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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 ..... ament 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. 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, ICDS-II, Paragraph 10(a) & 12 of ICDS-III, para 5, para 6 & para 8(1) of ICDS-IV, ICDS-VI, ICDS-VII and Part-A of the ICDS-VIII failed to pass the test of judicial scrutiny. Specific ICDS as noted have been struck down as ultra vires the Act, the impugned notification Nos. 87 and 88 dated 29th September 2016 and Circular No. 10 of 2017 issued by the CBDT are also held to be ultra vires the Act and struck down as such. - W.P.(C) 5595/2017 & CM APL 23467/2017 - - - Dated:- 8-11-2017 - S. MURALIDHAR PRATHIBA M. SINGH JJ. Petitioners Through: Mr. S. Ganesh, Senior Advocate with Mr. Prakash ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... organization formed inter alia (i) to spread education in matters relating to tax laws and other laws and accountancy; and allied subjects of professionals' interest (iii) to carry on activities for the extension of knowledge in the fields of tax laws and other laws, accountancy and allied subjects of professionals' interest (iv) (e) to make representations to any government or non - government authority, committees, commissions and study teams, or at conferences or similar gatherings (iv) (l) to seek representation and appear before the other tax law enforcement authorities, tribunals and courts in matters of public interest and in cases of importance to professionals and Assessees in general, including taking up and pursuing public interest litigations. 4. Petitioner No. 2, Mr. C.S. Mathur, is stated to be a qualified Chartered Accountant (CA) practising in the area of Direct Tax Laws for the last 40 years. He is stated to be the Past Chairman of the Delhi Chapter of Petitioner No. 1. 5. The CBDT has been impleaded as Respondent No. 2 and the Union of India through the Department of Revenue, Ministry of Finance is Respondent No. 1. 6. Notic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In terms of the said amendments, an Assessee had to follow either the mercantile or cash system of accounting. The Central Government was empowered to notify in the Official Gazette, from time to time, the accounting standards (AS) to be followed by any class of Assessees or in respect of any class of income. The amended Section 145 of the Act fell in Chapter XIV which deals with the Procedure for Assessment and read as under: 145. Method of accounting (1) Income chargeable under the head Profits and gains of business or profession or Income from other sources shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the Assessee. (2) The Central Government may notify in the Official Gazette from time to time accounting standards to be followed by any class of Assessees or in respect of any class of income. (3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the Assessee, or where the method of accounting provided in sub-section (I) or accounting standards as notified under sub-section (2)) have not been re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... No. 1 also highlighted the fallacies concerning each of the Tax ASs. 15. After almost two years, i.e., in July 2014, an amendment was made to Section 145 of the Act by the Finance (No. 2) Act, 2014. The amended Section 145 reads as under: Section 145: Method of accounting (1) Income chargeable under the head Profits and gains of business or profession or Income from other sources shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the Assessee. (2) The Central Government may notify in the Official Gazette from time to time income computation and disclosure standards to be followed by any class of Assessees or in respect of any class of income. (3) Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the Assessee, or where the method of accounting provided in sub-section (I) has not been regularly followed by the Assessee, or income has not been computed in accordance with the standards notified under sub-section (2), the Assessing Officer may make an assessment in the manner provided in section 144. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome Tax Simplification Committee (ITSC) in the notified ICDS for clarification in respect of the representations received from the stakeholders and general public. The second reason was to make revisions in the Tax Audit Report for ensuring compliance with the provisions of the ICDS and for capturing the disclosures mandated by the ICDS. Impugned notifications and circular 20. Following the above, the CBDT issued two further notifications in the Official Gazette on 29th September 2016: (i) Notification No. 86/2016 [S.O. 3078 (E)] dated 29th September 2016 rescinding Notification No. 32/2015 [S.O. 892(E)] dated 31 st March 2015 (ii) Notification No. 87/2016 [S.O. 3079(E)], dated 2nd September, 2016 notifying the ten ICDS applicable from assessment year 2017-18 onwards. 21. By a separate notification No. 88 of 2016 dated 29th September 2016, the CBDT in exercise of the powers conferred by Section 44AB read with Section 295 thereof, further substituted the existing sub-clause (d) to Clause 13 in the Form No. 3CD, in Part B of the Tax Audit Report, with sub-clauses (d) and (e), so as to reflect the adjustments required to be made to the profit or loss, as the ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the enabling Act. It must be specifically conferred by the enabling Act. It must thereafter be exercised within the strict limits of the authority conferred by such Act. Further, it is well settled that no tax, fee, or compulsory charge can be imposed by any bye-law, rule or regulation or notification unless the statute under which the subordinate legislation is made, specifically authorizes such imposition. (v) The impugned notification notifying ICDS is contrary to the settled