Vildirect: IncomeTax-caselaws-1993-VIL-181-ITAT-

1993-VIL-181-ITAT-

Equivalent Citation: ITD 051, 339,

Income Tax Appellate Tribunal BOMBAY

Date: 18.11.1993

BOMBAY TYRES INTERNATIONAL LTD.

DEPUTY COMMISSIONER OF INCOME-TAX.

BENCH

Member(s) : R. D. AGRAWALA., T. V. K. NATARAJACHANDRAN.

JUDGMENT

Per T. V. K. Natarajachandran, AM -- This is an appeal by the assessee which is directed against the order of the Commissioner of Income-tax (Appeals) XIV, Bombay, dated 25-1-1993, wherein the assessee has impugned the order on several grounds.

2. The first and foremost ground is that the CIT(A) erred on facts and in law in confirming the action of the Assessing Officer in making adjustment to the book profit under section 115J of a sum of Rs. 641.44 lakhs being the differential depreciation arising out of retrospective change in the method of charging depreciation. He has also erred in agreeing and observing that the change of method of depreciation was not bona fide, but was a design to avoid lawful payment of tax.

3. Assessment is a widely held public limited company and is engaged in manufacturing activities of tyres in the brand name of 'Modistone'. The assessment year involved is 1989-90 for which the accounting year ended on 31-3-89. It appears that the previous year consisted from 1-11-1987 to 31-3-1989. It filed the return on 17-12-1989 declaring NIL income. The Assessing Officer computed the total income as per the provisions of the Income-tax Act, 1961, at Rs. 9,71,40,348 and after setting off carry-forward loss and depreciation loss of earlier years, determined the taxable income at NIL. He has also computed the book profit of the company at Rs. 2,76,96,351 and in view of the fact that the total income as per the Act was NIL, he has adopted 30 per cent of the book profits as taxable income in terms of section 115J of the Income-tax Act, 1961, at Rs. 83,08,905. While computing the book profits in terms of section 115J, the Assessing Officer noticed from the audited accounts, the assessee has claimed arrears of depreciation due on the basis of written down value method of depreciation in respect of the past years which amounted to Rs. 6,41,44,000 besides the depreciation relating to current year which worked out to Rs. 3,10,90,000. When enquired about this aspect, the assessee explained that the depreciation in respect of original cost of fixed assets acquired prior to 1-11-1976 was charged on w.d.v. method in accordance with section 205(2)(a) of the Companies Act, 1956 and in respect of cost of fixed assets, acquired on or after that date on Straight Line method in accordance with section 205(2)(b) of the said Act. The company has now changed its policy of providing for depreciation to w.d.v. method under section 205(2)(a) of the Act, uniformly in respect of all its fixed assets. Consequently, debit to the Profit & Loss account and depreciation for current period includes a sum of Rs. 641.44 lakhs being additional depreciation charged in respect of earlier years. The stand taken by the assessee in this regard was that the profits shown in the P & L account prepared in accordance with Parts II & III of Schedule VI of the Companies Act is sacrosanct to be adjusted only if any one of the clauses of the explanation to section 115J is attracted. The profit under section 115J is the profit declared by the assessee-company to its shareholders and has no co-relation with the income computed under the provisions of the Act. The arrears of depreciation provided w.d.v. method is in accordance with Parts II & III of the Schedule VI of the Companies Act and it does not fall in clauses (a) to (ha) of Explanation to section 115J and hence there is no provision in section 115J empowering the Assessing Officer to adjust book profits.

4. The stand taken by the Assessing Officer was the set-off of the arrears of depreciation relating to earlier years against the profits of the current year, assuming that such adjustment was permissible, should have been separately shown in the Appropriation account and not in the profit & loss account. In other words, the arrears of depreciation should have been shown below the line, so to say -- He also observed that the charging of earlier years depreciation was not in consonance with the Companies Act. In effect, the sum of Rs. 641.44 lakhs was set aside or provided for meeting the liability which may arise in future for replacement of the assets, but the liability of which was unascertainable since only ascertained liability could be adjusted and this being unascertained liabilities, that could not be adjusted under section 115J. The Assessing Officer also recorded that it was a colourable device for the purpose of tax planning, and it was at best an attempt to defeat the provisions of section 115J. He pointed out that despite the changing over to written down method of depreciation which was continued till the assessment year 1990-91, it was given up in the assessment year 1991-92 when the provisions of section 115J was deleted and the assessee reverted back to the old method of providing depreciation on Straight Line method. Therefore, the change now made was not bona fide. For all these reasons, he rejected the claim of adjustment of arrears of depreciation made by the assessee.

5. Thereupon, the Assessing Officer proceeded to make adjustment to the book profits as contemplated in clause (iv) of Explanation to section 115J. Tabulating the year-wise position of loss vis-a-vis, the depreciation provided therefor during the assessment years 1978-79 to 1988-89, the Assessing Officer worked out the amount of loss or depreciation required to be set of against the profits of the previous year at Rs. 585.83 lakhs as against Rs. 613.56 lakhs claimed by the assessee inclusive of loss after depreciation for the assessment year 1986-87 at Rs. 7.26 lakhs and loss for the assessment year 1987-88 at Rs. 20.47 lakhs respectively.

