Query No. 10
Subject: Accounting for disputed entry tax.1
A. Facts of the Case 1. A company (hereinafter referred to as ‘the company’) is engaged in manufacturing and selling of precured tread rubber and allied products which are used for retreading of tyres. The company has its manufacturing unit in Himachal Pradesh (hereinafter referred to as ‘the State’). The shares of the company are listed on Bombay and Delhi Stock Exchanges. Given below is the summary of audited financials of the company: Six Months ended 30th September, 2011 Year Ended 31st March, 2011 Turnover 10,212.35 14,946.74 Profit before Tax (PBT) 1,170.62 1,364.58 Profit after Tax (PAT) 905.66 1,075.25 2. The querist has stated that the Legislative Assembly of the State has passed “The Himachal Pradesh Tax on Entry of Goods into Local Area Act, 2010” (hereinafter referred to as ‘the Act’). This Act applies to all local areas within the State. Under this Act, every dealer who brings any goods into local area for use in manufacturing or processing of goods, is liable to pay entry tax at the rate indicated in Schedule II of Entry Tax Act. The industries of the State have filed writ petition before the Hon’ble High Court of the State challenging the constitutional validity of the Act. The querist has also pointed out that several similar matters are pending before the 7-Judges Constitution Bench of the Hon’ble Supreme Court of India. Details of the case are given hereunder: (i) The State Government has passed the Act with effect from 7th April, 2010. Entry tax was levied only on specified 13 items, as mentioned in Schedule II of the Act, viz., Diesel, Furnace oil and lubricants (7%), Explosives (5%), Iron and Steel (4%), Cement (5%), etc. (ii).The State Government amended the Schedule II vide Notification No. EXN-F(10)-2/2010 dated 24th January, 2011 and a new item (Sl. No. 14) was inserted to impose 2% entry tax on all industrial inputs, raw materials and packing materials brought from outside the State for consumption, for use in manufacturing including contract manufacturing, processing, conversion, jobwork, assembling or for sale. Therefore, from 24.1.2011, the State Government imposed 2% entry tax on all goods across the board brought into the local area falling within the municipality limits. (iii) Consequently, the company had filed a civil writ petition before the Hon’ble High Court of the State challenging constitutional validity of the above levy. (iv) Hon’ble High Court has issued an interim order dated 16th March, 2011, referring the Supreme Court judgment SLP (C) No. 14454-14778/2008, State of Orissa and others vs. Reliance Industries Ltd. and others dated 3.2.2010, and directed to pay 1/3rd of the assessed amount in cash and furnish security for the balance 2/3rd amount. As per the order, the deposit of 1/3rd and 2/3rd security of the assessed amount will be made only after the assessment order is served on the company. (v) Hon’ble High Court had made it clear that the amount, thus paid by the company, shall be treated as deposit and not as tax till the final disposal of the matter. It is also made clear that in the event of the State losing its case, it shall be liable to refund the amount with interest to be fixed at the time of final hearing. Similarly, in case the company loses its case in the High Court, it shall be liable to pay the balance amount with interest to be fixed at the time of final hearing. (vi) The State Government has further amended Schedule II vide Notification No. EXN- F(10)-2/2010 dated 13th July, 2011 and reduced rate of entry tax from 2% to 1% on all industrial inputs, raw materials and packing materials brought from outside the State for consumption, sale or use in manufacturing. (vii) As per the querist, the company has not provided for the entry tax but is disclosing the same as contingent liability in the books of account. But the statutory auditors are insisting to make to provision against the entry tax otherwise they will qualify their report to this effect. Company’s view point 3. In view of the interim order of the Hon’ble High Court, the entry tax payments have been treated as ‘deposits’ upto 1/3rd amount deposited with the State Government under ‘Recoverable’ in the books of account and shown as contingent liability for 100% value of entry tax. However, the following disclosure was made under point no. 9 of the Notes to Accounts forming part of audited accounts for the quarter ended 30th September, 2011: “The company had obtained a stay of the State Government order levying entry tax @ 2% on all goods entering the state with effect from 24th January, 2011. The Hon’ble High Court while staying the levy in an interim order, directed the company to deposit 1/3rd of the assessed amount as “deposit” with the State Government and furnish bank guarantee for the balance 2/3rd amount to them. Since the cash payment as per Court order is in the nature of deposits, no amount has been charged to the accounts as entry tax. The estimated amount of entry tax upto 30th September, 2011 is Rs. 1,13,98,000. However, the cash deposited so far is Rs. 15,36,000 and bank guarantee furnished is for an amount of Rs. 57,96,000”. (Emphasis supplied by the querist.) The querist has stated that the company was required to deposit Rs. 37,99,235 in cash and furnish bank guarantee of Rs. 75,98,468 against estimated amount of entry tax of Rs. 1,13,97,703 upto 30.09.2011. However, the cash deposit was Rs. 15,35,739 (1/3rd of assessed amount of entry tax upto 31.05.2011) and bank guarantee was Rs. 57,96,575 (2/3rd of assessed amount of entry tax upto 31.07.2011) upto 30th September, 2011. 