Case Law Details
Sarda Gums & Chemicals F-54 Vs ACIT (ITAT Jodhpur)
ITAT Jodhpur held that merely by transferring the reserve created out of the tax paid profit subsequently transferred to capital account of the firm is not a mistake apparent on record and cannot be rectified under the guise of provision of section 154 of the Act
Facts- The assessee is a Firm. The assessee derives income from manufacturing and trading of Gwar Gum Powder Cassia Tore, Psyllium Husk, and Tamarind Powder. The case was selected for scrutiny through CASS. AO disallowed Rs. 4,73,780/- i.e. 1/10th of the various expenses claimed. The assessment u/s. 143(3). AO issued a notice u/s. 154 of the Income Tax Act requesting the assessee to file the reply. AO noted that the assessee was not able to prove that the export reserve of Rs. 6,12,000/- distributed by M/s. Sarda Gums and Chemicals were created after payment of tax liability and assessee could not establish the fact that the reserve creation was done subject to tax. Therefore, ld AO taken a view that the assessee could not prove the distribution of Export reserve, Investment Allowance reserve and state investment subsidy reserve was made out of tax free profit hence distribution of these reserve is subject to tax. Therefore, distribution of export reserve Rs. 6,12,000/-, Investment Allowance Reserve of Rs. 1,01,378/- and State Investment Subsidy reserve of Rs. 5,71,700/- to the credit of partner’s capital account in A. Y. 2012-13 added to the income of the firm.
CIT(A) dismissed the appeal. Being aggrieved, the present appeal is filed.
Conclusion- Merely by transferring the reserve created out of the tax paid profit subsequently transferred to capital account of the firm is not the real income chargeable to tax in the year when transferred to partner and the reserve so created where statutory reserve created under the old provision of the law and now the same being not carried out to carried in the balance sheet and thereby credited the account of the partner is not a mistake apparent on record and cannot be rectified under the guise of provision of section 154 of the Act and the same cannot be considered as mistake apparent on record.
FULL TEXT OF THE ORDER OF ITAT JODHPUR
This appeal is filed by assessee and is arising out of the order of the National Faceless Appeal Centre, Delhi dated 01/11/2021 [here in after (NFAC)] for assessment year 2012-13 which in turn arise from the order dated 31.03.2019 passed under section 143(3)/154 of the Income Tax Act, by the ACIT, Circle- Pali.
2. The assessee has marched this appeal on the following grounds:-
“1.The ld. CIT(A), NFAC has erred on facts and in law in upholding the order of AO passed u/s 154 of the Act.
2. The Ld. CIT(A), NFAC has erred on facts and in law in confirming the addition of Rs. 12,85,078/- made by the AO ignoring that Export Profit Reserve, Investment Allowance Reserve and State Investment Subsidy created in earlier years by appropriation of profits is not taxable in the hands of firm on its distribution to its partners.
3. The appellant craves to alter, amend and modify any ground of appeal.
4. Necessary cost be awarded to the assessee.”
3. The fact as culled out from the records is that the assessee is a Firm. During the year under consideration, the assessee derives income from manufacturing and trading of Gwar Gum Powder Cassia Tore, Psyllium Husk, Tamarind Powder. The return of income was e-filed by the assessee on 28.09.2012 declaring total income at Rs. 14,44,83,440/-. The case was selected for scrutiny through CASS. After considering facts and circumstances of the case, the ld. AO disallowed Rs. 4,73,780/- i.e. 1/10th of the various expenses claimed. The assessment u/s 143(3) was completed on 27.02.2015 determining total income at Rs. 14,49,57,220/-. Further, on perusal of the assessment record, it is noticed that:-
“During the previous year, assessee firm has distributed reserve and surplus amongst the partners amount of Rs. 12,85,078/- as below:
| Export Profit Reserve | Rs. 6,12,000/- |
| Investment Allowance Reserve | Rs. 1,01,378/- |
| State Investment Subsidy | Rs. 5,71,700/- |
It was noticed that without checking the taxability of above reserves and surplus they were transferred to partner’s capital account, which is required to be considered as business income. This resulted into under computation of income by Rs. 12,85,078/-.”
