and applicable procedural safeguards.

Cash method versus mercantile method

Illustration: If a service is completed in March but payment is received in May, mercantile accounting may recognise income in March, while cash accounting generally recognises it in May. Specific tax provisions and facts may change the outcome.

Income Computation and Disclosure Standards (ICDS)

Notification No. 87/2016 dated 29 September 2016 notified ten ICDS for tax computation, generally effective from assessment year 2017-18. The notification applies to assessees using mercantile accounting, excluding individuals and Hindu undivided families not required to have accounts audited under Section 44AB. Presumptive taxation and other special regimes require separate examination.

For authoritative explanations and notified text, consult the Income Tax Department ICDS guide and Notification No. 87/2016 and ICDS I.

When can books of account be rejected?

Section 145(3) does not mean that every accounting error automatically justifies estimating taxable income. The officer should identify statutory grounds, such as material defects affecting reliability, failure to maintain a consistent accounting method, or non-compliance with applicable ICDS. Taxpayers should respond to notices with books, reconciliations, supporting vouchers, stock records and explanations of accounting policies. Assessment under Section 144 remains subject to its own procedural requirements.

Related provisions and practical compliance

• Section 145A: special valuation and accounting rules for specified items.
• Section 145B: rules concerning taxability of specified income.
• Section 44AA: maintenance of books of account for prescribed persons.
• Section 44AB: tax audit requirements, where applicable.
• Section 144: best judgment assessment under the 1961 Act.

Maintain a documented accounting policy, follow it consistently, reconcile books with tax returns and financial statements, separately compute ICDS adjustments when applicable, and retain evidence supporting revenue and expense recognition.

Income-tax Act, 2025: Section 276

Section 276 of the Income-tax Act, 2025 carries forward the central framework of cash or mercantile accounting, notified standards and assessment where accounts are unreliable or the statutory method or standards are not followed. Under Section 276(3), the corresponding best judgment assessment reference is Section 271 of the 2025 Act. Apply the legislation governing the relevant tax year and any transition provisions, rather than treating section numbers as interchangeable.

Legislative background

Section 145 was substituted by the Finance Act, 1995 with effect from 1 April 1997. The Finance (No. 2) Act, 2014 replaced the reference to accounting standards with income computation and disclosure standards with effect from 1 April 2015, and adjusted Section 145(3) accordingly. This history explains the shift from general accounting standards to tax-specific computation standards.

Official statutory and departmental resources

• Income Tax Department: Section 145 of the Income-tax Act, 1961
• Income Tax Department: ICDS applicability and standards
• Income Tax Department: ICDS I and notification
• Income Tax e-Filing portal

Frequently asked questions

This article provides general information and should be read with the statutory text, notifications and applicable assessment-year provisions.