Ita/154/2014 Of M/S Padmini Products (P) Ltd v. The Deputy Commissioner Of Income Tax

IN THE HIGH COURT OF KARNATAKA AT BENGALURU DATED THIS THE 5 DAY OF OCTOBER 2020| PRESENT THE HON’BLE MR. JUSTICE ALOK ARADHE AND| THE HON’BLE MR. JUSTICE H.T.NARENDRA PRASAD LT.A. NO.154 OF 2014 BETWEEN: M/S. PADMINI PRODUCTS (P) LTD.,NO.157, K. KAMARAJ ROADBENGALURU - 56004)(REPRESENTED BY ITS DIRECTOR|SRI. PRABHU KIRAN, AGED ABOUT 60 YEARS|S/O LATE NAGARAJ N. VEMULKAR). ... APPELLAN[. (BY SRI. K.K. CHYTHANYA, ADV.,) AND: THE DEPUTY COMMISSIONER OF INCOME TAXCIRCLE-12(2), 14/3, 4 FLOORRASHTROTHANA BHAVANNRUPATUNGA ROAD, BENGALURU-560001. ... RESPONDENT (BY SRI. K.V. ARAVIND, ADV.) THIS ITA IS FILED UNDER SECTION 260-A OF I.T. ACT,1961L ARISING OUT OF ORDER DATED 14.11.2014 PASSED IN ITANO.242/BANG/2013, FOR THE ASSESSMENT YEAR 2009-10,PRAYING THAT THIS HON'BLE COURT MAY BE PLEASED TO: (1) FORMULATE THE SUBSTANTIAL QUESTIONS OF LAWSTATED ABOVE. (II) ALLOW THE APPEAL AND SET ASIDE THE IMPUGNED-ORDER OF THE ITAT, BENGALURU ‘C’ BENCH BEARING IN ITANO.242/BANG/2013, DATED 14.11.2014 THIS ITA COMING ON FOR FURTHER HEARING, THIS DAY,ALOK ARADHE J.,DELIVERED THE FOLLOWING: JUDGMENT This appeal under Section 260A of the Income Tax|Act, 1961 (hereinafter referred to as the Act for short)Nas been preferred by the assessee. Tne subject matterof the appeal pertains to the Assessment years 2005-06to 2008-09. The appeal was admitted by a bench of thisCourt vide order dated 26.09.2014 on the followingsubstantial question of law: (1)Whether on the facts and In thecircumstances of the case, the HonourableITAT was right in law in upholding the actionof Learned Respondent in re-opening the.assessment for the assessment years 2005-06, 2006-07 & 2008-09 under Section 147 ofthe IT Act in the absence of any tangiblematerial but merely on the basis of additionsmade in subsequent assessment year 200/7O88? (il)Whether on the facts and In thecircumstances of the case, the HonourableITAT was right in law in holding that theAppellant is eligible to claim depreciation onlywith reference to the written down value of.transferred assets in the hands of predecessorfirm and not with reference to actual costincurred by it? (iii) Whether on the facts and in the|circumstances of the case, the HonourableITAT was right in law in upholding the actionof the Learned Respondent in tnvoking 5th-proviso to Section 32(1) of the IT Act in theassessmen.Yearssubsequent|to.theassessment year in which the succession tookplace?| (iv) Whether on the facts and in the|circumstances of the case, the HonourableITAT was right in law tn upholding the action.of the Learned Commissioner Appeals in-invoking Explanation 3 to section 43(1)? 2 |Facts leading to filing of this appeal in nutshell are that the assessee is a Private Limited Company engaged in the business of manufacturing, dealing andexporting of incense sticks and allied products. Theassessee succeeded to, in the business of partnershipfirm VIZ.,.‘Padmin|Products’witheffectfrom01.02.2005. Before the firm was converted into privatelimited company, the partnership firm had revalued allits intangible assets and arrived at a value ofRs.65,26,40,150/- using standard valuation methods.All assets and liabilities of Padmini Products tI.e., theerstwhile partnership firm, including the aforesaidintangible assets were transferred to the assessee. Inconsideration, the assessee allotted shares at the facevalue of Rs.1,000/- and premium of Rs.13,500/- perShare each to the partners of the erstwhile partnershipfirm and no other consideration in any other form waspaid by the assessee either to Padmini Products or to itspartners. The assessee filed the returns of income for.the Assessment Years 2005-06 and 2007-08 declaring alossofRs.14,98,22,351/-.and|Rs.12,08,55,111/- respectively. The assessee filed return of income forAssessment Year 2006-07 and 2008-09 declaring theincome as ‘NIL’. The case of the assessee for the.Assessment Year 2005-06 was reopened under Section147 of the Act on the ground that during the course ofthe proceeding for Assessment Year 2007-08, it wasnoticed by the Assessing Officer that assessee had madeclaim of depreciation on intangible assets, which was notin accordance witn Section 32(1) of the Act. Tnereafter,a notice under Section 148 of the Act was issued. Theassessee by a communication dated 17-02.2010 statedthat return of income for