section 115JA -Book profit-profit on sale of fixed assets credited in P & L account not be excluded so held in GKW Ltd. Vs. CIT 2011 (7) TMI 86 - CALCUTTA HIGH COURT

[CA DEV KUMAR KOTHARI]

section 115JA -Book profit-profit on sale of fixed assets credited in P & L account not be excluded so held in GKW Ltd. Vs. CIT 2011 (7) TMI 86 - CALCUTTA HIGH COURT - some vital provisions and aspects about P & L account and provisions of the companies Act altogether missed by the assessee.

Facts of the case relevant to book profit are analyzed:

Profit and Loss account:

The previous year ended 31.03.1997 relevant to Assessment Year 1997-98 when section 115JA was applicable to impose (Minimum Alternate Tax by way of tax on book profit –MAT) At that time in the Companies Act, 1956 the old Schedule VI was applicable.

The assessee/ the appellant during the previous year ending on March 31, 1997 disposed off fixed asset. The excess of sale value over cost/ book value of such assets was shown as profit realised amounting to Rs. 6,02,91,024. The said amount was reflected in the appellant's profit and loss as forming part of the miscellaneous income.

Computation:

In the computation under section 115JA, the appellant claimed that the profit of Rs. 6,02,91,024 credited to the profit and loss account on account of disposal of fixed assets did not form part of the book profits for the purposes of the said section, though the same is included in miscellaneous income.

Contrary contentions:

It appears that the assessee had raised contrary contentions by including excess of sale value over cost or book value of assets as miscellaneous income. Whereas in case of sale of fixed assets held for very long period of time, such excess is not profit or gain of the financial year. This is because over a long period, which includes earlier financial years also, there is accumulation of capital by way of improvement in and increase in valuation of assets. Furthermore, disposal of assets (otherwise in course of normal operations of company), is not a part of operations or working of company for the financial year. Such excess represents realization of capital accumulated over last several years or decades. Such excess cannot properly be called result of working of the company.

However, the assessee himself has credited the said excess in Profit and Loss account and that too under head “miscellaneous income” and not even as “miscellaneous receipts”. Had the sum been credited as “miscellaneous receipts” contention that the receipt is capital receipt, and is not in nature of profit or loss could find better force.

Thus having credited the excess amount under head miscellaneous income and claiming the same not to be profit are contrary contentions raised. It appears that there was not even a note and qualification to the accounts to state that by inclusion of the said sum in miscellaneous receipt , the profit of company has been overstated since the amount does not represent ‘working of company”.

Claim disallowed at all stages:

The Assessing Officer in the order under section 143(3) of the Act, did not exclude the sum of Rs. 6,02,91,024 on account of profit on sale of fixed assets on the ground that the Department had preferred an appeal before this Hon'ble Court against the order dated 14-7-1999 of the Tribunal. The CIT(A) and Tribunal both confirmed the assessment order.

Against the decision of the Tribunal, the assessee preferred appeal before the High Court.

A Division Bench of the High Court at the time of admission of this appeal formulated the following substantial questions of law on issue of S. 115JA,for determination in the appeal:

(iii) Whether the Tribunal was justified in law in holding that the profit on sale of fixed assets amounting to Rs. 6,02,91,024 formed part of the book profit under section 115JA of the Income-tax Act, 1961?

The High Court observed that “as regards the point No. (iii) formulated by the Division Bench, in order to appreciate the said question, it would be profitable to refer to the provisions contained in section 115JA of the Act which is quoted below:

"115JA. Deemed income relating to certain companies.--(1) Notwithstanding anything contained in any other provisions of this Act, where in the case of an assessee, being a company, the total income, as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 1997 [but before the 1st day of April, 2001] (hereafter in this section referred to as the relevant previous year) is less than thirty per cent of its book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to thirty per cent of such book profit.

