Month: July

Under the second proviso to section 32(1), the depreciation allowed to an assessee is reduced to 50% of the depreciation otherwise allowable, in cases where the asset is put to use for less than 180 days in a year.

Depreciation remaining to be absorbed is carried forward to the following year and is allowed to be set off against the income of such year in accordance with the provisions of section 32(2) of the Income-tax Act.

An interesting issue has arisen, in the context of the above provisions, specifically for additional depreciation, in cases where the new plant and machinery is used for less than 180 days. The issue is about whether, in the circumstances narrated above, an assessee has the right to set off the balance 50% of additional depreciation in the year subsequent to the year of purchase and installation of new plant and machinery. While the Delhi, Mumbai and Cochin benches of tribunal have held that the balance additional depreciation can be set-off in the subsequent year, the Chennai bench of tribunal has taken a contrary view, leading us to take notice of this controversy.

Cosmo Films Ltd .’s case
The issue first came up for consideration in the case of DCIT vs. Cosmo Films Ltd., 13 ITR(T) 340 (Delhi), involving the disallowance of arrears of additional depreciation of Rs. 3,34,78,825 and negating an alternate claim for deduction of additional depreciation for assessment year 2004-05.

The assessee company had purchased new plant and machinery during the financial year 2002-03 which were eligible for additional depreciation. They were put to use in that year for less than 182 days. The company had claimed additional depreciation at 50% of the total additional depreciation for assessment year 20003-04 and the balance 50% for the assessment year 2004-05. The claim of the company was disallowed by the AO for assessment year 2004-05 and his action was confirmed by the Commissioner(Appeals).

In the appeal to the Tribunal, the assessee reiterated that, as per the provisions of section 32(1)(iia), the assessee was entitled for a further sum of depreciation equal to 15% of the actual cost of new plant and machinery acquired during the year and installed; that the assessee had been granted a statutory right by provisions of section 32(1) (iia) to claim a further sum equal to 15% of the actual cost in the year of acquisition; that it had claimed additional depreciation during the year which pertained to the additions to the fixed assets during the preceding previous year; the said additions were made during the second half of the financial year 2002-03 relevant to Assessment Year 2003-04 and the additional depreciation was claimed only for 50% of the eligible additional depreciation otherwise available on all the additions made after 30th September, 2002 on account of the second proviso to section 32(1) (ii). Hence, the same was being claimed during the assessment year 2004-05 as it was the balance of the additional depreciation.

The company further explained that the expression “shall be allowed” made it clear that the assessee was entitled to claim an overall deduction equivalent to 15 % of the actual cost of the said additions to the plant and machinery. It contended that the second proviso to section 32(1)(ii) restricted the allowance to 50% in cases where the assets were used for less than 180 days based on the period of usage and such a restriction could not have abrogated the statutory right provided to the assessee by section 32 (1)(iia). It claimed that nowhere in the Act it was prohibited that remaining balance of additional depreciation on the assets added after 30th September, should not be allowed and the second proviso to section 32(1)(ii) could not overlook the one time allowance, which was a statutory right earned in the year of acquisition; had there been intention to restrict the one time allowance to 50%, then it could have been provided in the proviso to clause (iia), as provided in respect of the second hand machines and those used in office, etc. or in respect of office appliances or road transport vehicles.

It was pointed out that the scope of the additional depreciation u/s. 32(1)(iia) introduced by the Finance (No. 2) Act, 2002 w.e.f. 01-04-2003 was explained by Circular No. 8 of 2002 dated 27-08-2002 reported in 258 ITR (St.) 13 as being ‘a deduction of a further sum’ as depreciation. Therefore what was proposed to be allowed was depreciation simplicitor though it was called as additional depreciation. Therefore, any balance of the amount of additional sum of depreciation was to be considered to be available for being carried forward and set off in terms of s/s. (2) of section 32 of the Act which provided that where, in the assessment of the assessee, full effect could not be given to any allowance u/s/s. (1) of section 32 in any previous year, then the allowance should be added to the amount of allowance for depreciation for the following previous year and deemed to be part of that allowance, or if there was no such allowance for that previous year, then it would be deemed to be the allowance for that previous year, and so on for the succeeding previous year.

