DEPRECIATION - section 32. - Controversy due to words 'use and used' in old law and word 'used' in new law - a clarification is desirable.

[C.A. DEV KUMAR KOTHARI]

Summary

Depreciable assets have limited useful life extending over more than one year. Assets, though having some durability but of less than one year useful life is considered as consumable assets- like small tools and zigs. Some assets have limited number of years as useful life because even without full use they get worn out by natural factors. In one way passing of each year of useful life can be considered as depreciation because the remaining life of asset is reduced every day. For allowing depreciation on assets the facts must be in favour to establish that the assets have been used (either actively or passively) for business or profession. Merely relying on legal provisions may not be taken very kindly by the authorities and courts. To avail statutory deductions it is necessary that the facts must be in your favour. As a routine we have experience of the Supreme Court re considering the earlier judgments, retrospective amendments to over come judicial ruling. Therefore,  it is necessary that the facts of taxpayer  must be fully supportive to claim a relief.

Deduction of deprecation from taxable income:

Vide Section 32 of the Income Tax Act, 1962 depreciation is allowed to the owner of specified assets like building, furniture, plant & machinery and intangible assets while computing income from business and profession and also in some cases of income falling under the head income from other sources. The relevant part of the section 32 reads as follows:

Depreciation 32(1) in respect of depreciation (i) … (ii) ……. owned fully or partly by the assessee and used for the purpose of business or profession, the following deduction shall be allowed …….

Thus in the above section  "used" word has been used. The meaning of the term "used" has faced  and is being facing controversy in view of the different views taken by high courts. Off course the majority view is that even passive user entitles assessee to claim depreciation. Relevant portions of Section 32, as they stand now, for the purpose of study of the subject matter are reproduced below with highlights:

Depreciation.

32. (1)In respect of depreciation of—

(i) buildings, machinery, plant or furniture, being tangible assets;

(ii) know-how, patents, copyrights, trade marks, licences, franchises or any other business or commercial rights of similar nature, being intangible assets acquired on or after the 1st day of April, 1998,

owned, wholly or partly, by the assesse and used for the purposes of the business or profession, the following deductions shall be allowed—]

 [(i) in the case of assets of an undertaking engaged in generation or generation and distribution of power, such percentage on the actual cost thereof to the assessee as may be prescribed

(ii) [in the case of any block of assets, such percentage on the written down value thereof as may be prescribe:]

[Provided further that where an asset referred to in clause (i) or clause (ii) [or clause (iia)], as the case may be, is acquired by the assessee during the previous year and is put to use for the purposes of business or profession for a period of less than one hundred and eighty days in that previous year, the deduction under this sub-section in respect of such asset shall be restricted to fifty per cent of the amount calculated at the percentage prescribed for an asset under clause (i) or clause (ii) [or clause (iia)], as the case may be :]

[Provided also that where an asset being commercial vehicle is acquired by the assessee on or after the 1st day of October, 1998 but before the 1st day of April, 1999 and is put to use before the 1st day of April, 1999 for the purposes of business or profession, the deduction in respect of such asset shall be allowed on such percentage on the written down value thereof as may be prescribed.

xxx

 [(iia) in the case of any new machinery or plant (other than ships and aircraft), which has been acquired and installed after the 31st day of March, 2005, by an assessee engaged in the business of manufacture or production of any article or thing, a further sum equal to twenty per cent of the actual cost of such machinery or plant shall be allowed as deduction under clause (ii) :

xxx

We find the following expressions in the above provisions:

a. used for the purposes of the business…

b. is put to use for the purposes of business or profession for a period of less…

c. has been acquired and installed

Therefore, it can be said that in the present law merely word 'used' is not used. Though we find different expressions at three places, but it indicates that the intention is to give wider scope for allowing different type of deprecation and that actual use is not an essence. When for incentive deprecation word used are acquired and installed, there cannot be any reason to infer that for normal deprecation actual use is essential.

Contrary views of Bombay High Court due to different language:

Majority view of High courts is on use- active or passive. Bombay High Court has taken  both views for different years on consideration of some difference in language used in old and new  sections. 

In Dineshkumar Gulabchand Agarwal Vs. CIT [2008 -TMI - 11253 - BOMBAY High Court], the Bombay high court has held that the word "used", as used in section 32 means actually used for the purpose of the business and therefore, depreciation was not allowed when the asset was not used actively, though it was ready for use.

