Income Tax Appellate Tribunal - Hyderabad
Surana Steels Pvt. Ltd. vs Deputy Commissioner Of Income Tax (Also ... on 4 February, 1993
Equivalent citations: (1993)46TTJ(HYD)458
ORDER
BY THE TRIBUNAL :
These appeals have been set down for hearing by a Special Bench as they involve a common question of law of general importance relating to the construction of S. 115J of the IT Act, 1961.
2. The facts relating to M/s. Surana Steels (P) Ltd. (ITA No. 1845/Hyd/90) are as follows. The assessee is a Pvt. Ltd. Co. For the asst. yr. 1988-89, corresponding to the previous year ended 22nd Oct., 1987, the net profit according to the Profit & Loss account was Rs. 27,67,443. The Assessing Officer by assessment order dt. 7th April, 1989 read with the rectification order dt. 20th Sept., 1989 deducted unabsorbed depreciation of Rs. 10,63,855 (made up of Rs. 10,10,304 for asst. yr. 1986-87 and Rs. 53,551 for asst. yr. 1987-88) and determined the book profits at Rs. 17,03,588 in order to apply the provisions of S. 115J. Thirty per cent of this amount came to Rs. 5,11,076 which was determined as the taxable income since it was higher than Rs. 4,26,714 being the income computed under the other provisions of the Act. On a review of this assessment, the CIT considered it to be erroneous and prejudicial to the interests of the Revenue, as according to him, the unabsorbed depreciation of the earlier asst. yrs. 1986-87 and 1987-88 amounting to Rs. 10,63,855 was not deductible with the result that the book profit would be Rs. 27,67,443 and 30% thereof, namely Rs. 8,30,230 which being higher had to be assessed as the taxable income instead of Rs. 5,11,076 taken by the Assessing Officer. The assessee objected to the revision on the ground that the unabsorbed depreciation had to be deducted under the provisions of S. 115J, Expln. (iv). In order to appreciate the controversy, the relevant figures can be tabulated as follows.
Asst. yr.
Loss or Profit before depreciation Rs.
Depreciation Rs.
Loss or profit after depreciation Rs.
1986-87 (+) 81,493 10,91,797 10,10,304 1987-88 (+) 15,72,553 16,26,104 (-) 53,551 Total deduction claimed 10,63,855 The assessee claimed that the loss determined as a net result being less than the depreciation, it should be allowed as a deduction. The Commissioner was, however, of the view that since the assessee was entitled to deduction only of loss or depreciation whichever is less and there was no loss before depreciation, the assessee was not entitled to any deduction of depreciation at all. He, accordingly, rejected the claim of the assessee for deduction of unabsorbed depreciation and directed the Assessing Officer to modify the assessment to enhance the taxable income.
3. The facts in M/s. Agroha Extractions Ltd. (ITA No. 811/Hyd/92) are as follows. The assessee in this case is a public company. For the asst. yr. 1988-89, corresponding to the previous year ended 30th June, 1987, the assessee filed a return declaring total income of Rs. 73,960. The profit according to the profit & loss account was Rs. 9,05,324 and adding back the provision for wealth-tax it was Rs. 9,06,924. The assessee deducted the unabsorbed depreciation as detailed below :
Asst. yr.
Loss or profit before depreciation Rs.
Depreciation Rs.
Profit after Rs.
1986-87 (+) Rs. 6,126 (-) 9,57,806 (-) 9,51,680 1987-88 (+) Rs. 17,18,831 (-) 14,27,540 (+) 2,91,291 Deduction claim (-) 6,60,389 The book profit therefore, came to Rs. 2,46,535 and 30% of the same namely, Rs. 73,961 was shown as the taxable income. The Assessing Officer was, however, of the view that since the assessee had profit in the earlier two years, the assessee was not entitled to deduction of the net loss. This view was confirmed on appeal.
4. The facts in the case of M/s. Binjusaria Metal Box Co. P. Ltd. (ITA No. 822/Hyd/92) are as follows. The assessee in this case is a public company. For the asst. yr. 1989-90, corresponding to the previous year ended 31st March, 1989, the assessee filed a return declaring total income of Rs. 5,72,770. The profit according to the P&L account was Rs. 28,93,297 and after deducting electricity charges paid (wrongly debited to deposit account) and adding provision for taxation and investment allowance reserve, it was Rs. 30,60,710. The assessee deducted the unabsorbed depreciation as detailed below :
Asst. yr.
Loss or profit before depreciation Rs.
Depreciation Rs.
Profit after depreciation 1987-88 (+) 61,906 12,40,899 (-) 11,78,993 1988-89 (+) 29,50,017 29,22,492 (-) 27,525 Total deduction claimed 12,06,518 The book profit according to the assessee came to Rs. 19,09,242 and 30% thereof namely, Rs. 5,72,773 was shown as the taxable income. The Assessing Officer was, however, of the view that since the assessee had profit in the earlier two years, the assessee was not entitled to deduction of the net loss. This view was confirmed on appeal.
