Case Law Details
Amount withdrawn from revaluation reserve and credited to the Profit & Loss account cannot be reduced from the book profit if such amount had not increased the book profit at the time of creation of reserve
Facts
• The taxpayer is a limited company engaged in the business of manufacture of yarn and polyester.
• The taxpayer during the assessment year (“AY”) 2000-01 revalued its fixed assets by increasing the net book value by INR 2885.8 million and credited the said sum to the revaluation reserve.
• In the subsequent year i.e. AY 2001-02, the taxpayer debited to the Profit & Loss account an amount of INR 1275.7 million towards depreciation. In accordance with Accounting Standard-10 and Accounting Standard-6, the tax payer transferred INR 261.2 million from revaluation reserve and set it off against the depreciation resulting in a net depreciation allowance of INR 1014.5 million.
• While computing the book profit under section 11 5JB of the Income-tax Act (“ITA”), the taxpayer claimed that the amount of INR 261.2 million transferred from the revaluation reserve had to be excluded and the depreciation allowance had to be considered at INR 1275.7 million.
• The Assessing Officer (“AO”) rejected the claim of the taxpayer on the ground that the revaluation reserve created in the AY 2000-01 had not been added back while computing the book profit for the said AY in terms of the proviso to clause (i) of Explanation to Section 11 5JB.
• The Commissioner of Income-tax (Appeals), Income-tax Appellate Tribunal and the High Court upheld the finding of the AO.
• Aggrieved by the above, the tax payer filed an appeal before the Supreme Court.
Issue before the Supreme Court :- Whether the amount transferred from the revaluation reserve and set off against the amount of depreciation debited to the Profit & Loss account can be excluded in computing book profit in terms of clause (i) of Explanation to section 11 5JB(2) read with the proviso?
Observations and Ruling of the Supreme Court
• The Supreme Court observed that any amount withdrawn from reserves created on or after 1 April 1997 and which is credited to the Profit & Loss account shall not be reduced from the book profit, unless the book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.
• The adjustment of the amount of INR 261.2 million from revaluation reserve was primarily in the nature of contra adjustment in the Profit & Loss account and not a case of effective credit in the Profit & Loss account as contemplated in clause (i) of Explanation of section 11 5JB(2).
• The credit in the Profit & Loss account implies that the Profit & Loss account per se has been effectively credited by the said amount. As per accounting principles, the contra adjustment does not at all affect any particular account to which it has been carried.
• Had the taxpayer deducted the full depreciation from the profit before depreciation during the AY 2001-02, it would have shown a loss and in which event it could not have paid a dividend. The taxpayer had credited the amount to the extent of the additional depreciation from the revaluation reserve to present a more healthy balance sheet to its shareholders. It is precisely to tax these kinds of companies that Minimum Alternate Tax (“MAT”) provisions had been introduced. The object of MAT provisions is to bring out the real profits of the companies.
• Neither the amount of INR 2885.8 million nor INR 261.2 million had ever increased the book profits in the AY 2000-01. Thus, when such amount has not increased the book profits at the time of creation of reserve, there is no question of reducing the amount transferred from such revaluation reserve to the Profit & Loss account.
• Accordingly, the reduction sought by the taxpayer under clause (i) of Explanation of section 11 5JB(2) in respect of the adjustment of the revaluation reserve from the depreciation allowance was not permissible.
Conclusion :- The above ruling lays down that the amount withdrawn from revaluation reserve and credited to the Profit & Loss account cannot be reduced from book profit if such amount had not increased the book profit at the time of creation of reserve.
