TMI Blog1999 (4) TMI 118X X X X Extracts X X X X X X X X Extracts X X X X ..... accounting for foreign exchange fluctuations. 2. That the CIT (Appeals) erred on facts and in law in not giving any finding with regard to the Grounds of Appeal No. 10 regarding disallowance under Rule 68 of the Income-tax Rules.' 6.1 Shri Ajay Vohra, the ld. counsel invited our attention towards a chart in which the facts relating to aforesaid grounds and the gist of arguments on behalf of the assessee have been briefly stated. The facts and submissions relating to Ground Nos. 1, 1.1 and 1.2 as given in the said Chart arc as under: 6.2 The assessee in the course of its business entered into management service agreement with Eicher GmbH. Subsequently, the assessee with the approval of the Government of India invested in the capital of Eicher GmbH as a business investment, by availing foreign currency loan. 6.3 Initially the additional liability on account of foreign exchange fluctuations was being recognised on cash basis. With the amendment of section 209 of the Companies Act by the Companies (Amendment) Act, 1988, w.e.f. 156-1988, making it mandatory for companies to maintain accounts on accrual basis, the company changed the method of accounting for foreign exchange fluc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om the date of the asset coming into use. The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged to the profit and loss account." 6.9 Taking into accounting the aforesaid views of the Institute of Chartered Accountants of India, it has been held by the following Benches of the Tribunal that arrears of depreciation consequent upon the change in the basis of providing depreciation is a necessary charge while calculating book profits in the year of change and such arrears debited to the profit and loss account cannot be added back while calculating book profits under section 115J of the Act : Appolo Tyres Ltd. v. Dy. CIT [1992] 43 ITD 464 (Coch.); Bombay Tyres International Ltd. v. Dy. CIT [1994] 51 ITD 339 (Bom.); Beta Naphthol (P.) Ltd. v. Dy. CIT [1994] 50 TTJ (Indore) 375 andSterlingSteels Wires Ltd. v. Dy. CIT [Appeal No. 35 (Asr.) of 1991] (AmritsarBench). 6.10 It has been further held in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of foreign exchange fluctuations made in the year under consideration was in confirmity with the guidance notes, accounting standards and was necessitated in view of mandatory requirement introduced in section 209 of the Companies Act w.e.f. 15-6-1988. The ld. counsel also invited our attention towards decisions in New India Industries Ltd. v. CIT [1993] 203 ITR 933 (Guj.), Padamjee Pulp Paper Mills Ltd. v. CIT [1994] 210 ITR 97 (Bom.) and Telemecanique Controls (India) Ltd. v. Dy. CIT [1997] 60 ITD 483 (Delhi), to support his contention that such accrual of liability has to be understood with reference to the method of accounting followed by the assessee. Since the provisions of Companies Act were amended w.e.f. 15-6-1988 making it mandatory for the companies to maintain accounts on accrual basis, the company had to debit the entire amount of additional liability on account of foreign exchange fluctuations in the year under consideration. No sub-clause under Section 115J authorises the Assessing Officer to add back such amount debited in profit and loss account. The profit and loss account prepared by the assessee was perfectly in confirmity with Part II and Part III of Sched ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l as in the order of the CIT(A). 6.17 The ld. Sr. D.R. also heavily relied upon the judgment of Hon'ble Kerala High Court in the case of CIT v. Appollo Tyres Ltd. [1998] 101 Taxman 167, wherein the decision rendered by the Tribunal in the case of Apollo Tyres Ltd. was reversed. The Hon'ble High Court has held that arrears of depreciation of earlier years cannot be taken into account for computing book profits under section 115J as per profit and loss account prepared in accordance with Part II and Part III of Schedule VI of Companies Act, 1956. He submitted that the decision of the Hon'ble Kerala High Court squarely applies to the facts of the present case. The ld. Sr. D.R. thus strongly supported the order of the CIT(A). 6.18 In the Rejoinder, Shri Ajay Vohra submitted that profits of the previous year used in section 115J(1A) or the expression "financial year" used in section 211(2) of the Companies Act does not mean that the amount in question should relate to that year only but it refers to the events on the basis of which liability has accrued in the relevant previous year or relevant financial year. The term accrual of liability and the relating of the liability to a part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ies Act. Shri Vohra, the ld. counsel for the assessee once again strongly urged that the assessee's contention should be accepted. 6.20 We have carefully considered the submissions made by the ld. representatives of the parties and have gone through the orders of the ld. Departmental Authorities as well as all other documents to which our attention was drawn during the course of hearing. We have also carefully gone through all the judgments cited by the ld. representatives of both sides. 6.21 The relevant previous year relating to assessment year 1989-90, being the transitional year, when uniform previous year was introduced in section 3 of Income-tax Act, 1961, covered the period from1-7-1987to31-3-1989. The first audited balance sheet of the appellant-company relates to the year ended on30th June, 1988. The balance sheet for the second period relates to the period from1st July, 1988to31st March, 1989. The accounts of the appellant-company were audited by M/s. A.F. Ferguson Company, Chartered Accountants under the provisions of the Companies Act, 1956. The tax Audit report under section 44AB of Income-tax Act year was given by M/s. Vaish and Associates, Chartered Accountants ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or depreciation, whichever is lower, the book profits for the purpose of section 115J was adopted at Rs. 86,30,022. 