The Assessing Officer has taken the accumulated profits figure straight off the lender's balance sheet. Can I insist that depreciation at Income-tax Act rates be deducted first?
Yes. The Tribunal held that accumulated profits for s.2(22)(e) have to be arrived at after allowing depreciation as computed under the Income-tax Act and not as per the Companies Act. On the facts, once Income-tax Act depreciation was taken into account the accumulated profits were negative, so there was nothing to support the deemed dividend and the entire addition was deleted.
Decided by the ITAT (Rajesh Kumar, Accountant Member and Sonjoy Sarma, Judicial Member (Kolkata 'C' Bench)) on 2023-03-23, reported as I.T.A. No. 2105/Kol/2019, assessment year 2012-13. It bears on section 2(22)(e), section 133(6) of the Income Tax Act 1961, in Assessment & Scrutiny matters.
s.2(22)(e) charges only 'to the extent to which the company possesses accumulated profits', which makes the accumulated-profits computation a jurisdictional step and not an arithmetic afterthought. Assessing Officers routinely lift the reserves-and-surplus figure from the payer's audited balance sheet, obtained under a s.133(6) notice, and stop there. This decision is the answer: book depreciation is not the measure, depreciation is a first charge on profits, and the rates prescribed by the Income-tax Act are what must be deducted. The line runs from the Bombay High Court in Navnitlal C. Jhaveri and Jamnadas Khimji Kothari through Pushparthy Packs, and the Tribunal read P.K. Badiani as having indirectly approved treating normal depreciation as a real charge while holding only that initial depreciation and development rebate are not deductible in arriving at commercial profits. The practical prize is large: where the payer is asset-heavy, the difference between Companies Act and Income-tax Act depreciation is often enough to wipe the accumulated profits out entirely, as it did here. Note too the CIT(A)'s unchallenged direction that an opening balance carried in from an earlier year is not a payment made during the year and must come out of the addition.
Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere.
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XL Enterprises Ltd filed a nil return for assessment year 2012-13. In scrutiny the Assessing Officer found that it had received advances of Rs 8,58,26,789 from P N Memorial Neurocentre & Research Institute Ltd, on which no interest was paid or provided. From a reply to a notice under s.133(6) the Assessing Officer established that XL Enterprises held 17.94 per cent of the equity of the payer company and that the payer had accumulated profit of Rs 12,42,02,096 as on 31 March 2012. The assessee did not reply to the show cause notice and the whole amount was added as deemed dividend under s.2(22)(e). The CIT(A) held the transactions were not shown to be business dealings and were covered by s.2(22)(e), but noticed from the ledger that Rs 4,02,43,658 was an opening balance not paid during the year, directed that it be deleted, and sustained the addition to the extent of Rs 4,55,83,131 received during the year. Before the Tribunal the assessee argued for the first time that the accumulated profit of Rs 12,42,02,096 was computed under the Companies Act without adjusting depreciation as per the Income-tax Act, and that on the correct basis there were no accumulated profits at all.
The appeal of the assessee was allowed. Accumulated profits for the purposes of s.2(22)(e) have to be arrived at after allowing depreciation as per the Income-tax Act and not as per the Companies Act; on that basis the accumulated profits of the payer company worked out to be negative, so there were no accumulated profits for the purpose of the section, and the Assessing Officer was directed to delete the addition.
The Tribunal accepted the assessee's argument on the strength of the authorities cited to it. It set out at length the Bombay High Court's decision in CIT v. Pushparthy Packs P Ltd, in which the Revenue's contention that depreciation as provided under the Companies Act should be used was rejected and the appeal dismissed, the Court holding that depreciation arising from wear and tear is a first charge on profits and that normal depreciation as provided under the Income-tax Act, not book depreciation, must be taken into account. It also set out the coordinate bench decision in ACIT v. Yasin Hotels Pvt Ltd, which reasoned that although accumulated profits mean commercial profits following P.K. Badiani, the question of what commercial profits are is separate; that the Bombay High Court in Navnitlal C. Jhaveri and Jamnadas Khimji Kothari had held that depreciation at the rates provided by the Income-tax Act must be deducted in arriving at accumulated profits; and that those decisions were not overruled by P.K. Badiani, which was concerned with initial depreciation and development rebate and which indirectly approved the Gujarat High Court's view that normal depreciation is a real charge. Applying those decisions, the Tribunal found that with Income-tax Act depreciation taken into account the accumulated profits were negative.
