By Kirit S. Sanghvi, Chartered Accountant
1.0 Facts of the case :
1.1 The following is the Profit and Loss account of ABC Ltd. for the year ended 31st March, 2006.
The company values its stock at lower of the cost or the net realisable value (NRV). The NRV in this case was lower than the cost.
1.2 The company filed the return of income for A.Y. 2006-07 as under:
1.3 The Profit and Loss account of the company for EY, 2006-07 relevant to A.Y. 2007-08 was as under:
1.4 The company declared income in its return for A.Y. 2007-08 as under:
1.5 Since there was no tax payable under the normal computation of income and since there was book profit as worked out u/s.115JB of the Act, the company paid MAT for A.Y. 2007-08 on the book profit of Rs.0.25 cr.
1.6 Thereafter, the AO completed assessment for A.Y. 2006-07 by adding Rs.0.25 cr. to the value of the closing stock on the ground that the company should have valued its stock at cost instead of at an amount being the lower of the cost or the NRV. Since the final tax still was nil the company did not opt to file an appeal. The assessed loss stood at Rs.0.25 cr. in place of the returned loss of Rs.0.50 cr.
1.7 The AO accepted the return for A.Y. 2007-08. Believing that the adjustment to the value of the closing stock would have a bearing on the taxable income of the succeeding year, the assessee contended in an application made u/ s.154 of the Act for A.Y. 2007-08 that the value of the opening stock should be adjusted by the amount of the adjustment made to the value of the closing of stock of the preceding year. It also contended that a similar adjustment should also be made to the book profit worked out u/s.115JB. According to the company, the revised book profit for A.Y. 2007-08 should appear as under:
It claimed refund of MAT paid.
1.8 The Aa rejected the application in so far as it concerned adjustment to the book profit, on the grounds that:
i) the accounts of the assessee for the year relevant to AY. 2007-08 were prepared in accordance with the provisions of parts II and III of Schedule VI to the Companies Act, 1956; and
ii) therefore, he had no power to make any adjustment to the book profit, as was held by the Honourable Supreme Court in Apollo Tyres Ltd. v. ClT, (2002) 255 ITR 273 and ClT v. Comnet Systems & Services Ltd., (2008) 305 ITR 409.
1.9 The company seeks your advice on whether an appeal should be filed against the stand of the AO.
2.0 Advice:
2.1 The company is advised to prefer an appeal for the reasons to be stated hereafter.
2.2 It is true that in the cases referred to by the AO, the SC held that the AO does not have power to make adjustment to the book profit other than the adjustments permitted in the provisions relating to MAT. The SC, however, did not say that no adjustment can ever be made by the AO to the book profit. The AO is empowered to make the permitted adjustments. Let us, therefore see the nature of the adjustment made by the AO in the form of addition to the value of closing stock for AY. 2006-07, and whether the adjustment sought by the assessee is a permitted one.
2.2.1 The assessee valued the closing stock at the lower of the cost or the NRV. Therefore, when the assessee found the NRV of the stock to be lower than the cost for AY. 2006-07, it scaled down the value of stock as at 31st March, 2006 in the books. Thus, the assessee effectively created a provision for eventual loss that might be incurred at the time of realisation of stock. When the AO did not allow the reduction in the value of stock for AY. 2006-07, what he was effectively doing was that he was disallowing the provision for loss, and he was permitted to make such adjustment to the ‘book profit’ for AY. 2006-07. (I leave aside for the present the ratio of decisions that hold that a provision in recognition of reduction in value of an asset is not it was not challenged in appeal). However, since the total book loss for A.Y. 2006-07 at Rs.0.50 cr. exceeded the disallowance of Rs.O.25cr., there was a negative ‘book profit’ after the said adjustment and there was no liability for AY. 2006-07 u/s.115JB of the Act.
2.2.2 It must be noted that though the Aa disallowed the hidden provision for loss in A.Y. 2006-07, the assessee had not made any corresponding changes in its books in the succeeding year. As a result, the assessee continued to carry the hidden provision in the books. In the next year relevant to AY. 2007-08, the profit and loss account of the assessee can be restated as under:
Based on the above, the assessee has the right to exclude the credit of Rs.0.25 cr. from the book profit since that figure represents provision recalled which was not allowed while computing the book profit for AY. 2006-07. S. 115JB, in clause (i) of Explanation (1) to S. 115JB, read with Proviso thereto, permits exclusion from the book profit of the amount withdrawn from reserve or provision (excluding a reserve created before 1-4-1997, otherwise than by way of a debit to the profit and loss account), if any such amount is credited to the profit and loss ac-count. The only issue that can survive is: whether the provision recalled at Rs.0.25 cr. as shown in the restated profit and loss account is an amount credited to the profit and loss account and thereby forming part of the book profit and therefore meriting exclusion from the book profit, for one may remember that this amount was not originally credited in the account and it appeared only in the rested profit and loss account. The author is of the view that though this amount did not appear in credit in the original profit and loss account, it was nevertheless de facto credited in the profit and loss account as is shown in the restated profit and loss account which is the same as the original profit and loss account except that it differs in presentation. It is submitted that the substance of a transaction rather than its presentation should decide taxability or otherwise.
2.2.3.1 There is one more aspect to be considered also. The assessee has prepared accounts for both the years following accounting standards in general and AS-2 relating to valuation of inventory in particular. Therefore, a question can arise whether there was any mistake committed by the AO in the next year as far as the working u/s.115JB is concerned. If there was no mistake, no rectification will lie u/s.154 of the Act.
2.2.3.2 In my view, it is true that AS-2 has been followed by the assessee for valuing inventory and therefore there is no mistake in the accounts which could be the subject matter of rectification u/s.154 of the Act. However, the AO, in my view, cannot take two different stands in two years in respect of one and the same issue. The AO holds the view for AY. 2006-07 that there is an uncalled for provision for loss in respect of closing stock, which should not be allowed. Here, for AY. 2006-07, I concede to the AO the right to make adjustment to the book profit of that year without providing justification to his right. However, as shown above, the book profit still would be a negative figure after such addition and the addition would have had no effect on the final tax. Now, when the AO comes to A.Y. 2007-08, he cannot hold the’ view that the addition to the closing stock for AY. 2006-07,which is also the opening stock for AY. 2007-08, did not represent addition on account of an uncalled for provision. If he could have made adjustment to the book profit for AY. 2006-07 on account of the addition, he should make adjustment to the book profit for AY. 2007-08. In other words, it is expected that the AO keeps his stand consistent for both the years.
3.0 Thus, in view of the above, the assessee is not liable to MAT for AY. 2007-08. MAT paid by it should be refunded.
Author’s Note:
There can be other angles to the issue. For example, it is a question whether the booking of reduction in value of stock in this case was a provision for a loss or was recognition of an actual loss. If it is a provision, the amended S. 115JB now may not permit reduction of the book profit by such amount, whereas if it is recognition of an actual loss, the provisions may permit reduction of the book profit. The issue discussed here also shows that it is advisable, in case the NRV of an inventory is less than the cost, that a separate provision is made by debiting the profit and loss account instead of reducing the closing value of the inventory in the trading account and recall such provision to the trading account in the next year and repeat the process every year. Thus, in case such a provision is disallowed u/s.115JB, its recall next year cannot form part of the book profit.
