1. Challenge to Accounting Standard 22 (deferred taxation) as ultra vires Companies Act, Income-tax Act, and Constitution. (Para 1 , 2 )
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2007 Supreme(SC) 1468
S.H. Kapadia & B. Sudershan Reddy
J. K. Industries Ltd. & Anr PETITIONER
Versus
Union of India & Ors RESPONDENT
Appeal (civil) 3761 of 2007
Civil Appeal Nos.3478/2007, 3479/2007, 3480/2007 and 3482/2007.
Decided on: 19/11/2007
Accounting Standard 22 is intra vires the Companies Act; the mandate for a "true and fair view" justifies deferred tax accounting as it employs matching principles and fair valuation, making deferred tax liabilities/assets real obligations consistent with the accrual system of accounting.
Headnote:(A) Companies Act, 1956 - Sections 209, 210A, 211, 641, 642 and Schedule VI - Accounting Standard 22 (AS 22) - Deferred taxation - Validity of rule prescribing mandatory compliance with accounting standards - The requirement to provide a "true and fair view" of the state of affairs is the controlling consideration and a stand-alone concept that overrides technical form (Paras 66, 113, 119).
(B) Accrual System of Accounting - Matching Principle - Deferred Tax Liability (DTL) and Deferred Tax Asset (DTA) are not notional or contingent liabilities but result from timing differences that create real future cash outflows or inflows, thus aligning with the accrual basis of accounting (Paras 77, 92, 100).
(C) Power of delegated legislation - Rule making under Section 642 is a gap-filling exercise to supplement the parent Act - Accounting Standards provide details for recognition, measurement, and disclosure, whereas the Act's schedules provide for presentation (Paras 67, 68, 113, 127).
(D) Transitional Provisions - Provisions requiring recognition of accumulated deferred tax balances upon first-time adoption are transitional in nature and not retrospective (Paras 130-132).
Facts of the case:
Public limited companies challenged a notification making Accounting Standard 22 mandatory for financial statements, alleging that accounting for deferred taxation creates fictional liabilities that are contrary to the accrual basis of accounting required under Section 209. They further contended that the rule was ultra vires the power to make rules under the Companies Act and conflicted with the prescribed forms for balance sheets and profit and loss accounts in Schedule VI.
Findings of Court:
The rule adopting the accounting standard is intra vires and consistent with the parent Act. The mandate to present a "true and fair view" necessitates a paradigm shift toward fair valuation and matching principles. Deferred tax liabilities are real, as they relate to timing differences (primarily in depreciation) that result in future cash outflows, and are therefore consistent with accrual accounting. The transitional provisions are for first-time adoption and are not retrospective.
Issues: Whether the rule adopting AS 22 is ultra vires the Companies Act; whether deferred tax accounting is inconsistent with the requirement to maintain books on an accrual basis; and whether the transitional provisions in the standard are retrospective.
Ratio Decidendi: The mandate for a "true and fair view" is the primary requirement of the Act. Since the Act does not detail methods for recognition and measurement of items, delegated legislation providing these details is a valid gap-filling exercise. Because timing differences create a known liability/asset that will reverse over time, accounting for them under the matching principle is an integral part of the accrual system.
Result: Civil appeals dismissed.
Legal Category Hierarchy
-
company law
-
accounts and audit
- balance sheet and profit and loss account (Para 11, 12, 13, 14, 15, 17, 18, 19)
-
accounting standards
- accounting standard 22 (deferred taxation) (Para 20, 57, 58, 59, 60, 61, 62, 75, 76, 77, 79, 80, 81, 82, 84, 85, 86, 87, 88, 89, 90, 91, 92, 93, 94, 95, 96, 97, 98, 99, 100, 101, 103, 104, 106, 107, 108, 109, 110, 111, 112, 113, 114, 115, 116, 117, 118, 119, 120, 121, 122, 123, 124, 125, 126, 127, 128, 129, 130, 131, 132, 133, 134, 135)
- rule-making power
-
accounts and audit
- taxation law
- constitutional law
Table of Contents
2. Appellants argued AS 22 inconsistent with Schedule VI and rule-making power; respondents defended as valid subordinate legislation for true and fair view. (Para 21 , 23 , 24 , 25 , 26 , 27 , 28 , 29 , 30 , 31 , 32 , 33 , 34 , 35 , 36 , 37 , 38 , 39 , 40 , 41 , 42 , 43 , 44 , 45 , 46 , 47 , 48 , 49 , 50 , 51 , 52 , 53 , 54 , 55 )
3. Court held AS 22 is valid subordinate legislation, consistent with true and fair view, and not inconsistent with Companies Act or Schedule VI. (Para 56 , 57 , 63 , 64 , 65 , 66 , 67 , 68 , 69 , 70 , 75 , 76 , 77 , 79 , 80 , 81 , 82 , 84 , 85 , 86 , 87 , 88 , 89 , 90 , 91 , 92 , 93 , 94 , 95 , 96 , 97 , 98 , 99 , 100 , 101 , 103 , 104 , 106 , 107 , 108 , 109 , 110 , 111 , 112 , 113 , 114 , 115 , 116 , 117 , 118 , 119 , 120 , 121 , 122 , 123 , 124 , 125 , 126 , 127 , 128 , 129 , 130 , 131 , 132 , 133 , 134 , 135 )
4. AS 22 is intra vires Companies Act; deferred taxation is valid accounting standard; transitional provision is not retrospective. (Para 56 , 133 , 134 , 135 , 136 )