(2) Every assessee, being a company, shall, for the purposes of this section prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956):

Provided that xxxx

After reproducing the entire section and considering it, the High Court observed and held as follows:

1. A plain reading of the aforesaid provisions makes it abundantly clear that where in the case of an assessee, being a company, the total income, as computed under the Act in respect of any previous year relevant to the assessment year commencing on or after the 1-4-1997 but before the 1-4-2000 is less than thirty per cent of its book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to thirty per cent of such book profit.
2. and in such a case, such assessee shall prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956.
3. Under Clause 2 of Part II of Schedule VI to the Companies Act, where a company receives an amount on account of surrender of leasehold rights, it is bound to disclose in the profit and loss account the said amounts as non-recurring transaction or a transaction of an exceptional nature irrespective of its nature whether it is capital or revenue.
4. Even under Clause 2(b) of Part II of Schedule VI of the Companies Act, the profit and loss accounts shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transaction or transactions of an exceptional nature which includes profits on sale of fixed assets.

In view of the above provisions taken from Part II of Schedule VI the High Court held that                          

“Thus, it is absurd to suggest that the profit on sale of fixed assets amounting to Rs. 6,02,91,024 did not form part of the book profit under section 115JA of the Income-tax Act, 1961. We, therefore, find that the Tribunal below rightly decided the aforesaid point in favour of the revenue and we find no reason to interfere with the said finding.

An analsyis

From observations and ruling of the High Court:	Observations of author:
Under Clause 2 of Part II of Schedule VI to the Companies Act, where a company receives an amount on account of surrender of leasehold rights, it is bound to disclose in the profit and loss account the said amounts as non-recurring transaction or a transaction of an exceptional nature irrespective of its nature whether it is capital or revenue.	There seems no such provision in clause 2 of Part II of Schedule VI to the Companies Act, 1956 that company is bound to disclose in P & L account amount received on surrender of leasehold rights.
Even under Clause 2(b) of Part II of Schedule VI of the Companies Act, the profit and loss accounts shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transaction or transactions of an exceptional nature which includes profits on sale of fixed assets.	There seems some confusion. In the P & L account non-recurring and exceptional transactions will find only to the extent they relate to working of company and not other transactions which are on capital account.

With due respect, the author feels that in respect of both matters as discussed in above table, the matter was not properly argued hence the observations of honorable High Court seems contrary to the provisions (please see detailed discussion in later part of the article) and also basic underlying aspect of preparing a profit and loss account. The basic purpose of preparing a profit and loss account for a given period (financial year) is to show net results of working of the company. Items of exceptional nature or non recurring nature referred to in the clause related to working of company and not those items which have no relation to working of company.

Contentions raised and facts found by Tribunal not available:

Unfortunately from reading of the reported judgment we are unable to find arguments advanced by assessee before the AO, the CIT(A), and Tribunal. The facts found and conclusion drawn by the Tribunal is also not available.

It is also not clear as to why the Tribunal has apparently taken a different view than the view taken by coordinate bench vide order dated 14-7-1999 against which appeal of department was pending, as noted by the learned AO in his order u/s 143(3) as summarized in the judgment.

It is also not clear as to what was decision of the High Court against the said order dated 14.07.1999.

Certain vital points not argued and considered:

Basic nature of final accounts:

The basic nature of the final accounts of a company is that the Balance sheet is the main document. Balance sheet must show true state of affairs of the company as on the date of balance sheet. The profit and Loss account is annexed to the Balance Sheet. P & L account should show profit or loss for the accounting period.

The nomenclature “ Profit and Loss Account” it self suggest that the statement under that heading represents profit and loss of the company. It is not supposed to include within its ambit any capital receipt or capital payment.

It appears that certain vital points were not at all raised, argued or considered. Though the provisions of Income-tax Act have been reproduced and analyzed in the judgment. It seems that attention of the court was not drawn to the relevant provisions relating to Profit and Loss account as applicable at relevant time. Provisions so far considered relevant are reproduced, analyzed and summarized below:

From the Companies Act,1956:

Annual accounts and balance sheet.

From section 210. (1) At every annual general meeting of a company held in pursuance of section 166, the Board of directors of the company shall lay before the company^___

     (a) a balance sheet as at the end of the period specified in sub-section (3); and

     (b) a profit and loss account for that period.

(4) The period to which the account aforesaid relates is referred to in this Act as a "financial year" and it may be less or more than a calendar year, but it shall not exceed fifteen months:

Form and contents of balance sheet and profit and loss account.

