ORDER
G. Santhanam. Accountant Member
1. This is an appeal by the assessee. The dispute is about the computation of ‘net profit’ for purpose of Section 115J of the Income-tax Act, 1961.
2. The previous year of the assessee, a manufacturer of tyres and tubes, ended on 31st October, 1987 relevant to the assessment year 1988-89. The profit and loss account of the assessee is as follows :-
For the
Income Schedule year ended 31st
October, 1987
Rs.
Sales 1,46,19,06,716
Other Income 8 1,84,11,759
-----------------
1,48,03,18,475
Expenditure -----------------
Manufacturing and Other expenses 9 82,12,24,384
Work in Process and Finished
Goods 10 3,25,10,148
Finance Charges 11 5,31,22,473
Excise Duty 38,80,54,797
[Depreciation (Note 7, Gross
Rs. 41720438) Less: Transferred
from Revaluation Reserve
Rs. 15,44,122-1986 Rs. Nil 4,01,76,316
-----------------
1,33,50,88,118
-----------------
Profit before Taxation 14,52,30,357
Provision for Taxation 16,00,000
-----------------
Profit after Taxation 14,36,30,357
Deduct :
Depreciation Relating to
earlier years 13,66,39,051
Miscellaneous Expenditure
written off -
-----------------
Net Profit 69,91,306
Add : Surplus/(Deficit) brought
forward from previous year 32,00,000
-----------------
1,01,91,306
-----------------
Deduct : Transfer to Investment
Allowance Reserve -
-----------------
Surplus Carried to Schedule 1,01,91,306
-----------------
3. Schedule 12 contains Notes on accounts and against Serial Number 7, the following observations are found :-
Depreciation for the year has been provided in the accounts in accordance with the provisions of Section 205(2)(b) of the Companies Act, 1956 taking into consideration extra shift allowances, where applicable. Consequent on the above, a sum of Rs. 1,366.39 Lacs being additional depreciation for the earlier years has been debited to the Profit & Loss Account. Had the company followed the practice as in the previous year the Profit for the year would have been higher by Rs. 120.44 Lacs.
4. The appellant computed the book profits for purpose of 80J, as follows :-
Rs. Amount (Rs.)
Net Profit as per Profit &
Loss Account 69,91,306
Add : Provision for Income-tax 16,00,000
------------
85,91,304
------------
Less : a. Amount transferred
from Capital Reserve -
Adjusted against Depreciation 15,44,122
b. Interest on Post
Office Savings Bank 52,201
Account exempt under Section ---------
10(15)(ii) -Chapter III 15,96,323
------------
69,94,983
------------
30% of above = Rs. 20,98,495.
5. The learned Dy. Commissioner of Income-tax (Asst.) felt that the deduction of arrears of depreciation amounting to Rs. 13,66,39,051 for arriving at the net profit of Rs. 69,91,306 was not in accordance with the provisions of Part II and Part III of 6th Schedule to the Companies Act, 1956. It was his view that neither in Part II nor in Part III of Schedule VI to the Companies Act nor in the Income-tax Act, it is specified that the depreciation relating to the earlier year calculated and not provided for in the accounts should be computed and charged against the profits of a later assessment year. He drew support for this proposition from the figures contained in the Directors’ Report to the Shareholders wherein the arrears of depreciation amounting to Rs. 1,366.39 lakhs was shown only by way of an adjustment below the line of net profit (vide page of the published accounts for the year 1986-87). Therefore, he concluded that the book profit as per accounts should be taken at Rs. 14,36,30,357. He made further adjustments to the same under the provisions of Section 115J of the Income-tax Act, as follows :-
Computation of book profit for the purpose of Section 115J of the Income-tax Act, 1961 :
Net profit as per profit and loss account
as discussed Rs. 14,36,30,357
Add : Provision for Income-tax Rs. 16,00,000
------------
Total Rs. 14,52,30,357
------------
Less : Amount transferred from
Capital Reserve adjusted Rs.
against depreciation 15,44,122
Int. on Post Office
Savings Bank account
exempt under Section 10(15)(1) 52,201
----------
Rs. 15,96,323
------------
Balance Rs. 14,36,34,034
------------
30% of the above Rs. 4,30,90,210
------------
The assessee appealed.
6. The learned CIT(Appeals) has dealt with the contentions of the appellant in paras 28 to 32 of his order dated 14-2-1991. The reasonings of the learned CIT(A) are set out in paras 33 to 38 of his order. It was his view that Section 350 of the Companies Act has not undergone any change except for the amendment in relation to rates of depreciation and nowhere it has been stated that arrears of depreciation should be provided for purpose of ascertaining the book profits, as contemplated in Section 205(1)(b) of the Companies Act. It was not mandatory on the part of any company to provide for the arrears of depreciation if it was not originally provided in the earlier years, and in this connection he referred to the note relating to the changes made by the Companies (Amendment) Act, which reads as follows :-
Companies are now required to provide for depreciation as per the rates prescribed in Schedule XIV for the purpose of this Act. The rates of depreciation under Schedule XTV have come into force from 2-4-1987. However, for purpose of Income-tax Act, the companies may continue to avail of the benefit by resorting to rates prescribed under that Act.
Therefore, he held that the amount of Rs. 69,94,983 shown as net profit in the books of accounts cannot be accepted. He then dealt with the provisions of Section 115J and found that only clause which is applicable to the assessee’s case is clause (iii) of the Explanation (under Section 115J) which contemplates deduction of loss or amount of depreciation whichever is less that would be required to be set off against the profit of the relevant previous year. Therefore, he felt that the loss or the arrears of depreciation that has been provided in the accounts in respect of the earlier years should first be ascertained and the lesser of the two should be deducted from the book profits shown in the accounts, and for that limited purpose, he set aside the order of the Dy. CIT (Asst.) and restored the issue to him with a direction to recompute the book profits in accordance with the provisions of Section 205(1) (b) of the Companies Act. He did not see any merit in the contention of the assessee that if depreciation had been provided in full in the earlier years, it would have resulted in the corresponding amount of loss in those years and such loss would have to be allowed as deduction under clause (iii) of Explanation to Section 115J. He held that this contention was purely hypothetical and the argument of the assessee would be valid only if the assessee had provided for the full quantum of depreciation in the earlier years. The assessee is aggrieved and is on second appeal.
7. Shri Sarangan, the learned counsel for the assessee submitted that the authorities have not appreciated the published accounts in the proper perspective and had drawn adverse Inferences against the assessee without properly appreciating the provisions of the Companies Act, the requirements of profit and loss account and balance-sheet, as set out in Parts II and III of Schedule VI to the Companies Act and changes brought about by the Companies (Amendment) Act, 1988 in the rate of depreciation by insertion of Schedule XIV to the Companies Act with effect from 2-4-1987. Depreciation is an element of cost and therefore it cannot be considered as an appropriation of profit. Merely because it is shown as a separate item in the profit and loss account, as per the requirements of Parts II & III of Schedule VI to the Companies Act, it does not loose its intrinsic character as an element of cost. It is obligatory on the part of the assessee to provide for adequate depreciation before the net profit is ascertained. Prior to the Companies (Amendment) Act, 1988, thedeprecia-tion has to be provided as per the rates prescribed in the IT Act, from time to time. The rates prescribed in the Income-tax Act are the minimum rates prescribed and it is open to the company to depreciate its assets even at a higher rate if the company estimated the useful life of an asset for a shorter period than that envisaged in the Income-tax Act. Again, prior to Companies (Amendment) Act, 1988 it was not free from doubt whether the rate of depreciation should cover additional shift allowance. Some thought that it was obligatory on the part of the company to provide for not only normal depreciation but also depreciation on extra shift and triple shift, if the machineries worked for such shifts. If provision for depreciation on extra shift and triple shift was not made in the accounts it would result in understatement of depreciation and to that extent the profit and loss account will not exhibit a true and fair view of the profits of the undertaking. Therefore, the Institute of Chartered Accountants of India has come out with the opinion that in case the correct quantum of depreciation has not been charged resulting in understatement of depreciation, the Auditors had to qualify their report by high lighting the understatement. Further, the company is also obliged to disclose the amount of depreciation not charged in the accounts. The purpose of such disclosure is to enable the shareholder to understand its effect on the profits of the concern. The company has been following the straight line method of depreciation in the preceding years in respect of normal depreciation but it did not provide for depreciation for double shift and triple shift working. To that extent, there has been understatement of depreciation in the past. The Companies (Amendment) Act, 1988 has prescribed the rates of depreciation on straight line method not only for normal depreciation but also for double shift and triple shift working of the assets. Schedule XIV to the Companies Act has come into force with effect from 2-4-1987. The company’s previous year ended on 31-10-1987 and therefore it was obligatory for the company to charge double shift and triple shift depreciation allowances also on straight line method. Charging depreciation for the year under review alone would not be proper especially when the auditors of the company have been consistently pointing to under-provision of depreciation in the accounts of the assessee from year to year. The result was that the company in order to comply with the amended provisions of the Companies Act and also in recognition of the accounting principles and procedures and having regard to the requirements of the profit and loss account and the balance-sheet as set out in Parts II and III of Schedule VI of the Companies Act, chose to provide for arrears of depreciation as far as double shift and triple shift workings are concerned. Such depreciation cannot be considered as an appropriation of profit. Though depreciation does not represent cash outlay, inasmuch as it affects the effective life of the asset due to constant wear and tear efflux of time, not to speak of obsolescence, the charge to depreciation has to be recognised as a commercial necessity before ascertainment of net profits. As the depreciation is a charge against the profits, any under-provision has go through the profit and loss account only. It can never be viewed as an appropriation of profit. By definition ‘depreciation’ is a provision for diminution of value of an asset and a provision is always charged against the profits.
