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.

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.

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.

Profit on sale of property used for residence.

 

54. (1) Subject to the provisions of sub-section (2), where, in the case of an assessee being an individual or a Hindu undivided family, the capital gain arises from the transfer of a long-term capital asset, being buildings or lands appurtenant thereto, and being a residential house, the income of which is chargeable under the head Income from house property (hereafter in this section referred to as the original asset), and the assessee has within a period of one year before or two years after the date on which the transfer took place purchased, or has within a period of three years after that date constructed, a residential house, then, instead of the capital gain being charged to income-tax as income of the previous year in which the transfer took place, it shall be dealt with in accordance with the following provisions of this section, that is to say,

 

(i) if the amount of the capital gain is greater than the cost of the residential house so purchased or constructed (hereafter in this section referred to as the new asset), the difference between the amount of the capital gain and the cost of the new asset shall be charged under section 45 as the income of the previous year; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be nil; or

 

(ii) if the amount of the capital gain is equal to or less than the cost of the new asset, the capital gain shall not be charged under section 45; and for the purpose of computing in respect of the new asset any capital gain arising from its transfer within a period of three years of its purchase or construction, as the case may be, the cost shall be reduced by the amount of the capital gain.

 

(2) The amount of the capital gain which is not appropriated by the assessee towards the purchase of the new asset made within one year before the date on which the transfer of the original asset took place, or which is not utilised by him for the purchase or construction of the new asset before the date of furnishing the return of income under section 139, shall be deposited by him before furnishing such return [such deposit being made in any case not later than the due date applicable in the case of the assessee for furnishing the return of income under sub-section (1) of section 139] in an account in any such bank or institution as may be specified in, and utilised in accordance with, any scheme which the Central Government may, by notification in the Official Gazette, frame in this behalf and such return shall be accompanied by proof of such deposit; and, for the purposes of sub-section (1), the amount, if any, already utilised by the assessee for the purchase or construction of the new asset together with the amount so deposited shall be deemed to be the cost of the new asset:

 

Provided that if the amount deposited under this sub-section is not utilised wholly or partly for the purchase or construction of the new asset within the period specified in sub-section (1), then,

 

(i) the amount not so utilised shall be charged under section 45 as the income of the previous year in which the period of three years from the date of the transfer of the original asset expires; and

 

(ii) the assessee shall be entitled to withdraw such amount in accordance with the scheme aforesaid.

As is evident, there is no requirement in s. 54 that the sale proceeds of the old house have to be utilized for purchase of the new house. The fact that the section permits a purchase of the new house one year before the sale of the old house itself makes it clear that such utilization is not even possible. All that the section requires is that the new house property should be purchased within the time period specified. The source of funds is irrelevant.

The direct judgement on this point is that of the Bombay High Court in CIT vs. Dr. P. S. Pasricha. In this case also, the assessee sold a house and used the sale proceeds to buy commercial property. Subsequently (but within the specified period) he borrowed funds and purchased a new house. The AO denied deduction u/s 54 on the ground that the new house had been purchased out of borrowed funds and not out of the consideration received for the old house. On appeal, the Tribunal and High Court upheld the claim on the ground that s. 54 merely required the purchase of the new house to be within the specified period. The source of funds for the purchase was irrelevant.

The same view has been taken by the Kerala High Court in K. C. Gopalan 162 CTR 566.

The only requirement for availing deduction u/s 54 is that the new residential house must be purchased or constructed within the period specified in the section. The source of funds is irrelevant.

Regulation 33(7) of the Development Control Regulations of the Municipal Corporation of Greater Bombay, 1991 (‘DCR’) provide for the grant of additional FSI if an existing building is redeveloped. The said additional FSI can be utilized either for the extension of the existing building or for the construction of a new building or may be sold for a consideration.

