Case Law Details
Issue – Whether on the facts and in the circumstances of the case the Tribunal in computing book profit under Section 115JB was justified in confirming the addition of Rs. 9,80,00,000/- transferred to the special reserve pursuant to the provisions of Section 45-IC of the Reserve Bank of India Act, 1934 under Clause (b) of the Explanation to Section 115JB?
Whether on the facts and in the circumstances of the case the Tribunal in computing book profit under Section 115JB was justified in confirming the additions of :-
(a) Rs. 16,00,00,000/- transferred to the special reserve pursuant to the provisions of Section 45-IC of the Reserve Bank of India Act, 1934; and
(b) Rs. 18,66,00,000/- transferred to the debt redemption reserve, both under Clause (b) of the Explanation to Section 115JB?
The appellant is a non-banking financial company engaged, inter alia, in the business of leasing of commercial vehicles, infrastructure construction machinery/equipment and financing of infrastructure projects equipment/machinery. For the assessment year 2006-07, the appellant had filed return on 27th November, 2006, declaring total income of Rs. 2,03,13,738/- under normal provisions and had declared book profit of Rs.38,95,04,834/- under Section 115JB of the Act. This return was revised on three occasions and in the last revised return dated 3 1st March, 2008, the returned income under normal provisions was revised to Rs.1,25,92,360/-. The book profits remained unchanged at Rs.38,95,04,834/-. By assessment order dated 31st December, 2008, the total income of the appellant-assessee was assessed under the normal provisions at Rs.16,17,08,631/- and the book profits under Section 1 15JB of the Act were computed at Rs.67,92,04,834/-. The appellant approached the Commissioner of Income Tax (Appeals) and then filed an appeal before the Tribunal. By the impugned order, addition of Rs.9,80,00,000/- to the special reserve as per the mandate of Section 45-IC of the Reserve Bank of India Act, 1934 stands confirmed relying upon Explanation 1 clause (b) to Section 11 5JB(2) of the Act.
In the assessment year 2007-08, the assessee had filed return declaring loss of Rs.37,94,15,570/- under normal provisions and book profit of Rs.47,54,42,043/-. Assessee had created a special reserve of Rs. 16 crores under Section 45-IC of the Reserve Bank of India Act, 1934. The Assessing Officer by his assessment order applied clause (b) to Explanation 1 to Section 11 5JB (2) of the Act and added back the said amount to Book profit. For the same reason, the Assessing Officer also made adjustment of Rs.18,66,00,000/-, which were treated by the assessee as Debt Redemption Reserve. The Commissioner of Income Tax (Appeals) and the Tribunal have affirmed the said findings of the Assessing Officer.
The contention of the appellant-assessee is two-fold. Firstly, the reserve created as per the mandate of Section 45-IC of the Reserve Bank of India Act, 1934, is in fact a liability and not a reserve. Reliance is placed upon decision of the Supreme Court in National Rayon Corporation Vs. Commissioner of Income Tax (1997) 227 ITR 764 (SC), and Vazir Sultan Tobacco Company Ltd. Vs. CIT (1981) 132 ITR 559 (SC). Secondly, it is submitted that in terms of Section 45-IC of the Reserve Bank of India Act, 1934, the appellant-assessee does not have any title over the reserve and, therefore, it is a case of diversion of income at source. Reliance is placed upon several decisions relating to Molasses Storage Fund, namely, DCM Ltd. Vs. Commissioner of Income Tax [2004] 192 CTR 0408, Commissioner of Income-tax Vs. Salem Co-operative Sugar Mills Ltd (1998) 229 ITR 285, Commissioner of Income-tax Vs. Pandavapura Sahakara Sakkare Kharkane Ltd. (1992) 198 ITR 690, Somaiya Orgeno Chemicals Ltd. Vs. Commissioner of Income-tax (1995) 216 ITR 291. On the issue of Debt Redemption Reserve, again reliance is placed upon decision in National Rayon Corporation (supra) to the effect that the amount was neither a reserve nor a provision for unascertained liability so as to attract clause (b) or (c) of Explanation 1 to Section 1 15JB(2) of the Act. Revenue has contested and argued to the contrary. Decision of the Supreme Court in Southern Technologies Ltd. Vs. Joint Commissioner of Income Tax, [2010] 320 ITR 577 (SC), was referred.
The reserve, which is required to be created under Section 45-IC, is out of the profits earned by a non-banking financial institution. It is not an amount diverted at source by overriding title. The Reserve Bank of India Act, 1934 can permit appropriation in respect of the said reserve. The assessee can also ask for specific directions from the Central Government subject to proviso to sub-section (3) of the said Section.
