Constitution of India is the father of all laws and the authority to levy a tax is derived from the Constitution. It allocates the power to levy various taxes between the Centre and the State. An important restriction on this power is contained in Article 265 of the Constitution which states that ‘No tax shall be levied or collected except by the authority of law’. Therefore, each tax levied or collected has to be backed by an accompanying law.

When we deal with the subject of income tax, the authority to levy and collect tax is vested with the Centre by virtue of Entry 82 of the Seventh Schedule to the Constitution which reads ‘Taxes on income other than agricultural income’. Backed by the said entry, Income-tax Act, 1961 (‘the Act’) was enacted by the Parliament.

Main charging provision of the Act

The main charging section i.e. section 4 of the Act states that income-tax shall be charged for an assessment year in accordance with, and subject to the provisions of the Act in respect of the total income of the previous year of every person.Thus, as per section 4, tax is to be levied on the total income of every person. Further, total income is defined in section 2(45) so as to mean the total amount of income referred to in section 5, computed in the manner laid down in this Act. Whereas section 5, inter-alia, states that subject to the provisions of this Act, the total income of any previous year of a person who is a resident includes all income from whatever source derived whether accruing or received in India or not. Lastly, income has been defined u/s 2(24) in an inclusive manner.

Thus, tax is payable on the total income of the previous year of every person, which as per section 2(45) means total amount of income as referred to in section 5 and computed in the manner laid down in the Act.

Provisions of section 115JB (erstwhile section 115J and 115JA)

Section 115JB of the Act, the head note of which reads as ‘Special provision for payment of tax by certain companies,’ provides an alternate mechanism to tax companies which are actually earning income in terms of net profits as per its books of account but whose taxable income is nil or less because of various beneficial provisions of the Act. It is in common parlance referred to as minimum alternate tax (‘MAT’). If we go by the wordings of the statute, then it can be inferred that a company has to first compute its total income as per the normal provisions of the Act and tax thereon and if tax on such income is less than 18.5% of the book profit, then the book profit is deemed to be the total income of the company and tax is payable on such book profit at 18.5%. Thus, section 115JB is in the nature of a deeming fiction which deems book profit to be the total income of the company.

If the above section is read in juxtaposition with the provisions of section 5, then one finds that section 5 opens with the phrase‘subject to the provisions of this Act’ which shall, inter alia, include section 115JB and therefore, if the conditions prescribed u/s 115JB are fulfilled, then book profit will bedeemed to be the total income, thus, giving the computation under normal provision a go-by.

The book profitfor the above purposes has to be computed in accordance with the provisions of Schedule III to the Companies Act, 2013 while using the same accounting policies and accounting standards which are adopted for preparation of P&L account laid before the company at its AGM. Further, the said book profitis subject to certain adjustments as provided in Explanation 1 to section 115JB(2) and sub-section (2A) of section 115JB.

Taxability of capital receipts under normal provisions

The top court of this Country has on many occasions laid down a fundamental principle that all receipts cannot be termed as income and therefore, cannot be taxed under the Act. Only those receipts which in common parlance be understood as income can be subject to tax under the Act. As a result of various lost battles, the Government made ingress in this field by way of introducing express provisions to tax capital receipts like capital gains, winning from lottery etc. Thus, the Government can tax capital receipts provided necessary provisions to that effect are inserted in the Act. The Bombay High Court in case of Cadell Weaving Mills Co. Ltd vs. CIT [TS-4-HC-2001(BOM)-O] has held that capital receipts are not taxable unless specifically made so by including them in the definition of income.

The capital receipts are thus, not chargeable to tax unless specific provisions are inserted in the Act. Can these items be subject to MAT u/s 115JB?

Can capital receipts be subject to MAT u/s 115JB?

All receipts and all outlays have to be routed through the P&L account as per Schedule III to the Companies Act, 2013. Accordingly, even capital receipts which are otherwise not subject to tax under normal provisions of the Act, form part of the book profit and in absence of any specific adjustment in Explanation 1 to section 115JB(2), they shall be liable to tax @ 18.5%. The above treatment raises an important question as to whether capital receipts which are otherwise not subject to tax being not in the nature of income and therefore, beyond the jurisdiction of the Government, be taxed by way of an alternate route called MAT?

There are several arguments against and in favour of the said treatment of the capital receipts which are analysed hereunder.

