Incentive by way of initial or additional depreciation under section 32(1)(iia) can be allowed in two years.

[C.A. DEV KUMAR KOTHARI]

References:

Section 32 of the Income-tax act, 1961.

Deputy Commissioner of Income-tax, Circle 3(1), New Delhi Versus Cosmo Films Ltd. 2012 (9) TMI 281 - ITAT DELHI

Initial or additional depreciation – 20% need to be allowed in first year to achieve the purpose of incentive. An amendment is desirable.http://www.taxmanagementindia.com/wnew/print_Article.asp?ID=1544

Initial depreciation- recent back ground

Section 32(1)(iia) was inserted by Finance (No. 2) Act, 2002 with effect from 1.4.2003. As per the speech of Finance Minister, this clause was inserted to provide incentives for fresh investment in industrial sector to provide impetus to new investment in setting up a new industrial unit or for expanding the installed capacity of existing units by at least 25%.  Subsequently by the Finance (No. 2) Act of 2004 w.e.f. 1.4.2005 it was liberalized to provided that in the case of any machinery or plant which has been acquired after the 31st day of March, 2005 the rate was increased to 15% of actual cost of such machinery or plant shall be allowed as deduction under clause (iia) of section 32(1). Thereafter by the Finance (No. 2) Act of 2004 the rate was increased to 15% w.e.f. 1.4.2005.  Then w.e.f. 01.04.2006 the rate was increased to 20% and condition of substantial expansion was removed to provide further fillip and incentive.

This additional allowance u/s 32(1)(iia) is made available as certain percentage of actual cost of new machinery and plant acquired and installed. As per mandatory language such allowance is to be allowed in the first year itself. However, it seems that by way of a drafting error, this clause was inserted in second proviso which restrict allowance to 50% in case new asset is used for less than 180 days. Thus there is a conflict.

 Amount allowable  u/s 32(1)(iia) has been  called as initial depreciation by the Finance Minister in his budget speeches and  has also been called as  additional deprecation,  in the memorandum explaining amendments and circulars etc. is allowable  @20% on new eligible plant and machinery in the first year as per clear and mandatory language used in section 32(1)(iia). However in a proviso in s.32 it is provided that in case of new plant and machinery which is used for less than 180 days in the first year, depreciation including additional depreciation shall be restricted to 50% of otherwise allowable amount.

As per author, when there is conflict in two provisions the conflict should be resolved in favor of assessee and full initial deprecation should be allowed in the first year. This is because otherwise the purpose of incentive will not be full filled. Our Government frames various incentive schemes in various manner. Considering the purpose, the schemes and related provisions should be construed liberally and purpose seeking manner. However, unfortunately, generally revenue authorities have an inbuilt tendency to make disallowances even of incentives by adopting too technical approach and ignoring the purpose of such incentive.

Whether deduction can be allowed in two years:

As per scheme of the provision and mandatory language used 20% deduction should be allowed in first year. However, on application of the proviso, deduction is restricted to 10% in new case plant and machinery is not used for 180 days or more in the first year.

Apparently there is no express provision to allow deduction in two years. But logically it can be allowed either @ 10)% in two years – in first year when assets is purchased/ installed but used for less than 180 days and in second year again @10% when  period of 180 is completed. This approach will also be to achieve purpose. However, this is only based on logic and not strictly as per law. Whereas, 20% deduction in first year can be considered as per specific law by resolving conflict in main provision and the proviso, which as discussed earlier, appears to be a drafting error or in any case insertion of the clause (iia) in the proviso is against the main provision of clause (iia).

Ground reality- deduction in first year will serve purpose without much loss to revenue:

In case where large investment is made in plant and machinery in a majority of cases, there remains unabsorbed depreciation. Therefore, particularly in case loss is determined, it makes no difference whether deduction of 20% is allowed in one year or is split in two years. Therefore, taking an overall picture, deduction of 20% in first year can serve purpose of the incentive in a better and simple way without making any adverse impact on revenue.     

Tribunal allowed initial depreciation in two years:

In Deputy Commissioner of Income-tax, Circle 3(1), New Delhi Versus Cosmo Films Ltd. 2012 (9) TMI 281 - ITAT DELHI considered provisions of initial deprecation.

Tribunal has decided this issue in favor of assessee in light of claim of assessee to allow 10% in first year and balance 10% in second year so as to allow full amount of initial deprecation to which, as per ITAT assessee becomes entitled on putting to use of eligible plant and machinery.

