UNIVERSITY OF PETROLEUM AND ENERGY STUDIES COLLEGE OF LEGAL STUDIES

To be submitted in the partial fulfillment of

Subject: - Petroleum Law Course: - B.A. LL.B. (Hons.) Semester: - X

Submitted To: Mr. Raj Kumar

Submitted By: DEBABRAT MISHRA

CAIRN EXPLORATION (NO.7) LIMITED V UNION OF INDIA (Special Civil Application No. 11581 of 2008) Gujarat High Court 21 October 2010

Facts of the Case: The Petitioner is a private company, limited by shares, incorporated in Scotland, U.K. under the Companies Act, 1985 and is a subsidiary of M/s Cairn India Holdings Ltd., a company registered in Jersey Channel Island. The Petitioner No.1 Company is engaged in the business of prospecting, drilling, exploring, producing and generally dealing in minerals, oils, gas and other related by-products. On 23.09.2005, the petitioner company, entered into a Production Sharing Contract with the Government of India and, Oil & Natural Gas Corporation Ltd. (ONGC) for the exploration of natural resources. According to the PSC, the petitioner had a 49% participating interest in the contract area and, therefore, the petitioner company formed an Unincorporated Joint Venture with other co-venturers to carry out the operations under the PSC. For the financial year ending 31.3.2006, the petitioner company incurred expenditure of Rs.8, 17,245/- on exploration, as its proportionate share in the unincorporated joint venture. According to the petitioner, the business of prospecting, drilling, exploring, producing and generally dealing in minerals, oils, gas and other related by-products is a capital intensive industry in initial years and, therefore, the companies of this industry, in accordance with Generally Accepted Accounting Principles reflect investments in oil well as expenditure incurred during the year in the financial statements. Therefore, the investments made before production of oil is though actually work-in-progress, but the same is claimed as expenditure for the year in accordance with Guidance Note issued by the Institute of Chartered Accountants of India on Accounting for Oil and Gas Producing Activities. Accordingly, while preparing the profit and loss account for the financial year ending 31.3.2006, the petitioner company, out of the above exploration expenditure of Rs.8,17,245/debited profit and loss account by a sum of Rs.7,33,264/- apart from operating expenses of Rs.75,000/-. At the beginning of the financial year 2007-08 relevant to the assessment year

2008-09, the petitioner company had aggregate brought forward business loss of Rs.11,67,85,411/-, comprising of business loss of Rs.8,06,755/- for assessment year 2006-07 and, business loss of Rs.11,59,78,656/- for assessment year 2007-08. The petitioner company had only brought forward business losses, but no unabsorbed depreciation owing to the peculiar fact that it never charged any depreciation in the past/current year since neither the petitioner nor the UJV owned any fixed assets. In fact, whenever any asset was needed for carrying out the business activities by the UJV, these were taken on hire basis by the UJV. Up till the date of assignment, the petitioner company had incurred aggregate expenditure of Rs.16,17,33,783/- on exploration. The petitioner company on assignment of its participatory interest in the UJV to M/s Cairn India Ltd., recouped its entire cost of Rs.16,17,33,783/-, including the expenditure on exploration incurred in the financial year 2007-2008 of Rs.4,50,64,691/-. Accordingly, while preparing the profit and loss account for the financial year 2007-08 relevant to assessment year 2008-09 in accordance with Part II and III of Schedule VI to the Companies Act, 1956, the petitioner company disclosed the above recoupment of exploration cost of Rs.16,16,49,805/- as income, and further claimed expenditure incurred during the year of Rs.4,51,81,932/- being the expenditure on exploration of Rs.4,50,64,693/- incurred during the year and operating expenses of Rs.1,17,239/-. As a result of the above, there was net profit as per the profit and loss of Rs.11, 64, 67,873/- for the financial year 2007-08 relevant to the assessment year 2008-09. However, despite the fact that the above profit of Rs.11,64,67,873/- represented the recoupment of exploration cost incurred on assignment of participating interest, which had been also brought forward as business loss of Rs.11,65,85,112/-, on strict construction of statutory provisions contained section 115 JB of the Act there was a book profit, when as a matter of fact, there was no income. It is the case of the petitioner that as a result of assignment of the participatory interest at cost, there is mere artificial book profit, out of which no dividend under the Companies Act, 1956 could be declared or can be said to be available for the purpose of distribution of dividend.

