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Case Name: The Chamber of Tax Consultants & Anr. vs. Union of India & Ors., 2017
Court and order date: The Delhi High Court and order dated 08.11.2017
Petitioner: The Chamber of Tax Consultants & Anr.
Respondent: Union of India & Ors.
In the case of the Chamber of Tax Consultants & Anr. vs. Union of India & Ors. (2017), the Delhi High Court, in a judgement dated November 8, 2017, struck down parts of the “Income Computation and Disclosure Standards” (ICDS) notified by the CBDT on November 3, 2015, as violating the Income Tax Act, 1961. The order also struck down notification nos. 87 and 88 dated June 29, 2016 and Circular No. 10 of 2017 issued by the CBDT on the same grounds.
Facts of the case
- A writ petition was filed by the petitioners to get the court to declare the following as constitutionally invalid because they violate Articles 14, 19(1)(g), 141, 144, and 265 of the Constitution of India.
- the “Income Computation and Disclosure Standards” (ICDS) notified by the Central Board of Direct Taxes (CBDT) under Section 145 (2) of the Income Tax Act, 1961 (the Act).
- Circular No. 10 of 2017 issued on March 23, 2017 by CBDT provided clarifications to the notified ICDS.
- Section 145 of the Act (Substituted and amended by the Finance Acts of 1995 and 2014.
They also requested the quashing of the Notification dated September 29, 2016 and Circular No. 10 of 2017, issued on March 23, 2017.
- The notified ICDS is based on the idea that the income computed under the headings “Profits and gains of business or profession” or “Income from other sources” need not match the amount of income as shown in the books of accounts.
- The Preamble of each ICDS clearly states that the ICDS is not for the maintenance of books but only for the computation of income. The Act shall always prevail over ICDS in case of any conflict between the provisions of the two.
- But according to the Chamber of Tax Consultants (CTC), for the implementation of ICDS, an assessee needs to maintain another set of books of accounts for implementing ICDS.·
- Notifications and circulars:
- CBDT issued notification Nos. 86/2016 and 87/2016 rescinding notification No. 32/2015 and notifying 10 ICDS applicable from Assessment year 2017-18 respectively.
- CBDT, on notification no. 88/2016 dated September 29, 2016, by the powers conferred under Section 44AB read with Section 295, substituted sub-clause (d) to clause (13) in Form 3CD, in part B of the tax audit report, with sub-clauses (d) and (e) to reflect the adjustments made to profit or loss for complying with the notified ICDS.
- On a further representation by the CTC, the CBDT issued clarifications by circular no. 10 of 2017 in the form of 25 Frequently asked questions for better implementation of ICDS
- Section 145 is a part of Chapter XIV, which states the “Procedure for assessment”.
Method of accounting
- Subject to Section 145(2), an assessee can compute income under the heading PGBP or IFOS by following either the cash or mercantile system of accounting, whichever is consistently used.
- The Central Government may notify the ICDS to be followed by any assessee or for any income. (In this case, ICDS is to be followed for computing PGBP or IFOS income by assessees employing the mercantile system of accounting to maintain the books of accounts.)
- The AO may assess under Section 144 (best judgement assessment) if he is unsatisfied with the books of accounts, if the method of accounting is not regularly followed, or if the income is not computed as per ICDS provisions.
Submissions by the petitioners
- The ICDS was implemented to modify the basis of taxation by modifying the computation of income as per the provisions of the ICDS.
- The legislation has the power to amend the provisions of the Act, but in the act of delegating power to issue AS/ICDS, this legislative power has been delegated to the executive, i.e., the Central Government. This amounts to giving up powers and delegating excessively.
- Unless the enabling Act specifically confers or authorises a power to impose a tax by introducing ICDS from the mere general powers conferred on the Central Government, this is not possible.
- The ICDS notification would invalidate various judgements of the Supreme Court and other courts of India and is thus contrary to the law as concluded by these judgements. With the ICDS being mandatory, the assessee can no longer compute income as per the explanation of the Act in the judgements of the courts. This leads to overriding the binding decisions of courts, which is contrary to the law.
- An assessee following the cash system of accounting would avoid complying with the ICDS and its implications, as ICDS applies only to assessees opting for the mercantile system. There is no reasonable basis given for this differentiation. This violates Article 14 of the Constitution of India.
- The ICDS and the notifications lacked legal certainty, which would result in unequal and discriminatory taxation. This outweighs the gains of ICDS and restricts the freedom to conduct business, which makes the notifications violative of Article 19 (1) (g) of the Indian Constitution.
Submissions by the respondents
- As per the reports of the expert committee formed by the CBDT, ICDS notified under Section 145 of the Act should apply only for the computation of income, and there should not be any compulsion to maintain books following the ICDS.
