Depreciarion in case of conversion of firm into Co.

In the ITAT Ahmedabad Bench ‘C’ Amin Machinery (P.) Ltd. v. Deputy Commissioner of Income-tax, Co. Cir. 2-cum-New ‘A’ S. Co. Circle, Baroda R.P. Tolani, Judicial Member and sanjay arora, accountant member IT Appeal No. 774 (Ahd.) of 2002 [Assessment year 1998-99] January 12, 2007 Section 37(1), read with section 170, of the Income-tax Act, 1961 - Business expenditure - Allowability of - Assessment year 1998-99 - Assessee-company was incorporated through conversion of a partnership firm - It claimed deduction of payment of sales commission which arose on execution of sales by predecessor firm - Whether assessee was eligible to claim said expenditure - Held, no - Whether since liability arose on execution of corresponding sales by predecessor-firm, same could be claimed in firm’s return only even if expenditure stood accounted for in company’s books - Held, yes Section 78, read with section 170, of the Income-tax Act, 1961 - Losses - Carry forward and set-off of in case of change in constitution of firm or on succession - Assessment year 1998-99 - Whether assessee-company, which was incorporated through conversion of a partnership firm, could be allowed to carry forward unabsorbed business loss of erstwhile firm - Held, no Section 32 of the Income-tax Act, 1961 - Depreciation - Allowance/Rate of - Assessment year 1998-99 - Whether where assessee-company was incorporated through conversion of a partnership firm, depreciation as allowable in terms of relevant provisions of Act, should be allowed in hands of both predecessor-firm and successor-assessee-company, purpose of assessment being determination of correct liability under Act and fair assessment in terms of extant law which would require allowance of depreciation at correct amount(s) in hands of both, including adjudication of correct amount of WDV in assessee’s hands - Held, yes - Whether, however, carry forward of depreciation under section 32(2) could only be in hands of partnership firm - Held, yes [Matter remitted back to Assessing Officer to decide question as to whether WDV in assessee’s hands could be made after excluding depreciation that stood held as not eligible for carry forward in terms of section 32(2)] FACTS The assessee-company, which was incorporated under Part-IX of the Companies Act, 1956 through the conversion of a partnership firm, claimed deduction of payment of sales commission, liability of which arose on execution of corresponding sales by predecessor-firm; set-off of unabsorbed business loss of erstwhile partnership firm; and carry forward and set-off of unabsorbed depreciation of the said partnership firm. The assessee claimed aforesaid deduction on the basis that it was only a case of change of form; the older entity (partnership firm) getting itself registered under a different statute (Companies Act, 1956), preferring to be henceforth governed by its provisions. The Assessing Officer held that the assessment up to the date of succession and, thereafter, during the year of succession, was to be in the hands of the predecessor and the successor respectively, and, as such, the claim of expenditure contracted by the predecessor-partnership firm could not be allowed in the hands of the successor-company. The assessee’s second claim for carry forward and consequent set-off of unabsorbed business loss was disallowed on the basis of the provision of section 78(2). The Assessing Officer also disallowed the assessee’s claim for grant of carry forward of unabsorbed depreciation as determined in the case of the erstwhile firm, relying upon section 32(2). On appeal, the Commissioner (Appeals) confirmed the order of the Assessing Officer. HELD The stand of the assessee-company as being only a modified version of the erstwhile firm, which only stood registered under the Companies Act, 1956, was unacceptable. A partnership firm and a company are distinct and separate legal entities and are recognized as separate persons under the Act. A partnership has no identity of its own, i.e., apart and distinct from the several persons constituting it for the time being, only signifying the contractual relationship between them, and the firm’s name is only a compendious name given to all of them together. A company, as defined under section 2(10), read with section 3 of the Companies Act, 1956, on the other hand, is a separate legal entity, a creature of the statute, separate and distinct from several persons, natural or purely legal, who may be its members for the time being. As such, that the assessee-company stood formed and registered in terms of Part IX of the Companies Act, 1956, would, therefore, by itself, be of no consequence. It might well have been a company formed and registered under the said Act by the partners of the erstwhile firm, and taking over the running business of the said firm. In other words, no special significance could be attached to the manner of the formation of the assessee-company. Further, that the erstwhile partnership ceased to be in existence upon the registration of the assessee, was of little significance, its legal effect being of its dissolution, which, in terms of the partnership law, to which it is subject to, could be on the partners mutually deciding so, and which the act of registration (of the firm) under the Companies Act, 1956 itself conveys. As such, the two could not be treated as one even as, without doubt, thereby a succession to business of the partnership takes place, with