Assessing Officer's Limited Power in Book Profit Computation Upheld

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Case Name:

Sri Hariram Hotels (P) Ltd. Vs Commissioner of Income Tax-III (High Court of Karnataka)

ITA No. 53 of 2009

Date: 16th December 2015

Key Takeaways:

- The AO's power is limited to making specific adjustments as per the explanation to Section 115JB (of Income Tax Act, 1961).

- The court reinforced that the AO cannot conduct a fresh inquiry into the company's certified accounts.

- The judgment aligns with the precedent set by the Supreme Court in Apollo Tyres Ltd. vs Commissioner of Income Tax.

Issue

Should capital gains be included in the book profit for computing tax under Section 115JB (of Income Tax Act, 1961)?

Facts

- SRI HARIRAM HOTELS (P) LTD. was incorporated to run a hotel and purchased land for this purpose.

- The land was later sold, resulting in a capital gain, which the company directly credited to the capital reserve instead of the profit and loss account.

- The AO argued that this capital gain should be included in the profit and loss account for computing book profit under Section 115JB (of Income Tax Act, 1961).

Arguments

- Assessee's Argument: The company maintained its accounts as per the Companies Act, and the AO has no jurisdiction to alter the certified book profits. They relied on the Supreme Court's decision in Apollo Tyres Ltd. vs Commissioner of Income Tax.

- Revenue's Argument: The capital gains should be included in the profit and loss account as per the Companies Act's Schedule VI, and the AO is justified in recomputing the book profit.

Key Legal Precedents

- Apollo Tyres Ltd. vs Commissioner of Income Tax (2002) 255 ITR 273: The Supreme Court held that the AO cannot alter the book profits certified under the Companies Act, except for specific adjustments allowed by the Act.

- C.I.T. Vs. HCL COMNET SYSTEMS AND SERVICES LIMITED (2008) 305 ITR 409: Reinforced the limited power of the AO in adjusting book profits.

Judgement

The court ruled in favor of SRI HARIRAM HOTELS (P) LTD., stating that the AO does not have the power to recompute book profits beyond the specific adjustments allowed under Section 115JB (of Income Tax Act, 1961). The court emphasized reliance on the certified accounts as per the Companies Act.

FAQs

Q1: What was the main legal question in this case?

A1: Whether capital gains should be included in the book profit for tax purposes under Section 115JB (of Income Tax Act, 1961).

Q2: What did the court decide?

A2: The court decided in favor of the assessee, stating that the AO cannot alter the book profits certified under the Companies Act, except for specific adjustments allowed by the Act.

Q3: What precedent did the court rely on?

A3: The court relied on the Supreme Court's decision in Apollo Tyres Ltd. vs Commissioner of Income Tax, which limits the AO's power to adjust book profits.

Q4: What does this mean for companies?

A4: Companies can rely on their certified accounts under the Companies Act for tax purposes, with limited adjustments allowed by the AO under Section 115JB (of Income Tax Act, 1961).

1. This appeal is directed against the order of the Income Tax Appellate Tribunal, Bangalore Bench “A” relating to the assessment year 2003-04.

2. The appeal was admitted to consider the following substantial question of law:

“Whether on the facts and circumstances of the case, the Tribunal is

justified in holding that the income from capital gain should be included for the purpose of computing Book Profit under Section 115JB (of Income Tax Act, 1961)?”

3. Facts in brief are:

The appellant/company was incorporated on 3.2.1992 with an object to commence business of running a hotel. It transpires that for this purpose, it had purchased a land measuring 2 acres 32 guntas at Mahadevapura through public auction from the appropriate authority of the Income Tax Department for Rs.26,60,000/-. The appellant borrowed unsecured loan of Rs.24.00 lakhs from its directors for meeting the purchase consideration of the land. As the Appellant/company could not commence the hotel project in the said land, it was decided to sell the land and the same was sold for Rs.1,22,50,000/- on 23.01.2003. In the books of accounts of the appellant, the loan was capitalized during the financial year ended on 31.03.2003. The appellant created the capital gain of Rs.51,71,820/- arising out of the sale of the land directly to the capital reserve and not to the profit and loss account. The Assessing Officer took the view that the capital gains ought to have been included to the profit and loss account, according to the accounting

standard referred to by him in the assessment order and hence, arrived at a conclusion that the profit shown in the profit and loss account should be increased by the amount of capital gain of Rs.51,71,820/-. The assessee

objected to the inclusion of capital gain to the book profit. However, the Assessing Officer confirmed that the capital gain has to be shown in the profit and loss account, it cannot be straight away credited to the capital reserve.

