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Losses shown as set off in Balance Sheet against reserves created earlier — whether available as deduction in computing book profits u/s.115JB

Subject : Income Tax Law
Month-Year : Aug 2004
Author/s : Chetan A. Karia
Chartered Accountant
Topic : Losses shown as set off in Balance Sheet against reserves created earlier — whether available as deduction in computing book profits u/s.115JB
Article Details :

Facts :

1. The querist, a company, is expecting to earn profits for the previous year relevant to A.Y. 2004-05. Losses were incurred in previous years relevant to A.Y. 2001-02 to 2003-04, but in years prior to the same, it had earned healthy profits, out of which general reserves had been created. In its balance sheets for the three years when losses were incurred, the querist company had shown accumulated loss/depreciation as deduction against ‘General Reserve’ as per requirements of Schedule VI.

2. The querist has neither passed any Journal entry in its books of account, nor any resolution has been passed by the Board of Directors for set off of the losses against general reserves and that the deduction shown in the balance sheet was only as a matter of presentation. Separate ledger accounts exist in the books of accounts for general reserves and accumulated losses. Also, general reserves were appropriated out of profits of years prior to the year(s) in which the loss has been incurred.

Query :

3. On the above facts, the querist seeks opinion as to whether the losses/depreciation of earlier years would be allowed as deduction in computing the book profit for the current year in accordance with S. 115JB ?

Object of MAT provisions :

4. Provisions relating to Minimum Alternate Tax (MAT) were first introduced by S. 115J by the Finance Act, 1987 with effect from 1-4-1988 to provide for levy of tax on the book profits of companies which were otherwise not liable to tax on account of their total income being NIL due to various incentives claimed. The intent of the provision was to ensure that companies having large profits and declaring substantial dividends pay a percentage of the book profit as minimum alternate tax, if their tax liability was otherwise less than the said amount. S. 80VVA was the forerunner to the provisions of MAT.

S. 115J :

5. Clause (iv) of the Explanation to S. 115J(1A) provided that the book profit so arrived at shall be reduced by the amount of any brought forward losses or unabsorbed depreciation, whichever is less, as per S. 205(1)(b) of the Companies Act, 1956. Provisions of MAT, as originally enacted, called for determination of unabsorbed loss or depreciation as calculated in terms of S. 205(1)(b) of the Companies Act, according to which, if the company had incurred loss for any earlier year(s), then the amount of the loss or an amount equal to the amount provided for depreciation for that year, 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 earlier year(s), arrived at after providing for depreciation.

6. Due to reference to S. 205(1)(b) of the Companies Act and difference in concept of unabsorbed losses and depreciation as per books and as per income-tax act, dispute arose as to whether the loss would include depreciation. The same was put to rest by the decision of the Supreme Court in Surana Steels Ltd. v. Dy. CIT, (1999) 237 ITR 777 (SC), which held that the loss would include depreciation.

7. The provision of S. 115J remained on the statute book for A.Ys. 1989-90 and 1990-91.

S. 115JA :

8. The Finance (No. 2) Act, 1996 with effect from 1-4-1997 reintroduced MAT by S. 115JA. In the new Section, clause (iii) of Explanation to S. 115JA(2) provided that the book profit is to be reduced by the amount of loss brought forward or unabsorbed depreciation, whichever is less as per the books of account and that the loss shall not include depreciation.

9. An important change as compared to S. 115J was that the provisions of S. 205(1)(b) of the Companies Act were not referred to and it was also clarified that loss shall not include depreciation. By the said change, set off of unabsorbed loss and depreciation is in line with income-tax concept of loss and depreciation being treated separately and carried forward independently, unlike the concept in accounting of loss being all inclusive including depreciation.

S. 115JB :

10. S. 115JA was replaced by S. 115JB by the Finance Act, 2000 with effect from 1-4-2001. The case of the querist is concerned with the provision of S. 115JB. Clause (iii) of Explanation to S. 115JB(2) provides that the book profit is to be reduced by the amount of loss brought forward or unabsorbed depreciation, whichever is less as per the books of account and the loss shall not include depreciation and the provision will not apply if the amount of loss brought forward or unabsorbed depreciation is nil.

Clause (iii) of Explanation to S. 115JB(2) :

11. The issue revolves around the wordings of clause (iii) of Explanation to S. 115JB(2). As per the said clause, the brought forward loss or unabsorbed depreciation, whichever is less as per the books of account is to be reduced while computing taxable book profit.

