Simplify Corporate Income Tax-Concept paper

Complexities of taxation of income of corporates
Taxation of companies under the Income-Tax Act,1961 is riddled with  too many complexities , exemptions and provisions that give rise to artificial income such as sections 30 to 43B.  In case of companies, we have the unique spectacle of two sets of computations:

(A)One for Minimum Alternate Tax (MAT) based on book profits determined with reference to Accounting Standards notified under the Companies Act and 

(B)Another based on regular income-tax provisions riddled with exemptions and complexities giving rise to artificial income and with reference to Income Computation and Disclosure Standards notified under the Income-Tax Act,1961. The ICDS are a poor copy of the AS

Then the corporates have to pay the higher of (A) and (B). If (A) happens to be greater than (B), the difference is a MAT credit carried forward and set off in those years when (B) exceeds (A)

In Chamber of Tax Consultants vs. Union of India [2017] 87 taxmann.com 92 (Delhi), the Delhi High Court held that section 145 (2) of the Income-Tax Act,1961, 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 articles 144 and 265 of the Constitution.The ICDS is not meant to overrule the provisions of the Act, the Rules thereunder and the judicial precedents applicable thereto as they stand. Further, the Delhi High Court struck down various ICDSs as ultra vires to the extent indicated below  

• 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.
• 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 Shakthi 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.
• 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. (vi) Para 12 of ICDS III read with para 5 of ICDS IX, dealing with borrowing costs, which makes it clear that no incidental income can be reduced from borrowing cost. This is contrary to the decision of the Supreme Court in Bokaro Steel Ltd. (supra) and is therefore struck down.
• 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 Ltd. (supra), and is, therefore, ultra vires the Act and struck down as such.
• 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 Bilhari Investment (P.) Ltd. (supra) and this Court in Manish Build Well (P.) Ltd. and Paras Buildtech India (P.) Ltd. (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
• 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. (x) 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. (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
• ICDS VII which provides that recognition of government grants cannot be postponed beyond the date of accrual receipt, being 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.
• 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.
• To the extent the specific ICDS as noted hereinbefore have been struck down as ultra vires the Act, the impugned notification Nos. 87 and 88 dated 29-9-2016 and Circular No. 10 of 2017 issued by the CBDT are also held to be ultra vires the Act and struck down as such

Accounting Standards notified under the Companies Act-nature and role
The Ministry of Company Affairs(MCA) has notified Accounting Standards under the Companies Act,2013. Every company is required to prepare its accounts in accordance with these Accounting Standards which have statutory force. The Accounts are required to be audited by qualified professionals (CAs) who have to satisfy statutory norms of independence and have to conduct audit in accordance with auditing standards notified under the Companies Act . Further, the National Financial Reporting Authority (NFRA) is to be set up which will not only play an advisory role in setting accounting standards and auditing standards but also oversee compliance with norms by companies and audit firms. Even with all these, one arm of the Government(CBDT) is not prepared to trust the financials determined in accordance with Accounting Standards notified by the other arm(MCA). The pre-tax book profit is not accepted as the taxable income This makes a mockery of the Standards.This is akin to a Govt issuing Rupee currency which citizens will use to transact but Government itself will accept payments from citizens in say US Dollars.

There is inadequate appreciation of what the Accounting Standards are despite the Supreme Court having elucidated their nature and role in J.K. Industries Ltd. v. Union of India [2007] 80 SCL 283 (SC). The Court held as under:

• In its origin, an accounting standard is a policy document.
• In matters of recognition of various items of income, expenditure, assets and liabilities, the aim is to achieve standards/norms which would help to reflect true and fair view of the accounts of a company.
• AS are established rules relating to recognition, measurement and disclosures thereby ensuring that all enterprises that follow them are comparable and that their financial statements are true and fair. 
• The core of Accountancy is Book-keeping. 
• The rules of Book-keeping are clear.
• For example, the value of a fixed asset mentioned in a Balance Sheet is based on cost which may involve subjective estimation of the amount to be apportioned.
• Similarly, the quantum of depreciation is again an estimate, which can vary depending on the persons preparing the accounts as to when and at what stage he wants to record the depreciation.
• Accounting Standards are an attempt to overcome some of these deficiencies of accountancy.
• Accounting Standards involve codification of fundamental accounting rules, rules which explain and standardize the application of the fundamental rules to a variety of uncertain situations like retirement, contingencies, intangibles, consolidation, merger, etc.
• Accounting Standards basically attempt to reduce the subjectivity and lay down rules so as to arrive at the best possible estimates. 
• For example, net assets refer to the difference between total assets less liabilities but the value attributable to each asset and each liability is often subjective. It depends on estimates. This is where the Accounting Standards help. They reduce the subjectivity. Therefore, Accounting Standards help to arrive at the best possible estimates. 
• The object of Accounting Standards is to standardize and to narrow down the options (in accounting policies).
• The object of Accounting Standards is to evolve methods by which accounting income is determined.
• The object behind the Accounting Standards is to evolve methods by which accounting income is determined, made more transparent and leave less and less room for subjective selection of methods and provide for more attention to the quality of estimates used in arriving at accounting income

