Deprecation in case of composite income from cultivation, manufacture and sale of tea, coffee and rubber. Explanation 7 to section 43(6) appears to be an invalid insertion.

[C.A. DEV KUMAR KOTHARI]

CREATE NEW CONTROVERSIES AND UNSETTLE SETTLED THINGS IS THE ORDER OF THE DAY.  

Synopsis:

Amendment of meaning of WDV by insertion of new Explanation 7 in Section 43(6) in relation to WDV in case of assets used in  business yielding  composite incomes, has effect of amending even meaning of agricultural income, furthermore this will unsettle legal position well settled by the Supreme Court long ago. This amendment may, on challenge is likely to be considered as ultravirse the Income Tax Act and also ultravirse the Indian Constitution. An attempt is made to analyze the provision and its implication.  

Tea Plantations in India :

Besides Assam, Darjeeling and Nilgiri other tea producing regions in India are the Cachar, Dehradun, Dooars, Kangra, Manipur, Terai and Travancore.

From website of Tea Board

Tea plantations in India are mainly located in rural hills and backward areas of North-eastern and Southern States. Major tea growing areas of the country are concentrated in Assam, West Bengal, Tamil Nadu and Kerala. The other areas where tea is grown to a small extent are Karnataka, Tripura, Himachal Pradesh, Uttaranchal, Arunachal Pradesh, Manipur, Sikkim, Nagaland, Meghalaya, Mizoram, Bihar and Orissa. In many of these states there is no agricultural income tax.

The new Explanation shall also effect composite  income of Rubber Estates  and coffee Estates. Coffee and Rubber are also grown in few states were there is agricultural income tax.  

Power of Central Government to impose tax on income :

The Central Government has authority to impose tax on income other than agricultural income. Accordingly, agricultural income cannot be taxed by the Central Government and in fact exemption vide Section 10 (1) of the Income-tax Act,1961 itself is a superficial provision, because even in absence of such a provision the agricultural income will not be subject to income-tax levied by the Central Government.

Depreciation allowance:

 Under the Income Tax Act, as per scheme of depreciation provisions,  depreciation on eligible assets can be actually allowed to the extent of actual cost, until and unless full cost is actually allowed under the Income-tax Act, the asset will form part of block of assets (unless the asset all assets in the block are sold or sale value of some assets exceed WDV b/f + cost of additions in the block. This is to compute real business income or chargeable income over a period of time. The scheme of depreciation, as applicable in relevant cases is to allow depreciation on written down value at prescribed rate from year to year.

Well settled and interpreted meaning of "actually allowed"

Long ago the Supreme Court has interpreted meaning of 'actually allowed' as used in provisions relating to depreciation allowance under old and new provisions both. Recently the Supreme Court in case of Doom Dooma Tea [2009 -TMI - 32437 - SUPREME COURT] considered two examples for computing business income of  tea namely taking 40% of revenue , expenses and depreciation and other example by taking 100% of revenue, expenses and depreciation and then taking 40% proportionate income as business income liable to tax. In both cases Supreme Court found that only 40% of total allowable deprecation at prescribed rates is actually allowed and only such actuall allowance can be deducted from cost to determine WDV.

In case of partly taxable income where world income or composite income is computed at first instance and then only a proportion of such world income or composite income is taxable the Supreme Court had considered such issues long ago. The legal position that only proportionate depreciation which is actually allowed or debited against taxable income can be deducted. Thus the legal position was well settled long ago. Some excerpts from judgments are as follows:

Madeva Upendra Senai V UOI [2008 -TMI - 6436 - SUPREME Court]. A larger constitutional  Bench of seven Judges decided this matter. The concept and the term 'written down value', as defined in section 43(6) was considered. According to this judgment  WDV  means the actual cost of a depreciable asset minus depreciation actually allowed by the assessing officer while computing taxable income under the provisions of the Income-tax Act, 1961 and earlier enactments for computation of income for the purpose of income tax levied by the Central Government on income chargeable to the Central income-tax. The key words 'actual cost' and  `actually allowed' were held as the pivot of the meaning of 'written down value'. Any notional allowance or any allowance merely allowable will not be deducted from the actual cost or WDV unless benefit of depreciation has been actually given effectively in the assessment of taxable income by the Assessing Officer it will not be deducted.

