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TMI Blog1982 (7) TMI 135X X X X Extracts X X X X X X X X Extracts X X X X ..... of Explanation 1 to rule 2 of the Second Schedule of the Act. The revaluation reserve had been created by the assessee-company in 1966 when the devaluation of rupee had taken place by valuing the assets in question at a higher sum than the book value of the said assets at that time and creating the corresponding credit by crediting the revaluation reserve account. Up to the assessment year 1974-75, the said revaluation reserve was not being included in the capital of the assessee-company in terms of the above referred Explanation 1 to rule 2 of the Second Schedule which reads as follows : "A paid-up share capital or reserve brought into existence by creating or increasing (by revaluation or otherwise) any book asset is not capital for computing the capital of a company for the purposes of this Act." 3. At the end of the accounting period corresponding to the assessment year 1974-75, i.e., on 30-9-1973, the amount in question standing to the credit of revaluation reserve account was transferred to general reserve account by debiting the revaluation reserve account and crediting general reserve account, so that, as on 1-10-1973, revaluation reserve account did not appear in the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t had to be excluded was the reserve "brought into existence by creating or increasing (by revaluation or otherwise) any book asset". The machines, etc., of the assessee-company could not be described as 'book asset', they were real assets and their revaluation was not caught in the mischief of the Explanation. It was only the revaluation of the book asset of intangible nature, for example, goodwill which would be affected by the said Explanation 1. Support for the above view was drawn from the following observations of their Lordships of the Supreme Court in the case of CIT v. Standard Vacuum Oil Co. [1966] 59 ITR 685 : "The Explanation to rule 2 has no relevance in the present case. The difference between the assets received by the company and the par value of the shares issued cannot be called a book asset 'brought into existence by creating or increasing (by revaluation or otherwise)'. The assets received by the assessee-company are real and tangible assets . . . ." According to the learned counsel, the above observations clearly underscored the difference between a book asset and the real and tangible assets and inasmuch as in the present case, the revaluation reserve was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ars on account of the operation of Explanation 1 to rule 2 of the Second Schedule, there was no logic in the submission of the assessee that the same treatment should not be given this year to the amount representing revaluation reserve simply because the sum stands transferred this year to the general reserve account. The opinion of the Expert Advisory Committee, submitted the learned departmental representative, might be good authority for transferring the revaluation reserve account to the general reserve account, but that did not constitute good authority for determining as to whether or not the reserve in question would be excluded from the computation of the capital for the purpose of the Second Schedule. For that, guidance would have to be taken from the plain language of Explanation 1 to rule 2 of the Second Schedule. The distinction between the 'book asset' and 'real asset' which was sought to be drawn by the learned counsel for the assessee was also, according to the learned departmental representative, unreal on the facts and in the circumstances of the present case. The facts of the case relied upon by the assessee, namely, Standard Vacuum Oil Co. were altogether differ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ses or losses are not assets at all and, therefore, there could be no question of their revaluation and consequent surplus arising therefrom. But goodwill is certainly an asset which can either be 'created' if not already there to begin with, or the value of which can be increased in course of time on account of the standing of the company. The 'creation' of a book asset, apparently, excludes the 'acquisition' of a book asset. The 'creation' is done by an act of the company. Before its 'creation', the asset was not in existence ; after the company decided to create it and passed the consequent entry in its books, it appears in the balance sheet. The corresponding credit, on account of the appearance of the new asset in the balance sheet, could be given either to the paid-up capital account or to a reserve account. In either situation, the paid-up capital or reserve so created is to be excluded from the computation of capital in terms of Explanation 1 to rule 2. In the present case, it is common ground that new asset has not been 'created' by the company in the aforementioned sense and, as such, there is nothing to be excluded from the computation of the capital of the assessee-comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een acquired first. In one situation, the creation of paid-up capital and reserve is the effect and the creation or increasing the value of an asset is the cause, in the other, the acquisition of additional resources or capital is the cause and the acquisition of asset is its effect. The Explanation covers the situation where an asset, which is in existence, is increased in value or, if an asset is not in existence, it is brought into existence by an act of the company without spending its resources. As already explained, a book asset created in the aforesaid manner could be only an intangible asset like goodwill, which is self-generated and for acquiring which, resources of the company are not utilized. When an existing book asset is increased in value, there is also no spending or utilisation of the resources of the company. Something already exists in the balance sheet of the company and its value is increased arithmetically in the books and thereby a surplus is created on account of the difference in the market price of the assets and the book value of the assets. This surplus, though notional, may be real but the statute requires that even if it be real, it would be excluded f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... servation is significant because their Lordships were faced with the case wherein neither there had been a 'creation' of new asset by the amalgamated company, nor did it 'revalue' any of its existing assets. It was a case where the company was buying the assets from the market, so to say, and allotting to the vendors of the said assets its own shares, fully paid, and charging from them a premium for such allotment of shares. The following observations of their Lordships have to be understood in the above context : ". . . The difference between the assets received by the company and the par value of the shares issued cannot be called a book asset 'brought into existence by creating or increasing (by revaluation or otherwise)'. The assets received by the assessee-company are real and tangible assets. It is only for accountancy purposes that a part of the value of the assets is allocated to the par value of the shares and the balance to the 'Capital Surplus brought in' account". . . . [Emphasis supplied] The aforesaid observations of their Lordships cannot be interpreted to mean that their Lordships were intending to make a distinction between the 'book' asset and the 'real' asset. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the nomenclature in that case, the authorities would be justified to treat the transferred part of the reserve as revaluation reserve, despite the change in its nomenclature, for such change in the name does not bring about a change in the nature and quality of the reserve. But, when the nature and the quality of the reserve changed, a change in the nomenclature is but appropriate and due regard should be given to it. In the present case, as the report of the directors to the shareholders indicates, the transfer of revaluation reserve account to general reserve account was done because 'many of these assets had since been fully depreciated'. The amount transferred from revaluation reserve to general reserve was Rs. 78,69,681 "equivalent to the amount by which the value of such assets now fully depreciated were written off at the time of devaluation". This being the factual position, we feel that the transfer of the revaluation reserve to general reserve was justified on account of the change in the nature and the quality of the reserve. The reserve to the extent of Rs. 78,69,681 was no more a revaluation reserve. It rather represented accumulation of the company's profits and o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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