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Judgment
This income tax appeal preferred by the CIT, Bareilly under s. 260A of the IT Act, 1961 arises out of judgment and order dt. 28th Sept., 1999 passed by the Tribunal in ITA No. 4126/Del/1993 relating to the asst. yr. 1990-91. The appeal was admitted on 11th Jan., 2007 on the questions of law as follows:
Whether on the facts and circumstances of the case, the Tribunal was justified in law in upholding the order of CIT(A) who observed that the effect of higher claim of depreciation on the revalued assets to the extent of Rs. 17,26,809 get set off against a like amount of Rs. 17,26,809 transferred from the revaluation reserve and credited to the P&L a/c, while it is not so, and depreciation on revalued asset is not permissible for computation of income under s. 115J of IT Act, 1961 ?
Whether on the facts and circumstances of the case, the Tribunal was justified in upholding the order of CIT(A) who directed to allow a reduction of Rs. 17,29,809 within the meaning of cl. (1) read with proviso thereto of the Explanation to s. 115J which was already allowed by the AO ?
We have heard Shri Dhananjay Awasthi, learned counsel appearing for the IT Department. Shri Rupesh Jain and Shri R.S. Agrawal appear for the respondent-assessee.
Brief facts necessary for deciding this appeal are that the assessee company is engaged in the manufacture and sale of industrial alcohol, IMFL; and country liquor, The assessee company filed a return of income on 31st Dec, 1990, showing nil income after setting off carry forward loss of Rs. 2,31,67,914. The return was processed under s. 143(1)(a) vide intimation dt. 31st Aug., 1991, following prima facie adjustment in the return income. The book profit under s. 115J of the Act was determined at Rs. 81,26,600 and the tax was levied on the total adjusted income of Rs. 81,26,600.
On computation of book profit under s. 115J of the Act, the assessee was asked to justify the claim of depreciation on revalued assets. The assessee filed written submissions and stated that "the depreciation of assets on revalued figures are to be allowed because in s. 115J there is nothing to disallow the depreciation on revalued figure so as to arrive at the figure of book profit",
The AO observed that in computation of book profit under s. 115J two options are available namely, whether claim of depreciation be accepted on revalued assets and whether the loss can be taken inclusive of depreciation for the purposes of deduction under s. 205(1)(b) of the Companies Act, 1956. So far as claim of depreciation of revalued assets, the AO held that under sub-s. (2) of s. 205 of the Companies Act two methods are provided for depreciation namely: (1) WDV method and (ii) straight line method, Under s. 350 of the Companies Act for maintainable remuneration depreciation is calculated with reference to WDV of the assets as shown by the books of the company at the end of the financial year at the commencement of the Act, or immediately thereafter at the end of each subsequent financial year. The provisions of s. 205(1)(b) of the Companies Act permit the company to provide depreciation either on WDV method or straight line method. Sec. 115J does not provide for any adjustment/interference in the P&L a/c except under cls. (a) to (f) and cls. (i) to (iii), however, the P&L a/c has to be made as per the provisions of parts (ii) and (iii) of the Sixth Schedule of the Companies Act, 1956 [vide Circular No. 10(1)(CL) vi/61 dt. 27th Sept., 1961], which prohibits the companies from taking the revalued figure for the purposes of calculation of depreciation. As per the circular, only WDV method and not revalued figure has to be taken in the case of revaluation of assets shown after 1956. The; AO held that depreciation on revalued figure is not allowable for the purposes of computation of book profit under s. 115J of the Act.
The CIT(A) upheld the findings and did not allow any set off from book profit. It held that the business loss being lower than the unsupported depreciation, no deduction under s. 205(1)(b) of the Companies Act is liable to be set off against the book profits.
