2025 (7) TMI 684 - HC - Income Tax

Provision for doubtful debts cannot be added back to book profit under Section 115JA clause (b) as reserves

The Bombay HC ruled in favor of the assessee regarding computation of book profit under Section 115JA for MAT purposes. The court held that provision for ... Minimum Alternate Tax (MAT) - Computation of book profit for the purpose of application of provisions of Section 115JA - Deemed income relating to certain companies - addition of 'provision for doubtful debts/advances' to book profit under clause (b) of Explanation to Section 115JA - whether provision for doubtful debts/advances as a “Reserve” and therefore, the book profit had to be increased by the said amount under clause (b) of the Explanation to section 115JA? - HELD THAT:-Under provisions of Section 115JA an Assessee, which is a Company, becomes liable to pay tax in amount equal to 30% of the book profit, if the total income computed for a particular year is less than 30% of its book profit. Under sub-section 2 of Section 115JA of the Act, every company is required to prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI of the Companies Act, 1956. Under Explanation to Section 115JA of the Act, the book profit means net profit shown in the profit and loss account for the relevant previous year, which is required to be increased by amounts indicated in clauses (a) to (g) to the Explanation. Applying the ratio of HCL Comnet Systems & Services Ltd.[2008 (9) TMI 18 - SUPREME COURT] we are of the view that Assessing Officer grossly erred in invoking clause (c) of Explanation to 115JA of the Act for the purpose of adding back the amount of Rs. 2,49,73,218/- in the book profit of the Assessee. CIT(A) corrected the error committed by the AO and invoked the provisions of clause (b) of Explanation to Section 115JA of the Act by holding that the said amount represented ‘reserves’ and deserves to be added back to the book profit of the Company. The ITAT has upheld the finding recorded by CIT(A). Perusal of the findings recorded by ITAT while upholding the findings of CIT(A) would indicate that the ITAT has considered the provisions of clause 7(2) of Part III of Schedule VI of the Companies Act,1956. As observed above, under sub-section 2 of Section 115JA of the Act, the Assessee Company is required to prepare profit and loss account in accordance with provisions of Parts II and III of Schedule VI to the Companies Act,1956. ITAT proceeded to extract the provisions of clause 7 and held that under clause 7(2), any excess amount of provision, even if resulting in diminution in value of assets, has to be treated as ‘reserve’ and not as a ‘provision’. In our view, the ITAT has grossly erred in treating the amount of provision resulting in diminution in value of assets as ‘reserve’. Provisions of clause (g) of Explanation to Section 115JA of the Act would indicate that the Legislature made provision for adding back the amount set aside as provision for diminution in the value of any asset by amending Section 115JA of the Act vide Finance Act, 2009 with effect from 1 April 1998. During the assessment year 1997-1998, clause (g) was absent in the Explanation to Section 115JA of the Act. If the amount set aside as provision for diminution in the value of any asset formed a part of ‘reserves’ under clause (b), there was no necessity for the Legislature to include such amount in a separate category under clause (g). Clause (g) appears to have been added by the Legislature after noticing that there was no provision in Section 115JA of the Act for adding back the amount set aside by the Assessee for diminution in the value of any assets. In the present case, the Assessee had set aside the amount under a belief that though the same was its assets, its value was likely to be diminished. It actually diminished as the Assessee ended up in recovery less than 50% of the due amount from its supply in the USA. After insertion of clause (g) in Explanation to Section 115JA of the Act with effect from 1 April 1998, such amount set apart in the profit and loss account towards provision for diminution in the value of assets, became addable in the book profit of the Company with effect from 1 April 1998. This position is also borne out in the two judgments relied upon in Peerless General Finance & Investment Company Limited [2016 (5) TMI 713 - CALCUTTA HIGH COURT] and M/s. EID Parry (India) Ltd. [2019 (7) TMI 29 - MADRAS HIGH COURT] where clause (g) is held to be inapplicable to the amount set apart as bad and doubtful debt for assessment year 1997-1998 on account of introduction of clause (g) with