Notional assessment basis for depreciation permits successor allowance, but prior losses and interest cannot be added to asset cost.

On a notional assessment under section 26(2), depreciation under section 10(2) had to be computed as if the successor had carried on the business throughout the previous year, so ownership change during the year did not defeat the allowance. Amounts representing earlier working losses, interest on advances to liquidators, and interest on invested capital were not part of the original cost of the transferred machinery and buildings and could not be added for depreciation purposes. However, proved expenditure on additions to the buildings and machinery during the assessee's incumbency was allowable in computing depreciation.

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Issues: (i) Whether, on an assessment under section 26(2), the assessee was entitled to depreciation on the machinery and buildings with effect from the date it was put in possession of the mills; (ii) whether losses incurred in working the mills, interest on sums advanced to the liquidators, and interest on capital invested during management formed part of the original cost of the machinery and buildings for depreciation purposes; (iii) whether the assessee was entitled to depreciation on the cost of additions made to the buildings and machinery during its incumbency.

Issue (i): Whether, on an assessment under section 26(2), the assessee was entitled to depreciation on the machinery and buildings with effect from the date it was put in possession of the mills.

Analysis: An assessment under section 26(2) is a notional assessment made on the footing that the successor carried on the business throughout the previous year and received its profits. In computing such notional profits, the allowances contemplated by section 10(2) cannot be denied merely because the ownership changed during the year. The successor is treated, for this limited purpose, as standing in the shoes of the predecessor in relation to the previous year.

Conclusion: The answer to this issue was in favour of the assessee.

Issue (ii): Whether losses incurred in working the mills, interest on sums advanced to the liquidators, and interest on capital invested during management formed part of the original cost of the machinery and buildings for depreciation purposes.

Analysis: The sale deed showed that the consideration for the transfer was confined to the stated purchase price. The earlier losses and the interest on advances or invested capital were not part of the consideration for the transfer and therefore could not be treated as part of the original cost of the assets for depreciation.

Conclusion: The answer to this issue was against the assessee.

Issue (iii): Whether the assessee was entitled to depreciation on the cost of additions made to the buildings and machinery during its incumbency.

Analysis: It was accepted that the stated amounts were actually spent on additions to the buildings and machinery. Such expenditure had to be taken into account in computing the depreciation allowance available to the assessee.

Conclusion: The answer to this issue was in favour of the assessee.

Final Conclusion: The reference was answered by holding that depreciation had to be allowed on the notional assessment basis under section 26(2), but the claimed prior losses and interest could not be added to the original cost of the transferred assets, while the cost of proved additions remained allowable.

Ratio Decidendi: For an assessment under section 26(2) of the Income-tax Act, depreciation allowances under section 10(2) must be computed on a notional basis as if the successor had carried on the business throughout the previous year, but only expenditures forming part of the asset cost or proved additions to the assets are allowable for depreciation.

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