Section 211, read with sections 209 and 642, of the Companies Act, 1956

Held Save and except the case of depreciation, which is to be provided by every corporate enterprise in accordance with the rates laid down in Schedule XIV, having regard to the provisions contained in sections 205 and 350, the Act does not lay down the procedure for recognition and measurement of either the income or the expenses and/or the assets and liabilities. [Para 30] Since the Act nowhere deals with the recognition and measurement of various items of income and expenses, assets and liabilities and it only deals with the presentation thereof, there can never be any conflict with the provisions of the Act on one hand and the Accounting Standard and Guidance Notes issued by the Institute, on the other hand, in discharge of its statutory obligation under the Chartered Accountants Act, 1949, read with the Companies Act, which clearly requires that every corporate enterprise must maintain such books for the purpose of giving the true and fair view of the state of affairs of the company and to explain its transaction, and that every balance-sheet of the company shall give a true and fair view of the state of affairs at the end of the financial year. [Para 31] In the instant case, it was sought to be argued on behalf of the petitioners that Part I of Schedule VI deals with recognition and measurement in respect of foreign exchange transactions. In this respect, particular reference was made to the ‘instruction in accordance with which assets should be made out’ appearing against the heading ‘Fixed assets’ in Part I of Schedule VI. The instruction indicated above says that where the original cost of a fixed asset, including additions and deductions thereto, relate to any fixed asset acquired from a country outside India, and in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or part of the cost of such asset, either by way of borrowing or otherwise, the amount by which the liability so increased or reduced during the year, shall be added to, or, as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset. Explanation (2) under the said instruction refers to the provisions of section 43A of the Income-tax Act, 1961, in respect of such matter. [Para 32] It is, therefore, clear that the said instructions, appearing under the heading ‘Fixed assets’ in Part I of Schedule VI, deal with presentation of fixed assets, which had been acquired from countries overseas, and the cost whereof undergoes a change consequent to a change in the rate of foreign currency. This reflection/presentation in the accounts is clearly based on the provisions of section 43A of the Income-tax Act, which lay down the special provisions consequential to the changes in the rate of exchange of currency. Further, the AS-22 is in no way contradictory to and/or in conflict with Schedule VI, having regard to the overall statutory requirement/consideration of reflecting true and fair view as laid down in section 211(1) and (2). Clause (vi) under paragraph 3 of Part II of Schedule VI deals with the amount of charge for the Indian income-tax and other Indian taxation on profits, including where practicable with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where practicable, between income-tax and other taxation. Therefore, the said clause (vi) also talks only about presentation of income-tax liability in the profit and loss account. It does not speak of the methods of its recognition and/or measurement, which aspects are dealt with only by the Accounting Standard, the AS-22. [Para 33] Therefore, there was no contradiction and the contention of the petitioners in this regard was devoid of any substance. [Para 34] The writ petitioners had next attacked the paragraph 33 of the AS-22 as unconstitutional on the ground that by this paragraph, the AS-22 appears to act retrospectively, which is not permitted, this being a subordinate legislation. However, there is nothing wrong with paragraph 33, as it does not make anything retrospective. [Paras 35 & 36] It appears that section 209(3)(b), as inserted in the statute book by the Companies (Amendment) Act, 1988 with effect from 15-6-1988, requires that the books of account of every corporate undertaking must be kept on accrual basis and according to the double entry system of accounting. In other words, if a company prior to the said amendment earned out in the year 1988, was maintaining its accounts on ‘cash basis’, it is required to convert the same to mercantile/accrual basis with effect from 15-6-1988. Therefore, the question is as to whether even after such amendment, a company can, for the period between 1-4-1988 and 15-6-1988, still maintain its accounts on cash basis. Further, question is as to whether it can be legitimately contended on behalf of a company that while maintaining accounts on mercantile basis, it would not record the opening balances of its assets and liabilities, since section 209(3)(b) does not specifically talk about retrospective application. If answer is given of those questions in favour of the company, the result will be that the accounts cannot be said to have been maintained on mercantile/accrual basis, and the balance-sheet and the profit and loss account drawn at the end of the relevant financial year, viz., 31-3-1989 cannot be said to represent true and fair view of the affairs, unless the company records all opening balances of its assets and liabilities, as existing, at least on 1-4-1988. In such cases, it cannot be said that section 209(3)(b) operates retrospectively, although the statute specifically talks about its operation only with effect from 