30% thereof comes to Rs. 25,89,006 on which tax was paid by the assessee under section 115J. 6.23 The Assessing Officer observed that the appellant company have availed of foreign currency loan of DM-5 million from the Hongkong Shanghai Banking Corporation,Londonin February, 1984 to purchase shares of Eicher (Germany). The investment in shares was capital investment insofar as it was for the purposes of extension of business by controlling the other company. The Assessing Officer has given elaborate reasons in the assessment order. He also relied on several decisions including the decision of Hon'ble Calcutta High Court in the case of Bestobell (India) Ltd. v. CIT [1979] 117 ITR 789. The Assessing Officer relying on the aforesaid judgment of Hon'ble Calcutta High Court and in view of elaborate discussions made in the assessment order, held that the expenditure of Rs. 1,52,78,000 debited under the head 'Foreign Exchange Fluctuations' is capital in nature. The Assessing Officer further considered the question relating to computation of profits under section 115J. He ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ating to earlier years. He relying upon the elaborate reasons given in the assessment order, provisions of section 115J, provisions of Companies Act and the requirements of Parts II and III to Schedule VI of the Companies Act, 1956, held that the profit and loss account of the company in order to give a true and fair picture of the profit and loss account of the Company should incorporate the items of expenditure of the relevant financial year and then alone it can comply with the requirements of Part II and Part III of Schedule VI. He, therefore, further held that the Assessing Officer was fully justified in adding the previous year's expenses in order to arrive at the book profits of the previous year as per section 115J of Income-tax Act. Thus it appears that the CIT(A) had confirmed an addition of Rs. 135.13 lakhs made by the Assessing Officer for computing the book profits under section 115J of the Act. 6.26 The provisions of section 115J(1A) alongwith Explanation is reproduced hereunder:--- "115J(1A) 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liable to tax under section 115J of Income-tax Act, 1961. 6.28 It may be relevant here to refer to the judgment of ITAT Special Bench in the case of Sutlej Cotton Mills Ltd. At pages 197 to 199, the Special Bench has held as under :--- "Can the Assessing Officer recast the book profit ? - The contention of the Revenue was that if the book profit shown by the assessee is not in accordance with the provisions of the Companies Act or if it had been manipulated to show less than the amount which was required to be shown in the profit and loss account, the Assessing Officer had the power to recast the profit and loss account. The contention of the assessee was that the tax was on the book profit as shown by the assessee and whatever is shown has to be accepted without question. This proposition is too widely stated, for, obviously, it cannot take into account a case of fraud or misrepresentation or a case where the profit and loss account was not prepared in accordance with the provisions of Part II and Part III of the Sixth Schedule to the Companies Act, 1956. If the profit and loss account prepared by the assessee is fraudulent or misleading giving figures which arc found to be f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g point for the computation of the income of the assessee which could be the basis for the tax under section 115J also. It would, therefore, be anomalous to concede to the Assessing Officer the power to disturb the starting point itself in a case other than a case where the profit and loss account was not prepared in accordance with Part II and Part III of the Sixth Schedule to the Companies Act. In a case where the profit and loss account was prepared in accordance with the provisions of Part II and Part III of the Sixth Schedule to the Companies Act, the Assessing Officer will have no power to disturb the book profit except as stated in section 115J. We are, therefore, of the opinion that the Assessing Officer is bound to proceed with the computation only on the basis of the book profit as shown in the profit and loss account, unless it is discovered that the profit and loss account is not drawn up in accordance with the provisions of the Companies Act, 1956." 6.29 In view of the aforesaid decisions and in view of the plain language of section 115J(1A), it is clear that where the Assessing Officer finds that where the profit and loss account was not prepared in accordance with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the profit and loss account should disclose turnover, commission, brokerage discount, raw material, consumed, goods purchased, opening and closing stock, depreciation, interest paid, provision for income-tax, reserves and provisions, expenditure on account of consumption of stores and spare parts, power and fuel, rent repairs to buildings machinery, salary, wages, bonus, contribution to P.F. and other funds. Staff welfare expenses, Insurance, rate and taxes and Misc. Expenses, etc." 6.33 The insertion of the concept of "true and fair" in place of "true and correct" was made to do away with the view prevailing that accounts should disclose only arithmetical accuracy. The Companies Act does not give definition of the expression "true and fair view". The substitution of the expression "true and fair' as against earlier expression used in these provisions as "true and correct" clearly indicates that the annual financial statements should not only be made correctly but they should convey an overall fair view and should not give any misleading impression. All the relevant information should be disclosed in the balance sheet and profit and loss account in such a manner that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ements disclosed a true and fair view of the state of affairs as well as of the profit or loss of the company. 