8. In this context he referred to the following publications :-
(a) ‘Guidance Note on Accounting for Depreciation in Companies’ issued by Research Committee of the Institute of Chartered Accountants of India – Sept. 1989;
(b) Depreciation Accounting (AS-6), issued by the said Forum – November 1982;
(c) ‘Provision for Depreciation in Respect of Extra or Multiple Shift Allowance’ (Compendium of Guidance Notes) Published in the Chartered Accountant Journal, May 1984; and
(d) Circulars of the Company Law Board issued from time to time;
and submitted that from a review of the above publications, it would be abundantly clear that depreciation can never be considered as an appropriation of profit.
9. Shri Sarangan further submitted that Section 115J does not define ‘book profits’. The said Section only provides for certain adjustments that are to be made to the book profits by way of additions or deductions. No doubt, the book profits must be in accordance with the requirements of Parts II & III of the Sixth Schedule to the Companies Act. Depreciation has been described as a provision and provision is always a charge against the profits. If there had been understatement of such a provision in the past and the company recognises the need for making up the deficiency in such provision, it has to go only through the profit and loss account before ascertainment of the net profit. In fact one of the publications of the Institute of Chartered Accountants of India clearly lays down that if there has been understatement of depreciation, the auditor has to quantify the same and bring it to the notice of the shareholders so as to consider its impact and effect on the net profit. Further, he contended that the terminology used in Section 115J is not current profit but rather book profit. The rates prescribed under the Income-tax Act or even under the amended provisions of the Companies Act are minimum rates of depreciation and if the company felt that such rates are lower in its view, it has got the discretion to depreciate its assets at a higher rate. Having regard to these facts, the action of the company in providing for arrears of depreciation to make up the deficiency cannot be construed as not within its competence nor as an infraction of the provisions of the Companies Act. If Section 115J had used the expression ‘current profit’, the department might be having a case but it had only used the term ‘book profit’ in tune with Schedule VI to Companies Act. Such book profit was ascertained in the case of the company for the impugned assessment year by making up the under-provision of depreciation and therefore it is only the net profit after making such provision, that is relevant as a starting point of computation for purpose of Section 80J. The authorities below, have not considered the import of the requirements of profit and loss account and the balance-sheet under the Companies Act, the principles and practices on depreciation accounting suggested by the Institute of Chartered Accountants of India, and the Circulars issued by Department of Company Affairs.
10. Shri Sarangan, submitted that the Department of Company Affairs entrusted with the working of the Companies Act with wide powers of supervision and control over the Registrar of the Companies, is something akin to CBDT in tax matters. That authority has approved the profit and loss account and therefore it is not for the Income-tax Officer to say that the accounts of the assessee are not in accordance with the Provisions of the Companies Act. Once the accounts are audited and placed before the General Meeting and filed with the Registrar of Companies, the statements found therein should be taken to be true reflecting the “true and fair view” unless the contrary is proved. While computing the total income of an assessee, the Income-tax Officer has got all the powers to make additions and disallowances. But so far as Section 115J is concerned, he has to take the book profits as starting point and his power is only confined to make such adjustments as are enumerated in Section 115J. He has no right to substitute the figure of book profits, as he liked. In other words, the authorities did not have the jurisdiction to go behind the book profit and substitute a figure of their choice in its place.
11. Shri Abraham, the learned Senior Departmental Representative submitted that the profit in the profit and loss account implies a comparison between the state of business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates. If the total assets of the business at the two dates be compared, the increase which they show at the later date as compared with the earlier date (due allowance, of course, being made for capital introduced into or taken out of the business in the meanwhile) represents in strictness, the profits of the business during the period in question. (Fletcher Moulton, L.J. In Spanish Prospecting Co. Ltd., In re. [1911] 1 Ch 92) (from page 609 of Guide to the Companies Act by A. Ramaiya – 11th Edn.).
12. Section 210 of the Companies Act refers to the profit and loss account for that period which may be called a financial year and Part II of Schedule VI refers to the profit and loss account being prepared to disclose the result of the working of the company during the period covered by the account. From a perusal of the relevant provisions and format of the profit and loss account prescribed in Part II of Schedule VI, it would thus be clear that there is no basis for taking into account items which do not relate to the period of account. Therefore, the arrears of depreciation cannot be a legitimate charge to the profit and loss account of the year. In the assessee’s case the depreciation including extra-shift depreciation for the period 1-11-1986 to 31-10-1987 has already been charged to the Profit and Loss account in arriving at the profit before taxation of Rs. 14.52 crores. The further deduction of Rs. 13,66,39,051, being the extra shift and triple shift depreciation may, be a legitimate charge for the limited purpose of declaration of dividends under Section 205(1)(a). But, it cannot be deducted as an admissible deduction in arriving at the book profits of the year.
13. As for the argument of the learned counsel that arrears of depreciation is not one of the items enumerated in Section 115J of the Act, he submitted that the adjustments referred to in Section 115J are only in respect of the items which are expected to find a place in the profit and loss account of the year. In this view of the matter, he submitted that the current depreciation is a legitimate charge but not the arrears of depreciation. As for the assessee’s argument that arrears of depreciation is allowed as a deduction from the book profits, within the meaning of Sub-clause (iii) of Explanation 1 to Section 115J of the Act, he submitted that only when the company has suffered losses and declaration of dividend is in contemplation, the loss or depreciation that had been provided in the books of accounts whichever is less is eligible for deduction from the book profits in terms of Explanation to Section 115J. The sine qua non for such adjustment to be made is that the loss or the depreciation should have been provided in the books; otherwise not. The absence of reference to Section 205(1)(a) in Sub-clause (iii) of the Explanation is significant and if the legislative intention was to allow adjustment for arrears of depreciation for purpose of computing the book profits for Section 115J, it would have provided so by referring to Section 205(1)(a) of the Companies Act under the Explanation. Further it was argued by Shri Abraham that if the depreciation computed as per Sections 205(2) and 350 of the Companies Act included the arrears in respect of the earlier years, there was no need for Section 205(l)(a) to find a place in the Companies Act and the cardinal principle of interpretation is not to make any section of the Act otiose.
14. Shri Abraham after referring to the provisions of Section 205(2) of the Companies Act, submitted that it cannot be said that the manner in which the depreciation was computed by the assessee in the relevant previous year was due to the change in the method of depreciation. In the earlier years, the assessee was adopting straight line method and in the relevant previous year also the assessee was adopting the same straight line method though for purpose of depreciation, the rates prescribed under the IT Act were abandoned and the assessee had opted for rates prescribed in the Schedule XIV of the Companies Act. Mere change of rate cannot be construed as a change in the method of depreciation. Therefore, the assessee cannot seek refuge in what has been stated in para 6 of the guidance note, about the change in the method of depreciation. He referred to the Circular No. 1/86 dated 21st May, 1986 and 2/89 dated March 1989 issued by the Department of Company Affairs and submitted that the department has re-examined its earlier Circular of 1985 and has opined that once the “specified period” was determined at the time of purchase of an asset, in accordance with the procedure laid down under Section 205 r.w.s. 350 of the Companies Act with the rates of depreciation prescribed under the Income-tax Act, the same need not be changed subsequently consequent on changes in the rates of depreciation in the Income-tax Act. Further the Circular No. 2/89 stated that the Companies which followed Circular No. 1/86 “may therefore continue to charge depreciation at the old SLM rates in respect of the already acquired assets against which depreciation has been provided in earlier years on SLM basis”. The effect of the clarification by the Department of Company Affairs through its Circulars Nos. 1/86 and 2/89 is that in spite of the changes in the Companies Act by way of amendment to Section 350, the assessee’s obligation to account for depreciation remains at the same level as it existed prior to the amendment. Thus, he submitted that the Companies (Amendment) Act, 1988 did not affect the assessee in any manner. He referred to the guidance note issued by the Research Committee of Institute of Chartered Accountants of India and contended that in terms of paras 15, 16, 17, 18, 20, 21 and 22 the company is required to charge the depreciation on the revised rates only from the year of change of rates and a company following Circular No. 1/86 can continue to charge depreciation on straight line basis at the old rates in respect of the assets existing on the date on which the revision regarding the depreciation came into force and SLM rates prescribed in Schedule XIV can be straightaway applied to the original cost of all assets including assets from the year of change of rates. The assessee has deliberately charged arrears of depreciation in the previous year ended 31-10-1987 relevant to the assessment year 1987-88 by one stroke of pen just to reduce its tax liability under the provisions of Section 115J of the Act; and therefore, the ratio laid down in McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 22 Taxman 11. (SC) is clearly attracted.
