2008 (9) TMI 89 - HC - Income Tax

Prior-period and extraordinary items under AS-5 form part of net profit for computation under section 115JA, AO erred

HC dismissed the appeal and upheld the ITAT, holding that prior-period and extraordinary items shown separately under AS-5 are components of net profit ... Computation of Net Profit under Section 115JA - prior period / extraordinary items shown separately in the P/L A/c due to the specific requirement of the Accounting Standards prescribed by the ICAI - HELD THAT:- We feel that the fundamental flaw that entered into the Assessing Officer's approach was that he was under an impression that the assessee was claiming a reduction in the net profit in terms of clauses (i) to (ix) of the Explanation to Section 115JA (2). The assessee had all along contended that the net profit was to be computed on the basis of the profit and loss account which, in turn, was to be in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act. Such a computation of net profit, in view of the prescribed Accounting Standard (AS-5), required the prior period expenses/extraordinary items to be shown separately. As indicated in the accounting standard, in either case, the objective is to indicate the effect of such items on the current profit or loss. It is obvious that because of the prescribed accounting standard which has to be followed by the assessee in view of the provisions of Section 115JA (2) read with Section 211 of the Companies Act, 1956, the assessee was required to show the prior period items / extraordinary items separately so that their impact on the current profit or loss could be perceived. The fact that the assessee adopted the alternative approach of showing such items in the statement of profit and loss after determination of current net profit or loss, does not mean that these items are not to be taken into account in computing net profit as envisaged in Section 115JA of the said Act. Thus, what the assessee had done was only to indicate prior period items/extraordinary items separately. This did not mean that the figure of net profit was to be arrived at de hors these items. The foregoing discussion makes it clear that these items were components of net profit as shown in the profit and loss account prepared under Section 115JA (2). The assessee was not claiming any reduction in the net profit on the basis of any of the clauses appearing in the Explanation. The assessee's claim was that the prior period items/extraordinary items were, in any event, subsumed in the computation of net profit. It is only that they were to be shown separately so that their impact on the current net profit or loss could be perceived. The decision of the Income-tax Appellate Tribunal is upheld and the appeal is dismissed. Issues Involved:1. Whether the Income-tax Appellate Tribunal was correct in law in holding that the Assessing Officer failed to appreciate that the net profit of the assessee company is to be computed only after deducting the expenses on prior period/extraordinary items.Issue-wise Detailed Analysis:1. Computation of Net Profit under Section 115JA:The central issue revolves around the correct computation of net profit as per Section 115JA of the Income-tax Act, 1961. The assessee initially declared a loss and later revised the return post-merger, calculating taxes as per Section 115JA. The net profit was computed after reducing prior period expenses/extraordinary items and profit from the generation of the power plant.2. Revenue's Argument:The revenue contended that the net profit should be Rs 240.56 lakhs without deducting prior period expenses/extraordinary items, as these deductions are not covered under clauses (i) to (ix) of the Explanation to Section 115JA (2). Hence, the net profit for computing book profit under Section 115JA (2) should not exclude these items.3. Assessee's Argument:The assessee argued that the net profit should be computed in accordance with Parts II and III of Schedule VI to the Companies Act, 1956, which requires compliance with accounting standards. Specifically, AS-5 (Accounting Standard 5) mandates that prior period items and extraordinary items be shown separately in the profit and loss account but still be included in the net profit computation.4. Interpretation of Section 115JA (2):Section 115JA (2) mandates that the profit and loss account be prepared as per Parts II and III of Schedule VI to the Companies Act, 1956. Section 211 of the Companies Act requires that the profit and loss account give a true and fair view of the company's profit or loss and comply with accounting standards.5. Role of Accounting Standards:AS-5 defines prior period items as income or expenses arising in the current period due to errors or omissions in previous financial statements. Paragraphs 5 to 7 of AS-5 state that all items of income and expense recognized in a period should be included in the net profit or loss determination. Paragraphs 15 and 19 clarify that prior period items should be separately disclosed to show their impact on the current profit or loss.6. Tribunal's Decision:The Tribunal held that the Assessing Officer failed to appreciate that net profit should be computed after deducting prior period expenses/extraordinary items as per AS-5. These items are part of the net profit and should be separately disclosed but not excluded from the net profit computation.7. Court's Conclusion:The Court affirmed the Tribunal's decision, stating that the Assessing Officer's approach was flawed. The net profit must be computed based on the profit and loss account prepared under Section 115JA (2), which includes prior period items and extraordinary items as per AS-5. These items are components of net profit and must be shown separately to indicate their impact on the current profit or loss.8. Final Judgment:The Court answered the question in the affirmative, upholding the Tribunal's decision and dismissing the revenue's appeal. The net profit for Section 115JA purposes must include prior period expenses/extraordinary items as per the prescribed accounting standards.