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TMI Blog2017 (11) TMI 465X X X X Extracts X X X X X X X X Extracts X X X X ..... omputation 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 purposes 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 44 AB 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 the Finance Acts (FA) of 1995 and 2014]. 2. The declaration is sought on the ground of their being violative of Articles 14, 19 (1) (g), 141, 144 and 265 of the Constitution of India. Another specific prayer is for the quashing of the Notification dated 29th September 2016 and Circular No. 10 of 2017 dated 23rd March 2017. The Petitioners 3. Petitioner No. 1 is stated to be a society established and registered under the Societies Registration ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... issue in the present petition concerns the validity of the ICDS notified by the Central Government for the purpose of computing the income of Assessees following the mercantile system of accounting, taxable under the head "Profits and gains of business or profession" or "income from other sources". The major premise on which the impugned ICDS is based is that the income computed for the purposes of income tax under the above two heads need not be (as is often not) the income as reflected in the books of accounts maintained by such Assessee. Although the computation of such taxable income would normally be based on the books of accounts of the Assessee, and dependant on the method of accounting followed by the Assessee subject to the adjustments for allowances and deductions under the Act, an Assessing Officer (AO) can, for the purposes of computation of the taxable income, and in exercise of the powers under Section 145 (3) of the Act, reject the books of accounts maintained by the Assessee if he is not satisfied about their correctness or completeness. In such an event the AO can resort to a 'best judgment assessment' under Section 144 of the Act. In order, therefore to a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fessionals like CAs, with the following objects: (i) to study the harmonization of ASs issued by the ICAI with the direct tax laws in India, and suggest ASs which need to be adopted under Section 145 (2) of the Act along with the relevant modifications; (ii) to suggest a method for determination of the tax base (book profit) for the purpose of Minimum Alternate Tax (MAT) in the case of companies migrating to International Financial Reporting Standards ("IFRS") (to be known as Ind-AS) in the initial year of adoption and thereafter; and (iii) to suggest appropriate amendments to the Act in view of transition to Ind-AS regime. 13. The aforementioned Committee examined 31 ASs issued by the ICAI. The Committee drafted 14 Tax ASs and recommended that the said standards be notified under the Act only for the purposes of computation of taxable income. The Committee was of the view that "a taxpayer would not be required to maintain books of account on the basis of the AS notified under the Act". By a Press Release dated 26th October 2012, the CBDT issued the Final report of the Committee and sought for comments from general public and stakeholders by 26th November 2012. 14. Petitioner ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of books of accounts. In the case of conflict between the provisions of the Act and this Income Computation and Disclosure Standard, the provisions of the Act shall prevail to that extent." 17. According to the Petitioners, a conjoint reading of the ten ICDS suggested that for their implementation, parallel sets of books of accounts/ records were required to be maintained. 18. The CBDT appeared to have issued a comprehensive guidance/clarification by a Press Release dated 26th November 2015 stating that the stakeholders and general public may bring out, by 15th December 2015, the issues/points which in their opinion would require further clarification/guidance. In response thereto, Petitioner No. 1 made a detailed representation dated 15th December 2015 comprising of three parts. Part A dealt with general points which should supersede all ICDS, Part B dealt with those provisions of ICDS which need to be deleted or substantially modified so as not to cause any conflict between the provisions of the ICDS and the provisions of the IT Act as interpreted by the Supreme Court. Part C dealt with other provisions that would cause hardship to taxpayers and needed clarification, guidance ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es but to the extent now modified by the provisions of the ICDS. (ii) In the guise of delegating powers to the Central Government to issue accounting standards/ICDS, what has been effectively done is to delegate the essential legislative power to amend the provisions of the Act, especially those affecting the chargeability and computation of taxable income. The Central Government cannot be conferred with such unfettered powers by the Parliament in the guise of delegated legislation to notify ICDS modifying the basis of taxation which otherwise, if at all, can be done only by the Parliament by making amendments to the provisions of the Act. (iii) A delegate cannot override the Act either by exceeding its authority or by making provisions inconsistent with the Act. The ICDS are not based on any policy or principle discernible from the Act and in particular Section 145 thereof. In the circumstances, such delegation to the Central Government and further sub-delegation by the Central Government to the CBDT would amount to abdication of legislative powers and excessive delegation by the Parliament. Reliance was placed on the decision in Avinder Singh v. State of Punjab AIR 199 SC 321. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... create confusion, interpretation issues, multiplicity of records and additional compliance burden which would outweigh the gains of ICDS and constitute an unreasonable restriction on the freedom to conduct business. Thus, the impugned notifications were violative of Article 19 (1) (g) of the Constitution. Submissions on behalf of the Respondents 24. Mr. Sanjay Jain, learned Additional Solicitor General of India, appearing for Respondent No. 2, replied to the above submissions and also submitted a written note of arguments. Mr. Jain placed the background to the changes brought about by Section 145 of the Act. The CBDT constituted an expert committee and submitted its first report in August 2001. The committee invited comments on the report from the stakeholders. In August 2012, the Committee submitted its recommendations to the effect that standards proposed to be notified under the Act should apply only to the computation of taxable income but there should not be any compulsion to maintain books in terms of the notified AS. Eventually, the final report was submitted in October 2013 and in 2014 the amended Section 145 was brought about. 25. According to Mr. Jain, at every stage o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he emergent trends in business, technology and law and the corresponding revision of the AS issued by the ICAI. Reliance was placed on the decisions in Spences Hotel P. Limited v. State of West Bengal (1991) 2 SCC 154 and Union of India v. Dhanwanti Devi (1996) 6 SCC 44. It is denied that the computation provided under ICDS amounted to overruling the judicial precedents. It is claimed that the changes brought about are only aimed at bringing uniformity and clarity in the computation of income. 28. Reliance was placed on the decision in Saraswati Sugar Mills v. Commissioner of Central Excise 2011 (270) ELT 465 and National Agricultural Cooperative Marketing Federation of India Limited v. Union of India (2003) 260 ITR 548 to urge that where the law has itself been changed, the question of legislature overruling the judiciary did not arise. Mr. Jain pointed out that the ICAI which is the apex body regulating accountancy had accepted the ICDS. Questions that arise 29. From the above submissions, the following questions arise for consideration: (i) Whether the amendments to Section 145 are an instance of delegation by the Parliament of essential legislative powers to the Central Gov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e was submitted in October 2013, an amendment to Section 145 of the Act was brought about in 2014. Ten ICDS were notified by Notification No. SO 892 (E) dated 31st March 2015 and was made applicable from the Financial Year 2015-16 (AY 201617). It is stated that prior thereto, detailed consultations were held with the stakeholders. Based on the representations received, the Central Government decided to defer the commencement date of the ICDS from 1st April 2015 to 1st April 2016, i.e., relevant FY 2017-18. Eventually, the impugned notification dated 29th September 2016 was issued making the ICDS applicable effective 1st April 2017. 34. The Circular No. 10 of 2017 issued by the CBDT on 23rd March 2017 is titled "Clarifications on Income Computation and Disclosure Standards (ICDS) notified under Section 145 (2) of the Income-tax Act, 1961." The Circular acknowledges that it had been brought to the notice of the CBDT that some of the ICDS may require "amendment/ clarification for proper implementation." The matter was then referred to the Committee which, after duly consulting the stakeholders recommended a two-fold approach for the implementation of ICDS. One was to amend the ICDS i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ential legislative function. 39. To elaborate, if the power to notify standards has to be exercised consistent with the recognised ASs that do not contradict any principle recognised in the Act or as explained in judicial precedents, it would be a permissible exercise of the delegated power of notifying ASs. However, where the notified AS or as in this case the ICDS, seeks to alter the system of accounting, or according accounting or taxing treatment to a particular transaction, then it will require the legislature to step in to amend the Act to incorporate such change. This may be unique to a fiscal statute like the Act. However, in the guise of a delegated power, the Central Government cannot do what is otherwise legally impermissible. 40. The system of checks and balances in the Constitution of India envisages judicial review of legislative action. Equally, it recognises the power of the legislature to enact 'validating laws' to overcome the defects (or plug the loopholes as it were) pointed out by judicial precedents. 