The Bombay High Court has considered the case where the assets were ready for use but were not actually used during the previous year. The assets for consideration was Vehicle which was ready for use and therefore the assessee claimed benefit of depreciation allowance. The assessee also relied on earlier judgment of Bombay High Court in the case of Whittle Anderson Ltd. CIT [2008 -TMI - 7958 - BOMBAY High Court]. In that case the Bombay High Court had earlier held that when the machinery was kept in working condition and ready for use though kept idle was entitled to depreciation allowance. In that case the High Court also noted that the word "use" in Section 10(2) should be understood in a wide sense so as to embrace passive as well as active users. When the machinery is kept ready for use at any moment in a particular factory under an expresses agreement from which taxable profits are earned, the machinery kept can be said to be used for the purpose of business, which earn the profit although it was not actually worked. Therefore it appears that in this case the word use was considered to include active as well as passive users.

However, unfortunately in the recent judgment in Dineshkumar Gulabchand Agarwal Vs. CIT [2008 -TMI - 11253 - BOMBAY High Court] it appears that due to inadvertence of the Counsels the language used in the old provision was not brought to the notice of Hon'ble High Court and the High Court has noted that in case of Whittle Anderson Ltd. CIT [2008 -TMI - 7958 - BOMBAY High Court], the court was concerned with the word "use" or "used" whereas in the present case we are concerned with the interpretation of the word "used" only. Therefore the High Court held that after a judgment in the case of Whittle Anderson Ltd. there was an amendment to Section 32 of the Income Tax Act. The court held that the word "used" denotes actually used and not merely ready for use. The expression used means actually used for the purpose of business. This view is taken by the Tribunal and in this view of the matter the court held no substantial question of law is involved. Therefore the appeal was dismissed in limine.

The Special Leave Petition dismissed:

It is also noticed that the SLP filed by the assessee against judgment of the Bombay High Court dismissing the appeal in limine has also been dismissed by the Supreme Court vide news from Supreme Court (2004) 266 ITR (St.) 106.

Appeal was dismissed in limine- hence judgment may not be binding :

In this case it is seen that the honorable Bombay high court has dismissed the appeal filed under section 260A, by the assessee. The dismissal of the appeal was in limine for the reason that no substantial question of law is involved - that means that it was a matter of fact, or the law involved was not substantial enough to admit the appeal. Therefore, it can be said that the judgment of the Bombay High Court is not a binding judgment or precedent.   

Whether, dismissal of SLP amounts to confirm legal position :

As noted above, the judgment of the Bombay high court is on the point of admittance of appeal. Once the appeal was not admitted and decided it has no binding force even in the jurisdictional area of the Bombay High Court. Thus, the observations made by the high court on the issue of word "used," appear not to be binding.

Once there is no finality of the judgment of the high court, the dismissal of SLP of assessee against order of dismissal of appeal by high court in limine, does not make the order of the high court as final or confirmed. This is because dismissal of SLP at best can be said to confirm the order of the High Court to the effect that in the facts and circumstances of the case there was no substantial question of law, the needed consideration by the High Court.

Mistake of the counsel- heavy reliance on law ignoring the facts is not good :

It appears that the learned counsel has considered the matter as squarely covered by the earlier judgment of the Bombay High Court in Whittle Anderson Ltd. CIT [2008 -TMI - 7958 - BOMBAY High Court], therefore, he did not refer to any other judgments on similar issues, definition and factors for depreciation of assets, active and passive use, he did not even tried to establish passive user by way of readiness of assets or by way of upkeep, maintenance and repair of assets which can also amount to used. However, the high court distinguished the word "used" from combined words "use" or "used," which were considered in earlier judgment of the same court.

Other judgments not considered:

There were judgments of other high courts under the Income Tax Act, 1961 also in which passive use has been considered and depreciation has been allowed. Those judgments were not referred by the counsels and not considered by the high court in case of Whittle Enderson. For example in the case of CIT V. Geo Tech Construction Corporation 2000 -TMI - 15117 - (KERALA High Court) wherein after considering many other judgments including that of the Supreme Court in the case of Liquidator of Pursa Ltd V CIT 1954 -TMI - 49708 - (SUPREME Court), and CIT V Elecon Engineering Co. Ltd [2008 -TMI - 9231 - GUJARAT High Court] {Which was affirmed in 166 ITR 66 (SC)}, Machinery Manufacturer Corpn. Ltd V CIT (1957) 31 ITR 203 (Bom.)  held that the word "used" has to be given a wider meaning, and it will include active and passive users. In this case assessee purchased "Tippers"-(vehicles mounted with machinery for material handling) on 29th March, 1986 they were kept ready for use so the assessee claimed depreciation for A.Y. 1986-87 (previous year ended on 31 st March, 1986). The high court by following principle of passive user allowed depreciation allowance.