The Tribunal on the question of depreciation on revaluation reserve held in paras 21 to 23 as follows:
The facts are that while computing the book profits under s. 115J of the Act, the AO had added to the profits an amount of Rs. 17,26,809 which was transferred from revaluation account. The assessee challenged this working before the learned CIT(A) who decided the issue in favour of the assessee in the following manner:
15.2 I have carefully considered the submissions of learned Authorised Representative and I have also perused the computation of book profits made by the AO under s. 115J. As per the provisions of s. 115J the computation of book profits has to be made with reference to the book profits as per the books of account as further adjusted by the additions and deductions enumerated under the Explanation to s. 115J. From a perusal of the P&L a/c for the relevant assessment year under appeal it is seen that the appellant has debited depreciation in the books to the extent of Rs. 1,32,20,584 which also includes depreciation on revalued assets to the extent of Rs. 17,26,809. However, it is also noticed that out of the revaluation reserve a sum of Rs. 17,26,809 has been transferred to the P&L a/c and credited to the said account. Thus the effect of higher claim of depreciation on the revalued assets to the extent of Rs. 17,26,809 gets sets off against a like amount of Rs. 17,26,809 transferred from the revaluation reserve and credited to the P&L a/c. I am of the considered view that the computation of book profits was liable to be made by the AO with reference to the book profits of Rs. 2,70,88,675 as rightly pointed out by the AO. Starting from that stage the AO should have made further adjustments, inter alia, within the meaning of cl. (1) read with proviso thereto of the Explanation to s. 115J. In terms of the said clause the book profits have to be reduced by the amount withdrawn from reserves, if any, such amount is credited to the P&L a/c. The proviso to the said clause further provides that the amount withdrawn from reserves created in any previous year relevant to asst. yr. 1988-89 onwards shall not be reduced from the book profits unless the book profits of that year have been increased by those reserves. Against the aforesaid provisions, it is seen that in the case of the appellant the P&L a/c is credited by a sum of Rs. 17,26,809. Accordingly, in my considered opinion, the appellant shall be entitled to a deduction of Rs. 17,26,809 within the meaning of cl. (1) read with proviso thereto of the Explanation to s. 115J. The AO is, therefore, directed to allow a reduction of Rs. 17,26,809 from the book profits computed by him under s. 115J.
Before us the learned Departmental Representative had nothing to say except referring to the ground taken by the Department. The learned counsel for the assessee pointed out that the treatment given by the AO in effect amounted to double addition. He relied on the order of the learned CIT(A).
On a careful consideration of the facts and circumstances of the case in its entirely, we are unable to record a finding on the issue different from the one recorded by the learned CIT(A). The object (sic) fails.
Shri Dhananjay Awasthi appearing for the Revenue submits that the Tribunal was not justified in observing that the effect of the higher claim of depreciation on the revalued assets would get set off against the like amount transferred front the revaluation reserve and credited to the P&L a/c. He submits that depreciation on revalued asset is not permissible for computation of income under s. 115J of the Act. He has relied upon Commissioner of Income Tax Vs. SRF Ltd., in which it was held after referring to the scheme of Chapter XII-B by which minimum alternate tax (in short MAT) was introduced to get over the situation whereby the companies, which were otherwise earning large profits and distributing huge amounts in the form of dividend to its shareholders were paying no tax or negligent amount of tax by virtue of deductions and exemptions made available to them under various provisions of the IT Act. Relying on Indo Rama Synthetics (I) Ltd. Vs. Commissioner of Income Tax , New Delhi, , the Delhi High Court observed that the legislature in the scheme introduced for MAT companies devised methodology whereby at least 30 per cent of the book profits was made taxable. In reply to the submissions as to whether depreciation can be allowed to revaluation reserve, the Delhi High Court held that where credit is made to the P&L a/c in the first instance at the time of creation of the reserve, the book profit would stand increased and consequently any withdrawal from the revaluation reserve would stand squared of by reducing the amount from the book profit. Since that situation did not arise in the case considered by the Delhi High Court, it was held that the assessee cannot be allowed reduction in the amount and relied upon the Expln. (i) appended to s. 115J dealing with situation, where some delinquent companies were taking advantage by reducing their net profit by the amount withdrawn from the reserve created or provision made in the same year itself, though reserve, when created was not added to the book profit, Explanation (i) was to apply to amount withdrawn from the reserves or provisions only if reserves were created before 1st April, 1988. The Court did not accept the contention that it is only when the proviso is attracted that the assessee would be disabled from seeking reduction in terms of cl. (i) to the Explanation appended to s. 115J even though reserve, when created or provision made did not get reflected in the P&L a/c.
Shri Rupesh Jain has relied on Apollo Tyres Ltd. Vs. Commissioner of Income Tax, Kochi, followed by this Court in CIT vs. Hindustan Pipe Udyog Ltd., IT Appeal No. 182 of 2000, decided on 28th Aug., 2012 [reported at (2013) 255 CTR (All) 389 : (2013) 81 DTR (All) 175--Ed.].