15. To the assessee’s argument that the Department of Company Affairs had in its letter dated 21-10-1991 clarified that the charging of arrears of depreciation in the profit and loss account of the company for the year ended 31-10 1987 appears to be in accordance with the provisions of the Companies Act, 1956, Shri Abraham submitted that the adjustment envisaged under Section 205(1)(a) is a special adjustment required under the Companies Act for the limited purpose of declaration of dividend and in the absence of mention of that Section in Section 115J, such adjustment is not to be reckoned for the purpose of computation of book profits. Further the expression “appears to be” as contained in the letter dated 21-10-1991 betrayed lack of conviction on the part of Department of Company Affairs and the interpretation of Section 115J is within the province of Ministries of Law and Finance. As for the assessee’s argument that the auditors have certified the accounts as reflecting true and fair profits for the year ended on the date, Shri Abraham submitted that first of all it is not clear which of the two figures that has been certified to be true and fair, the figure of Rs. 14,52,30,357 viz. the figure before taxation or the other figure of Rs. 69,91,306 described as net profit? In short it was his submission that the charging of arrears of depreciation was neither necessitated by the statutory changes nor such action was in accordance with the guidance note of the Research Committee of the Institute of Chartered Accountants of India. Lastly, he submitted that a reference to the Directors’ report would show that the directors are informing the shareholders that the company had earned a net profit of Rs. 1,436.30 lakhs and thus their understanding of the net profit was only in that sum and that represented the correct net profit for the year and not figures after charging arrears of depreciation.
16. Shri Sarangan, in his reply submitted that it is strange to suggest that the department of Company Affairs has not applied its mind when it opined that the depreciation charged in the accounts of the relevant previous year was in accordance with the provisions of the Companies Act. Much milage has been made out of the expression “appears to be” occurring in their letter. It is usual for the Government authorities to employ protective expressions or words of caution in their communications. He would rather say that if the department of Company Affairs did not concur with the profit and loss account furnished before it by the assessee it would have not only expressed itself against it but also would have taken steps to penalise the company for acts of omissions and commissions. The accounts have to be prepared not only in the manner indicated in Schedule VI of the Companies Act but also in accordance with provisions of the Companies Act. For the convenience of the Companies, on account of frequent and far reaching amendments in the rates of depreciation in the Income-tax Act, or amendments to the Companies Act, certain course of action such as charging depreciation on the straight line method on the basis of the rates originally adopted for reducing the cost of the assets to 95% of its value was permitted or was not frowned upon. It was only a permissive action in the nature of removal of hardships granted by the Department of Company Affairs and the same would be binding on Company Law enforcing authorities. However, that doesn’t mean that such a course of action has the sanction of the provisions of Section 205 read with Section 350 of the Companies Act. No doubt, Section 205(1)(b) of the Companies Act has been engrafted in Section 115J of the Income-tax Act but to read that Section in isolation de hors the other provisions of Section 205 of the Companies Act would be to take a very lopsided view of the legal position. Thus, he submitted that the net profit as shown in the accounts has to be considered as book profit ascertained in accordance with Parts II and III of Schedule VI of the Companies Act and the Income-tax authorities cannot meddle with that figure.
17. We have thus heard rival submissions and perused the records. The dispute is about the meaning of book profit for purpose of Section 115J of the Income-tax Act. Provisions of Section 115J of the Act came into force for the first time with effect from 1-4-1988. In terms of Explanation to Section 115J, “book’profit” means the net profit as shown in the profit and loss account for the relevant previous year prepared in accordance with the provisions of Parts II and III of the Sixth Schedule to the Companies Act, 1956 (1 of 1956) as increased by,-
(a) the amount of income-tax paid or payable, and the provision therefor; or
(b) the amounts carried to any reserves, by whatever name called; or
(c) the amount or amounts set aside to provisions made for meeting liabilities other than ascertained liabilities; or
(d) the amount by way of provision for losses of subsidiary companies; or
(e) the amount or amounts of dividends paid or proposed; or
(f) the amount or amounts of expenditure relatable to any income to which any of the provisions of Chapter III applies,
if any such amount is debited to the profit and loss account, and as reduced by,-
(i) the amount withdrawn from reserves or provisions, if any, such amount is credited to the profit and loss account; or
(ii) the amount of income to which any of the provisions of Chapter III applies, if any, such amount is credited to the profit and loss account; or
(iii) the amount of the loss or the amount of depreciation which would be required to be set off against the profit of the relevant previous year as if the provisions of clause (b) of the first proviso to sub- Section (1) of Section 205 of the Companies Act, 1956 (1 of 1956), are applicable.
The assessee emphasises that the net profit as shown in the profit and loss account in accordance with the provisions of Parts II & III of Sixth Schedule to the Companies Act should be the basis for computation and the assessing authority has no right to go behind the net. profit as disclosed in the accounts except to the extent of adjustments specified in (a) to (f) and (i) to (iii) of Explanation to Section 115J. The appellant’s further contention is that its accounts are subjected to audit under the provisions of Companies Act, 1956, they have in fact been audited by a duly qualified Chartered Accountant under the provisions of the Companies Act, and the same were approved at the Annual General Body Meeting of the company and the documents were filed with the Registrar of Companies, who has not found any fault with the accounts of the company. Further the Department of Company Affairs has approved the net profit as shown in the accounts when it sought clarification and therefore the Income-tax Officer cannot question the correctness of the net profit as shown in the company’s accounts.
18. On the other hand, the learned Sr. Departmental Representative contends that one need not be guided by the net profit as shown in the profit and loss account, if the same is not in accordance with the provisions of Parts II and III of Sixth Schedule to the Companies Act. In other words, it is the contention of the revenue that the Income-tax Officer can substitute his own figure of net profit, thus going behind the net profit as shown in the accounts if he is not satisfied that the same was not in accordance with provisions of Parts II and III of Sixth Schedule to the Companies Act, 1956. The mere fact that the Department of Company Affairs has in a letter of clarification, has stated that net profit shown in the accounts appears to be proper cannot be stretched to the extent of saying that the net profit in the profit and loss account was in accordance with the provisions of Parts II & III of Sixth Schedule to the Companies Act. The Department of Company Affairs might not have applied their mind to the issue before it when the assessee sought clarification from it. Therefore, the Income-tax Officer is justified in taking a different net profit as book profit for purpose of Section 115J of the Act.
19. In our considered opinion the stand of the Department should fall. The Department of Company Affairs is entrusted with the task of monitoring the working of the Companies Act; towards the smooth working of the Companies Act, it issues clarifications and instructions which are binding on the authorities working under it… To some extent its functions are akin to some of the functions of Central Board of Direct Taxes in tax matters. In the relevant previous year ending on 31-10-1987, the assessee charged in its accounts the arrears of depreciation towards extra shift and triple shift workings in a sum of Rs. 1,366.39 lakhs for the first time in arriving at its net profit and addressed a letter to the Department of Company Affairs dated 24-9-1991, which reads as follows :-
The Secretary,
Department of Company Affairs,
Ministry of Law, Justice & Company Affairs,
Shastri Bhawan, 5th Floor, A-Wing,
Dr. R.P. Road, New Delhi – 110 001.
Sub : Clarification on arrears of Depreciation – Computation of Net profit as shown in Profit and Loss Account for year ended 31st October, 1987- Apollo Tyres Ltd.-
Dear Sir,
Under Section 115J of the Income-tax Act, 1961, the company has to pay income-tax on its net profit as shown in the Profit & Loss Account for the relevant previous year prepared in accordance with the provisions of Parts II & III of the Sixth Schedule to the Companies Act, 1956…’.
Company’s Profit & Loss Account for the year ended 31st October, 1987 showing ‘net profit’ at Rs. 69.91 lakhs after, inter alia, providing for Rs. 1,366.39 lakhs towards depreciation relating to earlier years is considered to be in accordance with the provisions of Parts II & Part III of the Sixth Schedule to the Companies Act, 1956. A copy of the Company’s Profit & Loss Account for the relevant year is enclosed. Kindly refer page 17.
Part III of the Sixth Schedule only interprets certain words and phrases used in Part I & Part II and, therefore, is not relevant here. Part II of the Sixth Schedule lays down as to how the Profit & Loss Account shall be made out and which items of income and expenditure shall be disclosed. The relevant portion of Part II reads as follows :-
3. The profit and loss account shall set out the various items relating to the income and expenditure of the company arranged under the most convenient heads; and in particular, shall disclose the following information in respect of the period covered by the account:-
(i) …
(ii) …
(iii) …
(iv) The amount provided for depreciation, renewals or diminution in value of fixed assets.
If such provision is not made by means of a depreciation charge, the method adopted for making such provision.
If no provision is made for depreciation, the fact that no provision has been made shall be stated [and the quantum of arrears of depreciation computed in accordance with Section 205(2) of the Act shall be disclosed by way of a note.]
