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Commissioner of Income-tax, Gujarat I Vs. Gujarat State Warehousing Corporation - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-tax Reference No. 70 of 1974
Judge
Reported in[1976]104ITR1(Guj)
ActsIncome Tax Act, 1961 - Sections 2(24), 32, 32(1), 32(2), 35, 71, 72, 72(1), 72(2), 73 and 73(3)
AppellantCommissioner of Income-tax, Gujarat I
RespondentGujarat State Warehousing Corporation
Appellant Advocate K.H. Kaji and; R.P. Bhatt, Advs.
Respondent Advocate J.P. Shah, Adv.
Cases ReferredMother India Refrigeration Industries (P.) Ltd. v. Commissioner of Income
Excerpt:
direct taxation - depreciation - sections 32 and 72 of income tax act, 1961 - depreciation allowance in relation to speculation business should be treated in same manner in which such allowance in relation to any other business required to be treated under provisions of section 72 (2) - depreciation allowance required to be 'carried forward' as contemplated by section 32 (2) - effect shall first be given to provisions of section 72. - - 1,409. the net result of this assessment made by the income-tax officer was that while carried forward depreciation as well as current depreciation were absorbed, the business loss of rs. 6. the assessee's suggested method of adjustment was rejected by the income-tax officer as well as by the appellate assistant commissioner in appeal with the result.....t.u. mehta, j.1. an intricate question regarding the priorities in adjustment as between the current depreciation, carried forward depreciation and carried forward losses against the profits and gains of business for the current year arises in this reference in view of the provisions contained in sections 32(2) and 72(2) of the income-tax act, 1961 (which is hereinafter referred to as 'the act'). 2. short facts of the case, which form the background in which this question arises for our consideration, can be stated as under. the respondent-assessee is a warehousing corporation established under the warehousing corporation act, 1962. the assessment years with which we are concerned are 1967-68 and 1968-69. for the assessment year 1967-68, the respondent-assessee made the business profit of.....
Judgment:

T.U. Mehta, J.

1. An intricate question regarding the priorities in adjustment as between the current depreciation, carried forward depreciation and carried forward losses against the profits and gains of business for the current year arises in this reference in view of the provisions contained in sections 32(2) and 72(2) of the Income-tax Act, 1961 (which is hereinafter referred to as 'the Act').

2. Short facts of the case, which form the background in which this question arises for our consideration, can be stated as under. The respondent-assessee is a warehousing corporation established under the Warehousing Corporation Act, 1962. The assessment years with which we are concerned are 1967-68 and 1968-69. For the assessment year 1967-68, the respondent-assessee made the business profit of Rs. 2,18,488. It is an admitted position that before this assessment year 1967-68, the respondent-assessee had suffered business losses of Rs. 2,43,339 which were carried forward from the years 1964-65, 1965-66 and 1966-67. It has also carried forward unabsorbed depreciation for all these three previous years amounting to Rs. 46,696. It is also an admitted position that for the current year 1967-68, the assessee was to absorb the current depreciation of Rs. 27,047. Since the assessee had earned business profit of Rs. 2,18,488 without deducting the current depreciation, the question which arose during the course of the assessment was ether the carried forward business loss of Rs. 2,43,339 should first be deducted from the above stated profit of Rs. 2,18,488 or whether from the said profit, the current depreciation of Rs. 27,047 should first be deducted and thereafter the carried forward loss of Rs. 2,43,339 should be deducted. It should be mentioned here that for this assessment year 1967-68, the assessee had also the income of Rs. 48,105 from other sources. What the Income-tax Officer, who has carried out the assessment, has done is to deduct the current depreciation of Rs. 27,047 from the profit of Rs. 2,18,488. This gave the balance of Rs. 1,81,041. From this, carried forward loss of Rs. 2,43,339 was deducted with the result that the assessee had to carry forward the balance of Rs. 61,898 as business loss. So far as the carried forward depreciation of Rs. 46,696 was concerned, the Income-tax Officer deducted it from the income from other sources, i.e., Rs. 48,105. This gave the net profit from other sources of Rs. 1,409. The net result of this assessment made by the Income-tax Officer was that while carried forward depreciation as well as current depreciation were absorbed, the business loss of Rs. 61,898 was carried forward to the next year, i.e., the assessment year 1968-69.

3. Now, so far as the assessment year 1968-69 is concerned, the assessee had no business profit or gain but its non-business income was Rs. 42,540. But since the carried forward business loss of Rs. 61,898 could not be legally set off against the non-business income of Rs. 42,540, the said carried forward loss was required to be carried further.

