2025 (7) TMI 1059 - HC - Income Tax

Denal of claim of depreciation on the revalued assets - explanation 3 to Section 43(1) - value of the assets was on the basis of a valuation that was done in April 1982 when the original partnership which had five partners was re-constituted. Originally there were five partners three of whom retired and only the two partners who retired in 1984 continued as the partners. HELD THAT - Rule 5 of the Income Tax Rules 1962 which deals with depreciation also states provided that the aggregate depreciation allowed in respect of any asset for different assessment years shall not exceed the actual cost of the said asset . In this case for the assessment year 1985-86 it is only the assessee that claimed depreciation. The erstwhile firm came to an end on 31.03.1984. Assessee as per Section 32 of the Act read with Rule 5 quoted above will be entitled to claim depreciation in respect of any asset on the actual cost of the said asset. The actual cost of the said asset will be actual cost which the assessee paid to the erstwhile partners. The amount paid was as per the valuation of April 1982. Certainly in our view assessee will be entitled to claim depreciation for the subsequent years on the basis of the actual cost paid. It is immaterial whether the erstwhile partners or shareholders or directors are all of the same family. The Act does not provide for any exclusion in such cases. We find support for our view in the judgment of Dharmanandan Diamonds Pvt Ltd 2023 (6) TMI 823 - BOMBAY HIGH COURT Questions of law framed are answered in favour of the assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

(i) Whether the Tribunal was justified in holding that Explanation 3 to Section 43(1) of the Income Tax Act applies to the assessee's case, thereby denying the claim of depreciation on revalued assetsRs.

(ii) Whether the Tribunal was justified in not following the Supreme Court decisions in M/s. Jogta Coal Co. Ltd. and Kalooram Govindram, which were argued to be directly applicable to the facts of the assessee's caseRs.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Applicability of Explanation 3 to Section 43(1) and denial of depreciation claim on revalued assets

Relevant legal framework and precedents: Section 43(1) of the Income Tax Act defines "actual cost" of an asset for the purpose of depreciation claims. Explanation 3 to Section 43(1) provides that where assets were previously used by another person in business and the transfer to the assessee is primarily for reducing income-tax liability by claiming depreciation on an enhanced cost, the Assessing Officer, with prior approval, may determine the actual cost to the assessee considering all circumstances.

Rule 5 of the Income Tax Rules, 1962 states that aggregate depreciation allowed on any asset cannot exceed its actual cost.

Court's interpretation and reasoning: The Court examined whether Explanation 3 applied to the facts where the assessee took over the entire business and assets of a partnership firm through a dissolution deed. The assets' valuation was based on an earlier valuation from April 1982, predating the dissolution in 1984. The assessee claimed depreciation on the cost actually paid to the erstwhile partners as per this valuation.

The Court noted that the dissolution deed executed on 31.03.1984 transferred all assets and liabilities to the assessee, who then carried on the business from 01.04.1984. The payment to the other partners was as per the valuation done in 1982, which was the basis for the actual cost paid by the assessee.

The Assessing Officer invoked Explanation 1 to Section 43(6) (though the judgment primarily discusses Explanation 3 of Section 43(1)) to deny the depreciation claim, alleging that the transfer was for tax avoidance by inflating asset cost. The Tribunal upheld this view.

The Court rejected this reasoning, holding that the actual cost to the assessee is the amount paid to acquire the assets, irrespective of family relationships among partners or shareholders. The Act does not exclude such cases from depreciation claims. The Court emphasized that the valuation was a bona fide business valuation predating the dissolution and that the assessee legitimately took over the business and assets.

Key evidence and findings: The dissolution deed, the valuation report from April 1982, and the payment made by the assessee to the erstwhile partners as per that valuation were critical. The Court found no evidence that the transfer was primarily to reduce tax liability by inflating asset cost.

Application of law to facts: The Court applied the definition of actual cost under Section 43(1) and found that the actual cost to the assessee was the amount paid to the partners. Explanation 3 was not applicable as there was no tax avoidance motive established. Hence, depreciation on the actual cost paid was allowable.

Treatment of competing arguments: The Revenue argued that Explanation 3 applied, denying depreciation on revalued assets to prevent tax avoidance. The Court disagreed, holding that Explanation 3 requires satisfaction of the Assessing Officer and approval of the Joint Commissioner based on the main purpose of transfer being tax reduction. No such satisfaction or approval was recorded, and the facts did not support such a conclusion.

Conclusions: Explanation 3 to Section 43(1) did not apply. The assessee was entitled to claim depreciation on the actual cost paid for the assets taken over from the partnership firm.

Issue (ii): Whether the Tribunal erred in not following Supreme Court precedents

Relevant legal framework and precedents: The assessee relied on Supreme Court decisions in M/s. Jogta Coal Co. Ltd. and Kalooram Govindram, which dealt with similar issues on determination of actual cost and depreciation claims on assets acquired from partners or firms.

Court's interpretation and reasoning: The Court observed that these decisions were directly applicable and supported the assessee's claim. These precedents recognized that where an assessee acquires assets from a partnership firm by paying the actual cost, depreciation should be allowed on that cost.

Key evidence and findings: The Court noted that the Tribunal failed to follow these binding precedents without adequate reasons, thereby causing an error in law.

Application of law to facts: Applying the principles from these precedents, the Court found that the assessee's claim for depreciation on actual cost was justified and consistent with the law.

Treatment of competing arguments: The Revenue's reliance on Explanation 3 and the Tribunal's approach was rejected as inconsistent with the Supreme Court rulings.

Conclusions: The Tribunal was not justified in disregarding the Supreme Court precedents. The Court held that these decisions apply fully to the facts of the present case.

3. SIGNIFICANT HOLDINGS

"... assessee will be entitled to claim depreciation for the subsequent years on the basis of the actual cost paid. It is immaterial whether the erstwhile partners or shareholders or directors are all of the same family. The Act does not provide for any exclusion in such cases."

"... Explanation 3 to Section 43(1) does not apply where the transfer is bona fide and not primarily for the purpose of reducing income-tax liability by claiming depreciation with reference to an enhanced cost."

"The Tribunal erred in not following the Supreme Court decisions in M/s. Jogta Coal Co. Ltd. and Kalooram Govindram which apply on all fours to the facts of the assessee's case."

Core principles established include that actual cost for depreciation purposes is the amount paid by the assessee to acquire the asset, even if acquired from partners of a dissolved firm, and that Explanation 3 to Section 43(1) is applicable only where there is clear evidence of tax avoidance motive and proper satisfaction and approval by authorities.

Final determinations were that the assessee was entitled to claim depreciation on the actual cost paid for the assets acquired from the partnership firm, and the appeals were allowed accordingly.