While Company has been providing depreciation and appending necessary notes for arrears of depreciation in earlier years, Company, in its Profit & Loss Account for the captioned year, provided full depreciation for the relevant year as also balance of arrears of depreciation relating to earlier years and appended the following note to its Profit & Loss Account :-
7. Depreciation for the year has been provided in the accounts in accordance with the provisions of Section 205(2)(b) of the Companies Act, 1956 taking into consideration extra shift allowance, where applicable. Consequent on the above, a sum of Rs. 1,366.39 lakhs being additional depreciation for the earlier years has been debited to the Profit & Loss Account.
We request you to kindly confirm that, as a consequence of provision of depreciation in terms of Section 205(2)(b), Company’s net profit of Rs. 69.91 lakhs is in accordance with Parts II & III of Schedule VI to the Companies Act, 1956.
Thanking you, Yours faithfully,
Encl : as above. Sd/-
(Namo Narain).
The Department of Company Affairs, Government of India, by letter dated 21-10-1991, replied as follows :-
Shri Namo Narain,
Company Secretary,
D-372, Narmada Apartments,
Alaknanda, New Delhi - 110 019.
Sub : Apollo Tyres Limited - Clarification on arrears of depreciation . Computation of net profit as shown in Profit & Loss accounts for the year 31-10-1987.
D/Sir,
I am directed to refer to your letter No. NN/Apollo/CIC/105 dated 24-9-1991 on the subject cited above and to say that the depreciation charged by the Company for the relevant year viz. 31-10-1987 and also the charging of the arrears of depreciation for earlier years in the Profit and Loss accounts of the Company for the period 31-10-1987 is in accordance with the provisions of Section 205 of the Companies Act, 1956 read with Parts II and III of Schedule VI to the Companies Act, 1956 and therefore, the Profit arrived at after the charging of such depreciation and arrears of depreciation in respect of the earlier years, appears to be in accordance with the provisions of the Companies Act, 1956.
From the above it will be evident that the net profit shown in the profit and loss account of the appellant for the year ending on 31-10-1987 is in accordance with the provisions of Parts II & III of Sixth Schedule to the Companies Act, as has been held by the Department of Company Affairs. The argument of the learned departmental representative that as the Department of Company Affairs has in relation to the profit has used the expression “appears to be in accordance with the provisions of Companies Act, 1956” would go to show that the Department has not applied its mind to the issue before it, is to be stated only to be rejected. It is normal practice for the governmental authorities to use the words of caution or protective languages even while giving clarification on an issue. Therefore, much mileage cannot be made out of the expression “appears to be” found in the communication of Department of Company Affairs dated 21-10-1991. The assessee is a public limited company, whose shares are quoted in the Stock Exchange. Its accounts are subjected to annual audit by duly qualified Chartered Accountants. The Accounts have been audited and the auditor had not passed adverse remarks about the manner in which the arrears of depreciation had been charged in the accounts of the relevant previous year. The Department of Company Affairs also has agreed that the profit arrived at after charging of arrears of depreciation in respect of earlier years appears to be in consonance with the provisions of Companies Act. Hence we hold that the net profit as shown in the accounts of the assessee after writing off arrears of depreciation of the earlier years can alone represent the book profits of the company and it is not for the assessing officer to substitute his own figures in its place.
20. Section 205 of the Companies Act provides for declaration of dividend only out of profits after providing for depreciation in the manner stated in Sub-section (2) of Section 205. Sub- Section (2) of Section 205 reads as follows :
(2) For the purpose of Sub-section (1), depreciation shall be provided either-
(a) to the extent specified in Section 350; or
(b) in respect of each item of depreciable asset for such an amount as is arrived at by dividing ninety-five per cent of the original cost thereof to the company by the specified period in respect of such asset; or
(c) on any other basis approved by the Central Government which has the effect of writing off by way of depreciation ninety-five per cent of the original cost to the company of each such depreciable asset on the expiry of the specified period; or
(d) as regards any other depreciable asset for which no rate of depreciation has been laid down by the Indian Income-tax Act, 1922, or the rules made thereunder, on such basis as may be approved by the Central Government by any particular case :
Provided that where depreciation is provided for in the manner laid down in clause (b) or clause (c), then, in the event of the depreciable asset being sold, discarded, demolished or destroyed the written down value thereof at the end of the financial year in which the asset is sold, discarded, demolished or destroyed, shall be written off in accordance with the proviso to Section 350.
Sub-section (5)(a) defines specified period as follows :-
‘specified period’ in respect of any depreciable asset shall mean that number of years at the end of which at least ninety-five per cent of the original cost of that asset to the company will have been provided for by way of depreciation if depreciation were to be calculated in accordance with the provisions of Section 350.
In this context reference to Section 350 may be relevant:
350. Ascertainment of depreciation – The amount of depreciation to be deducted in pursuance of clause (k) of Sub-section (4) of Section 349 shall be the amount calculated with reference to the written down value of the assets as shown by the books of the company at the end of the financial year expiring at the commencement of this Act or immediately thereafter and at the end of each subsequent financial year, at the rate specified for the assets by the Indian Income-tax Act (1961), and the rules made thereunder for the time being in force, as normal depreciation including therein extra and multiple shift allowances but not including therein any special, initial or other depreciation or any development rebate, whether allowed by the Act or those rules or otherwise.
The Department of Company Affairs issued the following memorandum on the subject which is found in pages 783 to 789 of the Guide to Companies Act by A. Ramaiya, Tenth Edition 1984. The following questions and answers found in the memorandum at pages 787 and 788 of the Guide to the Companies Act cited supra are relevant :
(3) Whether any company which had adopted and widely used ‘straight line method’ of providing depreciation in the past is required to change it in view of the provisions of the amended Section 205, provided of course that 95 per cent of the original cost of the asset is written off by way of depreciation before the expiry of specified period.
Section 205(2)(b) seeks to authorities the use of ‘straight line method’ of depreciation and no company following the method is obliged to change this provided the provisions of that section are complied with. The reference to this section to ‘original cost’ is only for the purpose of determining the quantum of annual instalment of depreciation under the straight line method and the ‘specified period’ in accordance with Section 205(5)(a).
(4) Under Section 205, it is required that arrears of depreciation should be provided for before any dividend is declared. This may create an anomaly in relation to the provisions of the Income-tax Act.
It is expected that depreciation would be provided every year as it is a charge on the revenue of the company, and should not be allowed to fall in arrears.
(5) Whether it would be open to company to charge depreciation on straight line method in respect of major fixed assets like plant and machinery, building etc. while adopting the reducing balance method for fixed assets of a lesser value, like motor vehicles, equipments, furniture, fittings etc.
It is permissible to adopt different methods for different types of assets provided the same basis is consistently adopted from year to year in accordance with the provisions of Section 205(2).
(6) If extra and multiple shift allowance is not claimed by a company, for the purpose of income-tax assessment, whether it would be necessary to take into account such allowances in calculating the specified method.
The real criterion would be whether the assets concerned are used for more than one shift and if so, the shift allowance will have to be taken into consideration for the purpose of Section 205(5)(a) and Section 350 and it would be immaterial whether such allowances are claimed by the company for the purpose of its tax assessment.
Though the view of the Department of Company Affairs was that proper provision for depreciation for double shift and triple shift workings should be provided for in the accounts and such view was also held by the Institute of Chartered Accountants of India in its Bulletins, the issue was not free from doubt. In this connection, the Editor’s note in page 788 is relevant :
The view taken by the Company Law Board that while determining depreciation according to the straight line method requires the company to take into account the provision for multiple shift allowance, does not appear to be correct. A company has at the inception to determine whether it will adopt in maintaining its accounts the straight line method or the written down value method for providing depreciation. Adoption of the straight line method predicates determination of the specified period, at the inception since the period is fixed in respect of an asset it cannot go on changing year after year, according as the company works additional shifts. When the straight line method is adopted the amount to be deduced annually will be uniformly deductible throughout the lift of the asset till 95 per cent of the cost to the company is provided. The view of the Department will be inconsistent with the scheme of determining depreciation according to the straight line method.
21. Thus two views were possible on the mode of computation straight line method of depreciation. The official view was that the straight line method should take into account not merely normal depreciation but also the double shift and triple shift depreciation in working out the specified period. The other view was that it would be impracticable to compute the specified period by entering into an exercise as to the number of days for which the concern will work additional shifts so as to reduce the cost of the asset to its 95% value. This is because while it is possible to estimate in advance the number of days for which a concern will work single shift so as to be eligible for normal depreciation, it would be anybody’s guess to foresee in advance the number of days for which the concern will work additional shifts and the more the number of years (are involved) larger will be the element of guess involved in such calculations. Therefore, it was considered impracticable to give effect to the views of the Company Law Department as also the view of the Institute of Chartered Accountants of India. At any rate there were two possible views on the ascertainment or computation of straight line method of depreciation. Till the assessment year 1987-88 the assessee has been adopting the straight line method of depreciation at the rates prescribed in the Income-tax Act and the Rules made thereunder. In setting up the straight line method only the rates prescribed for normal depreciation was taken into account by the appellant and no provision was made for depreciation on double shift or triple shift workings of the concern. This is evident from Note No. 7 to Schedule 12 – Notes on Accounts for the year ending 31-10-1986:
7. The depreciation for the year has been computed under Section 205(2)(b) of the Companies Act on:
(a) The legal view that extra shift allowance need not be considered under straight line method under Section 205(2)(b) of the Companies Act in respect of the plant and machinery.
