Indo Rama Synthetics
(I) Ltd Vs C.I.T., New Delhi
JUDGMENT
S.H. KAPADIA, CJI
1.
Leave
granted Facts
2.
Assessee
is a widely held quoted limited company and is engaged in the business of
manufacture of yarn and polyester.
3.
During
the previous year ending 31.3.2000 relevant to the assessment year 2000-01,
fixed assets were revalued resulting in increase in the net book value of such
assets byRs.288,58,19,000/-, which was credited to the revaluation reserve. Consequently,
the balance sheet for the preceding assessment year, resulted in enhancement of
cost of fixed assets by the said amount with corresponding credit to revaluation
reserve.
4.
For
the previous year ending 31.3.2001, relevant to the assessment year 2001-02,
the P & L Account showed the charge of depreciation at Rs.127,57,06,000/-
which was reduced by transfer from revaluation reserve to the extent
ofRs.26,11,74,000/- resulting in a net debit on account of depreciation of Rs.101,45,32,000/-.
The A.O., while computing the book profit under Section 115JB of the Act, did not
allow reduction of the afore-stated amount ofRs.26,11,74,000/- on the ground
that the revaluation reserve stood created in the assessment year 2000-01 and
had not been added back while computing the book profit in that year in terms
of the proviso to clause (i) of explanation to Section115JB. This order was
upheld by the C.I.T. (A) and by the ITAT and by the High Court, hence, this
civil appeal is filed by the assessee.
5.
In
the present case, the controversy is whether the amount transferred from the
revaluation reserve and set off against the amount of depreciation debited to P
& L Account can be excluded in terms of clause (i) of explanation to
Section115JB(2) read with the proviso. Case of the Assessee
6.
It
is the case of the assessee that the main provision of clause (i) seeks to
exclude from the net profit, as per P & L Account, any amount withdrawn
from any reserves and credited to P & L Account. According to the assessee,
the proviso introduces a caveat by providing that such exclusion can be made
only in circumstances where the book profit of the year in which the reserve is
created (out of which the withdrawal has been made in the subsequent years) has
been increased to the extent of such reserve. Thus, according to the assessee,
the said proviso has no application to cases like the present one because in
this case the revaluation reserve is created, inter alia, for revaluation of
assets, which are ordinarily stated in the balance sheet at the historical cost
of acquisition by debiting the value of the fixed assets to the extent of revaluation
with corresponding credit to the revaluation reserve. Such creation of the
revaluation reserve does not impact the P & L Account in the year of
creation of such reserves.
That, such revaluation
reserve is not a free reserve. It is not available for distribution of profits.
Unlike revenue reserves, a "revaluation reserve" is not an Appropriation
of Profits and the same is not debited by way of debit entry through the P
& L Account. That, a revaluation reserve is in the nature of adjustment
entry to balance both sides of the balance sheet. That, the treatment of
revaluation reserve is governed by the Accounting Standards 10 and 6 and the
Guidance Note on Treatment of Reserves Created on Revaluation of Fixed Assets
issued by the Institute of Chartered Accountants of India (ICAI). That, in the
year in which the revaluation reserve is created, the amount of such reserve is
not debited to P & L Account and is credited directly to a revaluation reserve
as provided by ICAI and, thus, the profit as reflected in the P & L Account
is not depressed by the creation of the reserve and, is, therefore, effectively
increased to that extent. Thus, there is no question of increasing the amount
shown in the P & L Account further by the revaluation amount as per Section
115JB, as the profit has, in any case, not been reduced by such an amount in
the first place.
That, since in the
year of creation of reserves the book profit suffers full tax, without the same
being affected by creation of such revaluation reserves, in the year of
withdrawal, the amount withdrawn would be liable to be reduced while computing
the book profit. It cannot be said that even if the entire book profit has
suffered tax in the year of creation of reserve, the revaluation reserve
created in that year should artificially again be added back for computing such
book profit. That, by the Finance Act, 2007, w.e.f. 1.4.2007, clause (iia) is
inserted in Section 115JB under which the depreciation on historical cost alone
would be taken into account while calculating the book profit. In other words,
depreciation attributable to the revaluation of the fixed assets to be debited
to the P & L Account cannot be taken into account to calculate book profit w.e.f.
the assessment year 2007-08.Relevant Provisions
7.