In case the department has not appealed against the judgment of Kerala High Court in the case of Geo Tech (supra.), therefore, it can be said that it has attained finality.

In CIT V Maps Tours & Travels [2008 -TMI - 12123 - MADRAS High Court] the assessee a firm engaged in business of renting cars purchased motor car on 30 th March, 1989 and claimed depreciation allowance for assessment year 1989-90. The car was not registered for plying on road during the previous year. There was no evidence that the car was used for the business (of running on rent), and car was not also capable of use for such business, in those circumstances the court held that assessee was not entitled to depreciation. In this case, in fact the car was not ready for use (since not registered to ply on road). Therefore, passive user was also out of question. Therefore, this case is distinguishable.

PASSIVE USE -DEPRECIAITON ALLOWED

In several other judgments passive use or ready for use condition of asset was considered as used for business and depreciation was allowed. There are some assets which have to be kept as standby arrangement and as a part of a group of machinery or a block of assets and in that case if the concern works than it can be said that all the assets within the concern have been used. Few judgments on this point are mentioned below:

Whittle Anderson Ltd. CIT [2008 -TMI - 7958 - BOMBAY High Court]

CIT V Viswanath Bhaskar Sathe (1937) 5 ITR 621 (Bom)

CIT V. Dalmia Cement Ltd. (1945) 13 ITR 415 (Patna)

Forest Industries Travancore Ltd. V. CIT (1964) 51 ITR 329 (Ker).

Capital Bus Service Ltd. V. CIT 1980 -TMI - 36904 - (DELHI High Court)

CIT V O.P. Khanna and Sons (1983) 140 ITR 558 (P&H)

CIT V. Geo Tech Construction Corporation 2000 -TMI - 15117 - (KERALA High Court).

CIT Vs. PANACEA BIOTECH LTD [2009 -TMI - 34294 - DELHI HIGH COURT] decided on July 27, 2009 the Delhi High Court considered passive use of assets in context of Section 32. High Court also considered earlier judgments of Delhi High Court and other courts in favor of assessee and Bombay High Court which is against the assessee. The courts observations and decision about deprecation are discussed below:

Facts:  assessee  had purchased  a flat for office use , furnished the same and kept ready for use. Assessee  claimed depreciation. The  AO disallows on the ground  that there was no actual use and  passive use of the asset was not enough to entitle deduction.

He CIT(A) and Tribunal allowed deduction holding that the expression "used for the purpose of business" includes passive user of the assets in the business. On appeal the High Court observed and held as follows in respect of depreciation allowance:

The first issue is that the ITAT has erred in allowing depreciation on the flat purchased by the assessee at Mumbai.

Qua the first issue, the facts which have emerged from the record are that the possession of the flat was obtained on 21.3.2000, the deed in respect of the same was registered on 29.3.2000 (though the Sub-Registrar returned it to the assessee on 7.4.2000), the charges to the society where the flat is situated were paid on 29.3.2000, One consignment was sent to this office/flat through M/s. Mayur Roadways, and the flat had been fitted with the requisite amenities for using it as an office. Thus, the office was ready for use and functional and was actually used for the purpose of business. User of the flat is, therefore, a finding of fact by the two concurrent authorities below in which we need not interfere.

The counsel for the Revenue has urged that passive use does not entitle the assessee to claim depreciation. In the facts of the case, there is an actual user and not passive user. Besides, so far use as an office is concerned, user of the same need not be full-fledged and nor is it so urged by the Revenue. Obviously, the assessee must have purchased this flat within the relevant financial year to take benefit of depreciation as tax planning.

The high court held that "we do not see any illegality in the action of the assessee in the facts and circumstances of the case. The counsel for the Revenue has relied upon the judgment of the Bombay High Court in the case of Dineshkumar Gulabchand Agarwal Vs. CIT [2008 -TMI - 11253 - BOMBAY High Court].

