The Ruling

In a recent decision in the case of Forever Diamonds, the Bombay High Court has upheld the claim of the Taxpayer that Book profits tax (under section 115JB) is not payable on the gains which are direct credited to reserves, bypassing Profit and loss account.

The Controversy

Book profits tax is levied on a company which is not otherwise caught under the ‘regular Tax’ net.  The basis for levy of the Book-profits tax is the Profit & loss account which is prepared under the Companies Act. To mitigate the impact of Book-profits Tax levy, companies often resort to clever accounting by routing  lumpsum gains directly to the Reserves, instead of reporting it in the Profit & Loss account. The Revenue authorities frown upon such practices and in one of the earliest reported rulings on this Tax planning, the Bombay High Court [Veekaylal Investment] had sided with the Revenue on this issue.

However, more recently (Akshay Textiles, Adbhut Trading),  the Bombay High Court  has adopted a different line and refused to  upset the Taxpayer’s  planning  on the ground that the ruling of the Supreme Court in Apollo Tyre’s case lays down the principle that the Profit & Loss accounts as prepared by the Taxpayer and certified by its auditors have to be accepted at face value. The latest in this line of rulings was rendered in the case of Forever Diamonds.

Our Comment

The nature of the gain (whether a non-taxable ‘capital receipt’ or a taxable ‘capital gain’) as well as propriety of the treatment under the Companies Act would be two relevant factors, in our view, which would have a significant bearing on determination of Taxability under Book-profits Tax provisions. Companies would need to make a careful assessment of these two critical factors, before deciding on the tax position. Adequate disclosure of the position would be advisable to prevent penal consequences.