12. The emphasis is thus on the wordings ‘as per the books of account’. The issue is whether presentation of the brought forward loss or unabsorbed depreciation as being reduced from earlier years’ accumulated general reserves in the balance sheet in accordance with requirements of Schedule VI of Companies Act, can be interpreted as adjustment/set off of losses against such general reserve, so that there remains no brought forward loss or unabsorbed depreciation that could be set off against the current year’s book profit.

‘As per the books of account’

— what it connotes :

13. As different rules for determination of business income for the purpose of taxation are prescribed, it is not uncommon that figures of profit, depreciation, losses and unabsorbed depreciation would be different amounts as per books and as per income-tax act. The words ‘as per the books of account’ means brought forward loss or unabsorbed depreciation quantified as per the books of account maintained i.e., book loss or book depreciation in contrast to the brought forward loss or unabsorbed depreciation quantified as per the income-tax provision. This is for the simple reason that the computation of the taxable book profits starts with the profit as per the books of account computed in accordance with Parts II and III of Schedule VI of the Companies Act, 1956. This view gets strengthened by the provisions of other clauses of the Explanation to S. 115JB(2). For example — clauses (iv), (v) and (vi) to the Explanation categorically refer to the amounts of profits to be computed as per the provisions of the particular Section of the Income-tax Act. Clause (iv) refers to the benefit to be provided for the profits derived from exports included in the book profits. As per clause (iv), deduction from the book profits of export profits would be the amount of profit calculated as per the provisions of S. 80 HHC of the Act itself and not as per the books.

14. Thus, wherever the legislature deemed it fit to reduce the book profit as per the computation of the income-tax provisions, appropriate wordings are placed in the relevant clauses. Thus, the meaning of the words, ‘as per books’, used in clause (iii) to Explanation to S. 115JB(2) would mean the brought forward book loss or unabsorbed book depreciation and not as per the income-tax provisions.

Effect of presentation in Balance Sheet :

15. The next issue that arises is whether by reflection of accumulated losses as reduction from general reserves in balance sheet, it can be said that there are no losses as per the books of accounts.

16. S. 210 of the Companies Act provides that at every annual general meeting of the Company, the Board of Directors of the Company shall lay before the company a balance sheet as at the end of the period and a profit and loss account for that period. However, the term balance sheet is not defined under the Companies Act. S. 211 of the Companies Act provides for the form and contents of balance sheet. S. 211(1) provides that :

"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 . . . . . .; 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 the heading ‘Notes’ at the end of that Part".

17. Some relevant entries regarding the term ‘balance sheet’ in Law Lexicon by P. Ramanatha Aiyer, 2004 edition are :

"A statement which would exhibit all the balances of debits and credits, the value of merchandise, and the result of the whole made of merchants and others to show the true state of a particular business. Credits and debit entries of mercantile dealings exhibited together on a single page, and so grouped and arranged as to close into each other and be summed up in one general result, constitute the ‘balance sheet’. It is a statement designed to show the assets and liabilities and the profit and losses of a company. (Marsh, Bank Book-keeping)."

"A balance sheet need not be and must not be a mere inventory. It is supposed to be pictorial representation of the trading position of the company easily appreciated not by ignorant people but by persons who are reasonably able to understand commercial expressions and commercial conditions. Legal Remembrancer v. Akhil Bandu, (1936) 6 Com. Cases 464, 471 (Cal.)."

18. It can be said that a balance sheet is a document whose function is to show the source of funds in the form of capital and liabilities and how funds have been applied in the form of assets. The same needs to be in the form set out in Part I of Schedule VI. Balance sheet is not a mere collection of closing balance of all accounts in books, but presentation of such closing balance in the prescribed manner. It is different from a trial balance, which merely lists out all the accounts as per books and would be totally unintelligible to person not involved in accounting of the company. Balance sheet is the presentation of such balances as per books in a particular manner, and thus, the same may not necessarily be in the same manner as the accounts may be reflected in the books of account. Though balance sheet is a financial statement derived from the books of accounts, it is not an exact photocopy of the books of accounts, but the accounts so derived are put in the prescribed format. In the books of account, different accounts may be shown separately, however, for the purpose of balance sheet, the same may have to be aggregated and reflected as per the form set out in Part I of Schedule VI. In other words, Part I of Schedule VI is merely a presentation format of the balance sheet and does not necessarily represent each account as actually maintained in the books of accounts.