4. The assessee felt aggrieved by the above method adopted by the Income-tax Officer in giving priority to the adjustment of the current depreciation over the carried forward loss. According to the assessee, the adjustment ought to have been made by the Income-tax Officer as under for the assessment year 1967-68 :

Business profit of Rs. 2,18,488 minus carried forward loss, Rs. 2,43,339. According to the assessee, this would give the negative balance of Rs. 24,851 as loss to be carried forward to the next year. The assessee further contended that the carried forward depreciation of Rs. 46,696 ought to have been clubbed with the current depreciation of Rs. 27,047 and should have been adjusted against the amount of Rs. 48,105 which was the income from other sources for the assessment year 1967-68. This would have enabled the assessee to carry forward depreciation of the amount of Rs. 25,638. Thus, according to the assessee, so far as the assessment year 1967-68 is concerned, it should have been allowed to carry forward the loss of Rs. 24,851 and the depreciation of Rs. 25,638 to the next year, i.e., assessment year 1968-69.

5. Since in the next year 1968-69 there was no business profit and gain, but there was non-business income of Rs. 42,540 the carried forward loss of Rs. 24,851 of the previous year could not have been set off but the carried forward depreciation of Rs. 25,638 from the previous year could have been legally set off against this amount and if that was done, a there would have been the net profit in the non-business income amounting to Rs. 16,902. Thus, according to the assessee, if this method of adjustment had been followed, it would have been able to carry forward a small loss of Rs. 24,851 and nil unabsorbed depreciation to the next year.

6. The assessee's suggested method of adjustment was rejected by the Income-tax Officer as well as by the Appellate Assistant Commissioner in appeal with the result that the assessee approached the Appellate Tribunal in appeal. The Tribunal considered the provisions of sub-section (2) of section 32, which contains a deeming fiction that carried forward depreciation should be treated as current year's depreciation by clubbing the same with the current year's depreciation. In this connection, the Tribunal relied upon certain observations made by the Supreme Court in Commissioner of Income-tax v. Jaipuria China Clay Mines (P.) Ltd., and came to the conclusion that the lower authorities were not justified in not giving priority to the adjustment of the carried forward loss as against current year's depreciation for assessment year 1967-68 in view of the provisions contained in sub-section (2) of section 72. The Tribunal, therefore, allowed the appeal on this point and directed the assessing authority to make the adjustment as under : Against the income of Rs. 2,18,488 for assessment year 1967-68 first the carried forward loss of the earlier years should be deducted and thereafter current depreciation and unabsorbed depreciation of earlier years should be deducted.

7. In view of this decision of the Tribunal, the revenue has preferred this reference, in which the following three questions have been referred to us for our opinion by the Tribunal :

'1. Whether, on the facts and in the circumstances of the case, since the profits of the business for the assessment year under reference are insufficient to absorb the depreciation allowance and losses deductible under the Act, the deductions from such profits can be allowed in law under section 72 read with section 32 of the Act only in the following order :

(i) first, current depreciation under section 32(1);

(ii) secondly, the carried forward accumulated losses of earlier years under section 72(1);

(iii) thirdly, unabsorbed accumulated depreciation of earlier years under section 32(2);

and the balance is to be carried forward and set off in the succeeding years

2. Whether the finding of the Tribunal that the ratio of the decision of the Supreme Court in the case of Commissioner of Income-tax v. Jaipuria China Clay Mines (P.) Ltd., decided under the provisions of the Indian Income-tax Act, 1922, applies to the instant case under the provisions of the Income-tax Act, 1961, and that, therefore, the carried forward losses should be deducted first from the current year's business profits before deducting the current year's depreciation, is erroneous in law

3. Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in setting aside the assessment order and remanding the case to the Income-tax Officer for recalculation of the assessee's income in the light of its decision herein ?'

8. Though the Tribunal has referred the above-stated three questions for our opinion, in fact, the only question which arises to be considered in : Whether while giving effect first to the provisions of section 72 where any allowance is to be carried forward under sub-section (2) of section 32, it would be correct to split up the current year's depreciation from the carried forward depreciation and to give priority to the current year's depreciation over the carried forward business loss in the set-off against the current year's business profit, in spite of the deeming fiction contemplated by sub-section (2) of section 32

9. Before discussing this question, it would be necessary to note some legal implications of the relevant provisions of law. Section 32 of the Act deals with deduction in the form of depreciation allowance, and is one of the sections which must be taken into consideration for determining the taxable 'profits and gains of business'. Sub-section (2) of this section permits the assessee to carry forward unabsorbed depreciation in case the profits for a particular year are found to be insufficient for absorbing the whole amount of depreciation admissible for that year. The provisions of this sub-section are very much relevant for the purpose of this reference and hence it would be necessary to quote the relevant portions thereof as under :

'(2) Where in the assessment of the assessee,..... full effect cannot be given to any allowance under........in any previous year owing to there being no profits or gains chargeable for that previous year, or owing to the profits or gains chargeable being less than the allowance, then, subject to the provisions of subsection (2) of section 72 and subsection (3) of section 73, the allowance or part of the allowance to which effect has not been given, as the case may be, shall be added to the amount of the allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there is no such allowance for that previous year, be deemed to be the allowance for that previous year, and so on for the succeeding previous years.'

