TaxTMI 
TaxTMI 
2007 (11) TMI 401
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....e Companies Act'), the Income-tax Act, 1961 ('Income-tax Act') and the Constitution of India?" 2. M/s. J.K. Industries Ltd. is a public limited company. It was incorporated in 1951. It carries on the business of manufacture and sale of automotive tyres, tubes, sugar and agrigenetics. It has a registered office at Calcutta. It seeks to challenge AS 22 issued by Institute of Chartered Accountants of India (for short, 'Institute') which has been made mandatory for all companies listed in Stock Exchanges in India in preparation of their accounts for the financial year 2001-02 onwards. 3. On 7-12-2006 the Central Government prescribed AS 22 under section 211 (3C) of the Companies Act by the Companies (AS) Rules, 2006. Before that date, AS 22, when issued in 2001, was challenged in writ petitions filed before Madras, Karnataka, Calcutta and Gujarat High Courts. On transfer petitions, under section 139A of the Constitution, filed by the Institute, this Court vide order dated 17-2-2003 was pleased to transfer the writ petitions filed in various High Courts to the Calcutta High Court. Meaning and purpose of AS 4. In its origin, Accounting Standard is a policy statement or docume....
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....le estimates. For example, net assets refer to the difference between total assets less liabilities but the value attributable to each asset and each liability is often subjective. It depends on estimates. This is where the Accounting Standards help. They reduce the subjectivity. Therefore, Accounting Standards help to arrive at the best possible estimates. This estimation/subjectivity is also on account of the conceptual difference between 'accounting income' and 'taxable income'. Accounting income is the real income. Tax laws lay down rules for valuation of inventories, fixed assets, depreciation, bad debts, etc., based on artificial rules and not on the basis of accounting estimates, which results in mismatch between accounting and taxable incomes. For example, a fixed rate of depreciation may, for some companies, result in computing lower than the actual income if the actual erosion in the value of the asset is lower than the depreciation calculated at the fixed rate and higher than actual income for others where assets erode faster. Accounting income is normally used as a relevant measure by most stakeholders. However, on account of artificial set of rules used in computation ....
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....nal Accounting Standards and IFRS have got to be eliminated. For example, exchange difference in respect of unpaid liability for acquisition of an imported asset has been allowed in the past to be adjusted with the carrying costs of the fixed assets instead of recognizing the exchange difference in the profit and loss account. 10. Lastly, it is important to note that Accounting Standards and taxation of income are two independent subjects. The object behind AS is to remove this divergence by making Accounting Income a Taxable Income. Accounting income can never negate True Income. Relevant provisions of the Companies Act, 1956 and Analysis thereof 11. Before analyzing the provisions of the Companies Act, we quote hereinbelow the following provisions from the Companies Act, which read as follows : "PREAMBLE The Companies Act, 1956 (ACT 1 OF 1956) [18th January, 1956] An Act to consolidate and amend the law relating to companies and certain other associations. Be it enacted by Parliament in the Sixth Year of the Republic of India as follows:-" "PRELIMINARY Section 2(33) 'prescribed' means, as respects the provisions of this Act relating to the winding up....
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....books are not kept on accrual basis and according to the double entry system of accounting. (4) The books of account and other books and papers shall be open to inspection by any director during business hours. (4A) The books of account of every company relating to a period of not less than eight years immediately preceding the current year together with the vouchers relevant to any entry in such books of account shall be preserved in good order : Provided that in the case of a company incorporated less than eight years before the current year, the books of account for the entire period preceding the current year together with the vouchers relevant to any entry in such books of account shall be so preserved. (5) If any of the persons referred to in sub-section (6) fails to take all reasonable steps to secure compliance by the company with the requirements of this section, or has by his own wilful act been the cause of any default by the company thereunder, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to ten thousand rupees, or with both : Provided that in any proceedings....
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....n 166, by more than six months and the extension so granted. (4) The period to which the account aforesaid relates is referred to in this Act as a 'financial year' and it may be less or more than a calendar year, but it shall not exceed fifteen months : Provided that it may extend to eighteen months where special permission has been granted in that behalf by the Registrar. (5) If any person, being a director of a company, fails to take all reasonable steps to comply with the provisions of this section, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to ten thousand rupees, or with both : Provided that in any proceedings against a person in respect of an offence under this section, it shall be a defence to prove that a competent and reliable person was charged with the duty of seeing that the provisions of this section were complied with and was in a position to discharge that duty : Provided further that no person shall be sentenced to imprisonment for any such offence unless it was committed wilfully. (6) If any person, not being a director of the company, having been c....
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....licies and standards and auditing as may be referred to it for advice from time to time. (4) The members of the Advisory Committee shall hold office for such terms as may be determined by the Central Government at the time of their appointment and any vacancy in the membership in the Committee shall be filled by the Central Government in the same manner as the member whose vacancy occurred was filled. (5) The non-official members of the Advisory Committee shall be entitled to such fees, travelling, conveyance and other allowances as are admissible to the officers of the Central Government of the highest rank. Section 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 inst....
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.... deemed to be the Accounting Standards until the accounting standards are prescribed by the Central Government under this sub-section. (4) The Central Government may, on the application, or with the consent of the Board of directors of the company, by order, modify in relation to that company any of the requirements of this Act as to the matters to be stated in the company's balance sheet or profit and loss account for the purpose of adapting them to the circumstances of the company. (5) The balance sheet and the profit and loss account of a company shall not be treated as not disclosing a true and fair view of the state of affairs of the company, merely by reason of the fact that they do not disclose- (i )in the case of an insurance company, any matters which are not required to be disclosed by the Insurance Act, 1938; (ii )in the case of a banking company, any matters which are not required to be disclosed by the Banking Companies Act, 1949; (iii)in the case of a company engaged in the generation or supply of electricity, any matters which are not required to be disclosed by both the Indian Electricity Act, 1910, and the Electricity (Supply) Act, 1948; (iv)in th....
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.... Form of Balance-sheet The balance sheet of a company shall be either in horizontal form or vertical form A. HORIZONTAL FORM] Balance sheet of................. . [Here enter the name of the Company] As at.............................. [Here enter the date as at which the balance-sheet is made out.] Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the curr- ent year Rs. (b ) *Share Capital *Fixed Assets *Terms of redemption or conversion Authorised ... shares of Rs. ... each. Distinguishing as far as possible *Under each head the original cost, and the additions Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with w....
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....ter such addition or deduction shall be taken to be the cost of the fixed asset. Explanation 1: This paragraph shall apply in relation to all balance-sheets that may be made out as at the 6th day of June, 1966, or any day thereafter and where, at the date of issue of the notification of the Government of India, in the Ministry of Industrial Development and Company Affairs (Department of Company Affairs), G.S.R. No. 129, dated the 3rd day of January, 1968, any balance sheet, in relation, to which this paragraph applies, has already been made out and laid before the company in annual general meeting, the adjustment referred to in this paragraph may be made in the first balance-sheet made out after the issue of the said notification. Explanation 2: In this paragraph, unless the context otherwise re-quires, the expressions Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) ....
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.... particulars specified below, in respect of each class.) Each balance sheet for the first five years subsequent to the date of the reduction, shall show also the amount of the reduction made. ( c) ... shares of Rs. ... each. Similarly, where sums have been added by writing up the assets, every balance- sheet subsequent to such writing up shall show the increased figures with the date of the increase in place of the original cost. Each balance sheet for the first five years subse-quent to the date of writing up shall also show the amount of increase made. Rs. ... called up. Explanation.- Nothing contained in the preceding two paragraphs shall apply to any adjustment made in accordance with the second paragraph. Of the above shares ...shares are allotted as fully paid-up pursuant to Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets sho....
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....eserves. Showing nature of investments and mode of valuation, for example, cost or market value and distinguishing between- Aggregate amount of company's unquoted investments shall also be shown. (2) Capital Redemption Reserve. *(1) Investments in Government or Trust Securities. All unutilised monies out of the issue must be separately disclosed in the balance sheet of the company indicating the form in which such unutilised funds have been invested. (3) Share Premium Account (cc). *(2) Investments in shares, debentures or Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for The previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the curr- ent year Rs. (b ) bonds (showing ....
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....In regard to Sundry Debtors particulars to be given separately of - (a) debt's considered good and in respect of which the company is fully secured; and (b) debts considered good for which the company holds no security other than the debtor's personal security; and (c) debts considered doubtful or bad. Where loans have been guaranteed by managers and/or directors, a mention thereof shall also be made and the aggregate +(4) Other Loans and Advances. (3) Loose Tools. Debts due by directors or other officers of the company or any of them either severally or jointly with any other person or debts due by firms or private companies respectively in Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the curr- ent year Rs. (b ) ....