Relevant portion from order of ITAT in case of Cosmo Films Ltd:

The relevant portion from the order of ITAT dated 05.08.2012 is reproduced with necessary highlights added by author for analysis:

Ground on issue:

Relevant grounds of appeal being grounds no. 2 and 3 in appeal of the assessee ITA No. 2508/Del/2007 are as under:-

“(2)  That the Commissioner of Income tax (Appeals)-VI, New Delhi has grossly erred on facts and in the circumstances of the case and in law in confirming disallowance of arrears of additional depreciation of Rs. 3,31,78,825 as certified by the Chartered Accountant on qualifying assets put to use in the second half of the immediately preceding previous year.

(3)  That the Commissioner of Income tax (Appeals)-VI, New Delhi has grossly erred on facts and in the circumstances of the case and in law in negating an alternate claim for deduction of additional depreciation of Rs. 11,29,06,214 in AY 2004-05.”

The observations and order of the Tribunal is analyzed below (by adding highlights):

13. In Ground Nos. 2 & 3, the issue involved is against the disallowance of arrears of additional depreciation of Rs. 3,34,78,825/- and negating an alternate claim for deduction of additional depreciation of Rs. 11,29,06,214/-.

14. The assessee has claimed additional depreciation during the year which was not pertaining to the addition to the fixed asset during the year. The claim of the assessee was that the additions made during the second half of the financial year 2002-03 relevant to Assessment Year 2003-04, the additional depreciation was claimed only on 50% on all the additions made after 30th September, 2002. The balance 50% could not be claimed in that Assessment Year on account of second proviso to section 32(1)(ii), hence the same is being claimed during this year as it was balance of the additional depreciation. The learned AR submitted that as per the provisions of section 32(1)(iia), the assessee was entitled for further sum of depreciation equal to 15% of the actual cost of new plant and machinery acquired during the year and installed. The assessee has been granted a statutory right by provisions of section 32(1)(iia) to allow a further sum equal to 15% in the year of acquisition. The expression used in the provision is "shall be allowed". The Second Proviso to section 32(1)(ii) restricts the allowance to 50% if used for less than 180 days. Thus, it is a restriction for period of usage. The statutory right provided to the assessee cannot be get divested by the second proviso to section 32 (1)(ii). Nowhere in the Act it is prohibited that remaining balance of additional depreciation on the assets added after 30th September, shall not be allowed. The cross reference to clause (iia) in the Second Proviso to section 32(1)(ii) provides that 50% rule will apply if assets are purchased in second half of financial year but it cannot overlook the one time allowance which is a statutory right earned in the year of acquisition. Had there been intention to restrict the one time allowance to 50% then it could have been provided in proviso to clause (iia). The restriction is only for period of usage. The proviso to clause (iia) restricts/prohibits deduction only in respect of following:-

"(A) any machinery or plant which, before its installation by the assessee, was used either within or outside India by any other person; or

(B)  Any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest-house; or

(C) Any office appliances or road transport vehicles; or

(D) Any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head "Profits and gains of business or profession" of any one previous year;"

There is no bar in law that once the amount @ 15% of new plant and machinery is calculated and only 50% is allowable in that particular year on account of period of usage then balance shall not be allowed forever. The law does not restrict/prohibit that the balance of 50% so calculated shall not be allowed in the immediate succeeding year. The additional depreciation u/s 32(1)(iia) as provided by the Finance (No. 2) Act, 2002 w.e.f. 1.4.2003 is explained by Circular No. 8 of 2002 dated 27.08.2002 reported in 258 ITR (ST) 13 as being 'a deduction of a further sum' as depreciation, therefore what was proposed to be allowed is depreciation simplicitor though it was called as additional depreciation. Section 32(1)(iia) mandates the grant of additional sum of depreciation. Therefore, any balance of the amount of additional sum of depreciation would have to be considered to be carry forward and set off in terms of sub-section (2) of section 32 of the Act. This sub-section of section 32(2) provides that where, in the assessment of the assessee, full effect cannot be given to any allowance under sub-section (1) of section 32 in any previous year, than the allowance shall be added to the amount of 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, then it will be deemed to be the allowance for that previous year, and so on for the succeeding previous year. Section 32 (iia) of the Act is an incentive provision for encouraging the industrialization and such a provision would have to be construed liberally. A provision for promoting economic growth has to be interpreted liberally. This benefit is one time allowance and the restrictions, if any, on such incentive provisions have to be construed so as to advance the objective of the provision and not to frustrate it. The construction which frustrates the basic purpose of the provision should be avoided. The ITAT should take a pragmatic view. He also relied on the decision of Hon'ble Supreme Court in the case of Bajaj Tempo Ltd. v. CIT 1992 (4) TMI 4 - SUPREME COURT. The second proviso to clause (ii) to sub-section (1) of section 32 provides a restriction on the quantum of depreciation based on the usage period. As per this provision, the assets acquired and put to use for the purposes of business or profession for a period of less than 180 days, the deduction in respect of such assets is to be restricted to 50% of the amount calculated. But it does not restrict that balance shall not be allowed forever. The additional depreciation as provided in clause (iia) of sub-section (1) of section 32 is a one time benefit whereas the normal depreciation is year to year feature. If the benefit is restricted only to 50% then it will be against the basic intention to provide incentive for encouraging the industrialization. This will also frustrate the object of the provision and it will be unfair, unequitable and unjust. There is no restriction provided in law which restrict the carry forward of the additional sum of depreciation which is a one time affair available to assessee on the new machinery and plant. It was also pleaded that what is expressly granted as an incentive cannot be denied through a pejorative interpretation of second proviso to section 32(1)(ii) when such provisions by itself does not bar consideration u/s 32(2) of the Income-tax Act. He pleaded that the orders of the authorities below on this issue is to be set aside.