We
quote here in below the relevant provisions of Section 115JB, which reads as
under: Special provision for payment of tax by certain companies. 115JB. (1) Notwithstanding
anything contained in any other provision of this Act, where in the case of an
assessee, being a company, the income-tax, payable on the total 6 income as
computed under this Act in respect of any previous year relevant to the assessment
year commencing on or after the 1st day of April, 2001, is less than seven and one-half
per cent of its book profit, 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 seven and one-half per
cent.(2) Every assessee, being a company, shall, for the purposes of this
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 (1 of 1956) :Provided that while preparing the annual accounts
including profit and loss account,--
i.
the
accounting policies;
ii.
the
accounting standards adopted for preparing such accounts including profit and
loss account;
iii.
the
method and rates adopted for calculating the depreciation, shall be the same as
have been adopted for the purpose of preparing such accounts including profit
and loss account and laid before the company at its annual general meeting in accordance
with the provisions of section 210 of the Companies Act, 1956 (1 of 1956)
:Explanation.—
For the purposes of
this section, "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-- (b)the amounts carried to any reserves, 7 by
whatever name called, other than a reserve specified under section 33AC; or if
any amount referred to in clauses (a) to (f) is debited to the profit and loss
account, and as reduced by-- (i) the amount withdrawn from any reserve or
provision (excluding a reserve created before the 1st day of April, 1997 otherwise
than by way of a debit to the profit and loss account), if any such amount is credited
to the profit and loss account: Provided that where this section is applicable to
an assessee in any previous year, the amount withdrawn from reserves created or
provisions made in a previous year relevant to the assessment year commencing
on or after the 1st day of April, 1997 shall not be reduced from the book
profit unless the book profit of such year has been increased by those reserves
or provisions (out of which the said amount was withdrawn) under this Explanation
or Explanation below the second proviso to section 115JA, as the case may be;
8.
Before
answering the submissions advanced on behalf of the assessee, we wish to
explain the history of MAT provisions, which is as follows: History of MAT
Provisions
9.
MAT
is applicable only where the normal total income computed is less than 30% of
the book profit.
10.
MAT
was introduced by the Finance Act of 1996 w.e.f.1.4.1997. This was necessary
due to a rise in the number of zero-tax companies paying marginal tax which
situation arose in view of preferences granted in the form of exemptions, deductions
and high rates of depreciation. The rate of minimum tax was kept at 30% of the
book profit as deemed total income. MAT was levied under Section 115JA from assessment
year 1997-98. Section 115JA is made inoperative w.e.f. 1.4.2001. In its place,
the Finance Act, 2000 inserted Section 115JB. The new provision provides that
all companies having book profit under the Companies Act, shall be liable to pay
MAT at a specified rate of the book profit. It further provides that every MAT company
shall follow same accounting policies and standards as are followed for preparing
its statutory account.
11.
For
the purposes of the afore-stated provision, "book profit" means the
net profit as shown in the P & L Account in the relevant previous year in
accordance with the provisions of Part II and Part III of the Schedule VI to
the Companies Act, subject to certain adjustments which increases or decreases the
book profit. Thus, even under Section 115J, certain adjustments were to be made
to the net profits as shown in the P & L Account. One such adjustment
stipulates that the net profit shall be decreased by the amount withdrawn from any
reserves, if any such amount is credited to the P & L Account. Some
companies have taken advantage of Section115J by decreasing their net profit by
the amount withdrawn from the reserve created in the same year itself, though
the reserve when created had not gone to increase the book profit. Such
adjustments led to lowering of profits and, consequently, the quantum of tax
payable got reduced. Thus, by amending Section 115J, it was provided that
"book profit" will be allowed to be decreased by the amount withdrawn
from any reserves only in two cases: (i) if such reserve has been created in
the previous year relevant to the assessment year commencing w.e.f. 1.4.1998 OR
(ii) if the reserve so created in the previous year has gone to increase the
book profit in any year when Section 115J was applicable.
