Companies Act Section 198 — Calculation of profits

CHAPTER XIII APPOINTMENT AND REMUNERATION OF MANAGERIAL PERSONNEL

Commercial / Corporate

Summary

Sub-section (1) sets out the basic rule for calculating a company's net profits for the purposes of section 197. It says that when making this calculation, the company must give credit for the sums listed in sub-section (2) and must not give credit for the sums listed in sub-section (3). It also says that the sums listed in sub-section (4) must be deducted, while the sums listed in sub-section (5) must not be deducted.

Sub-section (2) states that in the calculation, credit must be given for bounties and subsidies received from any Government, or from any public authority that a Government has constituted or authorised for this purpose. This applies unless and except to the extent that the Central Government directs otherwise.

Sub-section (3) lists the sums for which credit must not be given in the calculation. Under clause (a), credit is not given for profits from premiums on shares or debentures that the company issues or sells, unless the company is an investment company as referred to in clause (a) of the Explanation to section 186. Under clause (b), credit is not given for profits on sales by the company of forfeited shares. Under clause (c), credit is not given for profits of a capital nature, including profits from the sale of the company's undertaking or any of its undertakings, or any part of such an undertaking. Under clause (d), credit is not given for profits from the sale of any immovable property or fixed assets of a capital nature that are part of the company's undertaking or undertakings, unless the company's business consists, wholly or partly, of buying and selling such property or assets. However, the proviso to clause (d) says that if a fixed asset is sold for more than its written-down value, credit must be given for the excess amount, but only up to the difference between the original cost of that asset and its written-down value. Under clause (e), credit is not given for any change in the carrying amount of an asset or liability that is recognised in equity reserves, including surplus in the profit and loss account, when the asset or liability is measured at fair value. Under clause (f), credit is not given for any amount representing unrealised gains, notional gains, or revaluation of assets.

Sub-section (4) lists the sums that must be deducted in the calculation. Under clause (a), all the usual working charges are deducted. Under clause (b), directors' remuneration is deducted. Under clause (c), bonus or commission paid or payable to any member of the company's staff, or to any engineer, technician, or person employed or engaged by the company, whether on a whole-time or part-time basis, is deducted. Under clause (d), any tax notified by the Central Government as being in the nature of a tax on excess or abnormal profits is deducted. Under clause (e), any tax on business profits imposed for special reasons or in special circumstances and notified by the Central Government in this behalf is deducted. Under clause (f), interest on debentures issued by the company is deducted. Under clause (g), interest on mortgages executed by the company and on loans and advances secured by a charge on its fixed or floating assets is deducted. Under clause (h), interest on unsecured loans and advances is deducted. Under clause (i), expenses on repairs, whether to immovable or movable property, are deducted, provided the repairs are not of a capital nature. Under clause (j), outgoings inclusive of contributions made under section 181 are deducted. Under clause (k), depreciation to the extent specified in section 123 is deducted. Under clause (l), the excess of expenditure over income that had arisen in computing net profits in accordance with this section in any year is deducted, to the extent that such excess has not been deducted in any subsequent year preceding the year for which net profits have to be ascertained. Under clause (m), any compensation or damages to be paid by virtue of any legal liability, including a liability arising from a breach of contract, is deducted. Under clause (n), any sum paid by way of insurance against the risk of meeting any liability such as is referred to in clause (m) is deducted. Under clause (o), debts considered bad and written off or adjusted during the year of account are deducted.

Sub-section (5) lists the sums that must not be deducted in the calculation. Under clause (a), income-tax and super-tax payable by the company under the Income-tax Act, 1961, or any other tax on the income of the company that does not fall under clauses (d) and (e) of sub-section (4), is not deducted. Under clause (b), any compensation, damages, or payments made voluntarily, that is to say, otherwise than by virtue of a liability such as is referred to in clause (m) of sub-section (4), is not deducted. Under clause (c), loss of a capital nature, including loss on the sale of the undertaking or any of the undertakings of the company or any part thereof, is not deducted, but this does not include any excess of the written-down value of any asset that is sold, discarded, demolished, or destroyed over its sale proceeds or its scrap value. Under clause (d), any change in the carrying amount of an asset or liability that is recognised in equity reserves, including surplus in the profit and loss account, when the asset or liability is measured at fair value, is not deducted.

