Gain on transfer of capital assets to wholly own subsidiary is not INCOME at all in Income Tax Act. Hence, even MAT is not applicable

Brief of the case-  In the case of Venture Pvt.Ltd vs. DCIT,  ITAT Mumbai has held that (1) the Net profit shown in the Profit and loss account should be adjusted with the items given in Notes to accounts, meaning thereby, the profits arising on sale of capital asset to its wholly owned subsidiary company should be excluded from the Net profit. Profits arising on sale of capital asset to its wholly owned subsidiary company does not fall under the definition of “income” at all and since it does not enter into the computation provisions at all, there is no question of including the same in the Book Profit as per the scheme of the provisions of sec. 115JB of the Act.

Facts of the case

1. Assessee company is engaged in the business of Development and leasing of Commercial Complexes and Rehabilitation of buildings under Slum Rehabilitation Scheme. The assessee company also owns a wholly owned Indian subsidiary company named “SVI Realtors Private Limited”. The assessee company held a parcel of land admeasuring about 61,506/- sq.mtr., as its capital asset and the said land was attached with development rights/FSI. The assessee transferred development rights/FSI of 55,464.04 sq.mtr which was available on a portion of above said land, i.e., on a land admeasuring 19,423 sq.mts (out of 61506 sq.mt) to its wholly owned Indian subsidiary company viz., SVI Realtors Pvt Ltd (referred above).

2. The above said transfer generated Long Term Capital Gain (LTCG) of 300.68 crores. The assessee disclosed the same as “Extra Ordinary Income” in the profit and loss account. Under the provisions of sec. 47(iv) of the Act, the transfer of a capital asset by a company to its wholly owned Indian subsidiary company (subject to certain conditions) is not regarded as “transfer” and hence the Capital gain arising on such transfer is not chargeable to tax u/s 45 of the Act.

3. The assessee had earned dividend income of Rs.3,49,66,452/- and claimed the same as exempt. It also disallowed a sum of Rs.60,01,613/- as per the provisions of sec. 14A of the Act.

4. The assessee is a company, the provisions of sec. 115JB are applicable to it. The assessee did not offer the above said amount of Rs.300.68 crores while computing the “book profit” u/s 115JB of the Act by attaching following Notes to its accounts:-

“During the year the company has derived a surplus over cost of acquisition of assets held by it as CWIP amounting Rs.300.24 crores. In view of the fact that it is a capital receipt and a transaction is not regarded as a transfer under the Income-Tax Act, the company interprets that since it is not being in the nature of income it does not came within purview of Section 115JB.

The company interpretation on the matter of applicability to minimum alternative tax on such book profits is also supported by opinion of the experts which were taken on the issue.”

5. The AO did not agree with the contentions of the assessee and accordingly, he included the above said amount as part of “net profit” for the purpose of computing the “book profit” under the provisions of section 115JB of the Act. The AO further noticed that the disallowance worked out by the assessee is not in accordance with the provisions of Rule 8D of the I.T Rules. Hence the AO computed the disallowance in accordance with the provisions of Rule 8D at Rs.96,42,062/- and accordingly disallowed the same.

6. Aggrieved by the action of AO, assessee preferred before CIT(A) and held that an identical issue was considered by the Hyderabad Bench of the Tribunal in the case of Rain Commodities Ltd V/s DCIT (2010) (40 SOT 265; 131 TTJ 514). In the above said case also, the assessee therein generated a gain of Rs. 99.42 crores on transfer of assets to its 100% subsidiary company and claimed that the same was exempt under the provisions of sec. 47(iv) of the Act. The Special bench took the view that the same cannot be excluded from the Net profit, since the Explanation to section 115JB does not specifically provide for exclusion of income covered by sec. 47(iv) of the Act, while computing the book profit and . Accordingly, the Ld CIT(A) upheld the order of the AO by following the above said decision rendered by the Special Bench. And for disallowance of 14A Before Ld CIT(A), the assessee contended that the disallowance worked out by the AO was on the higher side and accordingly pleaded that the disallowance made by it in the return of income should be upheld. The assessee also submitted that the average value of investments worked out by the AO was not correct. The Ld CIT(A), however, did not agree with the contentions of the assessee, but directed the AO to re-work the disallowance by adopting correct amount of average value of investments.

