Income Tax Appellate Tribunal - Mumbai
Modern Woollens Ltd. vs Deputy Commissioner Of Income-Tax on 9 June, 1993
Equivalent citations: [1993]47ITD154(MUM)
ORDER
V.K. Sinha, Accountant Member
1. This is an appeal filed by the assessee. Ground No. 1 is reproduced below :-
The learned Commissioner of Income-tax (Appeals) had erred in confirming the 30% of the Book Profit under Section 115J of the Income-tax Act, 1961, determined at a figure of Rs. 47,43,691; as against the NIL Book Profit declared by the assessee in its return of income. Under the facts and circumstances of the matter, he ought not to have confirmed the said 30% of the Book Profit under Section 115J determined at Rs. 47,43,691.
2. Section 115J of the Income-tax Act, 1961 contains special provisions relating to certain companies. It is laid down in Clause (1) that where the total income, as computed under the Income-tax Act in respect of certain assessment years is less than 30% of its "Book Profit", the total income of such assessee chargeable to tax shall be deemed to be an amount equal to 30% of such "Book Profit". It is further provided in Clause (1A) that every company assessee shall prepare its profit and loss account in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 for the purposes of Section 115J. Thereafter, the Explanation below the above clauses defines "Book Profit". It means the net profit as shown in the profit and loss account prepared under Clause (1A), as increased by certain items enumerated from (a) to (ha) and as reduced by certain items enumerated from (i) to (iv).
3. Applying the above provision, the assessee computed the book profit at Nil and declared it in the return of income. However, the Assessing Officer computed 30% of the book profits at Rs. 47,43,691 under the same provisions. This has led to the present dispute before us.
4. The assessee-company was maintaining its books of account from 1st October to 30th September every year and the same previous year was being adopted for filing the returns of income. However, w.e.f. assessment year 1989-90, the Income-tax Act prescribed a uniform previous year for all assessees ending on 31st March. The previous year for the assessee for assessment year 1989-90, which is under consideration, therefore consisted of 18 months from 1-10-1987 to 31-3-1989. This consisted of two periods, the first being for 12 months from 1-10-1987 to 30-9-1988 and the second being for 6 months from 1-10-1988 to 31-3-1989. The return of income was prepared by taking figures from the statutory accounts maintained for the first period from 1-10-1987 to 30-9-1988 and also the books of account maintained for the period ended 31-3-1989. However, a tax audit report under Section 44AB of the Income-tax Act was prepared for the entire period of 18 months from 1-10-1987 to 31-3-1989 and was filed with the return of income.
5. The return of income, filed by the assessee disclosed a loss of Rs. 1,52,60,750. Along with the return, the assessee filed a computation of book profits for the purpose of Section 115J, which amounted to Nil. On the other hand, the Assessing Officer determined 30% of the book profit at Rs. 47,43,691. We need not go into the detailed computation and it will suffice to note that the dispute in the computation relates to the depreciation to be allowed in computing the book profits.
6. In the Profit and Loss Account, the assessee debited depreciation allowance as under :-
Period Amount
1-10-1987 to 30-9-1988 Rs. 14,25,000
1-10-1988 to 31-3-1989 Rs. 2,39,74,000
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Rs. 2,53,99,000
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On the other hand, the computation of depreciation by the Assessing Officer was as under :-
Period Amount
1-10-1987 to 30-9-1988 Rs. 14,25,000
1-10-1988 to 31-3-1989 Rs. 38,05,000
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Rs. 52,30,000
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7. In order to narrow down the dispute even further, it will be seen that there is no difference in the amount of depreciation relating to the first period of 12 months from 1-10-1987 to 30-9-1988. The entire difference relates to the second period from 1-10-1988 to 31-3-1989. In the first period, where there is no dispute, the depreciation has been calculated according to Schedule XIV of the Companies Act, 1956, whereas in the second period, the assessee has calculated the depreciation according to the Income-tax Rules; whereas the Assessing Officer has calculated it as per Schedule XIV of the Companies Act, 1956. The Assessing Officer observed that as far as the application of Section 115J was concerned, the profit of the assessee was to be taken on the basis of its accounts prepared under the Companies Act, 1956, which means that the assessee could not debit depreciation at a higher rate prescribed by the Income-tax Rules instead of a much lower rate prescribed under the Companies Act. He also observed that the assessee had charged depreciation at the higher rate under the Income-tax Rules solely with the intention of avoiding the implications of Section 115J of the Income-tax Act. He, therefore, recast the book profits after taking depreciation as per Companies Act arrived at the above mentioned figure.
