1986 (3) TMI 59 - HC - Income Tax

Court rules unabsorbed depreciation can't offset income without ongoing business.

The court held that unabsorbed depreciation from earlier years cannot be set off against income from business, income from other sources, and capital ... Carry forward and set off of unabsorbed depreciation - deeming fiction in section 32(2) - deductibility under section 32(1) contingent on continuance/use of assets in business - distinction between unabsorbed depreciation and business loss - scope of Explanation to section 41(2) - effect of Explanation 3 to section 43(6)Carry forward and set off of unabsorbed depreciation - deeming fiction in section 32(2) - deductibility under section 32(1) contingent on continuance/use of assets in business - Unabsorbed depreciation of earlier years could not be set off against income for the assessment year when the business in respect of which the depreciation arose was not carried on in that year. - HELD THAT: - Section 32(2) permits unabsorbed depreciation to be carried forward by deeming it part of the allowance for the following year, but that deeming fiction is limited to the purpose of treating carried forward depreciation as an allowance for deductibility. The Court held that the actual deductibility of that deemed allowance remains governed by section 32(1), which requires that the asset be used for the purposes of a business or profession carried on in the relevant previous year. Relying on this Court's decision in Tube Suppliers Ltd. and earlier precedents (including Dutt's Trust and Sahu Rubbers), and on the Supreme Court's exposition of the limited purpose of the deeming fiction, the Court rejected the contention that the fiction in section 32(2) dispenses with the substantive condition of continuance/use prescribed by section 32(1). Consequently, carried forward unabsorbed depreciation cannot be set off against income where the relevant business has ceased to exist in the year for which set off is claimed.Assessee not entitled to set off carried forward unabsorbed depreciation for AY 1971-72 because the business in which the depreciation arose was not carried on in the relevant year.Distinction between unabsorbed depreciation and business loss - sections 71 and 72 - scope of set off and carry forward - Unabsorbed carried forward depreciation is not a 'loss' within the scheme of sections 70-72 and cannot be set off under section 71(1). - HELD THAT: - The Court observed that sections 70-72 deal with business losses and their set off/carry forward, whereas section 32(2) is the specific provision for carry forward of unabsorbed depreciation. Section 72(2) itself recognises the separate treatment of carried forward allowances under section 32(2). The Court followed precedent (including Concord Industries and decisions of High Courts) to hold that carried forward unabsorbed depreciation retains its character as depreciation allowance and is not to be equated with business loss for the purposes of sections 71/72; hence section 71(1) cannot be invoked to permit its set off as a loss under another head.Claim that unabsorbed depreciation should be set off under section 71(1) rejected.Scope of Explanation to section 41(2) - The Explanation to section 41(2) that treats a discontinued business as being in existence for the limited purpose of charging recoupment income cannot be extended to confer rights under section 32(2). - HELD THAT: - The Court held that the Explanation to section 41(2) creates a limited fiction solely to determine taxability under section 41(2) where moneys become due after the business has ceased. That limited purpose cannot be expanded to affect entitlement to carry forward or set off unabsorbed depreciation under section 32(2)/32(1). The Explanation therefore does not assist the assessee's claim to set off carried forward depreciation when the business has ceased.Argument to apply the Explanation to section 41(2) for the purpose of section 32(2) rejected.Effect of Explanation 3 to section 43(6) - Explanation 3 to the definition of 'written down value' in section 43(6) does not alter the requirement in section 32(1) that assets be used in a business for deduction of depreciation. - HELD THAT: - Explanation 3 deems carried forward depreciation to be 'depreciation actually allowed' for computing written down value, but it merely defines the phrase and does not enlarge the substantive conditions for allowing depreciation under section 32(1). The Court held that this definitional provision cannot affect the construction that continuance/use of assets in the business is a prerequisite to deductibility of depreciation in the relevant year.Explanation 3 to section 43(6) does not assist the assessee's claim to set off carried forward unabsorbed depreciation where the business is not carried on.Final Conclusion: The reference is answered in the affirmative against the assessee: carried forward unabsorbed depreciation cannot be set off against income for AY 1971-72 where the business in respect of which the depreciation arose was not carried on in the relevant year; related contentions under sections 71, the Explanation to section 41(2) and Explanation 3 to section 43(6) were rejected. The assessee must pay costs. Issues Involved:1. Whether the unabsorbed depreciation of earlier years could be set off against the income from business u/s 41(2), income from other sources, and capital gains.Summary:Issue 1: Set off of Unabsorbed Depreciation Against IncomeThe assessee showed a total loss of Rs. 63,53,460 for the assessment year 1971-72, with Rs. 61,84,273 carried forward from earlier years. The Tribunal could not ascertain the split between carried forward business loss and unabsorbed depreciation. The assessee, relying on CIT v. Rampur Timber & Turnery Company Limited [1973] 89 ITR 150 (Allahabad High Court), claimed entitlement to set off the carried forward unabsorbed depreciation despite having no business activities in the relevant year.The Income-tax Officer computed the assessee's profit u/s 41(2) of the Income-tax Act, 1961, at Rs. 49,802 and set off the unabsorbed depreciation from the assessment year 1963-64 against this profit. The assessee was assessed on an income of Rs. 2,79,427. This was upheld by the Appellate Assistant Commissioner and subsequently by the Tribunal, which referred to CIT v. Dutt's Trust, Calicut [1942] 10 ITR 477, emphasizing that the business in which unabsorbed depreciation arose must be carried on in the succeeding years to claim set off.Interpretation of Section 32(2)The court focused on the interpretation of section 32(2) of the Income-tax Act, which allows unabsorbed depreciation to be carried forward and added to the depreciation allowance for the following year. The court examined whether the business must be carried on in the succeeding year for the set-off of unabsorbed depreciation. The assessee's counsel cited decisions from the Andhra Pradesh High Court (Hyderabad Construction Co. Ltd. v. CIT [1981] 129 ITR 81) and Karnataka High Court (Addl. CIT v. Kapila Textiles (P.) Ltd. [1981] 129 ITR 458), which did not require the business to continue for claiming set off.Contrary Decisions and PrecedentsHowever, the court noted contrary decisions from its jurisdiction, including CIT v. Dutt's Trust [1942] 10 ITR 477 and Tube Suppliers Ltd. v. CIT [1985] 152 ITR 694, which required the business to be carried on for set off. The court also referred to the Supreme Court's decision in CIT v. Jaipuria China Clay Mines (P.) Ltd. [1966] 59 ITR 555, which supported the view that unabsorbed depreciation must be treated as an allowance for the following year, requiring the business to continue.ConclusionThe court concluded that the business must be carried on in the succeeding year to claim set off of unabsorbed depreciation. The court rejected the argument that the fiction in section 32(2) dispenses with the requirement of carrying on the business. The court also dismissed the applicability of sections 71 and 72 for setting off unabsorbed depreciation, emphasizing that these sections deal with business losses, not depreciation allowances.Final DecisionThe court answered the referred question in the affirmative, holding that the unabsorbed depreciation of earlier years could not be set off against the income from business u/s 41(2), income from other sources, and capital gains. The assessee was ordered to pay the costs of the reference.