New eligible plant and machinery- further deduction of 20% of cost u/s 31(1)(iia)- some issues and exploration of beneficial provisions- a discussion about need to amend the provisions to avoid litigation.

[C.A. DEV KUMAR KOTHARI]

Popular understanding:

It is generally and popularly understand that in case of new eligible plant and machinery a further deduction equal to 20% of cost of such machinery or plant  is allowable in the first year. This further deduction is also called as initial depreciation or additional depreciation. In this write-up we are concerned with two aspects relating to such further deduction. These are:

a.       Whether, full amount of 20% can be claimed and allowed in the first year even if the machinery or plant is used for less than 180 days? And

b.       Whether, such further deduction is in nature of incentive and not deprecation, and therefore it should not be deducted from WDV.

Relevant provision:

Provision of section 32 in relation to further deduction allowable in respect of new machinery or plant are reproduced below:

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 assessee 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 prescribed:

[Provided further that where an asset referred to in clause (i) or clause (ii) ⁹[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) ¹⁰[or clause (iia)], as the case may be :]

**[(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) :

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;]

Notes :-

** Brief history of clause (iia):

 The present clause as reproduced above was substituted by the Finance Act, 2005, w.e.f. 1-4-2006. Prior to its substitution clause (iia) as inserted by the Finance (No. 2) Act, 2002, w.e.f. 1-4-2003 and amended by the Finance (No. 2) Act, 2004, w.e.f. 1-4-2005, read as under :

## {'(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, 2002, by an assessee engaged in the business of manufacture or production of any article or thing, a further sum equal to fifteen per cent of the actual cost of such machinery or plant shall be allowed as deduction under clause (ii):

Provided that such further deduction of fifteen per cent shall be allowed to—

(A) a new industrial undertaking during any previous year in which such undertaking begins to manufacture or produce any article or thing on or after the 1st day of April, 2002; or

(B) any industrial undertaking existing before the 1st day of April, 2002, during any previous year in which it achieves the substantial expansion by way of  increase in installed capacity by not less than ten per cent:

Provided further 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:

Provided also that no deduction shall be allowed under clause (A) or, as the case may be, clause (B), of the first proviso unless the assessee furnishes the details of machinery or plant and increase in the installed capacity of production in such form, as may be prescribed along with the return of income, and the report of an accountant, as defined in the Explanation below sub-section (2) of section 288 certifying that the deduction has been correctly claimed in accordance with the provisions of this clause.

Explanation.—For the purposes of this clause,—

(1) "new industrial undertaking" means an undertaking which is not formed,—

(a) by the splitting up, or the reconstruction, of a business already in existence; or

(b) by the transfer to a new business of machinery or plant previously used for any purpose;

(2) "installed capacity" means the capacity of production as existing on the 31st day of March, 2002;'}

## Going into further past we find that the clause (iia), was originally inserted by the Finance (No. 2) Act, 1980, w.e.f. 1-4-1981 and omitted by the Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986, w.e.f. 1-4-1988.

Brief discussion:

We find that further deduction came back in the Act from assessment year 2003-04 with several conditions relating to new unit or substantial expansion of existing unit. Eligibility vis a vis type of machinery or plant has more or less remain similar and is also on similar lines as the case was in respect of other incentive deductions like investment allowance, development rebate and old additional/ initial depreciation allowance. The deduction is a one time deduction and it is not allowed year after year. From assessment year 2005-06 the conditions were relaxed and rate was also increased. However, it is still allowable in respect of certain eligible plant and machinery and not on all plant and machinery. Therefore, the benefit is given with a view to achieve certain socio-economic purposes.  

Boards circular on amendment:

The nature of additional depreciation u/s 32(1)(iib) is discussed in the memorandum on budget proposals and Boards circular as follows:

            3.6 Enhancement of the rate of additional depreciation on new machinery and plant and withdrawal of certain conditions - Under the existing provisions of clause (iia) of sub-section (1) of section 32, additional depreciation is allowed at the rate of fifteen per cent of the actual cost of the new machinery and plant (other than ships and aircraft) acquired and installed after the 31st day of March, 2002. Additional depreciation is allowed in the case of a new industrial undertaking during any previous year in which it begins to manufacture or produce any article or thing on or after the 1st day of April, 2002 or to any industrial undertaking existing before that date if it achieves substantial expansion during the previous year by way of increase in its installed capacity by not less than ten per cent.