15-6-1988. [Para 36.1] Therefore, there was no merit in the submissions made on behalf of the petitioners that paragraph 33 is ultra vires. [Para 37] The deferred tax liability is not a notional tax liability but a real liability because it will result in future cash outflow in the form of tax payment to the tax recovering authorities. For example, the depreciation on a fixed asset for the tax purposes is higher in comparison with the accounting depreciation under the Schedule XIV of the Act in the initial years in which the asset is used. This is because the rates of tax depreciation are primarily the incentive-rates and are not based on the useful life of the assets, which is the concept broadly followed in Schedule XIV. Thus, an asset under the Income-tax Act would be charged over a much shorter period as compared to the useful life of the asset. For instance, if the functional life of the asset is say 10 years, for taxation purposes, it may be written off fully over a period of say 4 years. Thus, in the first year in which the tax depreciation is higher than the accounting depreciation, the deferred tax-liability on the difference between the amounts of depreciation, i.e., the timing difference arises as it relates to the depreciation amounts for the year. It would become payable in future years when the timing differences reverses, i.e., the accounting depreciation becomes higher than the tax depreciation. It is, thus, important that a liability, which arises in the current year (i.e., the year in which timing difference arises) and is payable in a future year, is not a future liability. A future liability arises in a future period, whereas the deferred tax liability arises in the current year, in which the timing difference originates, i.e., during the year the difference in the tax depreciation and accounting depreciation arise. The deferred tax liability, therefore, exists on the balance sheet date for the financial year in which it originates. The deferred tax liability is, therefore, a real liability and not a notional liability. A notional liability is not payable in future, whereas the deferred tax liability arises in current financial year, but is payable in a future financial year. [Paras 40 and 40.1] Regarding the contention of the petitioners that the deferred tax liability is a contingent liability because it may or may not arise in future, it may be noted that the deferred tax liability actually arises in the financial year in which the timing difference originates. Therefore, the question of liability being contingent in nature does not arise. A ‘contingent’ liability becomes a liability on happening or not happening of an uncertain event in future. Deferred tax liability is not contingent, as it does not arise in future on happening or not happening of a future event. There is, thus, a difference in a liability arising in future or contingent on a future event and a liability, which exists today but payment in respect of which is to be made in future. Any existing liability, which is payable in future, is not a future liability or a contingent liability. Deferred tax liability is of this nature, as it is an existing liability on the balance-sheet date. [Para 40.2] The petitioners’ argument that the liability may or may not arise in future on the basis that it may not reverse in future was also not correct because the reversal of the timing difference in respect of an asset is definite over the life of the asset. In view of this, there is no uncertainty with regard to the reversal of the timing difference in future. Regarding the contention of the petitioners that the asset may be destroyed or disposed of before the timing difference reverses, the answer is that the accounts of a company are prepared under the fundamental accounting assumption of ‘going concern’, which is defined in AS -1, Disclosure of Accounting Policies, issued by the Institute of Chartered Accountants of India. [Para 40.3] The deferred tax liability is, therefore, a liability for the current period, i.e., for the period in which the timing difference originates on the basis of the matching concept (which is very much a part of accrual basis of accounting). [Para 40.4] Therefore, the charge of deferred tax expense in the profit and loss account is in respect of a known liability, which is definitely payable in future and, therefore, is fully covered by the definition of the expression ‘provision’ as contained in Part III of Schedule VI. [Para 41] The submission made on behalf of the petitioners, to the effect that if the provision for deferred taxes is made and reflected in the final accounts, the banks and financial institutions would start recalling their loans, was inconsequential, as the sole object of the Rules is to implement the object of the statute that the true and fair view of the affairs of the companies should be reflected from their balance-sheet lest anybody is deceived by the apparent balance-sheet of the company, which does not show the true and fair view. The object of the Rules is to enable not only the bank and other financial institution to discover the ‘real health’ of the company to whom it proposes to lend money, but also to give the true and fair view of the affairs of the company to those persons who wish to invest money in the said company or to enter into the business relationship with the same. [Para 42] On consideration of the entire materials on record, it was found that the Rules framed by the Central Government were quite in conformity with the intention reflected in the Act; therefore, the writ applications were to be dismissed. [Paras 55 & 56]