CIT V Dharampur Leather Co. Ltd 1965 -TMI - 49238 - (SUPREME Court).

Depreciation allowed or merely allowable during tax holiday period by State Government under state tax Act was also held to be not depreciation actually allowed under Income-tax act, and therefore such depreciation was not to be deducted from written down value and actual cost of assets was taken as actual cost and WDV when the provisions of the income-tax were extended.

CIT V Nandlal Bhandari Mills Ltd 1965 -TMI - 49240 - (SUPREME Court), Hukumchand Mills Ltd V CIT 1966 -TMI - 39897 - (SUPREME Court). 

When only a portion of gross income, or global income is taxable, then depreciation actually allowed will be only to the extent and in proportion of taxable income comprised in the gross income or global income and not the full amount of depreciation considered while computing gross income or global income

In case of Tea Company :

In many cases formulae to deduct of 40% of total notional allowance was accepted by Assessing Officers while computing depreciation allowance from year to year on WDV basis. In case of Suman Tea and Plywood Industries P. Ltd, when assessee sold tea estate, and question of  computation of balancing charge or terminal depreciation arose. The CIT(A) held that entire amount of depreciation considered while computing composite income in earlier years is to be deducted instead of 40% o such amount which is actually allowed under I.T.Act. The matter before the Tribunal was argued by the author. And Tribunal  while interpreting the expression "actually allowed" when Rule 8 is applicable, concluded that only 40% of total deprecation is actually allowed and that much only can be deducted from actual cost to determine WDV. This happened some time during 1986 -87 that is about 23 years ago. This was affirmed by the Calcutta High Court in CIT V Suman Tea 1993 -TMI - 20686 - (CALCUTTA High Court) vide judgment dt. 25.08.1993 that is about sixteen years ago. This judgment was not challenged by the Revenue before the Supreme Court and the legal position was settled. Again in the case of same assessee in judgment reported as CIT V Suman Tea & Plywood Ind. P. Ltd 1997 -TMI - 17682 - (CALCUTTA High Court) dated 04.03.1997 the Court followed the earlier ruling and allowed claim of WDV based on actual cost less depreciation actually allowed that is 40% of notional depreciation charged against composite income. Departments SLP against this judgment was dismissed long ago on 13.02.1998 for want of merit and delay both in the following terms:

 " There is a delay of 157 days in the filing of the special leave petition for which no satisfactory explanation has been offered. The applications for condonation of delay are therefore, dismissed. Even otherwise, we see no merit in the petition and the same are accordingly dismissed on the ground of delay as well as merits."

Source: (2004) 7 CAPJ at page 918 (in section knowledge resource).  

Therefore, legislative intention was interpreted long ago and there is no factor of any change in it. There is no question of ascertainment of legislative intention in this regard by the newly formed government.

Legislative intention as apparent from old circulars of CBDT :

Board's circulars issued from time to time (first being in the year 1955 - that is more than fifty years ago) in connection with development rebate, development allowance and investment allowance in which it has consistently been held by the Board that in case of tea companies where rule 8 applies only 40% of total composite income is business income chargeable under the Act, the rebate or allowance actually allowed against business income under income-tax act is only 40% and therefore, there will be sufficient compliance if relevant reserve is created equal to 40% of rebate or allowance claimed. In this regard extract from some are given below to indicate consistent intention:

Relevant part from the Circular no. 27 (LIIX-2), dated 06.07.1955 :

"TEA COMPANIES

The rates of development rebate in the case of a tea company are the same as in the case of any other company engaged in a non-priority industry. However, as the total income of a tea company consisting of its non-agricultural profits is computed at 40 per cent of its total profit and gains from the business of growing and manufacturing tea, the development rebate is, in effect, allowed only to the extent of 40 per cent of the amount of development rebate calculated at the prescribed rates."

Again in 1958 also similar views were take by the Board Vide Board's Circular Letter F. No. 1(8)-58-TPL, dated 1-11-1958.

From the above two referred circulars we find  that even in context of I.T. Act, 1922 it was consistently considered that in case of tea company where only 40% of total tea income is taxable, only 40% of total allowance deducted from composite income is actually allowed.

