The case involves a challenge by M/s. J.K. Industries Ltd., a public limited company incorporated, against Accounting Standard 22 (AS 22) titled "Accounting for Taxes on Income." The standard was ...
No Acts & Articles mentioned in this case
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 108
CASE NO.:
Appeal (civil) 3761 of 2007
PETITIONER:
J. K. Industries Ltd. & Anr
RESPONDENT:
Union of India & Ors
DATE OF JUDGMENT: 19/11/2007
BENCH:
S.H. Kapadia & B. Sudershan Reddy
JUDGMENT:
J U D G M E N T
With
Civil Appeal Nos.3478/2007, 3479/2007, 3480/2007 and 3482/2007.
KAPADIA, J.
1. A short question which arises for determination in this
batch of civil appeals is :
\023Whether Accounting Standard 22 (AS 22) entitled
\023accounting for taxes on income\024 insofar as it
relates to deferred taxation is inconsistent with and
ultra vires the provisions of the Companies Act,
1956 (the Companies Act), the Income-tax Act, 1961
(I.T. Act) and the Constitution of India?\024
2. M/s. J.K. Industries Ltd. is a public limited company. It
was incorporated in 1951. It carries on the business of
manufacture and sale of automotive tyres, tubes, sugar and
agrigenetics. It has a registered office at Calcutta. It seeks to
challenge AS 22 issued by Institute of Chartered Accountants of
India (for short, \023Institute\024) which has been made mandatory for
all companies listed in Stock Exchanges in India in preparation
of their accounts for the financial year 2001-02 onwards.
3. On 7.12.06 the Central Government prescribed AS 22 under
Section 211 (3C) of the Companies Act by the Companies (AS)
Rules 2006. Before that date, AS 22, when issued in 2001, was
challenged in writ petitions filed before Madras, Karnataka,
Calcutta and Gujarat High Courts. On transfer petitions, under
Section 139A of the Constitution, filed by the Institute, this Court
vide order dated 17.2.03 was pleased to transfer the writ
petitions filed in various High Courts to the Calcutta High Court.
Meaning and purpose of AS:
4. In its origin, Accounting Standard is a policy statement or
document framed by Institute. Accounting Standards
establishes rules relating to recognition, measurement and
disclosures thereby ensuring that all enterprises that follow them
are comparable and that their financial statements are true, fair
and transparent. Accounting Standards (\023A.S.\024 for short) are
based on a number of accounting principles. They seek to arrive
at true accounting income. One such principle is the matching
principle. The other is fair value principle. The aim of the
Institute is to go for paradigm shift from matching to fair value
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 108
principle.
5. Today the revised Accounting Standards seeks to arrive at
true accounting income. In the age of globalization the attempt
is to reconcile the accounts of Indian companies with their joint
venture partners abroad. The aim is to harmonise Indian
Accounting Standards with International Accounting Standards.
With the object of bridging gap between IAS and IFRS, the
Institute formulated new A.S. and introduced new concepts, e.g.,
Deferred Tax Accounting (AS 22 impugned herein), Segment
Reporting (AS 17) etc.. However, as a matter of prudence and
necessary adjustment, to arrive at real income, Accounting
Standards require provision to be made for liabilities payable in
future, provision to be made for contingencies, provision to be
made for diminution, provision to reflect impairment and so on
which have the effect of reducing incomes and were, therefore,
not readily accepted by some enterprises and tax authorities.
6. The core of Accountancy is Book-keeping. The rules of
Book-keeping are clear. For example, the value of a fixed asset
mentioned in a Balance Sheet is based on cost which may involve
subjective estimation of the amount to be apportioned. Similarly,
the quantum of depreciation is again an estimate, which can vary
depending on the persons preparing the accounts as to when and
at what stage he wants to record the depreciation. Accounting
Standards are an attempt to overcome some of these deficiencies
of Accountancy. Accounting Standards involve codification of
fundamental accounting rules, rules which explain and
standardize the application of the fundamental rules to a variety
of uncertain situations like \026 retirement, contingencies,
intangibles, consolidation, merger etc. Accounting Standards
basically attempt to reduce the subjectivity and lay down rules so
as to arrive at the best possible estimates. For example, net
assets refer to the difference between total assets less liabilities
but the value attributable to each asset and each liability is often
subjective. It depends on estimates. This is where the
Accounting Standards help. They reduce the subjectivity.
Therefore, Accounting Standards help to arrive at the best
possible estimates. This estimation/subjectivity is also on
account of the conceptual difference between \023accounting
income\024 and \023taxable income\024. Accounting income is the real
income. Tax laws lay down rules for valuation of inventories,
fixed assets, depreciation, bad debts, etc. based on artificial rules
and not on the basis of accounting estimates, which results in
mismatch between accounting and taxable incomes. For
example, a fixed rate of depreciation may, for some companies,
result in computing lower than the actual income if the actual
erosion in the value of the asset is lower than the depreciation
calculated at the fixed rate and higher than actual income for
others where assets erode faster. Accounting income is normally
used as a relevant measure by most stakeholders. However, on
account of artificial set of rules used in computation of taxable
income one finds that accounting income differs from taxable
income. Looking to these problems, the evolution of Accounting
Standards and their greater application is necessary as it results
in reducing the need for tax laws to depend upon artificial rules.
The object of Accounting Standards is, therefore, to standardize
and to narrow down the options. The object of Accounting
Standards is to evolve methods by which \023accounting income\024 is
determined. The object behind the Accounting Standards is to
evolve methods by which accounting income is determined, made
more transparent and leave less and less room for subjective
selection of methods and provide for more attention to the quality
of estimates used in arriving at accounting income.
7. The main object sought to be achieved by Accounting
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 108
Standards which is now made mandatory is to see that
accounting income is adopted as taxable income and not merely
as the basis from which taxable income is to be computed.
Thus, if the rules by which inventories are to be valued are laid
down in the Accounting Standards and are followed in the
determination of accounting income, then tax laws do not need to
lay down the rules and the tax authorities do not need to
examine the computation of the value of inventories and its effect
on computation of income. Similarly, if there is an accounting
standard on depreciation which requires estimation of the useful
life and prescribes the appropriate method for apportionment of
cost of fixed assets over their useful life, it is unnecessary for tax
laws to apply an artificial rule to decide the extent of allowance
for depreciation.
8. Finally, the adoption of Accounting Standards and of
accounting income as \023taxable income\024 would avoid distortion of
accounting income which is the real income.
Reasons for introducing AS 22:
9. In the backdrop of globalization and liberalization the world
has become an economic village. Today, the capital market all
over the world knows no barriers. Fiscal distances and barriers
have been removed by developments in transport,
communication and e-commerce. In this backdrop, Convergence
of Accounting Standards is aimed at removing barriers in the
flow of financial information and capital. Based on the above
developments in the global economy and the Indian economy, the
conceptual differences and consequent deviations in the National
Accounting Standards and IFRS have got to be eliminated. For
example, exchange difference in respect of unpaid liability for
acquisition of an imported asset has been allowed in the past to
be adjusted with the carrying costs of the fixed assets instead of
recognizing the exchange difference in the profit and loss
account.
10. Lastly, it is important to note that Accounting Standards
and taxation of income are two independent subjects. The object
behind AS is to remove this divergence by making Accounting
Income a Taxable Income. Accounting income can never negate
True Income.
Relevant provisions of the Companies Act, 1956 and
Analysis thereof:
11. Before analyzing the provisions of the Companies Act, we
quote hereinbelow the following provisions from the Companies
Act which read as follow:
\023PREAMBLE \026
The Companies Act, 1956 (ACT 1 OF 1956)
[18th January, 1956]
An Act to consolidate and amend the law
relating to companies and certain other
associations.
Be it enacted by Parliament in the Sixth Year
of the Republic of India as follows:-\024
\023PRELIMINARY
Section 2(33) "prescribed" means, as respects the
provisions of this Act relating to the winding up of
companies except sub-section (5) of section 503,
sub-section (3) of section 550, section 552 and sub-
section (3) of section 555, prescribed by rules made
by the Supreme Court in consultation with The
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 108
Tribunal, and as respects the other provisions of
this Act including sub-section (5) of section 503,
sub-section (3) of section 550, section 552 and sub-
section (3) of section 555, prescribed by rules made
by the Central Government;\024
\023ACCOUNTS
Section 209. Books of account to be kept by
company
(1) Every company shall keep at its registered office
proper books of account with respect to-
(a) all sums of money received and expended by the
company and the matters in respect of which the
receipt and expenditure take place;
(b) all sales and purchases of goods by the
company;
(c) the assets and liabilities of the company; and
(d) in the case of a company pertaining to any class
of companies engaged in production, processing,
manufacturing or mining activities, such particulars
relating to utilisation of material or labour or to
other items of cost as may be prescribed, if such
class of companies is required by the Central
Government to include such particulars in the
books of account:
Provided that all or any of the books of account
aforesaid may be kept at such other place in India
as the Board of directors may decide and when the
Board of directors so decides, the company shall,
within seven days of the decision, file with the
Registrar a notice in writing giving the full address
of that other place.
(2) Where a company has a branch office, whether
in or outside India, the company shall be deemed to
have complied with the provisions of sub-section (1),
if proper books of account relating to the
transactions effected at the branch office are kept at
that office and proper summarised returns, made
up to dates at intervals of not more than three
months, are sent by the branch office to the
company at its registered office or the other place
referred to in sub-section (1).
(3) For the purposes of sub-sections (1) and (2),
proper books of account shall not be deemed to be
kept with respect to the matters specified therein,-
(a) if there are not kept such books as are necessary
to give a true and fair view of the state of the affairs
of the company or branch office, as the case may
be, and to explain its transactions; and
(b) If such books are not kept on accrual basis and
according to the double entry system of accounting.
(4) The books of account and other books and
papers shall be open to inspection by any director
during business hours.
(4A) The books of account of every company relating
to a period of not less than eight years immediately
preceding the current year together with the
vouchers relevant to any entry in such books of
account shall be preserved in good order :
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 108
Provided that in the case of a company incorporated
less than eight years before the current year, the
books of account for the entire period preceding the
current year together with the vouchers relevant to
any entry in such books of account shall be so
preserved.
(5) If any of the persons referred to in sub-section
(6) fails to take all reasonable steps to secure
compliance by the company with the requirements
of this section, or has by his own wilful act been the
cause of any default by the company thereunder, he
shall, in respect of each offence, be punishable with
imprisonment for a term which may extend to six
months, or with fine which may extend to ten
thousand rupees, or with both :
Provided that in any proceedings against a person
in respect of an offence under this section
consisting of a failure to take reasonable steps to
secure compliance by the company with the
requirements of this section, it shall be a defence to
prove that a competent and reliable person was
charged with the duty of seeing that those
requirements were complied with and was in a
position to discharge that duty :
Provided further that no person shall be sentenced
to imprisonment for any such offence, unless it was
committed wilfully.
(6) The persons referred to in sub-section (5) are the
following namely :-
(a) where the company has a managing director or
manager, such managing director or manager and
all officers and other employees of the company;
and;
(d) where the company has neither a managing
director nor manager, every director of the
company;
Section 210. Annual accounts and balance sheet
(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.
(2) In the case of a company not carrying on
business for profit, an income and expenditure
account shall be laid before the company at its
annual general meeting instead of a profit and loss
account, and all references to "profit and loss
account", "profit" and "loss" in this section and
elsewhere in this Act, shall be construed, in relation
to such a company, as references respectively to the
"income and expenditure account", "the excess of
income over expenditure", and "the excess of
expenditure over income".
(3) The profit and loss account shall relate-
(a) in the case of the first annual general meeting of
the company, to the period beginning with the
incorporation of the company and ending with a day
which shall not precede the day of the meeting by
more than nine months; and
(b) in the case of any subsequent annual general
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 108
meeting of the company, to the period beginning
with the day immediately after the period for which
the account was last submitted and ending with a
day which shall not precede the day of the meeting
by more than six months, or in cases where an
extension of time has been granted for holding the
meeting under the second proviso to sub-section (1)
of section 166, by more than six months and the
extension so granted.
(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 :
Provided that it may extend to eighteen months
where special permission has been granted in that
behalf by the Registrar.
(5) If any person, being a director of a company,
fails to take all reasonable steps to comply with the
provisions of this section, he shall, in respect of
each offence, be punishable with imprisonment for
a term which may extend to six months, or with fine
which may extend to ten thousand rupees, or with
both :
Provided that in any proceedings against a person
in respect of an offence under this section, it shall
be a defence to prove that a competent and reliable
person was charged with the duty of seeing that the
provisions of this section were complied with and
was in a position to discharge that duty :
Provided further that no person shall be sentenced
to imprisonment for any such offence unless it was
committed wilfully.
(6) If any person, not being a director of the
company, having been charged by the Board of
directors with the duty of seeing that the provisions
of this section are complied with, makes default in
doing so, he shall, in respect of each offence, be
punishable with imprisonment for a term which
may extend to six months, or with fine which may
extend to ten thousand rupees, or with both :
Provided that no person shall be sentenced to
imprisonment for any such offence unless it was
committed wilfully.
Section 210A. Constitution of National Advisory
Committee on Accounting Standards
(1) The Central Government may, by notification in
the Official Gazette, constitute an Advisory
Committee to be called the National Advisory
Committee on Accounting Standards (hereafter in
this section referred to as the "Advisory Committee")
to advise the Central Government on the
formulation and laying down of accounting policies
and accounting standards for adoption by
companies or class of companies under this Act.
(2) The Advisory Committee shall consist of the
following members, namely :-
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 108
(a) a Chairperson who shall be a person of eminence
well versed in accountancy, finance, business
administration, business law, economics or similar
discipline;
(b) one member each nominated by the Institute of
Chartered Accountants of India constituted under
the Chartered Accountants Act, 1949, the Institute
of Cost and Works Accountants of India constituted
under the Cost and Works Accountants Act, 1959
and the Institute of Company Secretaries of India
constituted under the Company Secretaries Act,
1980;
(c) one representative of the Central Government to
be nominated by it;
(d) one representative of the Reserve Bank of India
to be nominated by it;
(e) one representative of the Comptroller and
Auditor-General of India to be nominated by him;
(f) a person who holds or has held the office of
professor in accountancy, finance or business
management in any university or deemed
university;
(g) the Chairman of the Central Board of Direct
Taxes constituted under the Central Boards of
Revenue Act, 1963 or his nominee;
(h) two members to represent the chambers of
commerce and industry to be nominated by the
Central Government, and
(i) one representative of the Securities and Exchange
Board of India to be nominated by it.
(3) The Advisory Committee shall give its
recommendations to the Central Government on
such matters of accounting policies and standards
and auditing as may be referred to it for advice from
time to time.
(4) The members of the Advisory Committee shall
hold office for such terms as may be determined by
the Central Government at the time of their
appointment and any vacancy in the membership in
the Committee shall be filled by the Central
Government in the same manner as the member
whose vacancy occurred was filled.
(5) The non-official members of the Advisory
Committee shall be entitled to such fees, travelling,
conveyance and other allowances as are admissible
to the officers of the Central Government of the
highest rank.
Section 211. Form and contents of balance sheet
and profit and loss account
(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
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 108
the heading "Notes" at the end of that Part :
Provided that nothing contained in this sub-section
shall apply to any insurance or banking company or
any company engaged in the generation or supply of
electricity, or to any other class of company for
which a form of balance sheet has been specified in
or under the Act governing such class of company.
(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 :
Provided that nothing contained in this sub-section
shall apply to any insurance or banking company or
any company engaged in the generation or supply of
electricity, or to any other class of company for
which a form of profit and loss account has been
specified in or under the Act governing such class of
company.
(3) The Central Government may, by notification in
the Official Gazette, exempt any class of companies
from compliance with any of the requirements in
Schedule VI if, in its opinion, it is necessary to grant
the exemption in the public interest.
Any such exemption may be granted either
unconditionally or subject to such conditions as
may be specified in the notification.
(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.
(3C) For the purposes of this section, the expression
"accounting standards" means the standards of
accounting recommended by the Institute of
Chartered Accountants of India constituted under
the Chartered Accountants Act, 1949 as may be
prescribed by the Central Government in
consultation with the National Advisory Committee
on Accounting Standards established under sub-
section (1) of section 210A :
Provided that the standard of accounting specified
by the Institute of Chartered Accountants of India
shall be deemed to be the Accounting Standards
until the accounting standards are prescribed by
the Central Government under this sub-section.
(4) The Central Government may, on the
application, or with the consent of the Board of
directors of the company, by order, modify in
relation to that company any of the requirements of
this Act as to the matters to be stated in the
company's balance sheet or profit and loss account
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 9 of 108
for the purpose of adapting them to the
circumstances of the company.
(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 affairs
of the company, merely by reason of the fact that
they do not disclose-
(i) in the case of an insurance company, any
matters which are not required to be disclosed by
the Insurance Act, 1938;
(ii) in the case of a banking company, any matters
which are not required to be disclosed by the
Banking Companies Act, 1949;
(iii) in the case of a company engaged in the
generation or supply of electricity, any matters
which are not required to be disclosed by both the
Indian Electricity Act, 1910, and the Electricity
(Supply) Act, 1948;
(iv) in the case of a company governed by any other
special Act for the time being in force, any matters
which are not required to be disclosed by that
special Act; or
(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.
(7) If any such person as is referred to in sub-
section (6) of section 209 fails to take all reasonable
steps to secure compliance by the company, as
respects any accounts laid before the company in
general meeting, with the provisions of this section
and with the other requirements of this act as to the
matters to be stated in the accounts, he shall, in
respect of each offence, be punishable with
imprisonment for a term which may extend to six
months, or with fine which may extend to ten
thousand rupees, or with both :
Provided that in any proceedings against a
person in respect of an offence under this
section, it shall be a defence to prove that a
competent and reliable person was charged
with the duty of seeing that the provisions of
this section and the other requirements
aforesaid were complied with and was in a
position to discharge that duty :
Provided further that no person shall be
sentenced to imprisonment for any such
offence, unless it was committed wilfully.
(8) If any person, not being a person referred to in
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 10 of 108
sub-section (6) of section 209, having been charged
by the managing director or manager, or Board of
directors, as the case may be, with the duty of
seeing that the provisions of this section and the
other requirements aforesaid are complied with,
makes default in doing so, he shall, in respect of
each offence, be punishable with imprisonment for
a term which may extend to six months or with fine
which may extend to ten thousand rupees, or with
both:
Provided that no person shall be sentenced to
imprisonment for any such offence, unless it was
committed wilfully.
SCHEDULE VI
(See section 211)
1[PART I
Form of Balance-sheet]
The balance sheet of a company shall be either in horizontal form or
vertical form
A. HORIZONTAL FORM]
Balance sheet of \005\005\005\005\005\005\005\005\005\005\005\005\005.
[Here enter the name of the Company]
As at \005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005
[Here enter the date as at which the balance-sheet is made out.]
Instructions
in accordance
with which
liabilities
should be
made out
LIABILITIES
ASSETS
Instructions in
accordance with
which assets
should be made
out
Figures for
the
previous
year Rs.
(b)
Figur
es
for
the
curre
nt
year
Rs.
(b)
Figures for the
previous year
Rs. (b)
Figu
res
for
the
curr
ent
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 11 of 108
year
Rs.
(b)
*SHARE
CAPITAL
*FIXED ASSETS
Terms of
redemption or
conversion
(if any), or
any
redeemable
preference
capital to be
stated,
together with
earliest date
of redemption
or
conversion.
Authorised\005
\005shares of
Rs.\005\005each.
Distinguishing
as far as
possible
between
expenditure
upon (a)
goodwill, (b)
land, (c)
buildings, (d)
leaseholds, (e)
railway
sidings, (f)
plant and
machinery, (g)
furniture and
fittings, (h)
development of
property, (i)
patents, trade
marks and
designs, (j)
live-stock and
(k) vehicles,
etc.
*Under each head the
original cost, and
the additions
thereto and
deductions therefrom
during the year, and
total depreciation
written off or
provided up to the
end of the year to
be stated.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 12 of 108
Where the original
cost aforesaid and
additions and
deductions thereto,
relate to any fixed
asset which has been
acquired from a
country outside
India, and in
consequence of a
change in the rate
of exchange at any
time after the
acquisition of such
asset, there has
been an increase or
reduction in the
liability of the
company, as
expressed in Indian
currency, for making
payment towards the
whole or a part of
the cost of the
asset or for
repayment of the
whole or a part of
moneys borrowed by
the company from any
person, directly or
indirectly in any
foreign currency
specifically for the
purpose of acquiring
the asset (being in
either case the
liability existing
immediately before
the date on which
the change in the
rate of exchange
takes effect), the
amount by which the
liability is 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.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 13 of 108
Explanation 1: This
paragraph shall
apply in relation to
all balance-sheets
that may be made out
as at the 6th day of
June, 1966, or any
day thereafter and
where, at the date
of issue of the
notification of the
Government of India,
in the Ministry of
Industrial
Development and
Company Affairs
(Department of
Company Affairs),
G.S.R. No. 129,
dated the 3rd day of
January, 1968, any
balance sheet, in
relation, to which
this paragraph
applies, has already
been made out and
laid before the
company in Annual
General Meeting, the
adjustment referred
to in this paragraph
may be made in the
first balance-sheet
made out after the
issue of the said
notification.
Explanation 2:-In
this paragraph,
unless the context
otherwise requires,
the expressions
"rate of exchange",
"foreign currency"
and "Indian
Currency" shall have
the meanings
respectively
assigned to them
under sub-section
(1) of section 43A
of the Income-tax
Act, 1961 (43 of
1961), and
Explanation 2 and
Explanation 3 of the
said sub-section
shall, as far as may
be, apply in
relation to the said
paragraph as they
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 14 of 108
apply to the said
sub-section (1).
In every case where
the original cost
cannot be
ascertained, without
unreasonable expense
or delay, the
valuation shown by
the books shall be
given. For the
purposes of this
paragraph, such
valuation shall be
the net amount at
which an asset stood
in the company\022s
books at the
commencement of this
Act after deduction
of the amounts
previously provided
or written off for
depreciation or
diminution in value,
and where any such
asset is sold, the
amount of sale
proceeds shall be
shown as deduction.
Particulars
of any option
on un-issued
share capital
to be
specified.
Issued
(distinguis
hing
between the
various
classes of
capital and
stating the
particulars
specified
below, in
respect of
each class)
\005\005 shares
of Rs. \005\005
each
Where sums have been
written off on a
reduction of capital
or a revaluation of
assets, every
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 15 of 108
balance sheet,
(after the first
balance sheet)
subsequent to the
reduction or
revaluation shall
show the reduced
figures and with the
date of the
reduction in place
of the original
cost.
Particulars
of the
different
classes of
preference
shares to be
given.
Subscribed
(distinguis
hing
between the
various
classes of
Capital and
stating the
particulars
specified
below in
respect of
each
class.)
Each balance sheet
for the first five
years subsequent to
the date of the
reduction, shall
show also the amount
of the reduction
made.
(c)
\005\005shares of
Rs. \005\005
each.
Similarly, where
sums have been added
by writing up the
assets, every
balance-sheet
subsequent to such
writing up shall
show the increased
figures with the
date of the increase
in place of the
original cost. Each
balance sheet for
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 16 of 108
the first five years
subsequent to the
date of writing up
shall also show the
amount of increase
made.
Rs. \005\005
called up.
Explanation.-
Nothing contained in
the preceding two
paragraphs shall
apply to any
adjustment made in
accordance with the
second paragraph.
Of the
above
shares
\005\005shares
are
allotted as
fully paid-
up pursuant
to a
contract
without
payments
being
received in
cash.
Specify the
source from
which bonus
shares are
issued, e.g.,
capitalisatio
n of profits
or Reserves
or from Share
Premium
Account.
Of the
above
shares ___
shares are
allotted as
fully paid-
up by way
of bonus
shares+
Any capital
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 17 of 108
profit on
reissue of
forfeited
shares should
be
transferred
to Capital
Reserve.
Less: calls
unpaid:
1[(i) By
managing
agent or
secretaries
and
treasurers
and where
the
managing
agent or
secretaries
and
treasurers
are a firm,
by the
partners
thereof,
and where
the
managing
agent or
secretaries
and
treasurers
are a
private
company by
the
directors
or members
of that
company.]
(ii) By
directors.
(iii) By
others.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 18 of 108
Add:
Forfeited
shares
(amount
originally
paid up)].
Additions and
deductions
since last
balance sheet
to be shown
under each of
the specified
heads.
*RESERVES
AND SURPLUS
INVESTMENTS
*Aggregate amount of
company\022s quoted
investment and also
the market value
thereof shall be
shown.
The word
"fund" in
relation to
any "Reserve"
should be
used only
where such
Reserve is
specifically
represented
by earmarked
investments.
(1) Capital
Reserves.
Showing nature
of investments
and mode of
valuation, for
example, cost
or market value
and
distinguishing
between-
Aggregate amount of
company\022s unquoted
investments shall
also be shown.
(2) Capital
Redemption
Reserve.
*(1)
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 19 of 108
Investments in
Government or
Trust
Securities.
All unutilised
monies out of the
issue must be
separately disclosed
in the Balance Sheet
of the company
indicating the form
in which such
unutilised funds
have been invested.
(3) Share
Premium
Account
(cc).
*(2)
Investments in
shares,
debentures or
bonds (showing
separately
shares fully
paid-up and
partly paid-up
and also
distinguishing
the different
classes of
shares and
showing also in
similar details
investments in
shares,
debentures or
bonds of
subsidiary
companies.
(4) Other
Reserves
specifying
the nature
of each
Reserve and
the amount
in respect
thereof.
(3) Immovable
properties.
Less: Debit
balance in
profit and
loss
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 20 of 108
account (if
any) (h).
(4) Investments
in the Capital
of partnership
firms.
(5) Surplus
i.e.,
balance in
profit and
loss
account
after
providing
for
proposed
allocations
, namely:-
(5) Balance of
unutilised
monies raised
by issue.
Dividend,
Bonus or
Reserves.
(6)
Proposed
additions
to
Reserves.
(7) Sinking
Funds.]
SECURED
LOANS:
CURRENT ASSETS,
LOANS AND
ADVANCES:
Loans from
Directors,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 21 of 108
Manager
should be
shown
separately.
(1)
Debentures
A. CURRENT
ASSETS
Mode of valuation of
stock shall be
stated and the
amount in respect of
raw material shall
also be stated
separately where
practicable.
Interest
accrued and
due on
Secured Loans
should be
included
under the
appropriate
sub-heads
under the
head "SECURED
LOANS".
(2) Loans
and
Advances
from Banks.
(1) Interest
accrued on
Investments
Mode of valuation of
works-in-progress
shall be stated.
The nature of
the security
to be
specified in
each case.
(3) Loans
and
Advances
from
subsidiarie
s.
(2) Stores and
spare parts.
In regard to Sundry
Debtors particulars
to be given
separately of- (a)
debts considered
good and in respect
of which the company
is fully secured;
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 22 of 108
and (b) debts
considered good for
which the company
holds no security
other than the
debtor\022s personal
security; and (c)
debts considered
doubtful or bad.
Where loans
have been
guaranteed by
managers
and/or
directors, a
mention
thereof shall
also be made
and the
aggregate
amount of
such loans
under each
head
(4) Other
Loans and
Advances.
(3) Loose
Tools.
Debts due by
directors or other
officers of the
company or any of
them either
severally or jointly
with any other
person or debts due
by firms or private
companies
respectively in
which any director
is a partner or a
director or a
members to be
separately stated.
Terms of
redemption or
conversion
(if any) of
debentures
issued to be
stated
together with
earliest date
of redemption
or
conversion.
(4) Stock-in-
trade.
