1.14 Query: Provision for income-tax demands, applicability of Accounting Standard (AS) 4.
1. A public limited company, engaged in the manufacture of chemicals and pharmaceuticals, has been consistently following, as per the querist, a prudent and well accepted policy of making provisions for income-tax for years where the income has been assessed by the tax authorities on the basis of the assessed income and the demand raised by the tax authorities. As per the querist, this policy, is based on the view that the assessed tax liabilities are statutory demands and hence, crystallised liabilities. Accordingly, provisions are made irrespective of the fact that the company has preferred an appeal in respect of disputed issues before the concerned Appellate Authorities on what the company believes to be bonafide and valid grounds. Where the company succeeds in an appeal, the tax provision made in respect of the matters allowed in appeal is reversed. In case the tax authorities file a further appeal against such appellate order in favour of the company, the amount of the tax involved is disclosed as contingent liability. The policy followed has also been clearly disclosed in the Summary of Significant Accounting Policies in the notes to the company’s financial statements for the year ended 31st March, 1993.
2. As per the querist, an alternative view has been expressed that the issues in appeal are contingencies in terms of Accounting Standard (AS) 4 issued by the Institute of Chartered Accountants of India on “Contingencies and Events Occurring After the Balance Sheet Date”, and should be provided for only if it is probable that the subsequent events will confirm that the liability has been incurred. The querist has also drawn the attention of the Committee to one of its earlier opinions* in this regard. Where the Expert Advisory Committee has opined that it is not necessary to provide for the tax liability that has been contested on bonafide and valid grounds.
3.As per the querist, statutory tax demands are crystallised liabilities and, accordingly, the question of a contingency occurring does not arise. Also, there is a vital difference between a final assessment order and a show cause notice. In the case of a show cause notice, a contingency would arise because of the fact that the demand may or may not arise depending upon the final order that may be passed in respect of the show cause notice. No such contingency, however, exists where a final demand is assessed by the Income-tax Department because such a demand creates a crystallised liability. The querist has further stated that it is not for the company or its auditors or its tax advisors to sit in judgement as to whether a demand is valid and bonafide or as to what would be the outcome of the appeal preferred. Further, a crystallised demand, and accordingly, the liability arising therefrom, will only get cancelled if the competent appellate authority decides the matter in favour of the company. This view, as per the querist, is supported by the Supreme Court’s decision in Kedarnath Jute Mfg. Co. Ltd. vs CIT (82 ITR 363), where the Supreme Court has stated “that a liability did not cease to be a liability because the assessee had taken proceedings before higher authorities for getting it reduced or wiped out so long as the contention of the assessee did not prevail”. As per the querist, the Supreme Court dictum lays down the law of the land and has to be respected. The querist has also pointed out that in paragraph 3 of its opinion, referred to in para 2 above, the Expert Advisory Committee had opined that it is not necessary to provide for tax liability that has been contested on bonafide and valid grounds. It, however, does not say categorically that “no provision should be made”. This, as per the querist, would rather imply that it is optional, based on the management’s best assessment. Also, in the view of the querist, given the uncertainties in the tax laws, a prudent policy for providing for all crystallised tax demands is correct.
4. The querist has further stated that according to clause (2)(b) of Part III of Schedule VI to the Companies Act, 1956, where any amount retained by way of providing for any known liability is in excess of the amount, which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this schedule as a reserve and not as a provision. As per the querist, it is, thus, quite clear that it is for the directors of a company to form an opinion as to whether it is reasonably necessary to provide for a known liability for crystallized tax demands should be made and, accordingly, the prudent policy of making provision for such demands is quite justified.
5. The querist has sought the opinion of the Expert Advisory Committee as to whether Accounting Standard (AS) 4 on ‘Contingencies and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered Accountants of India is applicable in a case where the company follows a policy of providing for all crystallised tax demands as described in para 1 above.
Opinion June 13, 1994
1. The Committee notes that Section 211 of the Companies Act, 1956, inter alia, requires that “Every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year”, and “Every profit and loss account of a company shall give a true and fair view of the profit or loss of the company for the financial year.”
2. The Committee also notes paras 4 and 9 of Statement on Standard Auditing Practice (SAP) 2 on “Objective and Scope of the Audit of Financial Statements” issued by the Institute of Chartered Accountants of India, which read as follows:
“4. While the auditor is responsible for forming and expressing his opinion on the financial statements, the responsibility for their preparation is that of the management of the enterprise. Management’s responsibilities include the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies and the safeguarding of the assets of the enterprise. The audit of the financial statements does not relieve management of its responsibilities.
9. The auditor’s work involves exercise of judgement, for example, in deciding the extent of audit procedures and in assessing the reasonableness of the judgements and estimates made by management in preparing the financial statements. Furthermore, much of the evidence available to the auditor can enable him to draw only reasonable conclusions therefrom. Because of these factors, absolute certainty in auditing is rarely attainable.”
3. The Committee is of the view on the basis of the above that primarily it is the responsibility of the management to select such accounting policies that the accounts prepared on the basis thereof reflect a true and fair view of the financial position and operating results of the enterprise. Accordingly, in case of a specific liability for taxation, it is for the management of the company to decide, considering all the relevant facts and circumstances, whether the liability is absolute or contingent one; and whether any provision is required for the same or not. The Committee is further of the view that the statutory auditor of the company, who has to form an independent opinion on the truth and fairness of the financial statements, has the responsibility to form an independent opinion which may or may not agree with the assessment of the management.
4. On the basis of the above, the Committee is of the opinion that where it is considered that a tax demand is a crystallised liability and a provision for taxation is made accordingly, AS-4 issued by the ICAI would not be applicable. However, in this situation, if the auditor considers that the provision for taxation is excessive and such excess is material in amount, he should qualify his report to this effect. ____________________________
* Vide query no. 1.7, Compendium of Opinions, Volume III, published by the Institute of Chartered Accountants of India. |