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TMI Blog2007 (4) TMI 374X X X X Extracts X X X X X X X X Extracts X X X X ..... ernment under section 642(1) of the Companies Act, 1956 ( the Act ), are ultra vires the statute, viz., sections 209(1)/(3) and 211 of the Act and consequently, void, inoperative and in excess of the statutory provisions of the Act or the Constitution of India. 3. Dr. Pal, the learned senior advocate appearing on behalf of the Simplex Concrete Piles (India) Ltd. and others, the writ petitioners in WP No. 1459 of 2002, advanced the main argument on behalf of all the writ petitioners and those were supplemented by Mr. Arvind Datar and Mr. V. Ramchandran, Mr. J.P. Khaitan, the learned senior counsel for the other writ petitioners. 4. Dr. Pal, at the very outset, points out that paragraph 9 of AS-22 lays down that the tax expense for the period comprising the current tax and deferred tax should be included in the determination of the net profit or loss for the period concerned, i.e., the relevant financial year. He then refers to the definition of the deferred tax as provided in paragraph 4 to mean the tax effect of the timing differences. Deferred tax-liability due to timing differences can arise, according to Dr. Pal, if at all, only in the future years in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements shall be prepared in conformity with such law. 7. It is also relevant to note that prescribed Rules have incorporated the AS-22. Therefore, the Accounting Standards as prescribed by the Rules are to be considered for the purpose of the present application. 8. On an analysis of the aforesaid provisions of the Act and the prescribed Rules, Dr. Pal refers to the following features, which according to him, are relevant for consideration : ( a )Section 209(1) obliges the company to keep at its registered office the proper books of account with respect to all sums of money received and expended by the company and the matters relating thereto. ( b )Under section 209(3), the proper books of account shall not be deemed to be kept with respect to the matters specified in sub-section (1) of section 209, if such books are not kept as are necessary to give the true and fair view of the state of affairs of the company or branch office, as the case may be, and at the same time, such books are required to be kept on accrual basis and according to the double entry ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... its that it will appear, therefore, that what is charged to tax is the amount which is liable to be taxed by way of income-tax for that financial year and any amount which is not charged to income-tax for that financial year cannot be debited to the profit and loss account in determining the true and fair profits or losses of that financial year. If any amount, which is not so charged to income-tax for that financial year, is included in the profit and loss account, Dr. Pal submits, it will not present or reflect a true and fair view of the state of affairs and also of the profits and losses for that financial year of the company. 14. By giving example of the timing difference which has been defined in clause 4/6 of the Accounting Standard as prescribed by the Rules, Dr. Pal contends that such timing differences has been defined to mean the differences between the taxable income and accounting income for a period that originates in one period and are capable of reversal in one or more subsequent periods. Timing differences, according to clause 4.7 of the said Standards, arise because the period, in which some items of revenue and expenses are included in the taxable income, do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ble income and accounting income in subsequent future years and such differences are required to be charged to the profit and loss account of the year according to para 9 of the AS-22 in which the machinery has been acquired. 15. Dr. Pal in this connection produced a chart showing such differences for a proper appreciation of the correct situation and submits that it will, therefore, appear that the liability arising in the future years as a result of the timing differences is not a liability which has accrued. Such liability in the future years, according to Dr. Pal, may or may not arise depending upon the subsequent events but the liability arising out of timing differences cannot be said to have accrued during the financial year when the plant and machinery had been acquired and the depreciation of such plant and machinery has been provided for according to Income-tax Act. By way of example. Dr. Pal points out that the machinery which has been purchased in the relevant year may be destroyed or lost or the machinery in the subsequent year, say in the third or fourth or fifth year, may be sold away. In such a case, according to Dr. Pal, the timing differences between the taxab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd upon factors like the working of the company and the state of the law. He submits that it is wholly arbitrary and unreasonable to require the company to make tax accounting with reference to the difference between the income assessable under the Income-tax Act and the income as reflected in the accounts on the assumption that such difference would give rise to a liability in a future year. On the face of it, Mr. Khaitan continues, such an approach is contrary to the accrual basis of accounting. He submits that any amount on account of income-tax for which there is no liability under the Income-tax Act cannot be considered as tax expense for