J.K. INDUSTRIES LTD. & ANR. v. UNION OF INDIA AND ORS.

A Government in the form of a Rule. Therefore, vide the impugned notification, AS 22 stands prescribed by the Central Government in consultation with NAC which has been established under Section 210A of the Companies Act. It is made clear that the Accounting Standards prescribed by the Central Government in consultation with NAC need B not be identical with the Accounting Standards specified by the Institute. In the present case, the impugned notification indicates that the Central Government has been given the authority to enact a Rule and accordingly the rule-making authority, namely, the Central Government has prescribed the Accounting Standard No.22 in consultation with NAC by adopting c AS 22 originally specified by the Institute.

16Copy pinpoint16. Under Section 211 (1) every balance-sheet of a company has to comply with the following requirements: (i) It must give true and fair view of the affairs of the company at D the end of the financial year; (ii) it must be in the form set out in Part I of Schedule VI or as r-- near thereto as circumstances admit; and (iii) it must give regard to the general instructions for preparation of balance-sheet under the heading "Notes". E

17Copy pinpoint17. Similarly, Section 211 (2) of the Companies Act requires that every P&L ale of a company must give a true and fair view of the profit or loss of the company for the financial year and comply with the requirements of Paii II of Schedule VI so far as they are applicable thereto. p It may be noted that the balance-sheet prescribed by Part I of Schedule VI has to be in the form of a proforma~ However, the Companies Act does not prescribe a proforma of P&L ale. Pait I of Schedule VI prescribes a profom1a of balance-sheet. Pait II of Schedule VI only prescribes the particulars which must be furnished in the P&L ale. G Therefore, as far as possible, the P&L ale must be drawn up according to the requirements of Part II of Schedule VI. It is important to note that Section 211 read with Part I and Part II of Schedule VI prescribes the form and contents of balance-sheet and P&L a/c. However, Section 211 (1 ), imer alia, states that every balance-sheet of a company shall H subject to the provisions of that section, be in the fom1 set out in Paii I

j J.K. INDUSTRIES LTD. v. UNION OF INDIA [KAPADIA, J.] 213

--1 of Schedule VI. The words ''subject to the provisions of this section" A would mean that every sub-section following sub-section (1) including sub- sections (3A), (3B) and (3C) shall have an overriding effect and consequently every P&L ale and balance-sheet shall comply with the Accounting Standards. Therefore, implementation of the Accounting Standards and their compliance are made compulsory and mandatory by B the aforestated sub-sections (3A), (3B) and (3C). The insertion of the concept of "true and fair view" in place of "true and correct" has been made to do away with the view that accounts should disclose arithmetically accuracy. Adherence to the disclosure requirements as per Schedule VI is subservient to the overriding requirement of "true and fair view" as c regards the state of affairs. Therefore, the annual financial statements should convey an overall fair view and should not give any misleading infonnation or impression. All the relevant infonnation should be disclosed in the balance-sheet and the P&L ale in such a manner that the financial position and the working results are shown as they are. There should be neither an overstatement nor an understatement. Further, the infonnation to be disclosed should be in consonance with the fundamental accounting assumptions and commonly accepted accounting policies. Therefore, failure· to make provision for taxation would not disclose true and fair view of the state of affairs. Non-compliance for taxation would, therefore, amount to contravention of Sections 209 and 211 of the Companies Act. Accordingly, it is necessary for the auditor to qualify in his report, and such qualification should bring out in what manner the accounts do not disclose a true and fair view of the state of affairs of the company as well ~~ as the profit/loss of the company. Severdl Accounting Standards prescribed by the Institute have been made mandatory. The Institute has, however, clarified that the expression "mandatory in nature" implies that while discharging their functions, it will be the duty of the Chartered Accountants who are members of the Institute to examine whether the said Accounting Standard has been complied with in the presentation of financial statements covered by their audit (See: Section 227(3)(d)). In this regard it may be noted that under Section 227(3)(d) it is the duty of the auditor, to state in '""',;..i, his audit report whether the P&L ale and the balance-sheet complies with the Accounting Standards referred to in Section 211 (3C). Before introduction of sub-sections (3A), (3B) and (3C) in Section 211 (w.e.f. H

214 SUPREME COURT REPORTS [2007] 12 S.C.R. ~""

A 31.10. 98), these Standards were not mandatory. Therefore, the companies were then free to prepare their annual financial statements, as per the specific requirements of Section 211 read with Schedule VI. However, with the insertion of sub-sections (3A), (3B) and (3C) in Section 211 the P&L ale and the balance-sheet have to comply with the . I

B Accounting Standards. For this purpose the expression "Accounting Standards" shall mean the standards of accounting recommended by the Institute as may be prescribed by the Central Gevernment in consultation with NAC on Accounting Standards. Thus, the Accounting Standards are prescribed by the Central Government. Thus, the Accounting Standards c prescribed by the Central Government are now mandatory qua the companies and non-compliance with these Standards would lead to violation of Section 211 inasmuch as the annual accounts may then not be regarded as showing a "true and fair view".

18Copy pinpoint18. Section 641 empowers the Central Government to alter any of D the regulations, rules, tables, forms and other provisions contained in Schedule VI to the Companies Act. However, this power can be used only for making simple alterations which will not affect the legislative policies enshrined in the Companies Act.

19Copy pinpoint19. Section 642 refers to the powers of the Central Government to make rules. It states that in addition to the powers conferred by Section 641, the Central Government may, by notification in the official gazette, make rules for all or any of the matters which by the Companies Act are to be prescribed by the Central Government and to carry out the purposes of the Companies Act. Therefore, Section 641 and Section 642 form part of the same scheme. Under Section 642, the Central Government exercises power of delegated legislation by prescribing rules. Under various provisions of the Act, Rules are to be prescribed. Rules can also be prescribed vide clause (b) to Section 642(1) to carry out the purposes of the Act..

20Copy pinpoint20. In exercise of the powers conferred by clause (a) to sub-section (1) of Section 642 of the Companies Act read with sub-section (3C) of Section 211 and Section 21 OA( l ), the Central Government in consultation with NAC on Accounting Standards has made the following Rules vide H

J.K. INDUSTRIES LTD. v. UNION OF INDIA 215

[KAPADIA,J.] the impugned notification dated 7.12.06. The said Rules are called as the A Companies (Accounting Standards) Rules, 2006. We quote hereinbelow the said impugned notification in entirety together with annexures: "Ministry of Company Affairs NOTIFICATION B New Delhi, the 7th December, 2006 ACCOUNTING STANDARDS

G.S.R. 739 (E). - In exercise of the powers conferred by clause (a) of sub-section (1) of section 642 of the Companies Act, 1956 C (1 of 1956), read with sub-section (3C) of section 211 and sub- section (1) of section 2 lOA of the said Act, the Central Government, in consultation with National Advisory Committee on Accounting Standards, hereby makes the following mies, namely:-

1. Short title and commencement.- D

1. These rules may be called the Companies (Accounting Standards) Rules, 2006.

2. They shall come into force on the date of their publication in the Official Gazette. E

2. Definitions.- In these rules, unless the context otherwise requires,- a. "Accounting Standards" means the Accounting Standards as specified in rule 3 of these rules; F b. "Act" means the Companies Act, 1956 (1 of 1956); c. "Annexure" means an Annexure to these rules; d. "General Purpose Financial Statements" include balance G sheet, statement of profit and loss, cash flow statement (wherever applicable), and other statements and explanatory notes which form part thereof. e. "Enterprise" means a company as defined in section 3 of H

216 ~ SUPREME COURT REPORTS. [2007] 12 S.C.R. '\.

,._ A the Companies Act, 1956. f "Small and Medium Sized Company" (SMC) means, a company- I. whose equity or debt securities are not listed or are not in B the process of listing on any stock exchange, whether in India or outside India; II. which is not a bank, financial institution or an insurance company; c Ill. whose tum over (excluding other income) does not exceed rupees fifty crore in the immediately preceding accounting year; iv. which does not have borro\vings (including public deposits) in excess of rupees ten crore at any time during the immediately preceding accounting year; and v. which is not a holding or subsidiary company of a company which is not a small and medium-sized company. E-cplanation: For the purposes of clause (f), a company shall qualify as a Small and Medium Sized Company, if the conditions mentioned therein are satisfied as at the end of the relevant accounting period. (2) Words and expressions used herein and not defined in these rules but defined in the Act shall have the same meaning respectively assigned to them in the Act. F

3. Accounting Standards. - (1) The Central Government hereby prescribes Accounting Standards 1 to 7 and 9 to 29 as recommended by the Institute of Chartered Accountants of India, which are specified in the G Annexure to these rules. (2) The Accounting Standards shall come into effect in respect of accounting periods commencing on or after the publication of these Accounting Standards. H

/ f J.K. INDUSTRIES LTD. v. UNION OF INDIA 217 --i [KAPADIA,J.]

1. Obligation to comply with the Accounting Standards.- A (1) Every company and its auditor( s)shall comply with the Accounting Standards in the manner specified in Annexure to these rules. (2) The Accounting Standards shall be applied in the preparation of General Purpose Financial Statements.

