2006 (11) TMI 112 - HC - Income Tax

Book profit u/s 115J of the Act- HC held that once the management after due care made provision for the doubtful debts was not consider as provision for unascertained liability, hence the amount added back to Profit and loss account by the AO not sustained

Summary

Issues:
1. Interpretation of provisions of section 115J(1A) of the Income-tax Act, 1961 regarding the treatment of provision for doubtful debts in determination of book profit.
2. Whether section 115J overrides other provisions of the Act in computing taxable book profit.
3. Determination of provision for doubtful debts as diminishing the value of assets and its impact on book profit calculation.

Issue 1:
The case involved an appeal under section 260A of the Income-tax Act, 1961, challenging the treatment of provision for doubtful debts in determining book profit. The appellant, a company, had made a provision for doubtful debt of Rs. 11,52,221 during the relevant assessment year. The dispute arose when the Assessing Officer added back this provision to the total income of the company, considering it as not an ascertained liability. The Commissioner of Income-tax (Appeals) held that section 115J has an overriding effect on other provisions of the Act and deleted the addition. However, the Tribunal set aside this decision, leading to the appeal in question.

Issue 2:
The Tribunal's decision was based on the view that the provision of doubtful debt was not an ascertained liability and therefore should be added back to the profits for book profit determination under section 115J. The Tribunal relied on a decision of the Madras High Court in Deputy CIT v. Beardsell Ltd. [2000] 244 ITR 256. However, the appellant argued that the provision for ascertained liability is permissible even when the recovery of a debt is doubtful, citing various judgments including those of the Supreme Court. The Bombay High Court's decision in CIT v. Echjay Forgings P. Ltd. [1996] 251 ITR 15 was also referred to in support of this contention.

Issue 3:
The court analyzed the provisions of the Companies Act, 1956, regarding the preparation of profit and loss accounts by the appellant company. It was highlighted that the provision made for doubtful debts was supported by the opinion of the directors and was in accordance with the relevant accounting procedures. The court emphasized that the board of directors is the competent authority to determine the extent of liability, and once they decide on a provision for known liability, it cannot be added to the profit and loss account. References were made to decisions of the Supreme Court in National Rayon Corporation Ltd. v. CIT [1997] 227 ITR 764 and Apollo Tyres Ltd. v. CIT [2002] 255 ITR 273 to support this stance.

In conclusion, the court set aside the Tribunal's order and ruled in favor of the assessee, emphasizing the importance of the board of directors' authority in determining provisions for known liabilities and the distinction between provisions and reserves in accounting practices.