DEPRECIATION-WRITTEN DOWN VALUE- EXPLANATION 6 TO S.43(6): DEDUCTION OF NOTIONAL DEPRECIATION FROM COST IS AGAINST SCHEME OF DEPRECIATION AND WELL SETTLED LEGAL POSITION.

[C.A. DEV KUMAR KOTHARI]

Summary- As per scheme of the I.T.Act, 1961 actual cost of eligible depreciable asset is to be actually allowed under the I.T.Act over a period of time as per prescribed methods. It was also long ago settled by the Supreme court  that ‘written down value’ means actual cost minus depreciation actually allowed under the Income -tax Act, and any notional depreciation for the period during which exemption was granted under I.T.Act or when the I.T.Act was not applicable  is not deductible from actual cost to determine WDV . Therefore, insertion of Explanation 6 to Section 43(6) on the basis of a decision of Tribunal and to overcome such decision of Tribunal appears to be principally and legally wrong, unjust and illegal and  desirable  to  struck off by amendment or by court ruling.

Depreciation- scheme of the Act:

As per scheme of the Act, actual cost of assets is allowed by way of normal depreciation or terminal deprecation, in case any depreciation is recovered, on sale of assets it may be taxable as income. In scheme of block of assets also the actual cost and WDV of block of assets is considered. Under this scheme also the underlying principal is that  entire cost of block of assets is to be actually allowed against taxable income over a period of time consisting of use and termination of block. For simplification purpose sale value of any assets is deducted from WDV of block of assets and that may cover either  extra  depreciation in future on block of asset if the sale value is less than the WDV of asset sold or reduced depreciation in future if the sale value is higher than the WDV of asset sold. Thus, on overall basis on consideration of block of assets entire cost is to be allowed during useful life and on termination of use, when it take place on exhaustion of block of asset. In case excess value is realized on such termination or exhaustion of block of assets such excess can be taxable as capital gains in some circumstances.    

Written down value:

Broadly speaking the term ‘written down value’, as defined in section 43(6) 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  term ‘actual cost’ is defined in S.43(1). In both definitions certain explanations are provided to deem actual cost and WDV in case of certain types of transfer of assets from one person to other, as the actual cost and WDV in hands of the previous owner. These are basically because there is  no actual  consideration flowing from transferee or because of exemptions granted to transferor on transfer of such assets to transferee. Some explanations are for excluding certain costs from ‘actual cost’ and hence from WDV.

It is now very well settled that the key words ‘actual cost’ and `actually allowed’ are 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. For sake of brevity and also in view of regular use of these provisions by readers these meanings are not reproduced entirely. And relevant parts in context of subject matter are only reproduced.

Definition or meaning of WDV

A bare reading of  S.43(6) suggest that as per beginning of the section 43 there is general wordings used before definition clause and says definitions are  subject to contextual requirement. However, sub-section (6) which is about WDV, actually begins with words so as to provide  a meaning of the term WDV.  As there is conflict in the wordings of starting phrases in S. 43 and starting phrase in sub-section (6) it can be said that in case of need context is also required to be considered and the meaning of WDV as given in S. 43(6) is also subject to context and have some flexibility and need not always be strictly interpreted.

From the actual cost only depreciation actually allowed is to be deducted in all cases where a computation is made under the income-tax Act. Even in case of succession, merger, demerger etc. the WDV in hands of previous owner / transferor is considered as WDV in hands of new owner/ transferee. The concept of ‘actually allowed’ is similarly applicable in case of any asset prior to 01.04.1988 and in case of block of assets from 01.04.1988.The explanations are in respect of change in ownerships as specified  legal consequences and specified circumstances. In other cases these are not applicable. In case of sale of assets by previous owner to new owner (purchaser) the actual cost of the asset to the new owner shall be the WDV in first year and not the WDV in hands of transferor who sold the asset. In this regard it is also worth to mention that actual sale price shall be deducted from the WDV of asset/ block of asset in hands of the previous owner and on that basis, short-term capital gains will be taxable in his hands. Therefore, in case of sale of assets by one person to other, the revenue will have no justification to blame that the price charged is excessive and therefore the A.O. should not exercise his discretion to re determine actual cost of assets in hands of buyer.    

New Explanation 6:

New Explanation in S.43(6) was inserted By the Finance Act,2008  w.r.e.f.  01.04.2003. This  reads as follows (with high lights):

                Explanation 6.—Where an assessee was not required to compute his total income for the purposes of this Act for any previous year or years preceding the previous year relevant to the assessment year under consideration,—

      (a)  the actual cost of an asset shall be adjusted by the amount attributable to the revaluation of such asset, if any, in the books of account;

      (b)  the total amount of depreciation on such asset, provided in the books of account of the assessee in respect of sch previous year or years preceding the previous year relevant to the assessment year under consideration shall be deemed to be the depreciation actually allowed under this Act for the purposes of this clause; and

      (c)  the depreciation actually allowed under clause (b) shall be adjusted by the amount of depreciation attributable to such revaluation of the asset.]