2. An existing company, which was previously not a Small and Medium Sized Company (SMC) and subsequently becomes an SMC, shall not be qualified for exemption or relaxation in respect of Accounting Standards available to an SMC until the company remains an SMC for two consecutive accounting periods. [No. 1/3/2006/CL-V] JITESH KHOSLA, Jt. Secy. -·. ANNEXURE D (See rule 3) ACCOUNTING STANDARDS General Instructions

1. SMCs shall follow the following instructions while complying with Accounting Standards under these rules:-

1. l the SMC which does not disclose certain information . .. . pursuant to the exemptions or relaxations given to it shall disclose (by way of a note to its financial statements) the fact that it is an SMC and has complied with the Accounting Standards insofar as they are applicable to an SMC on the following lines: "The Company is a Small and Medium Sized Company (SMC) as defined in the General Instructions in respect of Accounting Standards notified under the Companies Act, 1956. Accordingly, the Company has complied with the Accounting Standards as applicable to a Small and Medium Sized Company." 1.2 Where a company, being a SMC, has qualified for any H

\ ~ 218 SUPREME COURT REPORTS [2007] 12 S.C.R. ." ~

-,-....- A exemption or relaxation previously but no longer qualifies for the relevant exemption or relaxation in the current accounting period, the relevant standards or requirements become applicable from the current period and the figures for the corresponding period of the previous accounting B period need not be revised merely by reason of its having ceased to be an SMC. The fact that the company was an SMC in the previous period and it had availed of the exemptions or relaxations available to SMCs shall be disclosed in the notes to the financial statements. c 1.3 If an SMC opts not to avail of the exemptions or relaxations available to an SMC in respect of any but not all of the Accounting Standards, it shall disclose the standard(s) in respect of which it has availed the exemption or relaxation. D ~- 1.4 If an SMC desires to disclose the information not required '

to be disclosed pursuant to the exemptions or relaxations available to the SMCs, it shall disclose that information in compliance with the relevant accounting standard. E 1.5 The SMC may opt for availing certain exemptions or relaxations from compliance with the require ments prescribed in an Accounting Standard: Provided that such a partial exemption or relaxation and ' ,"--.., F disclosure shall not be permitted to mislead any person or public.

2. Accounting Standards, which are prescribed, are intended to be in conformity with the provisions of applicable laws. However, if due to subsequent amendments in the law, a G particular accounting standard is found to be not in conformity with such law, the provisions of the said law will prevail and ,l:"' the financial statements shall be prepared in conformity with # such law. ".) . Accounting Standards are intended to apply only to items H

J.K.INDUSTRIESLTD. v. UNIONOFINDIA 219

[KAPADIA, J.] --i . which are material. A

4. The accounting standards include paragraphs set in bold italic type and plain type, which have equal authority. Paragraphs · in bold italic type indicate the main principles. An individual accounting standard shall be read in the context of the objective, if stated, in that accounting standard and in B accordance with these General Instructions. Accounting Standard (AS) 22 Accounting for Taxes on Income c (This Accounting Standard includes paragraphs set in bold italic type and plain type, which have equal authority. Paragraphs in bold italic type indicate the main principles. This Accounting Standard should be read in the context of its objective and the General Instructions contained in part A of the Annexure to the Notification.) Objective The objective of this Standard is to prescribe accounting treatment for taxes on income. Taxes on income is one of the significant items in the statement of profit and loss of an enterprise. In accordarice with the matching concept, taxes on income are accrued in the same period as the revenue and expenses to which they relate. Matching of such taxes against revenue for a period poses special problems arising from the fact that in a number of cases, taxable income may be significantly different from the accounting income. This divergence between taxable income and accounting income arises due to two main reasons. Firstly, there are differences between items of revenue and expenses as appearing in the statement of profit and loss and the items which are considered as revenue, expenses or deductions for tax purposes. Secondly, there are differences between the amount in respect of a particular item of revenue or expense as recognised in the statement of profit and loss and

220 SUPREME COURT REPORTS [2007] 12 S.C.R.

A Scope

1. This Standard should be applied in accounting for taxes on income. This includes the determination of the amount of the expense or savingrelated to taxes on income in respect of an accounting period and the disclosure ofsuch an amount in the B financial statements.

2. For the purposes of this Standard, taxes on income include all domestic and foreign taxes which are based on taxable income.

3. This Standard does not specify when, or how, an enterprise c should account for taxes that are payable on distribution of dividends and other distributions made by the enterprise. Definitions

4. For the purpose of this Standard, the following terms are D used with the meanings specified: .

4.1 Accounting income (loss) is the net profit or loss for a period, as reported in the statement ofprofit and loss, before deducting income tax expense or adding income tax saving E 4.2 Taxable income (tax loss) is the amount ofthe income (l,oss) for a period, determined in accordance with the tax laws, based upon which income tax payable (recoverable) is determined 4.3 Tax expense (tax saving) is the aggregate ofcurrent tax and F deferred tax charged or credited to the statement ofprofit and loss for the period. 4.4 Current tax is the amount of income tax determined to be payable (recoverable) in respect of the taxable income (tax loss) for a period . G 4.5 Deferred tax is the tax effect of timing differences. 4.6 Timing differences are the differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more H

/ t / J.K. INDUSTRIES LTD. v. UNION OF INDIA 221 .._...__ [KAPADIA, J.] subsequent periods. A 4.7 Permanent differences are the differences between taxable income and accounting income for a period that originate in one period and do not reverse subsequently.

5. Taxable income is calculated in accordance with tax laws. In B '~ some circumstances, the requirements of these laws to compute taxable income differ from the accounting policies applied to determine accounting income. The effect of this difference is that the taxable income and accounting income may not be the same.

6. The differences between taxable income and accounting income c can be classified into permanent differences and timing differences. Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of \ computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference.

7. Timing differences are those differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or.more subsequent periods. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and "~ expenses are included or considered in arriving at accounting income. For example, machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machinery for accounting purposes· .... G --..-l and the amount allowed as deduction for tax purposes will ultimately be the same, but periods over which the depreciation is charged and the deduction is allowed will differ. Another example of timing difference is a situation where, for the purpose of computing taxable income, tax laws allow depreciation on the basis H

222 SUPREME COURT REPORTS [2007] 12 S.C.R.

' ~ A of the written down value method, whereas for accounting purposes, straight line method is used. Some other examples of timing differences arising under the Indian tax laws are given in Illustration I.

8. Unabsorbed depreciation and carry forward of losses which can B be setoff against future taxable income are also considered as timing differences and result in deferred tax assets, subject to consideration >-- of prudence (see paragraphs 15-18). Recognition c 9. Tax expense for the period, comprising current tax and deferred tax, should be included in the determination of the net profit or loss for the period. I 0. Taxes on income are considered to be an expense incurred by the enterprise in earning income and are accrued in the same period y I as the revenue and expenses to which they relate. Such matching may result into timing differences. The tax effects of timing differences are included in the tax expense in the statement of profit and loss and as deferred tax assets (subject to the consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, i!l the balance sheet.

11. An example of tax effect of a timing difference that results in a deferred tax asset is an expense provided in the statement of profit and loss but not allowed as a deduction under Section 43B of the ).. '-4, F Income-tax Act, 1961. This timing difference will reverse when the deduction of that expense is allowed under Section 43B in subsequent year(s). An example of tax effect of a timing difference resulting in a deferred tax liability is the higher charge of depreciation allowable under the Income-tax Act, 1961, compared to the G depreciation provided in the statement of profit and loss. In subsequent years, the differential will reverse when comparatively lower depreciation will be allowed for tax purposes. v'

12. Permanent differences do not result in deferred tax assets or deferred ta"< liabilities. H

r J.K. INDUSTRIES LTD. v. UNION OF INDIA [KAPADIA, J.] 223

--·r 13. Deferred tax should be recognised for all the timing differences, subject to the consideration of prudence in respect of deferred tax assets as set out in paragraphs 15-18. Explanation: (a) The deferred tax in respect of timing differences which reverse during the tax holiday period is not recognised to the extent the enterprise's gross total income is subject to the deduction during the tax holiday period as per the requirements of sections 80-IA/ 80 IB of the Income-tax Act, 1961 (hereinafter referred to as the 'Act'). In case of sections lOA/lOB of the Act (covered under c . Chapter III of the Act dealing with incomes which do not form part of total income), the deferred tax in respect of timing differences which reverse during the tax holiday period is not recognised to the extent deduction from the total income of an enterprise is allowed during the tax holiday period as per the D -( provisions of the said sections. (b) Deferred tax in respect of timing differences which reverse after the tax holiday period is recognised in the year in which the timing differences originate. However, recognition of deferred tax assets is subject to the consideration of prudence as laid down in E paragraphs 15 to 18. (c) For the above purposes, the timing differences which originate first are considered to reverse first. The application of the above explanation is illustrated in the F ' Illustration attached to the Standard.

14. This Standard requires recognition of deferred tax for all the timing differences. This is based on the principle that the financial statements for a period should recognise the tax effect, whether G current or deferred, of all the transactions occurring in that period. ~">\ 15. Except in the situations stated in paragraph 17, deferred tax assets should be recognised and carried forward only to the extent that there is a reasonable certainty that sufficient future taxable H

\ 224 SUPREME COURT REPORTS [2007] 12 S.C.R. ~ A income will be available against which such deferred tax assets can __ ..,... ~

be realised.

16. While recognising the tax effect of timing differences, consideration of prudence cannot be ignored. Therefore, deferred tax assets are recognised and carried forward only to the extent B that there is a reasonable certainty of their realisation. This reasonable level of certainty would normally be achieved by examining the past record of the enterprise and by making realistic estimates of profits for the future. r< \.., 17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax laws, deferred tax assets should be recognised only to the extent that there is virtual certainty supported by convincing evidence that sufficient future taxable income will be available against which such deferred tax assets can be realised. D Explanation:

1. Determination of virtual certainty that sufficient future taxable income will be available is a matter of judgement based on convincing evidence and will have to be evaluated on a case to E case basis. Virtual certainty refers to the extent of certainty, which, for all practical purposes, can be considered certain. Virtual certainty cannot be based merely on forecasts of perfonnance such as business plans. Virtual certainty is not a matter of perception and is to be supported by convincing evidence. Evidence is a F matter of fact. To be convincing, the evidence should be available )-_ at the reporting date in a concrete form, for example, a profitable binding export order, cancellation of which will result in payment of heavy damages by the defaulting party. On the other hand, a projection of the future profits made by an enterprise based on the future capital expenditures or future restructuring etc., submitted G even to an outside agency, e.g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence. r .

