Commissioner of Income Tax vs Nagapatinam Import and Export Corpn.

Sethuraman, J.—In this reference made u/s 256(1) of the income tax Act, 1961, the following question has been referred for the opinion of

this court:

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in directing that the unabsorbed depreciation of

Rs. 3,60,000 of the year 1970-71 should be given set-off against the income of the assessee, which is a registered firm, in the year 1971-72?

The question itself shows that the assessee is a registered firm and we are concerned with the assessment year 1971-72

The ITO computed the total income for this year at Rs. 3,73,730. The assessee was not satisfied with the assessment so made and, therefore,

appealed to the AAC of income tax contending that the loss of Rs. 3,60,000 determined in the assessment for the assessment year 1970-71

should have been set off against the total income of the assessment year 1971-72. The AAC did not accept this claim of the assessee and he,

therefore, dismissed the appeal relying in support of his view on section 75(2) of the income tax Act, 1961. The assessee thereafter appealed to

the Tribunal and reiterated the claim for adjustment of the loss of Rs. 3,60,000. The Tribunal, relying on the decision of the Bombay High Court in

Ballarpur Collieries Co. Vs. Commissioner of Income Tax, Poona, , held that the assessee''s claim for adjustment of the sum of Rs. 3,60,000 was

proper. It, therefore, allowed the appeal of the assessee. It is this order of the Tribunal that has given rise to the present reference.

For the assessment year 1970-71, the assesses filed a. return showing a loss of Rs. 4,39,005. The ITO noticed that depreciation amounting to

Rs. 8,75,533 had been claimed by the assessee in arriving at the income returned. He, however, computed the income on his own and found that

there was a sum of Rs. 3,60,974 as unabsorbed depreciation which was described by him as net loss. He fixed the said loss roundly at Rs.

3,60,000. As the assessee-firm consisted of 19 partners, he allocated the loss among them in accordance with the shares enjoyed by them under

the instrument of partnership.

The narration of facts given above would show that the assessee had a sum of Rs. 3,60,000 as unabsorbed depreciation in the assessment for

1970-71 and that this amount had been allocated among the partners. We do not have any figures relating to the assessment made on the

respective partners. Nor do we have any idea as to how far the said sum of Rs. 3,60,000 allocated among the partners has been set off against

any other income in the hands of the respective partners.

The claim of the assessee requires to be considered in the light of the provisions of the income tax Act, 1961. Section 182 of the Act makes a

provision for the assessment of the registered firms. In the case of a registered firm, after assessing the total income of the firm, the income tax

payable by the firm itself has, under the said provision, to be determined and the share of each partner in the income of the firm has to be included

in his total income and assessed to tax accordingly. Sub-section (2) section of 182 provides that if such share of any partner is a loss it shall be set

off against his other income or carried forward and set off in accordance with the provisions of sections 70 to 75.

As the present claim relates to depreciation, we have to refer to section 32 of the Act to find out how far the assessee''s claim is justified.

Section 32(2) of the income tax Act, 1961, in so far as it is material, runs as follows:

(2) Where, in the assessment of the assessee (or, if the assessee is a registered firm or an unregistered firm assessed as a registered firm, in the

assessment of its partners), full effect cannot be given to any allowance under clause (i) or clause (ii) or clause (iv) or clause (v) of sub-section (1)

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 sub-section (2) of section 72 and sub-section (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.

The above extract shows that this provision is subject to sections 72(2) and 73(3) of the Act. Section 72 provides for the carry forward and set

off of business losses. Where for any Assessment year, the net result of the computation under the head ""Profits and gains of business or

profession"" is a loss to the assessee, then so much of the loss has to be carried forward and set off in the manner prescribed by section 72(1).

Section 72(2) provides that 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. Section 75 is the provision dealing with losses of registered firms. That

provision runs as follows:

(1) Where the assessee is a registered firm, any loss which cannot be set off against any other income of the firm shall be apportioned between

the partners of the firm, and they alone shall be entitled to have the amount of the loss set off and carried forward for set off under sections 70, 71,

72, 73, 74.