6. On appeal, the assessee raised various contentions and justifications in support of the claims by way of letter dated 11th March, 1992 which are reproduced in the appellate order. It would appear that the accounts of the assessee have been prepared and complied as per provisions of Parts II & III of Schedule VI of the Companies Act. Auditors have certified that the accounts reflected a true and fair view and the balance sheet reflects the state of affairs as on 31-3-1989 and the Profit & Loss account for a period of 17 months without any qualification and adoption of new method of depreciation was not in violation of the Companies Act, and the change has been made in consonance with the recommendations of the Institute of Chartered Accountants of India (ICAI) and the guidance notes of the Institute of Chartered Accountants. Regarding the accounting for depreciation in companies the change of method of depreciation could not be termed as provision for contingent liability just because debit of greater amount of depreciation to Profit & Loss account and the change effected was based on the opinion of the Board of Directors as to what is proper and necessary depreciation and it could not partake the character of contingent liability, which depends upon the happening or non-happening of a certain event or fulfilment of certain conditions. The changed method of accounting of depreciation is in accordance with the recognised and sole method of depreciation provided under the Income-tax Act. Even Part III of Schedule VI of the Companies Act defines the "provisions" to mean, any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. Reliance was also placed on the decision of the Cochin Tribunal in the case of Apollo Tyres Ltd. v. Dy. CIT [1992] 43 ITD 464 and the decision of the CIT(A) in Gujarat Filaments Ltd., (Appeal No. CAB/XIV- 1/92-93 dt. 22nd Sept. 1992). As regards adjustment of loss or depreciation, the assessee contended the approach of the Assessing Officer that only cash loss (before depreciation) and the actual depreciation should be compared and the lower of the two would be allowed as a deduction from the book profits was not correct interpretation of law. Reliance was placed on the observation of their Lordship of the Supreme Court in the case of Garden Silk Wvg. Factory v. CIT [1991] 189 ITR 512 for the proposition that the words "depreciation" emanates/originates from the genus described as a "loss" which arises only after debiting the profit & loss account with the amount of depreciation. The opinion of the learned author Sri Latta was also relied upon by the appellant in this connection. The opinion of the Expert Committee of ICAI regarding the interpretation and meaning of the word 'loss' is that the terms profit & loss used in the Companies Act, denote profit after depreciation and tax and "loss after depreciation". On consideration of the various contentions raised by the appellant, the CIT(A) observed that the Assessing Officer had not made any incorrect interpretation of law and he has rightly concluded that a change of method of depreciation which was not bona fide could not be said to be anything but a design to avoid lawful payment of tax. He was inclined to observe that it was quite obvious that a fraudulent change has no legal sanctity. The decision of the Tribunal in the case of Apollo Tyres Ltd. was distinguishable on facts. The CIT(A) also went on to observe that the changed method of depreciation having been given up in the assessment year 1991-92 when the provisions of section 115J ceased to operate, brought the case within the ambit of the ratio of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148. Considering the totality of the circumstances, the book profits computed by the Assessing Officer was held to be justified and consequently, the CIT(A) upheld the decision of the Assessing Officer on these points. At the time of hearing, the learned counsel for the assessee referred to pg. 15 of the Final Statement of accounts wherein the depreciation provided for by the assessee was Rs. 9,25,34,000 which included arrears of depreciation relating to earlier years worked out on the basis of w.d.v. method at Rs. 641.44 lakhs. He has drawn our attention to Note No. 20 contained in the Balance-sheet which explains the changed policy of providing depreciation and the arrear amount of depreciation provided for earlier years. He referred to clause (iv) of the section 3 of Part II of VIth Schedule of the Companies Act which require arrears of depreciation should be shown by way of Note and sub-section (2) of section 7 of Part III of the VIth Schedule which require excess provision should be shown as Reserve. He referred to section 205 of the Companies Act which provides for depreciation in accordance with sub-section (2) which provides to the extent specified in section 350 of the Companies Act, and also by way of Straight Line method contained in clause (b). Section 350 of the Companies Act, provides that depreciation should be calculated with reference to the w.d.v. at the rate specified for the Assets by the Indian Income-tax Act, 1961 and the rules made thereunder. Schedule XIV of the Companies Act provides for rates of depreciation with effect from 2-4-1987 for the purpose of section 205 and 350 of the Companies Act. He referred to the decision of the Tribunal in the case of Apollo Tyres Ltd. for the proposition that unless it is a case of fraud, one should go by the accounts of the assessee, i.e., book profits. He stated that there is a clarification note regarding change of depreciation method and effect and therefore it is to be considered fair. Page 12 of the Final Statement of Accounts contains Auditor's report and no adverse comment is contained therein. Therefore, in terms of 2(11) of the Companies Act, the statement is fair and true. The change in the method of providing depreciation was effected in the background of the fact the plant and machinery was over 50 years old and they have not worked during the lockout period of about 14 months and the plant and machinery was obsolete and the present cost of replacement of the plant is Rs. 350 crores. A note to the Chairman and Vice-chairman was given on 2nd May 1989 by technical experts and the extract of the Minutes of the meeting of the Board of Directors dated 26th June 1989 approved the change in the process of providing depreciation. The ICAI in 'Guidance Note on Accounting for Depreciation in Companies' has clarified that in the year of change the additional depreciation, provision for earlier years is a necessary charge on the profits for the year in which the change is effected. In Accounting Standard (AS 6) on 'Depreciation Accounting' the ICAI has reiterated that short provision for depreciation in earlier years pursuant to change in the method of providing depreciation has to be debited against the profits in the year of change. Even in Accounting Standard 5, relating to prior period and extraordinary items and changes in accounting policies, the Institute has clarified that any change in the accounting policy which has a material effect should be disclosed and the impact of, and the adjustments resulting from such change, if material should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. The Cochin Bench of the Tribunal in the case of Apollo Tyres Ltd. held that arrears of depreciation debited to the Profit & Loss account pursuant to a change in the rates of providing depreciation could not be regarded as a prior period item in the year of change. It was further held that no adjustment for the same could be made for the purpose of computation of profit under section 115J. He further contended that such provision cannot be regarded as provision for contingency, the liability for which is unascertained, as viewed by the Assessing Officer. In this connection, he referred to the Budget Speech of the Prime Minister and the Minister for Finance reported in 165 ITR St. 14. The Assessing Officer has to adopt the profits as shown in the P & L account and the change of method of providing depreciation was not adversely commented by the Statute Auditors of the assessee nor the report has been qualified in this respect. That the auditors have stated that the P & L a/c. after taking into account the arrears of depreciation presented a true and fair view of the profits and losses for the relevant year. Reliance was also placed on the Special Bench decision of the Tribunal in the case of Sutlej Cotton Mills Ltd. v. Asstt. CIT [1993] 199 ITR 164 (Cal.). At pg. 164-165 that in a case where profit and loss account was prepared in accordance with the provisions of Part II & Part III of Sixth Schedule to the Companies Act, the Assessing Officer will have no power to disturb the book profits except as stated in section 115J and the Assessing Officer is bound to proceed with the computation only on the basis of the book profits as shown in the profit and loss account unless it is discovered that the profit & loss account is not drawn up in accordance with the provisions of the companies Act. In this connection, he has also clarified that the assessee-company had switched over to Straight Line method of depreciation in assessment year 1991-92 so that that the company could have sufficient profits for distribution of dividends, in order to meet the long-standing demand of the shareholders of the company and when the present changeover was effected, it had not planned or anticipated to switch back to the old system of providing depreciation nor the present changeover was effected so as to avoid tax liability under section 115J.