2(a) As per the relevant provisions of the Income-tax Act, 1961 H (hereinafter referred to as the 'Act'), the 'loss' arising under the

) J.K.INDUSTRIESLTD. v. UNION OF INDIA 225 / [KAPADIA,J.] head 'Capital gains' can be carried fotward and set-off in future years, only against the income arising under that head as per tlie requirements of the Act. (b) Where an enterprise's statement of profit and loss include$ an item of' loss' which can be set-off in future for taxation purposes, only against the income arising under the head 'Capital gains 1 as per the requirements of the Act, that item is a timing difference to the extent it is not set-off in the current year and is allowed to be set-off against the income arising under the head 'Capital gains' in subsequent years subject to the provisions of the Act. In respect of such 'loss', deferred tax asset is recognised and carried fotward subject to the consideration of prudence. Accordingly, in respect of such 'loss', deferred tax asset is recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, that sufficient future taxable income will be available under the head 'Capital gains' against which the loss can be set-off as per the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would depend on the facts and circumstances of each case. The examples of situations in which the test of virtual certainty, supported by convincing evidence, for the purposes of the recognition of deferred tax asset in respect of loss arising under the head 'Capital gains' is normally fulfilled, are sale of an asset giving rise to capital gain (eligible to set-off the capital loss as per the provisions of the Act) after the balance sheet date but before the financial statements are approved, and binding sale agreement which will give rise to capital gain (eligible to set- F off the capital loss as per the provisions of the Act). (c) In cases where there is a difference between the amounts of 'loss' recognised for accounting purposes and tax purposes because of cost indexation under the Act in respect of long-term capital assets, the deferred tax asset is recognised and carried G fotward (subject to the consideration of prudence) on the amount which can be carried forward and set-off in future years as per the provisions of the Act.

18. The existence of unabsorbed depreciation or carry_fotward H

226 SUPREME COURT REPORTS [2007] 12 S.C.R.

A of losses under tax laws is strong evidence that future taxable .. <~

·f-"" income may not be available. Therefore, when an enterprise has a history of recent losses, the enterprise recognises deferred tax assets only to the extent that it has timing differences the reversal of which will result in sufficient income or there is other convincing B evidence that sufficient taxable income will be available against which such deferred tax assets can be realised. In such circumstances, the nature of the evidence supporting its recognition is disclosed. Re-assessment of Unrecognised Deferred Tax Assets c

19. At each balance ·sheet date, an enterprise re-assesses unrecognised deferred tax assets. The enterprise recognises previously unrecognised deferred tax assets to the extent that it has become reasonably certain or virtually certain, as the case may be D (see paragraphs 15 to 18), that sufficient future taxable income will be available against which such deferred tax assets can be realised. For example, an improvement in trading conditions may make it reasonably certain that the enterprise will be able to generate sufficient taxable income in the future. E Measurement

20. Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws.

21Copy pinpoint21. Deferred tax assets and liabilities should be measured using .J.-...., the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. bxplanation: G (a) The payment of tax under section Jl 5JB of the Income- tax Act, 1961 (hereinafter referred to as the 'Act') is a current tax for the period. v (b) Jn a period in which a company pays tax under section J 15JB of the Act, the deferred tax assets and liabilities in H

J.K. INDUSTRIES LTD. v. UNION OF INDIA 227

[KAPADIA,J.] respect of timing differences arising during the period, tax effect of which is required to be recognised under this Standard, is measured using the regular tax rates and not the tax rate under section 115JB of the Act. (c) In case an enterprise expects that the timing differences arising in the current period would reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the current period, tax effect of which is required to be recognised under AS 22, is measured using the regular tax rates and not the tax rate under section 115JB of the Act. C

22Copy pinpoint22. Deferred tax assets and liabilities are usually measured using the tax rates and tax laws that have been enacted. However, certain announcements of tax rates and tax laws by the government may have the substantive effect of actual enactment. In these D circumstances, deferred tax assets and liabilities are measured using such announced tax rate and tax laws.

23Copy pinpoint23. When different tax rates apply to different levels of taxable income, deferred tax assets and liabilities are measured using average rates. E

24Copy pinpoint24. Deferred tax assets and liabilities should not be discounted to their present value.

25Copy pinpoint25. The reliable determination of deferred tax assets and liabilities on a discounted basis requires detailed scheduling of the timing of the reversal of each timing difference. In a number of cases such scheduling is impracticable or highly complex. Therefore, it is inappropriate to require discounting of deferred tax assets and liabilities. To permit, but not to require, discounting would result in deferred tax assets and liabilities which would not be comparable between enterprises. Therefore, this Standard does not require or pem1it the discounting of defe1Ted tax assets and liabilities.

228 SUPREME COURT REPORTS [2007] 12 S.C.R.

A Review of Deferred Tax Assets

26Copy pinpoint26. The carrying amount of deferred tax assets should be reviewed at each balance sheet date. An enterprise should write-down the carrying amount of a deferred tax asset to the extent that it is no longer reasonably certain or virtually certain, as the case may be B (see paragraphs 15 to 18), that sufficient future taxable income will be available against which deferred tax asset can be realised. Any such write-down may be reversed to the extent that it becomes reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income will be c available. Presentation and Disclosure

27Copy pinpoint27. An enterprise should offset assets and liabilities representing current tax if the enterprise: D (a) has a legally enforceable right to set off the recognised amounts; and (b) intends to settle the asset and the liability on a net basis.

28Copy pinpoint28. An enterprise will normally have a legally enforceable right to set off an asset and liability representing current tax when they relate to income taxes levied under the same governing taxation laws and the taxation laws permit the enterprise to make or receive a single net payment.

29Copy pinpoint29. An enterprise should offset deferred tax assets and deferred tax liabiliti'es if: (a) the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and G (b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws.

30Copy pinpoint30. Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period. Deferred tjlx assets and liabilities should be disclosed under c: H

J.K. INDUSTRIES LTD. v. UNION OF INDIA 229

/ [KAPADIA, J.] separate heading in the balance sheet of the enterprise, separately from current assets and current liabilities. Explanation: Deferred tax assets (net of the deferred tax liabilities, if any, in accordance with paragraph 29) is disclosed on the face of the balance sheet separately after the head 'Investments' and deferred tax liabilities (net of the deferred tax assets, if any, in accordance with paragraph 29) is disclosed on the face of the balance sheet separately after the head 'Unsecured Loans'.

31Copy pinpoint31. The break-up of deferred tax assets and deferred tax liabilities into major components of the respective balances should be disclosed in the notes to accounts.

32Copy pinpoint32. The nature of the evidence supporting the recognition of deferred tax assets should be disclosed, if an enterprise has unabsorbed depreciation or carry forward oflosses under tax laws. Transitional Provisions

33Copy pinpoint33. On the first occasion that the taxes on income are accounted for in accordance with this Standard, the enterprise should recognise, in the financial statements, the deferred tax balance that has accumulated prior to the adoption of this Standard as deferred tax asset/liability with a corresponding credit/charge to the revenue reserves, subject to the consideration of prudence in case of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the revenue reserves should be the same as that which would have resulted if this Standard had been in effect from the begimung.

34Copy pinpoint34. For the purpose of determining accumulated deferred tax in the period in which this Standard is applied for the first time. the opening balances of assets and liabilities for accounting purposes and for tax pUiposes are compared and the differences, if any, are detennined. The tax effects of these differences, if any, should be recognised as deferred tax assets or liabilities, if these differences H

230 SUPREME COURT REPORTS [2007] 12 S.C.R.

A are timing differences. For example, in the year in which an enterprise adopts this Standard, the opening balance of a fixed asset is Rs. 100 for accounting purposes and Rs. 60 for tax purposes. The difference is because the enterprise applies written down value method of depreciation for calculating taxable income B whereas for accounting purposes straight line method is used. This difference will reverse in future when depreciation for tax purposes will be lower as compared to the depreciation for accounting purposes. In the above case, assuming that enacted tax rate for the year is 40% and that there are no other timing differences, c deferred tax liability of Rs. 16 [(Rs. 100 - Rs. 60) x 40%] would be recognised. Another example is an expenditure that has already been written off for accounting purposes in the year of its incurrance but is allowable for tax purposes over a period of time. In this case, the asset representing that expenditure would have a D balance only for tax purposes but not for accounting purposes. The difference between balance of the asset for tax purposes and the balance (which is nil) for accounting purposes would. be a timing difference which will reverse in future when this expenditure would be allowed for tax purposes. Therefore, a deferred tax asset would be recognised in respect of this difference subject to the E consideration of prudence (see paragraphs 15 - 18). Submissions

21. Dr. D. Pal, learned senior counsel appearing on behalf of Mis. F Simplex Infrastructures Ltd. and Anr., submitted that under para 9 of AS J. • 22 tax expense for the period, comprising current tax and deferred tax, is now required to be included in the determination of net profit (loss) for that period. That, deferred tax is now defined under the said AS 22 to mean the tax effect of timing differences. Timing difference in turn is defined G to mean the difference between the taxable income and the accounting income for a period that originates in one period and is capable of reversal in one or more subsequent periods. Therefore, DTL along with current '!--:......_ tax liability (CTL) are now required to be included in the determination of the net profit (loss) for the period. This inclusion ofDTL along with CTL in the determination of the net profit (loss), according to learned H

i f / J.K. iNDUSTRIES LTD. v. UNION OF INDIA 231 [KAPADIA,J.] counsel, is repugnant to Part II of clause 3(vi) of Schedule VI to the A Companies Act. In this connection, learned counsel urged that under the said Part II only the tax liability of the relevant accounting year can be charged to P&L ale. Therefore, clause 9, insofar as it provides for the · inclusion ofDTL in the determination of the net profit (loss) is contrary to and inconsistent with Part II of clause 3(vi) of Schedule VI. According B to the learned counsel, DTL as an element of P&L ale is not mentioned in the form prescribed for the balance-sheet or the P&L ale but it is made substantive provision by para 9 by making it a charge on the P&L ale and th\ls resulting in enhancement of tax liability for the year.

