In the year 2012, the then Government had introduced retrospective amendments to the Indian Income- tax Act in order to nullify the decision rendered by the Apex Court in the case of Vodafone International Holdings B.V. vs Union of India with regard to taxation of indirect transfer of shares.
The decision to reverse the decision of the Apex Court did not go down well with taxpayers at large. However, the practice of reversing judicial decisions seems to have become a norm. In the last budget, several direct tax judgements were overruled or impacted by the Finance Act 2017. This year too, the Finance Bill 2018, has once again proposed to nullify the ruling of the Hon’ble Delhi High Court rendered on the validity of Income Computation and Disclosure Standards (ICDS) notified by the Central Board of Direct Taxes. Further, enacting the proposed provisions pertaining to ICDS would also result in nullifying several Apex and High Court rulings which have laid down certain guiding principles in connection with the provisions of the Income-tax Act.
Income Computation and Disclosure Standards or ICDS as it is more popularly known in tax parlance were notified by the CBDT and were made applicable to taxpayers having business income and income from other sources from 1 April 2016. The taxable profits of such taxpayers are now required to be determined after making appropriate adjustments to the financial statements – prepared either under existing AS or Ind AS to bring them in conformity with ICDS.
Given that ICDS requires the taxpayer to make certain adjustments to arrive at the taxable income and were also not in line with several Apex and High Court judicial precedents, the Chamber of Tax Consultants filed a writ petition before the Delhi High Court challenging the notification on ICDS. It was argued that the effect of ICDS was to modify the basis of taxation and that they are contrary to settled law.
The Delhi High Court pointed out that there are several binding judicial precedents which have settled principles in connection with interpretation and explanation of statutory provisions of the Act. It was held by the High Court that the powers of the Central Government to notify ICDS is restricted to the extent that binding judicial precedents are not overruled.
Proposed Amendments in the Finance Bill 2018
In order to overcome the decision of the Hon’ble Delhi High Court and the principles laid down by the Apex and High Court decisions, it has been proposed in the Finance Bill 2018 to amend the provisions of the Act to bring the same in sync with ICDS. The key proposed amendments in connection with ICDS are:
– Marked to market losses / other expected losses: ICDS provides that marked to market loss or expected loss be allowed only if the loss is recognized in accordance with the provisions of specified ICDS. The ICDS pertaining to foreign currency loss/ gain did not allow marked to market losses/ gains in the case of foreign currency derivatives held for trading or speculative purposes. As this was contrary to the Apex Court decision in the case of Sutlej Cotton Mills Ltd., the ICDS was struck down as ultra vires by the Delhi High Court.
The Finance Bill, 2018 proposes to insert an amendment which provides for allowability of marked to market loss or other expected loss as computed in accordance with ICDS. Further, it is also proposed that no deduction or allowance be allowed in respect of any marked to market loss or other expected loss, except as allowable under the proposed provisions stated earlier.
– Valuation of Inventory: In a scenario of dissolution of a firm, where the business is not discontinued, it was held by the Apex Court in the case of Shakti Mills Ltd. that the stock-in-trade of the firm can be valued at cost or market value whichever is lower. However, ICDS II sidestepped the decision of the Apex Court and provided that stock-in-trade would have to be valued at market price, even in a scenario where the business continues. This was struck down by the Delhi High Court decision.
An amendment has been proposed which provides for valuation of inventory at cost or net realizable value (“NRV”) computed in accordance with ICDS. Here, it is interesting to note that the issue pertaining to dissolution of partnership firm has not been specifically dealt with in the proposed amendment. Hence, it may be possible to argue that the decision of the Apex Court still holds good and in cases where business is not discontinued, the stock-in-trade could be valued at cost or market value whichever is lower.
– Foreign currency gains or losses: A new section is proposed to be inserted in the Income-tax Act to provide that gain or loss arising due to changes in foreign currency rates is to be treated as income or loss. The gain or loss is required to be computed in the manner provided in the ICDS.
It is proposed to take into consideration effect of changes of all foreign currency transactions including monetary and non-monetary items, translation of financial statements of foreign operations, forward contracts and foreign currency translation reserves.
– Construction contracts:ICDS III provides for recognition of revenue on the basis of Percentage of Completion Method. Further, retention money is to be considered as part of the contract. It also does not allows reduction of incidental income from contract cost.
The above provisions of ICDS are contrary to various judicial precedents including Apex Court’s judgement in the case of Bokaro Steel Limited. The Finance Bill, 2018 has proposed to insert an amendment which is in line with ICDS III. Thus, the settled position will been changed by way of proposed amendment.
– Export incentives:ICDS IV requires the taxpayer to recognise income from export incentives in the year in which its ultimate collection is reasonably certain. This is contrary to the Apex Court decision in the case of Excel Industries Ltd. wherein it was held that it is only in the year in which the claim is accepted by the Government that a right to receive the payment accrues in favour of the taxpayer. The Para pertaining to taxability of export incentives was struck down by the Delhi High Court.
It has now been proposed to amend the Act to tax the export incentives as income of the previous year in which reasonable certainty of its realisation is achieved.
– Government Grants:ICDS VII provides that recognition of government grants cannot be postponed beyond the date of actual receipt. As the provisions were in conflict with the accrual system of accounting, the same was stuck down by the Delhi High Court.
The proposed amendment to the Income-tax Act now deems government grants to be the income of the previous year in which it is received, if not offered to tax in earlier years.
Conclusion
Looking at the proposed amendments, in a bid to give sanctity to the provisions of ICDS, the Government is proposing to overrule several judicial precedents. However, it may be noted that the Delhi High Court decision had also observed that a competent legislature could make a validation law to override judicial precedents by removing the defect pointed out by the precedents.
Given that it is proposed to give the provisions of ICDS legal certainty by amending the Act, once approved, the proposed amendments will become the law of the land and hence, going forward, these amended provisions would need to be factored while computing taxable income.
Information for the editor for reference purposes only
Authors:- Rajiv Bajoria is a Partner with Deloitte Haskins and Sells LLP, Fiona Rodrigues is a Senior Manager with Deloitte Haskins and Sells LLP & Neeraj Bajaj is a Deputy Manager with Deloitte Haskins and Sells LLP
25 FAQs on Income Computation and Disclosure Standards (ICDS)