(b) Company Law Board clarification that depreciation on additions to assets during a year need be computed on pro rata basis from the date of addition.
(c) Clarification issued in circular dated 21-5-1986 by the Department of Company Affairs in respect of application of the revised rates of depreciation under the amended Income-tax Rules in respect of various assets.
(d) Reclassification of certain items of plant under the main head ‘Plant & Machinery’. A sum of Rs. 1267.60 lakhs representing depreciation provided in the accounts for earlier years in excess of the amount required to be provided as re-computed on the above basis has been adjusted in arriving at the depreciation relating to earlier years debited to the Profit & Loss Account.
Had the company followed the practice adopted in previous years the charge of depreciation would have been higher by Rs. 31.27 lacs. The extra shift depreciation not provided as per (a) above for the period up to 31-10-1986 amounts to Rs. 1,948 lakhs including Rs. 127 lacs for the year.
However, in the previous year ending 31-10-1987, relevant to the assessment year 1988-89, the assessee had provided for arrears of depreciation in respect of additional shifts, in view of Schedule XIV to the Companies Act coming into force with effect from 2-4-1987. Schedule XTV has prescribed the rate of normal depreciation and also the rate for double shift and triple shift workings. At page 1706 in Datta on The Company Law (5th Edition 1991) the learned author Shri Kamal Gupta has this to say on the introduction of Schedule XIV to the Companies Act with effect from 2-4-1987 :
Rate on shift-basis – Schedule XIV provides separate depreciation rates for single shift, double shift and triple shift working. This sets at rest the controversy about the necessity to provide depreciation in respect of multiple shift working.
The assessee’s previous year ended after the coming into force of Schedule XTV to the Companies Act. Hence, we hold that for the first time unambiguous and clear liability was cast on the assessee to work out the depreciation on the basis of the rates prescribed in Schedule XIV for the normal depreciation, double shift depreciation and triple shift depreciation.
22. The “accrual” concept is a basic assumption in the financial statements as has been held by Accounting Standard (AS1). When a liability accrues for the first time in an year, irrespective of the fact whether the liability related to earlier years or not, it is an accepted accounting practice to recognise the liability in the year in which it accrues. Courts have upheld the claim for deduction of expenditure or liability for expenditure in the year of its accrual. Looked at from this angle the appellant is legally bound to provide for arrears of depreciation in the profit and loss account for the year ended 31-10-1987 before ascertainment of its “book profits” and therefore we hold that the “book profit” meaning thereby the “net profit” as shown in the profit and loss account for the relevant previous year prepared in accordance with Part II and Part III of Schedule XIV to the Companies Act (1 of 1956) is on order. The tax authorities erred in disallowing the arrears of depreciation.
23. The learned CIT (Appeals) at para 34 of his order held that ” Section 350 of the Companies Act has not undergone any change except that the amendment has only brought in specified rate in respect of depreciation and that it is nowhere mentioned in the said section that the arrears of depreciation should be provided for the purpose of ascertaining the book profits as contemplated in Section 205(1)(b) of the Companies Act. For the purpose of this section depreciation should be provided as contemplated in Section 205(2) read with Section 350 of the Companies Act, 1956. As mentioned earlier, it is not mandatory on the part of the company to provide the arrears of depreciation if it was not originally provided in the earlier years. The so-called amendment is only in respect of depreciation to be provided for the current year with effect from 2-4-1987″. We are in respectful disagreement with the views expressed by the learned first appellate authority. Companies which are desirous of paying dividend have to follow the mandatory provisions of Section 205 of the Companies Act. Under Section 205(1), a company cannot declare or pay dividend out of its profits of any financial year falling after the commencement of the Companies (Amendment) Act, 1960, without providing for depreciation. Proviso (a) to Section 205(1) provides that, in case a company has not provided for depreciation for any previous financial year or years after the commencement of the Companies (Amendment) Act, 1960, the arrears of such depreciation have also to be provided before declaring or paying dividend out of profits. Thus, before declaring or paying dividend for any financial year out of its profits, a company has to provide for depreciation for the financial year concerned as well as any arrears of depreciation. Therefore, the CIT(A) erred in concluding that it is not mandatory on the part of any company to provide the arrears of depreciation if it was not originally provided in the earlier years.
24. In fact, Section 350 of the Companies Act as it was enacted originally and even as it stands now prescribes the mode of calculating depreciation on the written down value method for purpose of ascertaining the managerial remuneration under Section 349(k) of the Companies Act. The obligation to provide for depreciation in the accounts arises only under Section 205 and not under Section 350. Section 205, besides creating a charge for depreciation, provides for alternative methods of depreciation and one such alternative method is found in Section 350 of the Companies Act. In other words, Section 205 is a charging Section in so far as depreciation is concerned and Section 350 is one of the machinery Sections. The CIT (Appeals) erred in focusing his attention on Section 350 to the exclusion of Section 205. Part II of Schedule VI to Companies Act set out the requirements of Profit and Loss Account. Sub-clause (iv) of Section 3 thereon is as follows :
(iv) The amount provided for depreciation, renewals or diminution in value of fixed assets.
If such provision is not made by means of a depreciation charge, the method adopted for making such provision.
If no provision is made for depreciation, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with Section 205(2) of the Act shall be disclosed by way of a note.
Part III which gives the interpretation of profit and loss account considers depreciation as a provision and is as follows :
(a) The expression ‘provision’ shall, subject to Sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.
and Clause (2) of Part III is as follows :-
(2) where-
(a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or
(b) any amount retained by way of providing for any known liability.
is in excess of the amount which in the opinion of the Directors is reasonably necessary for the purpose, the excess shall be treated for the purpose of this Schedule as a reserve and not as a “provision”. From the definitions appearing in the interpretation clause as respects “provision” and the requirement in Sub-clause (iv) of Clause 3 of Part II to Schedule VI to the Companies Act, it can be safely inferred that the profit and loss account must disclose the provision for depreciation on its fixed assets. If provision for depreciation was not made, in addition to the fact that no such provision has been made the arrears of depreciation in terms of Section 205(2) should also be quantified and highlighted by way of a separate note. In other words, the intention of the Legislature as found in Sub-clause (iv) cited supra is to look upon “arrears of depreciation” as part of current depreciation. We draw additional support for this proposition from clause (a) to proviso to Section 205(1) of the Companies Act, which is as follows :
If the company has not provided for depreciation for any previous financial year or years which falls or fall after the commencement of the Companies (Amendment) Act, 1960 (65 of 1960), it shall, before declaring or paying dividend for any financial year provide for such depreciation out of the profits of that financial year or out of the profits of any other previous year financial year or years:
In the light of our discussion, we uphold the computation of “book profit” as given by the appellant.
25. Whether or not the arrears of depreciation is considered as part of current depreciation, even then the charging of arrears of depreciation in the profit and loss account is a necessary requirement in assessing its impact on the current profits. Accounting standard (AS 5) (Page 31 of Compendium of Statements and Standards issued by the Institute of Chartered Accountants of India in November 1982) defines prior period items as “material charges or credits which arise in the current period as a result of errors or omissions in the preparation of financial statements of one or more prior periods”. The non-charging of depreciation in the earlier years can at the worst be viewed as an error or omission in the prior periods. Kamal Gupta in his Contemporary Auditing IV Edition, at page 229 observes as follows :-
This definition of prior period items is some what restrictive since it includes only errors or omissions in preparation of financial statements of prior periods. The standard requires that prior period items should be separately disclosed in the current profit and loss account. Their nature and amount should be disclosed in such a manner that their impact on current profit or loss can be perceived.
Therefore, it is not as if the profit and loss account of a period cannot be burdened with prior period charges or incomes as contended by the revenue. In fact, they are to be reckoned with in the profits of the current period, but the disclosure of such items should be highlighted in the accounts. In this context it would be useful to refer to clause 2 of Part II of Schedule VI to the Companies Act which reads as follows :-
2. The profit & loss account-
(a) shall be so made out as clearly to disclose the working of the company during the period covered by the account and
(b) shall disclose every material feature including credits or receipts or debits or expenses in respect of non-recurring transactions or transaction of an exceptional nature.
The revenue places strong emphasis on Sub-clause (a) of Clause 2 cited above and in that process overlooks the provisions of sub-clause (b) thereof. Sub-clause (b) is wider in its import than sub-clause (a) as it is inclusive in its contents. The prior period expenses or income would fall under Sub-clause (b) as material features affecting the accounts. In our considered opinion both the sub-clauses (a) and (b) should be read together. In other words, the arrears of depreciation, even if it is considered as a prior period expenditure, will have its natural accommodation in the profit and loss account of the period covered by the accounts. To ignore that is to ignore the obvious.