22. Learned counsel further contended that Section 211 ( 1) of the C Companies Act lays down that every balance-sheet of a company shall give a true and fair view of the state of affairs of the company at the end of the financial year and shall subject to the provisions of the said section, be in the form set out in Part I of Schedule VI or as near thereto as circumstances admit or in such other form as may be approved by the D Central Government. According to learned counsel, Section 211 ( 1) of the Companies Act should be read with the proviso which inter alia provides that nothing contained in Section 211 (1) shall apply to insurance company, banking company, electricity company etc. for which a separate balance- sheet has been specified in the Companies Act. Therefore, according to learned counsel, what is contemplated by the expression "subject to the provisions of Section 211" is that where there is inconsistency or conflict between the other provisions of Section 211, the other provision will prevail as there are circumstances when insurance and banking company or any company for which a form or balance-sheet has been specified under the Act. Therefore, according to learned counsel, because Section 211 is subject to the said provision, the provision contained in the proviso shall apply whenever there is any inconsistency or conflict between Section 211(1) and the proviso.

23. Learned coun_sel next contended that the impugned rule has been G fran1ed in exercise of power w1der Section 642 of the Companies Act. Therefore, Accounting Standard has been prescribed by the rules framed under that Section. The rules so framed are placed before the Parliament. However, Section 642(1) has not the effect as if it is enacted in the Act. H

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A That, on the other hand, under Sectior. 641(1) the Central Government ....,..." has been given the power to alter any of the existing regulations, rules, tables or fonns or any of the schedules to the Act including Schedule VI. Therefore, any alteration notified in Section 641 (1) has the effect as if enacted in the Act and shall come into force on the date of the notification B unless the notification otherwise directs. These rules are also required to be placed before the Parliament. Therefore, Schedule VI can be amended or altered by a notification issued under Section 641 (1) of the Companies Act. If Schedule VI is not altered or amended in exercise of power under Section 641(1) of the said Act, then, Schedule VI being part of the Act, c the rule adopting the AS under Section 642(1) of the Act cannot modify or amend the provisions of Schedule VI to the Companies Act. In this connection, learned counsel urged that AS 22 has now been prescribed by the rules framed under Section 641(1) of the Companies Act. That, it runs counter to or inconsistent with Schedule VI to the Companies Act D and consequently it amounts to excessive exercise of the powers conferred under Section 211 read with Section 642(1) of the Companies Act as '.- well as in excess of the provisions of Sections 209, 211 and Schedule VI to the Companies Act and is ultra vires the said Act. In other words, learned counsel submitted that Section 641 empowers the Central E Govenunent to amend Schedule VI but Section 642 does not confer any such power. According to the learned counsel, if Schedule VI is amended under Section 641 the amendment will have the effect as if enacted in the Act and the schedule so amended under Section 641 of the Act becomes part of the Act but that is not the case where AS is prescribed by the rules under Section 641 ( 1) of the Act. Learned counsel, therefore, submitted that Accounting Standard, as prescribed by the rules under Section 642(1) of the Act run contrary to or being inconsistent with Schedule VI of t11e Companies Act without any amendment being made under Section 641 (I) of the Act. According to the learned counsel, rules framed under Section 642( 1) of the Act do not have any effect as if enacted in the Companies Act; that, the effect of an1endment of schedule under Section 641 is as if enacted in the Act but rules framed under Section 642 do not have that effect. Therefore, the effect of the notifications under Section 641 on the one hand and the notifications issued under Section 642 on the other hand is entirely different. According to learned H

f- / J.K. INDUSTRIES LTD. v. UNION OF INDIA 2"" .) .)

[KAPADIA,].] -+ counsel, so long as Schedule VI to the Companies Act is not altered or A amended by exercising the power under Section 641 (I) of the Act the AS prescribed by the rules notified under Section 642(1) cannot alter or amend Schedule VI and if the said rules are contrary to or inconsistent with Schedule VI then the same are liable to be struck down as inconsistent with the provisions of the Companies Act. B

24. Learned counsel further submitted that in any case the requirement of maintaining accounts on accrual basis and on double entry system of accounting as required under Section 209 of the Companies Act is mandatory and it is not subject to any provisions of Section 211 of the Companies Act. Therefore, according to learned counsel, the rule c prescribing AS 22 under Section 642(1) is not only contrary to and inconsistent with Section 209 but also "V.~th Schedule VI to the Companies Act insofar as it requires the DTL to be included in the determination of net profit (loss) for the current year. That, it is in excess of the provisions ~ of Section 209 and Schedule VI to the Companies Act. According to the leamed cow1sel, if the accounts are to be maintained on accrual basis, DTL cannot be considered as an accrued liability. That, the requirements of giving true and fair view can be made only on accrual basis and on double entry system of accounting. However, if DTL is a notional and contingent liability, it cannot be charged to the P&L ale. It can only be disclosed by way of a Note in the balance-sheet and P&L ale which will give a true and fair view of the state of affairs of the company.

25. Lastly, ieamed counsel submitted that clause 33 of AS 22 gives a retrospective effect to the transactions which have taken place much earlier and in respect of which the DTL is to be calculated as if the said AS 22 has been in effect from the beginning and the entire amount of such DTL is now required to be provided for in the opening balance of the year in which AS 22 has been given effect to i.e. in the year 2001.

26. Mr. Arvind P. Datar, learned senior counsel appearing on behalf of M/s. First Leasing Company oflndia Ltd., submitted that AS 22 is a '"' ' subordinate legislation. It cannot be contrary to the provisions of the parent Act, namely, Companies Act, 1956 and, in particular, Sections 205, 209, Schedule VI and Schedule XIV thereof According to the learned counsel, AS 22 is ultra vires the rule making power conferred by Section 642 H

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A to the e:x.ient it seeks to create a fictional tax liability. According to learned counsel, AS 22 is also ultra vires as no subordinate legislation can seek to reconcile divergent profits that are arrived at by two independent enactments, namely, accounting or book profits as per the Companies ~ct and taxable profits under the LT. Act. In this connection, it was urged B that all 29 Accounting Standards stood notified by Notification No.739(E) dated 7.12.2006. Accordingly, all 29 Accounting Standards are now contained in the Companies (Accounting Standards) Rules, 2006. They have, therefore, the status of subordinate legislation. That, para 2 of the Annexure to the Accounting Standards has expressly stated that the C Standards are intended to be in conformity with the provisions of applicable laws and, therefore, according to learned counsel, the intention is not to treat the Accounting Standards as part of the Companies Act but as a subordinate legislation. Therefore, AS 22 cannot be treated as amending or altering Schedule VI which is part of the Companies Act D and which can only be done under Section 641 (2) by way of appropriate notification. That, under Section 641 (2), any amendment to the schedules by way of notification is treated as if it is enacted in the Act. Such a provision is absent in Section 642. That, as the Accounting Standards in the present case have not been notified under Section 641, they cannot E alter or amend the Schedule VI to the Companies Act.

27. As regards matching principle, learned counsel submitted that the said principle has to be applied in two ways: (i) on revenue basis; and

F (ii) on tin1e basis

That, the said principle can be applied for both the profits, namely, accounting profits and taxable profits. That, broadly speaking, the matching principle can be applied by matching expenditure against specific revenues as having been used in generating those specific revenues or by matching G expenses against the revenues of a given period in general on the basis that the expenditure pertains to thatperiod. The former is termed as ;.,..,.. "matching principle on revenue basis" and the latter is termed as "matching p1inciple on time basis''. According to learned counsel, the said principle applies only where the assessee has a choice of debiting or crediting H

J.K. INDUSTRIES LTD. v. UNION OF INDIA 235

[KAPADIA,J.] ' ---) expenditure or income in a particular financial year (time basis) or for A correlating a particular expenditure against particular revenue (revenue basis). That, matching principle cannot be extrapolated to divergent results that arise under tWo statues and, therefore, Accounting Profits and Taxable Profits computed under the Companies Act and the LT. Act respectively cannot be reconciled by applying the matching principle or on the basis B --\ ofeffect of Time Differences. In this connection, learned counsel pointed out that in India the timing difference arises mainly because different rates of depreciation are statutorily prescribed by Schedule XIV to the Companies Act and by Rule 5, Appendix-I to the Income Tax Rules. It is submitted that 99% of DTL arises only on account of difference c in depreciation rates. This position is not disputed by the Institute. Learned counsel, therefore, urged that if the rates of depreciation are statutorily different, then the Institute or the Central Government, as a rule making authority, has no power to apply the matching principle or timing ~ difference and bring the "accounting depreciation" in line with "tax depreciation". Therefore, according to learned counsel, the Institute as well as the Central Government has erred in prescribing AS 22 as a mandatory rule to bring about a reconciliation between tax depreciation and accounting depreciation for which it has no such jurisdiction or power. According to learned counsel, in India, unlike U.K., rates of depreciation are statutorily prescribed. They are separately prescribed under LT. Act and Companies Act. Therefore, it is only for the court/tax department to apply the matching principle in a given case. It would depend on the facts of a given case. The matching principle cannot be prescribed by a rule or ....\ an Accounting Standard. Learned counsel, therefore, submitted that the Central Government as a rule making authority under Section 642 or the F Institute has no power to apply the matching principle or timing difference across the board to bring the accounting depreciation in line with tax depreciation. The rates of depreciation are not prescribed statutorily in U.K. In U.K. the assessee is at liberty to adopt any rate of depreciation he chooses and, therefore, according to learned counsel, there could be G >---..._ ~~ some justification for invoking the matching principle and applying an accounting standard for deferred taxation.

28. On the concept of "true and fair" view, leaned counsel urged that under Section 211 (1 ), a balance-sheet has to present a true and fair H

236 SUPREME COURT REPORTS (2007] 12 S.C.R.

A view. Similarly, t.!nder Section 211(2), P&L ale must also be true and fair. However, according to learned counsel, the said concept does not mean that Accounting Standards can alter Schedule VI or enable alteration of accounting profits which have been computed as per Sections 205, 209 read with Schedule VI and Schedule XIV to the Companies Act. B Learned counsel further pointed out that in fact under Section 211(5)(v) there is a stipulation that anything not disclosed as per Schedule VI will •- not render the balance-sheet/P&L ale as not disclosing the true and fair view.