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....; (c) the nature of the interest, if any, of any director or his relative or in each of the bankers (other than Scheduled Banks) referred to in (b) above. (7B) Bank balances- All unutilised monies out of the issue must be separately disclosed in the balance sheet of the company indicating the form in which such unutilised funds have been invested. ( a) with Sched-uled Banks, and ( b) with others. B. LOANS AND ADVANCES *The above instructions regarding 'Sundry Debtors' apply to "loans and advances" also. (8)(a) Advances and loans to sub-sidiaries. Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the ....
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....sp; (4) Other Loans and Advances: (6) Other items (specifying nature). ( a) From Banks. ( b) From others. CURRENT LIABILITIES AND PROVISIONS: +PROFIT AND LOSS ACCOUNT. +Show here the debit balance of profit and loss account carried forward after deduction of the uncommitted reserves, if any. The name(s) of the small scale industrial undertaking(s) to whom the Company owe any sum exceeding Rs.1 lakh which is outstanding for A. CURRENT LIABILITIES Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the curr- ent year Rs. (b ) more than 30 days, are to be disclosed. &nbs....
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....ities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. (b ) Figur- es for the curre- nt year Rs. (b ) Figures for the previous year Rs. (b) Figu- res for the curr- ent year Rs. (b ) shares partly paid. The period for which the dividends are in arrear of if there is more than one class of shares, the dividends on each such class are in arrear, shall be stated. ++ (3) Arrears of fixed cumulative dividends. The amount shall be stated before deduction of income-tax, except that in the case of tax-free dividends the amount shall be shown free of income-tax and the fact that it is so shown shall be stated. (4) Estimated amount of contracts remaining to be executed on capital account and not provided for. The amount of any guarantees given by the company on behalf of....
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....Particulars of any redeemed debentures which the company has power to issue should be given. (k )Where any of the company's debentures are held by a nominee or a trustee for the company, the nominal amount of the debentures and the amount at which they are stated in the books of the company shall be stated. (l )A statement of investments (whether shown under 'Investment' or under 'Current assets' as stock-in-trade) separately classifying trade investments and other investments should be annexed to the balance sheet, showing the names of the bodies corporate (indicating separately the names of the bodies corporate under the same management) in whose shares or debentures, investments have been made (including all investments whether existing or not, made subsequent to the date as at which the previous balance sheet was made out) and the nature and extent of the investment; so made in each such body corporate; provided that in the case of an investment company that is to say, a company whose principal business is the acquisition of shares, stock, debentures or other securities, it shall be sufficient if the statement shows only the investments existing on the date as at which th....
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....visions Net current assets (4)(a ) Miscellaneous expenditure to the extent not written off or adjusted (b) Profit and Loss account TOTAL: Notes 1.Details under each of the above items shall be given in separate Schedules. The Schedules shall incorporate all the information required to be given under A-Horizontal Form read with notes containing general instructions for preparation of balance sheet. 2.The Schedules, referred to above, accounting policies and explanatory notes that may be attached shall form an integral part of the balance sheet. 3.The figures in the balance sheet may be rounded off to the nearest '000' or '00' as may be convenient or may be expressed in terms of decimals of thousands. (TO BE COMPARED) 4.A foot-note to the balance sheet may be added to show separately contingent liabilities. PART II Requirements as to profit and loss account.-(1) The provisions of this Part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a profit and loss account, but subject to the modification of references as specified in that sub-section. (2) The profi....
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....ent compliance with the requirements herein if the total amounts are shown in respect of the opening and closing stocks, purchases, sales and consumption of raw material with value and quantitative break-up and the gross income from services rendered is shown. (e )In the case of other companies, the gross income derived under different heads. Note 1 - The quantities of raw materials purchases, stocks, and the turnover shall be expressed in quantitative denominations in which these are normally purchased or sold in the market. Note 2 - For the purpose of items (ii)( a), (ii)( b) and (ii)( d), the items for which the company is holding separate industrial licences, shall be treated as separate classes of goods, but where a company has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class. In the case of trading companies, the imported items shall be classified in accordance with the classification adopted by the Chief Controller of Imports and Exports in granting the import licences. Note 3 - In giving the break-up of purchases, sto....
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....tion of stores and spare parts. (b )Power and fuel. (c )Rent. (d )Repairs to buildings. (e )Repairs to machinery. (f )(1) Salaries, wages and bonus. (2) Contribution to provident and other funds. (3) Workmen and staff welfare expenses to the extent not adjusted from any previous provision or reserve. Note 1 - Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account. Note 2** ** ** (g )Insurance. (h )Rates and taxes, excluding taxes on income. (i )Miscellaneous expenses : Provided that any item under which the expenses exceed one per cent of the total revenue of the company or Rs. 5,000 whichever is higher shall be shown as a separate and distinct item against an appropriate account head in the profit and loss account and shall not be combined with any other item to be shown under 'Miscellaneous expenses". ( xi)( a)The amount of income from investments, distinguishing between trade investments and other investments. (b )Other income by way of interest, specifying the nature of the income. (c )The amount of income-tax deducted if the gross income is stated under ....
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....r contain or give by way of a note detailed information in regard to amounts paid to the auditor, whether as fees, expenses or otherwise for services rendered- (a )as auditor; (b )as adviser, or in any other capacity, in respect of- (i )taxation matters; (ii )company law matters; (iii)management services; and (c )in any other manner. 4C. In the case of a manufacturing companies, the profit and loss account shall also contain, by way of a note in respect of each class of goods manufactured, detailed quantitative information in regard to the following, namely :- (a )the licensed capacity (where licence is in force); (b )the installed capacity; and (c )the actual production. Note 1 - The licensed capacity and installed capacity of the company as on the last date of the year to which the profit and loss account relates, shall be mentioned against items (a) and ( b) above, respectively. Note 2 - Against item (c), the actual production in respect of the finished products meant for sale shall be mentioned. In cases where semi-processed products are also sold by the company, separate details thereof shall be given. Note 3 - For the purposes of this pa....
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.... (2) The requirement in sub-clause (1) shall, in the case of companies preparing quarterly or half-yearly accounts, relate to the profit and loss account for the period which entered on the corresponding date of the previous year." "AUDIT Section 227. Powers and duties of auditors.-(1) Every auditor of a company shall have a right of access at all times to the books and accounts and vouchers of the company, whether kept at the head office of the company or elsewhere, and shall be entitled to require from the officers of the company such information and explanations as the auditor may think necessary for the performance of his duties as auditor. (1A) Without prejudice to the provisions of sub-section (1), the auditor shall inquire- (a )whether loans and advances made by the company on the basis of security have been properly secured and whether the terms on which they have been made are not prejudicial to the interest of the company or its members; (b )whether transactions of the company which are represented merely by book entries are not prejudicial to the interests of the company; (c )where the company is not an investment company within the meaning of sectio....
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.... are in agreement with the books of account and returns; (d )whether, in his opinion, the profit and loss account and balance-sheet comply with the accounting standards referred to in sub-section (3C) of section 211; (e )in thick type or in italics the observations or comments of the auditors which have any adverse effect on the functioning of the company; (f )whether any director is disqualified from being appointed as director under clause (g) of sub-section (1) of section 274; (g )whether the cess payable under section 441A has been paid and if not, the details of amount of cess not so paid. (4) Where any of the matters referred to in clauses (i) and (ii ) of sub-section (2) or in clauses (a), (b ), (bb), (c) and (d )] of sub-section (3) is answered in the negative or with a qualification, the auditor's report shall state the reason for the answer. (4A) The Central Government may, by general or special order, direct that, in the case of such class or description of companies as may be specified in the order, the auditor's report shall also include a statement on such matters as may be specified therein : Provided that before making any such order the Central....
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....les.-(1) In addition to the powers conferred by section 641, the Central Government may, by notification in the Official Gazette, make rules- (a )for all or any of the matters which by this Act are to be, or may be, prescribed by the Central Government; and (b )generally to carry out the purposes of this Act. (2) Any rule made under sub-section (1) may provide that a contravention thereof shall be punishable with fine which may extend to five thousand rupees and where the contravention is a continuing one, with a further fine which may extend to five hundred rupees for every day after the first during which such contravention continues. (3) Every rule made by the Central Government under sub-section (1) shall be laid as soon as may be after it is made before each House of Parliament while it is in session for a total period of thirty days which may be comprised in one session or in two or more successive sessions, and if, before the expiry of the session immediately following the session or the successive sessions aforesaid, both Houses agree in making any modification in the rule or both Houses agree that the rule should not be made, the rule shall thereafter have effe....
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....on by companies or class of companies. The accounting policies and Accounting Standards were required to be prescribed by the Central Government as contemplated by section 2(33). The object behind section 210A was to make it obligatory on the part of the companies to comply with the Accounting Standards. NAC was constituted vide Notification dated 18-9-2003. Under section 211(3C) it is provided, that till such time the Accounting Standards are prescribed by the Central Government in consultation with NAC on Accounting Standards; the Accounting Standards prescribed by the Institute shall be deemed to be the Accounting Standards to be complied with by all the companies. In all, the Institute has so far framed 29 Accounting Standards. 14. Section 211(1) requires the balance-sheet to be in the form set out in Part I of Schedule VI 'or as near thereto as circumstances admit'. The said phrase 'or as near thereto as circumstances admit' allows adoption of improved techniques in the presentation of accounts to shareholders. It is important to note that the information which is required to be given to shareholders pursuant to Schedule VI should be given in a manner which they will unders....
