Supreme
Court of
J.K. Industries Ltd.
v.
Union of
Section 211, read with sections 209 and 642, of the Companies Act, 1956
- Balance-sheet and profit and loss account - Form and contents of - Whether
Companies (Accounting Standards) Rules, 2006 framed under section 642(1), which
adopts Accounting Standards (‘AS’) 22 issued by Institute of Chartered
Accountants of India, suffers from vice of excessive delegation and same is
incongruous/inconsistent with provisions of Act including Schedule VI - Held,
no - Whether AS 22 insofar as it relates to deferred taxation is inconsistent
with and ultra vires provisions of Companies Act, 1956, Income-tax Act, 1961
and Constitution of India - Held, no
Facts
In exercise of the powers conferred by section
642(1)(a) read with sections 211(3C) and 210A(1), the Central
Government in consultation with the National Advisory Committee (NAC) on
Accounting Standards, (‘AS’) made certain rules called as the Companies
(Accounting Standards) Rules, 2006 vide
notification dated 7-12-2006 whereby AS 22 issued by the Institute of Chartered
Accountants of India (Institute) has been made mandatory for all the companies
listed in Stock Exchange in India in preparation of their accounts for the
financial year 2001-02 onwards. Before that date, AS 22, prescribing accounting
for taxes on income insofar as it relates to deferred taxation, when issued in
2001, was challenged in writ petition but the same were dismissed by the High
Court. In the instant appeals before the Supreme Court, various companies
including the appellant submitted, inter alia, that so
long as Schedule VI to the Companies Act is not altered or amended by
exercising the power under section 641(1) the ‘AS’ prescribed by the rules
notified under section 642(1) cannot alter or amend or Schedule VI and if the
said rules are contrary to or inconsistent with said Schedule then the same are
liable to be struck down as inconsistent with the provisions of the Companies
Act, Income-tax Act; that in any case the requirement of maintaining accounts
on accrual basis and on double entry system of accounting as required under
section 209 is mandatory and it is not subject to any provisions of section
211; therefore, the rule prescribing AS 22 under section 642(1) is not only
contrary to and inconsistent with section 209 but also with Schedule VI insofar
as it requires the Deferred Tax Liability (DIL) to be included in the
determination of net profit (Loss) for the current year; that it is in excess
of the provisions of section 209 and Schedule VI; and that by AS22, the Central
Government has attempted to encroach upon the areas far beyond those covered by
the delegation.
Held
MEANING AND PURPOSE OF AS :
In its origin, Accounting Standard is a
policy statement or document framed by Institute. Accounting Standards establishes
rules relating to recognition, measurement and disclosures thereby ensuring
that all enterprises that follow them are comparable and that their financial
statements are true, fair and transparent. Accounting Standards are based on a
number of accounting principles. They seek to arrive at true accounting income.
One such principle is the matching principle. The other is fair value
principle. The aim of the Institute is to go for paradigm shift from matching
to fair value principle. [
Today the revised Accounting Standards seeks
to arrive at true accounting income. In the age of globalization the attempt is
to reconcile the accounts of Indian companies with their joint venture partners
abroad. The aim is to harmonise Indian Accounting Standards with International
Accounting Standards. With the object of bridging gap between IAS and IFRS, the
Institute formulated new A.S. and introduced new concepts, e.g.,
Deferred Tax Accounting (AS 22), Segment Reporting (AS 17), etc. However, as a
matter of prudence and necessary adjustment, to arrive at real income,
Accounting Standards require provision to be made for liabilities payable in
future, provision to be made for contingencies, provision to be made for
diminution, provision to reflect impairment and so on which have the effect of
reducing incomes and were, therefore, not readily accepted by some enterprises
and tax authorities. [
The core of Accountancy is Book-keeping. The
rules of Book-keeping are clear. For example, the value of a fixed asset
mentioned in a Balance Sheet is based on cost which may involve subjective
estimation of the amount to be apportioned. Similarly, the quantum of
depreciation is again an estimate, which can vary depending on the persons
preparing the accounts as to when and at what stage he wants to record the
depreciation. Accounting Standards are an attempt to overcome some of these
deficiencies of accountancy. Accounting Standards involve codification of
fundamental accounting rules, rules which explain and standardize the
application of the fundamental rules to a variety of uncertain situations like
retirement, contingencies, intangibles, consolidation, merger, etc. Accounting
Standards basically attempt to reduce the subjectivity and lay down rules so as
to arrive at the best possible estimates. For example, net assets refer to the
difference between total assets less liabilities but the value attributable to
each asset and each liability is often subjective. It depends on estimates.
This is where the Accounting Standards help. They reduce the subjectivity.
Therefore, Accounting Standards help to arrive at the best possible estimates.
