Depreciation on Non-Compete Fee Remanded as Foundational Genuineness Was Never Examined.

(i) when there is decline in revenue by 48%

(ii) when there is decline in revenue by 52%”

“An asset must be one for which a market value can be ascertained. A right to personal services under a contract of service is unassignable, it cannot be bought or sold. It cannot survive the demise of either of the parties. It can have no actual market value and so it cannot be an asset. [O’ Brien (Inspector of Taxes) v. Bensons Hosiery (Holdings) Ltd. [1978] 3 All ER -1057, 1063]

The right to trade freely and to compete in the market place is not an asset [Kirby V/s Thorn Emi Plc. [1988] 2 All ER 947, 959 (CA)].”

“When a businessman pays money to another businessman for restraining the other businessman from competing with the assessee, he gets a vested right which can be enforced under law and without that the other businessman can compete with the first businessman. When by payment of non-compete fee, the businessman gets his right what he is practically getting is kind of monopoly to run his business without bothering about the competition.

Moreover, this right (asset) will evaporate over a period of time of five years in this case because after that the protection of non-competition will not be available to the assessee. This means, this right is subject to wear and tear by the passage of time, in the sense that after the lapse of a definite period of five years, this asset will not be available to the assessee and, therefore, this asset must be held to be subject to depreciation.”

“Similarly, the question of payment to be made as compensation by way of non-competing fee also would not arise, considering the fact that the assessee firm has been taken over as a going concern in its entirety by the new company. As observed earlier, the partners of the assessee firm are the new Directors of the company. The consideration was paid to the assessee firm and not the partners. There was no competition as alleged between the assessee firm and the new private limited company. There was also no control between the partners of the assessee and the new private limited company. Hence, considering above said factual position, we are of the considered view that the findings of the Tribunal in holding that in as much as there was no competition between the partners of the assessee firm and the new private limited company, coupled with the fact that the entire business of the assessee company was transferred the same cannot be found fault with.”

1. Genuineness of the payment made and necessity of paying noncompete fee.

2. Non-compete fee not being in the nature of an intangible asset as defined in section 32(1)(ii), depreciation is not allowable.

“8. Now, we take up the common issue involved in all the appeals. The assessee is in the business of running satellite television channels. These channels telecast films, serials etc., through satellite channels. The rights over these films are purchased from the producers of the respective films for broadcasting through satellite television. These rights come with an embargo that the films shall not be broadcasted or aired for a specified period from the date of release in theatres depending upon the success at the box office and other factors. Till the time, such films are broadcasted, they are to be treated as stock in trade. Once the films are broadcasted, the purchase value of the films is written-off. The expenditure on purchase of films is claimed in the first year itself. The assessee has got only satellite telecasting rights and has no universal rights for airing the films or serials. Once the film or the serial is aired, its value is diminished in subsequent telecasts. The assessee earns substantial revenue in the first telecast itself. In repeat telecast, the assessee is able to generate marginal revenue. Whatever income is earned from the subsequent telecasts is offered as income without claiming any expenditure.

The assessee also generates revenue from broadcasting serials through satellite channels. The assessee gets revenue from production and broadcasting serials on the lines of feature films, the rights of broadcasting such serials are also treated as stock in trade till the time they are aired and the expenses are debited to the Profit & Loss account. The assessee treats the films and the serials at par and applied the provisions of Rule 9A and 98 of the Income Tax Rules, as are applicable in case of films on serials as well.

On the other hand, the contention of the Revenue is that the film and serial broadcasting rights acquired by assessee are perpetual in nature. After first telecast, the assessee does not discard the films but carefully store the same in digital library for airing the same again. Therefore, the assessee gets enduring benefit from the rights acquired in films and serials and they do not expire on the date of first telecast as contemplated by the assessee. The rights are intangible assets within the meaning of Explanation (iii) to Section 32 and do not fall within the purview of Section 37(1). The assessee is entitled to claim depreciation on same.

9. The issue of amortization of cost of movie and serial rights, programme production expenses, consumable and media expenses by treating them as intangible assets u/s.32(1)(ii) has been dealt in detail by the CIT (Appeals) in his order dated 23-02-2013 relevant to the A Y. 2006-07 and 2007-08. We fully agree with the detailed findings and the reasoning given by the CIT(Appeals) in his order allowing this ground of appeal of the assessee. For the sake of brevity, we are not reproducing the findings of CIT (Appeals) in accordance with the judgment of the Hon’ble Supreme Court of India in the case of CIT v. K. Y. Pillah & Sons reported as 63 ITR 411 subsequently followed by the Hon’ble Delhi High Court in the case of CIT v. Global Vantedge (P) Ltd. , reported as 354 ITR 21 (Del). The Id. DR has not been able to controvert the well reasoned order of the CIT (Appeals) on the issue. Accordingly, the findings of the CIT (Appeals) on the issue are affirmed and this ground of appeal of the Revenue in respect of all the AYs is dismissed.”

