In a recent judgment, Honorable Delhi High Court (Delhi HC)1 read down the powers of the Central Government [CG] in notifying Income Computation and Disclosure Standards [ICDS] which conflict the principles of taxation provided under the Income Tax Act 1961, Rules thereunder and applicable judicial precedents as they stand.

ICDS in India

The central government through the Central Board of Direct Taxes (CBDT), India's apex direct tax administrative body, had notified 10 ICDS under Section 145(2) of the Act. The ICDS aim to provide standards to be followed by taxpayers while determining their taxable income under the Act. ICDS in the following manner:

Period Event
March 2015 10 ICDS notified for taxpayers (other than Individuals and Hindu Undivided Family [HUF] not liable to tax audit) following mercantile system of accounting while computing income under the heads 'Profits and gains of business or profession' and/or 'Income from other sources' with effect from 1 April 2015.
December 2015 Representation filed with CBDT by the Chamber of Tax Consultants (CTC), requiring clarification, guidance or dispensation of specific provisions of ICDS.
January 2016 The Income Tax Simplification Committee (ITSC) chaired by Justice Easwar recommends that ICDS should be deferred in light of other impending regulatory changes and that a detailed study of ICDS implications was required before its implementation.
July 2016 CBDT defers applicability of ICDS to 1 April 2016
September 2016 Old ICDS are rescinded and 10 updated ICDS are notified through
Notification No. 87/2016
March 2017 CBDT issues Circular No. 10/2017 providing 25 clarifications for implementation or applicability of the ICDS. One of the clarifications suggests that in case of conflict between ICDS and judicial precedents, ICDS would prevail.

Petition filed before Delhi High Court

In light of the provisions of the updated ICDS and clarifications issued by the CBDT, the CTC filed a writ petition before the Delhi HC challenging the constitutional validity of ICDS itself and many of its provisions which were contradicting rationale laid down by the settled judicial precedents. The contentions of CTC before the Delhi HC were:

  • The central government cannot be conferred with such unfettered powers to notify ICDS modifying the basis of taxation. Any modification in chargeability and computation of taxable income can be done only by the Parliament by making amendments to the provisions of the Act.
  • ICDS is contrary to the settled judicial positions since its implementation would nullify the judgments of the Supreme Court (SC) and the HCs and therefore, ICDS is liable to be struck down.
  • ICDS is violative of several Articles of the Constitution of India

    Accordingly, CTC prayed that the updated ICDS and clarifications provided by CBDT on ICDS should be quashed.

Judgment of the Delhi HC

After considering the petition and submissions on behalf of CTC and that of the respondents (i.e. Union of India and CBDT), the Delhi HC held under:

  • Section 145(2) of the Act is to be read down such that they restrict the power of the CG to only notify ICDS that do not seek to override binding judicial proceedings or provisions of the Act. (Specific observations on ICDS provisions are mentioned below).
  • To the extent that specific ICDS have been struck down as ultra vires2 the Act, the updated ICDS and clarifications issued by the CBDT are also held to be ultra vires the Act and struck down as such.

Specific observations of the Delhi HC on individual ICDS:

ICDS Issue raised before the Delhi HC
ICDS I
(Accounting Policies)		 ICDS I which does away with concept of prudence is contrary to the provisions of the Act, as well as judicial precedents and hence is unsustainable in law
ICDS II
(Valuation of Inventories)		 ICDS II requiring valuation of inventory at a net realisable value at the time of the dissolution of partnership firm whether the business is discontinued or not is against the settled judicial position explained by the SC in Shakti Trading Co.3

Furthermore, since Section 145A of the Act allows valuation of inventory as per the method of accounting regularly employed, it is independent of
Section 145(2) under which the ICDS has been notified.

Accordingly, ICDS II is held to be ultra vires the Act and struck down as such.
ICDS III (Construction Contracts) Provisions of ICDS III treating retention money as revenue without considering uncertainty/performance of conditions, i.e. concept of accrual, is ultra vires the Act. Taxation of retention money needs to be determined on a case to case basis after considering settled principles of accrual of income.

Restriction on the reduction of incidental income from borrowing costs is contrary to the decision of SC in Bokaro Steel Limited4 and cannot be sustained.
ICDS IV
(Revenue recognition)		 ICDS IV requires a taxpayer to recognise income from export incentive in the year of making the claim if there is a reasonable certainty of its ultimate collection. SC in Excel Industries Limited5 held that the right to receive the payment accrues in favour of the taxpayer only in the year in which the claim is accepted by the Government i.e. a corresponding obligation to pay arises in the hands of the Government. To the extent ICDS IV is inconsistent with the law explained by the SC, it is ultra vires the Act and struck down as such.