211. ^[1][(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 xxx

(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 requirements of Part II of Schedule VI, so far as they are applicable thereto:

^[5][(3A) Every profit and loss account and balance sheet of the company shall comply with the accounting standards.

(3B) Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely:^___

     (a) the deviation from the accounting standards;

     (b) the reasons for such deviation; and

     (c) the financial effect, if any, arising due to such deviation.

(5) The balance sheet and the profit and loss account of a company shall not be treated as not disclosing a true and fair view of the state of affaris of the company, merely by reason of the fact that they do not disclose

     (v) in the case of any company, any matters which are not required to be disclosed by virtue of the provisions contained in Schedule VI or by virtue of a notification issued under sub-section (3) or an order issued under sub-section (4).

(6) For the purposes 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.

 Profit and loss account to be annexed and auditors' report to be attached to balance sheet.

216. The profit and loss account shall be annexed to the balance sheet and the auditors' report ^[1][(including the auditors' separate, special or supplementary report, if any)] shall be attached thereto.

PART II

Requirements as to Profit and Loss Account

1. The provisions of this Part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a profit and loss account, but subject to the modification of references as specified in that sub-section.

2. The profit and loss account—

     (a) shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account ; and

     (b) shall disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature.

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) ^[53][(a) The turnover, that is, the aggregate amount for which sales are effected by the company, giving the amount of sales in respect of each class of goods dealt with by the company, and indicating the quantities of such sales for each class separately.]

     ^[54][(b) Commission paid to sole selling agents within the meaning of section 294 of the Act.

     (c) Commission paid to other selling agents.

     (d) Brokerage and discount on sales, other than the usual trade discount.

     ^[55][(ii) (a) In the case of manufacturing companies,—

(1) The value of the raw materials consumed, giving item-wise break-up and indicating the quantities thereof. In this break- up, as far as possible, all important basic raw materials shall be shown as separate items. The intermediates or components procured from other manufacturers may, if their list is too large to be included in the break-up, be grouped under suitable headings without mentioning the quantities, provided all those items which in value individually account for 10 per-cent or more of the total value of the raw material consumed shall be shown as separate and distinct items with quantities thereof in the break-up.

(2) The opening and closing stocks of goods produced, giving break-up in respect of each class of goods and indicating the quantities thereof.

     (b) In the case of trading companies, the purchases made and the opening and closing stocks, giving break-up in respect of each class of goods traded in by the company and indicating the quantities thereof.

     (c) In the case of companies rendering or supplying services, the gross income derived from services rendered or supplied.

     (d) In the case of a company, which falls under more than one of the categories mentioned in (a), (b) and (c) above, it shall be sufficient compliance with the requirements herein if the total amounts are shown in respect of the opening and closing stocks, purchases, sales and consumption of raw material with value and quantitative break-up and the gross income from services rendered is shown.

     (e) In the case of other companies, the gross income derived under different heads.

Note 1.—The quantities of raw materials purchases, stocks, and the turnover shall be expressed in quantitative denominations in which these are normally purchased or sold in the market.

Note 2.—For the purpose of items (ii)(a), (ii)(b) and (ii)(d), the items for which the company is holding separate industrial licences, shall be treated as separate classes of goods, but where a company has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class. In the case of trading companies, the imported items shall be classified in accordance with the classification adopted by the Chief Controller of Imports and Exports in granting the import licences.

Note 3.—In giving the break-up of purchases, stocks and turnover, items like spare parts and accessories, the list of which is too large to be included in the break-up, may be grouped under suitable headings without quantities, provided all those items, which in value individually account for 10 per-cent or more of the total value of the purchases, stocks, or turnover, as the case may be, are shown as separate and distinct items with quantities thereof in the break-up.]

     (iii) In the case of all concerns having works-in-progress, the amounts for which ^[56][such works have been completed] at the commencement and at the end of the accounting period.

     (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 ^[57][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.]

     (v) The amount of interest on the company's debentures and other fixed loans, that is to say, loans for fixed periods, stating separately the amount of interest, if any, ^[58][paid or payable] to the managing director ^[59][* * *] and the manager, if any.

     (vi) The amount of charge for Indian income-tax and other Indian taxation on profits, including, where practicable, with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where practicable, between income-tax and other taxation.