10. The provisions of this sub-section contain a deeming clause which says that the carried forward depreciation allowance should be taken to be a part of the current depreciation, which, in other words, means that it should stand on the same footing as the depreciation of the current year. The Supreme Court has explained this aspect in Commissioner of Income-tax v. Jaipuria China Clay Mines (P.) Ltd.

11. It should, however, be noted that this deeming fiction is not absolute but is made subject to the provisions of sub-section (2) of section 72 and sub-section (3) of section 73. Therefore, it is necessary to see how far and to what extent the provisions of sub-section (2) of section 72 affect the operation of this deeming fiction. The combined effect of the provisions contained in sub-section (2) of section 32 and sub-section (2) of section 72, (which are in pari material with section 10(2)(vi), proviso (b), and section 24(2), proviso (b), of the Act of 1922) is explained by the Supreme Court for a limited purpose as under in the above referred decision in Jaipuria China Clay Mines (P) Ltd. :

'The unabsorbed depreciation allowance is carried forward under proviso (b) to section 10(2)(vi) and the method of carrying it forward is to add it to the amount of the allowance or depreciation in the following year and deeming it to be part of that allowance; the effect of deeming it to be part of that allowance is that it falls in the following year within clause (vi) and has to be deducted as allowance. If the legislature had not enacted proviso (b) to section 24(2), the result would have been that depreciation allowance would have been deducted first out of the profits and gains in preference to any losses which might have been carried forward under section 24, but as the losses can be carried forward only for six years under section 24(2), the assessee would be certain circumstances have in his books losses which he would not be able to set off. It seems to us that the legislature, in view of this, gave a preference to the deduction of losses first. But it is wrong to assume that section 24(2) also deals with the carrying; forward of depreciation. This carry-forward having been provided in section 10(2)(vi) and in a different manner, section 24(2) only deals with losses other than the losses due to depreciation.'

12. These observations make it clear that provisions of sub-section (2) of section 72 have an overriding effect on the deeming fiction contained in sub-section (2) of section 32. Before referring to the terms of sub-section (2) of section 72 it should be noted that section 72 contemplates carrying forward and setting off of business losses. At the relevant time such business losses could be carried forward only for 8 years. Now, it is evident that if the deeming fiction contemplated by sub-section (2) of section 32 is operative without being subjected to sub-section (2) of section 72, then the current depreciation as well as the carried forward depreciation would be the first charge on profits and gains of business for the year in question. If both the types of depreciations are to be treated as the first charge on the profits and gains of business, the result would be that there would be substantial number of cases in which carried forward losses contemplated by section 72 would not be having any chance of being adjusted even for the period of 8 successive years and after the end of 8 years, their adjustment would become impossible. In order to prevent such a situation, the legislature has enacted sub-section (2) of section 72 and has made the deeming section of section 32(2) subject to it. This sub-section (2) of section 72 is in the following terms :

'(2) Where any allowance or part thereof is, under sub-section (2) of section 32 or sub-section (4) of section 35, to be carried forward, effect shall first be given to the provisions of this section.'

13. As already noted above, the deeming fiction contemplated by sub-section (2) of section 32 is also made subject to sub-section (3) of section 73. section 73 is with reference to the losses in speculation business and sub-section (3) thereof provides as under :

'(3) In respect of allowance on account of depreciation or capital expenditure on scientific research, the provisions of sub-section (2) of section 72 shall apply in relation to speculation business as they apply in relation to any other business.'

14. Thus, it is apparent, an the bare reading of sub-section (3) of section 73, that it makes back reference to the provisions of sub-section (2) of section 72 and provides that the depreciation allowance in relation to the speculation business should be treated in the same manner in which such allowance in relation to any other business is required to be treated under the provisions of sub-section (2) of section 72. In other words, sub-section (3) of section 73 does not provide anything more than what is provided by sub-section (2) of section 72. Therefore, the question is how far the deeming fiction contemplated by sub-section (2) of section 32 is affected in cases where losses, as well as depreciation allowances, are carried forward from the previous years. Answer to this question will depend upon the construction which can be put on the language of sub-section (2) of section 72. The language of this sub-section is rather cryptic, but, on a plain reading, it conveys that if, in a case, the depreciation allowance is required to be 'carried forward' as contemplated by sub-section (2) of section 32, effect shall first be given to the provisions of section 72 before any effect is given to the depreciation which is 'carried forward'.