Accounting Standard-9 and various SC and HC decisions permit proportionate completion method [PCM] as well as the contract completion method as a valid method of accounting under mercantile system of accounting. Hence, ICDS IV permitting only one method of accounting i.e. PCM, is ultra vires the Act to that extent and struck down as such.

Provision of ICDS IV requires taxing interest income of non-performing assets (NPAs) of financial institutions on accrual (i.e. time) basis irrespective of their recoverability. However, an option is available to such taxpayers to claim a deduction for bad debts of such income under section 36(1)(vii) of the Act. Accordingly, this provision of ICDS IV is not shown to be contrary to any judicial precedent or any section of the Act and hence, is upheld as it is not ultra vires the Act.
ICDS VI
(Effects of changes in foreign exchange rates)		 The losses or gains arising from the valuation of monetary assets and liabilities of the foreign operations as at the end of the year cannot be treated as real income.

ICDS VI provision treating foreign exchange fluctuation on the valuation of closing value of foreign currency loan taken for acquiring capital assets as revenue is contrary to the decision of the SC in Sutlej Cotton Mills6.

ICDS VI provision not allowing a deduction for marked to market loss/gain in case of foreign currency derivatives held for trading or speculation purposes is also against the rationale laid down by the SC in the Sutlej Cotton Mills ruling. Therefore, the relevant provisions under ICDS VI are ultra vires the Act and struck down as such.
ICDS VII (Government grants) ICDS VII provides that recognition of government grants cannot be postponed beyond the date of actual receipt and conflicts the accrual system of accounting. This is because grants even if received can be subject to certain conditions and if these are not fulfilled, the taxpayer would be required to return the amount.

To that extent, this provision is ultra vires the Act and struck down as such.
ICDS VIII (Valuation of Securities) Part A of ICDS VIII which requires entities not governed by RBI to follow 'bucket approach' for valuation of securities held as inventory differs from the valuation of inventory under accounting standards. Since such entities will be required to maintain separate records for income tax purposes, to this extent Part A of ICDS VIII is held to be ultra vires the Act and is struck down as such.

* There is no discussion about ICDS V - Tangible Fixed Assets, ICDS IX - Borrowing Costs and ICDS X - Provisions, Contingent liabilities & Contingent assets in the Delhi HC judgment.

Footnotes

[1] W.P.(C) 5595/2017 & CM APL 23467/2017 dated 8 November 2017

[2] Ultra vires is a Latin phrase meaning "beyond the powers"

[3] Shakti Trading Co. v. CIT [(2001) 250 ITR 871 (SC)]

[4] CIT v. Bokaro Steel Limited (1999) 236 ITR 315

[5] CIT v. Excel Industries Limited (2015) 358 ITR 295 (SC)

[6] Sutlej Cotton Mills Limited v. CIT (1979) 116 ITR 1 (SC)

SKP's comment's
  • The Delhi HC judgment has provided much-required clarity on the matter that ICDS is not meant to overrule the provisions of the Act, rules thereunder and the settled judicial positions. However, since the ICDS have not been completely struck down by the Delhi HC, the balance ICDS provisions currently survive. Whether the CG or the CBDT will contest this judgment before the SC is unknown as of now.
  • Considering that this is a Delhi HC judgment, ideally, taxpayers covered by the jurisdiction of Delhi HC can consider relying on the said judgment and take a position that they are not required to comply with the specific ICDS provisions struck down by the Delhi HC. Whether taxpayers from other jurisdictions can also rely on this judgment on the ground that this is an outcome of a writ petition on an issue affecting all taxpayers at large, would need to be carefully analysed.
  • In our view, considering that many provisions of the ICDS have been struck down by the Delhi HC, in order to provide certainty to taxpayers from the perspective of ease of doing business, it would be desirable that the CG either:

    • Clarifies on the status of ICDS and its applicability to taxpayers across India; or
    • Rescinds the current ICDS and replaces the same with modified ICDS applicable from a later date (if the Delhi HC ruling is not to be challenged before the SC); or
    • Defers the applicability of current ICDS provisions to a later date (if the Delhi HC ruling is to be challenged before the SC).
  • Taxpayers relying on this judgment should also consider the possibility of applying similar rationale for ICDS / situations not specifically discussed in the Delhi HC judgment (especially ICDS V - Tangible Fixed Assets, ICDS IX - Borrowing Costs and ICDS X - Provisions, contingent liabilities and contingent assets after undertaking analysis of SC and HC rulings on the issue at hand. Also, the impact of Delhi HC judgment on ICDS compliance by companies adopting Ind AS must be evaluated holistically in light of their facts.
  • With regard to ICDS compliance in tax returns, taxpayers relying on this judgment can revise their tax returns of FY 2016-17 (if already filed) or not provide any impact of ICDS which have been struck down in its tax return (if pending to be filed). However, the contingency of additional tax and interest liability arising on account of reversal of Delhi HC judgment in the future should be adequately considered before taking a decision.

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