all its legal incidents. [Para 5.1] As regards the assessee’s claim of deduction of sales commission, the assessee’s case could not be considered as meriting acceptance. No doubt, the assessee assumed all the assets and liabilities of the erstwhile partnership firm, but that only implied that the liability in that respect actually existed as on the date of conversion/succession, so that the assessee-company, as a successor, honoured the same. But acceptance of a liability, even in relation to the business, would not, by itself, qualify for claim for deduction thereof. It was not a case where the liability, which was only a contractual one, crystallized subsequent to the date of conversion, being under dispute at the relevant time. The liability arose on the execution of the corresponding sales by the predecessor firm, so that it could be taken into account by the said firm on the closure of its accounts for the relevant year (period), and which would only subsequent to 30-1-1998, i.e., the date on which the relevant debit notes were stated to have been received. The firm’s income was to be computed only on the basis of the method of accounting which it regularly followed, and which is, admittedly, mercantile/accrual system. In any case, even booking of the expenditure was not a precondition, so that the same could be claimed in the firm’s return, only filed subsequently, even if the expenditure stood accounted for in the company’s books. As such, the discharge by the assessee-company of the firm’s existing liability would not entitle it to claim deduction of the relevant expenditure in its respect; it being subject to the provision of section 145, and neither it being a case of under-provision by the said firm, so that, having been made bona fide, on the basis of the available information, the difference in the amount of the liability, on its actual determination, could be said to have crystallized later. Therefore, the order of the Commissioner (Appeals) denying deduction of said expenses could not be interfered with. [Para 5.2] The assessee’s second claim was for carry forward and consequent set-off of unabsorbed business loss which the revenue had disallowed on the basis of the express provision of section 78(2). The law under section 78 envisages succession of business, but precludes the carry forward of unabsorbed business loss, except where the same is by way of inheritance. The only question, therefore, would be whether the word ‘inheritance’ could cover within its ambit the conversion of a partnership firm into a company as defined under the Companies Act, 1956, under the provisions of Part IX thereof. There is a statutory devolution of the assets and liabilities of the firm on its registration as a Part IX company. As such, could a statutory devolution be considered as amounting to inheritance, which, by definition, can only be to and by individuals. Another essential feature of inheritance is that it is purely a natural phenomenon, as neither the time of one’s expiry nor the set of individuals who would stand to inherit (the property, business in the instant case) can be defined or specified by the predecessor, which is not the case in case of the conversion of an incorporeal entity, though through the process of law. The Act is a separate code in itself and, therefore, transmission would stand to be viewed in the context of its provisions. Section 170 contemplates the transmission of assets or business from one entity to another. [Para 5.3] It is not that succession to business is a phenomenon/transaction that the Act does not contemplate or is silent upon, so that analogy from the general law may have to be resorted to. The Act, evidently, considers ‘inheritance’ as one of the modes of succession, excluding it, while barring the benefit of carry forward of business loss in the hands of the successor (section 170). Similarly, section 47(iii)(a), which defines the cost of acquisition in respect of certain modes of acquisition as being equal to the cost of acquisition to the previous owner (plus cost of improvement, if any), considers acquisition by succession, inheritance or devolution, as one of the specified modes. Clearly, devolution of assets (including business) is treated as separate and distinct mode of acquisition, so that there is no scope for considering the two as one, by carving out a separate case for a Part IX company, in contradistinction to other modes of succession, the law on which is clear, on the ground of a statutory devolution (as sought to be pleaded), and which does not bear the essential attributes of inheritance (which stands specified, i.e., where so deemed fit by the Legislature). In fact, the provisions of section 47(xiii) and section 72A[(4) and (5)] stand co-opted statute by the Finance (No. 2) Act, 1998, with effect from 1-4-1999; and which, clearly provide for the case of the succession of a proprietary firm or a partnership firm by a company subject to fulfilment of certain conditions (extending over a period of time), as not amounting to transfer, as also for the benefit of carry forward of the unabsorbed depreciation and business loss of the erstwhile firm in the hands of the succeeding company. Vide the memorandum explaining the provisions of the Finance (No. 2) Bill, (clause 23), it stood explained that under the existing provisions of the Income-tax Act, business re-organisations, which have definite tax implications, transfer of assets attracts levy of capital gains tax. Similarly, carry