Impact of section 145A of the Income Tax Act, 1961 on a non-scheduled Bank [Part – II]
The author has already authored part one on this subject with a link at Impact of sec 145A on baking sector, no less than a surgical strike ?
It is more on the issue of validity of retrospectivity. It also covers the issue as to how the banks may respond to this legislative amendment.
Facts
The Assessee is a co-operative society engaged in the business of banking having Banking license from Reserve Bank of India. It is not a scheduled bank. For at least last 7-8 years, the Bank is treating securities as stock in trade for the purposes of Income Tax Act, 1961
The Finance Act, 2018 has substituted section 145A with retrospective effect from FY 2016-17. It has significant impact on the valuation of securities treated as stock in trade.
Question-:
What will be the impact of section 145A [as substituted] on the computation of taxable income of the bank whether for FY 2017-18 or FY 2016-17 or even for the earlier year(s)?
Final Opinion
In view of the analysis made by us, it is reasonably possible to have two views about validity of retrospective amendment of the legislative amendment.
In such a case, in view of the decision of Supreme Court in the case of Vegetable products, a view favourable to the assesse may be adopted.
The bank may also take an argument that, the section 145A(iv) is not applicable to the co-operative banks [non scheduled]
Headings in which the article is divided.
a) Only timing difference
b) Approach
c) Structure
d) Basic Observations about the legislative amendment
e) Discussion – the legislative amendment is Substantive and hence prospective
f) Comparison at “Category” level never existed
g) Decision of Essar Technologies
h) Decision of Vatika Township
i) Applying principles of Essar Technologies and Vatika Township
j) Real income vis-à-vis artificial income
k) Apparent Discrimination
l) Option to postpone losses – only for scheduled banks
m) Impact of absence of validation section
n) Alternate Harmonised Interpretation
o) Securities being the only business
p) Discussion – the legislative amendment is Curative or declaratory hence retrospective
q) ICDS / TAS existed
r) Decision of Eurotex
s) Applying principles of Eurotex
t) Retrospectivity Qua FY 2017-18
u) Applicability of section 145A to a co operative Bank.
v) In any case, revenue neutral ?
w) Tax planning – response to the legislative amendment for 2018-19
Only timing difference
It may have potential impact on the method of valuation of securities treated as stock in trade.
It is a matter of timing difference because it relates only to valuation of securities held as stock in trade. Once the security is sold, the difference in the carrying value and the sale proceeds will get chargeable to tax.
At the outset, one thing should be noted that this phenomenon giving rise to tax impact is more of a timing difference i.e. it will / may change the assessment year in which and what portion of profit / loss on sale of securities held as stock in trade will be taxed.
It does not have a permanent difference i.e. making a permanent difference in the income as per books of account and income as offered to tax.
Approach
Before going into the nuances of section 145A with a parallel amendment to section 36(1) and 40A of the Act [hereinafter referred to as “the legislative amendment”], we thought it fit to determine following questions namely;
- Validity of retrospective enforceability or otherwise.
- Applicability of section 145A(iv) to a co-operative Bank
Structure
We firstly compiled the material relevant to form an opinion on the question posed before us.
The opinion is divided into two broad parts namely
- Application of principles of law to the legislative amendment
- Material relied upon [given by way of attachment]
The portion of the text of legislative enactment and / or judicial pronouncement relied upon is reproduced in Italics. The Emphasis by way of underline or Bold is ours.
The fiscal statutes, besides having economic purpose, also have social and political purposes. The interpretation of judiciary is also influenced by the objective of the legislation.
We have taken up four judgements, three of Supreme Court and one of full bench of Delhi High Court in recent past. In these judgments, the higher courts have discussed the principles for bringing a legislative enactment with retrospective effect and have applied the same to varied situations.
On application of our knowledge and / or wisdom gained from information collected in this regard, we have observed that it is possible that there can be two diametrically opposite views both being equally authentic.
Basic Observations about the legislative amendment
Before we start the exercise of application of the principles of law, let’s firstly read the section as it stood before the amendment and after the amendment.