In view of the above, it was contended by the learned counsel for the assessee, the arrears of depreciation charged to the profit and loss account was a necessary charge on the profits of the relevant previous year and cannot be excluded while calculating the book profit under section 115J of the Income-tax Act.

7. The assessee has filed an additional ground through letter dated 8-5-1993 in which it was stated that the CIT(A) erred on facts and in law in upholding the action of the Assessing Officer fit allowing set off of Rs. 585.83 lacs, being lower of loss excluding depreciation and that of depreciation while calculating book profits under section 115J of the Act, as against the appellant's claim for set off of Rs. 613.56 lacs. As this ground raises purely a legal issue, it is admitted.

8. While computing the book profits in terms of clause (iv) of Explanation to section 115J, the Assessing Officer allowed set off of Rs. 585.83 lacs only as against claim of Rs. 613.56 lacs. It is relevant that the calculation of the adjustment particulars are extracted below for easy reference and appreciation :

"ASSESSMENT YEAR 1989-90

(Year ended 31-03-1989)

CALCULATION OF AMOUNT ADJUSTABLE UNDER CLAUSE (IV)

OF THE EXPLANATION TO SECTION 115J OF INCOME-TAX ACT, 1961

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Year of Year Book Depreciation Book Loss Assessed assess- of profit/ provided for profit/ available by DCIT vide ment accounts loss this year (loss) for adjust- order u/s 143(3) before after ment depr'n. depr'n.

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1977-78 31-10-76 53.84 profit 37.64 16.20 x ----

1978-79 31-10-77 80.40 loss 39.60 (120.00) 39.60 39.60

1979-80 31-10-78 227.85 loss 62.83 (290.68) 62.83 62.83

1981-82 31-10 80 74.16 loss 66.98 (141.14) 66.98 66.98

1982-83 31-10-81 271.83 loss 67.53 (339.36) 67.53 67.53

1983-84 31-10-82 95.60 profit 68.74 26.86 x x

1984-85 31-10-83 86.15 profit 81.32 4.83 x x

1985-86 31-10-84 396.64 loss 230.05 626.69 230.05 230.05

1986-87 31-10-85 235.43 profit 249.69 (7.26) 7.26 ---

1987-88 31-10-86 209.14 profit 229.61 (20.47) 20.47 ---

1988-89 31-10-87 763.48 loss 118.84 (882.32) 18.84 118.84

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TOTAL 613.56 585.83

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Notes :--

1. The above statement is prepared on the basis of the published accounts of the Co. relevant to assessment years 1978-79 to 1988-89 (copies enclosed).

2. The profit/loss shown in the above statement represents the profit/loss for the relevant financial year without considering transfer from/to reserves and/or provisions.

3. The balance of the loss after adjustment under section 115J will be carried for adjustment in the subsequent assessment years, i.e., 1990-91 onwards.

Sd/- S.K. Gupta

For BOMBAY TYRES INTERNATIONAL LTD.

MANAGER TAXATION."

The Assessing Officer was of the view that loss for the purpose of adjustment is exclusive of depreciation element and it would represent pure cash loss only. This stand is opposed to the stand of the assessee that loss is inclusive of depreciation element, inasmuch depreciation loss is "specie of large genus called loss". In the view of the Assessing Officer in whichever year there were book profits and after granting depreciation of the relevant year, there profit, the adjustment of loss or depreciation whichever is less was not called for, for specific adjustment in terms of clause (iv) of the said Explanation. Accordingly, for the assessment year 1986-87, the loss of Rs. 6.26 lakhs claimed by assessee was not allowed for adjustment because the profits were Rs. 235.43 lakhs net exclusive of depreciation and for the assessment year 1987-88 the loss of Rs. 20.47 lakhs claimed was not allowed because the profit of Rs. 209.14 lakhs was net exclusive of depreciation but in both these years, profits before depreciation were higher than the corresponding provision of depreciation with the result there were net profits for those years and hence did not call for any adjustment. Thus, the difference in the claim of adjustment lies in the difference in the approach of the Assessing Officer and the assessee.