15. Shri Shah, who appears on behalf of the assessee, however, contends, relying upon the above quoted observations of the Supreme Court in the case of Jaipuria China Clay Mines (P.) Ltd., that the effect of sub-section (2) of section 72 is to postpone the adjustment of all depreciation allowances including the current depreciation allowance till the carried forward losses are adjusted against the profits and gains from the business. We shall advert to the decision given by the Supreme Court in Jaipuria China Clay Mines (P.) Ltd., subsequently, but before doing so, it would be necessary to construe the language of sub-section (2) of section 72. As alreadya stated by us above, on a plain reading, this sub-section (2) says that whenever any allowance or part thereof is to be 'carried forward', the effect should first be given to the provisions of section 72. In other words, the sub-section itself makes it clear that priority to the adjustment of 'carried forward losses' should be given only when any 'allowance or part thereof' is to be 'carried forward.' This necessarily implies that when no allowance or part thereof is to be 'carried forward', first effect to carried-forward losses contemplated by section 72 is not to be given. It is obvious that current year's depreciation is not a 'carried-forward' depreciation, and hence when a question arises as to whether carried forward loss contemplated by section 72 should get priority in adjustment over the current year's depreciation, sub-section (2) of section 72 has no application. Therefore, when we take up a particular assessment year for consideration, the first question which is required to be asked is whether for that year any allowance is required to be 'carried forward'. If the answer is in the affirmative, then the sub-section directs that before setting off the 'carried forward allowance', the provisions of section 72 should be first given effect to. In other words, 'carried-forward losses' should be first adjusted towards the profits and gains of the business before adjusting 'carried-forward allowances'.

16. It was contended by Shri Shah that the opening words of sub-section (2), namely, 'Where any allowance or part thereof is to be carried forward', referred to a situation wherein provisions relating to the deeming fiction contemplated by sub-section (2) of section 32 come into play. According to Shri Shah, therefore, sub-section (2) of section 72 comesa into play not merely where the question of the adjustment of carried forward allowances arises, but also where the deeming fiction contemplated by sub-section (2) of section 32 comes into existence. Since, according to this deeming fiction, carried forward depreciation allowance is to be added to the current year's depreciation allowance, and is to be treated as such, effect to sub-section (2) of section 72 can be given only by giving priority to the adjustment of carried forward losses over the adjustment of current year's as well as carried forward depreciation allowance.

17. The contention of Shri Shah is not acceptable. It is no doubt true that sub-section (2) of section 72 makes a reference to sub-section (2) of section 32. But simply because this reference is made, it does nota follow that sub-section (2) of section 72 brings in, even the deeming fiction, for treatment. Sub-section (2) of section 32 is in two parts and provides for two things, Its first part provides for carrying forward of unabsorbed depreciation and in its second part provides for clubbing the said carried forward depreciation with the current year's depreciation and deeming the aggregate to be the current year's depreciation. Therefore, when sub-section (2) of section 72 refers to an allowance which is to be 'carried forward', it refers to the first part of sub-section (2) of section 32, which enables an assessee to carry forward unabsorbed depreciation and not the second part which creates the deeming fiction. This is evident from the fact that this second part of sub-section (2) of section 32 is made 'subject to' the provisions of sub-section (2) of section 72. The fact that the deeming fiction of sub-section (2) of section 32 is not made absolute, and is to be operative subject to the provisions of sub-section (2) of section 72 shows, beyond any dispute, that before giving effect to the deeming fiction, provisions of sub-section (2) of section 72 have to be worked out, since the impact of sub-section (2) of section 72 is only on 'carried forward allowance', it must follow that at the time of working out sub-section (2) of section 72, the concept of the deeming fiction should not enter into nor consideration. Thus, the extent and the operation of the said deeming fiction of section 32(2) are thus circumscribed and limited by the operation of section 72(2).

18. The reason for this rule is found in the basic principles of accountancy as recognised even by the statutory provisions relating to the set-off and carry forward of losses. Section 71 of the Act shows that where the net result of computation under any head of income is a loss, such a loss can be set off against the assessee's 'income' under any other head. According to section 72(1) unabsorbed loss under the head of 'profits and gains of business' can be carried forward and set off against the 'profits and gains' of the next year. The definition of the words 'income' (which is used in section 71), as given in section 2(24), shows that 'income' includes 'profits and gains'. It, therefore, follows both for the purpose of section 71 as well as for the purpose of section 72(1), that if is necessary to decide what is meant by the expression 'profits and gains' Can loss - whether it is current year's loss or carried forward loss - be deducted from gross profits and gains, or from net profits and gains In our opinion, the answer is obvious. It in : that the expression 'profits and gains' means only 'net profits and gains' and that current or carried forward loss can be set off only against net profits and gains. If that be so, the next question in : Can net profits and gains be ascertained without debiting the current year's depreciating to the profit and loss account The basic and well recognised principles of accountancy show that so far as the current year's depreciation is concerned, it is always to be treated as the first charge on profit and gains earned by an assessee from a particular business, and before this first charge is satisfied, it would not be possible to arrive at a correct figure of the net profits and gains, which would be chargeable to tax. This basic principle of accountancy is recognised not only by eminent authors on accountancy but also by the Supreme Court in the above referred case of Jaipuria China Clay Mines (P.) Ltd., as will be seen presently.

