Indo Rama Synthetics (I) Ltd vs C.I.T,New Delhi

Rs.288,58,19,000/-, which was credited to the revaluation 2

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 of

Rs.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 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 explanation to Section

115JB. 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 3

against the amount of depreciation debited to P & L Account

can be excluded in terms of clause (i) of 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 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Account, any amount withdrawn from any reserves and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 4

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 5

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 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 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.

8

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 9

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 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

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 1

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 Section

115JB(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. Section

115JB is a self-contained code. It applies notwithstanding

other provisions of the Act. There is no scope for any 1

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 & L

Account.

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 1

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 Section

115JB(2)?

1

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 of

Rs.288,58,19,000/- and credited to the P & L Account which

the AO disallowed and consequently the said sum of

Rs.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 1

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

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 1

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 1

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 1

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 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 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.

1

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 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, i.e., 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

P & L Account which the A.O. disallowed by placing reliance

on the proviso to clause (i) of the explanation to Section

115JB(2). Consequently, the A.O. added back the said 1

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 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 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 2

(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 shows

that though the profit was not impacted, depreciation as the

head of A/c. was impacted. By inter play of the balance sheet

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 2

(S. H. Kapadia)

...........................................J. (K.S. Panicker Radhakrishnan)

...........................................J. (Swatanter Kumar)

New Delhi;

January 5, 2011