Yogesh S. Limaye

The author Discusses the impact of newly inserted section 145A on the banking sector.

In case of those banks treating their securities as stock in trade and thereby booking less loss as per RBI and more loss for income tax purposes, it is no less than a surgical strike.  

The text of important legislative enactments and judicial pronouncements is re-produced in Annexure 1.

Background-: 

a) The assesse is a Co-operative Bank having Banking license from Reserve Bank of India. It is a co-operative society formed under the Maharashtra Co-operative Societies Act, 1960.

b) The Finance Act, 2018 has made with retrospective effect from 1-4-2017 i.e. FY 2016-17 by which Section 145A [newly inserted],  section 36(1)(xviii), 40A(13) has been introduced by the Finance Act, 2018.

c) It has introduced a new method of comparison between cost and net realisable value on a category basis.

d) Thus the assesse is under dual control i.e. under

a. the Banking Regulation Act, 1949 and

b. the Maharashtra Co-operative Societies Act, 1960

e) Till FY 2016-17, the bank is treating securities as stock in trade and has conducted the valuation on cost and net realisable value whichever is lower on an item wise basis.

f) The ban has to maintain 19.5% of its deposits being invested into securities which are prescribed by the Reserve Bank of India.

Restriction on the bank 

Legislative restrictions

a. Section 24 read with section 56 of the Banking Regulation Act, 1949

b. Circular RBI/2015-16/262 DBR.No.Ret.BC.64/12.01.001/2015-16 dated December 10, 2015

c. Notification DBR.No.Ret.BC.69/12.02.001/2014-15 dated February 03, 2015 and DCBR.BPD. (PCB/RCB).Not. No. 2/16.26.000/2014-15 dated February 03, 2015,

g) The investment in prescribed securities cannot come below 19.5% of the deposits. Table – 1 gives factual situation of value of securities of the bank.

Particulars for the year ending March 31,  2016 Rs.  2017 Rs.  2018 Rs.
1A HTM-Books of account 66.00 80.00 58.00
1B HTM – Book value – Income Tax 63.00 77.00 57.00
1C HTM-Market 69.00 85.00 59.00
2A AFS-Books of account 46.00 7700 8500
2B AFS – Book value – Income Tax 45.25 77.00 83.00
2C AFS-Market 45,18 74.34 81.80

Questions 

What will be the impact of section 145A [as amended] especially second proviso thereof on the computation of taxable income of the bank whether for FY 2017-18 FY 2016-17 or even for earlier year(s)?

Findings [elaborated later]

a) The second proviso is common to section 145A and does not provide any exception based on type of bank.

b) Irrespective of whether covered by whichever ICDS, till the point the securities are being treated as stock in trade, the second proviso will still apply.

c) The definition of “category” will be governed by para 10 of the ICS – VIII – Securities.

d) Thus the valuation as at 31-3-2016 made on itemised basis or individual script wise will remain intact.

e) Category-wise sum total will be taken to compare cost and net realisable value whichever is less.

f) The legislation is well within their powers to bring the amendment with retrospective effect.

Opinion

g) The bank can take the closing value of securities as per Income Tax Act, 1961 as at 31-3-2016 as opening as on 1-4-2016.

h) The bank will have to firstly re-calculate the value of securities as at 31-3-2017 on category basis and revise the closing value of securities and the amount of loss on valuation of securities.

i) The same will act as opening value of securities as on 1-4-2017.

j) The bank will be required to pay interest u/s 234B on the incremental income tax liability for FY 2016-17 from 1-4-2018.

Suggestions

k) There will be consequential effect on deduction under clause (viia) and (viii) of section 36(1).

l) The bank may consider taking an opinion about the artificiality / absurdity.

Relevant Legislative changes

 Newly substituted section 145A in a para phrased manner.

Method of accounting in certain cases

‘145A. For the purpose of determining the income chargeable under the head “Profits and gains of business or profession”,––

 (i) …;

 (ii) …;

Relevant for a bank

(iii) the inventory being securities

which securities ?

not listed on a recognised stock exchange, or listed but not quoted on a recognised stock exchange with regularity from time to time,

method of valuation

shall be valued at actual cost initially recognised 

accounting standard 

in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145;

 Most crucial proviso

Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise.

 Explanation 1.—…

Explanation 2.—..

Finding 1 The second proviso is common to section 145A and does not provide any exception based on type of bank.

Which ICDS will apply – apparent infinite loop

Nature of Investment in the hands of the Banker 

The object of banking is to accept deposits, give loans and investment. Secondly the Bank has, in past years, treated the securities as stock in trade.

