2.6 Query:          

  Issues relating to section 115J of the Income-tax Act, 1961.

1. A deemed public limited company under section 43A of the Companies Act, 1956, is closely held domestic company under the provisions of the Income-tax Act 1961. Since the inception, the company has not declared any dividend. There are no reserves in the books of the company other than Capital Reserve and Investment Allowance Reserve. Its profit and loss account for the year ended 31^st March, 1989, and 31^st March, 1990, are as follows:

Profit & Loss Account for the year ended 31.03.1989

 Profit &Loss Account for the year ended 31.03.1990

 2.  It is the practice of the company to create Investment Allowance Reserve in the year in which machineries are installed.

3. A dispute has arisen in the computation of book profit for the purpose of section 115J of the Income-tax Act, 1961, for the previous year ending 31.03.90 insofar as it relates to deduction allowable under sub-section (1A)(iv) of the section. The Income Tax Department, relying upon Circular No. 495 dated 22.09.87, issued by the Central Board of Direct Taxes, contends that no deduction is permissible under section 115J(1A)(iv) as there is profit before depreciation for the year ended 31.03.1989.

4.  The contention of the assessee company, relying upon the illustration given in Final Study Material of Auditing (FSP AUD-3) issued by the Institute of Chartered Accountants of India, is that loss means loss after providing for depreciation.

5. The relevant provisions of section 115J are as under:

                                    “The book profit has to be reduced by –

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 (1 of 1956) are applicable.”

6.Clause (b) of the first proviso to section 205(1) states: -

“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.”

7. According to the querist, the illustration given in the Final Study Material (FAP AUD-3) is contrary to the views expressed by the CBDT in the illustration given in the Circular under reference.

8.The querist has referred the following issues for the opinion of the Expert Advisory Committee:

(a) What is the true meaning of the word “loss” appearing in clause (b) of the first proviso to section 205(1) of the Companies Act, 1956:

            (b)  In particular-

                                                (i)            Is it loss of the previous year prior to depreciation?

                                                (ii)            Is it loss of the previous year after depreciation?

(iii) Is it loss after depreciation, provision for taxes and Investment Allowance Reserve?

(iv) Should surplus carried forward from the earlier year be deducted from such loss?

                                                                                                 Opinion                     May 2,1991

1.   The Committee is of the view that the terms ‘profit’ and ‘loss’ used in Companies Act, 1956 denote ‘profit after depreciation and tax’ and ‘loss after depreciation and tax’, respectively. The true and fair view of the ‘profit’ or ‘loss’ of a company can be ascertained only after providing for depreciation and income-tax. Hence, the term ‘loss’ referred to in clause (b) of the first proviso to sub-section (1) of section 205 of the Companies Act, 1956, means ‘loss after providing for depreciation’.

2.  The Committee is also of the view that if for purposes of clause (b) of the first proviso to sub-section (1) of section 205, the term ‘loss’ is taken to mean ‘loss before depreciation’, then the depreciation for the previous financial years may not get set off against the profits of the company before it declares dividend as is clear from the following situations and that will go against the objective of section 205 which requires adjustment of depreciation before declaration of dividend.

3. The Committee is also of the view that creation of a reserve is an appropriation of profits and is not a charge against the profits. The investment allowance reserve is required to be created only in case an assessee intends to claim deduction under section 32A of the Income-tax Act, 1961. The Committee is, therefore, of the view that the term “loss” referred to in clause (b) of the first proviso to sub-section (1) of section 205 of the Companies Act, 1956, means the ‘loss before Investment Allowance Reserve’.

4.            The Committee is accordingly of the following opinion in respect of issues raised in paragraph 8 of the query:

(a) The word “loss” appearing in the clause (b) of the first proviso to section 205(1) means the ‘loss after depreciation and tax’.

       (b)  (i)        Same as (a) above.

                                                (ii)          Same as (a) above.

(iii) The loss referred to in (a) above is loss after depreciation and income-tax. Investment allowance reserve is not to be considered for the purpose of computing the loss.

(iv) The surplus carried forward from earlier years should be deducted from such loss.

                                                ___________________________