12.
The
Finance Act, 2002 now specifically provides vide Section 115JB that the amounts
withdrawn from any reserves, if credited to the P & L Account, shall be
reduced from the book profit. It also provides that any amount withdrawn from such
reserves created on or after 1.4.1997 and which is credited to P & L
Account shall not be reduced from the book profit, unless the book profit in
the year of creation of such reserves stood increased by the amount transferred
to such reserves at that time. Scope of Section 115JB
13.
The
expression "book profit" for the purposes of Section 115JB has been
defined in the explanation to Section115JB(2) to mean: - the net profit as
shown in the P & L Account for the relevant previous year prepared under
Section 115JB(2), as increased by the amount(s) mentioned in clauses (a) to (f)
and as reduced by the amount(s) covered by clauses (i) to (vii) of the said
explanation.
14.
It
is, thus, clear that what is "book profit" has been defined and
explained in the above explanation. Section115JB is a self-contained code. It
applies not withstanding other provisions of the Act. There is no scope for any
allowances or deductions under any other section from what is deemed to be
total income of the company (assessee).
15.
The
first step for arriving at the "book profit" is that the net profit
as shown in the P & L Account for the relevant previous year prepared under
Section 115JB(2) has to be increased by the amount(s) in clauses (a) to (f) if
such amount(s) is debited to the P & L Account. Clause (b) refers to amount(s)
carried to any reserves by whatever name called. As stated above, such increase
needs to be made only if any amount referred to in clauses (a) to (f) is
debited to P & LAccount.
16.
The
second step for arriving at the "book profit" is that the net profit
as shown in the P & L Account for the relevant previous year prepared under
Section 115JB(2) and as increased by any amount, as stated above, has to be
reduced by the amount(s) in clauses (i) to (vii).
17.
For
the purposes of deciding this case it may be noted that we are concerned with
clause (i) which inter alia refers to an amount(s) withdrawn from any reserves
if any such amount(s) is credited to P & L Account. During the relevant assessment
year, clause (i) had an exception to such exclusion. That exception was in the
form of a proviso which inter alia stated that the exclusion in clause (i) to
the explanation will not apply "to the amount(s) withdrawn from reserves
created in a previous year relevant to the assessment year 1997-98 or any
subsequent assessment year unless the book profit of such year stood increased
by those reserves (out of which the said amount(s) stood withdrawn)".
18.
Thus,
the book profits calculation would be as under: Take profit as per P & L
Account xx
Add: (if debited to P
& L Account)
(a) Income tax paid/
payable & provision xx
(b) Any transfer for
reserves xx
(c) Unascertained
liabilities (contingent) xx
(d) Provision for
losses of subsidiaries xx
(e) Dividend paid/
proposed xx
(f) Expenses relating
to exempt income under sections xx
10, 10A, 10B, 11, 12
Less: (if credited to
P & L Account)
(i) Withdrawal from
reserves or provisions subject to xx
Proviso
Q.: Could Rs.26,11,74,000/-,
being the differential depreciation recouped from the revaluation reserves
created during the earlier assessment year 2000-01, be said to be credited in
the P & L Account during the assessment year in question in terms of clause
(i) to the explanation to Section115JB(2)?
19.
The
brief facts apropos this issue are that the assessee had revalued its fixed
assets as on 31st March, 2000 and the resultant surplus of Rs.288,58,19,000/-
stood added to the cost of the assets on the asset side of the balance sheet
and to equalize both sides thereof the revaluation reserve of an equivalent
amount was created on the liability side of the balance sheet. Thus, the said
reserve was merely an adjustment entry. The figure of profit remained untouched
during the assessment year 2000-01 so far as the revaluation of assets to the
tune of Rs.288,58,19,000/- was concerned. During the assessment year 2001-02, an
amount of Rs.26,11,74,000/-, being the differential depreciation, was transferred
out of the said revaluation reserve ofRs.288,58,19,000/- and credited to the P
& L Account which the AO disallowed and consequently the said sum
ofRs.26,11,74,000/- stood added back to the net profits. Hence, this civil
appeal is filed by the assessee.