The Supreme Court in Apollo Tyres Ltd. (supra) held:
Therefore, we are of the opinion, the AO while computing the income under s. 115J has only the power of examining whether the books of account are certified by the authorities under the Companies Act as having been properly maintained in accordance with the Companies Act. The AO thereafter has the limited power of making increases and reductions as provided for in the Explanation to the said section. To put it differently, the AO does not have the jurisdiction to go behind the net profit shown in the P&L a/c except to the extent provided in the Explanation to s. 115J.
Shri Rupesh Jain submits that in the present case the effect on the depreciation of the revaluation reserve was set off by transferring equal amount of Rs. 17,26,803, from the revaluation account by withdrawing the amount from revaluation account to the P&L a/c. He has demonstrated it from the computation of book account (sic-profit) under s. 115J of the IT Act, 1961 in the computation made by the AO as follows:
Computation of book profit under s. 115J of IT Act, 1961
The book profit under s. 115J of IT Act, 1961 was computed vide intimation under s. 143(1)(a) of IT Act dt. 31st Aug., 1991.
Shri Rupesh Jain has relied upon notes of the audited annual accounts along with notes of accounts of the asst. yr. 1990-91 by the respondent assessee in which the auditors have provided:
(c) An amount of Rs. 17,26,803 has been transferred from revaluation reserve to P&L a/c being the difference between the depreciation on revalued account and original cost, WDV of the assets.
Shri Rupesh Jain has referred to copy of AS-6 "accounting for fixed assets" issued by the ICAI, which provides for the revaluation of fixed assets and the guidance note issued by the ICAI on the treatment of reserves created on revaluation of fixed assets and which provides as follows:
GN(A) 3 (Issued 1982) Guidance Note on treatment of reserve created on revaluation of fixed assets
In the preparation of the financial statements of a company, various fixed assets are stated on the basis of their historical cost. Sometimes, in order to bring into the balance sheet their replacement cost, a company revalues its fixed assets on the basis of a valuation made by competent valuers. When the value of fixed assets is written up in the books of account of a company on revaluation, a corresponding credit is given to the revaluation reserve. Such reserve represents the difference between the estimated present market values and the book values of the fixed assets. When such reserve is created, a question arises about its nature and the manner in which it can be utilized. This guidance note deals with accounting treatment of the reserve created on revaluation of fixed assets (herein referred to as ''revaluation reserve'').
Part I of Sch. VI to the Companies Act, 1956 provides that every company shall classify its fixed assets under convenient heads and show under each head the original cost, additions/deductions and the total depreciation provided upto the end of each accounting period. When a company revalues its fixed assets, it is necessary for the company to show separately the date of revaluation and, for a period of five years thereafter, the amount of increase made.
When a company revalues its fixed assets, depreciation should be provided on the basis of the revalued figures.
A view has been expressed in some quarters that, for measurement of profits, revenue is deemed to have arisen when it is actually collected or when a justifiable claim to collect it arises (e.g. credit sale) or when there is knowledge and evidence that it is capable of being collected if a sale were to be made (i.e. prevailing market price). According to this view, this principle will apply equally to current and fixed assets and, therefore, when fixed assets are written upto their present value, the corresponding revaluation reserve cannot be considered as an unrealised reserve. It is, therefore, argued that past accumulated losses as well as depreciation for the year or arrears of depreciation for earlier years which are required to be provided under s. 205 of the Companies Act can be written off or adjusted against such revaluation reserve.
There is a contrary view that such revaluation reserve is created as a result of a book adjustment only and, therefore, such a reserve is an unrealised reserve which is not available for distribution as dividends. When accounts are prepared on the basis of historical cost, measurement of profits can be made by comparing the cost of the assets at the beginning and at the end of the accounting period. As such there is no justification for taking credit for unrealised gains because the increase in market value may be due to various extraneous factors such as fall in the purchasing power of currency or other factors not related to the operations of the company. So far as fixed assets are concerned, these are held for the use in the business and not for sale in the normal course of business. In the circumstance, the difference between the market value and the book value does not represent realised gain and cannot be treated as such in the books of account.
Sec. 205 of the Companies Act provides that a company can declare or pay dividend only out of its profits. The profits for this purpose are to be arrived at after providing for depreciation. If dividend is to be declared out of the profits of any earlier year or years, it is necessary that such profits should be arrived at after providing for depreciation for the respective years.