5. In the appeals of the assessee, it was contended that the provisions of S. 205(1)(b) of the Companies Act, 1956 incorporated in S. 115J had not been applied properly. It was submitted that the object of the provisions of S. 205 itself was to limit the declaration of dividend to current profits after providing for unabsorbed depreciation of the earlier years. It was further submitted that on representation by the assessee with regard to the hardship in imposing the tax on book profits without setting off past losses and unabsorbed depreciation, the Finance Minister had incorporated S. 205(1) of the Companies Act in the IT Act, 1961 only for the purpose of granting relief by way of setting off the unabsorbed depreciation. It was submitted that only it the term loss in that section were understood to be the net result of the operation could the section be applied properly. It was pointed out that if the term "loss" in that section were to be understood as business loss prior to deduction of depreciation, it would not lead to the desired result. In the alternative, it was argued that even if the word "loss" was to be understood as referring to the book loss before deduction of depreciation, the assessee should be allowed deduction of depreciation because even when there is a profit, the depreciation would be less than the profit. In other words, it was submitted that merely because the assessee had a profit, the claim for deduction of depreciation which remained unabsorbed could not be defeated.
6. On the other hand, Shri Mani appearing for the Departments and also the authorised representative of the Department presented the view of the CIT with consummate skill, by referring to various canons of interpretation of statutes that once the provisions of S. 205(1)(b) of the Companies Act had been incorporated in the IT Act, the meaning and implications with reference to the Companies Act were irrelevant and that section had to be understood only in the context of the provisions of the IT Act. It was submitted that the provisions should be approached with the object of imposing a tax and not with the object of declaration of dividends. It was then submitted that the meaning of the word "loss" should also be understood in the context of the IT Act and not the Companies Act, and when the word loss had been understood in judicial decisions as meaning loss before & after depreciation, the same meaning has to be given for the purpose of S. 115J. It was argued that since the net resultant loss will always include the depreciation which is deducted for arriving at that figure, the expression "loss or depreciation whichever is less" cannot refer to the whole or part of it but only the two components which make up the whole. It was argued that the adjectival clause beginning with which in cl. (iv) of the Explanation qualified both loss and depreciation and hence a segregation of the business loss from the depreciation, was contemplated. It was submitted that from that point of view when there was a profit it must be taken as if the loss was nil and that being less than the depreciation, no relief was available to the assessee. According to the Revenue, the circular of the CBDT explaining the provisions of S. 115J did not amount to a contemporaneous exposition of the statute as that doctrine related only to ancient statutes. It was also argued that the interpretation placed by the assessee will lead to a discrimination between manufacturing companies and trading companies because trading companies a which incur large loss without any depreciation, will not get any relief. It was submitted that since the object of S. 115J was to mop up the resources, the denial of the claim of the assessee must be upheld.
7. Before we consider the arguments of both sides, it is necessary to keep in mind the legislative history of the provisions under consideration.
8. In the Budget Speech for 1987-88 on 28th Feb., 1987, the Finance Minister observed : [(1987) 165 ITR (St) 1 at p. 14] :
"80. It is only fair and proper that the prosperous should pay at least some tax. The phenomenon of so-called "zero-tax" highly profitable companies deserves attention. In 1983, a new S. 80VVA was inserted in the Act so that all profitable companies pay some tax. This does not seem to have helped and is being withdrawn. I now propose to introduce a provision whereby every company will have to pay a "minimum corporate tax" on the profits declared by it in its own accounts. Under this new provision, a company will pay tax on at least 30% of its book profit. In other words, a domestic widely held company will pay tax of at least 15% of its book profit. This measure will yield a revenue gain of approximately Rs. 75 crores."
Consequently, S. 80VVA was omitted by S. 40 of Finance Act, 1987 and S. 115J was introduced by S. 43 of Finance Act, 1987 [ (1987) 166 ITR (St) 26]. In the Bill as introduced the provisions of item (iv) of the Explanation to S. 115J did not exist. In other words, there was no provision for deducting past losses or unabsorbed depreciation. While moving the Finance Bill, the Prime Minister and the Finance Minister stated as follows :
"4. In respect of direct taxes, I propose to make the following amendments :
(a) Apprehensions have been expressed that the proposed new S. 194E of the IT Act, which seeks to extend the area of tax deduction at source may cause unnecessary harassment to large numbers of honest tax-payers who might have to seek refunds. After careful consideration of representations received, this proposal is being withdrawn.
(b) The Finance Bill inserts a new S. 115J in the IT Act to levy a minimum tax on "book profits" of certain companies. Representations have been received that in computing book profits for the purpose of determining the minimum tax, losses and unabsorbed depreciation pertaining to earlier years should be allowed to be set off. Otherwise, new projects that have just begun to make profits after some years of losses, and sick companies that have just turned the corner, will become subject to minimum tax. There is merit in this suggestion. Under S. 205 of the Companies Act, 1956, past losses or unabsorbed depreciation, whichever is less, are allowed to be set off against the book profits of the current year for determining profits for the purpose of declaring dividend. It is proposed to allow the same adjustments in computation of book profits for purposes of the new provision for levy of minimum tax."
The section which was subsequently adopted by Parliament contained the specific provision for setting off the past losses or unabsorbed depreciation whichever was less. Consequently, the provisions of S. 115J as passed by Parliament were in the following terms :
"115J. Special provisions relating to certain companies. -(1) Notwithstanding anything contained in any other provision of this Act, where in the case of an assessee being a company (other than a company engaged in the business of generation or distribution of electricity), the total income, as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 1988 but before the 1st day of April, 1991 (hereinafter in this section referred to as the relevant previous year), is less than thirty per cent of its book profit, the total income of such assessee chargeable to tax for the relevant previous year shall be deemed to be an amount equal to thirty per cent of such book profit.
(1A) Every assessee, being a company, shall, for the purpose of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Sch. VI to the Companies Act, 1956 (1 of 1956).
