2008 (12) TMI 20 - HC - Income Tax

Depreciation disclosed in notes must be included under s.211(6) and counted for book profit under s.115J

COMMISSIONER OF INCOME TAX (CENTRAL) -I, NEW DELHI Versus SAIN PROCESSING and WEAVING MILLS (P) LTD.

HC held that depreciation not charged to the profit and loss account but disclosed in the notes forms part of the accounts under s.211(6) of the Companies ... Deduction claimed on account of current year depreciation, calculating 'book profit' u/s 115J - Whether the Tribunal was correct in law in allowing depreciation in computation of book profits u/s 115J, even though it was not debited in the P/L account - HELD THAT:- As long as the depreciation which is not charged to profit and loss account but is otherwise disclosed in the notes of the accounts, it would come within the ambit of the expression 'shown' in the profit and loss account, as notes to the account, form part of the profit and loss account by virtue of a sub-section (6) of Section 211 of the Companies Act, 1956. This is quite evident if the provisions of sub-section (6) of the Section 211 of the Companies Act, are read in conjunction with, sub-section (1A), as well as, the explanation to Section 115J of the Act. The net profit of a company cannot be determined till all items of income and expenses as recognized, as well as, depreciation are taken into account. Depreciation is nothing but loss of value of an asset arising from its use, efflux of time or obsolescence over a period of its useful life. Depreciation, undoubtedly has a major impact in determination of the financial position of a company/enterprise. To our minds the use of the expression 'net profit' makes it clear that depreciation not debited to the profit and loss account will have to be taken into while determining 'book profit' under Section 115J of the Act, as long as it forms part of the prescribed accounts. In our view, the ratio of the judgment in Khaitan Chemicals Fertilizers Ltd. [2008 (9) TMI 89 - DELHI HIGH COURT]; would apply notwithstanding the fact that there is no debit to the profit and loss account, in view of our discussion above that net profit cannot be determined without taking into account the information disclosed in the notes appended to the accounts which as observed by us hereinabove, form part of the accounts of the company/assessee. According to us, if unabsorbed depreciation can be reduced from 'net profit' to arrive at book profit we see no reason why current year's depreciation even though, not charged, to the profit and loss account though disclosed in the notes appended to the accounts cannot be deducted from the 'net profit' in determining 'book profit' for the purposes of Section 115J of the Act. In our opinion the assessee is entitled to seek deduction of current year depreciation from net profit to arrive at the 'book profit' even though it is not charged to the profit and loss account, though disclosed in the notes appended to the accounts. Thus, we answer the question of law framed by us in favour of the assessee and against the Revenue. In the result, the appeal is dismissed. ISSUES PRESENTED AND CONSIDERED 1. Whether depreciation for the current year, not charged to the profit and loss account but disclosed in the notes to the accounts, may be deducted from 'net profit' in computing 'book profit' under Section 115J. 2. Whether notes to the profit and loss account form part of the profit and loss account for the purposes of the definition of 'book profit' in the explanation to Section 115J. 3. Whether adjustments to the profit and loss account for computing 'book profit' are confined exclusively to the heads enumerated in the explanation to Section 115J, or whether items shown in accounts prepared under Parts II and III of Schedule VI (including notes) can affect 'net profit'. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Deductibility of current-year depreciation not debited to P&L but disclosed in notes Legal framework: Section 115J (including sub-section (1A) and the Explanation) requires companies to prepare profit and loss accounts in accordance with Parts II and III of Schedule VI to the Companies Act; 'book profit' is defined as the net profit 'as shown' in that profit and loss account, as increased or decreased by specified items (clauses (a)-(ha) and (i)-(iv)). Clause (iv) allows reduction for loss or depreciation to the extent set off as if certain Companies Act provisions applied. Clause 3(iv) of Part II of Schedule VI and Section 211(6) of the Companies Act require disclosure by note where depreciation is not provided and require that notes be treated as part of the accounts. Precedent Treatment: The Tribunal remanded to the appellate authority to apply the Supreme Court's approach on Section 115J. This Court relied on its own recent treatment of analogous items (prior period/extraordinary items) in the context of Section 115JA to inform approach here. Interpretation and reasoning: The Court construed 'net profit as shown in the profit and loss account prepared under sub-section (1A)' to include information disclosed in notes mandated by Schedule VI and Section 211(6). Depreciation, whether charged to P&L or disclosed as unabsorbed arrears in the notes (computed under Section 205(2) of the Companies Act), is essential to determine net profit. The Court emphasized the purpose of Section 115J (to tax prosperous companies paying little or no tax) and the accounting reality that 'net profit' inherently requires taking depreciation into account. The statutory obligation to prepare accounts