In order to encourage investment, the Finance Act, 2005 has amended section 32 to increase the rate of additional depreciation to twenty per cent on new machinery and plant other than ships and aircraft, acquired and installed after the 31st day of March, 2005, and dispensed with the condition of additional depreciation to be allowed to a new industrial undertaking and the condition of expansion in installed capacity.

Depreciation rates have been modified through a Notification dated 28th February, 2005. The modified depreciation rates are effective from assessment year 2006-07. Among other things, the rate of depreciation on plant and machinery has been reduced from 25% to 15%.

Applicability : From A.Y. 2006-07 onwards.

Thus we find that the further deduction is allowed as an incentive to encourage investment in eligible plant and machinery. It is also worth to note that rate of depreciation were also reduced form 25% to 15%.

Explanations about  full deductions u/s 32 (1(iia):

In view of  true nature of further deduction being incentive and one time deduction it can be said that full deduction should be allowed in the first year of purchase/ put to use of the plant and machinery. Therefore, there should not be  restriction even if the use is for less than 180 days.  

Regarding full (20%) claim of further deduction:

As per S. 32 (1) (iia) a further sum equal to 20% of actual cost of eligible new machinery or plant shall be allowed as deduction  under clause (ii).

The language used is mandatory by use of word 'shall be allowed'. Furthermore, any clarification has not been made as to whether in case such allowance is restricted to half of amount, in case machinery or plant is used for less than 180 days, then how balance amount can be claimed. Therefore considering the purpose of allowance u/s 32(1)(iia), full amount is allowable in the year of acquisition of machinery or plant irrespective of number of days on which such machinery or plant was put to use.

In proviso after  S. 32 (1) the clauses (iia) has been inserted. Therefore there is conflict between two provisions. As per S. 32 (1) (iia) deduction equal to 20% shall be allowed in the first year. Therefore, the conflict in two provisions needs to be resolved by taking the beneficial provision as having overriding effect on the restrictions imposed by other provision, particularly when a purpose seeking approach is adopted.

In case proviso to S. 32 (1) (ii) is applied, then the purpose of S. 32(1)(iia) shall be defeated because in case an assets is not used for 180 days or more, the incentive allowance shall stand restricted to half of otherwise allowable amount and that is not the intention as appears from the memorandum explaining the provisions of S. 32 (1) (iia) . We also find that  there is no reason or  explanation given for  insertion of ' clause (iia)' in the proviso after section 32 (1) (ii) . In the memorandum and circular it is stated that 20% deduction shall be allowed in the first year. There is no rider that it will be restricted to 50% in case of less than 180 days use. Furthermore, it is also not provided that in such cases, balance of further deduction shall be allowed in the next year. Thus if the deduction is restricted to 10% in first year, then the promise of allowing  further 20%  deduction shall fail. Therefore, it appears that the insertion of clause (iia) in the said proviso is a drafting error. In any case when there are two conflicting provisions, the provision which serve the purpose and which is liberal and beneficial to the tax payer need to be adopted.

Whether deductible from WDV:   

As analyzed above further deduction  u/s 32(1)(iib) is  an incentive for investment in new eligible plant and machinery, although it has been stated that it is  a deduction u/s 31(1) (ii) but it is also true that it is not a deduction from year to year but it is restricted to first year only. Therefore, it is not allowed for  wear and tear, it is allowed once in life of asset and not year after year, hence this is  different  from normal depreciation allowance. As the amount is an incentive and to encourage investment it cannot be considered as an allowance of deprecation deductible from WDV. If the amount be considered as depreciation and deducted from WDV, then the purpose of incentive shall also be defeated. In that case the benefit of such further deduction shall be just to defer payment of tax, and not reduction of tax liability.