The principal argument which one can make is whether taxability of capital receipts u/s 115JB is constitutionally valid when the Constitution itself allows Centre to tax income and not capital receipts. Even the Constitution of India uses the term ‘tax on income’and the term ‘income’ therein, must be construed in the same manner as the one defined under the Income tax Act and therefore, taxability of capital receipts is impermissible even under MAT regime. The above argument seems attractive and pleasing at first instance, however, the same fizzles out if one looks at certain landmark judgments. The Hon’ble Apex in Court in judgment of Navinchandra Mafatlal [TS-6-SC-1961-O] followed by the judgment in case of Bhagwan Das Jain [TS-5000-SC-1981-O] held that the term ‘income’ under the Constitution cannot be understood in a narrow manner and that it has to be interpreted in a widest possible manner, even wider than the definition of the term ‘income’ given under the Income tax Act. In the above judgments, the Court has approved the right of the Government to tax capital receipts not constituting income. Thus, it becomes clear that the Government can tax any receipt under the Constitution, however the said power is not unregulated as it has to pass through the fetter put by Article 265of having an appropriate law in place.

Logically extending the above argument, after accepting the fact that the Government can legally tax capital receipts under the Constitution, the next argument which arises, is whether under the Income-tax Act, which is the only law to tax income, can the Government tax capital receipt without there being any specific provision to tax the same under normal mechanism? This arguments has two facets to it. Firstly, the main charging section i.e. section 4r.w.s. 2(24)provides for levy of tax only in respect of income of the assessee. Once an item is not considered as income of the person as the same constitutes capital receipt, it is not subject to tax under this Act. As discussed earlier, a capital receipt can be taxed only when the same has been specifically included in the definition of income. Since, capital receipts are not included in the definition of income, the same cannot be taxed under normal provision. Can therefore, MAT provision override the provision of the main charging section 4 r.w.s. 2(24) (i.e. definition of the term ‘income’) and tax capital receipts, especially when the same is devised only as an alternate mechanism to tax profit making companies otherwise not liable to tax. Even if we have a glance over the intention behind introduction of section 115J (predecessor of section 115JB), Circular no. 495 dated 22/09/1987, para 36 states that by virtue of various tax concessions and incentives certain companies making huge profits andalso declaring substantial dividends, have been managing their affairs in such a way as toavoid payment of income-tax, and to plug such loopholes, section 115J was introduced. Thus, never the intention was to tax something which is otherwise not chargeable to tax.

The only lacuna in this argument is the fact that thought the rationale behind MAT is different, however, the wordings of the statute are capable of annullingthis argument. Section 115JB, deems the book profit to be the total income of the company. Thus, there is a deeming fiction in place which deems certain item to be the total income and therefore, the Government can argue that because of the fiction, there isn’t any need to adhere to the definition of the term ‘income’ as given in section 2(24). Further, several courts have held that the MAT provisions are a separate code in itself and therefore, one cannot interpret the term book profit in line with the definition of the term income. However, then one has to ponder as to the interpretation of a fiction introduced by the Government. Can one stretch the interpretation of a deeming fiction so far that it overrides the main charging section of the Act and the object behind insertion of such deeming fiction?

The second facet of the argument; whether book profit per se can be deemed to be the total income without it being included in the definition of the term ‘income’ u/s 2(24). This argument puts the entire concept of MAT at peril. The said argument has never been tested before. Though there are judgments which have upheld the constitutional validity of section 115J (predecessor of section 115JB), the same has been upheld on some other grounds and reasons. When the provision of section 115JB deems book profit computed in the manner laid down in the ensuing part of that section to be the total income, then atleast the definition of the term ‘income’ should be amended to include the same. Sans such amendment, the legislature has no right to tax book profits as total income especially when the section 115JB is in the nature of a charging section and not merely a machinery provision. Even if it is treated as a mere machinery provision then the same cannot surpass the charging provision and tax capital receipt which is not considered as income u/s 2(24) [Cadell Weaving Mills Co. Ltd vs. CIT (supra)]. Section 115JB charges something which does not find a mention in the definition of the term ‘income’. If the same is permissible, the Government may introduce as many alternate codes for taxing items without them being constituted as income u/s 2(24), which shall then put the entire concept of the income vs. capital receipt in danger. However, this argument can be nullified by the Government, by simply amending the definition of the term income u/s 2(24) to include book profit.

