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MAT AND NECESSARY ADJUSTMENT IN BOOK PROFIT IN VIEW OF NOTES, OBSERVATION, DISCLOSURES OR QUALIFICATION ON ACCOUNTS

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'MAT' AND NECESSARY ADJUSTMENT IN BOOK PROFIT IN VIEW OF NOTES, OBSERVATION, DISCLOSURES OR QUALIFICATION ON ACCOUNTS
By: DEV KUMAR KOTHARI
July 31, 2008

Summary:

The profit and loss account and balance sheet in case of companies is generally prepared according to the provisions of the companies Act. The notes on accounts, accounting policies disclosed and other statements enclosed are part and parcel of annual accounts. The profit and loss account and balance sheet are to be read with such notes. Therefore, in some cases, it may be necessary to make adjustments in the amount of profit as shown in the P  &  L account read with notes on accounts  to derive at the profit as per schedule VI. The author is of view that the Assessing Officer is also duty bound to make such adjustments in the figure of profit and thereafter he can make other adjustments as permitted in the sections relating to MAT- S.115J, 115JA, or S115JB.

As per provisions it appears that in case of a company it is mandatory to prepare a separate  profit and loss account as per part II of the Schedule VI. This view also find support from a decision of Madras High Court and Calcutta ITAT.

1. Book Profit and annual accounts:

In this write- up the term 'book profit' means the profit as shown by the P&L A/c. prepared by a company in accordance with the provisions of the Companies Act namely section 211 and part II and III of Schedule VI of the Companies Act. The Balance Sheet is to be prepared in accordance with the part I of the Schedule VI. Any change in the profit and loss account may have a consequential impact in the Balance Sheet. Therefore, finality of balance sheet is dependent on P & L account.  Furthermore, while preparing the account the company is also required to observe accounting standards and generally accepted accounting polices. If the accounts are not prepared according to these provisions, then the accounts cannot be described as having been made in accordance with the provisions of the Companies Act, 1956. The company has also to disclose its accounting policies and some time certain notes on accounts are given to explain specific treatment of certain items of income, receipt, payments or expenses and assets and liabilities. These are to inform the user of the statements bout peculiar aspects concerning the accounts which may have a bearing on the decision making based on the accounts. In case, accounts are not in conformity with the provisions, relevant information has to be given by way of notes on accounts and / or qualification by the auditors.

The exceptions are insurance companies, banking companies and companies engaged in generation or supply of electricity or other notified / exempted companies for which form of profit and loss account and balance sheet has been provided in the relevant enactments governing such class of companies. The Central government may also exempt any company or class of company from any requirement of the Schedule VI. The statutory provisions are found in section 211, of the Companies Act, 1956 relevant portion of which reads as follows:

211. Form and contents of balance sheet and profit and loss account -

(1). Every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of this section, be in the form set out in Part I of Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in any particular case, and in preparing the balance sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance sheet under the heading "Notes" at the end of that part:

Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity or to any other class of company for which a form of balance sheet has been specified in or under the Act governing such class of company.

(2) Every profit and loss account of a company shall give a true and fair view of the profit or loss of the company for the financial year and shall, subject as aforesaid, comply with the requirements of Part II of Schedule VI, so far as they are applicable thereto:

Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity, or to any other class of company for which a form of profit and loss account has been specified in or under the act governing such class of company.

(3) The Central Government may, by notification in the Official Gazette, exempt any class of companies from compliance with any of the requirements in Schedule VI if, in its opinion, it is necessary to grant the exemption in the public interest.

Any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the modification.

Therefore, it is clear that unless exempted, the annual account of a company  have to be prepared in accordance with the schedule VI.

2. Notes on accounts are integral part of the annual accounts:

Notes on accounts are important and integral part of the final accounts. Notes explains and inform the accounting policies followed by the company, any special features relating to the accounts, deviation from accounting policies and generally accepted accounting policies, etc., if any. Therefore, final accounts are always read with the notes thereon. In this regard the following provision by way of sub-section (6) to the section 211 is relevant:

 

"(6) For the purposes of this section, except where the context otherwise requires, any reference to a balance sheet or profit and loss account shall include any notes thereon or documents annexed thereto, giving information required by this Act, and allowed by this Act to be given in the form of such notes or documents."

3. Accounting Standards must be followed:

As per sub-section (1) and (2) of section 211 of the Companies Act, 1956 the final accounts have to be prepared as per the Schedule VI as discussed in preceding paragraph. Sub-section (3A) as inserted by the Companies (Amendment) Act, 1999, w.r.e.f. 31.10.1998 it is also required that accounts should be prepared in accordance with the accounting standards (as defined in sub-section (3C) that is accounting standards issued and recommended by the  Institute of Chartered Accountants of India until the accounting standards are prescribed by the National Advisory Committee on Accounting Standards established under section 210A of the Act. The relevant statutory provisions are found in section 211 of the Act as follows:

S. 211

(3A) every profit and loss account and balance sheet of the company shall comply with the accounting standards.

(3B) Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following namely: -

(a) the deviation from the accounting standards;

(b) the reasons for such deviation; and

(c) the financial effect, if any, arising due to such deviation.

(3C) For the purposes of this section, the expression "accounting standards" means the standards of accounting recommended by the Institute of Chartered accountants of India constituted under the Chartered Accountants Act, 1949 (38 of 1949) as may be prescribed by the Central Government in consultation with the National Advisory Committee on Accounting Standards established under sub-section (1) of section 210A:

Provided that the standards of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the Accounting Standards until the accounting standards are prescribed by the Central Government under this sub-section.