Official Text

(1) In computing the net profits of a company in any financial year for the purpose of section 197,—

(a) credit shall be given for the sums specified in sub-section (2), and credit shall not be given for those specified in sub-section (3); and

(b) the sums specified in sub-section (4) shall be deducted, and those specified in sub-section (5) shall not be deducted.

(2) In making the computation aforesaid, credit shall be given for the bounties and subsidies received from any Government, or any public authority constituted or authorised in this behalf, by any Government, unless and except in so far as the Central Government otherwise directs.

(3) In making the computation aforesaid, credit shall not be given for the following sums, namely:—

(a) profits, by way of premium on shares or debentures of the company, which are issued or sold by the company 1[unless the company is an investment company as referred to in clause (a) of the Explanation to section 186];

(b) profits on sales by the company of forfeited shares;

(c) profits of a capital nature including profits from the sale of the undertaking or any of the undertakings of the company or of any part thereof;

(d) profits from the sale of any immovable property or fixed assets of a capital nature comprised in the undertaking or any of the undertakings of the company, unless the business of the company consists, whether wholly or partly, of buying and selling any such property or assets:

Provided that where the amount for which any fixed asset is sold exceeds the written-down value thereof, credit shall be given for so much of the excess as is not higher than the difference between the original cost of that fixed asset and its written-down value;

(e) any change in carrying amount of an asset or of a liability recognised inequity reserves including surplus in profit and loss account on measurement of the asset or the liability at fair value. 2[

(f) any amount representing unrealised gains, notional gains or revaluation of assets.]

(4) In making the computation aforesaid, the following sums shall be deducted, namely:—

(a) all the usual working charges;

(b) directors’ remuneration;

(c) bonus or commission paid or payable to any member of the company’s staff, or to any engineer, technician or person employed or engaged by the company, whether on a whole-time or on a part-time basis;

(d) any tax notified by the Central Government as being in the nature of a tax on excess or abnormal profits;

(e) any tax on business profits imposed for special reasons or in special circumstances and notified by the Central Government in this behalf;

(f) interest on debentures issued by the company;

(g) interest on mortgages executed by the company and on loans and advances secured by a charge on its fixed or floating assets;

(h) interest on unsecured loans and advances;

(i) expenses on repairs, whether to immovable or to movable property, provided the repairs are not of a capital nature;

(j) outgoings inclusive of contributions made under section 181;

(k) depreciation to the extent specified in section 123;

(l) the excess of expenditure over income, which had arisen in computing the net profits in accordance with this section in any year 3***, in so far as such excess has not been deducted in any subsequent year preceding the year in respect of which the net profits have to be ascertained;

(m) any compensation or damages to be paid in virtue of any legal liability including a liability arising from a breach of contract;

(n) any sum paid by way of insurance against the risk of meeting any liability such as is referred to in clause (m);

(o) debts considered bad and written off or adjusted during the year of account.

(5) In making the computation aforesaid, the following sums shall not be deducted, namely:—

(a) income-tax and super-tax payable by the company under the Income-tax Act, 1961 (43 of 1961), or any other tax on the income of the company not falling under clauses

(d) and

(e) of sub-section (4);

(b) any compensation, damages or payments made voluntarily, that is to say, otherwise than in virtue of a liability such as is referred to in clause (m) of sub-section (4);

(c) loss of a capital nature including loss on sale of the undertaking or any of the undertakings of the company or of any part thereof not including any excess of the written-down value of any asset which is sold, discarded, demolished or destroyed over its sale proceeds or its scrap value;

(d) any change in carrying amount of an asset or of a liability recognised inequity reserves including surplus in profit and loss account on measurement of the asset or the liability at fair value.