The company, relying on the decision of the Supreme Court in the case of Bajaj Tempo Ltd. vs. CIT 196 ITR 188, claimed that a provision for promoting economic growth had to be interpreted liberally and that additional depreciation, being an incentive provision, had to be construed so as to advance the objective of the provision and not to frustrate it. The additional depreciation as provided in Clause (iia) of s/s. (1) of section 32 was a one time benefit whereas the normal depreciation was a year to year feature.;If the benefit was restricted only to 50% then it would be against the basic intention to provide incentive for encouraging industrialisation, which would be unfair, unequitable and unjust. There was no restriction provided in law which restricted the carry forward of the additional sum of depreciation which was a one time affair available to assessee on the new machinery and plant. It was also pleaded that what was expressly granted as an incentive could not be denied through a pejorative interpretation of second proviso to section 32(1)(ii), when such provision by itself did not bar consideration of the balance u/s. 32(2) of the Income-tax Act. Alternatively, it was pleaded that the provisions of section 32(1)(iia) did not stipulate any condition of put to use. Therefore, full deduction was allowable in the year of purchase itself and had to be allowed in full in the assessment year 2003-04, itself.

In reply, the Revenue submitted that the full additional depreciation could be allowed as per section 32(1) (iia) only when the assets were put to use for more than 180 days in the year of acquisition; that the additional depreciation on the assets which were put to use by the assessee for less than 180 days was restricted to 50% of the amount by the second proviso to section 32(1)(ii); that there could not be any carried forward additional depreciation to be allowed in subsequent year; and that compliance of the condition to put to use, in the year of claim, was necessary for allowing any type of depreciation.
On hearing both the sides the tribunal observed and held as under;

•    Additional depreciation was introduced for promoting investment in industrial sector.

•    The intention was clarified by the Finance Minister, the Memorandum explaining the provisions and the Circular explaining the amendments.

•    The provision contained in section 32(1)(iia) wherever desired had placed restriction on the allowance of additional depreciation.

•    The said provision did not contain any restriction on allowance of the unabsorbed additional depreciation in the subsequent year.

•    The intention was not to deny the benefit to the assesses who had acquired or installed new machinery or plant. The second proviso to section 32(1)(ii) restricted the allowance only to 50% where the assets had been acquired and put to use for a period less than 180 days in the year of acquisition which restriction was only on the basis of period of use. There was no restriction that balance of one time incentive in the form of additional sum of depreciation should not be available in the subsequent year.

•    Section 32(2) provided for a carry forward and set off of unabsorbed depreciation. The additional benefit in the form of additional allowance u/s. 32 (1)(iia) was a one time benefit to encourage industrialisation and in view of the decision in the case of Bajaj Tempo Ltd. (supra), the provisions related to it had to be constructed reasonably, liberally and purposively to make the provision meaningful while granting the additional allowance.

•    The assessee deserved to get the benefit in full when there was no restriction in the statute to deny the benefit of balance of 50% when the new plant and machinery were acquired and used for less than 180 days.

•    One time benefit extended to assessee had been earned in the year of acquisition of new plant and machinery. It has been calculated at 15% but restricted to 50% only on account of period of usage of these plant and machinery in the year of acquisition.

•    The expression “shall be allowed” confirmed that the assessee had earned the benefit as soon as he had purchased the new plant and machinery in full but was restricted to 50% in that particular year on account of period of usage. Such restriction could not divest the statutory right.

•    The extra depreciation allowable u/s. 32(1)(iia) was an extra incentive which had been earned and calculated in the year of acquisition but restricted for that year to 50% on account of usage. The incentive so earned must be made available in the subsequent year.

BRAKES INDIA LTD.’S CASE

The issue had again come up for consideration before the Chennai Tribunal in the case of Brakes India Ltd. DCIT(LTU), 144 ITD 0403.

In this case, the assessee company contested the disallowance of additional depreciation of Rs. 4,91,39,749 by the AO and confirmed by the Commissioner (Appeals), which was the balance of its claim carried forward from the preceding assessment year. The company had claimed additional depreciation for machinery newly added by it during the preceding assessment year 2006-

7.    Since the machinery were used for a period less than 180 days in the preceding assessment year, the assessee had to restrict its claim to 50% of the normal rate of additional depreciation allowed under the Act. However, for the subsequent assessment year 2007-08, the company claimed carry forward of the balance 50% of the additional depreciation. The AO was of the opinion that additional depreciation could be allowed only for new assets added during the year and since the claim of the assessee related to additions to assets made in the preceding assessment year, it could not be allowed. In other words, as per Assessing Officer, residual additional depreciation from earlier year could not be allowed for carry forward to a subsequent year. The Commissioner (Appeals) confirmed the action of the AO following the decision of the tribunal for the preceding assessment year in the company’s own case, wherein the Tribunal had confirmed the disallowance of such a claim.

In appeal before the Tribunal, the company supported its claim on several grounds on the lines of the contentions raised by it before the tribunal for assessment year 2006-07 (copy of unreported decision not available) besides contending that section 32(1 )(iia) was amended with effect from 01-04-2006. and under the amended provision, the only condition for the claim was installation of the asset on which additional depreciation was claimed and that such additional depreciation was statutorily allowable, once assets were installed.

