Expert Advisory Committee

2.5 Query

Computation of ‘profits’ for the purpose of section 32AB(3).

1. A public limited company is engaged in the manufacture and sale of urea, commercial blasting explosives and accessories, nitrocellulose, paints, rubber chemicals, polythene, textile auxiliaries, catalysts etc. All business activities of the Company are ‘eligible business’ within the meaning of Section 32 AB 2(i) of the Income-tax Act.

2. During the year ended 30-6-86 the company has made the following provisions in its Profit & Loss Account : -

(i) Provision for doubtful debts and advances.

(ii) Provision for debenture redemption premium.

3. In the balance sheet, while the provisions for doubtful debts and advances have been adjusted against sundry debtors and loans and advances receivable, the provision for premium on debenture redemption has been shown under ‘Current Liabilities and Provisions’.

4. In-so-far as provision for doubtful debts and advances is concerned, it is the practice of the company to make the provisions after considering the following aspects : -

(a) Age of the debt.

(b) Customers’ financial viability.

5. When a debt becomes actually bad in the subsequent years, it is written-off in the company’s Profit and Loss A/C and an equivalent amount of provision is written-back in that year.

6. The company has issued certain debentures redeemable at a premium from the year 1990 onward. As a matter of prudent accounting practice certain sum has been provided in the accounts towards premium on debentures redemption although there is no statutory obligation to do so. While computing profits under Sub-section 3 of section 32 AB, the querist is of the view that the aforesaid two items namely ‘provision for doubtful debts’ and ‘provision for debenture redemption premium’ should be added back. The querist’s views are based on the following Court judgments:

(a) Supreme Court, while enunciating the definition of ‘provision’ under the Sur-tax Act in the case of Metal Box of India Ltd. vs. their Workmen (1969) 73 ITR 53 has held that if any amount is retained by way of providing for any ‘known liability’ for which the amount cannot be determined with substantial accuracy, it would amount to a ‘provision’ and not ‘reserve’. The expression ‘known liability’ in the context of Super Profit Tax Act, should be taken to refer only to a liability existing on the relevant date and not a future liability. In CIT vs. Orissa Cement Ltd. (1980) 124 ITR 251 (Delhi) it has been held that so long as the assessee has not estimated the current liability and set it apart or charged it to the current year and claimed a deduction therefor for the purpose of Income-tax Act, it cannot be said that a ‘provision’ has been made by it towards an existing liability.

(b) The Calcutta High Court in the case of CIT vs. Karamchand Thaper & Bros (131 ITR) held that in case there is any conflict between the expressions ‘reserve’ and ‘provision’, they should be understood in the ordinary sense in contra-distinction to the sense in which these words are understood in company jurisprudence. Similar views have been held by the same High Court in the case of CIT vs. Burn & Co. (114 ITR).

(c) The items (ii) to (v) in clause A of Sub-section 3 of Section 32 AB are to be understood in the context of the provisions of the Income-tax Act.

7. In view of the foregoing, the company proposes to add back the items, namely, provision for doubtful debts and advances and provisions for debenture redemption premium while computing its profit under sub-section 3 of section 32 AB of the Income-tax Act 1961. The querist has accordingly sought the opinion of the Expert Advisory Committee as to whether the company’s understanding of the above two additions is correct or not and in case the Committee does not concur with the views expressed by the company, a suitable advice may be given on the subject.

Opinion September 16, 1988

1. The Committee notes that section 32 AB (3) (a), as amended by Finance Act 1987, inter alia, prescribes as below:

“(3) The profits of eligible business or profession of an assessee for the purpose of sub-section (1) shall, -

(a) in a case where separate accounts in respect of such eligible business or profession are maintained, be an amount arrived at after deducting an amount equal to the depreciation computed in accordance with the provisions of sub-section (1) of section 32 from the amounts of profits computed in accordance with the requirements of parts II and III of the Sixth Schedule to the Companies Act, 1956 (1 of 1956) as increased by the aggregate of

(v) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities.”

2. The Committee is of the view that since the amount of premium payable on redemption of debentures is determined in advance, the provision made for the debenture redemption premium is a provision for ascertained liability.

3. With regard to provision for bad and doubtful debts, the Committee notes that the term ‘provision’ has been defined in clause 7 (1) (a) of Part III of Schedule VI to the Companies Act, as below: -

“The expression ‘provision’ shall, subject to sub-clause (2) of this clause, means any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.”

The Committee also notes that the above-mentioned sub-clause (2) prescribes as follows:

(a) “Where-

any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or

(b) 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.”

4.The Committee notes from the above that clause 7 (1)(a) distinguishes between provision made for a liability and that made for diminution in value of assets. Since provision for bad and doubtful debts is of the nature of provision for diminution in value of the asset, viz., sundry debtors, it is not covered by clause (v) of Section 32 AB (3) (a) of the Income-tax Act, 1961, as that clause covers only ‘provision made for meeting liabilities’ subject to sub-clause 7 of Part III of Schedule VI to the Companies Act, 1956.

5. On the basis of the above, the Committee is of the opinion that provision for debenture redemption premium and the provision for bad and doubtful debts (subject to sub-clause (2) of clause 7 of Part III of Schedule VI to the Companies Act, 1956) should not be added back in the figure of profit determined as per parts II and III of Schedule VI to the Companies Act, 1956, for the purpose of arriving at the amount of profit under section 32 AB (1) of the Income-tax Act,1961.

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