Debts due from other
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 23 of 108
companies under the
same management
within the meaning
of sub-section (1B)
of section 370, to
be disclosed with
the names of the
Companies.
(5) Works-in-
Progress.
The maximum amount
due by directors or
other officers of
the company at any
time during the year
to be shown by way
of a note.
(6) Sundry
debtors-
The provisions to be
shown under this
head should not
exceed the amounts
of debts stated to
be considered
doubtful or bad and
any surplus of such
provision if already
created, should be
shown at every
closing under
"Reserves and
Surplus" (in the
liabilities side)
under a separate
sub-head "Reserve
for Doubtful or Bad
Debts".
(a) Debts
outstanding for
a period
exceeding six
months.
In regard to bank
balances,
particulars to be
given separately of-
(b) Other
debts.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 24 of 108
(a) the balances
lying with Scheduled
Banks on current
accounts, call
accounts and deposit
accounts;
Less: Provision
(b) the name of the
bankers other than
Scheduled Banks and
the balance lying
with each such
banker on current
accounts, call
accounts and deposit
account the maximum
amount outstanding
at any time during
the year from each
such banker; and
(7A) Cash
balance on
hand.
(c) the nature of
the interest, if
any, of any director
or his relative or
the in each of the
bankers (other than
Scheduled Banks)
referred to in (b)
above.
(7B) Bank
balances-
All unutilised
monies out of the
issue must be
separately disclosed
in the Balance Sheet
of the company
indicating the form
in which such
unutilised funds
have been invested.
(a) with
Scheduled
Banks, and
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 25 of 108
(b) with
others.
B.LOANS AND
ADVANCES
*The above
instructions
regarding "Sundry
Debtors" apply to
"Loans and Advances"
also.
(8) (a)
Advances and
loans to
subsidiaries.
(b) Advances
and loans to
partnership
firms in which
the company or
any of its
subsidiaries is
a partner.
(9) Bills of
Exchange.
(10) Advances
recoverable in
cash or in kind
or for value to
be received,
e.g., Rates,
Taxes,
Insurance, etc.
(11) ***]
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 26 of 108
(12) Balances
with Customs,
Port Trust,
etc. (where
payable on
demand).
UNSECURED
LOANS:
MISCELLANEOUS
EXPENDITURE
(to the extent
not written off
or adjusted):
Loans from
directors,
manager
should be
shown
separately.
Interest
accrued ant
due on
Unsecured
Loans should
be included
under the
appropriate
sub-heads
under the
head
"Unsecured
Loans".]
(1) Fixed
Deposits.
(1) Preliminary
expenses.
Where loans
have been
guaranteed by
managers and/
or directors,
a mention
thereof shall
be made and
also
aggregate
amount of
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 27 of 108
such loans
under each
head.
(2) Loans
and
Advances
from
subsidiarie
s.
(2) Expenses
including
commission or
brokerage on
underwriting or
subscription of
shares or
debentures.
See note (d)
at foot of
Form
(3) Short
Term Loans
and
Advances:
(3) Discount
allowed on the
issue of shares
or debentures.
(a) From
Banks.
(4) Interest
paid out of
capital during
construction
(also stating
the rate or
interest.)
(b) From
others.
(5) Development
expenditure not
adjusted.
(4) Other
Loans and
Advances:
(6) Other items
(specifying
nature).
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 28 of 108
(a) From
Banks.
(b) From
others.
CURRENT
LIABILITIES
AND
PROVISIONS:
PROFIT AND LOSS
ACCOUNT.
Show here the debit
balance of profit
and loss account
carried forward
after deduction of
the uncommitted
reserves, if any.
The name(s)
of the small
scale
industrial
undertaking(s
to whom the
Company owe a
sum exceeding
Rs. 1 lakh
which is
outstanding
for more than
30 days, are
to be
disclosed.
A. CURRENT
LIABILITIES
(1)
Acceptances
(2) Sundry
creditors.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 29 of 108
(i) Total
outstanding
dues of
small scale
industrial
undertaking
(s); and
(ii) Total
outstanding
dues of
creditors
other than
small scale
industrial
undertaking
s(s).
(3)
Subsidiary
companies.
(4) Advance
payments
and
unexpired
discounts
for the
portion for
which value
has still
to be given
e.g., in
the case of
the
following
classes of
companies:-
Newspaper,
Fire
Insurance,
Theatres,
Clubs,
Banking,
Steamship
Companies,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 30 of 108
etc.
(5)
Unclaimed
Dividends.
(6) Other
Liabilities
(if any).
(7)
Interest
accrued but
not due on
loans.
B.
PROVISIONS
(8)
Provisions
for
taxation.
(9)
Proposed
dividends.
(10) For
contingenci
es.
(11) For
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 31 of 108
provident
fund
scheme.
(12) For
insurance,
pension and
similar
staff
benefit
schemes.
(13) Other
provisions.
A foot-note
to the
balance-
sheet may
be added to
show
separately:
(1) Claims
against the
company not
acknowledge
d as debts.
(2)
Uncalled
liability
on shares
partly
paid.
The period
for which the
dividends are
in arrear of
if there is
more than one
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 32 of 108
class of
shares, the
dividends on
each such
class are in
arrear, shall
be stated.
(3)
Arrears of
fixed
cumulative
dividends.
The amount
shall be
stated before
deduction of
income-tax,
except that
in the case
of tax-free
dividends the
amount shall
be shown free
of income-tax
and the fact
that it is so
shown shall
be stated.
(4)
Estimated
amount of
contracts
remaining
to be
executed on
capital
account and
not
provided
for.
The amount of
any
guarantees
given by the
company on
behalf of
Directors or
other
officers of
the company
shall be
stated and
where
practicable,
the general
nature and
amount of
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 33 of 108
each such
contingent
liability, if
material,
shall also be
specified.
(5) Other
money for
which the
company is
contingentl
y liable.
General instructions for preparation of balance sheet.-
(a) The information required to be given under any of the
items or sub-items in this Form, if it cannot be
conveniently included in the balance sheet itself, shall
be furnished in a separate Schedule or Schedules to be
annexed to and to form part of the balance sheet. This is
recommended when items are numerous.
(b) Naye Paise can also be given in addition to Rupees,
if desired.
(c) In the case of subsidiary companies the number of
shares held by the holding company as well as by the
ultimate holding company and its subsidiaries must be
separately stated.
The auditor is not required to certify the correctness of
such shareholdings as certified by the management.
(cc) The item "Share Premium Account" shall include
details of its utilisation in the manner provided in
section 78 in the year of utilisation.
(d) Short Term Loans will include those which are due for
not more than one year as at the date of the balance-
sheet.
(e) Depreciation written off or provided shall be
allocated under the different asset heads and deducted in
arriving at the value of Fixed Assets.
(f) Dividends declared by subsidiary companies after the
date of the balance sheet should not be included] unless
they are in respect of period which closed on or before
the date of the balance sheet.
(g) Any reference to benefits expected from contracts to
the extent not executed shall not be made in the balance
sheet but shall be made in the Board's report.
(g) Any reference to benefits expected from contracts to
the extent not executed shall not be made in the balance
sheet but shall be made in the Board's report.
[(h) The debit balance in the Profit and Loss Account
shall be shown as a deduction from the uncommitted
reserves, if any.
(i) As regards Loans and Advances, amounts due by the
Managing Agents or Secretaries and Treasurers, either
severally or jointly with any other persons to be
separately stated; the amounts due from other companies
under the same management within the meaning of sub-
section (1B) of section 370 should also be given with the
names of the companies the maximum amount due from every
one of these at any time during the year must be shown.
(j) Particulars of any redeemed debentures which the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 34 of 108
company has power to issue should be given.
(k) Where any of the company's debentures are held by a
nominee or a trustee for the company, the nominal amount
of the debentures and the amount at which they are stated
in the books of the company shall be stated.
(l) A statement of investments (whether shown under
"Investment" or under "Current Assets" as stock-in-trade)
separately classifying trade investments and other
investments should be annexed to the balance sheet,
showing the names of the bodies corporate (indicating
separately the names of the bodies corporate under the
same management) in whose shares or debentures,
investments have been made (including all investments
whether existing or not, made subsequent to the date as
at which the previous balance sheet was made out) and the
nature and extent of the investment ; so made in each
such body corporate; provided that in the case of an
investment company that is to say, a company whose
principal business is the acquisition of shares, stock,
debentures or other securities, it shall be sufficient if
the statement shows only the investments existing on the
date as at which the balance sheet has been made out. In
regard to the investments in the capital of partnership
firms, the names of the firms (With the names of all
their partners total capital and the shares of each
partner) shall be given in the statement.
(m) If, in the opinion of the Board, any of the current
assets, loans and advances have not a value on
realisation in the ordinary course of business at least
equal to the amount at which they are stated, the fact
that the Board is of that opinion shall be stated.
(n) Except in the case of the first balance sheet 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 balance sheet
shall be also given in the balance sheet The requirement
in this behalf shall, in the case of companies preparing
quarterly or half-yearly accounts, etc., relate to the
balance sheet for the corresponding date in the previous
year.
(o) The amounts to be shown under Sundry Debtors shall
include the amounts due in respect of goods sold or
services rendered or in respect of other contractual
obligations but shall not include the amounts which are
in the nature of loans or advances.
(p) Current accounts with directors, and Manager,
whether they are in credit or debit, shall be shown
separately.
(q) A small scale industrial undertaking has the same
meaning as assigned to it under clause (j) of section 3
of the Industries (Development and Regulation) Act, 1951.
B. VERTICAL FORM
Name of the Company \005\005\005\005\005\005\005
Balance Sheet as at \005\005\005\005\005\005\005\005
Schedule
No.
Figures as
at the end
of current
financial
year
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 35 of 108
Figures
as at the
end of
previous
financial
year
1
2
3
4
5
I. Sources of funds:
(1) Shareholder's funds
(a) Capital
(b) Reserves and Surplus
(2) Loan funds
(a) Secured loans
(b) Unsecured loans
TOTAL:
II. Applications of funds:
(1) Fixed assets
(a) Gross block
(b) Less depreciation
(c) Net block
(d) Capital work-in-progress
(2) Investments
(3) Current assets, loans, and advances:
(a) Inventories
(b) Sundry debtors
(c) Cash and bank balances
(d) Other current assets
(e) Loans and advances
Less:
Current liabilities and provisions:
(a) Liabilities
(b) Provisions
Net current assets
(4) (a) Miscellaneous expenditure to the extent
not written off or adjusted
(b) Profit and Loss account
TOTAL:
Notes.-
1. Details under each of the above items shall be given
in separate Schedules. The Schedules shall
incorporate all the information required to be given
under A-Horizontal Form read with notes containing
general instructions for preparation of balance
sheet.
2. The Schedules, referred to above, accounting
policies and explanatory notes that may be attached
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 36 of 108
shall form an integral part of the balance sheet.
3. The figures in the balance sheet may be rounded off
to the nearest "000" or "00" as may be convenient or
may be expressed in terms of decimals of thousands.
(TO BE COMPARED)
4. A foot-note to the balance sheet may be added to
show separately contingent liabilities.
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 deb
its 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) (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.
(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.
(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.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 37 of 108
(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 trade 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 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 and the quantum of arrears of
depreciation computed in accordance with
section 205(2) of the Act shall be disclosed by
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 38 of 108
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, paid
or payable to the managing director 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 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 to the
extent not adjusted from any previous provision
or reserve.
Note 1-Information in respect of this item
should also be given in the balance sheet under
the relevant provision or reserve account.
Note 2. * * *
(g) Insurance.
(h) Rates and taxes, excluding taxes on income.
(i) Miscellaneous expenses:
Provided that any item under which the expenses
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 39 of 108
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 and 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.
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), 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), manager,
if any;
(ii) ***;
(iii) ***;
(iv) ***;
(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,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 40 of 108
(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), 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, whether as fees,
expenses or otherwise for services rendered-
(a) as auditor;
(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
4C. In the case of a 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.
Note 1.- 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 purpose 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;
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 41 of 108
(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 shareholders,
the number of shares held by them on 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.\024
\023AUDIT
Section 227. Powers and duties of auditors
(1) Every auditor of a company shall have a right of
access at all times to the books and accounts and
vouchers of the company, whether kept at the head
office of the company or elsewhere, and shall be
entitled to require from the officers of the company
such information and explanations as the auditor
may think necessary for the performance of his
duties as auditor.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 42 of 108
(lA) Without prejudice to the provisions of sub-
section (1), the auditor shall inquire-
(a) whether loans and advances made by the
company on the basis of security have been
properly secured and whether the terms on which
they have been made are not prejudicial to the
interest of the company or its members;
(b) whether transactions of the company which are
represented merely by book entries are not
prejudicial to the interests of the company;
(c) where the company is not an investment
company within the meaning of section 372 or a
banking company, whether so much of the assets of
the company as consist of shares, debentures and
other securities have been sold at a price less than
that at which they were purchased by the company;
(d) whether loans and advances made by the
company have been shown as deposits;
(e) whether personal expenses have been charged to
revenue account;
(f) where it is stated in the books and papers of the
company that any shares have been allotted for
cash, whether cash has actually been received in
respect of such allotment, and if no cash has
actually been so received, whether the position as
stated in the account books and the balance-sheet
is correct, regular and not misleading.
(2) The auditor shall make a report to the members
of the company on the accounts examined by him,
and on every balance-sheet and profit and loss
account and on every other document declared by
this Act to be part of or annexed to the balance-
sheet or profit and loss account which are laid
before the company in general meeting during his
tenure of office, and the report shall state whether,
in his opinion and to the best of his information and
according to the explanations given to him, the said
accounts give the information required by this Act
in the manner so required and give a true and fair
view-
(i) in the case of the balance-sheet, of the state of
the company's affairs as at the end of its financial
years; and
(ii) in the case of the profit and loss account, of the
profit or loss for its financial year.
(3) The auditor's report shall also state-
(a) whether he has obtained all the information and
explanations which to the best of his knowledge and
belief were necessary for the purposes of his audit;
(b) whether, in his opinion, proper books of account
as required by law have been kept by the company
so far as appears from his examination of those
books, and proper returns adequate for the
purposes of his audit have been received from
branches not visited by him;
(bb) whether the report on the accounts of any
branch office audited under section 228 by a person
other than the company's auditor has been awarded
to him as enquired by clause (c) of sub-section (3) of
that section and how he has dealt with the same in
preparing the auditor's report;
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 43 of 108
(c) whether the company's balance-sheet and profit
and loss account dealt with by the report are in
agreement with the books of account and returns;
(d) whether, in his opinion, the profit and loss
account and balance-sheet comply with the
accounting standards referred to in sub-section (3C)
of section 211;
(e) in thick type or in italics the observations or
comments of the auditors which have any adverse
effect on the functioning of the company;
(f) whether any director is disqualified from being
appointed as director under clause (g) of sub-
section (1) of section 274.
(g) whether the cess payable under section 441A
has been paid and if not, the details of amount of
cess not so paid.
(4) Where any of the matters referred to in clauses
(i) and (ii) of sub-section (2) or in clauses (a), (b),
(bb) (c) and (d)] of sub-section (3) is answered in the
negative or with a qualification, the auditor's report
shall state the reason for the answer.
(4A) The Central Government may, by general or
special order, direct that, in the case of such class
or description of companies as may be specified in
the order, the auditor's report shall also include a
statement on such matters as may be specified
therein:
Provided that before making any such order the
Central Government may consult the Institute of
Chartered Accountants of India constituted under
the Chartered Accountants Act, 1949 (38 of 1949),
in regard to the class or description of companies
and other ancillary matters proposed to be specified
therein unless the Government decides that such
consultation is not necessary or expedient in the
circumstances of the case.
(5) The accounts of a company shall not be deemed
as not having been, and the auditors report shall-
not state that those accounts have not been
properly drawn up on the ground merely that the
company had not disclosed certain matters if-
(a) those matters are such as the company is not
required to disclose by virtue of any provisions
contained in this or any other Act, and
(b) those provisions are specified in the balance-
sheet and profit and loss account of the company.\024
(emphasis supplied)
\023SCHEDULES, FORMS AND RULES
Section 641. Power to alter Schedules.
(1) Subject to the provisions of this section, the
Central Government may, by notification in the
Official Gazette, alter any of the regulations, rules,
tables, forms and other provisions contained in any
of the Schedules to this Act, except Schedules XI
and XII.
(2) Any alteration notified under sub-section (1)
shall have effect as if enacted in this Act and shall
come into force on the date of the notification,
unless the notification otherwise directs :
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 44 of 108
Provided that no such alteration in Table A of
Schedule I shall apply to any company registered
before the date of such alteration.
(3) Every alteration made by the Central
Government under sub-section (1) shall be laid as
soon as may be after it is made before each House
of Parliament while it is in session for a total period
of thirty days which may be comprised in one
session or in two or more successive sessions, and
if, before the expiry of the session immediately
following the session or the successive sessions
aforesaid, both Houses agree in making any
modification in the alteration, or both Houses agree
that the alteration should not be made, the
alteration shall thereafter have effect only in such
modified form or be of no effect, as the case may be,
so, however, that any such modification or
annulment shall be without prejudice to the validity
of anything previously done in pursuance of that
alteration.
Section 642. Power of Central Government to
make rules.
(1) In addition to the powers conferred by section
641, the Central Government may, by notification in
the Official Gazette, make rules-
(a) for all or any of the matters which by this
Act are to be, or may be, prescribed by the
Central Government; and
(b) generally to carry out the purposes of this
Act.
(2) Any rule made under sub-section (1) may
provide that a contravention thereof shall be
punishable with fine which may extend to five
thousand rupees and where the contravention is a
continuing one, with a further fine which may
extend to five hundred rupees for every day after the
first during which such contravention continues.
(3) Every rule made by the Central Government
under sub-section (1) shall be laid as soon as may
be after it is made before each House of Parliament
while it is in session for a total period of thirty days
which may be comprised in one session or in two or
more successive sessions, and if, before the expiry
of the session immediately following the session or
the successive sessions aforesaid, both Houses
agree in making any modification in the rule or both
Houses agree that the rule should not be made, the
rule shall thereafter have effect only in such
modified form or be of no effect, as the case may be,
so, however, that any such modification or
annulment shall be without prejudice to the validity
of anything previously done under that rule.
(4) Every regulation made by the Securities and
Exchange Board of India under this Act shall be
laid, as soon as may be after it is made, before each
House of Parliament, while it is in session, for a
total period of thirty days which may be comprised
in one session or in two or more successive
sessions, and if, before the expiry of the session
immediately following the session or the successive
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 45 of 108
sessions aforesaid, both Houses agree in making
any modification in the regulation or both Houses
agree that the regulation should not be made, the
regulation shall thereafter have effect only in such
modified form or be of no effect, as the case may be;
so however, that any such modification or
annulment shall be without prejudice to the validity
of anything previously done under that regulation.\024
12. Analysing the above provisions of the Companies Act the
position is that at every AGM of a company the Board of Directors
is required to place before it a balance-sheet and a P&L a/c for
the financial year. Section 210 of the Companies Act requires a
company to place before AGM, a balance-sheet and a P&L a/c for
the relevant period. The function of a balance-sheet is to show
the share capital, reserves and liabilities of the company at the
date on which it is prepared and the manner in which the total
moneys representing them are distributed over several types of
assets. A balance-sheet is a historical document. As a general
rule it does not show the net worth of an undertaking at any
particular date. It does not show the present realizable value of
goodwill, land, plant and machinery etc. It also does not show
the realizable value of stock-in-trade, except in cases where the
realizable value of stock-in-trade is less than cost. Therefore, it
cannot be said that the balance-sheet shows the true financial
position.
13. Section 210A was inserted by Companies (Amendment) Act,
1999 with effect from 31.10.98 to provide for constitution of
National Advisory Committee (NAC) on Accounting Standards.
The said NAC was constituted to advice the Central Government
on the formation and laying down of accounting policies and
Accounting Standards for adoption by companies or class of
companies. The accounting policies and Accounting Standards
were required to be prescribed by the Central Government as
contemplated by Section 2(33). The object behind Section 210A
was to make it obligatory on the part of the companies to comply
with the Accounting Standards. NAC was constituted vide
Notification dated 18.9.03. Under Section 211(3C) it is provided,
that till such time the Accounting Standards are prescribed by
the Central Government in consultation with NAC on Accounting
Standards; the Accounting Standards prescribed by the Institute
shall be deemed to be the Accounting Standards to be complied
with by all the companies. In all, the Institute has so far framed
29 Accounting Standards.
14. Section 211(1) requires the balance-sheet to be in the form
set out in Part I of Schedule VI \023or as near thereto as
circumstances admit\024. The said phrase \023or as near thereto as
circumstances admit\024 allows adoption of improved techniques in
the presentation of accounts to shareholders. It is important to
note that the information which is required to be given to
shareholders pursuant to Schedule VI should be given in a
manner which they will understand and which must give a true
and fair view of the company\022s affairs as also it must give a
proper picture of the company\022s profits(losses) for the relevant
year.
15. By Companies (Amendment) Act, 1999, sub-sections (3A),
(3B) and (3C) as well as a proviso thereto stood inserted in
Section 211 of the Companies Act w.e.f. 31.10.98 in order to
provide for compliance of Accounting Standards by companies in
the preparation of P&L a/c and balance-sheet. By virtue of the
said amendment, Accounting Standards are required to be
prescribed by the Central Government in consultation with the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 46 of 108
NAC established under Section 210A. Until the NAC is
established and Accounting Standards are prescribed by the
Central Government, the Accounting Standards specified by the
Institute shall be followed by all the companies. In the present
case, the NAC has been established. In the present case, by the
impugned notification dated 7.12.06, the Accounting Standards
have been prescribed by the Central Government. In the present
case, by the impugned notification, AS 22 earlier specified by the
Institute has been adopted by the Central Government in the
form of a Rule. Therefore, vide the impugned notification, AS 22
stands prescribed by the Central Government in consultation
with NAC which has been established under Section 210A of the
Companies Act. It is made clear that the Accounting Standards
prescribed by the Central Government in consultation with NAC
need not be identical with the Accounting Standards specified by
the Institute. In the present case, the impugned notification
indicates that the Central Government has been given the
authority to enact a Rule and accordingly the rule-making
authority, namely, the Central Government has prescribed the
Accounting Standard No.22 in consultation with NAC by adopting
AS 22 originally specified by the Institute.
16. Under Section 211(1) every balance-sheet of a company has
to comply with the following requirements:
(i) It must give true and fair view of the affairs of the
company at the end of the financial year;
(ii) it must be in the form set out in Part I of Schedule VI
or as near thereto as circumstances admit; and
(iii) it must give regard to the general instructions for
preparation of balance-sheet under the heading
\023Notes\024.
17. Similarly, Section 211(2) of the Companies Act requires that
every P&L a/c of a company must give a true and fair view of the
profit or loss of the company for the financial year and comply
with the requirements of Part II of Schedule VI so far as they are
applicable thereto. It may be noted that the balance-sheet
prescribed by Part I of Schedule VI has to be in the form of a
proforma. However, the Companies Act does not prescribe a
proforma of P&L a/c. Part I of Schedule VI prescribes a proforma
of balance-sheet. Part II of Schedule VI only prescribes the
particulars which must be furnished in the P&L a/c. Therefore,
as far as possible, the P&L a/c must be drawn up according to
the requirements of Part II of Schedule VI. It is important to note
that Section 211 read with Part I and Part II of Schedule VI
prescribes the form and contents of balance-sheet and P&L a/c.
However, Section 211(1), inter alia, states that every balance-
sheet of a company shall subject to the provisions of that section,
be in the form set out in Part I of Schedule VI. The words
\023subject to the provisions of this section\024 would mean that every
sub-section following sub-section (1) including sub-sections (3A),
(3B) and (3C) shall have an overriding effect and consequently
every P&L a/c and balance-sheet shall comply with the
Accounting Standards. Therefore, implementation of the
Accounting Standards and their compliance are made
compulsory and mandatory by the aforestated sub-sections (3A),
(3B) and (3C). The insertion of the concept of \023true and fair view\024
in place of \023true and correct\024 has been made to do away with the
view that accounts should disclose arithmetically accuracy.
Adherence to the disclosure requirements as per Schedule VI is
subservient to the overriding requirement of \023true and fair view\024
as regards the state of affairs. Therefore, the annual financial
statements should convey an overall fair view and should not give
any misleading information or impression. All the relevant
information should be disclosed in the balance-sheet and the
P&L a/c in such a manner that the financial position and the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 47 of 108
working results are shown as they are. There should be neither
an overstatement nor an understatement. Further, the
information to be disclosed should be in consonance with the
fundamental accounting assumptions and commonly accepted
accounting policies. Therefore, failure to make provision for
taxation would not disclose true and fair view of the state of
affairs. Non-compliance for taxation would, therefore, amount to
contravention of Sections 209 and 211 of the Companies Act.
Accordingly, it is necessary for the auditor to qualify in his report,
and such qualification should bring out in what manner the
accounts do not disclose a true and fair view of the state of affairs
of the company as well as the profit/loss of the company. Several
Accounting Standards prescribed by the Institute have been
made mandatory. The Institute has, however, clarified that the
expression \023mandatory in nature\024 implies that while discharging
their functions, it will be the duty of the Chartered Accountants
who are members of the Institute to examine whether the said
Accounting Standard has been complied with in the presentation
of financial statements covered by their audit (See: Section
227(3)(d)). In this regard it may be noted that under Section
227(3)(d) it is the duty of the auditor, to state in his audit report
whether the P&L a/c and the balance-sheet complies with the
Accounting Standards referred to in Section 211(3C). Before
introduction of sub-sections (3A), (3B) and (3C) in Section 211
(w.e.f. 31.10.98), these Standards were not mandatory.
Therefore, the companies were then free to prepare their annual
financial statements, as per the specific requirements of Section
211 read with Schedule VI. However, with the insertion of sub-
sections (3A), (3B) and (3C) in Section 211 the P&L a/c and the
balance-sheet have to comply with the Accounting Standards.
For this purpose the expression \023Accounting Standards\024 shall
mean the standards of accounting recommended by the Institute
as may be prescribed by the Central Government in consultation
with NAC on Accounting Standards. Thus, the Accounting
Standards are prescribed by the Central Government. Thus, the
Accounting Standards prescribed by the Central Government are
now mandatory qua the companies and non-compliance with
these Standards would lead to violation of Section 211 inasmuch
as the annual accounts may then not be regarded as showing a
\023true and fair view\024.
18. Section 641 empowers the Central Government to alter any
of the regulations, rules, tables, forms and other provisions
contained in Schedule VI to the Companies Act. However, this
power can be used only for making simple alterations which will
not affect the legislative policies enshrined in the Companies Act.
19. Section 642 refers to the powers of the Central Government
to make rules. It states that in addition to the powers
conferred by Section 641, the Central Government may, by
notification in the official gazette, make rules for all or any of the
matters which by the Companies Act are to be prescribed by the
Central Government and to carry out the purposes of the
Companies Act. Therefore, Section 641 and Section 642 form
part of the same scheme. Under Section 642, the Central
Government exercises power of delegated legislation by
prescribing rules. Under various provisions of the Act, Rules are
to be prescribed. Rules can also be prescribed vide clause (b) to
Section 642(1) to carry out the purposes of the Act.