19. In Spicer & Pegler's book on Practical Auditing, fourth Indian edition, by Shri S. V. Ghatalia, we find the following useful observations at page 170 :

'Depreciation may be defined as the measure of the exhaustion of the effective life of an asset from any cause during a given period. If an asset has been acquired for the purpose of being utilized to earn income and in the course of such process it becomes worn out or obsolete, such expired capital outlay is a loss which should be set off against the income derived from working the asset, before the balance of divisible profit can be ascertained. If this is not done, the profit and loss account will not show the correct profit for the period, and the balance-sheet cannot be said to represent a true and correct view of the state of the affairs of the business, inasmuch as the assets will remain at their original cost, notwithstanding the fact that depreciation has taken place. Moreover, the profits for the period will not have been charged with the proportion of the original cost which has been absorbed within that period.'

20. In William Pickles' book on Accountancy, 3rd edition, we find the following observations in Chapter VII at page 168 :

'All attachable and incidental revenue expenses must be provided for before the true profits can be computed, so that whether the particular expenses is wages, repairs, or depreciation it follows that a proportion-exact or as approximately as on the circumstances permit-for the use or consumption of an asset must be included in the charge for running the business.

The provision for depreciation does not depend upon what the business 'can afford' as the debit therefor is an essential one, constituting not an appropriation of, but a charge against, profits for the period in question.'

21. These are the basic principles of accountancy which go to show that before carried forward losses are adjusted against the profits and gains of business for the purpose of the particular assessment year, the current depreciation for that year must be deducted in order to arrive at the correct figure of net profits or gains.

22. This particular principle has been explained by this court in Commissioner of Income-tax v. Viramgam Mills Co., Ltd. Therein the following observations as regards the concept of 'profits' made by Fletcher Moulton L.J.in In re Spanish Prospecting Co., Ltd., have been quoted with approval :

''Profits' implies a comparison between the state of a business at two specific dates usually Separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets at the two dates... if the total assets of the business at the two dates be compared, the increase which they show at the later date as compared with the earlier date (due allowance of course being made for any capital introduced into or taken out of the business in the meanwhile) represents in strictness the profits of the business during the period in question.'

23. After discussing various authorities on the principles of accountancy, this court has observed in that judgment :

'In fact the profits of the assessee-company for the relevant years could only be truly ascertained after providing for the depreciation in the aforesaid assets of the company. An allowance for depreciation has to be made before the true profits are ascertained. The amount of depreciation does not represent something set apart out of the profit after the same are ascertained. In the present case the 'Buildings and Machinery Depreciation Fund' account represents the amounts deducted year after year by way of depreciation in order to arrive at the true profits of the company.'

24. Then, at the end of the judgment, this court has further observed :

'If it is intended to suggest that depreciation in every case comes out of the profits of a company, with great respect, we are unable to agree with the same. Such observations would be contrary to the fundamental notion of commercial profits. Profits in the commercial sense can only be ascertained after taking into account depreciation. The correct amount representing depreciation does not come out of the profits of the company.'

25. These observations make it clear that the basic accountancy principles with regard to the depreciation, as quoted by us above, from Spicer & Pegler as well as from William Pickles, have been judicially recognised.

26. We find that the Supreme Court has also made similar observations in Jaipuria China Clay Mines (P.) Ltd., on which the Tribunal has put reliance. Reference to the facts of that case shows that on behalf of the revenue, it was contended that the expression 'loss of profits and gains' in section 24(1) (of the Act of 1922) does not include any deficiency resulting from depreciation and, therefore, an assessee was not entitled to ask the department to include the depreciation in the amount, which can be set off against the income, profit and gains under other heads such as income from property or dividends. This contention was rejected by the Supreme Court by making the following observations, which are very pertinent to the facts of this case :

'Apart from authority, looking at the Act as it stood on April 1, 1952, it is clear that the underlying idea of the Act is to assess the total income of an assessee. Prima facie, it would be unfair to compute the total income of an assessee carrying on business without pooling the income from business with the income or loss under other heads. The second consideration which is relevant is that the Act draws no express distinction between the various allowances mentioned in section 10(2). They all have to be deducted from the gross profits and gains of a business. According to commercial principles, depreciation would be shown in the accounts and the profit and loss account would reflect the depreciation accounted for in the accounts. If the profits are not large enough to wipe off depreciation, the profit and loss account would show a loss. Therefore, apart from proviso (b) to section 10(2)(vi), neither the Act nor commercial principles draw any distinction in section 10(2); the only distinction is that while the other allowances may be outgoings, depreciation is not an actual outgoing.'

27. These observations of the Supreme Court make it clear that the taxable profit or gains from a particular business cannot be ascertained without debiting the current year's depreciation to profits and gains. Even the recently amended Companies Act has recognised this position by enacting section 205 thereof.

