1.7       Query

Disclosure of disputed tax liability in the final accounts.

The querists sought the opinion of the Expert Advisory Committee in the context of its opinion published in the Institute’s Journal ‘The Chartered Accountant’ (Volume XXX  No. 7 of January, 1982) on the following issues:

         (i)         Whether mere contestation of the income-tax liability on valid and bonafide grounds would make such a liability a   contingent one so that it is not considered a charge against the profits in view of the fact that the assessing officer, acting within his jurisdiction and the four corners of law, has imposed the statutory liability and whether the contingency attaches to the liability or to its abatement by appellate or revisional forums (The querists considered the latter more correct).

         In this connection, the querists have drawn the attention of the Committee to the Supreme Court’s decision in Keddernath          Jute Manufacturing Co. Ltd. V. CIT (82 ITR 363) wherein the Court observed that “a liability does 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 does not prevail.”

         (ii)        In case the liability in question is disclosed by way of a note to the accounts and dividend is declared without taking cognizance of this liability, whether such a distribution of profits is out of capital if the company does not possess adequate reserves to cover such a liability. Further, even if there are adequate reserves to cover such a liability, will it not mean that the company is utilising its accumulated resources for distribution of dividends without complying with the requirements of Section 205 A (3) of the Companies Act, 1956 and the rules framed by the Central Government in this respect.

Opinion                                                                                                                 February 28, 1983

1. The Committee notes 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 a contingent liability and disclosed by way of a note to the accounts. Paras 10 and 11 of the Accounting Standard –4--- “Contingencies and Events Occurring After the Balance Sheet Date” state as follows:

“10.            The amount of a contingent loss should be provided for as a charge in the statement of profit and loss if:

         (a)        it is probable that at the date of the financial statements events subsequent   thereto will confirm that (after taking into          account any related probable recovery) an asset has been impaired or a liability has been incurred as at that date, and

         (b)        a reasonable estimate of the amount of the resulting loss can be made.”

“11.The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of loss is remote.”

2.The Committee is of the view that where a company disputes its liability on valid and bonafide reasons in regard to the tax demands raised, it is not ‘probable’ that a liability has been incurred on the balance sheet date. In deciding what can be the valid and bonafide grounds for contesting a liability, regard must be had to the circumstances of each case, e.g., there is a decision of a higher court supporting the contention of the company, or a retrospective amendment of law has been made which goes in favour of the company.

3.The Committee is therefore of the opinion that where a tax liability has been contested on bonafide and valid grounds, it is not necessary to provide for the liability, but a disclosure thereof must be made by way of a note to the accounts as required by para 11 of the aforementioned Accounting Standard. This view is also supported by the Institute’s “Statement of Auditing Practices” (Para 9.10,Chapter 9). It follows that where a tax liability has been contested without valid or bonafide grounds, a provision against such liability should be made.

4.Regarding the second point raised by the querists, the Committee notes that Section 205 of the Companies Act, 1956 does not require the deduction of contingent liabilities for the computation of divisible profits. The Committee is therefore of the opinion that the disputed tax liability, where shown by way of a note to the accounts on the considerations described in paras 2 and 3 above, need not be deducted for computing the divisible profits whether or not the company possesses adequate reserves to cover such a liability.