26. Even if it is held that arrears of depreciation is not a legitimate charge against the profits of the year but should be viewed only as an appropriation of profit, still the same cannot be added back to arrive at the book profit for purposes of Section 115J. The Explanation to Section 115J deals with certain specific adjustments. Some of the items mentioned therein can be viewed as forming part of the income or the expenditure of the year under review, as for example, the adjustment mentioned in clause (f) and (f)(ii), which deal with income and the expenditure which are not subjected to Central Income-tax, though the same are found in the profit and loss account before the ascertainment of profit. Past losses to the extent of depreciation provided in the accounts in the earlier years for which adjustment is stipulated in clause (f)(iii) of the Explanation will not figure anywhere in the profit and loss account of the relevant previous year. There are also adjustments envisaged in Section 115J for certain items which can be viewed only as appropriation of profits and such items are specifically mentioned in clause (a) to (e) of the Explanation cited supra. In addition there is an item of adjustment as provided in clause (f) (i) which deals with withdrawal of reserves representing profits taken to the reserves in the earlier years. So also adjustments is provided for in respect of excess provision written back into the profit and loss account in clause (f)(i) of the Explanation. But nowhere is there any mention for adjustment of prior period expenses such as arrears of depreciation no matter whether it is looked upon as a charge against the profit or as an appropriation of profit. The legislature which has referred to Part II and III of Schedule VI to the Companies Act must be credited with the knowledge of several items that appear in the profit and loss account including the appropriations found therein. Therefore, any item which is not earmarked for adjustment in the Explanation cannot be brought within the mischief of the Explanation to Section 115J. In other words the assessing authority has no jurisdiction to make additions or subtractions as he likes contrary to what is specifically provided for in Section 115J.
27. The assessing authority had mentioned the figures given in the directors’ report to buttress the point that the net profit should be taken at the figure indicated by him. The financial results given in the directors’ report is an abridged version of the detailed profit and loss account, and therefore, no adverse inference can be drawn against the assessee from out of the directors’ report.
28. In the light of our discussions, the order of the CIT(Appeals) on the issue of book profits for purposes of Section 115J is set aside and the appellant’s computation of the same is upheld. We order accordingly.
29. to 38. [These paras are not reproduced here as they involve minor issues.]
39. Further grounds of appeal are as follows:
7. (a) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in confirming the exclusion of dividend income amounting to Rs. 1,51,89,760 in computing the profits of eligible business under Sub-section (3) of Section 32AB and holding that such adjustment was in accordance with Sub-section (3) of Section 32AB of the Income-tax Act, 1961.
(b) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in not holding that the entire business of the assessee-company including earning of dividend income is “eligible Business or Profession” within the meaning of Sub-section (2) of Section 32AB of the Income-tax Act, 1961. He further erred in equating the concept of “profits & gains of business or profession” under Section 28 of the Income-tax Act, 1961, with the profits of ‘eligible business or profession’ under Section 28 of the Income-tax Act, 1961, with the profits of eligible business or profession as referred to in Sub-section (3) of Section 32AB of the Income-tax Act, 1961, by discarding the concept of profits computed in accordance with the requirements of Part II & III of the VI Schedule to the Companies Act, 1956 as referred to In Sub-section (3) of Section 32AB of the Income-tax Act, 1961.
The assessee during the previous year had purchased certain new machinery or plant from out of its income chargeable under the head “profits and gains of business or profession”. In terms of Sub-clause (ii) of Sub-section (2) of Section 32AB, the assessee would be entitled to 20% of the profits of eligible business. Sub-section (2) defines the meaning of “eligible business”. Clause (a) of Sub-section (3) deals with the mode of computation of the profits of eligible business in a case where separate accounts are maintained and clause (b) thereof deals with such computation in a case where no separate accounts are maintained. Sub-clause (4) deals with certain situations where deduction under Section 32AB would not be available. There is no dispute that the business of the assessee falls within the meaning of eligible business. The dispute is only about the computation of profits of such business. The assessee had included the advances paid in the preceding assessment year towards the machinery which were purchased during the previous year relevant to the assessment year in the cost of purchase of such machinery. It had also included a sum of Rs. 1,51,89,760 representing the dividend on units of Unit Trust of India in computing the profits of eligible business. The Deputy Commissioner of Income-tax (Assessment) held that the advances paid in the preceding periods for purchase of machinery cannot be considered as forming part of the cost of the machinery purchased during the relevant previous year and, therefore, excluded the same from the cost of the purchase. He also excluded the dividend on units of Unit Trust of India from the profits of eligible business on the ground that it is not income from eligible business. The assessee appealed. The learned CIT(Appeals) saw no justification for excluding the amount of advance paid against the purchase order which was adjusted during the relevant previous year in the purchase price of the asset as such advance payment will shed its character as advance and merge in the cost of the asset when adjusted. The revenue is not on appeal on this aspect of the matter.
40. As for the exclusion of the dividend on units of Unit Trust of India from the profits of eligible business, the learned CIT(Appeals) sustained the order of the Deputy Commissioner of Income-tax (Assessment) on the ground that such income will not fall within any of the items of clause (a) of Section 32AB(3). The assessee is aggrieved.
41. Shri Sarangan submitted that the assessee was having only one account for both manufacture of tyres for sale and purchase and sale of Units. The income from Unit Trust was recognised as an income in the profit and loss account and thus the business profit was ascertained. It is one thing to assess it under other sources; but it is another thing to say that it does not form part of the eligible business profits. As far as the assessee is concerned, the units are held as stock-in-trade as it is frequently buying and selling the same, and there is one common account of funds and management and, therefore, the activities of (a) manufacture and sale of tyres and (b) dealing in the units of Unit Trust of India cannot be segregated one from the other and must be considered as part of the same business.
42. Shri Abraham, the learned senior departmental representative contended that what the assessee received from the Unit Trust of India was dividend. It was declared as such by the Unit Trust and it was received as such by the assessee. Dividends are assessable under “other sources”. The heads of income prescribed in Section 14 of the Income-tax Act, 1961, are mutually exclusive. Once a particular receipt falls in a particular head of income as in the case of the assessee under ‘other sources’ it cannot be held that it was part of income from business for assessment purposes. Therefore, the CIT(Appeals) was right in excluding the dividend on the units of Unit Trust of India from the eligible business profit for purposes of computing the deduction under Section 32AB of the Income-tax Act, 1961.
43. We have thus heard rival submissions and perused the records. Section 32AB was inserted by Finance Act, 1986 with effect from 1-4-1987. We are now concerned with the assessment year 1988-89. Sub-sections (1), (2) and (3) of Section 32AB which are material for our purposes are as follows :-
32AB. Investment deposit account,-(1) subject to the other provisions of this section, where an assessee, whose total income includes income chargeable to tax under the head ‘Profits and gains of business or profession’, has, out of such income,-
(a) deposited any amount in any account (hereinafter in this section referred to as deposit account) maintained by him with the Development Bank before the expiry of six months from the end of the previous year or before furnishing the return of his income, whichever is earlier, or
(b) utilised any amount during the previous year for the purchase of any new ship, new aircraft, new machinery or plant, without depositing any amount in the deposit account under clause (a), in accordance with, and for the purpose specified in, a scheme (hereafter in this section referred to as the scheme) to be framed by the Central Government, or if the assessee is carrying on the business of growing and manufacturing tea in India, to be approved in this behalf by the Tea Board, the assessee shall be allowed a deduction (puch deduction being allowed before the loss, if any, brought forward from earlier years is set off under Section 72) of-
(i) a sum equal to the amount, or the aggregate of the amounts, so deposited and any amount so utilised; or
(ii) a sum equal to twenty per cent of the profits of eligible business or a profession as computed in the accounts of the assessee audited in accordance with Sub-section (5),
whichever is less :
(2) For the purposes of this section,-
(i) ‘eligible business or profession’ shall mean business or profession, other than-
(a) the business of construction, manufacture or production of any article or thing specified in the list in the Eleventh Schedule carried on by an industrial undertaking, which is not a small scale industrial undertaking as defined in Section 80HHA;
(b) the business of leasing or hiring of machinery or plant to an industrial undertaking, other than a small scale industrial undertaking as defined in Section 80HHA, engaged in the business of construction, manufacture or production of any article or thing specified in the list in the Eleventh Schedule;
(3) The profits of eligible business or profession of an assessee for the purpose of Sub-section (1) shall-
(a) in a case where separate accounts in respect of such eligible business or profession are maintained, be an amount arrived at after deducting an amount equal to the depreciation computed in accordance with the provisions of Sub-section (1) of Section 32 from the amounts of profits computed in accordance with the requirements of Part II and III of the Sixth Schedule to the Companies Act, 1956 (1 of 1956) as increased by the aggregate of-
(i) the amount of depreciation;
(ii) the amount of income-tax paid or payable, and provision therefor;
(iii) the amount of surtax paid or payable under the Companies (Profits) Surtax Act, 1964 (7 of 1964);
(iv) the amounts carried to any reserves, by whatever name called;
(v) the amount or amounts set aside to provisions made for meeting liabilities;
(vi) the amount by way of provision for losses of subsidiary companies; and
(vii) the amount or amounts of dividends paid or proposed, if any, debited to the profit and loss account; and as reduced by any amount or amounts withdrawn from reserves or provisions, if such amounts are credited to the profit and loss account; and
(b) iri a case where such separate accounts are not maintained or are not available, be such amount which bears to the total profits of the business or profession of the assessee after allowing depreciation in accordance with the provisions of Sub-section (1) of Section 32, the same proportion as the total sales, turnover or gross receipt of the eligible business or profession bear to the total sales, turnover or gross receipts of the business or profession carried on by the assessee.