9. The learned counsel for the assessee brought our attention to the judgment of the Supreme Court in the case of Garden Silk Wvg. Factory wherein it has been held that the word "depreciation" emanates/originates from the genus described as "loss" which arises only after debiting the profit & loss account with the amount of depreciation. The "amount of loss" and "amount equal to depreciation" appearing in section 205(1) and amount equal to depreciation appearing in clause (b) of proviso to section 205 of the Companies Act to which reference is made in clause (iv) of Explanation to section 115J of the I.T. Act, are two different expressions and should not be substituted with "business/cash loss" and "unabsorbed depreciation". In other words, the simple principle involved was that before dividend is declared minimum depreciation as envisaged in sub-section (2) of section 205 must be fully provided including arrears of depreciation of earlier years. This legislative intent or object could be attended only when the word "loss" is interpreted to mean and include cash loss plus depreciation. In other words, the loss should include the element of depreciation also. Sri Datta, learned author on Company Law, while explaining the provision of clause (b) of first proviso to section 205(1) has opined that the word "loss" includes word "depreciation". By way of illustration, the learned author has observed that if the company provided for depreciation say Rs. 6,000, and the loss suffered after depreciation was, say Rs. 1,000, for the year ending 31-3-82, and the company made profits of Rs. 10,000 for the year ending on 31-3-83, then under the proviso only Rs. 1,000 should be set off against the profit of Rs. 10,000 and the balance of Rs. 9,000 will be available for distribution as dividend. In other words, he has opined that the loss includes depreciation also. Even the Expert Committee of the ICAI expressed the view that the terms "profits" and "loss" used in the Companies Act denote "profit after depreciation and tax" and "loss after depreciation and tax". Reliance was also placed on the decision of the Tribunal in the case of Buttwelded Tools (P.) Ltd. v. Asstt. CIT [1991] 39 ITD 432 (Mad.) (SMC) and Steel Authority of India Ltd. v. Dy. CIT [1991] 38 ITD 193 (Delhi). Further reliance was placed on the judgment of the Supreme Court in the case reported in Challapalli Sugars Ltd. v. CIT [1975] 98 ITR 167 for the proposition that except where statutory definition of cost is there, one can go by the accounting practice of Chartered Accountants Institute. Further reliance was placed on the decision of the Special Bench of the Tribunal in the case of Surana Steels (P.) Ltd. v. Dy. CIT [1993] 45 ITD 1 (Hyd.) wherein it has been held that loss for purpose of clause (iv) of Explanation to section 115J had to be taken to be loss including depreciation.