4. The company’s viewpoint is based on Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the Institute of Chartered Accountants of India (ICAI) and an earlier opinion of the Expert Advisory Committee (EAC) of the ICAI finalised on 28.04.2005 (published as Query No.11 of Volume XXV of Compendium of Opinions), a copy of which has been provided by the querist for the perusal of the Committee, as below: (i) Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’: A clear distinction has been made between liabilities for which a ‘Provision’ needs to be made and the liabilities which require disclosure as ‘Contingent Liabilities’. Where it is more likely than not (probable) that a present obligation exists at the balance sheet date, the enterprise recognises a provision and where it is more likely that no present obligation exists (possible) at the balance sheet date, the enterprise discloses a contingent liability, unless the possibility of an outflow of resources embodying economic benefits is remote. (ii) Opinion of the EAC of the ICAI: The company’s view is also in line with the above-mentioned opinion of the EAC on provision for disputed income tax/interest demand. Moreover, the accounting policy of the company is not to make any provision in respect of taxation cases which are in appeal and is to disclose them as a contingent liability. (iii) Doctrine of unjust enrichment: The querist has further emphasised that in addition to the above facts, doctrine of unjust enrichment might also be invoked if the company decides to make a provision and charge-off the entry tax as revenue expenditure in the books of account: (a) The refund provision of section 28 of the State VAT Act, 2005, applies, mutatis mutandis to refund of entry tax. In case, the High Court decides the matter in favour of the company holding the levy of entry tax on all goods as unconstitutional, the company will be entitled to claim refund of the entry tax so paid with interest that the High Court may fix at the time of final hearing. In that case, the company will have to claim refund of entry tax under section 12 of the Act read with section 28 of the State VAT Act, 2005. While processing the application for refund, the VAT authorities may examine the applicability of doctrine of unjust enrichment and probe whether the company has passed on the incidence of entry tax to their buyers as entry tax or in some other form. The above doctrine can be invoked to deny refund to which the company is otherwise entitled. (b) As per the doctrine, if a person has collected tax from his customer directly or indirectly through pricing or in any other form, refund if granted by the Government to that person will amount to double benefit which is unjust. In such a case, the refund can be denied to the person on the application of principle of unjust enrichment. (c)The Hon'ble Supreme Court, in the case of Sahakari Khand Udyog Mandal Ltd. Vs. Commissioner of Central Excise & Customs – 2005 (181) ELT 328 (S.C.), held that even if there is no statutory provision in any law, it is incumbent upon the applicant to prove that he has paid the amount for which relief is sought, he has not passed on the burden to the consumers and if such relief is not granted, he would suffer loss. The Supreme Court further, inter alia, held that the doctrine of unjust enrichment arises when the retention of benefit is considered contrary to the justice or against the equity. The juristic basis of the unjust enrichment is not based on any contract or tort but upon a third category of law, namely, quasi-contract or doctrine of restitution. (d)There are series of judgments of Tribunals, High Courts and Supreme Court and in various other judgments, the management of the company is afraid that at the stage of claiming refund of entry tax, the Department would apply the doctrine of unjust enrichment and ensure that refund is not allowed to the company in case it has passed on the incidence of entry tax to its customers by way of pricing of its final product manufactured out of inputs on which entry tax is levied. It is a settled law that the doctrine of unjust enrichment is applicable even in respect of duty or tax paid on raw materials used within the factory in the manufacture of some other product. (e)In case the amount so paid by the company under interim order of the High Court is treated as deposit or entry tax recoverable from the Government, the company can plead that it has not considered the entry tax payment as part of cost of production and hence, not recovered the incidence of entry tax payment from its customers. Therefore, the doctrine of unjust enrichment would not apply. (f)There are several Supreme Court/Tribunal judgments where assessee has been denied for refund, some of them are given below: (i)Sahakari Khand Udyog Mandal Ltd.Vs.Commissioner of Central Excise & Customs – 2005(181) ELT 328 (S.C.) (ii)State of Maharashtra & Others Vs. Swanstone Multiplex Cinema (P) Ltd. reported in 2009 (24) VST 552 (S.C.) (iii)Jaipur Syntex Limited Vs. Commissioner of Central Excise, Jaipur – 2002 (143) ELT 605 (Tri. Del.) (iv)Chambal Fertilizers & Chemicals Limited Vs. Commissioner of Customs (Import), Mumbai – 2006 (200) ELT 231 (Tri. Delhi) (v)MRF Limited Vs. Commissioner of Customs (Port), Kolkata – 2008 (225) ELT 246 (Tri.-Kolkata 5.The querist has further stated that the company has also examined the annual reports of some renowned companies for the financial year 2010-11, wherein similar types of issues are appearing. In one case, the company has given the disclosure in its notes to accounts on the matter of State levying tax on mineral bearing land. However, the statutory auditors have not even disclosed the above liability in the Companies (Auditor’s Report) Order, 2003 (CARO). Thus, neither the companies have made the provision against the State levy where the constitutional validity of the Act is under challenge before the Apex Court nor the auditors have qualified the audit report to this effect. The company had also obtained the legal opinion from three consultants/advocates on the matter. They have also confirmed the viewpoint of the company. 6. Auditor’s viewpoint: The auditor has stated that as per internal policy of his Firm, any liability arising out of interpretation of constitutional validity of any Act should be provided for in the books of account otherwise a qualification note is to be given in the audit report of the company. 