Analysis:

On an analysis of the above explanation we find that:

Regarding applicability and extent of effect:

1. This is applicable only in cases where the assessee was not required to compute his income for the purposes of the income –tax Act,1961 and not in other cases.
2.  It  provide  an exception of general rule, but by way of an explanation and not as a proviso.
3.  It states that in some cases depreciation not actually allowed will also be deducted from actual cost to determine WDV.
4.  In nut shall it can be said that actual cost minus depreciation provided in books of account , against the amount of actual cost, shall be deemed as deprecation actually allowed during the period when assessee was not required to compute his income for the purpose of the Act. Therefore, in case an assessee has not provided depreciation in books of account then the explanation shall not be applicable.

1.    When return is filed or required to be filed or  where an assessee has filed return of loss or return of income not taxable or below tax free limit or where a return is filed to claim refund or in cases where a return is required to be filed, this explanation will not be applicable because in such cases the assessee is required to compute his income for the purposes of the Act. Even when income is exempt, assessee who are required to file return are required to compute income, and file return to substantiate claim for exemption, and therefore this explanation will not be applicable.
2. In practical manner this explanation will be applicable only in case of low income earner individuals , HUF, BOI, AOP who are not required to file return where income is below threshold limit. In such cases also if depreciation is not provided in books of account then any depreciation shall not be deductible to determine WDV.  However, on consideration of the explanation ( as reproduced and analyzed later) for this amendment, it can be said that even in such  cases the explanation will not apply, because the explanation says that it is introduced because some persons were exempt from tax and, therefore, not required to compute their income under the head “profits and gains of business or profession” and they claimed that  the actual cost is WDV when their income became taxable upon withdrawal of exemption, and that their claim was allowed by Tribunal and this is not intended and in accord with scheme of depreciation allowance.
3. Depreciation provided in books of account: even if deprecation was provided in accounts in earlier years, one has option to write it back and state the assets at actual cost to avoid deduction of notional depreciation. For example suppose in case of an individual who has started new business, his earnings are below threshold basic exemption. He is not required to file return of income for first three years. Therefore, he is not required to compute his income for the purpose of the Act.  He does not provide depreciation in books of account and state the fixed assets like furniture, office space, shop, work shop, office equipments, tools ,books etc. at actual cost. Therefore, in fourth year when he is required to file return of income and compute income, he can claim depreciation on actual cost of assets acquired during first three years. Suppose he provided depreciation in books of account in some year, then he can write back such depreciation to state the assets at actual cost during the period when income is not taxable.  

Some questions about explanation:

As this provision is against well settled legal position by several judgments of the Supreme Court decided long ago when Act of 1922 was applicable as well as when Act of 1961 was applicable. Therefore, questions which arise are:

1.   Why this explanation has been inserted?
2. Whether it can be applied even prior to 01.04.2003, if it an explanation?
3. Whether the provision is a valid provision?
4. Whether the provision is justified?

To answer the question “why this explanation has been inserted”? We need to refer to the memorandum explaining the relevant proposal in the Finance Bill, 2008. The same is reproduced below (with high lights by way of underlining):

CLARIFICATORY AMENDMENTS

Clarification regarding definition of written down value under section 43(6)

Clause (ii) of sub-section (1) of section 32 provides that depreciation shall be allowed 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 written down value in the case of assets acquired before the previous year means the actual cost to the assessee less all depreciation actually allowed to him under the Income-tax Act.

Some persons were exempt from tax and, therefore, not required to compute their income under the head “profits and gains of business or profession”. Upon withdrawal of exemption, such persons became liable to income-tax and hence, required to compute their income for income-tax purposes. In this context, dispute has arisen on the basis for allowing depreciation under the Income-tax Act in respect of assets acquired during the years when it enjoyed exemption.

The Income-tax Appellate Tribunal has held that since there was no liability to tax, there was no occasion to compute the income of such person under the provisions of the Income-tax Act. Therefore, the depreciation provided in the books in the years when the income was exempt can not be treated as the depreciation “actually allowed”. Accordingly, it was held that the actual cost of the asset was the written down value for the purposes of claiming depreciation under the Income-tax Act in the previous year in which such person first ceases to enjoy the income-tax exemption. This interpretation is not in conformity with the intent and purpose of the provisions of depreciation. Accordingly, it is proposed to amend section 43(6) to provide that,—

  (a)  the actual cost of an asset shall be adjusted by the amount attributable to the revaluation of such asset, if any, in the books of account;

  (b)  the total amount of depreciation on such asset provided in the books of account of the assessee in respect of such previous year or years preceding the previous year relevant to the assessment year under consideration shall be deemed to be the depreciation actually allowed under the Income-tax Act for the purposes of section 43(6);

  (c)  the depreciation actually allowed as above shall be adjusted by the amount of depreciation attributable to such revaluation.