Thus, broadly speaking the accounting standard prescribed by the ICAI, which have been made mandatory, must be followed. In case any Accounting Standard has not been followed it has to be explained fully as per sub-section 3B, as discussed above.

4. Qualifications on Accounts.

Generally the auditors certify the accounts  subject to "read with notes thereon"  because   the accounts are subject to such notes on accounts as per sub-section (6) of section 211 as discussed above. Therefore true and fair profit or loss and fair view of the state of affairs is to be seen by looking at  profit and loss account and the balance sheet along with  notes thereon. If the accounts read with notes are not prepared according to the provisions, and if profit or loss shown by the profit and loss account  accounts and the state of affairs reflected in the balance sheet are not fully in accordance with the Companies Act then the Auditors have to qualify the accounts and the accounts are certified subject to such qualifications. Therefore, it can be said that in such cases, the accounts are prepared according to the provisions only subject to those notes and / or qualification on accounts.

5.Non-compliance with accounting standards:

In this regard relevant provision is contained in sub-section (3B) of section 211 as discussed earlier. Thus, in case of non-compliance of accounting standards full information is required to be given. This is to enable the people who read and /or use the profit and loss account and the balance sheet with the given information to suitably adjust the figures accordingly while considering the purpose for which he read and / or use the final accounts.   

6. Book Profit under Income Tax Act in the context of MAT:

In the context of "Minimum Alternate Tax"  (MAT) as applicable from time to time vide sections 115J, 115JA and 115JB, the term 'book profit' means profit as shown in the P&L A/c prepared as per part II and III of the schedule VI to the Companies Act. In this context it would be useful to read relevant part of the provisions, which reads as follows:

Sub-section (1A) to section 115J:

(1A) Every assessee, being a company, shall, for the purpose of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956)".

Exactly similar is sub-section (2) of section 115JA and sub-section (2) of section 115JB requiring the accounts to be prepared in accordance with Part II and III of the Schedule VI. Except that in sub-section (2) of sections 115JA,  there is a proviso for  additional requirement relating to adoption of the same depreciation rates and method as followed by the company for preparing the annual accounts for laying before the annual general meeting and in sub section (2) of section 115JB there is a  proviso for adoption of the  same accounting policies, accounting standards and depreciation rates and method as has been adopted for accounts to be laid before the annual general meeting. For ready reference the relevant sub sections with the proviso are reproduced below:

Sub-section (2) to S. 115JA

(2) Every assessee, being a company, shall, for the purpose of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956)".

 "Provided that while preparing profit and loss account, the depreciation shall be calculated on the same method and rates which have been adopted for calculating the depreciation for the purpose of preparing the profit and loss account laid before the company at its annual general meeting in accordance with the proviso of section 210 of the Companies Act, 1956 (1 of 1956).

Provided further that where a company has adopted or adopts the financial year under the Companies Act, 1956 (1 of 1956) which is different from the previous year under the Act, the method and rates for calculation of depreciation shall correspond to the method and rates which have been adopted for calculating the depreciation for such financial year or part of such financial year falling within the relevant previous year."

Section 115JB (2) reads as follows: -

(2) Every assessee, being a company, shall, for the purpose of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956)".

 "Provided that while preparing the annual accounts including profit and loss account-

(i) the accounting policies

(ii) the accounting standards adopted for preparing such accounts including profit and loss account;

(iii) the method and rates adopted for calculating the depreciation shall be the same as have been adopted for the purpose of preparing such accounts including profit and loss account and laid before the company at its annual general meeting in accordance with the provisions of section 210 of the Companies Act, 1956 (1 of 1956):

Provided further that where the company has adopted or adopts the financial year under the Companies Act, 1956 (1 of 1956), which is different from the previous year under the act -

(i) the accounting policies

(ii) the accounting standards adopted for preparing such accounts including profit and loss account;

(iii) the method and rates adopted for calculating the depreciation, shall correspond to the accounting policies, accounting standards and the method and rates for calculating the depreciation which have been adopted for preparing such accounts including profit and loss account for such financial year or part of such financial year falling within the relevant previous year.

7. FOREMOST REQUIREMENT IS COMPLIANCE WITH

SECTION 211 and SCHEDULE VI:

Thus, it can be said that the foremost requirement is that the profit and loss account should be in accordance with the part II and III of the Schedule VI. Schedule VI is supplementary to the section 211 of the Companies Act; this is clear from the  heading of schedule which reads as follows:

SCHEDULE VI.

(See section 211)

 Therefore, it can be said that the profit and loss account should be in conformity with section 211 as a whole that is read with the Schedule VI and the Accounting Standards. Any deviation from the Schedule VI and other accounting standards will require disclosure of such deviations on the Profit and Loss Account and Balance Sheet in accordance with the sub-section (3B), as discussed above. Therefore, from the amount of profit shown in the profit and loss account for the current year as well as for ascertaining the amount of loss or depreciation brought forward any such deviations may have to be adjusted for the purpose of S. 115J, 115JA and 115JB.  

Therefore, it can be said that for the purposes of sections 115J, 115JA, and 115JB  the primary figure to be adopted is adjusted profit to derive "profit"  as per  S. 211 read with  the Schedule VI and accounting standards. The adjustments are to be made  in view of notes given on accounts, which are part and parcel of accounts  so adjustments may be required.