20. In exercise of the powers conferred by clause (a) to sub-
section (1) of Section 642 of the Companies Act read with sub-
section (3C) of Section 211 and Section 210A(1), the Central
Government in consultation with NAC on Accounting Standards
has made the following Rules vide the impugned notification
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 48 of 108
dated 7.12.06. The said Rules are called as the Companies
(Accounting Standards) Rules, 2006. We quote hereinbelow the
said impugned notification in entirety together with annexures:
\023Ministry of Company Affairs
NOTIFICATION
New Delhi, the 7th December, 2006
ACCOUNTING STANDARDS
G.S.R. 739 (E). \026 In exercise of the powers conferred by clause (a) of
sub-section (1) of section 642 of the Companies Act, 1956 (1 of 1956),
read with sub-section (3C) of section 211 and sub-section (1) of section
210A of the said Act, the Central Government, in consultation with
National Advisory Committee on Accounting Standards, hereby makes the
following rules, namely:-
1. Short title and commencement.-
1. These rules may be called the Companies (Accounting
Standards) Rules, 2006.
2. They shall come into force on the date of their publication in
the Official Gazette.
2. Definitions.- In these rules, unless the context otherwise
requires,-
a. \023Accounting Standards\024 means the Accounting Standards as
specified in rule 3 of these rules;
b. \023Act\024 means the Companies Act, 1956 (1 of 1956);
c. \023Annexure\024 means an Annexure to these rules;
d. \023General Purpose Financial Statements\024 include balance
sheet, statement of profit and loss, cash flow statement
(wherever applicable), and other statements and
explanatory notes which form part thereof.
e. \023Enterprise\024 means a company as defined in section 3 of the
Companies Act, 1956.
f. \023Small and Medium Sized Company\024 (SMC) means, a
company-
i. whose equity or debt securities are not listed or are
not in the process of listing on any stock exchange,
whether in India or outside India;
ii. which is not a bank, financial institution or an
insurance company;
iii. whose turnover (excluding other income) does not
exceed rupees fifty crore in the immediately preceding
accounting year;
iv. which does not have borrowings (including public
deposits) in excess of rupees ten crore at any time
during the immediately preceding accounting year;
and
v. which is not a holding or subsidiary company of a
company which is not a small and medium-sized
company.
Explanation: For the purposes of clause (f), a company
shall qualify as a Small and Medium Sized Company, if the
conditions mentioned therein are satisfied as at the end of
the relevant accounting period.
(2) Words and expressions used herein and not defined in
these rules but defined in the Act shall have the same
meaning respectively assigned to them in the Act.
3. Accounting Standards.-
(1) The Central Government hereby prescribes Accounting
Standards 1 to 7 and 9 to 29 as recommended by the
Institute of Chartered Accountants of India, which are
specified in the Annexure to these rules.
(2) The Accounting Standards shall come into
effect in respect of accounting periods commencing on or
after the publication of these Accounting Standards.
1. Obligation to comply with the Accounting Standards.-
(1) Every company and its auditor(s)shall comply with the
Accounting Standards in the manner specified in Annexure to
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 49 of 108
these rules.
(2) The Accounting Standards shall be applied in the preparation
of General Purpose Financial Statements.
2. An existing company, which was previously not a Small and
Medium Sized Company (SMC) and subsequently becomes an SMC,
shall not be qualified for exemption or relaxation in respect of
Accounting Standards available to an SMC until the company
remains an SMC for two consecutive accounting periods.
[No. 1/3/2006/CL-V]
JITESH KHOSLA, Jt. Secy.
ANNEXURE
(See rule 3)
ACCOUNTING STANDARDS
General Instructions
1. SMCs shall follow the following instructions while complying
with Accounting Standards under these rules:-
1.1 the SMC which does not disclose certain information
pursuant to the exemptions or relaxations given to it
shall disclose (by way of a note to its financial
statements) the fact that it is an SMC and has complied
with the Accounting Standards insofar as they are
applicable to an SMC on the following lines:
\023The Company is a Small and Medium Sized Company
(SMC) as defined in the General Instructions in respect
of Accounting Standards notified under the Companies
Act, 1956. Accordingly, the Company has complied with
the Accounting Standards as applicable to a Small and
Medium Sized Company.\024
1.2 Where a company, being a SMC, has qualified for any
exemption or relaxation previously but no longer
qualifies for the relevant exemption or relaxation in the
current accounting period, the relevant standards or
requirements become applicable from the current period
and the figures for the corresponding period of the
previous accounting period need not be revised merely
by reason of its having ceased to be an SMC. The fact
that the company was an SMC in the previous period
and it had availed of the exemptions or relaxations
available to SMCs shall be disclosed in the notes to the
financial statements.
1.3 If an SMC opts not to avail of the exemptions or
relaxations available to an SMC in respect of any but not
all of the Accounting Standards, it shall disclose the
standard(s) in respect of which it has availed the
exemption or relaxation.
1.4 If an SMC desires to disclose the information not
required to be disclosed pursuant to the exemptions or
relaxations available to the SMCs, it shall disclose that
information in compliance with the relevant accounting
standard.
1.5 The SMC may opt for availing certain exemptions or
relaxations from compliance with the require ments
prescribed in an Accounting Standard:
Provided that such a partial exemption or
relaxation and disclosure shall not be permitted to
mislead any person or public.
2. Accounting Standards, which are prescribed, are intended to be
in conformity with the provisions of applicable laws. However, if
due to subsequent amendments in the law, a particular
accounting standard 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.
3. Accounting Standards are intended to apply only to items which
are material.
4. The accounting standards include paragraphs set in bold italic
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 50 of 108
type and plain type, which have equal authority. Paragraphs in
bold italic type indicate the main principles. An individual
accounting standard shall be read in the context of the
objective, if stated, in that accounting standard and in
accordance with these General Instructions.
Accounting Standard (AS) 22
Accounting for Taxes on Income
(This Accounting Standard includes paragraphs set in bold italic type and plain type, which
have
equal authority. Paragraphs in bold italic type indicate the main principles. This Accountin
g
Standard should be read in the context of its objective and the General Instructions contain
ed in
part A of the Annexure to the Notification.)
Objective
The objective of this Standard is to prescribe accounting treatment for taxes on income. Tax
es on
income is one of the significant items in the statement of profit and loss of an enterprise.
In
accordance with the matching concept, taxes on income are accrued in the same period as the
revenue and expenses to which they relate. Matching of such taxes against revenue for a peri
od
poses special problems arising from the fact that in a number of cases, taxable income may b
e
significantly different from the accounting income. This divergence between taxable income a
nd
accounting income arises due to two main reasons. Firstly, there are differences between ite
ms of
revenue and expenses as appearing in the statement of profit and loss and the items which ar
e
considered as revenue, expenses or deductions for tax purposes. Secondly, there are differen
ces
between the amount in respect of a particular item of revenue or expense as recognised in th
e
statement of profit and loss and
Scope
1. This Standard should be applied in accounting for taxes on income. This includes the
determination of the amount of the expense or savingrelated to taxes on income in respect of
an
accounting period and the disclosure of such an amount in the financial statements.
2. For the purposes of this Standard, taxes on income include all domestic and foreign taxes
which
are based on taxable income.
3. This Standard does not specify when, or how, an enterprise should account for taxes that
are
payable on distribution of dividends and other distributions made by the enterprise.
Definitions
4. For the purpose of this Standard, the following terms are used with the meanings specifie
d:
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 51 of 108
4.1 Accounting income (loss) is the net profit or loss for a period, as reported in the stat
ement of
profit and loss, before deducting income tax expense or adding income tax saving.
4.2 Taxable income (tax loss) is the amount of the income (loss) for a period, determined in
accordance with the tax laws, based upon which income tax payable (recoverable) is determine
d.
4.3 Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or cre
dited
to the statement of profit and loss for the period.
4.4 Current tax is the amount of income tax determined to be payable (recoverable) in respec
t of
the taxable income (tax loss) for a period
.
4.5 Deferred tax is the tax effect of timing differences.
4.6 Timing differences are the differences between taxable income and accounting income for
a
period that originate in one period and are capable of reversal in one or more subsequent
periods.
4.7 Permanent differences are the differences between taxable income and accounting income f
or
a period that originate in one period and do not reverse subsequently.
5. Taxable income is calculated in accordance with tax laws. In some circumstances, the
requirements of these laws to compute taxable income differ from the accounting policies app
lied
to determine accounting income. The effect of this difference is that the taxable income and
accounting income may not be the same.
6. The differences between taxable income and accounting income can be classified into
permanent differences and timing differences. Permanent differences are those differences
between taxable income and accounting income which originate in one period and do not revers
e
subsequently. For instance, if for the purpose of computing taxable income, the tax laws all
ow
only a part of an item of expenditure, the disallowed amount would result in a permanent
difference.
7. Timing differences are those differences between taxable income and accounting income for
a
period that originate in one period and are capable of reversal in one or more subsequent pe
riods.
Timing differences arise because the period in which some items of revenue and expenses are
included in taxable income do not coincide with the period in which such items of revenue an
d
expenses are included or considered in arriving at accounting income. For example, machinery
purchased for scientific research related to business is fully allowed as deduction in the f
irst year
for tax purposes whereas the same would be charged to the statement of profit and loss as
depreciation over its useful life. The total depreciation charged on the machinery for accou
nting
purposes and the amount allowed as deduction for tax purposes will ultimately be the same, b
ut
periods over which the depreciation is charged and the deduction is allowed will differ. Ano
ther
example of timing difference is a situation where, for the purpose of computing taxable inco
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 52 of 108
me,
tax laws allow depreciation on the basis of the written down value method, whereas for accou
nting
purposes, straight line method is used. Some other examples of timing differences arising un
der
the Indian tax laws are given in Illustration I.
8. Unabsorbed depreciation and carry forward of losses which can be setoff against future ta
xable
income are also considered as timing differences and result in deferred tax assets, subject
to
consideration of prudence (see paragraphs 15-18).
Recognition
9. Tax expense for the period, comprising current tax and deferred tax, should be included i
n
the determination of the net profit or loss for the period.
10. Taxes on income are considered to be an expense incurred by the enterprise in earning in
come
and are accrued in the same period as the revenue and expenses to which they relate. Such
matching may result into timing differences. The tax effects of timing differences are inclu
ded in
the tax expense in the statement of profit and loss and as deferred tax assets (subject to t
he
consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, in
the
balance sheet.
11. An example of tax effect of a timing difference that results in a deferred tax asset is
an expense
provided in the statement of profit and loss but not allowed as a deduction under Section 43
B of
the Income-tax Act, 1961. This timing difference will reverse when the deduction of that exp
ense
is allowed under Section 43B in subsequent year(s). An example of tax effect of a timing
difference resulting in a deferred tax liability is the higher charge of depreciation allowa
ble under
the Income-tax Act, 1961, compared to the depreciation provided in the statement of profit a
nd
loss. In subsequent years, the differential will reverse when comparatively lower depreciati
on will
be allowed for tax purposes.
12. Permanent differences do not result in deferred tax assets or deferred tax liabilities.
13. Deferred tax should be recognised for all the timing differences, subject to the conside
ration of
prudence in respect of deferred tax assets as set out in paragraphs 15-18.
Explanation:
(a) The deferred tax in respect of timing differences which reverse during the tax holiday p
eriod is
not recognised to the extent the enterprise\022s gross total income is subject to the deduct
ion during
the tax holiday period as per the requirements of sections 80-IA/80 IB of the Income-tax Act
,
1961 (hereinafter referred to as the \021Act\022). In case of sections 10A/10B of the Act (c
overed under
Chapter III of the Act dealing with incomes which do not form part of total income), the def
erred
tax in respect of timing differences which reverse during the tax holiday period is not reco
gnised
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 53 of 108
to the extent deduction from the total income of an enterprise is allowed during the tax hol
iday
period as per the provisions of the said sections.
(b) Deferred tax in respect of timing differences which reverse after the tax holiday period
is
recognised in the year in which the timing differences originate. However, recognition of de
ferred
tax assets is subject to the consideration of prudence as laid down in paragraphs 15 to 18.
(c) For the above purposes, the timing differences which originate first are considered to r
everse
first.
The application of the above explanation is illustrated in the Illustration attached to the
Standard.
14. This Standard requires recognition of deferred tax for all the timing differences. This
is based
on the principle that the financial statements for a period should recognise the tax effect,
whether
current or deferred, of all the transactions occurring in that period.
15. Except in the situations stated in paragraph 17, deferred tax assets should be recognise
d and
carried forward only to the extent that there is a reasonable certainty that sufficient futu
re taxable
income will be available against which such deferred tax assets can be realised.
16. While recognising the tax effect of timing differences, consideration of prudence cannot
be
ignored. Therefore, deferred tax assets are recognised and carried forward only to the exten
t that
there is a reasonable certainty of their realisation. This reasonable level of certainty wou
ld
normally be achieved by examining the past record of the enterprise and by making realistic
estimates of profits for the future.
17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax law
s,
deferred tax assets should be recognised only to the extent that there is virtual certainty
supported
by convincing evidence that sufficient future taxable income will be available against which
such
deferred tax assets can be realised.
Explanation:
1. Determination of virtual certainty that sufficient future taxable income will be availabl
e is a
matter of judgement based on convincing evidence and will have to be evaluated on a case to
case
basis. Virtual certainty refers to the extent of certainty, which, for all practical purpose
s, can be
considered certain. Virtual certainty cannot be based merely on forecasts of performance suc
h as
business plans. Virtual certainty is not a matter of perception and is to be supported by co
nvincing
evidence. Evidence is a matter of fact. To be convincing, the evidence should be available a
t the
reporting date in a concrete form, for example, a profitable binding export order, cancellat
ion of
which will result in payment of heavy damages by the defaulting party. On the other hand, a
projection of the future profits made by an enterprise based on the future capital expenditu
res or
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 54 of 108
future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for
obtaining
loans and accepted by that agency cannot, in isolation, be considered as convincing evidence
.
2(a) Asper the relevant provisionsof the Income-taxAct, 1961 (hereinafter referred to as the
\021Act\022),
the \021loss\022 arising under the head \021Capital gains\022 can be carried forward and set
-off in future years,
only against the income arising under that head as per the requirements of the Act.
(b) Where an enterprise\022s statement of profit and loss includes an item of \021loss\022wh
ich can be set-
off in future for taxation purposes, only against the income arising under the head \021Capi
tal gains\022
as per the requirements of the Act, that item is a timing difference to the extent it is not
set-off in
the current year and is allowed to be set-off against the income arising under the head \021
Capital
gains\022 in subsequent years subject to the provisions of the Act. In respect of such \021l
oss\022, deferred
tax asset is recognised and carried forward subject to the consideration of prudence. Accord
ingly,
in respect of such \021loss\022, deferred tax asset is recognised and carried forward only t
o the extent
that there is a virtual certainty, supported by convincing evidence, that sufficient future
taxable
income will be available under the head \021Capital gains\022 against which the loss can be
set-off as per
the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would d
epend on
the facts and circumstances of each case. The examples of situations in which the test of vi
rtual
certainty, supported by convincing evidence, for the purposes of the recognition of deferred
tax
asset in respect of loss arising under the head \021Capital gains\022 is normally fulfilled,
are sale of an
asset giving rise to capital gain (eligible to set-off the capital loss as per the provision
s of the Act)
after the balance sheet date but before the financial statements are approved, and binding s
ale
agreement which will give rise to capital gain (eligible to set-off the capital loss as per
the
provisions of the Act).
(c) In cases where there is a difference between the amounts of \021loss\022 recognised for
accounting
purposes and tax purposes because of cost indexation under the Act in respect of long-term c
apital
assets, the deferred tax asset is recognised and carried forward (subject to the considerati
on of
prudence) on the amount which can be carried forward and set-off in future years as per the
provisions of the Act.
18. The existence of unabsorbed depreciation or carry forward of losses under tax laws is st
rong
evidence that future taxable income may not be available. Therefore, when an enterprise has
a
history of recent losses, the enterprise recognises deferred tax assets only to the extent t
hat it has
timing differences the reversal of which will result in sufficient income or there is other
convincing evidence that sufficient taxable income will be available against which such defe
rred
tax assets can be realised. In such circumstances, the nature of the evidence supporting its
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 55 of 108
recognition is disclosed.
Re-assessment of Unrecognised Deferred Tax Assets
19. At each balance sheet date, an enterprise re-assesses unrecognised deferred tax assets.
The
enterprise recognises previously unrecognised deferred tax assets to the extent that it has
become
reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that
sufficient
future taxable income will be available against which such deferred tax assets can be realis
ed. For
example, an improvement in trading conditions may make it reasonably certain that the enterp
rise
will be able to generate sufficient taxable income in the future.
Measurement
20. Current tax should be measured at the amount expected to be paid to (recovered from) the
taxation authorities, using the applicable tax rates and tax laws.
21. Deferred tax assets and liabilities should be measured using the tax rates and tax laws
that
have been enacted or substantively enacted by the balance sheet date.
Explanation:
(a) The payment of tax under section 115JB of the Income-tax Act, 1961 (hereinafter referred
to
as the \021Act\022) is a current tax for the period.
(b) In a period in which a company pays tax under section 115JB of the Act, the deferred tax
assets and liabilities in respect of timing differences arising during the period, tax effec
t of which
is required to be recognised under this Standard, is measured using the regular tax rates an
d not
the tax rate under section 115JB of the Act.
(c) In case an enterprise expects that the timing differences arising in the current period
would
reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax
assets
and liabilities in respect of timing differences arising during the current period, tax effe
ct of which
is required to be recognised under AS 22, is measured using the regular tax rates and not th
e tax
rate under section 115JB of the Act.
22. Deferred tax assets and liabilities are usually measured using the tax rates and tax law
s that
have been enacted. However, certain announcements of tax rates and tax laws by the governmen
t
may have the substantive effect of actual enactment. In these circumstances, deferred tax as
sets
and liabilities are measured using such announced tax rate and tax laws.
23. When different tax rates apply to different levels of taxable income, deferred tax asset
s and
liabilities are measured using average rates.
24. Deferred tax assets and liabilities should not be discounted to their present value.
25. The reliable determination of deferred tax assets and liabilities on a discounted basis
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 56 of 108
requires
detailed scheduling of the timing of the reversal of each timing difference. In a number of
cases
such scheduling is impracticable or highly complex. Therefore, it is inappropriate to requir
e
discounting of deferred tax assets and liabilities. To permit, but not to require, discounti
ng would
result in deferred tax assets and liabilities which would not be comparable between enterpri
ses.
Therefore, this Standard does not require or permit the discounting of deferred tax assets a
nd
liabilities.
Review of Deferred Tax Assets
26. The carrying amount of deferred tax assets should be reviewed at each balance sheet date
. An
enterprise should write-down the carrying amount of a deferred tax asset to the extent that
it is no
longer reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18)
, that
sufficient future taxable income will be available against which deferred tax asset can be r
ealised.
Any such write-down may be reversed to the extent that it becomes reasonably certain or virt
ually
certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income
will be
available.
Presentation and Disclosure
27. An enterprise should offset assets and liabilities representing current tax if the enter
prise:
(a) has a legally enforceable right to set off the recognised amounts; and
(b) intends to settle the asset and the liability on a net basis.
28. An enterprise will normally have a legally enforceable right to set off an asset and lia
bility
representing current tax when they relate to income taxes levied under the same governing
taxation laws and the taxation laws permit the enterprise to make or receive a single net pa
yment.
29. An enterprise should offset deferred tax assets and deferred tax liabilities if:
(a) the enterprise has a legally enforceable right to set off assets against liabilities
representing current tax; and
(b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levie
d
by the same governing taxation laws.
30. Deferred tax assets and liabilities should be distinguished from assets and liabilities
representing current tax for the period. Deferred tax assets and liabilities should be discl
osed
under a separate heading in the balance sheet of the enterprise, separately from current ass
ets and
current liabilities.
Explanation:
Deferred tax assets (net of the deferred tax liabilities, if any, in accordance with paragra
ph 29) is
disclosed on the face of the balance sheet separately after the head \021Investments\022 and
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 57 of 108
deferred tax
liabilities (net of the deferred tax assets, if any, in accordance with paragraph 29) is dis
closed on
the face of the balance sheet separately after the head \021Unsecured Loans\022.
31. The break-up of deferred tax assets and deferred tax liabilities into major components o
f the
respective balances should be disclosed in the notes to accounts.
32. The nature of the evidence supporting the recognition of deferred tax assets should be
disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax
laws.
Transitional Provisions
33. On the first occasion that the taxes on income are accounted for in accordance with this
Standard, the enterprise should recognise, in the financial statements, the deferred tax bal
ance that
has accumulated prior to the adoption of this Standard as deferred tax asset/liability with
a
corresponding credit/charge to the revenue reserves, subject to the consideration of prudenc
e in
case of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the re
venue
reserves should be the same as that which would have resulted if this Standard had been in e
ffect
from the beginning.
34. For the purpose of determining accumulated deferred tax in the period in which this Stan
dard
is applied for the first time, the opening balances of assets and liabilities for accounting
purposes
and for tax purposes are compared and the differences, if any, are determined. The tax effec
ts of
these differences, if any, should be recognised as deferred tax assets or liabilities, if th
ese
differences are timing differences. For example, in the year in which an enterprise adopts t
his
Standard, the opening balance of a fixed asset is Rs. 100 for accounting purposes and Rs. 60
for
tax purposes. The difference is because the enterprise applies written down value method of
depreciation for calculating taxable income whereas for accounting purposes straight line me
thod
is used. This difference will reverse in future when depreciation for tax purposes will be l
ower as
compared to the depreciation for accounting purposes. In the above case, assuming that enact
ed
tax rate for the year is 40% and that there are no other timing differences, deferred tax li
ability of
Rs. 16 [(Rs. 100 - Rs. 60) x 40%] would be recognised. Another example is an expenditure tha
t
has already been written off for accounting purposes in the year of its incurrance but is al
lowable
for tax purposes over a period of time. In this case, the asset representing that expenditur
e would
have a balance only for tax purposes but not for accounting purposes. The difference between
balance of the asset for tax purposes and the balance (which is nil) for accounting purposes
would
be a timing difference which will reverse in future when this expenditure would be allowed f
or tax
purposes. Therefore, a deferred tax asset would be recognised in respect of this difference
subject
to the consideration of prudence (see paragraphs 15 - 18).
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 58 of 108
Submissions
21. Dr. D. Pal, learned senior counsel appearing on behalf of
M/s. Simplex Infrastructures Ltd. and Anr., submitted that
under para 9 of AS 22 tax expense for the period, comprising
current tax and deferred tax, is now required to be included in
the determination of net profit (loss) for that period. That,
deferred tax is now defined under the said AS 22 to mean the tax
effect of timing differences. Timing difference in turn is defined to
mean the difference between the taxable income and the
accounting income for a period that originates in one period and
is capable of reversal in one or more subsequent periods.
Therefore, DTL along with current tax liability (CTL) are now
required to be included in the determination of the net profit
(loss) for the period. This inclusion of DTL along with CTL in the
determination of the net profit (loss), according to learned
counsel, is repugnant to Part II of clause 3(vi) of Schedule VI to
the Companies Act. In this connection, learned counsel urged
that under the said Part II only the tax liability of the relevant
accounting year can be charged to P&L a/c. Therefore, clause 9,
insofar as it provides for the inclusion of DTL in the
determination of the net profit (loss) is contrary to and
inconsistent with Part II of clause 3(vi) of Schedule VI. According
to the learned counsel, DTL as an element of P&L a/c is not
mentioned in the form prescribed for the balance-sheet or the
P&L a/c but it is made substantive provision by para 9 by
making it a charge on the P&L a/c and thus resulting in
enhancement of tax liability for the year.
22. Learned counsel further contended that Section 211(1) of
the Companies Act lays down that every balance-sheet of a
company shall give a true and fair view of the state of affairs of
the company at the end of the financial year and shall subject to
the provisions of the said 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. According to learned counsel, Section 211(1) of the
Companies Act should be read with the proviso which inter alia
provides that nothing contained in Section 211(1) shall apply to
insurance company, banking company, electricity company etc.
for which a separate balance-sheet has been specified in the
Companies Act. Therefore, according to learned counsel, what is
contemplated by the expression \023subject to the provisions of
Section 211\024 is that where there is inconsistency or conflict
between the other provisions of Section 211, the other provision
will prevail as there are circumstances when insurance and
banking company or any company for which a form or balance-
sheet has been specified under the Act. Therefore, according to
learned counsel, because Section 211 is subject to the said
provision, the provision contained in the proviso shall apply
whenever there is any inconsistency or conflict between Section
211(1) and the proviso.
23. Learned counsel next contended that the impugned rule has
been framed in exercise of power under Section 642 of the
Companies Act. Therefore, Accounting Standard has been
prescribed by the rules framed under that Section. The rules so
framed are placed before the Parliament. However, Section
642(1) has not the effect as if it is enacted in the Act. That, on
the other hand, under Section 641(1) the Central Government
has been given the power to alter any of the existing regulations,
rules, tables or forms or any of the schedules to the Act including
Schedule VI. Therefore, any alteration notified in Section 641(1)
has the effect as if enacted in the Act and shall come into force on
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 59 of 108
the date of the notification unless the notification otherwise
directs. These rules are also required to be placed before the
Parliament. Therefore, Schedule VI can be amended or altered by
a notification issued under Section 641(1) of the Companies Act.
If Schedule VI is not altered or amended in exercise of power
under Section 641(1) of the said Act, then, Schedule VI being part
of the Act, the rule adopting the AS under Section 642(1) of the
Act cannot modify or amend the provisions of Schedule VI to the
Companies Act. In this connection, learned counsel urged that
AS 22 has now been prescribed by the rules framed under
Section 641(1) of the Companies Act. That, it runs counter to or
inconsistent with Schedule VI to the Companies Act and
consequently it amounts to excessive exercise of the powers
conferred under Section 211 read with Section 642(1) of the
Companies Act as well as in excess of the provisions of Sections
209, 211 and Schedule VI to the Companies Act and is ultra vires
the said Act. In other words, learned counsel submitted that
Section 641 empowers the Central Government to amend
Schedule VI but Section 642 does not confer any such power.
According to the learned counsel, if Schedule VI is amended
under Section 641 the amendment will have the effect as if
enacted in the Act and the schedule so amended under Section
641 of the Act becomes part of the Act but that is not the case
where AS is prescribed by the rules under Section 641(1) of the
Act. Learned counsel, therefore, submitted that Accounting
Standard, as prescribed by the rules under Section 642(1) of the
Act run contrary to or being inconsistent with Schedule VI of the
Companies Act without any amendment being made under
Section 641(1) of the Act. According to the learned counsel, rules
framed under Section 642(1) of the Act do not have any effect as
if enacted in the Companies Act; that, the effect of amendment of
schedule under Section 641 is as if enacted in the Act but rules
framed under Section 642 do not have that effect. Therefore, the
effect of the notifications under Section 641 on the one hand and
the notifications issued under Section 642 on the other hand is
entirely different. According to learned counsel, so long as
Schedule VI to the Companies Act is not altered or amended by
exercising the power under Section 641(1) of the Act the AS
prescribed by the rules notified under Section 642(1) cannot alter
or amend Schedule VI and if the said rules are contrary to or
inconsistent with Schedule VI then the same are liable to be
struck down as inconsistent with the provisions of the
Companies Act.
24. Learned counsel further submitted that in any case the
requirement of maintaining accounts on accrual basis and on
double entry system of accounting as required under Section 209
of the Companies Act is mandatory and it is not subject to any
provisions of Section 211 of the Companies Act. Therefore,
according to learned counsel, the rule prescribing AS 22 under
Section 642(1) is not only contrary to and inconsistent with
Section 209 but also with Schedule VI to the Companies Act
insofar as it requires the DTL to be included in the determination
of net profit (loss) for the current year. That, it is in excess of the
provisions of Section 209 and Schedule VI to the Companies Act.