The Tribunal noted and held as under;

•    The first requirement for being eligible for a claim of additional depreciation was that the claim should be for a new machinery or plant. A machinery was new only when it was first put to use. Once it was used, it was no longer a new machinery.

•    Admittedly, the machinery, on which carry forward additional depreciation had been claimed, was already used in the preceding assessment year, though for a period of less than 180 days.

•    Therefore, for the impugned assessment year, it was no more a new machinery or plant. Once it was not a new machinery or plant, allowance u/s. 32(1 ) (iia) could not be allowed to it.

•    Additional depreciation itself was only for a new machinery or plant. Carry forward of any deficit of additional depreciation which, as per the assessee, arose on account of use for a period of less than 180 days in the preceding year, if allowed, would not be an allowance for a new machinery or plant.

•    A look at the second proviso to section 32(1)(iia) clearly showed that it restricted a claim of depreciation to 50% of the amount otherwise allowable, when assets were put to use for a period of less than 180 days, irrespective of whether such claim was for normal depreciation or additional depreciation.

•    The intention of the Legislature was to give such additional depreciation for the year in which assets were put to use and not for any succeeding year.

•    There was nothing in the statute which allowed carry forward of such depreciation. There could not be any presumption that unless it was specifically denied, carry forward had to be allowed. What could be carried forward and set off had been specifically mentioned in the Act.

•    The Tribunal in the assessee’s own case in I.T.A. No. 1069/Mds/2010 dated 6th January, 2012, at para 15, held as under:-

“15. We have considered the rival submissions. A perusal of the provisions of section 32 as applicable for the relevant assessment year clearly shows that additional depreciation is allowable on the plant and machinery only for the year in which the capacity expansion has taken place, which has resulted in the substantial increase in the installed capacity. In the assessee’s case, this took place in the assessment year 2005-06 and the assessee has also claimed the additional depreciation during that year and the same has also been allowed. Each assessment year is separate and independent assessment year. The provisions of section 32 of the Act do not provide for carry forward of the residual additional depreciation, if any. In the circumstances, the finding of the learned CIT(A) on this issue is on a right footing and does not call for any interference. Consequently, ground No.1 of the assessee’s appeal stands dismissed.”

The tribunal upheld the orders of the AO and the Commissioner (Appeals) and held that the Commissioner (Appeals) was justified in following the view taken by co-ordinate Bench of the Tribunal for the preceding assessment year.

OBSERVATIONS

Section 32(1)(iia) was inserted by Finance (No. 2) Act, 2002 with effect from 01-04-2003. The Finance Minister, in his budget speech, stated that the provision for additional depreciation was introduced to provide incentives for fresh investment in industrial sector and that the clause was intended to give impetus to new investment in setting up a new industrial unit or for cases where the installed capacity of existing units is expanded by at least 25%. The section provided, initially, for additional depreciation at the rate of fifteen percent in respect of the new plant and machinery acquired and installed after 31st March, 2002. These provisions were substituted by the Finance (No. 2) Act of 2004 w.e.f. 01-04-2005 and in its present addition provides for additional depreciation at the rate of twenty percent in respect of the new plant and machinery acquired and installed after 31st March, 2005 by an assessee engaged in the business of manufacture or production of any article or thing. The benefit of additional depreciation is not allowed in respect of the second hand assets, assets installed in office or residence or guest-house, ship, aircraft, vehicles, etc.

The view that an assessee is entitled to claim the deduction for the balance additional depreciation in the succeeding year has been upheld by the Cochin Tribunal in the case of Apollo Tyres Ltd., 45 taxmann.com 337, the Mumbai Tribunal in the case of MITC Rolling Mills (P) Ltd., ITA No. 2789/M/2012 dated 13.05.2013 and again by the Delhi Tribunal in the case of SIL Investments, 54 SOT 54. The Chennai bench of the Tribunal however held that the claim for additional depreciation was not allowable every year but only in the year of the installation of the new asset, CRI Pumps, 58 SOT 154. It is therefore clear that but for the lone decision of the Chennai bench in Brakes India Ltd’s case, the overwhelming view is in favour of the allowance of the balance depreciation in the subsequent years.

The original provision for grant of additional depreciation, operating during the period 01-04-2003 to 31-03-2005, contained a very specific provision in the form of first Proviso, to allow a deduction in a previous year in which the new industrial undertaking began to manufacture or produce any article or thing. A specific reference was therefore made to the previous year in which the deduction was allowed. Significantly, under the new provision, no such restriction based on the year is retained, and this again confirms that the new provision effective from A.Y 2006-07, has no limitation concerning the year or years of claim.

