1. This appeal is directed against the disallowance of the claim for deduction of Rs. 31,385.50 under Section 32(1)(iii) of the Income-tax Act, 1961 ('the Act').
2. The assessee is a registered firm. The assesses was carrying on business in bus body building and also had machine shops and foundries as well as a unit making bolts and nuts as ancillary unit for carrying on the main business. The business of the manufacture of bolts and nuts was being carried on in the name of Annamallais Bolts & Nuts until 1-11-1976, when it was closed down. Though the assessee was maintaining separate accounts for these activities, the profit and loss of the units were consolidated and the entire business was treated as one single unit for income-tax purposes. After the closure of the bolts and nuts unit, the written down value of the plant and machinery in that section was continued to be shown in the balance sheet as on 31-3-1977, 31-3-1978, 31-3-1979 at Rs. 1,31,138.50. The furniture and fixtures were also transferred to the main account as on 31-3-1977. Later, on 23-4-1979, the assessee sold the machinery to a sister concern, Nachimuthu Polytechnic, Pollachi, for a sum of Rs. 1 lakh.
Consequently, in the accounts of the assessee for the previous year ended 31-3-1980 corresponding to the assessment year 1980-81, the assessee claimed that the loss of Rs. 31,138.50 arising by the sale of the machinery for Rs. 1 lakh as against written down value of Rs. 1,31,138.50 should be allowed as a deduction under Section 32. The ITO was of the opinion that because the sale was to a sister concern, the sale value could not be accepted as the market value and secondly, the business of nuts and bolts having been suspended two years earlier, there was no income from that unit against which the loss could be written off. He, accordingly, disallowed the deduction claimed. On appeal, the Commissioner (Appeals) confirmed this disallowance relying on the decision of the Supreme Court in the case of Liquidators of Pursa Ltd. v. CIT  25 ITR 265.
3. In further appeal before us, it was contended on behalf of the assessee that the decision of the Supreme Court relied on by the Commissioner (Appeals) related to the taxability of the profit arising by sale of the plant and machinery after a company went into liquidation and could not be a proper guide for deciding the question whether the loss cold be allowed under Section 32. On the other hand, it was contended on behalf of the revenue that one of the conditions under Section 32 was that the plant and machinery should have been in use and since, admittedly, they had ceased to have been used even two years back, the deduction under Section 32 could not be allowed.
4. On consideration of the rival submissions, we are of the opinion that the assessee is entitled to succeed. Section 32 provides for deduction of depreciation in computing the income from the business of the assessee. Depreciation represents that part of the cost of fixed asset to its owner which is not recoverable when the asset is finally put out of use by him. The assessment of depreciation involved the consideration of three factors, the cost of the asset used which is known, the probable value realised on ultimate disposal which can generally be estimated only within fairly wide limits and the length of time during which the asset will be commercially useful to the undertaking. With regard to the third factor, the Act has enabled the framing of rules to allow the depreciation over fixed periods of time.
With regard to the second factor, since the depreciation allowed is in the form of ad hoc percentages not necessarily reflecting the real depreciation in the value of the assets over the years, the Act envisages an additional allowance to compensate an assessee in the event of actual loss at the time when the asset is discarded or sold.Section 32(1)(iii) provides that in the case of a machinery which is sold, discarded, demolished or destroyed in the previous year, the amount by which the moneys payable in respect of such machinery, together, with the scrap value, if any, falling short of the written down value thereof, would be allowed as a deduction provided that deficiency is actually written off in the books of the assessee. The Supreme Court has held in the case of CIT v. National Syndicate  41 ITR 225, 234 that there are four conditions for the allowance of this deduction, namely, first, that the business must be carried on by the assessee which is a condition found in the first sub-section; second, that the plant must have been used for the purpose of business; third, that the sale should have taken place during the year of account; and fourth, that the loss should have been brought into the books and written off. As we understand it, there is no dispute that on the facts of the present case, the sale took place in the year of account and the loss has been written off. But the dispute is with reference to the first and second conditions, namely, that the business had not been carried on by the assessee and that the machinery has not been used for the purpose of the business during the previous year.
This objection of the revenue stems from the fact that the nuts and bolts unit of the business was closed down two years ago. If that part of the business had been considered as a separate business by itself, the objection of the revenue may be quite valid. But, it is not disputed by the revenue that the nuts and bolts wing was only a part of the business of the assessee which is still being carried out and, therefore, it is not possible to say that the assessee has gone out of business as such. Therefore, this is not a case where there was a sale of the machinery after closing down of the business as such so as to apply the principles laid down by the Supreme Court in the case of Liquidators of Pursa Ltd. (supra). The other objection of the revenue is that the machinery was not used in the business of the assessee in the previous year. Here again, we have no precedent to go by. In the case of National Syndicate (supra) it was pointed out that there was no condition that that business must be carried on for the whole year or the machinery should have been used for the whole of the accounting period and, therefore, if the assessee worked only for a part of the year and then sells out, he would still be entitled to the deduction.
That was also a case where the business itself was closed down and has no pari materia with the present case where the business not confined to only a part of the activities is questioned. We have, therefore, to come to the conclusion that even the first condition that the business is being carried on is satisfied and is left only with the second condition as to the use of the machinery in the previous year. In a situation, such as one we have for consideration, it is a moot question whether the phrase 'used for the purpose of the business' would mean current use in the previous year or would refer to the fact that the machinery was a commercial asset of the assessee. We are inclined to accept the contention of the assessee that we cannot stress the current use of the machinery in a case where only apart of the business of the assessee is closed and thereby the assessee has to discard or sell a machinery. On these aspects, we must perhaps refer to the object of the section rather than the literal meaning of the section. The section talks of the moneys payable in respect of the manner together with scrap value where the machinery is sold, discarded, demolished or destroyed. The word 'discarded' suggests that an asset is to be out of use not only due to obsolescence but also due to the decision of the assessee not to use that asset any longer in the business. If this is the right approach, then what is sold is a machine which is discarded and then the amount realised by the sale can be regarded as the scrap value which has to be taken into account in determining the allowance under the section. It is not possible that an asset is sold immediately after it is discarded and there would be a time-lag between the discarding of the asset and the subsequent sale to realise its scrap value. The realisation of the scrap value is only for the purpose of computing the actual loss that has occurred and the allowance that can be claimed under the section. It would follow that the assessee would be entitled to the deduction either with reference to the date on which it is discarded or on the date on which the actual loss is computed and written off in the accounts of the assessee. But, in neither case, the assessee can be denied the allowance under that section. It cannot be the case of the revenue that if the asset is taken to have been discarded two years ago, the assessee would not be entitled to the deduction because the scrap value was not immediately realised and written off in that year of account and at the same time, contend that when the asset is actually sold and the scrap value is realised and written off in the accounts, the assessee would not be entitled to the deduction because the machine had been discarded two years earlier and was not, therefore, in use in the year of accounting in which it was sold. The only way of resolving this question is two allow the deduction in the year in which the scrap value is taken into account and the loss is written off because we are primarily concerned with the accounting of the value of the, machinery by taking the view that the reference to the use of the machine in the business is the treatment of the asset as commercial asset and not the actual use. The period between the discarding of the machine due to the closure of the unit and the actual sale and realisation of the scrap value has to be treated as the passive user of the commercial asset in the continuing business of the assee. In this view, which comments itself to us, we are of the considered opinion that the assessee is entitled to the deduction of Rs. 31,385.50 claimed in computing the total income of the previous year relevant to the assessment year under appeal. We, therefore, direct the ITO to recompute the total income and we also authorise him to amend the assessment of the partners as a consequence.