29. On the question of effect of AS 22, learned counsel urged that the effect of implementation of AS 22 would result in drastic reduction in profits of a company. In this connection, learned counsel urged that AS 22 provides for TOI. That, the difference between accounting profit (profit under the Cornpanies Act after providing for depreciation and taxation) and the taxable profit (profit as per LT. Act) are to be multiplied by the rate of income tax. This amount has to be reduced/deducted from the accounting profit. Therefore, the formula would be read as under: (AP-TP) x rate of income tax= DTL In other words, if the accounting profit is Rs.50 crores and the taxable profit is Rs.30 crores and the rate of income tax is 30% then DTL will be Rs.6 crores (50-30 x 30/100).

30. Similarly, (loss/unabsorbed depreciation) x rate ofincome tax is = DTA. If a company has a loss and carry forward depreciation of Rs.40 F crores and the rate of income tax is 30% then DTA will be: 40 x 30/100 = Rs.12 crores In such a case the loss ofRs.40 crores will be reduced to Rs.28 crores (40-12). G Relying upon the above illustrations, learned counsel submitted that if a ·~ company is making accounting profits year after year the said profits will I stand reduced year after year by DTL if AS 22 is implemented. Similarly, according to learned counsel, the DTL of each year will become accumulated and shown on the liability side of the balance-sheet, below H

J.K. INDUSTRIES LTD. v. UNION OF INDIA 237

[KAPADIA,J.] "Unsecured Loans". That, this accumulated liability on account o( DTL A will reduce the net-worth of a company. On the other hand, DTA has to be shown on the Asset side. But DTA can be claimed as an asset only on the basis of the concept of "virtual certainty" (See: paras 17 and 18 of AS 22). Accordingly, it is urged that profits available for distribution as dividend shall also be reduced between 20% to 30% each year if DTL B is shown as accumulated liability. According to learned counsel, the Institute has not produced any evidence of any company getting any benefit from implementation of AS 22. In this connection, learned counsel submitted that provision for DTL unfortunately has not been treated as a reserve which can be utilized in times of financial crisis. That the Institute has not c given a single example of a situation where timing difference has been reversed. According to lea.med counsel, AS 22 does not in any way help collection of higher taxes. That, as long as a company continues to be profitable, it is impossible for any reversal by timing difference. In this connection, learned counsel urged that, in India, income tax depreciation D \ is substantially higher than accounting depreciation as per Schedule XIV and, therefore, the accounting profits will always be more than the book profits. Therefore, every year, there would be DTL which will keep on accumulating. For example, according to learned counsel, accumulated DTL of Reliance Industries Ltd. was Rs.6982 crores as on 31.3 .07 and this liability will keep on accumulating. According to learned counsel, except in the case of companies which are likely to make loss in the near future, reversal will never take place. Therefore, the basic stipulation of timing difference getting reversed will never happen. Learned counsel further submitted that DTL is made chargeable to the P&L ale even when it is a non-existent or fictional liability; that the amount which is reduced from the profit is not even treated as a reserve and, therefore, DTL cannot be utilized if the company runs into financial difficulty.

31. According to learned counsel, under para 33 of AS 22 . companies are required to rework the entire liability from the beginning of the existing assets. For example, in the case oflndian Railway Finance Corporation Ltd., provision is required to be made in respect DTL of Rs. 940.55 crores. The transitional provision took place for the year ended 2001-02. The said provision ofRs.940.55 crores has diminished Bond Redemption Reserve. Similarly, according to learned counsel, in the case H

238 SUPREME COURT REPORTS [2007] 12 S.C.R.

;.,.- . A of Mis. First Leasing Company oflndia Ltd., application of para 33, as transitional provision, has resulted in DTL ofRs.62 crores.

32. On the question of legal status of AS 22, learned counsel submitted that the said Standard is a subordinate legislation and, therefore, it cannot create a tax liability. DTL is neither a liability nor a tax. It is not B a deferral. That, the levy of tax can either be by the Central Government or State· Government under List I or List II of Schedule VII to the Constitution. That, under Article 366(28), taxation includes imposition of any tax or impost. Under Article 265, taxes can be levied only by authority of law. DTL, according to learned counsel, is not a tax by C definition or by understanding. It cannot be treated as a tax by any process of interpretation. If it is a tax, it has to be credited to the Consolidated Fund oflndia/State. DTL is also not a fee or a cess or any surcharge. That, under para 3(vi) of Part II of Schedule VI deduction of taxes on income has to be shown. At present, the taxes that can be deducted are D Income Tax, Fringe Benefit Tax (FBI), Minimum Alternate Tax (MAT). Similarly, any surcharge or cess levied by the Finance Act as a percentage of such taxes will also be deductible. According to learned counsel, gross receipts of any company can be reduced by following items to arrive at profits before taxation. These items are expenses such as salaries, raw E materials and overheads; liability towards gratuity, PF, etc .. A tax liability can be created only under an Act of Parliament. DTL can only be a liability by way of tax. It is not a liability of any other nature since it is not required to be discharged in future. It is not enforceable against the company. Thus, DTL creates a legal fiction with respect to the jl-. I F concepts of taxation and liability which is contrary to the legal meaning enunciated by several judgments of this Court (See: State of Kerala v Madras Rubber Factory Ltd., AIR ( 1998) SC 723 at 730 and Shree Digvijay Cement Co. Ltd. v. Union of India, [2003] 2 SCC 614 at 627, para 26 and 27). G

33. On the question of effect of Section 211(3A), (3B) and (3C), learned counsel submitted that Section 211 (3 A) cannot be read to imply )-<~ that Accounting Standards have to be complied with even if they are inconsistent with the Act or that they alter/amend any provisions of the Companies Act. As regards Section 211(3B), learned counsel submitted H

( J.K. INDUSTRIES LTD. v. UNION OF INDIA 239 ( / [KAPADIA,J.]

.. - -.A that any deviation from the Accounting Standards has to be qualified by the auditors which may lead to adverse consequences for the company. According to learned counsel, unless the company is likely to make loss in near future, timing difference can never arise. According to learned counsel, tax depreciation, in India, is higher than book depreciation and, therefore, DTL will exist in the financial statements indefinitely. This is one more effect of AS 22 being implemented in India. On the other hand, --\ . according to learned counsel, the very purpose of AS 22 of presenting true and fair view can be easily achieved by making AS 22 a disclosure requirement as Notes to the Accounts, rather than inserting it in Schedule VI, Parts I and II to the Companies Act. c

34. Mr. S.K. Bagaria, learned counsel appearing on behalf of J.K. Tyre & Industries Ltd. (formerly known as "J.K. Industries Ltd."), submitted that AS 22 requires charging the P&L ale for an assumed liability on account of deferred tax which is not payable according to the provisions of LT. Act for the accounting period nor does it represent D -4 any tax which would become payable in future. That, AS 22 requires provision to be made for alleged tax liabilities and recognition of alleged tax assets which are not at all accrued liabilities or assets. According to learned counsel, AS 22 requires provision for assumed tax liabilities and recognition of assumed tax assets which are in reality non-existent, commercially or under the law. According to the learned counsel, notional and imaginary working is required to be made for AS 22; that, deferred ta-x is neither an asset nor a liability; that, the accrual basis of accounting requires a provision to be made for a known liability existing on the , >, balance-sheet date and that any provision made on account of tax not payable under LT. Act for the accounting period is not a provision for any known liability according to the accrual basis of accounting. According to the learned counsel, any amount set aside on account of tax for which there is no liability under the LT. Act cannot be considered as a "tax expense " for the period of account; that, statutory levy of tax has to be G ........_ measured and recognized as per the I. T. Act or the Companies Act or ~ any other applicable enactment and that ifthe LT. Act does not create DTL, such liability does not exist at all. According to the learned counsel, under the "accrual" basis of accounting, a company is required to make provision only for a liability which has accrued in the relevant accounting H

240 J SUPREME COURT REPORTS [2007] 12 S.C.R. "

A year; that, in respect of contingent liability, it is not required to make any provision but only a note is required to be given in the accounts known as "Disclosure Note"; that, DTL is not even a contingent liability; and that, on the balance-sheet date several events such as the working of the company in future years, whether the company will earned a taxable profit B (loss) in future are events which are totally unknown at the end of the accounting period when the company is required to recognize, measure !- - and account for DTL. According to the learned counsel, if there is no income in future, there would be no liability for tax in future and if there is income and additions to assets in future, the difference in depreciation c under the Companies Act and under the I.T. Act for the accounting period will not result in any tax liability in future and there would be no reversal of the DTL created in the accounting period. According to learned counsel, AS 22 requires recognition of the tax effect, whether current or deferred, in respect of individual transaction during the accounting period as if in future the company would have to make payment on account ofdeferred tax. According to learned counsel, the aforestated concept is merely an assumption. Under the l T Act, tax is determined with reference to the total income and not with reference to any individual transaction. The total income in future is uncertain. The total statutory tax liability in future is also uncertain. The difference between the current accounting income and the current taxable income, for example, on account of depreciation, may or may not have any impact on the computation of the total income of a future year or it may or may not entail any tax liability. Therefore, it cannot be said with certainty that deferred tax in respect ofan individual transaction ofthe accounting period would result in any cash outflow on account of tax in a future year. According to learned counsel, AS 22 has been framed on the fundamental accounting assumption of "going concern". However, it is one thing to assume that business would go on and quite another to assume that it will produce profits. If there is no taxable income in future, the tax effect of the transactions of the accounting period will not translate into any actual liability or cash outflow. According to learned counsel, AS 22 assumes that there would be sufficient taxable income in future entailing tax liability in future and that the tax effect of the transactions in the accounting period would have a role to play in the detennination of future H

/ I i J.K. INDUSTRIES LTD. v. UNION OF INDIA [KAPADIA,J.] 241

taxable income and liability. According to learned counsel, the above is A \ '--\ also an assumption. According to learned counsel, the accrued liability for tax is the liability in respect of the amount of tax statutorily pay~ble on the taxable income computed from the accounting income in accordance with the l.T. Act after making appropriate deduction allowances and disallowances. Such liability for tax represents the B provision for taxation. Any amount in excess of such liability would be a --~ reserve. If the LT. Act does not create any liability for tax, such liability does not exist in fact or in law and, therefore, it would be contrary to all norms of prudence to recognize or provide for a non-existent liability. According to learned counsel, liability for tax must exist under LT. Act c for it to be called an accrued liability; that the contention of the Institute that liability for tax should be considered in the accounting sense and not in the strict legal sense proceeds on the basis that deferred tax is not an accrued liability in the legal sense; that, the tax liability in the income is only to the extent the IT Act provides for such liability; that real D ~ liability for income tax is only as computed under the LT. Act; that, merely because the difference between the accounting income and taxable income is ascertainable and merely because tax effect on account of Such difference can be worked out on the basis of existing tax rates, it cannot be said that such tax effect represents a real liability payable today E or tomorrow. According to learned counsel, the difference between accounting and taxable income in a given year may or may not give rise to a liability or outflow of money in future. According to learned counsel, this is an assumption. This is totally uncertain. Therefore, according to learned counsel, to give tax effect on such difference cannot be treated F ' ·" \ as an accrued liability and in respect of such difference, no income tax is payable under the I.T. Act for the accounting period.