U/s 2(14), “capital asset” is defined to mean “property of any kind”, held by the assessee whether or not connected with his business or profession, but excluding ‘stock in trade’. The definition is wide enough to cover development rights within its ambit.

U/s 45, any profits and gains arising from the transfer of a capital asset is chargeable to tax. U/s 48, the profits and gains have to be computed by deducting from the full value of the consideration, the cost of acquisition and cost of improvement of the asset.

Though development rights are a capital asset, the moot question is whether there is a ‘cost of acquisition’ attached to them.

The leading judgements on the issue are that of the Mumbai Bench of the Tribunal in ITO vs. Lotia Court Co-operative Housing Society Ltd (2008) 12 DTR (Mumbai) (Trib) and New Shailaja CHS vs. ITO (ITAT Mumbai)

In Lotia Court Co-operative Housing Society the society and its members entered into a development agreement with a builder pursuant to which Transferable Development Rights (TDR) entitled to be received under the Development Control Regulations was assigned to the developer for the repairs and redevelopment of the building and the construction of additional floors. The AO sought to assess the society on the ground that it had made capital gains. However, the Tribunal held that as the TDRs were owned by the flat owners individually and as no consideration for the transfer of the TDRs was received by the assessee society nor any area in the constructed portion was allocated to the assessee society, the society was not chargeable to tax.

In New Shailaja CHS, the assessee-society became entitled by virtue of the Development Control Regulations to Transferable Development Rights (TDR) and the same were sold by it for a price to a builder. On the question of taxability in the hands of the Society, the Tribunal noted that the Supreme Court had laid down the law in B. C. Srinivasa Setty 128 ITR 294 (SC) that if there was an asset for which a cost of acquisition was not determinable, the gains could not be assessed as ‘capital gains’. It was accordingly held that though the TDR was a ‘capital asset’, there being no ‘cost of acquisition’ for the same, the consideration could not be taxed.

The said view has been followed in Om Shanti Co-op Society vs. ITO (ITAT Mumbai). In this case, the assessee co-op housing society gave permission to a developer to construct 2 floors and 8 flats on the building belonging to the society by using the TDR / FSI available to the developer. In consideration, the developer paid Rs. 26 lakhs to the assessee and Rs. 66 lakhs to its members aggregating Rs. 92 lakhs. The AO took the view that the assessee had relinquished its right “to load TDR and construct additional floors” and as there was no cost of acquisition, the entire consideration of Rs. 26 L was assessable as long-term capital gains. On appeal, the CIT (A) took the view that even the amounts received by the Members were assessable in the assessee’s hands. He accordingly enhanced the assessment and directed that the consideration be taken at Rs. 92 L. However, the Tribunal reversed the AO and CIT (A) on the ground that the assessee and its members had no right to construct additional floors on the existing building as they had exhausted the right available while constructing the flats in the building. The TDR was not obtained by the assessee and sold to the developer. It was held that the assessee had not transferred any existing right to the developer nor any cost was incurred / suffered prior to permitting the developer to construct the additional floors. The Tribunal held that in the absence of a cost of acquisition, the judgement in B. C. Srinivasa Setty 128 ITR 294 (SC) applied and the consideration was not assessable as capital gains.

The taxability in the hands of the members of the society was considered in Jethalal D. Mehta vs. DCIT (2005) 2 SOT 422 (Mum). There also, following the judgment of Apex Court in CIT vs. B.C. Srinivasa Setty 128 ITR 294 (SC), it was held that as the TDR granted by DCR, 1991 qualifying for equivalent F.S.I had no cost of acquisition, the sale of the same did not give rise to assessable capital gains.

The entire case rests on there not being a ‘cost of acquisition’ of the development right / FSI obtained pursuant to the Development Control Regulations. In respect of buildings that have been erected after the DC Regulations of 1991 came into force, it is a possible argument in favour of the Revenue that some part of the cost of the building is attributable to the said development right / FSI and that the principle of B. C. Srinivasa Setty does not apply.