5. Appeals dismissed with no order as to costs; impugned judgment of High Court affirmed. (Para 136 )
6. Is Accounting Standard 22 ultra vires the Companies Act?
No, AS 22 is valid subordinate legislation within the rule-making power and not inconsistent with the Act. (Para 56 , 63 , 64 , 65 , 66 , 67 , 68 , 69 , 70 , 133 , 134 , 135 )
7. Is AS 22 inconsistent with Schedule VI of the Companies Act?
No, AS 22 deals with recognition and measurement not covered by Schedule VI, and is consistent with the true and fair view requirement. (Para 111 , 112 , 113 , 114 , 115 , 116 , 117 , 118 , 119 , 120 , 121 , 122 , 123 , 124 , 125 , 126 , 127 , 128 )
8. Is paragraph 33 of AS 22 retrospective and invalid?
No, paragraph 33 is a transitional provision, not retrospective; it applies on first adoption to accumulated timing differences. (Para 130 , 131 , 132 )
9. Does AS 22 violate the accrual basis of accounting under section 209 of the Companies Act?
No, AS 22 applies the matching principle which is part of accrual accounting and is required for true and fair view. (Para 75 , 76 , 77 , 79 , 80 , 81 , 82 , 84 , 85 , 86 , 87 , 88 , 89 , 90 , 91 , 92 , 93 )
JUDGMENT
KAPADIA, J.
1.A short question which arises for determination in this batch of civil appeals is : Whether Accounting Standard 22 (AS 22) entitled accounting for taxes on income insofar as it relates to deferred taxation is inconsistent with and ultra vires the provisions of the Companies Act, 1956 (the Companies Act), the Income-tax Act, 1961 (I.T. Act) and the Constitution of India?
2.M/s. J.K. Industries Ltd. is a public limited company. It was incorporated in 1951. It carries on the business of manufacture and sale of automotive tyres, tubes, sugar and agrigenetics. It has a registered office at Calcutta. It seeks to challenge AS 22 issued by Institute of Chartered Accountants of India (for short, Institute ) which has been made mandatory for all companies listed in Stock Exchanges in India in preparation of their accounts for the financial year 2001-02 onwards.
3.On 7.12.06 the Central Government prescribed AS 22 under Section 211 (3C) of the Companies Act by the Companies (AS) Rules 2006. Before that date, AS 22, when issued in 2001, was challenged in writ petitions filed before Madras, Karnataka, Calcutta and Gujarat High Courts. On transfer petitions, under Section 139A of the Constitution, filed by the Institute, this Court vide order dated 17.2.03 was pleased to transfer the writ petitions filed in various High Courts to the Calcutta High Court. Meaning and purpose of AS:
4.In its origin, Accounting Standard is a policy statement or document framed by Institute. Accounting Standards establishes rules relating to recognition, measurement and disclosures thereby ensuring that all enterprises that follow them are comparable and that their financial statements are true, fair and transparent. Accounting Standards ( A.S. for short) are based on a number of accounting principles. They seek to arrive at true accounting income. One such principle is the matching principle. The other is fair value principle. The aim of the Institute is to go for paradigm shift from matching to fair value principle.
5.Today the revised Accounting Standards seeks to arrive at true accounting income. In the age of globalization the attempt is to reconcile the accounts of Indian companies with their joint venture partners abroad. The aim is to harmonise Indian Accounting Standards with International Accounting Standards. With the object of bridging gap between IAS and IFRS, the Institute formulated new A.S. and introduced new concepts, e.g., Deferred Tax Accounting (AS 22 impugned herein), Segment Reporting (AS 17) etc.. However, as a matter of prudence and necessary adjustment, to arrive at real income, Accounting Standards require provision to be made for liabilities payable in future, provision to be made for contingencies, provision to be made for diminution, provision to reflect impairment and so on which have the effect of reducing incomes and were, therefore, not readily accepted by some enterprises and tax authorities.
6.The core of Accountancy is Book-keeping. The rules of Book-keeping are clear. For example, the value of a fixed asset mentioned in a Balance Sheet is based on cost which may involve subjective estimation of the amount to be apportioned. Similarly, the quantum of depreciation is again an estimate, which can vary depending on the persons preparing the accounts as to when and at what stage he wants to record the depreciation. Accounting Standards are an attempt to overcome some of these deficiencies of Accountancy. Accounting Standards involve codification of fundamental accounting rules, rules which explain and standardize the application of the fundamental rules to a variety of uncertain situations like retirement, contingencies, intangibles, consolidation, merger etc. Accounting Standards basically attempt to reduce the subjectivity and lay down rules so as to arrive at the best possible estimates. For example, net assets refer to the difference between total assets less liabilities but the