41.1 In Shri Prithvi Cotton Mills Limited v. Broach Borough Municipality (supra) the facts were that Section 73 of the Bombay Municipal Boroughs Act 19 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew words about validating statutes in general. When a legislature sets out to validate a tax declared by a court to be illegally collected under an ineffective or an invalid law, the cause for ineffectiveness or invalidity must be removed before validation can be said to take place effectively. The most important condition, of course, is that the legislature must possess the power to impose the tax, for, if it does not, the action must ever remain ineffective and illegal. Granted legislative competence, it is not sufficient to declare merely that the decision of the Court shall not bind for that is tantamount to reversing the decision in exercise of judicial power which the legislature does not possess or exercise. A court's decision must always bind unless the conditions on which it is based are so fundamentally altered that the decision could not have been given in the altered circumstances. Ordinarily, a court holds a tax to be invalidly imposed because the power to tax is wanting or the statute or the rules or both are invalid or do not sufficiently create the jurisdiction. Validation of a tax so declared illegal may be done only if the grounds of illegality or invalidity a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Question (ii): Excessive delegation of legislative powers 44. The next, but related, aspect is the excessive delegation of legislative powers. The Court finds merit in the contention of the Petitioners that ICDS notified under Section 145 (2) of the Act has the effect of modifying the basis for computation of taxable income as recognised by the Act and as interpreted by the Supreme Court. 45. For taxation purposes, profits are required to be computed as per the ICDS notified by the Central Government in exercise of the power delegated to it under Section 145 (2) of the Act as amended. For this purpose it is necessary to look at each of the ICDS which are contrary to or seek to overcome binding judicial precedents. 46. There are ten ICDS that have been notified. However, the Petitioners have focussed their challenge on some of them as will be discussed hereafter. The ICDS that have been challenged are discussed hereafter in seriatim. 47. ICDS I talks of accounting policies. It is settled law that accounting standards can ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v. Commissioner of Income Tax (supra) proceeded to observe thus: "It is true that this Court has very often referred to accounting practice for ascertainment of profit made by the company or value of the assets of a company. But when the question is whether a receipt of money is taxable or not or whether certain deductions from that receipt are permissible in law or not, the question has to be decided according to the principles of law and not in accordance with accountancy practice. Accounting practice cannot override Section 56 or any other provision of the Act. As was pointed out by Lord Russel in the case of B.S.C. Footwear Ltd (1970) 77 ITR 856, (CA), the income-tax law does not march step by step in the footprints of the accounting profession." 47.5 On the facts of the case before it, the Supreme Court concluded as under: "Whether a particular receipt is of the nature of income and falls within the charge of Section 4 of the income-tax Act is a question of law which has to be decided by the Court on the basis of the provisions of the Act and the interpretation of the term "income" given in large number of decisions of the High Courts, the Privy Council and also this court ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... all prevail to that extent." 52. Thus, it is clear that the ICDS is not meant to overrule the provisions of the Act, the Rules thereunder and the judicial precedents applicable to the provisions of the Act as they stand. As noted hereinbefore, the challenge in the present case is to a few clauses of the various ICDSs notified on 29th September, 2016 by the Central Board of Direct Taxes ("CBDT"), Department of Revenue, Ministry of Finance. ICDS I 53. This standard deals with significant accounting policies. The Petitioners contend that the concept of "prudence' has been completely done away with by the Respondents, which was present in the earlier AS - I. It is submitted that the ICDS now stipulates that prudence is not to be followed unless specified, and that this is contrary to the decisions in CIT v. Triveni Engineering & Industries Ltd (2011) 49 DTR 253 (Del) and CIT v. Advance Construction Co. Pvt. Ltd. (2005) 275 ITR 30 (Guj). 