effect from 1 April 1998. Thus,AO, CIT(A) and ITAT grossly erred in adding back the amount indicated in the profit and loss account as provision for doubtful debts/advances by resorting to either clauses (b) or (c) of Explanation to Section 115JA of the Act. The said amount was not a “Reserve” and therefore, the book profit could not be increased by the said amount under clause (b) of the Explanation to section 115JA of the Act. Question of law formulated is accordingly answered in the negative. The orders passed by the ITAT, CIT(A) and AO to the extent of adding back the amount in the book profit of the Assessee for the assessment year 1997-1998 are set aside. The core legal question considered in this judgment is whether the amount of Rs. 2,49,73,218/- shown by the Assessee as 'provision for doubtful debts/advances' can be added back to the book profit for the purpose of Section 115JA of the Income Tax Act, 1961 (the Act), specifically under clause (b) or (c) of the Explanation to that section.Another related issue is the interpretation of the terms 'provision' and 'reserve' within the context of the Explanation to Section 115JA, and whether the provision for doubtful debts/advances constitutes a reserve or a provision under the relevant legal framework, including the Companies Act, 1956.Additionally, the judgment considers the applicability of clause (g) of the Explanation to Section 115JA, which deals with provisions for diminution in the value of assets, and its temporal applicability to the assessment year in question.Lastly, the judgment addresses the extent of the Assessing Officer's jurisdiction to question the profit and loss account certified by statutory auditors under the Companies Act, and the limits of adjustments permissible under Section 115JA.Issue-wise Detailed Analysis:1. Whether the provision for doubtful debts/advances can be added back to book profit under clause (b) or (c) of Explanation to Section 115JA:Legal Framework and Precedents: Section 115JA imposes a minimum tax on companies based on their book profits, which are defined as net profits shown in profit and loss accounts prepared under Parts II and III of Schedule VI to the Companies Act, 1956, increased by certain specified amounts under clauses (a) to (g) of the Explanation. Clause (b) refers to amounts carried to any reserves 'by whatever name called,' while clause (c) refers to amounts set aside as provisions for meeting liabilities other than ascertained liabilities.The Supreme Court in Apollo Tyres Ltd. held that the Assessing Officer cannot question the correctness of profit and loss accounts certified by statutory auditors except as provided in the Explanation to Section 115J (now 115JA). In CIT Delhi vs. HCL Comnet Systems & Services Ltd., the Supreme Court clarified that provisions for doubtful debts, being amounts set aside against assets (debts receivable), do not constitute provisions for liabilities and hence cannot be added back under clause (c).Court's Interpretation and Reasoning: The Assessing Officer initially added back the provision for doubtful debts under clause (c), reasoning that the provision was not for an ascertained liability and had not been written off as irrecoverable. The CIT(A) and ITAT, however, disagreed with the invocation of clause (c) and instead treated the amount as a reserve under clause (b), relying on clause 7(2) of Part III of Schedule VI of the Companies Act, which treats excess provisions as reserves.The Court analyzed clause 7(2) of Schedule VI, which states that any amount retained as provision in excess of what is reasonably necessary shall be treated as reserve. The CIT(A) and ITAT concluded that the provision was premature and excessive, thus qualifying as a reserve. However, the Court noted that clause (g) of the Explanation to Section 115JA, which explicitly addresses provisions for diminution in the value of assets, was not in force for the relevant assessment year (1997-1998), having been introduced only with effect from 1 April 1998.Key Evidence and Findings: The Assessee had created a provision for doubtful debts based on amounts due from Regal International Inc. and others, pending recovery and litigation. The provision was reflected in the profit and loss account, audited and filed without objection. Subsequent recoveries amounted to approximately 50% of the dues. The Assessing Officer found no proof of bad debts or write-off and thus disallowed the provision under clause (c). CIT(A) and ITAT treated it as a reserve under clause (b).Application of Law to Facts and Treatment of Competing Arguments: The Court agreed with the