Query No. 11

Subject:

Provision for disputed income-tax/interest demands from Income-tax authorities in respect

of which appeals are filed with higher authorities.¹

A. Facts of the Case

1. A public sector undertaking is registered under the Companies Act, 1956. The Government has recognised it as a public financial institution under section 4A of the Act.

2. During the course of assessment proceedings under the Income-tax Act, 1961, certain disallowances/additions are made by the Assessing Officer and the demands are raised. Such demands are either paid by the company or are adjusted by the Income-tax (IT) authorities against the income-tax refund due to the company. In respect of disallowances/ additions, which are accepted by the company and are not contested/ appealed before the higher authorities, e.g., Income Tax Appellate Tribunal (ITAT), High Court, etc., necessary provision for the demand paid is duly made in the books of account of the company. However, in respect of the disallowances/additions which are contested before the higher authorities, the demands paid/adjusted are shown as advances under ‘income-tax/ interest payments subject to litigation’ under the ‘Schedule of Advances’.

3. The company has adopted the following accounting policy for making provision in respect of income-tax cases under appeal:

“In respect of disputed income-tax/interest/wealth tax demands, where the company is in appeal, provision for tax is made when the matter is finally decided.”

Further, in all such cases, the appeals are filed and, therefore, no provision is made in the books of account.

4. Keeping in view the above accounting policy, no provision in this regard is made by the company in the books of account. In addition, the following disclosure is made under ‘contingent liabilities not provided for’ in the notes forming part of accounts:

“Disputed income-tax/interest demands paid/adjusted, against which the company has gone in appeal in view of the facts of the cases/ opinion obtained – Rs. x crore.”

5. The querist has stated that during the course of audit of accounts for the financial year 2003-2004, the Comptroller and Auditor General of India (C&AG) has observed that the above accounting policy is against the principle of prudence as per Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, issued by the Institute of Chartered Accountants of India, and the company should have made provision for all known liabilities and losses.

6. In response to the C&AG’s query, the company has replied that no provision has been made since the appeals have been filed in these cases and the final decision is awaited. As regards the principle of prudence, it was submitted that the company has framed this policy since appeals are filed after giving due consideration to the past decisions of the appellate authorities, judicial pronouncements and opinions of tax experts and the company is hopeful to get full relief.

B. Query

7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the accounting policy adopted by the company of not making provision in respect of taxation cases which are in appeal is correct as per the generally accepted accounting practices and the principle of prudence.

(b) In case the accounting policy being followed is not correct, what should be the prudent accounting policy?

(c) Whether the disclosure under ‘contingent liabilities’ is correct in view of the fact that the demands raised by the income-tax authorities have been paid/adjusted.

C. Points considered by the Committee

8. The Committee, while expressing its opinion, has considered only the specific issues raised by the querist in paragraph 7 above and has not dealt with any other issue arising from the Facts of the Case, e.g., whether it is appropriate to disclose the amount of income-tax demands paid/ adjusted as advance, has not been considered by the Committee.

9. The Committee notes that Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the Institute of Chartered Accountants of India, defines the terms ‘provision’, ‘liability’, ‘contingent liability’ and ‘present obligation’ as follows:

“A provision is a liability which can be measured only by using a substantial degree of estimation.”

“A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”

“A contingent liability is:

(a) a possible obligation that arises from past events and the existence of which will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the enterprise; or

(b) a present obligation that arises from past events but is not recognised because:

(i) it is not probable that an outflow of resources embodying economic benefits will be required to settle the obligation; or
(ii) a reliable estimate of the amount of the obligation cannot be made.”

 

“Present obligation - an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not.”

10. The Committee further notes paragraphs 14, 15 and 22 of AS 29, which state as follows:

“14. A provision should be recognised when:

(a) an enterprise has a present obligation as a result of a past event;

(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.

 

If these conditions are not met, no provision should be recognised.

15. In almost all cases it will be clear whether a past event has given rise to a present obligation. In rare cases, for example in a lawsuit, it may be disputed either whether certain events have occurred or whether those events result in a present obligation. In such a case, an enterprise determines whether a present obligation exists at the balance sheet date by taking account of all available evidence, including, for example, the opinion of experts. The evidence considered includes any additional evidence provided by events after the balance sheet date. On the basis of such evidence:

(a) where it is more likely than not that a present obligation exists at the balance sheet date, the enterprise recognises a provision (if the recognition criteria are met); and

(b) where it is more likely that no present obligation exists at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).”

 

“22. For a liability to qualify for recognition there must be not only a present obligation but also the probability of an outflow of resources embodying economic benefits to settle that obligation. For the purpose of this Statement, an outflow of resources or other event is regarded as probable if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not. Where it is not probable that a present obligation exists, an enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote (see paragraph 68).”

11. The Committee notes from the above that an element of judgement is required to determine whether a disputed liability for income-tax should be provided for in the accounts or treated as contingent liability and disclosed by way of a note to the accounts. It is for the management of the enterprise to decide and for the auditor to assess, considering the circumstances of each case, whether the liability is absolute or contingent one; and, whether any provision is required for the same or not.

12. In the view of the Committee, where an enterprise disputes its liability on valid and bonafide reasons, e.g., on the basis of a past decision of a higher authority supporting the contention of the enterprise, or a retrospective amendment of law which goes in favour of the enterprise, or on the basis of the opinions of tax experts, etc., it is not ‘probable’ that a liability has been incurred on the balance sheet date and, accordingly, no provision is required as per the requirements of AS 29. Further, the Committee is also of the view that in determining whether a provision is required at the balance sheet date or not, events occurring after the balance sheet date but, before the date of finalisation of accounts, should also be taken into consideration. Where an enterprise does not provide for a disputed tax liability on the aforesaid grounds, the same should be considered as a contingent liability and a disclosure thereof should be made by way of a note to the accounts as required in paragraph 68 of AS 29.

D. Opinion

13. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7 above:

(a) The accounting policy adopted by the company of not making provision in respect of taxation cases which are in appeal would be correct if the demands have been contested on valid and bonafide grounds as stated in paragraph 12 above.

(b) In cases other than those covered in (a) above, provision therefor should be made.

(c) The disclosure under contingent liabilities would be correct if the non-provision for such demands is on the considerations stated in paragraph 12 above. The fact that the demands raised by the income-tax authorities have been paid/adjusted, has no relevance.

¹ Opinion finalised by the Committee on 28.4.2005