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Commissioner Of Income-Tax, Kerala v. Official Liquidator, New Era Mfg. Co. Ltd.

Kerala High Court
Jun 14, 1977
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Structured Summary of the Legal Opinion (Kochu Thommen, J.)

Factual and Procedural Background

The Income-tax Appellate Tribunal, Cochin Bench referred the following question to the High Court at the instance of the Commissioner of Income-tax, Kerala, Ernakulam:

“Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in holding that the assessee, a company (in liquidation) during the assessment year 1963–64, is entitled to carry forward and set off the unabsorbed depreciation of the assessment year 1963–64 and earlier years against the profits worked out under section 41(2) for the assessment year 1970-71?”

The assessee-company went into liquidation during the financial year 1963–64. Returns for subsequent years, including assessment year 1970–71 (accounting year 1969–70), were filed by the official liquidator. During the accounting year 1969–70 some plant, machinery and furniture were sold for Rs. 1,08,743 (Rs. 1,00,000 for plant and machinery; Rs. 8,743 for furniture). The plant and machinery had been the subject of depreciation in earlier assessment years, and an unabsorbed depreciation of Rs. 1,81,019 existed at the time the company went into liquidation.

In the return, no profit under section 41(2) was disclosed; a note stated that the value realised by sale of plant and machinery was less than book value. The Income-tax Officer estimated a written down value (WDV) of Rs. 35,692 for the plant and machinery for purposes of section 41(2), adjusted this against the Rs. 1,00,000 sale proceeds, and assessed a profit of Rs. 64,308 under section 41(2). On appeal, the Appellate Assistant Commissioner allowed the assessee to treat unabsorbed depreciation (under section 32(2)) as available for the previous year and set it off against profits computed under section 41(2) for assessment year 1970–71.

The department appealed to the Tribunal. Before the Tribunal the assessee did not challenge the computation of WDV or the profit under section 41(2); the only question considered by the Tribunal was whether the carried forward unabsorbed depreciation could be set off against profits under section 41(2). The Tribunal, following an Allahabad High Court decision (Commissioner of Income-tax v. Rampur Timber & Turnery Co. Ltd.), held that the carried forward unabsorbed depreciation was available and could be set off against the section 41(2) profits.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, the assessee (a company in liquidation during the accounting/assessment year 1963–64) is entitled to carry forward and set off the unabsorbed depreciation of the accounting year 1963–64 and earlier years against the profits computed under section 41(2) for the assessment year 1970–71?

Arguments of the Parties

Appellate Assistant Commissioner's / Assessee's Position

  • The Appellate Assistant Commissioner held that under section 32(2) the unabsorbed depreciation allowance of earlier years could be treated as depreciation allowance for the relevant previous year and thus set off against the profits computed under section 41(2) for assessment year 1970–71.
  • In the assessee’s return no profit under section 41(2) was shown; a note indicated sale value was less than book value. The assessee did not dispute the computation of written down value or the arithmetic of the profit under section 41(2) before the Tribunal.

Revenue's Arguments

  • Counsel for the revenue relied on the Supreme Court decision in Commissioner Of Income Tax, Madras v. The Ajax Products Limited, [1965] 55 ITR 741 (SC), invoking principles from section 10(2)(vii) of the 1922 Act to argue the need for the business to have been carried on in the relevant previous year for such receipts to be treated as profits of the business. The revenue thus sought to distinguish or challenge the availability of carried-forward depreciation to offset section 41(2) receipts.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Commissioner of Income-tax v. Rampur Timber & Turnery Co. Ltd., [1973] 89 ITR 150 (All) Authority for applying carried forward unabsorbed depreciation as available to set off against receipts charged under section 41 (interpretation under a provision of section 41 identical on this point) The Tribunal followed this Allahabad High Court decision in holding that past unabsorbed depreciation was available as depreciation allowance and could be set off against profits determined under section 41(2).
East End Dwellings Co. Ltd. v. Finsbury Borough Council, [1952] AC 109 (HL) Quotation used to explain the approach to statutory fictions—if legislature creates a fiction, one must accept its corollaries (Lord Asquith's formulation) The court invoked this authority (Lord Asquith) to justify giving effect to the corollaries resulting from the legislative fiction in the Explanation to section 41(2), i.e., projecting the business into the relevant previous year.
Commissioner Of Income Tax, Madras v. The Ajax Products Limited, [1965] 55 ITR 741 (SC) Examined requirement under section 10(2)(vii) (1922 Act) that business be carried on during the whole or part of the previous year for sale proceeds to be treated as business profits The court observed that this Supreme Court decision was not in pari materia with the provisions under consideration (section 41(2) with its Explanation) and therefore of little help; the High Court did not follow the Ajax decision for the present provisions.