7. As per the querist, considering the stand taken by auditor, if the company provides for entry tax in the profit and loss account, following implications would arise: a. Doctrine of unjust enrichment would arise even if the case is decided in favour of the company. Thus, the company would loose 1/3rd deposit amount as well as the department might ask to deposit the balance 2/3rd amount against the entry tax as the company has already recovered this amount. b. Company will not get any deduction in the income tax against the provision of entry tax made in the books of account. Accordingly, since the company will be looser on all fronts, it does not see any reason for making the provision against entry tax levy which has not been held constitutionally valid so far and the petition is pending for final adjudication in Hon’ble Supreme Court. 8. The querist has further stated that since the company has not made the provision for entry tax in the books of account but has shown as contingent liability in the notes to accounts (full disclosure has been made), the statutory auditors of the company are qualifying the audit report to this effect. B. Query 9. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether the statutory auditors of the company are justified in qualifying the audit report. C.Points considered by the Committee 10. The Committee notes that the issue raised by the querist in paragraph 9 above is whether the statutory auditors of the company are justified in qualifying the audit report due to the company not recognising provision for disputed entry tax. The Committee is of the view that to express an opinion on the financial statements is the prerogative of the auditor. Therefore, the issue being answered by the Committee is restricted to whether in the extant case, the company should recognise a provision or disclose only a contingent liability in respect of disputed entry tax. The Committee has also not examined any other issue that may arise from the Facts of the Case, e.g., calculation of the amount as per the Act, treatment and disclosure of amount paid to the State Government under the interim order of the High Court, determination of amount to be recognised as provision or contingent liability for entry tax, etc. Further, the Committee wishes to point out that its opinion is expressed purely from accounting point of view and the Committee does not undertake any legal interpretations, such as, interpreting the provisions of Income-tax Act, 1961, Doctrine of Unjust Enrichment, etc. 11. The Committee notes that Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, notified under the Companies (Accounting Standards) Rules, 2006, defines the terms, ‘provision’, ‘liability’, ‘contingent liability’, ‘present obligation’ and ‘possible obligation’ as follows: “10.1 A provision is a liability which can be measured only by using a substantial degree of estimation. “10.4 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.” “10.6 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. 10.7 Possible obligation - an obligation is a possible obligation if, based on the evidence available, its existence at the balance sheet date is considered not probable.” 12. 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; 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 Standard, 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).” The Committee notes on a perusal of the interim order passed by the High Court in the case of the company that the Court has taken note of the similar matters pending before the Supreme Court, challenging constitutional validity of the levy of entry tax and has directed the company to pay 13rd of the liability to the State Government which “shall be treated as a deposit and not as tax...”. The Committee is of the view that the direction of the Court that the amount deposited shall not be treated as tax but as a deposit implicitly means that it is refundable in case the decision is in favour of the company. The Committee, therefore, feels that there is adequate ground to support the contention of the querist that there is no present obligation to pay tax. In this regard, the Committee also notes that paragraph 10.4 of AS 29 states that “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…”. The Committee is of the view that in the extant case, there is a possible obligation that arises from the past event of the entry of the goods into the State and whether this will result in outflow of economic resources through payment of tax would depend on the outcome of the Court’s judgement, which is an uncertain future event not wholly within the control of the enterprise. Therefore, the possible obligation that could arise would qualify for being considered as a contingent liability. As such, the approach adopted by the company as mentioned in paragraph 2 above, viz., not providing for the entry tax in the books of account but disclosing the same as contingent liability in the financial statements is correct. This view is based on the prevailing facts and circumstances as mentioned in the query. It may be pointed out that assessment of provision or liability should be reviewed at the date of every subsequent financial statement. 13.The Committee notes that querist has referred to an earlier opinion of the EAC in paragraph 4 above, which is stated by the querist to be supporting the company’s accounting treatment in the extant case and a copy of which has been provided by the querist for the perusal of the Committee. Further, the Committee notes that the said opinion of EAC has not been reproduced correctly and in entirety. The Committee is of the view that this opinion is distinguishable and does not strictly support to disclose a disputed liability as only a contingent liability. The said opinion, has however, been taken into consideration in reaching the conclusion as given hereunder. D. Opinion 14.On the basis of the above, the Committee is of the opinion that based on all facts and circumstances, it cannot be considered probable (i.e., more likely than not) that a present obligation exists for the company. Hence, the amount of disputed entry tax should be disclosed as a contingent liability as discussed in paragraph 12 above. Further, assessment of liability or contingent liability should be reviewed at the date of every subsequent financial statement. ______________________________ |
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