We summarised here the ruling of the Delhi High Court (HC) [2009-TIOL-531-HCDEL-IT] in the case of Indo Rama Synthetics (I) Ltd. (Taxpayer) where the HC, upholding the order of the Income Tax Appellate Tribunal (ITAT), denied reduction from book profit, for the purpose of Section 115JB (Section) of the Indian Tax Law (ITL), of the amount withdrawn from revaluation reserve. This is for the reason that such reserve was not added back to the net profit in the year of creation of revaluation reserve (year of creation), in terms of the requirement of the Section.
Background and facts of the case
- Corporate taxpayers in India are liable to book profit-based tax, popularly known as Minimum Alternate Tax (MAT). Under the MAT provisions, if the normal tax liability of a corporate taxpayer is less than the specified percentage of its book profit for the relevant tax year, the taxpayer is liable to pay minimum tax, calculated with reference to a percentage of its book profit. The computation of book profit is based on profit and loss account (P&L), prepared as per the relevant provisions of the Companies Act. It is computed by applying the same accounting standards, policies and rates and methods of depreciation as may be adopted for preparing such accounts for presenting them to the shareholders in an annual general meeting. The net profit as per such P&L is further adjusted by certain additions and deductions which are specified in the Section. The specified adjustments, inter alia, include adjustments intended to eliminate the cross-effect of items of appropriation of profit reflected in the P&L, like transfers to and from reserves, provisions for income tax, proposed dividend etc.
- As part of the computation, the Section provides for reduction of the amount withdrawn from any reserve or provision, if any such amount is credited to the P&L. However, withdrawal from a reserve created before 1 April 1997, otherwise than by way of debit to P&L, is not permitted to be reduced. Further, withdrawal from a reserve created after 1 April 1997 is permitted to be reduced only if the book profit of the year in which the reserve was created was increased by such reserve.
- The Taxpayer is a company engaged in the business of manufacture of yarn and polyester. For the tax year 20002001, the Taxpayer computed book profit after reducing the net profit by the amount withdrawn from the revaluation reserve, created on revaluation of the fixed assets. However, the Tax Authority did not allow the reduction on the ground that, when the revaluation reserve was created in the tax year 1999-2000, the said amount was not added back in the computation of the book profit for that year.
- The first appellate authority and the ITAT confirmed the action of the Tax Authority. The Taxpayer appealed further to the HC.
Contentions of the Taxpayer
- The credit of withdrawal from the revaluation reserve is in terms of the accounting standards prescribed by the Institute of Chartered Accountants of India. It is essentially in the nature of a book entry.
- The revaluation reserve was created by revaluing the fixed assets and crediting the reserve directly in the Balance Sheet. It was not created by any debit to the P&L. Hence, there was no question of increasing the book profit in the year of creation.
Contentions of the Tax Authority
- The book profit of the year of creation was not increased by the amount of the revaluation reserve, since it was credited directly to the reserve account in the Balance Sheet.
- On a plain and literal reading, the Section permits a reduction from the book profit in the year of withdrawal only in a case where the book profit was increased by the amount of reserve in the year of creation. In the present case, since the book profit was not so increased in the year of creation, the reduction is also not permissible in the year of withdrawal.
Ruling of the HC
The HC upheld the decision of the ITAT for the following reasons:
- The provision of the Section, which permits reduction of book profit by the amount of withdrawal from reserve only in a case where the book profit was increased by the amount of reserve in the year of creation, is plain and clear and admits no other interpretation.
- Prior to the insertion of the above provision, it was possible for a taxpayer to reduce his book profit by the amount of withdrawal, even though the book profit in the year of creation was not increased by the amount of reserve. After the insertion, the taxpayers have been deprived of this benefit. This is evident from a plain literal reading of the provision, without any ambiguity.
- By creating a revaluation reserve, the taxpayer avails the benefit of higher depreciation on revalued amount of fixed assets which has the effect of reducing the net profit. The restriction on reducing withdrawal from the reserve, only where book profit is earlier increased by such reserve, has the effect of countering this benefit.
Comments :-This ruling provides guidance that withdrawal from a revaluation reserve is permitted to be reduced from the book profit, computed under the MAT provisions, only in a case where the book profit was increased by the amount of revaluation reserve in the year of creation.