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.... P & L account of a company must give a true and fair view of the profit or loss of the company for the financial year and comply with the requirements of Part II of Schedule VI so far as they are applicable thereto. It may be noted that the balance-sheet prescribed by Part I of Schedule VI has to be in the form of a proforma. However, the Companies Act does not prescribe a proforma of P & L account. Part I of Schedule VI prescribes a proforma of balance-sheet. Part II of Schedule VI only prescribes the particulars which must be furnished in the P & L account. Therefore, as far as possible, the P & L account must be drawn up according to the requirements of Part II of Schedule VI. It is important to note that section 211 read with Part I and Part II of Schedule VI prescribes the form and contents of balance-sheet and P&L account. However, section 211(1), inter alia, states that every balance-sheet of a company shall subject to the provisions of that section, be in the form set out in Part I of Schedule VI. The words 'subject to the provisions of this section' would mean that every sub-section following sub-section (1) including sub-sections (3A), (3B) and (3C) shall have an overrid....
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.... 211 (with effect from 31-10-1998), these Standards were not mandatory. Therefore, the companies were then free to prepare their annual financial statements, as per the specific requirements of section 211 read with Schedule VI. However, with the insertion of sub-sections (3A), (3B) and (3C) in section 211 the P & L account and the balance-sheet have to comply with the Accounting Standards. For this purpose the expression 'Accounting Standards' shall mean the standards of accounting recommended by the Institute as may be prescribed by the Central Government in consultation with NAC on Accounting Standards. Thus, the Accounting Standards are prescribed by the Central Government. Thus, the Accounting Standards prescribed by the Central Government are now mandatory qua the companies and non-compliance with these Standards would lead to violation of section 211 inasmuch as the annual accounts may then not be regarded as showing a "true and fair view". 18. Section 641 empowers the Central Government to alter any of the regulations, rules, tables, forms and other provisions contained in Schedule VI to the Companies Act. However, this power can be used only for making simple alteration....
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....applicable), and other statements and explanatory notes which form part thereof. (e )'Enterprise' means a company as defined in section 3 of the Companies Act, 1956. (f )'Small and Medium Sized Company' (SMC) means, a company- (i )whose equity or debt securities are not listed or are not in the process of listing on any stock exchange, whether in India or outside India; (ii )which is not a bank, financial institution or an insurance company; (iii)whose turnover (excluding other income) does not exceed rupees fifty crore in the immediately preceding accounting year; (iv)which does not have borrowings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year; and (v )which is not a holding or subsidiary company of a company which is not a small and medium-sized company. Explanation.-For the purposes of clause (f), a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period. (2) Words and expressions used herein and not defined in these rules but defined in the Act shall have the same meaning respectivel....
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....s available to SMCs shall be disclosed in the notes to the financial statements. 1.3If an SMC opts not to avail of the exemptions or relaxations available to an SMC in respect of any but not all of the Accounting Standards, it shall disclose the standard(s) in respect of which it has availed the exemption or relaxation. 1.4If an SMC desires to disclose the information not required to be disclosed pursuant to the exemptions or relaxations available to the SMCs, it shall disclose that information in compliance with the relevant accounting standard. 1.5The SMC may opt for availing certain exemptions or relaxations from compliance with the requirements prescribed in an Accounting Standard : Provided that such a partial exemption or relaxation and disclosure shall not be permitted to mislead any person or public. 2. Accounting Standards, which are prescribed, are intended to be in conformity with the provisions of applicable laws. However, if due to subsequent amendments in the law, a particular accounting standard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements shall be prepared in conformity with s....
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....tributions made by the enterprise. 4. Definitions.-For the purpose of this Standard, the following terms are used with the meanings specified : 4.1 Accounting income (loss) is the net profit or loss for a period, as reported in the statement of profit and loss, before deducting income-tax expense or adding income-tax saving. 4.2 Taxable income (tax loss) is the amount of the income (loss) for a period, determined in accordance with the tax laws, based upon which income-tax payable (recoverable) is determined. 4.3 Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or credited to the statement of profit and loss for the period. 4.4 Current tax is the amount of income-tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period. 4.5 Deferred tax is the tax effect of timing differences. 4.6 Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. 4.7 Permanent differences are the differences between taxable income and accounting income for a period that originate ....
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.... Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. 10. Taxes on income are considered to be an expense incurred by the enterprise in earning income and are accrued in the same period as the revenue and expenses to which they relate. Such matching may result into timing differences. The tax effects of timing differences are included in the tax expense in the statement of profit and loss and as deferred tax assets (subject to the consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, in the balance sheet. 11. An example of tax effect of a timing difference that results in a deferred tax asset is an expense provided in the statement of profit and loss but not allowed as a deduction under section 43B of the Income-tax Act, 1961. This timing difference will reverse when the deduction of that expense is allowed under section 43B in subsequent year(s). An example of tax effect of a timing difference resulting in a deferred tax liability is the higher charge of depreciation allowable under the Income-tax Act, 1961, compared to the depreciation provid....
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....re recognised and carried forward only to the extent that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future. 17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be released. Explanation.-(1) Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgment based on convincing evidence and will have to be evaluated on a case to case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of performance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a matter of fact. To be convincing, the evidence ....
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....per the provisions of the Act). (c) In cases where there is a difference between the amounts of 'loss' recognised for accounting purposes and tax purposes because of cost indexation under the Act in respect of long-term capital assets, the deferred tax asset is recognised and carried forward (subject to the consideration of prudence) on the amount which can be carried forward and set-off in future years as per the provisions of the Act. 18. The existence of unabsorbed depreciation or carry forward of losses under tax laws is strong evidence that future taxable income may not be available. Therefore, when an enterprise has a history of recent losses, the enterprise recognises deferred tax assets only to the extent that it has timing differences the reversal of which will result in sufficient income or there is other convincing evidence that sufficient taxable income will be available against which such deferred tax assets can be released. In such circumstances, the nature of the evidence supporting its recognition is disclosed. 19. Re-assessment of Unrecognised Deferred Tax Assets.-At each balance sheet date, an enterprise reassesses unrecognised deferred tax assets. The en....
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....ed tax assets and liabilities on a discounted basis requires detailed scheduling of the timing of the reversal of each timing difference. In a number of cases such scheduling is impracticable or highly complex. Therefore, it is inappropriate to require discounting of deferred tax assets and liabilities. To permit, but not to require, discounting would result in deferred tax assets and liabilities which would not be comparable between enterprises. Therefore, this Standard does not require or permit the discounting of deferred tax assets and liabilities. 26. Review of Deferred Tax Assets.-The carrying amount of deferred tax assets should be reviewed at each balance sheet-date. An enterprise should write-down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income will be available against which deferred tax asset can be realised. Any such write-down may be reversed to the extent that it becomes reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income will be available.....
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.... of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the beginning. 34. For the purpose of determining accumulated deferred tax in the period in which this Standard is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are compared and the differences, if any, are determined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences are timing differences. For example, in the year in which an enterprise adopts this Standard, the opening balance of a fixed asset is Rs. 100 for accounting purposes and Rs. 60 for tax purposes. The difference is because the enterprise applies written down value method of depreciation for calculating taxable income whereas for accounting purposes straight line method is used. This difference will reverse in future when depreciation for tax purposes will be lower as compared to the depreciation for accounting purposes. In the above case, assuming that enacted tax rate for th....
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....ccount and thus resulting in enhancement of tax liability for the year. 22. Learned counsel further contended that section 211(1) of the Companies Act lays down that every balance-sheet of a company shall give a true and fair view of the state of affairs of the company at the end of the financial year and shall subject to the provisions of the said 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. According to learned counsel, section 211(1) of the Companies Act should be read with the proviso which inter alia provides that nothing contained in section 211(1) shall apply to insurance company, banking company, electricity company etc. for which a separate balance-sheet has been specified in the Companies Act. Therefore, according to learned counsel, what is contemplated by the expression "subject to the provisions of section 211" is that where there is inconsistency or conflict between the other provisions of section 211, the other provision will prevail as there are circumstances when insurance and banking company or any company for which a form or balance-sheet h....
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....ribed by the rules under section 641(1) of the Act. Learned counsel, therefore, submitted that Accounting Standard, as prescribed by the rules under section 642(1) of the Act run contrary to or being inconsistent with Schedule VI of the Companies Act without any amendment being made under section 641(1) of the Act. According to the learned counsel, rules framed under section 642(1) of the Act do not have any effect as if enacted in the Companies Act; that, the effect of amendment of Schedule under section 641 is as if enacted in the Act but rules framed under section 642 do not have that effect. Therefore, the effect of the notifications under section 641 on the one hand and the notifications issued under section 642 on the other hand is entirely different. According to learned counsel, so long as Schedule VI to the Companies Act is not altered or amended by exercising the power under section 641(1) of the Act the AS prescribed by the rules notified under section 642(1) cannot alter or amend Schedule VI and if the said rules are contrary to or inconsistent with Schedule VI then the same are liable to be struck down as inconsistent with the provisions of the Companies Act. 24. Le....