the period of account. In other words, he contends that the AS-22 is inconsistent with and contrary to the accounting standards notified by the Central Government under section 145(2) of the Income-tax Act and is, therefore, wholly imaginary, unrealistic and unworkable and thereafter, ultra vires the provisions of the Act and the Income-tax Act as well as the Constitution of India. He further submits that the AS-22 would not result in present-ation of the true and fair view, but in fact, will bring about a distorted picture by which healt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reviously prevailing that the account should disclose only the arithmetical accuracy. All that could be inferred is that the annual financial statement should not only be made out correctly, but they should convey an overall view and would not give any misleading impression. Adherence to the disclosure of the requirements as per Schedule VI is subservient to the overriding requirement of true and fair view as regards the state of affairs. The observance to the disclosure requirements under Schedule VI, as laid down, are the minimum requirement. Thus, is apparent from section 211, which stipulates that the balance sheet shall be in such form or as near thereto as the circumstances admit and clause (3) of Part II of the Schedule VI also stipulates that the profit and loss account shall in particular disclose the information specified therein. The use of these expressions shows that the writings may be included in the accounts, if their inclusion is necessary to present a true and fair view. The basic objective is to ensure that the financial statements disclosed are not only a true but also a fair view of the state of affairs and the working results of the company and that they do no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccounting Standards are prescribed by the Central Government under section 211(3C). Clause 50 of the Listing Agreement clearly provides that every listed company will mandatorily comply with all the Accounting Standards issued by the Institute of Chartered Accountants of India from time to time and clause 41 of the listing agreement further provides that every listed company would comply with the Accounting Standards on accounting for taxes on income in respect of the quarterly unaudited financial result with effect from the quarter ending on or after 30-9-2001. Before the introduction of sub-sections (3A), (3B), and (3C) in section 211 of the Act, the Accounting Standards issued by the Institute of Chartered Accountants of India were not mandatory qua the corporate management. At that time, the management of the companies was free to adopt such accounting practice while preparing the annual financial statement, as they deemed expedient. However, the Institute had laid down that it was the duty of the statutory auditors to qualify their audit report furnished by them under section 227 of the Act, if there was deviation from the Accounting Standards. After the enactment of the Rul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the year in which a higher tax is payable because of lower charge of tax depreciation, it may not have funds. Deferred tax accounting, therefore, ensures that profits are mea- sured in a real and the actual manner. It also ensures that the advantage obtained in one year, which would be reversed a subsequent year, it duly recognised as a liability. 20. By making the aforesaid submissions, the learned counsel appearing on behalf of the Institute concluded by pointing out that the Institute was established by the Act of the Parliament in order to regulate the profession of accounting and by formulating Accounting Standard, the Institute has done nothing more than to fulfil its statutory obligation in furthering the legislative interest of the Parliament which requires that the account should be true and fair. The long and short of their submission is that the Parliament required that the accounts of the companies should be true and fair but it has not defined what is true and fair and in such circumstances, the Parliament has assigned the task of certifying the truth and fairness to the auditor of the companies who by law are the chartered accountants. The Parliament has also es ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tive competence of the Central Government or the authority of the Institute in guiding the Central Government in the matter. 25. We are, therefore, called upon to decide whether the Rules framed by the Central Government after adopting the suggestion given by the Institute through the AS-22 are inconsistent with any of the provisions of the Act or any of the provisions of the Constitution of India. 26. Before we proceed to answer the question, we must bear in mind the limitation of a writ court in the matter of interfering with the matters concerning accounting policies or practices as laid down by the expert body like the Institute. The fact that the Institute is an expert recognised under the law is without any doubt. As laid down by the Supreme Court in the case of Peerless General Finance Investment Co. Ltd. v. RBI [1992] 2 SCC 343, the function of the court is to see that lawful authority is not abused but at the same time, the court is not to appropriate itself the task entrusted to that authority. According to the Supreme Court, a public body vested with the statutory power must take care not to exceed or abuse its power. It must act in good faith and reasonabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Schedule XIV of the Act having regard to the