The Hindu Business Line : Adjustments to book profits

Paragraph 30 of Accounting Standard-22 prescribed by the Institute of Chartered Accountants of India clearly states that deferred tax assets and liabilities should
be distinguished from assets and liabilities representing current tax for the period.

H.P. Ranina

Section 115-JB brings to tax book profits at the prescribed rate for the relevant assessment year, where the tax computed under normal provisions of the Act is less than 10 per cent of the book profits.

In such a case, by a fiction of law, the book profits are treated as the taxable income of the company. Book profits are the profits determined under Schedule VI to the Companies Act, 1956, subject to the adjustments that are required to be made in conformity with the Explanation to section 115-JB(2).

Subject matter of litigation

One such adjustment requires that book profits have to be increased by the provision for taxation. The question whether the provision for deferred taxation has to be added to the book profits under section 115-JB has been the subject matter of litigation.

In M. J. Pharmaceuticals Ltd v. C.I.T. (297 I.T.R. 119), the assessee filed its return for A.Y. 2003-04. In the profit and loss account, the assessee had made provision of Rs 2,16,01,248 for deferred taxation.

During the course of the assessment proceedings, the Assessing Officer called upon the assessee to show cause as to why the provision for deferred taxation amounting to Rs. 2,16,01,248 made in the profit and loss account should not be taken into account for determining the book profit under section 115-JB.

The assessee, in its reply, submitted that the provision for deferred taxation was made in accordance with Accounting Standard 22 and it could not be taken into account for determining the book profit, because it was not covered by any of the clauses (a) to (f) set out in the Explanation to section 115-JB of the Act.

On being satisfied with this explanation given by the assessee, the Assessing Officer passed an order under section 143(3) of the Act without making any additions to the book profit on account of provision for deferred taxation.

Notice was issued in December 2006 on the ground that the book profits of the assessee had been under-assessed by Rs 2,16,01,248. The assessee objected to the reopening of the assessment but the Assessing Officer rejected the objection. On a writ petition, the Bombay High Court held that the reasons recorded by the Assessing Officer for reopening the assessment showed that the explanation given by the assessee and accepted by the Assessing Officer was not erroneous.

Further, there was no other material/information on the basis of which a prima facie opinion was formed to the effect that by not increasing the book profit with the amount of the provision for deferred taxation, income chargeable to tax had escaped assessment. Thus, the reopening of the assessment was not based on any material but merely on change of opinion without any basis.

Tribunal’s stance

The issue of adjustment to book profits on account of deferred taxation has been elaborately considered by the Kolkata Bench of the Income-tax Appellate Tribunal in C.I.T. v. Balarampur Chini Mills Ltd (297 I.T.R. (A.T.) 15).

The Tribunal observed that paragraph 30 of Accounting Standard-22 prescribed by the Institute of Chartered Accountants of India clearly states that deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period. Interest on income-tax and income-tax paid/payable are to be treated separately as they are separate and distinct from each other.

Likewise deferred tax charge cannot be kept on a par with income-tax paid/ payable as both are quite different.

Apart from this, the objective behind enacting Accounting Standard-22 was that deferred tax charge was meant to remove the difference between taxable income and accounting income arising due to difference between items of revenue and expenses as appearing in the profit and loss account and items that are considered as revenue expenses or deduction for tax purposes or difference between the amount in respect of a particular item of revenue or expense as recognised in the profit and loss and the corresponding amount recognised for the computation of taxable income.

Understanding ‘reserve’

Therefore, the deferred tax charge could not be termed as income-tax paid or payable which has to be paid out of the profit earned by the assessee for the year under consideration. There are many differences between the term ‘reserve’ as stipulated in Explanation (b) to section 115-JB(2) and reserve created for the purpose of the deferred tax charge.

A ‘reserve’ within the meaning of Explanation (b) can unilaterally be transferred back to the profit and loss account, whereas a deferred tax charge cannot be so transferred to the profit and loss account.

Furthermore, the reserve mentioned in clause (b) can be utilised for issuing bonus shares or for declaration of dividend, whereas the deferred tax charge cannot be utilised for such purposes.

It is also pertinent to note that as per Accounting Standard-22, deferred tax charge is treated as an expense of the period in which it is charged, and such expense cannot be treated as a reserve within the meaning of clause (b) of the Explanation to section 115-JB(2).

A close perusal of paragraphs 20 to 23 of Accounting Standard-22 makes it clear that deferred tax charges are measured scientifically and as per strict guidelines of the Institute issued from time to time and accepted not only in India but globally.

Where the Revenue has not disputed the calculation of such deferred tax charge by the assessee made as per the guidelines stipulated in Accounting Standard-22 and the computation of deferred tax charge is scientifically made and globally accepted, it cannot be considered as an unascertained liability within the meaning of Explanation (c) to Section 115-JB(2).

On deferred tax charge

Any withdrawal from the provision for deferred tax liability would be offered for tax in accordance with the proviso to section 115-JB(i). Hence, the Revenue would not be worse off (except the timing difference) if the deferred tax charge is not added back to arrive at the book profits.

In case a deferred tax asset is created by crediting the profit and loss account, it would be considered as part of book profits and it would result in absurdity if provision for deferred tax liability (which is debited to the profit and loss account) is also added back to arrive at the book profits.

The conclusion reached was that deferred tax charge is a provision for giving effect to the difference between taxable income and accounting income and not provision for income-tax paid or payable. Therefore, it would not be covered by Explanation (a) to section 115-JB(2). The deferred tax charge is not covered by any other clause of the Explanation to section 115-JB(2) and is not required to be added back in the computation of book profits for the purpose of section 115-JB.

The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in

More Stories on : Income Tax | Accounting Standards

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
Oil logic

Retrospective liability under the MAT

A narrow view on charity

Clear the air for the heirs as well

IMF grappling with fiscal woes

Entertainment & Media: Demands that await a break

Adjustments to book profits

Driven by greed