Assessment Year 2005-06already filed on 31.10.2005 be treated as return inresponse to the notice under Section 148 of the Act.Thereafter, a notice under Sections 143(2) and 142(1)of the Act was issued to the assessee. The AssessingOfficer by an order dated 31.12.2010 inter alia neld thatintangible assets valued in the hands of the company atthe time of succession, were valued as per assessee’s own valuation and not for any actual consideration. Itwas further held that assessee neither purchased /acquired intangible assets from any third party norincurred any actual cost. It was further held that since,assessee has not actually acquired or purchased assetsfor actual consideration, therefore, value of the assetspar takes the nature of notional value and not the realvalue and depreciation under Section 32(1)(ii) of the Actcannot be allowed. It was further held that depreciationis only allowable as per proviso (5) to Section 32(1) ofthe Act, which was actually existing in the earlierconcern viz., the partnership firm. Therefore, theOriginal assets, which were added in the company at thetime of succession cannot be considered for thepurposes of depreciation. Accordingly, the claim fordepreciation on intangible assets was disallowed.3.Being aggrieved, the assessee filed an appealbefore the Commissioner of Income Tax (Appeals) whoby an order dated 20.02.2013 dismissed the appeal. The Tribunal (hereinafter referred to as theTribunal’ for short) by filing an appeal. The Tribunal byan order dated 10.01.7013 #$6inter alia held thtransaction itself is not a transfer but Is akin tosuccession and therefore, in view of sub-Clause (ii) to5[:.]proviso to Section 32(1), depreciation is notpermissible. It was further held that Section 43(6) of theAct, defines the expression ‘written down value’ andprovides for both the acquisition of assets during therelevant Previous year and acquisition of assets beforethe relevant Previous year and both the clauses mentionactual cost to the assessee. Therefore, the claim fordepreciation can be examined even in the AssessmentYears subsequent to the Assessment Year, in whichsuccession has taken place. It was also held thatCommissioner of Income Tax (Appeals) has not invokedthe provisions of Explanation 3 to Section 43(1) of theAct but has only justified the action of the Assessing Officer in questioning the claim of depreciation by citingthe provision of Section 43(1) and Explanation 3thereof. The Tribunal therefore, dismissed the appealpreferred by the assessee. Being aggrieved, theassessee is in appeal before us. aLearned counsel for the assessee at theoutset submitted that he does not want to press thesubstantial question of law No.1. It is submitted that theauthorities grossly erred in holding that there is notransfer of intangible asset from one entity to anotherentity. Therefore, the assessee is not entitled fordepreciation on the tangible assets. It is furtherSubmitted that valuation aspect was not questioned byany of the authorities and even the Assessing Officer inits remand report has not doubted the genuineness ofthe transaction. It is also submitted that revaluation ofthe intangible assets was done by the firm and not bythe company and therefore, the case of the assessee.was covered under Section 4/(xili) of the Act. It is aLearned counsel for the assessee at theoutset submitted that he does not want to press thesubstantial question of law No.1. It is submitted that theauthorities grossly erred in holding that there is notransfer of intangible asset from one entity to anotherentity. Therefore, the assessee is not entitled fordepreciation on the tangible assets. It is furtherSubmitted that valuation aspect was not questioned byany of the authorities and even the Assessing Officer inits remand report has not doubted the genuineness ofthe transaction. It is also submitted that revaluation ofthe intangible assets was done by the firm and not bythe company and therefore, the case of the assessee.was covered under Section 4/(xili) of the Act. It is further submitted that 5[:.]proviso to Section 32(1) of)the Act would not apply to the fact situation of the case.It is also pointed out that with regard to Explanation 3to Section 43 of the Act, the Assessing Officer neithermentioned anything in the order nor in the remandreport. It is also argued that in any case the assesseewas entitled to notice before invocation of