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....-tax Act. In this connection, it was urged that all 29 Accounting Standards stood notified by Notification No. 739(E), dated 7-12-2006. Accordingly, all 29 Accounting Standards are now contained in the Companies (Accounting Standards) Rules, 2006. They have, therefore, the status of subordinate legislation. That, para 2 of the Annexure to the Accounting Standards has expressly stated that the Standards are intended to be in conformity with the provisions of applicable laws and, therefore, according to learned counsel, the intention is not to treat the Accounting Standards as part of the Companies Act but as a subordinate legislation. Therefore, AS 22 cannot be treated as amending or altering Schedule VI which is part of the Companies Act and which can only be done under section 641(2) by way of appropriate notification. That, under section 641(2), any amendment to the schedules by way of notification is treated as if it is enacted in the Act. Such a provision is absent in section 642. That, as the Accounting Standards in the present case have not been notified under section 641, they cannot alter or amend the Schedule VI to the Companies Act. 27. As regards matching principle, l....
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....-tax Act and Companies Act. Therefore, it is only for the court/tax department to apply the matching principle in a given case. It would depend on the facts of a given case. The matching principle cannot be prescribed by a rule or an Accounting Standard. Learned counsel, therefore, submitted that the Central Government as a rule-making authority under section 642 or the Institute has no power to apply the matching principle or timing difference across the board to bring the accounting depreciation in line with tax depreciation. The rates of depreciation are not prescribed statutorily in U.K. In U.K., the assessee is at liberty to adopt any rate of depreciation he chooses and, therefore, according to learned counsel, there could be some justification for invoking the matching principle and applying an accounting standard for deferred taxation. 28. On the concept of "true and fair" view, learned counsel urged that under section 211(1), a balance-sheet has to present a true and fair view. Similarly, under section 211(2), P&L account must also be true and fair. However, according to learned counsel, the said concept does not mean that Accounting Standards can alter Schedule VI or en....
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.... Institute has not produced any evidence of any company getting any benefit from implementation of AS 22. In this connection, learned counsel submitted that provision for DTL unfortunately has not been treated as a reserve which can be utilized in times of financial crisis. That the Institute has not given a single example of a situation where timing difference has been reversed. According to learned counsel, AS 22 does not in any way help collection of higher taxes. That, as long as a company continues to be profitable, it is impossible for any reversal by timing difference. In this connection, learned counsel urged that, in India, income-tax depreciation is substantially higher than accounting depreciation as per Schedule XIV and, therefore, the accounting profits will always be more than the book profits. Therefore, every year, there would be DTL which will keep on accumulating. For example, according to learned counsel, accumulated DTL of Reliance Industries Ltd. was Rs. 6,982 crores as on 31-3-2007 and this liability will keep on accumulating. According to learned counsel, except in the case of companies which are likely to make loss in the near future, reversal will never tak....
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.... tax liability can be created only under an Act of Parliament. DTL can only be a liability by way of tax. It is not a liability of any other nature since it is not required to be discharged in future. It is not enforceable against the company. Thus, DTL creates a legal fiction with respect to the concepts of taxation and liability which is contrary to the legal meaning enunciated by several judgments of this Court (See : State of Kerala v. Madras Rubber Factory Ltd. AIR 1998 SC 723 at 730 and Shree Digvijay Cement Co. Ltd. v. Union of India [2003] 2 SCC 614 at 627, paras 26 and 27). 33. On the question of effect of section 211(3A), (3B) and (3C), learned counsel submitted that section 211(3A) cannot be read to imply that Accounting Standards have to be complied with even if they are inconsistent with the Act or that they alter/amend any provisions of the Companies Act. As regards section 211(3B), learned counsel submitted that any deviation from the Accounting Standards has to be qualified by the auditors which may lead to adverse consequences for the company. According to learned counsel, unless the company is likely to make loss in near future, timing difference can never aris....
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....required to make any provision but only a note is required to be given in the accounts known as 'Disclosure Note'; that, DTL is not even a contingent liability; and that, on the balance-sheet date several events such as the working of the company in future years, whether the company will earn a taxable profit (loss) in future are events which are totally unknown at the end of the accounting period when the company is required to recognize, measure and account for DTL. According to the learned counsel, if there is no income in future, there would be no liability for tax in future and if there is income and additions to assets in future, the difference in depreciation under the Companies Act and under the Income-tax Act for the accounting period will not result in any tax liability in future and there would be no reversal of the DTL created in the accounting period. According to learned counsel, AS 22 requires recognition of the tax effect, whether current or deferred, in respect of individual transaction during the accounting period as if in future the company would have to make payment on account of deferred tax. According to learned counsel, the aforestated concept is merely an as....
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....crued liability in the legal sense; that, the tax liability in the income is only to the extent the Income-tax Act provides for such liability; that real liability for income-tax is only as computed under the Income-tax Act; that, merely because the difference between the accounting income and taxable income is ascertainable and merely because tax effect on account of such difference can be worked out on the basis of existing tax rates, it cannot be said that such tax effect represents a real liability payable today or tomorrow. According to learned counsel, the difference between accounting and taxable income in a given year may or may not give rise to a liability or outflow of money in future. According to learned counsel, this is an assumption. This is totally uncertain. Therefore, according to learned counsel, to give tax effect on such difference cannot be treated as an accrued liability and in respect of such difference, no income-tax is payable under the income-tax Act for the accounting period. 35. Mr. Bagaria, learned counsel, further submitted that "accrual" is a legal concept. It has not been defined under Income-tax Act. It has not defined under the Companies Act. An....
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.... the word "accrual" is the same both in the Accounting Standard prescribed under section 211(3C) and that which is notified under section 145(2) of the Income-tax Act. Therefore, according to learned counsel, the word "accrual" for the purposes of the Companies Act does not carry any meaning different from that mentioned for the purposes of the Income-tax Act. That, only the amount of income-tax actually payable under the Income-tax Act with reference to the taxable income for the period covered by the account computed in accordance with the provisions of that Act can constitute a charge for income-tax and is, therefore, an accrued liability. Any amount in excess of such tax is a reserve and not a provision for taxation. According to learned counsel, therefore, for the above reasons AS 22 insofar as it relates to deferred tax is contrary to the concept of "accrual" which concept is recognized under section 209(3)(b) read with section 209(1) of the Companies Act. 37. On the question of matching principle, learned counsel urged that the matching concept is fully complied with when a provision is made for tax computed in accordance with the provisions of the Income-tax Act with ref....
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....ement of "true and fair view" stands incorporated in section 209(3)(a), section 211(1), (2) and (5); section 217(2AA)(ii); and section 227(2). According to learned counsel, on bare reading of section 227 read with section 209 it is clear that the auditor of the company has to report that "proper books of account" as required by law has been kept by the company; that, "proper books of account" shall not be deemed to be kept unless they are kept on accrual basis and double entry system of accounting; that, the auditor has to report that the balance-sheet and the P&L account are in agreement with the books of account and that the auditor has also to report whether profit and loss account as well as balance-sheet complies with the Accounting Standards referred to in section 211(3C). According to learned counsel, sub-section (3A) of section 211 requires every P&L account and balance-sheet of the company to comply with the Accounting Standards; that, sub-sections (3A), (3B) and (3C) do not refer to keeping of proper books of account; that this subject is covered by section 209 only which mandates that proper books of account shall not be deemed to be kept unless the same are kept on accr....
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....earned counsel, the power under sub-sections (3A), (3B) and (3C) only relates to prescribing Accounting Standards for presentation of P&L account and balance-sheet whereas AS 22 directly and immediately encroaches upon preparation of books of account and maintenance and proper books of account on accrual basis and in the process violates the mandate statutorily imposed by section 209(3). That, there is no power conferred by sub-sections (3A), (3B) and (3C) nor by any other sub-sections of section 211 to prescribe Accounting Standards relating to maintenance of proper books of account. In this connection, learned counsel pointed out that the duty of the auditor is to report in terms of section 227(3)(d) about compliance with the Accounting Standards referred to in sub-section (3C) of section 211 which applies only in respect of P&L account and balance-sheet; that, the said provision makes it clear that compliance with the Accounting Standards is to be made only in respect of the P&L account and balance-sheet whereas keeping of books of account in terms of section 209 is required to be reported upon by the auditor only in terms of section 227(3)(d) and, therefore, AS 22 exceeds the p....