Explanation. - For the purposes of this section, "book profit" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-s. (1A), as increased by -
(a) the amount of income-tax paid or payable, and the provision therefor; or
(b) the amount carried to any reserves (other than the reserves specified in S. 80HHD) or sub-s. (1) of S. 88AC), by whatever name called; or
(c) the amount or amounts set aside to provisions made for meeting liabilities other than ascertained liabilities; or
(d) the amount by way of provision for losses of subsidiary companies; or
(e) the amount or amounts or dividends paid or proposed; or
(f) the amount or amounts of expenditure relatable to any income to which any of the provisions of Chapter III applies; or
(g) the amount withdrawn from the reserve account under S. 80HHD, where it has been utilised for any purpose other than those referred to in sub-s. (4) of that section; or
(h) the amounts credited to the reserve account under S. 80HHD, to the extent that amount has not been utilised within the period specified in sub-s. (4) of that section;
(ha) the amount deemed to be the profits under sub-s. (3) of S. 33AC;
If any amount referred to in cls. (a) to (f) is debited or, as the case may be, the amount referred to in cls. (g) and (h) is not credited to the profit and loss account, and as reduced by, -
(i) the amounts withdrawn from reserves (other than the reserves specified in S. 80HHD) or provisions, if any such amount is credited to the profit and loss account :
Provided that, where this section is applicable to an assessee in any previous year (including the relevant previous year), the amount withdrawn from reserves created or provisions made in a previous year relevant to the assessment year commencing on or after the 1st day of April, 1988, shall not be reduced from the book profit unless the book profit of such year has been increased by those reserves or provisions (out of which the said amount was withdrawn) under this Explanation; or
(ii) the amount of income to which any of the provisions of Chapter III applies, if any such amount is credited to the profit and loss account; or
(iii) the amounts as arrived at after increasing the net profit by the amounts referred to in cls. (a) to (f) and reducing the net profit by the amounts referred to in cls. (i) and (ii) attributable to the business, the profit from which are eligible for deduction under S. 80HHC or section 80HHD; so, however, that such amounts are computed in the manner specified in sub-s. (3) or sub-s. (3A) of S. 80HHC or sub-s. (3) of S. 80HHD, as the case may be; or
(iv) the amount of the loss or the amount of depreciation which would be required to be set off against the profit of the relevant previous year as if the provisions of cl. (b) of the first proviso to sub-s. (1) of S. 206 of the Companies Act, 1956 (1 of 1956), are applicable.
(2) Nothing contained in sub-s. (1) shall affect the determination of the amounts in relation to the relevant previous year to be carried forward to the subsequent year or years under the provisions of sub-s. (2) of S. 32 or sub-s. (3) of S. 32A or cl. (ii) of sub-s. (1) of S. 72 or S. 73 or S. 74 or sub-s. (3) of S. 74A or sub-s. (3) of S. 80J."
9. Sec. 115J thus provides for the book profit of the assessee to be computed in accordance with Sch. VI of the Companies Act and thereafter the items mentioned from (a) to (h) are to be added back and items (i) to (iv) are to be reduced from such net profit to arrive at a resultant amount called book profit for the purpose of that section. If 30% of the said book profit is more than the total income determined under the provisions of the IT Act, the amount has to be taken as the taxable income.
10. A Circular of the CBDT No. 495 dt. 22nd Sept., 1987 [ (1987) 168 ITR (St) 87 at 110] explained this provision as follows :
"New provisions to levy minimum tax on "book profit" of certain companies :
36.1. It is an accepted canon of taxation to levy tax on the basis of ability to pay. However, as a result of various tax concessions and incentives certain companies making huge profits and also declaring substantial dividends, have been managing their affairs in such a way as to avoid payment of income-tax.
36.2. Accordingly, as a measure of equity, S. 115J has been introduced by the Finance Act. By virtue of the new provisions, in the case of a company whose total income as computed under the provisions of the IT Act is less than 30 per cent of the book profit computed under the section, the total income chargeable to tax will be 30 per cent of the book profit as computed. For the purpose of S. 115J, book profits will be the net profit as shown in the profit and loss account prepared in accordance with the provisions of Sch. VI to Companies Act, 1956, after certain adjustments. The net profit as above will be increased by income-tax paid or payable or the provision thereof, amount carried to any reserve, provision made for liabilities other than ascertained liabilities, provision for losses of subsidiary companies, etc., if the amounts are debited to the profit and loss account. Liability relating to expenditure which has been incurred or which has accrued in respect of expenses which are otherwise deductible in computing income will not be added back. The amount so arrived at is to be reduced by -
(i) amounts withdrawn from reserves if any, such amount is credited to the profit and loss account;
(ii) the amount of income to which any of the provisions of Chapter III applies, if any such amount is credited to the profit and loss account; and
(iii) the amount of any brought forward losses or unabsorbed depreciation whichever is less as computed under the provisions of S. 205(1)(b) of the Companies Act, 1956, for the purposes of declaration or dividends. Sec. 205 of the Companies Act requires every company desirous of declaring dividend to provide for depreciation for the relevant accounting year. Further, the company is required under S. 205 to set off against the profit of the relevant accounting year, the depreciation debited to the profit and loss account of any earlier year(s) or loss whichever is less.
