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Commissioner Of Income Tax, Mumbai v. M/S Echjay Forgings Pvt. Ltd., Mumbai .
Case Summary — Appeal under Section 260A (Income Tax Act)
Factual and Procedural Background
The Department appealed under section 260A against the Tribunal's decision dated 4 August 1999. The assessee, a company engaged in manufacturing steel forgings, filed its return on 31-12-1990 for assessment year 1990–1991 declaring a total loss of Rs. 32.34 lakhs. The Assessing Officer (AO) disallowed deductions and directed additions to book profit under section 115-J for: wealth tax paid, provision for doubtful debts (Rs. 1,67,411), provision for gratuity (Rs. 5,00,000), provision for bonus (Rs. 3,46,370) and foreign exchange rate difference (Rs. 1,38,234). The First Appellate Authority (CIT(A)) agreed with the AO and added these items to net profit. The Tribunal reversed that view (following an earlier Tribunal decision), holding that book profits must be computed in accordance with the Companies Act and allowed the assessee's appeal. The Department challenged the Tribunal's conclusion in this Court.
Legal Issues Presented
- Whether the Tribunal erred in law in holding that provisions made for doubtful debts, bonus, gratuity, wealth tax liability and foreign exchange rate difference could not be added to the net profit shown in the profit and loss account within the meaning of the Explanation to Section 115-J(1A) while working out the book profit under Section 115-J of the Income Tax Act, 1961?
Arguments of the Parties
Appellant (Department)
- The AO/Department contended that the amounts in question (wealth tax, provisions for doubtful debts, gratuity, bonus and foreign exchange difference) should be disallowed as deductions and added back to the net profit for computing book profit under Section 115-J, relying on the Explanation to Section 115-J(1A).
- In respect of foreign exchange fluctuations, the AO treated the expenditure as capital in nature (forming part of the cost of plant and machinery) and directed the amount to be added back to income to be capitalised and subject to depreciation.
- By their conduct the Department applied adjustments under assessment provisions, invoking factual findings to justify the additions (the appeal record shows the Department invoked section 143(3) in this matter).
Respondent (Assessee)
- The assessee contended that the questioned items were either not within the scope of the Explanation to Section 115-J(1A) (wealth tax) or represented provisions for ascertained liabilities (doubtful debts, gratuity, bonus) and therefore should not be added back to the book profit.
- With respect to foreign exchange difference, the assessee showed that the amount was debited to the profit and loss account under the Companies Act (and that the liability arose from a foreign exchange loan from ICICI), supporting inclusion in book profit computation as per companies law treatment.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Echjay Forgings Pvt. Ltd., Mumbai v. DCIT, Spl. Range-30, Mumbai in ITA No. 7865 Bombay, 94 dated 4th November, 1997 | Tribunal's earlier decision on computation of book profits in accordance with the Companies Act (supporting non-addition of such items to book profit). | The Tribunal followed this earlier judgment; the Court records that the Tribunal's reliance on that judgment supported its conclusion that book profits should be computed per the Companies Act and that disallowances by the Department were impermissible. |
| Dy. CIT v. Beardsell Ltd., reported in 244 ITR. page 256 | Decision where an amount was added to net profit because the provision was held not to be for ascertained liabilities; adjustment in that case was made under section 143(1)(a). | The Court held this precedent inapplicable to the present case because the adjustment in Beardsell Ltd. was under section 143(1)(a), whereas the Department in the present matter invoked section 143(3); accordingly the Beardsell decision did not support the Department's position here. |
Court's Reasoning and Analysis
The Court addressed each of the five contested additions separately and applied the statutory explanation to Section 115-J(1A), the factual record, and the Companies Act treatment of the profit and loss account.
- Wealth tax: The Court accepted the Department's Senior Counsel's concession that clause (a) of the Explanation to Section 115-J(1A) contemplates income tax paid, not wealth tax. Accordingly, wealth tax paid does not increase the net profit for the purpose of Section 115-J.
- Provision for doubtful debts (Rs. 1,67,411): Clause (c) of the Explanation to Section 115-J states that provisions made for liabilities which are not ascertained must be added back. The assessee had asserted (and the Department did not dispute) that this provision related to an ascertained liability. The AO and CIT(A) gave no factual finding to the contrary. The Tribunal followed its earlier decision (Echjay Forgings). The Court held that there was no material to support the AO's conclusion that the liability was unascertained and that, given the absence of a factual finding and the Department's reliance on section 143(3), the Department should have recorded a proper finding before making the addition. On the facts of this case the Court decided this point in favour of the assessee.
- Provision for gratuity (Rs. 5,00,000): The assessee made the gratuity provision on the basis of actuarial calculations. The AO gave no reasons for adding the amount to net profit. The Court held that such a provision, being actuarially calculated, could not be said not to be an ascertained liability; accordingly the addition was not justified.