Thus making investment is integral part of the activity of the banking business and thus the securities are required to be treated as stock in trade. Refer [2014] 45 taxmann.com 13 (Pune – Trib.)/[2014] 64 SOT 90 (Pune – Trib.) – IN THE ITAT PUNE BENCH ‘A’ – Cosmos Co-op Bank Ltd. v. Deputy Commissioner of Income-tax, Circle -7, Pune

It has been succinctly explained in the case of Pune District Central Co.Op. Bank … vs Addl CIT on 28 November, 2014 by Pune ITAT A bench – ITA No.1796/PN/2013. The text is re-produced.

The above decision makes it clear that though the categories as prescribed by RBI are Held to maturity or Available for Sale, for income tax purposes, there is no such bifurcation and securities are treated as stock in trade.

If we approach ICDS – II – Valuation of inventories, it defines the applicability as follows;

Scope

1. This Income Computation and Disclosure Standard shall be applied for valuation of inventories, except:

(a) ..;

(b) …;

(c) Shares, debentures and other financial instruments held as stock-in-trade which are dealt with by the Income Computation and Disclosure Standard on securities;

(d) ..;

(e) …

Definitions

3(1) The following terms are used in this part of Income Computation and Disclosure Standard with the meanings specified:  

(a)   “Fair value” is the amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm’s length transaction.  

(b)   “Securities” shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and shall include share of a company in which public are not substantially interested but shall not include derivatives referred to in sub-clause (ia) of that clause (h).  

3(2) Words and expressions used and not defined in this part of Income Computation and Disclosure Standard but defined in the Act shall have the meaning respectively assigned to them in the Act. 

Part B

Scope

1. This part of Income Computation and Disclosure Standard deals with securities held by a scheduled bank or public financial institutions formed under a Central or a State Act or so declared under the Companies Act, 1956 (1 of 1956) or the Companies Act, 2013 (18 of 2013). 

Definitions  

2(1) The following terms are used in this part of Income Computation and Disclosure Standard with the meanings specified:  

(a)   Scheduled Bank” shall have the meaning assigned to it in clause (ii) of the Explanation to clause (viia) of sub-section (1) of section 36 of the Act.

(b)   “Securities” shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contract (Regulation) Act, 1956 (42 of 1956) and shall include share of a company in which public are not substantially interested;  

2(2) Words and expressions used and not defined in this part of Income Computation and Disclosure Standard but defined in the Act shall have the meaning respectively assigned to them in the Act.  

Apparent discrepancy in the definition 

An important contrast emerges out of proposed section definition of ‘securities’ as defined in section 145A (iii) and in para 3(1)(b) of ICDS VIII. Whereas the tax standard defines securities as defined under Securities Contracts (Regulations) Act, 1956, the definition used in the proposed section states that securities listed but not regularly quoted on a recognized stock exchange shall be covered.

Accordingly, one may infer that the bucket approach of valuation shall not apply on regularly traded listed securities. But it will defeat the purpose of the proviso and make the proviso infructuous.

Force of second Proviso 

Refer the following observation of Delhi High Court in the case of The chamber of Tax Consultants [2017] 87 taxmann.com 92 (Delhi)/[2018] 252 Taxman 77 (Delhi)/[2018] 400 ITR 178 (Delhi)/[2017] 299 CTR 137 (Delhi) 

ICDS I

 53. This standard deals with significant accounting policies. The Petitioners contend that the concept of ‘prudence’ has been completely done away with by the Respondents, which was present in the earlier AS – I. It is submitted that the ICDSnow stipulates that prudence is not to be followed unless specified, and that this is contrary to the decisions in CIT v. Triveni Engg. & Industries Ltd. [2011] 336 ITR 374/196 Taxman 94/[2010] 8 taxmann.com 146 (Del) and CITv. Advance Construction Co. (P.) Ltd. [2005] 275 ITR 30/143 Taxman 61 (Guj).

 54. The stand of the Respondents is that the concept of prudence has not been done away with but has been followed on a case to case basis and cannot be dealt with 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 ICDS-2.

  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 inventory under ICDS VIII retain the concept of cost or market price whichever is lower. The change is made primarily for taking RBI approved “bucket principle of valuation”.

  Recognizing the provisions for the future liabilities in ICDS 10.”  

55.1 Since considerable reliance has been placed by Mr. Jain on the decision in J.K. Industries Ltd. (supra), it requires to be examined in depth. There the Supreme Court was tasked with determining the validity of AS-22′ framed by the Central Government in consultation with the National Advisory Committee on Accounting Standards (‘NAC’) under Section 211 (3C) of the Companies Act, 1956. While dealing with the objective of AS-22, the SC explained:  

‘In its origin, an accounting standard is the policy document. In matters of recognition of various items of income, expenditure, assets and liabilities, the aim is to achieve standards/norms which would help to reflect a “true and fair” view of the accounts of a company………………….  