36.3. Sec. 115J, therefore, involves two processes. Firstly, an assessing authority has to determine the income of the company under the provisions of the IT Act. Secondly, the book profit is to be worked out in accordance with the Explanation to S. 115J(1) and it is to be seen whether the income determined under the first process is less than 30 per cent of the book profit. Sec. 115J would be invoked if the income determined under the first process is less than 30 per cent of the book profit. The Explanation to sub-s. (1) of S. 115J gives the definition of the "book profit" by incorporating the requirement of S. 205 of the Companies Act in the computation of the book profit. Brought forward losses of unabsorbed depreciation whichever is less would be reduced in arriving at the book profits. Sub-s. (2), however, provides that the application of this provision would not affect the carry forward of unabsorbed depreciation, unabsorbed investment allowance, business losses to the extent not set off, and deduction under S. 80J, to the extent not set off as computed under the IT Act.
36.4. *********** 36.5. The following example illustrate how the amended provisions relating to the new section will be applied :
NEW COMPANIES Book profits for the purposes of the Profit under the IT Act Companies Act, 1956 Year 1984 Rs.
Rs.
Loss excluding depreciation 3,00,000 Loss excluding depreciation 80,000 Depreciation 1,00,000 Depreciation year 1985 4,00,000 Profit before depreciation 5,00,000 Profit before depreciation 5,00,000 Less : Depreciation as per books 2,00,000 Less : Depreciation 4,00,000 3,00,000 1,00,000 Less : Deduction under section 205(2) for the year 1984 1,00,000 Less : Business loss for 1984 80,000 2,00,000 20,000 C.F. Business loss 1984 3,00,000 Less : Unabsorbed depreciation 20,000 C.F. unabsorbed depreciation 1985 Nil C.F. unabsorbed depreciation 1985 3,80,000 Year 1986 Net loss as per books before depreciation (-) 10,00,000 Business loss (-) 10,00,000 Depreciation 2,00,000 Add : Depreciation as per IT Rules (-) 4,00,000 Business loss to be carried forward (-) 10,00,000 Unabsorbed depreciation to be carried forward (-) 2,00,000 Year 1987 Net profit 10,00,000 Profit before depreciation 10,00,000 Book depreciation 2,00,000 Less : Depreciation as per IT Rules 8,00,000 2,00,000 Less : Carried forward business loss for 1986 to the extent adjusted 2,00,000 Assessed income Nil Application of S. 115J Profit before depreciation 10,00,000 Less : Book depreciation 2,00,000 8,00,000 Less : Deduction under S. 205(2) 2,00,000 6,00,000 Out of the amount whichever is less :
1984 : Business loss 3,00,000 1986 : Business loss 10,00,000 Total loss 13,00,000 1986 : Depreciation 2,00,000 Assessable income 30% of Rs. 6 lakhs, i.e., Rs. 1.8 lakhs.
Amount to be carried forward as per sub-s. (2) of S. 115J 1984 : Unabsorbed depreciation 3,80,000 1986 : Business loss 8,00,000 Unabsorbed depreciation 4,00,000."
11. As noted above, the item (iv) in Explanation to S. 115J requires a deduction in arriving at the book profit as if the provisions of S. 205(1)(b) were applicable. It is, therefore, necessary to read that section, which is as follows :
"205. Dividend to be paid only out of profits. - (1) No dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of sub-s. (2) or out of the profits of the company for any previous financial year or years arrived at after providing for depreciation in accordance with those provisions and remaining undistributed or out of both or out of moneys provided by the Central Government or a State Government for the payment of dividend in pursuance of a guarantee given by that Government :
Provided that -
(a) if the company has not provided for depreciation for any previous financial year or years, which falls or fall after the commencement of the Companies (Amendment) Act, 1960, it shall, before declaring or paying dividend for any financial year provide for such depreciation out of the profits of that financial year or out of profits of any other previous financial year or years;
(b) if the company has incurred any loss in any previous financial year or years which falls or fall after the commencement of the Companies (Amendment) Act, 1960, then the amount of the loss or an amount which is equal to the amount provided for depreciation for that year or those years whichever is less, shall be set off against the profits of the company for the year for which dividend is proposed to be declared or paid or against the profits of the company for any previous financial year or years, arrived at in both cases after providing for depreciation in accordance with the provisions of sub-s. (2) or against both.
(c) the Central Government may, if it thinks necessary so to do in the public interest, allow any company to declare or pay dividend for any financial year out of the profits of the company for that year on any previous financial year or years without providing for depreciation :
Provided further that it shall not be necessary for a company to provide for depreciation as aforesaid where dividend for any financial year is declared or paid out of the profits of any previous financial year or years which falls or fall before the commencement of the Companies (Amendment) Act, 1950."
12. Sub-s. (1A) of S. 115J states that every assessee being a company shall, for the purpose of this section, prepare a P&L account in accordance with the provisions of parts II and III of Sch. VI to the Companies Act, 1956. It may be noted that Part II of Sch. VI of the Companies Act lays down the requirements as to P&L account. Rule 3 of Part II thereof states that the P&L 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 information in respect of items thereunder. Item (iv) under that rule is the amount provided for depreciation, renewals or diminution in value of fixed assets. It also states that if such provision is not made by means of a depreciation charge, the method adopted for making such provision and 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 S. 205(2) of the Act shall be disclosed by way of a note. It is thus apparent that the loss required to be shown in a P&L account under the Companies Act is the net loss after providing for depreciation of that year. This is made clear by S. 205(1)(b) itself which states that even while setting of the loss or depreciation of the earlier years against the profits of the company of the year for which dividend is proposed to be declared, such profit is to be arrived at after providing for depreciation. The contrast between sub-cl. (b) and sub-cl. (a) also makes this clear because under sub-cl. (a) there is a provision for setting off depreciation which is not accounted for whereas sub-cl. (b) provides for setting off depreciation which has been accounted for but not absorbed. Since the P&L account will display only the net result as loss after deduction of depreciation, the section itself can come into play only in a case where there is a net loss after adjusting depreciation and cannot be applied to a case where there is a net profit after adjusting depreciation.