     (vii) The ^[60][amounts reserved for—]

          (a) repayment of share capital; and

          (b) repayment of loans.

     (viii) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside, to reserves, but not including provisions made to meet any specific liability, contingency or commitment known to exist at the date as at which the balance-sheet is made up.

     (b) The aggregate, if material, of any amounts withdrawn from such reserves.

     (ix) (a) The aggregate, if material, of the amounts to set aside to provisions made for meeting specific liabilities, contingencies or commitments.

     (b) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.

     (x) Expenditure incurred on each of the following items, separately for each item:—

          (a) Consumption of stores and spare parts.

          (b) Power and fuel.

          (c) Rent.

          (d) Repairs to buildings.

          (e) Repairs to machinery.

          (f) (1) Salaries, wages and bonus.

(2) Contribution to provident and other funds.

(3) Workmen and staff welfare expenses ^[61][to the extent not adjusted from any previous provision or reserve.

Note ^[62][1].—Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account.]

Note 2.—^[63][* * *]

     (g) Insurance.

     (h) Rates and taxes, excluding taxes on income.

     (i) Miscellaneous expenses:

^[64][Provided that any item under which the expenses exceed one per cent of the total revenue of the company or Rs. 5,000 whichever is higher shall be shown as a separate and distinct item against an appropriate account head in the Profit and Loss Account and shall not be combined with any other item to be shown Under 'Miscellaneous expenses'.]

     (xi) (a) The amount of income from investments, distinguishing between trade investments and other investments.

     (b) Other income by way of interest, specifying the nature of the income.

     (c) The amount of income-tax deducted if the gross income is stated under sub-paragraphs (a) and (b) above.

     (xii) (a) Profits or losses on investments showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm to the extent not adjusted from any previous provision or reserve.

Note.—Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account.

     (b) Profits or losses in respect of transactions of a kind, not usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature, if material in amount.

     (c) Miscellaneous income.

     (xiii) (a) Dividends from subsidiary companies.

     (b) Provisions for losses of subsidiary companies.

     (xiv) The aggregate amount of the dividends paid, and proposed, and stating whether such amounts are subject to deduction of income-tax or not.

     (xv) Amount, if material, by which any items shown in the profit and loss account are affected by any change in the basis of accounting.

^[67][4. The profit and loss account shall also contain or give by way of a note detailed information, showing separately the following payments provided or made during the financial year to the directors (including managing directors), ^[68][* * *] or manager, if any, by the company, the subsidiaries of the company and any other person:—

     (i) managerial remuneration under section 198 of the Act paid or payable during the financial year to the directors (including managing directors), ^[69][* * *] manager, if any;

    (vi) other allowances and commission including guarantee commission (details to be given)];

     (vii) any other perquisites or benefits in cash or in kind (stating approximate money value where practicable);

     (viii) pensions, etc.,—

          (a) pensions,

          (b) gratuities,

          (c) payments from provident funds, in excess of own subscriptions and interest thereon,

          (d) compensation for loss of office,

          (e) consideration in connection with retirement from office.]

4A. The profit and loss account shall contain or give by way of a note a statement showing the computation of net profits in accordance with section 349 of the Act with relevant details of the calculation of the commissions payable by way of percentage of such profits to the directors (including managing directors), ^[75][* * *] or manager (if any).

4B. The profit and loss account shall further contain or give by way of a note detailed information in regard to amounts paid to the auditor, ^[76][whether as fees, expenses or otherwise for services rendered—]

     (a) as auditor; ^[77][* * *]

     ^[78][(b) as adviser, or in any other capacity, in respect of—

          (i) taxation matters;

          (ii) company law matters;

          (iii) management services; and

     (c) in any other manner].]

^[79][4C. In the case of manufacturing companies, the profit and loss account shall also contain, by way of a note in respect of each class of goods manufactured, detailed quantitative information in regard to the following, namely:—

     (a) the licensed capacity (where licence is in force);

     (b) the installed capacity; and

     (c) the actual production.

Note1.—The licensed capacity and installed capacity of the company as on the last date of the year to which the profit and loss account relates, shall be mentioned against items (a) and (b) above, respectively.