Accounting Standard are established rules relating to the recognition, measurement and disclosures thereby ensuring that all enterprises that follow them are comparable and that their financial statements are “true and fair”……………………………… ‘ (emphasis supplied)  

ICDS-VIII  

94. ICDSVIII 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, and other financial bodies regulated by the RBI. For other entities, the AS prescribes the valuation of inventories on individual basis.  

95. There are two parts of ICDS-VIII; Part A dealt with entities other than scheduled banks and public financial institutions and Part B deals with scheduled banks and public financial institutions. Under Part B, ICDS-VIII has prescribed that recognition of securities should be in accordance with the RBI guidelines. To that extent, it is consistent with the RBI norms. However, for those entities not governed by the RBI to whom Part A of ICDSVIII 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.

 96. It is pointed out that under 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. 

Finding 2 Irrespective of whether covered by whichever ICDS, till the point the securities are being treated as stock in trade, the second proviso will still apply.

Definition of “category” 

ICDS – VIII – Securities does not apply to a co-operative bank. But para 10 of the ICDS VIII – Securities gives definition of the word “category”

10. For the purpose of para 9, the comparison of actual cost initially recognised and net realisable value shall be done categorywise and not for each individual security. For this purpose, securities shall be classified into the following categories, namely:-

 (a)   shares;

(b)   debt securities;

(c)   convertible securities; and

(d)   any other securities not covered above.

 Having regard to judgement of Delhi High Court referred to above, we are not inclined to provide benefit of above mentioned discrepancy in the definition and infinite loop between which ICDS to apply.

Finding 3 The definition of “category” will be governed by para 10 of the ICDS – VIII – Securities.

Opening Balance as on 1-April-2016 

The amended section has come into force from 1-April-2016. Thus all the transactions / valuations has to be done in accordance with the amended section. Para 22 to 25 of Income Computation and Disclosure Standard II relating to valuation of inventories are relevant in this regard.

Value of Opening Inventory  

22. The value of the inventory as on the beginning of the previous year shall be  

(i) the cost of inventory available, if any, on the day of the commencement of the business when the business has commenced during the previous year; and

(ii) the value of the inventory as on the close of the immediately preceding previous year, in any other case.  

Finding 4 Thus the valuation as at 31-3-2016 made on itemised basis or individual script wise will remain intact.

Revised return / appln u/s 264 for FY 2016-17 

The banks till date would have received notices u/s 142 r.w.s 143 for FY 2016-17. Nonetheless, the banks must have received intimation u/s 143(1)(a). Also the period for filing revised return as per section 139 is also over.

In such a case, refer the decision of Bombay High Court in the case of Danny Denzongpa (Alias Tshering Pintso) v CIT dated 20th September ,2010 with WP No. 1549 OF 2010, 1550 OF 2010, 1552 OF 2010, 1554 OF 2010, 1555 OF 2010,1561 OF 2010, 1641 OF 2010, 1658 OF 2010

The text of the case is re-produced in the annexure. In substance, the judgment held that when substantial justice and technicalities are pitted against each other, substantial justice should be given a way over technicalities.

The Bank may consider making

  • a submission u/s 143 itself at the time of scrutiny assessment.
  • an application u/s 154 as mistake apparent from record
  • an application u/s 264.

Blocking other route for deduction 

Before we apply the “categorywise” rule, we need to take into consideration other amendments in section 36(1) and section 40A as follows  

A clause (xviii) is inserted with retrospective effect to section 36(1) which reads as  

“(xviii) marked to market loss or other expected loss as computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145.”.  

a sub section has been inserted (13) with retrospective effect to section 40A  

“(13) No deduction or allowance shall be allowed in respect of any marked to market loss or other expected loss, except as allowable under clause (xviii) of sub-section (1) of section 36.”. 

Mark to market means a particular phenomenon where all the closing items of a particular category are re-instated at market value irrespective of gain or loss.

Thus the legislation has ensured that any loss or depreciation arising vide reduction in value of securities treated as stock in trade will not be available as deduction under any other section.

Application of “categorywise” rule 

On a literal reading, it infers that the computation has to be firstly done by computing the market value of each of the script and then taking vertical total category-wise.

The two methods give different results with categorywise total being the same.

