"Provision for Bad Debts Not a Provision for Liability, Cannot be Added Back Under Explanation to Section 115JA (of Income Tax Act, 1961).

The Department filed a civil appeal questioning whether the Assessing Officer (AO) was justified in adding back the provision for doubtful debts to the net profit under clause (c) of the Explanation to Section 115JA (of Income Tax Act, 1961). The case pertained to the Assessment Year 1997-98.

The assessee-company, engaged in trading in data communication equipment and satellite communication services, had debited an amount on account of bad debts to the profit and loss account. However, the AO treated it as a provision for bad and doubtful debts and added it to the book profits.

The CIT(A) allowed the assessee's appeal, a decision that was upheld by the Tribunal and the High Court. The Supreme Court quoted the relevant provisions of Section 115JA (of Income Tax Act, 1961) and the Explanation, which defines the expression "book profit." It noted that Section 115JA (of Income Tax Act, 1961) has an overriding effect on other provisions of the Income-tax Act and applies only to companies.

The Court referred to its earlier decision in the case of Apollo Tyres Ltd. v. Commissioner of Income-tax, which clarified the powers of the AO in computing book profits. It held that the AO's jurisdiction is limited to examining whether the accounts are certified and maintained in accordance with the Companies Act. The AO cannot go beyond the net profit shown in the profit and loss account except as provided in the Explanation to Section 115JA (of Income Tax Act, 1961).

The Court specifically addressed Item No. (c) of the Explanation, which deals with provisions made for meeting liabilities other than ascertained liabilities. It emphasized that the provision for bad and doubtful debts in this case related to debt receivable by the assessee, not any liability payable by the assessee. Therefore, such a provision cannot be considered a provision for liability.

Based on this analysis, the Court concluded that Item (c) of the Explanation was not applicable to the present case. Consequently, the AO was not justified in adding back the provision for doubtful debts to the net profit under clause (c) of the Explanation to Section 115JA (of Income Tax Act, 1961).

Therefore, the civil appeal was dismissed with no order as to costs. The judgment was delivered on September 23, 2008.

Leave granted.

The short question which arises for determination in this

civil appeal filed by the Department is : whether AO was

justified in adding back the provision for doubtful debts of

Rs.92,15,187/- to the net profit under clause (c) of the

Explanation to Section 115JA (of Income Tax Act, 1961).

In this civil appeal we are concerned with the

Assessment Year 1997-98.

Assessee-company was engaged in trading in data

communication equipment and satellite communication

services. During the course of assessment proceedings, the

AO found that the assessee had debited an amount of

Rs.92,15,187/- on account of bad debts to the ‘profit and loss

account’. However, on the ground that it was a provision for

bad and doubtful debts, the AO added the aforestated amount

to the book profits as per Explanation (c) to Section 115JA (of Income Tax Act, 1961) of

the Income-tax Act, 1961 (“1961 Act”, for short).

On appeal, the CIT(A) allowed the assessee’s appeal.

That decision of CIT(A) stood affirmed by the Tribunal and also

by the High Court vide its impugned judgment dated 18.5.07

in ITA No.56 of 2007.

At the outset, we quote hereinbelow Section 115JA (of Income Tax Act, 1961) read

with clause (c) of the Explanation which defines the

expression “book profit” as under:

“Chapter XII-B

Special provisions relating to certain companies

Deemed income relating to certain companies

115JA. (1) Notwithstanding anything contained in any

other provisions of this Act, where in the case of an

assessee, being a company, the total income, as computed

under this Act in respect of any previous year relevant to

the assessment year commencing on or after the 1st day

of April, 1997 (hereafter in this section referred to as the

relevant previous year) is less than thirty per cent of its

book profit, the total income of such assessee chargeable

to tax for the relevant previous year shall be deemed to be

an amount equal to thirty per cent of such book profit.

(2) Every assessee, being a company, shall, for the

purposes of this section prepare its profit and loss account

for the relevant previous year in accordance with the

provisions of Parts II and III of Schedule VI to the

Companies Act, 1956 (1 of 1956) :

Provided that while preparing profit and loss account, the

depreciation shall be calculated on the same method and

rates which have been adopted for calculating the

depreciation for the purpose of preparing the profit and

loss account laid before the company at its annual general

meeting in accordance with the provisions of section 210 (of Income Tax Act, 1961) of

the Companies Act, 1956 (1 of 1956):

Provided further that where a company has adopted or

adopts the financial year under the Companies Act, 1956

(1 of 1956), which is different from the previous year

under the Act, the method and rates for calculation of

depreciation shall correspond to the method and rates

which have been adopted for calculating the depreciation

for such financial year or part of such financial year falling

within the relevant previous year.

Explanation.- For the purposes of this section, "book

profit" means the net profit as shown in the profit and loss

account for the relevant previous year prepared under sub-

section (2), as increased by-

(c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or

if any amount referred to in clauses (a) to (f) is

debited to the profit and loss account, and as

reduced by, -

From the above, it is evident that Section 115JA (of Income Tax Act, 1961) of the

1961 Act which refers to “deemed income relating to certain

companies” has an overriding effect upon other provisions of

the Income-tax Act. It is applicable only in the case of a

company. As per Section 115JA (of Income Tax Act, 1961), the AO has to first compute

the total income of the assessee as per the provisions of the

Income-tax Act. Thereafter, he has to compute 30% of the

book profit. Then he has to compare the total income as

computed as per the provisions of the Income-tax Act with

30% of book profit computed as per Section 115JA (of Income Tax Act, 1961). If 30% of

the book profit is more than the total income, then 30% of the

book profit shall be deemed to be the “total income” of the

assessee for such previous year. As per sub-section (2), the

assessee has to prepare the ‘profit and loss account’ for the

relevant previous year in accordance with the provisions of

Parts II and III of Schedule VI to the Companies Act. The

Explanation defines the words “book profit” which means “net

profit” as shown in the profit and loss account for the relevant

previous year. Such book profit has to be increased by Item

Nos.(a) to (f) of the said Explanation if they are debited to the

profit and loss account and from such profit Item Nos.(i) to (ix)

of the Explanation are to be reduced. The figure arrived at

after the above exercise is the book profit of the assessee for

the relevant previous years.

