CIT vs Adeep Roloforms (P.) Ltd.

This appeal is by the revenue being aggrieved by the order passed by the Income Tax Appellate Tribunal, Bangalore Bench B (hereinafter referred to as the ITAT) in ITA No. 810/Bang/2002 for the assessment year 1996-1997 wherein ITAT has dismissed the appeal filed by the Revenue and confirmed the order passed by the Commissioner of Income Tax (Appeals)-I, Bangalore in ITA No. 147/R-11/CIT(A)I/99-00 dated 19-3-2002. The appeal has been admitted for consideration of the following substantial questions of law by order dated 14-12-2010:

(1) "Whether the Tribunal was correct in holding that the set off of investment allowance need not be availed of in the first year, when there are profits and the assessee would be entitled to skip that year and effect the carry forward law to the set off in a subsequent year of a profit?

(2) Whether the appellate authorities were correct in reserving the finding of assessing officer that the assessee had profit during the assessment year 1995-96 and the assessee should have created necessary reserve and claimed set off of brought forward investment allowance in the assessment year 1995-96 itself instead of creating reserve for the assessment year 1996-97 and claim set off?

The material facts leading up to this appeal with reference to rank of the parties before the assessing officer are as follows:

The assessee filed his return on 27-11-1996 declaring an income of Rs. 73,12,840 and subsequently filed a revised return on 31-10-1997 declaring an income of Rs. 66,45,730.

The assessee is engaged in the manufacture of Rims required for scooters and two wheelers. The assessee made a claim on brought forward investment allowance of Rs. 6,64,606 pertaining to the assessment years 1988-89, 1989-90 and 1990-91. The assessee filed revised return claiming set-off of unabsorbed investment allowance pertaining to the said three assessment years. The assessing officer held that if the set off is not availed in the immediately succeeding year, it cannot be availed in the later years. The provisions of set off and carry forward go hand in hand. It is only after set off, the question of further carry forward arises. There should be continuity. Therefore, set off of brought forward investment allowance is not allowed and disallowed the claim of the assessee. Being aggrieved by the said order passed by the assessing officer dated 31-3-1999, the assessee preferred an appeal before the Commissioner of Income Tax (Appeals)-I, Bangalore in ITA No. 147/R-11/CIT (A)/99-2000. The appellate authority by order dated 19-3-2002 held that the assessee had taxable profits during the year 1995-96. However, since reserve was not created in books of account, deduction u/s 32A was not claimed. The appellant-assessee created reserve to the extent of Rs. 5 lakhs during the assessment year 1996-97 and the investment allowance was claimed in revised return of income based on the Circular of CBDT No. 189 dated 30-1-1976. Along with the revised return, the appellant filed a detailed letter explaining the circumstances under which claim u/s 32A of the Act was made and it was contended by the assessee that return filed earlier for the assessment year 1992-93, there was a total investment allowance of Rs. 23,92,025 carried forward from the assessment years 1984-85 to 1990-91. However, only a reserve of Rs. 10 lakhs was created in the books of account and therefore, only an amount of Rs. 13,33,333 was allowed as investment allowance in the order u/s 154 of the Act dated 4-8-1997 in respect of the assessment years 1992-93 and 1993-94. The appellant-assessee further created a fresh reserve of a sum of Rs. 5 lakhs during the accounting year ended 31-3-1996 out of the profits available and therefore it was claimed that investment allowance to the extent of Rs. 6,64,606 for the assessment years 1988-89, 1989-90 and 1990-91 was required to be allowed. It was also contended that in the original balance sheet submitted, by inadvertence, reserve was not created and hence, the shareholders have amended appropriation of profit at their Extraordinary General Meeting held on 4-9-1997. The appellate authority, in view of the amendment of Section 32A of the Act and also in view of the Boards circular No. 572 dated 3-8-1990, held that when there was no profit, creation of reserve was not mandatory. However, sufficient reserve was created when the investment allowance was claimed and therefore, the assessee was entitled to investment allowance claimed and allowed the claim of investment allowance of Rs. 6,64,606 pertaining to the assessment years 1988-89 to 1990-91. Being aggrieved by the said order of the first appellate authority, the Revenue preferred an appeal before the ITAT in ITA No. 810/Bang/2002. The ITAT having regard to the observations made by the first appellate authority regarding amendment of Section 32A and in view of sub-section (4) in clause (ii) of section 32A and the circular issued by the CBDT referred to in the order of the first appellate authority, held that since the assessee had created sufficient reserve, the order passed by the first appellate authority was justified and does not suffer from any error or illegality so as to call for interference in the appeal and accordingly, ITAT dismissed the appeal by order dated 6-5-2005. Being aggrieved by the said order, this appeal is filed by the Revenue for consideration of the above said substantial questions of law.