The controversy boils down to insignificance when the Revenue realises that the assessee in no case, over a period of life of the asset, can claim a deduction on account of the depreciation as well as the additional depreciation higher than the actual cost of the asset. It perhaps needs to appreciate that there is no loss of revenue at all over a period of time, confirming the fact that the attempts of the Revenue are misdirected when it is contesting the claim of the assessee for the allowance of the balance additional depreciation.

It is true that Clause (iia) of section 32(1) does not contain any restriction or prohibition for claiming the balance additional depreciation in the subsequent year. At the same time, it is also true that the said clause does not expressly provide for such a claim. There neither is an enabling provision nor a disabling provision. In the circumstances a view favourable to the assessee is preferable, more so when the proviso to the said Clause lists several exclusions, and none of them limit the right of an assessee to claim additional deprecation in full nor deny the right of carry forward of the balance amount.

The provision admittedly has been directed towards encouraging industrialisation by allowing additional benefit for acquisition and installation of new plant and machinery. The incentive is aimed to boost new investments in preferred direction. A construction which frustrates the basic purpose of the provision should be avoided in preference of a pragmatic view.

The Finance Minister in his budget speech and the Finance Bill in the Memorandum and the CBDT in its Circular have amplified that the grant of additional depreciation is for incentivising the promotion of capital goods industry. In the circumstances, it is in the fitness of the scheme that the Revenue Department rises to supplement the intentions of the legislature, instead of frustrating the same. It is a settled position in law that an incentive provision should be liberally construed in favour of grant of the deduction. (see Bajaj Tempo Ltd., 196 ITR 188 (SC)). Even otherwise, an interpretation favourable to the assessee should be adopted in cases where two views are possible, Vegetable Products Ltd. 88 ITR 192 (SC), and for the case under consideration, surely two views are possible, as is confirmed by the conflicting decisions of the tribunal on the subject.

In our opinion, the issue under consideration has moved in a narrow compass and in the process, the larger controversy has remained to be addressed, which is, whether there ever was a need to restrict the claim of additional deprecation to 50%, of the eligible amount under the second proviso, in cases where the new asset in question was used for less than 180 days. Had this aspect been addressed by the concerned parties, the understanding of the issue on hand would have been more clear.

Our understanding of the larger issue is as under:

•    The claim for regular depreciation is made possible vide clauses (i) and (ii) of s/s. (1) of section 32 of the Act.
•    The quantum of regular depreciation, so allowed, has been circumscribed to 50% of the deprecation, otherwise allowable, by virtue of the second proviso to the said provision contained in clauses (i) and (ii) of s/s. (1) of section 32 of the Act.

•    The claim for additional depreciation is allowed under a separate Clause namely, Clause (iia) of section 32(1) of the Act, which Clause is otherwise independent of clauses (i) and (ii) above, though it does refer to clause (iia), and therefore, the claim for additional depreciation is independent of the said restrictive second proviso that has application only to the regular depreciation claim made under the said Clauses (i) and (ii).

•    The limitation contained in the said second proviso to Clauses (i) and (ii) should have no application to clause (iia) while claiming additional depreciation.

•    Clause(iia) operates in an altogether different field than that of Clauses (i) and (ii).

•    The claim for additional deprecation therefore shall be allowed in full in the first year itself, irrespective of the number of days of use and should be set off against the income of the year and importantly, to the extent not so set-off, should be carried forward to the subsequent year for being set off against the income for the succeeding year as per the provisions of s/s. (2) of section 32 of the Act.

In our respectful opinion, the additional depreciation is investment based, while the regular depreciation is period based and both are unrelated to each other. For a valid claim of additional depreciation, it is sufficient to establish that new assets are acquired and installed, and once that is proved, the claim has not to be restricted on account of use of such asset for a period of less than 180 days. The additional depreciation, in full, should be allowed, where possible, in the first year itself, and the balance, where remaining to be absorbed, should be carried forward to the succeeding year and should be allowed to be set off against the income of that year.

The Supreme Court in the
case of CIT v. B. C. Srinivasa Setty, 128 ITR 294, held that no capital
gains tax is payable by an assessee where it was not possible to compute
the capital gains u/s.48 of the Act. It held that capital gains could
not be computed in cases where the cost of acquisition could not be
conceived at all. Of course, this position of law has been slightly
altered by the insertion of section 55(2)(a), which provides that the
cost of certain assets shall be deemed to be nil in cases of the assets
specified therein. Sale of such specified assets, though not having any
cost of acquisition, is now subjected to capital gains tax by virtue of
this amendment. Section 55(2)(a) however does not include such property
of ex-rulers.