Aggrieved against the order of CIT(A) , the assessee has filed an appeal before ITAT

Issue

1. Whether the profit arising on transfer of development rights to the fully owned subsidiary company is required to be included in the book profit u/s 115JB of the Income Tax Act, 1961(the Act) or not; and

2. Whether the disallowance made by the AO u/s 14A is to be sustained or not.

Assessee’s contention

1. That the Special bench has specifically observed that the capital gains arising in the hands of assessee therein has been included in the profit and loss account and it has further been accepted that the accounts have been prepared in accordance with the provisions of Part II and Part III of Schedule VI to the Companies Act. He submitted that the Special bench has specifically observed that the assessee before it did not clarify anything about the same in the Notes to accounts. He submitted that the Special bench, based on the above said facts, held that the profit arising on transfer of capital assets to a wholly owned Indian subsidiary company cannot be excluded while computing book profit.

2. the assessee before the Special Bench did not comment about such (which in the instant case has commented) inclusion in the Notes of accounts, but claimed deduction only at the time of computing “Book Profit” u/s 115JB of the Act, the Special Bench took the view that the assessee, having included the capital gain in the Profit and Loss account which was agreed to have been prepared in accordance with Parts II and III of the Schedule VI to the Companies Act, cannot claim that the same should be excluded from net profit for the purpose of computing book profit u/s 115JB of the Act.

3. that the assessee herein has taken a specific stand that the impugned profit is not includible in the net profit for the purposes of sec. 115JB of the Act and accordingly attached a specific

4. note in the “Notes to accounts” clearly stating that the gains arising on transfer of assets to the subsidiary company is not includible in the book profit and further the said interpretation is supported by the opinion of experts. that the Notes forming the part of accounts should also be read along with the profit and loss account and hence expression “net profit as shown in the profit and loss account” used in the section 115JB is required to be understood by giving due effect to the items stated in Notes to accounts accompanying annual accounts and having effect over the net profit, i.e., the Profit and loss account should be read along with the Notes to accounts. For this proposition, the ld.AR placed reliance on the following case law:

a) CIT V/s Sain Processing & Wvg. Mills (P.) Ltd. (2010) 325 ITR 565 (Delhi)

b) K.K. Nag Ltd. V/s Additional Commissioner of Income-tax [2012] 52 SOT 381 (Pune).

5. That transfer of a capital asset by a holding company to its wholly owned Indian subsidiary company is not regarded as “transfer” under sec. 47 of the Act and hence the profits or gains arising from such transfer is not chargeable to tax under the head “Capital gains” in terms of provisions of sec. 45. Hence the profits or gains so generated shall not fall within the definition of “income” at all as per the definition of the term “Income” given in sec. 2(24) of the Act. In view of the above said provisions, such profit is not includible in computing the total income under the normal provisions of the Act.

6. Since the profits arising on transfer of a capital asset to a wholly owned Indian subsidiary company is not treated as “income” at all under the provisions of the Act, the Ld A.R submitted that the same falls outside the computation provisions of the Income tax Act and hence such profit should not be included while computing Book Profit under sec. 115JB of the Act also.

Regarding disallowance u/s 14A

That the assessee is possessing sufficient amount of interest free funds, which is far in excess of the investments and hence it cannot be presumed that the assessee has used interest bearing funds for making investments. That interest bearing funds have been utilized for specific purposes. Accordingly, there was no requirement of making any disallowance out of interest expenditure. That the AO had adopted incorrect figure of average value of investments and hence the Ld CIT(A) has restored the matter to the file of the AO.

Revenue’s Contention

1. that the provisions of sec. 115JB is a self contained code and hence only those items prescribed under that section can alone be added or excluded from the Net Profit disclosed in the Profit and Loss account. He further submitted that the assessee has credited the Profit and Loss account with the profit or gains arising on transfer of capital assets to its subsidiary company and hence the same forms part of the Net profit.

2. that the assessee has prepared the Profit and Loss account in accordance with Part II and Part III of Schedule VI to the Companies Act. The Ld D.R submitted that the provisions of sec. 115JB do not provide for the exclusion of gain arising on transfer of asset to its subsidiary. He submitted that the identical issue was considered by the Special bench in the case of Rain Commodities Ltd (supra) and the Special bench of Tribunal has held that such kind of profit cannot be excluded while computing “Book Profit”.

