Delhi High Court strucks down seven ICDS as ultra vires with CBDT Notification Nos. 87 and 88 dated 29th September 2016 and Circular No. 10 of 2017
ABCAUS Case Law Citation:
ABCAUS 2117 (2017) (11) HC
The Challenge/Grievance:
The Petitioners had challenged 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 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].
The declaration was 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 was made for the quashing of the Notification dated 29th September 2016 and Circular No. 10 of 2017 dated 23rd March 2017.
The Substantial Questions of Law framed/urged for determination:
1. Whether the amendments to Section 145 are an instance of delegation by the Parliament of essential legislative powers to the Central Government?
2. 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?
3. 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?
Observations made by the High Court:
Question No. 1: Delegation of essential legislative functions
The Hon’ble High Court doubted that if the Circular No. 10 of 2017 had been issued under Section 119 of the Act. However, it noted that the question No. 2 in the said Circular and an answer thereto is significant and reads thus:
“Question 2: Certain ICDS provisions are inconsistent with the judicial precedents. Whether these judicial precedents would prevail over ICDS?
Answer: The ICDS have been notified after due deliberations and after examining judicial views for bringing certainty on the issues covered by it. Certain judicial pronouncements were pronounced in the absence of authoritative guidance on these issues under the Act for computing income under the head ‘Profits and gains of business or profession’ or income from other sources. Since certainty is now provided by notifying ICDS under Section 145 (2), the provisions of ICDS shall be applicable to the transactional issues dealt therein in relation to assessment year 2017-18 and subsequent assessment years.” (emphasis supplied)
The Hon’ble High Court observed that from the above clarification of CBDT, it is unmistakable that the ICDS is intended to prevail over judicial precedents which may be to the contrary.
The Hon’ble High Court opined that 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.
Question No. 2: Excessive delegation of legislative powers
The Hon’ble High Court concurred with 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.
The Hon’ble High Court opined that ICDS talks of accounting policies. It is settled law that accounting standards cannot override the basis on which the taxable income is computed. It was observed that the settled legal position is that the AS has hardly any role to play in the principles governing determination of income, which has been well settled by the provisions of the Act as well as by judicial precedents. The ASs have existed more than 35 years. However, the basic taxation principles remain the same and would remain binding even in the application of the ICDS.
The Hon’ble High Court opined 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. The Hon’ble High Court observed the challenge was to a few clauses of the various ICDSs notified on 29th September, 2016 by the Central Board of Direct Taxes (CBDT).
With respect to various ICDS, the Hon’ble High Court held as under
ICDS-I Significant Accounting Policies
Non acceptance 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 Valuation of Inventories
ICDS II is also an attempt to overreach the binding judicial precedents 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 Construction Contracts
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 Revenue Recognition
The Hon’ble High Court opined that since there is no challenge to Section 36(1) (vii), para 8 (1) ICDS-IV cannot be held to be ultra vires the Act. This is to create a mechanism of tracking unrecognized interest amounts for future taxability, if so accrued. In fact the practice of moving debts which the bank or NBFC considers irrecoverable to a suspense account is a practice which makes the organisations lose track of the same. The justification by the Respondent clearly demonstrates that this is a matter of a larger policy and has the backing of Parliament with the enactment of 36 (1) (vii). It has not been demonstrated by the Petitioner that para 8 (1) of ICDS IV is contrary to any judgment of the Supreme Court, or any other Court.
ICDS-V Effects of changes in foreign exchange rates
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 1 st 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 Government grants
The Hon’ble High Court opined that many a times, conditions are attached to the receipt of government grant, non-fulfilment of which may lead to return of such amount. In such instance, it cannot be said that there is any accrual of income although the money has been received in advance. ICDS VII however requires that amount has to be taxed in the year of receipt. This again is contrary to and in conflict with the accrual system of accounting.
ICDS-VIII Valuation of securities
It was noted that 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. This 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.
The Hon’ble High Court opined that as pointed out under the similar circumstances, ICDS II which deals with valuation of inventories does not prescribe such a ‘bucket approach‟. Thus the Respondents themselves have adopted separate approaches at different places for the purpose of valuation of securities. This change is therefore not possible to be effectuated without a corresponding amendment to the Act. To that extent Part A of ICDS VIII is ultra vires the Act.
Question No. 3: Constitutional validity of the ICDS, Circular
The Hon’ble High Court opined that in exercise of its power to issue notifications under Section 119 of the Act, the CBDT is meant to clarify the law, not change it. At the highest it can additionally notify the change in rates of depreciation etc. Some of the ICDS, to the extent discussed above 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.
The Hon’ble High Court further observed 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.
The Hon’ble High Court observed that in the present case there are no guiding principles in Section 145 (2) of the Act for the scope and ambit of the delegated power of the central government. Section 145 (1) is only an enabling provision to effectuate the statute. When the rules framed under an Act have to conform to the Act. A mere notification under Section 119 of the Act cannot go beyond the provision of the Act so as to bring to tax any income not so envisaged by the Act. That a tax cannot be levied by way of an executive action is a settled position. Tax cannot also be levied by way of administrative instructions as observed by the Supreme Court.
It was observed that in order to preserve its constitutionality, Section 145 (2) of the Act as amended is required to and is hereby read down to restrict power of the Central Government to notify ICDS that do not seek to override binding judicial proceedings or provisions of the Act.
Summary of findings:
The Hon’ble High Court summarised the findings of the judgment 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 (supra) is distinguishable in its application 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 in the decisions referred to in para 68 and to that extent para 10 (a) of ICDS III would be rendered ultra vires.
(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 (supra) and is therefore struck down.
(viii) Para 5 of ICDS-IV requires an Assessee to recognize 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 (supra), 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 recognized as valid method of accounting under the mercantile system of accounting by the Supreme Court in CIT v. Bilhari Investment Pvt. Ltd. (supra) and this Court in CIT v. Manish Buildwell Pvt. Ltd and Paras Buildtech India Pvt. Ltd. v. CIT (supra). 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 (supra), insofar 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.
Decision/ Conclusion/Held:
To the extent the specific ICDS as noted above struck down as ultra vires the Act, the notification Nos. 87 and 88 dated 29th September 2016 and Circular No. 10 of 2017 issued by the CBDT also held to be ultra vires the Act and struck down.
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