28. Now, if this is the situation, can it be said that carried forward losses should be deducted from the profits of a particular business without first deducting the current year's depreciation In view of the above referred established principles of accountancy, which have received judicial recognition, we have no doubt in our mind that out of the current year's profits and gains, the first charge should be that of current year's depreciation, because, but for that depreciation, the said profit or gain could not have been earned by the assessee and, therefore, it is only after deducting the current year's depreciation that the carried forward loss should be adjusted. In other words, there is no question of any competition on the point of priority as between current year's depreciation and carried forward loss. This particular principle has been well stated by the Calcutta High Court in Aluminium Corporation of India Ltd. v. Commissioner of Income-tax. The facts of that case were that the assessee-company showed the profit of Rs. 9,56,479 for the accounting year 1948-49. The company was entitled in that year to depreciation allowance amounting to Rs. 12,52,117. There was also an amount of Rs. 27,359 being the loss carried forward from earlier years. The assessee-company claimed that the amount of loss carried forward from the earlier years should be first set off against the profits under proviso (b) to section 24(2) of the Act of 1922 (which is equivalent to section 72(2) of the Act of 1961), before giving effect to the depreciation allowance, it being to the advantage of the assessee-company to have only one sum carried forward as unabsorbed depreciation which was not subject to any time limit. The Income-tax Officer set off depreciation allowance against the profits and directed the amounts of unabsorbed depreciation and loss carried forward from earlier years, to be carried over to the next year separately. Chakravarti C.J., after considering various provisions of the Act, held that the procedure adopted by the Income-tax Officer was the right one, because there could be no competition between the loss carried forward from previous years and depreciation allowance for the current year (i.e., the accounting year for which the depreciation allowance is due), because, in order to ascertain the profits of the current year, the depreciation allowance would, in any case, have to be set off against the profits first. Construing the provisions of section 24(2) of the Act of 1922, the court observed that section 24(2) comes into play after all the operations contemplated by section 24(1) have been carried out. The court in that decision also considered the language of proviso (b) of section 24(2), which is in pari material with sub-section (2) of section 72 of the Act of 1961, and made the following pertinent remarks, which, to a great extent, cover the controversial points raised before us by the parties :

'It is now to be seen what the effect is of the provision for the surplus allowance being added to the allowance for the following year being made subject to the provision of clause (b) of section 24(2). I am bound to say that if one takes this provision as also clause (b) of section 24(2) literally, one encounters an apparent difficulty. The language of the proviso (b) to section 10(2)(vi) is that the surplus allowance shall be 'added to the amount of the allowance' for the following year, while the language of clause (b) of section 24(2) is that there is a depreciation allowance to be 'carried forward'. The effect is perhaps the same, because, unless the surplus amount is carried forward, it cannot be added to the amount of the allowance for the following year. But the difficulty which arises from the language of the two provisions is that if the surplus depreciation allowance is to be carried forward subject to the provision of clause (b) of section 24(2), it would seem that the operation is to be subject to the whole of clause (b) of section 24(2). That clause provides that effect shall first be given to the provisions of section 24(2) where depreciation allowance is, under proviso (b) to section 10(2)(vi), also to be carried forward, and, therefore, the clause would seem to imply that when the stage for giving effect to the previsions of section 24(2) has arrived, it has already been found that there is a depreciation allowance to be carried forward under clause (b) of the proviso to section 10(2)(vi). On the other hand, the language of the proviso suggests that whether or not the surplus amount of the depreciation allowance is to be added to the allowance for the following year, that is to say, to be carried forward, will appear only after the provisions of clause (b) of section 24(2) has been carried out, that is to say, where, on it being found that there is a depreciation allowance also to be carried forward, effect has first bee given to section 24(2). The procedure for something co be decided is thus made subject to another procedure which, if carried out, will involve the decision of that very thing, so that after it has been carried out, there will be nothing further to decide. It appears to me, however, that what clause (b) of the proviso to section 10(2)(vi) really intends to lay down is that the surplus amount of depreciation shall be added to the amount of depreciation allowance for the following year subject only to the operative portion of clause (b) of section 24(2), that is to say, subject to the losses being first set off.'

29. We find that the same view is taken by the High Court of Bombay in Commissioner of Income-tax v. Ravi Industries Ltd. The question there was whether unabsorbed depreciation allowance of an earlier year, which is carried forward to the current year and which is deemed to be a part of depreciation allowance of the current year under proviso (b) to section 10(2)(vi) of the Indian Income-tax Act, 1922, can be set off, unlike other business losses, against income other than business income. While considering this question, the court also happened to consider the qualification contained in proviso (b) to sub-section (2) of section 24 of the Act of 1922 (which is in pari material with sub-section (2) of section 72 and observed as under :