The question has arisen before the courts as to
whether such property of ex-rulers acquired by their forefathers by way
of conquest or by way of jagir has no cost of acquisition, and the gains
arising on sale of such property is not subject to capital gains tax,
or whether such property has a cost of acquisition and the gains thereon
is subject to capital gains tax on sale. While the Madhya Pradesh,
Madras, and Gujarat High Courts have taken the view that the sale of
such property would not be subject to capital gains tax, the Full Bench
of the Punjab and Haryana High Court has recently taken a contrary view
that the provisions relating to capital gains tax do apply to such
properties. The decision, though rendered in the context of an ex-ruler,
has far-reaching implications inasmuch as it seeks to chart a new
course of thinking by relying on the provisions of section 55(3) for
bringing to tax gains arising even in cases not covered by section
55(2).

Lokendra Singhji’s case : The issue first came up before
the Madhya Pradesh High Court in the case of CIT v. H.H. Maharaja Sahib
Shri Lokendra Singhji, 162 ITR 93.

In this case, the assessee
was the ex-ruler of the erstwhile State of Ratlam, which was founded by
Maharaja Ratansinghji. A jagir of the entire state of Ratlam was
conferred on Ratansinghji in the 17th century by Emperor Shahjahan for
his daring feat of killing a mad elephant with a dagger. The assessee
sold certain land and building within the compound of Shri Ranjit Vilas
Palace, Ratlam during the relevant year, which property was a part of
the estate received as jagir, and which had been inherited by the
assessee in his capacity as the ruler.

The assessee initially
included the capital gains (loss) on sale of the property in his tax
return, by claiming the fair market value of the land and building on
1st January 1954 as the substituted cost of acquisition. The Assessing
Officer computed the assessment by taking such fair market value as on
1st January 1954 at a lower figure, which figure was slightly enhanced
by the Commissioner (Appeals).

Before the Tribunal, for the 1st
time the assessee raised an additional ground claiming that there was no
cost of acquisition of the asset and as such there could be no capital
gains as a result of the transfer of the property. The Tribunal admitted
the additional ground and came to the conclusion that no capital gains
arose as a result of the sale of the land and building.

Before
the Madhya Pradesh High Court, on behalf of the Revenue, it was argued
that the Tribunal was not justified in holding that no capital gains
arose, and that the main controversy was whether the sale proceeds of
the property were in the nature of capital receipts and whether such
receipts attracted the provisions of section 45. It was argued that as
the assessee had received the property by way of inheritance and himself
opted for substitution of the cost of the capital asset as on 1st
January 1954, the Tribunal was not right in concluding that there being
no cost of acquisition of the property to the initial owner, there was
no question of capital gains.

On behalf of the assessee, it was
submitted that though the property was a capital asset, there was no
gains because the forefathers of the assessee were not required to pay
any cost in terms of money for acquiring the property, given the history
of Ratlam State. It was argued that in the absence of any cost of
acquisition, no liability to capital gains could be fastened on the
assessee, though he might have accepted the valuation as on 1st January
1954 and had disclosed the capital loss in his return of income.
Reliance was placed on the decisions of the Bombay High Court in the
case of CIT v. Home Industries and Co., 107 ITR 609, of the Madhya
Pradesh High Court in CIT v. Jaswantlal Dayabhai, 114 ITR 798, and of
the Supreme Court in CIT v. B. C. Srinivasa Setty, 128 ITR 294, all of
which decisions were rendered in the context of goodwill, for the
proposition that the charging section and the computation provisions
together constituted an integrated code, and where the computation
provisions could not apply at all, such a case was not intended to fall
within the charging section. Reliance was also placed on the decisions
of the Delhi High Court in the case of Bawa Shiv Charan Singh v. CIT,
149 ITR 29, and the Bombay High Court in the case of CIT v. Mrs.
Shirinbai P. Pundole, 129 ITR 448 in the context of tenancy rights.

The
Madhya Pradesh High Court noted that though none of the cases cited by
the assessee related to the sale of an immovable property as was the
case before it, but the gist of all these decisions was that if there
was no cost of acquisition, then the gains on sale would not attract the
provisions of capital gains. According to the Madhya Pradesh High
Court, the liability to capital gains tax would arise in respect of only
those capital assets in the acquisition of which the element of cost
was either actually present or was capable of being reckoned and not in
respect of those assets in acquisition of which the element of cost was
altogether inconceivable, as in the case before it.

The Madhya
Pradesh High Court observed that a case where a person acquired some
property by way of gift or reward (for instance, jagirs from a ruler)
and the property passed on by inheritance to succeeding generations, and
was sold for a valuable consideration, because the initial owner had
not acquired it at some cost in terms of money, it would not attract
capital gains tax in such a transaction of sale, there being no gains
that could be computed as such. The Madhya Pradesh High Court therefore
held that the gains on sale of the property would not attract capital
gains tax.

