Summary of Delhi HC Judgement in Chamber of tax Consultants Vs. UOI

THE CHAMBER OF TAX CONSULTANTS & ANR. V. UOI & ANR. (Delhi High Court)

Brief Facts of the Case

• Vide notification No. 87/ 2016 dated September 29, 2016 Central Board of Direct Taxes (“CBDT”) (“Respondents”) had notified ten Income Computation and Disclosure Standards (“ICDS”) to be adopted by the taxpayers having income under the head “Profits and Gain from Business or Profession” and “Other Sources” and following mercantile system of accounting.
• Vide Notification No. 88/ 2016 of same dated, CBDT also notified certain changes Tax Audit Report in Form 3CD. Circular no. 10/ 2017 dated March 23, 2017 was also issued wherein CBDT issued clarifications to the ICDS.
• Recently, on a writ petition was filed by Chamber of Tax Consultants (“Petitioners”), Hon’ble Delhi High Court (“DHC”) struck down certain ICDS and wherever necessary, only certain paragraphs contained in the ICDS and held the notification 87/ 2016 & 88/ 2016, circular 10/ 2017 are ultra vires the provisions of Income Tax Act, 1961 (‘Act’) to that extent.
  

Contentions of Petitioners:

The petitioners put forward following contentions: –

1. Unfettered Powers to Central Govt.

• The Central Govt. (“CG”), being just a delegate of the Parliament, cannot have unfettered powers to notify ICDS modifying the basis of taxation which otherwise, if at all, can be done only by the Parliament by making amendments to the provisions of the Act. Delegation to CG and further sub-delegation to CBDT would lead to abdication of legislative powers and excessive delegation by the Parliament. Reliance was placed on Avinder Singh v. State of Punjab AIR 199 SC 321.
• It is well settled that no tax, fee or compulsory charge can be imposed by any subordinate legislation unless the statute under which it is made specifically authorizes such imposition.

2. ICDS in conflict with Judicial Precedents

• The notification notifying ICDS is contrary to the settled law since its implementation would nullify the judgements of the Supreme Court and the High Courts. This method of overriding the binding decision of Courts by the executive was contrary to law explained in Shri Prithvi Cotton Mills Limited v. Broach Borough Municipality (1969) 2 SCC 283.
• Even though CBDT itself clarified that in case of a conflict between the provisions of ICDS and the Act, the provisions of Act would prevail, yet, making ICDS mandatory no longer allows the Assessee to compute taxable income in terms of the Act as explained in the judicial precedents.

3. ICDS violative of Constitution of India

• ICDS was applicable to taxpayers following mercantile system of accounting except individuals and HUFs whose accounts are not required to be audited under Section 44AB of the Act). This would allow the assessees following cash system of Accounting to easily escape from the implications and compliance requirement of the ICDS. This is violative of Article 14 of the Constitution.
• ICDS lacked legal certainty. The vagueness or subjectivity in the ten ICDS would result in unequal and discriminatory taxation leading to unreasonable restriction on the freedom to conduct business which is violative of Article 19 (1) (g) of the Constitution.

Contentions of Respondents:

In response to the above contentions, the respondents submitted the following: –

1. Unfettered Powers to Central Govt.

• Relying upon decision placed in Sashi Prasad Barohaa v. Agricultural Income Tax Officer (1977) 107 ITR 784 (SC), the respondents submitted that “it is not unconstitutional for the legislature to leave it to the executive to determine details relating to the working of taxation laws, such as the selection of persons on whom the tax is to be laid, the rates at which it is to be charged in respect of different clauses of goods and the like.”

2. ICDS in conflict with Judicial Precedents

• Relying on Supreme court ruling in the case of Commissioner of Income Tax v. Poddar Cement P. Limited (1997) 226 ITR 625 (SC), it was submitted that doctrine of “updating construction” was to be applied, which required acknowledgment of the emergent trends in business, technology and law and the corresponding revision of the AS issued by the ICAI.
• It was denied that the computation provided under ICDS amounted to overruling the judicial precedents. It was claimed that the changes brought about are only aimed at bringing uniformity and clarity in the computation of income.
• It was submitted that where the law has itself been changed, the question of legislature overruling the judiciary did not arise.

3. ICDS violative of Constitution of India

• The respondents referred to the judgement in case of 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.”
• It is not for the Court to examine the merits or demerits of such a policy and how the provisions of the statute can best be implemented.