13. In Northman vs. Barnet London Borough Council (1978) 1 WLR 220 at p. 228 (CA). Lord Denning M. R. observed thus :
"The literal method is now completely out of date. It has been replaced by the approach which Lord Diplock described as the purposive approach... In all cases now in the interpretation of statutes we adopt such a construction as will promote the general legislative purpose underlying the provision."
This is reiterated by our Supreme Court in CIT vs. K. S. Vaidyanathan (1985) 153 ITR 11 (Mad) (FB) at p. 33 and Maharashtra State Financial Corporation vs. Jaycee Drugs and Pharmaceuticals Pvt. Ltd. (1991) 2 SCC 637. Approaching the provisions of the Companies Act in this manner, we may now consider the object of S. 205(1)(b). That section has been enacted in the context declaration of dividends. Sub-s. (1) itself states that the dividend shall be paid only out of the profits of the company. Proviso (a) requires depreciation to be set off if it had not been provided. Proviso (b) requires loss or depreciation of the earlier year whichever is less to be deducted against the profits of current or earlier year which is utilised for paying out dividends. In other words, the company can declare dividends only after setting off depreciation. But it can declare dividends even if there was past loss still remaining to be set off. The basis for this distinction is that loss is taken to be a charge on the capital while depreciation is taken to be a charge on the profit. Clause (b) itself starts with a phrase "if the company has incurred any loss in any previous financial year" which means that it refers only to a situation where the net result is a loss after setting off depreciation. Wherever the earlier years net result has been a loss, then the company is required to set off such entire loss or an amount equal to depreciation which was charged whichever is less before declaring dividend out of the current profit.
13A. To understand this provision, we may now consider a few illustrations. Let us take the current profit as Rs. 10,00,000 after current years depreciation. We may consider five different situations in the result of the preceding year as follows :
Profit or loss before depreciation Depreciation Profit or loss after depreciation (net result)
1. (-) 4 lakhs (-) 3 lakhs (-) 7 lakhs
2. (-) 3 lakhs (-) 3 lakhs (-) 6 lakhs
3. (-) 2 lakhs (-) 3 lakhs (-) 5 lakhs
4. 0 lakh (-) 3 lakhs (-) 3 lakhs
5. (+) 1 lakh (-) 3 lakhs (-) 2 lakhs We may note that in all the above five situations, the net result is a loss and, therefore, the provisions of S. 205(1)(b) will be attracted. The company cannot declare dividend out of the current profits without a deduction as required by S. 205(1)(b). The only question is what should be the deduction in each such situations. The case of the Revenue is that we should compare first column with second column is if the word loss refers to loss before depreciation. The case of the assessee is, we should compare the second column with third column taking the word loss to mean the net result after depreciation. The question of comparison itself arises only where we have to choose one of two figures whichever is less. In the illustration above, it is the contention of the Revenue that the fifth situation will not be a case of loss and no deduction should be given. This view is obviously untenable because the fifth situation is also a case where the company has incurred a loss being the net result of the operations. If we consider otherwise by referring only to the loss before depreciation, then the P&L account itself will not be in conformity with the provisions of the Companies Act because the deduction of depreciation before arriving at the net result is mandatory.
14. In the above illustration if we proceed on the basis that loss refers to the net result in the expression "loss or depreciation whichever is less" (i.e., comparing the 3rd column with the second column) we find that in the first situation the assessee would be entitled only to the deduction of depreciation of Rs. (-) 3 lakhs and not deduction of the loss of (-) 4 lakhs. In the second situation also, there will be the deduction of Rs. (-) 3 lakhs which is less than the total loss of (-) 6 lakhs and the loss of (-) 3 lakhs before depreciation would be disregarded. In the third situation, the assessee would still be entitled to the deduction of Rs. (-) 3 lakhs being the depreciation since it is less than the net loss of (-) 5 lakhs and, therefore, the loss before depreciation of Rs. (-) 2 lakhs would be disregarded. Again in the fourth situation, the assessee will be entitled to the deduction of Rs. (-) 3 lakhs being depreciation which is equivalent to the net loss of Rs. (-) 3 lakhs. In the last situation, the assessee will be entitled to the deduction of unabsorbed depreciation of Rs. (-) 2 lakhs only which is the net result even thought the depreciation actually charged was Rs. (-) 3 lakhs. This is because the profit of (+) 1 lakh would have absorbed part of the depreciation and only the unabsorbed depreciation would be allowed as a deduction. It is only when the profit of earlier year is enough to wipe out the depreciation that there will be no deduction under that section from the current profits before declaring divided. It will be seen from this that a working of this rule taking the expression "loss" to mean the net result would always result in the deduction of depreciation alone and only to the extent it is unabsorbed and the company would not be able to set off past losses out of current profit before declaring dividend.