The petitioner has challenged the provisions of clause (iii) of Explanation 1 to section 115 JB of the Act, as being ultra vires the Constitution and seeking a direction against the respondents No.2 and 3 to allow reduction of brought forward losses of Rs.11,67,85,411/- of the petitioner company from the net profit in order to compute the book profit under Minimum Alternate Tax provisions (115JB of the Act), in the absence of any unabsorbed depreciation in respect of the assessment year 2008-09.

Issues Raised in the Present Case 1. Whether the provisions of clause (iii) of Explanation 1 of section 115JB of the Act as ultra -vires the Constitution and struck down. 2. Whether the Respondents be restrained from giving effect to the provisions of clause (iii) of Explanation 1 of section 115JB of the Act. 3. Whether to allow the respondent No.2 & 3 for the reduction of the brought forward losses of Rs.11,67,85,411/- of the petitioner company from the net profit in order to compute the book profit under the MAT provisions (i.e. 115 JB of the Act) of the Income Tax Act, 1961 in the absence of any unabsorbed depreciation in respect of the assessment year 2008-2009

Provisions: Section 115JB of the Income Tax Act, 1961 (the Act) is a special provision for payment of tax by certain companies. Under the said provision, where in the case of an assessee, being a company, the income tax, payable on the total income as computed under the Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April 2007, is less than ten per cent of its book profit, then notwithstanding anything contained in any other provision of the Act, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income tax at the rate of ten percent. Sub-section (2) thereof provides that, every assessee, being a company, shall, for the purpose of the section, prepare its profit and loss account for the relevant previous year in accordance

with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956. The proviso thereto provides for the manner in which annual accounts are to be prepared. Explanation 1 provides that"book profit" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by clauses (a) to (f) thereof, if any amount referred to in clauses (a) to (f) thereof is debited to the profit and loss account, and as reduced by clause (i) to (vii) thereof. Clause (iii) of the Explanation provides for reduction from the net profit of the amount of loss brought forward or unabsorbed depreciation, whichever is less as per books of account. The explanation to clause (iii) provides that (a) the loss shall not include depreciation, and (b) the provisions of this clause shall not apply if the amount of loss brought forward or unabsorbed depreciation is nil.

Argument on Behalf of Petitioner

It was submitted that clause (iii) of Explanation 1 to section 115JB of the Act read with clause (b) of the Explanation thereto are contrary to the purpose of the enactment of section 115JB of the Act, which provides for levy of Minimum Alternative Tax. It was further submitted that, the said provision was introduced to tax such companies which were having large profits and, were distributing dividends, without paying any tax, by claiming various deductions provided in the Act like depreciation, investment allowance and, other deductions as are contained in Chapter VIA of the Act. Hence, the intention of the legislature was to tax companies with large profits and not companies who did not have any profit. The provisions contained in clause (iii) of Explanation 1 to section 115JB of the Act provide for reduction from book of loss brought forward or unabsorbed depreciation, whichever is less, and further, in case either of the two is absent no reduction is allowable, despite the fact that no depreciation is provided or can be provided and in fact, even not debited. In the circumstances, the said provision is discriminatory inasmuch as the same provides for distinction between an assessee who has taken plant and machinery on hire and, therefore has only unabsorbed business loss, and an assessee who has invested in acquisition of plant and machinery and therefore, has both unabsorbed business losses and unabsorbed depreciation. The provision also discriminates against companies that have incurred substantial expenditure on the capital assets eligible for