'On a consideration of the provisions of section 10(1), section 10(2)(vi) proviso (b), and section 24(1), (2), it appears to us that the depreciation allowance permitted under section 10(2)(vi) is available in the first place in the computation of the income from the business in which the depreciation is given and is adjusted against the profits and gains of that business. If the depreciation allowance is larger than the profits or gains in that business so that an excess remains after the said profits and gains are absorbed. Such excess comes under section 10(1) for absorption of the profits and gains of other business, if any, carried on by the assessee. If a balance from the depreciation allowance is left even thereafter, that becomes available for set off against the income, profits and gains from any other head during that year. In case there is still a balance left over, it is taken to the following year, and if there is current depreciation for the following year, it is added on to that current depreciation and deemed a part of it, and if there is no current depreciation for the following year, the balance carried forward becomes the depreciation allowance for the following year available for adjustment in the same manner as the current depreciation for the following year except where there are also carried forward losses of the earlier years the said carried forward losses will be first absorbed against the profits and gains of the business before the carried forward part of the depreciation allowance is allowed to be adjusted. Except for this distinction between the carried forward part of the allowance and the current depreciation, there is no other distinction between them. No difficulty in taking this view is created by the language of section 24(2) or by the proviso (b) to that section.'

30. This court has also made similar observations in Commissioner of Income-tax v. Girdharlal Harivallabhadas Mills Co., Ltd. There also the question was whether unabsorbed depreciation allowance of earlier years deemed to be part of the depreciation allowance of the current year under section 10(2)(vi) of the Indian Income-tax Act, 1922, can be set oft against income under the heads other than business. But while discussing this question, the court has construed the proviso (b) of sub-section (2) of section 24 of the Act of 1922 and has made the following observations, which are very useful for purpose of this reference :

'The proviso lays down that effect should first be given to the provisions contained in sub-section (2) of section 24 before proceeding to deal with the unabsorbed depreciation allowance of the preceding years under the provisions contained in section 24(1). In effect, what is provided is that where loss has been carried forward from the preceding years which arises otherwise than on account of unabsorbed depreciation allowance, the same shall first be set off under the provisions of section 24(2) before the amount of unabsorbed depreciation allowance of the preceding years is set off under the provisions of section 24(1). It may be noticed that at the relevant time losses under section 24(2) could not be carried forward for more than eight years. There is no such limitation in connection with the unabsorbed amount of depreciation allowance. The legislature has thus provided that the type of loss which could be carried forward for a limited number of years under section 24(2) should first be set off before the amount of unabsorbed depreciation allowance of previous years is not set off under section 24(1). It is to carry not this intention that the legislature has stated in proviso (b) to section 10(2)(vi) that the deeming provisions will apply 'subject to the provisions of clause (b) of the proviso to sub-section (2) of section 24'.'

31. All these decisions, therefore, completely support our view that before carried forward loss contemplated by section 72 is set off against the profits and gains of business, for a particular assessment, the said profits and gains of business should be ascertained after deducting the current year's depreciation.

32. Shri Shah, however, relied much upon the observations of the Supreme Court in the case of Jaipuria China Clay Mines (P.) Ltd., wherein their Lordships have stated the effect of the deeming clause contained in sub-section (2) of section 32. Shri Shah's contention was that once carried forward depreciation is deemed to be the depreciation of the current year's the only manner in which sub section (2) of section 72 can be implemented is to give priority to the carried forward loss over the whole amount of depreciation without splitting it up into current year's depreciation and carried forward depreciation. For this proposition he has principally relied upon the following lines which are taken from the relevant observations, which are already quoted above by us in the foregoing portion of this judgment :

'The effect of deeming it to be part of that allowance is that it falls in the following year within clause (vi) and has to be deducted as allowance. If the legislature had not enacted proviso (b) to section 24(2), the result would have been that depreciation allowance would have been deducted first out of the profits and gains in preference to any losses which might have been carried forward under section 24, but as the losses can be carried forward only for six years under section 24(2),a the assessee would in certain circumstances have in his books lossesa which he would not be able to set off. It seems to us that the legislature, in view of this, gave a preference to the deduction of losses first.'