Since there are judgments of two Division Benches of this Court in the case reported as CIT Vs. Refrigeration & Allied Industries Ltd., 2000 -TMI - 14585 - (DELHI High Court) and Capital Bus Services vs. CIT, 1980 -TMI - 36904 - (DELHI High Court), The Delhi High Court considered that it would be bound by the same.

In the case of Refrigeration & Allied Industries Ltd. it had been held  that the expression "used for the purpose of business" includes passive user of the assets in the business. It was held that the asset cannot be said to be not used when the same is kept ready for use. Hence depreciation was allowed.

The court also noted that the Division Bench of this Court had even much earlier in Capital Bus Services Pvt. Ltd. held that the expression used for the purpose of the business and depreciation would be allowed where the buses were kept ready by the owner for its use. Merely because the buses did not ply cannot mean that the depreciation was not allowable.

Finding no merit in contention of the revenue, the appeal was dismissed on the issue of depreciation and other issues also.

Thus we find that though in the case in hand the court found that the flat purchased was actually used for business purpose and there was no need to apply test of 'passive use', however, the court held that the test of passive use is still applicable and can be applied.

'USE' OR 'USED' and liberal approach:

It is worth to mention that the word "used" has always been used in the provisions relating to depreciation. However, as it appears from the observations of the Bombay High Court earlier, both the words namely "use" and "used" were used whereas in the 1961 Act, there is only the word "used."

It is worth mention that so far depreciation is concerned there has been legislative tendency to liberalize the provisions to provide higher depreciation at higher rates. Lapsing of time is also considered as a factor for depreciation allowance. Therefore, even if there is some change in the language used, it cannot be said that there is any change in the policy regarding depreciation in this regard.

A drafting omission, if at all, can be remedied:

We may usefully refer to the judgment of the Calcutta high court in the case of ITC Ltd. V CIT  (1994) 1992 -TMI - 20513 - (CALCUTTA High Court). In this case the court was concerned with the question whether initial depreciation should be reduced form the actual cost to determine written down value? In the Income Tax Act, 1922 initial depreciation was specifically not excluded from cost to determine the written down value. However, initial depreciation was withdrawn and again came back. When the initial depreciation was re-introduced, corresponding provision was not made to the effect that initial depreciation should not be reduced from written down value. In that context the Calcutta high court held:

" That there should have been corresponding insertion of clause (v) of sub-section (1) of section 32 in that proviso below the definition of written down value. If the initial depreciation under the old act of 1922 is to be excluded from the aggregate depreciation actually received, there is no perceivable reason why the initial depreciation under the present act should have different treatment; it is a case of mere drafting omission that has gone unnoticed…"

Thus applying this test in the case of provision for use of word "used" only as against use of two words use and used in the old Act, it can be said that in there is at best a drafting error or omission. There is no change in intention in this regard.

BLOCK OF ASSETS AND INTENTION:

a) From A/Y 1988-89, the new scheme for depreciation allowance was introduced and the rate of depreciation and depreciation allowance is applied to a block of assets, instead of particular asset in the block.

b) 50% DEPRECIATION FOR NEW ASSETS ONLY AND NOT FOR OLD ASSETS

Under new provisions ide second proviso to Section 32(1) in respect of newly acquired assets, it is provided that in respect of assets acquired by the assessee during the previous year and is put to use for the purpose of business or profession for a period of less than 180 days in that previous year, the deduction under the section in respect of such asset shall be restricted to 50% of the amount calculated at the percentage prescribed. Thus we find that only in respect of assets acquired during the year this proviso is applicable and if the new asset is used for 180 days or more in the year of acquisition then full depreciation is allowed otherwise depreciation is allowed at half of the rate.

c) for assets acquired and put to use in earlier years there are no such restrictions. The asset is eligible for full depreciation allowance irrespective of number of days it is used. Even if any asset has not at all been used, still depreciation is allowed for the entire block of assets.

d) In respect of certain new commercial vehicles also we find that higher depreciation is allowed if the vehicle is acquired by the assessee and is put to use during specified period for the business or profession than deduction is allowed at the prescribed rate.

Natural depreciation:

There are several factors for depreciation of assets i.e. wear & tear due to use and wear and tear due to climatic conditions, accidents, movement, technical obsolescence etc.  Therefore an asset suffers wear and tear not only because of use but also for other reasons. Even if an asset is not used, it will get worn out over a period of time. Many assets has useful life described as maximum number of years/ days and also maximum number of working hours/ days. Thus if assets is not at all used, still it may depreciate. In case of advancement of technology, and fast global economies, obsolescence due to technical advancement is also a major factor.