- Provision for bonus (Rs. 3,46,370): The assessee showed liability under the Payment of Bonus Act and provided for bonus accordingly. The Court held that this created an ascertained liability, and therefore the provision could not be treated as an unascertained liability requiring addition to book profit.
- Foreign exchange rate difference (Rs. 1,38,234): The AO treated the amount as arising from purchase of plant and machinery and directed that it be added into asset cost (capitalised). The Tribunal, however, found on facts that the assessee had taken a foreign exchange loan from ICICI and that though typically such fluctuations might be treated as capital account under the Income Tax Act, the amount had been debited to the profit and loss account under the Companies Act. The Court agreed with the Tribunal that for purposes of section 115-J the AO must go by the computation of book profit as permitted under the Companies Act (Schedule VI) and that the amount was debited to P&L; therefore the Department erred in ordering the addition.
Holding and Implications
Holding: The central question was answered in the negative, i.e., in favour of the assessee and against the Department. The Court agreed with the Tribunal's approach and findings on the items considered.
DEPARTMENT'S APPEAL DISMISSED; TRIBUNAL'S ORDER UPHELD
Implications: The practical consequence is that the AO's additions of the specified amounts to the net profit for the purpose of computing book profits under Section 115-J were set aside:
- Wealth tax: not added to net profit.
- Doubtful debts (Rs. 1,67,411): not added (no material to show liability unascertained; decided for assessee on facts).
- Gratuity (Rs. 5,00,000): not added (actuarial provision treated as ascertained liability).
- Bonus (Rs. 3,46,370): not added (liability under Payment of Bonus Act treated as ascertained).
- Foreign exchange difference (Rs. 1,38,234): not added (debited to profit and loss account under Companies Act; Tribunal and Court so found).
The opinion makes no claim to establishing a new broader principle beyond applying the Explanation to Section 115-J(1A) and confirming that book profits for the purposes of Section 115-J must be computed in accordance with the Companies Act (subject to the statutory adjustments). The appeal was disposed of accordingly and no order as to costs was made.
S.H Kapadia, J.:— Being aggrieved by the decision of the Tribunal dated 4th August, 1999, the Department has filed this appeal under section 260A of the Income Tax Act.
2. The short question which arises for consideration before this Court in the above appeal is as follows:
“Whether on the facts and in the circumstances of the case the Tribunal erred in law in holding that the provisions made for doubtful debts, bonus, gratuity, wealth tax liability and foreign Exchange rate difference could not be added to the net profit shown in the profit and loss account within the meaning of Explanation to Section 115-J(1A) while working out the book profit under Section 115-J of the Income Tax Act, 1961?”
FACTS:
4. The assessee-company filed its return on 31-12-1990 for the assessment year 1990–1991 declaring total loss of Rs. 32.34 lacs. The business of the assessee is to manufacture steel forgings. The AO disallowed the deductions claimed by the assessee on account of payment of wealth tax. He also disallowed the provisions made by the assessee for doubtful debts; for gratuity; for bonus and in respect of foreign exchange rate difference while computing the book profits under section 115-J of the Income Tax Act. They were disallowed only on the ground that while computing the book profits under Section 115-J(1A), the above items were required to be added back to the net profit as shown in the profit and loss account as per the explanation to Section 115-J(1A). Being aggrieved, the assessee carried the matter in appeal to CIT (Appeals). The First Appellate Authority agreed with the view of the AO. The First Appellate Authority came to the conclusion that the net profit in the profit and loss account stood increased by the amount of wealth tax paid as also by the amounts set aside to meet liabilities, other than ascertained liabilities. The CIT (Appeals) added all the above items to the net profit. Being aggrieved the assessee preferred an appeal to the Appellate Tribunal. In view of the earlier decision of the Tribunal, it was held that book profits were required to be computed in accordance with the provisions of the companies act and, therefore, the dis-allowances made by the Department under section 115-J were impermissible. The Tribunal accordingly allowed the appeal. Hence, the Department has come by way of appeal under section 260-A of the Income Tax Act.
FINDINGS:
6. The short point which arises for consideration in this appeal is, whether the AO was right in disallowing the claims for deduction in respect of the five items and ordering addition thereof to the net profit for the purposes of section 115-J of the Act.
7. The addition of the five items to the net profit is accordingly discussed hereinbelow:
(I) ADDITION OF WEALTH TAX PAID BY THE ASSESSEE TO THE NET PROFIT.
8. Mr. Desai, learned Senior Counsel for the Department, fairly concedes that the net profit, as shown in the profit and loss account, will not be increased by the amount of wealth tax paid because under clause (a) of the Explanation to Section 115-J(1A), what is contemplated is the amount of income tax paid. Under the said clause, payment of wealth tax is not contemplated. Therefore, the net profit shall not be increased by the amount of wealth tax paid by the assessee.