8. It was submitted before the CIT (A) that the Assessing Officer was under a wrong impression that the assessee-company had not prepared its profit and loss account in accordance with the provisions of Part II and Part III of Schedule VI of the Companies Act, 1956. It was argued that the rates of depreciation allowance prescribed in Schedule XIV of the Companies Act were not applicable to Part II and Part III of Schedule VI of the Companies Act and were meant only for Sections 205 and 350 of the Companies Act, which relate to the declaration of dividends and fixation of managerial remuneration respectively. It was further submitted that the rates prescribed in Schedule XIV were only minimum rates and higher rates could be provided after giving a suitable note. It was also argued that the Assessing Officer had no jurisdiction to recast the profit and loss account for the purpose of computing book profits under Section 115J and could only make specific adjustments as provided in the Explanation below Section 115J.
9. The CIT (A) emphasised that the assessee had adopted two methods of computing depreciation for the same assessment year, the first for the 12 months period ending 30-9-1988 and the second for the 6 months period ending 31-3-1989. According to him, this also showed that the sole intention of the assessee was to avoid the implication of Section 115J. He did not find force in the contention of the assessee for reasons which are extracted below :-
This submission of the appellant's counsel does not carry any force whatsoever for two reasons - (i) for the purpose of computing book profit under Section 115J, Clause (iv) of Explanation to Sub-section (1A) of Section 115J provides for reduction by the amount of loss of amount of depreciation which would be required to be set off against the profit of the relevant previous year as if the provisions of Clause (b) of the first proviso to Sub-section (1) of Section 205 of the Companies Act are applicable. There is no dispute to the fact that Schedule XIV of the Companies Act, 1956 provides for rates of depreciation in the context of provisions of Sections 205 and 350 of the Companies Act, 1956. It is therefore, apparent that the rates of depreciation prescribed in Schedule XIV of the Companies Act are applicable to working out profits of a company for the purpose of dividend to be paid out of such profits, & (ii) Section 350 of the Act prescribes mode of ascertainment of depreciation and as has been discussed above, it provides that the amount of depreciation to be deducted in pursuance of Section 349(4)(K) of Companies Act, 1956 shall be the amount calculated with reference to the written down value of the assets as shown by the books of the assessee at the end of the financial year at the rates specified in the Schedule XIV.
10. The CIT (A), therefore, rejected the assessee's contention. The assessee is aggrieved by this decision and is now in appeal before us.
11. The learned counsel for the assessee reiterated the arguments which were made before the CIT (A) and thereafter went further into the rates of depreciation to be adopted under the Companies Act. He invited our attention to Part II of the Schedule VI to the Companies Act and submitted that the rates of depreciation were not prescribed therein at all. All that was provided was that there should be a proper disclosure about the depreciation. Relevant extract of para 3(iv) is given below :-
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) ....
(ii) ....
(iii) ....
(iv) The amount provided for depreciation, renewals or diminution in value of fixed assets.
12. Our attention was thereafter invited to Schedule XIV of the Companies Act, inserted by the Companies (Amendment) Act, 1988 with retrospective effect from 2-4-1987. It was narrated in the heading itself "see Sections 205 and 350". It was submitted that it was clear from the narration that the rates of depreciation were relevant for Sections 205 and 350 only. Section 205 related to payment of dividends out of profits, whereas Section 350 related to payment of managerial remuneration. He also invited attention to Circular No. 2 of 1989 dated 7-3-1989 issued by the Department of Company Affairs on the question whether higher rates of depreciation could be charged. The same is reproduced below :-
1. Can higher rates of depreciation be charged ? - It is stated that Schedule XIV clearly states that a company should disclose depreciation rates if they are different from the principal rates specified in the Schedule. On this basis, it is suggested that a company can charge depreciation at rates which are lower or higher than those specified in Schedule XIV.