provisions contained in sections 205 and 350 of the Act, the same does not lay down the procedure for recognition and measurement of either the income or the expenses and/or the assets and liabilities. This fact would be evident from the following Illustrations : (1)Part I of Schedule VI lays down that investments are to be reflected in the corporate balance sheet in the manner indicated therein. However, the Schedule VI does not point out any item of assets, which should be recognised as investments. The said provision also does not indicate the method of valuing the investments. This aspect had been dealt with by the Institute in its Accounting Standard AS-13 by describing the same as Accounting for Investments . (2)Part I of Schedule VI directs that current assets, loans and advances are required to be reflected in the corporate balance sheet in the manner laid down therein in which the current assets, which includes, inter alia, stock-in-trade should be valued. This aspect had been dealt with by the Institute in its Accounting Standard AS-2 titled valuation of inventories . (3)Save and except the statutory fixed rates of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... which the liability so increased or reduced during the year, shall be added to, or, as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset. Explanation (2) under the said instruction refers to the provisions of section 43A of the Income-tax Act in respect of such matter. 33. It is, therefore, clear that the said instructions, appearing under the heading Fixed Assets in Part I of Schedule VI to the Act, deal with presentation of fixed assets, which had been acquired from countries overseas, and the cost whereof undergoes a change consequent to a change in the rate of foreign currency. This reflection/presentation in the accounts is clearly based on the provisions of section 43A of the Income-tax Act, which lay down the special provisions consequential to the changes in the rate of exchange of currency. Further, the Accounting Standard AS-22, in our opinion, is in no way contradictory to and/or in conflict with Schedule VI of the Act, having regard to the overall statutory requirement/consideration of reflecting true and fair view as laid down, in section 211(1) and (2) of the Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... They are also not rendered valid by subsequent relaxations of the law, whether relating to form or to substance. Similarly, provisions in which a contrary intention does not appear neither impose new liabilities in respect of events taking place before their commencement, nor relieve persons from liabilities then existing, and the view that existing obligations were not intended to be affected has been taken in varying degrees even of provisions expressly prohibiting proceedings. ( See Halsbury s Laws of England , 4th edn., Vol. 44, Paras 921, 922, 925 and 926)." (p. 1034) 36. In our view, however, there is nothing wrong with paragraph 33. It does not make anything retrospective.This can best be explained by the following two simple illustrations given by the learned counsel for the Institute: 36.1 It appears that section 209(3)( b ) of the Act, as inserted in the statute book by the Companies (Amendment) Act, 1988 with effect from 15th June, 1988 requires that the books of account of every corporate undertaking must be kept on accrual basis, and according to the double entry system of accounting. In other words, if a company prior to the said amendment earned out in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erit in the submissions made on behalf of the petitioners that paragraph 33 is ultra vires. 38. We now propose to deal with the question whether the provisions of the deferred tax-liability under the AS-22 is notional or contingent in nature as laboriously contended by the learned counsel for the writ petitioners. 39. According to the learned counsel for the writ petitioners, the deferred tax-liability is a notional and contingent liability and, therefore, it is not required to be charged to the profit and loss account as per the requirements of the Act. In support of their contention, they have argued that the deferred tax-liability is a future liability and, therefore, it does not exist on the balance sheet date. They have also argued that it is a contingent liability because it may or may not arise in future. Accordingly, they contend that the deferred tax-liability is not in accordance with the requirement of section 209(3)( b ) of the Act as it does not amount to keeping the books of account on accrual basis. 40. In our opinion, the deferred tax liability is not a notional tax liability but a real liability because it will result in future cash-outflow in the for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this Standard)." 40.2 Regarding the contention of the petitioners that the deferred tax-liability is a contingent liability because it may or may not arise in future, it may be noted from the above that the deferred tax-liability actually arises in the financial year in which the timing difference originates. Therefore, the question of liability being contingent in nature does not arise. A contingent liability becomes a liability on happening or not happening of an uncertain event in future. Deferred tax-liability is not contingent, as it does not arise in future on happening or not happening of a future event. There is, thus, a difference in a liability arising in future or contingent on a future event and a liability, which exists today but payment in respect of which is to be made in future. Any existing liability which is payable in future is not a future liability or a contingent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The object of the Rules is to enable not only the bank and other financial institution to discover the real health of the company to whom it proposes to lend money but also to give the true and fair view of the affairs of the company to those persons who wish to invest money in the said company or to enter into the business relationship with the same. 43. We now propose to deal with the decisions cited on behalf of the writ petitioners. 