15. Alternatively, he also pleaded that the provisions of section 32(1)(iia) do not stipulate any condition of put to use, therefore, full deduction is allowable in the year of purchase itself and it may be allowed in full even plant & machinery acquired after 31st September, 2003.

16. On the other hand, the learned DR submitted that the full additional depreciation can be allowed as per section 32(1)(iia) only when the assets are put to use for more than 180 days in the year of acquisition. The additional depreciation on the assets which are put to use by the assessee for less than 180 days is restricted to 50% of the amount by second proviso to section 32(1)(ii). There cannot be any carried forward additional depreciation to be allowed in subsequent year. The second proviso to section 32(1)(ii) restricts such allowances. The proviso laid down conditions for restricting the depreciation where the assets are used for less than 180 days. The condition to put to use is necessary the condition for allowing any type of depreciation, therefore, the CIT(A) has rightly confirmed the addition.

17. We have heard both the sides on this issue. Section 32(1)(iia) inserted by Finance (No. 2) Act, 2002 with effect from 1.4.2003. In speech of Finance Minister, this clause was inserted to provide incentives for fresh investment in industrial sector. This clause was intended to give impetus to new investment in setting up a new industrial unit or for expanding the installed capacity of existing units by at least 25%. Thereafter these provisions were amended by the Finance (No. 2) Act of 2004 w.e.f. 1.4.2005 and provided that in the case of any machinery or plant which has been acquired 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 15% of actual cost of such machinery or plant shall be allowed as deduction under clause (ii) of section 32(1). This additional allowance u/s 32(1)(iia) is made available as certain percentage of actual cost of new machinery and plant acquired and installed. This provision has been directed towards encouraging industrialization by allowing additional benefit to the setting up new industrial undertakings making or for expansion of the industrial undertaking by way of making more investment in capital goods. Thus, these are incentives aimed to boost new investments in setting up and expanding the units. The proviso to section 32(1)(iia) restricts the benefit in respect of following :-

"Provided that no deduction shall be allowed in respect of—

(A)  any machinery or plant which, before its installation by the assessee, was used either within or outside India by any other person; or

(B)  any machinery or plant installed in any office premises or any residential accommodation, including accommodation in the nature of a guest-house; or

(C)  any office appliances or road transport vehicles; or

(D)  any machinery or plant, the whole of the actual cost of which is allowed as a deduction (whether by way of depreciation or otherwise) in computing the income chargeable under the head "Profits and gains of business or profession" of any one previous year;"

Thus, this incentive in the form of additional sum of depreciation is not available to any plant or machinery which has been used either within India or outside India by any other person or such machinery and plant are installed in any office premises or any residential accommodation, including accommodation in the nature of a guest house or any office appliances or road transport vehicles, or any machinery or plant, the whole of the actual cost of which is allowable as deduction (where by way of depreciation or otherwise) in computing the total income under the head "Profits and gains of business or profession" of any one previous year. Thus, the intention was not to deny the benefit to the assets who have acquired or installed new machinery or plant. The second proviso to section 32(1)(ii) restricts the allowances only to 50% where the assets have been acquired and put to use for a period less than 180 days in the year of acquisition. This restriction is only on the basis of period of use. There is no restriction that balance of one time incentive in the form of additional sum of depreciation shall not be available in the subsequent year. Section 32(2) provides for a carry forward set up of unabsorbed depreciation. This additional benefit in the form of additional allowance u/s 32(1)(iia) is one time benefit to encourage the industrialization and in view of the decision of Hon'ble Supreme Court in the case of Bajaj Tempo Ltd. v. CIT 1992 (4) TMI 4 - SUPREME COURT. the provisions related to it have to be constructed reasonably, liberally and purposive to make the provision meaningful while granting the additional allowance. This additional benefit is to give impetus to industrialization and the basic intention and purpose of these provisions can be reasonably and liberally held that the assessee deserves to get the benefit in full when there is no restriction in the statute to deny the benefit of balance of 50% when the new plant and machinery were acquired and use for less than 180 days. One time benefit extended to assessee has been earned in the year of acquisition of new plant and machinery. It has been calculated @ 15% but restricted to 50% only on account of usage of these plant & machinery in the year of acquisition. In section 32(1)(iia), the expression used is "shall be allowed". Thus, the assessee had earned the benefit as soon as he had purchased the new plant and machinery in full but it is restricted to 50% in that particular year on account of period of usages. Such restrictions cannot divest the statutory right. Law does not prohibit that balance 50% will not be allowed in succeeding year. The extra depreciation allowable u/s 32(1)(iia) in an extra incentive which has been earned and calculated in the year of acquisition but restricted for that year to 50% on account of usage. The so earned incentive must be made available in the subsequent year. The overall deduction of depreciation u/s 32 shall definitely not exceed the total cost of plant and machinery. In view of this matter, we set aside the orders of the authorities below and direct to extend the benefit. We allow ground no. 2 of the assessee's appeal. Since we have decided ground no. 2 in favour of assessee, there is no need to decide the alternate claim raised in ground no.3. The same is dismissed.