20.
Book
profit is not defined in the Act. It is income computed under the company law. By
virtue of the MAT provisions, in the case of a company whose total income as computed
under the normal provisions of the Act is less than30% of the book profit, the
total income chargeable to tax will be 30% of the book profit as computed. For
the purposes of Section 115J, book profit will be the net profit as shown in
the P & L Account prepared in accordance with the provisions of Schedule VI
to Companies Act, 1956 after certain adjustments. The net profit will be
increased by income tax paid or payable, amount carried to any reserve,
provision made for liabilities etc. provided the amount(s) is debited to the P
& L Account. The amount so arrived at is to be reduced by item (i) to item
(vii) including amounts withdrawn from reserves, if any such amount is credited
to P & L Account. Clauses (i) to (vii) of the explanation to Section 115JB (2)
represent items of reduction from the net profits. Clause (i) mandates
reduction for the amount(s) withdrawn from the reserves earlier created,
provided such amount(s) is credited to P & L Account. Such credit is
mandated so that the true working result gets reflected in the financial statement
of the assessee-company. The said clause (i) contemplates only those reserves
which actually affect the net profits as shown in the P & L Account (see
also clause (ii) for comparison). The object of various clauses (i) to clause
(vii) is to find out the true working result of the assessee-company.
21.
In
the present case, the adjustment made in the P & L Account was as per
Accounting Standards 6 and 10 read with Guidance Note issued by Institute of
Chartered Accountants of India which is in conformity with Section 211 of the Companies
Act. The said adjustment was primarily in the nature of contra adjustment in
the P & L Account and not a case of effective credit in the P & L
Account (as contemplated in clause (i) of explanation). The credit in the P
& L Account implies that the P & L Account per se has been effectively credited
by the said amount. Thus, the amount withdrawn from any reserve must in effect
impact the net profit as shown in the P & L Account. As per accounting
principles, the contra adjustment does not at all affect any particular account
to which it has been carried.
Unless an adjustment
has the effect of increasing the net profit as shown in the P & L Account, that
entry cannot be said to be a credit to the P & L Account and, therefore,
though the amount has been literally credited to the P & L Account,
however, in substance there is no credit to P & L Account. MAT provisions
were introduced as number of zero tax companies had grown. It was found that
companies had earned substantial book profits and had paid huge dividends but
paid no tax. In the present case, had the assessee deducted the full
depreciation from the profit before depreciation during the accounting year
ending 31.3.2001, it would have shown a loss and in which event it could not
have paid the dividends and, therefore, the assessee credited the amount to the
extent of the additional depreciation from the revaluation reserve to present a
more healthy balance sheet to its shareholders enabling the assessee possibly
to pay out a good dividend. It is precisely to tax these kinds of companies that
MAT provisions had been introduced. The object of MAT provisions is to bring
out the real profit of the companies. The thrust is to find out the real
working results of the company. Thus, the reduction sought by the assessee
under clause (i) to the explanation to Section 115JB(2) in respect of
depreciation has been rightly rejected by the AO.
22.
Take
the facts of the present case. As stated above, the revaluation reserve of
Rs.288,58,19,000/- was created during earlier assessment year 2000-01. During
the accounting year ending 31.3.2001 (assessment year 2001-02), the profits of assessee
stood at Rs.120,18,97,000/- whereas depreciation stood at Rs.127,57,06,000/-.
Depreciation is a no-cash charge against the profits. Thus, company had a loss of
Rs.7,38,09,000/- (i.e. Rs.127,57,06,000/- of depreciation as against profit of Rs.120,18,97,000/-).
