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Unabsorbed depreciation — Rules for carry forward

Subject : Income Tax Law
Month-Year : Jan 2006
Author/s : Pradip Kapasi
Gautam Nayak
Chartered Accountants
Topic : Unabsorbed depreciation — Rules for carry forward
Article Details :

1. Introduction :

1.1 S. 32(2) provides for the carry forward of unabsorbed depreciation. It reads as :

"where in the assessment of the assessee, full effect cannot be given to any allowance under Ss.(1) in any previous year, owing to there being no profits or gains chargeable for that previous year or owing to the profits or gains chargeable being less than the allowance, then subject to the provisions of Ss.(2) of S. 72 and Ss.(3) of S. 73, the allowance or the part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of that allowance or if there is no such allowance for that previous year, be deemed to be the allowance for the previous year and so on for the succeeding previous years."

1.2 S. 80 provides for the need to file the return and the need to file the same within the prescribed time. It reads as :

"notwithstanding anything contained in this Chapter, no loss which has not been determined in pursuance of a return filed in accordance with the provisions of Ss.(3) of S. 139, shall be carried forward and set-off under Ss.(1) of S. 72 or Ss.(2) of S. 73 or Ss.(1) or Ss.(3) of S. 74 for Ss.(3) of S. 74A".

1.3 S. 157 provides that an Assessing Officer should notify to the assessee by an order in writing the circumstances narrated therein. It reads as :

"when, in the course of the assessment of the total income of any assessee, it is established that a loss has taken place which the assessee is entitled to have carried forward and set-off under the provisions of Ss.(1) of S. 72, Ss.(2) of S. 73, Ss.(1) or Ss.(3) of S. 74 or Ss.(3) of S. 74A, the Assessing Officer shall notify to the assessee by an order in writing the amount of the loss as computed by him for the purposes of Ss.(1) of S. 72, Ss.(2) of S. 73, Ss.(1) or Ss.(3) of S. 74 or Ss.(3) of S. 74A".

1.4 It is common to come across cases where as-sessees, due to losses and other factors, ignore to file the returns or file delayed returns. Issues arise, in such cases, while carrying forward the unabsorbed depreciation and claiming set-off of the same against the income of the subsequent year, about the need (i) to file the return (ii) within the prescribed time, and (iii) passing of an order assessing such unabsorbed depreciation and permitting the carry forward of the same.

2. Sri Rajarathinam Transports Pvt. Ltd.’s case :

2.1 The assessee, a private limited company in this case, before the Madras High Court reported in 199 ITR 203, in the course of the assessment proceedings, for A.Y. 1965-66 claimed that unabsorbed depreciation totalling to Rs. 78,984 in respect of the A.Ys. 1960-61 to 1964-65 be allowed to him. The Assessing Officer held that the unabsorbed depreciation of Rs.78,984 could not be allowed to be set-off in view of the fact that the depreciation had not been determined for the purpose of being carried forward. In that view, the Income-tax Officer accepted the income returned by the assessee and completed the assessment.

2.2 The Tribunal, also relying on S. 80, concluded that no loss inclusive of depreciation could be carried forward and set-off, unless it had been determined in pursuance of a return. The Tribunal dismissed the appeal of the assessee.

2.3 The following questions of law were referred to the Court, at the instance of the assessee. "Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the assessee is not entitled to set-off of the depreciation claimed to the extent of Rs.13,016, Rs.18,012, Rs.2,304 and Rs.19,487 in the A.Ys. 1960-61, 1961-62, 1662-63 and 1964-65, respectively, inasmuch as the amount was not determined for the respective assessment years ?" and that "Whether, on the facts and in the circumstances of the case, the Tribunal’s decision that the assessee is not entitled to, in view of S. 80 of the Income-tax Act, 1961, the depreciation and allowance in 1965-66 of depreciation relating to the earlier years even though they were not quantified and notified for carry forward in those assessment years, is correct ?"

2.4 The Court noted that u/s.32(2) read with S. 34 of the Act, the depreciation or part of the depreciation in a previous year to which effect has not been given, shall be added to the amount of depreciation for the following previous year and deemed to be part of that allowance, or if there was no such allowance for that previous year, it should be deemed to be the allowance for that previous year and so on for the succeeding previous years. The Court further observed that such finding that the depreciation was not absorbed was possible only in the assessment where full effect could not be given to the depreciation as claimed in any previous year owing to there being no profits or gains chargeable for that previous year or, owing to the profits or gains chargeable being less than the allowance. That in the absence of any specific and clear findings in the assessment order regarding the claim for depreciation, its allowance either in full or in part, as the case may be, and the carry forward of the unabsorbed depreciation in accordance with S. 32(2) of the Act, it was not possible for the assessee to claim set-off of unabsorbed depreciation.