3.1 Based on the above observation the ld. AO issued notice u/s. 154 of the Act on 27.03.2019 requesting the assessee to file the reply. The assessee filed the reply dated 31.03.2019. On perusal of the reply ld. AO noted that the assessee was not able to prove that the export reserve of Rs. 6,12,000/- distributed by M/s. Sarda Gums and Chemicals were created after payment of tax liability and assessee could not establish the fact that the reserve creation was done subject to tax. Therefore, ld AO taken a view that the assessee could not prove the distribution of Export reserve, Investment Allowance reserve and state investment subsidy reserve was made out of tax free profit hence distribution of these reserve is subject to tax. Therefore, distribution of export reserve Rs. 6,12,000/-, Investment Allowance Reserve of Rs. 1,01,378/- and State Investment Subsidy reserve of Rs. 5,71,700/- to the credit of partner’s capital account in A. Y. 2012-13 added to the income of the firm.
4. Aggrieved from the order of the ACIT, assessee preferred an appeal before the ld. CIT(A)/NFAC. A propose to the grounds so raised the relevant finding of the ld. CIT(A)/NFAC is reiterated here in below:
“The contentions of the A.O. and appellant have been carefully examined. The appellant’s basic contention is that the issue involved is a debatable point of law and was not a mistake apparent from record. Therefore, the A.O. had no jurisdiction to invoke the provisions of Section 154 on a debatable issue. The said contention of the appellant cannot be accepted. The issue involved viz. whether the tax free reserves had been distributed to the partners after payment of taxes, or whether the reserves were directly credited to partners’ capital account before payment of taxes, is clearly an issue of fact and is not a debatable issue involving any question of law. In fact, in the appellant’s own submission, in point No.2 above, the appellant has himself submitted as follows:
“2. In the present case whether the distribution of reserves to the partners is taxable in the hands of the firm or not can be determined only by going through all the records of earlier years when these reserves are created. The assessee has filed some of the old records which proves that the reserves are created out of the profit appropriation and therefore not taxable on distribution to the partners.”
Therefore the appellant itself admits that the issue can be determined after going through all the records of the earlier years. Hence, this conclusively proves that the issue is purely a question of fact and therefore the A.O. had validly invoked the provisions of Sec. 154.
5. Regarding the merits of the issue, the A.O. has correctly held that inspite of repeated opportunities, the appellant could not prove that the distribution of the Export Profit Reserve, Investment Allowance Reserve and State Investment Subsidy amounting to Rs. 12,85,078/- were made out of taxable profit, i.e. after payment of due taxes by the appellant firm. Therefore, the A.O. had correctly held that the distribution of such reserves were made directly to the partners’ capital account out of tax free profit and therefore has rightly taxed the same in the hands of the appellant firm. In view of the same, the appellant’s appeal is dismissed.”
5. As the assessee did not find any favour from the appeal so filed with the ld. CIT(A), the assessee preferred the present appeal before this tribunal on the grounds so raised in para 2 above. The ld. AR appearing on behalf of the assessee in support of the grounds so raised has relied upon the written submission and the same is extracted here in below;
1. The assessee filed the return on 28.09.2012 declaring total income at Rs.14,44,83,440/-. It was assessed u/s 143(3) dt. 27.02.2015 at total income of Rs.14,49,57,220/- .
2. The AO issued notice u/s 154 dt. 27.03.2019 (PB 3) stating that assessee distributed the export profit reserve, investment allowance reserve and state investment subsidy amounting to Rs.12,85,078/- amongst the partners which is required to be considered as business income. The assessee filed reply on 13.03.2019 (PB 4) stating that all reserves are created out of profits after tax and therefore the same is not taxable when credited to partner’s capital account.
3. The AO however held that assessee could not prove that export reserves were created after payment of tax. The reserve was created for the purpose of claiming deduction u/s 80HHC but assessee could not prove that the same has been used for the purpose. Further investment allowance reserve and state investment subsidy reserve were created by M/s Pali Gum Industries who merged with the assessee in AY 1997-98 but assessee could not furnish proof that the same were created out of profit after tax. Accordingly, these amounts were added to the income of assessee.
4. The Ld. CIT(A) after reproducing the observations of AO and submission of the assessee at Para 4 upheld the validity of section 154 and at Para 5 held that assessee could not prove that the distribution of reserve were made out of taxable profits and therefore the same is rightly taxed in the hands of assessee.