law since its implementation would nullify the judgments of the Supreme Court and the High Courts. Reference was made to the various judgments which would now stand virtually inapplicable on account of the ICDS. It was clarified by the CBDT itself that in the case of conflict between the provisions of the ICDS and the Act, the provisions of the Act shall prevail. Consequently, with the ICDS being made mandatory it was no longer open to an Assessee to compute taxable income in terms of the Act as explained by the judgments of the Supreme Court and High Courts. This method of overriding the binding decision of Courts by the executive was contrary to the law explained in Shri Prithvi Cotton Mills Limit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e was shifted from 1st April 2015 to 1st April 2016. Mr. Jain does not dispute that ICDS is applicable only to the Assessees following the mercantile system. Mr. Jain pointed out that the amendment to Section 145 was aimed to codify the law and give complete guidance to the Assessee to ensure that if they follow the guiding principles, then the AO has no option but to accept it. There should be no reason why an attempt to codify standards for computation of income for greater clarity and to act as a check on the powers of the AO should be objected to. 26. Mr. Jain referred to the decision of the Supreme Court in Subhash Photographics v. Union of India 1993 Suppl (3) SCC 323 and submitted that a distinction had to be drawn between taxing statutes and other statutes. He also referred to R.K. Garg v. Union of India (1982) 1 SCR 947 , where it was observed that every legislation particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method and therefore, it cannot provide for all possible situations or anticipate all possible abuses. Reliance was placed on the decision in Union of India v. Azadi Bach ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s? Whether the impugned ICDS are contrary to the settled law as explained in various judicial precedents and are, therefore, liable to be struck down? (iii) 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? Question (i): Delegation of essential legislative functions 30. The substitution of Section 145 with an amended version by the FA 1995, with effect from 1st April 1997, was intended to restrict the options available to an Assessee following a system of accounting other than mercantile or cash. The legislature felt the need to provide accounting standards for income computation. The Central Government could thus by notification in the Official Gazette notify from time to time ASs to be followed by any class of Assessees or in respect of any class of income. On 25th January 1996 the ASs of ICAI were notified by the Central Government. 31. On 7th December 2006, Ministry of Corporate Affairs ( MCA ) notified as many as 28 ASs of the ICAI under Section 211 of the Companies Act, 1956, and mandated that the same to be followed by the companies. In Ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Circular No. 10/2017 was in the form of FAQs. 35. It is unclear whether Circular No. 10 of 2017 has been issued under Section 119 of the Act. However, 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? 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) 36. From the above clarification, it is unmistakable that the ICDS is intended to prevail over judicial precedents which may be to the contrary. The question that arises is whet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... levy a rate on buildings or lands or both situate within the municipal borough. The rules under the Act applied the rates on the basis of the percentage on the capital value of lands and buildings. 41.2 Earlier in Patel Gordhandas Hargovindas v. Municipal Commissioner, Ahmedabad (1964) 2 SCR 608, the Supreme Court had interpreted the word rate to mean a tax for local purposes imposed by local authorities. The basis of such tax was the annual letting value of the lands or building ascertained by taking into account the actual rent fetched by the land or building where it is let or where it was not let, by taking into account the hypothetical tenancy and where neither method was available by applying 'suitable percentage'. Rule 350A which laid the rate on land at a percentage of the valuation based upon capital was, therefore, declared ultra vires the Act itself. 41.3 By Section 3 of the Gujarat Imposition of Taxes by Municipalities (Validation) Act, 1963 ( Validation Act ), the rates so imposed were validated notwithstanding the above judgment of the Supreme Court in Patel Gordhandas Hargovindas (supra). Section 3 of the Validation Act stated that they were not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... moved and are in fact removed and the tax thus made legal. Sometimes this is done by providing for jurisdiction where jurisdiction had not been properly invested before. Sometimes this is done by re-enacting retrospectively a valid and legal taxing provision and then by fiction making the tax already collected to stand under the re-enacted law. Sometimes the legislature gives its own meaning and interpretation of the law under which the tax was collected and by legislative fiat, makes the new meaning binding upon courts. The legislature may follow any one method or all of them and while it does so it may neutralise the effect of the earlier decision of the court which becomes ineffective after the change of the law. Whichever method is adopted it must be within the competence of the legislature and legal and adequate to attain the object of validation. If the legislature has the power over the subject-matter and competence to make a valid law, it can at any time make such a valid law and make it retrospectively so as to bind even past transactions. The validity of a Validating law, therefore, depends upon whether the legislature possesses the competence which it claims over the sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... override the basis on which the taxable income is computed. 