Case Law Details

Case Name : The ITO Ward -6(3)(1) Vs M/s. Galaxy Saws P. Ltd (ITAT Mumbai)
Appeal Number : ITA No. 3747/M/2010
Date of Judgement/Order : 11/03/2011
Related Assessment Year : 2005- 06

Revaluation reserve not routed through Profit and Loss Account could not be added to net profit while computing the book profit for the purpose of MAT

Recently, the Mumbai bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of ITO v. Galaxy Saws P. Ltd. (ITA No. 3747/M/2010) (Judgement Date: 11 March 2011, Assessment Year: 2005-06) held that revaluation reserve not routed through Profit & Loss Account but directly transferred to balance sheet could not be added to net profit while computing the book profit for the purpose of Minimum Alternate Tax (MAT). Further, the Tribunal reiterated that principle that once the accounts have been prepared as per the provisions Schedule VI of the Companies Act and adopted at the Annual General Meeting (AGM) of the company, the net profit disclosed in such accounts cannot be tinkered with by the Assessing Officer (AO) while computing the book profit.

Facts of the case

The taxpayer during the Assessment Year (AY) 2005-06 sold its premises for INR 96 lacs. The value of the premises in the books of account at the beginning of the year was shown at INR 3.3 lacs. Before the sale of premises, the taxpayer got the premises revalued at INR 97.44 lacs by a registered valuer. The taxpayer had taken the revaluation reserve directly to the balance sheet and the loss of INR 1.44 lacs was debited to profit and loss account.

The AO observed that the taxpayer had adopted a device to avoid tax by revaluing the property in the year of transfer and such device was not permitted in view of the judgment of Supreme Court in case of Mcdowell & Co v. CTO [1985] 154 ITR 148 (SC) AO also referred to Bombay High Court’s judgement in case of CIT v. Veekaylal Investment Pvt. Ltd. [2001] 249 ITR 597 (Bom)

The AO also noted that under the MAT provisions  , the net profit had to be increased by the amounts carried to any reserve by whatever name called and therefore the reserve was required to be added while computing book profit.

Tax department’s contentions

  • Tribunal’s decision in the case of the sister concern of the taxpayer, had not considered the decision of Supreme Court in case of Mcdowel & Co. whereas in taxpayer’s case the AO had denied the claim following the said decision.
  • Reliance was also placed on the judgment of Karnataka High Court in case of CIT v. Brindavan Beverages Ltd. [2011] 321 ITR 197 (Kar).
  • The taxpayer had revalued the asset in the year of sale of the property only to avoid tax and such device has to be discouraged. Reference was also made to the Supreme Court decision in the case of Motibhai Phulabhai Patel and Co. (AIR 1970 SC 829) in which it was observed that no rule of law should be interpreted so as to permit or encourage its circumvention.
  • The taxpayer had revalued only the immovable property and not other assets which indicated that the taxpayer used it as a device to avoid tax which should not  be permitted.

Taxpayer’s contentions

  • The taxpayer contended that the issue was covered in its favour by the Tribunal’s decision in case of Galaxy Knives Pvt. Ltd. who was a sister concern and also a co-owner of the same property. In that case also in respect of transfer of the same property the sister concern had shown notional loss of INR 1.93 lacs but the AO had made adjustments to the book profit for the same reasons as in the present case. The Tribunal however following judgment of the Supreme Court in case of  Apollo Tyres v. CIT [2002] 255 ITR 273 (SC) had allowed the sister concern’s claim.
  • The taxpayer referred Section 21 1(3A) of the Companies Act which provides that while preparing accounts, accounting standards have to be followed. Accordingly, reference was made to Para 13.7 of Accounting Standard (AS) 10 in which it is mentioned that any increase in net book value on account of revaluation has to be taken into capital account as revaluation reserve and is not available for distribution. Therefore, revaluation reserve was correctly taken to the balance sheet and there were no provisions for making any adjustments on account of such reserve which had not been routed through profit and loss account.
  • The provisions of clause (iia) of the Explanation to section 11 5JB(2) of the Act provide for reduction of book profit by the amount of depreciation debited to the profit and loss account excluding the depreciation on account of revaluation of assets. But there is no corresponding provisions in relation to the addition to the book profit on account of revaluation of assets which clearly showed that the legislature had consciously not made any provision for any adjustment on account of revaluation reserve taken to the balance sheet.
  • Reference was made to Para 13.5 of AS-10 which states that while making a revaluation the whole class of assets in a unit should be considered and not selective assets. The taxpayer contended that it had only one immovable property which had been revalued and therefore the whole class of asset being the immovable property was revalued in terms of AS- 10 and therefore there was no violation of any provisions.
  • The taxpayer further contended that the judgment of High Court of Karnataka in case of Brindavan Beverages Ltd. was distinguishable on facts.

