The Hindu Business Line : Depreciation: The user test

Depreciation allowance is a concession granted by the state in the computation of income based on very many factors relevant to a wholesome fiscal administration. It represents diminution in the value of the asset when applied to making profits or gains. It is related to the asset and is a notional loss as against actual loss in the sense of outgoings of a business.

Under Section 32 of the Income-Tax Act, 1961, depreciation allowance is statutory and not confined expressly to diminution in value of the asset by reason of wear and tear. It can be allowed according to accounting principles.

Key conditions

The allowance is dependent on fulfilment of two vital conditions. The asset must be owned by a person who claims the allowance. The owner need not have the right to dispose of the property. Just dominion and control over property as a matter of right will suffice. The second important condition is that the asset must have been used in the business to which the allowance relates. It is while applying the user test that difficulties arise in interpreting Section 32.

The preponderant view is that ‘use’ meant ‘kept ready for use’ and not ‘actual use’. The machinery in question must have been employed by the assessee for that particular business and for no other business. It should be kept by him ready for actual use in the profit-making apparatus the moment a need arises. Even passive use will suffice. The Madras High Court considered depreciation as allowable even on standby spare-parts even though they were not taken for use during the year (292 ITR 362).

The contra view holds that ‘user’ denoted actual use and not merely kept ready for use. The Karnataka High Court held that when the legislature has used the word ‘used’, full meaning must be given to it.

Apex court’s view

Surprisingly, the High Courts, taking contrary views on the subject of user, rely heavily on pronouncements by the Supreme Court. Mere preparation for use cannot amount to user. There must be actual, effective and real user in the commercial sense and the user must be so linked with the business that it can be said that there is immediate nexus between the user and the real business of the assessee.

In this situation, the matter was taken to the Supreme Court by the I-T department in the N. K. Industries Ltd (305 ITR 274) case. The court was concerned with the block period April 1, 1988 to February 24, 1999.

The department argued that for allowance for depreciation, the asset must not only be owned by the assessee but it must also be used for the business or profession of the assessee.

The department argued that the word “used” in Section 32 refers to actual use of the asset. Having regard to the scheme of the I-T Act, and particularly after the introduction of the concept of the “block of assets”, actual use is the only requirement apart from ownership for allowance of depreciation under Section 32. According to the department, the Gujarat High Court was not justified in rejecting to take up the issue as not giving rise to a substantial question of law while deciding the matter against the Revenue.

The Supreme Court observed that the Income-Tax Appellate Tribunal (ITAT) had examined statements of certain witnesses and analysed the material on record before coming to the conclusion on facts that there was nothing to show that the machinery remained idle for the entire block period April 1, 1998 to February 24, 1999.

The Supreme Court examined the records and agreed with the view expressed by the Tribunal on the facts of the case. Hence, the court considered it not necessary to go into the larger question of law regarding the connotation of the word “used” appearing in Section 32.

Block concept

The Revenue is not entirely justified in agitating the matter which many thought was concluded in favour of the taxpayer. Even if the asset is not actually used in business, once it enters the block of assets, it should be allowed depreciation. Under the concept of block of assets, it will not be possible to go by use of item-wise machinery. Inclusion in the block should lead to the inference that it is brought to use.

It is necessary that the Central Board of Direct Taxes (CBDT) clarifies its stand finally instead of waiting for a ruling from the Supreme Court.

(The author is a former Chief Commissioner of Income-Tax.)