15. Let us now consider the same illustration on the basis that the word loss refers to loss before depreciations. In the first situation, the assessee would be entitled to the deduction of Rs. (-) 3 lakhs depreciation being less than the loss of (-) 4 lakhs. In the second situation also, the assessee would be entitled to the depreciation of Rs. (-) 3 lakhs since it is equal to the loss of Rs. (-) 3 lakhs. In the third situation, the company would deduct loss of Rs. (-) 2 lakhs only as against the depreciation of Rs. (-) 3 lakhs. In the fourth situation, the loss being nil no deduction would be available, in spite of the company having unabsorbed depreciation of Rs. (-) 3 lakhs. In the fifth situation also the unabsorbed depreciation would not be allowed to be set off only on the ground that there was a profit though it was not enough to wipe out the provision for depreciation. It is seen that on the basis that loss is equivalent of loss before depreciation, there is no underlying principle on which the deduction is to be made because in certain years the depreciation is allowed and in certain years the loss is allowed and in certain years no deduction is allowed even though deprecation has not been absorbed either in full or in part. Clearly, the section cannot be understood to give such a haphazard result in preference to the basis on which it could have a clearly defined underlying principle, viz., the intention to allow only unabsorbed deprecation as deduction as against business loss. Since business loss is always understood to have to come out of capital and since depreciation is always understood as a charge on the profit, the basis that the phrase "loss or depreciation whichever is less" must refer to the resultant loss alone, becomes meaningful. Admittedly, this is the view taken by the Company Affairs Department also.
16. Let us now consider whether this phrase could have a different meaning when incorporated in the IT Act. The contention of the Revenue was that while the purpose of the Companies Act was to restrict the amount available out of the current profit for distribution as dividends, the purpose under the IT Act was different and, therefore, the same meaning could not be gathered in the context of the IT Act. However, we find that the context makes no difference to the meaning of this phrase. As we have noted above, the Explanation to S. 115J provided for the computation of the book profit being the current profit as shown in the P&L Account, 30% of which was to be taken as a taxable income. Since such a computation did not take into account past losses and depreciation, the representations had been made and the Prime Minister, who was also the Finance Minister, accepted that the representation had some merit. That was the reason why a further deduction of the loss or depreciation of the earlier years was allowed as a deduction where it was required to be set off under S. 205(1)(b) of the Companies Act. In other words, the Finance Minister has accepted the representation to the limited extent that the amount of the current profits which could be lawfully distributed as dividend under the Companies Act, would be the same as would be liable to tax under S. 115J. Hence, he stated that the same adjustment will be made. Therefore, even if the computation is to be made in two different contexts the amount arrived at would have to be the same for both the purposes of declaration of dividend as well as the taxability under S. 115J. Moreover, the Expln. to S. 115 itself has, as noted earlier, referred to the profit or loss as computed in accordance with the provisions of the Companies Act and, therefore, the word loss in item (iv) can only refer to the loss finally determined as the net result after adjustment of depreciation. Further, since item (iv) requires the deduction to be made as if S. 205(1)(b) of the Companies Act is applicable, there could be no departure from the manner in which the computation is made in the Companies Act while making the computation under the Expln. to S. 115J. It follows that the deduction which becomes meaningful under the Companies Act for the purpose of allowing the unabsorbed depreciation will continue to hold good for the purpose of S. 115J also. Consequently, the deduction claimed by the assessee cannot be disallowed, only because there was a profit before deprecation in the earlier years, when the net result is a loss. Since S. 205(1)(b) itself applies only to a situation where the net result is a loss in the earlier year, the Revenue cannot deny the deduction of the unabsorbed depreciation of the earlier years which is worked our by the phrase "loss or depreciation whichever is less". It is only the unabsorbed loss other than depreciation which can be ignored as such loss is to be treated as a capital loss.
17. The contention of the Revenue that the word loss has been judicially understood as a loss before depreciation under the IT Act is also untenable. Firstly, the word loss has not been defined in the IT Act. Secondly, S. 28 provides for a charge on the profits and gains of a business and S. 29 states that it shall be computed in accordance with the provisions contained in Ss. 30 to 48C. Since S. 32 provides for depreciation even a loss determined as profits and gains of a business would be a loss after allowing deduction. Sec. 70 provides for set off of loss from one source against the income from another source and S. 72 provides for carry forward and set off of business loss. Here again, it refers only to the net result of the computation under the head profits and gains of the business, which will be a loss after deduction of depreciation. Since that section provides for a limitation of the period upto which the unabsorbed loss could be carried forward sub-s. (2) of S. 72 provides that depreciation allowance could be carried forward separately without such a limitation. This in no way defines a loss in the IT Act to mean only a business loss determined before deduction of depreciation. On the other hand, the Supreme Court has observed in the case of Garden Silk Weaving Factory vs. CIT (1991) 189 ITR 512 (SC) :
"Unabsorbed depreciation is indeed a part of the "loss". This is so because in the first place, depreciation is a normal outgoing, though in a sense notional, which has to be debited in the computation of the profits of a business on commercial principles (quite apart from statute) and it is difficult to say why, when such deduction yields a negative figure of profits, it cannot be a "loss" as generally understood."
The Revenue has not been able to point out anything in the IT Act to indicate that the word loss in S. 115J should have a meaning other than that so generally understood. Nor has the Revenue pointed to any decision where the acceptation of the word loss in a P&L Account was loss before depreciation. We are, therefore, convinced that even for purposes of S. 115J, Expln. (vi), the word loss must refer only to the net result after setting off depreciation.
