Delhi High Court upholds constitutional validity of ICDS but strikes down provisions inconsistent with Act/ Judicial precedents
Background:
As per section 145 of the Income Tax Act, 1961 ('the Act'), income of an assessee chargeable to tax under the head "Profits and gains of business and profession" is determined as per the method of accounting consistently followed by an assessee. Sub-section (2) of the aforesaid section was amended by the Finance (No.2) Act, 2014 w.e.f. April 1, 2015 to provide that the Central Government may notify the Income Computation and Disclosure Standards (hereinafter referred as 'ICDS') to be followed by any class of assessee for accounting of any specified class of income.
In view of the above mandate, the Central Government ('CG') had vide Notification No. 87/2016 dated September 29, 2016 notified 10 ICDS for the purpose of computing income chargeable to tax under the head "Profit and gains of business or profession" or "Income from other sources" for all assessees following mercantile system of accounting, which are applicable from assessment year 2017-18 and onwards. The Central Board of Direct Taxes (CBDT) vide Circular No. 10 of 2017 dated March 23, 2017 also issued clarifications on various issues concerning the interpretation of ICDS.
The Chamber of Tax Consultants had filed a writ petition before the Delhi High Court challenging the constitutional validity of the aforesaid amendment to section 145 of the Act and the subsequent notification of ICDS.
Decision of the Delhi High Court:
The Delhi High Court has upheld the constitutional validity of the amendment to section 145 of the Act and notification of ICDS for computing taxable income; however, the key provisions of ICDS which were inconsistent with the provisions of the Act and the settled judicial position have been stuck down.
The key highlights of the decision of the Delhi High Court are as under:
- Legislature is only competent to amend law to override judicial precedents. Such a power is not available to the Executive by virtue of Articles 141 and 144 of the Constitution. It was not, therefore, open to the Executive/CG to override a binding judicial precedent through notification of ICDS, without a corresponding amendment to the Act.
- Section 145(2)of the Act has, therefore, been read down as not empowering the Central Government to notify ICDS that seek to override binding judicial precedents or provisions of the Act.
- In view of the above, the Court has struck down/read down the following provisions of different ICDS to the extent the same override the provisions of the Act and settled judicial precedents:
Relevant provision of ICDS struck down | Relevant provision of ICDS struck down |
ICDS I:
Accounting Polices Concept of prudence was not to be followed unless specifically allowed to be followed under other ICDS |
Rejection of concept of prudence which was specifically recognized by the Courts in case of CIT v. Triveni Engineering & Industries Ltd (2011) 49 DTR 253 (Del) and CIT v. Advance Construction Co. Pvt. Ltd. (2005) 275 ITR 30 (Guj), has been struck down. |
ICDS II:
Valuation of Inventories Valuation of stock-in-trade at market value in case of dissolution of a firm. |
This provision was contrary to the decision of the Supreme Court in Shakti Trading Co. v. CIT (2001) 250 ITR 871 (SC) wherein it was held that in the case of dissolution of a partnership firm, where the business of firm is not discontinued and is taken over by other partners, the stockin- trade of the firm can be valued at cost or market value, whichever is lower. Accordingly, the Court has read down the provision of ICDS II to the aforesaid extent in relation to dissolution of a firm, without discontinuation of business, by way of being taken over by other partners. |
ICDS III:
Construction Contract
|
|
ICDS IV: Revenue
Recognition
|
|
ICDS VI: Effects
of change in foreign exchange rates It states that mark to market loss in case of foreign currency derivatives held for trading or speculation purposes is not to be allowed as deduction. |
This is contrary to the law laid down by the Supreme Court in the case of Sutlej Cotton Mills Limited v. CIT: [1979] 116 ITR 1 (SC) wherein the Court held that profit or loss arising to an assessee on account of appreciation or depreciation in the value of an asset, on conversion into another currency, would, ordinarily, be trading profit or loss if the asset is held by the assessee on revenue account or as part of circulating capital embarked in the business. If on the other hand, the asset is held as a capital asset or as fixed capital, such profit or loss would be of capital nature. The Court, accordingly, struck down the provision to the aforesaid extent. |
ICDS VII:
Government Grants I t prov ides that recogni t ion of governmental grants as income cannot be postponed beyond the date of receipt. |
In so far as the ICDS states that income has to be recognized on receipt basis even if the same may not have accrued, the same is in conflict with the accrual system of accounting. To this extent, the aforesaid ICDS has been held to be ultra-vires. |
ICDS VIII:
Securities There are two parts of ICDS VIII; Part A deals with entities other than scheduled banks and public financial institutions and Part B deals with scheduled banks and public financial institutions. Under Part B, ICDS VIII has prescribed that recognition of securities should be in accordance with the RBI guidelines. |
The method prescribed by
the Reserve Bank of India (RBI) for valuation of securities is
applicable only to banks, financial institutions, and other
financial bodies regulated by the RBI. For other entities, the
Accounting Standard ('AS') prescribes the valuation of
inventories on individual basis. For entities not governed by the RBI, the accounting prescribed under AS have to be followed, which are different from the ICDS. In effect, such entities will be required to maintain separate records of income for tax purposes for every year since the closing value of the securities would be valued separately for income tax purposes and for accounting purposes. This change is therefore not possible to be effectuated without a corresponding amendment to the Act. To that extent, Part A of ICDS VIII has been held to be ultra vires the Act. |
VA Comments:
- The aforesaid decision of the Delhi High Court has per se upheld the constitutional validity of ICDS, but has read down/struck down the relevant part(s) of ICDS which run contrary to the provisions of the Act or binding judicial precedents.
- The aforesaid decision has come after the expiry of the due date of filing income tax return for various assessees (except assessees required to furnish Transfer Pricing report, which is due on November 30, 2017), who would have already complied with the provisions of the notified ICDS for computing their tax liability for the relevant assessment year. Such assessees may have to evaluate filing revised return of income for revising claims taken on the basis of ICDS, which have been read down/struck down by the Delhi High Court.
- For assessees covered by transfer pricing provisions, where return of income is yet to be filed before November 30, 2017, such assessees would need to analyse the impact of the aforesaid decision on the computation of income as per the extant provisions of ICDS.
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