Introduction
In backdrop of the decision of Hon’ble Delhi High Court in case of “Chamber of Tax Consultants versus Union of India” (87 taxmann.com 92), the Government in the recent budget, 2018 proposes to incorporate certain amendments in the Income Tax Act, 1961 (“the Act”) to overcome the observations of Hon’ble Delhi High Court and provide legal backing to some of the Income Computation and Disclosure Standards (“ICDS”). The said decision of Hon’ble Delhi High Court rendered various parts of the said ICDS unconstitutional in light of the well settled proposition of the law that a delegated legislation (i.e. the “ICDS” notified by the Central Government under section 145(2) of the Act) cannot override binding judicial precedents and provisions of the Act. In the budget speech, the Hon’ble Finance minister expressed the clear intention behind introduction of certain provisions relating to the ICDS which reads as under:
“In order to provide statutory backing and certainty to Income Computation and Disclosure Standards (ICDS), it is proposed to amend the provisions of chapter IV-D of the Act relating to computation of business income and Chapter XIV of the Act.” (Para 28 of Annexure V to Part B of Budget speech)
This article deals with section 145A and Section 145B which have been proposed to water down the decision referred to above.
At the outset, it is important to note that proposed section 145A and section 145B will substitute existing section 145A of the Act. The proposed sections incorporate the existing provisions of section 145A and in addition thereto, provide statutory backing to certain provisions of the ICDS.
Applicability
Clause 45 of the Finance Bill, 2018 provides that existing section 145A of the Act shall be substituted and shall be deemed to have been substituted with effect from the 1st day of April, 2017. It means both the sections are applicable from 1st April, 2017. (i.e. applicable from the assessment year 2017-18). One may wonder that how these provisions are proposed to be made effective from 1st April, 2017 and the reason for the same is explained in the memorandum reads as under:
“Recent judicial pronouncements have raised doubts on the legitimacy of the notified ICDS. However, a large number of taxpayers have already complied with the provisions of ICDS for computing income for assessment year 2017-18. In order to regularise the compliance with the notified ICDS by large number of taxpayers so as to prevent any further inconvenience to them, it is proposed to bring the amendments retrospectively with effect from 1st April, 2017 i.e. the date on which the ICDS was made effective and will, accordingly, apply in relation to assessment year 2017-18 and subsequent assessment years.”
No doubt it is definitely a welcome move to protect taxpayers who had already gone ahead and complied with the said “ICDS” while furnishing their income tax returns for the assessment year 2017-18. However at the same time a question arises what will happen to other taxpayers who have filed their Income Tax returns by taking a stand which was in consonance with the law as it then stood. In this entire process, protracted litigation on various issues may arise.
Now we proceed to discuss proposed section 145A of the Act as under:
Provisions of section 145A
“‘145A. For the purpose of determining the income chargeable under the head “Profits and Gains of business or profession”,––
(i) the valuation of inventory shall be made at lower of actual cost or net realisable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145;
(ii) the valuation of purchase and sale of goods or services and of inventory shall be adjusted to include the amount of any tax, duty, cess or fee (by whatever name called) actually paid or incurred by the assessee to bring the goods or services to the place of its location and condition as on the date of valuation;
(iii) the inventory being securities not listed on a recognised stock exchange, or listed but not quoted on a recognised stock exchange with regularity from time to time, shall be valued at actual cost initially recognised in accordance with the income computation and disclosure standards
(iv) the inventory being securities other than those referred to in clause (iii), shall be valued at lower of actual cost or net realisable value in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145:
Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise.
Explanation 1.–For the purposes of this section, any tax, duty, cess or fee (by whatever name called ) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment.
Explanation 2. –For the purposes of this section, “recognised stock exchange” shall have the meaning assigned to it in clause (ii) of Explanation 1 to clause (5) of section 43.”