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Section 145A as it stood before the legislative amendment is referred to as Old section 145A. |
Section 145A as it stood after the legislative amendment is referred to as New section 145A. |
|
Old section 145A started with non-obstante clause. |
New section 145A does not have non obstante clause but is independent of section 145. |
| Old section 145A allowed the method regularly adopted by the assesse. It also did not make any separate provision for securities treated as stock in trade |
New section 145A draws a cross reference to ICDS. It specifically makes specific provisions for some aspects of valuation of securities treated as stock in trade which will over ride ICDS. |
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It was sufficiently elastic to consider situations like stock of firm under dissolution or to incorporate the judicial pronouncements in this regard which still hold the field. |
It does not make any exception to situations like stock of firm under dissolution. Additionally it over-rides all the judicial precedents in this regard. |
|
New section 145A does not necessarily refers to definitions as per ICDS and thus there is a difference in the definitions referred to in ICDS vis-a-vis those referred to in the section. |
Discussion – the legislative amendment is Substantive and hence prospective
Comparison at “Category” level never existed
Delhi High Court, in no uncertain terms has pronounced ICDS to be ultra-virus. Going by the decision of Smt. Godavari Dei Saraf, when there is only one decision on a specific issue of a high court [jurisdictional or otherwise], every authority below high court is obliged to respect it.
Valuation of inventories including valuation of securities treated as stock in trade at lower of cost and net realisable value on an individual item basis was an accepted and settled principle as per various High court and Supreme Court Judgements.
The ICDS itself has stated that, in case of a clash, the provisions of Act will prevail over the provisions of the ICDS.
Thus on first principles itself, there was no case that ICDS had changed the point of comparison between cost and net realisable value from item level to category level.
Alternatively, Delhi High Court has held that, this portion of ICDS VIII amounts to excessive delegated legislation and hence ultra-virus.
Thus before an amendment by the Finance Act, 2018, the law of comparison of cost and net realisable value at categorywise level never existed.
Decision of Essar Technologies
The question was in relation to measurement mechanism of expenditure relatable to exempt income as referred to in section 14A prescribed vide rule 8D.
The Rule 8D was introduced with retrospective effect giving the measurement mechanism.
Decision of Vatika Township
A proviso was inserted to section 113 charging surcharge with retrospective effect.
The surcharge was on the tax unearthed vide a search i.e. it was for tax evaders.
Applying principles of Essar Technologies and Vatika Township
The respective amendments were held to be substantive and hence can only have prospective effect.
Real income vis-à-vis artificial income
The only pursuit of ITA, 1961 is to tax income and in absolute sense, the real income. While so doing, law in its wisdom, at times, provides for taxation of artificial situations, some of which are as follows.
Gift received by assessees in certain cases, to the extent provided for u/s 56(2)(vii).
Loans & Advances given by company taxed as deemed dividend [sec 2(22)(e).
Difference between stamp duty value and consideration in the agreements relating to transfer of land and building, etc. etc. [sec 50C].
Law can certainly provide for certain mechanisms for taxing artificial streams of income, but, settled wisdom is that, same can’t be done on a retrospective basis.
Valuating stocks / inventories at lower of cost or NRV is a well-accepted principle in accounting as well as under tax laws and thus it is also well accepted norm for calculation of real income.
Partially, the same gets disturbed when, category-wise valuation methodology is imposed on an assessee, as so in the present case.
Any such artificial income necessitates a corresponding amendment to section 2(24) i.e. inclusive definition of income. The Finance Act, 2018 has made a corresponding amendment in respect of “valuation of inventory” at the instance of conversion of stock in trade into a capital asset to section 2(24) but not in respect of section 145A.
It is pertinent to note the words of Justice Patanjali Sastri in the case of Sir Kikabhai Premchand which still holds the field in the matter of taxable income from artificial valuation.
Apparent Discrimination
Refer first proviso to section 145A(iv);
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“,—
…
…
(iv) the inventory being securities other than those referred to in clause (iii), shall be valued at lower of actual cost or net realisable value in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145:
Provided that the inventory being securities held by a scheduled bank or public financial institution shall be valued in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145 after taking into account the extant guidelines issued by the Reserve Bank of India in this regard:
Provided further that the comparison of actual cost and net realisable value of securities shall be made category-wise.
First proviso is applicable to specified banks to whom part B of ICDS – VIII is applicable. But an Act will prevail on rules and ICDS has the same status as that of Rules.
RBI guidelines as far as valuation of securities are concerned, are uniform for all banks, whether a scheduled bank or a co-operative bank. Thus this tax treatment is discriminaroty.
Secondly, it itself is a question as to what is the exact meaning of the phrase “the extant guidelines issued by the Reserve Bank of India in this regard”. Does it means that the “extant” guidelines should be read into the Act as it forms part of the Act?
AS per relevant RBI guidelines, the securities are required to be bifurcated into following categories but they very ,much remain under the heading “investment” only whereas section 145A(iv) is applicable only for securities treated as stock in trade.
Thus a question may arise as to whether there are any extant guidelines of RBI that will be of any relevance. But if this method of interpretation is adopted, it will make the proviso infructuous and this is definitely not the intention of the legislation.
Option to postpone losses – only for scheduled banks
Refer circular of RBI in this regard RBI/2017-18/147 DBR.No.BP.BC.102 /21.04.048 /2017-18 dated April 2, 2018.
