Notification No. 87/ 2016 dated September 29, 2016 notifying
ICDS isultra vires the Act
The writ petition filed by the Chamber of Tax Consultants and Mr. C. S. Mathur sought a declaration of the Constitutional invalidity of:
(i) the Notification No. 87/2016 dated 29th September 2016 issued by the Central Board of Direct Taxes (CBDT), Department of Revenue, Ministry of Finance, Government of India whereby in exercise of the powers conferred by Section 145(2) of the Income-tax Act, 1961 (Act), the Central Government notified ten ‘Income Computation and Disclosure Standards’ (ICDS), as specified in the Annexure to the said notification to be followed by all assessees following the mercantile system of accounting, for the purpose of computation of income chargeable to income tax under the head “Profits and gains of Business or Profession” or “Income from Other Sources”. [The expression ‘Assessee’ excluded an individual or a Hindu Undivided Family who is not required to get his accounts of the previous year audited in accordance with the provisions of Section 44AB of the Act].
(ii) Circular No. 10 of 2017 dated 23rd March 2017 issued by the CBDT (TPL Division) issuing clarifications to the said ICDS.
(iii) The substituted and amended Section 145 of the Act, by raising the following questions:
(i) Whether the amendments to Section 145 are an instance of delegation by the Parliament of essential legislative powers to the Central Government?
(ii) Are the ICDS an instance of excessive delegation of legislative powers? Whether the impugned ICDS are contrary to the settled law as explained in various judicial precedents and are, therefore, liable to be struck down?
(iii) Whether the impugned amendments to Section 145 of the Act and the consequential ICDS and Circular violate Articles 14, 19(1)(g), 141, 144 and 265 of the Constitution?
The Delhi High Court in W.P. © 5595/2017 & CM APL 23467/2017 dated November 8, 2017 held as under:
(i) Section 145(2) as amended, has to be read down to restrict power of the Central Government to notify ICDS that do not seek to override binding judicial precedents or provisions of the Act. The power to enact a validation law is an essential legislative power that can be exercised, in the context of the Act, only by the Parliament and not by the executive. If Section 145(2) of the Act as amended is not so read down it would be ultra vires the Act and Article 141 read with Article 144 and 265 of the Constitution.
(ii) The ICDS is not meant to overrule the provisions of the Act, the Rules thereunder and the judicial precedents applicable thereto as they stand.
(iii) The decision in J.K. Industries Ltd. v. Union of India [297 ITR 176 (SC) is distinguishable in its application to the case on hand. Because in that decision the question was whether AS 22 is contrary to sections 209 and 211 of the Companies Act 1956 read with Part I and II of Schedule VI of the Act.
The Supreme Court in J. K. Industries (Supra) held that the impugned rules did not seek to modify the essential features of the Companies Act. The relevant portion of the judgment reads as under:
“In our view, paragraph 9 of AS-22 merely represents a gap-filling exercise, therefore, there is no merit in the contention advanced on behalf of the appellants that AS 22 is inconsistent with the provisions of the Companies Act including Schedule VI. It proceeds on the principle that every transaction has a tax effect. The words “true and fair” view in section 211(1) connotes the widest law making powers and, in that context, we hold that the impugned rule adopting AS 22 is intra vires as the said rule is incidental and/or supplementary to the specific powers given to the Central Government to make rules, particularly when such power is given to fill in details. The word “supplementary” means something added to what is there in the Act, to fill in details for which the Act itself does not provide …. In the present case, in our view, the impugned rule constitutes a legitimate aid to construction of the provisions of the Companies ……”
Thus, unlike AS 22, the ICDS-I does not attempt to merely fill the gaps in the Act or the Rules when it comes to the question of recognizing the principle of prudence. As far as the Act is concerned several aspects of the computation of taxable income are governed by specific provisions of the Act and the Rules and, where an issue of interpretation arises, by decisions of the Court. Therefore, unlike the Companies Act 1956, there is no aspect of computation of taxable income that is not governed either by the Act or the Rules or some binding judicial pronouncement. For e.g., even the prudence principle is acknowledged in at least two decisions i.e. in CIT v. Triveni Engineering & Industries Ltd. [49 DTR 253 (Del.)] and in CIT v. Advance Construction Co. Pvt. Ltd. [275 ITR 30 (Guj.)]. Importantly, there was no parallel provision in the Companies Act that was in conflict with the said AS. The AS did not seek to override a binding judicial precedent. Therefore to draw an analogy with the upholding of the validity of AS 22 in the context of Section 211(C) of the Companies Act may not be apposite in considering the validity of the ICDS that seek to alter the principles of computation of taxable income that is governed by the Act or Rules or judicial precedent without first effecting corresponding changes to the Act and Rules.