This estimation/subjectivity is also on account of the conceptual difference
between accounting income and taxable income. Accounting income is the real
income. Tax laws lay down rules for valuation of inventories, fixed assets,
depreciation, bad debts, etc. based on artificial rules and not on the basis of
accounting estimates, which results in mismatch between accounting and taxable
incomes. For example, a fixed rate of depreciation may, for some companies,
result in computing lower than the actual income if the actual erosion in the
value of the asset is lower than the depreciation calculated at the fixed rate
and higher than actual income for others where assets erode faster. Accounting
income is normally used as a relevant measure by most stakeholders. However, on
account of artificial set of rules used in computation of taxable income one
finds that accounting income differs from taxable income. Looking to these
problems, the evolution of Accounting Standards and their greater application
is necessary as it results in reducing the need for tax laws to depend upon
artificial rules. The object of Accounting Standards is, therefore, to standardize
and to narrow down the options. The object of Accounting Standards is to evolve
methods by which accounting income is determined. The object behind the
Accounting Standards is to evolve methods by which accounting income is
determined, made more transparent and leave less and less room for subjective
selection of methods and provide for more attention to the quality of estimates
used in arriving at accounting income. [
The main object sought to be achieved by
Accounting Standards which is now made mandatory is to see that accounting
income is adopted as taxable income and not merely as the basis from which
taxable income is to be computed. Thus, if the rules by which inventories are
to be valued are laid down in the Accounting Standards and are followed in the
determination of accounting income, then tax laws do not need to lay down the
rules and the tax authorities do not need to examine the computation of the
value of inventories and its effect on computation of income. Similarly, if there
is an accounting standard on depreciation which requires estimation of the
useful life and prescribes the appropriate method for apportionment of cost of
fixed assets over their useful life, it is unnecessary for tax laws to apply an
artificial rule to decide the extent of allowance for depreciation. [
Finally, the adoption of Accounting
Standards and of accounting income as taxable income would avoid distortion of
accounting income which is the real income. [
REASONS FOR INTRODUCING AS 22
In the backdrop of globalization and
liberalization the world has become an economic village. Today, the capital
market all over the world knows no barriers. Fiscal distances and barriers have
been removed by developments in transport, communication and e-commerce. In
this backdrop, Convergence of Accounting Standards is aimed at removing
barriers in the flow of financial information and capital. Based on the above
developments in the global economy and the Indian economy, the conceptual
differences and consequent deviations in the National Accounting Standards and
IFRS have got to be eliminated. For example, exchange difference in respect of
unpaid liability for acquisition of an imported asset has been allowed in the
past to be adjusted with the carrying costs of the fixed assets instead of
recognizing the exchange difference in the profit and loss account. [
Lastly, it is important to note that
Accounting Standards and taxation of income are two independent subjects. The
object behind AS is to remove this divergence by making Accounting Income a
Taxable Income. Accounting income can never negate True Income. [
RELEVANT PROVISIONS OF THE COMPANIES ACT AND ANALYSIS
THEREOF
Section 210 requires a company to place
before AGM, a balance-sheet and a P&L account for the relevant period. The
function of a balance-sheet is to show the share capital, reserves and
liabilities of the company at the date on which it is prepared and the manner
in which the total moneys representing them are distributed over several types
of assets. A balance-sheet is a historical document. As a general rule it does
not show the net worth of an undertaking at any particular date. It does not
show the present realizable value of goodwill, land, plant and machinery etc.
It also does not show the realizable value of stock-in-trade, except in cases
where the realizable value of stock-in-trade is less than cost. Therefore, it
cannot be said that the balance-sheet shows the true financial position. [
Section 210A was inserted by Companies
(Amendment) Act, 1999 with effect from 31-10-1998 to provide for constitution
of National Advisory Committee (NAC) on Accounting Standards. The said NAC was
constituted to advice the Central Government on the formation and laying down
of accounting policies and Accounting Standards for adoption by companies or
class of companies. The accounting policies and Accounting Standards were
required to be prescribed by the Central Government as contemplated by section
2(33). The object behind section 210A was to make it
obligatory on the part of the companies to comply with the Accounting
Standards. NAC was constituted vide Notification dated 18-9-2003. Under section
211(3C) it is provided, that till such time the Accounting Standards are
prescribed by the Central Government in consultation with NAC on Accounting
Standards, the Accounting Standards prescribed by the Institute shall be deemed
to be the Accounting Standards to be complied with by all the companies. In
all, the Institute has so far framed 29 Accounting Standards. [
Section 211(1) requires the balance-sheet to
be in the form set out in Part I of Schedule VI or as near thereto as
circumstances admit. The said phrase ‘or as near thereto as circumstances
admit’ allows adoption of improved techniques in the presentation of accounts
to shareholders. It is important to note that the information which is required
to be given to shareholders pursuant to Schedule VI should be given in a manner
which they will understand and which must give a true and fair view of the
company’s affairs as also it must give a proper picture of the company’s
profits(losses) for the relevant year. [
By Companies (Amendment) Act, 1999,
sub-sections (3A), (3B) and (3C) as well as a proviso thereto stood were
inserted in section 211 with effect from 31-10-1998 in order to provide for
compliance of Accounting Standards by companies in the preparation of P&L
account and balance-sheet. By virtue of the said amendment, Accounting
Standards are required to be prescribed by the Central Government in
consultation with the NAC established under section 210A. Until the NAC is
established and Accounting Standards are prescribed by the Central Government,
the Accounting Standards specified by the Institute shall be followed by all
the companies. By the impugned notification dated 7-12-2006, the Accounting
Standards have been prescribed by the Central Government. To be in other words,
AS 22 earlier specified by the Institute has been adopted by the Central
Government in the form of a Rule. Therefore, vide