Submission:-
1. At the outset it is submitted that an order u/s 154 can be passed only to rectify the mistakes apparent on record. In the notice issued u/s 154 AO has nowhere specified that under which provision of the Act the reserve and surplus distributed to the partners is liable for taxation in the hands of the firm. The AO only presumed that such transfer/ distribution is required to be considered as business income of the assessee. Hon’ble Supreme Court in case of ITO Vs. Volkart Bros. 82 ITR 50 has held that “a mistake apparent on record must be an obvious and patent mistake and not something which can be established by a long-drawn process of reasoning on points on which there may conceivably be two opinions. A decision on a debatable point of law is not a mistake apparent from record.” Therefore in the absence of any statutory provision under which such amount can be taxed in the hands of the assessee, the same cannot be added by passing order u/s 154. The Ld. CIT(A) has not appreciated this legal provision and therefore the order passed u/s 154 is illegal, bad in law & be quashed.
2. On merit it can be noted that all these reserves are created as per the provisions of the Act out of the profit of the assessee as discussed hereunder:-
(i) The assessee has transferred an amount equal to the amount eligible for deduction u/s 80HHC to reserve for export profit. This is verifiable from the profit & loss account for the year ending 02.11.1986 (PB 21) from which it can be noted that in the previous year export reserve of Rs.70,000/- was created and for the year ending 02.11.1986 further addition of Rs.1,92,000/-was made out of the taxable profits (PB 19-20). Thereafter some more amounts were transferred to export profit reserve and as on 31.03.1991 it stood at Rs.6,12,000/- (PB 7). Thus it is evident that export profit reserve is created out of the taxed profit.
(ii) In FY 1997-98 M/s Pali Gum Industries merged with the assessee. In the balance sheet of M/s Pali Gum Industries as on 31.03.1996 and 31.03.1997 (PB 18 & 15) the investment allowance reserve stood at Rs.44,336/- and state investment subsidy at Rs.5,71,700/-. On merger these amounts were taken to the balance sheet of the assessee which as on 31.03.1998 (PB 12) stood at Rs.1,01,378/- and Rs.5,71,700/- respectively. As per section 32A(4) of the Act, for claiming deduction under this section, an amount equal to 75% of investment allowance to be actually allowed was required to be credited to investment allowance reserve account and such amount to be utilized for the purpose of business of undertaking. Thus investment allowance reserve is created out of the taxed profit. So far as state investment subsidy is concerned the same is a capital receipt being provided by the state government for industrialization and employment generation in the state.
All these reserves /subsidy were appearing on the balance sheet of the assessee from more than last 15 years and therefore during the year under consideration they were transferred to capital account of the partners. On such transfer no tax liability arises in the hands of the firm and therefore, addition made by the AO and confirmed by the Ld. CIT(A) is not as per law.
In view of above, addition confirmed by the Ld. CIT(A) be directed to be deleted.”
6. Further, the ld. AR appearing on behalf of the assessee has also placed their affidavit which is extracted in below;
7. The ld DR is heard who has relied on the findings of the lower authorities based and supported the contentions raised in the respective orders.
8. We have heard the rival contentions and perused the material placed on record. The bench noted from the copy of the balance sheet so filed by the assessee of 1990, 1996, 1997, 1998 demonstrating that the reserve so created was carried over since so many years. The bench noted the assessee has not credited the said sum in the profit and loss account in the year under consideration. The bench also noted from the affidavit of the assessee where in the it has been stated the same is not created out of the debit to the profit and loss account. On this aspect revenue did not bring anything contrary on record so as to counter the contention of the assessee and therefore, merely by transferring the reserve created out of the tax paid profit subsequently transferred to capital account of the firm is not the real income chargeable to tax in the year when transferred to partner and the reserve so created where statutory reserve created under the old provision of the law and now the same being not carried out to carried in the balance sheet and thereby credited the account of the partner is not a mistake apparent on record and cannot be rectified under the guise of provision of section 154 of the Act and the same cannot be considered as mistake apparent on record. Therefore, considering the decision of apex court in case of ITO Vs. Volkart Bros. 82 ITR 50 holding that “a mistake apparent on record must be an obvious and patent mistake and not something which can be established by a long-drawn process of reasoning on points on which there may conceivably be two opinions. Considering the decision relied upon and facts of the case as discussed here in above we are of the considered view the ld. AO erred in invoking the provision of section 154 of the Act in the instance case based on the facts on record. Therefore, we quashed the order under attach passed u/s. 154 of the Act dated 31.03.2019.
In the result, appeal of the assessee is allowed.
Order pronounced under rule 34(4) of the Appellate Tribunal Rules, 1963, by placing the details on the notice board.
Author Bio
whether a private limited can transfer entire amount of profit and loss amount after tax to its reserve and surplus account showing in the balance sheet