Conclusion from order of Tribunal:

The Tribunal has considered initial depreciation, as an incentive, to which assessee becomes entitled to when he put to use eligible plant and machinery. Tribunal considered it as one time deduction. The actual allowance in one year, may be restricted to 50% due to less than 180 days use in first year, in such situation balance 50% can be allowed in second year as unabsorbed initial depreciation (or un-allowed initial depreciation of first year).

In this case assessee has taken alternative contention to allow full amount in first year, however, tribunal did not consider that aspect because relief has been allowed on primary claim of assessee for deduction of balance amount of initial depreciation in second year. 

Before the Tribunal there was no issue about deductibility of initial deprecation from actual cost to determine written down value (WDV). However, incidentally tribunal has observed that the overall deduction of depreciation u/s 32 shall definitely not exceed the total cost of plant and machinery.

This is observation of the Tribunal and cannot be considered as order. However, if initial deprecation is considered as part of deprecation, then there will remain hardly any incentive element and will only be considered as an accelerated depreciation.

There is well known difference between accelerated depreciation and an incentive allowance. As noted by tribunal also, initial depreciation is an incentive. We find it to be a onetime allowance allowed on basis of actual cost of particular plant and machinery. It is not allowed based on WDV of block of asset, it is not allowed as a regular or normal allowance from year to year, as would be case of deprecation for wear and tear of assets. Thus, there are sufficient reasons to differentiate allowance for wear and tear that is normal depreciation which is allowed on WDV of block of asset and from year to year, and an incentive allowance which is allowed once on actual cost of asset. Therefore, author find that there is sufficient force in contention that initial deprecation is different from normal deprecation and it is an incentive to be allowed over and above actual cost of asset and need not be deducted from WDV of block of assets.   

Request for amendment to avoid litigation:

It is desirable that the insertion of clause (iia) in the proviso to section 32 should be omitted/ withdrawn so that incentive allowance can be allowed at full rate which is @20%, in the first year without any litigation and contingency. Furthermore, clear provision should be made to the effect that initial deprecation shall not be deducted from WDV and that it will be allowed over and above actual cost of eligible plant and machinery so as to achieve purpose of incentive.

In case initial deprecation is reduced from actual cost, and it forms part of total deprecation, then it cannot be considered as an incentive. It is empirically noticed that generally in case of new projects and even in case of expansion, where industry is capital intensive, there is loss in initial year. Therefore, deduction of initial deprecation from cost to determine WDV or to consider initial depreciation as a part of allowance for wear and tear of assets goes against the declared purpose of providing an incentive.

Earlier article:

Readers may also refer to the following article:

Initial or additional depreciation – 20% need to be allowed in first year to achieve the purpose of incentive. An amendment is desirable.http://www.taxmanagementindia.com/wnew/print_Article.asp?ID=1544

It seems that in cosmo Films, the assessee had not claimed full deduction as primarily sought relief but only an alternate relief. The counsel of assessee had relied on section 32(2) to press that half of initial deprecation which could not be allowed due to limitations for period of use, can be allowed as forming part of unabsorbed initial depreciation in second year. Since the Tribunal allowed relief on primary ground seeking relief in two years, tribunal did not at all consider the alternate claim of full deduction in first year.

Deputy Commissioner of Income-tax, Circle 3(1), New Delhi Versus Cosmo Films Ltd. 2012 (9) TMI 281 - ITAT DELHI