forward of losses and that of unabsorbed depreciation is not available to the successor business entities, while it is so in the case of amalgamation. As such, the bill proposed that : (a) subject to the satisfaction of the certain conditions, transfer of assets to a company would not be regarded as transfer under the Act; and (b) similarly, carry forward of business loss and unabsorbed depreciation to successor companies on the satisfaction of the aforesaid conditions. Further, the amendment would be effective from 1-4-1999 and, accordingly, would apply in relation to the assessment year 1999-2000 and to subsequent years. The said explanatory notes, explaining the basis and the rationale of the proposed amendments to the Act, for the consideration of the Legislature, have a definitive interpretative value; in the instant case clearly pointing out to the fact of, except in the case of amalgamations, the business reorganizations as being not tax-neutral. [Para 5.4] In view of the foregoing, the issue under reference being the subject-matter of a specific provision of the Act, and a substantive one at that, which stood clearly worded, there was no scope for allowance of the assessee’s claim, i.e., in respect of carry forward of unabsorbed business loss of the predecessor partnership firm, a distinct and separate person under the Act. [Para 5.5] The assessee’s third claim was for grant of carry forward of unabsorbed depreciation, as determined in the case of the erstwhile firm. Proviso 4 to section 32(2) clarifies that in case of succession to business, the aggregate of depreciation allowance in the hands of both the predecessor and the successor would not exceed the amount of depreciation allowable if the succession has not taken place, and further, would stand allocated amongst the two in the ratio of the number of days the relevant assets stood used by them during the relevant year. [Para 5.6] The Assessing Officer had denied the assessee’s claim by construing the word ‘him’ as occurring in section 32(2)(i) to mean as the assessee only and not the succeeding entity. The Act enjoins the assessee to have business/professional income, not necessarily from the same business in which the relevant depreciable asset(s) stood employed, in the year in which the set-off of the carried forward depreciation takes place. Section 43(6), which defines ‘written down value’ (‘WDV’ for short), states that the WDV in the hands of the successor shall be the same as would be in the case of the predecessor if the succession has not taken place; further, the WDV is to be computed after deducting therefrom the depreciation actually allowed, and it would include the depreciation allowed to be carried forward for subsequent set-off in terms of and under the provision of section 32(2). [Para 5.7] A conjoint and harmonious reading of the different provisions of law, having a bearing in the matter, clarify that under the Act: (a) predecessor and successor have been considered as separate persons; (b) succession to business has been sought to be made into tax neutral transaction, i.e., from the stand-point of the revenue; (c) envisages the survival of the assessee beyond the date of expiry of the relevant previous year, for the claim of depreciation to be carried forward. [Para 5.8] In the instant case, the Assessing Officer had allowed full depreciation in the hands of the partnership firm only, while denying any depreciation allowance in the assessee-company’s hand, on the ground of being not claimed in the original return, but done so only subsequently in the assessment proceedings. He, therefore, allowed depreciation for the full year in the hands of the firm, i.e., as claimed in the return of income filed by it, denying any depreciation in the assessee’s hand, arguing that the depreciation for the said period could be claimed by only one person. The assessment, both for the preceding and succeeding period during the relevant previous year, the predecessor having lost its identity, can only be in the hands of the successor-company (though in a different capacity); the partnership firm dissolving with effect from the date of conversion, so that it did not survive the succession. As such, depreciation as allowable in terms of relevant provisions of the Act, should be allowed in the hands of both the predecessor-firm and the successor assessee-company, the purpose of assessment being the determination of the correct liability under the Act and fair assessment in terms of the extant law which would require allowance of depreciation at the correct amount(s) in the hands of both, including adjudication of the correct amount of WDV in the assessee’s hands. However, the carry forward of depreciation under section 32(2) could only be in the hands of the partnership firm. That gave rise to the question, that remained unaddressed to by the Assessing Officer, that, in view thereof, (whether WDV in the assessee’s hands could be made after excluding depreciation that stood held as not eligible for carry forward in terms of section 32(2). Therefore, the matter was to be remitted to the file of the Assessing Officer. [Para 5.9] Cases referred to CIT v. Texspin Engg. & Mfg. Works [2003] 263 ITR 345/129 Taxman 1 (Bom.) (para 4.3), Krishna Prasad v. CIT [1974] 97 ITR 493 (SC) (para 4.3), Prem Kumar v. CIT [1980] 121 ITR 347/3 Taxman 559 (All.) (para 4.3) and Tarulata Shyam v. CIT [1977] 108 ITR 345 (SC) (para 5.4). Aseem Thakkar for the Appellant. Sandeep Kapoor for the Respondent.