The special reserve under Section 40IC of the Reserve Bank of India Act, 1934 of Rs.9,80,00,000/- and Rs.16,00,000/- relating to Assessment Years 2006-07 and 2007-09, respectively was not on account of specific or known liability to repay. It is not the case of charge on profits. It was only appropriation of profits after they had been earned. It is not an expense.
During the course of argument it was ascertained and accepted on behalf of appellant assessee that the reserve under Section 45-IC of the Reserve Bank of India Act, 1934 and debt redemption reserve were below the line allocations, after computing the financial profit and were not treated and regarded as expenditure/liability for the for the purpose of the profit and loss account in the accounts. The amount treated as reserve created under Section 45-IC of the Reserve Bank of India Act, 1934 was not regarded as diversion of income at source by the statutory auditor.
Indeed, the reserve created under Section 45-IC of the Reserve Bank of India Act, 1934 can neither be diversion of income at source nor constitute an expenditure or liability. Reserve under Section 45-IC of the Reserve Bank of India Act, 1934 of not less than 20% of net profit every year can only be computed after net profit is calculated and computed. Reserve, so created is not a liability known or ascertained, even estimated. Section 45- IC ensures that a Non- Banking Finance Company does not appropriate entire net profit as disclosed in the Profit and Loss account but this percentage is either ploughed back into business or is represented by a portion of the asset. No separate bank account is required to be maintained. It is an added measure of protection created by the statute, to prevent defaults by the Non Banking Financial Companies. Section 45-IC of the Reserve Bank of India Act, 1934 also permits appropriation but in restricted or controlled manner by a Non Banking Financial Company.
Accounts in case of a company are prepared as a going concern assuming that the business will continue in the foreseeable future. To ascertain the ‗net profit‘ of each year, not only the current liabilities and the contingencies but future contingencies should also be considered. Thus, Chapter VI of the Companies Act in Part II and III provides for ‘Provision‘and ‘Reserve’ which relate to future payments, future needs and contingencies for which a part of the current earning is set aside.
The underlying purposes of financial accounts may not necessarily be the same as those of taxing accounts which are maintained and computed in accordance with the provisions of the taxing statute, i.e. the Income Tax Act, 1961. Notwithstanding clear commonalities such as matching of income with expenses, in the case of financial accounts there is greater emphasis on ensuring that the profits are not overstated, in contrast in the tax accounts the emphasis is on ensuring that the profits are not understated.
DIFFRENCE BETWEEN RESERVES AND PROVISIONS
A provision created to meet a known liability is a charge against the profit. Hence, it is debited to the Profit and Loss account and reduces the profit. Provisions should be created, even if there is insufficient profit. Provision is not, therefore, invested. On the other hand, ‗reserve‘ s only appropriation of profit and, therefore, it is not debited to the Profit and Loss account. The purpose of reserve is to strengthen the financial position and to meet unforeseen liabilities which may arise in future. The reserves are created out of adequate profits. However, once reserve is created, it reduces divisible profit. This is the amount of profit which is retained for use in business when difficulty arises. Reserves can be invested. The said investments can be even outside the business and in such cases the reserve is called the reserve fund. Reserves are shown on the liability side of the balance sheet and are generally treated as belonging to the proprietor just as capital. It is a sum owned by the business to the proprietor. Reserves themselves are not assets but represent a portion of the assets which the proprietor is free to utilize for business as one likes, i.e. the assets equalling the reserves that are not required to pay liabilities. Generally reserves are created at the discretion of the management as a matter of prudence, but in certain cases a statute can direct creation of special reserves. For the purpose of Section 11 5JB of the Act, statutory reserves are treated alike and in a similar manner as other reserves.
Reserves are normally treated as a part of equity which is defined as residual, i.e. assets less liabilities, but as recorded above sometimes reserves are required to be created by statute in order to give the entity and its creditors an added measure of protection from the effect of losses.
To reiterate, a reserve is below the line of allocation of profits. The amount mentioned in the reserve does not get reflected in the Profit and Loss account. Further, the amount mentioned in the reserve is not to be kept in a designated bank account, but would get reflected in the form of assets under the heading ―’assets’, etc.
In view of the aforesaid reasoning, the two substantial questions of law answered against the appellant-assessee and in favour of the respondent-Revenue.
Sub-section (2) of 45IC: No appropriation of any sum from the reserve fund shall be
made by the non-banking financial company except for the purpose as may be
specified by the Bank from time to time.
Two Questions to have clarity about:
1. How to apply RBI for appropriation;
2. What are the instances of appropriation.