Section 32, Section 41 of the Income Tax Act, 1961

Facts of the Case:

The assessee who is the manufacturer of soft drinks, purchased bottles and crates, each item of which costed less than Rs. 5,000/- and, therefore, was entitled to and allowed 100% depreciation on the cost of the said bottles and crates, in the year in which they were acquired, under the proviso to Section 32(1)(ii) of the Income Tax Act, 1961.

When bottles and crates got worn out, they were sold by the assessee and proceeds therefrom were shown as "miscellaneous income" in the subsequent years.

If these sales had taken place in the previous years relating to the assessment years prior to 1988-89, the same would, without doubt, would have been included in the business income of the assessee under Section 41(2). This was because prior to the assessment year 1988-89, Section 41(2) inter alia provided for balancing charge which was chargeable as income taxable under the 1961 Act. However, with effect from assessment year 1988-89, Section 41(2), which inter alia dealt with profit on sale of depreciable asset (balancing charge), stood deleted.

Notwithstanding such deletion, the Department sought to tax Rs. 50,850/- holding that the sale proceeds of the 100% depreciated and written off assets can still be treated as the business income of the assessee under Section 41(1) of the 1961 Act.

Observations and Findings of the Supreme Court:

The entire controversy stands resolved if one understands the meaning of "balancing charge".

Where any allowance or deduction had earlier been made in respect of any loss, expenditure or trading liability and subsequently the assessee has obtained or realized any amount towards such loss, expenditure or trading liability, Section 41(1) deems such realization/recoupment as assessee's income for the year in which it is realized.

Section 41(2) as it stood at the material time stated that if in respect of any plant and machinery, any depreciation had been allowed and subsequently such plant and machinery was sold, discarded or destroyed, the assessee might get some value either as a result of sale or insurance or from salvage or compensation thereabout.

The necessity to keep Section 41(2) as a provision in addition to Section 41(1) arose from the fact that, in its very nature, depreciation is neither a loss, nor an expenditure, nor a trading liability, referred to in Section 41(1). The depreciation recovered on sale of the capital asset was includible in the total income as balancing charge only under Section 41(2). That concept was foreign to the scheme of Section 41(1). The balancing charge under Section 41(2) arose only where any depreciable asset (building, machinery, plant or furniture) was sold. In fact, when the concept of "block of assets" stood introduced w.e.f. 1.4.1988, Section 41(2) stood deleted.

However, even after 1.4.1988, the proviso to Section 32(1)(ii) continued till 1.4.1996 when by the Finance (No. 2) Act, 1995 the bottles and crates even below Rs. 5,000/- came within the "block of assets" as defined under Section 2(11) of the 1961 Act. As stated, this judgment is confined to depreciable assets costing less than Rs. 5,000/-which did not enter the block of assets during the assessment years in question (when Section 41(2) stood deleted). Effect of introducing Finance (No. 2) Act, 1995 w.e.f. 1.4.1996:

Decision of the Supreme Court

The bottles and crates purchased prior to 31.3.1995 did not form part of the block of assets, hence, profits on sale of such assets were not taxable as a balancing charge, neither under Section 41(1) nor under Section 50.

In respect of bottles and crates purchased after 1.4.1995, on account of deletion of proviso to Section 31(1)(ii) (vide Finance Act, 1995) such bottles and crates formed part of block of assets and consequently such assets purchased after 1.4.1995, in this case, became exigible to capital gains tax under Section 50.

 

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Nectar Beverages Pvt. Ltd. Versus Deputy Commissioner of Income Tax [2009 -TMI - 34091 - SUPREME COURT]

 

 

Balancing charge: sale proceeds of fully depreciated low-cost assets not taxable as recoupment; block regime alters treatment. Sale proceeds from disposal of fully depreciated low-cost packaging assets purchased before their inclusion in the block-of-assets regime are not taxable as recoupment under the general deeming provision or as a balancing charge; after statutory assimilation into the block regime, such disposals become subject to capital gains treatment under the asset-transfer provisions governing blocks of assets.