depreciation under section 32(1) of the Act and, consequently, has huge unabsorbed depreciation but has no cash loss. Likewise, the provision discriminates against companies which have huge cash loss but little depreciation or no depreciation, since the business of the company may not be capital intensive, like service industry or a business where all expenditure including expenditure incurred on capital assets have been booked as revenue expenditure like business of oil exploration. It was further submitted that Article 14 forbids class legislation but does not forbid reasonable classification. Reasonable classification must satisfy the two conditions, namely, (a) the classification must be founded on an intelligible differentia which distinguishes persons or things that are grouped together from other left out of the group, and (b) the differentia must have a rationale to the object sought to be achieved by the statute. According to the learned counsel, the provisions of clause (iii) of the Explanation to section 115JB are violative of Article 14 of the Constitution because by not allowing a reduction of loss, the legislature has not made a reasonable classification since assess who may not be owing any asset are required to pay tax despite the fact that there is no income, which has no nexus to the object sought to be achieved by the legislation, that is, to tax dividend paying companies. Next point put forth was that there was no rationale or valid basis to restrict the relief to unabsorbed depreciation or business loss, whichever is lower, particularly when the purpose of clause (iii) to the Explanation is to provide relief of losses of earlier years and not to deny relief of setting off of loss or unabsorbed depreciation, whichever is lower, even when there is no income to the petitioner company. It was reiterated that the intelligible differentia is absent in the provision denying the relief in a case where the amount of 'loss brought forward' or 'unabsorbed depreciation' is nil. According to the learned counsel, there may be service industries or trading concerns which may not have ownership of depreciable assets; thereby incurring no depreciation cost in their books. Unabsorbed depreciation in such cases would only be impossibility; but they may have normal business losses. Such companies may have the same quantum of loss (with nil depreciation) as other companies (with depreciation), but could be denied the setoff only due to operation of the explanation to clause (iii) of the Explanation to section 115JB of the Act. Thus, the provision creates discrimination between companies having the same quantum of losses. Referring to the decision of the Supreme Court in the case of Garden Silk Weaving Factory

Pvt. Ltd. v. CIT, 189 ITR 512 1991 Indlaw SC 922, it was submitted that there is no distinction between unabsorbed depreciation and brought forward losses in the commercial sense, hence while computing the commercial book profit, the distinction vide clause (iii) of the Explanation to section 115JB is unfair and discriminatory. It was further submitted that the tax levied goes beyond the intention of legislature, while enacting section 115J and section 115JA/115JB of the Act. In support of his submissions, the learned counsel placed reliance upon the decisions of the Supreme Court in the case of Surana Steels (P) Ltd. v. Commissioner of Income Tax, 237 ITR 777 and in the case of Apollo Tyres Ltd. v. Commissioner of Income Tax, 255 ITR 273 2002 , as well as the decision of the Bombay High Court in the case of Commissioner of Income Tax v. Ajanta Pharma Ltd., 318 ITR 252 (Bombay). It was further submitted that no reason emanates from the Finance Bill explaining the amendment and, therefore, the same is unconstitutional, as has been held in the case of Exide Industries Ltd., 292 ITR 470 2007 Indlaw CAL 4. Reliance was also placed upon the decision of the apex court in the case of Tata Motors Ltd. v. State of Maharashtra, AIR 2004 SC 3618 as well as the decision of the Madras High Court in the case of K. Jaya Prakash v. The Executive Authority, AIR 1982 Madras 272. It was pointed out that in the light of the provisions of clause (iii) of the Explanation below section 115JB of the Act, if a company has no depreciable assets, no deduction can be allowed despite the fact that, there are huge carried forward losses. If a business of a company is not carried through or is based on capital intensive infrastructure, it will not be entitled to set off of loss suffered; whereas if it is based on capital asset oriented infrastructure, it would be entitled to set off, may be to the extent of depreciation allowable or brought forward loss, which every is lower. In the circumstances, the said provision is arbitrary inasmuch as the same treats the two assess(es) differently, which was not the object behind the enactment. It was contended that the right to freedom guaranteed under Article 19(1)(g) of the Constitution is also violated, as the impugned provision does not provide the right to practice trade or business by providing level playing field and denies a citizen who may suffer a loss to set off the same after carrying forward the same unless he has both a carried forward loss as well as a carried forward unabsorbed depreciation. If either of them is absent, he is denied the set off by disregarding the fact that such a citizen may not have any depreciable asset and, carries the same business without a depreciable asset. Thus, by denying such a citizen the right to set off loss also

violates Article 19(1) (g) of the Constitution of India. In conclusion, it was submitted that the provisions of clause (iii) of Explanation 1 to section 115 JB of the Act are arbitrary, discriminatory and violative of petitioner's fundamental right under Articles 14 and 19(1) (g) of the Constitution and as such, ultra vires the Constitution and liable to be struck down. It was submitted that, in the alternative, if the Court is not inclined to strike down the said provision as being unconstitutional, the provision may be read down so as to achieve the obvious intention of the Legislature and produce a rational construction.