We have heard the learned counsel appearing for the Revenue and the learned counsel appearing for the respondent-assessee.

The learned Standing counsel for the appellant submitted that in view of section 32A and in view of section 34(3)(a) of the Act, creation of reserve fund in the year of installation or first use of machinery is essential notwithstanding that there is no profit or insufficient profit and mere book entries would suffice for creating such reserve; to secure the benefit of development rebate, necessary debit and credit entries relating to reserve fund must be made before the profits and loss account is finally drawn up and therefore the order passed by the assessing officer was justified and the first appellate authority was not justified in setting aside the assessment order and the assessee is not entitled to claim the benefit of rebate of investment allowance of Rs. 6,64,606. He submitted that the substantial questions of law may be answered in favour of the revenue. In support of the contentions, he has relied upon the decision in Shri Shubhlaxmi Mills Limited Vs. Additional Commissioner of Income Tax, Gujarat, wherein the Hon''ble Supreme Court held as follows:

To secure the benefit of development rebate creation of reserve fund though by mere passing of book entries in the year of installation or first use of machinery is essential notwithstanding that there is no profit or insufficient profit.

It is not necessary to refer to these cases, for it seems clear to us that the Explanation, which applies to the assessment year under consideration before us, removes the doubt altogether. What is contemplated is the creation of a reserve fund in the relevant previous year irrespective of the result of the profit and loss account disclosed by the books of the assessee. Mere book entries will suffice for creating such a reserve fund. The debit entries and the entries relating to the reserve fund have to be made before the profit and loss account is finally drawn up. That is a condition for securing the benefit of development rebate and if that condition is not satisfied, we fail to see how the deduction on account of development rebate can be claimed at all.

The learned counsel for the respondent-assessee submitted that the appeal is devoid of merit as the appellate authorities have concurrently held that sufficient reserve had been created and in view of the amendment of section 32 by Amending Act of 1990 and also as per the Boards circular No. 572 dated 3-3-1990 that if sufficient reserve has been created when the claim for rebate is made, the same should be allowed and the decision of the Hon''ble Supreme Court in Shubhlaxmi Mills Ltd.''s case cited supra, is also referred to in the said circular.

We have given careful consideration to the contentions of learned counsel appearing for the parties and scrutinised the material on record.

The material on record would clearly show that the assessee had originally filed return on 26-11-1996 declaring an income of Rs. 73,12,840 and subsequently a revised return was filed on 31-10-1997 declaring an income of Rs. 66,45,730. Both the returns were processed and were selected for scrutiny. The notice was issued u/s 143(2) of the Act and necessary details were called for. After hearing the assessee, assessing officer disallowed the claim in respect of Rs. 6,64,606 on the ground that no provision for set off had been made by creating reserve and provisions of set off and carry forward go hand in hand; that it is only after set off, the question of further carry forward arises. The assessing officer failed to consider as to whether there was sufficient reserve created on the date when the claim was made for Rs. 6,64,606 as investment allowance. However, the first appellate authority has referred to the amendment made to section 32A by the Finance Act, 1990 which reads as under:

(i) In section 32A of the Income Tax Act, in sub-section (4) in clause (ii), in the opening portion, for the words "the previous year in respect of which the deduction is to be allowed" the words, brackets and figure "any previous year in respect of which the deduction is to be allowed under sub-section (3) or any earlier previous year (being a previous year and not earlier than the year in which the ship or aircraft was acquired or the machinery or plant was installed or the ship, aircraft, machinery or plant was first put to use" shall be substituted and shall be deemed to have been substituted with effect from 1-4-1976."

