'MAT' AND NECESSARY ADJUSTMENT IN BOOK PROFIT IN VIEW OF NOTES, OBSERVATION, DISCLOSURES OR QUALIFICATION ON ACCOUNTS SECOND ARTICLE IN VIEW OF RECENT JUDGMENT OF DELHI HIGH COUTRT

[C.A. DEV KUMAR KOTHARI]

Earlier article hosted on 31^st July, 2008:

Earlier an article on the same subject was hosted on this website on 31^st July,2008 in which on consideration of relevant provisions of income Tax Act, 1961 relating to MAT, provisions of Companies Act, 1956 relating to accounts, accounting policies and notes on account and other accompanying documents, the author had  expressed view that the notes on accounts, accounting policies disclosed and other statements enclosed are part and parcel of annual accounts. The profit and loss account and balance sheet are to be read with such notes, qualifications and explanations. Therefore, in some cases, it may be necessary to make adjustments in the amount of profit as shown in the P  &  L account read with notes on accounts  to derive at the profit as per schedule VI. That the Assessing Officer is also duty bound to make such adjustments in the figure of profit and thereafter he can make other adjustments as permitted in the sections relating to MAT- S.115J, 115JA, or S115JB.  It is also  mandatory to prepare a separate  profit and loss account as per part II of the Schedule VI. At that time a decision of Madras High Court and Calcutta ITAT were also discussed in the article besides the landmark judgment of the Supreme Court  in the case of Appolo Tyres. The readers are requested to read that article.  Now  in this article, some recent judgments have been discussed in which it is held that un provided depreciation is to be deducted.

In CIT  v  Sain Processing & Weaving Mills (P.) Ltd. ITA No. 1128/2007 decided by Delhi High Court on December 17, 2008 it has been held that depreciation which has not been provided in accounts of current year is to be reduced from profit shown in the profit and loss account . The court has observed and decision of the court are analyzed below:

a.       There is requirement of disclosure on failure to provide for depreciation, in the profit and loss account, as also, the quantum of such arrears is provided in section 211, read with, clause 3(iv) of Part II of Schedule VI of the Companies Act.

b.      There is, an obligation cast, on the company to present a true and fair view of its state of affairs to those who rely on its accounts.

c.        The provisions of Section 211 and clause 3(iv) of Part II of Schedule VI of the Companies Act, in so far, as they are relevant for the purposes of the present appeal are extracted below:-

          "Section 211(1) Every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of this section, be in the form set out in Part I of Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central government either generally or in any particular case and in preparing the balance sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance sheet under the heading ?Notes? at the end of that part:

Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity or to any other class of company for which a form of balance s heet has been specified in or under the Act governing such class of company.

(2) Every profit and loss account of a company shall give a true and fair view of the profit or loss of the company for the financial year and shall, subject as aforesaid, comply with the requirement of part II of Schedule VI, so far as they are applicable thereto.

(6) For the purpose of this section, except where the context otherwise requires any reference to a balance sheet or profit and loss account shall include any notes thereon or documents annexed thereto, giving information required by this Act and allowed by this Act to be given in the form of such notes or documents.

xxxx xxxx xxxx

xxxx

Part II

REQUIREMENTS AS TO PROFIT AND LOSS ACCOUNT

1. xxxxxx

2. xxxxxx

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. xxxxxx

II. xxxxxx

III. xxxxxx

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 computed in accordance with Section 205(2) of the Act shall be disclosed by way of a note.

In view of the above provisions the court held that the disclosure,  in the notes to the account is obligatory by virtue of the provision of sub-section (1A) of Section 115J of the Act which requires that every assessee shall prepare profit and loss account in accordance with the provision of Parts II and III of Schedule VI of the Companies Act, 1956.

The court further found that  the issue still remains as to whether notes to accounts form part of the accounts, and whether the fact that the current year depreciation which has not been debited to the profit and loss account  would in any way deprive the assessee of its claim for the deduction from the "net profit" in arriving at the figure of ?book profit, for the purposes of Section 115J of the Act?.

Then the court observed that

 " the answer to this poser is found in sub-section (6) of Section 211 of the Companies Act, which provides that except where the context otherwise requires any reference to a balance sheet or profit and loss account shall include the notes thereon or documents annexed thereto, giving information required to be given and/or allowed to be given in the form of notes or documents by the Companies Act. As already noted it is obligatory under clause 3(iv) of Part II of Schedule VI to Companies Act to give information with regard to depreciation, which has not been provided for alongwith the quantum of arrears. According to us, once this information is disclosed in the notes to the account it would clearly fall within the ambit of the explanation to Section 115J of the Act which defines ?book profit? to mean ?net profit? as "shown" in the profit and loss account for the relevant assessment year".

