ANALYSIS OF DELHI HIGH COURT DECISION ON CONSTITUTIONAL VALIDITY OF ICDS December 10, 2017 Presentation by: Abhitan Mehta
Background Income Tax Act Section 145(1) method of accounting cash or mercantile Section 145(2) empowers Central Government to notify ICDS. Section 145(3) empowers Assessing Officer to do a best judgement assessment. CTC - Pune - Seminar 2
Background ICDS 10 ICDS were notified vide Notification No. S.O.3079 (E) dated September 29, 2016. CBDT Circular 10/ 2017 dated 23 March 2017 addressed several issues in form of FAQs ICAI Technical Guide on ICDS July 2017 CTC - Pune - Seminar 3
Controversy What is authoritative hierarchy of ICDS in case of a conflict? 1 st ICDS v. Income Tax Act Preamble of each ICDS In the case of conflict between the provisions of the Act and this ICDS, the provisions of the Act shall prevail to that extent. 2 nd ICDS v. Income Tax Rules FAQ 4 of CBDT Circular - In case of conflict, if any, between the provisions of Rules and ICDS, the provisions of Rules, which deal with specific circumstances, shall prevail. CTC - Pune - Seminar 4
Controversy (Cont ) 3 rd ICDS v. Supreme Court / High Court decision ICDS silent CBDT Circular FAQ No. 2 The ICDS have been notified after due deliberation and after examining judicial views for bringing certainty on the issues covered by it. Certain judicial pronouncements were pronounced in the absence of authoritative guidance on these issues under the Act... Since certainty is now provided by notifying ICDS under section 145(2), the provisions of ICDS shall be applicable to the transactional issues dealt therein in relation to assessment year 201718 and subsequent assessment years. CTC - Pune - Seminar 5
Controversy (Cont ) 3 rd ICDS v. Supreme Court / High Court decision (Cont...) ICAI Technical Guide (Para 15 at Page 15) Three buckets (i) amendment in the Act; (e.g. amendment to the definition of income) Act will prevail (ii) commercial accounting; (e.g. ICDS IV mandates % completion method for service providers) - ICDS will prevail (iii) interpretation of tax law; (e.g. point of accrual of income, nature or receipt capital v. revenue) Court decision will prevail CTC - Pune - Seminar 6
Controversy (Cont ) 3 rd ICDS v. Supreme Court / High Court decision (Cont...) Delhi High Court The Chamber of Tax Consultants v. Union of India Paragraph 102 (ii) of the order The ICDS is not meant to overrule the provisions of the Act, the Rules there under and the judicial precedents applicable thereto as they stand. {Also Para 37 & 52 of the Order} CTC - Pune - Seminar 7
Issues General Accounting Principles Delhi High Court Paragraph 38 & 39... The power under Section 145 (2) of the Act cannot permit changing the basic principles of accounting that have been recognized in the various provisions of the Act... changing the method of accounting for computation of taxable income, would partake of an essential legislative function.... However, where the notified AS or as in this case the ICDS, seeks to alter the system of accounting, or taxing treatment to a particular transaction, then it will require the legislature to step in to amend the Act to incorporate such change. CTC - Pune - Seminar 8
Issues ICDS I Prudence A.S. recognises the concept of prudence. ICDS I provides that expected losses or mark-to-market losses shall not be recognised unless permitted by any other ICDS. Court Ruling CIT v. Triveni Engineering & Industries Ltd [2011] 49 DTR 253 (Del) and CIT v. Advance Construction Co. Pvt. Ltd. [2005] 275 ITR 30 (Guj). Department Prudence to be followed only in specific situation and not generally. Delhi High Court (para 61 to 63) Prudence embedded in S. 37(1). CTC - Pune - Seminar 9
Issues ICDS II Dissolution Sakhti Trading Co. v. CIT (250 ITR 871) (SC) On dissolution of firm even if the business is continued Inventory to be valued at cost or market value whichever is lower. ICDS II On dissolution of firm even if the business is continued Inventory to be valued at Market Value. Delhi High Court Section 145A will govern valuation of inventory irrespective of ICDS. (para 67) ICDS II cannot override binding judicial precedent. (para 68) CTC - Pune - Seminar 10