Proviso (a) to s. 205(1) of the Companies Act reads as under:
(a) if the company has not provided for depreciation for any previous financial year or years which falls or fall after the commencement of the Companies (Amendment) Act, 1960, it shall before declaring or paying dividend for any financial year provide for such depreciation out of the profits of that financial year or out of the profits of any other previous financial year or years.
This proviso makes it clear that it is necessary to provide for arrears of depreciation of earlier years, if any dividend is to be declared out of profits of any subsequent year. For this purpose depreciation (or arrears of depreciation) is to be provided out of the profits of the company. Indeed, a reference to Part II of Sch. VI to the Companies Act indicates that the P&L a/c is to be so made as clearly to disclose the result of working of the company during the period covered by the account.
When accumulated losses and depreciation (including arrears of depreciation) are adjusted against revaluation reserve it will amount to setting off actual losses against unrealised gains. If dividend is declared out of the current profits after adjusting accumulated losses or arrears of depreciation against the revaluation reserve, it will mean that dividend is declared out of profits which should, in fact, have been utilised in setting off past losses and arrears of depreciation. In effect, the company will be declaring dividend out of profits which are not available for distribution. By adopting this method, the company will be declaring dividend out of unrealised gains appealing in the accounts in the form of revaluation reserve. Accordingly, accumulated losses or arrears of depreciation should not be set off against revaluation reserve.
A question may arise, as to whether the additional depreciation provision required in consequence of revaluation can be adjusted against ''revaluation reserve''. As stated earlier, depreciation is required to be provided with reference to the total value of the fixed assets as appearing in the account after revaluation. However, for certain statutory purposes e.g., dividends, managerial remuneration etc., only depreciation relatable to the historical cost of the fixed assets is to be provided out of the current profits of the company. In the circumstance, the additional depreciation relatable to revaluation may be adjusted against ''revaluation reserve'' by transfer to P&L a/c. In other words, as per the requirements of Part II of Sch. VI to the Companies Act, the company will have to provide the depreciation on the total book value of the fixed assets (including the increased amount as a result of revaluation) in the P&L a/c of the relevant period, and thereafter the company can transfer an amount equivalent to the additional depreciation from the revaluation reserve. Such transfer from revaluation reserve should be shown in the P&L a/c separately and an appropriate note by way of disclosure would be desirable. Such a disclosure would appear to be in consonance with the requirement of Part I of Sch. VI to the Companies Act, prescribing disclosure of write up in the value of fixed asset for the first five years after revaluation.
If a company ''has transferred the difference between the revalued figure and the book value of fixed assets to the ''revaluation reserve'' and has charged the additional depreciation related thereto to its P&L a/c, it is possible to transfer an amount equivalent to accumulated additional depreciation from the revaluation reserve to the P&L a/c or to the general reserve as the circumstances may permit, provided suitable disclosure is made in the accounts as recommended in this guidance note.
The revaluation reserve is not available for payment of dividends. This view is also supported by the Companies (Declaration of Dividend out of Reserves) Rules, 1975. Similarly, accumulated losses or arrears of depreciation should not be set off against revaluation reserve. However, the revaluation reserve can be utilised for adjustment of the additional. depreciation on the increased amount due to revaluation from year to year or on the retirement of the relevant fixed assets (as discussed in paras 9 and 10 above respectively).
The revaluation of fixed assets is normally done in order to bring into books the replacement cost of such assets. This is a healthy trend as it recognises the importance of retaining sufficient funds through additional depreciation in the business for replacement of fixed assets. As such, it will be prudent not to charge the additional depreciation against revaluation reserve, though this may result in reduction of distributable profits. This practice would also give a more realistic appraisal of the company''s operations in an inflationary situation.
The Accounting Standards prescribed by the ICAI are applicable by virtue of s. 211(3)(c) of the Companies Act, until such time the Accounting Standards are prescribed by the Central Government in consultation with the National Advisory Committee, on Accounting Standards established under s. 210A(1) of the Act. The Central Government has not prescribed the Accounting Standards, so far.
On the aforesaid discussion, we are of the view that the Tribunal did not commit any error in law in allowing the depreciation on the revaluation reserve, which is a prescribed and statutory method of accounting, and by which the book profits do not get reduced, giving any added benefit to the companies including MAT companies.
Both the questions of law are decided in favour of the respondent assessee and against the Revenue. The income tax appeal is dismissed.