the impugned notification, AS 22 would stands prescribed by the Central
Government in consultation with NAC which has been established under section
210A. It is made clear that the Accounting Standards prescribed by the Central
Government in consultation with NAC need not be identical with the Accounting
Standards specified by the Institute. The impugned notification indicates that
the Central Government has been given the authority to enact a rule and
accordingly the rule-making authority, namely, the Central Government has
prescribed the Accounting Standard No. 22 in consultation with NAC by adopting
AS 22 originally specified by the Institute. [
Under section 211(1) every balance-sheet of
a company has to comply with the following requirements:
(i) it
must give true and fair view of the affairs of the company at the end of the
financial year;
(ii) it
must be in the form set out in Part I of Schedule VI or as near thereto as
circumstances admit; and
(iii) it
must give regard to the general instructions for preparation of balance-sheet
under the heading ‘Notes’. [
Similarly, section 211(2) requires that
every P&L account of a company must give a true and fair view of the profit
or loss of the company for the financial year and comply with the requirements
of Part II of Schedule VI so far as they are applicable thereto. It may be
noted that the balance-sheet prescribed by Part I of Schedule VI has to be in
the form of a proforma. However, the Companies Act does not prescribe a
proforma of P&L account. Part I of Schedule VI prescribes a proforma of
balance-sheet. Part II of Schedule VI only prescribes the particulars which
must be furnished in the P&L account. Therefore, as far as possible, the
P&L account must be drawn up according to the requirements of Part II of
Schedule VI. It is important to note that section 211 read with Part I and Part
II of Schedule VI prescribes the form and contents of balance-sheet and P&L
account. However, section 211(1), inter alia,
states that every balance-sheet of a company shall subject to the provisions of
that section, be in the form set out in Part I of Schedule VI. The words
‘subject to the provisions of this section’ would mean that every sub-section
following sub-section (1) including sub-sections (3A), (3B) and (3C) shall have
an overriding effect and consequently every P&L account and balance-sheet
shall comply with the Accounting Standards. Therefore, implementation of the
Accounting Standards and their compliance are made compulsory and mandatory by
the sub-sections (3A), (3B) and (3C). The insertion of the concept of true and
fair view in place of true and correct has been made to do away with the view
that accounts should disclose arithmetically accuracy. Adherence to the
disclosure requirements as per Schedule VI is subservient to the overriding
requirement of true and fair view as regards the state of affairs. Therefore,
the annual financial statements should convey an overall fair view and should
not give any misleading information or impression. All the relevant information
should be disclosed in the balance-sheet and the P&L account in such a
manner that the financial position and the working results are shown as they
are. There should be neither an overstatement nor an understatement. Further,
the information to be disclosed should be in consonance with the fundamental
accounting assumptions and commonly accepted accounting policies. Therefore,
failure to make provision for taxation would not disclose true and fair view of
the state of affairs and, therefore, amount to contravention of sections 209
and 211. Accordingly, it is necessary for the auditor to qualify in his report,
and such qualification should bring out in what manner the accounts do not
disclose a true and fair view of the state of affairs of the company as well as
the profit/loss of the company. Several Accounting Standards prescribed by the
Institute have been made mandatory. The Institute has, however, clarified that
the expression mandatory in nature implies that while discharging their
functions, it will be the duty of the Chartered Accountants who are members of
the Institute to examine whether the said Accounting Standard has been complied
with in the presentation of financial statements covered by their audit. In
this regard it may be noted that under section 227(3)(d)
it is the duty of the auditor, to state in his audit report whether the P&L
account and the balance-sheet complies with the Accounting Standards referred
to in section 211(3C). Before introduction of sub-sections (3A), (3B) and (3C)
in section 211 (with effect from 31-10-1998), these Standards were not
mandatory. Therefore, the companies were then free to prepare their annual
financial statements, as per the specific requirements of section 211, read
with Schedule VI. However, with the insertion of sub-sections (3A), (3B) and
(3C) in section 211 the P&L account and the balance-sheet have to comply
with the Accounting Standards. For this purpose the expression Accounting
Standards shall mean the standards of accounting recommended by the Institute
as may be prescribed by the Central Government in consultation with NAC on
Accounting Standards. The Accounting Standards prescribed by the Central
Government are now mandatory qua the companies and non-compliance with these
Standards would lead to violation of section 211 inasmuch as the annual
accounts may then not be regarded as showing a true and fair view. [
Section 641 empowers the Central Government
to alter any of the regulations, rules, tables, forms and other provisions
contained in Schedule VI. However, this power can be used only for making
simple alterations which will not affect the legislative policies enshrined in
the Act. [
Section 642 refers to the powers of the Central
Government to make rules. It states that in addition to the powers conferred by
section 641, the Central Government may, by notification in the official
gazette, make rules for all or any of the matters which by the Companies Act
are to be prescribed by the Central Government and to carry out the purposes of
the Companies Act. Therefore, section 641 and section 642 form part of the same
scheme. Under section 642, the Central Government exercises power of delegated
legislation by prescribing rules. Under various provisions of the Act, Rules
are to be prescribed. Rules can also be prescribed vide
clause (b) to section 642(1) to carry out the
purposes of the Act. [
In exercise of the powers conferred by
clause (a) to sub-section (1) of section 642 read
with sub-section (3C) of section 211 and section 210A(1), the Central
Government in consultation with NAC on Accounting Standards has made the
Companies (Accounting Standards) Rules, 2006 vide
the impugned notification dated 7-12-2006. [
FINDING
The impugned Rule which adopts AS 22 neither
suffers from the vice of excessive delegation nor is the said Rule
incongruous/inconsistent with the provisions of the Act. [
REASONS for finding
Preface
In its origin, an accounting standard is the
policy document. In matters of recognition of various items of income,
expenditure, assets and liabilities, the aim is to achieve standards/norms
which would help to reflect true and fair view of the accounts of a company.
