In Indo Rama Synthetics (I) Ltd. v. Commissioner of Income Tax, New Delhi (Civil Appeal No. 33 of 2011), the Supreme Court of India held that an assessee company computing book profit under Section 115JB of the Income Tax Act, 1961, cannot reduce its net profit by withdrawing amounts from a revaluation reserve unless that reserve had increased the book profit in the previous year of its creation.
IN THE SUPREME COURT OF INDIA
CIVIL APPELLATE JURISDICTION
Before: S. H. Kapadia, CJI, K. S. Panicker Radhakrishnan, and Swatanter Kumar, JJ.
Decided on: January 5, 2011
Civil Appeal No. 33 of 2011 (Arising out of Special Leave Petition (Civil) No. 35133 of 2009)
From the Judgment and Order dated 22.09.2009 of the High Court of Delhi in ITA No. 851 of 2009.
Appearances: For the Appellant: Ajay Vohra, Senior Advocate, with Kavita Jha, Advocate. For the Respondent: Bishwajit Bhattacharya, Additional Solicitor General, with Rahul Kaushik, Yatinder Chaudhary, Ajay Singh, and B. V. Balaram Das, Advocates.
Judgment of the Supreme Court
S. H. KAPADIA, CJI delivered the judgment on behalf of the Bench: 1. Leave granted.
Factual Background and Controversy
2. The 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 March 31, 2000, relevant to the assessment year 2000-01, fixed assets were revalued resulting in an increase in the net book value of such assets by Rs. 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 March 31, 2001, relevant to the assessment year 2001-02, the Profit and Loss Account showed the charge of depreciation at Rs. 127,57,06,000 which was reduced by transfer from revaluation reserve to the extent of Rs. 26,11,74,000 resulting in a net debit on account of depreciation of Rs. 101,45,32,000. The Assessing Officer, while computing the book profit under Section 115JB of the Act, did not allow reduction of the afore-stated amount of Rs. 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 the Explanation to Section 115JB. This order was upheld by the Commissioner of Income Tax (Appeals), by the Income Tax Appellate Tribunal (ITAT), and by the High Court. Hence, this civil appeal was 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 Profit and Loss Account can be excluded in terms of clause (i) of the Explanation to Section 115JB(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 Profit and Loss Account, any amount withdrawn from any reserves and credited to Profit and Loss 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 Profit and Loss 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 Profit and Loss Account. That, a revaluation reserve is in the nature of an adjustment entry to balance both sides of the balance sheet. That, the treatment of revaluation reserve is governed by 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 Profit and Loss Account and is credited directly to a revaluation reserve as provided by ICAI and, thus, the profit as reflected in the Profit and Loss 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 Profit and Loss 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, with effect from April 1, 2007, clause (iia) was 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 Profit and Loss Account cannot be taken into account to calculate book profit with effect from the assessment year 2007-08. Legal practitioners and commerce students reviewing CS Executive tax laws and practice study material must note the interplay between historical cost depreciation and revaluation reserves under Indian tax statutes.
Relevant Statutory Provisions
7. We quote hereinbelow 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 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:
(a) the amounts of income-tax paid or payable, and the provision therefor; or
(b) the amounts carried to any reserves, by whatever name called, other than a reserve specified under section 33AC; or
(c) the amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or
(d) the amounts by way of provision for losses of subsidiary companies; or
(e) the amounts of dividends paid or proposed; or
(f) the amounts of expenditure relatable to any income to which section 10 or section 10A or section 10B or section 11 or section 12 apply;
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 with effect from April 1, 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 with effect from April 1, 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 Profit and Loss Account in the relevant previous year in accordance with the provisions of Part II and Part III of 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 Profit and Loss 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 Profit and Loss Account. Some companies have taken advantage of Section 115J 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 with effect from April 1, 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 Profit and Loss Account, shall be reduced from the book profit. It also provides that any amount withdrawn from such reserves created on or after April 1, 1997 and which is credited to the Profit and Loss 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 Section 115JB(2) to mean: the net profit as shown in the Profit and Loss 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. Section 115JB is a self-contained code. It applies notwithstanding 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 Profit and Loss 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 Profit and Loss 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 the Profit and Loss Account.