This view taken by the Court in this case was
followed subsequently by the Court in the case of CIT v. Pushparaj
Singh, 232 ITR 754 (shares/securities transferred to the assessee by the
government as a moral gesture), by the Gujarat High Court in the case
of CIT v. Manoharsinhji P. Jadeja, 281 ITR 19 (property acquired by
forefathers by conquest), and by the Madras High Court in the case of
CIT v. H.H. Sri Raja Rajagopala Thondaiman, 282 ITR 126. The Punjab and
Haryana High Court also took a similar view in the case of CIT v. Amrik
Singh, 299 ITR 14, in the context of ownership acquired by the assessee
by Court’s sanction in terms of section 3 of the Punjab Occupancy
Tenants (Vesting of Proprietary Rights) Act, 1952.

Raja
Malwinder Singh’s case :

The Assessing Officer assessed the capital gains by taking the cost of acquisition equal to the market value as on 1st January 1954/1964. The Commissioner (Appeals) rejected the assessee’s appeal and the contention that cost of acquisition was incapable of ascertainment, but the Tribunal reversed the decision, following the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra). The Division Bench of the Punjab and Haryana High Court prima facie differed with the view taken by the same court in the case of Amrik Singh (supra), and therefore referred the matter to a large Bench.

On behalf of the Revenue, before the Full Bench, a distinction was sought to be drawn between the judgment of the Supreme Court in the case of B. C. Srinivasa Setty (supra) and the case before the Court, on the ground that in a newly started business the value of goodwill was not ascertainable, whereas in the case of acquisition of land, the same was either acquired at some cost or without cost, and under the scheme of the Act, there could be no situation where the cost was incapable of ascertainment.

The Punjab and Haryana High Court noted that in the case before it, the assessee acquired the property by succession from the previous owner. It also noted that according to the assessee, the cost of acquisition by the previous owner could not be ascertained and had failed to exercise the option of adopting the market value on the date of acquisition or the cost of the previous owner. Therefore, according to the Court, the only option available to the Assessing Officer was to compute capital gains by taking the cost of asset to be the fair market value on the specified date (1st January 1954/1964, as the case may be).

According to the Full Bench of the Punjab and Haryana High Court, even in a case where the cost of acquisition could not be ascertained, section 55(3) statutorily prescribed the cost to be equal to the market value on the date of acquisition. Therefore, capital gains was not excluded even on the plea that value of the asset in respect of which capital gains was to be charged was incapable of ascertainment.

The Full Bench of the Punjab and Haryana High Court therefore held that the view taken by it earlier in Amrik Singh’s case was not correct, being against the statutory scheme. The Court also held that the view taken by the Madhya Pradesh High Court in Lokendra Singhji’s case (supra) could not be accepted, as it did not give effect to the mandate of section 55(3), which provided for a situation where the value of the asset acquired could not be ascertained. According to the court, if the market value of an asset on the date of its acquisition could be ascertained, the cost of acquisition had to be taken to be equal to that, and if the value could not be so ascertained, the cost had to be equal to the market value on a specified date (for example, 1-4-1964 or 1-4-1981) at the option of the assessee. The Court observed that it was not the case of the assessee that the land had no market value on the date of its acquisition.

The Full Bench of the Punjab and Haryana High Court therefore held that once an asset had a market value, on the date of its acquisition, capital gains tax would be attracted by taking the cost of acquisition to be fair market value as on the specified date or at the option of the assessee, the market value on the date of acquisition where no cost was incurred. The Court accordingly held that the gains made on sale of the property of the ex-ruler was subject to capital gains tax.

Observations:

Computation of capital gains is possible where all of the following information is available :

•     Date of acquisition,

•     Cost of acquisition,

•     Mode and manner of acquisition,

•     Date of transfer,

•     Consideration for transfer, and

•     Mode and manner of transfer.

These requirements are sought to be taken care of by provisions of section 45(2) to (6), section 46 to 49, 50 and section 55(1) to (3) and section 2(42A). Further, the decision of the Supreme Court provides for the course of action, to be adopted, where the cost of acquisition and the date of acquisition are not known or cannot be determined. One dimension however, i.e., the mode and the manner of acquisition remains unexplored where no information is available about the mode of acquisition of the previous owner who had acquired the asset by any of the modes not specified by section 49(1). On a harmonious reading of the provisions of Chapter IVE, it appears that the capital gains cannot be brought to tax where the information in relation to any of the above referred dimensions is not available.