Overview of section 145A
Proposed section 145A has limited application to the extent of “determination” of income under the head “Profit and gains from business or profession”. It means the proposed section neither affects maintainance of books of accounts nor method of accounting regularly employed under section 145 of the Act. Further the said section has applicability while determining the income under the head “profit and gains from business or profession” meaning thereby the said section cannot be pressed into service while dealing with other heads of income. The said section contains four clauses out of which three clauses other than clause (ii) refer to the ICDS. Clause (ii) of the proposed section is similar to existing section 145A(a) of the Act. The said section is divided into four parts and each part is discussed at length as under:
Analysis of clause (i) of section 145A
From the plain reading of the aforesaid clause, following points emerge:
1) The clause has applicability for valuation of inventory.
Though the entire focus of the said clause is to value “Inventory”, the definition of the same is nowhere provided in the Act. In absence of any precise definition of the same in the Act, some issues may arise. However, at the same time, it must be borne in mind that the said term “inventory is defined in ICDS II at paragraph 2(1)(a) which is as under:
a. Held for sale in ordinary course of business
b. In the process of production for such sale
c. In the form of materials for supplies to be consumed in the production process on in the rendering of services.
In view of the same, it will be advisable to adopt the definition of “inventory” which has already been given in ICDS II to avoid unnecessary litigation.
2) It uses the verb “shall” and means that valuation of the inventory at lower of actual cost or net realisable value is mandatory and not optional.
From the plain reading, it emerges that there is no option given to assessees to value the inventory at their own discretion and valuation of inventory at lower of actual cost or net realisable value is mandatory.
3) Valuation of inventory shall be at lower of cost or net realisable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145.
Though valuation of inventory was never provided on the statute book before, judicial forums including Hon’ble Apex Court on various occasions have accepted the principle to value the inventory at lower of cost or net realisable value based on commercial accounting principles and accounting standard – 2 dealing with valuation of inventory issued by the Institute of Chartered Accountants of India. The distinction is that the clause categorically uses the phrase “in accordance with” the income computation and disclosure standards notified under sub-section (2) of section 145 meaning thereby cost or net realisable value is required to be computed in accordance with the ICDS notified under section 145(2) of the Act which deals with valuation of inventories.
Analysis of clause (ii) of section 145A
Clause (ii) of proposed section 145A read with explanation 1 is similar to existing section 145A(a) of the Act. However, it is pertinent to note that the proposed provision also covers valuation of purchases or sale of services which in not currently covered by existing section 145A of the Act. As per the proposed amendment, while valuing purchases and sales of services, items enumerated in section 145A(ii) are required to be included henceforth. Since the said clause is similar to existing section 145A(a) of the Act, a detailed analysis of interpretation of terms such as tax, duty, cess or fees or any other phrase as appearing in the section is not made in this article and one may refer to decisions on the subject matter as and when required.
At this juncture, it is extremely important to deal with a major difference between existing section 145A(a) and section 145A(ii). It is pertinent to note that existing section 145A appearing on the statute clearly overrides section 145 of the Act. It means a method of accounting regularly employed by an assessee is not a relevant factor for applicability of section 145A(a) of the Act and in view of the same, all assessees irrespective of their system of accounting are required to adhere to section 145A(a) of the Act for arriving at valuation of purchases, sales of goods and of inventory while determining income chargeable under the head profit and gains from business or profession.
Now if one comes to proposed section 145A(ii), the said section does not override section 145 of the Act in the first place meaning thereby a system of accounting regularly employed by an assessee under section 145 of the Act still holds field and is relevant while dealing with section 145A(ii). It means both sections will operative simultaneously and conflict with each other. Keeping the same in mind, a question arises for consideration whether a method of accounting will make a difference for applicability of the said clause in absence of an overriding effect. That is to say an assessee computing his business profits as per the cash system of accounting can take a shelter and say that he is not under obligation to adjust any tax, duty, cess or fee as mentioned in section 145A(ii) while determining valuation of sales, purchases of goods, services or inventory unless such tax, duty, cess or fee are actually paid or received.
