2005 (9) TMI 218 - AT - Income Tax

Addition u/s 35D - amortization of certain preliminary expenses - According to the AO assessee could claim such expenditure under section 35D subject to upper limit of 1/10th of 21/2 per cent of capital employed or cost of project whatever is higher as per the provisions of section 35D(3) - CIT(A) deleted the addition - whether share premium has to be considered as issued share capital ? - Whether other amounts stand credited under the head Reserve and Surplus i.e. Investment Allowance (utilized) Reserve General Reserve and the sum Transferred from Profit and Loss a/c all other sums standing to the credit of Reserve and Surplus a/c to be considered as issued share capital ? - HELD THAT - Section 78 of the Companies Act 1956 as dealing with the subject application of premiums received on issue of shares will reveal that any share premium collected by a company shall be treated as if the same is paid-up share capital of the company and it is also required to be retained in a separate account. The said amount cannot be utilized for any purpose other than the one specified in sub-section (2). If amount lying in separate premium account is used for any other purposes it would tantamount to reduction in share capital which will attract the provisions of sections 100 to 105 of the Companies Act. Thus the effect of this section is to create a new class of capital of a company which is not distributable as income any more than any other capital asset. On a winding up the surplus monies in the share premium account will be returned to the shareholders as capital and so long as the company is a going concern the same monies can never be returned to the shareholders except through the medium of reduction petition or in other words except under exactly the same conditions as those under which any other capital asset can reach the shareholder s hand. However the same analogy will not apply to the other amounts stand credited under the head Reserve and Surplus i.e. (i) Investment Allowance (utilized) Reserve (ii) General Reserve and the sum (iii) Transferred from Profit and Loss a/c (total Rs. 7, 97, 46, 150 all other sums standing to the credit of Reserve and Surplus a/c). Therefore we hold that CIT(A) was wrong in concluding that entire sum of Rs. 18, 87, 35, 238 (Rs. 4, 00, 71, 000 as share capital and amount of Rs. 14, 86, 64, 238 as reserve and surplus) was issued share capital within the meaning of Explanation (b) to section 35D(3). Therefore we modify his order and hold that a sum of Rs. 7, 97, 46, 150 as computed above was not issued share capital within the meaning of Explanation (b) to section 35D(3) of the Act. Therefore issued share capital of the assessee can only be considered to be a sum of amount outstanding as share premium account - 2.5 per cent of Rs. 10, 88, 97, 000 is of Rs. 27, 22, 425 and thus the expenditure incurred by assessee have to be restricted to that sum and therefore the assessee is entitled to maximum 10 per cent of the sum of Rs. 27, 22, 425 which comes to Rs. 2, 72, 242. Thus, we direct Assessing Officer to restrict the addition to the extent of Rs. 1, 99, 002. Appeal filed by the revenue is therefore partly allowed.

Summary

Issues:
- Interpretation of section 35D of the Income-tax Act, 1961 regarding amortization of preliminary expenses for a company.
- Determining the capital employed for the purpose of claiming deductions under section 35D.
- Dispute over whether share premium should be considered as part of issued share capital.
- Application of the Companies Act, 1956 in relation to the treatment of share premium.

Analysis:
1. Interpretation of Section 35D: The case involved an appeal by the revenue against the order of CIT(A) regarding the deletion of an addition made under section 35D of the Income-tax Act. The Assessing Officer restricted the claim based on the capital employed, leading to an addition to the income of the assessee. However, the CIT(A) found that the assessee was entitled to claim the full deduction based on the share capital, reserve, and surplus as per the balance sheet, thereby deleting the addition.

2. Determining Capital Employed: The dispute centered around the definition of "capital employed in the business of the company" as per Explanation (b) to section 35D(3). The revenue contended that only issued share capital should be considered for calculating capital employed, while the assessee argued that share premium should also be included. The Tribunal analyzed the provisions and held that share premium should indeed be treated as part of issued share capital, allowing for a higher deduction under section 35D.

3. Share Premium Consideration: The Tribunal examined the treatment of share premium under the Companies Act, 1956, specifically Section 78. It was established that share premium collected by a company is akin to paid-up share capital and should be retained separately. The Tribunal agreed with the assessee's argument that share premium should be included in the calculation of issued share capital for the purpose of determining deductions under section 35D.

4. Application of Companies Act: The Tribunal delved into the provisions of the Companies Act, 1956, to understand the treatment of share premium and other reserves and surplus. It was clarified that share premium, when utilized, should adhere to the specified purposes outlined in the Act. The Tribunal differentiated between share premium and other amounts under reserves and surplus, ultimately concluding that only a portion of the total amount should be considered as issued share capital for the purpose of section 35D deductions.

In conclusion, the Tribunal partly allowed the revenue's appeal by modifying the CIT(A)'s order and restricting the addition to the extent of Rs. 1,99,002 based on the correct calculation of issued share capital, including share premium. The judgment provided clarity on the interpretation of section 35D and the treatment of share premium under the Income-tax Act and the Companies Act.