16. The second step for arriving at the 'book profit' is that the net profit as shown in the Profit and Loss 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 the Profit and Loss 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 Profit and Loss Account: [Amount]
Add: (if debited to Profit and Loss Account)
(a) Income tax paid / payable and provision
(b) Any transfer to reserves
(c) Unascertained liabilities (contingent)
(d) Provision for losses of subsidiaries
(e) Dividend paid or proposed
(f) Expenses relating to exempt income under sections 10, 10A, 10B, 11, 12
Less: (if credited to Profit and Loss Account)
(i) Withdrawal from reserves or provisions subject to the proviso.
Question: 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 Profit and Loss Account during the assessment year in question in terms of clause (i) to the Explanation to Section 115JB(2)?
19. The brief facts apropos this issue are that the assessee had revalued its fixed assets as on March 31, 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 of Rs. 288,58,19,000 and credited to the Profit and Loss Account which the Assessing Officer disallowed and consequently the said sum of Rs. 26,11,74,000 stood added back to the net profits. Hence, this civil appeal was filed by the assessee.
Judicial Analysis of Book Profits and Revaluation Accounting
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 than 30% 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 Profit and Loss 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 Profit and Loss 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 the Profit and Loss 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 the Profit and Loss 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 Profit and Loss 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 Profit and Loss 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 Profit and Loss Account and not a case of effective credit in the Profit and Loss Account (as contemplated in clause (i) of the Explanation). The credit in the Profit and Loss Account implies that the Profit and Loss 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 Profit and Loss 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 Profit and Loss Account, that entry cannot be said to be a credit to the Profit and Loss Account and, therefore, though the amount has been literally credited to the Profit and Loss Account, however, in substance there is no credit to the Profit and Loss 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 March 31, 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 Assessing Officer.
Detailed Examination of Numerical Facts and Ledger Entries
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 March 31, 2001 (assessment year 2001-02), the profits of the assessee stood at Rs. 120,18,97,000 whereas depreciation stood at Rs. 127,57,06,000. Depreciation is a non-cash charge against the profits. Thus, the company had a loss of Rs. 7,38,09,000 (that is, 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 of Rs. 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 assessee artificially brings down the depreciation only to Rs. 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 of Rs. 7,38,09,000 got converted to profit of Rs. 18,73,65,000. Thus, the financial statement for the year ending March 31, 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.
The Proviso to Clause (i) of Explanation to Section 115JB(2)
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 (that is, financial year ending March 31, 2000) and the 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 of Rs. 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, that is, assessment year 2001-02, 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 Profit and Loss Account which the Assessing Officer disallowed by placing reliance on the proviso to clause (i) of the Explanation to Section 115JB(2). Consequently, the Assessing Officer added back the said amount of Rs. 26,11,74,000 to the net profits. We agree with the Assessing Officer. Under the provisions, as they then existed, certain adjustments were required to be made to the net profit as shown in the Profit and Loss 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 Profit and Loss 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 the Profit and Loss Account. Now, from the above facts, it is clear that neither the said amount of Rs. 288,58,19,000 nor Rs. 26,11,74,000 had ever gone to increase the book profits in the said year ending March 31, 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 Profit and Loss 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 year 2000-01. 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 show that though the profit was not impacted, depreciation as the head of account was impacted. By interplay of the balance sheet items with Profit and Loss Account 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. Such principles of statutory interpretation are firmly established across Supreme Court judicial precedents on corporate taxation.
Conclusion and Disposition of the Appeal
25. For the above reasons, we see no reason to interfere with the concurrent orders of the High Court and statutory appellate authorities. Hence, the civil appeal filed by the assessee shall stand dismissed with no order as to costs.