According to the learned counsel, if the accounts are to be
maintained on accrual basis, DTL cannot be considered as an
accrued liability. That, the requirements of giving true and fair
view can be made only on accrual basis and on double entry
system of accounting. However, if DTL is a notional and
contingent liability, it cannot be charged to the P&L a/c. It can
only be disclosed by way of a Note in the balance-sheet and P&L
a/c which will give a true and fair view of the state of affairs of
the company.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 60 of 108
25. Lastly, learned counsel submitted that clause 33 of AS 22
gives a retrospective effect to the transactions which have taken
place much earlier and in respect of which the DTL is to be
calculated as if the said AS 22 has been in effect from the
beginning and the entire amount of such DTL is now required to
be provided for in the opening balance of the year in which AS 22
has been given effect to i.e. in the year 2001.
26. Mr. Arvind P. Datar, learned senior counsel appearing on
behalf of M/s. First Leasing Company of India Ltd., submitted
that AS 22 is a subordinate legislation. It cannot be contrary to
the provisions of the parent Act, namely, Companies Act, 1956
and, in particular, Sections 205, 209, Schedule VI and Schedule
XIV thereof. According to the learned counsel, AS 22 is ultra
vires the rule making power conferred by Section 642 to the
extent it seeks to create a fictional tax liability. According to
learned counsel, AS 22 is also ultra vires as no subordinate
legislation can seek to reconcile divergent profits that are
arrived at by two independent enactments, namely, accounting or
book profits as per the Companies Act and taxable profits under
the I.T. Act. In this connection, it was urged that all 29
Accounting Standards stood notified by Notification No.739(E)
dated 7.12.2006. Accordingly, all 29 Accounting Standards are
now contained in the Companies (Accounting Standards) Rules,
2006. They have, therefore, the status of subordinate legislation.
That, para 2 of the Annexure to the Accounting Standards has
expressly stated that the Standards are intended to be in
conformity with the provisions of applicable laws and, therefore,
according to learned counsel, the intention is not to treat the
Accounting Standards as part of the Companies Act but as a
subordinate legislation. Therefore, AS 22 cannot be treated as
amending or altering Schedule VI which is part of the Companies
Act and which can only be done under Section 641(2) by way of
appropriate notification. That, under Section 641(2), any
amendment to the schedules by way of notification is treated as if
it is enacted in the Act. Such a provision is absent in Section
642. That, as the Accounting Standards in the present case have
not been notified under Section 641, they cannot alter or amend
the Schedule VI to the Companies Act.
27. As regards matching principle, learned counsel submitted
that the said principle has to be applied in two ways:
(i) on revenue basis; and
(ii) on time basis
That, the said principle can be applied for both the profits,
namely, accounting profits and taxable profits. That, broadly
speaking, the matching principle can be applied by matching
expenditure against specific revenues as having been used in
generating those specific revenues or by matching expenses
against the revenues of a given period in general on the basis that
the expenditure pertains to that period. The former is termed as
\023matching principle on revenue basis\024 and the latter is termed as
\023matching principle on time basis\024. According to learned
counsel, the said principle applies only where the assessee has a
choice of debiting or crediting expenditure or income in a
particular financial year (time basis) or for correlating a
particular expenditure against particular revenue (revenue basis).
That, matching principle cannot be extrapolated to divergent
results that arise under two statues and, therefore, Accounting
Profits and Taxable Profits computed under the Companies Act
and the I.T. Act respectively cannot be reconciled by applying the
matching principle or on the basis of effect of Time Differences.
In this connection, learned counsel pointed out that in India the
timing difference arises mainly because different rates of
depreciation are statutorily prescribed by Schedule XIV to the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 61 of 108
Companies Act and by Rule 5, Appendix-I to the Income Tax
Rules. It is submitted that 99% of DTL arises only on
account of difference in depreciation rates. This position is
not disputed by the Institute. Learned counsel, therefore, urged
that if the rates of depreciation are statutorily different, then the
Institute or the Central Government, as a rule making authority,
has no power to apply the matching principle or timing difference
and bring the \023accounting depreciation\024 in line with \023tax
depreciation\024. Therefore, according to learned counsel, the
Institute as well as the Central Government has erred in
prescribing AS 22 as a mandatory rule to bring about a
reconciliation between tax depreciation and accounting
depreciation for which it has no such jurisdiction or power.
According to learned counsel, in India, unlike U.K., rates of
depreciation are statutorily prescribed. They are separately
prescribed under I.T. Act and Companies Act. Therefore, it is
only for the court/tax department to apply the matching principle
in a given case. It would depend on the facts of a given case. The
matching principle cannot be prescribed by a rule or an
Accounting Standard. Learned counsel, therefore, submitted
that the Central Government as a rule making authority under
Section 642 or the Institute has no power to apply the matching
principle or timing difference across the board to bring the
accounting depreciation in line with tax depreciation. The rates
of depreciation are not prescribed statutorily in U.K. In U.K. the
assessee is at liberty to adopt any rate of depreciation he chooses
and, therefore, according to learned counsel, there could be
some justification for invoking the matching principle and
applying an accounting standard for deferred taxation.
28. On the concept of \023true and fair\024 view, leaned counsel urged
that under Section 211(1), a balance-sheet has to present a true
and fair view. Similarly, under Section 211(2), P&L a/c must
also be true and fair. However, according to learned counsel, the
said concept does not mean that Accounting Standards can
alter Schedule VI or enable alteration of accounting profits
which have been computed as per Sections 205, 209 read with
Schedule VI and Schedule XIV to the Companies Act. Learned
counsel further pointed out that in fact under Section 211(5)(v)
there is a stipulation that anything not disclosed as per Schedule
VI will not render the balance-sheet/P&L a/c as not disclosing
the true and fair view.
29. On the question of effect of AS 22, learned counsel urged
that the effect of implementation of AS 22 would result in drastic
reduction in profits of a company. In this connection, learned
counsel urged that AS 22 provides for TOI. That, the difference
between accounting profit (profit under the Companies Act after
providing for depreciation and taxation) and the taxable profit
(profit as per I.T. Act) are to be multiplied by the rate of income
tax. This amount has to be reduced/deducted from the
accounting profit. Therefore, the formula would be read as
under:
(AP-TP) x rate of income tax = DTL
In other words, if the accounting profit is Rs.50 crores and the
taxable profit is Rs.30 crores and the rate of income tax is 30%
then DTL will be Rs.6 crores (50-30 x 30/100).
30. Similarly, (loss/unabsorbed depreciation) x rate of income
tax is = DTA. If a company has a loss and carry forward
depreciation of Rs.40 crores and the rate of income tax is 30%
then DTA will be:
40 x 30/100 = Rs.12 crores
In such a case the loss of Rs.40 crores will be reduced to
Rs.28 crores (40-12).
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 62 of 108
Relying upon the above illustrations, learned counsel submitted
that if a company is making accounting profits year after year the
said profits will stand reduced year after year by DTL if AS 22 is
implemented. Similarly, according to learned counsel, the DTL of
each year will become accumulated and shown on the liability
side of the balance-sheet, below \023Unsecured Loans\024. That, this
accumulated liability on account of DTL will reduce the net-worth
of a company. On the other hand, DTA has to be shown on the
Asset side. But DTA can be claimed as an asset only on the basis
of the concept of \023virtual certainty\024 (See: paras 17 and 18 of AS
22). Accordingly, it is urged that profits available for distribution
as dividend shall also be reduced between 20% to 30% each year
if DTL is shown as accumulated liability. According to learned
counsel, the Institute has not produced any evidence of any
company getting any benefit from implementation of AS 22. In
this connection, learned counsel submitted that provision for
DTL unfortunately has not been treated as a reserve which can
be utilized in times of financial crisis. That the Institute has not
given a single example of a situation where timing difference has
been reversed. According to learned counsel, AS 22 does not in
any way help collection of higher taxes. That, as long as a
company continues to be profitable, it is impossible for any
reversal by timing difference. In this connection, learned counsel
urged that, in India, income tax depreciation is substantially
higher than accounting depreciation as per Schedule XIV and,
therefore, the accounting profits will always be more than the
book profits. Therefore, every year, there would be DTL which
will keep on accumulating. For example, according to learned
counsel, accumulated DTL of Reliance Industries Ltd. was
Rs.6982 crores as on 31.3.07 and this liability will keep on
accumulating. According to learned counsel, except in the case
of companies which are likely to make loss in the near future,
reversal will never take place. Therefore, the basic stipulation of
timing difference getting reversed will never happen. Learned
counsel further submitted that DTL is made chargeable to the
P&L a/c even when it is a non-existent or fictional liability; that
the amount which is reduced from the profit is not even treated
as a reserve and, therefore, DTL cannot be utilized if the company
runs into financial difficulty.
31. According to learned counsel, under para 33 of AS 22
companies are required to rework the entire liability from the
beginning of the existing assets. For example, in the case of
Indian Railway Finance Corporation Ltd., provision is required to
be made in respect DTL of Rs. 940.55 crores. The transitional
provision took place for the year ended 2001-02. The said
provision of Rs.940.55 crores has diminished Bond Redemption
Reserve. Similarly, according to learned counsel, in the case of
M/s. First Leasing Company of India Ltd., application of para 33,
as transitional provision, has resulted in DTL of Rs.62 crores.
32. On the question of legal status of AS 22, learned counsel
submitted that the said Standard is a subordinate legislation
and, therefore, it cannot create a tax liability. DTL is neither a
liability nor a tax. It is not a deferral. That, the levy of tax can
either be by the Central Government or State Government under
List I or List II of Schedule VII to the Constitution. That, under
Article 366(28), taxation includes imposition of any tax or impost.
Under Article 265, taxes can be levied only by authority of law.
DTL, according to learned counsel, is not a tax by definition or by
understanding. It cannot be treated as a tax by any process of
interpretation. If it is a tax, it has to be credited to the
Consolidated Fund of India/State. DTL is also not a fee or a cess
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 63 of 108
or any surcharge. That, under para 3(vi) of Part II of Schedule VI
deduction of taxes on income has to be shown. At present, the
taxes that can be deducted are Income Tax, Fringe Benefit Tax
(FBT), Minimum Alternate Tax (MAT). Similarly, any surcharge
or cess levied by the Finance Act as a percentage of such taxes
will also be deductible. According to learned counsel, gross
receipts of any company can be reduced by following items to
arrive at profits before taxation. These items are expenses such
as salaries, raw materials and overheads; liability towards
gratuity, PF, etc.. A tax liability can be created only under an Act
of Parliament. DTL can only be a liability by way of tax. It is
not a liability of any other nature since it is not required to
be discharged in future. It is not enforceable against the
company. Thus, DTL creates a legal fiction with respect to the
concepts of taxation and liability which is contrary to the legal
meaning enunciated by several judgments of this Court (See:
State of Kerala v Madras Rubber Factory Ltd. \026 AIR 1998 SC
723 at 730 and Shree Digvijay Cement Co. Ltd. v. Union of
India (2003) 2 SCC 614 at 627, para 26 and 27).
33. On the question of effect of Section 211(3A), (3B) and (3C),
learned counsel submitted that Section 211(3A) cannot be read to
imply that Accounting Standards have to be complied with even if
they are inconsistent with the Act or that they alter/amend any
provisions of the Companies Act. As regards Section 211(3B),
learned counsel submitted that any deviation from the
Accounting Standards has to be qualified by the auditors which
may lead to adverse consequences for the company. According to
learned counsel, unless the company is likely to make loss in
near future, timing difference can never arise. According to
learned counsel, tax depreciation, in India, is higher than book
depreciation and, therefore, DTL will exist in the financial
statements indefinitely. This is one more effect of AS 22 being
implemented in India. On the other hand, according to learned
counsel, the very purpose of AS 22 of presenting true and fair
view can be easily achieved by making AS 22 a disclosure
requirement as Notes to the Accounts, rather than inserting it in
Schedule VI, Parts I and II to the Companies Act.
34. Mr. S.K. Bagaria, learned counsel appearing on behalf of
J.K. Tyre & Industries Ltd. (formerly known as \023J.K. Industries
Ltd.\024), submitted that AS 22 requires charging the P&L a/c for
an assumed liability on account of deferred tax which is not
payable according to the provisions of I.T. Act for the accounting
period nor does it represent any tax which would become payable
in future. That, AS 22 requires provision to be made for alleged
tax liabilities and recognition of alleged tax assets which are not
at all accrued liabilities or assets. According to learned counsel,
AS 22 requires provision for assumed tax liabilities and
recognition of assumed tax assets which are in reality non-
existent, commercially or under the law. According to the
learned counsel, notional and imaginary working is required to be
made for AS 22; that, deferred tax is neither an asset nor a
liability; that, the accrual basis of accounting requires a provision
to be made for a known liability existing on the balance-sheet
date and that any provision made on account of tax not payable
under I.T. Act for the accounting period is not a provision for any
known liability according to the accrual basis of accounting.
According to the learned counsel, any amount set aside on
account of tax for which there is no liability under the I.T. Act
cannot be considered as a \023tax expense\024 for the period of
account; that, statutory levy of tax has to be measured and
recognized as per the I.T. Act or the Companies Act or any other
applicable enactment and that if the I.T. Act does not create DTL,
such liability does not exist at all. According to the learned
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 64 of 108
counsel, under the \023accrual\024 basis of accounting, a company is
required to make provision only for a liability which has accrued
in the relevant accounting year; that, in respect of contingent
liability, it is not required to make any provision but only a note
is required to be given in the accounts known as \023Disclosure
Note\024; that, DTL is not even a contingent liability; and that, on
the balance-sheet date several events such as the working of the
company in future years, whether the company will earned a
taxable profit (loss) in future are events which are totally
unknown at the end of the accounting period when the company
is required to recognize, measure and account for DTL.
According to the learned counsel, if there is no income in future,
there would be no liability for tax in future and if there is income
and additions to assets in future, the difference in depreciation
under the Companies Act and under the I.T. Act for the
accounting period will not result in any tax liability in future and
there would be no reversal of the DTL created in the accounting
period. According to learned counsel, AS 22 requires
recognition of the tax effect, whether current or deferred, in
respect of individual transaction during the accounting
period as if in future the company would have to make
payment on account of deferred tax. According to learned
counsel, the aforestated concept is merely an assumption. Under
the I.T. Act, tax is determined with reference to the total
income and not with reference to any individual transaction.
The total income in future is uncertain. The total statutory tax
liability in future is also uncertain. The difference between the
current accounting income and the current taxable income, for
example, on account of depreciation, may or may not have any
impact on the computation of the total income of a future year or
it may or may not entail any tax liability. Therefore, it cannot be
said with certainty that deferred tax in respect of an
individual transaction of the accounting period would result
in any cash outflow on account of tax in a future year.
According to learned counsel, AS 22 has been framed on the
fundamental accounting assumption of \023going concern\024.
However, it is one thing to assume that business would go on and
quite another to assume that it will produce profits. If there is no
taxable income in future, the tax effect of the transactions of the
accounting period will not translate into any actual liability or
cash outflow. According to learned counsel, AS 22 assumes that
there would be sufficient taxable income in future entailing tax
liability in future and that the tax effect of the transactions in the
accounting period would have a role to play in the determination
of future taxable income and liability. According to learned
counsel, the above is also an assumption. According to learned
counsel, the accrued liability for tax is the liability in respect of
the amount of tax statutorily payable on the taxable income
computed from the accounting income in accordance with the I.T.
Act after making appropriate deduction allowances and
disallowances. Such liability for tax represents the provision for
taxation. Any amount in excess of such liability would be a
reserve. If the I.T. Act does not create any liability for tax, such
liability does not exist in fact or in law and, therefore, it would be
contrary to all norms of prudence to recognize or provide for a
non-existent liability. According to learned counsel, liability for
tax must exist under I.T. Act for it to be called an accrued
liability; that the contention of the Institute that liability for tax
should be considered in the accounting sense and not in the
strict legal sense proceeds on the basis that deferred tax is not an
accrued liability in the legal sense; that, the tax liability in the
income is only to the extent the I.T. Act provides for such
liability; that real liability for income tax is only as computed
under the I.T. Act; that, merely because the difference between
the accounting income and taxable income is ascertainable and
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 65 of 108
merely because tax effect on account of such difference can be
worked out on the basis of existing tax rates, it cannot be said
that such tax effect represents a real liability payable today
or tomorrow. According to learned counsel, the difference
between accounting and taxable income in a given year may or
may not give rise to a liability or outflow of money in future.
According to learned counsel, this is an assumption. This is
totally uncertain. Therefore, according to learned counsel, to give
tax effect on such difference cannot be treated as an accrued
liability and in respect of such difference, no income tax is
payable under the I.T. Act for the accounting period.
35. Mr. Bagaria, learned counsel, further submitted that
\023accrual\024 is a legal concept. It has not been defined under I.T.
Act. It has not defined under the Companies Act. An accrued
liability arises only if that liability has arisen in the accounting
year concerned. This position has been settled by various
decisions of this Court. It has been further held in numerous
decisions by this Court that provision for taxation is the provision
for tax liability under the I.T. Act as on the last date of the
accounting year and that if anything is provided in excess of such
tax liability, it will not be a provision but it will be a reserve (See:
the judgment of this Court in Metal Box Company of India Ltd.
v. Their Workmen \026 AIR 1969 SC 612). Therefore, according to
learned counsel, if the I.T. Act does not create any liability for
tax, there is no liability for tax either in fact or in law. Learned
counsel, however, invited our attention to the difference between
contractual liability in case of cars sold with warranties and tax
liabilities which, according to learned counsel, stand on a totally
different footing as it is to be determined in accordance with the
principles laid down in various judgments of this Court under the
I.T. Act.
36. Learned counsel next contended that under Section
209(3)(b) of the Companies Act read with Section 209(1), income
and expenditure and assets and liabilities should be accounted
for in the books of account on \023accrual basis and according to the
double entry system of accounting\024; that, the concept of \023accrual\024
in Section 209(3)(b) is required to be understood in the same
manner as it is required to be understood judicially. According to
the learned counsel, \023accrual\024 has been defined in AS 1, which
has also been prescribed by the impugned Notification dated
7.12.06, as revenues and costs recognized as they are earned or
incurred and recorded in the financial statements of the periods
to which they relate. According to learned counsel, the definition
of the word \023accrual\024 in Notification dated 25.1.96 issued by the
Central Government under Section 145(2) of the I.T. Act also
referred to the word \023accrual\024 as an assumption, namely, that
revenues and costs are recognized as they are earned or incurred
and so recorded in the financial statements for the period(s) to
which they relate. According to learned counsel, the Accounting
Standard notified under I.T. Act also requires the accounts to
give a true and fair view. Therefore, according to learned
counsel, the definition of the word \023accrual\024 is the same both in
the Accounting Standard prescribed under Section 211(3C) and
that which is notified under Section 145(2) of the I.T. Act.
Therefore, according to learned counsel, the word \023accrual\024 for
the purposes of the Companies Act does not carry any meaning
different from that mentioned for the purposes of the I.T. Act.
That, only the amount of income tax actually payable under the
I.T. Act with reference to the taxable income for the period
covered by the account computed in accordance with the
provisions of that Act can constitute a charge for income tax and
is, therefore, an accrued liability. Any amount in excess of such
tax is a reserve and not a provision for taxation. According to
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 66 of 108
learned counsel, therefore, for the above reasons AS 22 insofar as
it relates to deferred tax is contrary to the concept of \023accrual\024
which concept is recognized under Section 209(3)(b) read with
Section 209(1) of the Companies Act.
37. On the question of matching principle, learned counsel
urged that the matching concept is fully complied with when a
provision is a made for tax computed in accordance with the
provisions of the I.T. Act with reference to the taxable income
derived from the accounting income after making appropriate
deductions, allowances and disallowances in accordance with the
statutory provisions. According to learned counsel, matching
tax in respect of accounting income is only the tax computed
for the accounting period, according to the provisions of the
I.T. Act. It is not any assumed future taxation dependent upon
any assumed future working of the company. The object of
incurring expenses is to produce revenue. In measuring the
income for a period, revenue is to be adjusted against
expenses incurred for producing that revenue. This concept of
adjusting/offsetting the expenses against revenue is the
matching principle. This concept is fully satisfied when
provision for taxation is made for tax liability in accordance with
the provisions of the I.T. Act and it is such tax alone which is the
tax liability incurred on the income earned during the period
concerned.
38. As regards the question of the functional utility of
Accounting Standards under Section 211(3A), (3B) and (3C) is
concerned, learned counsel submitted that Section 209 provides
that every company keeping proper books of account with respect
to moneys received and expended and the matters in respect of
which the receipt and expenditure takes place as well as the
assets and liabilities of the company. According to learned
counsel, therefore, Section 209(1) recognizes the receipt and
expenditure as well as assets and liabilities; that, prior to
substitution of Section 209(3) by the Companies Act
(Amendment) Act, 1988 w.e.f. 15.6.88, did not provide for keeping
the books of account on accrual basis. However, based on the
report of Sachar Committee to the effect that \023true and fair\024 view
should be projected, Section 209 was suitably amended to make
it obligatory on all companies to maintain accounts on mercantile
system of accounting. Based on the recommendation of the
Sachar Committee sub-section (3) was substituted. Thus, from
Section 209, according to learned counsel, the following position
becomes clear, namely, that Section 209 recognises receipt and
expenditure as well as assets and liabilities on accrual basis and
on double entry system for accounting. After the said
amendment, books of account are required to be kept on accrual
basis. Therefore, according to learned counsel, the requirement
of \023true and fair view\024 stands incorporated in Section 209(3)(a),
Section 211(1), (2) and (5); Section 217(2AA)(ii); and Section
227(2). According to learned counsel, on bare reading of Section
227 read with Section 209 it is clear that the auditor of the
company has to report that \023proper books of account\024 as required
by law has been kept by the company; that, \023proper books of
account\024 shall not be deemed to be kept unless they are kept on
accrual basis and double entry system of accounting; that, the
auditor has to report that the balance-sheet and the P&L a/c are
in agreement with the books of account and that the auditor has
also to report whether profit and loss account as well as balance-
sheet complies with the Accounting Standards referred to in
Section 211(3C). According to learned counsel, sub-section (3A)
of Section 211 requires every P&L a/c and balance-sheet of the
company to comply with the Accounting Standards; that, sub-
sections (3A), (3B) and (3C) do not refer to keeping of proper
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 67 of 108
books of account; that this subject is covered by Section 209 only
which mandates that proper books of account shall not be
deemed to be kept unless the same are kept on accrual basis and
double entry system of accounting; that, the said mandate of
Section 209 cannot be altered by the Accounting Standards and
since the Accounting Standards as per sub-section (3A) can only
relate to the P&L a/c and balance-sheet and not to keeping
proper books of account which are basic primary records from
which the P&L a/c and balance sheet are prepared and since
P&L a/c and balance-sheet are not books of account but only
abstracts.
39. AS 22 relating to deferred tax is directly in conflict with
Section 209 of the Companies Act and in excess of the powers
vested under sub-section (3A), (3B) and (3C) of Section 211. In
this connection, learned submitted that the power conferred
upon the Central Government under sub-section (3C) of Section
211 for prescribing Accounting Standards by framing of rules is
in the nature of delegated legislation; that under the scheme of
sub-section (3A), (3B) and (3C) of Section 211, Accounting
Standards can be prescribed only in relation to P&L a/c and
balance-sheet; that a delegatee of power cannot assumed
jurisdiction in areas or over subjects which are not delegated;
that the power being limited to prescribing Accounting Standards
for P&L a/c and balance-sheet, cannot be exercised in relation to
maintenance of books of account and that too on a basis different
from accrual basis mandated in Section 209 and any such
exercise of power by prescribing any Accounting Standard
affecting the maintenance of proper books of account and that
too on a basis different from accrual basis will be in excess of the
powers vested in the Central Government under sub-section (3A),
(3B) and (3C) of Section 211 and will be directly in conflict with
Section 209 of the Companies Act. In this connection, learned
counsel submitted that AS 22 requires a company to reduce or
increase its net profit by passing journal entries in its books of
account in respect of DTL or DTA; that it is only after these
entries are made in the books of account in respect of DTA or
DTL that the net profit in the P&L a/c can be increased or
reduced and DTA or DTL can be reflected in the balance-sheet
after the head \023Investments\024 in case of DTA and after the head
\023Unsecured Loans\024 in case of DTL and, therefore, according to
learned counsel, AS 22 exceeds the power conferred by sub-
sections (3A), (3B) and (3C). According to learned counsel, the
power under sub-sections (3A), (3B) and (3C) only relates to
prescribing Accounting Standards for presentation of P&L a/c
and balance-sheet whereas AS 22 directly and immediately
encroaches upon preparation of books of account and
maintenance and proper books of account on accrual basis and
in the process violates the mandate statutorily imposed by
Section 209(3). That, there is no power conferred by sub-sections
(3A), (3B) and (3C) nor by any other sub-sections of 211 to
prescribe Accounting Standards relating to maintenance of
proper books of account. In this connection, learned counsel
pointed out that the duty of the auditor is to report in terms of
Section 227(3)(d) about compliance with the Accounting
Standards referred to in sub-section (3C) of Section 211 which
applies only in respect of P&L a/c and balance-sheet; that, the
said provision makes it clear that compliance with the
Accounting Standards is to be made only in respect of the P&L
a/c and balance-sheet whereas keeping of books of account in
terms of Section 209 is required to be reported upon by the
auditor only in terms of Section 227(3)(d) and, therefore, AS 22
exceeds the power conferred by sub-sections (3A), (3B) and (3C)
of Section 211. Learned counsel submitted that AS 22 is
confined to prescribing Accounting Standards for presentation of
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 68 of 108
P&L a/c and balance-sheet. It does not deal with preparation of
books of account. That subject falls under Section 209(3).
Therefore, AS 22 prescribes Accounting Standards only for
P&L a/c and balance-sheet without directing that exercise to
be made in respect of preparation and maintenance and
proper books of account on accrual basis and, therefore, AS 22
brings about inconsistency between the provisions of Section
209(3) on one hand and sub-sections (3A), (3B) and (3C) of
Section 211. According to learned counsel, Section 217(2AA)(i)
merely relates to \023preparation of annual accounts\024; it does not
deal at all with preparation and maintenance of books of account;
that annual accounts are not books of account (See: Section 210)
and, therefore, the said Section 217(2AA)(i) has nothing to do
with preparation and maintenance of proper books of account
which subject is independently dealt with in Section 209.
According to learned counsel, the provisions of AS 22 insofar as it
requires making of entries in the books of account reducing the
profit by accounting for DTL or increasing the profit by
accounting for DTA and to reflect such entries in the P&L a/c
and balance-sheet, are ultra vires sub-sections (3A), (3B) and (3C)
of Section 211 and Section 209 of the Companies Act. That, by
AS 22, insofar as the same relates to \023deferred tax\024, the delegatee
of power (Central Government) has attempted to encroach upon
the areas far beyond those covered by the delegation.
40. According to the learned counsel, Section 211(1) starts with
the mandate that \023every balance-sheet of a company shall give a
\021true and fair\022 view at the end of the financial year\024. This
mandate is, according to learned counsel, not subject to
anything. It is not qualified by the expression \023subject to the
provisions of this section\024. Similar is the position in sub-section
(2) of Section 211 with regard to the P&L a/c. Therefore,
according to learned counsel, \023true and fair view\024 requirement is
the primary requirement of Section 211(1) and Section 211(2)
which requirement stands satisfied only if the accrual basis is
followed as mandated in Section 209(3). According to learned
counsel, the expression \023subject to the provisions of this
section\024 in Section 211(1) obviously includes the provision of
sub-section (1). Therefore, according to learned counsel, even in
terms of the specific language of Section 211(1) the requirement
of \023true and fair view\024 in that sub-section is a stand-alone
concept and it is not subject to anything. According to
learned counsel, accrual basis in Section 209(3) is a necessary
component of \023true and fair\024 view as a requirement and,
therefore, the said requirement in Section 211 and in Section 209
would have the same meaning. However, according to learned
counsel, the expression \023subject to the provisions of this section\024
in Section 211(1) only qualifies the requirement of balance-sheet
being in the form set out in Part I of Schedule VI; that, similarly
the expression \023subject as aforesaid\024 in sub-section (2) of Section
211 only qualifies the requirement of Part II of Schedule VI in
respect of P&L a/c; that, sub-section (3A) of Section 211 inter alia
provides that every P&L a/c and balance-sheet of the company
shall comply with the Accounting Standards and, therefore,
according to learned counsel in the entire scheme relating to
accounts and audit in Part VI, Chapter I, Section 209 to Section
233B of the Companies Act, the statutory mandate of keeping
proper books of account on accrual basis is not allowed to be
altered or encroached upon by any Accounting Standards.