2.5 The Court further observed that Section D of the return of income applicable to companies required adjustments to be made in the income on account of items shown in Section A and Section B of Part I of the return including on account of depreciation or capital expenditure on scientific research carried forward from earlier assessment years as per S. 32(2), S. 35(4) read with S. 72(2) and S. 73(3) of the Act. These adjustments were required to be indicated in the relevant part of the return and that in spite of the details having been so indicated, the depreciation or the carry forward of unabsorbed depreciation was disallowed, then it was for the assessee to further agitate its entitlement to the same and, if it was not so done, then the assessee could not turn around in a later assessment year and claim the benefit of set-off of unabsorbed depreciation, which, according to the Court was not in accordance with S. 32(2) read with S. 34 of the Act.

3. Haryana Hotels Ltd.’s case :

3.1 The Punjab & Haryana High Court was recently asked to deal with the same issue in the case of CIT v. Haryana Hotels Ltd., 197 CTR 449. In this case, in passing the order of assessment u/s.143(3) of the Act for A.Y. 1987-88, the AO disallowed the brought forward losses and unabsorbed depreciation of earlier assessment years and their set-off on the ground that no valid assessment had been made for A.Y. 1986-87.

3.2 The assessee preferred an appeal before the Commissioner (Appeals) wherein it challenged the action of the AO in not allowing set-off of unabsorbed depreciation on the ground that the assessment for the year 1986-87 had not been completed. The Commissioner (Appeals), however, partly allowed the appeal and directed the AO to recalculate the depreciation by taking written-down value determined as on 31st March 1985, and thereafter to calculate and allow the same for the assessment year in question and ordered that the written-down value should accordingly be re-determined for being carried forward to the succeeding year.

3.3 The assessee preferred further appeal to the Tribunal, challenging the order of the Commissioner (Appeals) regarding the carry forward of unabsorbed losses and disallowance of unabsorbed depreciation. The Tribunal allowed the appeal of the assessee and directed the AO to allow the claim of carry forward of unabsorbed depreciation as well as unabsorbed losses.

3.4 At the instance of the Revenue, the Court was requested to address the following question of law. "Without prejudice of the above, whether on the facts and in the circumstances of the case, the Tribunal was right in law in allowing the carry forward of business losses and depreciation when neither any valid return for the A.Y. 1986-87 was filed, nor any business loss and depreciation was determined for the A.Y. 1986-87 to be carried forward in the succeeding year i.e., the A.Y. 1987-88 ?"

3.5 Attention of the Court was drawn to the provisions of S. 72, S. 80, S. 139(3) and S. 157 of the Act and it was contended by the Revenue that in the event of failure on the part of the assessee to file a valid return, no business loss could be carried forward and the Tribunal had, thus, erred in granting relief to the assessee. It was submitted that on the same analogy, as applicable to the carry forward of unabsorbed losses, even unabsorbed depreciation u/s.32(2) of the Act could not be allowed to be carried forward and that the Commissioner (Appeals) and the Tribunal had wrongly allowed the same. The Revenue placed reliance on Sri Rajarathinam Transports (P) Ltd. v. CIT, 199 ITR 203 (Mad.) to augment its submissions.

3.6 In reply, the assessee, controverting the submissions of the Revenue, supported the orders of the Commissioner (Appeals) and the Tribunal, and submitted that in view of the decision of the Apex Court in CIT v. Virmani Industries (P) Ltd. etc. 261 ITR 607 (SC), the Tribunal had rightly allowed set-off and carry forward of unabsorbed depreciation and business losses.

3.7 The Court observed that the reading of S. 32(2) of the Act made it clear that a carried forward unabsorbed depreciation allowance was deemed to be part of and stood on the same footing as current depreciation. It further observed that if in the assessment of the assessee, full effect could not be given to any allowance in any previous year, owing to there being no profits or gains chargeable for that previous year, the allowance or part of the allowance to which effect had not been given, should be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of the said allowance. That there was no time limit provided u/s.32(2) of the Act for carry forward of unabsorbed depreciation to any subsequent year. The Court took note of the decision of the Apex Court in CIT v. Jaipuria China Clay Mines (P) Ltd., 59 ITR 555 (SC), which had held that unabsorbed depreciation of past years had to be added to the depreciation of the current year and the aggregate unabsorbed and current year’s depreciation had to be deducted from the total income of the assessment year.

3.8 The Court, on giving thoughtful consideration, was unable to accept the view as laid down by the Madras High Court in Sri Rajarathinam Transports’ case (supra), as according to the Court, u/s.32(2) of the Act, unabsorbed depreciation of earlier previous years formed part of the current year’s depreciation and thereafter allowance for depreciation was given from the current year’s income. That there was no such provision in S. 72 of the Act by virtue of which business losses of earlier years formed part of the current year’s business losses and allowed to be set-off from current year’s income and in view of that, only such business losses of earlier years which were notified by the AO were allowed to be carried forward and set-off from the current year’s income. That there was no similar provision under the Act which made it mandatory for the assessee to file return for carry forward and set-off of unabsorbed depreciation which was to be notified by the AO as in the case of unabsorbed business loss. On a reading of the provisions of the Act, the distinction between unabsorbed depreciation and unabsorbed business loss for the purposes of set-off and carry forward was clear to the Court.