8. ADJUSTMENTS PROVIDED IN  SECTION 115J, 115JA AND 115JB:

The requirement that profit should be as per Schedule VI is again made clear from the opening paragraph of the Explanation, which defines the term 'book profit'. The important words used are

'Book profit' means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2).

Therefore it is necessary to derive profit as per sub-section (2) that is to make it in accordance with Schedule VI. From such adjusted profit or loss only adjustments of increases or decreases is allowed as mentioned in the relevant sub section or explanation for computation of book profit. The adjustments provided in the section are in respect of certain incomes which are not taxable or which are partly taxable and other adjustments are in respect of certain provisions and reserves made during the year or withdrawal made from such provisions and reserves during the year.

Meaning of Book profit:

The term book profit has been defined in the respective sections. A question arises whether the amounts, which can be added or reduced from the book profit as prescribed in Section 115J, 115JA and Section 115JB are exhaustive or illustrative. A reading of the amount prescribed for such adjustments shows the following items in the  Section 115JB which is in force now:

Explanation - For the purposes of this section, 'book profit' means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2) as increased by -

a) the amount of income-tax paid or payable, and the provision therefore, or

b) the amounts carried to any reserves, by whatever name called [other than a reserve specified under section 33AC] or

c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or

d) the amount by way of provision for losses of subsidiary companies; or

e) the amount or amounts of dividends paid or proposes; or

f)  the amount or amounts of expenditure relatable to any income to which section 10 or section 10A or section 10B or section 11 or section 12 apply.

g) The amount of depreciation

h) The amount of deferred tax and the provision therefor,

If any amount referred to in clauses (a) to (h) is debited to the profit and loss account, and as reduced by -

(i) the amount withdrawn from any reserve or provision (excluding a reserve created before the 1st day of April, 1977 otherwise than by way of a debit to the profit and loss account), if any such amount is credited to the profit and loss account;

Provided that where this section is applicable to an assessee in any previous year, the amount withdrawn from reserves created or provisions made in a previous year relevant to the assessment year commencing on or after the 1st day of April, 1977 shall not be reduced from the book profit unless the book profit of such year has been increased by those reserves or provisions (out of which the said amount was withdrawn) under this Explanation or explanation below the second proviso to section 115JA, as the case may be: or)

(ii) the amount of income to which any of the provisions of section 10 (other than the provisions contained in clause (38) thereof)  or section 11 or section 12 apply, if any such amount is credited to the profit and loss account, or

(iii) the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account.

Explanation - for the purposes of this clause -

(a) the loss shall not include depreciation;

(b)  the provisions of this clause shall not apply if the amount of loss brought forward or unabsorbed depreciation is nil, or

(iv) the amounts of profits eligible for deduction under section 80HHC, computed under clause (a) or clause (b) or clause (c) of sub-section (3) or sub-section (3A) as the case may be of that section and subject to the conditions specified in that section; or

(v)  the amount of profits eligible for deduction under section 80HHE computed under sub-section (3) or sub-section (3A), as the case may be, of that section, and subject to the conditions specified in the section, or

(vi) the amount of profits eligible for deduction under section 80HHF computed under sub-section (3) of that section, and subject to the conditions specified in that section, or

(vii) the amount of profits of sick industrial company for the assessment year commencing on and from the assessment year relevant to the previous year in which the said company has become a sick industrial company under sub-section (1) of section 17 of the Sick Industrial Companies, (Special Provisions) Act, 1985 (1 of 1986) and ending with the assessment year during which the entire net worth of such company becomes equal to or exceeds the accumulated losses.

Explanation - For the purposes of this clause, 'net worth' shall have the meaning assigned to it in clause (ga) of sub-section (1) of section 3 of the Sick Industrial Companies (Special Provision) Act, 1985 (1 of 1986).

(viii) the amount of deferred tax, if any such amount is credited to the profit and loss account.

A reading of the above explanation would show that certain items, which are profit or gain in true senses, are excluded because they are exempt from taxation. For example, income, which is exempt under section 10, 10A, 10B, 11 or 12, profit eligible for deduction under section 80HHHC, 80HHE & 80HHF, profit of sick industrial company etc-  all these items are profit  from operations of the company and naturally find credit in the profit and loss account in usual course. There can be some other profits, which are business profit but are eligible for exemption in the Income tax Act or certain receipts credited in the profit and loss account, which are not at all taxable by their nature. Therefore, it appears that the adjustments provided in the sections may not be considered as exhaustive. Any amount credited in the P&L A/c., which is not at all taxable due to exemption, or which is not taxable because of its nature being capital receipt will have to be excluded from profit because what is exempted or what is not income at all cannot be included in book profit for MAT.

9. SPECIAL TAX TREATMENT ITEMS:

There are certain items, which may or may not find credit in the profit and loss account depending upon the accounting policy followed. There is special treatment for some incomes like (a) for long-term Capital gains - benefit of cost inflation and a concessional rate of tax is provided , (b) profit on sale of depreciable assets forming block of assets - sale value of assets is reduced form the written down value of the block of assets and reduced depreciation is allowed on the block of assets, usually there may not be any taxable capital gain u/s 50 in case of a continuing business where replacement value of new asset is more and the block remains eligible for depreciation.

In such cases inclusion of such credits  in book profit will  not be justified.