Issues ICDS III Retention Money Various High Courts Retention Money does not accrue to an Assessee until and unless the defect liability period is over and Engineer-in-Charge certifies that no liability is attached to the Assessee. ICDS III Retention Money is taxable in proportion to the work done. Delhi High Court The treatment to retention money will have to be determined on a case to case basis by applying settled principles of accrual of income. (Para 74) CTC - Pune - Seminar 11
Issues ICDS III Incidental Income CIT v. Bokaro Steel Limited (236 ITR 315)(SC) Receipt which are inextricably linked with the process of setting up of its plant and machinery, should be reduced the cost of such asset. ICDS III Receipt in the nature of interest, dividend or capital gain not to be reduced. Delhi High Court Contrary to Supreme Court ruling, cannot be sustained. (Para 76) CTC - Pune - Seminar 12
Issues ICDS IV Export Incentive CIT v. Excel Industries Limited (358 ITR 295) (SC) Export incentive is taxable in the year in which claim is accepted by the Government. ICDS IV If there is reasonable certainty export incentive taxable in the year of raising the claim. Delhi High Court Not consistent with the law explained by the Supreme Court. (Para 80) As far as the accrual of income is concerned, Sections 4 and 5 of the Act governs. (Para 81) CTC - Pune - Seminar 13
Issues ICDS IV Service Provider A.S. permits completed contract and % completion method for recognition of revenue by service provider. CIT v. Bilahari Investment Pvt. Ltd. (299 ITR 1) (SC) permits recognition of revenue on completed contract method. ICDS IV mandates % completion method for service providers. Delhi High Court Contrary to the decisions (Para 83) CTC - Pune - Seminar 14
Issues ICDS IV Interest ICDS IV mandates recognition of income on time basis. Department 36(1)(vii) has been amended; Objective to get information and keep track; Recognised as income and allowed expense in the same year; There is no enlargement of scope of income. Delhi High Court The reasoning of department is logical and petitioner has pointed out no contrary judgement. (Para 87) CIT v Vasisth Chay Vyapar Ltd. (330 ITR 440) (Del HC) Where recovery of inter corporate deposits (ICD) itself had become doubtful, the interest thereon could not be said to have accrued to the assessee. CTC - Pune - Seminar 15
Issues ICDS VI Forex Foreign Exchange Gain/Loss distinction capital v. revenue (Sutlej Cotton Mills Limited v. CIT (116 ITR 1) (SC)) (para 89) Recognition of MTM Gain/ Loss on derivative contract for trading or speculation to be permitted. (para 90) The losses/gains arising by valuation of monetary assets and liabilities of the foreign operations as at the end of the year cannot be treated as real income. (para 91) CTC - Pune - Seminar 16
Issues ICDS VII & VIII ICDS Government Grant to be recognised on receipt. Delhi HC Contrary to accrual system of accounting. (Para 93) ICDS VIII Bucket approach for valuation of securities held as stock-in-trade. Delhi HC Different approach at different places (ICDS II & ICDS VIII); maintain separate records can be done by the legislature. (para 96) CTC - Pune - Seminar 17
Constitutional Validity of S. 145(2) Background 3 Wings Legislature (Parliament) Judiciary (Courts) Executive (e.g. CBDT) Challenge Delegation of essential legislative function CTC - Pune - Seminar 18
Constitutional Validity of S. 145(2) Delhi High Court (Para 42, Para 43 and Para 101) Principles of Validation Law it is only a competent legislature that can make a validation law to override judicial precedents and that too by actually removing the defect pointed out by such precedent. Such a power is not available to the executive.... If Section 145 (2) of the Act as amended is not so read down it would be ultra vires the Act and Article 141 read with Article 144 and 265 of the Constitution.... 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. CTC - Pune - Seminar 19
Way Forward Impact on issues not dealt by Delhi High Court. Example Interest accrues on coupon date - DIT v. Credit Suisse First Boston (Cyprus) (Ltd. 351 ITR 323) (Bombay HC); Borrowing Cost Own Funds u/s 36(1)(iii) - CIT v. Reliance Utilities & Power Ltd. (313 ITR 340) (Bombay HC) (debatable)... etc. Delhi High Court decision binding on other Jurisdictions? Kusum Ingots and Alloys Ltd. vs. Union of India [2004]120 Comp Cas 672 (SC) File revised return? CTC - Pune - Seminar 20
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