 It is practically noticed that in case of new units or expansion or modernization, of existing units ,substantial investment is made, and in most of such cases, the amount of income is not enough to fully absorb depreciation and further incentives like further deduction u/s 32(1) (iia). Therefore, in majority of cases no real benefit is derived in the first year by way of further deduction.

In view of the above discussion it can be said that the further deduction u/s 32(1)(iia) being an incentive to encourage investment, is not deductible from WDV of assets. In this regards reliance  on judgment and principal laid down in  ITC Ltd v. CIT [1994] 205 ITR 126(Cal.) can be placed to contend  that it  is not deductible from  written down value(WDV) of block of assets on a purposive construction and taking a beneficial view.  

From judgment in case of ITC Ltd:

In the case the honorable court observed and held as follows:

In determining the written down value of depreciable assets for purposes of computing capital under section 80J of the Income-tax Act, 1961, the special allowance under section 32(1)(v) is not to be reckoned as the true nature of the allowance is not depreciation though it bears the appellation "initial depreciation".  The enactment had not left the matter to any ambiguity, if one reads all its related provisions conjointly.  At the time the proviso to section 43(6) was inserted in the present Act by the Finance (No.2) Act, 1965, with retrospective effect from April 1, 1962, there was no scheme for initial depreciation over and above the normal depreciation.  The law re-enacted as the Income-tax Act, 1961, contemplated originally only one class of depreciation, the depreciation for the normal wear and tear of depreciable assets.  The same was the position when the proviso was inserted by the Finance (No.2) Act, 1965.  The concept of initial depreciation re-emerged and made its entry in the new Act by the Finance act, 1967, with effect from April 1, 1968.  But the Legislature while reintroducing initial depreciation in the present Act evidently omitted to note that the proviso below clause (6) of section 43 defining "written down value" should also be correspondingly amended conformably with the legislative policy of excluding such additional or initial depreciation from the scope of the expression "depreciation actually allowed" so that such depreciation does not go to reduce the written down value.  Reduction of the written down value by such depreciation would not at all be rational since such depreciation, in its true effect and nature, is not real depreciation but an incentive with the label of depreciation.  The proviso below clause (6) of section 43 makes it clear that the legislative policy is not to treat any depreciation other than normal depreciation for wear and tear of the assets as includible in the words "depreciation actually allowed".  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 a mere drafting omission that has gone unnoticed.  Along with the initial depreciation under the repealed Act of 1922 which was an incentive given in the garb of depreciation, the initial depreciation in section 32(1)(v) being of the same nature should also find a place in that exclusionary proviso.  In any case, the connotation of the expression "depreciation actually allowed" is intended not to take into account any depreciation other than normal depreciation.  This is also manifest from the language of clause (v) of section 32(1).  The last sentence "any such sum shall not be deductible in determining the written down value for the purposes of clause (ii)" leaves no room for doubt that it has never been in the contemplation of the law-makers to treat such depreciation as the depreciation proper to be taken into account whiled determining the written down value (see pp.136D, E, 134C - H, 135A, B, D, E).

Badiani (P. K. ) v. CIT [1976] 105 ITR 642 (SC) applied.

CIT v. Texmaco Ltd. [1983] 141 ITR 531 (Cal.) followed.

Application in present scenario:

We find that definition of written down value of block of asset came in the Act in 1987 w.e.f. assessment year 2008-09. At that time there was no initial / additional depreciation. As noted above the further deduction u/s 32(1) (iia) is to encourage investment. Therefore, applying the above judgments it should not be deducted from WDV. The judgment in case of ITC Ltd was in relation to s. 80J, however the definition of WDV was also considered and the principal of interpretations were applied. The same principals as to depreciation, WDV and the nature of incentive are applicable to further deduction u/s 32 (1) (iia).

Amendment is desirable:

To avoid confusions and litigation, it is desirable that the provisions should be amended to specifically provide for the above aspects in the section. For this purpose in the said proviso  the words "clause(iia)" should be omitted and in the definition of WDV it should be clearly provided that the amount of further deduction u/s 32(1) (iia) shall not be reduced from WDV.