Expert Advisory Committee

Query No. 8

Subject:

Accounting for entry tax demanded by a State Government.1

A.  Facts of the Case

1.  A public sector undertaking (hereinafter referred to as ‘the company’) is a leading steel-making company in India having five integrated steel plants and three special steel plants located at different places in India. The company produces both basic and special steels for domestic construction, engineering, power, railways, automotive and defence industries as well as for sale in export markets. The turnover (gross) of the company in the financial year 2010-11 was about Rs. 47,100 crore.  It provides direct employment to about 1,10,000 people.

2. The company also owns iron ore mines, flux mines and coal mines located in various states. The company has the distinction of being India’s second largest producer of iron ore. The company is in the process of developing new iron ore and coking coal mines.

3.  Entry tax is being levied since the year 1976 by the Government of the then State of Madhya Pradesh in lieu of octroi. Initial rate of entry tax on major industrial inputs was ½% in Madhya Pradesh (the then State) which has been raised to 6% in the year 2001 after formation of the State of Chhattisgarh.

4. The querist has stated that upto August 2008, the steel plant of the company was paying entry tax at the full rate laid down in the Entry Tax Schedule and also at the rates (which are stated by the querist to be discriminatory) for  major industrial inputs (iron ore and coal), which the State of Chhattisgarh (hereinafter referred to as ‘the State’), exercising powers conferred on it under section 4A, has laid down on the area in which the plant of the company is located. The rates for iron ore and coal for steel plant of the company is 6% as against 3% for iron ore and 1% on coal for other areas in the State, respectively, as per the details given below:

5. The querist has further stated that a petition was filed in the Hon’ble High Court of the State in February' 07 challenging the constitutional validity and also the discriminatory rates of taxes, which the steel plant of the company was subjected to.

6. Due to slow progress of the case in the Hon'ble High Court of the State  which resulted  into heavy cash outflow and increase in  the input cost, Special Leave Petition (SLP) was filed with the Hon'ble Supreme Court in August, 2008 seeking relief from the discriminatory rates that the steel plant of the company has to suffer together with the prayer that entry tax was compensatory in nature like octroi (in lieu of which entry tax was enacted) and also challenged the constitutional validity of the Entry Tax Act.

7. As per the querist, since the filing of SLP in the Supreme Court in August, 2008, the demand amount of entry tax is being reflected as firm liability in the books. Interest on such liability is also being provided in the books as firm liability. The case is being heard regularly and as per the orders of the Hon'ble Supreme Court, from time to time, payments have been made to Commercial Tax Department of the State Government, ‘Under Protest’ and are reflected in the books as ‘Deposit with Government Department’.

8 The Hon'ble Supreme Court, in its order dated 9th February, 2010 stated, inter alia, as follows:

"What is being submitted is that administration of Entry tax in the State is highly discriminatory; certain private sector companies are being taxed at one per cent whereas government and public sector companies are being taxed at the rate of six per cent. The State is directed to explain this differential treatment.”

“The special leave petitions shall stand over for four weeks. In the meantime, the company will pay entry tax on month-to-month basis, henceforth, at the rate of three per cent [ad hoc] which comes to approximately rupees fifteen crore per month. One more facet needs to be mentioned. We do not want this order to be cited as a precedent because in the case of the company, there is one more feature which needs to be kept in mind. The company is managing the Municipal Township of the area in which the steel plant of the company is located at a considerable expense which facet does not exist in the case of other companies.”

“Before concluding, we may state that the amounts which the company will pay to the State will be treated as a deposit and not as tax. However, this will not prevent the State from utilising the said amount. The State will treat this amount as a deposit so that in future if the assessee succeeds, refund will not be denied on the ground of unjust enrichment.” (Emphasis supplied by the querist.)

 

9. Even if the steel plant of the company provided entry tax at 6% on coal and iron ore and for other items at the scheduled rate, payments of entry tax from January, 2010 (payable in February, 2010) have been made for 50% of the demand amount on account of entry tax on coal and iron ore as per the order of the Hon'ble Supreme Court and such payments have been made "Under Protest".

10.The Order also states, “we may state that the amounts which the company will pay to the State will be treated as a deposit and not as tax. In the event of the State losing it's case at the final hearing of the matter, the amounts shall be refunded to the assessee with interest, which may be fixed by this Court at the final hearing of the matter." (Emphasis supplied by the querist.)

11. The steel plant of the company reviewed the order and took the legal opinion of Additional Solicitor General of India about proper recognition of the entry tax amount in the books. The opinion sought was that considering the merit of case which the steel plant of the company has filed in the Supreme Court and also the interim orders which the Hon'ble Supreme Court has passed from time to time, especially, the order dated 9th February, 2010, whether the liability on account of entry tax is ‘firm’ or ‘contingent’.

12. Additional Solicitor General of India, in his opinion dated 11th January, 2012, after deliberating the case in detail, has, inter alia,  held that, "Hence it is clear that the amount is a "Deposit" and not a "Tax". Moreover, there is a distinct possibility that the law may be held unconstitutional and hence the "Deposit" will be liable to be refunded. The order is in the nature of interim arrangement, pending final disposal. Hence the liability is "Contingent" and not "Firm"." (Emphasis supplied by the querist.)

13.  After considering the opinion of Additional Solicitor General of India dated 11th January, 2012, the steel plant of the company has a strong case to review the accounting treatment of entry tax.   Accordingly, in line with the legal opinion that has been obtained in January, 2012 and the interim orders of the Hon'ble Supreme Court, the steel plant of the company has treated the differential amount of the demand of entry tax during the period 1st April, 2011 to 31st December, 2011 at full rate of 6% on iron ore and coal, against which the payments have been made @ 3% as per the Hon'ble Supreme Court order dated 9th February, 2010 and interest thereon as contingent liability. Necessary accounting entries have been made in the books of account for the period 1st April, 2011 to 31st December, 2011, as on 31st December, 2011. 