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.... the provisions of this section' in section 211(1) obviously includes the provision of sub-section (1). Therefore, according to learned counsel, even in terms of the specific language of section 211(1) the requirement of 'true and fair view' in that sub-section is a stand-alone concept and it is not subject to anything. According to learned counsel, accrual basis in section 209(3) is a necessary component of 'true and fair view' as a requirement and, therefore, the said requirement in section 211 and in section 209 would have the same meaning. However, according to learned counsel, the expression 'subject to the provisions of this section' in section 211(1) only qualifies the requirement of balance-sheet being in the form set out in Part I of Schedule VI; that, similarly the expression 'subject as aforesaid' in sub-section (2) of section 211 only qualifies the requirement of Part II of Schedule VI in respect of P & L account; that, sub-section (3A) of section 211 inter alia provides that every P&L account and balance-sheet of the company shall comply with the Accounting Standards and, therefore, according to learned counsel in the entire scheme relating to accounts and audit in Par....
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....of account and financial statements and would not give a true and fair view. According to learned counsel, accrual basis is a necessary component of true and fair view requirement. The provision contrary to the accrual basis cannot satisfy the said requirement. Lastly, according to learned counsel, the only way out of the above inconsistencies is to harmoniously construe sections 209, 211 and AS 22 by reading down the said Standard so that the company is only required to make a disclosure in the P & L account and balance-sheet as regards DTA or DTL without requiring the company to make any entry in the books of account or without making any company to reduce or increase its net profit. 42. Lastly, learned counsel submitted that vide para 33 of AS 22 DTL is sought to be created in respect of individual transactions since the inception of the company which may be long before the AS 22 came into effect resulting in reduction of the revenue reserve by the amount of such DTL. That, the working required to be made in terms of para 33 of AS 22 is complicated. In this connection, learned counsel pointed out that under para 34 of AS 22, not only opening balances of assets but also openin....
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....lants have not challenged the competence of the Central Government to notify or provide for Accounting Standards, they have restricted their challenge only on the ground that AS 22 contravenes the provisions of Companies Act by stating that the same violates sections 205, 209, 211 and Schedule VI of the Companies Act. According to learned counsel, even in that regard no details have been given by the appellants in their original writ petition as to how the impugned Accounting Standard contravenes the provisions of the Companies Act. Therefore, according to learned counsel, the entire original writ petition filed by the appellant is misplaced, misconceived and not maintainable for want of details. Learned counsel urged that AS-22 provides for a different manner than Schedule VI in which account of a company required to be prepared. It is submitted that Schedule VI is the form set out under the Companies Act in which a company is required to submit its balance-sheet and profit and loss account. Section 211(1) requires the companies to prepare their balance-sheet in the form set out in Part-I of Schedule VI. A plain reading of section 211 reveals that the requirement of submission of ....
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....odified/amended to the extent it contravenes AS 22. This is particularly because Part I of Schedule VI is subject to section 211(3A) of the Companies Act. According to learned counsel, under section 211 every company is required to prepare its balance-sheet and P & L account in the manner provided therein. Sub-section (3A) of that section makes it mandatory to comply with Accounting Standards. While preparing P&L account and balance-sheet [See : section 211(3C)]. According to learned counsel, since AS 22 is an Accounting Standard prescribed under sub-section (3C) it has a statutory status, required to be followed while preparing the books of account in terms of section 211 of the Companies Act. Lastly, learned counsel urged that the Companies Act is a special statute; that, section 211 is a special provision aimed at providing the form and content of P & L account and balance-sheet required to be prepared by the company; that, a special provision like section 211 ordinarily overrides the general provision; that, if a special provision is made on a particular subject then that subject is excluded from the general provision and since AS 22 is a special provision notified under sectio....
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....ute has legal obligation of ensuring disclosure of 'true and fair view' in the corporate accounts. However, in the absence of a statutory definition of 'true and fair', it is the Institute's function to determine the basic rules for ensuring disclosure of a 'true and fair view'. According to learned counsel, 'true and fair view' is a concept which requires the Auditor to look at the substance rather than pure legal form and that is why all its Accounting Standards emphasize the importance of Substance over Form. The said view of the Institute is duly affirmed by Parliament when Parliament decreed that corporate accounts shall comply with the proper Accounting Standards [See : sub-sections (3A) and (3B) of section 211 of the Companies Act]. The basic reason for issuing AS 1 through Notification dated 25-1-1996 of Government of India, to be followed by all assessees following mercantile system of accounting, was to lay down that accounting policies adopted by an assessee should represent a 'true and fair' view of the state of affairs of the business in the financial statements prepared and presented based on such accounting policies. Therefore, the requirement 'true and fair' view ov....
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....ccording to the double entry system of accounting. According to learned counsel, the expressions 'accrual', 'accrual basis of accounting', 'accrued asset', 'accrued expense', 'accrued liability', 'accrued revenue', 'current assets', 'current liabilities', 'deferred expenditure', 'depreciation', 'provi-sion', 'prudence' etc. are explained and defined in the Guidance Note on Terms Used in Financial Statements issued by the Institute. Learned counsel submitted that the matching principle is the most important concept in 'accrual accounting'. The matching principle indicates as to when expenses should be recorded against the revenue. The Institute had issued Guidance Note on Accrual Basis of Accounting in 1988, since after the amendment of section 209, requiring all companies to maintain their accounts on accrual basis of accounting. All relevant abovementioned expressions relating to accrual basis of accounting including recognition of revenue and expenses, assets and liabilities have been explained in the said Guidance Note on Accrual Basis of Accounting which, inter alia, lays down the matching principle of recognizing costs against revenue or against the relevant time period to det....
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....and for that purpose learned counsel places reliance on the judgment of this Court on the same issue in the case of Madras Industrial Investment Corpn. Ltd. (supra). In short, learned counsel submitted that with globalization and with new concepts coming in, the law is no more confined to the strict legal concept of 'accrual' which does not recognize the matching principle. 49. Learned counsel urged that the requirement for 'accrual basis of accounting' was introduced in the Companies Act in 1988 through section 209. Under section 209(1) every company is required to maintain proper books of account with respect to receipts and expenses, sales and purchases of goods, assets and liabilities of the company, utilization of material or labour and such other items of costs incurred in production, process, manufacturing etc. Under section 209(3) proper books of account sshall not be deemed to be kept if such books of account do not give true and fair accounts and if such books fail to explain its transactions further if such books are not kept on accrual basis they have to be rejected for not giving a true and fair view of the state of affairs of the company. This position is also refl....
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....ertheless not represent true and fair view. According to learned counsel, for the aforestated reasons Accounting Standards require that the accrual basis should be adopted in the context of presenting/disclosing a 'true and fair' view. Therefore, the need to disclose a true and fair view is wider than the need for accrual accounts since it automatically includes accrual method of accounting. Learned counsel urged that there is overriding importance for the disclosure of a 'true and fair' view, since the entire structure of corporate credibility is built on this foundation. Therefore, if any rules for technical disclosure are not consistent with the true and fair view requirement, then the company has to depart from the technical provisions, to the extent necessary, to give a 'true and fair' view. That, the disclosure requirements are subservient to the overriding requirement of presenting a 'true and fair' view. Therefore, in other words, the need to present a 'true and fair' view should override technical compliance of the law on the basis of true and correct accrual. Therefore, according to the learned counsel, AS 22 goes far beyond technical compliance in order to ensure a 'true....
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.... of each financial year. That, Part I of Schedule VI lays down the form of balance-sheet whereas Part II lays down the requirements as to the presentation of various financial data in the P & L account. Part II deals with interpretation of some of the expressions, namely, 'provisions', 'reserve', 'capital reserve', 'liability', 'investment' etc. According to learned counsel, except in the case of depreciation which is provided by every corporate enterprise in accor-dance with the rates laid down in Schedule XIV of the Companies Act, having regard to the provisions contained in sections 205 and 350 of the said Act, the said Act does not lay down the procedure for recognition and measurement of either the income or expenses and/or the assets and liabilities. For example, Schedule VI nowhere lays down as to which assets should be recognized as 'Investments' and also the method of valuing 'Investments'. Similarly, AS 6 deals with 'Depreciation Accounting', how-ever, except the statutorily fixed rate of depreciation as laid down in Schedule XIV of the Companies Act, all other aspects relating to recogni-tion and measurement of depreciation are dealt with only in AS 6. They are not dealt....
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....ar back as in 1991, the Institute had issued the Guidance Note on Accounting for Taxes on Income. This Note recommended deferred tax adjustments. It also explained the taxes payable method. It also explained the tax effect accounting method. It also explained the method for calculating deferred tax adjustments under 'deferred method' and under 'liability method'. It recommended that till the tax effect accounting method stood developed, it would be permissible for an enterprise to follow the taxes payable method as an alternative. After 10 years, AS 22 was finally issued by the Institute in 2001 in order to ensure a 'true and fair' view of the profits earned during a financial year, and the taxes payable with reference thereto, to be presented in the corporate accounts. That is the reason why, AS 22 leaves out of account differences between book profits and taxable profits which are of permanent nature. But AS 22 requires that DTL/DTA arising on account of timing differences should be reflected in the corporate accounts through what is called as 'deferred tax account'. According to learned counsel, deferred tax accounting ensures that profits are measured in a real and factual mann....