The third argument is based upon clause (ii) of Explanation (1) to section 115JB which provides for an adjustment to the book profit of the company. The said item requires a company to exclude those income which do not form part of total income u/s 10, 11 and 12 except 10(38). Thus, those items of income which are exempt u/s 10 are specifically excluded from book profit. If that be so, then those items of receipts which are not income at all should be excluded in first place. Since capital receipts are not construed as income, they do not find a specific mention in section 10 because of which exclusion provided for in clause (ii) does not apply.

In this context it shall be worthwhile to deliberate upon an important judgment of the Hon’ble Supreme Court in case of Apollo Tyres Ltd. [TS-3-SC-2002-O] wherein the Court has held that

‘the assessing officer while computing the income under Section 115-J has only the power of examining whether the books of account are certified by the authorities under the Companies Act as having been properly maintained in accordance with the Companies Act. The assessing officer thereafter has the limited power of making increases and reductions as provided for in the Explanation to the said section. To put it differently, the assessing officer does not have the jurisdiction to go behind the net profit shown in the profit and loss account except to the extent provided in the Explanation to Section 115-J’

Thus, the Court has held that except for the adjustments as given in the Explanation, book profit cannot be touched. The above judgment has been followed by the same Court in case of HCL Comnet Systems and Services Ltd. [TS-53-SC-2008-O] and by several other judicial forums.

The above finding of the court stands as a massive roadblock in the claim of the assessee company that the capital receipts included in the book profit has to be reduced while calculating MAT. However, the above judgment has to be read in the context in which it was rendered. It was dealing with an issue as to whether the AO can tinker with the book profit as derived from the books of the company prepared in accordance with the provisions of the Companies Act. It never dealt with the question, whether the capital receipts can per se be taxed under MAT regime, particularly when the same is not taxable under the normal provision.

In order to cushion itself, many assessees are adopting a diversion by not routing the capital receipt through P&L account and by directly transferring it to some reserve like capital reserves etc., thereby reducing the book profit at the threshold itself. Validity of the above treatment in context of preparation of books of account under the Companies Act may be doubtful. The Hon’ble Bombay High Court in case of Veekaylal Investment Co. P. Ltd. [TS-12-HC-2001(BOM)-O] has held that direct transfer of an item to capital reserve account will not be in accordance with the requirement of the Companies Act and therefore, the AO has the power to compute the book profit as per the Companies Act. However, the said judgment was rendered prior to the judgment of the Hon’ble Supreme Court in case of Apollo Tyres and HCL Conmet and therefore, now has no binding effect. In fact, there are subsequent Bombay High Court judgments deviating from the ratio laid down in the said judgment. Thus, the settled position now is that such capital receipts not forming part of the P&L account cannot be brought to tax by including it in the book profit. Recently, the Hon’ble Karnataka High Court in case of Sri Hariram Hotels (P.) Ltd. [TS-5584-HC-2015(KARNATAKA)-O] has held that even if the treatment is not as per the provisions of the Companies Act and the relevant accounting standard and the auditor has qualified the accounts, still if the accounts are approved by the Board and has been filed with the ROC, then the AO cannot tinker with such book profit except where required by the Explanation 1 to section 115JB(2). This uptil now seems to be the safest manner to dodge the capital receipts being tax under the MAT regime.

Judgments relevant to the controversy

The controversy raked in the current article has been a subject matter of dispute in some forums. Let us understand the ratio laid down by various forums.

First and foremost judgment in this context is that of the Special Bench of the ITAT in case of Rain Commodities Ltd [TS-5941-ITAT-2010(HYDERABAD)-O]. In this case, the court was concerned with the issue as to whether capital gain arising from a transfer which is not considered as transfer u/s 47(iv) (transfer of assets to subsidiary) be taxed u/s 115JB or whether it has to be excluded while computing book profits? The Tribunal in this case held that the book profits derived from the accounts which are prepared in accordance with the provisions of the Companies Act and which has been adopted by the Board should be considered and only adjustments prescribed in Explanation 1 can be made. Thus, they have held that no other adjustment can be made except the ones specifically enumerated in Explanation 1 to section 115JB(2). In so far as capital gain was concerned, the Tribunal held that there is no exemption but only a deferment of tax and to specifically tax companies having substantial book profits but very meagre taxable profits by virtue of various exemptions provided, was section 115JB introduced. Though, the ratio of the judgment may thwart the claim of the assessee company in so far as the exclusion of capital receipts from book profit is concerned, however, the judgment can be distinguished on the lone ground that it never dealt with a case of a capital receipt which is per se not treated as income and therefore, not taxable under the Act itself; on the contrary it dealt with a case of an income which is exempted by virtue of specific provision of section 47.   