18. The Revenue while contending that the circular of the CBDT did not amount to a contemporaneous exposition relied on the same circular to contend that loss is to be understood as loss before depreciation. Actually, the examples given in the circular do not refer to the loss as such but what is called "business loss" as distinct from depreciation. In other words, the loss which comes as a net result in the P&L Account is bifurcated into depreciation and business loss for the purpose of carrying forward and deducting the same from subsequent profits. This is the pattern which the income tax computation is familiar with because of the restriction under S. 72 with reference to the carry forward of the loss excluding depreciation. That is, however, besides the point when it comes to the phrase "loss of depreciation whichever is less" because no such bifurcation is envisaged in the process. Moreover, the circular itself is incomplete because it does not deal with all the situations, one of them being a situation where there is a profit before depreciation. The Revenue seeks to extrapolate the circular to that situation by assuming that the word "loss" should refer to the business loss. But such an assumption is unwarranted. The argument made was that since loss as a net result will always include depreciation, the expression if understood that way would lead to the deduction of depreciation alone and there would be no real choice. The answer to this argument is firstly that the net resultant loss will not always be more than the depreciation as in a case where there is a profit before depreciation the net resultant loss is likely to be less than the depreciation which gets absorbed. Secondly, even if it should lead to the result of unabsorbed depreciation alone being allowed as a deduction, that was exactly the purpose of that expression as we have found earlier.
19. If we were to accept the contentions of the Revenue that the expression loss should be equated to a business loss prior to depreciation, then it leads to absurd results. Firstly, as in this case, because there was no loss prior to depreciation, the assessee will not be allowed the deduction of unabsorbed depreciation. When the mandate of the Companies Act as well as the intention of the IT Act is to allow the deduction of unabsorbed depreciation whether for distribution of profits as dividends or for taxing the profits for income tax, the tax on book profits under S. 115J alone would ignore such unabsorbed depreciation. On the other hand, if we understand loss to be the net loss after depreciation, the result is quite logical and the unabsorbed depreciation alone is allowed to be deducted in every case. There is the further aspect that it will be illogical to deny the deduction of one alternative, when the lower of the two alternatives is to be allowed as a deduction, only because one of the alternatives is absent. To give a common place illustration, if the intention is to offer to a thirsty man, tea or coffee which is cheaper, it cannot be said that he should be denied tea because coffee which is costlier is not available. As we have seen in the beginning the stated object of the Prime Minister who was the Finance Minister was to grant relief by giving deduction of either loss or depreciation whichever is less. It will be going against that stated policy of the Government if the Revenue were to deny the deduction of unabsorbed depreciation only because there was no loss before depreciation even though the net result of the business was a loss.
20. The contention of the Revenue that the construction placed by us would discriminate against trading companies misses the distinction between business loss before depreciation and depreciation. It has always been understood that the loss before depreciation must be borne by the capital and will be taken as a capital loss. It is only because of this fundamental idea that the IT Act provides for a separate deduction of the carried forward loss only to a limited extent. On the other hand, since depreciation is a charge on the profit, the deduction of unabsorbed depreciation is allowed without any time limit. If we keep this distinction in mind, it would be clear that the provisions of both S. 205(1)(b) of the Companies Act and S. 115J deliberately kept out the business loss being a capital loss and intended to allow only depreciation which is a charge on the profit. If a trading company incurs large amount of loss prior to depreciation and the depreciation chargeable is very small amount, the trading company could still declare divided and naturally has to pay higher tax under S. 115J on the current, profits because the company is supposed to bear the capital loss and not pass it on to the Revenue. On the other hand, if a manufacturing company incurs a smaller loss, but has a large unabsorbed depreciation, it cannot declare dividends and, hence, it is not the intention to tax the current profit without setting off the unabsorbed depreciation which is well recognised as a charge on the profit. This is exactly the relief which the Finance Minister has promised and which the Revenue wants to deny. Since there is a basis for this classification, there is no substance in the contention of the Revenue that the construction of the word loss as meaning net loss after depreciation would be discriminatory and should, therefore, be avoided.
21. The last contention of Revenue was that a Bench of the Tribunal in the case of V. V. Trans-investment (P) Ltd. vs. ITO (1992) 43 TTJ (Hyd) 466 : (1992) 42 ITD 242 (Hyd) had accepted that view of the Revenue and, therefore, that view should be allowed to prevail. We find that the view we have now taken was first taken by a Single Member of the Tribunal in the case of Buttwelded Tools (P) Ltd. vs. Asstt. CIT (1991) 39 ITD 432 (Mad). The Hyderabad Bench has given no reasons why the view of the Single Member was not preferable except to say that it relied on the decision of the Supreme Court in the case of Garden Silk Wvg. Factory vs. CIT (supra) and K. P. Varghese vs. ITO (1981) 131 ITR 597 (SC) which were decided on different facts. Naturally, those decisions did not arise under S. 115J and the Single Member had followed those decisions only to draw the principles on which the expression "loss or depreciation whichever is less" has to be understood. We also find that the Bombay Bench of the Tribunal in the case of Rim Textiles P. Ltd. in ITA No. 8606/Bom/91 and in the case of Royal Western (I) Hotels P. Ltd. in ITA No. 1487/Bom/92 have agreed with the decision of the Single Member. Even assuming that two views were possible on the meaning of the word loss in S. 115J, Expln. (iv), we are compelled to follow the dictum of the Supreme Court in the case of CIT vs. Vegetable Products Ltd. (1973) 88 ITR 192 (SC) that if the language of taxing provision is ambiguous or capable of more meaning, then the Court has to adopt that meaning which favours the assessee. This approach is particularly called for in a case where the provision itself was intended to grant relief to the assessee on the basis of representations made to the Finance Minister. We are, therefore, of the opinion that the view taken in the case of Buttwelded Tools P. Ltd. vs. Asstt. CIT (supra) must prevail over the view taken by the Hyderabad Bench in the case of V. V. Trans-Investments (P) Ltd. vs. ITO (supra).
