Karnataka H.C : The capital attributable to income for which deduction allowed under s. 80-I for income-tax purposes should not be deducted from the capital for purposes of surtax assessment

Counsel Appeared

K. Srinivasan & H. Raghavendra Rao, for the Revenue : G. Sarangan, for the Assessee

RAJENDRA BABU, J.:

The assessee is a public sector company to which the Uttar Pradesh Government granted some land free of cost and that had not been included in the books of account. On the advice of the statutory auditors and the Company Law Board, the assessee got the land valued and debited to land account by giving a corresponding entry in the capital reserve account amounting to Rs. 6,11,415. The assessee included the value of this asset in the surtax assessment for the purpose of working the capital base. The ITO rejected the claim of the assessee by applying Explanation 1 to r. 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 (“Act” for short). He also reduced the capital base with reference to income exempt from tax under s. 80-I of the IT Act, 1961.

On appeal, the CIT(A) held that the Explanation had no application to the case, and in his view, a book asset would be an intangible asset such as goodwill. He also held that the reserve had not been brought into existence by revaluing or by creating a book asset but by including the value of an asset which was brought into the accounts so as to truly reflect the state of affairs and, therefore, he directed the Surtax Officer to include the capital reserve of Rs. 6,11,415 for working out the capital base. He upheld the assessee’s contention in regard to the reduction of capital by excluding income exempt under s. 80-I of the IT Act and, thus allowed the appeal.

On further appeal against this order by the Revenue, the Tribunal held that this is not a case where a reserve is brought into existence by creating or revaluing any existing asset already included in the list of book assets and all that the assessee did was only to reflect in the books of account an asset which had not been so done earlier, and this being a valuable asset, its value had to be reflected in the books of account and agreed with the reasons given by the CIT in this regard. The Tribunal also upheld the finding of the CIT that the Surtax Officer was not justified in reducing the capital base with reference to income exempted under s. 80-1 of the Act, and dismissed the appeal. Aggrieved by the order of the Tribunal, the Revenue sought for a reference to this Court and at its instance, the following questions have been referred to us :

“( 1 ) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the capital attributable to income for which deduction allowed under s. 80-I for income-tax purposes should not be deducted from the capital for purposes of surtax assessment ?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that Explanation 1 to r. 2 of the Second Schedule to the Surtax Act does not apply to the capital reserve created by the assessee by bringing into the books the value of land received as gift from the U. P. Government ?”

Inasmuch as, in directing the inclusion of the income exempt under s. 80-I of the IT Act in assessing the capital base, the Commissioner (A) and the Tribunal have merely followed a judgment of this Court in Second ITO vs. Stumpp, Schuele and Somappa P. Ltd. (1977) 106 ITR 399, (Kar) which is binding upon us, we answer the first question referred to us in the affirmative and against the Revenue.

So far as the second question is concerned, learned senior standing counsel for the Revenue reiterated the contentions raised before the Tribunal and submitted that a sum of Rs. 6,11,415 was brought into existence either by creation or revaluation of a book asset. He submitted that this is a creation of a book asset which was not there earlier or amounts to revaluation from zero to Rs. 6,11,415 and is, therefore, hit by Explanation 1 to r. 2 of the Act incorporated in the Second Schedule to the Act (“the Rules” for short). Learned counsel for the assessee submitted that the order of the Tribunal was correct and urged that Explanation 1 to r. 2 of the Act has no application at all to the case on hand because the reserve is not brought into existence either by creation or revaluation or otherwise of a book asset. Learned counsel contended that the expression “book asset” is used in the context with reference to notional, fictitious and intangible assets and the assessee had made entries in relation to a tangible asset such as an immovable property.

The controversy in this case revolves round Explanation 1 to r. 2 of the Act and, therefore, it is necessary to carefully analyse the same. The said Explanation 1 reads as follows: “A paid-up share capital or reserve brought into existence by creating or increasing (by revaluation or otherwise) any book asset is not capital for computing the capital of a company for the purposes of this Act.”