Arguments on Behalf of Respondent

It was submitted that Article 265 of the Constitution read with Entry 82 of the Union List contained in the Seventh Schedule to the Constitution empower the Union Government to levy tax on income other than agricultural income and it is by virtue of this provision and as a measure of equity in taxation that Minimum Alternate Tax (MAT) is levied under section 115JB of the Act on companies having book profits under the Companies Act. Thus, MAT is essentially a tax on income and its levy is well within the legislative competence of the Union Government. The MAT provisions have basically been introduced as a measure of equity in taxation. The legislature does not have to tax everything in order to be able to tax something. If there is equality and uniformity within each group, the law would not be discriminatory. It was submitted that, in the facts of the present case, within each group, there is equality and uniformity insofar as the applicability of the impugned provision is concerned and as such, the same cannot be termed to be discriminatory. Referring to the decision of the Supreme Court in the case of State of A.P. v. McDowell and Co., (1996) 3 SCC 709, it was submitted that no enactment can be struck down on the ground that it is unreasonable or arbitrary and that, therefore, the petition deserves to be dismissed on this ground alone. It was contended that the Supreme Court has not held that an enactment cannot be struck down on the ground that it is arbitrary or unreasonable. It has held that Article 14 cannot be pressed into service merely on the allegation that the statutory provision was arbitrary or unreasonable,

and that some constitutional infirmity has to be shown for striking down the legislation which, in the instant case, the petitioner, is contending. It was urged that in the present case where the assessee who has not earned any income and has merely recouped the expenditure incurred in the preceding year is being held liable to pay tax, merely because in the preceding year expenditure had been incurred which had resulted into book loss and in the succeeding year, when there is such recoupment of expenditure, the same is to be treated to be a book profit so as to levy the Minimum Alternate Tax which is absolutely beyond the object and purpose of the enactment. The principal and only challenge in the present petition is to the constitutional validity of clause (iii) of Explanation 1 of section 115JB of the Act on the ground that the same is discriminatory and arbitrary inasmuch as while computing the book profit the same provides for reduction from the net profit of loss brought forward or unabsorbed depreciation whichever is less, which means that if either of the two are absent the assessee would not be entitled to reduction in the book profit. Thus, the provision has been challenged as being discriminatory towards those assess (es) like the petitioner, who do not have capital asset based infrastructure and as such would not have any unabsorbed depreciation. Thus, despite having substantial brought forward loss, the petitioner in the light of the provisions of clause (iii) of the Explanation to section 115JB of the Act is still liable to pay tax on the book profit without the same being reduced by the amount of brought forward loss. Under the proposed amendment, in the case of any company whose total income as computed under the other provisions of the Income Tax Act in respect of any previous year is less than 30 per cent of its book profit, the total income of such taxpayer chargeable to tax shall be deemed to be the amount equal to 30 per cent of such book profit. However, the expenditure relating to income as well as the receipts relating to incomes to which the provisions of Chapter III of the Income Tax Act apply, will be excluded from the computation of the "book profit". Thirty per cent of such "book profit" shall be treated as total income of the company to which the provisions of this new Chapter (section 115J) apply. It has also been provided that the aforesaid provisions shall not affect determination of the amount to be carried forward to the subsequent years under the provisions of section 32(2), 32A(3), 72, 73, 74, 74A and 80J relating to unabsorbed depreciation, unabsorbed investment allowance, unabsorbed loss and unabsorbed deduction relating to tax holiday.

The present petition relates to Section 115JB of the Act, which came to be inserted by Finance Act, 2000 with effect from 1.4.2000, and insofar as the same is relevant for the present purpose. In the facts of the present case, the petitioner does not have any unabsorbed depreciation as per its books of account and as such while computing its book profit; it is not entitled to the benefit of reduction of the net profit under clause (iii) of the Explanation to section 115JB. According to the petitioner, the impugned provision insofar as the same provides for reduction of the book profit in case of companies having both brought forward loss and unabsorbed depreciation to the extent of the lesser of the two, is violative of Article 14 of the Constitution of India vis-vis those companies who have either only brought forward loss or unabsorbed depreciation. It is accordingly contended that the classification made by the legislature by virtue of the impugned provision which seeks to classify companies on the basis as to whether they have both carried forward loss as well as unabsorbed depreciation in their books of account or only either of the two, has no nexus to the object sought to be achieved, viz., to tax prosperous companies. While examining the constitutional validity of the impugned provision, what has to be seen is whether, within the class, there is any discrimination. On a plain reading of clause (iii) of the Explanation to section 115JB of the Act, it is apparent that the same applies uniformly and equally to all companies falling within the ambit of section 115JB, without any discrimination. The provision does not create any class within the class of assessees falling within the ambit of section 115JB. The fact that in a given case an assessee may not have any unabsorbed depreciation or any brought forward loss in its books of account, as a consequence of which the assessee would not be entitled to reduction of the book profit under the impugned provision, is a mere fortuityous circumstance. The legislature, while enacting a provision is not required to meet with or envisage every fortuitous circumstance that may arise while implementing such provision. Merely because in a given circumstance, the provision may act to the disadvantage of a particular assessee would not render the provision arbitrary, nor can it be said that the same violates the equality clause. In the facts of the present case, the principal grievance ventilated is that the petitioner is put to undue hardship inasmuch as clause (iii) of the explanation to section 115JB of the Act does not permit reduction of book profit to the extent of brought forward loss, in case where