Tribunal’s ruling

  • The book profit under the provisions of section 11 5JB of the Act has to be computed on the basis of net profit disclosed as per the profit and loss account prepared under the provisions of Part-II and Part-III of the Schedule VI of the Companies Act. Once the accounts have been prepared in the manner aforesaid and adopted at the AGM of the company, the net profit disclosed in such accounts cannot be tinkered with by the AO while computing the book profit.
  • The AO can only make adjustments specified as per Explanation 1 to section 11 5JB(2) of the Act. This proposition of law is settled by the judgment of Supreme Court in case of Apollo Tyres Ltd.
  • In case of Veekaylal Investment Co. Ltd. which was relied on by the tax department, the capital gain had been credited to the profit and loss account which is not so in the present case and therefore the judgment is distinguishable on the basis of facts.+ In the case of Brindavan Beverages Ltd which was also relied on by the tax department, the Karnataka High Court held that the AO could apply the provisions of Explanation 1 to section 11 5JB(2) and remanded the matter back to the AO. It was nowhere held that the gain arising from the sale of the plant had to be added to the book profit.
  • Para 13.7 of AS -10 provides that any increase in net book value on account revaluation has to be taken to the capital account as revaluation reserve and is not available for distribution. The taxpayer has thus taken the revaluation reserve directly to the balance sheet in conformity with the accounting standard.
  • Para 13.5 of AS-10 provides that while making revaluation whole class of assets in a unit should be taken up and not on selective basis. The taxpayer has only one immovable property which had been revalued and therefore entire class of immovable properties got revalued without violating the provisions. Therefore revaluation cannot be considered as a color able device.
  • As per Explanation 1 to section 11 5JB(2) of the Act, the amount carried to any reserve by whatever name called has to be added to the net profit if the amount had been debited to the profit and loss account. In this case the revaluation reserve had been directly taken to the balance sheet and not debited to the profit and loss account and therefore the amount could not be added under clause (b) of Explanation 1 to section 1 15JB(2).
  • Clause (iia) was inserted to the Explanation 1 to Section 11 5JB of the Act with effect from 1 April 2007 in which it was provided that amount of depreciation debited to the profit and loss account excluding the depreciation on account of revaluation of assets has to be reduced from the net profit. However similar provisions were not inserted for addition of revaluation reserve to the net profit even if the same was not debited to the profit and loss account. This shows that the legislature had consciously not made any provision for addition on account of revaluation reserve taken to the balance sheet.
  • Accordingly, the Tribunal held that that no addition could be made to the net profit on account of revaluation reserve directly taken to the balance sheet while computing the book profit.

Our Comments

This is a welcome ruling by the Mumbai Tribunal in which it is held that that revaluation reserve not routed through Profit & Loss Account but directly transferred to balance sheet could not be added to net profit while computing the book profit for the purpose of MAT.

The Tribunal has also reiterated that principle that once the accounts have been prepared as per the provisions Schedule VI of the Companies Act, the net profit disclosed in such accounts cannot be tinkered with by the AO while computing the book profit.

The Tribunal has also examined AS-10 and identified conditions on which revaluation of assets could be carried out and concluded that all the conditions pertaining to revaluation were rightly observed by the taxpayer.

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