35Copy pinpoint35. Mr. Bagaria, learned cow1sel, further submitted that "accrual" is a legal concept. It has not been defined under LT. Act. It has not defmed under the Companies Act. An accrued liability arises only if that liability G has arisen in the accounting year concerned. This position has been settled \.. -' by various decisions ofthis Court. It has been further held in numerous decisions by this Collii that provision for taxation is the provision for tax liability under the I. T. Act as on the last date of the accounting year and that if anything is provided in excess of such tax liability, it will not be a H

242 SUPREME COURT REPORTS [2007] 12 S.C.R.

A provision but it will be a reserve (See: the judgment of this Court in Metal Box Company of India Ltd. v. Their Workmen, AIR (1969) SC 612. 1berefore, according to learned counsel, if the LT. Act does not create any liability for tax, there is no liability for tax either in fact or in law. Learned counsel, however, invited our attention to the difference between B contractual liability in case of cars sold with warranties and tax liabilities which, according to learned ·counsel, stand on a totally different footing as it is to be determined in accordance with the principles laid down in various judgments of this Court under the LT. Act.

36Copy pinpoint36. Learned counsel next contended that under Section 209(3)(b) C of the Companies Act read with Section 209(1 ), income and expenditure and assets and liabilities should be accounted for in the books of account on "accrual basis and according to the double entry system of accounting"; that, the concept of "accrual" in Section 209(3 )(b) is required to be understood in the same manner as it is required to be understood judicially. D According to the learned counsel, "accrual" has been defined in AS 1, which has also been prescribed by the impugned Notification dated 7.12.06, as revenues and costs recognized as they are earned or incurred and recorded in the financial statements of the periods to which they relate. According to learned counsel, the definition of the word "accrual" in E Notification dated 25.1.96 issued by the Central Government under Section 145(2) of the LT. Act also referred to the word "accrual" as an assumption, namely, that revenues and costs are recognized as they are earned or incurred and so recorded in the financial statements for the period(s) to which they relate. According to learned counsel, the F Accolinting Standard notified under LT. Act also requires the accounts to give a true and fair view. Therefore, according to learned counsel, the definition of the word "accrual" is the same both in the Accounting Standard prescribed under Section 211 (3C) and that which is notified under Section 145(2) of the LT. Act. Therefore, according to learned G counsel, the word "accrual" for the purposes of the Companies Act does not carry any meaning different from that mentioned for the purposes of the LT. Act. That, only the amount of income tax actually payable under the LT. Act with reference to the taxable income for the period covered by the account computed in accordance with the provisions of that Act H can constitute a charge for income tax and is, therefore, an accrued lial;>jlity.

./ j J.K. INDUSTRIES LTD. v. UNION OF INDIA [KAPADIA, J.] 243

-~-\ Any amount in excess of such tax is a reserve and not a provision for A taxation. According to learned counsel, therefore, for the above reasons AS 22 insofar as it relates to deferred tax is contrary to the concept of ''accrual'' which concept is recognized under Section 209(3 Xb) read with Section 209(1) of the Companies Act

37Copy pinpoint37. On the question of matching principle, learned counsel urged that B 4 the matching concept is fully complied with when a provision is a made \ for tax computed in accordance with the provisions of the LT. Act with reference to the taxable income derived from the accounting income after making appropriate deductions, allowances and disallowances in accordance with the statutory provisions. According to learned counsel, c matching tax in respect of accounting income is only the tax computed for the accounting period, according to the provisions of the I. T. Act. It is not any assumed future taxation dependent upon any assumed future working of the company. The object of incurring expenses is to produce revenue. In measuring the income for a period, revenue is to be adjusted against expenses incurred for producing that revenue. This concept of adjusting/offsetting the expenses against revenue is the matching principle. This concept is fully satisfied when provision for taxation is made for tax liability in accordance with the provisions of the LT. Act and it is such tax alone which is the tax liability incurred on the income earned during the period concerned.

38Copy pinpoint38. As regards the question of the functional utility of Accounting Standards under Section 211(3A), (3B) and (3C) is concerned, learned counsel submitted that Section 209 provides that every company keeping F ' proper books of account with respect to moneys received and expended and the matters in respect of which the receipt and expenditure takes place as well as the assets and liabilities of the company. According to learned counsel, therefore, Section 209(1) recognizes the receipt and expenditure as well as assets and liabilities; that, prior to substitution of Section 209(3) by the Companies Act (Amendment) Act, 1988 w.e.f. 15.6.88, did not G --.:;-'I provide for keeping the books of account on accrual basis. However, \ based on the report of Sachar Committee to the effect that ''true and fair" view should be projected, Section 209 was suitably amended to make it obligatory on all companies to maintain accounts on mercantile H

244 SUPREME COURT REPORTS [2007] 12 S.C.R.

A system of accounting. Based on the recommendation of the Sachar Committee sub-section (3) was substituted. Thus, from Section 209, according to learned counsel, the following position becomes clear, namely, that Section 209 recognises receipt and expenditure as well as assets and liabilities on accrual basis and on double entry system for accounting. After B the said amendment, books of account are required to be kept on accrual basis. Therefore, according to learned counsel, the requirement of' 'true and fair view" stands incorporated in Section 209(3)(a), Section 211(1), (2) and (5); Section 217(2AA)(ii); and Section 227(2). According to learned counsel, on bare reading of Section 227 read with Section 209 it c is clear that the auditor of the company has to report that ''proper books of account" as required by law has been kept by the company; that, "proper books of account" shall not be deemed to be kept unless they are kept on accrual basis and double entry system of accounting; that, the auditor has to report that the balance-sheet and the P&L ale are in D agreement with the books of account and that the auditor has also to report whether profit and loss account as well as balance-sheet complies with the Accounting Standards referred to in Section 211 (3C). According to learned counsel, sub-section (3A) of Section 211 requires every P&L al c and balance-sheet of the company to comply with the Accounting E Standards; that, sub-sections (3A), (3B) and (3C) do not refer to keeping of proper books of account; that this subject is covered by Section 209 only which mandates that proper books of account shall not be deemed to be kept unless the same are kept on accrual basis and double entry system of accounting; that, the said mandate of Section 209 cannot be F altered by the Accounting Standards and since the Accounting Standards as per sub-section (3A) can only relate to the P&L ale and balance-sheet and not to keeping proper books of account which are basic primary records from which the P&L ale and balance sheet are prepared and since P&L ale and balance-sheet are not books of account but only abstracts.

39Copy pinpoint39. AS 22 relating to deferred tax is directly in conflict with Section 209 of the Companies Act and in excess of the powers vested under sub- section (3A), (3B) and (3C) of Section 211. In this connection, learned submitted that the power conferred upon the Centrm Government under sub-section (3C) of Section 211 for prescribing Accounting Standards H by framing of rules is in the nature of delegated legislation; that under the

,- } J.K. INDUSTRIES LTD. v. UNION OF INDIA 245 [KAPADIA,J.] scheme of sub-section (3A), (3B) and (3C) ofSection21 l, Accounting A Standards can be prescribed only in relation to P&L ale and balance- sheet; that a delegatee of power cannot assumed jurisdiction in areas or over subjects which are not delegated; that the power being limited to prescribing Accounting Standards for P&L ale and balance-sheet, cannot be exercised in relation to maintenance of books of account and that too B on a basis different from accrual basis mandated in Section 209 and any such exercise of power by prescribing any Accounting Standard affecting the maintenance of proper books of account and that too on a basis different from accrual basis will be in excess of the powers vested in the Central Government under sub-section (3A), (3B) and (3C) of Section C 211 and will be directly in conflict with Section 209 of the Companies Act. In this connection, learned counsel submitted that AS 22 requires a company to reduce or increase its net profit by passing journal entries in its books of account in respect of DTL or DTA; that it is only after these entries are made in the books of account in respect of DTA or DTL that p the net profit in the P&L ale can be increased or reduced and DTA or DTL can be reflected in the balance-sheet after the head ''Investments'' in case ofDTA and after the head "Unsecured Loans" in case ofDTL and, therefore, according to learned counsel, AS 22 exceeds the power conferred by sub-sections (3A), (3B) and (3C). According to learned E counsel, the power under sub-sections (3A), (3B) and (3C) only relates to prescribing Accounting Standards for presentation of P&L ale and balance-sheet whereas AS 22 directly and immediately encroaches upon preparation of books of account and maintenance and proper books of account on accrual basis and in the process violates the mandate statutorily imposed by Section 209(3). That, there is no power conferred by sub- F sections (3A), (3B) and (3C) nor by any other sub-sections of 211 to prescribe Accounting Standards relating to maintenance of proper books of account. In this connection, learned counsel pointed out that the duty of the auditor is to report in terms of Section 227(3)(d) about compliance with the Accounting Standards referred to in sub-section (3C) of Section G 211 which applies only in respect of P&L ale and balance-sheet; that, the said provision makes it clear that compliance with the Accounting Standards is to be made only in respect of the P&L ale and balance- sheet whereas keeping of books of account in terms of Section 209 is H