provisioncontained in Explanation 3 to Section 43 of the Act. InSupport of aforesaid submissions, learned counsel forthe assessee has placed reliance on decisions ofSupreme Court in|“COMMISSIONER OF INCOME-TAX,CENTRAL - III VS. HCL TECHNOLOGIES LTD.’,(2018) 404 ITR 719 (SC), "BHOR INDUSTRIES LTD.VS. COMMISSIONER OF INCOME-TAX’, (1961) 42ITR 57 (SC)and"'GVK INDUSTRIES LTD. VS.INCOME TAX OFFICER’, (2011) 332 ITR 130 (SC).5.On the other hand, learned counsel for therevenue submitted that as per Section 45 of the Acct,transfer of entire business of firm to company amounts. to transfer of capital asset. It is further submitted thatSection 47(xili) only takes out succession of transfer ofcapital asset or intangible asset within the ambit ofSection 45 of the Act. It ts further submitted thatconversion of intangible assets by a firm to a companydoes not amount to transfer. It is also argued that therewas no occasion for the partnership firm to revalue theassets and in the light of 5[:.]proviso of Section 32 of the.Act if the asset is transferred, the depreciation nas to beapportioned between the transferor and transferee and.therefore, the question of depreciation does not arise. Itis furtner submitted that Section 43(6) of the Actdefines the expression ‘written down value’ and providesfor acquisition of assets. However, in the instant case, isneither a case of acquisition nor transfer of intangibleassets and notional valuation of intangible assets by theassessee IS only a device to claim depreciation on nonexistent asset. It is further submitted that entirevaluation has been done without any statutory provision and all the authorities have rightly found that theassessee is entitled to depreciation on intangible assetsonly with reference to written down value of transferredassets in the hands of predecessor firm. 6.|We have considered the submissions madeby learned counsel for the parties and have perused therecord. Before proceeding further, it is apposite to takenote of relevant provisions viz., Section 32(1), 5[:.]proviso to Section 32(1) of the Act, Explanation 3 toSection 43(1) and Section 4/7(xiii) of the Act, which readas under: 32.(1)In respect of depreciation of— (i) |buildings,machinery,plantOrfurniture, being tangible assets; (il) know-now, patents, copyrights, trade|marks, licences, franchises or any otherbusiness or commercial rignts of similarnature, being intangible assets acquired on orafter the 1st day of April, 1998, owned, wholly or partly, by the assesseeand used for the purposes of the business or profession, the following deductions shall be-alloowed— 6.|We have considered the submissions madeby learned counsel for the parties and have perused therecord. Before proceeding further, it is apposite to takenote of relevant provisions viz., Section 32(1), 5[:.]proviso to Section 32(1) of the Act, Explanation 3 toSection 43(1) and Section 4/7(xiii) of the Act, which readas under: 32.(1)In respect of depreciation of— (i) |buildings,machinery,plantOrfurniture, being tangible assets; (il) know-now, patents, copyrights, trade|marks, licences, franchises or any otherbusiness or commercial rignts of similarnature, being intangible assets acquired on orafter the 1st day of April, 1998, owned, wholly or partly, by the assesseeand used for the purposes of the business or profession, the following deductions shall be-alloowed— ()*+,-.-also thet|theaggregatededuction, in respect of depreciation § obuildings, machinery, plant or furniture, beingtangibleassetsOFKNOW-NOW,patents,copyrights, trademarks, licences, franchises orany other business or commercial rights ofsimilarnature,beingintangibleassetsallowabletOthepredecessor|andthesuccessor in the case of succession referred toin clause (xiii), clause (xilib) and clause (xiv)of section4/ or section1/0 or|iontheamalgamating company and the amalgamatedcompany in the case of amalgamation, or tothe demerged company and the _ resultincompany in the case of demerger, as the casemay be, snali not exceed in any previous yearthe deduction calculated at the prescribedrates as if the succession or the amalgamationor the demerger, as the case may be, nad nottaken place, anda such deduction snail beapportioned between the predecessor and thesuccessor, or the amalgamating company andthe amaigamated company, or the demerged company and the resulting company, as the.case may be, in the ratio of the number ofdays for which the assets were used by them. Explanation 1.