10. At the outset, the learned Departmental Representative referring to section 115J providing for tax on book profits of company stated that there is no room for intendment or there is no place for equity while interpreting taxing statutes for which the decision in CIT v. Veeraswami Nainar [1965] 55 ITR 35 (Mad.) was relied upon. He has also stated that the Finance Minister's speech cannot be taken as aid for the interpretation of statute. He further stated that the Auditor's report or certificate on accounts is not sacrosanct and book profits are nothing but commercial profits and what should be reflected from the books. The Assessing Officer can tamper with the book profits besides making adjustments in clauses (a) to (ha) if book profits were not computed according to Part II and Part III of Schedule VI of the Companies Act. He pointed out that by debiting extra depreciation this year vis-a-vis last year, the assessee has given distorted view as if machinery was purchased at 20 times the value of the arrear depreciation claimed which is not correct. The conclusion he was drawing at was that true and fair picture of the profits were not reflected. He pointed out that the assessee had gone back to the original Straight Line Method of providing depreciation in the assessment year 1991-92, and therefore the ratio of the Supreme Court in the case of Mcdowell applied in his case because the change of providing for depreciation to written down value method was not bona fide. In this connection, he has referred to the judgment of the Supreme Court in the case of CIT v. Durga Prasad More [1971] 82 ITR 540 for the proposition that the record of the subsequent years were also to be taken into account before finalising the assessment. He further pointed out that International Accounting Standard (IAS 4) covered the present and the future depreciation required to be adjusted and not the past depreciation. He referred to the decision of the Cochin Bench of Tribunal in the case of Apollo Tyres Ltd. and pointed out that in that case, the mandatory provision of extra shift allowance was required to be made and therefore such provision was made which was permissible in law and consequently that decision is not directly applicable to the assessee's case. He referred to the amendment made in the Company Law in the year 1988 according to which Schedule XIV was inserted in the Companies Act providing for rates of depreciation as per written down value. The sum and substance of the contention of the learned Departmental Representative was that the current year's profits should not be touched with arrears of depreciation based on written down value method. He pointed out that in the year 1988-89, when the provision of section 115J was in operation, the assessee has not changed the method of providing for depreciation because there was loss sustained in that year. Similarly when the provisions of section 115J was in operation in the assessment year 1991-92, the assessee switched back to Straight Line Method. Based on these facts, he vehemently contended that the assessee had no reasonable ground to change over to written down value method for the assessment year 1989-90 under consideration. It is the action of the assessee noticed in the assessment year 1991-92 provided material information to the Assessing Officer to take a proper perspective in rejecting the arrears of depreciation claimed by the assessee, and therefore he was justified with the action of the Assessing Officer. Further, in respect of the additional ground moved by the assessee regarding the actual quantum of adjustment of loss of depreciation against the book profits required to be done in clause (iv) of Explanation to section 115J, the learned Departmental Representative vehemently supported the findings of the authorities that loss was cash loss only and did not include depreciation and it should be compared with unabsorbed depreciation. In reply, the learned counsel for the assessee submitted that there is no dispute regarding the fact that there is no room for intendment and no place for equity while interpreting statutes. He has stated that he has relied on the Finance Minister's speech for the limited purpose that the legislative intention in introducing section 115J was to tax zero tax prosperous companies on the basis of profits declared in their own accounts. The profit made by the assessee was that the assessee was neither a prosperous company considering the accumulated losses nor had any profits declared in its accounts (after taking into account clause (iv) of Explanation to section 115J). Regarding the proposition of the learned Departmental Representative that the Auditor's report on accounts certifying as true and fair was totally misplaced, he refused the charge. The learned authors S/Sri Chaturvedi & Pithisaria in the context of section 104 imposing additional tax on undistributed dividends have stated that the mode of preparation of profit and loss accounts or determination of profit by the assessee cannot be taken to be final or conclusive and the quantum of commercial profits ascertained with reference to the true nature of the receipts and outgoings. However, under section 115J of the Act, what is relevant is that the book profits as shown in the profit and loss account prepared in accordance with Parts II & III of Schedule VI of the Companies Act and not commercial profits. He has also stated that there is no dispute to the proposition that the book profits as shown in the profit and loss account could be disturbed if it is not prepared in accordance with Parts II & III of Schedule VI of the Companies Act. He pointed out that the Departmental Representative was not able to show how the profit & loss account prepared by the assessee debiting the arrears of depreciation was not in accordance with Parts II & III of Schedule VI of the Companies Act. In this connection, he pointed out that in the case of Apollo Tyres Ltd., it sought opinion of the Department of Company Affairs as to whether profit & loss account prepared by it by debiting arrears of depreciation was in accordance with Parts II & III of Schedule VI of the Companies Act. The Deptt. of Co. Affairs confirmed that profit & loss a/c. prepared by that company was in accordance with the provisions of section 205 of the Companies Act, 1956, read with Parts II & III of Schedule VI of the Companies Act Apollo Tyres Ltd.'s case at pg. 480-482, para 19. Referring to the proposition of the learned Departmental Representative, that as per International Accounting Standard-4, any change in the basis of providing depreciation should be prospective, he brought our attention to the fact that the IASI in the Preface to the Statements of Accounting Standards has clarified in para 2.2 that the Institute is one of the Members of the International Accounting Standards Committee (IASC) and has agreed to support the objective of IASC. While formulating the Accounting Standards, ASB will give due consideration to the International Accounting Standards, issued by IASC and try to integrate them, to the extent possible in the light of the conditions and practices prevailing in India. In this view of the matter, the learned counsel for the assessee submitted that the Indian Accounting Standard and Guidance Notes would prevail over the International Accounting Standard even if it be assumed that the two are in conflict with each other, although in his respectful submission, there is no such conflict. Referring to the proposition of the learned D.R. that the change in the policy of providing depreciation was based on technical consideration and not financial implication and the policy was given up for the assessment year 1991-92, and such action should be taken into account to consider the bona fide of the policy, in the light of the Supreme Court decision in the case of Durga Prasad More and the application of Mcdowell & Co. Ltd.'s case, he submitted, that the Note dated 2-5-1989 recommending change in the policy of providing depreciation was prepared by both financial and technical personnel of the company and the change was suggested by them in order to result in a more appropriate preparation and presentation of accounts. He further submitted that the reversal of the policy in the assessment year 1991-92 does not impinge on the bona fide of the change effected as subsequent reversal was not in the contemplation of the assessee. The change of policy was bona fide and the principle of Mcdowell is not applicable. In fact, he pointed out that the Supreme Court in the subsequent decision in the case of CWT v. Arvind Narottam [1988] 173 ITR 479 and in the case of Union of India v. Playworld Electronics [1990] 184 ITR 308 held that tax planning may be legitimate provided it is within the framework of law. His pointed submission was that the change in the method of providing depreciation was not a colourable device, since the subsequent reversal was not pre-ordanied. Referring to the proposition of the learned D.R. regarding provision of arrears of depreciation below the line, the learned counsel for the assessee pointed out that even the author Kamal Gupta's opinion shows that there is option open to the assessee to set off arrears of depreciation either against current year's profits or past years' profits or against both. The learned D.R. referred to pg. 27 & 29 of Kamal Gupta's book in the context of section 205 of the Companies Act to submit that arrears of depreciation can be set off either against current year's profit or past year's profit or against both and in the light of that opinion he submitted that the current year's profits should be debited only to the extent of current year's depreciation and arrears of depreciation should be provided below the line. Referring to section 205 of the Companies Act, which regulates payment of dividend, clause (b) of proviso to sub-section (1) of section 205 does not regulate the debiting to the profit & loss a/c. of arrears of unprovided depreciation or arrears of depreciation consequent upon change in the basis of providing depreciation. Referring to the Guidance Note on Accounting for Depreciation in Companies contained in pp. 26 to 35 of the paper compilation, the learned counsel for the assessee drew our attention to para-6 contained at p. 28 for the proposition when a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from the retrospective recomputing of depreciation in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation of past years, the deficiency should be charged to the profit and loss account. It was also clarified that the relevant portion of the Accounting Standard (AS-6) on 'Depreciation Accounting' is being revised to bring it in line with the recommendation of the Guidance Note. He has also referred to the distinction made out by the learned D.R. in respect of the decision of the Cochin Bench in the case of Apollo Tyres Ltd.'s. He relied on the decision of the Cochin Bench at para 25 at pg. 488 of the decision and also para 26 of the decision to support his contention that arrears of depreciation will have to be accommodated in the profit & loss account of the current year and such arrears cannot be added back to arrive at the book profits for the purpose of section 115J. Such adjustment is also not contemplated by section 115J.

