By TIOL News Service

NEW DELHI, NOV 08, 2017: THE issue is - Whether amendments to Sec 145(2) enables the Govt of India as a delegate of the legislature, to change the basic principles of accounting recognised in the various provisions of the Act. No is the verdict.

Facts of the case

The Petitioner is a society of Advocates, CAs, CSs and other professionals. It challenged the validity of the ICDS notified by the Central Government for the purpose of computing the income of Assessees following the mercantile system of accounting, taxable under the head 'Profits and gains of business or profession' or 'income from other sources'. The key premise on which ICDS is based is that the income computed for the purposes of income tax under the above two heads need not be (as is often not) the income as reflected in the books of accounts maintained by such Assessee. Although the computation of such taxable income would normally be based on the books of accounts of the Assessee, and dependant on the method of accounting followed by the Assessee subject to the adjustments for allowances and deductions under the Act, an Assessing Officer (AO) can, for the purposes of computation of the taxable income, and in exercise of the powers under Section 145 (3) of the Act, reject the books of accounts maintained by the Assessee if he is not satisfied about their correctness or completeness. In such an event the AO can resort to a 'best judgment assessment' under Section 144 of the Act.

The counsels for the petitioners argued that in the guise of delegating powers to the Central Government to issue accounting standards/ICDS, what has been effectively done is to delegate the essential legislative power to amend the provisions of the Act, especially those affecting the chargeability and computation of taxable income. The Central Government cannot be conferred with such unfettered powers by the Parliament in the guise of delegated legislation 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.

The Counsels further contended that a delegate cannot override the Act either by exceeding its authority or by making provisions inconsistent with the Act. The ICDS are not based on any policy or principle discernible from the Act and in particular Section 145 thereof. In the circumstances, such delegation to the Central Government and further sub-delegation by the Central Government to the CBDT would amount to abdication of legislative powers and excessive delegation by the Parliament.

Having heard both the parties, the HC held that,

Delegation of essential legislative functions

++ the amendments to Section 145 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;

++ Article 265 of the Constitution of India states that no tax shall be levied or collected except under the authority of law. 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 unless of course corresponding amendments are carried out to the Act itself. Such amendments would be consistent with an acknowledgment that as far as the Act is concerned, changing the method of accounting for computation of taxable income, would partake of an essential legislative function;

++ if the power to notify standards has to be exercised consistent with the recognised ASs that do not contradict any principle recognised in the Act or as explained in judicial precedents, it would be a permissible exercise of the delegated power of notifying ASs. However, where the notified AS or as in this case the ICDS, seeks to alter the system of accounting, or according 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. This may be unique to a fiscal statute like the Act. However, in the guise of a delegated power, the Central Government cannot do what is otherwise legally impermissible;

++ the system of checks and balances in the Constitution of India envisages judicial review of legislative action. Equally, it recognises the power of the legislature to enact 'validating laws' to overcome the defects (or plug the loopholes as it were) pointed out by judicial precedents;

++ 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. In other words, where there is a binding judicial precedent, by virtue of Articles 141 and 144 of the Constitution, it is not open to the executive to override it unless there is an amendment to the Act by way of a validation law;

++ to that extent, 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;

Excessive delegation of legislative powers

++ the Court finds merit in the contention of the Petitioners that ICDS notified under Section 145 (2) of the Act has the effect of modifying the basis for computation of taxable income as recognised by the Act and as interpreted by the Supreme Court;

++ for taxation purposes, profits are required to be computed as per the ICDS notified by the Central Government in exercise of the power delegated to it under Section 145 (2) of the Act as amended. For this purpose it is necessary to look at each of the ICDS which are contrary to or seek to overcome binding judicial precedents;

ICDS vis-a-vis Prudence

++ there is merit in the contention of the Petitioners that ICDS I does away with the concept of 'prudence' which is present in AS1 notified under Section 145 (2) of the Act. A negative provision has in fact been made in the ICDS by stating that prudence is not to be followed unless it is specified. In its counter-affidavit, in para 6.1 (v) it is accepted by the CBDT that the concept of prudence has been done away with and has been replaced by specific aspects of prudence at the relevant places in the ICDS on a case to case basis;

++ ICDS IV only provides for the concept of realizing revenue in respect of recognition of income from sale of goods and recognition of income from rendering of services under the percentage completion method. In respect of interest income, royalty income and income from rendering of services other than the one specified, there is no such concept of reasonable certainty of realising the revenue. In response to the specific query in this regard, the CBDT has in Circular No. 10 of 2017, in answer to Question 13 stated that interest accrues on time basis and royalty accrues on the basis of contractual term and subsequent non-recovery can be claimed as deduction under Section 36 (1) (vii). Therefore, it is not correct for the CBDT to contend that the concept of reasonable certainty of realizing the revenue has been retained in ICDS IV;

++ ICDS II is also an attempt to overreach the binding judicial precedents by the device of notifications issued by the central government. It is an exercise of excessive delegation of legislative power which is impermissible in law;

++ ICDS III is interpreted and applied in a manner contrary to the law settled by the various decisions of the Supreme Court and the High Courts, it cannot be sustained;

++ since there is no challenge to Section 36(1) (vii), para 8 (1) ICDS-IV cannot be held to be ultra vires the Act. This is to create a mechanism of tracking unrecognized interest amounts for future taxability, if so accrued. In fact the practice of moving debts which the bank or NBFC considers irrecoverable to a suspense account is a practice which makes the organisations lose track of the same. The justification by the Revenue clearly demonstrates that this is a matter of a larger policy and has the backing of Parliament with the enactment of 36 (1) (vii). The reasoning given by the Revenue stands to logic. It has not been demonstrated by the Petitioner that para 8 (1) of ICDS IV is contrary to any judgment of the Supreme Court, or any other Court;

++ ICDS-VI states that marked to market loss/gain in case of foreign currency derivatives held for trading or speculation purposes are not to be allowed. This is not in consonance with the ratio laid down by the Supreme Court in Sutlej Cotton Mills Limited v. CIT, insofar as it relates to marked to market loss arising out of forward exchange contracts held for trading or speculation purposes;

Constitutional validity of the ICDS, Circular

++ in the present case there are no guiding principles in Section 145 (2) of the Act for the scope and ambit of the delegated power of the central government. 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.

(See 2017-TIOL-2353-HC-DEL-IT)