33. According to Shri Shah, these observations should be construed as having laid down that whatever allowance comes within the concept of depreciation allowance by virtue of the deeming fiction contemplated by sub-section (2) of section 32, should be deducted only after deducting the carried forward losses. We do not find any justification for construing these observations of the Supreme Court in the manner proposed by Shri Shah. In fact, the question, which has pointedly arisen before us was not at all before the Supreme Court in the case of Jaipuria China Clay Mines (P.) Ltd. The facts of that case show that the Income-tax Officer computed the total income of the assessee for the year 1952-53 at Rs. 14,041 before charging depreciation for that year. From that figure he deducted the depreciation for the year amounting to Rs. 5,360 and thus computed profit of Rs. 8,681. From this figure deducted an equivalent amount, i.e., Rs. 8,681, in respect of losses during 1947-48 and thus worked out the business income as nil. He then computed dividend income at Rs. 2,01,130 and determined the total income at this figure and levied tax or it. The assessee claimed that unabsorbed depreciation aggregating to Rs. 76,857 in its favour should be deducted from the income received from dividends, which, if done, would reduce the total income to Rs. 1,32,955, but the Income-tax Officer refused to accede to this contention. Thus, the contro-versial point which arose before the Supreme Court was whether unabsorbed depreciation of Rs. 76,857 could or could not be set off against the dividend income. There was no dispute on the question whether the current year's depreciation could or could not be deducted from the profits and gains earned by the assessee in business. Though the Income-tax Officer had deducted the current depreciation from the current income, the assessee had not taken any objection with regard to that procedure. In view of these facts, what the Supreme Court considered in that case was whether it was permissible for the assessee to claim adjustment of carried forward depreciation as against the dividend income. While dealing with this disputed question, the Supreme Court has made the above observations and has stated that on account of the deeming fiction contemplated by section 32(2) of the Act, the carried forward depreciation should also be considered as the depreciation for the current year and the same can, therefore, be deducted from the income earned by the assessee during the course of that year. The observations on which reliance is placed by Shri Shah, therefore, are of no help in determining the exact point which is raised by the parties before us. On the contrary, as we have already shown previously in this judgment, the Supreme Court has categorically held in this very case that, according to the commercial principles, depreiation should be shown in the accounts and the profit and loss account must reflect the depreciation accounted for in the accounts. In other wards, even in Jaipuria China Clay Mines (P.) Ltd.'s case, the Supreme Court has ultimately held that current year's depreciation is always the first charge on the profit earned in the business for the current year.

34. Shri Shah has also put reliance upon one Allahabad High Court decisions which supports the contention raised by him in this reference. We should, therefore, deal with this Allahabad decision before disposing of the point under our consideration. This decision is in Mother India Refrigeration Industries (P.) Ltd. v. Commissioner of Income-tax. The question seems to have been directly raised by the parties before the Allahabad High Court in this case. The High Court, after referring to the above observations of the Supreme Court in Jaipuria China Clay Mines (P.) Ltd., has disposed of this point in the following words :

'In that passage the Supreme Court recognised the broad principle that in the matter of carry forward, business losses should receive priority over depreciation allowance. Dr. Misra conceded that by virtue of proviso (b) to sub-section (2) of section 24, business losses have to be given priority over unabsorbed depreciation allowance. We have seen that under proviso (b) to section 10(2)(vi), depreciation allowance which is carried forward merges into depreciation allowance for the succeeding year. After such merger, the unabsorbed depreciation allowance is to be deemed to be direct allowance for the current year. If business losses have to be given priority over unabsorbed depreciation allowance, there is no good reason why depreciation (sic) losses which have been brought forward should not receive priority over current depreciation allowance.'

35. The first part of these observations contains the interpretation of the observations made by the Supreme Court in Jaipuria China Clay Mines (P.) Ltd., but the last portion of these observations clearly disposes of the point which is involved in the present reference. The learned judges have held that if carried forward business losses can get priority over unabsorbed depreciation allowance, there is no reason why the said priority cannot be given to the carried forward losses even over the current year's depreciation. We have already discussed this question and shown how net profits, which are chargeable to tax, cannot be ascertained without deducting current year's depreciation and, therefore, with respect to the learned judges to the Allahabad High Court, who have decided this case, we find ourselves unable to agree with them.

36. One more reason which impels us to take the view which we have taken is that carried forward depreciation cannot be put at par with current year's depreciation for all purposes because carried forward depreciation is made up of current depreciation of respective previous years and as such its components had the chance of being set off partially against the income of the relevant previous years. These components were carried forward only because they could not be fully set off against the income of those relevant years. Under the circumstances, it stands to reason that while working out the provisions of sub-section (2) of section 72 the carried forward depreciation cannot stand at par with the current year's depreciation, which like the components of the carried forward depreciation must get the chance of being first set off against the current year's income.

37. Shri Shah asked us to read the provisions of sub-section (2) of section 72 in the light of the provisions contained in sub-section (3) of section 73. Referring to the provisions of sub-section (3) of section 73 he contended that it speaks in general terms of 'allowance on account of depreciation' and, therefore, according to him, the carried forward loss in speculation business should, under sub-section (3) of section 73, get priority even over the depreciation for the current year. According to Shri Shah, therefore, the provisions of sub-section (2) of section 72 should be construed in the light of sub-section (3) of section 73. We do not find any substance in this contention, because it is obvious that even the allowance on account of depreciation with regard to the speculation business is to be calculated only in terms of sub-section (1) of section 72 for the simple reason that sub-section (3) of section 73 specifically asks the assessing authority to decided on so. Therefore, whatever be the construction of sub-section (2) of section 72, would be the construction which would govern even the allowance on account of depreciation with relation to speculation business.

38. In view of what is stated above, our answer to the first questions is in the affirmative, i.e., in favour of the revenue and against the assessee. So far as the second question is concerned, the discussion with regard to it is covered by what we have said above and, therefore, our answer to this question is in the affirmative as regards both of its parts. So far as the third question is concerned, our answer is in the negative. This reference is accordingly disposed of. It is ordered that the respondent-assessee shall bear the costs of the revenue in this reference.


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