[Deemed Dividend] Accumulated Profits Of Company U/S 2(22)(e) Of Income Tax Act Are Computed After Adjusting Depreciation: Telangana HC

In ruling so, a division bench of Chief Justice Alok Aradhe and Justice J. Sreenivas Rao cited two rulings of the Bombay High Court which held that “depreciation as granted in accordance with the rates prescribed by the Income-tax Act would have to be deducted for ascertaining the accumulated profits.”

The question arose in an assessee's appeal whose loan from a private company, in which he was a shareholder, was deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961.

The provision prevents companies from distributing profits to shareholders in the form of loans, without categorizing them as dividends, to avoid taxation.

The assessee contended that there are no accumulated profits and if the reworking of profits is done by deducting depreciation, there would be a negative figure.

Agreeing with this contention, the Commissioner of Income-tax (Appeals) had held that profits disclosed are subject to adjustment and depreciation as granted in accordance with the rates prescribed under the Act and therefore, the accumulated profits are to be computed taking into account the depreciation as per the Income-tax Rules.

The Income Tax Appellate Tribunal however relied on the Supreme Court's decision in PK Badiani v. Commissioner of Income Tax, Bombay (1976) to reverse CITA decision's. Thus, the assessee approached the High Court.

The High Court found that the issue already stands answered by two Division Benches of the Bombay High Court and “we concur with the view taken by the two Division Benches of Bombay High Court.”

In Navnit Lal C Javeri v. Commissioner of Income-tax, Bombay City (1971), the Bombay High Court had held that for the purpose of calculating profits within the meaning of the phrase “accumulated profits” under section 2(6A)(e) [of the Income-tax Act, 1922], an allowance of depreciation should be made by way of a deduction at the rates provided for by the Income-tax Act itself.

Similarly, in Commissioner of Income-tax, Bombay City v. Jamnadas Khimji Kothari (1973), the Bombay High Court held that “accumulated profits” does not mean profits as disclosed by the company's balance-sheet and would be subject to adjustment of depreciation.

So far as PK Badiani case (supra) is concerned, the High Court said the Top Court neither referred to the decisions of the two Division Benches of Bombay High Court in Navnit Lal C Javeri and Jamnadas Khimji Kothari (supra) nor dealt with the issue which is involved in the present appeal.

Accordingly, the appeal was allowed and the Court deleted the addition made by the Assessing Officer towards the Appellant's income tax return for the relevant assessment year.

Appearance: Advocate Duvva Pavan Kumar for Appellant; Senior Standing Counsel JV Prasad for Income-tax Department

Case title: Babulal Jain vs The Income Tax Officer

Case no.: ITTA No. 319 of 2007