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....f revenue and expenses are included in taxable income which items do not coincide with the period in which such items are included or considered in arriving at accounting income. This difference between taxable income and accounting income arises for two reasons. Firstly, there are differences between items of revenue and expenses, as appearing in the P & L account, and the items which are considered as revenue, expenses or deductions for tax purposes. Secondly, there are differences between the amount in respect of a particular item of revenue or expense, as recognized in the P & L account, and the corresponding amount, which is recognized for the computation of taxable income. This happens in the case of depreciation. The tax laws allow 'incentive depreciation' on increased rate, as prescribed in rule 5 read with the percentages mentioned in second column of the table in Appendix I to the Income-tax Rules, 1962 on the written down value of the block of assets, as are used by the assessee for the purpose of the business at any time during the relevant previous year. Depreciation includes amortization of assets whose useful life is predetermined. The commercial accounting princi....
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....from 15-6-1988. However, this would not mean that without maintaining accounts on mercantile basis, the company would not record the opening balances of its assets and liabilities merely because section 209(3)(b) does not refer to retrospective application. Learned counsel submitted that, therefore, there is no merit in the submissions made on behalf of the appellants that para 33 of AS 22 is ultra vires the provisions of the Companies Act. For the above reasons, learned counsel submitted that AS 22 is in no way contradictory to and/or in conflict of Schedule VI to the Companies Act having regard to the statutory requirement/consideration of presenting the financial statements in "true and fair" manner as laid down in section 211(1)(ii) of the Companies Act. That, clause (vi) under para 3 of Part II of Schedule VI to the Companies Act reference is made only to presentation of income liability in the P&L account. It does not refer to the method of its recognition and/or measurement which aspects are considered and dealt with only by AS 22. Therefore, the portion of income-tax expenses deferred to future tax returns is required to be credited to a Liability Account called as Deferred....
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....g to learned counsel, DTL is an existing liability on the balance-sheet date. According to learned counsel, reversal of timing difference in respect of an asset is definite during the life of an asset. Therefore, there is no uncertainty with regard to the reversal of timing difference in future over the life of the asset. The accounts of a company are prepared under the fundamental accounting assumption of "going concern" which is defined in AS 1 under which the enterprise is normally looked upon as a "going concern", i.e., continuing in operation for the foreseeable future. Under that assumption it is assumed that the enterprise has neither the intention nor the necessity of liquidation or to reduce the scale of its operations. Therefore, according to learned counsel, the examples, given on behalf of the appellants, of liquidation or fall in the scale of operations are not apposite illustrations for treating DTL as a notional liability. According to learned counsel, DTL is a liability for the current period, i.e., for the period in which the timing difference originates, on the basis of matching principle also, which is a part of accrual basis of accounting. In the light of the sa....
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....anches, e.g., Financial Accounting, Management Accounting and Government Accounting. The primary role of accounting is to provide an effective measurement and reporting system. This is possible only when accounting is based on certain coherent set of logical principles that constitute the general frame of reference for evaluation and development of sound accounting practices. That is why, we have different accounting concepts and fundamental accounting assumptions, such as, separate entity concept, going concern concept, accrual concept, matching concept etc. Therefore, Accounting Standards are based on a number of accounting principles. For example, the Matching Principle and Fair Valuation Principle. Historically, matching principles ensured that costs incurred matched with revenues they generated, though they resulted in assets and liabilities in the balance-sheet at other than fair values. Similarly, they resulted in assets, which were not assets in the real sense, e.g., deferred revenue expenditure. However, the matching principles ensured purity of the profit and loss statement. Therefore, matching principles ensure ascertainment of true income. Today under Advanced Accountan....
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....etent Legislature. Subor-dinate legislation may be questioned on any of the grounds on which plenary legislation is questioned. In addition, it may also be questioned on the ground that it does not conform to the statute under which it is made. It may further be questioned on the ground that it is inconsistent with the provisions of the Act or that it is contrary to some other statute applicable on the same subject-matter. Therefore, it has to yield to plenary legislation. It can also be questioned on the ground that it is manifestly arbitrary and unjust. That, any inquiry into its vires must be confined to the grounds on which plenary legislation may be questioned, to the grounds that it is contrary to the statute under which it is made, to the grounds that it is contrary to other statutory provisions or on the ground that it is so patently arbitrary that it cannot be said to be inconformity with the statute. It can also be challenged on the ground that it violates article 14 of the Constitu-tion. Subordinate legislation cannot be questioned on the ground of violation of principles of natural justice on which administrative action may be questioned. A distinction must, however, be....
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....rs of delegation. This, however, is subject to one limitation, namely, it cannot delegate uncontrolled power. Delegation is valid only when it is confined to legislative policy and guidelines. 66. In the present case, abovementioned guideline is provided by section 211(1), which has brought in a stand-alone concept of "true and fair" accounting. The said concept is the controlling consideration. As stated above, delegation is valid when it is confined to Legislative Policy and Guidelines which are adequately laid down and the delegate is only empowered to implement such Policy within the Guidelines laid down by the Legislature (see TISCO v. Workmen AIR 1972 SC 1917). 67. In the present case, we are required to consider the scope of section 642(1), which refers to the power of Central Government (rule-making authority) to make rules vis-a-vis section 641, which states that subject to the provision of the section, the Central Government may, by Notification in the Official Gazette, alter any of the regulations, rules, forms, tables and other provisions contained in any of the Schedules to the Companies Act (including Schedule VI). This aspect is of some importance. Section 642 ....
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....n excess of the powers conferred upon Central Government under section 642(1) of the Companies Act, 1956 ? 71. In the case of Pandit Banarsi Das Bhanot v. State of MP AIR 1958 SC 909 the State had issued a Notification under section 6(2) of the Central Provinces and Berar Sales Act, 1947 amending Item 33 in Schedule II by substituting for the words "goods sold to or by the State Government" by the words "goods sold by the State Government". As a result of the said Notification, amending the schedule, the assessee who was entitled for exemption from payment of sales tax in respect of goods sold to the State Government could no longer claim such exemption by reason of the said Notification. That Notification was challenged on the ground that it was not open to the Government in exercise of the authority delegated to it under section 6(2) to modify or alter what the Legislature had enacted and, therefore, the said Notification was bad as being unconstitutional delegation of legislative authority. It was argued on behalf of the assessee that earlier they had been granted exemption under section 6(1) of the Act which subsisted when the impugned Notification came to be issued and that....
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....rnment. Further, as stated above, sections 641 and 642 form part of the same scheme, hence, it cannot be said that merely because the impugned Notification has been issued under section 642 and not under section 641 the said Notification is exhaustive of the powers given to the Central Government to frame rules under the aforestated two sections. Moreover, in the present case, section 642(1) begins with the expression "in addition to the powers conferred by section 641", therefore, one has to read section 641 as an additional power given to the Central Government to make Rules, in addition to its power to alter the Schedule by making appropriate Rules under section 641. There is one more way of looking at the arguments. The Companies Act has been enacted to consolidate and amend the law relating to companies and certain other associations. Under section 211(3A) Accounting Standards framed by National Advisory Committee on Accounting Standards constituted under section 210A are now made mandatory. Every company has to comply with the said standards. Similarly, under section 227(3)(d), every auditor has to certify whether the P&L account and balance-sheet comply with the accounting s....
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....id view. Since we agree with the view of the High Court that professional and technical educational institutions are not covered by the Act and the Rules, we do not consider it necessary to go into the question whether the provisions of the Act fall within the ambit of Entry 25 of List III and do not relate to Entry 66 of List I." [Emphasis supplied] (para 356) 73. To the same effect is the judgment of this Court in the case of TELCO v. Gram Panchayat, Pimpri Waghere [1976] 4 SCC 177 in which the Court was required to consider the definition of the word "house" under the Rules framed in 1934. It was held that the rules provided internal legitimate aid for the interpretation of the words and phrases used in the main enactment. 74. In the present case also even under the Rules impugned herein AS 22, which is made mandatory, provides an internal legitimate aid to the meaning of the words in the Companies Act, including Schedule VI, namely, liability, provision for taxes on income, book profit, net profit, depreciation, amortization, etc. Therefore, it cannot be said that the impugned Rules framed under section 642(1) constitute an act on the part of the rule-making authority, na....