The role of Accounting Standards vis-à-vis determination of taxable income was explained by the Court in  J.K. Industries Ltd.(supra) as under:

• Accounting income is the real income.
• Tax laws lay down rules for valuation of inventories, fixed assets, depreciation, bad debts, etc., based on artificial rules and not on the basis of accounting estimates, which results in mismatch between accounting and taxable incomes.
• For example, a fixed rate of depreciation may, for some companies, result in computing lower than the actual income if the actual erosion in the value of the asset is lower than the depreciation calculated at the fixed rate and higher than actual income for others where assets erode faster.
• Accounting income is normally used as a relevant measure by most stakeholders.
• However, on account of artificial set of rules used in computation of taxable income one finds that accounting income differs from taxable income.
• Looking to these problems, the evolution of Accounting Standards and their greater application is necessary as it results in reducing the need for tax laws to depend upon artificial rules.
• The main object sought to be achieved by Accounting Standards which is now made mandatory is to see that accounting income is adopted as taxable income and not merely as the basis from which taxable income is to be computed.
• Thus, if the rules by which inventories are to be valued are laid down in the Accounting Standards and are followed in the determination of accounting income, then tax laws do not need to lay down the rules and the tax authorities do not need to examine the computation of the value of inventories and its effect on computation of income. 
• Similarly, if there is an accounting standard on depreciation which requires estimation of the useful life and prescribes the appropriate method for apportionment of cost of fixed assets over their useful life, it is unnecessary for tax laws to apply an artificial rule to decide the extent of allowance for depreciation.
• Finally, the adoption of Accounting Standards and of accounting income as taxable income would avoid distortion of accounting income which is the real income. Lastly, it is important to note that Accounting Standards and taxation of income are two independent subjects.
• The object behind AS is to remove this divergence by making accounting income a taxable income.

New Income-Tax Act for corporates-Convergence of taxable income and pre-tax profit determined as per Accounting Standards
Taking a cue from the Supreme Court's exposition of the nature of Accounting Standards, a beginning to modernise and simplify income-tax law can be made by delinking income-tax on corporates from the Income-Tax Act,1961 and enacting a new law (say Corporate Taxation Act,2016 ). The contours of the new law should be as under: 

• Levy income-tax with reference to pre-tax book profits  as per audited accounts determined in accordance with the Accounting Standards.  
• The only adjustments to be made should be for transfer pricing adjustments for related party transactions and auditor's qualifications in case of non-compliance with accounting standards.
• The new proposed Corporate Taxation Act should recognise the concept of true and fair override. 
• In other words, compliance with AS shall be mandatory unless management is of the opinion and can demonstrate that it departure from AS will achieve true and fair view of accounts which compliance with AS will not. In such cases, management should be required to give suitable disclosures in accounts to explain why its accounting method will better achieve true and fair view rather than the accounting method prescribed by the Accounting Standard
• Adjustments to taxable income shall be made on the basis of decision of NFRA that company has departed from Accounting Standards without legitimate true and fair override . Company should be provided one or two appeals against NFRA's decision
• Rate of tax should be no more than 20% .

This will kill three birds in one stone. The complexities of provisions determining taxable income which gives rise to artificial income and resentment will be done away with. Further, exemptions which cost the exchequer immensely and give rise to litigation will also be removed. The complexities of two parallel tax computations and complying with ASs and ICDSs will no longer be there. Only ASs will have to be complied with. Besides, the basis of computation of taxable income rests on terra firma as Accounting Standards are based on accounting principles which have evolved over time with broad-based consensus and have wide acceptibility. 

Conclusion
Now that India has Accounting Standards having statutory force, India can take the lead in evolving a world class widely acceptable corporate tax system.