Court's Reasoning and Analysis

The court's analysis proceeded by close textual interpretation of the relevant statutory provisions (section 32(2), section 41(2) including its Explanation, and section 41(5)):

  1. Section 32(2) permits an assessee to carry forward any unabsorbed depreciation allowance to succeeding previous years and treat the carried-forward amount as the depreciation allowance of those years. The court emphasised that the unabsorbed depreciation of the past is thus treated as the depreciation allowance for the relevant previous year in which the business ceased to exist.
  2. Section 41(5) allows losses that arose in the year in which the business ceased, and which could not be set off in that year, to be set off against income chargeable under certain subsections of section 41 (including subsection (2)). The court cited this to show a statutory route for set-off of carried-forward amounts against income under section 41(2).
  3. Section 41(2), and specifically its Explanation, creates a statutory fiction: where moneys payable for the sale of plant, machinery, etc., become due in a previous year in which the business is no longer in existence, the receipts are to be treated as if the business were in existence in that previous year. The court explained that this projects the business into the relevant previous year for tax purposes.
  4. Given this legislative fiction, the court held that it would be inconsistent to charge the income computed under section 41(2) without first allowing the legitimate corollary of set-off — namely the carried-forward unabsorbed depreciation that, under section 32(2), is to be treated as the depreciation allowance of the relevant previous year. The court relied on the East End Dwellings formulation to justify treating the corollaries of the fiction as inevitable and legitimate.
  5. The Tribunal's reliance on the Allahabad High Court decision in Commissioner of Income-tax v. Rampur Timber & Turnery Co. Ltd. was affirmed as correctly applying the same principle (the earlier decision turned on subsection (1) of section 41 which is identical on the relevant point to subsection (2)).
  6. The Supreme Court decision in Ajax was considered but rejected as not being in pari materia with the present statutory provision; accordingly the High Court found Ajax of little assistance and did not follow it for the special statutory scheme created by section 41(2) with its Explanation and section 32(2).

Holding and Implications

HOLDING: The court answered the referred question in the affirmative — in other words, it held in favour of the assessee and against the department. Concretely, the court held that the assessee (the company in liquidation) is entitled to carry forward and set off the unabsorbed depreciation of the earlier years (including the year the business ceased) against the profits computed under section 41(2) for assessment year 1970–71.

Implications:

  • The direct effect is that the carried-forward unabsorbed depreciation (treated as the depreciation allowance of the relevant previous year by section 32(2)) must be available to set off against the income chargeable under section 41(2) once the Explanation projects the business into the relevant previous year.
  • The court explicitly rejected reliance on the Ajax decision for present purposes, finding it not in pari materia with the statutory provisions before the court.
  • The opinion does not articulate any broader new precedent beyond applying and affirming existing interpretative principles to the statutory scheme; its immediate practical consequence is the entitlement of the assessee to the set-off and the direction that a copy of the judgment be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.

A copy of the judgment was ordered to be forwarded, under seal and signature, to the Income-tax Appellate Tribunal, Cochin Bench.

Show all summary ...