(iv) ICDS I which does away with the concept of ‘prudence’ is contrary to the Act and binding judicial precedents and is therefore unsustainable in law.
(v) ICDS II pertaining to valuation of inventories and eliminates the distinction between a continuing partnership business after dissolution from one which is discontinued upon dissolution is contrary to the decision of the Supreme Court in Shakti Trading Co. [250 ITR 871 (SC)]. It fails to acknowledge that the valuation of inventory at market value upon settlement of accounts of the outgoing partner is distinct from valuation of the inventory in the books of the business which is continuing. ICDS II is held to be ultra vires the Act and struck down as such.
(vi) The treatment to retention money under Paragraph 10 (a) in ICDS-III will have to be determined on a case-to-case basis by applying settled principles of accrual of income. By deploying ICDS-III in a manner that seeks to bring to tax the retention money, the receipt of which is uncertain/conditional, at the earliest possible stage,
irrespective of the facts, the Respondents would be acting contrary to the settled position in law.
(vii) Para 12 of ICDS III read with para 5 of ICDS IX, dealing with borrowing costs, makes it clear that no incidental income can be reduced from borrowing cost. This is contrary to the decision of the Supreme Court in CIT v. Bokaro Steel Limited [236 ITR 315] and is therefore struck down.
(viii) Para 5 of ICDS-IV requires an assessee to recognise income from export incentive in the year of making of the claim if there is ‘reasonable certainty’ of its ultimate collection. This is contrary to the decision of the Supreme Court in Excel Industries [358 ITR 295] and is, therefore, ultra vires the Act and struck down as such.
(ix) As far as para 6 of ICDS IV is concerned, the proportionate completion method as well as the contract completion method have been recognised as valid methods of accounting under the mercantile system of accounting by the Supreme Court in CIT v. Bilhari Investment Pvt. Ltd. [299 ITR 1] and this Court in CIT v. Manish Buildwell Pvt. Ltd. and Paras Buildtech India Pvt. Ltd. v. CIT [245 CTR 397 (Del.)]. Therefore, to the extent that para 6 of ICDS-IV permits only one of the methods, i.e., proportionate completion method, it is contrary to the above decisions, held to be ultra vires the Act and struck down as such.
(x) Para 8(1) of ICDS IV is not been shown to be contrary to any judicial precedent. There is also no challenge to Section 36(1)(vii) of the Act. Accordingly, para 8 (1) of ICDS-IV is held to be not ultra vires the Act. Its validity is upheld.
(xi) ICDS-VI which states that marked-to-market loss/gain in case of foreign currency derivatives held for trading or speculation purposes are not to be allowed, is not in consonance with the ratio laid down by the Supreme Court in Sutlej Cotton Mills Limited v. CIT [116 ITR 1], in so far as it relates to marked to market loss arising out of forward exchange contracts held for trading or speculation purposes. It is, therefore, held to be ultra vires the Act and struck down as such.
(xii) ICDS VII which provides that recognition of Government grants cannot be postponed beyond the date of accrual receipt, is in conflict with the accrual system of accounting. To that extent it is held to be ultra vires the Act and struck down as such.
(xiii) ICDS VIII pertains to valuation of securities. For those entities not governed by the RBI to whom Part A of ICDS VIII is applicable, the accounting prescribed by the AS has to be followed which is different from the ICDS. In effect, such entities will be required to maintain separate records for income tax purposes for every year since the closing value of the securities would be valued separately for income tax purposes and for accounting purposes. To this extent Part A of ICDS VIII is held to be ultra vires the Act and is struck down as such.
To the extent the specific ICDS as noted hereinbefore have been struck down as ultra vires the Act, the impugned Notification Nos. 87 and 88 dated September 29, 2016 and Circular No 10.
Thus, it is clear that the ICDS are not based on any policy or principle discernible from the Act. They have been notified out of delegated legislation and contrary to provisions of the Act. They are directly in conflict with well-established legal position under the Act about concept of accrual of income, prudence, materiality etc.,
Therefore, the Delhi High Court has struck down the several ICDS being contrary to the Act. Even Notification No. 87 dated September 29, 2016 and Circular No. 10 of 2017 issued by the CBDT are also held to be ultra vires the Act.
Hence, it is necessary to redraft the ICDS making it clear that the computation of income for the purpose of calculating total income would be as per the law and ICDS should remain only as disclosure standards.
H. N. Motiwalla