10. Whether, the prescribed items are exhaustive?

As discussed earlier the foremost requirement is that the "profit" should be derived as per sub-section (2), and thereafter the A.O. can make only additions or deductions as per the meaning given in the Explanation. Therefore, prior to determination of profit as per sub-section (2) there seems no limitation, however, once profit is derived as per Schedule VI the A.O. may have  limited power to make additions or deductions as prescribed. 

11. Different accounting treatment cannot make assessee taxable differently:

It is well known that an accounting treatment is not conclusive for tax treatment. If an item of income is taxable it will be taxed even it is not credited in the P&L A/c. Similarly if an item is credited in the P&L A/c. but it is not taxable, it will not be taxable and will have to be deducted from the profit shown in the P&L A/c. This rule has to be strictly applied in the case of book profit also. Suppose a company has not at all included in its income certain receipts which are accrued income, and has shown the same as liability due to disputes, it will have to be included in the book profit.

In case of normal computation certain accounting treatments can have balancing impact over a period of time. For example, different method of stock valuation, or cash and mercantile basis of accounting. However, in case of book profits, the effect is not balanced over a period of time unless adjustments are made. Therefore, certain adjustments are  required.

12. Decision in case of Apollo Tyres Ltd. Vs. CIT (2002) 255 ITR 273 (SC) [2008 -TMI - 6081 - SUPREME Court] Judgment dated  2May, 2002

In this case the matter relating to change in method of depreciation was before the Supreme Court. During the year the assessee changed the method of providing depreciation from straight line method to written down value method. The change was prompted to comply with  the new Schedule XIV , inserted in the Companies Act, 1956 providing for separate rates on SLM and WDV basis and also for multiple shift working. Therefore, arrear of depreciation including extra shift depreciation  was also debited in the P&L A/c ( below the line). Therefore, in view of change in policy for depreciation, that too due to change in law, which was adopted from the relevant year it was necessary to provide for arrear of depreciation so that to-date depreciation provided is in accordance with the new method  and rates adopted from the relevant year. This is exactly as per requirement under the Companies Act and the Accounting Standards. Therefore, the amount of depreciation charged in the P&L A/c. including arrear of depreciation was in accordance with the part II and III of the Schedule VI of the Companies Act.

In this regard it is worth to note that a company can change the method of accounting for depreciation, stock valuation, amortization of certain expenses, other accounting matters. The only requirement is that the changed method or the new method adopted should also be a recognized regular method of accounting, it should be followed consistently  and there should not be a casual departure. If that were the case, the accounts prepared following the new method of accounting shall also be in accordance with the provisions of the Schedule VI. In such case, the auditors are required to quantify the impact on the amount of profit or loss and assets and liabilities for information of the shareholders. This is simply a requirement to inform the shareholders that if there were no change in method what would have been position. This does not amount to qualification because the result is simply due to  revised accounting policy.

Therefore, the accounts as prepared by Appolo Tyres Ltd. were in accordance with the parts II & III of Schedule VI of the Companies Act. The accounts were approved  in the board meeting ,then  in the shareholders meeting. It appears that in the context of the above position the Hon'ble Supreme Court observed that the Assessing Officer has no jurisdiction to recast the P&L A/c, which is in accordance with the Companies Act and  which has been audited, approved by shareholders, and taken on record by the Registrar of Companies without any objection.

In this regard it is important to note that the accounts of Appolo Tyres were also subject to notes thereon. Taking note of change in method of accounting policy regarding depreciation allowance the accounts were in accordance with the Schedule VI as well as the Accounting Standards and generally adopted accounting policy about depreciation including that in the event of change from one method to other method. In such circumstances it was held that the A.O. has no jurisdiction to make adjustment for depreciation.

The observations of the Supreme Court are on the following lines:

1.  The Assessing Officer, while working out book profits of a company under section 115J of the Act has only the power of examining whether the books of account are certified by the authorities under the Companies Act as having been properly maintained in accordance with the Companies Act.

2. The A.O. thereafter has the limited power of making increases and reductions as provided for in the explanation to Section 115J.

3. The A.O. does not have the jurisdiction to go behind the net profits shown in the P&L A/c. except to the extend provided in the explanation.

4. The use of words "in accordance with the provisions of Part II & III of Schedule VI to the Companies Act" in section 115J was made for the limited purpose of empowering the A.O. to rely upon the authentic statement of the accounts of the company.

5. The A.O. has to accept the authenticity of the accounts with reference to the provisions of Companies Act, which requires the company to maintain its accounts in a manner provided by that Act and the same to be examined and certified by the Statutory Auditors of the company then to be approved by the company in a General Meeting and thereafter they have to be filed before the Registrar of Companies.

6. The Registrar of Companies has a statutory obligation also to examine and to  satisfy himself  that the accounts of the company are maintained in accordance with the requirements of the Companies Act.

7. Sub-section (1A) of section 115J does not empower the A.O. to embark upon a fresh enquiry in regard to the entries made in the books of account of the company.

In view of above observations, the Supreme Court held that while determining the book profits u/s 115J, the A.O. could not re-compute the profits in the P&L A/c. by excluding provisions made for arrears of depreciation.

13. Whether the books of account  have been properly maintained  in accordance with the Companies Act ?

As observed by the Supreme Court, the A.O. has power to examine whether the auditors have certified that the accounts have been properly maintained in accordance with the Companies Act.

