Depreciation on second hand assets: Anti abuse cost substitution requires recorded AO satisfaction and prior Joint Commissioner approval.

Challenge to the assessment notice fails: omission to specify the category of scrutiny and alleged non-compliance with a CBDT instruction did not vitiate a section 143(2) notice issued within time where the assessee participated and suffered no prejudice. Invocation of Explanation 3 to substitute declared cost for depreciation is unsustainable absent the mandatory prerequisites: a recorded satisfaction by the Assessing Officer about the transfer's primary tax-avoidance purpose and prior approval of the Joint Commissioner. Consequently, the depreciation disallowance on second hand machinery was deleted while the notice validity ground was dismissed.

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Issues: (i) Whether the notice issued under section 143(2) of the Income-tax Act, 1961 dated 09.08.2018 is invalid for non-mention of type of scrutiny and non-compliance with CBDT Instruction F. No. 225/157/2017/ITA-II dated 23.06.2017; (ii) Whether the disallowance of depreciation of Rs. 31,41,044/- claimed on second-hand machinery by invoking Explanation 3 to Section 43(1) of the Income-tax Act, 1961 is sustainable where no recorded satisfaction and no prior approval of the Joint Commissioner are on record.

Issue (i): Validity of notice under section 143(2) for non-mention of scrutiny type and alleged non-compliance with CBDT instruction.

Analysis: The notice was issued within the statutory time limit and scrutiny proceedings were conducted (CASS). CBDT Instruction is administrative. The assessee participated in assessment without raising jurisdictional objection before completion. Procedural omission of specifying scrutiny category in the notice does not show prejudice or nullify the statutory notice where selection and scrutiny occurred within time.

Conclusion: The notice under section 143(2) is not invalidated by omission to specify the type of scrutiny or by alleged non-compliance with the CBDT instruction; this ground is dismissed.

Issue (ii): Validity of disallowing depreciation on second-hand machinery by applying Explanation 3 to Section 43(1) without recorded satisfaction and prior approval of the Joint Commissioner.

Analysis: Section 32(1) permits depreciation where the asset is owned and used for business; there is no statutory bar on depreciation for second-hand assets. Explanation 3 to Section 43(1) can be invoked only if (a) the Assessing Officer records satisfaction that the main purpose of transfer was tax reduction by claiming depreciation on an enhanced cost, and (b) the Assessing Officer determines actual cost only after obtaining prior approval of the Joint Commissioner. Both conditions are mandatory. The assessment record and remand report contain no recorded satisfaction, no finding of collusion or inflated price, and no prior approval from the Joint Commissioner; the AO proceeded on an assumption that depreciation is limited to the residual value in the hands of the previous owner without statutory compliance.

Conclusion: Invocation of Explanation 3 to Section 43(1) is legally unsustainable in the absence of recorded satisfaction and prior approval; the disallowance of Rs. 31,41,044/- is deleted and Grounds Nos. 4 to 6 are allowed in favour of the assessee.

Final Conclusion: The appeal is partly allowed - the challenge to the validity of the notice under section 143(2) is dismissed while the addition relating to depreciation on second-hand machinery is deleted, resulting in a partly favorable outcome for the assessee.

Ratio Decidendi: Explanation 3 to Section 43(1) of the Income-tax Act, 1961 cannot be applied to substitute the actual cost declared by the assessee unless the Assessing Officer records the statutory satisfaction regarding the main purpose of transfer and obtains prior approval of the Joint Commissioner; absent these mandatory prerequisites the assessee is entitled to depreciation on the actual cost of the asset.

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