22. The Revenue resisted the hearing of these cases by the Special Bench and contended that the view taken by the Hyderabad Bench should not be disconded... It was submitted that even if the interpretation taken by the Revenue on S. 115J, Expln. (iv), was considered to be inequitable or unjust, it should be left to the Parliament to intervene and the provision should be effectuated and not defeated on equitable consideration. It was also submitted that an earlier decision should not be overruled unless it was manifestly wrong or proceeds upon a mistaken assumption in regard to the existence or continuance of a statutory provision nor is contrary to another decision of the Court as held by the Supreme Court in the case of Distributors (Baroda) P. Ltd. vs. Union of India (1985) 155 ITR 120 (SC). We find that the present case satisfies that criterion because the decision of the Hyderabad Bench has not considered the underlying purpose of S. 205(1)(b), namely to allow the deduction or unabsorbed depreciation and disallow the deduction of business loss which is of capital nature. With respect, while approaching the matter in the night perspective of purposive construction, the Hyderabad Bench concentrated on the object of the section which was to tax the so-called, zero-tax companies but overlooked the object of cl. (iv) in the Explanation which was to allow the deduction of unabsorbed depreciation in arriving at the "Book profit" and grant relief to the companies to that limited extent. It is also contrary to the decision of other Benches of the Tribunal. More than all that, the contention of the Revenue goes against the stated objective of the enactment as reflected in the Speech of the Finance Minister. It was contended that we should go by the words of the statute without reference to the stated objective. It was remarked that the noble idea of the Finance Minister was perhaps not translated into action. It is surprising to see the Revenue taking this contention which normally comes from an assessee to the effect that the words of the state have not carried out the intention of Parliament. It is a moot question whether the Revenue could hesitate to give effect to the stated objective on such a specious plea. It appears to us that this kind of an argument may even put the Finance Minister in on embarrassing situation if the matter is to be raised by the Parliamentary Committee on Government Assurance. It is also not clear whether this contention is taken after due consideration because it also goes against the statement given in the CBDT Circular explaining this provision, [See Emphasis given in paragraph 10 above]. We may recall that the Supreme Court has in the case of CWT vs. Vasudeo V. Dempo (1992) 196 ITR 216 (SC) discouraged litigation in respect of matters clarified by the CBDT. If at all the Revenue had any doubts about the matter, one would have expected that as a matter of policy the view of the Finance Minister would have been obtained before pursuing this litigation as it has led to wasteful expenditure.
23. In the case of Surana Steels Pvt. Ltd. (ITA No. 1845/Hyd/90), the assessee has challenged the order made under S. 263. The Commissioner before acting under that section is expected to know the object by that exercise. As explained by the Madras High Court in the case of Venkatakrishna Rice Co. vs. CIT (1987) 163 ITR 129 (Mad) the object is to review an erroneous order and not to raise an additional demand. If only a little care had been taken to ascertain the rationale behind S. 205(1)(b) of the Companies Act, certain interesting facts would have been discovered. Even that section did not find a place in the Companies (Amendment) Bill, 1959. It was the Select Committee which recommended its inclusion [See (1960) 30 Comp. Cas. (Journal) 1 at p. 5]. The formula of "loss or depreciation whichever is less" was devised to allow unabsorbed depreciation alone so that companies can declare dividends out of current profits even if they had unabsorbed business loss. The thrust on "zero-tax companies" by the IT Act was on companies which declared dividends and yet did not pay tax. But the companies pleaded for relief pointing out that they were allowed to distribute dividends out of current profits even if they had unabsorbed loss or depreciation of the earlier years. The Finance Minister, therefore, limited the deduction of past losses and depreciation to the same extent as would enable the companies to declare dividends under the Companies Act. As pointed out by J. M. Evans in "de Smiths Judicial Review of Administrative Action, 4th Edn., page 285, an authority in which a discretion is vested must act in good faith, must have regard to all relevant considerations and must not be swayed by irrelevant considerations, must not seek to promote purposes alien to the letter or to the spirit of the legislation that gives it power to act, and must not act arbitrarily or capriciously". If the exercise of the power is for an improper purpose, then it is regarded in law as an abuse of the discretionary power in bad faith. [See page 324]. Similarly, if the exercise of the discretionary power was by the disregard of relevant considerations, it is not validly exercised. The emphasis is on the implied duty to exercise discretionary power fairly. From this point of view the order made under S. 263 amounted to an unreasonable exercise of the discretionary power vested in the CIT and was, therefore, void. The order of the CIT has to be cancelled for this reason also.
24. To sum up, we hold that the word loss in the phrase "loss or depreciation whichever is less" an Expln. (iv) to S. 115J refers only to the net loss after deduction of depreciation so that the assessee-company whose income is computed under S. 115J in entitled to deduct unabsorbed depreciation of the earlier years even if there was a profit before deduction of such depreciation in the earlier years. The Assessing Officer is, therefore, directed to recompute the total income of the assessees on that basis. Consequently, the order of the CIT under S. 263 in the case of M/s. Surana Steels Ltd. is cancelled. In the other two cases, namely M/s. Agroha Extraction Ltd. and M/s. Binjusaria Metal Box Co., the orders of the authorities below are set aside and the Assessing Officer is directed to recompute the total income on the above basis.
25. In the result, the appeals are allowed.