It gives scheduled Banks and banks whose time and demand deposits were less than Rs. 100 crores[later another circular was issued], an option to postpone the losses for one quarter of FY 2017-18 to FY 2018-19.
This quarter is nothing but the last quarter i.e. quarter ending March 31, 2018 and this facility is not available to co-operative banks. Also the legislative amendment came to be effective with President’s assent on 28-Nov-2018 and above mentioned circular was issued on 3-4 April 2018
Impact of absence of validation section
Validation section is not mere a formality but is a powerful expression of parliament. As noted, there is no validation section congruent to section 145A.
Alternate Harmonised Interpretation
Also the memorandum to finance Bill, 2018 explains rationale behind making this amendment being retrospective.
In order to bring certainty in the wake of recent judicial pronouncements on the issue of applicability of ICDS, it is proposed to —
(v) amend section 145A of the Act to provide that, for the purpose of determining the income chargeable under the head “Profits and gains of business or profession,—
(a)…
(b) ….
(c) ..
(d) ..
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.
Thus a harmonized interpretation may be that, if the following twin conditions are followed, the amendment is retrospective.
for those who have followed the ICDS over judicial pronouncements, which have been held contrary to law by Delhi High Court in the case of Chamber of Tax Consultants AND
it is causing inconvenience to those assesses,
As informed, the assesse does not fit in condition (a) referred to above
An amendment can be declaratory or curative in nature only when there existed an ambiguity / error / mistake which is being mis-used or which needs a correction.
Thus there was no ambiguity / error / mistake regarding how comparison of cost and net realizable value be made.
In the absence of any error or ambiguity, the amendment has to be treated as substantive and thus prospective in nature.
Securities being the only business
If one considers that, trading in securities is the only business of an entity.
In that case, when it is notified on 28-Mar-2018, it practically will leave no room for the assesse to encash the virtual profit chargeable to tax.
Whether in such a case, the assesse is expected to make a forced sale of securities to pay the taxes rather than to pay taxes on virtual unrealized profit?
Discussion – the legislative amendment is Curative or declaratory hence retrospective
ICDS / TAS existed
We may note a point that, what is being taxed is a portion of real profit and not an artificial profit. The bank is definitely in a position to encash the same. At the most one may say that, the same is getting taxed before it is realized.
Mark to market concept is a settled one and there is only a change in method of measurement i.e. from individual script basis to category basis.
IF one looks at the history of ICDS or even TAS for that matter, there was a clear intention of legislature to bring standards to regulate computation of income.
Even Delhi HC in the case of Chamber of Tax Consultants has upheld the overall legality of notifying ICDS but with a rider that it cannot exceed the limits of delegated legislation.
In a nutshell, the Delhi High Court has observed that, a notification being a delegated legislation cannot bring about substantial changes especially contrary to settled judicial precedents.
Thus in this case, one may conclude that the Government has a right to decide the tax laws but not through the delegated legislation but will require parliamentary wisdom.
Decision of Eurotex
On a broad basis, the underlying facts in the case of Eurotex are the same. In Eurotex, a benefit was granted to units in backward areas by way not collecting and therefore none payment of sales tax.
The Government had an intention to put restriction on the benefit and thus an administrative circular was issued to that effect.
Bombay High Court quashed the same as it exceeded the limits of delegated legislation.
Later the legislation of Government of Maharashtra brought a retrospective amendment with a validation act to give effect to curtailment of the benefit.
The harshness of this amendment is much higher than the amendment under consideration. The unit holders were prohibited at that time to collect tax and after 5 years, a liability was imposed on them.
Applying principles of Eurotex
In the case before us, there is only a change in the year in which the profit will be taxed alongwith the manner of computation. This change in method of comparison does not amount to increase in the total quantum of profit / (loss] chargeable to tax.
Regarding prudence of this amendment, there was a need to align the method of valuation of securities treated as stock in trade in line with the method as prescribed by RBI and which is being computed to arrive at real income as per Books of Account.
Supreme Court in the case of Eurotex has heavily relied upon judgement of R.C. Tobacco (P) Ltd and has concluded as follows
It would also be pertinent to point out that in R.C. Tobacco (P) Ltd. case, this Court authoritatively pronounced the fact that the dealer upon whom the tax is imposed is not in a position to pass on tax on the consumers, is of no relevance to the competence of the legislature. Following observations in this behalf may be noted:
….
49. We are not in a position to determine the disputes raised. However, we cannot lose sight of the fact that although excise duty like other indirect taxes may be passed on to the customer of the goods under the law as it now stands, it is the manufacturer of the excisable goods to whom the Excise Authorities will look for payment.