6.34 Let us now examine the impact and effect of the amendment of section 209(3) of the Companies Act, w.e.f.15-6-1988by which accrual method of accounting was made mandatory in relation to assessee's liability for repayment of foreign currency loan of DM 5 Million borrowed from the Hongkong and Shanghai Banking Corporation,Londonin February, 1994. The loan was repayable in 11 equal half yearly instalments commencing after 2 years from the date of taking the loan. Upto the assessment year 1988-89, the assessee-company was charging the exchange rate different on repayment of the loan instalments to the profit and loss account of the year in which the instalment was repaid. The loss arising due to difference in exchange rate at the time of repayment of the respective instalment was debited in the profit and loss account, as and when the instalment was actually paid. However, the loan amount at the end of each previous year was shown as the balance amount of loan in DM (foreign currency) converted at the rate of exchange prevalent on the date when the loan was taken. Let us ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... requirement of law, the difference between the real amount of liability outstanding in terms of Indian currency at Rs. 3,20,00,000 as against the liability worked out on the basis of exchange rate prevailing at the time when the loan was taken (which comes to Rs. 2,40,00,000), will have to be debited in the profit and toss account in the year ended on 30th June, 1988 so that the outstanding amount of foreign currency loan is shown in the Balance Sheet at the correct and real amount payable by the assessee. In the present case, the company has changed its method of accounting for the fluctuations in foreign currency rates in respect of foreign currency loan taken by the company in the first accounting period ended on30th June, 1988in view of amendment to section 209 made w.e.f.15th June, 1988. As a result, of this change, the additional amount of Rs. 110.87 lakhs was charged to profit and loss account relating to earlier years. This was necessitated in view of the mandatory provisions introduced in section 209(3) of the Companies Act, 1956, which was amended in the currency of the relevant accounting year on15-6-1988i.e. before the relevant year ended on30th June, 1988. The debit of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the method of depreciation is made, depreciation should be recalculated in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged to the profit and loss account. In case the change in the method results in surplus, it is recommended that the surplus be initially transferred to the 'appropriations' part of the profit and loss account and thence to General Reserve through the same part of the profit and loss account. Such a change should be treated as a change in accounting policy and its effects should be quantified and disclosed." 6.36 It is clear from the aforesaid guidance note that whenever a change in the method of accounting is adopted, the liability should be recalculated in accordance with the new method from beginning and the deficiency arising from retrospective recomputation in accordance with the method should be charged to the profit and loss account. 6.37 The Accounting Standard marked as AS-11 (Revised) relating to accounting for the effects of changes in foreign ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case, the change in the method of accounting relating to foreign exchange fluctuation is not only bona fide but in confirmity with the normally accepted accounting practice but it had to be adopted in order to comply with a mandatory provisions of section 209(3) introduced by the Companies Act in the relevant year under consideration. 6.40 The ld. Sr. D.R. had placed reliance on the judgment of Hon'ble Kerala High Court in the case of Appollo Tyres Ltd. In that case, the assessee had shown net profits per profit and loss account at Rs. 69,91,306. While arriving at the net profit, the assessee made a deduction of Rs. 13,66,39,051 by way of arrears of depreciation. The deduction of Rs. 39,66,39,051 representing the arrears of depreciation, according to the assessing authority, was not in accordance with the provisions of Part II and Part III of the Schedule VI of the Companies Act. The Hon'ble High Court referred to the Accounting Standard AS-6 in paras 14 and 15 at pages 562 and 563. The Hon'ble High Court observed as under :--- "Paragraphs 21 to 30 deal with Accounting Standard. Paragraph 22 provides that the depreciation method selected should be applied consistently from peri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onfirmity with Part II and Part III of Schedule VI to the Companies Act. However the facts of the present case are absolutely different. The new method of accounting, namely, accrual method was adopted by the appellant-company to meet the mandatory requirement of section 209(3), which was amended w.e.f.15-6-1988falling in the relevant previous year. It is clear from the aforesaid judgment of Hon'ble Kerala High Court that in the case of Appollo Tyres Ltd. , the said company did not change the method of computation of depreciation from straight line method (SLM) but in addition to depreciation as per SLM method, the company calculated depreciation on the basis of extra shifts worked by the company on its plant and machinery from the date of acquisition of its original assets and charged the entire amount of such arrears of extra shifts depreciation in the profit and loss account of the relevant year in assessment year 1988-89, the year in which section 115J was introduced. In the present case, the change in the method of accounting had to be adopted by the appellant-company from assessment year 1989-90 in view of the amendment made in section 209(3) of Companies Act w.e.f.15-6-1988. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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