(2) Nothing contained in sub-section (1) of section 72, sub-section (2) of section 73 or sub-section (1) of section 74 shall entitle any assessee,

being a registered firm, to have its loss carried forward and set off under the provisions of the aforesaid sections.

The effect of these provisions may be described as follows:

In the case of a registered firm, there is a computation to be made of the income in accordance with the provisions of the Act and the firm pays its

own tax. After the income of the firm is arrived at, it is distributed or allocated among the partners in accordance with their respective shares as

shown by the instrument of partnership so that the income so allocated is added to the other income, if any, in the partners'' hands and assessed to

tax accordingly. Where the result of the computation in the hands of the firm is a loss, then section 75 provides that the loss also should be

apportioned among the partners.

The point to be considered is whether the allowance for depreciation is to be equated with the loss that had been contemplated for apportionment

among the partners. For some purposes of the Act, depredation forms part of the loss. The income of the firm or the loss in the hands of the firm

cannot be computed without making allowance for depreciation in case the assessee is eligible for, and has made such a claim by complying with

the relevant provisions of the Act. If there is any other loss, apart from the depreciation, then that loss will get added to the amount of depreciation

allowable to the assessee u/s 32 read with the rules. It is the total of this amount which will be allocated among the partners under the provisions of

section 75. However, the Act thus makes a distinction between the unabsorbed allowance of depreciation and other losses. It has already been

seen that section 72(2) of the Act provides that 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 section 72. In other words, section 72(2) contemplates the loss

other than the unabsorbed depreciation being given a priority in the matter of set-off, as there is a time limit within which such loss can be adjusted.

u/s 72(3) the loss other than from depreciation is eligible for being carried forward and set off only for a period of eight assessment years

immediately succeeding the assessment year for which the loss was first computed; in the ease of unabsorbed depreciation allowance, there is no

such time limit. The Legislature has, therefore, made a specific provision for priority in setting off the loss other, than the unabsorbed depreciation

allowance so that the unabsorbed depreciation allowance can be carried forward if necessary without any time limit and set off in the appropriate

succeeding years. It is thus clear that there is a separate identity maintained under the statute with reference to the unabsorbed depreciation

allowance though at the, time of computation it forms part of ""loss"". It may be that at the time of allocation among tile partners the unabsorbed

depreciation is taken along with any other ""loss that may have been sustained by the registered firm; but this identity of unabsorbed depreciation is

required to be maintained in order to enable it to be set off against the future income separately and independently of the other losses. If we

approach the construction of section 32(2) in the light of the above background, there appears to be no difficulty in construing the reference.

In the case of a registered firm, as seen already, the amount of unabsorbed depreciation allowance has to be allocated in the manner contemplated

by section 182 read with section 75. This is compendiously described as a loss u/s 182 and section 75. When once a point is reached that it is

necessary to find out the components of the said loss, then'' the loss will have to be split up into allowance for unabsorbed depreciation and other

losses. Though both the unabsorbed depreciation as well as other losses are eligible for set-off against the other income, if any, in the hands of the

partners still, there may be unabsorbed depreciation separately left for adjustment. In other words, the other income available is the hands of the

partners may not be sufficient to absorb also the depreciation allowance that has been allocated to a particular partner as a loss. In such a case, the

question arises as to whether it is the firm which is eligible for the adjustment of the depreciation allowance or whether the partner himself who is

eligible for it.

We have already extracted the relevant provisions of section 32(2) of the Act. Under that provision if there is any surplus out of the unabsorbed

depreciation left in the hands of the partner, then the unabsorbed depreciation so left is to be again transported into the assessment of the firm and

treated as depreciation in the succeeding, years and so on. This position appears to us to be clear from the words of the statute themselves. We

have to start with the assessment of the registered firm. We reach a stage at which we find that there are no profits or gains available for adjustment

as against the depreciation allowance due to the firm, because the profits are inadequate to absorb the whole of it. Full effect cannot be given to

such an allowance in the hands of the partners. In such a case, either the whole of the depreciation allowance or part of the allowance for which

effect has not been given by adjustment in the hands of the partner will have to be added to the amount of the depreciation in the following years

and deemed to be the part of the allowance for the later years. This is the clear result in the language of the provision.