—Where the business or profession of the assessee is carried on in abuilding not owned by him but in respect ofwhich the assessee holds a lease or other.rightofOCCUDAa/ICand|qdhhcapital expenditure is incurred by the assessee forthe purposes of the business or profession onthe construction of any structure or doing ofany work in or in relation to, and by way ofrenovation or extension of, or improvement.to, the building, then, the provisions of this—clause shall apply as if the said structure orwork is a building owned by the assessee. Explanation 2.—For the purposes of this|sub-section "written down value of the blockof assets’ shall have the same meaning as inclause* (c) of sub-sectionT (6) of section 43. Explanation 3.—For the purposes of this|sub-section, the expression “assets” shallneal) (a) tangible assets, being buildings,|machinery, plant or furniture; (b) intangible assets, being know-how,patents, copyrights, trade marks, licences,franchisesOrdhhyotherbDUSINESSOF|commercial rights of similar nature. Explanation 3- Where, before the dateof acquisition by the assessee, the assetswere at any time used by any other person forthe purposes of his business or profession andthe Assessing Officer is satisfied that themain purpose of tne transfer of sucn assets,directly or indirectly to the assessee, was thereduction of a liability to iIncome- tax (byclaiming depreciation with reference to an.ennanced cost), tne actual cost to theadSSCSSCESha!be|SUCh|al)amountaS|the Assessing Officer may, with the previousapprovalofthe DeputyCommissioner, determineNavingregaraqtOall thecircumstances of the case. 4/Transactionsnotregarded|aS|transfer Nothing contained in section 45 shallapply to the following transfers:- (/,,,) any transfer of a capital asset orintangible asset by a firm to a company as aresult of succession of the firm by a companyin the business carried on by the firm, or anytransfer of a capital asset to a company in thecourse of demutualisation or corporatisationof a recognised stock exchange in India as aresult of which an association of persons orbody of individuals is succeeded by suchCompany. Provided that—| 4/Transactionsnotregarded|aS|transfer Nothing contained in section 45 shallapply to the following transfers:- (/,,,) any transfer of a capital asset orintangible asset by a firm to a company as aresult of succession of the firm by a companyin the business carried on by the firm, or anytransfer of a capital asset to a company in thecourse of demutualisation or corporatisationof a recognised stock exchange in India as aresult of which an association of persons orbody of individuals is succeeded by suchCompany. Provided that—| (a) all the assets and liabilities of the|firm or of the association of persons or bodyOf|individualsrelatingto.thebuSsINeSSimmediately before the succession becomethe assets and liabilities of the company; (Db)allthepartners|ofthefirmimmediately before the succession becomethe shareholders of the company in the sameproportion in which their capital accountsstood in the books of the firm on the date ofthe succession; (c) the partners of the firm do_ notreceive any consideration or benefit, directlyor indirectly, in any form or manner, other than by way of allotment of shares in theCOmMmpahy, 7. After having noticed the relevant statutoryprovisions, we may advert to the issues arising in this.appeal. The business of manufacture and sale of incensesticks is built on an intangible experience of aromawhich can rarely be secured in the form of trade name/trade mark. It is pertinent to mention here thatAssessing Officer himself has found that the erstwhilepartnership firm was the registered owner of varioustrade marks. It is also pertinent to mention here thatvaluation of the shares was made by the assessee asper the accounting standards 10 & 26. It is alsonoteworthy that none of the authorities have eitherquestioned the valuation of the intangible assets or havedoubted the genuineness of the transactions. Thus, the.intangible asset of the assessee nas a real money value.The aforesaid trademark viz., the intangible assets weretransferred to the assessee for a valuable consideration. Section 32(1) of the Act provides for depreciation inrespect of trademarks owned wholly or partly by theassessee. In the instant case, the assessee succeeded tothe business