14. Year-wise details of the demand amount of entry tax provided in the books are given as under:

                                                                                                            (Rs. in crore)

B. Query

15. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee of the Institute on the following issues:

(i) Whether the total amount of entry tax demand as per the rates notified by the State Government for the area in which steel plant of the company is located should be treated as contingent liability or firm liability. In case, the entry tax demand is treated as contingent liability, whether the company should write back the total entry tax demand of Rs. 1271.20 crore and interest amount of Rs. 144.13 crore, provided in the books of account for the period August, 2008 to December, 2011.

 

or

Only the discriminatory portion of entry tax demand amount of Rs. 995.29 crore and interest amount of Rs. 144.13 crore  for the period August, 2008 to December,  2011 should be treated as contingent liability and written back in the books. The balance amount of entry tax demand of Rs. 275.91 crore should be treated as firm liability.

or

Only the entry tax demand amount of Rs. 646.82 crore for the period August, 2008 to December, 2011, deposited with State Government  should be treated as firm liability and balance entry tax demand amount of Rs. 624.38 crore and interest amount of  Rs. 144.13 crore, provided in books should be written back, treating the same as contingent liability.

 

(ii).If the entry tax liability and interest thereon is written back, whether the amount should be written back under the ‘normal heads of account’ or as ‘income pertaining to earlier years’.

C.Points considered by the Committee

16.The Committee, while expressing its opinion, has considered only the issues raised by the querist in paragraph 15 above and has not examined any other issue that may arise from the Facts of the Case, e.g., calculation of entry tax as per the Entry Tax Act, treatment and disclosure of entry tax paid ‘Under Protest’ to the State Government, and other payments, if any, made to the State Government. Further, the Committee wishes to point out that its opinion is expressed purely from accounting point of view and not from any legal point of view.

17. The Committee notes that Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’), 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.”

“10.2   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.”

“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.”

18. The Committee further notes paragraphs 14, 15 and 22 of AS 29, notified under the ‘Rules’, 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 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).”

 

19.The Committee notes from the above that an element of judgement is required to determine whether a disputed liability for entry 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 said liability warrants recognition of provision or disclosure of contingent liability. The Committee is of the view that while making such judgement, all facts and circumstances available on the balance sheet date, including for example, legal opinion of an expert on the possibility and extent of outcome (success or failure) of the company’s case in the court of law, experience of the company or other enterprises in similar cases, decisions of appropriate authorities, etc. should be considered.  The Committee is further of the view that mere expert opinion should not be considered in isolation; other factors prevailing on the balance sheet date, as suggested above should also be considered while making the judgement. The Committee is also of the view that in case appropriate authority has passed orders against the company, this in itself, indicates that it is more likely than not that a present obligation exists which may require recognition of a provision.

20. The Committee notes from the Facts of the Case that in the extant case, the management has taken a considered view and has already made certain provisions  (as detailed in paragraph 14 above) based on its judgement of the then prevailing circumstances regarding the likelihood of outflow of economic resources of the company. Therefore, recognition of such a provision was the result of exercise of judgement by the management as per facts then prevailing and cannot therefore be considered to be an error as on the current reporting date. Accordingly, the fact whether the whole or part of the said provision can be written back/reversed should be assessed on the basis of circumstances prevailing on each subsequent balance sheet date to reflect the current best estimate on that date as envisaged in paragraph 52 of AS 29, notified under the Rules, which is reproduced as below:

“52. Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision should be reversed.”

 

21. The Committee further notes that clause 5 (v) (b) of Part II of Schedule VI (revised) ²to the Companies Act, 1956, provides as follows:

“5.  Additional Information

 

 A Company shall disclose by way of notes additional information   regarding aggregate expenditure and income on the following items:-

 

(v) (b) The aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.

From the above, the Committee is further of the view that in case it is found that there exist cogent and very strong reasons indicating significant reduction in the probability of occurrence of such liability, a provision earlier made might qualify to be disclosed as a contingent liability.  However, to write back a provision, it must be demonstrated that the same is “no longer required”.  The Committee is of the opinion that a mere filing of writ petition in a court of law, in itself, does not mean that there is a significant reduction in the probability of occurrence of liability in the relevant subsequent financial statements.  The events which may justify the reduction may be availability of additional information, e.g., receipt of court orders, that may reduce the probability of incurring of the liability, etc.

22.In the extant case, however, it is noted that even the Supreme Court has, so far, not granted any relief in regard to amounts of entry tax payable by the company. The order of the Court of Law to deposit only a part of the amount of tax demanded (as mentioned in paragraphs 8 to 10 above) cannot be considered to be evidence of reduction in the probability of occurrence of liability. Hence, the company cannot reverse a provision, already made, based on the facts given in the case.  

D. Opinion

23.On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 15 above:

(i) Refer paragraphs 20 to 22 above. For the reasons mentioned above, the Committee is of the view that under the circumstances, no part of the provision made for entry tax and interest as described in paragraph 14 above qualifies to be written back in the manner contemplated in paragraph 52 of AS 29 and the provisions of Revised Schedule VI. Therefore, none of the proposed treatments as suggested by the querist in paragraph 15 (i) above would be appropriate as it would not be possible to demonstrate that the same is “no longer required”, as discussed in paragraph 22 above.

 

(ii)Since answer to question (i) above does not envisage writing back of any amount, query (ii) is infructuous.

 

_______________________________

¹Opinion finalised by the Committee on 26.4.2012

2 Revised Schedule VI came into force for the Balance Sheet and Profit and Loss Account for the financial year commencing on or after 01.04.2011.