How the manufacturer will adjust its liability with its customers does not concern the respondents nor can they be asked to recover their dues from persons who may have ultimately taken over the responsibility to pay the excise duty as a result of an agreement with the manufacturer. (See in this connection State of Rajasthan v. J.K. Udaipur Udyog Ltd. [(2004) 7 SCC 673] SCC at p. 692.)”
Retrospectivity Qua FY 2017-18
The phenomenon that the bill received assent of president on 28-Mar-2018 and the assesse did not get any meaningful opportunity to respond to the said amendment may not save the assesse.
Taxation is a matter of policy and in this case, the amendment alongwith the purpose was tabled on 1-Feb-2018. The assesse had a period of 2 months. There is a proposition that one can not rely only on the Bill unless it gets converted into an Act. But it will not dilute the fact that the assesse had at least information to believe and quantify the impact thereof.
Secondly, the prejudice that may cause is interest u/s 234C. There are provisions in the Act itself to remove this prejudice
In view of above discussion, there is always a case to treat this amendment as curative to rectify the defect of bringing the change by way of delegated legislation that requires parliamentary wisdom.
Once an amendment is being treated as curative, it will definitely have a retrospective effect.
Applicability of section 145A to a co operative Bank.
On perusal of the same, none of the above ICDS is applicable to the Bank. IF we read section 145A in a para-phrased manner, it will be as follows;
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 bankers
(iii) the inventory being securities not listed on a recognised stock exchange, or listed but not quoted on a recognised stock exchange with regularity from time to time, shall be valued at actual cost initially recognised in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145;
(iv) the inventory being securities
other than those referred to in clause (iii),
shall be valued at lower of actual cost or net realisable value
in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145:
Provided that the inventory being securities held by a scheduled bank or public financial institution shall be valued in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145 after taking into account the extant guidelines issued by the Reserve Bank of India in this regard:
Provided that the comparison of actual cost and net realisable value of securities shall be made category-wise.
Explanation 1.—For the purposes of this section, any tax, duty, cess or fee (by whatever name called) under any law for the time being in force, shall include all such payment notwithstanding any right arising as a consequence to such payment.
Explanation 2.—For the purposes of this section, “recognised stock exchange” shall have the meaning assigned to it in clause (ii) of Explanation 1 to clause (5) of section 43.
The bank does not have securities mentioned in clause(iii). Thus the cumulative conditions to fall within the clause (iv) can be read as follows;
|
(iv) the inventory being securities other than those referred to in clause (iii), |
– Complied |
| shall be valued at lower of actual cost or net realisable value – |
– Complied |
|
in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145: – |
there is no corresponding ICDS |
One may conclude that, as all the conditions are not complied with, the clause (iv) is not applicable.
Alternatively, there is a case that second proviso is applicable only to cases where first proviso is applicable.
The reason that one is inclined to think on above lines is that, even the memorandum says that this amendment is to bring the position that persisted and which was disturbed by Delhi High Court Judgment.
The erstwhile ICDS also was not applicable to a co-operative bank that is not a scheduled bank. It is not a drafting error but a conscious decision of legislation not to make this applicable to co-operative banks [ non scheduled].
In any case, revenue neutral?
Let’s assume that the amendment is indeed retrospective and is applicable to a co-operative Bank as well.
As noted in facts, it is a matter of timing difference because it relates only to valuation of securities held as stock in trade. Once the security is sold, the difference in the carrying value and the sale proceeds will get chargeable to tax.
This question is especially important because the holding period of the banks may extend from 5 to 7 years as the banks are under obligation to maintain a certain percentage of their deposits being invested into specified Government securities.
Needless to say, one income will be taxed only once. Being an amendment passed in March 2018, there is no question of charging interest or penalty on or before March 31, 2018. The liability will fall due as on 1-April-2018.
The interest u/s 234C will get triggered on or after 1-April-2018. The question is only pertaining to which assessment year the tax should be paid.
Tax planning – response to the legislative amendment for 2018-19
The banks may sell all the securities that are in loss [only for tax planning purposes because generally a banker is interested in showing higher profits] and re-purchase perhaps the same securities so that the portion of loss which may not be available by way of reduction in value of securities will get realised and question of deductibility will not arise.
This measure can be compared with the response strategy adopted by banks as a response to section 14A where the securities giving exempt income were sold in entirety at the time of year end and re-purchased at the beginning of the year just to get out of rule 8D.
Alternatively, the bank may sell all the securities that are in profit, realise the gain and re-purchase perhaps the same securities so that the portion of gain on which the bank is paying taxes is at least realised and not a notional one.
Download reference material on Impact of section 145A on a non-scheduled Bank [Part – II]
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