The learned counsel for the revenue submitted that when once the depreciation allowance has been allocated among the partners in accordance

with the provisions of section 182 and section 75, then it ceases any longer to be an unabsorbed allowance so as to come within the scope of

section 32(2). This argument appears to us to be untenable. Section 32(2) of the Act clearly contemplates two positions, one is that the

depreciation allowance should remain unadjusted as against the income of the firm as such and, the second is, it should remain unadjusted in the

hands of the partner also. When both the situations are reached, then the balance available is to be considered in the hands of the firm and treated

as depreciation allowance to be added for the purpose of computation of the total income in accordance with the provisions of section 32 read

with other sections. Otherwise, section 32(2) in so far as it applies to the registered firm would be meaningless. We do not find any warrant for the

contention of the revenue that the depreciation allowance, so long as it is allocated among the partners, ceases to be depreciation allowance

coming within the scope of section 32(2) so that it gets reduced only to the position of a loss. This contention would be contrary to section 72(2)

as well as section 73(3).

In the course of the argument, reference has been made to a few decisions of other High Courts which have dealt with a similar problem.

In Ballarpur Collieries Co. Vs. Commissioner of Income Tax, Poona, (Bom.-Nag.) the depreciation allowance allowable for the assessment year

1956-57 was Rs. 1,12,519. After setting off the depreciation to the extent of profits available in that year, there was unabsorbed depreciation of

Rs. 1,12,283. In the assessment year 1957-58, there was again a business loss and the depreciation allowable for that year was Rs. 2,15,911. For

the assessment year 1958-59, which was under consideration by the High Court, these two amounts of Rs. 1,12,283 and Rs. 2,15,911 were

claimed as liable to be adjusted against the total income of the firm. The ITO rejected the claim and the AAC as well as the Tribunal confirmed the

view of the ITO. When the matter came before the High Court of Bombay it was held that the assessee was entitled to deduct the unabsorbed

depreciation of Rs. 1,12,283 and Rs. 2,15,911 brought forward from the earlier years in the computation of the profits for the relevant assessment

year. At page 230, it is pointed out thus:

It is thus clear that even though for certain purposes of set-off, loss occasioned on account of unabsorbed depreciation is dealt with u/s 24 of the

Act (Indian income tax Act, 1922), it does not lose its character or nature as unabsorbed depreciation and is carried forward not by virtue of the

provisions of section 24(2) but by virtue of the express provisions of section 10(2)(vi), proviso (b).

We are in complete agreement with this statement of law and the provisions of the income tax Act, 1961, being identical, this statement of law will

hold good under the later enactment also. The following passage also sets out the position correctly, if we may say so, with respect:

Deduction of depreciation allowance is not permissible for computing the income of the partners in their capacity as such. Proviso (b) to section

10(2)(vi), therefore, in our view, clearly contemplates that the assessment of the partners is relevant only for the purpose of ascertaining whether

full effect has been given to the depreciation allowance contemplated by section 10(2)(vi). In our view, in the case of a registered firm if full effect

has not been given to the depreciation allowance in the assessment of the partners the unabsorbed depreciation allowance has to be given effect to

in the succeeding year to which it is carried forward before the income of the firm is determined, except that if there are any carried-forward

business losses they have to be given effect to first before the carried-forward depreciation allowance is given effect to in view of the provisions of

clause (b) of the proviso to section 24(2).