- At every stage of the issuance of the ICDS, stakeholders were consulted. The amended Section 145 was aimed at codifying the law, and if followed, the AO cannot reject the books of accounts. Also, ICDS monitors the powers of the AO under Section 145(3).
- Reliance was placed on various decisions of the courts to state the following:
- It is not prohibited for the legislature, i.e., Parliament, to delegate decision-making powers on the working of tax laws.
- The doctrine of ‘updating construction’, requires acknowledging emerging trends in business, technology, and law and the need for a corresponding revision of the AS by ICAI.
- Denied that the ICDS overrides the judicial precedents and the changes are brought only to bring uniformity and clarity in the income computation.
- While the law has been changed, it is not possible for the legislature to override the judiciary.
Questions before the High Court
- Has the parliament delegated its essential legislative powers to the Central Government through the amendments to Section 145?
- Have the legislative powers been delegated excessively in the case of ICDS? Are they contrary to various judicial precedents, and should they be struck down?
- Whether the violation of Articles 14, 19 (1) (g), 141, 144, and 265 of the Constitution occurred due to the amendments to Section 145 of the Act and the issuance of the notified ICDS and Circular?
Observations and judgement of the High Court
Question 1: Delegation of essential legislative functions
The High Court observed the following before providing its ruling on the question:
- From the clarification to question 2 in Circular No. 10 of 2017, it is clear that the ICDS overrides the judicial precedents, which are to the contrary, but is this permissible in the exercise of legislative power?
- The amendments to Section 145 allow the Central Government to notify standards for the computation of income but not to change the law as concluded by the judicial precedents, as it would lead to unrestricted powers for the Central Government.
- According to Article 265 of the Constitution of India, any tax can be collected or levied only if authorised by law. The power given under Section 145 (2) cannot permit changing the recognised basic principles of accounting unless corresponding amendments are made in the Act. In case the ICDS wants to make changes to the system of accounting or tax treatment of a particular transaction, the legislation will have to first amend the act to incorporate such changes before the ICDS can instruct it to do so.
- Where there is a binding judicial precedent, under Articles 141 and 144 of the Constitution, only a competent legislature can make a ‘validation law’ to override the said judicial precedent by rectifying the defects mentioned in such a precedent. Thus, an executive cannot override a judicial precedent unless the act is amended through a validation law.
- Thus, the amended Section 145 (2) has to be interpreted to restrict the power of the Central Government to notify ICDS, which does not override the act or the judicial precedents. Not doing so would lead to Section 145 (2) violating the Act and Article 141 read with 144 and 256 of the Constitution of India.
Question 2: Excessive delegation of legislative powers
The Court found the petitioner’s contention valid as the ICDS notified under Section 145 (2) results in the modification of the basis of income computation under the act and various judicial precedents.
Accounting standards cannot dictate the basis on which taxable income is computed. The basic principles of taxation remain the same and will continue to be binding even when the ICDS is applied. Any change in accounting policies impacting the computation of taxable income has to be brought about by a corresponding change in the act for tax purposes.
The preamble of the ICDS itself clarifies that the ICDS is for the computation of income only and not for the maintenance of books of accounts, and the act shall prevail over the ICDS in case of conflicts.
It went on to further observe the following about the ICDS, which are contrary to the judicial precedents. The ICDS that have been challenged are discussed below.
- ICDS I: This standard talks about significant accounting policies. The contention here is that the “prudence” concept has been completely ignored in ICDS I, which was present in the earlier AS-I. The respondents replied that the concept of prudence has not been ignored but followed on a case-to-case basis as income and losses have to be treated similarly and preferential treatment is to be given to losses only in certain situations.
The Court ruled that the non-acceptance of the prudence concept in ICDS I contradicts the provisions of the act and is therefore unsustainable.
- ICDS II: This standard deals with the valuation of inventories. ICDS II states that the stock-in-trade of a partnership firm on the dissolution of the firm would have to be valued at the market price only, irrespective of whether its business is discontinued or continued with other partners taking over the business. It fails to acknowledge the distinction between the two scenarios, and this is contrary to the ruling in Shakthi Trading Co., by the Supreme Court. This ruling provides for the valuation of stock-in-trade at cost or market price, whichever is lower, in case the business of a partnership is continued. ICDS II amounts to taxing notional income.
ICDS II is contrary to judicial precedents and violates the Act. Thus, it is struck down.
- ICDS III: It relates to construction contracts.
