1984 PLP 548 (SCMR)

Balance 13,62,366 Depreciation Allowable under rule 8 of the Wealth Tax Rules 36,76,173 50,38,542 ___________ 6,33,142 Break Up Value of one ordinary share of Rs. 10 is 6,33,142 ‑‑‑‑‑‑ ‑‑ ‑‑ = Rs. 3.33." 1,90,000

4. The I. C. A. Bench of the High Court, while dismissing the peti tioners appeal, came to the view that depreciation for the previous years could not be brought into the computation for the purpose of the "break‑up value" formula under rule 8(2)(c)(ii) of the Wealth Tax Rules, that the auditors could not deduct depreciation by going behind the Profit and Loss Account without notice to the affected persons, that if depreciation were to be deducted for the previous years it would also be open to the company to claim increased in value of assets and that the intention of the law was to augment the reserves by excluding from the provision for liabilities items which should really form part of the reserves. This Court found force in the reasoning adopted by the High Court and accordingly refused leave to appeal to the petitioners.

5. The grounds taken for review are that para. 4(a) of the Second Schedule has laid stress on "the latest audited Annual Balance‑Sheet" as the basis for the computation, that the balance‑sheets prepared in the tax holiday years, not showing depreciation could not represent a true and fair picture of the financial position of the company and as such could not be treated to be "audited Annual Balance‑Sheet" within the meaning of the said para. 4(a) and that it was necessary for the auditors to work out the amount of depreciation that ought to have been written off or provided for since 1965 when the company went into production in order to determine the true value of the fixed assets without which the true value of the fixed assets could not be worked out. He pointed out that Article 74 of the Company's own Articles of Association provided for setting aside, out of profits of the company, a depreciation fund but that the Directors of these company by not providing for such fund had acted in violation of the said Articles of Association and that in any case it could be asserted that during that period the plant, machinery, building, etc., of the company did not suffer depreciation.

6. Section 15‑BB of the Income‑tax Act, 1922, provides for tax holiday for new industries by exempting them from income‑tax and super‑tax for a specified period beginning with the month in which the undertaking is set up or the commercial production commenced, whichever is later. The profits and gains of such industries are to be computed in accordance with the provision of section 10 subject to the proviso that nothing contained in clauses (vi), (vi‑a) and (vii) of subsection (2) of this section shall apply to such profits and gains derived by the undertaking in respect of the period of the tax holiday. The said clauses relate to depreciation in regard to building, machinery, plant and furniture. Since no benefit on account of depreciation was thus separately available under the Income‑tax Act during the period of the tax holiday, the company did not provide for any depreciation for the initial four years.

7. Under section 130 of the Companies Act, 1913, every company is required to keep "proper books of accounts" with respect to "the assets and liabilities of the company". Under section 131 of that Act, the Directors of the company are required, once every calendar year, to lay before the general meeting of the company a balance‑sheet and a Profit and Loss Account which shall have been audited and the auditor's report attached thereto which report shall be read in the general meeting and shall be open to inspection by any member of the company. The balance‑sheet, according to section 1 32, shall contain a summary of the property and assets and of the capital and liabilities of the company, while the Profit and Loss Account shall include particulars showing, inter alia, total of the amount written off for depreciation. This deprecation of the capital assets has to be taken into account before arriving at the profits of the year. See Dent v. London Tramways Company ((1881) 16 Ch. D 344) and Re: Crabtree, Thomas v. Crabtree ((1912) L T 49). In the latter case, the following observa tion made by Swinfen Eady, J. had been approved: "But in the ordinary course of ascertaining the profits of a business where there is power machinery and trade machinery which is necessary in order to perform the work of the business, it is, in my opinion, essential that; in addition to all sums actually expended in repairing the machinery, or it renewing parts, that there should be also written off a proper sum for depreciation, and that sum ought to be written off before you can arrive at the net profits of the business, or at the profits of the business; and it is not profit until a proper sum, varying with the class of machinery, with the nature of the business, and with the life of the machinery, has been written off for depreciation."

