Intent to reduce tax liability need to be established before invoking explanation 3 to section 43(1)

Brief of the Case

ITAT Delhi held In the case of M/s. Continental Device India Ltd. vs. ACIT that Explanation 3 to section 43(1) is not an absolute rule. The Assessing Officer is empowered to substitute the value. However, such a valuation cannot be substituted where there is no intent to reduce the tax liability. In the instant case, as stated above, the assets as held by M/s. Deltron Ltd. and transferred to the appellant as part of transfer of electronic business on going concern basis cannot be said to be in any manner with intent to reduce the tax liability. Certainly, the effect of the transaction was that the gain declared by M/s. Deltron Ltd. was set off against the losses in its computation yet that fact cannot undetermine the genuineness of the transaction and in any case empower the Assessing Officer to substitute the valuation as determined in the registered valuer’s report which has not been found to be incorrect by any other technical valuation. Hence, we do not subscribe to the conclusion of the authorities below.

Ration decidendi – There is nothing on record to show that having regard to the value of the assets held by the transferor company, such amount paid by the assessee is excessive or unreasonable or irrational and the also valuer’s report has not been commented upon in any manner by the authorities below, explanation 3 to section 43(1) not applicable.

Facts of the Case

The assessee company is engaged in the business of manufacturing of electronic components. The return of income was filed on 28.10.2005 declaring an income of Rs. 7,04,54,286/- which was processed u/s 143(1) on 30.10.2006 at the returned income filed by the assessee. The case was selected under scrutiny and statutory notice u/s 143(2) dated 2.8.2006 was issued to the assessee.

The AO directed the assessee to furnish item-wise listing of additions to fixed assets in each block giving date of acquisition and date put to use with proof of acquision/delivery and use in respect of additions to assets for value exceeding Rs. 5,00,000/- and vide letter dated 14.9.2007, the assessee submitted these details. After perusing the details, the AO noticed that most of these assets had been claimed to put to use on 1.10.2004. Further, the AO observed that a new unit M/s Deltron Ltd. had been acquired in the AY 2005-06 as a going concern and all fixed assets thereof had been claimed to have been put to use on 1.10.2004.

From the details, the AO observed that the concerns were running under common management, the directors were also common and they were operating from the same address. The AO further observed that the facts of purchase of fixed assets of M/s Deltron Ltd. as a going concern was disclosed by the assessee only after the probe during assessment proceedings and no such details had been furnished in any manner in the audit report or papers enclosed with the return of income.The AO observed that the deprecation on building is claimed by the assessee at full rate, whereas it was admissible for half rate as all assets of the acquired plant were claimed to have been put to use is less than 180 days.

In the light of the aforesaid facts, the AO was satisfied that the main purpose of transfer of these assets was for reduction of a liability to income tax by claiming excess depreciation with reference to the enhanced cost of acquiring M/s Deltron Ltd. and therefore, the Explanation 3 below section 43(1) was clearly attracted. The AO relied on the decision of Hon’ble Supreme Court in the case of Mcdowell & Co. Ld. vs. CTRO 154 ITR 148 SC and, applied Explanation to section 43(1) to adopt the actual cost at the written down value of the assets in the hands of the transferor company, namely M/s Deltron Ltd. and excess deprecation claimed by the assessee was worked out. The AO after considering the legal position and facts and circumstances of the case and being unsatisfied with the explanation of the assessee, made disallowance of deprecation of Rs. 12,23,215/- and added it to the total income of the assessee.

Contention of the Assessee

The ld counsel of the assessee submitted that firstly, it is clarified that M/s Deltron Ltd. is a listed public ltd. company. All the necessary approvals of shareholders and approval of SEBI for selling any business has been obtained. All necessary disclosures as were required under law were made in the audited accounts of Deltron Ltd. as would be seen from its balance sheet. The assumption of the AO/CIT concerns, the transaction is not at arm’s length is misconceived and erroneous.

Further submitted that the transaction of sale of the business as a going concern was based upon a certificate of transaction was undertaken based on such valuation report. This valuation was absolutely necessary both from assessee’s as well as Deltron’s point of view because the sale was required to be approved by the shareholders of Deltron Ltd. In absence of any defect or even an allegation of any defect in such valuation, the AO/CIT(A) were not justified in ignoring the same and adopting the W.D.V. in the books of Deltron Ltd. as the actual cost under section 43(1) read with explanation 3. A direct judgment on this issue is Ashwin Vanaspati Industries vs. CIT 255 ITR 26 (Guj). Also there is not even an iota of evidence that something more or less has been paid or passed than the actual consideration stated in the government based on a valuation of assets by a government approved valauer. The findings of the AO are just surmises and conjectures not supported by any evidence.

On the matter of reducing depreciation on building, it was submitted that the existing business was purchased as a going concern along with building. There were no special formalities required for taking over building: The building was already housing all other assets i.e. plant and machinery etc. So, the allegation is totally out of context.

Contention of the Revenue

The ld counsel of the revenue relied on the order of lower authorities.

Held by CIT (A)

CIT (A) upheld the order of the AO in taking the ‘actual cost’ on WDV basis by applying the provisions of Explanation 3 to section 43(1). However, the AO was directed to take the correct figures of all the assets taken over from M/s Deltron Limited as per records and to recalculate the differences.