4. On appeal before the Commissioner of

Income Tax, the appellate authority, following the

judgment of the Bombay High Court in the case of

COMMISSIONER OF INCOME TAX vs VEEKAYLAL

INVESTMENT CO.(P) LTD. ((2001)249 ITR 597 (Bom)

has held that, even under clause 3(xii)(b) of Part II of

Schedule VI to the Companies Act, 1956 (‘Companies

Act’, for short), profit or losses in respect of transactions

of an exceptional or non-recurring nature are to be

disclosed. Thus, held that capital gains should be

included for the purpose of computing book profit. On

further appeal by the assessee before the ITAT, the

Tribunal confirmed the orders passed by the authorities

following the judgment of the Bombay High Court in

Veekaylal’s case (supra) and held that capital gains

should be included for the purpose of computing book

profit. This order passed by the ITAT is challenged in the

present appeal.

5. Learned counsel Sri.S P Bhat appearing along

with Sri C Basavaiah for the appellant submitted that the

authorities under the Income Tax Act,1961 (hereinafter

referred to as the ‘Act’ for brevity) exceeded the

jurisdiction in rescrutinising book profit, declared by the

assessee and approved by the Registrar of Companies.

The Assessing Officer has no power to disturb the profit

shown by the assessee in compliance with the standard

of accounting to be maintained under the Companies

Act. The provisions of Companies Act do not require any

capital gain to be disclosed in the profit and loss account

as a matter of sound accepted accounting practice, the

assessee is entitled to treat the capital gain as a capital

reserve.

The learned counsel would contend that the

purpose of Parts II and III of Schedule VI of the

Companies Act would be only for a limited purpose of

empowering the assessing authority to rely upon the

authentic statements of the account of the company. The

company is obligated to maintain its accounts in the

manner provided by the Companies Act, 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 to examine

and satisfy that the accounts of the company are

maintained in accordance with the requirements of the

Companies Act. In support of this contention, the

learned counsel strongly places reliance on the

Judgment of the Apex Court in APOLLO TYRES LTD. vs

COMMISSIONER OF INCOME TAX (2002) 255 ITR 273.

6. It is vehemently contended that all these

statutory obligations that were required to be followed by

the assessee in accordance with the Companies Act were

followed. The only objection raised by the Income Tax

Authorities was that capital gains cannot be directly

taken into the account of the capital reserve, first, it has

to be included in the profit and loss account for the

purpose of computing book profit under Section 115JB (of Income Tax Act, 1961)

of the Act. The Act provides that income prepared in

accordance with the Companies Act shall be ‘deemed

income’ for the purpose of Section 115JB (of Income Tax Act, 1961).

The Assessing Officer while computing the income under

Section 115JB (of Income Tax Act, 1961) has no power to rescrutinise

the books of accounts certified by the authorities under

the Companies Act. The Authorities as well as the

Tribunal not properly appreciating the Judgment relied

on by the Assessee in the case of Apollo Tyres (supra),

which is subsequent to the Judgment of VEEKAYLAL

(supra), wrongly held that the capital gains should be

included in the profit and loss account for the purpose of

computing book profit.

7. The learned Counsel further places reliance

on the Judgment of the Apex Court in the case of ‘C.I.T.

Vs. HCL COMNET SYSTEMS AND SERVICES LIMITED’

reported in 2008 [305] ITR 409 and the Judgment of

the Calcutta High Court in the case of ‘COMMISSIONER

OF INCOME TAX. WEST BENGAL VS N. GUIN &

COMPANY PVT LTD’ reported in 116 ITR 475.

8. On the other hand, Sri. E.R. Indra Kumar,

learned Senior Counsel assisted by Sri. E.I. Sanmathi

appearing for the Revenue contended that the assessee

has not followed standard accounting system in

maintaining the books of accounts as per the Companies

Act. Clause 3[XII](b) of Part II of Schedule VI to the

Companies Act, contemplates that profit 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 and miscellaneous income as per Clause-

3(XII)(b) & [c] has to be disclosed in the profit and loss

account which is mandatory requirement, as set out in

these provisions under Schedule VI of the Companies

Act, having not been followed, the Income Tax

Authorities are justified in rescrutinizing the book profit

as per Sub-section (2) of Section 115JB (of Income Tax Act, 1961). It is

further contended that the Judgment of Veekaylal

(supra) is squarely applicable to the facts of the case, as

such the authorities are justified in following the said

Judgment, that the capital gains should be included in

the profit and loss account for the purpose of computing

book profit.