According to learned counsel, it is the statutory mandate that
P&L a/c and balance-sheet shall be in consonance with the
books of account. Therefore, sub-sections (3A), (3B) and (3C) can
only relate to presentation of and disclosures in P&L a/c and
balance-sheet, keeping intact the statutory mandate of
maintaining proper books of account on accrual basis.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 69 of 108
Therefore, if the format of a balance-sheet or the requirements of
P&L a/c is allowed to be altered by any Accounting Standards it
would amount to encroachment upon the statutory mandate of
keeping proper books of account on accrual basis. Therefore,
according to learned counsel, Accounting Standards can provide
in relation to presentation of and disclosures in P&L a/c and
balance-sheet without touching upon the basic requirement of
maintaining proper books of account on accrual basis and only
thereby one can comply with the concept of \023true and fair view\024.
Any other interpretation would mean that AS 22 far exceeds the
power conferred by sub-sections (3A), (3B) and (3C) of Section
211 and it would amount to creating inconsistencies between
various sections of the Companies Act.
41. Learned counsel next contended that accrual basis of
accounting does not recognize DTA or DTL; that, accounting for
any DTA or DTL would be contrary to the accrual basis of
accounting and would not result in keeping of proper books of
account in terms of Section 209. Neither the books of account
nor the P&L a/c or balance-sheet which are required to be in
agreement with the books of account will give a true and fair view
if accounting has to be made in respect of DTA or DTL; that, AS
22 does not result in a true and fair measurement of the P&L a/c
or the state of affairs of a company and if any provision is made
on account of \023deferred tax\024 with reference to the difference
between accounting and taxable incomes for which no liability
exists under the I.T. Act, such provision would distort the books
of account and financial statements and would not give a true
and fair view. That, similarly creation of a deferred tax asset
because of current losses would distort the books of account and
financial statements and would not give a true and fair view.
According to learned counsel, accrual basis is a necessary
component of true and fair view requirement. The provision
contrary to the accrual basis cannot satisfy the said requirement.
Lastly, according to learned counsel, the only way out of the
above inconsistencies is to harmoniously construe Sections 209,
211 and AS 22 by reading down the said Standard so that the
company is only required to make a disclosure in the P&L a/c
and balance-sheet as regards DTA or DTL without requiring the
company to make any entry in the books of account or without
making any company to reduce or increase its net profit.
42. Lastly, learned counsel submitted that vide para 33 of AS
22 DTL is sought to be created in respect of individual
transactions since the inception of the company which may be
long before the AS 22 came into effect resulting in reduction of
the revenue reserve by the amount of such DTL. That, the
working required to be made in terms of para 33 of AS 22 is
complicated. In this connection, learned counsel pointed out
that under para 34 of AS 22, not only opening balances of assets
but also opening balances of liabilities for accounting purposes
and for tax purposes have got to be compared; that, para 33
requires a working to be made in respect of individual
transactions since the inception of the company in order to
ascertain DTAs or DTLs. That, in case of DTL, the revenue
reserve has to be reduced and conversely in case of a DTA, the
revenue reserve has to be increased. This is, according to
learned counsel, indicates that para 33 which is termed as
\023transitional provision\024 is clearly retrospective in its operation.
Therefore, according to learned counsel, para 33 of AS 22 would
result in reduction of the company\022s revenue reserves. It will
erode the company\022s net worth. It will alter the company\022s debt-
equity ratio. It will adversely effect the company\022s borrowing
capacity. Therefore, according to learned counsel, the High Court
had erred in dismissing the writ petitions filed by the appellants.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 70 of 108
According to learned counsel, Section 211(3C) does not enable
the Central Government to give any retrospective operation to the
Accounting Standards. The rule-making power under Section
642 of the Companies Act also does not permit the making of any
rules with retrospective effect and, therefore, according to learned
counsel, para 33 deserves to be set aside. For the above reasons,
learned counsel submitted that AS 22 far exceeds the power and
jurisdiction conferred by sub-sections (3A), (3B) and (3C) of
Section 211 and that it brings about inconsistencies between
various sections of the Companies Act and, therefore, the said AS
22 deserves to be struck down or in the alternative AS 22
deserves to be read down so that at best the company is required
to make a disclosure in the P&L a/c and balance-sheet as
regards any DTA or DTL without requiring it to make any entry in
the books of account and without requiring any company to
increase or reduce its net profit (loss).
43. Mr. A Sharan, learned Additional Solicitor General
appearing for Union of India, submitted that validity of a
legislation could be challenged on grounds of incompetence of the
legislation or same being violative of Part III of the Constitution.
That, a subordinate legislation can be challenged additionally on
the grounds that the same is beyond the authority of delegate or
that it is violative of provisions of the enactment. According to
learned counsel, in the present case, appellants have not
challenged the competence of the Central Government to notify or
provide for Accounting Standards, they have restricted their
challenge only on the ground that AS 22 contravenes the
provisions of Companies Act by stating that the same violates
Sections 205, 209, 211 and Schedule VI of the Companies Act.
According to learned counsel, even in that regard no details have
been given by the appellants in their original writ petition as to
how the impugned Accounting Standard contravenes the
provisions of the Companies Act. Therefore, according to learned
counsel, the entire original writ petition filed by the appellant is
misplaced, misconceived and not maintainable for want of
details. Learned counsel urged that AS-22 provides for a
different manner than Schedule VI in which account of a
company required to be prepared. It is submitted that Schedule
VI is the form set out under the Companies Act in which a
company is required to submit its balance-sheet and profit and
loss account. Section 211(1) requires the companies to prepare
their balance-sheet in the form set out in Part-I of Schedule VI. A
plain reading of Section 211 reveals that the requirement of
submission of balance-sheet in the said form is subject to the
other sub-sections of Section 211 and hence the format of the
said balance shall necessarily be guided by the Accounting
Standards provided under sub-section (3A) as same is having
overriding effect on Part I of Schedule VI. According to learned
counsel, when any provision made is subject to other provisions
of that section, then the said provision (Part I of Schedule VI) has
to give way the other provisions (AS-22 as provided by Section
221(3A)). In this connection, reliance is placed on the judgment
of this Court in the case of South India Corporation (P) Ltd. v.
Board of Revenue, Trivandrum and Anr. \026 AIR 1964 SC 207 at
p.215, in which this Court has held that the expression \023subject
to\024 conveys the idea of a provision yielding place to another
provision or other provision(s) to which it is subject to. Reliance
was also placed by the learned counsel on the judgment of this
Court in the cases:
The State of Bihar and Anr. v. Sir Kameshwan Singh and
Anr. \026 AIR 1952 SC 252;
K.R.C.S. Balakrishna Chetty and Sons & Co. v. The State
of Madras \026 AIR 1961 SC 1152; and
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 71 of 108
Heggade Janardhan Subbaraya v. The State of Mysore
and Ors. \026 AIR 1963 SC 702.
In the alternative, learned counsel submitted that in any event
Section 641 empowers the Central Government to amend
Schedule VI whereas Section 642 confers powers on the Central
Government to formulate rules. That, Part I of Schedule VI
prescribes the form in which the balance-sheet and P&L a/c is
required to be prepared. According to learned counsel, AS 22 is
prescribed by the Central Government with respect to
computation of tax liability; that, AS 22 lays down the manner in
which the said computation of tax liability in the balance-sheet is
required to be prepared and, therefore, in pith and substance AS
22, according to learned counsel, prescribes additional mode in
which tax liability of a company is required to be calculated.
Thus, according to learned counsel, exercise of power by the
Central Government under Section 642 providing for AS 22 is
exercise of power for same purpose which is required to be
exercised under Section 641 to amend Schedule VI and,
therefore, in pith and substance, according to learned counsel,
exercise of power by the Central Government under Section 642
will be deemed to be exercise of power by the Central Government
under Section 641 and accordingly Part I of Schedule VI will
stand modified/amended to the extent it contravenes AS 22.
This is particularly because Part I of Schedule VI is subject to
Section 211(3A) of the Companies Act. According to learned
counsel, under Section 211 every company is required to prepare
its balance-sheet and P&L a/c in the manner provided therein.
Sub-section (3A) of that Section makes it mandatory to comply
with Accounting Standards. While preparing P&L a/c and
balance-sheet (See: Section 211(3C)). According to learned
counsel, since AS 22 is an Accounting Standard prescribed under
sub-section (3C) it has a statutory status, required to be followed
while preparing the books of account in terms of Section 211 of
the Companies Act. Lastly, learned counsel urged that the
Companies Act is a special statute; that, Section 211 is a special
provision aimed at providing the form and content of P&L a/c
and balance-sheet required to be prepared by the company; that,
a special provision like Section 211 ordinarily overrides the
general provision; that, if a special provision is made on a
particular subject then that subject is excluded from the general
provision and since AS 22 is a special provision notified under
Section 211(3C) with respect to form and content of accounts of
the company, the same will override other provisions of the
Companies Act as well as any other statute to the extent provided
therein. In this connection, learned counsel placed reliance on
the judgment of this Court in the cases:
Gadde Venkateswara Rao v. Government of Andhra
Pradesh and Ors. \026 AIR 1966 SC 828;
State of Bihar v. Dr. Yogendra Singh GOL (Retired) and
Ors. \026 (1982) 1 SCC 664
Maharashtra State Board of Sec. and High. Sec.
Education and Anr. etc. v. Paritosh Bhupeshkumar
Sheth and Ors. etc. \026 (1984) 4 SCC 27
State of Gujarat and Anr. etc. v. Patel Ramjibhai
Danabhai and Ors. etc. \026 (1979) 3 SCC 347
44. In view of the aforestated submissions learned counsel
submitted that AS 22 is intra vires the Companies Act and,
therefore, the appeals deserve to be dismissed with costs.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 72 of 108
45. Mr. N.K. Poddar, learned senior counsel appearing for the
Institute, submitted that corporate accounts are required to
disclose a \023true and fair view\024. It is a requirement. That
requirement has to be ensured by the auditors who have to
certify that the accounts are prepared so as to provide \023true and
fair view\024 of the state of affairs of the company. This
responsibility is undertaken by accountants and auditors who
are members of the Institute. If Accounting Standards are not
followed, financial accounts would not be \023true and fair\024 and in
that case, the statutory requirement in Section 211 for preparing
true and fair accounts would not be satisfied. According to
learned counsel, prior to 1988 the requirement contemplated by
the Companies Act was disclosure of \023true and correct view\024.
This requirement was deliberately changed by the Legislature to
\023true and fair view\024. When it was a question of disclosing a true
and correct view, it was permissible to look into the legal liability
for tax, and make a provision accordingly; but when the
requirement in law is to disclose \023true and fair\024 accounts, a wider
perspective is warranted. That is why, the Institute states that
the I.T. provision should be based not only on the strict legal
liability to be discharged immediately, but also on the legal
liability based on book profits (real profits) which are earned
and reflected in the corporate accounts of the company.
Therefore, the Institute insists that there should be a reasonable
matching of cost and benefit, if the accounts are to disclose a
\023true and fair view\024. The Institute has legal obligation of ensuring
disclosure of \023true and fair view\024 in the corporate accounts.
However, in the absence of a statutory definition of \023true and
fair\024, it is the Institute\022s function to determine the basic rules for
ensuring disclosure of a \023true and fair view\024. According to
learned counsel, \023true and fair view\024 is a concept which requires
the Auditor to look at the substance rather than pure legal form
and that is why all its Accounting Standards emphasize the
importance of Substance over Form. The said view of the
Institute is duly affirmed by Parliament when Parliament decreed
that corporate accounts shall comply with the proper Accounting
Standards (See: sub-sections (3A) and (3B) of Section 211 of the
Companies Act). The basic reason for issuing AS 1 through
Notification dated 25.1.96 of Government of India, to be followed
by all assessee\022s following mercantile system of accounting, was
to lay down that accounting policies adopted by an assessee
should represent a \023true and fair\024 view of the state of affairs of
the business in the financial statements prepared and presented
based on such accounting policies. Therefore, the requirement
\023true and fair\024 view overrides all other statutory
requirements as to the matters to be included in the
corporate accounts. In order to give a \023true and fair view\024 it is
not necessary to provide information, additional to the one
needed to comply with all other statutory requirements or even to
depart from compliance with one or the other requirements. Any
departure has to be disclosed in a Note to the Financial
Statements giving reasons for such departure and its effects.
Moreover, the concept of \023true and fair\024 is not static. It is
dynamic in nature. It continues to evolve in accordance with the
changes in the requirements of economy.
46. It is the function of the Institute to regulate the profession of
Chartered Accountants. By formulating Accounting Standards,
Institute is fulfilling its statutory function. It is furthering
Legislative intent of Parliament, which requires that accounts
should be \023true and fair\024. Therefore, by laying down Accounting
Standards, which explains what is \023true and fair\024, the Institute is
merely fulfilling its statutory duty and function.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 73 of 108
47. Learned counsel submitted that conceptually, the
justification for Accounting Standards lies in the compelling logic
and conceptual validity of each Standard. Those who prepare
Accounting Standards are not framing the Standards without any
basis. The framers review accounting policies already adopted
and select those policies which are most appropriate in the
presentation of accounts based on the requirement of \023true and
fair view\024. The Standard represents the most appropriate
accounting policies out of various accounting policies adopted by
different companies over last several years. This is what is called
as conceptual validity. The acceptance in such cases is not only
recognized by statutory provisions but it is recognized by a wider
degree of acceptance in the corporate world. That is why, almost
all the major public companies, in India, have recognized and
accepted the validity of the Standards. Even, this Court has
expressed confirmation of commercial accounting Principles,
Practices & Standards recommended by the Institute (See:
Challapalli Sugars Ltd. v. Commissioner of Income Tax (1975)
98 ITR 167 at 172; Commissioner of Central Excise v. Dai Ichi
Karkaria Ltd. & Ors. (1999) 7 SCC 448 at 461.
48. On the topic of \023accrual\024 learned counsel submitted that
under Section 209(3)(b) all books of account are required to be
kept on accrual basis and according to the double entry system
of accounting. According to learned counsel, the expressions
\023accrual\024, \023accrual basis of accounting\024, \023accrued asset\024,
\023accrued expense\024, \023accrued liability\024, \023accrued revenue\024,
\023current assets\024, \023current liabilities\024, \023deferred expenditure\024,
\023depreciation\024, \023provision\024, \023prudence\024 etc. are explained and
defined in the Guidance Note on Terms Used in Financial
Statements issued by the Institute. Learned counsel submitted
that the matching principle is the most important concept in
\023accrual accounting\024. The matching principle indicates as to
when expenses should be recorded against the revenue. The
Institute had issued Guidance Note on Accrual Basis of
Accounting in 1988, since after the amendment of Section 209,
requiring all companies to maintain their accounts on accrual
basis of accounting. All relevant above mentioned expressions
relating to accrual basis of accounting including recognition of
revenue and expenses, assets and liabilities have been explained
in the said Guidance Note on Accrual Basis of Accounting which
inter alia lays down the matching principle of recognizing costs
against revenue or against the relevant time period to determine
the periodic income. According to learned counsel, in order to
understand the relevance of Accounting Standards issued by the
Institute for preparation and presentation of financial statements
vis-`-vis the accrual system of accounting and vis-`-vis the
matching principle it is necessary to refer to the concepts that
underline the preparation and presentation of such statements.
The main purpose of Accounting Standards is, therefore, to assist
the Accountants to prepare financial statements and to deal with
topics that have yet to form the subject of an Accounting
Standard. The entire object is to promote harmonization of
Regulations, Accounting Standards and Procedures relating to
the preparation of financial statements by providing a basis for
reducing a number of alternative accounting treatments
permitted by Accounting Standards. According to learned
counsel, \023accrual basis\024, \023going concern\024 and \023consistency\024 are
underlying assumptions in preparation of financial statements.
Prudence is important in the preparation of financial statements.
It is a degree of caution in the exercise of judgments needed in
making the estimates required under conditions of uncertainty so
that assets or income are not overstated and liabilities or
expenses are not understated. That, the principles to be followed
in the recognition of \023assets\024, \023liabilities\024, \023income\024 and
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 74 of 108
\023expenses\024 require application of the matching concept i.e.
matching of costs with revenue, which principle involves
combined recognition simultaneous recognition of revenues and
expenses that result directly from the same transactions or other
events. According to learned counsel, this Court has always
recognized the need for estimation in accrual system of
accounting. This Court, according to learned counsel, has
recognized the accounting concept of matching costs with
revenue in preparation of financial statements. In this
connection, learned counsel placed reliance on the judgment of
this Court in Calcutta Company Ltd. v. Commissioner of
Income Tax \026 (1959) 37 ITR 1; Madras Industrial Investment
Corporation Ltd. v. Commissioner of Income Tax - (1997) 225
ITR 802. According to learned counsel, at one point of time in
the past strict legal concept of \023accrual\024 was laid down in the
case of Commissioner of Income Tax v. Tungabhadra
Industries Ltd. \026 (1994) 207 ITR 553 (Cal.). However, according
to learned counsel, that strict legal concept is no longer accepted
by the Courts and for that purpose learned counsel places
reliance on the judgment of this Court on the same issue in the
case of Madras Industrial Investment Corporation Ltd.
(supra). In short, learned counsel submitted that with
globalization and with new concepts coming in, the law is no
more confined to the strict legal concept of \023accrual\024 which does
not recognize the matching principle.
49. Learned counsel urged that the requirement for \023accrual
basis of accounting\024 was introduced in the Companies Act in
1988 through Section 209. Under Section 209(1) every company
is required to maintain proper books of account with respect to
receipts and expenses, sales and purchases of goods, assets and
liabilities of the company, utilization of material or labour and
such other items of costs incurred in production, process,
manufacturing etc. Under Section 209(3) proper books of
account shall not be deemed to be kept if such books of account
do not give true and fair accounts and if such books fail to
explain its transactions further if such books are not kept on
accrual basis they have to be rejected for not giving a true and
fair view of the state of affairs of the company. This position is
also reflected in Section 211. Therefore, according to learned
counsel, under the scheme of Companies Act, two requirements
have to be satisfied, namely, \023accrual\024 system of accounting and
\023true and fair\024 view. Both must read together with each other.
According to learned counsel, the accrual basis of accounting
must be applied so that \023true and fair\024 accounts are
presented. Indeed, the requirement to present a \023true and fair\024
view precedes the requirement for accrual accounting. The
requirement to present true and fair accounts is wider than
the requirement of accrual accounting. Therefore, in a given
case it is possible that accounts prepared on accrual basis
may not present true and fair view because of certain
deficiencies, however, it is not possible for accounts to be
\023true and fair\024 unless they are prepared on accrual basis.
According to learned counsel, while Section 209(3)(b) mandates
the accrual basis of accounting, it does not indicate the
amount which should be recognized (accrued) in respect of
specific matters. This is left to the judgment of the Accountant.
According to learned counsel, accrual basis is a fundamental
accounting assumption which means that all Accounting
Standards including AS 22 are framed on the basis of accrual
system of accounting and, therefore, the question of conflict of an
Accounting Standard with the accrual basis of accounting does
not arise. That, all Accounting Standards are framed in order to
present a \023true and fair\024 view; that, the primary consideration in
the selection of accounting policies is to disclose a \023true and fair\024
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 75 of 108
view and, therefore, the purpose of all Accounting Standards
including AS 22 is to adopt the accrual basis of accounting in the
context of disclosing a \023true and fair\024 view and if this principle is
kept in mind then there would be no conflict between AS 22 with
accrual basis of accounting. In fact, according to learned
counsel, it is significant to note that while auditors are required
to certify that accounts are true and fair, they are not required to
certify that they are prepared on the accrual basis for the simple
reason that accounts cannot be true and fair unless the accrual
basis is adopted. For example, a particular liability is not
provided for, because it is not legally imminent, it could still be
argued that accrual basis bas been adopted in a legalistic sense,
but the accounts would nevertheless not represent true and fair
view. According to learned counsel, for the aforestated reasons
Accounting Standards require that the accrual basis should be
adopted in the context of presenting/disclosing a \023true and fair\024
view. Therefore, the need to disclose a true and fair view is
wider then the need for accrual accounts since it
automatically includes accrual method of accounting.
Learned counsel urged that there is overriding importance
for the disclosure of a \023true and fair\024 view, since the entire
structure of corporate credibility is built on this foundation.
Therefore, if any rules for technical disclosure are not
consistent with the true and fair view requirement, then the
company has to depart from the technical provisions, to the
extent necessary, to give a \023true and fair\024 view. That, the
disclosure requirements are subservient to the overriding
requirement of presenting a \023true and fair\024 view. Therefore, in
other words, the need to present a \023true and fair\024 view should
override technical compliance of the law on the basis of true
and correct accrual. Therefore, according to the learned
counsel, AS 22 goes far beyond technical compliance in order to
ensure a \023true and fair presentation\024. Therefore, according to
learned counsel, since Section 211(1) requires true and fair
presentation, AS 22, is not beyond the mandate of the Companies
Act.
50. Coming to the concept of \023prudence\024, learned counsel
submitted that when financial statements are prepared,
sometimes, the accountant comes across uncertainties that
surround many events and in such case caution in exercise of
the judgments is required while making estimates, so that assets
or income are not overstated and liabilities or expenses are not
understated. This is the principle of prudence. The said
principle applies in view of uncertainties attached to future
events. Profits are not anticipated, but they are recognized
only when they are realized. Similarly, Provision is made for
all known liabilities and losses, even though the amount
cannot be determined with certainty and, therefore,
Provision represents only an estimate in the light of available
information. The principle of prudence has also been recognized
in the Accounting Standard issued by the Central Government
under Section 145(2) of the I.T. Act through its notification dated
25.2.96 which is required to be followed by all assessees following
mercantile system of accounting. In this connection, reliance
was placed by learned counsel on the judgment of this Court in
the case of Chainrup Sampatram v. Commissioner of Income
Tax \026 (1953) 24 ITR 481 at 485 in which this Court has also
underlined the effect that even for income tax purposes profits
are to be computed in conformity with ordinary principles of
commercial accounting unless such principles stand modified by
specific legislative enactments/provisions contained in the
Income Tax Law. Similarly, in the case of Commissioner of
Income Tax v. Duncan Brothers & Co. Ltd. \026 (1996) 8 SCC 31
at 35, this Court has observed that the terms used in the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 76 of 108
Companies Act should be read in the manner as understood in
accounting parlance.
51. On the question of alleged conflict between AS 22 and
Schedule VI of Companies Act, learned counsel submitted that
Accounting Standards, issued by the Institute, deal with
recognition, measurement and disclosure and certain
elements in financial accounts of every enterprise. That,
Schedule VI deals with manner of presentation of financial
data in the annual financial statements, namely, the balance-
sheet and P&L a/c to be drawn by a corporate enterprise at the
end of each financial year. That, Part I of Schedule VI lays down
the form of balance-sheet whereas Part II lays down the
requirements as to the presentation of various financial data in
the P&L a/c. Part II deals with interpretation of some of the
expressions, namely, \023provisions\024, \023reserve\024, \023capital reserve\024,
\023liability\024, \023investment\024 etc. According to learned counsel, except
in the case of Depreciation which is provided by every corporate
enterprise in accordance with the rates laid down in Schedule
XIV of the Companies Act, having regard to the provisions
contained in Sections 205, 350 of the said Act, the said Act does
not lay down the procedure for recognition and measurement
of either the income or expenses and or the assets and
liabilities. For example, Schedule VI nowhere lays down as to
which assets should be recognized as \023Investments\024 and also the
method of valuing \023Investments\024. Similarly, AS 6 deals with
\023Depreciation Accounting\024, however, except the statutorily fixed
rate of depreciation as laid down in Schedule XIV of the
Companies Act, all other aspects relating to recognition and
measurement of depreciation are dealt with only in AS 6. They
are not dealt with in the Companies Act. Similarly, under Part II
of Schedule VI to the Companies Act the manner of presentation
of various items of income and expenses in the P&L a/c has been
laid down. However, the said Act nowhere lays down as to
how and when income or expenditure should be measured
and/or recognized. This aspect is dealt with by AS 9 alone and
not by the provisions of the Companies Act. According to learned
counsel, events and contingencies occurring after the balance-
sheet date mentioned in AS 4, net profit or loss for a given period,
prior period items and changes in accounting policies mentioned
in AS 5, Accounting for Construction Contracts in AS 7,
Accounting for Fixed Assets in AS 10, the Effect of changes in
Foreign Exchange Rates as mentioned in AS 11, Accounting for
Intangible Assets contained in AS 26, Accounting for Impairment
of Assets in AS 28 are various aspects dealt with only under
Accounting Standards and not under the Companies Act.
According to learned counsel, since the Companies Act
nowhere deals with recognition and measurement of various
items of income and expenses, assets and liabilities, and
since it deals with only presentation, there can never be any
conflict between the provisions of the said Act and the
Accounting Standards issued by the Institute in discharge of
its statutory obligations under the Chartered Accountants
Act, 1949 read with the Companies Act, 1956 which requires
that every corporate enterprise must maintain such books as
are necessary to give a \023true and fair\024 view of its state of
affairs and to explain its transactions (See: Section 209(3)),
and that every balance-sheet of a company shall give a \023true
and fair\024 view of the State of affairs of the company at the
end of the financial year, and that every P&L a/c of a
company shall also give \023true and fair\024 view of the P&L a/c
of a company for the financial year (See: Section 211(1)(ii)).
It is in this context of true and fair view requirement that the
Institute has framed Accounting Standards so as to enable
proper recognition and measurement of all income and expenses,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 77 of 108
assets and liabilities etc. as laid down in Section 209(1) read with
Section 211(3A), (3B) and (3C).
52. Coming to the question of true scope and AS 22, learned
counsel submitted that AS 22 deals with accounting for taxes
on income. According to learned counsel, as far back as in
1991, the Institute had issued the Guidance Note on Accounting
for Taxes on Income. This Note recommended deferred tax
adjustments. It also explained the taxes payable method. It
also explained the tax effect accounting method. It also
explained the method for calculating deferred tax adjustments
under \023deferred method\024 and under \023liability method\024. It
recommended that till the tax effect accounting method stood
developed, it would be permissible for an enterprise to follow the
taxes payable method as an alternative. After 10 years, AS 22
was finally issued by the Institute in 2001 in order to ensure a
\023true and fair\024 view of the profits earned during a financial year,
and the taxes payable with reference thereto, to be presented in
the corporate accounts. That is the reason why, AS 22 leaves out
of account differences between book profits and taxable profits
which are of permanent nature. But AS 22 requires that
DTL/DTA arising on account of timing differences should be
reflected in the corporate accounts through what is called as
\023deferred tax account\024. According to learned counsel, deferred
tax accounting ensures that profits are measured in a real and
factual manner. It also ensures that the benefit obtained in
one year, which could be reversed in a subsequent year, is
duly recognized as a liability. Therefore, according to learned
counsel, AS 22 not only complies with the requirement for
accrual accounting, but it applies the need for accrual
accounting, in the context of presenting a \023true and fair\024 view,
rather than purely on the basis of a true and correct view.