There is another interesting issue that crops up while interpretation of the proposed section along with section 145 of the Act. As mentioned earlier, existing section 145A which overrides section 145 of the Act is mainly divided into proposed section 145A(ii) and section 145B(1). It is interesting to note that though both the proposed provisions are substantially extracted from existing section 145A of the Act, it appears that an overriding effect of existing section 145A is restricted only to section 145B (1) and not extended to section 145A(ii). It means section 145 of the Act will operative in toto and will not get overridden by proposed section 145A(ii). In view of the same, a question arises for consideration whether it is possible to contend that in absence of an overriding effect to the provision of section 145 of the Act, profits and gains from business or profession computed as per chapter IV-D read with section 145 of the Act without giving any effect to section 145A(ii) are correct profits which cannot be disturbed. This aggressive interpretation seems to be possible. Needless to say, it may invite litigation.
Analysis of clauses (iii) and (iv) of section 145A
Since both the clauses deal with valuation of securities held as inventory, the same are analysed together and two major differences with regard to the same are tabulated as under:
Differences between clauses (iii) and (iv) of section 145A
| Particulars | Section 145A(iii) | Section 145A(iv) |
| Types of securities | The said clause deals with following two types of securities: 1) Securities not listed on recognised stock exchange. 2) Securities listed but not quoted on a recognised stock exchange with regularity from time-to-time. | The said clause is residuary in nature. It covers all securities which are not covered in clause (iii) |
| Valuation | It is to be valued at actual cost initially recognised in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145. | It is to be valued at lower of actual cost or net realisable value in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145. Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise. |
Common points applicable to both the clauses
For both the clauses, the term “securities” is not defined in the said section. However, one may refer to the definition given in ICDS-VIII dealing with ”Securities” for the same. From both the clauses, it is apparent that valuation of securities is mandatory and not optional. Further it is worth noting that both the clauses categorically mention that “actual cost” and “net realisable value “, as the case may be, are required to be determined only “in accordance with” the income computation and disclosure standards notified under sub-section (2) of section 145. Though the said clauses do not give specific reference to any ICDS, it is implied that ICDS-VIII which deals with “securities” has application for determination of “actual cost” or “net realisable value” for valuation of securities.
Special points applicable to clause (iii) of section 145A
It is pertinent to note that clause (iii) contains the term “recognised stock exchange” which is mentioned in explanation 2 of the said section. Further one of the types of securities covered in the said clause is “Securities listed but not quoted on a recognised stock exchange with regularity from time-to-ime”. In view of the same, how the term regularity is to be interpreted will be a main question while interpreting the said clause.
Special points applicable to clause (iv) of section 145A
The proviso to section 145A(iv) states that while comparing actual cost or net realisable value of securities, the comparison is to be done category wise. It is worth noting that the said proviso is similar to para 10 of ICDS VIII. However, the proviso does not mention how securities are required to be classified under different categories which is provided in the said ICDS. In view of the same, it is advisable to classify securities as mentioned in ICDS-VIII.
Now we proceed to discuss section 145B at this juncture. Broadly, section 145B contains three sub-sections:
Provision of section 145B(1)
“(1) Notwithstanding anything to the contrary contained in section 145, the interest received by an assessee on any compensation or on enhanced compensation, as the case may be, shall be deemed to be the income of the previous year in which it is received.”
Analysis of Section 145B(1)
Section 145B(1) is a replica of existing section 145A(b) of the Act which deals with interest on compensation or enhanced compensation. The section provides that the interest on compensation or enhanced compensation shall be deemed to be the income of the previous year in which it is received. It is pertinent to note that since the existing provision of section 145A from which section 145B (1) is extracted overrides section 145 of the Act to the extent it is contrary, proposed section 145B(1) also overrides section 145 of the Act in the same manner and starts with the phrase “Notwithstanding anything to the contrary contained in section 145”. It is necessary to appreciate that the application of proposed section 145B(1) is exactly identical to that of existing section 145A(b) of the Act. Keeping the said aspect in mind, it may not be out of place to mention that all judicial propositions rendered in the context of Section 145A(b) till date will hold the field and squarely apply to section 145B(1). As mentioned above, since proposed section 145B (1) is placed on the same lines of existing section 145A(b) of the Act, the detailed analysis of the proposed section is not done in this article.
