History – So far:
Under section 145(1) of the Income Tax Act, 1961 (the Act), the taxpayer can follow either mercantile or cash system of accounting for computing income chargeable under the head ‘profits and gains of business and profession’ or ’income from other sources’. Under section 145(2) of the Act, the government had also been empowered to notify Accounting Standards (AS). The government had notified the following two AS:
Considering the adoption of International Financial Reporting Standards (Ind-AS) and requirement of harmonisation of AS issued by the Institute of Chartered Accountants of India (ICAI), the Central Board of Direct Taxes (CBDT) had constituted the AS Committee with the following objects:
The aforesaid Committee had issued draft of 14 Tax AS and recommended to notify the same for the purposes of computation of taxable income. Several representations were made against the draft Tax AS on the grounds that the same is in conflict with certain well established principles.
Introduction of ICDS
Section 145(2) of the Act was subsequently amended by Finance (No. 2) Act, 2014 to empower the government to notify Income Computation and Disclosure Standards (ICDS). The CBDT circulated a draft of 12 ICDS for comments from stakeholders and public. After a lot of deliberations and considerations, 10 ICDS were notified by CBDT on 31 March 2015. These ICDS were applicable to all taxpayers following mercantile system of accounting for the purpose of computation of income under the heads of ‘Profits and gains of business / profession’ and ‘Income from other sources’ with effect from Assessment Year (AY) 2016-17.
Representations were again made to the CBDT stating that certain clauses of ICDS may require amendment/ clarification for proper implementation and accordingly the matter was referred to an expert committee. The committee recommended a two-fold approach for the smooth implementation of ICDS, which is as under:
Consequently, the applicability of ICDS was deferred by a year, certain amendments were carried out in the ICDS and FAQs were issued to clarify certain aspects based upon the representations received from the stakeholders and public.
Various representations were also made to the government challenging the constitutional validity of ICDS from time to time. Also, a writ petition was filed by the Chamber of Tax Consultants seeking ruling on the constitutional validity of the ICDS. The Delhi High Court recently pronounced a ruling on the writ petition striking down some of the ICDS in entirety and certain provisions of some ICDS.
Ruling of High Court
The ruling of the High Court on the ICDS is based on the following questions raised in the writ petition:
Key findings of the ruling pronounced by the Delhi High Court are as under:
A. Delegation of essential legislative functions
The High Court stated that the government, as a delegate of the legislature, has powers to notify ICDS but it cannot bring about changes to settled principles laid down in judicial precedents, which provide guidance to interpret the statutory provisions. Accordingly, the power to enact validation law can be carried out only through amendments in the Act by the Parliament and cannot be delegated and carried out by an executive.
A reference was also made to Article 265 of the Constitution which states that no tax shall be levied or collected except under the authority of law. It has been, accordingly, held that if such a power is permitted to be exercised by delegation then it would clearly be an instance of unfettered power in the hands of executive which is unguided and uncanalised.
B. Excessive delegations of legislative powers
The High Court also found merit in the contentions that ICDS notified under the Act has an effect of modifying the basis of computation of taxable income as recognized by the Act and interpreted by Supreme Court. Accordingly, the High Court considered it necessary to look at each of the ICDS which are contrary to, or overcoming binding judicial precedents and gave its key findings on each of the ICDS, which are as summarized below:
|I – Accounting Policies||Struck down in entirety||ICDS I does away with the concept of ‘prudence’ and accordingly was found contrary to the Act as well as binding judicial precedents.|
|II – Valuation of Inventory||Struck down in entirety||ICDS II eliminates distinction between “continuing partnership business after dissolution” and “discontinued upon dissolution” for valuation of inventory. It fails to acknowledge that the inventory at market value upon settlement of accounts of the outgoing partner is distinct from valuation of inventory in the books of business which is continuing. Accordingly, the same is contrary to the decision of Supreme Court wherein the aforesaid approach has been analysed and accepted.
|III – Construction Contract||Para 10(a) to certain extent||Para 10(a) of ICDS III dealing with taxability of retention money requires the determination of income on a case to case basis by applying principles of accrual of income. The same is contrary to the settled position in various rulings wherein it has been held that the receipt of retention money is uncertain/ conditional and accordingly, the same is taxable when the conditions attached thereto are satisfied.
|Para 12 of ICDS III read with Para 5 of ICDS IX||Para 12 of ICDS III dealing with borrowing costs provides that no incidental income can be reduced from borrowing cost. The same is contrary to the decision of Supreme Court wherein it was held that if a taxpayer receives any amounts which are inextricably linked with the process of setting up of its plant and machinery, the same would go to reduce the cost of its assets.
|IV – Revenue Recognition||Para 5||Para 5 of ICDS IV provides for recognition of income from export incentive in the year of making claim if reasonable certainty of ultimate collection exists. The same is contrary to the decision of Supreme Court wherein it was held that it is only in the year in which the claim is accepted by the government that right to receive the payment accrues in favour of the taxpayer and the corresponding obligation to pay arises in the hands of the government.
|Para 6||Para 6 of ICDS IV allows only proportionate completion method. The same is contrary to the decisions of Supreme Court and Delhi High Court which recognized both the methods proportionate completion and contract completion as valid method of accounting under the mercantile system of accounting.
