Depreciation on revalued assets taken over after partnership dissolution: Explanation 3 to s.43(1) blocks higher claim (1)

Whether depreciation could be claimed on assets taken over from a dissolved partnership at a revalued figure was determined by applying s. 43(1) and Explanation 3 of the IT Act. Although revaluation may be relevant in partnership accounting to adjust partners' rights on dissolution, s. 43(1) with its Explanations overrides general partnership law for computing "actual cost" for depreciation. Where assets were previously used by another person and the main purpose of transfer is to secure a higher depreciation allowance to reduce tax liability, Explanation 3 empowers the AO to substitute a reduced actual cost notwithstanding revaluation. Depreciation on the revalued figure was denied, and Explanation 3 was held attracted, in favour of Revenue.

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Issues Involved:
1. Entitlement to claim depreciation on revalued assets taken over from partnership firms.
2. Applicability of Explanation 3 to section 43(1) of the Income-tax Act.

Summary:

1. Entitlement to Claim Depreciation on Revalued Assets:
The primary issue was whether the assessee is entitled to claim depreciation on the assets taken over from the partnership firms at the revalued figure. The assessee, a company, took over the assets of a dissolved partnership firm where the written down value was Rs. 3,16,110, but the assets were revalued at Rs. 22,30,795. The Assessing Officer disallowed the depreciation claim on the revalued figure, stating that the main purpose of the revaluation and dissolution was to reduce tax liability. The Tribunal initially allowed the claim, but the High Court held that the assessee is not entitled to claim depreciation on the revalued figure, answering the question in the negative and in favor of the Revenue.

2. Applicability of Explanation 3 to Section 43(1):
An additional question was whether Explanation 3 to section 43(1) is applicable. Explanation 3 allows the Assessing Officer to determine the "actual cost" of assets if the main purpose of the transfer was to reduce tax liability by claiming depreciation on an enhanced cost. The High Court agreed with the Assessing Officer's application of Explanation 3, stating that the revaluation was a device to reduce tax liability. The court emphasized that the Assessing Officer has the discretion to fix the "actual cost" if satisfied that the main purpose of the transfer was tax reduction. The court answered this question in the affirmative, in favor of the Revenue.

Conclusion:
The High Court concluded that the assessee is not entitled to claim depreciation on the revalued assets and that Explanation 3 to section 43(1) is applicable to the facts of the case. The judgment was in favor of the Revenue and against the assessee.

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