Therefore, if the auditors have certified that the accounts have been properly maintained but subject to certain notes on accounts or qualifications on the accounts, then, the A.O.  appears to be duty bound to adjust the amount of 'profit' shown in P & L account with the figures affecting 'profit',  which are  reported in  notes on accounts suggesting deviation from S. 211 - Schedule VI , and  accounting standard.

14. SATISFACTION OF THE A.O AS TO AUDITORS CETIFICATION:

As analysed above the Supreme court in the case of Appolo Tyres has held that the A.O. has to satisfy himself as to whether, the auditors have certified that profit and loss account is in accordance with part II and III of the Schedule VI.

Such exercise of the A.O. has to be with a definite purpose. Therefore, to derive at such satisfaction the A.O. has to see whether  the auditors have  really made un-conditional certification or  whether  such certification is subject to some notes or qualifications. If there is un-conditional certification then the A.O. has no power to make adjustment except those permitted in the section 115J ) / 115JA / 115JB for addition or deductions.

However, where the auditors have made certification conditional that is subject to notes on accounts or qualification about  accounts , then the A.O. will  be duty bound to make necessary adjustments. And such duty is implicit in the following observation of the Supreme Court:

" The Assessing Officer, while computing the book profits of a company under section 115J of the Income tax Act, 1961, has only the power of examining whether the books of account are certified by the auditors under the Companies Act a having been properly maintained in accordance with the Companies Act.  The Assessing Officer, thereafter, has the limited power of making increases and reductions as provided for in the Explanation to section 115J. The Assessing Officer does not have the jurisdiction to go behind the net profit shown in the a profit and loss account except to the extent provided in the Explanation. The use of the words " in accordance with the provisions of part II and III of the Schedule VI to the Companies Act" in section 115J was made for the limited purpose of empowering the Assessing Officer to rely upon the authentic statement of accounts of the Company…..

EXAMPLES:

For example, let us take a case that the company has to follow accrual basis of accounting. However, certain accounts are maintained on cash basis and therefore some income or expenses have not been accounted for and for that purpose there is notes and  / or qualifications in the accounts. In that case, the auditors have certified the accounts subject to those notes or qualifications. Therefore the certification by the auditors is not without observations, reservations, or qualifications on the profit and loss account. Having found this position, the author feels that  the A.O. will be bound to  work out the amount of profit as per Schedule VI after making necessary adjustments in view of the notes/ observations or qualifications on the profit and loss account. Therefore, the relevant items have to be taken into account. For example:

A. Profit as per P&L A/c is  Rs. 10,00,000/-

The notes to accounts show that liability for gratuity has not been accounted for and the amount of liability as on the closing date is Rs. 50,00,000/- which includes a liability for the year under review amounting to Rs. 7,00,000/-.

The auditors have certified the accounts subject to the note relating to gratuity liability. In this case the profit for the year needs to be adjusted as follows:

Profit as per P&L A/c. Rs. 10,00,000/-

Less: Un-provided gratuity liabilities RS.  7,00,000/-

         -----------------

Profit as per Schedule VI  Rs.  3,00,000/-

         -----------------

Net Book Profit in accordance with provisions of Companies Act will therefore be Rs.3,00,000/- similarly  for computation of past losses also the un-provided gratuity  liability of Rs. 43,00,000/- will have to be considered to work out what is the amount of loss brought forward in accordance with Companies Act.

B. Let us take another example relating to un-provided Sales Tax liability. The company has during the previous year received a demand notice for Rs. 15,00,000/-. However, it has been disputed in an appeal filed by the company. The liability has accrued on issuance of the demand notice and therefore it should have been debited in the P&L A/c. Since it has not been debited  the accounts are not in accordance with the Companies Act and therefore an adjustment is required to work out the amount of profit in accordance with the Companies Act.

C. A Cinema Pvt. Ltd. has policy to credit subsidy received for production of regional  feature films  to the P&L A/c.. whereas B Cinema Pvt. Ltd. credit similar subsidy to reserve account. The nature of subsidy is capital subsidy and therefore it should no be credited in P&L A/c. In these cases, if, any adjustment is not made then it would be found that A Cinema Pvt. Ltd. will have higher book profit only because of a wrong or defective accounting policies adopted by them. If the account of A Cinema P. Ltd indicates a note about this aspect, then the A.O. will find that the auditors certification is subject to that note suggesting a compulsory  reduction from the profit shown in the p & L Account.

D. A Tea Pvt. Ltd. credits re-plantation subsidy  ( which is not exempt u/s 10 of the IT Act'61.in its profit & loss account, whereas, B Tea Pvt. Ltd. credits re-plantation subsidy to the  capital reserves  account. In these cases it is found that book profit of A Tea Pvt. Ltd. is more than B Tea Pvt. Ltd. only because of difference in accounting policy. The re-plantation expenses are  revenue expenditure and therefore the subsidy is a revenue receipt. Therefore, it should be added in the book profit in case of B Tea Pvt. Ltd.

D. A Industries Pvt. Ltd. and B Industries Pvt. Ltd. have received power subsidy. A Industries Pvt. Ltd. has policy to credit all subsidies to the P&L A/c. whereas B Industries Pvt. Ltd. credit such subsides to the reserve account because it is only due to governmental policy. In such circumstances the profit B Industries Pvt. Ltd. needs to be increased by the amount of power subsidy credited to the reserve account instead of to the Profit  & Loss account.

