AO cannot make changes in accounts certified under Companies Act for Computing book profit

Brief of the Case: In the cited case, ITAT held that the Assessing Officer does not have power to embark upon the fresh enquiry with regard to the entries made in the books of accounts of the Company when the accounts of an assessee Company is prepared in terms of Part II Schedule VI of the Companies Act scrutinized and certified by the statutory auditors, approved by the Company in general meeting and thereafter filed before the Registrar of Companies who has a statutory obligation also to examine and be satisfied that the accounts of the company are maintained in accordance with the requirements of the Companies Act.

Facts of the Case: The first dispute was relating to adjustment made by AO in computation of book profit under section 115JB. Under the provisions of section 115JB, in case, total income computed under normal provisions of the IT Act is less than certain percentage of book profit, the book profit is deemed to be total income of the assessee on which tax is payable on a specified rate. The book profit under the said provisions is computed on the basis of profit shown in the P&L Account prepared in accordance with provisions of Part-II and Part–III of Schedule-VI of Companies Act to which certain adjustments as provided in the Explanation-1 to Section 115JB(2) are required to be made.

The AO noted that the assessee had earned gross profit of Rs.1,68,95,500/- from sale of its rights in the immovable property which had not been shown in the P&L Account but had been taken directly to the balance sheet. AO referred to the sub-clause (xi) of clause-3 of Part-II of Schedule-VI as per which the assessee is required to show the amount of income earned from investment in the P/L Account, distinguishing between trade investments and other investments. It was thus mandatory for the company to show profit/loss on sale of assets in the P&L Account which had not been done. The AO thus concluded that the P/L account had not been prepared in accordance with Part-II and Part-III of Schedule-VI of the Companies Act. AO referred to the decision of the Tribunal in the case of M/s. Bombay Diamonds Co. P. Ltd. in ITA No.7488/Mum/07 in which it was held that the AO had power to re-work the book profit by re-casting the P/L account in the manner provided in Part-II and Part-III of Schedule-VI of the Companies Act. The AO, therefore, re-worked the book profit in which addition on account of sale of investment was made and tax computed accordingly.

The second dispute was regarding disallowance of expenses under section 14A of the IT Act in relation to income exempt from tax. The AO noted that the assessee had earned tax free dividend income of Rs.1,56,408/-. The AO therefore, allocated expenses relating to exempt income on proportionate basis and disallowed a sum of Rs.8,02,702/-.

On appeal by the Assessee, CIT (A) confirmed the adjustment made by AO to the book profit and directed the AO to re-compute the disallowance as per Rule-8D of Income tax Rules.

On aggrieved, the assessee filed appeal before the ITAT. The assessee in this appeal has raised disputes on two different grounds which relate to 1) adjustment made under section 115JB of the Income tax Act, 1961 and 2) disallowance of expenses under section 14A of the IT Act.

Contention of the Assessee: 1) Assessee submitted that the issue was covered in favour of the assessee by the judgment of the Hon’ble Supreme Court in the case of Apollo Tyres Ltd. vs. CIT (255 ITR 273) in which it was held that once accounts prepared as per Companies Act are verified by the authorities under Companies Act, it is not open to the AO to make changes in the accounts so prepared for the computation of book profit. Assessee also referred to the judgment of Hon’ble High Court of Bombay in case of CIT vs. Akshay Textiles Trading And Agencies P. Ltd. (304 ITR 401) and the judgment of same High court in case of CIT vs. Adbhut Trading Co. P. Ltd. (338 ITR 94) in which the Hon’ble High Court following the judgment of Hon’ble Supreme Court in the case of Apollo Tyres Ltd. (supra), held that the accounts prepared under the Companies Act and certified by the authorities under the said Act have to be accepted. It was accordingly urged that the adjustment made by the AO on account of profit from sale of investment was not justified.

Contention of the Revenue: 1) Revenue submitted that the specific issue as to whether capital gain not routed by the assessee through P&L Account prepared under the Companies Act can be added to the book profit had been considered by the Hon’ble High Court of Bombay in the case of CIT vs. Veekaylal Investment Co. P. Ltd. (249 ITR 597) and it was held that the adjustment by the AO was correct. It was argued that it was within the power of AO to go into the accounts prepared by the assessee under the Companies Act and re-cast the accounts in case the same was not prepared correctly. Revenue placed reliance on the decision of the Tribunal in the case of Sumer Builders (P) Ltd. (50 SOT 198) in which the Tribunal after considering the judgment of the Hon’ble Supreme Court in case of Apollo Tyres (supra) and the judgment of Hon’ble High Court of Bombay in case of CIT vs. Akshay Textiles Trading And Agencies P. Ltd. (supra), had upheld the adjustment made by the AO on account of profit from sale of investments. He also referred to the decision of the Mumbai Bench of the Tribunal in the case of Kopran Pharmaceuticals Ltd. Vs. DCIT (119 ITD 355) in which the Tribunal after referring to the judgment of Hon’ble Supreme Court in the case of Apollo Tyres (supra), held that the Hon’ble Supreme Court in the said case had laid down the general proposition of law whereas the judgment of the Hon’ble High Court of Bombay in case of Veekaylal Investment Co. P. Ltd. (supra) was specific on the issue of capital gain and, therefore, the judgment of Hon’ble High Court would prevail on the issue.

Held by CIT (A): The CIT (A) 1) confirmed the adjustment made by AO to the book profit and 2) directed the AO to re-compute the disallowance as per Rule-8D of Income tax Rules.

Held by ITAT: ITAT observed that

1) the issue raised has already been considered and decided by the Hon’ble Supreme Court in the case of Apollo Tyres Ltd. vs. CIT(255 ITR 273), wherein it was held that the AO has only the power to examine whether books of account are certified by authorities under the Companies Act as having been properly maintained in accordance with the provisions of the Companies Act. The AO, thereafter, has limited power of making adjustments as provided in Explanation to section 115J.

Therefore, ITAT held that once accounts are prepared under the Companies Act and have been certified by the authorities, the AO cannot tinker with the accounts and make any changes while computing book profit except making adjustments as provided in Explanation to Section 115JB. Therefore, the addition made by AO and confirmed by CIT(A) on account of profit on sale of asset not disclosed in the P&L Account prepared under the Companies Act was accordingly set aside.

2) The second dispute regarding disallowance of expenses relating to exempt income under section 14A of the IT Act; it was observed that under the said provisions, the disallowance of expenses relating to exempt income is required to be computed as per Rule 8D. It was relied on the judgment of the Hon’ble High Court of Bombay in the case of Godrej and Boyce Mfg. Co. vs. DCIT (328 ITR 81) have held that Rule 8D is applicable only from assessment year 2008-09 and in respect of prior years, it was held that disallowance had to be made on a reasonable basis after hearing the assessee. In this case, CIT(A) had directed the AO to make disallowance as per Rule 8D which is not correct. ITAT, therefore, set aside the order of CIT(A) and restore the matter back to CIT(A) for necessary examination in the light of judgment of Hon’ble High Court of Bombay in case of Godrej and Boyce Mfg. Co. vs. DCIT (supra) and for passing a fresh order after affording opportunity of hearing to the assessee .

In the result the appeal of assessee was allowed.