Kochu Thommen, J.:— At the instance of the Commissioner of Income-tax, Kerala, Ernakulam, the following question has been referred to us by the Income-tax Appellate Tribunal, Cochin Bench.

“Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal is correct in law in holding that the assessee, a company (in liquidation) during the assessment year 1963–64, is entitled to carry forward and set off the unabsorbed depreciation of the assessment year 1963–64 and earlier years against the profits worked out under section 41(2) for the assessment year 1970-71?”

[From the facts stated by the Tribunal, it would appear that the year 1963–64 has been mistakenly referred to in the question as the assessment year, whereas it should have been mentioned as the accounting year]. The assessee-company went into liquidation during the financial year 1963-64. Returns were filed by the official liquidator for the subsequent years including 1970-71. The accounting year for 1970–71 was the financial year 1969-70. During that accounting year some plant, machinery and furniture belonging to the assessee were sold for Rs. 1,08,743. Of this sum, Rs. 1,00,000 represented the sale of plant and machinery and the balance represented the sale of furniture. The plant and machinery were the subject-matter of depreciation in the earlier assessment years, but as the assessee did not make any profit, the depreciation which remained unabsorbed had to be carried forward from year to year. During the assessment year 1963–64 when the assessee went into liquidation it had an unabsorbed depreciation of Rs. 1,81,019. In the return filed by the assessee, no profit under section 41(2) of the Income-tax Act, 1961, was disclosed. A note was, however, added in the return showing “value realised by sale of plant and machinery is less than book value”. No income was shown.

2. The Income-tax Officer estimated the written down value of the plant and machinery for the purpose of section 41(2) at Rs. 35,692 and adjusted the same against Rs. 1,00,000 being the sale price of plant and machinery. He thus arrived at a profit of Rs. 64,308 which was held to be assessable under section 41(2). On appeal by the assessee, the Appellate Assistant Commissioner held that the assessee was entitled under section 32(2) to treat the unabsorbed depreciation allowance of the earlier years as depreciation allowance for the year previous to the assessment year 1964–65 and set off the same against the profits computed under section 41(2) for the assessment year 1970-71.

3. The department filed an appeal before the Tribunal. The assessee did not question before the Tribunal the correctness of the computation of the written down value or the profit under section 41(2). The only question-which was considered by the Tribunal was whether the unabsorbed depreciation brought forward from the earlier years was available to the assessee for a set-off against the profits under section 41(2) for the assessment year in question. Following the decision of the Allahabad High Court in Commissioner of Income-tax v. Rampur Timber & Turnery Co. Ltd., [1973] 89 ITR 150 (All), the Tribunal held that the unabsorbed depreciation of the past years was available as depreciation allowance in the relevant previous year and it could be set off against the profits determined as assessable under section 41(2) for the assessment year 1970-71.

4. Section 32 of the Act allows certain deductions in respect of depreciation of buildings, machinery, plant or furniture owned by an assessee and used for the purpose of his business or profession. Sub-section (2) of that section allows an assessee to carry forward any unabsorbed depreciation allowance to the following previous year and set off the same against that year's profits, and so on for succeeding previous years. This sub-section reads as follows:

“(2) Where, in the assessment of the assessee (or, if the assessee is a registered firm or an unregistered firm assessed as a registered firm, in the assessment of its partners) full effect cannot be given to any allowance under clause (i) or clause (ii) or clause (iv) or clause (v) or clause (vi) of subsection (1) or under clause (i) of sub-section (1A) 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 sub-section (2) of section 72 and sub-section (3) of section 73, the allowance or 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 that previous year, and so on for the succeeding previous years.”

5. The unabsorbed depreciation of the past is thus treated as the depreciation allowance for the relevant previous year in which the business ceased to exist.