Every Indian and foreign investor/partner before entering into joint venture
agreement(s) with its counterpart examines the financial statements and tries
to ascertain the real income of the Indian company. [
With globalization, Indians have
conventional/orthodox system of accounting (recognition, measurement and
disclosure) vis-a-vis modern system of advanced accountancy.
Therefore, the role of accounting has undergone a revolutionary change with the
passage of time. Traditionally, accounting was considered solely a historical
description of financial activities. That view is no longer acceptable.
Accounting is now considered as a service activity. Its function is to provide
quantitative information, primarily of financial nature about the economic
entities. Accounting today includes several branches, e.g.,
Financial Accounting, Management Accounting and Government Accounting. The
primary role of accounting is to provide an effective measurement and reporting
system. This is possible only when accounting is based on certain coherent set
of logical principles that constitute the general frame of reference for
evaluation and development of sound accounting practices. That is why, Indians
have different accounting concepts and fundamental accounting assumptions, such
as, separate entity concept, going concern concept, accrual concept, matching
concept, etc. Therefore, Accounting Standards are based on a number of
accounting principles. For example, the Matching Principle and Fair Valuation
principle. Historically, matching principles ensured that costs incurred
matched with revenues they generated, though they resulted in assets and
liabilities in the balance-sheet at other than fair values. Similarly, they
resulted in assets, which were not assets in the real sense, e.g.,
deferred revenue expenditure. However, the matching principles ensured purity
of the profit and loss statement. Therefore, matching principles ensure
ascertainment of true income. Today under advanced accountancy, matching
principles recognizes not only costs against revenue but also against the
relevant time period to determine the Periodic Income. Therefore, matching
principle today forms an important component of Accrual Basis of Accounting. [
On the other hand, Fair Valuation principles
are important in the context of valuing derivatives and other investments. If
one were to describe one single change in accounting practice over the last few
years, it would be the use of Fair Valuation principles. Today, the object
behind enactment of AS, which are now made mandatory under section 211(3A), is
to shift from historical method of accounting to fair valuation. In the case of
mergers and acquisitions, which is common today in the world of globalization,
fair valuation principles have important role to play. Mergers and acquisitions
are sometimes undertaken to defer revenue expenditure over future years by
invoking the matching concept, which results in putting fictitious assets on
the balance-sheet. This is one reason why fair valuation principles are
accepted. [
AS are established rules relating to
recognition, measurement and disclosures thereby ensuring that all enterprises
that follow them are comparable and that their financial statements are true
and fair. Measurements and disclosures based on fair value are becoming
increasingly important. Fair valuation is generally used in valuation and
disclosure of financial instruments, derivatives, conversions, auctions in a
bond, business combinations, impairment of assets, retirement obligations,
transactions involving exchange of assets without monetary consideration,
transfer pricing, etc. [Para 61]
In conclusion, the importance of the Preface
is to show a paradigm shift in the thinking of accountants all over the world,
particularly with the coming-in of the abovementioned new concepts. [
Doctrine of ultra
vires
On account of globalization and
socio-economic problems (including income disparities in Indian economy) the
power of Delegation has become a constituent element of legislative power as a
whole. However, subordinate legislation does not carry the same degree of
immunity which is enjoyed by a statute passed by a competent Legislature.
Subordinate legislation may be questioned on any of the grounds on which
plenary legislation is questioned. In addition, it may also be questioned on
the ground that it does not conform to the statute under which it is made. It
may further be questioned on the ground that it is inconsistent with the
provisions of the Act or that it is contrary to some other statute applicable
on the same subject-matter. Therefore, it has to yield to plenary legislation.
It can also be questioned on the ground that it is manifestly arbitrary and
unjust. That, any inquiry into its vires must be confined to the grounds on
which plenary legislation may be questioned, to the grounds that it is contrary
to the statute under which it is made, to the grounds that it is contrary to
other statutory provisions or on the ground that it is so patently arbitrary
that it cannot be said to be inconformity with the statute. It can also be
challenged on the ground that it violates Article 14 of the Constitution.
Subordinate legislation cannot be questioned on the ground of violation of
principles of natural justice on which administrative action may be questioned.
A distinction must, however, be made between delegation of a legislative
function in which case the question of reasonableness cannot be gone into and
the investment by the statute to exercise a particular discretionary power. In
the latter case, the question may be considered on all grounds on which
administrative action may be questioned, such as, non-application of mind,
taking irrelevant matters into consideration, failure to take relevant matters
into consideration, etc. A subordinate legislation may be struck down as
arbitrary or contrary to statute if it fails to take into account vital facts
which expressly or by necessary implication are required to be taken into
account by the statute or the Constitution. This can be done on the ground that
the subordinate legislation does not conform to the statutory or constitutional
requirements or that it offends article 14 or article 19 of the Constitution.
