The Delhi High Court, on Wednesday, struck down certain portions of Parts I, II, III, IV, VI, VII and VII of the Income Computation and Disclosure Standards (ICDS) and connected Notifications and circulars issued by the Central Board of Direct Taxes (CBDT).
The Bench comprising Justice S. Muralidhar and Justice Pratibha M. Singh declared certain parts of these provisions as ultra vires the parent act and various judicial precedents.
The Court was hearing two Petitions, one filed by the Chamber of Tax Consultants and the other filed by Mr. C.S. Mathur, challenging the Constitutional validity of the amended Section 145 of the Income Tax Act and the connected notifications requiring compliance with the ICDS.
The 10 Standards were notified by the Centre last year. These were challenged, contending that the ICDS intended to modify the basis of taxation. They had further contended that with the amendments, the Parliament had delegated some of its essential legislative powers relating to chargeability and computation of taxable income to the Central Government. This was challenged as impermissible.
Besides, the Petitioners had also alleged that the ICDS provisions lacked legal certainty, as they were vague and subjective. This, they said, would result in unequal and discriminatory taxation. "Maintaining one set of books of accounts for accounting purposes and another for tax purposes would create confusion, interpretation issues, multiplicity of records and additional compliance burden which would outweigh the gains of ICDS and constitute an unreasonable restriction on the freedom to conduct business. Thus, the impugned notifications were violative of Article 19 (1) (g) of the Constitution," they contended.
The Court began by examining whether the existing judicial precedents would prevail over ICDS. Answering the question in the positive, the Court observed, "The amendments to Section 145 noticed hereinbefore 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 uncanalised."
It then summarized its findings as follows:
"(i) Section 145 (2), as amended, has to be read down to restrict power of the Central Government to notify ICDS that do not seek to override binding judicial precedents or provisions of the Act. The power to enact a validation law is an essential legislative power that can be exercised, in the context of the Act, only by the Parliament and not by 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.
(ii) The ICDS is not meant to overrule the provisions of the Act, the Rules thereunder and the judicial precedents applicable thereto as they stand.
(iii) The decision in J.K. Industries Ltd. v. Union of India (supra) is distinguishable in its application to the case on hand.
(iv) ICDS I which does away with the concept of 'prudence' is contrary to the Act and binding judicial precedents and is therefore unsustainable in law.
(v) ICDS II pertaining to valuation of inventories and eliminates the distinction between a continuing partnership business after dissolution from one which is discontinued upon dissolution is contrary to the decision of the Supreme Court in Shakti Trading Co. (supra). It fails to acknowledge that the valuation of inventory at market value upon settlement of accounts of the outgoing partner is distinct from valuation of the inventory in the books of the business which is continuing. ICDS II is held to be ultra vires the Act and struck down as such.
(vi) 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, irrespective of the facts, the Respondents would be acting contrary to the settled position in law as explained in the decisions referred to in para 68 and to that extent para 10 (a) of ICDS III would be rendered ultra vires.
(vii) 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 (supra) and is therefore struck down.
(viii) Para 5 of ICDS-IV 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. This is contrary to the decision of the Supreme Court in Excel Industries (supra), and is, therefore, ultra vires the Act and struck down as such.
(ix) As far as para 6 of ICDS IV is concerned, the proportionate completion method as well as the contract completion method have been recognized as valid method of accounting under the mercantile system of accounting by the Supreme Court in CIT v. Bilhari Investment Pvt. Ltd. (supra) and this Court in CIT v. Manish Buildwell Pvt. Ltd and Paras Buildtech India Pvt. Ltd. v. CIT (supra). Therefore, to the extent that para 6 of ICDS-IV permits only one of the methods, i.e., proportionate completion method, it is contrary to the above decisions, held to be ultra vires the Act and struck down as such.
(x) Para 8 (1) of ICDS IV is not been shown to be contrary to any judicial precedent. There is also no challenge to Section 36(1) (vii) of the Act. Accordingly, para 8 (1) of ICDS-IV is held to be not ultra vires the Act. Its validity is upheld.
(xi) ICDS-VI which states that marked to market loss/gain in case of foreign currency derivatives held for trading or speculation purposes are not to be allowed, is not in consonance with the ratio laid down by the Supreme Court in Sutlej Cotton Mills Limited v. CIT (supra), insofar as it relates to marked to market loss arising out of forward exchange contracts held for trading or speculation purposes. It is, therefore, held to be ultra vires the Act and struck down as such.
(xii) ICDS VII which provides that recognition of government grants cannot be postponed beyond the date of accrual receipt, is in conflict with the accrual system of accounting. To that extent it is held to be ultra vires the Act and struck down as such.
(xiii) ICDS VIII pertains to valuation of securities. For those entities not governed by the RBI to whom Part A of ICDS VIII is applicable, the accounting prescribed by the AS has to be followed which 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. To this extent Part A of ICDS VIII is held to be ultra vires the Act and is struck down as such.