Accounting treatments contained in various Accounting
Standards issued by the Institute are based on accrual
accounting and, therefore, these Standards adopt the accounting
treatments mentioned therein to ensure that a company has
followed the accrual basis of accounting. According to learned
counsel, AS 22, therefore, fulfills, the need for accrual accounting
in the context of the true and fair view requirement. According to
learned counsel, there is a difference between accrual accounting
on the basis of true and correct view vis-`-vis accrual accounting
on the basis of true and fair view. In the case of former, the
profits are likely to be overstated and in which event the investors
would be misled. That, the purpose of true and fair accounts is
to protect investors and, therefore, the purpose of AS 22 is to
ensure that accrual is made on a true and fair basis, by reference
to the Substance rather than the Form. Learned counsel urged
that the very object behind issuance of AS 22 is that in
accordance with the matching concept, taxes on income are
recognized (accrued) in the same period as the revenue and
expenses to which they relate. Matching of such taxes against
income/revenue for a period raises problems as taxable income
may be different from accounting income significantly. According
to learned counsel, para 4 of AS 22 lays down the definitions of
various terms used in AS 22. One such term is \023current tax\024
which has been defined to mean the amount of income tax
determined as payable in respect of taxable income (loss) for a
particular period. Similarly, in para 4 the expression \023deferred
tax\024 has been defined to mean what is called as \023timing
differences\024 which in turn has been defined to mean the
differences between taxable income and accounting income for a
period. Such \023timing differences\024 originates in one period and are
capable of reversal in one or more subsequent periods. \023Timing
differences\024 arises because the period in which some items
of revenue and expenses are included in taxable income
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 78 of 108
which items do not coincide with the period in which such
items are included or considered in arriving at accounting
income. This difference between taxable income and accounting
income arises for two reasons. Firstly, there are differences
between items of revenue and expenses, as appearing in the P&L
a/c, and the items which are considered as revenue, expenses or
deductions for tax purposes. Secondly, there are differences
between the amount in respect of a particular item of revenue or
expense, as recognized in the P&L a/c, and the corresponding
amount, which is recognized for the computation of taxable
income. This happens in the case of depreciation. The tax laws
allow \023incentive depreciation\024 on increased rate, as prescribed in
Rule 5 read with the percentages mentioned in second column of
the table in appendix I to the I.T. Rules, 1962 on the written
down value of the block of assets, as are used by the assessee for
the purpose of the business at any time during the relevant
previous year. Depreciation includes amortization of assets
whose useful life is predetermined. The commercial accounting
principle requires that the original cost of an asset should written
off in the accounts by way of charge against income of each year
in such a manner that its entire cost is debited against the
income arising therefrom during life time of such asset. However,
the I.T. Act lays down incentive rates of depreciation. While for
accounting purposes, depreciation is provided for on straight line
method, the Income Tax Act allows depreciation by way of
incentive at much higher rate with reference to its written down
value. The total depreciation charged on the plant and
machinery for accounting purposes and the amount allowed as
deduction for tax purposes ultimately remains constant, but
period over which depreciation is charged in the accounts as
compared to the period during which the deduction is allowed
under I.T. Act, will differ. This is a case of timing difference. For
example, machinery purchased for scientific research is fully
allowed as deduction in the very first year for tax purposes,
whereas the same would charged in the P&L a/c, as depreciation,
over its useful life of, let us say, 15 years. Unabsorbed
depreciation and carry forward of losses, which can be set off
against future taxable income, are also examples of timing
differences. Such timing differences result in DTAs. According to
learned counsel, for the above reasons para 9 of AS 22 lays down
that tax expense for a given period, shall, therefore, consists of
current taxation and deferred tax which included in the
determination of the net profit or loss for the period. Similarly,
para 10 of AS 22 further provides that tax effects of timing
differences should be included in the tax expense in the P&L a/c
and as deferred tax assets or as deferred tax liabilities in the
balance-sheet.
53. Learned counsel for the Institute next submitted that para
33 of AS 22 is Transitional Provisions. According to the learned
counsel, it is not retrospective as alleged by the appellants.
According to learned counsel, under Section 209(3)(b) of the
Companies Act, books of account must be kept on accrual basis
and according to the double entry system of accounting. In other
words, if a company was maintaining its accounts on cash basis
prior to 1988 when the present section came into existence, the
said company is required to change the system of accounting
from cash to mercantile w.e.f. 15.6.88. However, this would not
mean that without maintaining accounts on mercantile basis, the
company would not record the opening balances of its assets and
liabilities merely because Section 209(3)(b) does not refer to
retrospective application. Learned counsel submitted that,
therefore, there is no merit in the submissions made on behalf of
the appellants that para 33 of AS 22 is ultra vires the provisions
of the Companies Act. For the above reasons, learned counsel
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 79 of 108
submitted that AS 22 is in no way contradictory to and/or in
conflict of Schedule VI to the Companies Act having regard to the
statutory requirement/consideration of presenting the financial
statements in \023true and fair\024 manner as laid down in Section
211(1)(ii) of the Companies Act. That, clause (vi) under para 3 of
Part II of Schedule VI to the Companies Act reference is made
only to presentation of income liability in the P&L a/c. It does
not refer to the method of its recognition and/or measurement
which aspects are considered and dealt with only by AS 22.
Therefore, the portion of income tax expenses deferred to future
tax returns is required to be credited to a Liability Account called
as Deferred Income Tax Account.
54. On behalf of the appellants it was vehemently submitted
that the DTL is a notional and contingent liability and, therefore,
it is not required to be charged to the P&L a/c as per the
requirements of the Companies Act. According to the appellants
DTL is a future liability and, therefore, it does not exist on the
balance-sheet. Appellants have also argued that DTL is a
contingent liability because it may or may not arise in future.
They have argued that DTL is not in accordance with the
requirement of Section 209(3)(b) of the Companies Act as it does
not amount to keeping books of account on accrual basis. In
reply, Mr. Poddar, submitted that DTL is not a notional tax
liability, but a real liability as it results in future cash outflow in
the form of tax payment to the Income Tax Department.
According to learned counsel, DTL arises in the current year in
which the timing difference originates i.e. during the year the
difference in the tax depreciation and accounting
depreciation arises. Therefore, according to learned counsel,
DTL exists on the balance-sheet date for the financial year in
which it originates and, therefore, it is a real liability. According
to learned counsel, the liability which arises in the current year
(i.e. the year in which timing difference arises) and is payable in a
future year is not a future liability. According to learned counsel,
DTL arises, therefore, in the current financial year in which
timing difference arises but is payable in a future financial year.
According to learned counsel, the aforestated concept is the
essence of the accrual basis of accounting which has been
defined in AS 1. Learned counsel further submitted that for the
above reasons DTL is not a contingent liability as it actually
arises in the financial year in which the timing difference
originates. According to learned counsel, a contingent liability
becomes a liability on happening or not happening of an
uncertain event in future. That DTL is not contingent. It does
not arise in future on happening or not happening of future
event. That, there is a difference in the liability arising in future
or contingent on a future event taking place and a liability, which
exists today, but payment in respect of which is to be made in
future. That, any existing liability payable in future is not a
future or contingent liability. According to learned counsel, DTL
is an existing liability on the balance-sheet date. According to
learned counsel, reversal of timing difference in respect of an
asset is definite during the life of an asset. Therefore, there is no
uncertainty with regard to the reversal of timing difference in
future over the life of the asset. The accounts of a company are
prepared under the fundamental accounting assumption of
\023going concern\024 which is defined in AS 1 under which the
enterprise is normally looked upon as a \023going concern\024, i.e.,
continuing in operation for the foreseeable future. Under that
assumption it is assumed that the enterprise has neither the
intention nor the necessity of liquidation or to reduce the scale of
its operations. Therefore, according to learned counsel, the
examples, given on behalf of the appellants, of liquidation or fall
in the scale of operations are not apposite illustrations for
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 80 of 108
treating DTL as a notional liability. According to learned
counsel, DTL is a liability for the current period i.e. for the
period in which the timing difference originates, on the basis
of matching principle also, which is a part of accrual basis of
accounting. In the light of the said submissions, learned
counsel contended that the charge in the P&L a/c for
deferred tax expense is in respect of a known liability
payable in future; and, therefore, it is covered by the definition
of the word \023Provision\024 as contained in Part II of Schedule VI to
the Companies Act.
55. On the question of ultra vires learned counsel for the
Institute had adopted the contentions advanced by learned
Additional Solicitor General on behalf of Union of India.
Finding:
56. For the following reasons we hold that the impugned
Rule which adopts AS 22 neither suffers from the vice of
excessive delegation nor is the said Rule
incongruous/inconsistent with the provisions of the
Companies Act, 1956.
Reasons:
(i) Preface:
57. India is an emerging economy. Globalization has helped
India to achieve the GDP rate of around 8 to 9 per cent.
However, with globalization, India is required to face
challenges in various forms. Corporate India has been
acquiring companies in India and abroad. Indian companies
are partners in joint ventures. They are part of international
consortium. Therefore, Indian Accounting Standards (IAS)
have to harmonize and integrate with International Accounting
Standards by which harmonization of various accounting
policies, practices and principles could take place.
58. In its origin, an accounting standard is the policy
document. In matters of recognition of various items of
income, expenditure, assets and liabilities, the aim is to
achieve standards/norms which would help to reflect \023true
and fair\024 view of the accounts of a company. Every Indian and
foreign investor/partner before entering into joint venture
agreement(s) with its counterpart examines the financial
statements and tries to ascertain the real income of the Indian
company.
59. With globalization, we have conventional/orthodox
system of accounting (recognition, measurement and
disclosure) vis-a-vis modern system of advanced accountancy.
Therefore, the role of accounting has undergone a
revolutionary change with the passage of time. Traditionally,
accounting was considered solely a historical description of
financial activities. That view is no longer acceptable.
Accounting is now considered as a service activity. Its function
is to provide quantitative information, primarily of financial
nature about the economic entities. Accounting today includes
several branches, e.g., Financial Accounting, Management
Accounting and Government Accounting. The primary role of
accounting is to provide an effective measurement and
reporting system. This is possible only when accounting is
based on certain coherent set of logical principles that
constitute the general frame of reference for evaluation and
development of sound accounting practices. That is why, we
have different accounting concepts and fundamental
accounting assumptions, such as, separate entity concept,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 81 of 108
going concern concept, accrual concept, matching concept
etc.. Therefore, Accounting Standards are based on a number
of accounting principles. For example, the Matching Principle
and Fair Valuation principle. Historically, matching principles
ensured that costs incurred matched with revenues they
generated, though they resulted in assets and liabilities in the
balance-sheet at other than fair values. Similarly, they
resulted in assets, which were not assets in the real sense,
e.g., deferred revenue expenditure. However, the matching
principles ensured purity of the profit and loss statement.
Therefore, matching principles ensure ascertainment of
true income. Today under Advanced Accountancy, matching
principles recognizes not only costs against revenue but also
against the relevant time period to determine the Periodic
Income. Therefore, matching principle today forms an
important component of Accrual Basis of Accounting.
60. On the other hand, Fair Valuation principles are
important in the context of valuing derivatives and other
investments. If one were to describe one single change in
accounting practice over the last few years, it would be the use
of Fair Valuation principles. Today, the object behind
enactment of A.S., which are now made mandatory under
section 211(3A) of the Companies Act, is to shift from
historical method of accounting to fair valuation. In the case of
mergers and acquisitions, which is common today in the world
of globalization, fair valuation principles have important role
to play. Mergers and acquisitions are sometimes
undertaken to defer revenue expenditure over future years
by invoking the matching concept, which results in
putting fictitious assets on the balance-sheet. This is one
reason why fair valuation principles are accepted.
61. A.S. are established rules relating to recognition,
measurement and disclosures thereby ensuring that all
enterprises that follow them are comparable and that their
financial statements are \023true and fair\024. Measurements and
disclosures based on fair value are becoming increasingly
important. Fair valuation is generally used in valuation and
disclosure of financial instruments, derivatives, conversions,
auctions in a bond, business combinations, impairment of
assets, retirement obligations, transactions involving exchange
of assets without monetary consideration, transfer pricing,
etc..
62. In conclusion, the importance of the Preface is to show a
paradigm shift in the thinking of Accountants all over the
world, particularly with the coming-in of the abovementioned
new concepts.
(ii) Doctrine of Ultra Vires
63. At the outset, we may state that on account of globalization
and socio-economic problems (including income disparities in our
economy) the power of Delegation has become a constituent
element of legislative power as a whole. However, as held in the
case of Indian Express Newspaper v. Union of India reported
in (1985) 1 SCC 641 at page 689, subordinate legislation does not
carry the same degree of immunity which is enjoyed by a statute
passed by a competent Legislature. Subordinate legislation may
be questioned on any of the grounds on which plenary legislation
is questioned. In addition, it may also be questioned on the
ground that it does not conform to the statute under which it is
made. It may further be questioned on the ground that it is
inconsistent with the provisions of the Act or that it is
contrary to some other statute applicable on the same subject
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 82 of 108
matter. Therefore, it has to yield to plenary legislation. It can also
be questioned on the ground that it is manifestly arbitrary and
unjust. That, any inquiry into its vires must be confined to the
grounds on which plenary legislation may be questioned, to the
grounds that it is contrary to the statute under which it is made,
to the grounds that it is contrary to other statutory provisions or
on the ground that it is so patently arbitrary that it cannot be
said to be inconformity with the statute. It can also be challenged
on the ground that it violates Article 14 of the Constitution.
Subordinate legislation cannot be questioned on the ground of
violation of principles of natural justice on which administrative
action may be questioned. A distinction must, however, be made
between delegation of a legislative function in which case the
question of reasonableness cannot be gone into and the
investment by the statute to exercise a particular discretionary
power. In the latter case, the question may be considered on all
grounds on which administrative action may be questioned, such
as, non-application of mind, taking irrelevant matters into
consideration, failure to take relevant matters into consideration
etc.. A subordinate legislation may be struck down as arbitrary or
contrary to statute if it fails to take into account vital facts which
expressly or by necessary implication are required to be taken
into account by the statute or the Constitution. This can be done
on the ground that the subordinate legislation does not conform
to the statutory or constitutional requirements or that it offends
Article 14 or Article 19 of the Constitution. However, it may be
noted that, a notification issued under a section of the statute
which requires it to be laid before Parliament does not make any
substantial difference as regards the jurisdiction of the Court to
pronounce on its validity.
64. Apart from the grounds referred to by this Court in the
above judgment in the case of Indian Express Newspaper, it
is important to bear in mind that where the validity of
subordinate legislation is challenged, the question to be asked
is whether the power given to the rule making authority (in the
present case the Central Government under section 642(1) of
the Companies Act) is exercised for the purpose for which it is
given. Before reaching the conclusion that the Rule is intra
vires (we have to begin with the presumption that the Rule is
intra vires), the court has to examine the nature, object and
the scheme of the legislation as a whole and in that context,
the court has to consider what is the Area over which powers
are given by the section under which the Rule Making
Authority is to act. However, the court has to start with the
presumption that the impugned Rule is intra vires. This
approach means that, the Rule has to be read down only to
save it from being declared ultra vires if the court finds in a
given case that the above presumption stands rebutted.
65. If the impugned rule is a delegated legislation it would
follow that the said rule is made in exercise of the power
conferred by the statute. Legislature has wide powers of
delegation. This, however, is subject to one limitation, namely,
it cannot delegate uncontrolled power. Delegation is valid only
when it is confined to legislative policy and guidelines.
66. In the present case, abovementioned guideline is
provided by section 211(1), which has brought in a stand-
alone concept of \023true and fair\024 accounting. The said
concept is the controlling consideration. As stated above,
delegation is valid when it is confined to Legislative Policy and
Guidelines which are adequately laid down and the delegate is
only empowered to implement such Policy within the
Guidelines laid down by the Legislature (see TISCO v. The
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 83 of 108
Workmen & ors. reported in AIR 1972 SC 1917)
67. In the present case, we are required to consider the
scope of section 642(1), which refers to the power of Central
Government (rule making authority) to make rules vis a vis
section 641, which states that subject to the provision of the
section, the Central Government may, by Notification in the
Official Gazette, alter any of the regulations, rules, forms,
tables and other provisions contained in any of the Schedules
to the Companies Act (including Schedule VI). This aspect is of
some importance. Section 642 is in addition to the powers
conferred by section 641, therefore, the two sections form part
of the same scheme. However, the scope of section 641 is
different from the scope of section 642. Power to alter any
provision of the Schedules and the power to carry out gap-
filling exercise are both entrusted to the Central Government.
The expression \023in addition\024 to in section 642 indicates that
both the above sections constitute one scheme. However,
section 642 enables Central Government to provide details
and, therefore, under section 642 the rules contemplated
refers to gap-filling exercise.
68. It is well settled that, what is permitted by the concept of
\023delegation\024 is delegation of ancillary or subordinate legislative
functions or what is fictionally called as \023power to fill up
the details\024. The judgments of this Court have laid down that
the Legislature may, after laying down the legislative policy,
confer discretion on administrative or executive agency like
Central Government to work out details within the
framework of the legislative policy laid down in the
plenary enactment. Therefore, power to supplement the
existing law is not abdication of essential legislative function.
Therefore, power to make subordinate legislation is derived
from the enabling Act and it is fundamental principle of law
which is self-evident that the delegate on whom such
power is conferred has to act within the limitations of the
authority conferred by the Act. It is equally well settled that,
Rules made on matters permitted by the Act in order to
supplement the Act and not to supplant the Act, cannot be
held to be in violation of the Act. A delegate cannot override
the Act either by exceeding the authority or by making
provisions inconsistent with the Act. (See Britnell v.
Secretary of State 1991 (2) AllER 726 at 730)
69. The issue before us in the present batch of civil appeals
is whether the Central Government, which is the rule making
authority, has overridden the Companies Act, 1956 either by
exceeding its authority in adopting AS 22 or by making
provisions inconsistent with sections 209 and 211 read with
Part I and Part II of Schedule VI to the Companies Act as
alleged by the appellants.
70. Since the said issue has two parts, for the sake of
convenience, the first point which needs to be decided is as
follows:
(a) Whether the impugned Rule adopting
AS 22 is in excess of the powers
conferred upon Central Government
under section 642(1) of the Companies
Act, 1956 ?
71. In the case of Banarsi Das v. State of M.P. reported in
AIR 1958 SC 909 the State had issued a Notification under
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 84 of 108
section 6(2) of the Central Provinces and Berar Sales Act, 1947
amending Item 33 in Schedule II by substituting for the words
\023goods sold to or by the State Government\024 by the words
\023goods sold by the State Government\024. As a result of the said
Notification, amending the schedule, the assessee who was
entitled for exemption from payment of sales tax in respect of
goods sold to the State Government could no longer claim
such exemption by reason of the said Notification. That
Notification was challenged on the ground that it was not open
to the Government in exercise of the authority delegated to it
under section 6(2) to modify or alter what the Legislature had
enacted and, therefore, the said Notification was bad as being
unconstitutional delegation of legislative authority. It was
argued on behalf of the assessee that earlier they had been
granted exemption under section 6(1) of the Act which
subsisted when the impugned Notification came to be issued
and that in consequences, while an exemption under section
6(1) existed any amendment to the Schedule under section
6(2) was bad as it had the effect of deletion of the exemption
which had been granted. Section 6(1) of the Act contemplated
exemption to be given by the State Government on certain
types of transactions whereas section 6(2) empowered the
State Government to amend the schedule. It is in this context
that the question arose as to whether the impugned
Notification was bad as being an unconstitutional delegation of
legislative authority. The said contention was rejected by this
Court stating that the two sub-sections together constituted
integral part of a single enactment. We quote hereinbelow para
11 of the said judgment, which reads as follows:
\02311. The contention of the appellant that the
notification in question is ultra vires must, in
our opinion, fail on another ground. The basic
assumption on which the argument of the
appellant proceeds is that the power to amend
the schedule conferred on the Government
under section 6(2) is wholly independent of
the grant of exemption under section 6(1) of
the Act, and that, in consequence, while an
exemption under section 6(1) would stand, an
amendment thereof by a notification under
section 6(2) might be bad. But that, in our
opinion, is not the correct interpretation of
the section. The two sub-sections together
form integral parts of a single enactment, the
object of which is to grant exemption from
taxation in respect of such goods and to such
extent as may from time to time be
determined by the State Government. Section
6(1), therefore, cannot have an operation
independent of section 6(2), and an exemption
granted thereunder is conditional and subject
to any modification that might be issued
under section 6(2). In this view, the impugned
notification is intra vires and not open to
challenge.\024 (emphasis supplied)
Applying the tests laid down in the aforestated judgment to the
present case, it may be noted that, in this case, we are
concerned only with the existence and the extent of the powers
given to the Central Government to make rules, both for
altering the Schedules to the Companies Act as well as to fill in
details. Power to alter the Schedule as well as power to fill in
details are two distinct powers. However, both the powers are
entrusted to the same delegate, namely, the Central
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 85 of 108
Government. Further, as stated above, sections 641 and 642
form part of the same scheme, hence, it cannot be said that
merely because the impugned Notification has been issued
under section 642 and not under section 641 the said
Notification is exhaustive of the powers given to the Central
Government to frame rules under the aforestated two sections.
Moreover, in the present case, section 642(1) begins with the
expression \023in addition to the powers conferred by section
641\024, therefore, one has to read section 641 as an additional
power given to the Central Government to make Rules, in
addition to its power to alter the schedule by making
appropriate Rules under section 641. There is one more way of
looking at the arguments. The Companies Act has been
enacted to consolidate and amend the law relating to
companies and certain other associations. Under section
211(3A) Accounting Standards framed by National Advisory
Committee on Accounting Standards constituted under
section 210A are now made mandatory. Every company has to
comply with the said standards. Similarly, under section
227(3)(d), every auditor has to certify whether the P&L a/c and
balance-sheet comply with the accounting standards referred
to in section 211(3)(c). Similarly, under section 211(1) the
company accounts have to reflect \023true and fair\024 view of the
state of affairs. Therefore, the object behind insistence on
compliance with the A.S. and \023true and fair\024 accrual is the
presentation of accounts in a manner which would reflect the
true income/profit. One has, therefore, to look at the entire
scheme of the Companies Act. In our view, the provisions of
the Companies Act together with the Rules framed by the
Central Government constitute a complete scheme. Without
the Rules, the Companies Act cannot be implemented. The
impugned Rules framed under section 642 are a legitimate aid
to construction of the Companies Act as contemporanea
expositio. Many of the provisions of the Companies Act, like
computation of book profit, net profit etc. cannot be put into
operation without the rules.
72. In the case of P. Kasilingam and ors. v. P.S.G. College
of Technology and ors. 1995 Suppl(2) SCC 348 vide para 20
this Court ruled as follows:
\02320. The Rules have been made in exercise of
the power conferred by Section 53 of the Act.
Under Section 54(2) of the Act every rule made
under the Act is required to be placed on the
table of both Houses of the Legislature as soon
as possible after it is made. It is accepted
principle of statutory construction that \023rules
made under a statute are a legitimate aid to
construction of the statute as contemporanea
expositio \024 (See : Craies on Statute Law , 7th
Edn., pp. 157-158; Tata Engineering and
Locomotive Co. Ltd. v. Gram Panchayat,
Pimpri Waghere (1976) 4 SCC 177.) Rule 2(b)
and Rule 2(d) defining the expression \021College\022
and \021Director\022 can, therefore, be taken into
consideration as contemporanea expositio for
construing the expression \023private college\024 in
Section 2(8) of the Act. Moreover, the Act and
the Rules form part of a composite scheme.
Many of the provisions of the Act can be put
into operation only after the relevant provision
or form is prescribed in the Rules. In the
absence of the Rules the Act cannot be
enforced. If it is held that Rules do not apply to
technical educational institutions the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 86 of 108
provisions of the Act cannot be enforced in
respect of such institutions. There is,
therefore, no escape from the conclusion that
professional and technical educational
institutions are excluded from the ambit of the
Act and the High Court has rightly taken the
said view. Since we agree with the view of the
High Court that professional and technical
educational institutions are not covered by the
Act and the Rules, we do not consider it
necessary to go into the question whether the
provisions of the Act fall within the ambit of
Entry 25 of List III and do not relate to Entry
66 of List I.\024 (emphasis supplied)
73. To the same effect is the judgment of this Court in the
case of TELCO v. Gram Panchayat, Pimpri Waghere
reported in (1976) 4 SCC 177 in which the Court was required
to consider the definition of the word \023house\024 under the Rules
framed in 1934. It was held that the rules provided internal
legitimate aid for the interpretation of the words and phrases
used in the main enactment.
74. In the present case also even under the Rules impugned
herein AS 22, which is made mandatory, provides an internal
legitimate aid to the meaning of the words in the Companies
Act, including Schedule VI, namely, liability, provision for
taxes on income, book profit, net profit, depreciation,
amortization etc.. Therefore, it cannot be said that the
impugned Rules framed under section 642(1) constitute an act
on the part of the rule making authority, namely, the Central
Government, in excess of its powers under section 642(1) of
the Companies Act. In our view, the impugned
Rule/Notification is valid. It has nexus with the matters
entrusted to the Central Government to be covered by
appropriate rules. Therefore, in our view, the impugned Rule is
valid as it has nexus with statutory functions entrusted to
Central Government which is the rule making authority under
the Act. It is important to bear in mind that the power to
regulate a business or profession implies the power to
prescribe and enforce all such proper reasonable rules as may
be deemed necessary to conduct business/profession in a
proper and orderly manner and the power includes the power
to prescribe conditions under which business/profession can
be carried on. (See Deepak Theatre, Dhuri v. State of
Punjab and ors. AIR 1992 SC 1519 at page 1521). The
Scheme of the Companies Act indicates that Accounting
Standards are made mandatory. They have to be followed by
the auditors. They have to be followed by the companies. The
Accounting Standards provide discipline. They provide
harmonization of concepts. They provide harmonization of
accounting principles. In the past, when Accounting
Standards were not mandatory, various companies used to
follow alternate system of accounting. This led to
overstatement of profits. Therefore, the said Standards have
now been made mandatory. In our view, it is the statutory
function given to the Central Government to frame Accounting
Standards in consultation with the National Advisory
Committee on Accounting Standards (NAC) under section
211(3C). It is not necessary for the Central Government to
adopt in every case the Accounting Standards issued by the
Institute. Nothing prevents the Central Government from
enacting its own Accounting Standards which may not be in
consonance with the Standards prescribed by the Institute.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 87 of 108
Similarly, nothing prevents the Central Government from
adopting the Standards issued by that Institute as is the case
in the present matter. Therefore, in our view, the impugned
Rule is valid as it has nexus with the statutory functions
entrusted to the Rule making authority, namely, the Central
Government.
(b) Whether the impugned Rule is
incongruous/contrary to sections 209
and 211 read with the provisions of Part I
and Part II of Schedule VI to the
Companies Act, 1956 and whether the
said Rule seeks to modify the essential
features of the Companies Act ?
(A) Concepts
75. To answer the above question, we need to examine the
following concepts prevalent in Accounting.
Accrual System of Accounting
76. In the conventional sense, amounts which become
receivables/recoverable are shown as income actually received
and the liabilities incurred are shown as amounts actually
disbursed in a given year. Therefore, under the aforestated
system of accounting, entries are posted in the books of
accounts on the date of the transaction, i.e., on the date on
which rights accrue or liabilities are incurred, irrespective of
the date of payment. In such cases, a company has to
account for its income or loss as per the above system and not
otherwise, if that company has adopted mercantile system of
accounting which is also known as accrual system of
accounting. However, accrual does not mean confinement of
items of revenue/expenditure to a given year. As stated
above, mergers and acquisitions are undertaken to defer
revenue expenditure over future years by invoking
matching principles. Therefore, the said principle forms an
important part of accrual accounting.