11. We have duly considered the rival submissions of the parties, gone through the voluminous paper compilations and the record. As regards the provision of arrears of depreciation on account of change in the method of providing depreciation to written down value from Straight Line Method, it cannot be said that the change is not bona fide and it is a colourable device to reduce the tax burden. In fact, both in the case of Mcdowell & Co. Ltd. as well as in the latter decision in the case of Arvind Narottam & Playworld Electronics (P.) Ltd., tax planning is held to be legitimate provided it is within the framework of law. It cannot be contended that the provision of depreciation or for that matter the arrears of depreciation, unprovided for and which require to be provided is beyond the four corners of law. Coming to the change in the policy of providing depreciation based on written down value, it was adopted on the basis of recommendations of financial and technical personnel of the company and which was considered and adopted by the Board of Directors in a meeting held on 26-6-1989 contained at pg. 24 & 25 respectively. The context or background in which such change of policy was adopted was also required to be kept in view. It is admitted that the company has sustained loss year after year on account of lock-out and accumulated loss with the result it had not declared dividends to the shareholders in the past. The fixed assets of the company on which depreciation is admissible had become obsolete and the assessee had not made proper provision for depreciation inasmuch as it has adopted Straight Line Method and not Written Down Value Method as per Income-tax rules. Having made cash profits during the relevant year, it is only fair and proper for the company to change the method of provision of depreciation for more appropriate preparation and presentation of financial statements of the enterprises for which the change could be effected in accordance with para 15 "Depreciation Accounting (AS-6)" issued by the Institute of Chartered Accountants of India in November 1982. This accounting standard stands modified by Guidance Note on Accounting for depreciation in companies issued recently which is contained at pg. 26 to 35 of the paper compilation. Section 205 of the Companies Act governs the provisions regarding charging of depreciation for the purpose of payment of dividends. As per the Guidance Note, which came into force on or after 1-4-1989, Para-6 of the Guidance Note is relevant and is extracted below :--

"6. The depreciation method selected should be applied consistently from period to period. A change from one method of providing depreciation to another should be made only if the adoption of the new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprise. When a change in the method of depreciation is made, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the new method would be adjusted in the accounts in the year in which the method of depreciation is changed. In case the change in the method results in deficiency in depreciation in respect of past years, the deficiency should be charged to the profit and loss account. In case the change in the method results in surplus, it is recommended that the surplus be initially transferred to the 'appropriations' part of the profit and loss account and thence to General Reserve through the same part of the profit and loss account. Such a change should be treated as a change in accounting policy and its effect should be quantified and disclosed."

From the above paragraph, it is seen that the change in the method of providing depreciation could be made only if the adoption of new method is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of the enterprises. When a change in the method is effected, depreciation should be recalculated in accordance with the new method from the date of the asset coming into use. The deficiency of surplus of depreciation should be charged to profit & loss account. By way of a footnote, the Guidance Note says that it is hereby clarified that the relevant portion of Accounting Standard (AS-6) on 'Depreciation Accounting' issued by the Institute of Chartered Accountants of India, is being revised to bring it in line with this recommendation of the Guidance Note. In paragraph 9 of the Guidance Note, it is stated that the company must consider the true commercial depreciation i.e., the rate which is adequate to write off the asset over its normal working life, and the rates of depreciation adopted in Schedule XIV of the Company represented the minimum rates of depreciation. It is also stated that since the determination of commercial life of an asset is a technical matter, the decision of the Board of Directors based on technological evaluation should be accepted by the auditor unless he has reason to believe that such decision results in a charge which does not represent true commercial depreciation.

In para 28, for certain statutory purposes, e.g., dividends, managerial remuneration etc. only depreciation relatable to the historical cost of the fixed assets is to be provided out of the current profits of the company. The amendment made to section 350 of the Companies Act did not affect or touch section 205 which pertains to declaration of dividends by the company. The statement on changes in the mode of charging depreciation in the Accounts is contained in Appendix IV. In para 2.1, it is stated that there is no bar either from the legal or from the accounting point of view to a company changing its method of providing depreciation. If the company proposes to pay dividends, the statutory auditor must satisfy himself that the new method of providing depreciation conforms to the requirements of section 205 of the Companies Act, 1956. In this connection, it is relevant to point out that the requirements of section 350 and that of section 205 are different, so far as provision of depreciation is concerned. Inasmuch as in respect of section 205, the company can choose any of the methods provided under sub-section (2) of section 205, and as a consequence based on the Guidance Note as well as the Statement on Changes in the mode of charging Depreciation contained in Appendix IV. Arrears of depreciation can also be adjusted subject to condition that such disclosure is mandatory in the accounts of the year in which the change has taken place.

