MAT . S. 115JA and 115JB – full Deferred Revenue Expenditure (DRE) is to be debited claimed in profit and loss account to be prepared even if in P & L account for shareholders a part is debited – window dressing to be eliminated for MAT

[CA DEV KUMAR KOTHARI]

Relevant links and references:

Section 115JA and 115JB of the Income-tax Act, 1961.

COMMISSIONER OF INCOME TAX AND ANR. Versus M/s. KARNATAKA SOAPSAND DETERGENTS LTD. 2016 (1) TMI 321 - SUPREME COURT OF INDIA

The Commissioner of Income Tax And Others Versus M/s. Karnataka Soaps And Detergents Ltd. 2015 (1) TMI 1023 - KARNATAKA HIGH COURT

In the case of Karnataka Soaps And Detergents Ltd. (supra) the following assessment years and provisions were involved: (

in ITA Nos. 257/2007 AY  1999-2000 S.115JA was in force.

in ITA no 266/2007 AY 2000- 2001     S.115JA was in force.

in ITA No. 63/2011  AY 2006-2007 – S.115JB was in force.

This is found on reading of judgment of High Court and relevant provisions applicable in different years, because in judgment for all three years S.115JA has been mentioned, whereas from AY 2001-02 S. 115JB was inserted.

Decision of the Supreme Court:

On behalf of revenue, the petitioners the following four counsels appeared;

1. Mr. P. S. Patwalia, ASG.,
2.  Mr. S. Wasim A. Qadri, Adv.,
3. Mr. Arijit Prasad, Adv.,
4. Mrs. Anil Katiyar, Adv.

There was petition for condonation of delay also.

Though it has not been mentioned in the order, the counsels of revenue argued the case and  were heard on COD petition and the SLP. The supreme court passed the following order:

1. Delay condoned.
2. The special leave petitions are dismissed.

Therefore we need to look into the judgment of the High Court and Tribunal. The judgment of Tribunal could not be found on websites including this website and website of ITAT and some other websites. Therefore, discussions and analysis is being made based on information available in the judgment of High Court.

Facts and issue involved (about MAT):

Assessee has prepared separate P & L account for presenting in AGM before shareholders, in which certain expenses were  not fully charged and a par was treated as Deferred Expenditure (DRE) and were written off in more than one years. Therefore, though expenditure were actually incurred but not fully charged in P & L account presented to shareholders ( this is considered as window dressing to satisfy shareholders). The purpose of full amount being charged was not to reduce tax but to show higher profit to shareholders, though such higher profit was not actually earned.

For the purpose of MAT entire amount of such expenditure was debited in  P & L account prepared for the purpose as required u/s 115JA and 115JB. So the book profit for the purpose of S. 115JA and 115JB was reduced. This was not allowed by the AO, but was allowed by Tribunal and High Court.

The High Court held that assessee was entitled to make such claim because DRE is expenditure of the year in which incurred, and spreading it over many years is window dressing to satisfy shareholders.

As per Tribunal and  High Court, this shows that company has shown profit, but in fact company has not earned profit (or less profit has been earned) on which only tax can be imposed. The AO should not be influenced by such window dressing, because tax can only be imposed on profit, even if for some purposes expenses actually incurred have not been debited in P & L account presented to shareholders.

Questions of law considered by honourable High Court:

As per paragraph 9 of the judgment of the Karnataka High Court we find that  while admitting the appeals , the Court had framed the following substantial questions of law, relating to MAT in  three appeals:

"1. Whether the Tribunal was correct in upholding the case of the assessee that deferred revenue expenditure towards (advertisement, publicity, distribution and sales promotion) debited to the P & L account and carried to the Balance Sheet and approved by the assessee's Board as per the Companies Act when maintaining regular books of accounts could be modified and other years expenditure can be claimed during the current assessment year itself when computing Book profits u/s.115JB of the Act contrary to judgment of Apex Court in Apollo Tyres and Malayalam Manorama?