However, by withdrawing Rs.26,11,74,000/-, being the differential depreciation,
from the revaluation reserve ofRs.288,58,19,000/-(which is only a notional
adjustment entry to balance both sides of the balance sheet) and reducing it from
the depreciation of Rs.127,57,06,000/-, the assesse artificially brings down the
depreciation only toRs.101,45,32,000/- which is then deducted from the profits before
depreciation amounting to Rs.120,18,97,000/- so that there is a profit of
Rs.18,73,65,000/-. This is how the loss ofRs.7,38,09,000 got converted to
profit of Rs.18,73,65,000/-.Thus, the financial statement for the year ending
31.3.2001 is made to look healthy.
23.
The
reasons given hereinabove are in addition to the reasons given by the
Authorities below while rejecting the claim of the assessee.
24.
The
matter could be examined from another angle. To recapitulate the facts, the
fixed assets of the assessee were revalued in the earlier assessment year
2000-01 (i.e. financial year ending 31.3.2000) and amount of enhancement in
valuation was Rs.288,58,19,000/- which was credited to the revaluation reserve.
In other words, at the time of revaluation of assets, the said figure of
Rs.288,58,19,000/- was added to the historical cost of assets on the asset side
of the balance sheet and in order to equalize both sides of the balance sheet the
revaluation reserve to that extent was created on the liability side. Thus, the
figure of profit remained untouched so far as the revaluation of assets to the tune
ofRs.288,58,19,000/- is concerned.
The profits were not increased
by the said amount when the asset was revalued. During the assessment year in
question, i.e., assessment year2001-02, an amount of Rs.26,11,74,000/-, being the
differential depreciation, was transferred out of the said revaluation reserve
of Rs.288,58,19,000/- and credited to the P & L Account which the A.O. disallowed
by placing reliance on the proviso to clause (i) of the explanation to
Section115JB(2). Consequently, the A.O. added back the said amount of
Rs.26,11,74,000/- to the net profits. We agree with the A.O. Under the
provisions, as they then existed, certain adjustments were required to be made
to the net profit as shown in the P & L Account. One such adjustment
stipulated that the net profit shall be reduced by the amount(s) withdrawn from
any reserves, if any such amount is credited to the P & L Account.
Thus, if the reserves
created had gone to increase the book profits in any year when the provisions
of Section 115JB were applicable, the assessee became entitled to reduce the
amount withdrawn from such reserves if such withdrawal is credited to P & L
Account. Now, from the above facts, it is clear that neither the said amount ofRs.288,58,19,000/-
nor Rs.26,11,74,000/- had ever gone to increase the book profits in the said
year ending 31.3.2000(being the financial year). Thus, when such amount(s) has not
gone to increase the book value at the time of creation of reserve(s), there is
no question of reducing the amount transferred from such revaluation reserves
to the P & L Account. Thus, the proviso to clause (i) of the explanation to
Section 115JB(2) comes in the way of the claim for reduction made by the
assessee. In our view, the reduction under clause
(i) to the
explanation could have been availed only if such revaluation reserve had gone
to increase the book profits. As the amount of revaluation reserves had not
gone to increase the book profits at the time it was created, the benefit of reduction
cannot be allowed. One more fact needs to be highlighted. In this case, as
indicated above, the revaluation reserve stood created during the earlier
assessment year2000-01. It has been vehemently argued on behalf of the assessee
that creation of such reserve did not impact the profits of that year. The
facts enumerated hereinabove shows that though the profit was not impacted,
depreciation as the head of A/c. was impacted. By inter play of the balance she
et items with Profit & Loss A/c. items the assessee, as stated above, has
sought to project the loss of Rs.7,38,09,000/- as profit of
Rs.18,73,65,000/-.Conclusion
25.
For
above reasons, we see no reason to interfere, hence, the civil appeal filed by
the assessee shall stand dismissed with no order as to costs
.
.......................................CJI (S. H. Kapadia)
...........................................J.
(K.S. Panicker Radhakrishnan)
...........................................J.
(Swatanter Kumar)
New
Delhi;
January
5, 2011
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