The Supreme Court in the case of B. C. Srinivasa Setty, 128 ITR 294 was concerned with the taxability of the receipts on transfer of goodwill. The Court in the context of the said case observed and held as under :

•     It was impossible to predicate the moment of the birth of goodwill and there can be no account in value of the factors producing goodwill. No business possessed goodwill from the start which generated on carrying on of business and augmented with the passage of time.

•     The charging section 45 and the computation provisions of section 48 together constituted an integrated code.

•     All transactions encompassed by section 45 must fall under the governance of its computation provisions. A transaction that cannot satisfy the test of computation must be regarded as never intended to be covered by section 45.

•     Section 48 contemplated an asset in the acquisition of which it was possible to envisage a cost, an asset which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it.

•     The date of acquisition of an asset was a material factor in applying the computation provisions and for goodwill, it was not pos-sible to ascertain such date.

•     Taxing the goodwill amounted to taxing the capital value of the asset and not the profits or gains.

The Supreme Court in the above-referred case observed that what was contemplated for taxation was the gains of an asset in the acquisition of which it was possible to envisage a cost; the asset in question should be one which possessed the inherent quality of being available on the expenditure of money to a person seeking to acquire it. Importantly, it observed that it was immaterial that although the asset belonged to such a class it might have been acquired without the payment of money, in which case section 49 would determine the cost of acquisition for the
purposes of section 48. This finding is heavily relied by the taxpayers to canvass that the Court implied that an asset for which no payment is made and which is not covered by section 49 is outside the scope of section 48.

The Court on a reference to section 50 and section 55(2) as also section 49 gathered that section 48 dealt with an asset that was capable of being acquired at cost; these provisions indicated that section 48 excluded such assets for which no cost element could be identified or envisaged and the goodwill was one such asset.

Significantly the Court observed that it was impossible to determine the cost of acquisition of goodwill even in the hands of the previous owner who had transferred the same in one of the modes specified in section 49(1). It also held that section 55(3) could not be invoked in such a case, because the date of acquisition of the previous owner re-mained unknown. In cases where the cost of an asset cannot be conceived at all, it appears that the fair market value as prescribed by section 55(3) cannot be adopted even where the date of acquisition of the previous owner is known. Whether the cost of acquisition is ascertainable or not should be examined from the standpoint of the assessee or the previous owner, as the case may be and in doing so, due importance should be given to the mode of acquisition by the assessee. An asset may be the one which is capable of being acquired at cost and may have a fair market value, but in the context of the assessee, it may not be possible to conceive any cost for him on account of his mode of acquisition.

The observation, findings and the ratio of the decision in the said Srinivasa Setty’s case when applied to the issue under consideration, the following things emerge:

•     It is essential to determine the cost of acqui-sition in the hands of previous owner where the asset was acquired in any of the modes specified in section 49(1). If such cost to the previous owner cannot be determined, there will be no liability to Capital Gains tax. It is impossible to determine the cost of acquisition of goodwill having regard to the nature of asset.

•     S/s. 55(3) cannot be invoked in cases where the date of acquisition by the previous owner remains unknown.

The asset i.e., the immovable property, in the facts of the cases under consideration, is an asset that was originally acquired by the forefathers of the transferor on conquest and/or ascension. The assessee transferor acquired the asset by inheritance. In computing the capital gains of the transferor, it was essential to adopt the cost of the previous owner and also determine the date of acquisition of the previous owner. It is an admitted fact that the immediate previous owner of the asset did not incur any cost of acquisition. In such cases, by virtue of the Explanation to section 49(1), one was required to travel back in time to reach such an owner who had last acquired it by a mode of acquisition other than that, that is referred in clause (i) to (iv) of section 49(1). Following the mandate provided by the said Explanation, it was essential to find out the cost of acquisition of the persons from whom the asset was acquired by the forefathers of the assessee, on conquest. Admittedly this was not possible for scores of reasons and therefore the cost to the assessee could not have been ascertained by resorting to the provisions of section 49(1) for computing the capital gains. Accordingly, while it was possible to ascertain the date of acquisition and the period of holding of the asset, the cost of acquisition of such asset remains to be determined as it is unknown and therefore the capital gains could not be computed and be brought to tax in the facts of the case. Further, no cost could have been envisaged in the cases ‘of conquest and/ or ascension. Similarly, where the property was acquired by conquest in a war, it cannot be said that the cost incurred on the war is the cost of acquisition of the property. Therefore, in all such cases of property of ex-rulers, one cannot envisage a cost of acquisition at all, and it is not merely a case of difficulty of determination or ascertainment of cost of acquisition.