“25. We have heard both the parties and perused the orders of the Revenue Authorities as well as the cited precedents and paper book filed before us. The case of the assessee on the merits is that the assessee has a method of valuation of the news items/non fictional in nature, TV programs and the film rights. The details are given in the aforementioned ‘Note No 7’ to the financial statements. According to the same, while the news items purchased are debited to the P and L account as they do not have the repeat telecast value, other items like the TV program and the film rights constitutes ‘current assets’, which are amortised over the years and the period of such amortization is given in the said Note. Per contra, the case of the revenue on these issues is that these items constitute ‘intangible depreciable capital assets’ and provisions of section 32 of the Act apply. Considering the same, we shall now undertake to discuss the item wise adjudication as follows.

a. On the debits relating to the purchases of the News items: Regarding the nature of the news items purchased by the assessee and debited to the P and L account, we find it is in the common knowledge of every citizen that the news items do not have enduring benefit. Normally, the news items/non fictional items purchased by the assessee lose its value once they are telecast. Therefore, such items do not have repeat telecast value in terms of the revenue generation by way of advertisement from the sponsors. As such, it is a settled issue at the level of Hon’ble Delhi High Court in the case of Television Eighteen India Ltd (supra) that the claims of the assessee relating to news/non-fictional items are allowable. Even otherwise, even if some income generated, that is not criterion for describing the items as ‘intangible assets’ for the purpose of invoking the provisions of section 32(ii) of the Act. We rely on the above referred Delhi High Court’s Judgment in the case of Television Eighteen India Ltd (supra). Further, we find that the assessee has a declared method of accounting relating to accounting of these transactions. He has been consistently following the same without any change. In fact, the Revenue has consistently allowed the claim in the past. This is for the first time, AO disturbed the claim of the assessee and invoked the provisions of section 32 (ii) of the Act, without any sustainable reasoning. Therefore, considering all the points mentioned above, we are of the firm opinion that the decision of the AO/CIT(A) is unsustainable legally. Hence, the assessee is entitled to claim the purchases of news items/non-fictional items as an allowable expenditure. Accordingly, we direct the AO to delete the relevant addition.

b. On the debits relating to the purchases of the TV Programs/Film rights: Assessee amortised the ‘inventories’ as per the method of accounting consistently followed by him over the years. In fact, the Revenue has consistently allowed the claim in the past. This is for the first time, AO disturbed the claim of the assessee and invoked the provisions of section 32 (ii) of the Act without any sustainable reasoning. We have perused he judgment of Honble High Court of Delhi and the order of the Tribunal of Chennai Bench in the case of M/s Sun TV Networks Ltd (supra). We have also extracted the relevant paragraphs and already placed in this order above. We find similar issue of amortization of the TV Programs/Film rights came up before the Chennai Bench of the Tribunal wherein the issue was decided in favour of the assessee and rejected the AD’s proposal to invoke the provisions of section 32(ii) of the Act in respect of the above programs/rights. As such, the Ld DR’s argument on the applicability of the AS-26 to the TV Programs and Film rights is not supported by any precedents and therefore, the arguments raised by the Revenue are not allowed. Thus, considering the covered nature of the issue as well as the consistent method of accounting followed by the assessee in this regard and also in the absence of any contrary material to support the arguments of the Revenue against the assessee’s claim, we are of the opinion that the decision taken by the CIT (A) in the impugned order is required to be reversed. Accordingly, Ground nos. 2 and 3 raised by the assessee are allowed.

“The revenue has preferred this appeal claiming to be aggrieved by an order of the Income Tax Appellant Tribunal (ITAT) dated 17.03.2006. The question of law framed in this case is:-

(i) Whether the Income Tax Appellate Tribunal was right in holding that the entire expenditure incurred by the assessee on production of programmes which became part of news archives should be allowed as a revenue expense under Section 37 of the Income Tax Act, 1961 and should not be treated as incurred for creating a capital asset?

