2017 (12) TMI 1067 - SC - Income Tax

Depreciation of assets acquired by assessee trust - the capital expenditure is treated as application of income for charitable purposes - Held that - As in Commissioner of Income Tax v. Institute of Banking Personnel Selection (IBPS) 2003 (7) TMI 52 - BOMBAY High Court correctly states the principles of law and there is no need to interfere with the same. It may be mentioned that most of the High Courts have taken the aforesaid view with only exception thereto by the High Court of Kerala which has taken a contrary view in Lissie Medical Institutions v. Commissioner of Income Tax 2012 (4) TMI 115 - KERALA HIGH COURT . It may also be mentioned at this stage that the legislature realising that there was no specific provision in this behalf in the Income Tax Act has made amendment in Section 11(6) of the Act vide Finance Act No. 2/2014 which became effective from the Assessment Year 2015-2016. The Delhi High Court has taken the view and rightly so that the said amendment is prospective in nature. It also follows that once assessee is allowed depreciation he shall be entitled to carry forward the depreciation as well.

Summary

The core legal questions considered by the Court in these appeals pertain to the allowance of depreciation to charitable institutions registered under Section 12A of the Income Tax Act, where the capital expenditure on acquisition of assets has already been treated as application of income for charitable purposes under Section 11(1)(a). Specifically, the issues can be summarized as follows:

1. Whether depreciation is allowable on assets, the cost of which has been fully allowed as application of income under Section 11 in the year of acquisition.

2. Whether allowing depreciation in such cases results in a double benefit to the assessee, effectively permitting both a 100% write-off of the asset cost and depreciation deduction.

3. The legal effect of amendments introduced by the Finance Act No. 2/2014 to Section 11(6) of the Income Tax Act, particularly their retrospective or prospective application.

4. The entitlement of the assessee to carry forward depreciation once allowed.

Issue-wise Detailed Analysis

Issue 1: Allowance of Depreciation on Assets Fully Allowed as Application of Income under Section 11

The Court examined the interplay between Sections 11 and 32 of the Income Tax Act. Section 11(1)(a) allows charitable institutions to claim exemption by treating application of income for charitable purposes, including capital expenditure on assets. Section 32 provides for depreciation allowances on assets used for business or profession.

Precedent from the Bombay High Court in the case involving a charitable trust (CIT v. Munisuvrat Jain) was pivotal. The Court observed that while Section 32 specifically deals with depreciation for business assets, charitable trusts compute income under Section 11 on commercial principles. The Bombay High Court held that depreciation is a legitimate deduction in computing the real income of the trust, even if the assets are not business assets and even if the capital expenditure was earlier treated as application of income.

The Court rejected the Department's argument that depreciation could only be claimed under Section 32 and not under general principles or Section 11(1)(a). It clarified that the income of a charitable trust derived from assets must be computed after allowing for normal depreciation, thus ensuring correct income computation on commercial principles.

Applying these principles to the facts, the Court found no error in the High Courts' acceptance of the ITAT's view that depreciation is allowable notwithstanding prior allowance of capital expenditure as application of income.

Issue 2: Whether Allowing Depreciation Results in Double Benefit to the Assessee

The Department contended that allowing depreciation after capital expenditure was fully allowed as application of income would amount to double benefit, effectively a 100% write-off plus depreciation deductions.

The Court referred to the Bombay High Court's reasoning in Director of Income-tax (Exemption) v. Framjee Cawasjee Institute, where the Tribunal and the High Court held that treating capital expenditure as application of income in the year of acquisition does not preclude depreciation deductions in subsequent years. The capital expenditure allowance pertains to the application of income in that year, while depreciation relates to income computation in subsequent years.

The Court emphasized that these are distinct concepts: the initial application of income for acquisition and the subsequent allowance for depreciation in income computation. Thus, no double benefit arises as the two allowances operate in different temporal and conceptual contexts.

The Court found the Department's argument unpersuasive and affirmed the view that depreciation is allowable even after capital expenditure is treated as application of income.

Issue 3: Effect of Amendment to Section 11(6) by Finance Act No. 2/2014

The Court noted that the legislature, recognizing the absence of specific provisions on this issue, amended Section 11(6) through the Finance Act No. 2/2014, effective from Assessment Year 2015-2016. This amendment clarifies the treatment of depreciation in relation to income application for charitable purposes.

The Court observed that the Delhi High Court had held this amendment to be prospective in nature. Therefore, the amendment does not affect the legal position in the years prior to its commencement, which are the subject of these appeals.

Issue 4: Entitlement to Carry Forward Depreciation

The Court held that once depreciation is allowed, the assessee is entitled to carry forward the depreciation as well. This follows from the principle that depreciation is a legitimate deduction in income computation for the relevant assessment years.

Treatment of Competing Arguments

The Department's contention of double benefit was addressed by distinguishing the nature of capital expenditure allowance under Section 11(1)(a) and depreciation allowance under Section 32 or general commercial principles. The Court relied heavily on authoritative precedents from the Bombay High Court and the ITAT, which had consistently rejected the Department's argument.

The Court also noted the divergence in judicial opinion, highlighting the Kerala High Court's contrary view in Lissie Medical Institutions v. Commissioner of Income Tax, but found the majority view and the legislative intent more persuasive.

Conclusions

The Court affirmed the High Courts' decisions allowing depreciation to charitable institutions despite prior allowance of capital expenditure as application of income. It held that depreciation is a legitimate deduction in computing income under Section 11 and that no double benefit arises. The amendment to Section 11(6) is prospective and does not affect the years under consideration. The assessee is entitled to carry forward depreciation once allowed.

Significant Holdings

"Section 11 of the Income Tax Act makes provision in respect of computation of income of the Trust from the property held for charitable or religious purposes and it also provides for application and accumulation of income. On the other hand, section 28 of the Income Tax Act deals with chargeability of income from profits and gains of business and section 29 provides that income from profits and gains of business shall be computed in accordance with section 30 to section 43C. That, section 32(1) of the Act provides for depreciation in respect of building, plant and machinery owned by the assessee and used for business purposes. It further provides for deduction subject to section 34."

"It was held that normal depreciation can be considered as a legitimate deduction in computing the real income of the assessee on general principles or under section 11(1)(a) of the Income Tax Act."

"The amount spent on acquiring those assets had been treated as 'application of income' of the Trust in the year in which the income was spent in acquiring those assets. This did not mean that in computing income from those assets in subsequent years, depreciation in respect of those assets cannot be taken into account."

"The amendment to Section 11(6) made by Finance Act No. 2/2014 is prospective in nature."

"Once assessee is allowed depreciation, he shall be entitled to carry forward the depreciation as well."

These principles establish that charitable institutions are entitled to claim depreciation on capital assets even if the capital expenditure was previously allowed as application of income for charitable purposes, and that such allowance does not constitute impermissible double benefit. The Court dismissed the appeals filed by the Income Tax Department, affirming the consistent judicial approach favoring the assessees in this context.