246 SUPREME COURT REPORTS [2007] 12 S.C.R. \ \

A required to be reported upon by the auditor only in terms of Section 227(3)(d) and, therefore, AS 22 exceeds the power conferred by sub- sections (3A), (3B) and (3C) of Section 211. Learned counsel submitted that AS 22 is confined to prescribing Accounting Standards for presentation of P&L ale and balance-sheet. It does not deal with B preparation of books of account. That subject falls under Section 209(3). Therefore, AS 22 prescribes Accounting Standards only for P&L ale and balance-sheet without directing that exercise to be made in respect ofpreparation and maintenance and proper books of account on accrual basis and, therefore, AS 22 brings about inconsistency c between the provisions of Section 209(3} on one hand and sub-sections (3A), (3B) and {3C) of Section 211. According to learned counsel, Section 2 l 7(2AA)(i) merely relates to "preparation of annual accounts"; it does not deal at .all with preparation and. maintenance of books of account; that annual accounts are not books of account (See: Section 210) D and_, ther~fore, ~he_said Section 217(2,~A)(i) has nothing to do with preparation and maintenance of proper books of account which subject is independently dealt with in Section 209. According to learned counsel, the provisions of AS 22 insofar as it requires making of entries in the books of account reducing the profit by accounting for DTL or increasing the E profit ~y ac~ounting for DTA and to reflec~ such entries in the P&L ale and balance-sheet, are ultra vires sub-sections (3A), (3B) and (3C) of Sectio.n 211 and Section _209 of the Companies Act. That, by AS 22, insofar as the same relates to ''deferred tax'', the de legatee of power (C~ntral Government).has attempted to encroach upon the areas far beyond those covered by the delegation. F

40Copy pinpoint40. According to the learned counsel, Section 211(1) starts with the mandate that ''every balance-sheet of a company shall give a 'true and fair' view at the end of the financial year". This mandate is, according to learned counsel, not subject to anything. It is·not qualified by the expression G "subject to the provisions ofthis section". Similar is the position in sub- section (2) of Section 211 with regard to the P&L ale. Therefore, according to learned counsel, ''true and fair view'' requirement is the primary requirement of Section 211(1) and Section 211(2) which requirement stands satisfied only if the accrual basis is followed as mandated in Section 209(3). According to learned counsel, the expression

; J.K. INDUSTRIES LTD. v. UNION OF INDIA 247 / [KAPADIA,J.] "subject to the provisions of this section" in Section 211 (1) obviously includes the provision of sub-section (1 ). Therefore, according to learned counsel, even in terms of the specific language of Section 211 (1) the requirement of ''true and fair view'' in that sub-section is a stand- alone concept and it is not subject to anything. According to learned counsel, accrual basis in Section 209(3) is a necessary component of B "true and fair" view as a requirement and, therefore, the said requirement in Section 211 and in Section 209 would have the same meaning. However, according to learned counsel, the expression "subject to the provisions of this section" in Section 211(1) only qualifies the requirement of balance-sheet being in the form set out in Part I of c Schedule VI; that, similarly the expression "subject as aforesaid" in sub- section (2) of Section 211 only qualifies the requirement of Part II of Schedule VI in respect of P&L a/c; that, sub-section (3A) of Section 211 inter alia provides that every P&L a/c and balance-sheet of the company shall comply with the Accounting Standards and, therefore, according to D learned counsel in the entire scheme relating to accounts and audit in Pait VI, Chapter I, Section 209 to Section 233B.of the Companies Act, the statutory mandate of keeping proper books of account on accrual basis is not allowed to be altered or encroached upon by any Accounting Standards. According to learned counsel, it is the statutory mandate that E P&L ale and balance-sheet shall be in consonance with the books of account. Therefore, sub-sections (3A), (3B) and (3C) can only relate to presentation of and disclosures in P&L ale and balance-sheet, keeping intact the statutory mandate of maintaining proper books of account on accrual basis. Therefore, if the format of a balance-sheet or the requirements of P&L ale is allowed to be altered by any Accounting F Standards it would amount to encroachment upon the statutory mai1date of keeping proper books of account on accrual basis. Therefore, according to learned counsel, Accounting Standards can provide in relation to presentation of and disclosures in P&L ale and balance-sheet without touching upon the basic requirement of maintaining proper books G of account on accrual basis and only thereby one can comply with the concept of' 'true and fair view''. Any other interpretation would mean that AS 22 far exceeds the power conferred by sub-sections (3A), (3B) and (3C) of Section 211 and it would amount to creating inconsistencies H

248 SUPREME COURT REPORTS . (2007] 12 S.C.R.

A between various sections of the Companies Act.

41Copy pinpoint41. Learned counsel next contended that accrual basis of accounting does not recognize DTA or DTL; that, accounting/or any DTA or DTL would be contrary to the accrual basis of accounting and would not result in keeping of proper books of account in terms of Section 209. Neither the books of account nor the P&L ale or balance-sheet which are required to be in agreement with the books of account will give a >- true and fair view if accounting has to be made in respect ofDTA orDTL; that, AS 22 does not result in a true and fair measurement of the P&L al c or the state of affairs of a company and if any provision is made on account of "deferred tax" with reference to the difference between accounting and taxable incomes for which no liability exists under the I. T. Act, such provision would distort the books of account and financial statements and would not give a true and fair view. That, similarly creation of a deferred tax asset because of current losses would distort the books of account and financial stateme:its and would not give a true and fair view. According to learned counsel, accrual basis is a necessary component of true and fair view requirement. The provision contrary to the accrual basis cannot satisfy the said requirement. Lastly, according to learned counsel, the oniy way out of the above inconsistencies is to harmoniously construe Sections 209, 211 and AS 22 by reading down the said Standard so that the company is only required to make a disclosure in the P&L ale and balance-sheet as regards DTA or DTL without requiring the company to make any. entry in the books of account or without making any company to reduce or increase its net profit. F

42Copy pinpoint42. Lastly, learned counsel submitted that vide para 33 of AS 22 DTL is sought to be created in respect of individual transactions since the inception of the company which may be long before the AS 22 came into effect resulting in reduction of the revenue reserve by the amount of G such DTL. That, the working required to be made in terms of para 33 of AS 22 is complicated. In this comection, learned counsel pointed out that under para 34 of AS 22, not only opening balances of assets but also opening balances ofliabilities for accounting purposes and fortax purposes have got to be compared; that, para 33requires a working to be made in respect of individual transactions since the inception of the company in H

) J.K. INDUSTRIES LTD. v. UNION OF INDIA 249 [KAPADIA,J.] order to ascertain DTAs or DTLs. That, in case of DTL, the revenue A reserve has to be reduced and conversely in case of a OTA; the revenue reserve has to be increased. This is, according to learned counsel, indicate<; that para 33 which is tenned as "transitional provision" is dearly retrospective in its operation. Therefore, according to learned counsel, para 33 of AS 22 would result in reduction of the company's revenue B -' reserves. It will erode the company's net worth. It will alterthe company's debt-equity ratio. It will adversely effect the company's borrowing capacity. Therefore, according to learned counsel, the High Court had erred in dismissing the writ petitions filed by the appellants. According to learned counsel, Section 211 (3C) does not enable the Central C Government to give any retrospective operation to the Accounting Standards. The rule-making power under Section 642 of the Companies Act also does not permit the making of any rules with retrospective effect and, therefore, according to learned counsel, para 33 deserves to be set ) aside. For the above reasons, learned counsel submitted that AS 22 far exceeds the power and jurisdiction conferred by sub-sections (3A), (3B) and (3C) of Section 211 and that it brings about inconsistencies between various sections of the Companies Act and, therefore, the said AS 22 deserves to be struck down or in the alternative AS 22 deserves to be read down so that at best the company is required to make a disclosure in the P&L ale and balance-sheet as regards any OTA or DTL without requiring it to make any entry in the books of account and without requiring any company to increase or reduce its net profit (loss).

-\ 43. Mr. A Sharan, learned Additional Solicitor General appearing for Union of India, submitted that validity of a legislation could be challenged on grounds of incompetence of the legislation or same being violative of Part III of the Constitution. That, a subordinate legislation can be challenged additionally on the grounds that the same is beyond the authority of delegate or that it is violative of provisions of the enactment. According to learned counsel, in the present case, appellants have not challenged the competence of the Central Government to notify or provide for Accounting Standards, they have restricted their challenge only on the ground that AS 22 contravenes the provisions of Companies Act by stating that the same violates Sections 205, 209, 211 and Schedule VI of the Companies Act. According to learned counsel, even in that regard H

250 ~, SUPREME COURT REPORTS [2007] 12 S.C.R. \

A no details,have been given by the appellants in their original writ petition as to how the impugned Accounting Standard contravenes the provisions of the Companies·Act. Therefore, according to learned counsel, the entire original writ petition filed by the appellant is misplaced, misconceived and not-maintainable for want of details. Learned counsel urged that AS-22 B provides for a different manner than Schedule VI in which account of a company required to be prepared. It is submitted that Schedule VI is the form set out under the Companies Act in which a company is required to submit its balance-sheet and profit and loss account. Section 211 ( 1) requires the companies to prepare their balance-sheet in the form set out C in Part-I of Schedule VI. A plain reading of Section 211 reveals that the requirement of submission of balance-sheet in the said form is subject to the other sub-sections of Section 211 and hence the format of the said balance shall necessarily be guided by the Accounting Standards provided under sub-section (3A) as same is having overriding effect on Part I of D Schedule VI. According to learned counsel, when any provision made is · subject to other provisions of that section, then the said provision (Part I of Schedule VI) has to give way the other provisions (AS-22 as provided by Section 221(3A)). In this connection, reliance is placed on the judgment of this Court in the case of South India Corporation (P) Ltd. v. Board of Revenue, Trivandrum and Anr., AIR (1964) SC 207 at p.215, in E which this Court has held that the expression "subject to" conveys the idea of a provision yielding place to another provision or other provision(s) to which it is subject to. Reliance was also placed by the learned counsel on the judgment ofthis Court in the cases: I- F The State of Bihar and Anr. v. Sir Kameshwan Singh and Anr., AIR (1952) SC 252; KR.CS. Balakrishna Chetty and Sons & Co. v. The State of Jovfadras, AIR (1961) SC 1152; and