47.1 In Tuticorin Alkali Chemicals and Fertilizers Limited v. Commissioner of Income Tax (1997) 227 ITR 172 after noticing that Section 14 of the Act lays down, for the purpose of computation of taxable income, six heads of income viz., (a) Salaries, (b) Interest on securities, (c) Income from house property (d) profits and gains of business or profession, (e) capital gains (f) income from other sources, the Supreme Court explained: The computation of income under each of the above six heads will have to be made independently and separately. There are specific rules of deduction and allowances under each head. No deduction or adjustment on account of any expenditure can be made except as provided by the Act. (emphasis supplied) 47.2 The Supreme Court in the above decision then proceeded to examine the issue of permitting the Assessee to set off its income against interest payable on capital. In this context it observed as under: It has been argued that the source from which the company has earned interest is borrowed capital. The company has to pay interest to its creditors on the same borrowed capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s, the Privy Council and also this court. It is well settled that income attracts tax as soon as it accrues. The application or destination of the income has nothing to do with its accrual or taxability. It is also well-settled that interest income is always of a revenue nature unless it is received by way of damages or compensation. 48. It is, therefore, the settled legal position 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. As pointed out by the Petitioners, 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. 49. In order to demonstrate that any change in accounting policies has to be brought about by a corresponding amendment to the Act, reference was illustratively made to Section 115 JB of the Act. That provision stipulates the adjustments be made to weed out the difference arising from the adoption of IFRS. This was to ensure that adoption of IND AS has no impact on taxation principles. This is of course, just one instance. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h generally. The justification provided is that income and losses generally have to be meted a similar treatment and preferential treatment for losses has to be given only in specific situations. Some illustrative examples have been set out to demonstrate that the concept of `prudence' continues to apply - Inventory valuation where the concept of cost or market price whichever is lower is adopted. This has been kept intact in the ICDS2. In recognizing the expected losses in case of the contract is considered, the same is also kept in ICDS 3 with the only modification that the said loss will be allowed in proportion of completion of the contract, rather than allowing the same for the unfinished portion of the contract. This was primarily for bringing horizontal equity of treating the contract profit and contract loss on the same principle. Retaining the concept of reasonable certainty of realizing the revenue in ICDS IV on revenue recognition. The losses on account of forward cover transactions in the nature of hedging (except to the extent the same pertain to highly probable or firm commitment contracts) is continued in ICDS VI. Valuation of i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act cannot be implemented.......................................................In our view, the impugned rule/notification is valid. It has nexus with the matter entrusted to the Central Government to be covered by the appropriate rules. Therefore, in our view, the impugned rule is valid as it has a nexus with the statutory functions entrusted to the Central Government which is the rule-making authority under the Act........ (emphasis supplied) 55.3 Finally, in deciding whether AS-22 were contrary to Sections 209 and 211 of the Companies Act, 1956, read with Parts I and II of Schedule VI thereto, the Supreme Court in J.K. Industries (supra) held that the impugned rules did not seek to modify the essential features of the Companies Act. The relevant portion of the judgment reads as under: In our view, paragraph 9 of AS-22 merely represents a gap-filling exercise, therefore, there is no merit in the contention advanced on behalf of the appellants that AS-22 is inconsistent with the provisions of the Companies Act including Schedule VI. It proceeds on the principle that every transaction has a tax effect. The words true and fair view in Section 211(1) connotes the wid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted 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 places in the ICDS on a case to case basis. 58. ICDS IV only provides for the concept of realizing revenue in respect of recognition of income from sale of goods and recognition of income from rendering of services under the percentage completion method. In respect of interest income, royalty income and income from rendering of services other than the one specified above, there is no such concept of reasonable certainty of realising the revenue . In response to the specific query in this regard, the CBDT has in Circular No. 10 of 2017, in answer to Question 13 stated that interest accrues on time basis and royalty accrues on the basis of contractual term and subsequent non-recovery can be claimed as deduction under Section 36 (1) (vii). Therefore, it is not correct for the CBDT to contend that the concept of reasonable certainty of realizing the revenue has been retained in ICDS IV. 59. The further averment is that the concept of prudence has been retained in ICDS X by allowing provision for further liability. This is contrary to what has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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, the stock-in-trade of the firm can be valued at cost or market value, whichever is lower. In arriving at the above conclusion, the Supreme Court distinguished the earlier decision in A.L.A. Firm (1989) 189 ITR 285 (SC) on the ground that in the case of dissolution of a partnership firm, if the business is discontinued then stock-in-trade has to be valued at market price only. However, if, on dissolution of a firm, the business is not discontinued, stock-in-trade has to be valued at cost or market value whichever is lower. 