The expression “book asset” is not defined under the Act or under the IT Act, 1961. But, by referring to similar expressions such as “book profits” and “book debts” as understood by well-known authors and with reference to decisions, the conclusion we can draw is that book assets are assets owned and possessed in connection with the company’s trade which are entered, or, commonly required to be entered in the books (see Paget’s Law of Banking, 9th Edn., page 50; Palmer’s Company Law, 22nd Edn. Vol. 1, para 44-06 ; Dawson vs. Isle (1906) 1 Ch. D. 633 ; Independent Automatic Sales Ltd. vs. Knowles and Foster (1962) 1 WLR 974 (Ch. D.) and Paul and Frank Ltd. vs. Discount Bank (Overseas) Ltd. (1967) 1 ch.D.348. Thus, the expression “book asset” used in Explanation 1 to r. 2 of the Act is used in the normal sense as any asset appearing as such in the books of account of an assessee. Even if it does not appear in the books of account and if it is commonly required to be entered in such books, such asset also should be treated or considered as a book asset. Therefore, we cannot agree with the contention raised by learned counsel for the assessee that the expression “book asset” in Explanation 1 to r. 2 of the Act refers only to notional, fictitious and intangible assets.

An analysis will reveal that the provision with which we are concerned simply means this : If an asset entered in the books of account of the assessee is created or revalued in the absence of real increase in order to create or increase its paid-up share capital or reserve, Explanation 1 to r. 2 would be applicable. The effect of the Explanation 1 to r. 2 is to deter companies from boosting up the figure of paid-up share capital or reserve by increasing by revaluation or creating any book asset. In this context, it is necessary to notice a decision of the Andhra Pradesh High Court in CIT vs. Warner Hindustan Ltd. (1985) 45 CTR (AP) 34 : (1986) 158 ITR 51 (AP). Learned counsel for the Revenue contended that the said decision has no application to the facts of the case, inasmuch as the Andhra Pradesh High Court, in that case, was concerned with revaluation of book assets ; while in the present case what we are concerned with is the creation of book asset and the bringing into existence of a reserve thereon. Learned counsel also submitted that the said decision does not lay down the correct law. In that case, the Andhra Pradesh High Court was concerned with the increase in the assessee’s account on the devaluation of the rupee and that was included under the head “Gain on devaluation” and in the balance sheet the assessee- company showed that sum under the head “Reserve and surplus”. The objection of learned counsel to adopting the reasoning of the Andhra Pradesh High Court, in the present case is that in that decision a distinction is made between an amount credited by the assessee to “gain on devaluation account” as representing a real increase in the value of the assets which is realised as opposed to any unrealised increase by taking recourse to the valuation ; and the value of the asset having actually gone up, it was necessary for the company to give effect to the actual increase and that was done by the assessee by crediting the increase to reserve account. According to learned counsel, Explanation 1 to r. 2 of the Act does not make any difference between real increase and unreal increase in the value of a book asset and even where there is a real increase and as a result of which a reserve is brought into existence, the Explanation is attracted. if one understands the concept of a “book asset” correctly, there should be no difficulty in the matter at all. As stated earlier, a “book asset” is such asset which is usually entered in the account books in the ordinary course of business. If an asset had not been entered in the books earlier for any reason, but is entered for the first time, the question is whether there is creation of a book asset ; similarly, if a book asset had already been entered in the books of account and the entries relating thereto reflect a particular figure as the value of the asset and if the value is altered so as to reflect the true position, whether revaluation of the book asset results therefrom ? What is to be reflected in the books is the true state of affairs and the true value of the asset. If, for any reason, the books of account did not truly reflect, either by non-inclusion of an asset or its true value, it is certainly open to an assessee to rectify the same and claim the benefit notwithstanding Explanation 1 to r. 2 in the Act. The Andhra Pradesh High Court stated that what was done in that case was only to truly reflect the value on the devaluation of the rupee and, therefore, the inhibition in Explanation 1 to r. 2 was not attracted with which we respectfully agree. The submission on behalf of the Revenue that the decision of the Andhra Pradesh High Court proceeds on a wrong premise is plainly incorrect.

In the present case, it may be seen that the asset, i.e., the land, was in existence, the same having been granted to the assessee by the Uttar Pradesh Government free of cost. Though the assessee had not incurred any expenditure in acquiring the asset, without that asset, the company could not have carried on its business and it formed its capital. It is plain that the book asset was neither created nor revalued by the assessee to boost up the capital base but the books were merely corrected to reflect the true position by its inclusion. Therefore, the contention raised on behalf of the Revenue to the contrary has got to be rejected. We agree with the conclusion reached by the Tribunal in this regard. Hence, we answer the second question also in the affirmative and against the Revenue.

[Citation : 179 ITR 129]