2.  about S. 80HHC -not relevant

3. Whether the finding of the Tribunal that the assessee is entitled to prepare profit and loss account for the purposes of Sec.115JA by claiming the entire expenditure as revenue expenditure while in the published accounts it was claimed only partly, is perverse, arbitary and contrary to law?

4. Whether the Tribunal was correct in upholding the case of the assessee that deferred revenue expenditure (exgratia payment spread over 2 years) debited to the P & L account and carried to the Balance Sheet and approved by the assessee's Board as per the Companies Act when maintaining regular books of accounts could be modified and both the years expenditure claimed during claimed during the current assessment year itself when computing Book profits u/s.115JB of the Act contrary to judgment of Apex Court in Apollo Tyres and Malayalam Manorama?"

Observations and order of High Court:

As seen above in questions as well as during arguments, revenue relied on judgments of the Supreme court, about  adjustments in P & L account and about separate P & L a/c for purpose of MAT.

1. About earlier judgments of the Supreme Court:

1. The Apex Court in the case of APOLLO TYRES LTD.-vs- COMMISSIONER OF INCOME TAX reported in 2002 (5) TMI 5 - SUPREME Court dealing with the object of introducing Section 115J in the Income Tax Act held that Section 115J makes the income reflected in the companies books of account as the deemed income for the purpose of assessing the tax. The words 'in accordance with the provisions of Part-II of Schedule VI to the Act' was made for the limited purpose of empowering the Assessing Authority to rely upon the authentic statement of accounts of the company.
2. While so looking into the accounts of the company, an Assessing Officer under the Income-Tax Act has to accept the authenticity of the accounts with reference to the provisions of the Companies Act which obligates the company to maintain its account in a manner provided by the Companies Act and the same to be scrutinized and certified by the statutory auditors and will have to be approved by the company in its general meeting and thereafter, to be filed before the Registrar of Companies, who has a statutory obligation also to examine and satisfy that the accounts of the company are maintained in accordance with the requirements of the Companies Act.
3. In spite of all these procedures contemplated under the provisions of the Companies Act, they found it difficult to accept the argument of the Revenue that it is still open to the Assessing Officer to re-scrutinise this account and satisfy himself that these accounts have been maintained in accordance with the provision of the Companies Act.
4. Sub-Section (1A) of Section 115J does not empower the authority under the Income Tax Act to probe into the accounts accepted by the authorities under the Companies Act. If the statute mandates that income prepared in accordance with the Companies Act shall be deemed income for the purpose of Section 115J of the Act, then it should be that income which is acceptable to the authorities under the Companies Act.
5.  There cannot be two incomes, one for the purpose of Companies Act and another for the purpose of Income Tax both maintained under the same Act. If the legislature intended the Assessing Officer to reassess the Company's income, then it would have stated in Section 115J that "income of the Company as accepted by the Assessing Officer". In the absence of the same and on the language of Section 115J, it will have to be held that view taken by the Tribunal is correct and the High Court has erred in reversing the said view of the Tribunal.
6. The Assessing Officer while computing the income under Section 115J has only the power of examining whether the books of account are certified by the authorities under the Companies Act as having been properly maintained in accordance with the Companies Act. The Assessing Officer thereafter has the limited power of making increases and reductions as provided for in the Explanation to the said Section. To put it differently, the Assessing Officer does not have the jurisdiction to go behind the net profit shown in the profit and loss account except to the extent provided in the Explanation to Section 115J of the Act.
7.   In coming to the said conclusion, they relied on the Budget Speech of the then Hon'ble Finance Minister of India made in the Parliament while introducing Section 115J of the Act which is as follows:

                   "It is only fair and proper that the prosperous should pay at least some tax. The phenomenon of so-called "zerotax" highly profitable companies deserves attention. In 1983, a new s. 80VVA was inserted in the Act so that all profitable companies pay some tax. This does not seem to have held and is being withdrawn. I now propose to introduce a provision whereby every company will have to pay a 'minimum corporate tax' on the profits declared by it in its own accounts. Under this new provision, a company will pay tax on at least 30 per cent of its book profit. In other words, a domestic widely-held company will pay tax of at least 15 per cent of its book profit. This measure will yield a revenue gain of approximately ₹ 75 crores."