8. The depreciation is generally shown in the Profit and Loss Account of a particular year separately or as part of costs of sales and operating expenses and to that extent the profits earned during the year are reduced. The balance or deficit, as the case may be of the Profit & Loss Account is then carried to the relevant balance‑sheet and is also brought forward to the Profit & Loss Account of the next year. The amount of depreciation is thus cumulatively reflected in the Profit & Loss Account of each succeeding year and consequently in the relevant balance‑sheets. It is among the duties of the auditor, as enjoined by section 145 of the Companies Act, to examine the books of accounts of the company to satisfy himself that the same exhibited "a true and correct view of the state of the company's affairs', according to the best of his opinion. He shall not certify what he does not believe to be true and in such situation, he must qualify his report with his reasons. Any knowing or willful default on the part of the auditor will render him liable to punitive action under subsection (5) of that section. It was held in Leeds Estate, Building and Investment Company v. Shepherd ((1887) 36 Ch. D 787), that it was the duty of the auditor, while auditing the accounts of the company, not to confine himself to verifying the arithmetical accuracy of the balance‑sheet, but to enquire into the substantial accuracy, and to ascertain that it contained the particulars specified in the articles of association, and was properly drawn up as to contain a true and correct representation of the state of the company's affairs.

9. In order to meet the situation created by companies not providing for depreciation during the period of tax holiday, the Council of the Institute of the Chartered Accountants, which is a statutory body established under section 9 of the Chartered Accountants Ordinance (X of 1961), observed in Resolution passed in its meeting held on 28th and 29th December, 1966, that "the provision for depreciation does not depend upon whether a profit has been made, since the debit is an essential one constituting a charge against, not an appropriation of, profit for the period in question. This provision must be made regardless of the depreciation allowed for income‑tax purposes, as such allowances are based on economic considerations not on accounting principles". The Council disapproved the procedure adopted by the tax holiday companies in preparing their accounts without making any provision for depreciation until after the expiration of the tax holiday period and expressed that "unless adequate provision is made for depreciation, the accounts will not exhibit a true and correct view of the state of the company's affairs as required by the Companies Act, 1913". It then enjoined upon the auditor "to satisfy himself that depreciation has been provided on the fixed assets at rates adequate to write off the cost of the assets over their life and he must confirm that these rates are consistently applied". If, however, the auditor is unable to satisfy himself on either of these two points, he is obliged by the said Resolution "to report accordingly to the shareholders by inser tion of notes on the accounts or explanatory information in the directors' report".

10. Messrs Rahim Jan & Co., the auditors, had, in their audit report for the relevant year ending 31‑8‑1972, duly noticed the shortcoming and bad observed: "(3) Depreciation on the fixed assets for the period 1964/65 to 1971/72 amounts, to Rs. 34,95,210 against which a total provision of Rs. 17,70,376, had been made during the years 1969/70 to 1971/72." They had made it clear that their certificate that the relevant balance‑sheet exhibited a true and correct state of affairs of the company was subject to the above observation.

11. The learned Deputy Attorney‑General stressed that as the break‑up value was to be computed on the basis of "the latest audited balance‑sheet", the Federal Government was justified in taking into consideration the depreciation which ought to have been provided for as assessed by the auditors notwithstanding the fact that the company had omitted to do so during the tax holiday period.

12. After hearing counsel for both the sides, we find that there is a error apparent on the face of record inasmuch as the "Audited Annual Balance Sheet" was taken to be one without the qualifying remarks of the Auditors pointing out the deficiency in it. This is a question which required fuller examination. This calls for a review of our order dated 11‑5‑1983 and allow ing the application, we set aside the dismissal of petitioners' Civil Petition and grant leave to appeal. Civil Petition No. 756 of 1982 of Muhammad Usman etc. is restored and shall be heard along with this appeal. S. Q. Application allowed.