Relevant portion from some circualr issued after I.T. Act, 1961

Vide Board's Circular Letter F. No. 1(8)-58-TPL, dated 1-11-1958, it was clarified that in the case of tea companies it would be sufficient compliance if the reserve created is equal to 75 per cent of the amount actually allowed as development rebate. Since the conditions regarding the creation of reserve for the grant of development allowance under section 33A are identical to those prescribed with regard to the creation of reserve for claiming deduction on account of development rebate, it is clarified that the reserve required to be created for claiming development allowance should be calculated at 75 per cent of the amount which is actually allowed by way of development allowance, i.e., 75 per cent of 40 per cent of the amount calculated on the basis of specified percentage of the cost of planting tea bushes.

Circular : No. 325 [F. No. 202/62/77-IT(A-II)], dated 3-2-1982.

Similar view is expressed in the Circular : No. 324 [F. No. 202/47/79-IT(A-II)], dated 3-2-1982 regarding Investment allowance.

Judicial note of circulars and application about depreciation :

The above circulars were  considered in CIT v. Suman Tea & Plywood Industries (P.) Ltd. 1993 -TMI - 20686 - (CALCUTTA High Court), and  it was observed that in CBDT Circular No. 27, dated 6-7-1955 as well as Circular No. 324, dated 3-2-1982, it has been explained that in respect of tea companies investment allowance, development rebate, etc., are  actually  allowed only to the extent of 40 per cent of the amounts calculated at the prescribed rates and therefore reserves of 75% of the  amount actually allowed is to be created.

The author has also relied on these circulars and various earlier judgments of Supreme Court on the point of "actually allowed' in context of WDV in case of tea company. Therefore the Tribunal took view of legislative intention as per language used in the Act as well as the views of the CBDT, which is the highest administrative authority for the Income-tax Act.

Therefore, it is clear that all along the legislative intention as well as bureaucratic view has been that in case of tea company where Rule 8 is applied, only 40% of total deduction allowed against composite income is "actually allowed".

Amendment vide The Finance (No.2) Act, 2009 :

In the corresponding Finance Bill we found  that honorable Finance Minister  proposed an amendment that is totally against the legislative intention as expressed by Board and Courts earlier, as discussed above. After amendment, entire amount of depreciation notionally considered as deduction from composite income will be deducted from actual cost to determine WDV. In view of New Explanation 7 which reads as follows:

'Explanation 7.— For the purposes of this clause, where the income of an assessee is derived, in part from agriculture and in part from business chargeable to income-tax under the head "Profits and gains of business or profession", for computing the written down value of assets acquired before the previous year, the total amount of depreciation shall be computed as if the entire income is derived from the business of the assessee under the head "Profits and gains of business or profession" and the depreciation so computed shall be deemed to be the depreciation actually allowed under this Act.'.

Notes on clause 17

Clause 17 of the Bill seeks to amend section 43 of the Income tax Act, relating to definitions of certain terms relevant to income from profits and gains of business or profession.

Clause (ii) of sub-section (1) of section 32 provides that depreciation is to be allowed and computed at the prescribed percentage on the written down value (WDV) of any block of assets. Sub-clause (b) of clause (6) of section 43 provides that WDV in the case of assets acquired before the previous year shall be computed by taking the actual cost to the assessee less all depreciation "actually allowed" to him under the Income-tax Act.

Rules 7A, 7B and 8 of the Income tax Rules, 1962, deal with the computation of composite income where income is derived in part from agricultural operations and in part from business chargeable to tax under the Income tax Act, 1961 under the head "Profits & Gains of Business". These rules prescribe the method of computation in the case of manufacture of rubber, coffee and tea. In such cases, the income which is brought to tax as "business income" is a prescribed fixed percentage of the composite income.