(II) WHETHER THE NET PROFIT WAS REQUIRED TO BE INCREASED BY Rs. 1,67,411/- BEING THE PROVISION FOR DOUBTFUL DEBTS.
9. Under clause (c) of the Explanation to section 115-J of the Act, unless a provision is made for ascertained liabilities, the provision made has to be included in book profit for the purpose of ‘taxation under section 115-J of the Act. The assessee, in the present case, has claimed exclusion for the sum of Rs. 1,67,411/- from the profit and loss account on the ground that the same has been made as a provision for doubtful debts in respect of an ascertained liability. In this case, on facts, we find that the Department has not disputed the contention of the assessee that the said liability is an ascertained liability. The assessee specifically contended before the Department that the provision has been made to meet ascertained liability. This was never disputed. No finding has been given on this point by the AO. No finding has been given by the First Appellate Authority as to how the above clause (c) of the Explanation stood attracted. On the other hand, the Tribunal has followed its Judgment in the case of Echjay Forgings Pvt. Ltd., Mumbai v. DCIT, Spl. Range-30, Mumbai in ITA No. 7865 Bombay, 94 dated 4th November, 1997. Hence, on facts, there is no material before the Court in support of the conclusion drawn by the AO that the provision made by the assessee was in respect of an unascertained liability. Therefore, we have decided this point only on the facts of this case. In the case of Dy. CIT v. Beardsell Ltd., reported in 244 ITR. page 256, the claim of the assessee was disallowed on the ground that the provision was not for ascertained liabilities and, accordingly, an amount of Rs. 33.49 lacs came to be added to the net profit. In that matter the adjustment was made under section 143(1)(a) of the Act. Hence, the said Judgment has no application to the facts of the present case. In the present case, the Department has invoked section 143(3) of the Act. Therefore, the Department was required to record a proper finding of fact before adding Rs. 1,67,411/-.
(III) WHETHER THE NET PROFIT WAS REQUIRED TO BE INCREASED BY AN AMOUNT OF Rs. 5,00,000/- BEING THE PROVISION FOR GRATUITY.
10. As stated above, no reasons have been given by the AO for adding the said amount to the net profit. The assessee has made the provision for gratuity on the basis of actuarial calculations. Hence, it cannot be said that the provision for gratuity is not an ascertained liability.
(IV) WHETHER THE NET PROFIT WAS REQUIRED TO BE INCREASED BY AN AMOUNT OF Rs. 3,46,370/- BEING THE PROVISION FOR BONUS:
11. The assessee has shown that it was liable to pay bonus under Payment of Bonus Act. Accordingly, it provided for payment of bonus to the employees. Therefore, it cannot be said that the provision for bonus amounting to Rs. 3,46,370/- is not an ascertained liability till it is actually paid to the employees.
(V) DISALLOWANCE OF Rs. 1,38,234/- AS REVENUE EXPENDITURE ON ACCOUNT OF FLUCTUATIONS IN FOREIGN EXCHANGE RATES:
12. The assessee debited the aforesaid amount on account of the foreign exchange rate fluctuations. They claimed deduction of the aforestated amount as revenue expenditure. According to the AO the said expenditure was incurred for purchase of plant and machinery and, therefore, the amount was required to be added back to the cost of the asset subject to depreciation. He accordingly directed Rs. 1,38,234/- to be added back to the total income of the assessee. This order was confirmed in appeal by the Commissioner of Income Tax (Appeals). However, on facts, the Tribunal found that the assessee had taken a foreign exchange loan from ICICI and though, normally, under the provisions of Income Tax Act such increase in the liability due to fluctuations in the foreign exchange rates is normally taken as on capital account, the same is debited to the profit and loss account under the Companies Act. We agree with the view expressed by the Tribunal. While applying section 115J, the AO has to go by computation of the book profit as permitted under the Companies Act. By virtue of section 115-J, in the case of a Company whose total income as computed under the Income Tax Act is less than 30% of the book profit, the total income chargeable to tax will be 30% of the book profit as computed. That, for the purposes of section 115-J book profit will be the net profit as shown in the profit and loss account prepared in accordance with Schedule-VI to the Companies Act subject to certain adjustments. The net profit, as calculated above, will be increased, inter alia, by the amounts debited to the profit and loss account. In the present case, the Tribunal has found, on facts, correctly, that the said amount of Rs. 1,38,234/- has been debited to the profit and loss account under the Companies Act. Hence, the Department erred in adding the said amount to the net profit.
13. Accordingly, the above question is answered in the negative i.e in favour of the assessee and against the Department.
14. Appeal is disposed of accordingly. No order as to costs.
Question answered in favour of assessee.
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