54. The stand of the Respondents is that the concept of prudence has not been done away with but has been followed on a case to case basis and cannot be dealt with generally. The justification provided is that income and losses generally have to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Supreme Court, in J. K. Industries (supra) while examining the scheme of the Companies Act, 1956 in relation to AS-22, and the rule making power of the Central Government under Section 642, held as follows: "The Companies Act has been enacted to consolidate and amend the law relating to companies and certain other associations. Under section 211(3A) Accounting Standards framed by the National Advisory Committee on Accounting Standards constituted under S. 210A are now made mandatory. Every company has to comply with the said standards.....Similarly, under Section 211(1) the company accounts have to reflect a "true and fair" view of the state of affairs. Therefore, the object behind insistence on compliance with the AS and "true and fair" accrual is the presentation of accounts in a manner which would reflect the true income/profit. One has, therefore to look at the entire scheme of the Act. In our view, the provisions of the Companies Act together with the rules framed by the Central Government constitute a complete scheme. Without the rules, the Companies Act cannot be implemented.......................................................In our view, the impugned rule/notificatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in at least two decisions referred to: CIT v. Triveni Engineering & Industries Ltd (supra) and CIT v. Advance Construction Co. Pvt. Ltd. (supra). 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. 57. There is merit in the contention of the Petitioners that ICDS I does away with the concept of 'prudence' which is present in AS1 notified under Section 145 (2) of the Act. A negative provision has in fact been made in the ICDS by stating that prudence is not to be followed unless it is specified. In its counter-affidavit, in para 6.1 (v) it is accepted by the CBDT that the concept of prudence has been done away with and has been replaced by specific aspects of prudence at the relevant p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... laid out" or "expended" for the purpose of business. The concept of prudence is inherent in this. 62. ICAI too has in para 6.9 of its Technical Guide clarified as under: "6.9 Chapter IV-D of the Income Tax Act houses Section 37 which deals with expenditure which is general in nature and not covered within sections 30 to 36. Section 37 covers expenditure laid out or expended wholly and exclusively for the purposes of the business. The phrase "laid down" connotes setting aside or storage for future. The expression "laid out" in Section 37 thus encompasses not only actual outflow of expenses but amounts parked in the present for future settlement. Accordingly, the concept of Prudence is inherent in the business income deductions." 63. Accordingly, the Petitioners are right in their contention that nonacceptance of the concept of prudence in ICDS I is per se contrary to the provisions of the Act and therefore, cannot be countenanced. ICDS II 64. ICDS-II pertains to valuation of inventories. In Shakti Trading Co. V. CIT (2001) 250 ITR 871 (SC) the Supreme Court held that on the dissolution of a firm, where the business of firm is not discontinued and is taken over by other partners ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nts by the device of notifications issued by the central government. It is an exercise of excessive delegation of legislative power which is impermissible in law. ICDS III 69. Turning now to ICDS-III which relates to construction contracts, para 10 thereof states that retention money would be a part of the contract and the same has to be assessed to tax based on "proportionate computation" method. This is reiterated in answer to Question No. 11 in Circular No. 10 of 2017. 70. The above justification is contrary to the law explained in the following decisions: (i) CIT v. Simplex Concrete Piles India (P) Ltd (1988) 179 ITR 8 (ii) CIT v. P & C Constructions (P) Ltd (2009) 318 ITR 113 (iii) Amarshiv Construction (P) Ltd v. DCIT (2014) 367 ITR 659 and (iv) DIT v. Ballast Nedam International (2013) 355 ITR 300 which followed the decision in Anup Engineering Limited v. CIT (2000) 247 ITR 114. 71. All the above decisions hold that the retention money does not accrue to an Assessee until and unless the defect liability period is over and the Engineer-in-Charge certifies that no liability is attached to the Assessee. 72. The ICST Committee noted what was sought to be done by the Tax A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng costs to be capitalised on that asset shall be the actual borrowing costs incurred during the period on the funds so borrowed." 76. 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 (1999) 236 ITR 315 wherein it was held that if an Assessee receives any amounts which are inextricably linked with the process of setting up of its plant and machinery, such receipts would go to reduce the cost of its assets. Plainly therefore, to the extent that ICDS III is interpreted and applied in a manner contrary to the law settled by the various decisions of the Supreme Court and the High Courts, it cannot be sustained. ICDS IV 77. ICDS-IV pertains to revenue recognition. It deals with the basis for recognition of revenue arising in the course of the ordinary activities of a person from: (i) the sale of goods; (ii) the rendering of services; (iii) the use by others of the person's resources yielding interest, royalties or dividends. 