However, a notification issued under a section of the statute which requires it
to be laid before Parliament does not make any substantial difference as
regards the jurisdiction of the Court to pronounce on its validity. [
Where the validity of subordinate
legislation is challenged, the question to be asked is whether the power given
to the rule making authority is exercised for the purpose for which it is
given. Before reaching the conclusion that the Rule is intra
vires the court has to examine the nature, object and
the scheme of the legislation as a whole and in that context, the court has to
consider what is the area over which powers are given by the section under
which the Rule Making Authority is to act. However, the court has to start with
the presumption that the impugned rule is intra vires.
This approach means that, the Rule has to be read down only to save it from
being declared ultra vires if the court finds in a given case that the
above presumption stands rebutted. [
If the impugned rule is a delegated
legislation it would follow that the said rule is made in exercise of the power
conferred by the statute. Legislature has wide powers of delegation. This,
however, is subject to one limitation, namely, it cannot delegate uncontrolled
power. Delegation is valid only when it is confined to legislative policy and
guidelines. [
Guideline vis-a-vis
Accounting Standard Rules is provided by section 211(1), which has brought in a
stand-alone concept of ‘true and fair’ accounting. The said concept is the
controlling consideration. [
Whether the
impugned Rule adopting AS 22 is in excess of the powers conferred upon Central
Government under section 642(1)
Power to alter the Schedule as well as power
to fill in details are two distinct powers. However, both the powers are
entrusted to the same delegate, namely, the Central Government. Further,
sections 641 and 642 form part of the same scheme, hence, it cannot be said
that merely because the impugned Notification has been issued under section 642
and not under section 641 the said Notification is exhaustive of the powers
given to the Central Government to frame rules under the said two sections.
Moreover, section 642(1) begins with the expression ‘in addition to the powers conferred
by section 641’, therefore, one has to read section 641 as an additional power
given to the Central Government to make Rules, in addition to its power to
alter the schedule by making appropriate Rules under section 641. There is one
more way of looking at the arguments. The Companies Act has been enacted to
consolidate and amend the law relating to companies and certain other
associations. Under section 211(3A) Accounting Standards framed by National
Advisory Committee on Accounting Standards constituted under section 210A are
now made mandatory. Every company has to comply with the said standards.
Similarly, under section 227(3)(d), every auditor
has to certify whether the P&L account and balance-sheet comply with the
accounting standards referred to in section 211(3)(c).
Similarly, under section 211(1) the company accounts have to reflect true and
fair view of the state of affairs. Therefore, the object behind insistence on
compliance with the AS and true and fair accrual is the presentation of accounts
in a manner which would reflect the true income/profit. One has, therefore, to
look at the entire scheme of the Act. The provisions of the Act together with
the Rules framed by the Central Government constitute a complete scheme.
Without the Rules, the Act cannot be implemented. The impugned Rules framed
under section 642 are a legitimate aid to construction of the Act as contemporanea
expositio. Many of the provisions of the Act, like
computation of book profit, net profit, etc., cannot be put into operation
without the rules. [
In TELCO v. Gram Panchayat, Pimpri
Waghere [1976] 4 SCC 177 it was held that Rules provide
internal legitimate aid for the interpretation of the words and phrases used in
the main enactment. [
Even under the Accounting Standard Rules
impugned AS 22, which is made mandatory, provides an internal legitimate aid to
the meaning of the words in the Act, including Schedule VI, namely, liability,
provision for taxes on income, book profit, net profit, depreciation, amortization
etc. Therefore, it cannot be said that the impugned rules framed under section
642(1) constitute an act on the part of the rule making authority, namely, the
Central Government, in excess of its powers under section 642(1). The impugned
Rule/Notification is valid. It has nexus with the matters entrusted to the
Central Government to be covered by appropriate rules. Therefore, the impugned
rule is valid as it has nexus with statutory functions entrusted to Central
Government which is the rule making authority under the Act. The power to
regulate a business or profession implies the power to prescribe and enforce
all such proper reasonable rules as may be deemed necessary to conduct
business/profession in a proper and orderly manner and the power includes the
power to prescribe conditions under which business/profession can be carried
on. The Scheme of the Companies Act indicates that Accounting Standards are
made mandatory. They have to be followed by the auditors. They have to be
followed by the companies. The Accounting Standards provide discipline. They
provide harmonization of concepts. They provide harmonization of accounting
principles. In the past, when Accounting Standards were not mandatory, various
companies used to follow alternate system of accounting. This led to
overstatement of profits. Therefore, the said Standards have now been made
mandatory. It is the statutory function given to the Central Government to
frame Accounting Standards in consultation with the National Advisory Committee
on Accounting Standards (NAC) under section 211(3C). It is not necessary for
the Central Government to adopt in every case the Accounting Standards issued
by the Institute. Nothing prevents the Central Government from enacting its own
Accounting Standards which may not be in consonance with the Standards
prescribed by the Institute. Similarly, nothing prevents the Central Government
from adopting the Standards issued by that Institute as is the case in the
instant matter. Therefore, the impugned Rule is valid as it has nexus with the
statutory functions entrusted to the Rule making authority, namely, the Central
Government. [
Whether the
impugned Rule is incongruous/contrary to sections 209 and 211 read with the
provisions of Part I and Part II of Schedule VI to the and whether the said
Rule seeks to modify the essential features of the Act?