This amendment will take effect retrospectively from 1st April, 2003 and will accordingly apply in relation to assessment year 2003-04 and subsequent assessment years.

Notes on relevant clause of the Bill  is also on similar line and any additional information is nto provided, therefore the same is not reproduced for sake of brevity.

Totally wrong reason for insertion of explanation:

The reason given for the amendment, that is a decision of ITAT is totally wrong. For the following reasons:

The reason is a decision of ITAT- this reason is wrong because  the Supreme Court has long ago decided that depreciation actually allowed is what is actually debited or actually allowed by the ITO under I.T.Act while computing taxable income and not any notional deprecation allowance. In this regard the following judgments are landmark judgments:

1.   CIT V Dharampur Leather Co. Ltd 1965 -TMI - 49238 – (SUPREME Court) judgment dated 03.12.1965 relevant to Assessment Year 1955-56 under the I.T.Act, 1922. The judgment of the Bombay High Court reported as  dharampur Leather Co. Ltd V CIT  [ 1965] 55 ITR 329 (BOM.)  dated 07 and 9.10.1961 was approved .  In this case the Supreme Court had decided inter alia as follows:

              The words 'actually allowed' occurring in section 10(5)(b) did not include any notional allowance.

The exemption granted by the Central Government was granted under paragraph 15 of the Merged States (Taxation Concessions) Order, 1949, which was itself issued under section 60A of the Act. The result was that the exemption was granted under the Act and not under any agreement. The case of the assessee must be determined with reference to section 10(5)(b), unaffected by the amendment made by the 1962 Order.

Hence, depreciation was allowable on the original cost of the various components of the plant and machinery and other assets of the assessee-company as acquired and used prior to 1-7-1963. The other  important decision of the Supreme Court on the issue are

CIT V Nandlal Bhandari Mills Ltd 1965 -TMI - 49240 – (SUPREME Court), dated 07.12.1965. 

Hukumchand Mills Ltd V CIT 1966 -TMI - 39897 – (SUPREME Court) dated 12.09.1966.

Madeva Upendra Senai V UOI 1974 -TMI - 6436 – (SUPREME Court) dated 07.11.1974 decided by a Constitutional Bench of the Supreme Court consisting of five judges..

Thus we find that there are several judgments of the Supreme Court on this issue in context of IT Act, 1922 and IT Act, 1961  The Constitutional bench had decided the issue in 1974 that is 35 years earlier. The Bombay High Court had on 07.10.1961 decided that depreciation actually allowed is to be deducted and any notional depreciation during exemption period under I.T.Act will not be deducted. The Decision of Tribunal which has been stated to be the reason for amendment by insertion of the new explanation is therefore not a valid reason because Tribunal has decided the issue based on judgment of Supreme Court. The question is why the explanation is silent about relevant judgments of the Supreme Court?.

 The reason given – scheme of the depreciation allowance is also wrong because     as per scheme of the Act, actual cost of assets eligible for depreciation is allowed under this Act to compute real income under the Act that is when tax is payable.  If this Explanation is applied then entire cost shall not be allowed. For example suppose an assessee had assets having  actual cost of Rs.500 and he has provided depreciation in his books of account, during exemption period  amounting to Rs.475/- leaving a balance of 5% of cost that is Rs.25 to continue assets at some value. In this case , if the explanation is applied Rs.25 will be taken as WDV and depreciation shall be provided on the same, therefore, he will get deduction of Rs.25 only under this Act when income is taxable. Whereas as per scheme of the Act, an assessee is to get effective benefit of deduction of Rs.500/- under this Act. Therefore, the amendment is not in tune with scheme of depreciation allowance.

Whether it can be applied even prior to 01.04.2003, if it an explanation?

To answer this question first we feel intrigued as to why the date 01.04.2003 has been adopted and why not any earlier date. There is no answer to this question. There is no logic to adopt this date. Exemptions have all along been found in the I.T.Act, 1922 as well as in I.T.Act, 1961. As discussed earlier, even in case  CIT V Dharampur Leather Co. Ltd  relevant to Assessment Year 1955-56 under the I.T.Act,1922 the notional depreciation for  period of exemption was  considered as not deductible.

An amendment which is clarificatory amendment can have retrospective effect, even if it is not so stated clearly. In this case it has been made effective from 01.04.2003, this shows that it really not clarificatory but is in nature of applying whims and bias of bureaucrats who drafted the provision.  However, since a date has been specified, it cannot be applied for any period prior to such date. Therefore, it cannot be applied till assessment year 2002-03 and can be applied only from assessment year 2003-04 onwards, if at all.