Para 2.4 of the Statement shows that on changing the method, depreciation should be recalculated from the date of the asset coming into use. Para 2.5 says that the method may be changed for all the assets of one or more classes of assets. In the case of the assessee, admittedly, it has followed written down value method in respect of assets acquired prior to 1-11-1976 and Straight Line Method in respect of assets acquired thereafter. It is only in respect of the assets acquired after 1-11-76 the change of method applies and the arrears of depreciation would relate to such assets and this method is also in accordance with para 2.5 of the Statement.

Para 2.7 of the Appendix IV states that in the year in which the method of depreciation is changed, full depreciation for that year, calculated in accordance with the new method must be debited to the profit & loss account of the year. Thus, the method of changing and the impact of changing by way of providing arrears of depreciation by charging the profit & loss account are in accordance with the Guidance Note on Accounting Standard and Statement on Changes contained in Appendix IV which is within the parameters of the Company Law. Thus, there is no colourable device in the change of policy adopted by the assessee. In this connection, the relevant inquiry that should be caused is whether the profit & loss account prepared by the assessee is in accordance with the provisions of Parts II & III of Schedule VI of the Companies Act, 1956, or not. Clause (iv) of section 3 of Part II of the Companies Act, shall contain the amount provided for depreciation, renewals or diminution in value of fixed assets. It also says that if such provision is not made by means of a depreciation charge, the method adopted for making such provision and if no provision is made, it shall be stated and the quantum of arrears of depreciation computed in accordance with section 205(2) of the Act shall be disclosed by way of a note. Therefore, it is abundantly clear that when appropriate depreciation rate is not adopted, by a company, the method adopted should be shown, and in case no provision is made, it shall be indicated together with the arrears of depreciation. Thus, section 205 of the Companies Act, for the purpose of declaration of dividend provides that no dividend shall be declared or paid by a company for any financial year except out of the profits of the company for that year arrived at after providing for depreciation in accordance with the provisions of sub-section (2). Sub-section (2) provides option to adopt written down value method specified in section 350 or Straight Line Method or any other method approved by the Government. Whatever be the method adopted, no dividend shall be declared or paid by the company without providing for depreciation in accordance with the provisions of sub-section (2). Therefore, in the context of the assessee being called upon to pay dividend which could normally be out of commercial profits and not hypothetical profits as held by the Supreme Court in the case of CIT v. Gangadhar Banerjee & Co. (P.) Ltd. [1965] 57 ITR 176, it was only proper to provide for the correct amount of depreciation including the arrears of depreciation in the year in which the dividends are declared. Even the International Standard of Accounting-4 requires adjustment of depreciation rates for the current year. Further the rejoinder given by the learned counsel for the assessee to the various propositions made out by the learned Departmental Representative, all go to clinch the issue in favour of the assessee changing the method of accounting for providing depreciation in the relevant accounting year for the assessment year 1989-90. The word 'provide' is used in section 205 and also in clause (iv) of section 3 of Part II of the VIth Schedule and also in clause (a) of section 7 of Part III of the VIth Schedule and the word 'appropriation' is not used therein. In clause (a) of sub-section (1) of section 7 of Part III of Schedule VI, it is clarified that the word 'provision' shall apply to sub-clause (ii) mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability for which the amount cannot be determined with substantial accuracy. Thus, in respect of the arrears of depreciation, yet to be provided for, the same could be written off straightway or provide for a known liability and it is not in doubt that the fixed assets depreciate in value which is a known factor and not an unknown factor. Sub-section (2) provides that any amount written off or retained which is in excess, then the excess shall be treated as a reserve and not as a provision. There is no dispute the arrears of depreciation claimed by the assessee is in accordance with the Written Down Value Method and there is no excess provision so as to call it a reserve. The Special Bench of the Tribunal in the case of Sutlej Cotton Mills Ltd., spelt out the mandate of section 115J given to the Assessing Officer and observed that in a case where there is no allegation of fraud or misrepresentation but only a difference of opinion as to the question whether a particular amount should be properly shown in the profit & loss account or in the balance-sheet, the provisions of section 115J do not empower the Assessing Officer to disturb the profits as shown by the assessee. It was also observed that as the intention of section 115J was only to extract some tax in spite of the companies being eligible for certain concessions in computing the income from business, it is the book profits which is the starting point of the computation of the income of the assessee which could be the basis for the tax under section 115J also. It would therefore be anomalous to concede the Assessing Officer has the power to disturb the starting point itself in a case other than a case where the profit & loss account was not prepared in accordance with Part II & Part III of the VIth Schedule of the Companies Act. In a case where the profit & loss account was prepared in accordance with the provisions of Part II & Part III of the Schedule VI to the Companies Act, the Assessing Officer will have no power to disturb the book profits except as stated in section 115J. In the case of Apollo Tyres Ltd., the assessee provided for normal depreciation year after year but in the assessment year 1988-89, decided to work out depreciation including extra shift allowance with the result an amount of Rs. 1,366.39 lakhs being additional depreciation for earlier years had been debited to the profit & loss account. On a reference, the Department of Company Affairs, confirmed that as a consequence of providing arrears of depreciation in terms of section 205(2)(b), the company's net profit was in accordance with Parts II & III of Schedule VI to the Companies Act. It is clear from the aforesaid confirmation given by the Deptt. of Co. Affairs, provision of arrears of depreciation relating to earlier years is also by inference in accordance with section 205(2)(b), read with Parts II & III of' Schedule VI to the Companies. Act. In that case, the Tribunal held that the net profit shown in the accounts of the assessee after writing off arrears of depreciation of earlier years alone represented the book profits of the company and it was not for the Assessing Officer to substitute his own figures in its place. It further observed that even if it is held that the arrears of depreciation was not a legitimate charge against the profits of the year but should be viewed only as an appropriation of profit still the same could not be added back by the Assessing Officer to arrive at the book profits for purposes of section 115J. Referring to Explanation to section 115J, dealing with certain adjustments, the Bench observed that nowhere is there any mention for adjustment of prior period expenses such as arrears of depreciation no matter whether it is looked upon as a charge against the profit or as an appropriation of profit. In this connection, the distinction made by the learned Departmental Representative that this case applied to a case of provision of extra shift allowance which is part of normal depreciation and therefore the case of the assessee could be distinguished from that case, in our opinion, is a distinction, there being no difference at all because Extra shift allowance is only a part of normal depreciation and for that matter, even the arrears of depreciation is also part of depreciation per se. Keeping in view the order of the Special Bench of the Tribunal in the case of Sutlej Cotton Mills Ltd. and the order of the Cochin Bench in the case of Apollo Tyres, and the opinion expressed by the Department of Company Affairs, we have no hesitation in concluding that arrears of depreciation provided for by the assessee is in accordance with Part II and Part III of Schedule VI to the Companies Act, and is also in accordance with section 115J(1)(a) of the Income-tax Act, 1961. Having held that the arrears of depreciation is claimed in accordance with section 115J, it is now considered necessary to ascertain the exact quantum of loss or the amount of depreciation which would be required to be set off against the profits of the relevant previous year as contemplated by clause (iv) of Explanation to section 115J. Considerable heat and dust was raised in this connection in the course of prolonged arguments advanced by the parties. We shall at once refer to the Tabulation contained at pg. 108 of the paper compilation and which has been reproduced above. The stand taken by the Revenue and which has been very strongly supported by the learned D.R. is that the element of loss contemplated in clause (iv) of Explanation to section 115J refers to cash loss exclusive of depreciation while the stand taken by the assessee which is diametrically opposite is that the loss is inclusive of depreciation and depreciation loss is a specie of the large genus "loss".