To answer the above question, one has to
examine the following concepts prevalent in Accounting.
u Accrual system of Accounting.
u Taxes on Income.
u Current tax.
u Timing Differences.
u Tax expenses.
u Assets.
u Matching principle.
u Depreciation.
u Reserves & Provisions
u Provisions for bad and doubtful debts.
u Tax base. [Paras 75 to 93]
Application of above
concepts - The power to alter the Schedule is distinct and
separate from the power to fill in the details, though both together form part
of the same scheme. Under section 641, the Central Government is empowered vide
the Notification to alter any of the Regulations, Rules, Forms and other
provisions contained in any of the Schedules except Schedules XI and XII. Under
section 641(2), any alteration notified under sub-section (1) has the effect as
if the notified alteration stood enacted in the parent Act and shall come into
force on the date of the Notification, unless the Notification directs
otherwise. The provisions of section 641(2) are relevant which is not there in
section 642. However, section 642 begins with the expression in addition to the
powers conferred by section 641. The point which is to be stressed is that
though the Central Government is vested with both the powers, namely, to amend
the Schedule and to fill in details, the nature of the rules framed under
section 641(2) continuous to have the status of the Rules despite the
phraseology used in section 641(2) which, as stated above, says that any
alteration notified under sub-section (1) of section 641 shall have effect as
if enacted in the Companies Act. Therefore, Rules framed under section 641 followed
by Rules framed under section 642(1) shall continue to be Rules subordinate to
the Companies Act though for the purposes of construction, they are to be
treated as forming part of the same scheme. [
Whether as 22 is
contrary to or inconsistent with the provisions of the act
Applying the test laid down by the Supreme
Court in CIT v. Duncan Brothers & Co. Ltd.
[1996] 85 Taxman 289/219 ITR 121 one has to interpret the words ‘the amount of
charge for Indian Income tax on profits’ in clause 3(vi)
in Part II of Schedule VI. Similarly, one is required to interpret the words
‘current liabilities and provisions’ in the form of balance-sheet in Part I of
Schedule VI. Part III of the said Schedule defines the words ‘provision’ as
well as ‘reserve’. [
The form of balance-sheet is prescribed by
Part I of Schedule VI. The Act does not prescribe a proforma of P&L
account. However, Part II of Schedule VI prescribes the particulars which must
be furnished in a P&L account. As far as possible, the P&L account must
be drawn up according to the requirements of Part II of Schedule VI. As stated
above, section 211(1) emphasizes true and fair view in place of true and
correct view of accounting. As stated above, the legislative policy is to
obliterate the difference between the accounting income and the taxable income.
The accounting income/book profit is the real income. Therefore, section 211(1)
emphasizes the concept of true and fair view. It is a stand-alone
consideration. It is the controlling element underlying the scheme of sections
209, 211 and 227. However, the Companies Act does not deal with Recognition,
Measurement and Disclosure. How much amount should be recognized in respect of
a specific matter is not covered by section 209(3)(b).
Recognition, measurement and disclosure are the three items which can only be
done by way of Accounting Standards and not by the provisions of the Companies
Act. This aspect is important because under section 642(1) the Central
Government is empowered to carry out ancillary/subordinate legislative
functions which is also fictionally called as power to fill-up the details.
Under section 211(1) Parliament has laid down the controlling consideration in
presentation of balance-sheet and P&L account by companies and it has thereafter
conferred discretion on Central Government to work out details within the
framework of that Policy. Presentation of balance-sheet and P&L account is
different from recognition, measurement and disclosure of various items of
revenue, expenses, assets, liabilities, etc. That part has been left to the
Central Government which is empowered to enact Accounting Standards in
consultation with National Advisory Committee on Accounting Standards (NAC),
which committee is to be established and which has been established under
section 210A(1). The Central Government is the rule making authority. It is not
bound to go by the recommendations of the Institute in the matter of framing of
accounting standards. Generally, it follows such recommendations. However, in law
nothing prevents the Central Government from enacting accounting standards in
consultation with NAC which are in variance from the Standards prescribed by
the Institute. [
The main objection of the appellants was
against paragraphs 9 and 33 of AS 22. [
As regards para 9, the appellants had no
objection to the disclosure of Deferred tax liability (DTL)/Deferred tax
accounting (DTA) in their financial statements. They object to a charge being
created qua P&L account for DTL mainly because it
results in reduction of reserves and net profits. Therefore, the main
contention is that the DTL is a notional concept. According to the appellants,
DTL is not a liability. Therefore, according to the appellants, there cannot be
a charge for DTL to the P&L account of the company. According to the
appellants, DTL distorts their financial statements; Schedule VI forms part of
the Companies Act; Part II of Schedule VI contains clause 3(vi);
the said clause 3(vi) refers to the amount of charge for
income-tax on the profits; when AS 22 states that tax expense for the period
shall consist of current tax and deferred tax and that such tax expense should
be included in the determination of net profit or loss, it amounts to
alteration of clause 3(vi) of Schedule VI which is the part thereof;
Rules framed by the Central Government as a delegate under section 642 cannot
alter the provisions of the Companies Act including Schedule VI. The appellants
further contended that para 9 of AS 22 is inconsistent with the provisions of
the Companies Act including Schedule VI and, therefore, void. It is also
contended on behalf of the appellants that section 211 deals with P&L
account and balance-sheet. That, para 9 only refers to filling in the details qua
items in P&L account and balance-sheet. According to the appellants,
P&L account and balance-sheet do not constitute primary books of account;
deferred taxation do not form part of accrual system of accounting; para 9 of
AS 22 requires the company to make provision for liability for taxation in the
balance-sheet and P&L account; P&L account and balance-sheet do not
constitute books of accounts and, therefore; such a standard brings about
inconsistency between maintenance of books of account which are primary
documents on one hand and balance-sheet an P&L account on the other hand.