Provision of section 145B (2)
“(2) Any claim for escalation of price in a contract or export incentives shall be deemed to be the income of the previous year in which reasonable certainty of its realisation is achieved.”
Analysis of Section 145B(2)
The above-mentioned section deals with two types of income:
1. Any claim for escalation of price in a contract
2. Export incentives
The section provides for year of chargeability with regard to certain types of income (i.e. escalation claim in a contract and export incentives) mentioned therein. As per the proposed amendment, the – two incomes would be chargeable to tax only in the year in which reasonable certainty of its realisation is achieved. Though the said section may appear simple on the statute book, its application in reality will be the toughest task for taxpayers as well as the department. Determination of a particular year in which reasonable certainty of collection is achieved, is a factual aspect and litigation may arise in that regard.
With regard to inclusion of export incentives in the said section, It is appears that the said provision is proposed to be inserted to overrule the observation of Hon’ble Delhi High Court in the decision referred to above in which Hon’ble High Court while dealing with para 5 of ICDS IV which deals with Revenue recognition concluded that the said paragraph is contrary to the decision of Hon’ble Apex Court in “CIT versus Excel Industries Ltd” 358 ITR 295 and is therefore held ultra vires.
Now as per the proposed amendment, an assessee is required to ffer export incentives as income of the year in which reasonable certainty of its collection is achieved.
Looking at the types of incomes specified in the proposed section, it is certain that both the types relate to business and the same would fall under the head “profit and gains from business or profession” It is equally important to note that as per section 145 of the Act, the income under the heads “profit and gains from business or profession and income from other sources” shall subject to provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by an assessee. From plain language of section 145B(2) and section 145 of the Act, it appears that there is a conflict regarding recognition of the same for assessees who maintain their accounts on cash system as per section 145 of the Act. A close look between section 145B(1) and section 145B(2) clarifies that unlike section 145B(1), section 145B(2) does not override section 145 of the Act. In view of the same, a question arises for consideration whether the aforesaid section that creates a deeming fiction has any applicability for assessees who determine their business income on cash system of accounting as per section 145 of the Act because the well settled proposition demands that a person opting for the cash system of accounting is not under any obligation to recognise any income or expense unless the same is followed by actual cash inflows/outflows. There appears to be a great conflict between section 145 and section 145B(2) which does not appear to have been considered. If the said conflict is not resolved properly, litigation may arise.
Provision of section 145B(3)
“(3) The income referred to in sub-clause (xviii) of clause (24) of section 2 shall be deemed to be the income of the previous year in which it is received, if not charged to income-tax in any earlier previous year.”
Analysis of Section 145B(3)
The above-mentioned provision is proposed to overrule the observation of Hon’ble Delhi High Court in regard to para 4(2) of ICDS VII which deals with Government grants. The said para enumerated that “recognition of Government grant shall not be postponed beyond the date of actual receipt. “While dealing with the said paragraph, Hon’ble High court observed that it is contrary to the well-settled principle of accrual system of accounting and held the same as same ultra vires.
In response to the same, the section is proposed to be inserted. The said section covers the income referred to in section 2(24)(XViii) of the Act and brings the same as deemed income of the previous year in which it is received. However to avoid double taxation of the same income, the said section provides an exception and brings the same to tax in the year of receipt only if such income is not charged to tax in any earlier previous year.
Conclusion
The intention behind proposed sections 145A and 145B is to provide clarity in computing income under the head “profits and gains from business or profession” and achieve certainty with regard to the same. However the manner in which the provisions have been drafted may lead to a fresh round of litigation defeating the purpose.