Name of Cost NRV Effect Cost NRV Effect Cost NRV Effect
security Year-1 Year-1 Year-1 Year-2 Year-2 Year-2 Year-3 Year-3 Year-3
S-1 100 150 100 100 200 100 100 060 60
S-2 100 080 100 100 040 100 100 050 50
200 230 200 200 240 200 200 110 110
Impact on P&L being loss NIL NIL 090

Name of Cost NRV Effect Cost NRV Effect Cost NRV Effect
security Year-1 Year-1 Year-1 Year-2 Year-2 Year-2 Year-3 Year-3 Year-3
S-1 100 150 120 120 200 160 160 060 090
S-2 100 080 080 080 040 040 040 050 040
200 230 200 200 240 200 200 110 110
Impact on P&L being loss NIL NIL 090

When the valuation is done on a category basis, some other investments will be valued at a price higher than cost because there is a set off of market price being less in respect of some securities against others.

It is so because the definition has not explicitly erased the individual identity of the security whether falling in same category or different.

To buttress the view point, please refer to the definition of “block of assets”.  

Section 2(11) “block of assets” means a group of assets falling within a class of assets comprising—

(a) tangible assets, being buildings, machinery, plant or furniture ;

(b) intangible assets, being know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature,  in respect of which the same percentage of depreciation is prescribed ;]  

Finding 5 Category-wise sum total will be taken to compare cost and net realisable value whichever is less.

Retrospective amendment 

The Finance Act, 2018 very specifically says that the provision will come into effect with retrospective effect from FY 2016-17.

Memorandum provides reason for retrospective amendment as follows

However, a large number of taxpayers have already complied with the provisions of ICDS for computing income for assessment year 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, it is proposed to bring the amendments retrospectively with effect from 1st April, 2017 i,e the date on which the ICDS was made effective and will, accordingly, apply in relation to assessment year 2017-18 and subsequent assessment years.

The difference as to at which stage the comparison of cost and net realisable value is applied i.e. whether it individual item or at category level. Can not change the character of the gain / loss.

Parliament is endowed with plenary powers of legislation, and it is competent to legislate with prospective or retrospective effect and such power to legislate retrospectively is upheld by the Courts. However, this power is subject to a caveat that such retrospective legislation should not be unreasonable.

Refer –

Ujagar Prints v. Union of India, [1989] 3 SCC 488;
National Agricultural Co-operative Marketing Federation of India Ltd. v. Union of India (2003) 260 ITR 548 SC;
Rai Ramkrishna & Ors. v. State of Bihar (1964) 1 SCC 897.

Retrospective amendments can be of following types-  

(i) to correct apparent mistakes/anomalies in the Statute

(ii)to remove technical defects, particularly in procedure, which had vitiated the substantive law

(iii) to “protect” the tax base from highly abusive tax planning schemes that have the main purpose of avoiding tax, without economic substance

(iv) to “expand” the tax base.

Retrospective amendments as mentioned at (i) & (ii) are necessary and fair as they do not create any additional burden on the taxpayer.

Retrospective amendments at (iii) above may also be justified as any avoidance of tax through exploitation of any loophole in the system means a windfall to a dishonest taxpayer at the cost of general body of the taxpayers. Refer – R v HMRC [2011] EWCA Civ 89 in respect of retrospective amendment of section 58 of UK Finance Act, 2008

However, retrospective amendment as mentioned at (iv) is against the basic tenet of the law as it affects the certainty of law.

In our opinion, the retrospective amendment falls in the category of (i) and / or (ii). It is more than apparent from judgement of Delhi High Court where it had held many of the provisions solely for the reason that, it was brought through the delegated legislation where it should have been brought by an amendment directly being made by Parliament.

Section 145A attempts to do the same thing.  

Finding 6 The legislation is well within their powers to bring the amendment with retrospective effect.

Artificiality / absurdity 

Refer the table of computation of caetgorywise cost and market value.

In view of the requirement of investing an appropriate percentage of deposits into securities, the bank has no option but to keep the amount invested. In such a case, loss in one investment is being loaded on other investment thereby indirectly increasing the price above cost.

These investments are typically the held to maturity where the market value is more than the cost. In such a case, the securities are getting valued at a price more than cost i.e. a bit of market price is getting taxed.

These are the investments which the bank has to held till maturity and on encashment i.e. maturity, the bank is eligible for face value.

In such a case, the bank will have to sale the investments on last day and mark the profit / loss being actual and re-purchase the same at market rate. Thus the actual cost of acquisition becomes equal to market value or rather net realisable value. It will be absurd situation.

The author is deeply indebted to CA. Kishor Phadke, CA. Sharad Vaze, CA. Girish Gokhale for their valuable inputs.

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