9. It is also submitted that the Judgments of the

Apex Court in the case of Apollo Tyres (supra), and HCL

Comnet Systems (supra), clarifies that the Assessing

Officer does not have the jurisdiction to go behind the

net profit shown in the profit and loss account except to

the extent provided in the explanation to Section 115JB (of Income Tax Act, 1961).

Much emphasis is placed on the explanation appended

to section 115JB (of Income Tax Act, 1961) to contend that the Income Tax

Authorities are empowered to increase the net profit as

shown in the profit and loss account prepared under

Sub-section [2] of Section 115JB (of Income Tax Act, 1961) in the case of amounts

carried to any reserves, by whatever name called, as

specified in clause [b] of the said explanation. The

learned senior counsel has filed a memo placing on

record the copy of Directors’ Report to the Members and

the Auditor’s Report and placed reliance on these reports

to substantiate his contention that Clause[d] of the

Auditor’s report specifies that the profit and loss account

and balance sheet referred to in the report complies

substantially in all material respects, except as stated in

Note-B[2] on accounts which refers to transferring of the

capital gain amount of Rs.51,71,819.20/- to capital

reserve account instead of crediting to profit and loss

account. Thus, it is argued that the books of accounts

maintained by the assessee is not as per the standard of

accounting to be maintained in accordance with the

Companies Act as disclosed in the Auditor’s report. In

view of not maintaining the statutory accounts as per the

Companies Act, the Income Tax Authorities have every

right to rescrutinize the net profit as per the book profit.

The Judgment passed by the Tribunal confirming the

orders of the Authorities is in accordance with the

provisions of the Act and the same cannot be faulted

with. As such, he seeks for dismissal of the appeal

answering the question of law in favour of the Revenue.

10. Heard the learned Counsel appearing for the

parties and perused the record.

11. Section 115JB (of Income Tax Act, 1961) during the relevant

period provides that notwithstanding anything contained in

any other provisions of this Act, in the case of an

assessee being a company, the income tax payable on

the total income as computed under the Act is less than

71⁄2% of the book profit, the tax payable for the relevant

previous year shall be deemed to be 71⁄2% of such book

profit. Thus, the assessee has to first compute the total

income in accordance with the Act and if the total income

is less than 71⁄2% of the book profit, then the assessee has to

prepare profit and loss account for the previous year,

then fictionally, it will be deemed that its total income

chargeable to tax would be an amount equal to 71⁄2% of

such book profit. The Income Tax Officer has computed

the book profit and the regular income. As tax on

regular income is more than tax on book profit, tax on

regular income is adopted. The Authorities have

consistently relied upon Clause 3 (XII[b]) of Part–II of

Schedule VI to the Companies Act, to come to a

conclusion that capital gains has to be mandatorily

taken into profit and loss account while computing the

book profit. That having not been done by the Assessee,

the authorities have recomputed the book profit. At this

juncture, it would be beneficial to refer to the Judgment

of the Apex Court in Apollo Tyres (supra) which is

rendered while dealing with an identical provision of

Section 115J (of Income Tax Act, 1961). It is held thus:

“Therefore, we are of the opinion, the

Assessing Officer while computing the income

under section 115J (of Income Tax Act, 1961) has only the power of

examining whether the books of account are

certified by the authorities under the

Companies Act as having been properly

maintained in accordance with the

Companies Act. The Assessing Officer

thereafter has the limited power of making

increases and reductions as provided for in

the Explanation to the said section. To put it

differently, the Assessing Officer does not

have the jurisdiction to go behind the net

profit shown in the profit and loss account

except to the extent provided in the

Explanation to section 115J (of Income Tax Act, 1961).”

12. In the subsequent Judgment of the Apex

Court in HCL Comnet Systems (supra), following the

Judgment of Apollo Tyres (supra), it is held that the

adjustment required to be made to the net profit

disclosed in the profit and loss account for the purpose

of section 349 of the Companies Act are quite different

from the adjustment required to be made under the

explanation to be made under section 115JA (of Income Tax Act, 1961).

For the purpose of section 115JA (of Income Tax Act, 1961), the Assessing Officer

can increase the net profit determined as per the profit

and loss account prepared as per Parts II and III of

Schedule VI to the Companies Act only to the extent

permissible under the explanation thereto.