One has to at the same time examine whether the conclusion reached in the above paragraph meets the test provided by section 55(3) of the Act. The Full Bench of the Punjab & Haryana High Court has heavily relied on the provisions of section 55(3) for the purposes of overruling the decision of Madhya Pradesh High Court. The said section 55(3) reads as : “where the cost for which the previous owner acquired the property cannot be ascertained, the cost of acquisition to the previous owner means the fair market value on the date on which the capital asset became the property of the previous owner”. Ordinarily, an assessee is required to ascertain his cost only and not of the previous owner unless where section 49(1) apply. From a reading of section 55(3), it is clear that the provision applies only in cases where an assessee is required to ascertain the cost of the previous owner which requirement arises only in cases where the asset is acquired by any of the modes specified in section 49(1) and not otherwise. Section 55(3) appears to take care of situations where the cost of previous owner can-not be ascertained.

On insertion of the said Explanation to section 49(1) w.e.f. 1-4-1965 by the Finance Act, 1965, an assessee is required to adopt that cost of acquisition which was the cost of the previous owner in time who had last acquired the asset under a mode other than the one specified in section 49(1). It appears that the said Explanation is specifically inserted to take care of the situations where it is difficult to ascertain the cost of the previous owner. It requires an assessee to travel back in time and adopt the cost of that owner, previous in time, who last acquired it by any of the mode not specified in section 49(1). It appears that the provisions of section 55(3) are rendered redundant on introduction of the said Explanation. The attention of the Full Bench of the Court was perhaps not invited to the presence of the said Explanation. Had that been done, the Court might not have relied solely on the provisions of section 55(3) for reaching the conclusion derived by it.

The said Explanation has the effect of defining the term ‘previous owner of the property’ to mean the last previous owner of the capital asset who acquired it by a mode of acquisition other than that referred to in section 49(1). The notes to clauses and the memorandum explaining the provi-sion of the Finance Bill, 1965 reported in 55 ITR 131 explain the objective behind the introduction of the said Explanation to section 49(1). Please also see Circular No. 31, dated 21-9-1962 and Circular No. 3-P, dated 11-10-1965.

The Supreme Court on page 301 specifically held that having regard to the nature of the asset, it was impossible to determine the cost of acquisition even of the previous owner for the purposes of section 49(1). It also held that section 55(3) could not be invoked because the date of acquisition by the previous owner remained unknown. It is relevant to note that the Court in that case was concerned with A.Y. 1966-67 and the said Explanation was inserted w.e.f. 1-4-1965. Even assuming that the provision of section 55(3) continues to be relevant, it may be difficult to substitute the fair market value prevailing on the date of conquest or ascension on account of the fact that the asset is acquired on conquest and due to the manner of acquisition of the asset no cost can be envisaged for acquisition of such an asset.

It is relevant to note that presently section 55(2) provides for adopting the cost of acquisition of certain specified assets, including the goodwill at Nil. It provides for cases of the goodwill, tenancy rights, loom hours, stage carriage permits, trade mark or a brand name associated with the business, no-compete rights, right to manufacture, etc. On a closer reading, it is seen that the assets specified for are the ones which are not acquired on a given day for a cost and whose value has been generated over a period of time on regular efforts made over a period. The cost of such an asset including the cost of the regular efforts cannot be identified and quantified. The said section does not provide for such a fiction in cases of the assets acquired on conquest and/or ascension. In the circumstances, it is fair for the assessee to contend that the capital gains in his case cannot be computed as the cost of an asset so acquired could not be taken to be Nil. Wherever the government has intended no cost assets to be subjected to capital gains tax, such assets have been specifically included in the provisions of section 55(2)(a). The very fact that such property of ex-rulers has not been included in this section over the years in spite of so many courts taking the view that the sale of such property is not subject to capital gains tax, clearly indicates that the intention is not to tax such sale proceeds. It is intriguing to note that the Revenue in the past has not relied on section 55(3) while defending the cases of tenancy rights and goodwill. The better view therefore is that such property of an ex-ruler acquired by way of conquest or grant by his ancestors does not have any cost of acquisition, and the capital gains on sale of such property is not subject to tax.

The Direct Tax Code, proposed to be introduced from Financial Year 2012-13, provides that the cost of acquisition will be taken as Nil in all cases where the asset is acquired for no cost in any of the modes for which the cost of the previous owner is not permitted to be adopted.

Neither section 49 nor section 55(3) shall apply in cases where no cost is paid for an asset by the assessee, and the asset is acquired by him by any of the modes not specified by section 49, inas- much as there is no previous owner. Even if there is one, his cost would be ascertainable and therefore section 55(3) does not apply in his case and that section 49(1) cannot apply as the asset is not acquired by any of the modes specified therein.