2000 (6) TMI 125 - AT - Income Tax

Issues Involved:
1. Deduction under section 80HHC and the necessity of creating a reserve.
2. Validity of the return filed and its implications on deductions.
3. Applicability of judicial precedents and circulars regarding the creation of reserves.
4. Timing for creating the reserve and its compliance with the statutory requirements.
5. Rectification proceedings and the opportunity to create a reserve.

Detailed Analysis:

1. Deduction under Section 80HHC and Necessity of Creating a Reserve:
The core issue revolves around the appellant's eligibility for deduction under section 80HHC, which mandates the creation of a reserve. The relevant proviso stipulates that an amount equal to the deduction claimed must be debited to the profit and loss account and credited to a reserve account to be utilized for business purposes. The appellant did not initially create this reserve, leading to the denial of the deduction by the CIT (Appeals).

2. Validity of the Return Filed and Its Implications on Deductions:
The appellant filed a return on 30th June 1986, showing a net loss and did not claim deductions under sections 80C, 80L, and 80HHC due to the absence of taxable income. The Assessing Officer later revised the assessment, determining a positive income and raising a demand. The appellant then filed a revised return claiming deductions, which the Assessing Officer rejected, citing the invalidity of the return under section 139(4) & (5) and the absence of a created reserve in the original return.

3. Applicability of Judicial Precedents and Circulars Regarding the Creation of Reserves:
The appellant relied on the Allahabad High Court's decision in CIT v. Modi Spg. & Wvg. Mills Co. Ltd., which allowed the creation of a reserve at any time before the assessment was made. This decision was affirmed by the Supreme Court, supported by CBDT Circular No. 189. However, the CIT (Appeals) referenced the Supreme Court's decision in Shri Shubhlaxmi Mills Ltd. v. Addl. CIT, which mandated the creation of a reserve before the profit and loss account was finalized. The CIT (Appeals) found the issue debatable and rejected the appellant's claim under section 154.

4. Timing for Creating the Reserve and Its Compliance with the Statutory Requirements:
The appellant argued that the reserve could not have been created at the time of filing the return due to the computed gross total income being a loss. The appellant contended that the reserve could be created after the assessment was revised to show a positive income. The Tribunal noted that the appellant did create the reserve in the same previous year for which the deduction was claimed, challenging the CIT (Appeals)'s view that the issue was debatable.

5. Rectification Proceedings and the Opportunity to Create a Reserve:
The Tribunal considered the appellant's argument that the Assessing Officer should have allowed an opportunity to create the reserve after proposing adjustments that resulted in a positive income. The Tribunal referenced the Allahabad High Court's decision in Saran Engg. Co. Ltd., which allowed the creation of a reserve until the end of rectification proceedings. The Tribunal also cited the Bombay Bench's decision in R.R. Hosiery (P.) Ltd., supporting the view that the reserve could be created even after the assessment.

Conclusion:
The Tribunal concluded that the appellant should not be penalized for not creating a reserve at the time of filing the return when the total income was a loss. The Tribunal found that the Assessing Officer should have provided an opportunity to create the reserve after the income was recomputed to a positive figure. Consequently, the Tribunal set aside the revenue authorities' orders, directing the Assessing Officer to examine the deduction claim under section 80HHC and allow it if other conditions were fulfilled, without denying the claim based on the belated creation of the reserve. The appeal was allowed.

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