E. New Sugar companies are allowed extra free sugar quota to generate additional funds to mitigate hardship in setting up highly capital intensive industry. The additional free quota resulting into additional fund is granted by the Central Government and now it has been settled that extra funds generated is capital receipt. Three sugar companies have different accounting policies regarding such capital receipts as follows:-

(i) A Sugar Co. Ltd. includes capital receipts in the sales account which is credited in the P&L A/c. However, a note is given on the face of P&L A/c. that "X" amount on account of capital receipt is included in sales.

(ii) B Sugar Company Ltd. has similar policy as in case of A. However, it transfers "X" amount to capital reserve account by way of appropriation. A note is given on the face of P&L A/c. that "X" amount on account of capital receipt is included in sales.

And then transferred to capital reserve account.

(iii) C Sugar Company Ltd. credits amount of capital receipt directly to capital reserve account and therefore the "X" amount stands credited in reserve account and profit is reduced by the same. A note is given on the face of P&L A/c. that "X" amount on account of capital receipt is not included in sales.

As per accounting standard, the method adopted by C Sugar Co. Ltd. is most appropriate and on such method no question can be raised. Therefore in case of A Sugar Co. Ltd. and B Sugar Co. Ltd. the profits are increased by the X amount of capital receipts. A disclosure is made by way of notes on account. Thus the certification of auditors is not without reservations. The reader of balance sheet & P&L a/c. of A Sugar Co. Ltd. and B Sugar Co. Ltd. can easily understand the difference in comparison to C Sugar Co. Ltd. and make an adjustment. They can very well understand that in case the subsidy scheme is changed the profitability will be affected.

The reduction of capital receipt is necessary even for the purpose of ascertaining normal business profit. This is so because suppose for any reason, capital subsidy by way of extra free quota is withdrawn, the same will affect the profitability. Therefore, it can be said the amount of capital subsidy has to be reduced from the profit shown by A Sugar Co. Ltd. and B Sugar Co. Ltd. in accordance with Schedule VI to the Companies Act and also Section 115J(1), 115JA(2) and 115JB(2).

15. THE IMPLICATIONS OF JUDGMENT IN APOLLO TYRES

During course of discussions and on reading of some orders of Appellate Authorities, it has come to notice that the Departmental Authorities while disallowing any reduction from the book profit are heavily relying on the judgment in Apollo Tyres whereas while adding back certain items in the amount of profit, they are trying to substantiate the same to make the profit as per Companies Act. For example, in one case the A.O. has added the amount of expenses relating to earlier years debited during the year on accrual, in the profit and loss account  but on the other hand he  disallowed reduction on account of income relating to earlier years credited to P&L A/c. and also certain capital receipts credited in P&L A/c. Thus, the Assessing Officer has adopted double standards to gain benefit on both the accounts.

In this case the auditors have not qualified the account in respect of expenses and  income  relating to  earlier years because they accrued during the year and therefore the Assessing Officer cannot make adjustments to the book profit for the same. However, in respect of the amount of capital receipt credited in the P&L A/c. it has been stated on the face of the P&L A/c  and also  by way of a detailed  note that the sale value includes certain amount of capital receipts realized under the  incentive scheme the auditors have stated that the P&L A/c. is in accordance with the Companies Act subject to that note. Therefore, to make the computation of book profit in accordance with the Companies Act, the assessee can reduce the amount of capital receipt from the profit shown in the P&L A/c. and the A.O. may accept the same because only the balance figure  will be  "profit"  in accordance with the Companies Act.

16. Some judgments on the issue:

In case of Balrampur Chini Mills Ltd the assessee, for the purpose of section 115JA prepared separate profit and loss account for excluding capital receipts from the amount of profit as shown in the profit and loss account under the Companies Act. The tribunal held that for the purpose of section 115JA it is mandatory to prepare P & l account as per part II of the Schedule VI to the Companies Act. Since the amount of capital receipt was credited in the profit and loss account for companies Act, it was excluded from profit in the profit and loss account prepared for the purpose of section 115JA.

The Tribunal held that in view of section 115JA (2) the assessee has to prepare a separate profit and loss account to compute profit as per part II  and III of the schedule VI to the Companies Act. Though in the order there is no specific mention about exclusion of capital receipt, but that was the main issue. Capital receipt is excluded from business income under normal computation of business income under section 28 and the legal position is well settled. The relevant portion of the  order of the Tribunal is reproduced below::

{IN THE INCOME TAX APPELLATE TRIBUNAL "B" BENCH KOLKATA

(Before Shri. G. Chowdhury, J.M. & Shri. K.K. Gupta, A.M)

I.T.A. No. 1422 (Cal) of 1999 order dated 07.06.2002

Assessment year 1997-98

M/s. Balrampur Chini Mills Ltd.             Vs.             Dy. Commissioner of Income-Tax

Kolkata               CC-XIX, Kolkat

        [Appellant]             [Respondent]

 

I.T.A. No. 1588 (Cal) of 19

Assessment year 1997-98

Dy. Commissioner of Income-tax       Vs.                M/s. Balrampur Chini Mills Ltd.