 To our minds, as long as the depreciation which is not charged to profit and loss account but is otherwise disclosed in the notes of the accounts, it would come within the ambit of the expression "shown" in the profit and loss account, as notes to the account, form part of the profit and loss account by virtue of a sub-section (6) of Section 211 of the Companies Act, 1956. This is quite evident if the provisions of sub-section (6) of the Section 211 of the Companies Act, are read in conjunction with, sub-section (1A), as well as, the explanation to Section 115J of the Act.

 Another important aspect of the matter is that the expression used by legislature is "net profit" in contra distinction to the well known accounting term "cash profit". The net profit of a company cannot be determined till all items of income and expenses as recognized, as well as, depreciation are taken into account. Depreciation is nothing but loss of value of an asset arising from its use, efflux of time or obsolescence over a period of its useful life.

Depreciation, undoubtedly has a major impact in determination of the financial position of a company/enterprise.

To our minds the use of the expression "net profit" makes it clear that depreciation not debited to the profit and loss account will have to be taken into while determining "book profit" under Section 115J of the Act, as long as it forms part of the prescribed accounts." 

Operating profit to be considered:

From the above write-up, and earlier article and  observations of the Supreme Court, Madras high Court , Delhi High Court and Tribunal's orders etc.   it can be concluded that a separate profit & Loss Account has to  be prepared by a company to ascertain exact "operating profit" as required under Schedule VI to the Companies Act. In that Profit & Loss Account adjustments for various notes having impact on 'operating profit', can be made. Under the Companies Act the Profit & Loss Accounts are to be read with notes thereon, therefore, the amount of profit may be different if different accounting treatment has been given to special items as illustrated above. Whereas in the case of Profit & Loss Account for the purpose of MAT the exact operating profit or loss is required to be shown. Furthermore, it can be said that the adjustments specified in the provisions relating to MAT  will come into picture only after a separate Profit & loss account has been prepared as per part II to the Schedule VI to the Companies Act to compute "Operating Profit". Therefore, effect of notes is to be given in the computation for not only  book profit but also 'operating profit'. Any credits in the profit and loss account which are not in nature of 'operating income', also need to be reduced from profit to ascertain profit as required under part II of the Schedule VI. Therefore, a possible view is that capital gains,  grants and subsidies, windfall gains etc. which are not from operations of the company need not be credited in the profit and loss account. They can directly be taken to proper reserve account. In case such sums are credited in the profit and loss account,, they need to be reduced.

Therefore, while preparing separate  profit and loss account, for the purpose of S. 115J, 115JA or 115JB, as the case may be such adjustments can be made to ascertain what is book profit for imposition of MAT.  

This can also be said that the adjustments specified are mandatory but not exhaustive. This is because no where it has been specifically mentioned nor there are any words to imply that "only the specified adjustments are to be made."  The judgment in case of Appolo Tyres is also to be interpreted in that manner, because in that case the Supreme Court has held that first of all it is to be seen that profit and loss account is made as per requirement of Companys Act. The profit and loss account under that Act is to be read with notes on account, therefore, effect of such notes is to be given while preparing separate profit and loss account.

Authors views:

As expressed in earlier article the author is of considered view that notes on account has to be considered to ascertained 'net profit' for the purpose of MAT under sections 115J, 115JA and 115JB. Therefore, if any income is not credited in the profit and loss account, then the same need to be added and if any expenditure or necessary provision for expenses  are not debited to the profit and loss account then the same also need to be deducted from profit as shown in the profit and loss account. Therefore care should be taken to correctly quantify such amounts and to mention the same by way of notes. The judgment of Delhi High Court fully support these views expressed earlier and now re-iterated by the author.  The other usual matters of adjustments are as follows:

a.       Un provided  gratuity , leave encashment, bonus  liability.

b.      Ascertained but disputed statutorily  or contractual liabilities.

c.       Un provided bad debts.

d.      Incomes credited in the profit and loss account when accrual or realization is doubtful.

e.      Any income, receipt that is not of the nature of 'operating income' of the company need to be excluded if it is credited in the profit and loss account.