The Hon'ble Supreme Court in the case of CIT Vs. Doom Dooma India Ltd [2009 -TMI - 32437 - SUPREME COURT] has held that in view of the language employed in sub-clause (b) of clause (6) of section 43 regarding depreciation "actually allowed", where any income is partially agricultural and partially chargeable to tax under the Income tax Act, 1961 under the head "Profits & Gains of Business", the depreciation deducted in arriving at the taxable income alone can be taken into account for computing the WDV in the subsequent year. For instance, Rule 8 prescribes the taxability of income from the manufacture of tea. Under the said rule, income derived from the sale of tea grown and manufactured by seller shall be computed as if it were income derived from business, and 40% of such income shall be deemed to be income liable to tax. As a result of the Court decision on depreciation to be "actually allowed" for computing WDV, the resultant computation of depreciation is as per the following illustration:                 

	Rs.
Sale proceeds of made tea -	1,000
Less : Expenses -
Depreciation -(10% of Rs. 1,000)	(100)
Others expenses-	(300)
Composite income -	600
Income subject to charge under the I.T. Act,1961 by application of Rule 8 (40% of 600) -	240
Income not chargeable to income-tax (60% of 600) -	360

According to the interpretation of the Court, the W.D.V. of the fixed asset for the immediately succeeding year is to be taken at Rs.960/- (Rs.1,000 minus Rs.40 being depreciation allocated for business income) and not Rs.900/- (Rs.1,000 minus depreciation of Rs.100/- allowed for determining composite income). Thus the depreciation for which deduction is allowed to the assessee while computing its agricultural income is to be ignored for computing the W.D.V. of the asset according to the Court ruling.

The above interpretation is not in accordance with the legislative intent. WDV is required to be computed by deducting the full depreciation attributable to composite income. Hence in the above illustration, the WDV of the fixed asset for the immediately succeeding year is to be taken at Rs.900/- and not 960/- as held by the Supreme court. The ambiguity in this case has arisen on account of the interpretation of the meaning of the phrase "actually allowed" in sub-clause (b) of clause (6) of section 43.

It is therefore proposed to provide that in the cases of 'composite income', notwithstanding that the assessee was not required to compute a part of his income for the purposes of Income-tax Act for any previous year, depreciation shall be computed as if the total composite income of the assessee is chargeable under the Income-tax Act and such depreciation shall be deemed to have been "actually allowed" to the assessee. This amendment will take effect from the 1st April, 2010 and will, accordingly, apply in relation to assessment year 2010-11 and subsequent years.

It is also proposed to insert an Explanation in clause (6) of the said section to clarify that where the income of an assessee is derived, in part from agriculture and in part from business of the assessee chargeable to income-tax under the head "Profits and gains of business and profession", for computing the written down value of assets acquired before the previous year, the total amount of depreciation shall be computed as if the entire income is derived from the business of the assessee under the head "Profits and gains of business or profession" and the depreciation so computed shall be deemed to be the depreciation actually allowed during the previous year under the Income-tax Act, 1961.

These amendments will take effect from 1st April, 2010 and will, accordingly, apply in relation to the assessment year 2010-2011 and subsequent years.

About interpretation and legislative intent :

As discussed earlier since 1955 to 1982 in its circulars the Board has consistently held that in case of tea company where Rule 8 applies only 40 % of rebate, allowance or deduction is  allowed or actually allowed under the I.T. Act.  Supreme Court also so held in respect of meaning of WDV long ago. The first  decision of  Tribunal was rendered some time during 1987-88 and the high Court affirmed the same in 1993 and department accepted the same. The second Judgment of Calcutta high Court  on the same issue in case of the same assessee that is Suman Tea & Plywood Ind. P.Ltd  was rendered on 04.03.1997 and affirmed by the Supreme Court on 13.02.1998.  On 18.02.2009 the Supreme Court decided the case of Doom Dooma Tea Co. [2009 -TMI - 32437 - SUPREME COURT] in which the first decision of Calcutta high Court rendered in 1993 has been referred to and approved. Surprisingly the any  counsel did not mention about second judgment of Calcutta High Court and dismissal of the SLP by the Supreme Court for lack of merit.

The present Finance Minister was also Finance Minister about twenty five years ago. He was a  Cabinet Minister of Finance from January, 1982 to December, 1984  and a Minister of State for Finance from October, 1974 to December, 1975.

The question arises as to why an amendment was not brought earlier in this regard when the Tribunal or High Court had decided the issue in favor of assessee and it was accepted by revenue.

There appears no  transparency in the sense that there was no  specific mention  by the Finance Minister on such a vita issue which has effect of indirectly amending the provisions of Indian Constitution ( meaning of agricultural income) and is also to the effect of superseding  judgment of the Supreme Court.  

Therefore, it appears that the amendment is not really due to legislative intention but it  may be  just due to Bureaucratic whim and zeal to show power over  judiciary.