in the prescribed form and to include notes means that a disclosed, uncharged current-year depreciation is 'shown' in the profit and loss account for the purposes of Section 115J. Ratio v. Obiter: Ratio - A company is entitled to deduct current-year depreciation disclosed in notes (though not debited to P&L) from net profit in computing book profit under Section 115J, because notes form part of the accounts under Section 211(6) and Schedule VI. Obiter - observations about policy and the broader accounting meaning of 'net profit' and comparison with 'cash profit' serve as explanatory support but are not separate holdings. Conclusion: Current-year depreciation, not charged to P&L but disclosed in notes in accordance with Schedule VI/Section 211, is deductible from 'net profit' when computing 'book profit' under Section 115J. Issue 2 - Whether notes to accounts form part of the profit and loss account for Section 115J purposes Legal framework: Section 211(6) of the Companies Act provides that references to balance sheet or profit and loss account include notes or documents annexed thereto; Part II of Schedule VI (clause 3(iv)) mandates disclosure by note where depreciation is not provided. Precedent Treatment: The Court followed the statutory text of Section 211(6) and the requirement in Schedule VI rather than construing the explanation to Section 115J narrowly to the numeric entries in the P&L alone. The Court also applied reasoning from a recent bench decision concerning prior period/extraordinary items which treated separately presented items as forming part of net profit. Interpretation and reasoning: Notes are obligatory disclosures required by the Companies Act; therefore they are intrinsic to the profit and loss account 'prepared under sub-section (1A)'. The expression 'shown' in the P&L account includes what is disclosed by way of mandated notes because the Companies Act explicitly incorporates notes into the accounts. This statutory incorporation renders information in notes as part of the P&L for Section 115J purposes. Ratio v. Obiter: Ratio - Statutory notes required by Schedule VI/Section 211(6) are part of the profit and loss account and count as being 'shown' in the accounts for computing 'book profit' under Section 115J. Obiter - commentary stressing the obligation to present a true and fair view and the interpretive significance of accounting terminology augment the holding. Conclusion: Notes to accounts, when required by Schedule VI and included under Section 211(6), form part of the profit and loss account and are to be considered in determining 'net profit' for Section 115J. Issue 3 - Scope of permissible adjustments to net profit for computing book profit Legal framework: The explanation to Section 115J specifies enumerated increases and reductions from the net profit 'as shown' in the prescribed P&L account. Sub-section (1A) mandates use of accounts prepared under Schedule VI. Clause (iv) permits reduction for loss or unabsorbed depreciation to the extent permitted by the Companies Act. Precedent Treatment: Revenue argued adjustments are limited to clauses enumerated in the explanation and that absence of a debit to P&L precludes deduction. The Court differentiated that argument by reference to the statutory prescription that the net profit must be determined from accounts prepared under Schedule VI which include notes; and by analogy to prior decisions allowing separately shown items to be treated as forming part of net profit for book profit computations. Interpretation and reasoning: The explanation's enumeration governs adjustments to the net profit figure, but the starting point - the 'net profit as shown' - must itself reflect accounts prepared in accordance with Schedule VI and Section 211(6). Therefore, items disclosed in the notes (mandated by Schedule VI) that affect the company's profit position (such as unprovided depreciation) are within the ambit of what may be 'shown' and hence can be taken into account. The Court further reasoned that the legislative intent (to tax actual economic net profits of prosperous companies) supports treating such disclosures as part of net profit. Ratio v. Obiter: Ratio - While adjustments to net profit are governed by the explanation to Section 115J, the 'net profit as shown' must include items disclosed in notes required by Schedule VI/Section 211(6); consequently such disclosed items can influence the base figure to which the enumerated adjustments apply. Obiter - broader policy statements about the purpose of minimum taxation and accounting principles. Conclusion: Adjustments to 'net profit' under the explanation to Section 115J are not rendered ineffective by the absence of a P&L debit when the relevant item (e.g., current-year depreciation) is disclosed in mandatory notes that form part of the accounts; such disclosed items may therefore be considered in computing 'book profit'. Cross-references See Issue 2 reasoning on statutory incorporation of notes by Section 211(6) for the foundation of the conclusion in Issue 1; see Issue 3 for interaction between the prescribed form of accounts and the enumerated adjustments in the explanation to Section 115J. Final Disposition (Court's Conclusion) The Court answered the substantial question in favour of the assessee: current-year depreciation not debited to the profit and loss account but disclosed in notes in accordance with Schedule VI and Section 211(6) is to be taken into account (deducted from net profit) in computing 'book profit' under Section 115J. The appeal by Revenue was dismissed.