78. The challenge by the Petitioners is to the paragraphs 5, 6 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Government, it would amount to giving a complete go by the rule of law and would tantamount to alleging that the Government would not abide by its law, is not convincing at all. As far as the accrual of income is concerned, Sections 4 and 5 of the Act governs. The law as explained by the Supreme Court in Excel Industries (supra) is that until and unless the right to receive accrues in favour of the Assessee no income can be said to have accrued. 82. AS-9 permits the completed contract method in specified circumstances. Para 7.1 of the AS-9 issued by the ICAI permits a person to follow proportionate completion method or completed service contract method without any qualification. Paras (i) and (ii) of AS-9 describes the functioning of the prescribed methods. Whether there is only a single act in performance of service contract or more than one act, a person can follow either of two methods. The AS issued by ICAI are not binding on all categories of the Assessee, firms etc. Therefore, Assessees are free to follow any method of accounting. 83. The proportionate completion method as well as the contract completion method have been recognized as valid method of accounting under mercan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vious year in which such debt or part thereof becomes irrecoverable and it shall be deemed that such debt or part thereof has been written off as irrecoverable in the accounts for the purpose of this clause." 86. In its counter-affidavit the Respondent has clearly explained this aspect in the following manner: "The Petitioners completely ignore the fact that this very provision of the ICDS have been given approval by the highest legislative body, i.e., the parliament by making an amendment to Section 36(1) (vii) of the Act with effect from 1.4.2016 by FA 2015. The Petitioners for furthering their point have erroneously mentioned that the Second Proviso to section 36(1) (vii) casts an additional burden on the Assessee prove that the debt is established to have become due. In fact, a provision which is for the benefit of the Assesses is being projected to be a provision which is against the interests of the Assessee. The ICDS does not in any way wish to alter the well laid down principles of real income by the Hon"ble Supreme Court, but is actually ensuring that there is a trace available of the income which is foregone on this concept. Therefore, if there is an interest income wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n has been taken for capital purposes. ICDS VI is therefore contrary to the decision in Sutlej Cotton Mills Limited v. CIT (supra). 90. ICDS-VI states that marked to market loss/gain in case of foreign currency derivatives held for trading or speculation purposes are not to be allowed. This is not in consonance with the ratio laid down by the Supreme Court in Sutlej Cotton Mills Limited v. CIT (supra), insofar as it relates to marked to market loss arising out of forward exchange contracts held for trading or speculation purposes. 91. In Circular No. 10 of 2017 an answer to Question No. 16 the CBDT has clarified that Foreign Currency Translation Reserve Account balance as on 1st April 2016 has to be recognized as income/loss of the previous year relevant to the AY 2017-18. The losses/gains arising by valuation of monetary assets and liabilities of the foreign operations as at the end of the year cannot be treated as real income. It is only in the nature of notional or hypothetical income which cannot be even otherwise subject to tax. ICDS VII 92. ICDS VII pertains to government grants which have to be recognized as income. It provides that recognition of government grants canno ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y notify the change in rates of depreciation etc. Some of the impugned ICDS, to the extent discussed hereinbefore, however do not merely clarify the existing law. Some of them mandate the applicability of accounting principles, contrary to what is recognised by the Act, for the purpose of computation of income. 98. As already concluded, if the ICDS is permitted, in exercise of the delegated power of the central government under Section 145 (2) of the Act, to override a governing principle recognised by the Act or the Rules or judicial precedents, it would be ultra vires the Act. It would then render the ICDS as an instance of excessive delegation of essential legislative functions. The books of account prepared on the basis of a valid accounting method can be rejected by an AO for not complying with the ICDS. This virtually permits an AO to disregard binding judicial precedents. 99. The cases cited at the bar on behalf the Respondents deal with the permissible limits of legislative power. In Harishankar Bagla v. State AIR 1954 SC 465 the Supreme Court upheld the validity of a particular provision of the Essential Supplies Act since the said Act was an emergency measure and was in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pplication to the case on hand. (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. (supra). 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 as explained ..... X X X X Extracts X X X X X X X X Extracts X X X X
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