The Hindu Business Line : Judicial definition of book profits

Minimum Alternate Tax (MAT) has been in the statute book for 20 years now. The concept of book profits to be arrived at in the case of zero taxpaying companies has been agitated at various levels. The Supreme Court ruling in the Apollo Tyres case was rendered in 2002.

It has been reiterated in several other cases, all pointing to the need for following the company law provision in the computation of book profits.

As recently as in September 2007, the Madras High Court pointed out that the assessing officer (AO) has to accept the authenticity of the accounts with reference to the provisions of the Companies Act. No power is conferred on the AO to embark upon a fresh enquiry in regard to entries made in the company’s books of accounts.

Explanation to Section 115J does not permit the AO to go behind the net profits shown in the P&L (profit and loss) account except to the extent provided in the Explanation [302 ITR 22].

Can the AO add back provision for obsolescence loss and reduction due to change in method of inventory? The Ahmedabad Bench of the Tribunal answered the question in favour of the company pointing out that any provision made for diminution in value of assets could not be added, though it is a provision under the Companies Act.

It is not covered under Section 115JA Explanation (C). Similarly, reduction in value due to change in method of valuation of inventory could not be added because it was not a provision but an amount stated to have decreased profits by the changed method of inventory. This was a more scientific method adopted consistently in subsequent years. The company law authorities accepted this method.

Lease Equalisation Charges

GE Capital Transportation Financial Services Ltd deducted the lease equalisation charges from the lease rental income. The company added back this amount in the computation of income but did not add it to the book profit for purposes of Section 115JA. This amount was not debited to the P&L appropriation account. The guidance note issued by the Institute of Chartered Accountants of India on ‘Accounting for leases’ supported the action of the company.

The amount was not transferred to any reserve accounts. It was adjusted against depreciation of relevant fixed assets given on lease. The Delhi Bench of the ITAT considered the adjustment made by the AO by adding the amount of lease equalisation charges to book profits as impermissible. It held such an adjustment was not covered by any of the clauses of the Explanation below Section 115JA (2) (301 ITR AT 69).

Escapade Resorts (P) Ltd changed the method of computing depreciation from the straight-line to the written-down value (WDV) method and debited arrears of depreciation to the P&L account. The AO thought the company was not entitled to add back depreciation of earlier years. He disallowed the amount of depreciation for earlier years and reworked the book profits.

The Tribunal held that book profits have to be worked out as per the Companies Act. There was no reference in the law about the treatment to be given to arrears of depreciation in case the company changed the method of depreciation which is debited to the P&L account. It upheld the right of the company to claim arrears of depreciation consequent on change in the method of calculation.

In the same case, the Tribunal ruled that advance tax was not payable in respect of liability under Section 115J. This is the law laid down by the Supreme Court in the Kwality Biscuits case. The Madras High Court had taken a different view.

What about Capital Gains?

Book profits tax is a code by itself. Other provisions relating to computation will not be applicable. The scheduler system for computing head-wise income is also not applicable. There is therefore no question of taxing capital gains included in book profits at concessional rate. Capital gain will have to be taxed at the rate applicable to all book profits (303 ITR AT 403).

The scheme for levying MAT has undergone a radical change. Sections 115JA and 115JB have been amended in such a way that instead of computing book profits, tax rates are stipulated.

All the rulings cited above will have to be read in conjunction with the latest amended law under Section 115JB levying 10 per cent tax on book profits. The new law provides for levy of book profits tax even with regard to income covered under Section 10(A)/10(B). Some of the amendments are prospective while others are retrospective. This shows how difficult it is to keep track of the law.

(The author is a former Chief Commissioner of Income-Tax. blfeedback@thehindu.co.in)