a company does not have any unabsorbed depreciation as per its books of account. The constitutional validity of the said provision is also challenged on the ground of absurdity on the ground that though the petitioner does not have any income in the year under consideration, merely because the petitioner has shown book profit under the Companies Act, 1956, the petitioner becomes liable to pay tax under the provisions of section 115JB of the Act, without being in a position to set off the brought forward losses of the earlier years, which is absurd as the petitioner does not have any income in the year under consideration. An assessee is entitled to carry forward its losses as well as unabsorbed depreciation and set off of the same in its regular assessment. It is only if after determining the total income of the company under the normal provisions, the income tax payable is less than 10% of its book profit that the income of such company is to be computed under section 115JB of the Act and the company becomes liable to pay tax at the rate of 10% of its book profit as computed under the provisions of section 115JB. The computation includes reduction of the book profit under clause (iii) of the Explanation to section 115JB of the Act. Thus, it is not as if the assessee company is deprived of any right by virtue of the provisions of section 115JB of the Act. In the case of the petitioner company, the petitioner itself had debited the expenditure incurred by it to the profit and loss account and thereafter, had assigned its participating interest in the UJV to M/s Cairn India Ltd. before it actually started making any profit in relation to the business and as such, was not in a position to set off its losses against the income earned by it. In the year under consideration, it is an admitted position, that the petitioner had a book profit of Rs.11,64,67,873/- as per its books of account as maintained in accordance with provisions of the Companies Act, 1956 and as such, became liable to pay income tax in respect thereof under section 115JB of the Act. It is also not as if the petitioner was not permitted to set off its brought forward losses against its income. In fact it is only after computing the income under the provisions of the Income Tax Act after allowing all allowable deductions, because the income tax payable works out to less than ten per cent of book profits that the petitioner has become liable to be assessed under provisions of section 115JB of the Act on its book profits. Thus, merely because, in the peculiar facts and circumstances of the case of the petitioner, the petitioner has not been able to set off its losses against its income while computing its income under section 115JB of the Act, the

same would not render the statutory provisions unconstitutional or invalid. In the circumstances, the challenge to the provisions of section 115JB of the Act must necessarily fail.

Judgment It is well settled that the Doctrine of Reading Down is an internal aid to construe the words or phrase in a statute to give it a reasonable meaning. The object of reading down is to keep the operation of the statute within the purpose of the Act and constitutionally valid. Thus, in order to save a statute or a part thereof from being struck down it can be suitably read down. However, reading down is not permissible in such a manner as would fly in the face of the express terms of the statutory provisions. It is a very well settled legal position, that if the Court while construing a provision, finds that the same is ambiguous, the Court instead of striking it down, may read it down so as to save the constitutional validity. Thus in the present case, the Court does not find the impugned provision to be in any manner unconstitutional, hence, the question of reading it down to save its constitutional validity does not arise. Besides, the provisions of clause (iii) of the Explanation to section 115JB are clear and ambiguous and it is not possible to take two views as to the meaning of the statutory language. Hence, the request to read down the provision also does not merit acceptance. Consequently, the question of directing the respondents to allow reduction of the brought forward losses of Rs.11,67,85,411/- of the petitioner company from the net profit in order to compute book profits under section 115JB of the Act in absence of any unabsorbed depreciation in the assessment year under consideration, also cannot be accepted. For the foregoing reasons, the Court does not find any merit in the petition. The petition, therefore, fails and is accordingly, rejected. Notice is discharged. No order as to costs.