Assessee that clause (c) was inapplicable since the provision related to assets (debts receivable) and not liabilities. The Court also rejected the CIT(A) and ITAT's reliance on clause 7(2) of Schedule VI to treat the provision as a reserve, reasoning that if such provisions were to be treated as reserves, there would have been no need for the Legislature to introduce clause (g) to deal specifically with provisions for diminution in asset values. Since clause (g) was not applicable for the assessment year in question, the provision could not be treated as a reserve either.The Court further emphasized that the Assessing Officer's jurisdiction to adjust the book profit is limited to the specific additions and deductions enumerated in the Explanation to Section 115JA and cannot extend to recharacterizing provisions certified by statutory auditors without legal basis.2. Applicability of clause (g) of Explanation to Section 115JA:Legal Framework: Clause (g), added by Finance Act 2009 effective from 1 April 1998, mandates addition to book profits of amounts set aside as provision for diminution in the value of any asset.Court's Interpretation: Since the assessment year was 1997-1998, clause (g) was not applicable. The Court observed that the legislative insertion of clause (g) indicates that prior to its introduction, such provisions were neither explicitly covered under clause (b) nor clause (c). This supports the conclusion that the provision for doubtful debts could not be treated as a reserve under clause (b) before clause (g) was introduced.3. Jurisdiction of Assessing Officer to question the profit and loss account:Legal Framework and Precedents: The Supreme Court in Apollo Tyres Ltd. held that the Assessing Officer's power to interfere with the profit and loss account is circumscribed by the Explanation to Section 115J/115JA. The accounts prepared under the Companies Act and certified by statutory auditors are to be accepted as authentic unless the Explanation requires adjustment.Court's Reasoning: The Court reiterated that the Assessing Officer cannot go behind the profit and loss account except to the extent provided in the Explanation. Since the provision for doubtful debts was reflected in the accounts and certified, and since the Explanation did not mandate addition under clause (b) or (c) at the relevant time, the Assessing Officer erred in making the addition.Significant Holdings:'The Assessing Officer grossly erred in invoking clause (c) of Explanation to 115JA of the Act for the purpose of adding back the amount of Rs. 2,49,73,218/- in the book profit of the Assessee.''Under clause 7(2) of Part III of Schedule VI to the Companies Act, any excess amount of provision, even if resulting in diminution in value of assets, has to be treated as 'reserve' and not as a 'provision'. However, the ITAT has grossly erred in treating the amount of provision resulting in diminution in value of assets as 'reserve'.''If the amount set aside as provision for diminution in the value of any asset formed a part of 'reserves' under clause (b), there was no necessity for the Legislature to include such amount in a separate category under clause (g). Clause (g) appears to have been added after noticing that there was no provision in Section 115JA for adding back the amount set aside by the Assessee for diminution in the value of any assets.''The question of law formulated is accordingly answered in the negative. The orders passed by the ITAT, CIT(A) and Assessing Officer to the extent of adding back the amount of Rs. 2,49,73,218/- in the book profit of the Assessee for the assessment year 1997-1998 are set aside.'Core Principles Established:1. Provisions for doubtful debts, being amounts set aside against assets (debts receivable), do not constitute provisions for liabilities and cannot be added back under clause (c) of the Explanation to Section 115JA.2. Provisions resulting in diminution in the value of assets cannot be treated as reserves under clause (b) of the Explanation to Section 115JA for assessment years prior to the insertion of clause (g).3. The Assessing Officer's authority to adjust book profits is limited to the specific items enumerated in the Explanation to Section 115JA and does not extend to recharacterizing provisions certified by statutory auditors without express legislative sanction.4. The legislative insertion of clause (g) to the Explanation to Section 115JA post-1997 indicates that prior to its introduction, provisions for diminution in asset value were not to be treated as reserves or provisions for liabilities for the purpose of book profit adjustments.