26 August 2010
Can any one provide me the case law of J.K. Chemicals ltd v/s ACIT (ITA no. 8206/ Bom./1989) and any other latest case law on "whether losses b/f can be set off against profit on sale of depreciable assets which is calculated as per section 50.
1.1 The querist is a public company engaged in the business of manufacturing and trading. During the financial year 2001-02, relevant to A.Y. 2002-03, the company has incurred a business loss as per Income-tax Act, 1961 to the extent of Rs.101.73 lakhs including Rs.16.26 lakhs of depreciation and has earned income on account of sale of depreciable assets to the extent of Rs.243.28 lakhs.
1.2 Whole of the block of asset of the particular plant, on which depreciation was allowable and claimed @ 100%, has been sold and gain of Rs.243.28 lakhs has been earned on sale of the said block of plant. As W.D.V. was Nil, whole of the sale price is treated as income. The sale price of Rs.243.28 lakhs is lower than the cost of the plant and is lesser than depreciation already allowed.
1.3 For the financial year 2000-2001 (assessment year 2001-2002) there is a loss as per Income-tax Act, 1961 to the extent of Rs.225.37 lakhs.
Queries :
2. Based on the above facts, the querist has sought opinion whether the past carried forward losses of Rs.225.37 lakhs can be set off against the income arising on sale of depreciable asset described earlier ?
Opinion :
Gain on sale of depreciable asset — Chargeable to tax under which head of income :
3.1 S. 14 of the Act prescribes the head under which income chargeable to tax is assessable. If a specific head has been prescribed, then income is assessable under the said head of income and same cannot be subjected to tax under other head of income. Further, the heads of income are mutually exclusive. (See United Commercial Bank Ltd. v. CIT, (1957) 32 ITR 688 (SC), Bihar State Cooperative Bank Ltd. v. CIT, (1960) 39 ITR 114 (SC), East India Housing and Land Development Trust Ltd. v. CIT, (1961) 42 ITR 49 (SC), Sultan Bros. Pvt. Ltd. v. CIT, (1964) 51 ITR 353 (SC), Nalinikant Ambalal Mody v. S. A. L. Narayan Row, (1966) 61 ITR 428(SC), CIT v. Chugandas & Co., (1965) 55 ITR 17 (SC)). However, though income would be assessable under specific heads of income, they do not limit and affect the source of income and if a particular income is profits of business, the character of income is not affected irrespective of the fact that it is assessable and so assessed under a different head of income.
3.2 As such, in the present case though gain from transfer of capital asset is chargeable to tax under the head Capital gains, it by itself would not negative the claim that income arises from business, if it can be so established.
Character of income arising on sale of depreciable asset :
4.1 This brings us to the next issue, as to the character of income arising on transfer of capital asset. In the case of the querist, gain has arisen on transfer of asset used for business and the gain wholly represents recoupment of depreciation allowed earlier in determining business profits.
4.2 The term profit and gains of business has not been defined under the Act and therefore its normal commercial meaning has to be considered. To quote the famous words of Lord Halsburry : “The word ‘Profits’ is to be understood in its natural and proper sense, in a sense which no commercial man would misunderstand”. (In Gresham Life Assce Society v. Style, 3 TC 185 (HL). Though to trade in capital asset is not regular business activity, but in the present case, though profit has arisen on sale of capital asset, the reason for profit is not because the querist has realised more than it had spent on acquiring the said asset. The gain has arisen only because depreciation was claimed and allowed and if the same had not been claimed, there would have been a loss rather than profit.
4.3 Depreciation on asset used for the purpose of business is not an expense incurred to earn profit; rather it is a charge on profits of the year. Depreciation as a general principle represents the diminution in value of a capital asset when applied to purpose of making profit or gain. The object is to get a true picture of the real income of the business. [see CIT v. Anand Theatres, [2000] 244 ITR 192 (SC)] Except land, all assets depreciate both due to normal wear and tear, due to use, and passage of time. When an asset is used for the purpose of business, providing for such wear and tear, called depreciation, is neces-sary to determine profits of an enterprise. Com-mercial principle of providing for depreciation to determine profits has been recognised u/s.32 of the Act.
4.4 However, the amount of depreciation to be provided is a matter of estimate even as per commercial principles. Under the Income-tax Act, rates at which depreciation has to be provided are prescribed and such rates are prescribed consider-ing not only normal wear and tear but in many cases also to encourage investment in certain areas or assets. Like in the case of querist, it has been entitled to depreciation @ 100% under the Act, in the year of installation itself. Depreciation being an estimate, it does happen that actual depreciation may vary with depreciation provided in books. Such variation between actual depreciation and depreciation provided is known only when the asset is sold or otherwise disposed of. In commercial accounting, such variation determined at the time of disposal, is treated as follows :
(a) If depreciation provided in books was more than necessary, amount realised in excess, to the extent it does not exceed depreciation provided in books is recoupment of charge to profit made earlier and is therefore commercial profit. As depreciation was a charge on profit in earlier years, in the year in which it is determined that such provision was in excess of need for depreciation, the same represents commercial profits of such year. It can be said that it is only commercial profit of earlier year which is now being realised. Therefore it is commercial profit of trade or business.
(b) If depreciation provided in books was less than necessary, whole of such shortfall is recognised as depreciation of the year of disposal and is charged to profits.