In the aforesaid decisions it has been held that the accumulated profits have to be arrived at after allowing depreciation as per the Act and not as per Companies Act.
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Handle my notice → Ask a CA on WhatsAppYes. The Tribunal held that accumulated profits for s.2(22)(e) have to be arrived at after allowing depreciation as computed under the Income-tax Act and not as per the Companies Act. On the facts, once Income-tax Act depreciation was taken into account the accumulated profits were negative, so there was nothing to support the deemed dividend and the entire addition was deleted. This was decided by the ITAT (Rajesh Kumar, Accountant Member and Sonjoy Sarma, Judicial Member (Kolkata 'C' Bench)) and bears on section 2(22)(e), section 133(6) of the Income Tax Act 1961. It is reported as I.T.A. No. 2105/Kol/2019, assessment year 2012-13. s.2(22)(e) charges only 'to the extent to which the company possesses accumulated profits', which makes the accumulated-profits computation a jurisdictional step and not an arithmetic afterthought. Assessing Officers routinely lift the reserves-and-surplus figure from the payer's audited balance sheet, obtained under a s.133(6) notice, and stop there. This decision is the answer: book depreciation is not the measure, depreciation is a first charge on profits, and the rates prescribed by the Income-tax Act are what must be deducted. The line runs from the Bombay High Court in Navnitlal C. Jhaveri and Jamnadas Khimji Kothari through Pushparthy Packs, and the Tribunal read P.K. Badiani as having indirectly approved treating normal depreciation as a real charge while holding only that initial depreciation and development rebate are not deductible in arriving at commercial profits. The practical prize is large: where the payer is asset-heavy, the difference between Companies Act and Income-tax Act depreciation is often enough to wipe the accumulated profits out entirely, as it did here. Note too the CIT(A)'s unchallenged direction that an opening balance carried in from an earlier year is not a payment made during the year and must come out of the addition. If it applies to you, the first step is this: Ask for the accumulated-profits working the Assessing Officer relied on, and if there is none, take the point that the addition has been made without the computation the section requires.
XL Enterprises Ltd filed a nil return for assessment year 2012-13. In scrutiny the Assessing Officer found that it had received advances of Rs 8,58,26,789 from P N Memorial Neurocentre & Research Institute Ltd, on which no interest was paid or provided. From a reply to a notice under s.133(6) the Assessing Officer established that XL Enterprises held 17.94 per cent of the equity of the payer company and that the payer had accumulated profit of Rs 12,42,02,096 as on 31 March 2012. The assessee did not reply to the show cause notice and the whole amount was added as deemed dividend under s.2(22)(e). The CIT(A) held the transactions were not shown to be business dealings and were covered by s.2(22)(e), but noticed from the ledger that Rs 4,02,43,658 was an opening balance not paid during the year, directed that it be deleted, and sustained the addition to the extent of Rs 4,55,83,131 received during the year. Before the Tribunal the assessee argued for the first time that the accumulated profit of Rs 12,42,02,096 was computed under the Companies Act without adjusting depreciation as per the Income-tax Act, and that on the correct basis there were no accumulated profits at all. The matter was decided on 2023-03-23 by the ITAT (Rajesh Kumar, Accountant Member and Sonjoy Sarma, Judicial Member (Kolkata 'C' Bench)). On those facts the ITAT held as follows. The appeal of the assessee was allowed. Accumulated profits for the purposes of s.2(22)(e) have to be arrived at after allowing depreciation as per the Income-tax Act and not as per the Companies Act; on that basis the accumulated profits of the payer company worked out to be negative, so there were no accumulated profits for the purpose of the section, and the Assessing Officer was directed to delete the addition.
