Profit from land sale in capital reserve can't be added to book profits under Section 115J

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Case Name:

Commissioner of Income Tax vs. Vijayashree Finance & Investment Co. (P) Ltd. (High Court of Madras)

Tax Case (Appeal) No.309 of 2004

Date: 18th December 2007

Key Takeaways:

1. Profits from the sale of land transferred to capital reserve cannot be added to book profits under Section 115J of the Income Tax Act.

2. The Assessing Officer's power is limited when computing income under Section 115J and cannot go beyond what's specified in the Explanation to that section.

3. The court relied on the Supreme Court's decision in Apollo Tyres Ltd. v. Commissioner of Income Tax (2002) to reach its conclusion.

Issue:

Can the Assessing Officer add profits from the sale of land, which were transferred to capital reserve, to book profits under Section 115J of the Income Tax Act?

Facts:

So, here's what happened. There's this company called Vijayashree Finance & Investment Co. (P) Ltd. They sold some land and made a profit of Rs. 10,17,207. Now, instead of including this in their regular profits, they put it into something called a 'capital reserve'. 

The Income Tax folks weren't too happy about this. They said, "Hey, wait a minute! This should be part of your book profits under Section 115J of the Income Tax Act." So they went ahead and added it to the company's book profits when calculating their tax.

The company, obviously, didn't agree with this. They appealed to the Commissioner of Income Tax (Appeals), but lost there too. Not giving up, they took it to the next level - the Income Tax Appellate Tribunal. This time, they won! The Tribunal said the tax folks were wrong to add that land sale profit to the book profits.

Now it was the tax department's turn to be unhappy. They brought the case to the High Court, which is where we are now.

Arguments:

The tax department's main arguments were:

1. The profit from the land sale should be added to book profits under Section 115J.

2. Even if the profit wasn't included in the book profits, the Assessing Officer should be able to add it if the Schedule VI of the Companies Act requires it.

The company, on the other hand, argued that once the profit was transferred to capital reserve, it shouldn't be considered part of book profits under Section 115J.

Key Legal Precedents:

The big gun in this case was a Supreme Court decision: Apollo Tyres Ltd. v. Commissioner of Income Tax, (2002) 255 ITR 273 (SC). 

The High Court also mentioned its own previous decision that followed Apollo Tyres: CIT v. Kovai Maruthi Paper & Board P. Ltd. (T.C. (A) No.1104 of 2007 decided on 06.08.2007).

These cases basically said that when it comes to Section 115J, the Assessing Officer can only check if the books are properly certified under the Companies Act. They can make adjustments, but only as allowed by the Explanation to Section 115J. They can't go digging around in the profit and loss account beyond that.

Judgement:

The High Court sided with the company. They said the Assessing Officer overstepped their bounds by adding the land sale profit to the book profits. The court agreed with the Tribunal's decision to reverse the Assessing Officer's order.

In essence, they're saying, "Look, the Apollo Tyres case made it clear what an Assessing Officer can and can't do under Section 115J. Adding this land sale profit to book profits? That's a no-go."

So, the appeal was dismissed. The company won, and the tax department lost.

FAQs:

1. Q: What does this mean for companies selling assets?

  A: It suggests that if companies transfer profits from asset sales to capital reserve, it might not be considered part of book profits under Section 115J.

2. Q: Does this apply to all types of profits?

  A: Not necessarily. This case specifically dealt with profits from land sales transferred to capital reserve.

3. Q: Can the tax department still challenge such transactions?

  A: They can, but their power to recalculate book profits under Section 115J is now more limited.

4. Q: What's the significance of the Apollo Tyres case?

  A: It set a precedent limiting the Assessing Officer's power to adjust book profits under Section 115J.

5. Q: Could this decision be overturned?

  A: While possible, it's based on a Supreme Court decision, so it carries significant weight.

By framing the following two substantial questions of law, the revenue has filed the present appeal :

1. Whether in the facts and circumstances of the case, the Tribunal was right in holding that the profit on sale of land carried to capital reserve cannot be added to book profit under section 115J?

2. Whether in the facts and in circumstances of the case, the Tribunal was right in holding that since notes form part of the accounts, even where profits of a non recurring nature have not been made part of the book profits, although the schedule VI stipulates the same, the assessing officer cannot add the same to re-work the book profit?

2. The facts culminating in filing of the appeal are as follows :

The assessee is a company in which public are not substantially interested. As provided under section 115J of the Act, the assessing officer found that the assessee has transferred the amount of Rs.10,17,207/- realised from the sale of the land to 'capital reserve' and did not form part of the book profit. The assessing officer added the profits from the sale of the land to the book profits while making computation under section 115J of the Income Tax Act.

3. Aggrieved by the order, the assessee filed an appeal before the Commissioner of Income Tax (Appeals), who by upholding the order of the assessing officer dismissed the appeal. The assessee carried the matter on appeal before the Income Tax Appellate Tribunal. By reason of the impugned order, the Tribunal allowed the appeal. The correctness of the same is now canvassed before this Court by the revenue.

4. Learned counsel on either side submit that the issue is covered in favour of the assessee, in the light of the decision in the case of Apollo Tyres Ltd. v. Commissioner of Income Tax, (2002) 255 ITR 273 (SC), which has also been followed by a Division Bench of this Court in T.C. (A) No.1104 of 2007 decided on 06.08.2007 in the case of CIT v. Kovai Maruthi Paper & Board P. Ltd. 5. The apex Court in the above cited decision has held that the assessing officer, while computing the income under section 115J of the Act 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 the extent provided for in the explanation to section 115J of the Act.

6. In the light of the exposition of law in respect of the jurisdiction of the assessing officer, which has been over-reached in this case, we are of the view that the order of the assessing officer is hit by the ratio laid down in the case of Apollo Tyres cited supra and the Tribunal has rightly reversed it. We do not find any ground to interfere with the order of the Tribunal. The appeal is dismissed. No costs.