8.   From the aforesaid speech of the Hon'ble Finance Minister of India, it is clear that the IT authorities were unable to bring certain companies within the net income tax because these companies were adjusting their accounts in such a manner as to attract no tax or very little tax. It is with a view to bring such of these companies within the tax net that Section 115J, was introduced in the Act with a deeming provision which makes the company liable to pay tax or at least 30% of its book profits as shown in its own account. Therefore, the object of this Section is to prevent the mischief. Therefore while applying the Section what is to be borne in mind is whether the assessee is trying to avoid payment of tax by any manipulative process by adjustment of accounts.
9.  Sub-Section (2) of Section 115J(1A) makes it clear that every assessee, being a company shall for the purpose of this Section, prepare its profit and loss account for the relevant previous year in accordance with the provision of Parts II and III of Schedule-VI of the Companies Act, 1956. Thereafter, the same shall be placed before the Company at its Annual General Meeting in accordance with the provisions of Section 210 of the Companies Act. When once it is adopted, it attains finality. Therefore, the explanation provides for the purpose of Section 115JA, 'book profit' means the net profit as shown in the P & L account for the relevant previous year prepared under Sub-Section (2).
10. Part-I of Schedule-VI of the Companies Act, 1956 deals with the Form of Balance Sheet. Part-II of Schedule-VI deals with the Requirements as to Profit and Loss Account. Clause (2) of Part-II of Schedule- VI which deals with the Profit and Loss Account reads as under:

              "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 exception nature".

Part-III of Schedule-VI deals with the Interpretation. Therefore, Part-II of Schedule-VI of the Companies Act specifically provides for preparation of profit and loss account disclosing the expenses in respect of non-recurring transactions or transactions of an exceptional nature.

Analysis of facts:

1. it is not in dispute that the assessee has incurred the expenses as stated above for the years 1999-2000, 2000-01 and 2006-07.
2. The net profit could be determined only after deducting the aforesaid amount.
3. The assessee is seeking for deduction of the said amount which has actually incurred.
4. However, in the P & L account which is printed for the purpose of showing it to the shareholders in order to show that they have earned some profits, they do not want to deduct the entire amount. They want to defer these expenses for the subsequent years in which they intend to earn profits because of the expenditure in those years.
5. Therefore, the figure of profits shown in the printed balance sheet is more than the profit earned by the assessee/company in terms of the books of accounts maintained according to Part-II and Part-III of Schedule VI of the Companies Act.
6.   The argument is even though they have incurred the entire expenditure as in the printed P & L account, the same is not shown and a portion of it is shown as deferred expenditure. That portion as deferred expenditure cannot be deducted. There cannot be two balance sheets - one for the purpose of income tax and another for the purpose of showing it to the share holders under the Income Tax Act and therefore, it was contended that the order passed by the Tribunal is incorrect.

On section 115JA:

1. It  is clear from Section 115JA of the Act, that it deals with the 'deemed income'.
2. In other words it is not the actual income earned by the assessee. The object behind it is to prevent the assessee from adjusting the accounts or manipulating the accounts so as to avoid payment of tax on the ground that they have not earned any profit at all.
3. Therefore, the said provision was introduced insisting of preparation of profit and loss account for the relevant previous year in accordance with the provisions of Part-II and III of Schedule-VI to the Companies Act, 1956.
4.  Once such an account is prepared and certified by the auditors, the same becomes the basis for levying tax on book profit.
5. When once the assessee has incurred an expenditure and it is deducted in terms of Part-II of Schedule-VI of the Companies Act and the profit is arrived at, merely because in the printed P & L account for the purpose of showing to the shareholders that a profit is made by the Company, the entire expenditure is not deducted and a portion of it is shown as a deferred expenditure, the assessee cannot be denied the benefit of actual expenditure incurred.
6. The assessee is not showing the actual expenditure incurred to avoid payment of tax. On the contrary when the actual expenditure is given deduction to, the profit margin gets reduced. It is by showing it to the P & L account, a portion of it as a deferred payment, artificially the profit has gone up. The object of Section 115JA being to avoid adjustment of account, manipulation of figures to avoid payment of tax. When the assessee has actually incurred expenditure and the tax liability is less when compared with the net profit arrived at after giving deduction to the actual expenditure, the tax payable is on that net profit and not on the fancy figure shown in the P & L account for the purpose of showing profit to the shareholders.
7.  In other words, to find out what is net profit one has to look into the books of accounts maintained by the company and the profit and loss account prepared on the basis of such book of accounts.
8. What is shown in the printed balance sheet is for the benefit of the shareholders as it will not reflect the true state of affairs and that cannot be made the basis for levying tax under the Act.
9. This is precisely what the Tribunal has held.
10. Neither under the Companies Act nor under the Income Tax Act, this concept of deferred expenditure is recognized. That is a pathology used by the chartered accountants to show to the shareholders that the company has made profit though it has not earned profits. In other words it is nothing but a window dressing and the authority should not be mislead or guided by this balance sheet which is prepared to satisfy the shareholders.
11. It is the P & L account prepared on the basis of the books of accounts as contemplated in Part-II of Schedule VI which should form and assist to find out what is the profit earned and on that profit, tax is levied.

Final order of High Court on questions:

17. In that view of the matter, the order passed by the Tribunal cannot be found fault with. It is in accordance with law. Hence, the substantial questions of law are answered in favour of the assessee and against the revenue.

Observations of author:

S.115J, 115JA and 115JB all are special  provisions to deem certain part of profit as income or to impose some tax on profit. In all three sections there is provision that for the purpose of the section P & L a/c shall be prepared as per part II of Schedule VI to the Companies Act.

Accordingly, author has advised his clients to prepare P & L account to show only revenue and actual profits. This was necessary to exclude certain capital receipts included in income in P & L, or some expense not fully charged in P & L a/c for share- holders. The view of author is that merely because different accounting treatments are made by companies in P & L a/c for shareholders, should really not affect tax liability under normal computation as well as in computation for the purpose of MAT. This was accepted in many cases and the legal position was well settled long ago.

Another aspect is that tax levied as MAT is really not a final tax, it is a provisional collection which may be refunded by way of adjustment against normal tax liability in excess of MAT liability in future (now up to ten years are permitted).

Therefore, what author had suggested long ago, has been now declared as law about MAT when the Supreme Court dismissed appeal of revenue against judgment of High Court.

The principal laid down in the judgment shall also be applicable in relation to other expenses which are spread over more than one year, in P & l a/c prepared for shareholders. For example: VRS expenses, Technical know-how expenses, brand building expenses, Scientific research expense, recruitment expenses, insurance expenses for more than one year paid at one time etc.

Let us hope that this will be accepted by revenue, and the finance Minister will, respecting Courts, will not try to bring in an amendment to nullify the ruling.

Whether MAT is tax on income within meaning under the Constitution:

In articles webhosted on this website, author had expressed that profit as per P & L a/c cannot be regarded as income for the purposes of the Constitution of India (COI). Because the COI contemplates tax on income means real income actually earned by assessee during one previous year (or it may be over a period of more than one year , due to certain allowances and deductions).

When there is no real income, there should not be deemed income due to adjustments in account for the purpose of tax on income. Over a period of time ,the taxable income should not be dependent on accounting treatment, but it should be real income over a period of time. 

It is admitted principal that there can be profit as per P & L ac/ but that does not mean that there is income. If there is no income, then how tax can be imposed on book profit? Readers may refer to articles about unconstitutional provisions.