The circular has been issued by the CBDT in No. 572 dated 3-8-1990 wherein it is stated that in a year when profits are insufficient or there are no profits, creation of reserve was not mandatory. The relevant provisions pertaining to the investment allowance is dealt with in the said circular which read as under:

The provisions of section 33 read with section 34 of the IT Act, relating to development rebate, provide for deduction of a percentage of the actual cost of a ship acquired or machinery or plant installed. One of the conditions for the deduction is that an amount equal to 75 per cent of the amount of development rebate to be actually allowed is debited to the P & L a/c of the relevant previous year and credited to a reserve account.

18.1 In the context that appropriation to a reserve presupposes existence of sufficient profits and it should suffice if the required amount is so appreciated before the deduction by way of development; rebate came to be allowed, the CBDT through a circular clarified that the requirement of creation of reserve will be considered to have been satisfied if the accumulated reserves in respect of the said machinery or plant up to the year or years of actual deductions is equal to seventy-five per cent of the amount of development rebate to be actually allowed. This means that in a year when profits are insufficient or there are no profits, the creation of reserve was not mandatory.

18.2 The Supreme Court in the case of Shri Shubhlaxmi Mills Limited Vs. Additional Commissioner of Income Tax, Gujarat, has held that in order to claim the deduction on account, of development rebate, it is obligatory that the reserve should be created in the year of acquisition/installation of machinery or plant, etc., even in a case where there are no profits. If the decision of the Supreme Court is to be followed, then taxpayers who have been following the Boards circulars for many years would be placed in a very difficult situation as their assessments already completed could be reopened. Apart from this, it may run contrary to accounting principles and the assurance given by the CBDT through its circular.

18.3 Though the decision of the Supreme Court has been pronounced only with regard to the provisions relating to development rebate, the underlying principle may apply equally to the grant of investment allowance. accordingly, sections 32A and 34 have been amended to secure that the condition of creation of reserve even in a year of loss or of insufficiency of profit as laid down by the Hon''ble Supreme Court will not be mandatory in respect of both development rebate and investment allowance and it is now provided that in considering whether the condition regarding creation of reserve is fulfilled or not, the reserve(s) created in the year in which the deduction is to be allowed and in any earlier year will be taken into account. Of course, the earlier year will not be a year earlier than the year in which the plant, machinery is installed or put to use or the ship is acquired.

18.4 These amendments will take effect retrospectively from 1-4-1962, in relation to the development rebate and 1-4-1976, in relation to investment allowance and will, accordingly, apply from assessment years 1962-63 and 1976-77 respectively and subsequent years.

It is clear from the above said circular that the said circular referred to the decision of the Hon''ble Supreme Court in Shubhlaxmi Mills Ltd.''s case cited supra and thereafter amendment to section 32A of the Act by Finance Act, 1990 and has issued a clarification to the effect that underlying principle may apply equally to the grant of investment allowance. Accordingly, sections 32A and 34 have been amended to secure that the condition of creation of reserve even in a year of loss or of insufficiency of profit as laid down by the Hon''ble Supreme Court will not be mandatory in respect of both development rebate and investment allowance and it is now provided that in considering whether the condition regarding creation of reserve is fulfilled or not, the reserve created in the year in which, the deduction is to be allowed and in any earlier year will be taken into account. Of course, earlier year will not be a year earlier than the year in which the plant, machinery is installed or put to use and the provisions of the Amending Act will take effect retrospectively from 1-4-1962 in relation to the development rebate and 1-4-1976 in relation to investment allowance and will apply from assessment years 1962-63 and 1976-77 respectively and subsequent years. The ITAT and the first appellate authority have relied upon the amendment made to section 32A and the circular issued by the CBDT referred to above. On the facts and circumstances of the case, it is clear that as on the date of claiming the benefit of investment allowance of Rs. 6,64,606, sufficient reserve had already been created which is also clear from the finding of fact arrived at by the first appellate authority. The assessing officer has not at all considered the said fact which is mandatory under the CBDT Circular. Accordingly, we hold that the order passed by the first appellate authority, confirmed by the ITAT is justified and the order passed by the assessing officer cannot be sustained.

Accordingly, we answer the substantial questions of law against the revenue and in favour of the assessee and pass the following order.

The appeal is dismissed.