It may be clarified that the rates as contained in Schedule XIV should be viewed as the minimum rates and therefore, a company shall not be permitted to charge depreciation at rates lower than those specified in the Schedule in relation to assets purchased after the date of applicability of the Schedule. However, if on the basis of a bonajide technological evaluation, higher rates of depreciation are justified, they may be provided with proper disclosure by way of a note forming part of annual account.
13. It was submitted that the rates of depreciation in Schedule XIV were only the minimum rates and charging of higher rates was permissible and the same had been done after a bonafide technological evaluation. A note forming part of annual account had also been duly given as a disclosure. Thus, it was submitted that the assessee was perfectly justified in adopting the depreciation rates as per Income-tax Rules for the second period.
14. In reply to a query from the Bench, it was clarified by the learned counsel for the assessee that the broken period of 6 months had entered into this assessment year only because the assessee was obliged to have a previous year of 18 months due to an amendment in the Income-tax Act providing a uniform previous year ending on 31st March from assessment year 1989-90. In fact, the assessee had adopted depreciation as per Income-tax Rules from 1-10-1988 onwards and the same method was being consistently followed in later years.
15. The learned counsel for the assessee thereafter invited attention to the decision of the Special Bench of the Tribunal in the case of Sutlej Cotton Mills Ltd. v. Asstt. CIT [1993] 199 ITR 164 (AT). Although the issue under consideration in that case was not rates of depreciation, there was observations regarding computing of book profits under Section 115J at pages 197 to 199. It was held that in a case where the profit and loss account was prepared in accordance with the provisions of Part II and Part III of the Sixth Schedule to the Companies Act, the Assessing Officer will have no power to disturb the book profit except as stated in Section 115J. The learned counsel submitted that in the present case also the Assessing Officer had no such power.
16. Lastly, it was submitted that the reliance of the CIT (A) on Clause (iv) of Explanation below Section 115J was misplaced because the depreciation rate could be objected to, even under Section 205 of the Companies Act, if it was lower than the rates prescribed in Schedule XIV, but not if they were higher than those rates, as was the case here.
17. For the above reasons, it was submitted that the rates of depreciation adopted by the assessee should be accepted and the computation of book profit should also be accordingly accepted at Nil.
18. The learned departmental representative, on the other hand, relied strongly on the orders of the Assessing Officer and the CIT (A). He submitted further that the only intention of the assessee in changing over to the rates of depreciation as per Income-tax Rules was to avoid the provisions of Section 115J and as such, it was a device for the sole purpose of avoiding tax. Such a device would not be permitted, as held by the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148. He, therefore, submitted that the assessee's ground of appeal should be rejected.
19. We have considered the rival submissions carefully. The dispute regarding application of Section 115J of the Income-tax Act is narrowed down to the computation of book profits i.e., the net profit as shown in the profit and loss account. This profit and loss account has to be prepared in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956. Certain adjustments to the book profit are permissible under the Explanation, but none beyond that. We have thus to see, firstly, if the book profit was computed in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 and secondly, whether there was any adjustment permissible under the Explanation.