(underlined by us)

However, when it came to the question of giving effect to the relevant statutory provisions, it has been considered that the losses could be

carried forward by the partners only by virtue of section 24(2), and since section 24(2) deals only with business losses and does not deal with

carrying forward of unabsorbed depreciation which is expressly dealt with by section 10(2)(vi), prov. (b), unabsorbed depreciation could not

come in for adjustment in the hands of the firm. Since section 24(2) deals only with business losses, the loss referred to in prov. (c) to that sub-

section cannot be said to include losses on account of unabsorbed depreciation which is taken care of by section 10(2)(vi), prov. (b). Sufficient

recognition has not been given to these statutory provisions in the view that was adopted in answering the question.

A decision which has taken a view different from that of the Bombay High Court is in K.T. Wire Products Vs. Union of India (UOI) and

Others, That was a case which arose for consideration by the Allahabad High Court under a writ petition filed under art. 226 of the Constitution of

India. Unfortunately, the question of the distinct character of the allowance of unabsorbed depreciation as contrasted with loss argued before us

appears not to have been argued. This is dear from the following passage at page 462:

It is thus clear that, according to the specific provisions contained'' in sub-section (2) of section 32 and sub-section (2) of section 75, the un-

absorbed depreciation and loss cannot be carried forward by a registered firm for the simple reason that they are allocated between the partners

and there remains nothing to carry forward so far as the firm is concerned. This legal position is not disputed.

When there was no dispute about the unabsorbed depreciation not being eligible for being transported back into the assessment of the firm, the

High Court had no occasion to consider the question in the form in which it arises before us.

The Gujarat High Court in Commissioner of Income Tax, Gujarat Vs. Garden Silk Wvg. Factory, dealt with the question whether the claim of

the assessee to carry forward and set off the loss of Rs. 3,49,242 against its total income for the assessment year 1968-69 was rightly rejected.

The sum of Rs. 3,49,242 included Rs. 1,59,181 allowable to the assessee as depreciation. The Gujarat High Court took the view that such

unabsorbed depreciation allowance allocated among the partners of the firm cannot be considered for adjustment in the hands of the firm itself. It

has been held that once an allocation was made there remained nothing with the firm which was to be carried forward on account of either there

being net income or income being insufficient to absorb depreciation allowance. We consider that this decision also does not give sufficient regard

to the language of section 32(2) which we have already considered.

Mr. J. Jayaraman, learned counsel for the revenue, drew our attention to a decision of the Supreme Court in Commissioner of Income Tax,

Calcutta Vs. Jaipuria China Clay Mines (P) Ltd., . In that case, the assessee was a company. Its total income for the assessment year 1952-53

before charging depreciation was Rs. 14,041. The depreciation allowable for that year was Rs. 5,360. The ITO computed the profit at Rs. 8,681.

He set off the loss of an earlier year against the said income. The assessee had, however, dividend income of Rs. 2,01,130. There was unabsorbed

depreciation allowance of the earlier years amounting to Rs. 76,857. The claim of the assessee was that this sum of Rs. 76,857 should be adjusted

against the dividend income. The Supreme Court affirmed the conclusion of the High Court and held that the unabsorbed depreciation of past

years had to be added to depreciation of the current year and the aggregate unabsorbed and current year''s depreciation had to be deducted from

the total income of the previous year relevant to the assessment year 1952-53. The effect of the Supreme Court''s decision was that the sum of Rs.

76,857, which was termed as unabsorbed depreciation, should be adjusted against the dividend income assessed in that year. It is in this context

that the Supreme Court observed that in prov. (b) to section 10(2)(vi) the Legislature clearly assumed that effect can be given to depreciation

allowance in the assessment of a partner and the only way in which it could be given in the assessment of a partner was by setting it off against

income, profits and gains under other heads. Though the problem that arises for consideration in the present case did not arise in the same form

before the Supreme Court, still this decision of the Supreme Court is relevant in so far as it lays down that depreciation allowance can also be

given effect to in the assessment of the partner and that this is the statutory assumption. The following passage at page 559 may be reproduced:

Bearing these two considerations in mind, if one looks at the language of proviso (b) to section 10(2)(vi), the first question that arises is, what is the

meaning of the expression ''in the assessment of the assessee or if the assessee is a registered firm, in the assessment of the partners, full effect''

cannot be given to any such allowance in any year? ''It would be noted that the words used are'' in the assessment of the assessee or the

assessment of the partners''. Taking the case of the partners of a registered firm, the assessment must be their individual assessments, i.e.,

assessments in which the profits from the firm and other sources are pooled together. The Legislature is clearly assuming that effect can be given to

depreciation allowance in the assessment of a partner; the only way effect can be given in the assessment of a partner is by setting it off against

income, profits and gains under other heads.

The Supreme Court, however, did not have occasion to deal with the further question as to what is to happen to any surplus that remains after

adjustment in the hands of the partners. This is the problem that arises in the present case and, in our opinion, section 32(2) clearly contemplates

the adjustment being made in the hands of the firm to the extent that the depreciation allowance has not been given full effect in the hands of the

partners.

The learned counsel for the revenue submitted that the Supreme Court itself has pointed out that the unabsorbed depreciation would also be a

loss. It was submitted that the loss caused by depreciation would also be loss considered in sections 70 to 75. We are unable to accept this part of

the submission of the learned counsel because the word ""loss"" has been used in the somewhat general sense and in the same decision the distinction

is drawn between depreciation allowance and other losses. This decision also disposes of the argument attempted on the part of the assessee that

section 32(2) was a complete code by itself and that any amount which remains unabsorbed is not to be distributed or allocated among the

partners. It has been pointed out by the Supreme Court that there is a statutory assumption that effect can be given to depreciation allowance in the

hands of the partner. Therefore, the submission of the learned counsel for the assessee that in so far as the unabsorbed depreciation is concerned it

is not at all liable to be allocated among the partners u/s 182 read with section 75 will be contrary to this decision.

One other decision cited for the revenue is in Raj Narain Agarwala Vs. The Income Tax Commissioner, Delhi, . But that decision had no

occasion to consider the specific problem that is now before us and, in fact, the relevant passage to which our attention was drawn has been

described rightly as obiter in the headnote. In this decision, there is some discussion of some double benefit being available to the assessee, if the

view that the firm also is eligible for adjustment of the unabsorbed depreciation is accepted. We do not find that this could be the correct position.

In the view taken by us, it may be the unabsorbed depreciation that remains in the hands of the partners, will be transported to the assessment of

the firm and will come in for adjustment and the partner will not be able to get it adjusted in his own assessment. There is thus adjustment for it only

once. Some conundrum may arise in case it is held that the partner would be eligible for adjustment of the unabsorbed depreciation in his own

assessment for the subsequent years. For instance, a conceivable contention would be that the partner, not being the owner of the estate, will not

be in a position to get unabsorbed depreciation u/s 32 at all. All these complexities are avoided in the view taken by us, namely, that only to the

extent of the unabsorbed depreciation remaining unadjusted in the hands of the partner, there will be eligibility for adjustment in the hands of the

firm and the matter would have to be considered in each year in respective assessments.

The result of the discussion is that in so far as the unabsorbed depreciation allowance in the hands of the partners has not been adjusted as

against any other income, that amount Will have to be considered for adjustment in the hands of the firm. We have earlier pointed out that we have

no information as to whether any part of the said sum of Rs. 3,60,000 has been adjusted or not. It would be, therefore, necessary for the Tribunal

to go into the facts and see how much of the said sum of Rs. 3,60,000 remains unadjusted against the other income, if any, in the hands of the

partners. To that extent, the assessee will be eligible for set-off in the assessment under consideration.

There is an assumption in the question referred to us that the whole of the sum of Rs. 3,60,000 is available for adjustment in the hands of the

firm. This matter has to be investigated. We answer the question as follows:

The unabsorbed depreciation to the extent remaining unadjusted in the hands of the partners for 1970-71 should be given set off against the

income of the assessee-firm in the year 1971-72. There will be no order as to costs.