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....y the essental features of the Companies Act ? (A) Concepts : 75. To answer the above question, we need to examine the following concepts prevalent in Accounting. Accrual System of Accounting : 76. In the conventional sense, amounts which become receivables/recoverable are shown as income actually received and the liabilities incurred are shown as amounts actually disbursed in a given year. Therefore, under the aforestated system of accounting, entries are posted in the books of account on the date of the transaction, i.e., on the date on which rights accrue or liabilities are incurred, irrespective of the date of payment. In such cases, a company has to account for its income or loss as per the above system and not otherwise, if that company has adopted mercantile system of accounting which is also known as accrual system of accounting. However, accrual does not mean confinement of items of revenue/expenditure to a given year. As stated above, mergers and acquisitions are undertaken to defer revenue expenditure over future years by invoking matching principles. Therefore, the said principle forms an important part of accrual accounting. Taxes on Income (TOI) : 77....
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....ought in after the amendment to section 211(1) of the Companies Act which emphasizes that after 2001 the companies shall prepare their accounts so as to reflect "true and fair" view of the State of Affairs and to obliterate the difference between Accounting and Taxable Income. This concept bridges the gap between accounting income and taxable income. Deferred tax is the tax effect of such differences which are now required to be accounted for. As stated above, Accounting Standards today constitute a paradigm shift from the conventional system of accounting based on Historical Costs Method towards Fair Valuation Principles. Similarly, in the past, companies used to follow alternate system of accounting. The Accounting Standards today are trying to harmonize different accounting concepts and principles and, therefore, timing differences play an important role in harmonizing the matching principle under accrual system of accounting with the Fair Valuation Principles. The object is to achieve proper presentation of balance-sheet and P&L account. The object is to present before the investors, shareholders and other stake-holders the book profits (real income) of the company. The tax eff....
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....se in future when the expenditure would be allowed for tax purposes. In such a case, DTA would be recognized in respect of the timing difference, subject to the principle of prudence. This concept is important while deciding the question as to whether para 33 of AS 22 (transitional provision) is or is not inconsistent with the provisions of Schedule VI to the Companies Act. Matching Principle : 82. Matching Concept is based on the accounting period concept. The paramount object of running a business is to earn profit. In order to ascertain the profit made by the business during a period, it is necessary that 'revenues' of the period should be matched with the costs (expenses) of that period. In other words, income made by the business during a period can be measured only with the revenue earned during a period is compared with the expenditure incurred for earning that revenue. However, in cases of mergers and acquisitions, companies sometimes undertake to defer revenue expenditure over future years which brings in the concept of Deferred Tax Accounting. Therefore, today it cannot be said that the concept of accrual is limited to one year. 83. It is a principle of recognizi....
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....clusively or laid out for business purposes should be allowed in computing the business income. Therefore, depreciation and allowances have been dealt with in section 32 and the expression 'any expenditure' in section 37 covers both, allowances and depreciation. [See CIT v. Indian Jute Mills Association [1982] 134 ITR 68^1 (Cal.)]. Depreciation under Income-tax Act is an incentive/allowance. However, in commercial accountancy, it is reduction/deduction from the value of an asset on the balance-sheet. Reserves & Provisions : 85. In State Bank of Patiala v. CIT [1996] 219 ITR 706^2 (SC) substantial amounts were set apart by the assessee bank as reserves. No amount of bad debt was actually written off or adjusted against the amounts claimed as reserves. No claim for any deduction by way of bad debts was made during the relevant assessment years. The assessee never appropriated any amount against any 'bad and doubtful' debts. The amount remained in the account of the assessee by way of capital and the assessee treated the said amount as 'reserves' and not as 'provisions' designed to meet any liability, contingency, commitment or diminution in the value of assets known to exist on....
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....be asked in such cases is whether the liability was known or anticipated on the date when the balance-sheet was prepared and not whether the assessee can anticipate on the balance-sheet date the debt and doubtful debts. 88. Applying this test to the facts of the present case, the tax effect of the timing difference was known on the date when the balance-sheet was prepared and, therefore, AS 22 is right in stipulating that the tax effect of such timing differences should be included in the tax expense in the statement of profit and loss as DTA/DTL in the balance-sheet. 89. Depreciation in accounting sense is similar to bad and doubtful debts. Provision for bad and doubtful debt like depreciation is not a provision for liability but it is a provision for diminution in value of assets. Where such provision is made and if that provision is not excessive or unreasonable, it is not a reserve, however, any amount in excess of the requirement can be considered to be a reserve. Thus, provision can be made for depreciation, renewal, diminution in the value of an asset or for any known liability. In this case, we are concerned with depreciation mainly because in 99 per cent of the cases....
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....ppropriation of profit. The 'reserve account' is credited as a result of a debit to the appropriation account and not to the P&L account or revenue account. In a broad sense, all allocations to reserve represent additions to capital. In the case of a provision, unlike reserves, the charge is created as a result of debit to the P&L account and not a debit to the appropriation account. Tax Base : 91. The tax base of an asset or liability is the amount attributed to that asset or liability for tax purpose. As stated above, deferred tax has to be recognized for all timing differences. This is based on the principle that financial statements for a given period should recognize the tax effect, whether current or deferred, of all transactions occurring in a given period. One more principle needs to be noted that assets represent expenditure. Concept of DTL/DTA : 92. DTL/DTA is recognized for all timing differences. AS 22 requires the companies to make a provision for Deferred Tax Accounting with refer-ence to the difference between accounting income and taxable income. In our view, matching principle is an important component of Accrual Accounting. The said principle is not in....
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....rically, it may also be stated that prior to the introduction of AS 22, the companies used to follow what is called as Tax Payable Method. They were put to notice by the Institute that in future the companies shall have to follow what is called as Tax Effect Accounting method. AS 22 introduces tax effect accounting method. 93. Before us, it has been vehemently urged on behalf of the appellants that, unlike U.K., in India, rates of depreciation are statutorily prescribed under the Companies Act and under the Income-tax Act, 1961. According to the appellants, rates of depreciation are not prescribed statutorily in U.K.. Therefore, in U.K., the tax payer is at liberty to adopt any rate of depreciation and, therefore, there could be justification for invoking the matching principle and for applying AS 22 for deferred taxation. We find no merit in this argument. In our view, on the contrary, since in India we have two separate rates of depreciation statutorily prescribed under two different Acts, introduction of matching principle becomes relevant. Ultimately, AS 22 is for deferred taxation. It brings out for the information of shareholders, investors and stake-holders the hidden lia....
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....same effect as if contained in the Act. They continue to be rules subordinate to the Act, and though for certain purposes, including the purpose of construction, they are to be treated as if contained in the Act, their true nature as subordinate rule is not lost. Therefore, with regard to the effect of a repeal of the Act, they continue to be subject to the operation of section 24 of the General Clauses Act." (p. 45) Therefore, in our view, Rules framed under section 641 followed by Rules framed under section 642(1) shall continue to be Rules subordinate to the Companies Act though for the purposes of construction, they are to be treated as forming part of the same scheme. 95. In the present case, the most important question, which we have to decide is whether the impugned Rule adopted AS 22 is contrary to or inconsistent with the provisions of the Companies Act and in that connection our judgment proceeds on the basis that the impugned Rule is an example of subordinate legislation. 96. As stated above, tax expense or tax income represents total amount included in the determination of net profit or loss for the period in respect of current tax and deferred tax. 97. DTL ....
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....penses at Rs. 4 lakhs. There will, therefore, arise deductible timing difference which gives rise to Deferred Tax Asset (DTA). However, a DTA, as stated above, should be recognized for all deductible temporary difference to the extent it is probable that taxable profit will be available against which the deductible timing difference can be utilized. A DTA should also be recognized for carrying forward the unused tax losses and unused tax credits to the extent that it is probable that future taxable profit will be available against which the unused tax losses and unused tax credits can be utilized. It is, therefore, necessary to review DTA at each balance-sheet date. 107. We would also like to give few more examples of DTA and DTL as follows : Example-3 : 108. Cost of a Plant is Rs. 100 lakhs, its carrying amount is Rs. 80 lakhs whereas its tax base is Rs. 20 lakhs. Therefore, the Taxable Timing Difference is (Rs. 80-20) Rs. 60 lakhs. In case the tax rate is 25 per cent then the DTL shall be computed as follows : DTL = (Taxable Timing Difference) Rs. 60 lakhs x (Tax Rate) 25 per cent DTL= 60 x 25/100 = Rs. 15 lakhs 109. Similarly, if a company recognizes its liabil....
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....e II to the Super Tax Act, 1963 and Rule 2(ii) of Schedule II to the Companies (Profits) Super Tax Act, 1964 respectively. This contention was rejected. This Court held that since Schedule II to both the Acts pertained to computation of capital, the terms used in Schedule II should be interpreted in the context of the balance-sheet of a company and its P&L account which will have to be looked at to ascertain the company's capital and its profits. It was held that a provision for taxation of the kind in question was not a fund etymologically in accounting parlance. It was observed that words of accounting language should be interpreted as understood in accounting practice. 112. Applying the above test to the present case, we are now required to interpret the words 'the amount of charge for Indian Income-tax on profits' in clause 3(vi) in Part II of Schedule VI to the Companies Act. Similarly, we are required to interpret the words 'current liabilities and provisions' in the form of balance-sheet in Part I of Schedule VI to the Companies Act. Part III of the said Schedule defines the words 'provision' as well as 'reserve'. 113. As stated above, the form of balance-sheet is pres....
