Best-judgment contract profit rate vs machinery depreciation: s.32 claim must be separately considered, not presumed allowed

Where accounts were rejected and income was computed by best judgment assessment by applying a flat net profit rate on contract receipts, the dominant issue was whether depreciation on machinery used in execution of works stood automatically absorbed in the net profit rate. The HC held that, under s.119, CBDT circulars binding on tax authorities required separate consideration of a specific depreciation claim made with particulars under s.32, and such consideration must be apparent from the assessment order; it cannot be presumed. For periods prior to 1 April 1994, fixing a net profit rate does not deem depreciation to have been allowed. Consequently, the ITAT majority view was upheld and the assessees' appeals were allowed.

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Issues involved:
The judgment addresses the claim of the assessee for deduction on account of depreciation, specifically focusing on whether depreciation should be separately allowed when a net profit rate of 10 per cent. on contract receipts has been adopted.

Summary:

Claim for Depreciation:
The assessee, a private limited company engaged in construction contracts, filed a return for the assessment year 1988-89 declaring an income of Rs.48,810. The Income-tax Officer rejected the book results due to defects in account maintenance and determined the taxable income at Rs.3,91,340 after applying a net profit rate of 10 per cent. The assessee contended that depreciation on machinery used in construction works should have been allowed as claimed. The Commissioner rejected the claim, stating that the estimated net profit should cover all expenses, including depreciation, and the circular issued by the Board on this matter was deemed inapplicable.

Tribunal's Decision and Appeal:
The Tribunal, upon a difference of opinion, accepted the assessee's claim for depreciation deduction. The Revenue filed a petition under section 256(1) of the Income-tax Act, questioning the Tribunal's decision. The matter was then referred to the High Court to determine whether depreciation should be separately allowed when a net profit rate of 10 per cent. was adopted.

Legal Considerations:
The High Court emphasized that the Assessing Officer must consider all relevant material when making a best judgment assessment and cannot assume considerations. Referring to Section 119 of the Income-tax Act, the Court highlighted the mandatory nature of following Board instructions, including the circular on depreciation claims. The Court rejected the Revenue's argument that depreciation should be assumed to be considered in net profit estimation, citing relevant Supreme Court and High Court decisions.

Conclusion:
The High Court upheld the Tribunal's decision, ruling in favor of the assessee's claim for depreciation deduction. It clarified that in cases prior to April 1, 1994, where best judgment assessments are made based on a net profit rate, depreciation claims must be separately considered if the prescribed particulars are provided by the assessee. The appeals by the assessees were allowed, with consequential orders to be passed by the authorities, and no costs were awarded.

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