65. ICDS-II fails to take into account the two different scenarios aforementioned. It is, therefore, apparent that ICDS-II sidesteps the decision in Shakti Trading Co. (supra). The ICDS-II insists that the stock-in-trade of the firm in both scenarios would have to be valued at market price irrespective of whether the business discontinues. This would amount to taxing notional income. The counter affidavit of the CBDT states in para vi (a) that the Supreme Court in Shakti Trading Co. ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 AS proposed as ICDS as under: AS-7 is silent about treatment of accrual of income in respect of the retention money. There are some judicial pronouncements holding that the retention money is not deemed to have accrued for tax purposes. To overcome this unintended meaning, the TAS (CC) specifically provides that the retention money shall accrue to the person for computing revenue based on the percentage of completion method. 73. The stand of the Respondent seems to be that since retention money is treated as part of the revenue, it should also be considered as part of the income. The Respondent argues that it intends to bring uniformity between the accounting treatment and the tax treatment of retention money. The Respondent relies upon Rotork Controls Pvt. Ltd. v. CIT (2009) 314 ITR 62 which states that a provision for present obligations in respect of past events is allowed. 74. Paragraph 10 does not specify as to at what stage retention money would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 8(1) of the ICDS-IV. The said clauses are reproduced herein below: 5. Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim for escalation of price and export incentives, revenue recognition in respect of such claims shall be postponed to the extent of uncertainty involved. 6. Subject to Para 7, revenue from service transactions shall be recognised by the percentage completion method. Under this method, revenue from service transactions is matched with the service transaction costs incurred in reaching the stage of completion, resulting in the determination of revenue, expenses and profit which can be attributed to the proportion of work completed. Income Computation and Disclosure Standard on construction contract also requires the recognition of revenue on this basis. The requirements of that Standard shall mutatis mutandis ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ethods. 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 mercantile system of accounting by the Supreme Court in CIT v. Bilhari Investment Pvt. Ltd. (2008) 299 ITR 1 (SC). This Court too has done likewise in CIT v. Manish Buildwell Pvt. Ltd. (2011) 245 CTR 397 (Del) and Paras Buildtech India Pvt. Ltd. V. CIT (2016) 382 ITR 630 (Del). However, para 6 of ICDS-IV permits only one of the methods, i.e., proportionate completion method and therefore, it is contrary to the above decisions. 84. In ICDS-IV accrual of interest is dealt with as under:- 8. (1) Subject to sub paragraph (2), interest shall accrue on the time basis determined by the amount outstanding and the rate applicable. (2) Interest on refund of any tax, duty or cess shall be deemed to be the income of the previous year in which such interest is received. 85. This clause is applicable in myriad situations including for Banks, lenders, financial institutions, l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 which is not likely to be realised is written off by the assessee in the same very year immediately on its recognition (and even without passing through its books), then it would be first recognised as revenue and then allowed as a deduction under S. 36(1) (vii) of the Act, including in the case of NBFCs. However, in this process, the tax department would have information about the income which is so written off and keep a track of the said sum then realised. Therefore, there is no enlargement of scope of income or any deviation from the principles laid down by the Hon ble Supreme Court. 87. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 cannot be postponed beyond the date of accrual receipt. In other words, income has to be recognized on receipt basis which may not have accrued. 93. It is explained by the Petitioners 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 94. ICDS VIII pertains to valuation of securities. The method prescribed by the Reserve Bank of India (RBI) for valuation of securities is applicable only to banks, financial institutions, a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 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 intended to provide for the continuance, during a limited period, of powers to control the production, supply and distribution of, and trade and commerce in, certain commodities. The said guiding principles were discernable from the relevant tax statutes itself. 100. However, 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. As explained by the Madras High Court in CIT v. Standard Triumph Motor Co. Limited (1979) 119 ITR 573 (Mad) 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 [See Bimal Chandra v. State (1971) 81 ITR 105 (SC), Director of Inspection v. Pooranmall (1974) 96 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ck 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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