Regarding disallowance u/s 14A

The Ld D.R submitted that the Ld CIT(A) has upheld the disallowance, in principle, but set aside the matter to correct the clerical mistakes.

Tribunal decision / observations

1. In the case before Hon’ble Delhi High Court (Sain Processing & Weaving Mills (P) Ltd), the assessee therein issue did not charge depreciation to the Profit & Loss account, but disclosed the same in the Notes forming part of accounts. However, while computing book profit u/s 115J of the Act, it claimed the amount of depreciation as deduction from the Net profit disclosed in the Profit and loss account. The Hon’ble High Court considered the aforesaid aspect of the controversy in the following words:-

According to us, once this information is disclosed in the notes to the accounts it would clearly fall within the ambit of the Explanation to section 115J of the Act which defines “book profit” to mean “net profit as shown in the profit and loss account for the relevant assessment year”.

To our minds, as long as the depreciation which is not charged to the profit and loss account but is otherwise disclosed in the notes of the accounts, it would come within the ambit of the expression “shown” in the profit and loss account, as notes to accounts form part of the profit and loss account by virtue of subsection (6) of section 211 of the Companies Act, 1956. This is quite evident if the provisions of sub-section (6) of section 211 of the Companies Act, are read in conjunction with sub section (1A) as well as the Explanation to section 115J of the Act”.

2. The decision rendered by Hon’ble Delhi High Court, cited above, was followed by the Pune “A” Bench of the Tribunal in the case of K.K. Nag Ltd Vs. Addl CIT (2012)(52 SOT 381). In this case, the incremental liability towards leave encashment was not debited to Profit and Loss account, but otherwise disclosed in Notes to Accounts. The Tribunal held that the said liability would have to be deducted while determining “Book Profits” under section 115JB of the Act.

3. We notice that an identical issue was considered by the Visakhapatnam bench of ITAT also in the case of Hindustan Shipyard Ltd Vs. DCIT (6 ITR (Trib) 407). In this case The Tribunal, after considering the decision of Hon’ble Delhi High Court in the case of CIT Vs. Sain Processing Mills (P) Ltd. (2010)(325 ITR 565), held that the Assessing Officer is entitled to include the waiver benefit that was disclosed in the notes on accounts.

4. in the decision given by Hon’ble Delhi High Court (supra and also other two decisions rendered by the Tribunal (supra), it has been held that the notes given in the Notes forming part of accounts have to be read along with the Profit and Loss account, meaning thereby the items having effect over the Net profit shown in the Profit and Loss account, but otherwise disclosed in the Notes to accounts should be adjusted to the said Net profit. Such kind of adjustment is held to be falling “within the ambit of the expression ‘shown’ in the profit and loss account”. The ratio of these decisions is that the expression “net profit as shown in the profit and loss account” should not be understood as the net profit disclosed in the profit and loss account, but the net profit adjusted to the effects of notes given in the Notes forming part of accounts.

5. In the case of Sain Processing Mills (P) Ltd (supra) and other two decisions rendered by the Tribunal (supra), the items not disclosed in the Profit and Loss account, but disclosed in the Notes forming part of accounts was held to be adjusted while arriving at Net profit. However, in the instant case, the assessee has disclosed an item of income in the Profit and Loss account, but claims that the same should be excluded by referring to the Notes to accounts. we are of the view that the ratio of the decisions rendered in aforesaid cases should be applied in the instant case also. This factual aspect distinguishes the instant case against the facts available in the case of Rain commodities Ltd, which was decided by the Special bench. Accordingly, we are of the view that the ratio of Special bench decision cannot be applied straingly in the instant case and hence we are unable to agree with the decision rendered by Ld CIT(A).