Taxes on Income (TOI)
77. It is an important item of P&L a/c. Taxes on income are
considered as expenses incurred by a company in earning
revenues. It is an expense which is recognized in the same
period as revenue and expense to which they relate. This is
called as matching principle. Such matching, results in what
is called as Timing Differences. Tax effects of Timing
Differences are included as tax expense in the statement
of profit and loss and as deferred tax asset (DTA) or as
deferred tax liability (DTL) in the balance-sheet. In short,
deferred tax should be recognized for timing differences.
This is the basic mandate of AS 22. This mandate is based on
an important principle of accounting, namely, that every
transaction has a tax effect. However, DTA is subject to the
principle of prudence and certainty that in future the company
will have adequate income. This principle of prudence states
that DTAs are recognized and carried forward only to the
extent of their being a reasonable certainty of their realization,
i.e., in future there would be taxable income. Therefore, under
the rule of prudence, DTAs are to be recognized only to the
extent of their being timing differences, the reversal whereof
will result in sufficient taxable income in future against which
they can be realized. On the other hand, DTL is to be
recognized as liability under the said standard as it results in
future cash outflow in the form of payments to the Income tax
Department in the case of TOIs.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 88 of 108
Current Tax
78. Current tax has to be measured by using the applicable
tax rates. This is because current tax has to be measured at
the amount expected to be paid to the Income tax Department
by way of tax. Not only the tax rates, but also tax laws
constitute the basis for measuring the amount of tax expected
to be paid to the Income tax Department. It is important to
note that while measuring current tax, companies have to go
by the balance-sheet date. The company has to examine the
tax rates and the tax laws on that date.
Timing Differences
79. They are differences which arises because the period
in which some items of revenue and expenses are included
in the taxable income do not tally with the period in
which items are considered to compute the Accounting
Income. In other words, it recognizes expenses against the
relevant time period to determine the periodic income. This
concept has been brought in after the amendment to section
211(1) of the Companies Act which emphasizes that after 2001
the companies shall prepare their accounts so as to reflect
\023true and fair\024 view of the State of Affairs and to obliterate
the difference between Accounting and Taxable Income.
This concept bridges the gap between accounting income and
taxable income. Deferred tax is the tax effect of such
differences which are now required to be accounted for. As
stated above, Accounting Standards today constitute a
paradigm shift from the conventional system of accounting
based on Historical Costs Method towards Fair Valuation
Principles. Similarly, in the past, companies used to follow
alternate system of accounting. The Accounting Standards
today are trying to harmonize different accounting concepts
and principles and, therefore, timing differences play an
important role in harmonizing the matching principle under
accrual system of accounting with the Fair Valuation
Principles. The object is to achieve proper presentation of
balance-sheet and P&L a/c. The object is to present before the
investors, shareholders and other stake-holders the book
profits (real income) of the company. The tax effect of timing
difference under AS 22 has to be included in the tax
expenses in the P&L a/c as DTA or DTL in the balance-
sheet. Therefore, timing difference is the tax effect which
forms part of tax expense in the P&L a/c. The primary
object of AS 22 adopted by the impugned Rule is to prescribe
an accounting treatment for TOI. In accordance with the
matching concept, TOIs are recognized in the same period as
revenue and expenses to which they relate. Matching of TOI
against revenue for a period poses problems due to the effect
that in a number of cases, taxable income is different from
accounting income. This difference arises for two reasons.
Firstly, there are differences between items of revenue and
expenses in the P&L a/c and items considered as revenue
expenses or taken for tax purposes. Secondly, there are
differences between the amount in respect of a particular item
of revenue or expenses as recognized in the P&L a/c and the
corresponding amount which is recognized for computing
taxable income.
Tax Expense
80. As stated above, current tax is the amount of income tax
determined to be payable in respect of taxable income for a
period. On the other hand, deferred tax is the tax effect of
Timing Differences. As stated above, Timing Differences are
differences between taxable income and accounting income for
a given period. Timing Difference originates in one period,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 89 of 108
but it is capable of reversal in one or more subsequent
period(s). As stated above, every transaction has a tax
effect, therefore, tax expense is the sum total of current
tax + deferred tax charged or credited to the statement of
profit and loss for the given period. Therefore, tax expense
for that period has to be included in the Net Profit. Therefore,
we see no inconsistency between liability as understood in the
conventional sense and DTL as submitted on behalf of the
appellants.
Assets
81. Assets represent expenditure. When an expenditure is
written off for accounting purposes in the year in which it is
incurred but is admissible as deduction for tax purposes over
a period of time then in such cases, the asset representing
expenditure would have a balance only for tax purposes but
not for accounting purposes. The difference between the
balance of the assets for tax purposes and the balance for
accounting purposes would be a timing difference which
will reverse in future when the expenditure would be
allowed for tax purposes. In such a case, DTA would be
recognized in respect of the timing difference, subject to the
principle of prudence. This concept is important while deciding
the question as to whether para 33 of AS 22 (transitional
provision) is or is not inconsistent with the provisions of
Schedule VI to the Companies Act.
Matching Principle
82. Matching Concept is based on the accounting period
concept. The paramount object of running a business is to
earn profit. In order to ascertain the profit made by the
business during a period, it is necessary that \023revenues\024 of the
period should be matched with the costs (expenses) of that
period. In other words, income made by the business during a
period can be measured only with the revenue earned during
a period is compared with the expenditure incurred for earning
that revenue. However, in cases of mergers and acquisitions,
companies sometimes undertake to defer revenue expenditure
over future years which brings in the concept of Deferred Tax
Accounting. Therefore, today it cannot be said that the concept
of accrual is limited to one year.
83. It is a principle of recognizing costs (expenses) against
revenues or against the relevant time period in order to
determine the periodic income. This principle is an important
component of accrual basis of accounting. As stated above,
the object of AS 22 is to reconcile the matching principle with
the Fair Valuation Principles. It may be noted that
recognition, measurement and disclosure of various items
of income, expenses, assets and liabilities is done only by
Accounting Standards and not by provisions of the
Companies Act.
Depreciation
84. As stated above, timing difference is the difference
between taxable income and accounting income for a period.
Depreciation is one of the important items in computation of
income, be it taxable income or accounting income. According
to Pickles Accountancy, fourth edn., at page 0518, depreciation
is the inherent decline in the value of an asset from any cause
whatsoever. The wearing out of a machine is a simple example
of depreciation. In double-entry system of accounting, there
has to be complete double-entry for depreciation adjustment.
The required entry under that system of Depreciation
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 90 of 108
Adjustment is debit Trading and Profit & Loss account and
credit the asset in respect of which depreciation is being
recorded. Such an entry conforms with the principles
enunciated, namely, that, the debit to Trading and Profit &
Loss account is necessary because the amount written-off
represents an expense and the credit to the asset is
required, as the asset has, pro tanto, reduced in value.
Therefore, from the above point of view in the principles of
accountancy, even distribution in certain cases is treated as
expenditure paid out over the years. The object of providing for
such distribution is to spread the expenditure incurred in
acquiring the assets over its effective lifetime. The amount of
provision to be made in respect of the accounting period is
intended to represent the portion of such expenditure which
has expired during the period. Therefore, in that sense, it is
money expended which is spread out over the effective life of
an asset. Even under the Income tax Act, Parliament has used
the expression \023allowances and depreciation\024 in several
sections in Chapter IV within which section 44A appears. In
this connection, reference may be made to section 37 which
enjoins that, any expenditure not falling in sections 30 to 36
expended wholly and exclusively or laid out for business
purposes should be allowed in computing the business
income. Therefore, depreciation and allowances have been
dealt with in section 32 and the expression \023any expenditure\024
in section 37 covers both, allowances and depreciation. [See
Commissioner of Income-tax v. Indian Jute Mills
Association (1982) 134 ITR 68 (Cal)]. Depreciation under
Income tax Act is an incentive/allowance. However, in
commercial accountancy, it is reduction/deduction from
the value of an asset on the balance-sheet.
Reserves & Provisions
85. In State Bank of Patiala v. CIT reported in (1996) 219
ITR 706 substantial amounts were set apart by the assessee-
bank as reserves. No amount of bad debt was actually written
off or adjusted against the amounts claimed as reserves. No
claim for any deduction by way of bad debts was made during
the relevant assessment years. The assessee never
appropriated any amount against any \023bad and doubtful\024
debts. The amount remained in the account of the assessee by
way of capital and the assessee treated the said amount as
\023reserves\024 and not as \023provisions\024 designed to meet any
liability, contingency, commitment or diminution in the value
of assets known to exist on the date of the balance-sheet.
86. The question which arose for consideration by this Court
was whether amounts set apart in the balance-sheet are
\023provisions\024 or \023reserves\024. The matter arose under the
provisions of Companies (Profits) Surtax Act, 1964 which
levied a charge on every company for every assessment year
called as surtax, insofar as the chargeable profits of the
previous year exceeded the statutory deduction at the rates
mentioned in the Third Schedule. Rule (1) of Schedule II
stipulated mandatory that the capital of the company shall be
the total of the amounts including reserves. The assessee
contended that the amounts set apart in the balance-sheet are
reserves. The Department contended that the said amounts
were provisions. The assessee succeeded. However, the
reasoning given in the judgment is important. It was held by
this Court, after referring to the relevant provisions of the
Companies Act regarding the form of balance-sheet wherein
the words \023reserves and surplus\024 and \023current liabilities and
provisions\024 are dealt with, that if any retention or
appropriation falls within the definition of \023provision\024 it can
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 91 of 108
never be a reserve but it does not follow that if the retention or
appropriation is not a provision it is automatically a reserve.
That question has to be decided having regard to the true
nature and character of the sum so retained depending on
several factors including the intention with which and the
purpose for which such retention has been made because the
substance of the matter is to be recorded. In the said
judgment, it has been further held that if any retention is
made to meet depreciation, renewal or diminution in value of
asset, the same is not a reserve.
87. In that case, one of the other questions which arose for
determination was whether a fund created or a sum of money
set apart by assessee-bank to meet any liability which the
assessee-bank can reasonably anticipate on the balance-sheet
date is equivalent to the case where the liability has actually
arisen. The High Court took the view that since the assessee is
the banking company, it would be reasonable and legitimate to
assume that the bank was in a position to anticipate any
liability by way of bad debt on the balance-sheet date. This
Court held that the aforestated assumption made by the High
Court was unjustified. According to this Court, the question
to be asked in such cases is whether the liability was
known or anticipated on the date when the balance-sheet
was prepared and not whether the assessee can anticipate on
the balance-sheet date the debt and doubtful debts.
88. Applying this test to the facts of the present case, the tax
effect of the timing difference was known on the date when the
balance-sheet was prepared and, therefore, AS 22 is right in
stipulating that the tax effect of such timing differences
should be included in the tax expense in the statement of
profit and loss as DTA/DTL in the balance-sheet.
89. Depreciation in accounting sense is similar to bad and
doubtful debts. Provision for bad and doubtful debt like
depreciation is not a provision for liability but it is a
provision for diminution in value of assets. Where such
provision is made and if that provision is not excessive or
unreasonable, it is not a reserve, however, any amount in
excess of the requirement can be considered to be a
reserve. Thus, provision can be made for depreciation,
renewal, diminution in the value of an asset or for any known
liability. In this case, we are concerned with depreciation
mainly because in 99 per cent of the cases the difference
between tax depreciation and accounting depreciation results
in timing differences.
90. The provision for bad and doubtful debt is always made
with reference to debt receivable where there is doubt about
full realization of debt. The provision is made in order to cover
up the probable diminution in the value of an asset, i.e., debt
which is amount receivable. For example, if the receivable is
Rs. 1 crore and the assessee is of the opinion that Rs. One
crore might not be realized and that only 90 per cent of the
debt would be realized and, therefore, he makes a provision for
Rs. 10 lacs for bad debts. By making the provision, the
assessee is valuing his asset, namely, debt, which is the
amount receivable, at Rs. 90 lacs as against the book figure
of Rs. 1 crore. Thus, the provision for bad and doubtful debt is
the provision for diminution in the value of asset, i.e., debt.
Such provision is not a provision for liability, because even if a
debt is not recovered, no liability would be fastened upon the
assessee. The debt is the amount receivable by the assessee. It
is not any liability payable by the assessee. Therefore, any
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 92 of 108
provision towards irrecoverability of debt cannot be said to be
provision for liability. It is the provision for diminution in the
value of assets. The expression \023reserve\024 has been defined in a
negative manner by clause 7(1)(b) of Part III of Schedule VI to
the Companies Act and it only says that the reserve shall not
include any amount written off or retained by way of provision
for depreciation, renewal, diminution in value of asset or by
way of provision for any known liability. Thus, if the provision
made by the assessee for depreciation, (diminution in value of
the asset) is in excess of the amount which is reasonably
necessary for the purpose for which the provision is made, the
excess shall be treated as a reserve and not a provision. This
aspect is important because the question as to whether the
provision made is in excess of the requirement would depend
on the facts of each case. This aspect is important also
because it has been vehemently argued on behalf of the
assessee that AS 22 requires the assessee to make provision
for DTL which, in fact, should have been treated as a reserve
and not as a provision. Reserve is not a charge to be deducted
before arriving at the profit for the period under review. It is
appropriation of profit. The \023reserve account\024 is credited as a
result of a debit to the appropriation account and not to the
P&L a/c or revenue account. In a broad sense, all allocations
to reserve represent additions to capital. In the case of a
provision, unlike reserves, the charge is created as a result of
debit to the P&L a/c and not a debit to the appropriation
account.
Tax Base
91. The tax base of an asset or liability is the amount
attributed to that asset or liability for tax purpose. As
stated above, deferred tax has to be recognized for all
timing differences. This is based on the principle that
financial statements for a given period should recognize the
tax effect, whether current or deferred, of all transactions
occurring in a given period. One more principle needs to be
noted that assets represent expenditure.
Concept of DTL/DTA
92. DTL/DTA is recognized for all timing differences. AS
22 requires the companies to make a provision for Deferred
Tax Accounting with reference to the difference between
accounting income and taxable income. In our view, matching
principle is an important component of Accrual Accounting.
The said principle is not in conflict with accrual accounting as
vehemently submitted on behalf of the appellants. Accrual
Accounting is the concept recognized by sections 205, 209,
211 and Schedule VI to the Companies Act. However, the said
provisions of the Companies Act nowhere lays down as to
which asset should be recognized as an investment and the
method of valuing investments. That exercise is left to the
accounting standards. Similarly, the Companies Act nowhere
lays down as to how and when income or expenditure should
be measured/recognized. That exercise is left to the
accounting standards. AS 22 proceeds on the basis that a
benefit obtained in one year could be reversed in the
subsequent year and, therefore, it has to be recognized as a
liability. One more concept needs to be mentioned. Deferred
tax is the same as timing difference. It arises on account of the
difference between taxable and accounting incomes. This
difference arises between items of revenue and expenses as
comparing in P & L a/c vis-`-vis items considered as revenue,
expenses or deduction for tax purposes. Secondly, difference
also arises between the amount in respect of an item of
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 93 of 108
revenue or expenses as recognized in the P & L a/c and the
corresponding amount required in the computation of taxable
income. It is the tax effect of time difference which is
required to be included in Tax Expense in the P & L a/c and
as DTA/DTL in the balance-sheet. Timing difference originates
in the year in which difference arises between the tax
depreciation and accounting depreciation. Therefore, it is a
known liability for the current year, though payable in future
period(s). Therefore, tax effect of timing difference is a real
liability for which a provision is required to be made in the P &
L a/c as well as DTL in the balance-sheet. As stated above,
deferred tax is the tax effect of timing difference. It has been
vehemently submitted that a provision for Matching Tax is
required to be made in respect of accounting income only for
accounting period. The emphasis is on the words \023only for
accounting period\024. In our view, even under accrual system of
accounting, the accounting period need not be confined to one
year alone. As stated hereinabove, mergers and acquisitions
today are sometimes undertaken by companies to defer
revenue expenditure over future period(s) by invoking the
matching concept. Historically, it may also be stated that prior
to the introduction of AS 22, the companies used to follow
what is called as Tax Payable Method. They were put to
notice by the Institute that in future the companies shall have
to follow what is called as Tax Effect Accounting method. AS
22 introduces tax effect accounting method.
93. Before us, it has been vehemently urged on behalf of the
appellants that, unlike U.K., in India, rates of depreciation are
statutorily prescribed under the Companies Act and under the
Income-tax Act, 1961. According to the appellants, rates of
depreciation are not prescribed statutorily in U.K.. Therefore,
in U.K. the tax payer is at liberty to adopt any rate of
depreciation and, therefore, there could be justification for
invoking the matching principle and for applying AS 22 for
deferred taxation. We find no merit in this argument. In our
view, on the contrary, since in India we have two separate
rates of depreciation statutorily prescribed under two different
Acts, introduction of matching principle becomes relevant.
Ultimately, AS 22 is for deferred taxation. It brings out for
the information of shareholders, investors and stake-holders
the hidden liability which earlier could not be brought out.
Today, we are living in the world of globalization in which,
apart from merger, acquisitions play an important role. The
buyer wants to know the income and liabilities of a company.
He wants to know the real income of the company, which he
proposes to buy. Because of the difference in the rates of
depreciation statutorily prescribed under the Income-tax Act
and the Companies Act, the concept of deferred taxation has
been introduced in order to obliterate the difference between
accounting depreciation and tax depreciation.
(B) Application of above Concepts:
94. As stated above, the power to alter the Schedule is
distinct and separate from the power to fill in the details,
though both together form part of the same scheme. In the
present case, under section 641, the Central Government is
empowered vide the Notification to alter any of the
Regulations, Rules, Forms and other provisions contained in
any of the Schedules except Schedules XI and XII. Under
section 641(2), any alteration notified under sub-section (1)
has the effect as if the notified alteration stood enacted in the
parent Act and shall come into force on the date of the
Notification, unless the Notification directs otherwise. In the
present case, we are concerned with the provision of section
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 94 of 108
641(2) which is not there in section 642. However, as stated
above, section 642 begins with the expression \023in addition to
the powers conferred by section 641\024. The point which we
would like to stress is that though the Central Government is
vested with both the powers, namely, to amend the Schedule
and to fill in details, the nature of the rules framed under
section 641(2) continuous to have the status of the rules
despite the phraseology used in section 641(2) which, as
stated above, says that \023any alteration notified under sub-
section (1) of section 641 shall have effect as if enacted in the
Companies Act\024. To this extent, we are in agreement with the
submission made on behalf of the appellants. Our view is
supported by the judgment of this Court in the case of Chief
Inspector of Mines v. Karam Chand Thapar AIR 1961 SC
838. We quote hereinbelow para 20 of the said judgment,
which read as follows:
\02420. The true position appears to be that the
Rules and Regulations do not lose their
character as rules and regulations, even
though they are to be of the same effect as if
contained in the Act. They continue to be rules
subordinate to the Act, and though for certain
purposes, including the purpose of
construction, they are to be treated as if
contained in the Act, their true nature as
subordinate rule is not lost. Therefore, with
regard to the effect of a repeal of the Act, they
continue to be subject to the operation of
Section 24 of the General Clauses Act.\024
Therefore, in our view, Rules framed under section 641
followed by Rules framed under section 642(1) shall continue
to be Rules subordinate to the Companies Act though for the
purposes of construction, they are to be treated as forming
part of the same scheme.
95. In the present case, the most important question, which
we have to decide is whether the impugned Rule adopted AS
22 is contrary to or inconsistent with the provisions of the
Companies Act and in that connection our judgment proceeds
on the basis that the impugned Rule is an example of
subordinate legislation.
96. As stated above, tax expense or tax income represents
total amount included in the determination of net profit or loss
for the period in respect of current tax and deferred tax.
97. DTL is a tax payable in future period(s) which arises out
of taxable temporary differences.
98. DTA is the tax recoverable in future period(s) which
arises out of deductible temporary difference, carry forward of
unused tax losses and carry forward of unused tax credits.
99. Temporary difference is the difference between the
carrying amount of an asset or liability in the balance-sheet
and its tax base, which is an amount attributable for tax
purpose.
100. Taxable temporary difference will result in future
period(s) when carrying amount of the asset or liability is
recovered. It will arise when the tax base of an asset/liability
is lower than the balance-sheet amount. Tax base of an asset
gets reduced by over-charge of depreciation as per the tax law.
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 95 of 108
The tax base of a liability gets reduced by over-charge of a
liability which is to be written back as income in the future
period(s). This analyses can be explained by the following
examples:
Example-1
101. A Plant costs Rs. 100 lacs. Accelerated depreciation is
charged on the Plant to the extent of Rs. 70 lacs as per the
Income tax Rules. Therefore, the tax base of the Plant is (100 \026
70) Rs. 30 lacs. On the other hand, Accounting Depreciation
charged as per the Accounting Standard is Rs. 25 lacs. In
such a case, the balance-sheet value or what is called as
depreciated book value of the Plant would be (100 \026 25) Rs. 75
lacs.
102. Therefore, a timing difference has arisen, in the above
example, between the depreciated book value (balance-sheet
value of the Plant) and its tax base.
103. The principle which emerges from the above example is
that when tax base is lower than the balance-sheet value of
the asset (depreciated book value of the Plant) a deferred tax
liability emerges.
104. Similarly, the following example will show as to when
DTA emerges.
Example-2
105. Preliminary expenses of Rs. 10 lacs are allowed to be
written off over a period of 10 years on a straight-line basis,
which are charged to the income statement over a period of 5
years. Therefore, after 3 years from the date the expenses are
incurred, book value (the balance-sheet value) of such
preliminary expenses would be Rs. 4 lacs (10\0266) and the tax
base will be Rs. 7 lacs (10-3).
106. In the above example, the tax base of the Plant (asset) at
Rs. 7 lacs is higher than the balance-sheet value of
preliminary expenses at Rs. 4 lacs. There will, therefore, arise
deductible timing difference which gives rise to deferred tax
asset (DTA). However, a DTA, as stated above, should be
recognized for all deductible temporary difference to the extent
it is probable that taxable profit will be available against which
the deductible timing difference can be utilized. A DTA should
also be recognized for carrying forward the unused tax losses
and unused tax credits to the extent that it is probable that
future taxable profit will be available against which the
unused tax losses and unused tax credits can be utilized. It is,
therefore, necessary to review DTA at each balance-sheet date.
107. We would also like to give few more examples of DTA and
DTL as follows:
Example-3
108. Cost of a Plant is Rs. 100 lacs, its carrying amount is Rs.
80 lacs whereas its tax base is Rs. 20 lacs. Therefore, the
Taxable Timing Difference is (Rs. 80 \026 20) Rs. 60 lacs. In case
the tax rate is 25 per cent then the DTL shall be computed as
follows:
DTL = (Taxable Timing Difference) Rs. 60 lacs x (Tax Rate) 25%
DTL = 60 x 25/100 = Rs. 15 lacs
109. Similarly, if a company recognizes its liability for
Provident Fund in its accounts at Rs. 30 lacs which is not
allowed by the Income tax Department unless actually paid
and if the tax rate is 30 per cent then the DTA will be Rs. 30
lacs x 30/100 = Rs. 9 lacs as in such a case the tax base is Nil
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 96 of 108
whereas the carrying amount is Rs. 30 lacs.
Example-4 (Matching Concept)
110. A leasing company deducts an amount of lease
equalization charges from lease rental income. For that
purpose, the company makes a provision for the said charges
in accordance with the guidelines issued by the Institute on
\023Accounting of income, depreciation and other aspects for
leasing company\024. This charge is created to equalize the
imbalance between lease rentals and depreciation charges
over the period of lease. It is based on the rationale of
matching costs with revenues so that the periodic net income
from a finance lease is true and fair. Such matching is
achieved by showing the lease rentals received under finance
lease separately under Gross Income in the P&L a/c of the
relevant period and against such lease rental income, a
matching lease annual charge is made to the P&L a/c. This
annual lease charge represents recovery of the net
investment/ fair value of the leased asset over the lease period
and is calculated by deducting the finance income for the
period from the lease rent for that period. Accordingly, where
the annual lease charge is more than the statutory
depreciation under the Income tax Act, lease equalization
charge account would be debited to that extent; whereas when
annual lease charge is less than statutory depreciation under
the Income tax Act, a lease equalization would emerge.
Therefore, lease equalization charge is created as a result of
debit to the P&L a/c. It is a charge which has to be deducted
to arrive at the true and correct profit of the leasing business
and is neither an appropriation of profit nor a reserve. This
example indicates applicability of matching concept.
(C) Whether AS 22 is contrary to or inconsistent with the
provisions of the Companies Act.
111. In the case of C.I.T. v. Duncan Brothers & Co. Ltd.
reported in (1996) 8 SCC 31 the assessee company submitted
that provision for taxation made by it for assessment years
1963-64 and 1964-65 should be treated as a fund and,
therefore, it should be deducted from the cost of asset required
to be excluded under Rule 1(ii) of Schedule II to the Super Tax
Act, 1963 and Rule 2(ii) of Schedule II to the Companies
(Profits) Super Tax Act, 1964 respectively. This contention was
rejected. This Court held that since Schedule II to both the
Acts pertained to computation of capital, the terms used in
Schedule II should be interpreted in the context of the
balance-sheet of a company and its P&L a/c which will have to
be looked at to ascertain the company\022s capital and its profits.
It was held that a provision for taxation of the kind in question
was not a fund etymologically in accounting parlance. It was
observed that words of accounting language should be
interpreted as understood in accounting practice.
112. Applying the above test to the present case, we are now
required to interpret the words \023the amount of charge for
Indian Income tax on profits\024 in clause 3(vi) in Part II of
Schedule VI to the Companies Act. Similarly, we are required
to interpret the words \023current liabilities and provisions\024 in the
form of balance-sheet in Part I of Schedule VI to the
Companies Act. Part III of the said Schedule defines the words
\023provision\024 as well as \023reserve\024.
113. As stated above, the form of balance-sheet is prescribed
by Part I of Schedule VI. The Act does not prescribe a proforma
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 97 of 108
of P&L a/c. However, Part II of Schedule VI prescribes the
particulars which must be furnished in a P&L a/c. As far as
possible, the P&L a/c must be drawn up according to the
requirements of Part II of Schedule VI. As stated above, section
211(1) emphasizes \023true and fair\024 view in place of \023true and
correct\024 view of accounting. As stated above, the legislative
policy is to obliterate the difference between the accounting
income and the taxable income. As stated above, the
accounting income/book profit is the real income. Therefore,
section 211(1) emphasizes the concept of \023true and fair\024 view.
As stated above, it is a stand-alone consideration. It is the
controlling element underlying the scheme of sections 209,
211 and 227. However, as stated above, the Companies Ac
does not deal with Recognition, Measurement and Disclosure.
As stated above, how much amount should be recognized in
respect of a specific matter is not covered by section 209(3)(b).
Recognition, measurement and disclosure are the three items
which can only be done by way of Accounting Standards and
not by the provisions of the Companies Act. This aspect is
important because under section 642(1) the Central
Government is empowered to carry out ancillary/subordinate
legislative functions which is also fictionally called as power to
fill-up the details. Under section 211(1) Parliament has laid
down the controlling consideration in presentation of balance-
sheet and P&L a/c by companies and it has thereafter
conferred discretion on Central Government to work out
details within the framework of that Policy. Presentation of
balance-sheet and P&L a/c is different from recognition,
measurement and disclosure of various items of revenue,
expenses, assets, liabilities etc.. That part has been left to the
Central Government which is empowered to enact Accounting
Standards in consultation with National Advisory Committee
on Accounting Standards (NAC), which committee is to be
established and which has been established under section
210A(1). As stated above, the Central Government is the rule
making authority. As stated above, it is not bound to go by the
recommendations of the Institute in the matter of framing of
accounting standards. Generally, it follows such
recommendations. However, in law nothing prevents the
Central Government from enacting accounting standards in
consultation with NAC which are in variance from the
Standards prescribed by the Institute. In the present case, we
are concerned with the accounting standards prescribed by
Central Government in consultation with NAC under section
642(1) of the Companies Act.