This Court has examined the powers of the AO while

computing the book profits for the purposes of Section 115J (of Income Tax Act, 1961) in

the case of Apollo Tyres Ltd. v. Commissioner of Income-

tax – [2002] 255 ITR 273 (SC) which reads as under:

“The Assessing Officer, while computing the book

profits of a company under Section 115-J (of Income Tax Act, 1961), has only the power of examining whether the books

of account are certified by the authorities under the Companies

Act as having been properly maintained in accordance with the

Companies Act. The Assessing Officer, thereafter, has the

limited power of making increases and reductions as provided

for in the Explanation to section 115J (of Income Tax Act, 1961). The Assessing Officer

does not have the jurisdiction to go behind the net profits

shown in the profit and loss account except to the extent

provided in the Explanation. The use of the words “in

accordance with the provisions of Parts II and III of Schedule

VI to the Companies Act” in section 115J (of Income Tax Act, 1961) was made for the

limited purpose of empowering the Assessing Officer to rely

upon the authentic statement of accounts of the company.

While so looking into the accounts of the company, the

Assessing Officer has to accept the authenticity of the accounts

with reference to the provisions of the Companies Act, which

obligate the company to maintain its accounts in a manner

provided by that Act and the same to be scrutinized and

certified by statutory auditors and approved by the company in

general meeting and thereafter to be filed before the Registrar

of Companies who has a statutory obligation also to examine

and be satisfied that the accounts of the company are

maintained in accordance with the requirements of the

Companies Act. Sub-section (1A) of Section 115J (of Income Tax Act, 1961) does not

empower the Assessing Officer to embark upon a fresh enquiry

in regard to the entries made in the books of account of the

company.”

From the above, it is evident that the AO has to accept

the authenticity of the accounts maintained in accordance

with the provisions of Part II and Part III of Schedule VI to the

Companies Act, which are certified by the Auditors and

pressed by the company in the general meeting. The AO has

only the power of examining whether the books of accounts

are duly certified by the authorities under the Companies Act

and whether such books have been properly maintained in

accordance with the Companies Act. The AO does not have

the jurisdiction to go beyond the net profit shown in the profit

and loss account except to the extent provided in the

Explanation. Thereafter, the AO has to make adjustment

permissible under the Explanation given in Section 115JA (of Income Tax Act, 1961) of

the 1961 Act. It may be noted, that the adjustments required

to be made to the net profit disclosed in the profit and loss

account for the purposes of Section 349 of the Companies Act

are quite different from the adjustment required to be made

under the Explanation to Section 115JA of the 1961 Act. For

the purposes of Section 115JA (of Income Tax Act, 1961), the AO can increase the net

profit determined as per the profit and loss account prepared

as per Parts II and III of Schedule VI to the Companies Act

only to the extent permissible under the Explanation thereto.

As stated above, the said Explanation has provided six

items, i.e., Item Nos.(a) to (f) which if debited to the profit and

loss account can be added back to the net profit for computing

the book profit. In this case, we are concerned with Item No.

(c) which refers to the provision for bad and doubtful debt.

The provision for bad and doubtful debt can be added back to

the net profit only if Item (c) stands attracted. Item (c) deals

with amount(s) set aside as provision made for meeting

liabilities, other than ascertained liabilities. The assessee’s

case would, therefore, fall within the ambit of Item (c) only if

the amount is set aside as provision; the provision is made for

meeting a liability; and the provision should be for other than

ascertained liability, i.e., it should be for an unascertained

liability. In other words, all the ingredients should be satisfied

to attract Item (c) of the Explanation to Section 115JA (of Income Tax Act, 1961). In our

view, Item (c) is not attracted. There are two types of “debt”.

A debt payable by the assessee is different from a debt

receivable by the assessee. A debt is payable by the assessee

where the assessee has to pay the amount to others whereas

the debt receivable by the assessee is an amount which the

assessee has to receive from others. In the present case

“debt” under consideration is “debt receivable” by the

assessee. The provision for bad and doubtful debt, therefore,

is made to cover up the probable diminution in the value of

asset, i.e., debt which is an amount receivable by the

assessee. Therefore, such a provision cannot be said to be a

provision for liability, because even if a debt is not recoverable

no liability could be fastened upon the assessee. In the

present case, the debt is the amount receivable by the

assessee and not any liability payable by the assessee and,

therefore, any provision made towards irrecoverability of the

debt cannot be said to be a provision for liability. Therefore,

in our view Item (c) of the Explanation is not attracted to the

facts of the present case. In the circumstances, the AO was

not justified in adding back the provision for doubtful debts of

Rs.92,15,187/- under clause (c) of the Explanation to Section

115JA of the 1961 Act.

For the aforestated reasons, there is no merit in this civil

appeal and accordingly the same is dismissed with no order as

to costs.

(S.H. Kapadia)

(B. Sudershan Reddy)

New Delhi;

September 23, 2008.