6. A decision rendered by the co-ordinate Mumbai bench and which stands approved by Hon’ble Bombay High Court. In the case of ACIT Vs. Akshay Textiles Tdg & Agencies P Ltd (ITA No.1139/M/2002 dated 28-06-2005), the assessee earned capital gains and the same was directly credited to Capital reserve account, i.e., it was not credited to the Profit and Loss account. The said method of accounting was approved in the Annual General Meeting. The AO sought to bring the above said Capital gain within the ambit of “Book Profit”, since it was not credited to the Profit and Loss account. The Tribunal rejected the said action of the AO. The Hon’ble Bombay High Court also upheld the order of the Tribunal in its order reported in (2008)(304 ITR 401). The said decision was later followed by the Tribunal in a group of cases, viz., DCIT Vs. M/s Arundhati Traders Pvt Ltd and others (ITA No.6293/Mum/2006 and others dated 02-12-2009). In all these cases, there is no mention about the notes, if any, given in the Notes to accounts with regard to the method of accounting followed by these assessees. Hence, the assessing officer was held to be not justified in including the income that was directly credited to Capital reserve account in the Book Profits.

7. Hence, the Net profit shown in the Profit and Loss account should be understood as the net profit arrived at after giving to the effect of notes, if any, given in Notes to Accounts.

8. Regarding 2nd contention as raised by assessee that profit earned on sale of capital against is not a income income at all under IT Act. It is pertinent to note that the provisions of sec. 10 lists out various types of income, which do not form part of Total income. All those items of receipts shall otherwise fall under the definition of the term “income” as defined in sec. 2(24) of the Act, but they are not included in total income in view of the provisions of sec. 10 of the Act. Since they are considered as “incomes not included in total income” for some policy reasons, the legislature, in its wisdom, has decided not to subject them to tax u/s 115JB of the Act also, except otherwise specifically provided for.

9. The logic of these provisions, in our view, is that an item of receipt which falls under the definition of “income”, are excluded for the purpose of computing “Book Profit”, since the said receipts are exempted u/s 10 of the Act while computing total income. Thus, it is seen that the legislature seeks to maintain parity between the computation of “total income” and “book profit”, in respect of exempted category of income. If the said logic is extended further, an item of receipt which does not fall under the definition of “income” at all and hence falls outside the purview of the computation provisions of Income tax Act, cannot also be included in “book profit” u/s 115JB of the Act.

10. A careful perusal of the decision rendered by the Special bench in the case of Rain Commoditites Ltd (supra) would show that the above said legal contentions were not considered by the Special bench. We notice that the Special bench considered the following decisions:-

(a) Malayala Manorama Co. Ltd Vs. CIT (2008)(300 ITR 251)(SC)

(b) N.J. Jose & Co. (P) Ltd (321 ITR 132)(Ker)

(c) CIT Vs. Veekaylal Investment Co. (P) Ltd (249 ITR 597)(Bom)

In all these cases, the Courts were dealing with the issue of inclusion of Capital gains in the computation of “Book Profits”, but such capital gains were otherwise chargeable to capital gain tax u/s 45 of the Act under the normal provisions of the Act. However, here is the case that the profits and gains arising on transfer of capital is not falling under the definition of “transfer” and hence under the definition of “Capital gains chargeable u/s 45” and consequently, the same does not fall within the purview of the definition of “income” given u/s 2(24) of the Act.

11. we find merit in the contentions of the assessee that the profit arising on transfer of capital asset to its wholly owned Indian subsidiary company is liable to be excluded from the Net profit., i.e., the Net profit disclosed in the Profit and Loss account should be reduced by the amount of profit arising on transfer of capital asset and the amount so arrived at shall be taken as “Net profit as shown in the profit and loss account” for the purpose of computation of book profit under Explanation 1 to sec. 115JB of the Act. Alternatively, since the said profit does not fall under the definition of “income” at all and since it does not enter into the computation provisions at all, there is no question of including the same in the Book Profit as per the scheme of the provisions of sec. 115JB of the Act.

Regarding disallowance u/s 14A

Before us, the ld A.R has contended that the interest free funds available with the assessee is sufficient to cover the value of investments and it was further submitted that the interest bearing funds were used for specific purposes. Accordingly, it was contended that there was not requirement of making any disallowance out of interest expenditure. Since this aspect has not been examined, we are of the view that this issue requires fresh examination.   Accordingly, we set aside the order of Ld CIT(A) on this issue and restore the same to the file of the AO with the direction to examine this issue afresh by duly considering all the contentions of the assessee, including the contention with regard to the availability of interest free funds and the average value of investments, and take appropriate decision in accordance with the law.