Surprisingly, making a substantial departure from the above ratio, while dealing with a similar controversy, the Hon’ble Mumbai ITAT in case of Shivalik Ventures P. Ltd. [TS-5900-ITAT-2015(MUMBAI)-O] has held that when a mention is made in the Notes to Account appended to the P&L account as to any item, the same should be adjusted from the book profiteven if there is no such specific requirement in the Explanation to section 115JB(2), as Notes to accounts form an integral part of the Final Accounts. Importantly, the ITAT has also distinguished the above judgment, on the ground that the transaction in question lead to generation of a capital receipt and not income which is not taxable u/s 4 r.w.s 2(24). By relying upon item (ii) of the Explanation to section 115JB(2), the Court held that if the logic of the said item is extended, then an item of receipt which does not fall under thedefinition of ‘income’ at all and hence, falls outside the purview of thecomputation provisions of Income tax Act, cannot also be included in‘book profit’ u/s 115JB of the Act.

In case of Shree Cements Ltd. [TS-5866-ITAT-2011(Jaipur)-O], the Hon’ble Jaipur Bench of ITAT was dealing with the issue as to whether subsidy received which was admittedly capital in nature can be subject to MAT. The ITAT held that there was never any intention behind introduction of section 115JB to tax something which is not taxable at all.They also have considered the fact that in respect of earlier year, the Hon’ble Rajasthan High Court did not admit the substantial question of law in this regard. Further, to take care of the judgment of the Hon’ble Apex court in case of Apollo tyres, the Tribunal held that a capital receipt (subsidy) which is neither ‘profit’ nor ‘income’ and which does not have any element thereofembedded there in, cannot be part of ‘profit’ as per Profit & Loss account prepared interms of Part II of Schedule VI to Companies Act. They have held that clause 2(a) of Part II clearly spells that the profit and loss a/c shallbe so made out as clearly to disclose the result of the working of the company during theperiod covered by the accounts andsince, subsidy can never be income, they should be excluded from the book profits. This part of the judgment, may not be agreeable to all in view of the fact that it is Schedule VI itself which requires each and every item of receipt and every item of outlay to be routed through P&L account including any capital receipt. Further, once Apex Court holds that books profits as derived from the accounts certified by the auditor and accepted by the Board cannot be touched, there arises no question of amending the book profits for any reason except for the adjustments provided in the Act.

Following the above ITAT judgment, the Lucknow bench of ITAT has in case of M/s L.H. Sugar Factory Ltd. [TS-7236-ITAT-2016(Lucknow)-O] held the amount received on sale of carbon credits is a capital receipt and that the same should be excluded while computing book profits.

Similarly, the Kolkata Tribunal in case of M/s Binani Industries Ltd. [TS-5363-ITAT-2016(KOLKATA)-O] has relying upon above mentioned judgments held that capital receipts being forfeiture of share warrants which are not chargeable to tax under the normal provision of the Act, cannot be taxed u/s 115JB.

Very recently, three new judgments have cropped up having bearing on the issue under consideration.

First one being the case of M/s. JSW Steel Limited vs. ACIT [TS-5655-ITAT-2017(Mumbai)-O], wherein the Mumbai ITAT dealt with a similar issue. The issue in this case was whether waiver of loan which was admittedly utilised for capital purposes was capital in nature and therefore, not taxable and if that was so held, then whether the said waiver, though credit to P&L account, was to be excluded from the book profits for the purposes of MAT. The ITAT first held that waiver of loan was capital in nature. After holding that the waiver of loan was capital in nature it held that such waiver cannot also be subject to MAT. In so holding the ITAT gave certain important findings that it was never the intention of the legislature that any receipts which is not taxable per se within the income tax provision can be brought to tax as a book profit or under any other provisions of the act.

The next judgment is that of the Kolkata Bench of the ITAT, in case of DCIT vs. M/s. McNally Bharat Engineering Co.Ltd. [TS-5601-ITAT-2017(Kolkata)-O]. In this case the ITAT held that retention moneyof Rs. 28 crores which was credited to P&L account over which the assessee had no right could not be taxed u/s 115JB, and in so stating it relied upon the judgment of the co-ordinate bench of the ITAT in case of Binani Industries (supra).