13. The explanation appended to Section 115JB (of Income Tax Act, 1961)

provides certain Items which if debited to the profit and

loss account can be added back to the net profit for

computing the book profit. Clause (b) of the said

explanation provides for the amount carried to any

reserves by whatever name called. In the present case,

it is true that the capital gains are directly taken to

capital reserve without taking the said amount of capital

gain to the profit and loss account however, no such

capital gain is debited to the profit and loss account, as

such, the said explanation is not applicable to the facts

of the present case.

14. We have noticed the auditor’s report,

certified with a qualification that the profit and loss

account and balance sheet referred to in the report

comply substantially in all material respects with the

applicable accounting standards referred to in Section

211(3C) of the Companies Act except the land and

building sold during the year, the capital gain has been

transferred directly to capital reserve account instead of

crediting to profit and loss account, which in the opinion

of the directors is more appropriate. However, it is not

disputed that this auditor’s report is accepted by the

General Body, the books of account and the balance

sheet are filed before the Registrar of Companies. It is

also noticed by us that Clause 3(XII)(b) and (c) of Part II

of Schedule VI of the Companies Act provides that profit

and losses in respect of transactions of a kind, not

usually undertaken by the Company or undertaken by

the company or undertaken in circumstances of an

exceptional or non-recurring nature, if material in

amount and miscellaneous income, are required to be

disclosed in the profit and loss account. Considering,

the capital gain income falling under these clauses, it is

incumbent on the Company to disclose the said amount

of capital gain in the profit and loss account. Section

211 of the Companies Act contemplates, form and

contents of balance sheet and profit and loss account.

Sub-sections 3(A),3(B) and 3(C) of Section 211 (of Income Tax Act, 1961) provides

that every profit and loss account and balance sheet of

the company shall comply with the accounting

standards, where the profit and loss account and

balance sheet of the company do not comply with the

accounting standards, such companies shall disclose in

its profit and loss account and the balance sheet the

following mainly:

(a) the deviation from the accounting standards;

(b) the reasons for such deviation; and

the financial effect, if any, arising due to such deviation.

15. For the purpose of Section (3C) of Sec.211 (of Income Tax Act, 1961) of

the Companies Act, the expression “accounting

standards” means the standards of accounting

recommended by the Institute of Chartered Accountants

of India constituted under the Chartered Accountants

Act, 1949 (38 of 1949) as may be prescribed by the

Central Government in consultation with the National

Advisory Committee on Accounting Standards

established under sub-section (1) of Section 210(A) (of Income Tax Act, 1961).

16. The proviso to the said Section 211(3)(C) (of Income Tax Act, 1961) of

the Companies Act makes it clear that the standards of

accounting specified by the Institute of Chartered

Accountants of India shall be deemed to be the

accounting standards until the accounting standards are

prescribed by the Central Government under the sub-

section 3(C) (of Income Tax Act, 1961). The Assessing Officer has placed reliance

on the accounting standards, vide No.9949 dated

25.1.1996 and has held that the transaction of sale

property should have been brought into the profit and

loss account as an extraordinary item since the assessee

has failed to follow the accounting standards,

determined the book profit after allowing the deduction

towards cost as per provision to Section 115JB(2) (of Income Tax Act, 1961) of the

Act. This order is confirmed by the appellate authority

as well as by the ITAT. However, this exercise of the

assessing authorities, in recomputing the book profit of

the assessee is contrary to the principles of law laid

down by the Apex Court in Appollo Tyres (supra). The

Apex Court has held that the only power vested with the

Assessing Officer is to make increases and deductions as

provided in the explanation to Section 115JB (of Income Tax Act, 1961).

Assessing Officer has no power to embark upon a fresh

enquiry in regard to the entries made in the books of

accounts of the company. In the light of the judgment of

Apollo Types (supra), we are of the opinion that the

Assessing Officer has no power to recompute the book

profit and has to rely upon the authentic statements of

accounts of the company, the accounts being

scrutinized and certified by the statutory auditors

though with a qualification, approved by the company in

general body meeting and thereafter filed before the

Registrar of Companies, who has a statutory obligation

to examine and be satisfied that the accounts of the

company are maintained in accordance with the

requirements of the Companies Act.

17. Accordingly, we answer the substantial

question of law in favour of the assessee and against the

revenue. For the foregoing reasons, appeal is allowed.

Sd/-

JUDGE

Sd/-

JUDGE