The Tribunal accepted the assessee's argument on the strength of the authorities cited to it. It set out at length the Bombay High Court's decision in CIT v. Pushparthy Packs P Ltd, in which the Revenue's contention that depreciation as provided under the Companies Act should be used was rejected and the appeal dismissed, the Court holding that depreciation arising from wear and tear is a first charge on profits and that normal depreciation as provided under the Income-tax Act, not book depreciation, must be taken into account. It also set out the coordinate bench decision in ACIT v. Yasin Hotels Pvt Ltd, which reasoned that although accumulated profits mean commercial profits following P.K. Badiani, the question of what commercial profits are is separate; that the Bombay High Court in Navnitlal C. Jhaveri and Jamnadas Khimji Kothari had held that depreciation at the rates provided by the Income-tax Act must be deducted in arriving at accumulated profits; and that those decisions were not overruled by P.K. Badiani, which was concerned with initial depreciation and development rebate and which indirectly approved the Gujarat High Court's view that normal depreciation is a real charge. Applying those decisions, the Tribunal found that with Income-tax Act depreciation taken into account the accumulated profits were negative. In the words reproduced by the source cited on this page: "In the aforesaid decisions it has been held that the accumulated profits have to be arrived at after allowing depreciation as per the Act and not as per Companies Act." The decision followed or applied CIT v. Pushparthy Packs P Ltd 2014 221 TAXMAN 403 (Bom) — followed; ACIT v. Yasin Hotels Pvt. Ltd. (2009) 121 TTJ 713 (Chennai) — followed; Navnitlal C. Jhaveri v. CIT 1971 80 ITR 582 (Bom) — relied on; CIT v. Jamnadas Khimji 1973 92 ITR 105 (Bom) — relied on; P.K. Badiani v. CIT 1976 105 ITR 642 (SC) — distinguished as concerning initial depreciation and development rebate.
It was decided by the ITAT on 2023-03-23 and is reported as I.T.A. No. 2105/Kol/2019, assessment year 2012-13. Binding on the AO and CIT(A) within the Tribunal's jurisdiction. Persuasive elsewhere. A Tribunal decision binds the assessing officer and the Commissioner (Appeals) within that Tribunal's jurisdiction, and is persuasive before other benches. It is not binding on a High Court, and a contrary co-ordinate bench decision will be argued against you, so check whether the point has been taken the other way before you build a reply around it. On section 2(22)(e), section 133(6), the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the taxpayer. The appeal of the assessee was allowed. Accumulated profits for the purposes of s.2(22)(e) have to be arrived at after allowing depreciation as per the Income-tax Act and not as per the Companies Act; on that basis the accumulated profits of the payer company worked out to be negative, so there were no accumulated profits for the purpose of the section, and the Assessing Officer was directed to delete the addition. It arises in Assessment & Scrutiny matters, on section 2(22)(e), section 133(6) of the Income Tax Act 1961, and was decided by Rajesh Kumar, Accountant Member and Sonjoy Sarma, Judicial Member (Kolkata 'C' Bench). Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. Obtain the payer company's depreciation schedule under the Income-tax Act and rework its accumulated profits by substituting Income-tax Act depreciation for book depreciation, year by year. If the reworked figure is nil or negative, say so as your primary ground — the charge under s.2(22)(e) then fails entirely regardless of the character of the payment. Separate out any opening balance brought forward from an earlier year; only sums actually paid during the year can be added, and an amount already taxed as deemed dividend cannot be taxed again. Check whether share premium has been included in the accumulated-profits figure and, if it has, take it out.
Validity check could not be completed. Validity check could not be completed — no search for later treatment or for a contrary Tribunal line was run on this pass, and this is a single-bench order following High Court authority rather than a decision of a High Court itself. The point sits alongside, and does not displace, P.K. Badiani's holding that accumulated profits mean commercial profits and not assessed income; the two are consistent only on the reading adopted here, that normal depreciation is a real charge in arriving at commercial profits while initial depreciation and development rebate are not. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The header of the order as reported is internally inconsistent: the Hindi line names the Judicial Member as Sanjay Sharma while the English line and the signature block name him as Sonjoy Sarma; the signature block has been preferred. The disputed figure is printed once as 'Rs. 4,55,83131/-' and elsewhere as Rs 4,55,83,131. The order reproduces long extracts from CIT v. Pushparthy Packs P Ltd and from ACIT v. Yasin Hotels Pvt Ltd, and the internal paragraph numbering of the Yasin Hotels extract (its paragraphs 7 to 10) runs on inside the Tribunal's own paragraph 7, which can mislead a reader into thinking those are paragraphs of this order. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal of the assessee was allowed. Accumulated profits for the purposes of s.2(22)(e) have to be arrived at after allowing depreciation as per the Income-tax Act and not as per the Companies Act; on that basis the accumulated profits of the payer company worked out to be negative, so there were no accumulated profits for the purpose of the section, and the Assessing Officer was directed to delete the addition.
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