44. Circular No. 461 dated 9-7-1986 (161 ITR Statutes 24) explains the provisions of Section 32AB as follows :-
The new scheme is applicable to all existing types of assessees as also to the professionals and leasing companies which have not leased out machinery to those industrial undertaking engaged in the manufacture or production of an article of thing listed in. the Eleventh Schedule to the Income-tax Act.
From the language of Section 32AB and the Circular thereunder it is clear that investment deposit or the purchase of a new asset or plant must have come out of the income chargeable to profits and gains of business or profession. Since the income from units of Unit Trust of India is chargeable under the head “other sources”, the same cannot be construed as forming part of the income chargeable to tax under the head “profits and gains of business or profession”. This is as far as the amount deposited in the investment deposit account or the amount invested in the purchase of new machinery or new plant is concerned. In other words, the source of the amount for deposit or for the purchase of the new machinery should come from income chargeable to tax under the head profits and gains of business. But the definition of “eligible business or profession” is in a sense wide. Except those business specified in clause (a) & (b) of Sub-section 2 of Section 32AB, all other business or profession have to be construed as “eligible business”. In other words, an eligible business need not necessarily be an industrial undertaking engaged in the manufacture or production of an article. One of the components to be considered for deduction under Sub-section (1)(ii) of Section 32AB is the profit of eligible business to the extent of 20% of the same. That profit has to be computed in the manner laid down in Sub-section (3) of Section 32AB cited supra. We, therefore, conclude that whatever income is earned by the assessee either from its activity of manufacture or production for sale or from other activities such as dealing in shares and earning profits thereon and receiving income on such shares in the interim period as long as they constituted the same business – all will fall under the category of “eligible business”. The reason is by definition, eligible business, is not confined to manufacture or production. Moreover inter-head and intra-head adjustments are the cardinal features of computation of income. Further in the case of the assessee the accounts have been prepared in accordance with Part II and Part III of the Sixth Schedule to the Companies Act, 1956 as is the mandate in Sub-section (3) of Section 32AB. From the published profit: and loss account prepared in accordance with Part II and Part III of Sixth Schedule to the Companies Act, it is seen that the income from units of Unit Trust of India and profit or loss on the sale of units were considered before ascertainment of the net profit of the undertaking. From such profit, the adjustments envisaged in Sub-section (3) of Section 32AB is to be given effect to. Moreover, these two activities of the assessee have to be construed as forming part of the same business as there is one account for all the funds, which are intertwined and interlaced with each other, and the business is conducted under a common management. There is one profit and loss account and one balance-sheet. It is the perception of the activities from the point of view of businessman that is material. It is such perception that is recognised in Part II and Part III of the Sixth Schedule to the Companies Act, wherein Miscellaneous incomes and other incomes are designed to enter the profit stream. In 32AB(3), or in 32AB(1){ii) the expression “chargeable to profits and gains of business” is conspicuous by its absence. Hence the dichotomy as between the income from manufacture and income from units of Unit Trust of India is not warranted in terms of Section 32AB(3) of the IT Act or in the ratio laid down by the Supreme Court in 41 ITR 272; 63 ITR 632 and 77 ITR 739. We hold accordingly. The authorities erred in holding otherwise. As both the activities constituted same business, which is an eligible business, provisions of Section 32AB(3)(b) is not applicable. The Income Tax Officer, is therefore, directed to first limit the amount of deposit or the amount utilised in the purchase of new machinery or new plant to the income chargeable under the head “profits and gains of business”, under 32AB(1). Then for the purpose of working out the deduction, rather more specifically, in computing 20% of the eligible profit, the income from units of Unit Trust of India (dividends and profit or loss on the sale of units) should also be considered along with other income as found in the profit and loss account prepared in accordance with Part II and Part III of the Sixth Schedule to the Companies Act, subject to such adjustments as have been prescribed therein. With these directions, we part with the issue.
45. [This para is not reproduced here as it involve minor issue.]
46. The further ground of appeal is in two parts which are as follows :-
(a) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in holding that buying and selling of units is a speculation business and the loss incurred on account of buying and selling of units amounting to Rs. 22,69,700 will amount, to speculation loss.
(b) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in applying the provisions of Section 73 of the Income-tax Act, 1961 to the units of Unit Trust of India which cannot be equated with the shares of the company.
During the course of appellate proceedings, the learned CIT(Appeals) noticed that the assessee had incurred loss on account of sale of units amounting to Rs. 22,69,700 which was claimed as business loss and was allowed as such in assessment. The learned first appellate authority was of the view that the loss on the sale of units should be treated as speculation loss in view of Explanation to Section 73 of the Income-tax Act, 1961 and hence he gave notice of enhancement. The assessee contended that the Unit Trust of India is not a company and the units issued by it cannot be construed as shares and therefore the Explanation to Section 73 of the Income-tax Act, 1961, cannot be invoked. However, the CIT(Appeals) rejected the same and his findings are to be found in paragraphs 25 and 26 of his order. According to him, the unit is a share as its price is not fixed but fluctuating in the market. Further, the income from unit is deemed as dividend. Therefore, the Explanation to Section 73 of the Income-tax Act, 1961 was attracted and the loss was only a loss in speculation business.
47. We have heard rival submissions and have gone through the provisions of the Unit Trust of India Act, 1963 which was further amended by the Unit Trust of India (Amendment) Act, 1985. The purpose of the Act is to provide for the establishment of a corporation with a view to encouraging savings and investments and participation in the incomes, profits and gains accruing to the corporation from the acquisition, holding, management and disposal of securities. Section 2 deals with definitions and the following clauses are relevant:
(i) “securities” means shares, debentures, bonds and other stock of any company or other body corporate whether incorporated in India or outside, and securities issued by any local authority in India, or by the Government of, or a local authority, in any such country outside India as may be approved by the Reserve Bank and includes Government security as defined in Section 2 of the Public Debt Act, 1944 (18 of 1944), but does not include mortgage on immovable property :
** ** **
(n) ‘unit’ means a unit issued under a unit scheme;
(o) ‘unit capital’ means the aggregate of the face value of the units sold under a unit scheme and outstanding for the time being;
(p) ‘unit certificate’ means a certificate issued to the purchaser of a unit under a unit scheme;
(q) ‘unit holder’ means a person for the time being recognised by the Trust as the holder of a unit certificate under a unit scheme;
(r) ‘unit scheme’ means a scheme made under Section 21.
48. According to Section 4, the initial capital of the trust will be five crores of rupees to be contributed by the Reserve Bank of India, Life Insurance Corporation of India, State Bank of India and its subsidiaries and such other institutions, viz., scheduled banks and other financial institutions as may be notified by the Central Government. From these definitions it is clear that a unit holder is not a shareholder of the Unit Trust of India. Only the institutions specified in Section 4 can be said to be the contributing institutions. A unit holder is just an investor. He has no right in the management of the Trust. The dividends that are declared by the Unit Trust of India are not at the instance or approval of the unit holder. The unit holder has no say in the affairs of the Trust. Therefore, the unit holder cannot be treated as a shareholder and the units cannot be treated as shares. Hence, the Explanation to Section 73 of the Income-tax Act, which concerns with the buying and selling of shares cannot be invoked.
49. Shri Abraham, the learned senior departmental representative, basing himself on Sub-section (3) of Section 32 of the Unit Trust of India Act vehemently contended that the units can be looked upon as shares. We do not accept his argument for the following reasons:
Section 32(3) of the Unit Trust of India Act is as follows :
32(3) subject to the foregoing Sub-sections for the purposes of the Income-tax Act, 1961 (43 of 1961),-
(a) any distribution of income received by a unit-holder from the Trust shall be deemed to be his income by way of dividends ; and
(b) the Trust shall be deemed to be a company.
