We have made a capital profit of Rs. 10 crores from sale of our property. We have been advised that the profits being capital in nature can be directly credited to the capital reserves account in the balance sheet and need not be routed through the P & L A/c. As the profits are not a part of the P&L A/c, can we avoid paying MAT book profits u/s 115JB?
Provisions of the Income-tax Act:
S. 115JB reads as follows:
115JB. (1) Notwithstanding anything contained in any other provision of this Act, where in the case of an assessee, being a company, the income-tax, payable on the total income as computed under this Act in respect of any previous year relevant to the assessment year commencing on or after the 1st day of April, 2007, is less than ten per cent of its book profit, such book profit shall be deemed to be the total income of the assessee and the tax payable by the assessee on such total income shall be the amount of income-tax at the rate of [ten per cent.
(2) Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act, 1956 (1 of 1956) :
Explanation [1].For the purposes of this section, book profit means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by ….
As is evident, the moot question is whether Parts II and III of Schedule VI to the Companies Act permit the exclusion of capital profits from the Profit & loss account. In other words, can a P&L Account drawn up without considering the capital profits be said to be “in accordance with the provisions of Parts II and III of Schedule VI to the Companies Act”?
Part II and Part III of Schedule VI to the Companies Act read as under:
PART II
REQUIREMENTS AS TO PROFIT AND LOSS ACCOUNT
1. The provisions of this Part shall apply to the income and expenditure account referred to in sub-section (2) of section 210 of the Act, in like manner as they apply to a profit and loss account, but subject to the modification of references as specified in that subsection.
2. The profit and loss account—
(a) shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account; and
(b) shall disclose every material feature, including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature.
3. The profit and loss account shall set out the various items relating to the income and expenditure of the company arranged under the most convenient heads; and in particular, shall disclose the following information in respect of the period covered by the account:
(i) ….
(ii) ….
(xi) (a) The amount of income from investments, distinguishing between trade investments and other investments.
(b) Other income by way of interest, specifying the nature of the income.
(c) The amount of income-tax deducted if the gross income is stated under sub-paragraphs (a) and (b) above.
(xii) (a) Profits or losses on investments showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm to the extent not adjusted from any previous provision or reserve.
Note: Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account.
(b) Profits or losses in respect of transactions of a kind, not usually undertaken by the company or undertaken in circumstances of an exceptional or non-recurring nature, if material in amount.
(c) Miscellaneous income.
(xiii) (a) ….
(b) ….
(xiv) ….
(xv) ….
As is evident from the above, the Profit and Loss A/c. of a company has to disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature. Further the company is also required to set out the various items relating to the income and expenditure of the company arranged under most convenient heads and disclosing profit or loss in respect of transactions of a kind not usually undertaken by the company or undertaken in circumstances of exceptional or non-recurring nature if material in amount.
Judgements:
This issue whether capital gains had to be included in book profits arose before the Bombay High Court in Veekaylal Investment Co 249 ITR 597. The Court held that if for computing the total income under the normal provisions, the capital gains computed u/s 45 hasd to be taken into account, it was not understood how in computing the book profits u/s 115J, the assessee could exclude capital gains. It was noted that under clause (2) of Part II of Schedule VI to the Companies Act where a Company receives the amount on account of surrender of leasehold rights, the Company is bound to disclose in the profit and loss account the said amount as non-recurring transaction or a transaction of an exceptional nature Irrespective of its nature i.e. whether capital or revenue and that it would be inappropriate to directly transfer such amount to capital reserve [see Companies Act by A. Ramaiya, page 1669 [Fourteenth Edition). It was also held that such receipts were covered by clause 2(b) of Part II of Schedule VI of the Companies Act which states that the profit and loss account shall disclose every material feature including credits or receipts and debits or expenses in respect of non-recurring transactions or transactions of an exceptional nature. It was also held that the reference in clause 3(xii)(b) to profits or losses in respect of transactions not usually undertaken by the Company or undertaken in circumstances of exceptional or non-recurring nature showed clearly that capital gains should be included for the purposes of computing book profits. It was noted that capital gains would certainly be one of the various items whose information was required to be given to the share holders under the said clause 3(xii)(b). So also, the disclosure was required to be made in respect of Investment in the capital of a partnership firm if the Company was a partner on the date of the balance sheet (page 1651 of the Companies Act by A. Ramaiya [Fourteenth Edition). Similarly, profits or losses on such investments are also required to be disclosed, (see clause 3(xii)(a) of Part II of Schedule VI of the Companies Act.
In Apollo Tyres Ltd 255 ITR 273 the Supreme Court held that the words “in accordance with the provisions of parts II and III of Schedule VI to the Companies Act” was made for the purpose of empowering the assessing authority to rely upon the authentic statements of accounts of the Company. It was held that while so looking into the accounts of the Company, the AO has to accept the authenticity of the accounts with reference to the provisions of the Companies Act which obligates the Company to maintain its accounts in a manner provided by the Companies Act and the same to be scrutinized and certified by the statutory auditors and will have to be approved by the Company in its General meeting and thereafter to be filed before the Registrar of Companies who has a statutory obligation also to examine and satisfy that the accounts of the Company are maintained in accordance with the requirement s of the Companies Act. It was held that if these procedures were complied with, it was not open to the AO to rescrutinize this account and satisfy himself that these accounts have been maintained in accordance with the provisions of the Companies Act. The same view was reiterated in Malayala Manorama 300 ITR 251 (SC).
This principle was applied by the Mumbai Bench of the Tribunal in DCIT vs. Bombay Diamond Co 33 DTR 59. Here, the assessee earned a capital profit of Rs. 10.38 crores on sale of rights to immovable property which was directly credited to the capital reserves in the balance sheet instead of being routed through the Profit & loss account. The accounts of the assessee company were duly certified by the auditors and were also adopted in the AGM. The audited accounts were filed with ROC. In the computation of “book profits” for s. 115JB, the said capital profits were not included. The AO took the view that by not crediting the capital profit to the P&L A/c, the assessee had contravened sub-clause (xi)(a) of clause (3) of Part II of the Schedule VI to the Companies Act and that he was, therefore, entitled to add the capital profit to the “book profit”. On appeal, the CIT (A) reversed the AO on the ground that the AO had no jurisdiction to go beyond the net profit shown in the P&L A/c except to the extent provided in the Explanation to s. 115JB. On appeal by the Revenue, the Tribunal upheld the stand of the AO on the ground that as the assessee had not routed the capital profits through the Profit and Loss A/c and directly credited it to the Balance Sheet, its accounts were not prepared in the manner provided in Part II and Part III of Schedule VI to the Companies Act. It was held that the fact that the auditors had certified the accounts was not relevant. The tribunal distinguished the judgements in Apollo Tyres Ltd 265 ITR 273 and Kinetic Motor Co. Ltd 262 ITR 340 on the ground that as the assessee had bypassed the provisions of Schedule VI and directly credited the capital profit to the reserve account, these judgements did not apply and the AO had the power to rework the book profit.
Update: 2nd July 2010: In Rain Commodities vs. DCIT the ITAT Hyderabad Special Bench has held that capital gains exempt u/s 47(iv) cannot be excluded from the “book profit” because no such exclusion was permitted under the Explanation to s. 115JB. The decision in Bombay Diamond Co 33 DTR 59 was referred to with approval.
Conclusion:
Even if capital profits are credited to the capital reserves a/c in the balance sheet, they have to be added to the “book profits” for purposes of s. 115JB.
CAclubindia