Coming to questions whether the provision is a valid provision?  And

 Whether the provision is justified?

In this regard the earlier discussions are important. As discussed it is found that  the  reasons given for amendment are wrong reasons. When the reasons are wrong, and when the amendment has effect of altogether altering the scheme of the Act on particular subject it cannot be called a valid and  legally correct or  justified amendment. Besides there are some other reasons to say that the provision is not valid as discussed in next paragraph.

Other reasons for holding the explanation invalid are as follows:

Un-certainty of law imposes unreasonable restrictions on freedom  to carry  profession  and business:

Retrospective amendments in a regular manner just to overcome judicial rulings , imposes unreasonable restrictions on carrying professions like profession of advocates, Chartered Accountants, Cost Accountants and Company Secretaries  who advice their clients on legal matters. This is because a professional can advice on basis of law as prevailing at the time of rendering advice and also based on rulings then prevailing. In case it become a routine for the government to change law even with retrospective effect, then it would be unreasonable restriction on professional persons because it is difficult for them to for see any amendment affecting their opinions and advice. Therefore, freedom to carry profession is impaired to a great extent.

This also affects freedom to trade and carry business. A business decision is always based and affected on what would be profit after tax (PAT). These decisions are taken as per law prevailing at the time of setting up of business as well as during carrying on business. If law is changes after several years with retrospective effect, and it creates additional tax liability, it is affecting freedom to trade.

In a situation of uncertain law, decision making for any business or profession is very difficult and creates unreasonable restrictions on carrying business and professions. 

Inequality before law:

The Explanation create inequality before law amongst affected assesses who have provided depreciation in their books of account in different manner and at different rates and also those who have not at all provided deprecation in books of account. For example in the example given earlier an assessee who has not provided depreciation in his books of account shall be entitled to deprecation on actual cost of Rs.500/- and another assesses who have provided depreciation of say Rs.100 under SLM method and Rs. 200 on WDV basis will be entitled to deprecation on WDV as per books that is  Rs.400 and 300 respectively. This creates inequality before law for the three parties. A vigilant and well advised assessee may choose to adopt changed method of accounting and write-back depreciation provided so that assets are stated at cost in books and the cost is considered as WDV whereas another assessee will have to bear reduction from actual cost and to pay higher tax. There is no rational or intelligent differentia between three assesses.

 The amendment cannot be called a reflection of legislative intent because there is no  change at all  in the scheme of depreciation allowance  after  01.04.2002 (except some changes in rates):

1.  About depreciation allowance  on actual cost and WDV as prescribed in S. 32
2. About  deprecation actually  allowed  vis a vis notional allowance.
3. There is no change in political ideology, in any case it is difficult to say that the legislative intention as prevailed earlier  till 01.04.2002 has undergone a change w.e.f. 02.04.2002 and that such change has  been  now  ascertained and applied.
4. The legislative intention having been ascertained by the Supreme Court, long ago, a new decision of Tribunal cannot be a reason to say that doubts have arisen newly and those doubts are clarified now. Particularly so  because the Tribunal followed decision of Supreme Court in which legislative intention was already ascertained.
5. In democracy legislators are selected by public by casting their votes and their decision is to some extent also affected on  consideration of then prevailing  government policies. We find that the Budgets of 2000,  2001 and 2002 were placed by the  then Finance Minister Shri Yashwant Sinha  and for 2003 and 2004 by Shri Jaswant Singh. Budget for 2005,2006,2007 and 2008  were placed by Shri P.Chidambaram.   

It is difficult to say as to how Shri P.Chidabamram, on 28^th February 2008 ascertained as to what was  legislative intention on 01.04.2003  when there was government headed by other Prime Minister with different ideology and polity. Suppose there was no change in government, in that case  also  a sudden shift in government policy, even when there is no substantial change in political ideology , constitution in the Parliament, declarations of Government or declarations by political parties in control cannot be called an amendment to clarify legislative intent after a gap of considerable period.

Even on individual basis intentions and desires go on changing from time to time, and an individual cannot say after few years that his intentions was different from what is written in his documents. Therefore, in case of collective intentions ( expressed by Parliament) it cannot be said that legislative intention is ascertained after so many years and therefore a clarification is desirable. All such changes are really not reflection of legislative intentions but they are really reflection of moods, behavior, and thinking of bureaucrats who draft budget or other legal proposals. Unless there is threadbare discussion in Parliament and the members are explained significance of proposals, it is misnomer to say that all legal proposals are reflection of true legislative intention and that such intentions can be modified at any time in name of explaining legislative intentions.

Therefore, it can be said that the amendment is not at all justified. In any case its retrospective effect from 01.04.2003 is not based on any reason or logic. The trend of amending law with retrospect effect must come to an end to maintain certainty and integrity of law, process of making law , process of interpretation of law and the  government policies.