Therefore, the reason given for the amendment is wrong and not justified.

The Explanation is inconsistent with main section :

The Explanation which deem depreciation which has never been allowed under I.T. Act as actually allowed, is inconsistent with main provision. It is also inconsistent with several circulars of the Board in which it has been held that in case of tea income where Rule 8 applies only 40% of deduction or allowance is actually allowed under I.T. Act.

It also goes against the concept that full cost of eligible assets  is actually  allowed over a period of time under the I.T. Act, against chargeable business income  by way of  normal depreciation and  terminal depreciation ( till 31.03.1988)  or as short term capital loss ( since 01.04.1988).

If 100% of depreciation notionally charged against composite income, is deducted from cost  the  net effect will be that the only 40% of actual cost will be allowed under the I.T. Act.

Agricultural income cannot be taxed by the Central Government and it  is not taxed even by most of the State Governments in major parts of our country. The Supreme Court has long ago, held that depreciation allowed by state governments was not actually allowed under I.T. Act and such depreciation is not deductible from actual cost to determine WDV.  See judgment dated 07.12.1965 in  CIT V Nandlal Bhandari Mills Ltd 1965 -TMI - 49240 - (SUPREME Court),  and judgment dated  03.12.1965  in case of CIT V Dharampur Leather Co. Ltd 1965 -TMI - 49238 - (SUPREME Court) and  dated 12.09.1966 in case of  Hukumchand Mills Ltd V CIT 1966 -TMI - 39897 - (SUPREME Court). 

In Straw Products Ltd. vs. Income-tax Officer [2008 -TMI - 5071 - SUPREME Court] OCTOBER 20, 1967 was decided by  honorable judges  (1)  K.N. WANCHOO, CJ. (2) M. HIDAYATULLAH,  J. (3)  J.C. SHAH, J. (4)  R.S. BACHAWAT J (5) V. RAMASWAMI J. (6) , G. K. MITTER AND (7)  K. S. HEGDE, JJ. In this case an order passed by the Central Government to determine WDV by  deducting depreciation allowed or allowable by State Government was held ultravirse the Act.

Supreme Court in judgment dated  07.11.1974 in case Madeva Upendra Senai V UOI [2008 -TMI - 6436 - SUPREME Court] in which honorable judges (1) K.K. MATHEW, (2) P.K. GOSWAMI AND (3) R.S. SARKARIA, JJ. Decided the issue in favour of assessee  by majority and only one of  honorable judge A. ALAGIRISWAMI, took view in favour of the revenue. In this case also it was held by majority  that the depreciation allowed or allowable by State Governments or merely allowable under the I.T. Act is not depreciation actually allowed and cannot be reduced from actual cost to determine WDV for allowing depreciation in future.

The Explanation is also not valid for the reason that the Central enactment like Income Tax Act has to be interpreted in like manner all over India, and its impact should also be similar. So far agricultural income is concerned; it cannot be taxed by the Central Government. Most of state governments had exempted agricultural income from levy of agricultural income tax. Few states where state governments levy tax on agricultural income has different rate of agricultural income tax, therefore, the explanation being inserted in the definition of WDV will have different impact on different assesses in different states and in different circumstances. 

In case of tea companies only 40% of notional depreciation allowance, which is actually allowed under I.T. Act is  carried forward as unabsorbed depreciation this also shows that only 40% of such depreciation is actually allowed as per scheme of the Act and legislative intention. Such  unabsorbed depreciation that is 40% may be  carried forward separately and for indefinite period.

In case State imposes a tax on agricultural income the rate of tax is different,  different provisions are applied in different states and in different circumstances for carry forward of loss for example in Assam carry forward of agricultural  loss is allowed only for three years. The treatment of even unabsorbed depreciation as agricultural loss and carry forward of the same  for different duration also places assessee in different situations although they are equally placed.

Thus, the impact of this provision shall also make impact on meaning of agricultural income and that too differently in different states and in different circumstances.

For example, even in tea growing states like  West Bengal there is no agricultural income tax for last  many years. In the states of Utter Pradesh and Utranchal also there are some tea plantations but there is no agricultural income tax.

For this reason also the proposed Explanation may also be held ultravirse the Constitution, if properly challenged.