44. In the case of Jai Parkash Omparkash Co. Ltd. ( supra ), the Supreme Court was dealing with the provisions of Income-tax Act for the purpose of deciding the question whether on the facts as ascertained, certain income could be said to have accrued to the assessee, and whether the same was a question of law. We fail to appreciate how the said decision can be of any help to the petitioners for the purpose of deciding the question whether the Rules framed by the Central Government in exercise of powers conferred under the Act is in conflict with any of the provisions of the Act. 45. In the case of P. Mariappa Gounder ( supra ), the Madras High Court was dealing with a case under the Income-tax Act where the question was whether t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he income is earned and taxability of income is not dependent upon its destination or the manner of its utilisation. According to the Supreme Court, it has to be seen whether at the point of the accrual, the amount is of a revenue nature and if so, the amount will have to be taxed. The Supreme Court further held that the question whether a particular receipt is of the nature of income and falls within the charge of section 4 of the Income-tax Act is a question of law which has to be decided by the court on the basis of the provisions of the Act and the interpretation of the term income given in a large number of decisions of the High Courts, the Privy Council and the Supreme Court. We fail to appreciate how the said decision can be of any help to the writ petitioners when the question is whether the Rules provided under the Act can ask a company to disclose something in its balance sheet which may be irrelevant for the computation of its income-tax under the provisions of the Income-tax Act and our answer is in the affirmative provided those requirements are for the purpose of showing the true and fair view of the affairs of the company. We, thus, find that the said decision is n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ct 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; ( b )the expression "reserve" shall not, subject as aforesaid, include 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;.... and in this sub-clause the expression "liability" shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liabilities. (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 purposes of this Schedule as a "reserve" and not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r of the sum so retained or appropriated having regard to several factors as mentioned above and if the concerned sum is in fact a reserve then it will be taken into account for the computation of capital." (p. 569) 48. In our view, the said decision cannot be of any help for resolving the question whether the impugned Rules framed under the Act can lawfully compel a company to disclose something which is irrelevant for the purpose of computation of income-tax if the same is necessary for the purpose of showing a true and fair view of its affairs. 49. In the case of Bakul Cashew Co. ( supra ), the Supreme Court was considering the question whether a subordinate legislation can be given retrospective in operation in the light of Kerala General Sales Tax Act, 1963. According to the Supreme Court, the power of the Government to grant exemption could not be exercised retrospectively unless the Government is specifically empowered. We have already discussed the similar decision of the Supreme Court in the case of K.S. Paripoornan ( supra ) earlier and have held that in this case, no question of giving any retrospective operation of the Rules arises. Therefore, we do not prop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wholesale prices, sometimes the net price was lower, and sometimes the sales resulted in a reduced profit. For some 30 years the taxpayers had valued the unsold stock-in-hand at the replacement value, i.e., the price that they would pay for that type of stock in the wholesale market. Until 1959, that method had been accepted by the Inland Revenue. For the year 1960-61, the taxpayers were assessed to income-tax on the basis that their stock-in-hand at the beginning and the end of the relevant accounting period, 1-1-1959 and 31-12-1959, ought to be valued either at cost or at the market value, whichever was the less, the market value being the price obtainable on a retail sale less selling expenses. The taxpayers appealed to the Special Commissioners, who decided in favour of the Revenue. On appeal, the same was dismissed on the ground that the words "market value" in the formula accepted by the law from the practice of accountants for valuation of stock-in-trade cost or market value, whichever is the less prima facie connoted the price obtainable in the market which offered the best price and that the evidence did not support the existence of an invariable accountancy practice ..... X X X X Extracts X X X X X X X X Extracts X X X X
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