In this connection, it is relevant to extract clause (iv) which is as under :--

"Explanation : [to section 115J(1A)

(iv) the amount of the loss or the amount of depreciation which would be required to be set off against the profit of the relevant previous year as if the provisions of clause (b) of the first proviso to sub-section (1) of section 205 of the Companies Act, 1956 are applicable."

The aforesaid clause (iv) refers to the provisions of clause (b) of the first proviso to sub-section (1) of section 205 of the Companies Act, 1956, and therefore it is also considered to extract it below :

"Section 205(1)

.................................................................................................

Proviso ...

(a)...

(b) if the company has incurred any loss in any previous financial year or years, which falls or fall after the commencement of the Companies (Amendment) Act, 1960, then, the amount of the loss or an amount which is equal to the amount provided for depreciation for that year or those years 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 previous financial year or years, arrived at in both cases after providing for depreciation in accordance with the provisions of sub-section (2) or against both ;"

From the relevant provisions extracted above, it is seen that the amount of loss or the amount of depreciation provided for depreciation for the year or years whichever is less shall be set off against the profits of the company for the year for which the dividend is proposed to be declared or paid. Even if this could be done, only after providing for depreciation in accordance with provisions of sub-section (2) of section 205. Therefore, provision of depreciation for the year in which declaration of dividend is made is obsolete or condition precedent for declaration of dividend. From the aforesaid clause (b) therefore, it is crystal clear that any resultant loss of any year is inclusive of the loss of depreciation, the profits being less than the amount of depreciation to be provided for, for that year. The Supreme Court in the case of Garden Silk Wvg. Factory has held likewise as pointed out by the learned counsel for the assessee during the course of his rejoinder to the proposition made by the learned Departmental Representative. Thus, we are inclined to accept the stand taken by the assessee in this regard and not the stand taken by the Revenue which is not in accordance with law. In this view of the matter, therefore, if we apply to the data provided, it is seen that there is no dispute regarding the adjustment required to be made for the assessment years 1978-79, 1979-80, 1981-82, 1982-83, 1985-86 and 1988-89. The controversy of the dispute relates to the intervening assessment years 1986-87 and 1987-88. The statement would show as if the book profits for those years were less than the amount of depreciation provided for those years. If the loss including the depreciation is taken into account and compared with the depreciation provided for the lesser of the two worked out to Rs. 7.26 lakhs and Rs. 20.47 lakhs for the assessment years 1986-87 and 1987-88 which together with the amount of adjustment allowed by the Assessing Officer at Rs. 585.83 lakhs amounts to Rs. 613.56 lakhs. In other words, the assessee would get further adjustment and set off Rs. 27.73 lakhs in respect of assessment years 1986-87 and 1987-88. Therefore, the correct amount of adjustment required to be made in terms of clause (iv) works out to the amount claimed by the assessee, namely, Rs. 613.56 lakhs which should be adjusted against the book profits. In this view of the matter, therefore, there is force in the various contentions raised on behalf of the assessee and the rejoinder given by the learned counsel for the assessee which are valid.

12. Accordingly, ground Nos. (1), (1.1) and the additional ground No. 1 taken before us are disposed of.

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