6. Sub-section (5) of section 41 says:

“(5) Where the business or profession referred to in this section is no longer in existence and there is income chargeable to tax under subsection (1), sub-section (2), sub-section (2A), sub-section (3) or sub-section (4) in respect of that business or profession, any loss, not being a loss sustained in speculation business or under the head ‘Capital gains’, which arose in that business or profession during the previous year in which it ceased to exist and which could not be set off against any other income of that previous year shall, so far as as may be, be set off against the income chargeable to tax under the sub-section's aforesaid.”

7. These provisions indicate that the carried forward unabsorbed depreciation is available for set-off against the income chargeable to tax under subsection (2) of section 41.

8. Sub-section (2) of section 41 reads:

“(2) Where any building, machinery, plant or furniture which is owned by the assessee and which was or has been used for the purposes of business or profession is sold, discarded, demolished or destroyed and the moneys payable in respect of such building, machinery, plant or furniture, as the case may be, together with the amount of scrap value, if any, exceed the written down value, so much of the excess as does not exceed the difference between the actual cost and the written down value shall be chargeable to income-tax as income of the business or profession of the previous year in which the moneys payable for the building, machinery, plant or furniture became due:…….

Explanation.— Where the moneys payable in respect of the building, machinery, plant or furniture referred to in this sub-section become due in a previous year in which the business or profession for the purpose of which the building, machinery, plant or furniture was being used is no longer in existence, the provisions of this sub-section shall apply as if the business or profession is in existence in that previous year.”

9. In the instant case, although the plant and machinery were sold only in the accounting year 1969–70, and the business of the company had ceased to exist during 1963–64, it is by means of the fiction introduced in the Explanation that the profits earned by the assessee by such sale are to be treated as the chargeable income of the business of the previous year in which the amounts were received. In other words, the Explanation projected the business into the relevant previous year in which the profits were received, thereby making such receipts chargeable to tax under the subsection.

10. The legislature having introduced the fiction to bring to charge the receipt by sale of plant and machinery in the relevant previous year as the income of the business of that previous year, although the business had ceased to exist earlier, one cannot, to quote Lord Asquith in East End Dwellings Co. Ltd. v. Finsbury Borough Council, [1952] AC 109, [1951] 2 All ER 587 (HL), permit one's imagination to boggle when it comes to the inevitable corollaries of the state of affairs introduced by the fiction. Consequently, the income computed under sub-section (2) of section 41, which with the aid of the Explanation is made chargeable to tax even when the business was no longer in existence in the relevant previous year, has to be, before it is charged, subjected to a set-off against the carried forward depreciation allowance by giving full play to the provisions of sub-section (2) of section 32 and sub-section (5) of section 41. In our view, the Tribunal correctly followed the principle laid down by the Allahabad High Court in the decision cited above, although that decision turned on the interpretation of sub-section (1) of section 41 which on this point is identical to subsection (2) of section 41.

11. Counsel for the revenue brought to our notice the decision of the Supreme Court in Commissioner Of Income Tax, Madras v. The Ajax Products Limited, [1965] 55 ITR 741 (SC). In that case the court examined the provisions of section 10(2)(vii) of the Indian Income-tax Act, 1922, and held that even after the 1949 amendment of that Act, it was necessary that during the whole or a part of the previous year, the business should have been carried on by the assessee in order that the excess realised on the sale of building, machinery or plant, could be treated as profits of the business under the second proviso to that sub-section. In our view, the sub-section considered by the Supreme, Court is not in pari materia with the provisions under consideration in the instant case and, therefore, that decision is of little help for the present purpose. We are of the view that since the business of the assessee should be deemed to have been in existence in the accounting year relevant to the, assessment year 1970–71, the unabsorbed depreciation of the past years is available as the depreciation allowance in the relevant accounting year in which the company closed its business, and such allowance can be set off against the sum computed in terms of section 41(2) for the assessment year 1970-71. In the circumstances, we answer the question referred to us in the affirmative, that is, in favour of the assessee and against the department.

12. A copy of this judgment, under the seal of the High Court and the signature of the Registrar, shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.