G Heggade .Janardhan Subbaraya v. The State of Mysore and Ors., AIR(1963) SC 702. In the alternative, learned counsel submitted that in any event Section 641 empowers the Central Government to amend Schedule VI whereas Section 642 confers powers on the Central Government to fom1ulate rules. H

) J.K.INDUSTRIESLTD. v. UNION OF INDIA 251 ~. ,.....,._...1i, [KAPADIA,J.] That, Part I of Schedule VI prescribes the form in which the balance- A sheet and P&L ale is required to be prepared. According to learned counsel, AS 22 is prescribed by the Central Government with respect to computation of tax liability; that, AS 22 lays down the manner in which the said computation of tax liability in the balance-sheet is required to be prepared and, therefore, in pith and substance AS 22, according to learned B -\ counsel, prescribes additional mode in which tax liability of a company is required to be calculated. Thus, according to learned counsel, exercise of power by the Central Government under Section 642 providing for AS 22 is exercise of power for same purpose which is required to be exercised under Section 641 to amend Schedule VI and, therefore, in c pith and substance, according to learned counsel, exercise of power by the Central Government under Section 642 will be deemed to be exercise of power by the Central Government under Section 641 and accordingly Part I of Schedule VI will stand modified/amended to the extent it contravenes AS 22. This is particularly because Part I of Schedule VI is D subject to Section 211 (3A) of the Companies Act. According to learned counsel, under Section 211 every company is required to prepare its balance-sheet and P&L ale in the manner provided therein. Sub-section (3A) of that Section makes it mandatory to comply with Accounting Standards. While preparing P&L ale and balance-sheet (See: Section E 211 (3C)). According to learned counsel, since AS 22 is an Accounting Standard prescribed under sub-section (3C) it has a statutory status, required to be followed while preparing the books of account in terms of ' Section 211 of the Companies Act. Lastly, learned counsel urged that the . ..\. Companies Act is a special statute; that, Section 211 is a special provision aimed at providing the form and content of P&L ale and balance-sheet F required to be prepared by the company; that, a special provision like Section 211 ordinarily overrides the general provision; that, if a special provision is made on a pmiicular subject then that subject is excluded from the general provision and since AS 22 is a special provision notified under Section 211 (3C) with respect to form and content of accounts of G - :.. -A the company, the same will override other provisions of the Companies Act as well as any other statute to the extent provided therein. In this connection, learned counsel placed reliance on the judgment of this Court in the cases: H

252 SUPREME COURT REPORTS [2007] 12 S.C.R.

A Gadde Venkateswara Rao v. Government of Andhra Pradesh and Ors., AIR (1966) SC 828; State of Bihar v. Dr. Yogendra Singh GOL (Retired) and Ors., [1982] 1 sec 664 B Maharashtra State Board ofSec. and High. Sec. Education and Anr. etc. v. Paritosh Bhupeshkumar Sheth and Ors. etc., [1984] 4 SCC >c- 27 State of Gujarat and Anr. etc. v. Patel Ramjibhai Danabhai and C Ors. etc., [1979] 3 SCC 347

44Copy pinpoint44. In view of the aforestated submissions learned counsel submitted that AS 22 is intra vires the Companies Act and, therefore, the appeals deserve to be dismissed with costs.

45Copy pinpoint45. Mr. N.K. Poddar, learned senior counsel appearing for the Institute, submitted that corporate accounts are required to disclose a ''true and fair view''. It is a requirement. That requirement has to be ensured by the auditors who have to certify that the accounts are prepared so as to provide "true and fair view" of the state of affairs of the company. TI1is responsibility is undertaken by accountants and auditors who are members of the Institute. If Accounting Standards are not followed, financial accounts would not be "true and fair" and in that case, the statutory requirement in Section 211 for preparing true and fair accounts would not be satisfied. According to learned counsel, prior to 1988 the requirement contemplated by the Companies Act was disclosure of' 'true and correct view''. This requirement was deliberately changed by the Legislature to ''true and fair view''. When it was a question of disclosing a true and correct view, it was permissible to look into the legal liability for tax, and make a provision accordingly; but when the requirement in law is to disclose ''true and fair'' accounts, a wider perspective is warranted. That is why, the Institute states that the LT. provision should be based not only on the strict legal liability to be discharged immediately, )---" but also on the legal liability based on book profits (l·eal profits) which are earned and reflected in the corporate accounts of the company. Therefore, the Institute insists that there should be a reasonable matching H

) J.K. INDUSTRIES LTD. v. UNION OF INDIA I 253 [KAPADIA,J.] of cost and benefit, if the accounts are to disclose a ''true and fair view''. A The Institute has legal obligation of ensuring disclosure of' 'true and fair view" in the corporate accounts. However, in the absence of a statutory definition of "true andfair", it is the Institute' s function to detennine the basic rules for ensuring disclosure of a ''true and fair view''. According to learned counsel, "true and fair view" is a concept which requires the B Auditor to look at the substance rather than pure legal form and that is why all its Accounting Standards emphasize the importance of Substance over Form. The said view of the Institute is duly affirmed by Parliament when Parliament decreed that corporate accounts shall comply with the proper Accounting Standards (See: sub-sections (3A) and (3B) of Section C 211 of the Companies Act). The basic reason for issuing AS 1 through Notification dated 25.1.96 of Government oflndia, to be followed by all assessee's following mercantile system of accounting, was to lay down that accounting policies adopted by an assessee should represent a ''true and fair'' view of the state of affairs of the business in the financial statements prepared and presented based on such accounting policies. Therefore, the requirement ''true and fair'' view overrides all other statutory requirements as to the matters to be included in the corporate accounts. In order to give a "true and fair view" it is not necessary to provide information, additional to the one needed to comply with all other statutory requirements or even to depart from compliance with one or the other requirements. Any departure has to be disclosed in a Note to the Financial Statements giving reasons for such departure and its effects. Moreover, the concept of' 'true and fair'' is not static. It is ' \ dynamic in nature. It continues to evolve in accordance with the changes in the requirements of economy. F

46Copy pinpoint46. It is the function of the Institute to regulate the profession of Chartered Accountants. By formulating Accounting Standards, Institute is fulfilling its statutory function. It is fu11hering Legislative intent of Parliament, which requires that accounts should be ''true and fair''. G Therefore, by laying down Accounting Standards, which explains what is "true and fair", the Institute is merely fulfilling its statutory duty and function.

47Copy pinpoint47. Learned counsel submitted that conceptually, the justification for H

254 SUPREME COURT REPORTS [2007] 12 S.C.R. \

A AC'.:ounting Standards lies in the compelling logic and conceptual validity of each Standard. Those who prepare Accounting Standards are not framing the Standards without any basis. The framers review accounting policies already adopted and select those policies which are most appropriate in the presentation of accounts based on the requirement of B ''true and fair view''. The Standard represents the most appropriate accounting policies out of various accounting policies adopted by different y.- companies over last several years. This is what is called as conceptual validity. The acceptance in such cases is not only recognized by statutory provisions but it is recognized 1'y a wider degree of acceptance in the C corporate world. That is why, almost all the major public companies, in India, have recognized and accepted the validity of the Standards. Even, this Court has expressed confirmation of commercial accounting Principles, Practices & Standards recommended by the Institute (See: Challapalli Sugars Ltd. v. Commissioner of Income Tax, (1975) 98 ITR 167 at D 172 and Commissioner of Central Excise v. Dai Jchi Karkaria Ltd. & Ors., [1999] 7 SCC 448 at 461. .f

48Copy pinpoint48. On the topic of "accrual" learned counsel submitted that under Section 209(3 )(b) all books of account are required to be kept on accrual basis and according to the double entry system of accounting. According E to learned counsel, the expressions "accrual", "accrual basis of accounting'', ''accrued asset'', ''accrued expense'', ''accrued liability'', ' 'accrued revenue'', ''current assets'', ' 'current liabilities' ', ' 'deferred expenditure'', ''depreciation'', ''provision'', ''prudence'' etc. are explained and defined in the Guidance Note on Terms Used in Financial F Statements issued by the Institute. Learned counsel submitted that the matching principle is the most important concept in "accrual accounting". The matching principle indicates as to when expenses should be recorded against the revenue. The Institute had issued Guidance Note on Accrual Basis of Accounting in 1988, since after the amendment of Section 209, requiring all companies to maintain their accounts on accrual basis of accounting. All relevant above mentioned expressions relating to accrual basis of accounting including recognition of revenue and .- /- expenses, assets and liabilities have been explained in the said Guidance Note on Accrual Basis of Accounting which inter alia lays down the matching principle of recognizing costs against revenue or against the

) J.K. INDUSTRIES LTD~ v. UNION OF INDIA 255 I [KAPADIA,J.] ~----\ relevant time period to determine the periodic income. According to learned counsel, in order to understand the relevance of Accounting Standards issued by the Institute for preparation and presentation of financial statements vis-a-vis the accrual system of accounting and vis- a-vis the matching principle it is necessary to refer to the concepts that underline the preparation and presentation of such statements. The main purpose of Accounting Standards is, therefore, to assist the Actountants -\ to prepare financial statements and to deal with topics that have yet to fom1 the subject of an Accounting Standard. The entire object is to promote harmonization of Regulations, Accounting Standards and Procedures relating to the preparation of financial statements by providing c a basis for reducing a number of alternative accounting treatments permitted by Accounting Standards. According to learned counsel, "accrual basis", "going concern" and "consistency" are underlying assumptions in preparation of financial statements. Prudence is important '