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....entral Government from enacting accounting standards in consultation with NAC which are in variance from the Standards prescribed by the Institute. In the present case, we are concerned with the accounting standards prescribed by Central Government in consultation with NAC under section 642(1) of the Companies Act. 114. In the present case, the main objection of the appellants is against paragraphs 9 and 33 of AS 22. Para 9 reads as under: "Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period." 115. Para 33 of AS 22 reads as under: "On the first occasion that the taxes on income are accounted for in accordance with this Statement, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Statement as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this ....
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....d balance-sheet and P&L account on the other hand. According to the appellants, para 9 of AS 22 does not touch the subject "maintenance of books of account". That, it only touches the presentation of balance-sheet and P&L account. According to the appellants, books of account constitute primary documents and if para 9 does not apply to the maintenance of books of account, para 9 cannot be made applicable only to balance-sheet and P&L account because if it is so permitted it would bring about inconsistency between "maintenance of books of account" under section 209 vis-a-vis presentation of financial statements under section 211. In short, according to the appellants para 9 and para 33 of AS 22 are inconsistent with the provisions of the Companies Act including Schedule VI. 117. We do not find any merit in the arguments of the appellants on the point of inconsistency. 118. As stated above, recognition and measurements bring in the concept of fair value. When a financial instrument is measured at fair value it brings transparency in financial reporting. Today, companies undertake multifarious activities which warrants segment reporting. For example in RIL we have three segments....
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..... & Co. Ltd. (supra) the words of accounting language should be interpreted as understood in accounting practice. Therefore, in our view, para 9 of AS 22 merely provides for details in the matter of provision for liability for taxation. 120. The words "tax expense" in para 9 under conservative system of accounting was confined to current tax. However, with para 9 of AS 22 coming into force, the words "tax expense" now includes both, current tax and deferred tax. This inclusion became necessary because of developments not only in concepts but also in accounting practices. This inclusion becomes necessary if one has to go by paradigm shift from historical costs accounting to fair value principles. In our view, with the insertion of the words "true and fair" view in section 211, which is the requirement in the matter of presentation of balance-sheet and P&L account the rule-making authority was entitled to include the concept of "deferred tax" in tax expense. It may be stated that under clause 3(vi) of Part II, Schedule VI the charge for tax on profit is contemplated. Provision for liability for taxation is contemplated by the said clause. Para 9 of AS 22 merely provides for a liab....
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....e as to how the DTL emerges out of timing differences and, secondly, the application of Fair Valuation principles in advanced accounting. Illustration 1 : 122. A company, ABC Ltd., prepares its accounts annually on 31st March. On 1st April, 2001, it purchases a machine at a cost of Rs. 1,50,000. The machine has a useful life of three years and an expected scrap value of zero. Although it is eligible for a 100 per cent first year depreciation allowance for tax purposes, the straight-line method is considered appropriate for accounting purposes. ABC Ltd. has profits before depreciation and taxes of Rs. 2,00,000 each year and the corporate tax rate is 40 per cent each year. The purchase of machine at a cost of Rs. 1,50,000 in 2001 gives rise to a tax saving of Rs. 60,000. If the cost of the machine is spread over three years of its life for accounting purposes, the amount of the tax saving should also be spread over the same period as shown below : Statement of Profit and Loss (for the three years ending 31st March, 2001, 2002, 2003) (Rupees in thousands) 2001 2002 2003 Profit before depreciation and taxes ....
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....benture is normally presented in the financial statements as a liability, while it has two components; a liability and an option to convert loan into equity. Appropriate accounting principle requires separate accounting for rights and obligations. Each component has to be separately accounted for. In the past, many of those rights and obligations were shown as off-balance-sheet items. Only recently, on account of accounting standards, the number of such items stand reduced. The issuer of a financial instrument is required to classify convertible debentures (financial instrument) as liability or as equity depending on the terms of the contract. A convertible debenture is a compound instrument. In case of such instrument, having different components, one has to present such components in financial statements either as equity or as liability based on the terms of the contract. As a general principle, a contract that will be settled by an entity receiving a fixed number of its own shares is an equity instrument. For example, when an enterprise issues shares in consideration of cash or some other asset/service, the transaction does not result in any cash outflow. For example, a redeemab....
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....ew in section 211(1) connotes the widest law-making powers and, in that context, we hold that impugned Rule adopting AS 22 is intra vires as the said Rule is incidental and/or supplementary to the specific powers given to the Central Govern-ment to make Rules, particularly when such power is given to fill-in details. The word "supplementary" means something added to what is there in the Act, to fill-in details for which the Act itself does not provide. It is something in the sense that is required to implement what is there in the Act. [See Daymond v. South West Water Authority [1976] 1 All ER 39]. There is no merit in the contention advanced on behalf of the appellants that the impugned Rule seeks to modify the essential features of the Companies Act. Rules made on matters permitted by the Act to supplement the Act cannot be held to be in violation of the Act. [See Britnell's case ( supra)]. When the power to make rules is limited to particular topics and if that rule falls within the ambit of that topic, namely, taxes on income in the present case, it cannot be said that the rule is inconsistent with the provisions of the Act. As stated above, the Act and the Rules form part of t....
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....isions of the Companies Act. We also do not find any merit in the argument advanced on behalf of the appellants that the impugned Rule does not touch upon maintenance of books of account to be kept by the company. Under section 209(3)(b) every company is required to keep its books of account on accrual basis and according to double-entry system of accounting. Under section 209(3)(a) every com-pany is required to maintain books of account necessary to provide a true and fair view of the state of affairs of the company and its accounts. In our view, books of account do not include balance-sheet and P&L account. However, as stated above, there is a difference between 'true and correct' accrual and 'true and fair' accrual. In the past, what prevailed was true and correct accrual. At that time, it was noticed in several cases that profits were overstated and, therefore, the Legislature inserted what is called as 'true and fair' accrual concept. The said concept is wider than the concept of true and correct accrual. When section 209(3) refers to maintenance of books of account on accrual basis it means 'true and fair' accrual, which would include not only matching principles but also fai....
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....urnished by the Act to the rule-making authority except to say that the rule made must lead to ascertainment of the value of the asset (unquoted equity share) as defined in section 7. It is thus left to the rule-making authority to prescribe an appropriate method for the purpose. Now, there may be several method of valuing an asset or for that method an unquoted equity share. The rule-making authority cannot obviously prescribe all of them together. It has to choose one of them which according to it is more appropriate. The rule- making authority has in this case chosen the break-up method, which is undoubtedly one of the recognised methods of valuing unquoted equity shares. Even if it is assumed that there was another method available which was more appropriate, still the method chosen cannot be faulted so long as the method chosen is one of the recognised methods, though less popular. One probable reason why yield method or dividend method was not adopted in the case of unquoted equity shares was that bulk of these companies are private limited companies where the divided declared does not represent the correct state of affairs and to estimate the probable yield is no simple exer....
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....d be followed. There may be cases where an assessee may be holding shares of a large number of private companies or other public limited companies whose shares are not quoted. Compared to them, the break-up method incorporated in rule 1-D is far simpler and far less time-consuming. It prescribes a simple uniform method to be followed in all cases. All that the Wealth-tax Officer has to do is to take the balance-sheet, delete some items from the columns relating to assets and liabilities as directed by Explanation-II, and then apply the formula contained in the rule. He need not have to look into the profitability, the earning capacity and the various other factors mentioned in propositions (2), (3) and (4) of the decision. The decision, it bears repetition, recognises that break-up method 'nonetheless is one of the methods.' In the circumstances, it is difficult to agree with the learned counsel for the assessees either that break-up method is not a recognised method or that yield method is the only permissible method for valuing the unquoted equity shares. It is not as if the rule-making authority has adopted a method unknown in the relevant circles or has devised an impermissible....
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....alance only for tax purposes and not for accounting purposes. Therefore, the difference between the Balance of the asset for tax purposes and balance for accounting purposes, which is nil, would give rise to a timing difference which will reverse in future when expenditure would be allowed for tax purposes. In such a case, DTA would be recognized in respect of difference, subject to the principle of prudence. In the circumstances, it cannot be said that para 33 is retrospective. Conclusion 133. For the aforestated reasons, we are of the view that the impugned Notification/Rule is neither ultra vires nor inconsistent with the provisions of the Companies Act, including Schedule VI. 134. To sum up, deferred tax is nothing but accrual of tax due to divergence between accounting profit and tax profit. This difference arises on two counts, namely, different treatment of items of revenue/expense as per profit and loss account and as per the tax law. It also arises on account of the difference between the amount of revenue/expense as per profit and loss account and the corresponding amount considered for tax purposes, e.g., depreciation. 135. However, we need to comment on one ....