The concept of substance over form is very difficult to understand for
the students in the initial stage. Owing to initial confusion many students
either keep it in option or even if they study, don’t understand it fully. I
have made a short attempt to explain this concept in a brief manner.
This phrase contains two words, ‘substance’ and ‘form’. The phrase ‘substance
over form’ is a short version of its original meaning “In case of conflict
between ‘substance’ and ‘form’ of a transaction, the ‘substance’ of transaction
shall prevail over its ‘form’.”
Let us understand the meanings of ‘substance’ and ‘form’ separately.
Substance of a transaction means its actual nature. Whatever is the original
nature of transaction is its substance. Form is the way the transaction is recorded
or presented. So, basically substance relates to content of transaction whereas
form relates to its presentation. It is not always necessary that the substance
of a transaction shall differ from its form. In most of the cases, the
substance of a transaction and its form are one and the same. However, in
select cases, the substance can be different from the form of the transaction.
The concept of ‘substance over form’ may be relevant in three cases
viz., accounting, audit, and regulatory assessments. But, it mainly comes under
focus either during audit or during regulatory assessments.
Accounting requires that whenever a transaction is recorded or it’s
presented in the financial statements of an enterprise, the substance of
transaction should prevail over its form. However, in case of accounting, it is
not independent of its management or ownership. So there can be bias in
avoiding this requirement.
In case of audit, an auditor is under obligation to follow substance over
form. So auditors require examining transactions (obviously considering the
materiality concept also) so as to check whether the financial statements
follow the concept of substance over form.
Also in the case of regulatory assessments, the assessing authorities always
go by substance and not by its mere presentation so as to make sure the revenue
of their department is not at loss.
Let us understand ‘substance over form’ by small example. X Limited has
paid a commission of Rs.1,00,000. to its agent. However, while recording, the company
recorded it as Rent. Now what can be the implication of this change in presentation?
With respect to net result of the business there shall be no impact as both
commission and rent shall be debited to profit and loss account and net profit
or loss shall remain unchanged.
But with respect to audit and regulatory point of view, it can make a
difference. In case of tax audit, the auditor is required to report on
compliance with respect to TDS of the company. Take in the same example, the
company has debited the amount to rent instead of commission. If we go by its
form, on a rent of Rs.1,00,000 there is no requirement of tax to be deducted
u/s 194I. However, if we go by the substance of transaction, i.e., its original
nature being commission, tax is required to be deducted @ 10% u/s 194H.
Now, the duty of auditor or regulatory authority is to consider the
actual nature of transaction and not merely the form in which it is presented.
This consideration of substance of transaction over its form is called as ‘substance
over form’.
CA. Amol Gopal Kabra, Latur
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