Opinion Of Eminent Legal Luminaries On Controversial Issues

Whether S. 115JB Is Applicable If Amount Is Directly Credited To Capital Reserve Account?

QUERY: A company has credited gain arising from transfer of a capital assets directly to capital reserve account, without routing through profit and loss account. The auditor has not qualified the accounts and the ROC also has not taken any objection to the accounts. Whether Assessing Officer can add back this amount to the book profit while calculating MAT liability?
ANSWER: From the query it is not clear what type of a capital asset has been transferred and directly credited to capital reserve account.

The cardinal principle has been propounded by the Supreme Court in Apollo Tyres Ltd. vs. CIT [255 ITR 273], while deciding the matter under Section 115J of the Income-tax Act, 1961 which was precursor to erstwhile Section 115JA and present Section 115JB of the Act.

“The Assessing Officer, while computing the ‘book profit’ of a company under section 115J of the 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 section 115J. 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. The use of words in accordance with the provisions of Parts II and III of Schedule VI of the Companies Act in section 115J was made for the limited purpose of empowering the Assessing Officer to rely upon the authentic statement of accounts of the company. While so looking into the accounts of the company the Assessing Officer has to accept the authenticity of the accounts with reference to the provisions of the Companies Act, while obligate the company to maintain its accounts in a manner provided by the Act and the same to be scrutinized and certified by the statutory auditors and approved by the company in general meeting and thereafter to be filed before the Registrar of Companies who has statutory obligation also to examine and be satisfied that the accounts of the company are maintained in accordance with the requirements of the Companies Act. Sub-section (1A) of section 115J does not empower the Assessing Officer to embark upon a fresh enquiry in regard to the entries made in the books of account of the company”

The said principle has been reaffirmed by the Supreme Court in Malayala Manorama Co. Ltd. vs. CIT [300 ITR 251].

Now, note 2 to Part II of the Old Schedule VI to the Companies Act, 1956 states that 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 accounts; 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.

Thus, in accordance with the provisions of Part II of the Old Schedule VI all notes prescribed in the said Part to be taken into account while preparing profit and loss account.

The Schedule III to Companies Act, 2013 has been introduced with effect from April 1, 2014 and applicable from April 1, 2014 i.e. any accounting year commencing from the said date. Part II of the said schedule prescribes form of “Statement of Profit and Loss”, which specifically requires disclosure of exceptional items and extraordinary items on the face of it. Further, general instructions to Schedule III states that the requirements of the Act and/or the notified Accounting Standards (AS) will prevail over the Schedule. Hence, it is necessary to understand the term “exceptional items” and “extraordinary items” as defined in AS-5 “Net Profit or loss for the period, Prior period items and changes in Accounting Policies”.

Paras 12 to 14 of the said Standard defines “exceptional items” as under:

“When items of income and expenses within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and the amount of such items should be disclosed separately”.

Although the items of income and expenses described in paragraph 12 are not extraordinary items, the nature and amount of such items may be relevant to users of financial statements in understanding the financial position and performance. Disclosure of such information is sometimes made in the notes to the financial statements.”

“Circumstances which may give rise to the separate disclosure of items of income and expenses in accordance with paragraph 12 include:

a) the write down of inventories to net realizable value as well as the reversal of such write downs;

b) a restructuring of the activities of an enterprise and the reversal of any provisions for the costs of restructuring;

c) disposals of items of fixed assets:

d) disposals of long-term investments;

e) legislative changes having retrospective application;

f) litigation settlements; and

g) other reversal provisions”

Further the said Standards defines “extraordinary items:” as”

“Extraordinary items are income and expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly”.

Thus all kinds of capital assets cannot directly be credited to capital reserve account to avoid MAT liability. Only those capital assets which are not falling in above categories can be directly credited to capital reserve account. Then only, the decisions of the Supreme Court mentioned above would be applicable. Otherwise, the Assessing Officer would be justified in making the adjustment for determining and calculating MAT liability. For this proposition, the reliance is placed on the following decisions:

a) GKW Ltd. vs. CIT [12 Taxmann. Com 234 (Cal) (HC)

b) CIT vs. Thiruvambadi Rubber Co. Ltd. [15 Taxmann Com 50 (Ker)(HC)

c) CIT vs. Veekayal Investments Co (P) Ltd. [249 ITR 597 (Bom)(HC)]

d) Duke Offshore Ltd. vs. DCIT [45 SOT 399(Mum) (Trib) and

e) Kopran Pharmaceuticals Ltd. vs. DCIT [119 ITD 355 (Mum) (Trib)

Posted in Income-tax
One comment on “Whether S. 115JB Is Applicable If Amount Is Directly Credited To Capital Reserve Account?
  1. Deepak Nagori says:


    Very nice article. Could you suggest if waiver of loan (for capital assets) can be directly credited to capital reserve to avoid being part of book profit u/s 115JB?


    CA Deepak Nagori

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