of the partnership firm, which hadtrademarks registered in its name. Therefore, theassessee under Section 32(1) of the Act was entitled fordepreciation. It is also pertinent to note that underSection 4/7 of the Act, any transfer of capital asset or aintangible asset by a firm to a company as are result ofsuccession of the firm Dy a company is a recognizedmode of transfer. Admittedly, the assessee and theerstwhile partnership firm are different entities andthere.WaStransfer|ofintangibleassetsby|thepartnership firm to the assessee for a_ valuableconsideration that is by way of allotment of shares.Thus, the aforesaid transaction is squarely coveredunder Section 4/7(xiii) of the Act and therefore, theassessee under Section 32(1) of the Act was entitled fordepreciation with reference to actual cost incurred by it with reference to intangible assets. Accordingly, the.second substantial question of law is answered in favourof the assessee and against revenue. 8. It is noteworthy to mention here that 5[:.]proviso to Section 32(1) of tne Act restricts tne totaldepreciation which can be claimed in case of successionetc. to the depreciation which would have beenallowable nad tnere been no succession. The 5[:.]Proviso.(earlier 4[:.]proviso) to Section 32(1) was inserted by |Finance Act, 1996 to restrict the claim of aggregatededuction, which is evident from the memorandum toFinance Bill, 1996, which reads as under: In cases of succession in DusInNeSS andamalgamation of companies, the predecessorOf|thebusiness|andSUCCeECSSOtheamalgamating company and amalgamatedcompany as tne case may De, are entitied todepreciation allowance on same assets whichin aggregate exceeds depreciation allowance.for Previous year at the prescribed dates. It is 8. It is noteworthy to mention here that 5[:.]proviso to Section 32(1) of tne Act restricts tne totaldepreciation which can be claimed in case of successionetc. to the depreciation which would have beenallowable nad tnere been no succession. The 5[:.]Proviso.(earlier 4[:.]proviso) to Section 32(1) was inserted by |Finance Act, 1996 to restrict the claim of aggregatededuction, which is evident from the memorandum toFinance Bill, 1996, which reads as under: In cases of succession in DusInNeSS andamalgamation of companies, the predecessorOf|thebusiness|andSUCCeECSSOtheamalgamating company and amalgamatedcompany as tne case may De, are entitied todepreciation allowance on same assets whichin aggregate exceeds depreciation allowance.for Previous year at the prescribed dates. It is proposed to restrict the aggregate deductionin a year to the deduction computed at theprescribed rates and apportion the allowancein the ratio of number of days for which theassets were used by them. 9. Thus, it is evident that 5[:.]proviso to Section32 of the Act restricts aggregate deduction both by thepredecessor and the successor and if in a particular yearthere is no aggregate deduction, the 5[:.]proviso does notapply. Thus, it is axiomatic that until and unless it is thecase of aggregate deduction, the proviso has no role to.play. The 5[:.]proviso in any case will apply only in the.year of succession and not in subsequent years and alsoin respect of overall quantum of depreciation in the yearof succession. Accordingly, the third substantialquestion of law is answered in favour of the assesseeand against the revenue. 10. The prerequisite for invoking Explanation 3.to Section 43(1) of the Act is that the Assessing Officer has to establish that the main purpose of the transfer ofsuch asset was reduction of liability to income tax byclaiming extra depreciation on enhanced cost. IN orderto establish aforesaid fact, it has to be established thatapart from claiming additional depreciation on enhancedcost there is no other main purpose for acquiring theasset in question and the Assessing Officer has to obtainthe previous approval of the joint commissioner todisregard the enhanced price. The Assessing Officer, inthe instant case, in the order of assessment has neithercomplied with the aforesaid conditions nor has recordedany finding in this regard. The Commissioner of IncomeTax(Appeals)however, failedtO|appreciate|theaforesaid aspect. Therefore, the Tribunal committed anerror of law in upholding the order of Commissioner ofIncome Tax (Appeals) in invoking Explanation 3 toSection 43(1)of tne Act. 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