114. In the present case, the main objection of the appellants
is against paragraphs 9 and 33 of AS 22. Para 9 reads as
under:
\023Tax expense for the period,
comprising current tax and deferred tax,
should be included in the determination of
the net profit or loss for the period.\024
115. Para 33 of AS 22 reads as under:
\023On the first occasion that the taxes on
income are accounted for in accordance with
this Statement, the enterprise should
recognise, in the financial statements, the
deferred tax balance that has accumulated
prior to the adoption of this Statement as
deferred tax asset/liability with a
corresponding credit/charge to the revenue
reserves, subject to the consideration of
prudence in case of deferred tax assets (see
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 98 of 108
paragraphs 15-18). The amount so
credited/charged to the revenue reserves
should be the same as that which would have
resulted if this Statement had been in effect
from the beginning.\024
116. As regards para 9, the appellants had no objection to the
disclosure of DTL/DTA in their financial statements. They
object to a charge being created qua P&L a/c for DTL mainly
because it results in reduction of reserves and net profits.
Therefore, the main contention is that the DTL is a notional
concept. According to the appellants, DTL is not a liability.
Therefore, according to the appellants, there cannot be a
charge for DTL to the P&L a/c of the company. According to
the appellants, DTL distorts their financial statements.
According to the appellants, Schedule VI forms part of the
Companies Act. According to the appellants Part II of Schedule
VI contains clause 3(vi). According to the appellants, the said
clause 3(vi) refers to the amount of charge for income tax on
the profits. According to the appellants when AS 22 states that
tax expense for the period shall consist of current tax and
deferred tax and that such tax expense should be included in
the determination of net profit or loss, it amounts to alteration
of clause 3(vi) of Schedule VI to the Companies Act which is
the part thereof. According to the appellants, Rules framed by
the Central Government as a delegate under section 642
cannot alter the provisions of the Companies Act including
Schedule VI. We have dealt with this aspect in the earlier
paragraphs. However, the appellants have further contended
that para 9 of AS 22 is inconsistent with the provisions of the
Companies Act including Schedule VI and, therefore, void. It is
also contended on behalf of the appellants that section 211
deals with P&L a/c and balance-sheet. That, para 9 only refers
to filling in the details qua items in P&L a/c and balance-
sheet. According to the appellants, P&L a/c and balance-sheet
do not constitute primary books of accounts. According to the
appellants, deferred taxation do not form part of accrual
system of accounting. According to the appellants para 9 of AS
22 requires the company to make provision for liability for
taxation in the balance-sheet and P&L a/c, further, according
to the appellants P&L a/c and balance-sheet do not constitute
books of accounts and, therefore, according to the appellants,
such a standard brings about inconsistency between
maintenance of books of accounts which are primary
documents on one hand and balance-sheet an P&L a/c on the
other hand. According to the appellants, para 9 of AS 22 does
not touch the subject \023maintenance of books of accounts\024.
That, it only touches the presentation of balance-sheet and
P&L a/c. According to the appellants, books of accounts
constitute primary documents and if para 9 does not apply to
the maintenance of books of accounts, para 9 cannot be made
applicable only to balance-sheet and P&L a/c because if it is
so permitted it would bring about inconsistency between
\023maintenance of books of accounts\024 under section 209 vis-`-
vis presentation of financial statements under section 211. In
short, according to the appellants para 9 and para 33 of AS 22
are inconsistent with the provisions of the Companies Act
including Schedule VI.
117. We do not find any merit in the arguments of the
appellants on the point of inconsistency.
118. As stated above, recognition and measurements bring in
the concept of fair value. When a financial instrument is
measured at fair value it brings transparency in financial
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 99 of 108
reporting. Today, companies undertake multifarious activities
which warrants segment reporting. For example in RIL we
have three segments, namely, refining, industry and
infrastructure. Similarly, in the case of Sterlite Industries
(India) Ltd., it has different segments. Each segment earns its
own revenue. For example, revenue from copper, revenue from
aluminium and revenue from others. Under clause 3(vi) of Part
II non-provision for taxation would amount to contravention of
the provisions of sections 209 and 211 of the Companies Act.
Accordingly, it is necessary for the auditor to say in what
manner the accounts do not disclose a \023true and fair\024 view of
the state of affairs of the company and the P&L a/c of the
company. AS 22 is mandatory. Therefore, it is the duty of the
members of the Institute to examine whether the accounting
standard is complied with the said standard in the
presentation of financial statement. [see also section 227(3)(d)]
119. In our view, para 9 only provides for details which are
necessary for giving effect to the concept of true and fair
accrual of accounts contemplated by section 211(1). As stated
above, the concept of \023true and correct\024 accrual is different
from the concept of \023true and fair\024 accrual. Both the concepts
fall under accrual system of accounting. However, there is a
difference. Under \023true and correct\024 accrual, the matching
principle was always recognized. However, fair valuation
principle is the concept which brings out the real income of
the company. Para 9 has been enacted, as stated above, to
obliterate the difference between the accounting income and
taxable income. Para 9 aims to present the real income to the
investors, shareholders and stake-holders in the company. As
stated above, there is also a difference between accounting
depreciation and tax depreciation. In order to harmonize these
differences, para 9 has been enacted. As stated above, true
and fair view is the basic requirement in the matter of
presentation of balance-sheet and P&L a/c. Therefore, in order
to bring out the true income of a company, one has to read the
provisions of the Companies Act with the accounting
standards adopted by the impugned Notification. As held in
the judgment of P. Kasilingam (supra) there are statute under
which the rules provide an internal aid to the construction of
the words used in the parent Act. The Companies Act uses the
words like, provision, reserve, liability etc. in the accounting
sense and as held in the case of Duncan Brothers (supra) the
words of accounting language should be interpreted as
understood in accounting practice. Therefore, in our view,
para 9 of AS 22 merely provides for details in the matter of
provision for liability for taxation.
120. The word \023tax expense\024 in para 9 under conservative
system of accounting was confined to current tax. However,
with para 9 of AS 22 coming into force, the word \023tax expense\024
now includes both, current tax and deferred tax. This
inclusion became necessary because of developments not only
in concepts but also in accounting practices. This inclusion
becomes necessary if one has to go by paradigm shift from
historical costs accounting to fair value principles. In our view,
with the insertion of the words \023true and fair\024 view in section
211, which is the requirement in the matter of presentation of
balance-sheet and P&L a/c the rule making authority was
entitled to include the concept of \023deferred tax\024 in tax expense.
It may be stated that under clause 3(vi) of Part II, Schedule VI
the charge for tax on profit is contemplated. Provision for
liability for taxation is contemplated by the said clause. Para 9
of AS 22 merely provides for a liability which arises on account
of timing difference as explained hereinabove. As stated above,
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 100 of 108
it is known on the balance-sheet date. One has to therefore
consider matching principle and fair valuation principles as
important concepts in Accrual Accounting. Further, as stated
above, recognition and measurement is not covered by the
provisions of the Companies Act, therefore, one has to read the
presentation of balance-sheet and P&L a/c together with
recognition and measurements. Therefore, one has to read the
provisions of the Companies Act along with the impugned Rule
which adopts AS 22 as recommended by the Institute. The
matching principle recognizes cost against revenue or against
the relevant time period to determine the periodic income.
Therefore, the said principle constitutes an important
component of the accrual basis of accounting. The concept of
accrual, in case of mergers and acquisition, is not limited to
one year. DTL/DTA arises out of timing differences. Therefore,
such differences have got to be reflected in Deferred Tax
Accounting. DTL in most cases arises on account of the
difference between tax depreciation and accounting
depreciation. When on account of over-charging of
depreciation under the Income-tax Rules, the taxable income
falls below the accounting income, DTL emerges. This is
because the rates of tax depreciation are incentive rates
whereas accounting depreciation is based on the useful life of
the asset. Thus, an asset under Income tax Act would be
charged over a much shorter period as compared to the useful
life of the asset. If the useful life of the asset is 10 years, for
tax purposes it should be written off fully in 4 years. Thus, in
the first year in which tax depreciation is higher than the
accounting depreciation, the taxable income would be less
than the accounting income, which would give rise to DTL on
account of the difference between the amount of depreciation,
i.e., the timing difference, which arises as it relates to the
depreciation amounts for that particular year. It would become
payable in future years when the timing difference reverses,
i.e., when the taxable income becomes higher than the
accounting income. Therefore, it is called as DTL. It is so
called because it results in future cash outflow on account of
the timing difference.
121. Hereinbelow, we are required to give two illustrations to
indicate as to how the DTL emerges out of timing differences
and, secondly, the application of Fair Valuation principles in
advanced accounting.
Illustration 1
122. A company, ABC Ltd., prepares its
accounts annually on 31st March. On 1st
April, 20x1, it purchases a machine at
a cost of Rs.1,50,000. The machine
has a useful life of three years and
an expected scrap value of zero.
Although it is eligible for a 100%
first year depreciation allowance for
tax purposes, the straight-line method
is considered appropriate for
accounting purposes. ABC Ltd. has
profits before depreciation and taxes
of Rs.2,00,000 each year and the
corporate tax rate is 40 per cent each
year.
The purchase of machine at a cost of
Rs.1,50,000 in 20x1 gives rise to a
tax saving of Rs.60,000. If the cost
of the machine is spread over three
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 101 of 108
years of its life for accounting
purposes, the amount of the tax saving
should also be spread over the same
period as shown below:
Statement of Profit and Loss
(for the three years ending 31st March, 20x1, 20x2,
20x3)
(Rupees in thousands)
20x1 20x2 20x3
Profit before depreciation
and taxes 200 200 200
Less: Depreciation for accounting
Purposes 50 50 50
Profit before taxes 150 150 150
Less: Tax expense
Current tax
0.40 (200-150) 20
0.40(200) 80 80
Deferred tax
Tax effect of timing differences
originating during the year
0.40(150-50) 40
Tax effect of timing differences
reversing during the year
0.40 (0-50) ___ (20) (20)
Tax expense 60 60 60
Profit after tax 90 90 90
Net timing differences 100 50 0
Deferred tax liability 40 20 0
In 20x1, the amount of depreciation allowed for tax
purposes exceeds the amount of depreciation charged
for accounting purposes by Rs.1,00,000 and,
therefore, taxable income is lower than the
accounting income. This gives rise to a deferred
tax liability of Rs.40,000. In 20x2 and 20x3,
accounting income is lower than taxable income
because the amount of depreciation charged for
accounting purposes exceeds the amount of
depreciation allowed for tax purposes by Rs.50,000
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 102 of 108
each year. Accordingly, deferred tax liability is
reduced by Rs.20,000 each in both the years. As
may be seen, tax expense is based on the accounting
income of each period.
In 20x1, the profit and loss account is debited and
deferred tax liability account is credited with the
amount of tax on the originating timing difference
of Rs.1,00,000 while in each of the following two
years, deferred tax liability account is debited
and profit and loss account is credited with the
amount of tax on the reversing timing difference of
Rs.50,000.
Illustration-2 (Application of \023Fair Value Principles\024)
123. A convertible debenture is normally presented in the
financial statements as a liability, while it has two
components; a liability and an option to convert loan into
equity. Appropriate accounting principle requires separate
accounting for rights and obligations. Each component has to
be separately accounted for. In the past, many of those rights
and obligations were shown as off-balance-sheet items. Only
recently, on account of accounting standards, the number of
such items stand reduced. The issuer of a financial
instrument is required to classify convertible debentures
(financial instrument) as liability or as equity depending on the
terms of the contract. A convertible debenture is a compound
instrument. In case of such instrument, having different
components, one has to present such components in financial
statements either as equity or as liability based on the terms
of the contract. As a general principle, a contract that will be
settled by an entity receiving a fixed number of its own shares
is an equity instrument. For example, when an enterprise
issues shares in consideration of cash or some other
asset/service, the transaction does not result in any cash
outflow. For example, a redeemable preference share should
be classified as liability and not as equity because it gives rise
to an obligation to deliver cash. This example is given to show
that DTL is a liability because it results in cash outflow in
future on account of timing differences.
124. A company has an option to designate a financial asset at
fair value through profit or loss. A financial asset held for
trading should be classified as an asset at fair value through
profit or loss. The difference in the fair value of financial asset
at the beginning of the period and at the end of the period is
generally recognized as profit or loss in the P&L a/c. Similarly,
loans and receivables are carried at amortized cost unless the
company intends to sell the same immediately. Similarly, there
are certain assets like Held-to-maturity-investments which are
required to be carried in the balance-sheet at the amortized
cost. In all such cases, the company will now have to classify
such assets or liabilities at fair value through profit or loss.
Therefore, fair value under the new A.S. has become the basis
for measurement of financial assets. Application of new
standards will require a change in the mind-set. At present,
non-financial companies carry current investments at cost or
market value, whichever is lower. However, they carry long
term investments at cost. They provide for permanent
diminution in value of long term investment.
125. Similarly, in case the company pays customs duty under
section 43B of Rs. 100. For tax purpose, that company is
entitled to deduction of Rs. 100/- in the year it makes
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 103 of 108
payment. But for accounting purpose, it can divide Rs. 100/-
into Rs. 80/- + Rs. 20/- (embedded in the closing stock). The
company can show Rs. 20/- as pre-paid expense, in the
balance-sheet.
126. The above examples indicate that measurement and
recognition of timing differences and financial instruments at
fair value brings transparency in presentation of financial
statements. Lastly, valuation is an important element of the
Method of Accounting.
127. In our view, para 9 of AS 22 merely represents gap-filling
exercise, therefore, there is no merit in the contention
advanced on behalf of the appellants that AS 22 is
inconsistent with the provisions of the Companies Act
including Schedule VI. It proceeds on the principle that every
transaction has a tax effect. The words \023true and fair\024 view in
section 211(1) connotes the widest law making powers and, in
that context, we hold that that impugned Rule adopting AS 22
is intra vires as the said Rule is incidental and/or
supplementary to the specific powers given to the Central
Government to make Rules, particularly when such power is
given to fill-in details. The word \023supplementary\024 means
something added to what is there in the Act, to fill-in details
for which the Act itself does not provide. It is something in the
sense that is required to implement what is there in the Act.
[See Daymond v. South West Water Authority (1976) 1 All
ER 39]. There is no merit in the contention advanced on behalf
of the appellants that the impugned Rule seeks to modify the
essential features of the Companies Act. Rules made on
matters permitted by the Act to supplement the Act cannot be
held to be in violation of the Act. [See Britnell v. Secretary of
State (supra)]. When the power to make rules is limited to
particular topics and if that rule falls within the ambit of that
topic, namely, taxes on income in the present case, it cannot
be said that the rule is inconsistent with the provisions of the
Act. As stated above, the Act and the Rules form part of the
composite scheme. The provisions of sections 205, 209 and
211 can be put into operation only if the Act and the Rules are
read together. In the present case, in our view, the impugned
Rule constitutes a legitimate aid to construction of the
provisions of the Companies Act. Further, as stated above, the
Central Government is the rule making authority under
section 211(3C). As rule making authority, the Central
Government is empowered to enact accounting standards in
consultation with NAC which may be at variance with the
Standards issued by the Institute.
128. In the case of Union of India and anr. v. Cynamide
India Ltd. and anr. reported in (1987) 2 SCC 720 one of the
arguments advanced on behalf of the company was that, in
calculating the \023net worth\024 the cost of works-in-progress and
the amount invested outside business were excluded from
\023free reserves\024 and that such exclusion could not be justified
on any known principle of commercial accountancy (See para
33). The matter related to price fixation. In the Control Order
vide para 2(g) the word \023free reserve\024 was defined. Similarly, in
the Form prescribed in the Fourth Schedule, several items like
bonus, bad debts and provisions, loss/gain on sale of assets
etc. were required to be excluded from the cost of production.
Therefore, it was argued that such exclusion was not
warranted by principles of commercial accountancy. This
argument was rejected by this Court on the ground that it was
open to the subordinate body to prescribe and adopt its own
mode of ascertaining the cost of production. That the said
body was under no obligation to adopt the method indicated
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 104 of 108
under the Income tax Act in allowing expenses for the
purposes of ascertaining income. It was further held that so
long as the method prescribed and adopted by the subordinate
legislating body is not opposite to the principle statutory
provisions and so long as the method prescribed is ancillary to
the provisions of the parent Act, it cannot be legitimately
questioned. In the present case, as stated above, measurement
and recognition methods are not the items under the
Companies Act. Methods of recognition and measurements are
talked about by the provisions of the Companies Act.
Recognition and measurement of various items of revenue
expenses etc. stand covered only by the accounting standards.
Therefore, it cannot be said that the said standards are
contrary to the provisions of the Companies Act. We also do
not find any merit in the argument advanced on behalf of the
appellants that the impugned Rule does not touch upon
maintenance of books of accounts to be kept by the company.
Under section 209(3)(b) every company is required to keep its
books of accounts on accrual basis and according to double-
entry system of accounting. Under section 209(3)(a) every
company is required to maintain books of accounts necessary
to provide a true and fair view of the state of affairs of the
company and its accounts. In our view, books of accounts do
not include balance-sheet and P&L a/c. However, as stated
above, there is a difference between \023true and correct\024 accrual
and \023true and fair\024 accrual. In the past, what prevailed was
true and correct accrual. At that time, it was noticed in several
cases that profits were overstated and, therefore, the
Legislature inserted what is called as \023true and fair\024 accrual
concept. The said concept is wider than the concept of true
and correct accrual. When section 209(3) refers to
maintenance of books of accounts on accrual basis it
means \023true and fair\024 accrual, which would include not only
matching principles but also fair valuation principles. These
principles do not contravene accrual system of accounting.
Moreover, we are concerned with presentation of balance-sheet
and P&L a/c. These are financial statements. An investor,
shareholder or stake-holder is entitled to know the real income
which the company has earned during the year. Provision for
diminution in value of an asset results in emergence of
liability. In the past, when timing difference concept was not
there, in many cases, profits were overstated, particularly
because provision for DTL (deferred taxation) was not
recognized. With the introduction of the timing difference
concept, it cannot be said that the accrual system of
accounting is violated. As stated above, it is the concept of
\023timing difference\024 which obliterates the difference between
accounting and tax incomes. Ultimately, the object is to
obliterate the difference between accounting income and
taxable income. Accounting income is the real income,
therefore, in our view, para 9 of AS 22 is not inconsistent with
the provisions of the Companies Act, including Schedule VI.
129. In the case of Bharat Hari Singhania and ors. V.
Commissioner of Wealth-tax (Central) and ors. reported in
AIR 1994 SC 1355 valuation of unquoted equity shares based
on the break-up method was challenged. That challenge was
rejected on the ground that the break-up method leads to
appropriate market value and, therefore, the said method
adopted by Rule 1-D of Wealth-tax Rules was neither ultra
vires nor inconsistent with section 7 of the Wealth tax Act. We
quote hereinbelow paras 13, 14 and 21 of the said judgment
which held that it is always open to the rule-making authority
to prescribe an appropriate method of valuation out of several
methods of valuing an asset. And since the break-up method
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 105 of 108
adopted by the rule-making authority was a known method in
the relevant circles, it cannot be said that the method adopted
was an impermissible method. Paras 13, 14 and 21 read as
under:
\02313. We may first take up the question
whether Rule 1-D is void for being inconsistent
with the Act or for the reason that it is beyond
the rule-making authority conferred by the
Act. Section 7(1) indeed defines the expression
"value of an asset." It is "the price which in the
opinion of the Wealth Tax Officer it would fetch
if sold in the open market on the valuation
date", but this is made expressly subject to the
Rule made in that behalf. No. guidance is
furnished by the Act to the rule-making
authority except to say that the Rule made
must lead to ascertainment of the value of the
asset (unquoted equity share) as defined in
Section 7. It is thus left to the rule-making
authority to prescribe an appropriate method
for the purpose. Now, there may be several
method of valuing an asset or for that method
an unquoted equity share. The rule-making
authority cannot obviously prescribe all of
them together. It has to choose one of them
which according to it is more appropriate. The
rule-making authority has in this case chosen
the break-up method, which is undoubtedly
one of the recognised methods of valuing
unquoted equity shares. Even if it is assumed
that there was another method available which
was more appropriate, still the method chosen
cannot be faulted so long as the method
chosen is one of the recognised methods,
though less popular. One probable reason why
yield method or dividend method was not
adopted in the case of unquoted equity shares
was that bulk of these companies are private
limited companies where the divided declared
does not represent the correct state of affairs
and to estimate the probable yield is no simple
exercise. The dividends in these companies is
declared to suit the purposes of the persons
controlling the companies. Maintainable profits
rather than the dividends declared represent
the correct index of the value of their shares.
The break-up method based upon the balance-
sheet of the company, incorporated in Rule 1-
D, is a fairly simple one. Indeed, no serious
objection can also be taken to this course
since the basis of the Rule is the balance-sheet
of the company prepared by the company itself
- subject, of course, to certain modifications
provided in Explanation-II.
14. We are not satisfied that the break-up
method adopted by Rule 1-D does not lead to
proper determination of the market value of
the unquoted shares. The argument to this
effect, advanced by the learned Counsel for the
assessees, is based upon the
assumption/premise that the value
determined by applying the yield method is the
correct market value. We do not see any basis
for this assumption. No empirical data is
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 106 of 108
placed before us in support of this submission
or assumption. It may be more advantageous
to the assessees but that is not saying the
same thing that it alone represents the true
market value. It cannot be stated as a principle
that only the method that leads to lesser value
is the correct method. The idea is to find out
the true market value and not the value more
favourable to the assessee. Accordingly, the
contention that rule 1-D is inconsistent with
Section 7(1) or that it travels beyond that
purview of Section 7 is rejected.
xxx
21. The statement of law in the decision would
thus establish that it does not purport to "lay
down any hard and fast rule." It recognises
that various factors in each case will have to
be taken into account to determine the method
of valuation to be applied in that case. The
dividend yield method is not the only method
indicated in the case of a going concern; there
is the 'earning method' and then a
combination of both methods. The several
qualifications added to the above rules, as
already stated, make them highly cumbersome
and time-consuming. The Wealth Tax Officer
has to examine the facts and circumstances of
each case including the nature of the
business, prospects of profitability and similar
other considerations before finally determining
whether to apply the dividend method, yield
method or whether the break-up method
should be followed. There may be cases where
an assessee may be holding shares of a large
number of private companies or other public
limited companies whose shares are not
quoted. Compared to them, the break-up
method incorporated in Rule 1-D is far simpler
and far less time-consuming. It prescribes a
simple uniform method to be followed in all
cases. All that the Wealth Tax Officer has to do
is to take the balance-sheet, delete some items
from the columns relating to assets and
liabilities as directed by Explanation-II, and
then apply the formula contained in the Rule.
He need not have to look into the profitability,
the earning capacity and the various other
factors mentioned in propositions (2), (3) and
(4) of the decision. The decision, it bears
repetition, recognises that break-up method
"nonetheless is one of the methods." In the
circumstances, it is difficult to agree with the
learned Counsel for the assessees either that
break-up method is not a recognised method
or that yield method is the only permissible
method for valuing the unquoted equity
shares. It is not as if the rule-making authority
has adopted a method unknown in the
relevant circles or has devised an
impermissible method. There is no empirical
data produced before us to show that break-up
method does not lead to the determination of
market value of the shares. Merely because
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 107 of 108
yield method may be more advantageous from
the assessee's point of view, it does not follow
that it alone leads to the ascertainment of true
market value and that all other methods are
erroneous or misleading. This aspect we have
emphasised hereinbefore too.\024
Validity of Para 33 of AS 22
130. We have already quoted hereinabove para 33. The said
para is challenged on the ground that a subordinate legislation
cannot be retrospective unless there is provision to that effect
in the parent Act. Therefore, the short question which we have
to decide is whether the said para is retrospective.
131. To decide the said question, we have to analyse the scope
of para 33. For the purpose of determining accumulated
deferred tax in the period in which the Standard is applied for
the first time, the opening balances of assets and liabilities for
accounting purposes and for tax purposes are to be compared
and the differences, if any, are to be determined. The tax effect
of these differences have got to be recognized as DTA or DTL, if
such differences are timing differences. For example, in the
year in which a company adopts AS 22, the opening balance of
a fixed asset is, let\022s say, Rs. 100 for accounting purposes and
Rs. 60 for tax purposes. This difference is because the
company applied written down value method of depreciation
for calculating taxable income, whereas for calculating
accounting income it adopts straight-line method. This
difference will reverse in future when depreciation for tax
purposes will be allowed as compared to depreciation for
accounting purposes. In this example, let\022s assume that the
tax rate is 40 per cent and that there are no other timing
differences then, DTL would be [Rs. 100 \026 Rs. 60] x 40/100 =
Rs. 16
132. Once we are required to take into account the concept of
opening balance of a fixed asset in para 33, it cannot be said
that the said para is retrospective. In fact, it is a transitional
provision. Let\022s say that there is an expenditure which is
written off for accounting purposes in the year in which it is
incurred but is admissible for deduction under Income-tax Act
over a period of time. In such a case, the asset representing
expenditure would have a Balance only for tax purposes and
not for accounting purposes. Therefore, the difference between
the Balance of the asset for tax purposes and balance for
accounting purposes, which is nil, would give rise to a timing
difference which will reverse in future when expenditure would
be allowed for tax purposes. In such a case, DTA would be
recognized in respect of difference, subject to the principle of
prudence. In the circumstances, it cannot be said that para 33
is retrospective.
Conclusion:
133. For the aforestated reasons, we are of the view that the
impugned Notification/Rule is neither ultra vires nor
inconsistent with the provisions of the Companies Act,
including Schedule VI.
134. To sum up, deferred tax is nothing but accrual of tax due
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 108 of 108
to divergence between accounting profit and tax profit. This
difference arises on two counts, namely, different treatment of
items of revenue/expense as per profit and loss account and
as per the tax law. It also arises on account of the difference
between the amount of revenue/expense as per profit and loss
account and the corresponding amount considered for tax
purposes, e.g., depreciation.
135. However, we need to comment on one aspect. Before the
Calcutta High Court, the impugned Notification adopting AS
22 was also challenged on the ground that the provisions of
AS 22 insofar as it relate to \023deferred taxation\024 is violative of
Articles 14 and 19(1)(g) of the Constitution of India. In this
connection, it was pleaded that by making AS 22 mandatory,
the appellants\022 companies will suffer erosion of its net worth.
That, as a result, the debt equity ratio will also increase and
that the lenders may recall the loans and thereby the
appellants\022 rights to carry on business in future would be
violated. Although, the aforestated challenge was pleaded in
the writ petition, when the matter came for hearing before the
High Court, it appears that the said grounds were not argued.
According to the appellants, implementation of AS 22 would
result in reduction of profits and reserves. In the
circumstances, we do not wish to express any opinion on the
constitutional validity of the said AS 22. Whether the said
Standard constitutes a restriction on the rights of the
appellants to carry on business under Article 19(1)(g) or
whether the said Standard is violative of Article 14 are
questions on which we express no opinion. We keep those
questions open. Suffice it to state that, in the present case, we
are of the view that the said AS 22 is neither ultra vires nor
inconsistent with the provisions of the Companies Act,
including Schedule VI.
136. For the aforestated reasons, we find no infirmity in the
impugned judgment of the High Court and, accordingly, the
civil appeals filed by the various companies stand dismissed
with no order as to costs.
Legal Notes
Add a Note....