According to the appellants, para 9 of AS 22 does not touch the subject
‘maintenance of books of account’. That, it only touches the presentation of
balance-sheet and P&L account. According to the appellants, books of
account constitute primary documents and if para 9 does not apply to the
maintenance of books of account, para 9 cannot be made applicable only to
balance-sheet and P&L account because if it is so permitted it would bring
about inconsistency between maintenance of books of account under section 209 vis-a-vis
presentation of financial statements under section 211. In short, according to
the appellants para 9 and para 33 of AS 22 are inconsistent with the provisions
of the Companies Act including Schedule VI. [
There is no merit in the arguments of the
appellants on the point of inconsistency. [
Recognition and measurements bring in the
concept of fair value. When a financial instrument is measured at fair value it
brings transparency in financial reporting. Today, companies undertake
multifarious activities which warrants segment reporting. Under clause 3(vi)
of Part II non-provision for taxation would amount to contravention of the
provisions of sections 209 and 211. Accordingly, it is necessary for the
auditor to say in what manner the accounts do not disclose a ‘true and fair’
view of the state of affairs of the company and the P&L account of the
company. AS 22 is mandatory. Therefore, it is the duty of the members of the Institute
to examine whether the accounting standard is complied with the said standard
in the presentation of financial statement. [
Para 9 only provides for details which are
necessary for giving effect to the concept of true and fair accrual of accounts
contemplated by section 211(1). As stated above, the concept of true and
correct accrual is different from the concept of true and fair accrual. Both
the concepts fall under accrual system of accounting. However, there is a
difference. Under true and correct accrual, the matching principle was always
recognized. However, fair valuation principle is the concept which brings out
the real income of the company.
The word ‘tax expense’ in para 9 under
conservative system of accounting was confined to current tax. However, with para
9 of AS 22 coming into force, the word ‘tax expense’ now includes both, current
tax and deferred tax. This inclusion became necessary because of developments
not only in concepts but also in accounting practices. This inclusion becomes
necessary if one has to go by paradigm shift from historical costs accounting
to fair value principles. With the insertion of the words ‘true and fair view’
in section 211, which is the requirement in the matter of presentation of
balance-sheet and P&L account, the rule making authority was entitled to
include the concept of deferred tax in tax expense. It may be stated that under
clause 3(vi) of Part II, Schedule VI the charge for tax
on profit is contemplated. Provision for liability for taxation is contemplated
by the said clause. Para 9 of AS 22 merely provides for a liability which
arises on account of timing difference. It is known on the balance-sheet date.
One has to, therefore, consider matching principle and fair valuation
principles as important concepts in accrual accounting. Further, recognition
and measurement is not covered by the provisions of the Companies Act;
therefore, one has to read the presentation of balance-sheet and P&L
account together with recognition and measurements. One has to read the provisions
of the Companies Act along with the impugned Rule which adopts AS 22 as
recommended by the Institute. The matching principle recognizes cost against
revenue or against the relevant time period to determine the periodic income.
Therefore, the said principle constitutes an important component of the accrual
basis of accounting. The concept of accrual, in case of mergers and
acquisition, is not limited to one year. DTL/DTA arises out of timing
differences. Therefore, such differences have got to be reflected in Deferred
Tax Accounting. DTL in most cases arises on account of the difference between
tax depreciation and accounting depreciation. When on account of over-charging
of depreciation under the Income-tax Rules, the taxable income falls below the
accounting income, DTL emerges. This is because the rates of tax depreciation
are incentive rates whereas accounting depreciation is based on the useful life
of the asset. Thus, an asset under Income-tax Act would be charged over a much
shorter period as compared to the useful life of the asset. If the useful life
of the asset is 10 years, for tax purposes it should be written off fully in 4
years. Thus, in the first year in which tax depreciation is higher than the
accounting depreciation, the taxable income would be less than the accounting
income, which would give rise to DTL on account of the difference between the
amount of depreciation, i.e., the timing difference, which arises as it
relates to the depreciation amounts for that particular year. It would become
payable in future years when the timing difference reverses, i.e.,
when the taxable income becomes higher than the accounting income. Therefore,
it is called as DTL. It is so called because it results in future cash outflow
on account of the timing difference. [
Measurement and recognition of timing
differences and financial instruments at fair value brings transparency in
presentation of financial statements. Lastly, valuation is an important element
of the Method of Accounting. [
Para 9 of AS 22 merely represents
gap-filling exercise; therefore, there is no merit in the contention advanced
on behalf of the appellants that AS 22 is inconsistent with the provisions of
the Companies Act including Schedule VI. It proceeds on the principle that
every transaction has a tax effect. The words ‘true and fair view’ in section
211(1) connotes the widest law making powers and, in that context, that
impugned Rule adopting AS 22 is intra vires
as the said rule is incidental and/or supplementary to the specific powers
given to the Central Government to make rules, particularly when such power is
given to fill-in details. The word ‘supplementary’ means something added to
what is there in the Act, to fill-in details for which the Act itself does not
provide. It is something in the sense that is required to implement what is
there in the Act. There is no merit in the contention advanced by the
appellants that the impugned Rule seeks to modify the essential features of the
Companies Act. Rules made on matters permitted by the Act to supplement the Act
