Is ICAIs accounting standard on deferred taxation ultra vires?
December, 01st 2007
Accounting Standard debate at the apex court.
Whether Accounting Standard 22 (AS-22) entitled Accounting for taxes on income insofar as it relates to deferred taxation is inconsistent with and ultra vires the provisions of the Companies Act, 1956, the Income-tax Act, 1961 and the Constitution of India?
This was the question before the apex court in the J. K. Industries Ltd case.
Justices S. H. Kapadia and B. Sudershan Reddy of the Supreme Court were of the view that the notification of the Standard was neither ultra vires nor inconsistent with the provisions of the Companies Act, including Schedule VI. Deferred tax is nothing but accrual of tax due to divergence between accounting profit and tax profit, they explained.
This difference arises on two counts, namely, different treatment of items of revenue/expense as per profit and loss account and as per the tax law. It also arises on account of the difference between the amount of revenue/expense as per profit and loss account and the corresponding amount considered for tax purposes, e.g., depreciation.
However, the judges did not express any opinion on whether AS-22 constitutes a restriction on the rights of the appellants to carry on business under Article 19(1)(g) of the Constitution, or whether the Standard is violative of Article 14. We keep those questions open, they said.
In the nearly 50,000-word verdict, decided on November 19, you can find some interesting submissions that the counsels made on behalf of companies they represented. Such as:
Inclusion of deferred tax liability (DTL) along with CTL (current tax liability) in the determination of the net profit (loss) is repugnant to Part II of Clause 3(vi) of Schedule VI to the Companies Act, said Dr D. Pal, representing Simplex Infrastructures Ltd. Under the said Part II only the tax liability of the relevant accounting year can be charged to P&L A/c, he argued.
According to the learned counsel, if the accounts are to be maintained on accrual basis, DTL cannot be considered as an accrued liability, reads a snatch in the text. Requirements of giving true and fair view can be made only on accrual basis and on double entry system of accounting. However, if DTL is a notional and contingent liability, it cannot be charged to the P&L A/c. It can only be disclosed by way of a Note in the balance-sheet and P&L A/c, which will give a true and fair view of the state of affairs of the company.
AS 22 is a subordinate legislation and it cannot be contrary to the provisions of the parent Act, namely, the Companies Act, contended Mr Arvind P. Datar, appearing for First Leasing Company of India Ltd. The Standard seeks to create a fictional tax liability, he said. Also, that no subordinate legislation can seek to reconcile divergent profits that are arrived at by two independent enactments, namely, accounting or book profits as per the Companies Act and taxable profits under the I-T Act.
According to the learned counsel, the Institute has not produced any evidence of any company getting any benefit from implementation of AS 22. In this connection, the learned counsel submitted that provision for DTL unfortunately has not been treated as a reserve which can be utilised in times of financial crisis. That the Institute has not given a single example of a situation where timing difference has been reversed.
AS 22 does not in any way help collection of higher taxes, it was urged, on behalf of companies. As long as a company continues to be profitable, it is impossible for any reversal by timing differenceIn India, income-tax depreciation is substantially higher than accounting depreciation as per Schedule XIV and, therefore, the accounting profits will always be more than the book profits. Therefore, every year, there would be DTL, which will keep on accumulatingExcept in the case of companies which are likely to make loss in the near future, reversal will never take place.
AS 22 requires charging the P&L A/c for an assumed liability on account of deferred tax which is not payable according to the provisions of I-T Act for the accounting period, said Mr S. K. Bagaria, counsel of J.K. Tyre & Industries Ltd. Nor does the liability represent any tax which would become payable in future, he added.
According to the learned counsel, AS 22 requires recognition of the tax effect, whether current or deferred, in respect of individual transaction during the accounting period as if in future the company would have to make payment on account of deferred taxUnder the I-T Act, tax is determined with reference to the total income and not with reference to any individual transaction.
For the Government, it was Mr A. Sharan, learned Additional Solicitor-General, who argued that if a special provision is made on a particular subject then that subject is excluded from the general provision. Since AS 22 is a special provision notified under Section 211(3C) with respect to form and content of accounts of the company, the same will override other provisions of the Companies Act, he said.
True and fair
The Institutes counsel Mr N. K. Poddar submitted that the requirement true and fair view overrides all other statutory requirements as to the matters to be included in the corporate accounts. In order to give a true and fair view it is not necessary to provide information, additional to the one needed to comply with all other statutory requirements, he emphasised. Moreover, the concept of true and fair is not static. It is dynamic in nature. It continues to evolve in accordance with the changes in the requirements of economy.
It is the function of the Institute to regulate the profession of CAs (chartered accountants), stated Mr Poddar. By formulating Accounting Standards, the Institute is fulfilling its statutory function. It is furthering Legislative intent of Parliament, which requires that accounts should be true and fair.
Therefore, by laying down Accounting Standards, which explains what is true and fair, the Institute is merely fulfilling its statutory duty and function.