C.C.-XIX, Kolkata                Kolkata

          [Appellant]         [Respondent]

XXXXXXXXXXXX-

12. The next issue is regarding the finding of the C.I.T.(A) that the A.O. was not justified in rejecting the P/L Account filed by the assessee u/s 115JA(2) of the I.T.Act. As we have already noticed that the A.O. placed reliance on the P/L Account which was laid at the A.G.M. For the sake of convenience, we shall call this account as AGM Account. According to the assessee for the purpose of computing book profit u/s 115JA, the assessee has to prepare its accounts in accordance with Parts-II & III of Schedule VI of the Companies Act, 1956. This issue has been decided by the Ld. C.I.T.(A) in favour of the assessee holding that the assessee is entitled to maintain a separate account under the Companies Act for the purpose of Sec. 115JA of the I.T. Act.

13. After hearing both the sides, we find that the first appellate authority has discussed the issue in details. The relevant portion of Sec. 115JA is quoted below:-

"115JA. (1) Notwithstanding anything contained in any other provisions of this Act, where in the case of an assessee, being a company, the total income, as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 1997 [but before the 1st day of April,2001] (hereafter in this section referred to as the relevant previous year) is less than thirty per cent of its book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be a amount equal to thirty percent of such book profit.

(2) Every assessee, being a company, shall, for the purposes of this section prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956)

Provided that while preparing profit and loss account, the depreciation shall be calculated on the same method and rates which have been adopted for calculating the depreciation for the purpose of preparing the profit and loss account laid before the company at its annual general meeting in accordance with the provisions of section 210 of the Companies act, 1956 (1 of 1956).

Provided further that where a company has adopted or adopts the financial year under the Companies act, 1956 (1 of 1956), which is different from the previous year under the Act, the method and rates for calculation of depreciation shall correspond to the method and rates which have been adopted for calculating the depreciation for such financial year or part of such financial year falling within the relevant previous year".

14. On perusal of the aforesaid provision, we find that the Legislature has created a special provision for the purpose of taxing the companies under deemed income. Under sub-Sec(2) of Sec.115JA, it has been specially provided that every company for the purpose of this section shall prepare its P/L Account for the relevant previous year in accordance with provisions of Part II & III of Schedule-VI of Companies Act, 1956. Thereafter a proviso has been inserted for the purpose of calculation of depreciation which says that the depreciation which says that the depreciation shall be calculated on the same method and the rates which have been adopted for calculating the depreciation for the purpose of preparing P/L Account laid before the company at its AGM in accordance with the provisions of Sec.216 of the Companies Act. The second proviso prescribes the mode of adoption of the financial year under the Companies Act which is different from the previous year under the I.T. Act. Therefore, if we consider these provisions, it is clear that the Legislature has framed two types of accounts to be maintained by the assessee - one may be called AGM Account which is laid out before the AGM and the other is to be maintained under Parts-II & III of Schedule-VI of the Companies Act for the purpose of Sec. 115JA of the I.T. Act. There is no ambiguity in the section. Further, we find that the provision of Sec. 115JA is started with non-obstante clause, i.e. it over rides the other provisions of the Act. The first appellate authority in his order placed reliance on the Special Bench decision of the Tribunal in the case of Sutlej Cotton Mills Ltd. [45 I.T.D. 22] , wherein it has been held that the book profit u/s 115JA has to be computed in relation to the P/L Account prepared in accordance with Parts-II & III of Schedule-VI of the Companies Act. In this connection, reliance can be placed on the decision of Hon'ble Madhya Pradesh High Court in the case of C.I.T. vs. Bandana Rolling Mills Ltd. reported in 234 ITR 693 which is a case u/s  115JA of the Act. Sec-sec(1A) of Sec.115J is parimateria with sub-sec (2) of Sec. 115JA of the I.T. Act. In this case, part of the P/L Account was prepared under Parts-II & III of Schedule-VI of the Companies Act. The Hon'ble High Court has held that the assessee should have prepared the Balance Sheet and P/L Account in terms of the Companies Act for the purpose of Sec. 115J of the I.T.Act. Therefore, considering the circumstances above, we are of the view that the first appellate authority has rightly decided the issue in favour of the assessee. Accordingly, we are not inclined to interfere with his order on this issue.

15. In the result, the assessee's appeal is allowed for statistical purposes and the Revenue's appeal is dismissed.}

On enquiry at the high court of Calcutta about pending appeals in the case of Balrampur Chini Mills Ltd. it has been observed that the revenue has not filed appeal against the above judgment dated 07.06.2002 of the Tribunal. This was informed by the author to honorable members of ITAT during hearing of some other case , and the fact was not controverted by the Departmental Representative who appeared on behalf of the revenue.

The above judgment was followed in another judgment dated October, 9 2002 passed by the "A" Bench in ITA No. 175/Cal/ 2001 for assessment year 1998-99. In that judgment the bench also considered the judgment of the Supreme Court in the case of Appolo tyres Ltd. and held that separate Profit & Loss account is to be prepared to find out profit as per part II of Schedule VI. The revenue has however, filed an appeal before the high court u/s 260A of the Act. It is felt that the appeal of the revenue may not be admitted because the earlier order has been accepted. In this regard one can follow the principles laid down in  Berger paints case 266 ITR 99 (SC) = [2008 -TMI - 6139 - SUPREME Court] and CIT V Narendra Doshi 254 ITR 606 (SC) and CIT V Shivsagar Estates 177 CTR (SC) 107. 

