Priority of Unabsorbed Depreciation over Investment Allowance in Income Calculation

The Supreme Court held that unabsorbed depreciation should be allowed before unabsorbed investment allowance in computing the income for the Assessment Year 1991-1992. The Court emphasized that once unabsorbed depreciation is carried forward, it merges with the current year's depreciation, and the assessee cannot selectively claim only the current year's depreciation. The decision aligned with statutory provisions and judicial precedents, dismissing the appeals in favor of the Revenue.

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Issues Involved:
1. Whether the unabsorbed depreciation should be allowed before the allowance of the unabsorbed investment allowance in computing the income of the assessee for the Assessment Year 1991-1992.

Detailed Analysis:

Issue 1: Priority of Unabsorbed Depreciation over Unabsorbed Investment Allowance

The central issue revolves around the priority of unabsorbed depreciation versus unabsorbed investment allowance in the computation of income for the Assessment Year 1991-1992. The appellant/assessee, a public limited company engaged in manufacturing paper, filed its return declaring 'Nil' income after claiming set off of unabsorbed investment allowance to the extent of Rs. 2,87,15,912. The Assessing Officer, however, adjusted the unabsorbed depreciation of earlier years first, leading to the acceptance of 'Nil' income but on a different basis.

The assessee's appeal was dismissed by the Commissioner (Appeals) and subsequently by the Income Tax Appellate Tribunal and the High Court, all of which upheld that unabsorbed depreciation should be set off before unabsorbed investment allowance.

The Supreme Court analyzed the provisions of Section 32 of the Income Tax Act, 1961, which deals with depreciation. Sub-section (2) of Section 32 allows unabsorbed depreciation to be carried forward and deemed as part of the depreciation allowance for the following previous year. This legal fiction means that unabsorbed depreciation from previous years becomes part of the current year's depreciation.

The Court noted that the consistent judicial view has been that unabsorbed depreciation should be allowed before unabsorbed investment allowance. This precedence is supported by the combined effect of Sections 32, 32A, 33, 33A, and 72 of the Act. The Supreme Court also referred to the CBDT Circular No. 202, which outlines the order of deductions where profits are insufficient to absorb all allowances.

The Court acknowledged the principle established in *Commissioner of Income-Tax v. Mahendra Mills* that depreciation is a benefit for the assessee and cannot be forced upon them if not claimed. However, the Court clarified that this principle applies when the assessee does not claim any depreciation at all. In the present case, the assessee claimed current year depreciation but chose not to claim unabsorbed depreciation from previous years.

The Supreme Court held that once unabsorbed depreciation is carried forward, it merges with the current year's depreciation due to the legal fiction created by Section 32(2). Therefore, the assessee cannot bifurcate and selectively claim only the current year's depreciation while ignoring the unabsorbed depreciation. The entire depreciation, including unabsorbed depreciation from previous years, must be set off first before considering unabsorbed investment allowance.

The Court concluded that the High Court correctly prioritized unabsorbed depreciation over unabsorbed investment allowance, aligning with the statutory provisions and judicial precedents. The appeals were dismissed with costs, and the question was decided against the assessee and in favor of the Revenue.

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