|NA||Para 8(1) of ICDS IV provides that interest shall accrue on time basis determined by the amount outstanding and the rate applicable. The same was found to be in line with the provisions of the Act and not in contradiction to any judicial precedent. Accordingly, the same is held to be not ultra vires the Act.
|VI – Changes in foreign exchange rates||Marked-to-market loss on forward exchange contract held for trading or speculation purposes
|ICDS VI provides that marked-to-market loss on forward exchange contract held for trading or speculation purposes is not to be allowed as a deduction. The same is contrary to the decision of Supreme Court.|
|VII – Government grants||Postponement of Government grants beyond actual receipt date||ICDS VII does not allow recognition of government grants to be postponed beyond the date of actual receipt. Accordingly, income has to be recognized on receipt basis even if the same has not been accrued. The same is in conflict with the accrual system of accounting.
|VIII – Valuation of Securities||Part A – to the extent applicable to the entities not governed by the Reserve Bank of India (RBI)||In case of entities not governed by the RBI to whom Part A of ICDS VIII is applicable, the accounting that has been prescribed by ICDS is different than as prescribed AS by ICAI. The same would require maintenance of separate records for income tax purposes. Accordingly, to this extent Part A of ICDS VIII is held to be ultra vires the Act and is struck down.
C. Constitutional validity of ICDS
The High Court held that in order to maintain its constitutionality, the power of the government shall need to be restricted to notify ICDS that do not seek to override binding judicial precedents or provisions of the Act.
In order to bring certainty on the issue of applicability of ICDS, the Finance Minister has proposed to bring certain provisions of ICDS under the purview of the Act itself. The rationale to propose the amendment related to ICDS was that large number of taxpayers have already complied with the provisions of ICDS for the purpose of computing income for AY 2017-18. In order to regularise the compliance with the notified ICDS by a large number taxpayers so as to prevent any further inconvenience to them, the amendments have been proposed retrospectively with effect from AY 2017-08.
Key amendments proposed in the Budget 2018
The key amendments proposed in the Budget 2018 relating to ICDS are summarized as under:
|Nature of Item||Particulars||Proposed amendment
|Marked-to-Market Losses||Marked-to-market Loss or other expected loss
|Deduction shall be allowed only if it is computed in the manner provided in ICDS|
|Changes in foreign exchange rates||Gain or loss on changes in foreign exchange rates||Any gain or loss arising on account of changes in foreign exchange rates in respect of specified foreign currency transactions shall be treated as income or loss, which shall be computed in the manner provided in ICDS
|Construction Contract||Profit from a construction contract or a contract for providing services||Profit shall be determined on the basis of percentage of completion method except for certain service contracts
|Valuation of Inventories||Inventory of goods||At lower of actual cost or net realizable value computed in the manner provided in ICDS
|Valuation of purchase and sale of goods or services or of inventory||Adjusted to include the amount of any tax, duty, cess or fee actually paid or incurred by the taxpayer to bring the goods or services to the place of its location and condition as on the date of valuation
|Valuation of Securities||Securities, Unlisted or Listed but not quoted, on a recognised stock exchange||At actual cost initially recognised in the manner provided in ICDS|
|Listed securities||At lower of actual cost or net realisable value in the manner provided in ICDS (the comparison of actual cost and net realisable value shall be done category-wise)|
|Compensation / Enhanced Compensation||Interest received on compensation or on enhanced compensation
|Deemed to be the income of the year in which it is received|
|Escalation of a of price / export incentives||the claim for escalation of price in a contract or export incentives
|Deemed to be the income of the previous year in which reasonable certainty of its realisation is achieved (in line with the provisions of ICDS IV)|
|Subsidy / Grant / Cash incentive / duty drawback / waiver / concession / reimbursement||Assistance in the form of subsidy or grant or cash incentive or duty drawback or waiver or concession or reimbursement||Deemed to be the income of the previous year in which it is received, if not charged to income tax for any earlier previous year (in line with ICDS VII)|
The journey of ICDS has been an interesting roller coaster ride – first introduced, then deferred, then partly struck down by Delhi High Court and now with a re-birth under the Act, that too with retrospective effect from AY 2017-18.
The taxpayers who have already filed their returns of income in line with the Delhi High Court ruling not considering ICDS, may need to analyse the need to revise the return of income for AY 2017-18.
 Shakti Trading Co. v. CIT (250 ITR 871) (SC)
 CIT v. Simplex Concrete Piles India (P) Ltd (179 ITR 8), CIT v. P & C Constructions (P) Ltd (318 ITR 113), Amarshiv Construction (P) Ltd v. DCIT (367 ITR 659), DIT v. Ballast Nedam International (355 ITR 300) and Anup Engineering Limited v. CIT (247 ITR114)
 CIT v. Bokaro Steel Limited (236 ITR 315) (SC)
 CIT v. Excel Industries Limited (358 ITR 295) (SC)
 CIT v. Bilhari Investment Pvt. Ltd. (299 ITR 1) (SC)
 CIT v. Manish Buildwell Pvt. Ltd. (245 CTR 397) and Paras Buildtech India Pvt. Ltd. v. CIT (382 ITR 630)
 Sutlej Cotton Mills Limited v. CIT (116 ITR 1) (SC)
Author Deepa Bakhru is Senior Manager with Deloitte Haskins & Sells LLP.