ITO 9(3)(4), MUMBAI vs. RAM FABRIC (I) P.LTD, MUMBAI

The assessee is aggrieved by the decision of Ld CIT(A) in holding that the “revaluation reserve” shown in the Balance sheet is includible in the Book profit computed u/s 115JB of the Act.

The revenue is aggrieved by the decision of Ld CIT(A) in holding that the gain arising on sale of business assets are not required to be computed in terms of sec. 50 of the Act.

We shall first take up the appeal filed by the assessee. We heard the parties and perused the record. The assessee company was engaged in the business of manufacturing of synthetic suitings, shirtings and dress materials. During the year under consideration, the assessee had sold all its assets for a consideration of Rs.1.70 crores. In the earlier years, the assessee had made upward revision of the values of its fixed assets and credited the amount of enhancement to “Revaluation Reserve” account. Whenever the assets were sold, the corresponding amount was adjusted against the cost. During the year under consideration, the Revaluation reserve account was having a balance of Rs.94,16,587/-. Since the assessee had sold all its assets, the assessee should have transferred the balance in Revaluation reserve to its profit and loss account or should have reduced the cost of assets sold by it and accordingly arrived at profit/loss on sale of assets. However, the assessee did not do both, but instead shown it in the assets side of Balance sheet as a negative figure. The AO took the view that the assessee has followed this methodology only to avoid the liability to pay tax u/s 115JB of the Act. The AO also noticed that the assessee has stated in the Notes on accounts that the balance available in Revaluation reserve has been transferred to the Profit and Loss account. However, the assessee did not follow the methodology stated in the Notes on accounts and the said fact also supported the view taken by 3 And the assessing officer. Hence the AO recomputed the amount of Book Profit u/s 115JB of the Act by including the balance of Revaluation reserve that was omitted to be transferred to the Profit and Loss account. The ld CIT(A) also confirmed the same.

The Ld A.R mainly contended that the assessing officer should not have disturbed the audited accounts that has been adopted in the AGM. On the contrary, the Ld D.R submitted that the assessee has adopted dubious method in order to avoid the tax liability u/s 115JB of the Act and hence the assessing officer was justified in including the amount of Revaluation reserve by computing the Book Profit.

A careful perusal of the methodology adopted by the assessee for presenting its accounts would show that the assessee has shown the “Revaluation Reserve” as a negative figure in the assets side of Balance Sheet. Hence, we are of the view that there is merit in the observation of the assessing officer that the assessee has done show only to avoid tax liability u/s 115JB of the Act. This is further fortified by the fact that the assessee has stated in its Notes on Accounts that the balance available in the Revaluation reserve is being transferred to the Profit and Loss account. In any case, the accepted accounting principle is to adjust the revaluation reserve with the value of the corresponding asset, whenever the asset is sold and the resulting profit or loss is transferred to the Profit and Loss account. In the instant case, the assessee has transferred the loss on sale of fixed assets to the Profit and loss account without adjusting the corresponding revaluation reserve, which may not be in accordance with the accepted method of accounting. Further the same contradicts with the notes given in the Notes on accounts. Under these set of facts, we are of the view that the Ld CIT(A) was justified in upholding the action of the 4 And Revaluation reserve in the Book profit, since such adjustment is being made at the source level, i.e., at the stage of ascertainment of Net Profit. Accordingly, we uphold the order of Ld CIT(A) on this issue.

We shall now take up the appeal filed by the revenue. The present assessment has been reopened by the assessing officer u/s 147 of the Act on the reasoning that the assessee has not computed the profits or loss arising on sale of its fixed assets by applying the provisions of sec. 50 of the Act, i.e., according to the assessing officer, the assessee should have declared Short term Capital Gain on sale of assets, since they formed part of block of assets and further the depreciation is compulsorily to be allowed in terms of Explanation 5 to sec. 32(1)(ii) of the Act, even if the assessee has not claimed depreciation.

However, a perusal of the order passed by Ld CIT(A) would show that the Ld CIT(A) has gone by the fact that the assessee did not claim depreciation from AY 1990-91 onwards, since the assessee did not carry on any business since that year. Even though the Explanation 5 to sec. 32(1)(ii) of the Act was introduced w.e.f. 2002-03, yet the said provision cannot be applied to the assessee, since it did not carry on any business in that year and hence the question of user of the assets does not arise, which is a mandatory condition for allowing depreciation. Accordingly, the Ld CIT(A) held that the provisions of sec. 50 does not apply to the assessee.

We notice that the concept of “Block of assets” was introduced from assessment year 1988-89 onwards. The opening portion of provisions of sec. 50 reads as under:-

Accordingly, we set aside the order of Ld CIT(A) on this issue and restore this matter to the file of the assessing officer with the direction to examine this issue afresh in the light of discussions made supra.