cannot be held to be in violation of the Act. When the power to make rules is
limited to particular topics and if that rule falls within the ambit of that
topic, namely, taxes on income in the instant case, it cannot be said that the
rule is inconsistent with the provisions of the Act. The Act and the Rules form
part of the composite scheme. The provisions of sections 205, 209 and 211 can
be put into operation only if the Act and the Rules are read together. The
impugned Rule constitutes a legitimate aid to construction of the provisions of
the Companies Act. Further, the Central Government is the rule making authority
under section 211(3C). As rule making authority, the Central Government is
empowered to enact accounting standards in consultation with NAC which may be
at variance with the Standards issued by the Institute. [
Measurement and recognition methods are not
the items under the Companies Act. Methods of recognition and measurements are
talked about by the provisions of the Companies Act. Recognition and
measurement of various items of revenue expenses, etc., stand covered only by
the accounting standards. Therefore, it cannot be said that the said standards
are contrary to the provisions of the Companies Act. There is also no merit in
the argument of the appellants that the impugned Rule does not touch upon
maintenance of books of account to be kept by the company. Under section
209(3)(b) every company is required to keep its
books of account on accrual basis and according to double-entry system of
accounting. Under section 209(3)(a) every company
is required to maintain books of account necessary to provide a true and fair
view of the state of affairs of the company and its accounts. Books of account
do not include balance-sheet and P&L account. However, there is a
difference between true and correct accrual and true and fair accrual. In the
past, what prevailed was true and correct accrual. At that time, it was noticed
in several cases that profits were overstated and, therefore, the Legislature
inserted what is called as true and fair accrual concept. The said concept is
wider than the concept of true and correct accrual. When section 209(3) refers
to maintenance of books of account on accrual basis it means true and fair
accrual, which would include not only matching principles but also fair
valuation principles. These principles do not contravene accrual system of
accounting. Provision for diminution in value of an asset results in emergence of
liability. In the past, when timing difference concept was not there, in many
cases, profits were overstated, particularly because provision for DTL
(deferred taxation) was not recognized. With the introduction of the timing
difference concept, it cannot be said that the accrual system of accounting is
violated. It is the concept of timing difference which obliterates the
difference between accounting and tax incomes. Ultimately, the object is to
obliterate the difference between accounting income and taxable income.
Accounting income is the real income, therefore, para 9 of AS 22 is not
inconsistent with the provisions of the Companies Act, including Schedule VI. [
Further the para 33 of AS 22 is challenged
on the ground that a subordinate legislation cannot be retrospective unless
there is provision to that effect in the parent Act. [
For the purpose of determining accumulated
deferred tax in the period in which the Standard is applied for the first time,
the opening balances of assets and liabilities for accounting purposes and for
tax purposes are to be compared and the differences, if any, are to be
determined. The tax effect of these differences have got to be recognized as
DTA or DTL, if such differences are timing differences. [
As the concept of opening balance of a fixed
asset in para 33 is required to be taken into account, it cannot be said that
the said para is retrospective. In fact, it is a transitional provision. Let’s
say that there is an expenditure which is written off for accounting purposes
in the year in which it is incurred but is admissible for deduction under
Income-tax Act over a period of time. In such a case, the asset representing
expenditure would have a Balance only for tax purposes and not for accounting
purposes. Therefore, the difference between the balance of the asset for tax
purposes and balance for accounting purposes, which is nil,
would give rise to a timing difference which will reverse in future when
expenditure would be allowed for tax purposes. In such a case, DTA would be
recognized in respect of difference, subject to the principle of prudence. In
the circumstances, it cannot be said that para 33 is retrospective. [
CONCLUSION
For the aforestated reasons, the impugned
Notification/Rule is neither ultra vires nor inconsistent with
the provisions of the Companies Act, including Schedule VI. [
To sum up, deferred tax is nothing but
accrual of tax due to divergence between accounting profit and tax profit. 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. [
The said AS 22 is neither ultra
vires nor inconsistent with the provisions of the Act,
including Schedule VI.
per court
We need to comment on one aspect. Before the Calcutta
High Court, the impugned Notification adopting AS 22 was also challenged on the
ground that the provisions of AS 22 insofar as it relate to ‘deferred taxation’
is violative of articles 14 and 19(1)(g) of the
Constitution of India. In this connection, it was pleaded that by making AS 22
mandatory, the appellants ‘companies will suffer erosion of its net worth.
That, as a result, the debt equity ratio will also increase and that the
lenders may recall the loans and thereby the appellants’ rights to carry on
business in future would be violated. Although, the aforestated challenge was
pleaded in the writ petition, when the matter came for hearing before the High
Court, it appears that the said grounds were not argued. According to the
appellants, implementation of AS 22 would result in reduction of profits and
reserves. In the circumstances, we do not wish to express any opinion on the
constitutional validity of the said AS 22. Whether the said Standard
constitutes a restriction on the rights of the appellants to carry on business
under article 19(1)(g) or whether the said Standard
is violative of article 14 are questions on which we express no opinion. We
keep those questions open. Suffice it to state that, in the present case, we
are of the view that the said AS 22 is neither ultra vires nor
inconsistent with the provisions of the Companies Act, including Schedule VI.