Note 2.—Against item (c), the actual production in respect of the finished products meant for sale shall be mentioned. In cases where semi-processed products are also sold by the company, separate details thereof shall be given.

Note 3.—For the purposes of this paragraph, the items for which the company is holding separate industrial licences shall be treated as separate classes of goods but where a company has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class.

4D. The profit and loss account shall also contain by way of a note the following information, namely:—

     (a) value of imports calculated on C.I.F. basis by the company during the financial year in respect of:—

          (i) raw materials;

          (ii) components and spare parts;

          (iii) capital goods;

     (b) expenditure in foreign currency during the financial year on account of royalty, know-how, professional, consultation fees, interest, and other matters;

     (c) value of all imported raw materials, spare parts and components consumed during the financial year and the value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption;

     (d) the amount remitted during the year in foreign currencies on account of dividends, with a specific mention of the number of non-resident share-holders, the number of shares held by them on which the dividends were due and the year to which the dividends related;

     (e) earnings in foreign exchange classified under the following heads, namely:—

          (i) export of goods calculated on F.O.B. basis;

          (ii) royalty, know-how, professional and consultation fees;

          (iii) interest and dividend;

          (iv) other income, indicating the nature thereof.]

5. The Central Government may direct that a company shall not be obliged to show the amount set aside to provisions other than those relating to depreciation, renewal or diminution in value of assets, if the Central Government is satisfied that the information should not be disclosed in the public interest and would prejudice the company, but subject to the condition that in any heading stating an amount arrived at after taking into account the amount set aside as such, the provision shall be so framed or marked as to indicate that fact.

6. (1) Except in the case of the first profit and loss account laid before the company after the commencement of the Act, the corresponding amounts for the immediately preceding financial year for all items shown in the profit and loss account shall also be given in the profit and loss account.

(2) The requirement in sub-clause (1) shall, in the case of companies preparing quarterly or half-yearly accounts, relate to the profit and loss account for the period which entered on the corresponding date of the previous year.

                                                     *****************

A reading of the above provisions clearly shows that the profit and loss account for any financial year should:

    be so made out as clearly to disclose the result of the working of the company during the period covered by the account ; and

     shall disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature.

The first aspects that is “result of the working of the company” is the foremost basic aspects of Profit and Loss Account. The second aspect about disclosure of material features is also related with ‘working of company’ and only “non-recurring transactions or transactions of an exceptional nature” are to be reported and disclosed however, they must relate to the working of company and should be in nature of profit or gain.

Capital receipts, capital profits, and capital payments, capital expenses and even capital losses should not be part of profit and loss account. Particularly when they are not arising from working of company.

If transactions on capital account are included in the profit and loss account, then result of working of company for the financial year will not be properly reflected. Therefore, transactions having no relation with the working of company should not find place in the Profit and Loss account.  

Transactions on capital account need to be adjusted in balance sheet by way of additions or deductions under proper head, so as to show true and fair view of the state of affairs.

Other instructions for P & L Account:

From reading of other provisions containing instructions for P & L account also we find that these instructions relates to presentations, grouping, information, inclusion and exclusion of items under proper heads etc. in relation to items which have direct relation with working of the company during the financial year. Therefore, with due respect author feels that some observation of the honorable court that there is no difference between capital and revenue is apparently wrong and goes to basic principal underlying preparation of a profit and loss account.  

It is also worth to note that for computation of profit under section 349 for determination of profit for managerial remuneration, profit on sale of fixed assets, if credited in P & L account, is to be excluded from amount of profit shown in the P & L account.

No discussion about the above provisions:

We find that in the reported judgment there is no discussion at all about the above provisions and perhaps the authorities and courts were unduly influenced by the fact that the assessee himself has treated the excess of sale value over cost/ book value of assets disposed off as an item of profit and credited in the miscellaneous receipts.  

New / revised Schedule VI:

In another article author will discuss provisions of the revised Schedule VI. Author find that as per revised form of P & L account also only items related with working of the company properly find place in various entries of the P & L account. Items which have no relation with working of company and those which are on capital account cannot properly find place in P & L account. Items of receipts or payments which are on capital account or which have no relation with working of company should most preferably and properly find place directly in the balance sheet to show true state of affairs.