19. Notes to Part I of Schedule VI specifically direct that — ‘The debit balance in the Profit and Loss Account shall be shown as a deduction from the uncommitted reserves, if any’. As such, reduction of the debit balance in the profit and loss account from the uncommitted reserves is only a form of presentation as stipulated in Part I of Schedule VI of the Companies Act and it does not mean that loss has been absorbed by past reserves in the books of account. The word used in the general instructions is that the debit balance in profit and loss account be ‘shown’ as reduction from general reserves. It nowhere states that the same has to be adjusted or set off with the general reserves or that the same also needs to be in conformity with the actual books of account i.e., in the books of account also the debit balance be reduced from the general reserves by way of a journal entry.

20. Thus, actual books of account show separate ledger accounts in respect of the brought forward loss and unabsorbed depreciation, however, for the purpose of presentation, which is merely in the form set out, the same is shown as reduction from the uncommitted reserves.

21. It can, therefore, be concluded that merely because losses have been shown as reduced from general reserves does not mean that the same have been necessarily absorbed by general reserves and that there are no accumulated losses as per the books of accounts.

 

Carry backward of losses for absorption :

22. General reserve is nothing but the accumulated profits over a period of years, which is available for payment of dividends, issue of bonus shares, etc. Profits transferred to general reserve are profits after payment of taxes. Thus, the company has already faced tax burden on the profits accumulated and shown as general reserves.

23. The concept of carry backward of losses and adjusting the same with past profits does not exist in Indian Tax Laws. Set off of losses is provided under the Act only to give benefit of non-payment of tax on future profits to the extent of losses incurred in past subject to satisfaction of prescribed conditions. Losses are to be set off against profits earned in years subsequent to the year in which losses have been incurred and no refund or rebate out of taxes paid on profits in the past is allowable.

24. Under the Companies Act, absorption of losses is dealt with by S. 205(1)(b) and it is for the purpose of declaration of dividend and for no other purpose. S. 205(1)(b) of the Companies Act provides that where there has been loss in any previous year, the amount of the loss or an amount equal to the amount of the depreciation provided for that year, whichever is less, should be set off against the profits of the year for which dividend is proposed. In any case, reference to S. 205(1)(b) has been excluded while inserting new provisions of MAT in terms of S. 115JA and S. 115JB. Thus, for the purposes of S. 115JB of the Income-tax Act, it can be concluded that the concept of set off of loss and depreciation is the same as under Income-tax Act and, therefore, there can be no carry backward of losses to be adjusted against profit of years prior to the year in which loss is incurred.

25. Once having concluded that there is no carry backward provisions, the losses incurred during the relevant year(s) could not be said to have been absorbed by the past profits, irrespective of whether for the disclosure and presentation purposes, the same have to be shown as a deduction from uncommitted reserves in compliance with Part I of Schedule VI to the Companies Act.

26. Even otherwise, if the legislature intent and the underlying object of the provisions of MAT are considered, the company ought to get the benefit of loss incurred before invoking the deeming provisions and levying tax on the basis of book profit. Since the company has already borne the burden of taxes on the past profits, which are ultimately reflected in the form of general reserves, the benefit of set off ought to be allowed against later year’s profits, else the benefit of set off would be denied to the assessee. This is against the intention of the legislature of allowing set off of losses while taxing the companies on the basis of deeming provisions in terms of MAT.

27. Therefore, the concept of carry forward and set off as provided in the Income-tax Act prevails and the same concept would need to be followed while computing the book profits.

 

Opinion :

28. Having regard to the following facts, the querist has a good case to contend that losses and depreciation of earlier years are as per the books of accounts and are available for deduction in determining book profits :

ŕ Though the brought forward loss and unabsorbed depreciation are shown as reduction in the balance sheet, the same are shown separately in the books of account and are carried forward from year to year in the books of account without being adjusted with the general reserves by passing appropriate journal entry;

ŕ No Board Resolution disclosing any conscious decision to adjust the loss incurred with past profits in the books of account;

ŕ The general reserve in the balance sheet is out of the past profits and that no profits were earned after losses were incurred except in the year under consideration.

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