4. Observations :

4.1 It is intriguing that the issue keeps on arising regularly and it is more disturbing that the controversy persists on an important aspect of the law. The issue concerns itself with a substantial question of law. From a bare reading of the relevant provisions, namely, S. 32(2), S. 72, S. 80, S. 139(3) and S. 157, it is apparent that (i) the depreciation and the business loss are two different concepts under the Income-tax Act, (ii) the two are independent of each other inasmuch as different set of rules are provided for their treatment including for carry forward and set-off of the same, (iii) there is nothing in the above provisions which necessitates passing of an order of carry forward of unabsorbed depreciation and the relevant provisions do not refer to S. 32 at all, and (iv) provisions like S. 72 are not found in S. 32(2).

4.2 The whole controversy seems to be arising out of the words, used in S. 32(2) :

". . . . where in the assessment of the assessee, full effect cannot be given to any allowance under Ss.(1) in any previous year, owing to there being no profits or gains chargeable for that previous year or owing to the profits or gains chargeable being less than the allowance, then subject to the provisions of Ss.(2) of S. 72 and Ss.(3) of S. 73, the allowance or the part of the allowance to which effect has not been given, as the case may be . . . ."

4.3 The Madras High Court has entirely relied upon the above referred words for coming to the conclusion that it was necessary for an assessee to have filed the return of the preceding previous year to enable the determination of the facts that the assessee was in first place eligible for depreciation and that the said depreciation could not be absorbed against the income of that year in full or in part. It was only on verification of these facts, the Madras High Court felt, that the assessee could carry forward the unabsorbed depreciation and claim the set-off of the same. In the circumstances, the Court, with respect, seems to have not given much importance and weightage to the fact that the express provisions of S. 80 and S. 157 do not support such an interpretation.

4.4 The issue of the qualification of the assessee and the determination of the quantum of carry forward can be examined even in the year in which the set-off is claimed by the assessee, as was held by the Supreme Court in the case of Manmohan Das, 59 ITR 699.

4.5 In Virmani Industries (P) Ltd.’s case (supra), the assessee was engaged in the manufacture of soap and oil, during the previous year relevant to the A.Y. 1956-57. The assessee had stopped the business in that year and had let out the factory on hire. Ten years later i.e., in the previous year relevant to the A.Y. 1965-66, the assessee started the business of manufacturing of steel pipes and that business used part of the old machinery which was being used for soap and oil. It was during the assessment proceedings relating to the A.Y. 1965-66, the assessee claimed that the unabsorbed depreciation should be brought forward and set-off against the profits of the new business in respect of the old machinery utilised in the new business. The Apex Court allowed set-off of such depreciation against the income for the accounting period relevant to A.Y. 1965-66.

4.6 In Pioneer Enterprises, 53 ITD 435 (Coch.), the claim of the assessee for set-off of the unabsorbed depreciation was allowed for A.Y. 1989-90, in spite of the fact that the claim for grant of depreciation for the A.Ys. 1986-87 to 1988-89 was specifically disallowed by the Assessing Officer in assessment of those years. It was this depreciation which was allowed to be carried forward and set-off while making the assessment of the subsequent year. In fact, the Tribunal applied the ratio of the above-referred decision of the Supreme Court in the case of Manmohan Das (supra) by holding that the said decision, though rendered in the context of the unabsorbed loss, was equally applicable to the case of unabsorbed depreciation.

4.7 In Jagdish Malpani, 94 TTJ 321 (Ind.), it was held that the provisions of S. 80 did not apply to the case of unabsorbed depreciation by following Vora Industries Tools (P) Ltd., 20 ITD 145 (Pune).

4.8 In Salem District Co-operative Milk Producers Union Ltd., 274 ITR 150 (Mad.), the Madras High Court, in the context of investment allowance, however, held that until the investment allowance was quantified and determined in the relevant assessment year after installation of the machinery, there could not be any question of carrying forward of investment allowance.

4.9 The law as noted earlier does not provide for the need to file the return and get the claim of the depreciation assessed. It also does not provide for an order of carry forward of unabsorbed depreciation. In the circumstances, it will be appropriate not to read too much in the provisions of S. 32(2) which have the effect of restricting the claim of set-off to such depreciation remaining after the set-off of income, if any, in that year. This exercise as noted by the Supreme Court can be carried out even where no return is filed and no order thereon is filed, by verifying the claim in the assessment of the year in which set-off is claimed.

4.10 A Circular of the CBDT accepting what is obvious, if issued, will put the controversy to rest.

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