Accounting Standard 10 (AS 10) issued by the Institute of Chartered Accountants of India relating to ‘Accounting for Fixed Assets’ in para 26 provides as follows : “Losses arising from retirement or gains or losses arising from disposal of fixed asset which is carried at cost should be recognised in the profit and loss statement.” Therefore, profit arising on sale of depreciable asset, at least to the extent of depreciation allowed in the past, is commercial business profit.
4.5 Prior to omission and amendment by Taxation Laws (Amendment and Miscellaneous Provisions) Act, 1986, w.e.f. 1-4-1988, S. 41(2) of the Act, dealt with situation described in (a) above and S. 32 dealt with situation described in (b) above. Both income and loss as above were part of determination of business profits for the purpose of the Act.
4.6 However, after the above stated amendment, concept of block of assets has been introduced. Under the block of assets theory, all assets owned by a business are classified as per rate of depreciation prescribed under the Act. Cost of written down value of asset so classified are aggregated and depreciation is allowed on such an aggregate. Adjustments on account of sale, disposal, etc. have to be made to written down value of the block of assets. When the block of assets ceases to exist, the net written down value as adjusted by consideration received is either treated as income or loss on account of capital asset u/s.50 of the Act. S. 50 also provides for taxation of capital gain, when the consideration received for transfer of any depreciable asset, forming part of block of assets, is more than its written down value, even if block of assets exists and some asset still forms part of block of assets.
4.7 In view of the above, it can be said that to the extent to which consideration realised on sale of depreciable assets represents depreciation provided in the past, it is commercial profits; it is profits and gains of business carried on. Also, such commercial treatment was accepted even by the Act before the block of assets theory was introduced for allowability of depreciation. As such, even after amendment, though such gain is assessable under the head ‘Capital Gain’, its character does not change and it continues to be business profit. The amendment has only made change as far as head under which such gain is assessable but it has not affected the source and character of such gain being business income.
Provisions relating to set off of unabsorbed business loss :
5.1 S. 72 of the Act deals with carry forward and set off of business loss, which cannot be set off against other income in the year in which it is incurred and determined.
5.2 Clause (a) of S. 72 allows set off of brought forward unabsorbed loss against ‘profits and gains of business’ as against use of words head of income in S. 71 as well as in the opening part of Ss.(1) of S. 72. It raises an issue as to whether for claim of set off, it is sufficient that income is profit and gain of business or is it necessary that the income against which set off is sought, should have been assessed under the head business income. As discussed in para 4 earlier, merely because an item of income is assessable under any head other than business income, it does not lose its character of being profit and gain of business. The issue has been considered in a number of cases, some of which are summarised below.
5.3 In United Commercial Bank Ltd. v. Commis-sioner of Income-tax, (1957) 32 ITR 688 (SC) a similar issue had arisen where the assessee bank claimed adjustment of business loss of earlier years against interest on securities which at the relevant time was assessable under separate head of income. As facts as to whether securities were held as trading asset was not clearly on record, the matter was remitted, but the hon’ble Supreme Court held that though heads of income prescribed are mutually exclusive and income assessable under one head cannot be assessed under another head, it does not negative the source being from business.
5.4 In Commissioner of Income-tax v. Cocanada Radhaswami Bank Ltd., (1965) 57 ITR 306 (SC) the issue was similar to the case of the querist. It had claimed set off of unabsorbed business loss of earlier years against interest on securities held as business assets. The assessing officer negatived the claim on the ground that interest on securities is assessable under different head of income and therefore business loss of earlier year cannot be set off as the same can be set off only against business income. The Supreme Court upheld the claim of the assessee bank and held : “The scheme of the Act is that income-tax is one tax. S. 6 only classifies the taxable income under different heads for the purpose of computation of the net income of the assessee. Though for the purpose of computation of the income, interest on securities is separately classified, income by way of interest from securities does not cease to be part of the income from business if the securities are part of the trading assets. Whether a particular income is part of the income from a business falls to be decided not on the basis of the provisions of S. 6 but on commercial principles”.
5.5 As such, even if a particular item of income has been assessed to tax under a head of income other than business income, if it is profits and gains of business in commercial terms, then unabsorbed business loss of earlier year can be set off against such income. The said proposition is also sup-ported by the decision in O. Rm. M. Sp. Sv. Firm v. Commissioner of Income-tax, (1967) 63 ITR 404 (SC).
5.6 As regards capital gains arising on transfer of business asset, the issue was considered in Killick Nixon and Co. v. Commissioner of Income-tax, (1967) 66 ITR 714 (SC) and it was held that capital gains cannot be considered to be profits and gains of business. In the said case, the Supreme Court was dealing with capital gains arising on transfer of various assets like managing agency, goodwill, and other assets and the business of the assessee was discontinued. Issue whether any of the assets were depreciable assets or that part of the gain related to recoupment of depreciation allowed earlier was not considered at all and therefore to the said extent the said judgement is, on facts, distinguishable with facts of the case of the querist. The issue in Querist’s case of whether gain on transfer of depreciable asset can be considered as profits and gains of business, has not been considered at all in Killick Nixon’s case.
6. In view of the above, the querist has a good case to contend that income arising on transfer of depreciable asset to the extent of depreciation claimed in the past, is profits and gains of business even though it is assessable under the head capital gains and therefore for the purpose of applying provisions of S. 72(2), unabsorbed business loss of Rs.225.37 lakhs can be set off against such income. The Mumbai Bench of Income-tax Appellate Tribunal, in case of J. K. Chemicals Ltd. v. ACIT (ITA No. 8206/Bom./1989 and 8618/Bom./1989) by its order dated 1st Nov., 1993 upheld similar claim of the assessee and it supports the case of the querist.
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