2012 (1) TMI 436 - AT - Income Tax

Application of income: depreciation and permitted FDR investments count toward the 85% application requirement, reducing taxable income.

Depreciation on assets whose cost was earlier treated as application of income is allowable for computing applied funds; the claim of depreciation was ... Allowance of depreciation where cost of assets treated as application of income - investment in fixed deposits as application of income under section 11(5) - computation of 85% of income for application to charitable purposesAllowance of depreciation where cost of assets treated as application of income - Claim of depreciation on assets whose cost was earlier allowed as application of income - HELD THAT: - The Tribunal followed the ratio of the jurisdictional High Court in CIT Vs. Market Committee Pipli and Karnal that there is no prohibition on claiming depreciation for the purpose of determining application of income where the income of the assessee is exempt; depreciation is to be allowed and is not a double deduction in the circumstances of this case. Accordingly the assessee was held entitled to depreciation of Rs. 2,16,39,334/-. [Paras 10]Depreciation allowed to the assessee.Investment in fixed deposits as application of income under section 11(5) - Whether net additions to FDRs during the year qualify as application of income under section 11(1) read with section 11(5) - HELD THAT: - The Tribunal held that the assessee's net additions to FDRs complied with the modes of investment specified in section 11(5) and that one of the society's objects permitted such investments; earlier assessments had accepted similar investments and, applying the principle of consistency, the investments in FDRs were to be treated as application of income of the year in which made. [Paras 11]Investments in FDRs held to be application of income of the previous year.Computation of 85% of income for application to charitable purposes - Correct approach to compute the 85% threshold for application of income and the validity of CIT(A)'s enhancement in para 6.6 - HELD THAT: - The Tribunal held that while computing the application of income only 85% of the 'income' (receipts after adjusting expenditure) is to be considered; because the assessee's allowed expenditure together with additions to fixed assets and FDRs exceeded gross receipts for the year, the CIT(A)'s treatment in para 6.6 was erroneous and the requirement to give a notice under section 11(2) did not arise where application exceeded income. [Paras 11, 12]CIT(A)'s computation in para 6.6 set aside; 85% to be computed on income after expenditure and no notice under section 11(2) required where application exceeded income.Final Conclusion: The Tribunal allowed the appeal in part, held that depreciation and investments in FDRs qualify as application of income for the year and that the CIT(A)'s computation was erroneous; the order of the CIT(A) was set aside and the Assessing Officer directed to adopt the assessee's income at nil. Issues: (i) Whether depreciation claimed on assets whose cost was allowed earlier as application of income is allowable; (ii) Whether investment in fixed deposit receipts (FDRs) in the modes specified under section 11(5) qualifies as application of income for deduction under section 11; (iii) Whether computation of 85% of income for application purposes should consider receipts after adjusting expenditure and affect requirement of notice under section 11(2); (iv) Whether the Assessing Officer/CIT(A) correctly enhanced the taxable income and erred in para 6.6.Issue (i): Whether depreciation on assets, the cost of which was earlier treated as application of income, is allowable for computing application of income for the previous year.Analysis: The Court considered jurisdictional High Court authority holding that where income is exempt, depreciation reduces the income for determining percentage of funds to be applied; double deduction is not accepted by Revenue where depreciation is required to be taken into account to compute applied funds. The Tribunal followed the High Court precedents and applied those principles to the facts.Conclusion: Depreciation of Rs. 2,16,39,334/- is allowable; the claim of depreciation in the year is accepted (in favour of the assessee).Issue (ii): Whether net additions to FDRs invested in modes specified by section 11(5) qualify as application of income under section 11(1).Analysis: The provisions of section 11(5) list permitted modes of investment; the entity's memorandum of association permitted investment as per section 11(5); the assessee invested surplus in FDRs meeting section 11(5) requirements and had similar investments accepted in earlier assessment years. The Tribunal applied the statutory test in section 11(2)/11(5) and the consistency principle given earlier assessments.Conclusion: The investment in FDRs (net additions) qualifies as application of income of the previous year and is allowed (in favour of the assessee).Issue (iii): Whether 85% computation for application of income should be based on receipts after adjusting expenditure and whether a notice under section 11(2) was required.Analysis: Only 85% of the income (receipts after adjusting expenditure) is to be considered for application requirement. Where application of income (including fixed assets and permitted investments) equals or exceeds receipts such that 85% requirement is met, there is no obligation to issue notice under section 11(2); statutory conditions in section 11(2) were examined and applied.Conclusion: The computation of applied income must consider 85% of income after expenditure; no notice under section 11(2) was required in the facts, and the CIT(A)'s contrary observation is set aside (in favour of the assessee).Issue (iv): Whether the Assessing Officer/CIT(A) correctly enhanced the assessed income and the consequential enhancement in para 6.6.Analysis: In light of conclusions on depreciation and FDRs being application of income, the surplus computed by the authorities was incorrect; prior acceptance of investment treatment and the corrected computations lead to different taxable result.Conclusion: The enhancement of income made by the CIT(A) is set aside; the Assessing Officer is directed to adopt income at nil (partly in favour of the assessee).Final Conclusion: The Tribunal allowed grounds relating to allowance of depreciation, qualification of FDR investments as application of income, and correct computation under section 11/12, set aside the CIT(A) enhancement, and directed recomputation leading to nil taxable income; an alternate ground regarding adjustment of earlier excess expenditure was dismissed as not adjudicated.Ratio Decidendi: Where a trust or society invests surplus in modes specified under section 11(5) and applies expenditure (including permitted investments and allowable depreciation) such application counts for section 11(1) purposes; depreciation on assets may be allowed for computing applied funds despite prior allowance of asset cost as application, and 85% application requirement is to be computed on receipts after adjusting expenditure.