Ruling of the High Court

1. Unfettered Powers to Central Govt.

• HC clarifies that the amendments to Section 145 only permit the Central Government, as a delegate of the legislature, to notify standards for income computation but not to bring about changes to settled principles as laid down in judicial precedents which seek to interpret and explain statutory provisions contained in the Act. If such power is permitted to be exercised by the central government then clearly it would be an instance of unfettered power in the hands of the executive which is unguided and uncanalized.

2. ICDS in conflict with Judicial Precedents

i) ICDS I dealing with significant Accounting Policies

The HC found merit in the petitioner’s contention that ICDS I does away with the concept of ‘prudence’ which is present in AS1 notified u/s 145(2) of the Act and is thus, contrary to the Act and binding judicial decisions given in CIT v. Triveni Engineering & Industries Ltd (2011) 49 DTR 253 (Del) and CIT v. Advance Construction Co. Pvt. Ltd. (2005) 275 ITR 30 (Guj) and hence, unsustainable in law. A negative provision has in fact been made in the ICDS by stating that prudence is not to be followed unless it is specified.

CBDT has in ICDS I notified that expected losses and marked-to-market losses are not to be recognized/allowed. HC agreed with the Petitioners that the concept of prudence is embedded in Section 37 (1) of the Act which allows deduction in respect of expenses “laid out” or “expended” for the purpose of business. The concept of prudence is inherent in this.

Thus, ICDS I was held to be contrary to the provisions of the Act and was struck down as such.

ii) ICDS II dealing with Valuation of Inventories

HC referred to the judgment given by Supreme court in Shakti Trading Co. 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.

HC held that ICDS II insists on valuing the Stock-in-trade at market price and has failed to distinguish a continuing partnership business after dissolution from one in which it is discontinued upon dissolution, being contrary to the above SC decision. Thus, it is impermissible in law.

iii) ICDS III dealing with Construction Contracts

While the judicial precedents hold that the retention money does not accrue to an Assessee until and unless the defect liability period is over and the Engineer-in-Charge certifies that no liability is attached to the Assessee, Para 10 of ICDS III states that retention money would be a part of the contract and the same has to be assessed to tax based on “proportionate computation” method which is contrary to the above.

HC held that 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, the Respondents would be acting contrary to the settled position in law as explained in the judicial decisions.

HC was of the view that 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 (1999) 236 ITR 315 wherein it was held that if an Assessee receives any amounts which are inextricably linked with the process of setting up of its plant and machinery, such receipts would go to reduce the cost of its assets. Therefore, ICDS III was struck down to the extent contrary to the law settled by the various decisions.

iv) ICDS IV dealing with Revenue Recognition

Considering Para 5 of ICDS IV which 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, HC held it to be against the decision in CIT v. Excel Industries Limited (2015) 358 ITR 295 (SC), wherein, SC said 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 Assessee and the corresponding obligation to pay arises in the hands of the Government. Only in such year the income from export incentive can be said to have accrued and can be recognized as income.

HC also struck down Para 7 of ICDS IV holding that while it only recognizes “Proportionate Completion Method” for recognizing Revenue from Services, SC has recognized both proportionate completion method as well as the contract completion method as valid method of accounting under mercantile system of accounting by the in CIT v. Bilhari Investment Pvt. Ltd. (2008) 299 ITR 1 (SC) making the Para 7 of ICDS IV contrary to the above decision.

HC clarified that Para 8 of ICDS IV is not contrary to any judicial precedent and its validity is upheld.

v) ICDS VI dealing with Effects of Changes in Foreign Exchange Rates

HC struck down ICDS VI on the ground that it states that marked to market loss/gain in case of foreign currency derivatives held for trading or speculation purposes are not to be allowed. which is not in consonance with the ratio laid down by the Supreme Court in Sutlej Cotton Mills Limited v. CIT (1979) 116 ITR 1 (SC), insofar as it relates to marked to market loss arising out of forward exchange contracts held for trading or speculation purposes.

vi) ICDS VII dealing with Government Grants

HC held that ICDS VII states that recognition of government grants cannot be postponed beyond the date of accrual receipt (i.e. to be recognized on Receipt Basis, whether accrued or not), which is in conflict with the accrual system of accounting. It was struck down being Ultra Vires to that extent.

vii) ICDS VIII dealing with Valuation of Securities

HC observed that there are 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. However accounting prescribed as per AS for those entities not governed by RBI falling under Part A is different from that prescribed by ICDS VIII. 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.

To this extent Part A of ICDS was struck down as such.

viii) ICDS violative of Constitution of India

HC ruled that ,“In order to preserve its constitutionality, Section 145 (2) of the Act as amended is required to and is hereby read down to restrict power of the Central Government to notify ICDS that do not seek to override binding judicial proceedings or provisions of the Act.”