This is only a Sub-section which is made subject to Sub-sections (1) and (2) of Section 32 of the Unit Trust of India Act. Under the provisions of Section 32(1) of the said Act income-tax or any other tax is not payable on the income of the Unit Trust of India and in relation to certain income distributed by it to certain categories of persons. Sub-section (2) declares that the provisions of Sections 193 and 194 of the Income-tax Act, 1961 would not be applicable to the interest or dividend payable to the Unit Trust of India and also the income distributed to the unit holder, who is an individual resident in India. The provision for deduction of tax is made in respect of the income distributed to an individual who is a non-resident in case such distribution exceeds Rs. 5,000 etc. It is in relation to these purposes that Sub-section (3) declares that the income distributed by the Unit Trust should be considered as dividend and it should be treated as a corporation. The fiction created in Section 32(3) of the Unit Trust of India Act is limited to the provisions of Section 32(1) and (2) and cannot be extended beyond. The flction ends there. Therefore, Shri Sarangan is right in his contention that merely because the Unit Trust of India describes the income distributed by it to the unit holder as dividend, that does not ipso facto make unit a share. A share is a bundle of rights and a shareholder is one who can exercise those rights on his own. One of the rights attaching the shareholder is to participate in the affairs of the company. The right to elect the Board of Directors and the right to approve the accounts and to vote for the dividend are some of the other rights. No such rights are available to the unit holder, such rights having been perhaps reserved for the initial contributors, such as Reserve Bank of India, Life Insurance Corporation of India, etc. The Explanation to Section 73 of the Income-tax Act, 1961 arises only when there is transaction in the purchase and sale of shares. Units not being shares, and further as each purchase and each sale was accompanied by physical delivery of units, it cannot be said that the assessee was indulging in speculative transactions when it dealt with the purchase and sale of shares. The order of the CIT (Appeals) is set aside on this issue.
50. This leaves us to consider the following ground of appeal:
2. (a) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in holding that the assessing officer was justified in setting off of brought forward depreciation against dividend income.
(b) That the learned Commissioner of Income-tax (Appeals) erred in law and on the facts and in the circumstances of the case in confirming the action of the assessing officer is not assessing the income from ‘other sources’ separately as returned by the assessee-company.
In computing the assessable income, the Income-tax Officer sought to set off the unabsorbed business loss and unabsorbed depreciation against the income from units assessed under other sources, as a result of which the total income came to nil according to his computation. Consequently, he did not allow deduction under Section 80M. Aggrieved, the assessee carried the matter in appeal. The learned CIT (Appeals) only rejected assessee’s objection against the set off of unabsorbed depreciation following the decision of the Supreme Court in the case of CIT v. Jaipuria China Clay Mines (P.) Ltd. [1966] 59 ITR 555. He did not consider the assessee’s objection to the set off of brought forward business loss against the income from other sources. In appeal before us also the objection is only against the set off of brought forward depreciation against the income from other sources.
51. Shri Sarangan took us through the provisions of Sections 70, 71, 72 etc., of the Income-tax Act and submitted that the expression used in the section is that the assessees “shall be entitled to have the amount of such loss set off. Such an expression gives an option to the assessee either to have the set off or not to have the set off. Section 71 dealing with set off of loss from one head against the income from another head uses similar expression. Section 72 provides for carry forward of business loss in some circumstances and in the event of the unabsorbed depreciation also being present, the business loss was first to be set off in preference to unabsorbed depreciation. Therefore, the option is left to the assessee either to have the set off or not. Hence, the assessee cannot be compelled to adjust the unabsorbed depreciation against the income from other sources.
52. Shri Abraham, the learned senior departmental representative relied on the decision of the CIT(Appeals) supported by the decision of the Supreme Court in the case of Jaipuria China Clay Mines (supra).
53. We have thus heard rival submissions. The issue before us is about the set off of unabsorbed depreciation against the income from other sources. The mere fact that the expression “shall be entitled to” occurred in Section 71 or 72 etc. does not mean that an unlimited option has been conferred on the assessee to disclaim the set off and carry forward of loss. In this connection, we extract the passage from Shri Sampath Iyengar’s Law of Income-tax, Eighth Edition, page 2935:
9. Set off, not a matter of opinion,-
The language of the present Section 70 and, earlier of Sub-section (1) of Section 70 and also of clause (i) and (ii) of Sub-section (2) thereof is that “the assessee shall be entitled to have the amount of such loss set off against the income …”. They do not confer an option to the assessee not to have the short-term capital loss or the long-term capital loss adjusted in the manner provided in Section 70. Such an option is negatived by the fact that Section 74 relating to carry forward of losses requires that the net result under the head “capital gains” shall be ascertained, i.e. in one single sum, which can only be achieved by adjusting all profits as against all losses. Moreover, such an option would contradict the entire scheme of the capital gains taxation which is separately provided for in Sections 71 and 74. The expression, hence “shall be entitled” occurring (formerly at three places) in Section 70 would have to be uniformly understood as no more than disentitling the Assessing Officer to deny the set off. Subject to the aforesaid exceptions or variations, the general rule is that losses or profits arising from whatever source or sources under each head should be aggregated and set off one against another and the final net figure so arrived at is the loss or profit for the relevant head.
In CIT v. Mahalaxmi Sugar Mills Co. Ltd. [1986] 160 ITR 920 at page 928 the Supreme Court dealt with a contention of the assessee as follows:
Learned counsel for the assessee has placed a number of cases before us which deal with the application of the Indian Income-tax Act and where it has been held that for the purpose of sub- Section (1) of Section 24 of that Act, income which does not fall within the purview of the Act at all cannot be set off against a loss arising under the Act. These are cases which are wholly inapposite and have no bearing at all upon the role played by the Agreement. It is also urged that it is open to the assessee to claim or not to claim the benefit of Section 24 of the Act, and that if he does not do so, no question arises of applying Section 24. In the first place, a perusal of the assessment orders for the two years shows clearly that the assessee did business. In the second place, there is a duty cast on the Income-tax Officer to apply the relevant provisions of the Indian Income-tax Act for the purpose of determining the true figure of the assessee’s taxable income and the consequential tax liability. Merely because the assessee fails to claim the benefit of a set-off, it cannot relieve the Income-tax Officer of his duty to apply Section 24 in an appropriate case.
The right of the assessee not to have set-off, if at all it had been intended, was specifically provided for, as for instance, in Section 71(2). As it stood prior to 1-4-1968, the said proviso was as follows :-
(2) Where in respect of any assessment year the net result of the computation under any head of income other than “Capital gains” is a loss and the assessee has income assessable under the head “Capital gains”, such loss may, subject to the provisions of this Chapter be set off against the income, if any, of the assessee assessable for that assessment year under any other head including income from capital gains relating to short term capital assets as well as other capital assets or, if the assessee so desires, shall be set off only against his income if any, assessable under any head of income other than ‘capital gains’.
We underline the expression “if the assessee so desires” and hold that no such option is found in relation to the set off and carry forward of unabsorbed depreciation. Moreover, the provisions relating to depreciation constitute a separate code by itself. In Rajapoloyam Mills Ltd. v. CIT[1978] 115 ITR 777 the Supreme Court has observed that it is settled law that though the profits of each distinct business carried on by an assessee have to be computed separately in accordance with the provisions of Section 28 etc., the tax is chargeable under those provisions not separately on the profits of each business, but on the aggregate of the profits of all the business carried on by the assesee. It follows, therefore, that where the assessee carries on several business, he is entitled to set off of loss in one business against profits in another. If in any year there is any loss in a business carried on by the assessee by reason of the profits of such business not being sufficient to absorb the depreciation allowance, such loss can be set off against the profits of another business carried on by the assessee in that year. If however, there are no profits chargeable under the head ‘business or profession’ or if the profits chargeable under that head are insufficient to cover the depreciation allowance, the amount of the allowance, to the extent to which it is not absorbed, can be set off against profits chargeable under any other head for that assessment year. If any loss due to depreciation remains outstanding even after set off against income under any other head for that assessment year, the assessee is entitled to have the loss due to depreciation carried forward to the next assessment year, but, at this stage, it is carried forward not as a ‘loss’ but as ‘unabsorbed depreciation’. The amount of it so brought forward shall be added to the amount of the depreciation allowance admissible for the next year and shall be deemed to be part of that year’s depreciation allowance; or if there is no such allowance (i.e., depreciation) for that year, the depreciation loss brought forward shall be deemed to be the depreciation allowance for that year. If still the whole or part of such depreciation is unabsorbed, it shall be carried forward to the succeeding year and so on indefinitely. No distinction can be made between the current year’s depreciation and carried forward unabsorbed depreciation of the earlier years. Giving effect to Section 32(2) which deems unabsorbed depreciation of the earlier year as part of the current year’s depreciation, the deduction under Section 32(1) must relate to both the current year’s depreciation as well as the depreciation of the earlier years – CIT v. North Arcot District Co-operative Spg. Mills Ltd. [1985] 151 ITR 238 [1984] 17 Taxman 40 (Mad.). The unabsorbed depreciation is thus carried forward to subsequent years without any limitation of time unlike the case of business losses which can be carried forward only for a period of eight assessment years. Since the unabsorbed depreciation-is placed on the same footing as the depreciation of the succeeding year, it can be set off not only against the profits of the same business but also the profits of any other business and against the income under any other head – Jaipuria China Clay Mines’ case (supra), Mysore Paper Mills Ltd. v. CIT[1979] 117 ITR 132 (Kar.) and N. Krishnammal v. CIT [1984] 147 ITR 431 (Mad.). (Courtesy : Iyengar’s Law of Income-tax).
54. Further the assessee’s business in the purchase and sale of units and its business in the manufacture and sale of tyres constituted one and the same business. There is thus nothing wrong in the assessing officer in having adjusted the brought forward depreciation against the dividends 011 units though assessed under the head “other sources”.
55. to 57. [These paras are not reproduced here as they involve minor issues.]