The CIT (A) further specifically held that the Assessing Officer was justified in allowing depreciation for half of the year and not for the entire year in respect of the assets acquired by the assessee company from M/s. Deltron Ltd

Held by ITAT

The AO comes to the conclusion that the main purpose of transfer of these assets was for reduction of a liability of income tax by excess depreciation with reference to the enhanced cost and, therefore Explanation 3 to section 43(1) gets attracted. Accordingly, the AO has taken the WDV of the assets as per Explanation 3 of section 43(1) of the Act from the books of account of the seller company and ignored the price paid by the assessee on which the assessee had claimed depreciation. He has noted that assessee had claimed depreciation of Rs. 20,41,601/- whereas, according to him, deprecation allowable on the WDV of these assets is only Rs. 8,18,386/- and the difference comes to Rs. 12,23,215/-. In arriving at the above figure of Rs. 8,18,386/-, the Assessing Officer has held that the assets acquired by the appellant company were to be used for less than 180 days and therefore, the assessee was entitled to depreciation for only half o the year and not for the entire year.

As per sub-section (1) of section 43, the AO needs to satisfy that the main purpose of the transfer of such assets directly or indirectly to the assessee was for the reduction of a liability of income tax by claiming deprecation with reference to an enhanced cost. Then only, the AO can invoke Explanation 3 to fix the actual cost. So, therefore, the requirement of law is that the main purpose of the transfer of assets was for the reduction of a liability to income tax without satisfying the same, the AO cannot invoke Explanation 3 to section 43(1).

In this case, we firstly notice that the AO’s observation that neither in the audit report or in the papers filed alongwith the return the acquisition was not mentioned, is not correct. We find that in the Director’s report, it has reported that the assessee had acquired business of Deltron Limited as a going concern (paper book page 2). Similarly, we find that in schedule T of balance sheet being notes on accounts as Note 10, assessee company has disclosed that it has purchased electronic business of M/s Deltron Ltd. at a net consideration of Rs. 7.54 Crores (Paper book Page 22). Thus, we find that the observation of the AO that the assessee did not disclose the transaction is factually incorrect.

A perusal of the agreement between parties makes it abundantly clear that the purport of the transfer of electronic business from the public limited company namely M/s. Deltron Ltd. to the assessee was on account of lack of sufficient financial source to run the said business as a profitable unit by the public limited company. This purpose as stated in the agreement has not been found to be rejected, commented or disputed by any of the authorities below. There is no material to dispute the assertion that M/s. Deltron Ltd., a public limited company had resources to invest heavily in R&D or develop process capability to keep pace with the advancing technology. No doubt, the ground of common management and common office is a relevant consideration but the same is not of conclusive nature.

The Assessing Officer vis-à-vis registered valuer’s report has held that both the companies were engaged in the same kind of electronic business and plant and machinery used by them was unique and they were not ordinarily marketable commodities, so as to have any valuation of their market price. He further observed that both the companies knew that there was no market for the old plant and machinery except for the opinion that the assets of one company doing the same business were used by the other. It will be thus seen that the Assessing Officer has not found any specific defect vis-à-vis valuation adopted by the appellant on the basis of registered valuer’s report. IT could not be said that an asset though having Nil value under the Income Tax Act would be transferred also Nil value to a third party more particularly when the transfer is not of an asset but of a business on a going concern basis.

The transfer of the business is not in dispute. The genuineness of the transfer of the business is also not in dispute. The purpose behind the transfer is also not in dispute. All what has been disputed by the Assessing Officer and upheld by the CIT (A) is valuation of the assets adopted for the purpose of transfer. In such circumstances, we find force in the claim made before us that it is not a case of valuation having been adopted by a higher price more particularly when the transaction is between the closely held company and public limited company and price is paid to public limited company by the closely held company. It is also not a case where price as stated in the agreement has not been paid by the assessee. The valuation is supported by registered valuer’s report which valuation has not been shown to either fantastic or imaginary or irrational by any cogent evidence.

We find support from the judgment of Hon’ble Gujarat High Court in the case of Ashwin Vanaspati Industries v. CIT reported in 255 ITR 26 wherein their Lordships had specifically held “The valuation report is by a registered valuer Neither in the assessment order nor in the Tribunal’s order is there any whisper that the valuation report by the registered valuer is incorrect in any manner whatsoever. Once there is a report by the registered valuer it is encumbent upon the authority to dislodge the same by bringing adequate material on record in the form of a departmental valuation report, because in the absence of the same a technical expert’s opinion cannot be dislodged by any authority by mererly ignoring the same.

In the instant case, as stated above, the assets as held by M/s. Deltron Ltd. and transferred to the appellant as part of transfer of electronic business on going concern basis cannot be said to be in any manner with intent to reduce the tax liability. Certainly, the effect of the transaction was that the gain declared by M/s. Deltron Ltd. was set off against the losses in its computation yet that fact cannot undetermine the genuineness of the transaction and in any case empower the Assessing Officer to substitute the valuation as determined in the registered valuer’s report which has not been found to be incorrect by any other technical valuation. Hence, we do not subscribe to the conclusion of the authorities below. Having regard to the above, we hold that Assessing Officer was not justified in invoking Explanation 3 to section 43(1) of the Act on the facts and circumstances of the case of the appellant company and therefore, appellant is entitled to claim of depreciation on the actual cost as incurred by the appellant on transfer of the electronic business on going concern basis from M/s. Deltron Ltd. to the appellant company.

Further we do not find any merit in the claim of the appellant that depreciation is to be allowed for the entire year particularly having regard to the fact that assessee itself had chosen to claim depreciation for half of the year for all assets other than the building. The assessee has also not placed on record any evidence to substantiate when the building was occupied/put to use by the appellant company. In such regard, the conclusion as drawn by both the Assessing Officer and CIT (A) is in order and therefore, it is directed that the depreciation is to be allowed only for half of the year and not for the entire year.

Accordingly appeals disposed of.