Case of Pratappur Sugar & Industries Ltd dated 28.12.2004:

In case of Pratappur Sugar & Industries Ltd the Tribunal held that capital receipt credited in Profit  & Loss account was rightly directed to be excluded from book profit  because it is capital receipt as per binding judgment of Calcutta High Court in the case of Balrampur Chini Mills Ltd. 238 ITR 445.

{The relevant portion of the order is reproduced below:

Order dt. 03.09.2004 in ITA No.2619/K/02 for A.Y. 1999-2000 paragraphs 5-7:

5. In ground nos. 3,4 & 5 - the revenue has challenged the order of the ld. CIT(A) holding that higher sale proceeds realization under Sugar Production Incentive Scheme totaling Rs.79,46,293/- in respect of additional free sugar quota sales was a capital receipt and therefore excludible while computing 'book profits' u/s 115JA of I.T.Act'61. The ld. CIT(A) relied on the judgment of the jurisdictional Calcutta High Court in the case of Balrampur Chini Mills Ltd. V CIT reported in 238 ITR 445 which has held realization for free sale quota sugar under the incentive scheme to be in the nature of capital receipt and accordingly he directed to exclude the sum of Rs.76,47,293/- while computing the book profits u/s 115JA of the IT Act'61.

6. During the course of hearing, it was submitted by the ld. DR that the ld. CIT(A) erred in excluding the amount while computing the book profit ignoring the provision of law that such adjustment in the Profit & Loss account is not permissible u/s 115JA. On the other hand the ld. AR of the assessee relied on the order of the ld CIT(A).

7. We have considered the submissions made by the rival parties and the facts of the case and the judgment of the Hon'ble Jurisdictional Calcutta High Court referred to above. We find that the incentive had been received by the assessee for repayment of loan, which has been taken for expansion and rehabilitation for its sugar mill- a capital asset and therefore, the realization through additional free sale sugar quota under the Sugar Production incentive Scheme' is in the nature of capital receipt. Therefore, we do not find any infirmity in the order of the ld. CIT(A) directing not to include the amount while computing the book profit u/s 115JA. Accordingly, the order of the ld. CIT(A) on this issue is confirmed.}

16. Observations of Madras high court:

In CIT V Essorope Mills Ltd (2004) 139 Taxman 180 (dated  the Madras High Court considered the matter under section 115J. On consideration of the provisions regarding preparation of Profit & Loss account by companies the court observed and held as follows in para 4 of the order: 

4. What section 115J(1A) contemplates is that the assessee prepares not a balance- sheet but a profit and loss account showing the transactions of the relevant previous year and that such amount (account) be in conformity with Parts II and III of Schedule VI to the Companies Act. The net profit, if any, arrived at after making such computation is to be increased by the amounts set  out in sub-clauses (a0 to (ha) under the Explanation to section 115J(1A) and reduced by the amounts mentioned in clauses (i) to (iv) in that section.}

From the above observations of the High Court it appears that preparation of separate Profit & Loss Account is required exclusively for the purpose of sections relating to MAT. In the case before the Madras high Court assessee did not prepare a separate profit and Loss Account but relied on the account placed before the AGM, and which were considered by the assessee itself that they are in accordance with the parts II and III to the Schedule VI to the Companies Act. In such circumstances the high court did not permit adjustments in profit sought by the assessee.

CIT V Gitanjali Mills Ltd (2004) 136 Taxman 21 (Mad.) dated 09.10.2002:

In this case the assessee claimed expenses for replacement of machinery which was allowed  under section 31 and replacement of ring frames was allowed as  revenue expenditure under section 37.  The Tribunal allowed both deductions from normal income as well as from book profits. The high court also held that these expenses are  also to be deducted from book profit under S. 115J. though it is not clearly mentioned  in  the reported judgment, but it seems that the assessee has capitalized such expenses in accounts and claimed in normal computation as well as in computation under section 115J.

It is worth to note that all above referred judgments are after the pronouncement of judgment in the case of Apolo Tyres ltd , therefore, it can be assumed that the Revenue must have citedand reied on Aplo Tyre and the Tribunal and courts have considered the same. In judgment dated 9th October, 2002 Calcutta bench of ITAT in the case of Balrampur Chini Mills Ltd has specifically considered and mentioned about Apollo tyre's case and held that a separate Profit and Loss account has to be prepared as per part II and III of schedule VI  to the Companies Act and and S. 115JA (2) of income tax Act,1961.

17. Conclusions:

From the above write-up, observations of the Supreme Court, Madras high Court and Tribunal's orders  it can be concluded that a separate profit & Loss Account has to  be prepared by a company to ascertain exact "operating profit" as required under Schedule VI to the Companies Act. In that Profit & Loss Account adjustments for various notes having impact on operating profit can be made. Under the Companies Act the Profit & Loss Accounts are to be read with notes thereon, therefore, the amount of profit may be different if different accounting treatment has been given to special items as illustrated above. Whereas in the case of Profit & Loss Account for the purpose of MAT the exact operating profit or loss is required to be shown. Furthermore, it can be said that the adjustments specified in the provisions relating to MAT  will come into picture only after a separate Profit & loss account has been prepared as per part II to the Schedule VI to the Companies Act to compute "Operating Profit". Therefore, effect of notes is to be given in the computation for book profit.

This can also be said that the adjustments specified are mandatory but not exhaustive. This is because no where it has been specifically mentioned nor there are any words to imply that "only the specified adjustments are to be made."

 
By: DEV KUMAR KOTHARI - July 31, 2008
 
 
 

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