Assets as block or group of assets

In libraries of any professional there are several books which are kept in the library and they may be used in time as and when a reference is required. It is not possible to keep a record of user of the books. However, the fact is that books are ready for use. They can be used any time as and when they are required for reference, copying or showing to authorities, clients, or other persons in the course of professional activity. Even if any book is not opened for use in any year, it can be said that the book is used as it is ready for use. Therefore it can be said that all the books are used. Similar will be the case of books in a lending library, suppose some of books kept in the lending library were not lent on any day and there was no revenue in form of book rent or reading fees earned for some books. But these books are kept ready for lending or reading by clients therefore depreciation has to be allowed. Similarly there are many other assets, which are kept as standby arrangement or according to requirement for example standby arrangements for power generation, back-ups of power, standby machines for use in case of break down of other machines.

They may not be used during the year but they are required for use as and when needed, they have to be maintained in proper working conditions. The expenses for maintenance and repair will be allowable, they can be insured and insurance premium will be allowable, therefore, there is no reason for not allowing depreciation allowance on such assets.

In case it is to be seen that each asset must have worked, then how many days each asset worked may also be required, but that is not legislative intention.

In view of the above write-up it is felt that passive use of assets should also be considered as eligible use for depreciation allowance.

Timely purchase is desirable:

Many time depreciable assets are purchased just on the crucial date  (taken generally as 30th September or 31st March) or a few days earlier, this naturally creates doubt in the mind of the Assessing Officer. Unfortunately, in some cases it was noticed that the assets was not put to use on or before the crucial date and therefore, depreciation was not allowable as claimed by the assessee. Under some circumstances, it can also be established by the Assessing Officer that the assessee attempted to claim higher depreciation. This is not good for honest taxpayer. However, by mistake, just considering the date of invoice for the assets purchased may claim higher depreciation. Therefore, care should be taken to find out actual date of starting use of the asset.

Timely purchase, installation, permission to use and use etc.:

In case of new assets acquire and put to use problem arises due to doubt by authorites. This is because of need to see how many days the new asset was put to use. Once an asset is covered by the block of asset, and the concern works during the year, the general consensus is that depreciation is allowable and on that point disputes are rare.

 Assessee must plan in advance and assets should be purchased, delivered and put to use   well in time after taking into account reasonable time for putting the assets to use before crucial date to claim depreciation allowance. Some assets can be put to use immediately after unpacking the assets like some furniture, tools, portable equipments etc. However, even in case of some portable equipment, some electrical fittings, cabling, wiring, some installation devices, some furniture, and fittings for proper use are required.

In case of some assets, specific permission from concerned authority is required by way of registration, certificate of fitness, authority to use by way of registration or licence etc. the relevant certificate etc. should be obtained well in time to avoid disputes.

Evidence of use:

It is always advisable to establish actual use and certification for the same from managers and government authorities wherever required. There should also be circumstantial evidence as to use for example- consumption of raw material, electricity, necessary process materials, production of goods or services rendered etc. In case of vehicles, if the vehicle is run even for the purpose of staff picnic, or for a short journey or trip for hire it will be considered as used for business. Therefore, it is necessary that one should first rely on the facts and then only help of law may be taken. If the facts are not in your favour, the law may not help you. 

Suggestion for assesses:

In view of the above discussion it is always advisable that any assets should be timely purchased, steps should be taken for the purpose of putting the assets to its proper and main business use well in advance. Necessary permission and licenses from the Govt. authorities must be obtained well before the crucial date so that facts are in your favour. Mere reliance of provisions of law, old judgments may not help because of changing times, changing thinking, and some cases of misuse of law coming in to picture, causing difficulties to all. 

Clarificatory amendment is desirable:

In view of controversy it is likely that the matter is pending or in future similar issues may be litigated before the Supreme Court. Depreciation is necessary to be allowed to compute income over a period of time therefore, it desirable that amendment be made to use both words 'use and used' or otherwise clarify the legal position. There is apparently no reason that there was different legislative intention when the Income-tax Act, 1961 was passed. Apparently the omission of word 'use' is a drafting error not supported by any reason to indicate that the legislative intention has been changed.