20. The dispute in computation of book profit has also narrowed down to the rates of interest to be provided for the second period of the previous year of 18 months, consisting of the period 1-10-1988 to 31-3-1989. Ultimately, the question to be decided is whether the assessee was obliged to follow the depreciation rates laid down in Schedule XIV to the Companies Act, 1956 or had the discretion to provide higher rates of interest as per Income-tax Rules. As we have noted earlier, Schedule XIV has been introduced by the Companies (Amendment) Act, 1988 only, line back-ground in which the amendment was made has been explained in the commentary "Guide to the Companies Act" by the learned author A. Ramaiya, Twelfth Edition, 1992 at page 891, which is extracted below :-
Changes made by the Amendment Act of 1988 (w.e.f. 15-6-1988) Earlier, while determining distributable profits for the purposes of declaring dividend, depreciation was required to be provided at the rates specified for the various assets by the Income-tax Act by virtue of reference thereto to Section 350, which in turn was referred to in Sub-section 2(1) of this Section. In the recent years, the depreciation rates under the Income-tax Act having undergone steep upward revision, companies were not left with sufficient profits, after providing for depreciation, to enable declaration of reasonable dividend by them to their shareholders. This Section has, therefore, been amended by the Amendment Act of 1988 vide note 26 of Notes on clauses which reads as follows: "This clause seeks to amend Section 205 to provide that, in future, depreciation shall be calculated in accordance with the rates specified in Schedule XIV to the Act, thus delinking depreciation under the Companies Act from that under the Income-tax Act....
The amendment has the effect of delinking the provisions for depreciation required to be made for determining distributable profits for purpose of declaration of dividend vide Section 205, as also for determining net profits under Section 349 for computing the managerial remuneration.
21. Thus, it is evident that the changes were intended to govern the computation of profits for distribution of dividends under Section 205 and computing the managerial remuneration under Section 349. It is relevant to note here that Section 348 lays down that remuneration of managing agent should not ordinarily exceed 10% of net profits. Section 349 gives guidelines for determination of net profits and Section 350 provides for ascertainment of depreciation to be deducted in pursuance of Section 349(4)(K) of the Companies Act. It appears to us that the scope of these depreciation rates in Schedule XIV is a limited one and has been so clarified by the Circular No. 2 of 1989 of the Department of Company Affairs reproduced above. The rates have been clarified to be only the minimum rates but higher rates are permissible on the basis of a bonafide technological evaluation and after a proper disclosure by way of note forming part of annual accounts. The assessee has claimed all along that these conditions are satisfied and nothing contradictory has been placed before us. We are, therefore, satisfied that the assessee was entitled to provide for higher rates of depreciation that laid down in Schedule XIV without in any way violating the provisions of Parts II and III of Schedule VI to the Companies Act, 1956. In other words, the computation of depreciation by the assessee as per Income-tax Rules was in accordance with Parts II and III of Schedule VI to the Companies Act, 1956.
22. We agree with the learned counsel for the assessee that the Department's reliance on Clause (iv) of the Explanation below Section 115J is misplaced, since a higher rate of depreciation is permitted as per Circular we have described above. In this connection, we may also observe that items (i) to (iv) of the Explanation below Section 115J can only go to reduce the profit as per profit and loss account by their very definition and, therefore, these provisions cannot possibly be invoked to enhance the profits, as was done by the CIT (A).
23. We also find no merit in the submission of the learned departmental representative that providing of higher rate of depreciation as per Income-tax Rules was only a device to reduce the tax and should, therefore, be ignored in terms of the decision of the Supreme Court in the case of McDowell & Co. Ltd. (supra). It is not a case where the assessee changed the depreciation rate in one year and went back to its old system in subsequent years. The revised method has been followed consistently in subsequent years. The rates adopted are not arbitrary but authorised by the Income-tax Rules themselves. In the facts and circumstances of the case, it cannot be called a colourable device for tax planning. This submission of the Department is, therefore, not acceptable.
24. Having come to the conclusion that the profits as per profit and loss account of the assessee are in accordance with Parts II and III of the Schedule VI to the Companies Act, 1956, we agree with the learned counsel for the assessee that the Assessing Officer has no authority to recast the profits, relying on the observations of the Special Bench of the Tribunal in the case of Sutlej Cotton Mills Ltd. (supra).
25. For the above reasons, we direct that the rates of depreciation as per Income-tax Rules adopted by the assessee for the period 1-10-1988 to 31-3-1989 should be accepted and the book profits should be computed accordingly for the purpose of Section 115J.
26 to 37. [These paras are not reproduced here as they involve minor issues.]