- Paragraph 10(a) requires the ‘retention money’ to be taxed on the ‘proportionate computation’ method as it is a part of the contract. Various decisions of the courts mention that the retention money accrues to an assessee only after the defect liability period is over and the engineer certifies that the assessee has no liability attached. Thus, Para 10(a) overrides the decision of the courts.
As per the High Court, retention money is to be taxed differently on a case-to-case basis by following income accrual principles. ICDS III intends to tax retention money at the earliest stage possible, when even the receipt could be uncertain.
Therefore, Paragraph 10(a) of ICDS III violates judicial precedent.
- Para 12 of ICDS III, read with Para 5 of ICDS IX, states that no incidental income can be deducted or set off against borrowing costs. But the decision of the Supreme Court in Commissioner of Income Tax vs. Bokaro Steel Limited (1998) states otherwise. The decision stated that if an assessee receives any amounts that are inextricably linked with the setting up of plant and machinery, such receipts can be deducted from the cost of its assets. To that extent, Para. 12 of ICDS III cannot be sustained and is struck down.
- ICDS IV: This standard relates to revenue recognition.
- According to Paragraph 5 of ICDS IV, if the ultimate collection of income from export incentives is reasonably certain, it is to be recognised in the year of claiming. This provision is contradictory to the decision of the Supreme Court in Commissioner of Income Tax vs. Excel Industries (2013). The said decision states that only in the year on which the claim is accepted by the government does a right to receive payment accrue to the assessee, and only in that year can the export incentive be recognised as income as it is said to be accrued. So, Paragraph 5 is inconsistent with the law and violates the Act. So, it is struck down.
- Under Paragraph 6 of ICDS IV, only one method of revenue recognition, i.e., the proportionate completion method, is allowed, whereas in Commissioner of Income Tax vs. M/S Bilhari Investment Pvt. Ltd. (2008), the Supreme Court ordered that both the proportionate completion method and the contract completion method are valid under the mercantile system of accounting.
Thus, Paragraph 6 is contrary to the above decision and violates the Act. Therefore, it is struck down.
- Paragraph 8 (1), which deals with the accrual of interest, creates a mechanism for tracking unrecognised interest amounts for future liability if accrued. Since there is neither a challenge to Section 36(1) (vii) nor is it contrary to any judicial precedent, it is not said to be Ultra Vires the act or overriding any judicial precedent and is valid.
- ICDS VI: This standard deals with the effects of changes in foreign exchange rates. Marked-to-market loss/gain in the case of foreign currency derivatives held for trading or speculation purposes are not allowed as per this ICDS. It goes against the decision of the Calcutta High Court in Sutlej Cotton Mills Limited vs. Commissioner of Income Tax (1949). It is struck down because it violates the Act.
- ICDS VII: It pertains to the recognition of government grants. It requires that government grants be recognised and taxed in the year of receipt.
Certain conditions are attached to a government grant, and failing to fulfil such conditions would entail returning the grant amount received. In such a scenario, no income is said to have been accrued, even if it is received in advance. Here, ICDS VII is contrary to and conflicts with accrual principles. So, it violates the Act and is struck down.
- ICDS VIII: It relates to the valuation of securities. Part A of the ICDS deals with entities that are not guided by RBI guidelines. They have to follow accounting prescribed by the AS, which is different from the ICDS. Thus, they will have to maintain separate sets of books of accounts for every year since the closing value of securities will be valued differently for tax and accounting purposes.
This change cannot be brought about without a corresponding amendment to the act. Part A of ICDS VIII violates the act and is struck down.
Question 3: Constitutional validity of the ICDS
- Under powers conferred by Section 119 of the Act, the CBDT can clarify the law but not change it. Some of the ICDS seeks to mandate the applicability of accounting principles, which overrides the requirements of the Act for income computation.
- As concluded above, if the ICDS is permitted to override the Act, the rules, or judicial precedent, it would violate the Act and amount to an instance of excessive delegation of essential legislative functions.
- There are no guiding provisions in Section 145 (2) of the Act defining the scope and ambit of the powers delegated to the central government.
- For it to not be unconstitutional, Section 145 (2) has to be interpreted to restrict the power of the Central Government to notify ICDS, which does not override the act or the judicial precedents.
As discussed above, the High Court struck down various ICDS or parts of it to prevent it from overriding the Act or judicial precedents. It also struck down notification nos. 87/2016, 88/2016 and Circular no. 10/2017.
It is evident from the ICDS, follow-up notifications, and circulars that they meant to go beyond the powers of the act to tax incomes that were not intended to be taxed by the act. If not struck down, the ICDS would have burdened the assessees with unfair taxation. The instance of excessive delegation of legislative power is also clearly visible, which is unconstitutional and would have resulted in unrestricted power for the Central Government to exploit the taxation laws to increase tax revenue.
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