The assessee, at the relevant time, was in the business of television programme production. The assessee reflected Rs.88,83,128/- being 10% of the total expenditure incurred by it as value of “news archives” under the head of fixed assets. In the return filed by the assessee for the Assessment Year 1997, the said amount was claimed as revenue expenditure. According to the assessee this expenditure was allocated for the creation of “news achieves”, which comprised of its published or telecasted programmes. The AO capitalised this amount holding that the expenditure led to creation of an asset of enduring advantage. The CIT (Appeals) on appeal, however, reversed the findings of the AO. It was noticed that the news archives were not in the nature of plant or income generating apparatus but part of the product. It was also held that the unavailability of any objective basis, to quantify with any decree of accuracy future revenue that were likely to be generated and the proportionate cost of production that could be deferred, led to the conclusion that the 10% of the total expenditure earmarked for creation of “news archives” could not be treated as a capital expenditure.

On the revenue’s appeal, the ITAT held as follows:-

“12. It is admitted that no separate account was maintained wherein any expenditure was debited which could be earmarked towards creation of News Archives library. The assessee felt a part of footage of the news based on programmes produced has repeat value which could be used for the production of programme in future. The assessee, therefore, estimated 10% expenditure incurred as reasonable to be attributable to the News Archives library. The assessee has been engaged in the production of such programmes since assessment year 1994-95 and all along the cost of production of such expenditure has been treated as revenue expenditure and also allowed by the Department. Learned A.R. has referred to judgment of Hon’ble Supreme Court in the case of Alembic Chemical Works Ltd. v. CIT 177 ITR 377 which laid down that what is capital expenditure and what is revenue are not eternal verities but must needs to be flexible so as to respond to the changing economic realities of business. Viewed in that perspective, we are of the opinion that the estimated value assigned to the News Archives cannot be treated to be an expenditure incurred in the capital field. We, therefore, uphold the order of CIT (A) on this ground.

In this case, there is no dispute that the data base of the programmes which are utilised for the creation of “news archives” belonged to the assessee. The future likelihood of these resources being a possible source of revenue, cannot in the opinion of this Court justify its inclusion in the capital stream. Furthermore, this Court notices that the expenditure i.e. 10% Rs.88,83,128/-is a part of the entire total expenditure incurred by the assessee which is concededly treated as revenue, even otherwise.

In view of the above discussions, this Court is of the opinion that the question of law framed is answered in favour of the assessee and against the revenue.

The appeal is dismissed.”

“4. Some intangible assets may be contained in or on a physical substance such as a compact disc (in the case of computer software), legal documentation (in the case of a license or patent) or film. In determining whether an asset that incorporates both intangible and tangible elements should be treated under Ind AS 16, Property, Plant and Equipment, or as an intangible asset under this Standard, an entity uses judgment to assess which element is more significant. For example, computer software for a computer-controlled machine tool that cannot operate computer software for a computer-controlled machine tool that cannot operate computer software for a computercontrolled machine tool that cannot operate without that specific software is an integral part of the related hardware and it is treated as property, plant and equipment. The same applies to the operating system of a computer. When the software is not an integral part of the related hardware, computer software is treated as an intangible asset.”

“43. In sections 28 to 41 and in this section, unless the context otherwise requires—

(1) “actual cost” means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority:

[Provided that where the actual cost of an asset, being a motor car which is acquired by the assessee after the 31st day of March, 1967, [but before the 1st day of March, 1975,] and is used otherwise than in a business of running it on hire for tourists, exceeds twenty-five thousand rupees, the excess of the actual cost over such amount shall be ignored, and the actual cost thereof shall be taken to be twenty-five thousand rupees.]

Explanation 1.—Where an asset is used in the business after it ceases to be used for scientific research related to that business and a deduction has to be made under 1[clause (ii) of sub-section (1)] of section 32 in respect of that asset, the actual cost of the asset to the assessee shall be the actual cost to the assessee as reduced by the amount of any deduction allowed under clause (iv) of sub-section (1) of section 35 or under any corresponding provision of the Indian Income-tax Act, 1922 (11 of 1922).

[Explanation 2.—Where an asset is acquired by the assessee by way of gift or inheritance, the actual cost of the asset to the assessee shall be the actual cost to the previous owner, as reduced by—

(a) the amount of depreciation actually allowed under this Act and the corresponding provisions of the Indian Income-tax Act, 1922 (11 of 1922), in respect of any previous year relevant to the assessment year commencing before the 1st day of April, 1988; and

(b) the amount of depreciation that would have been allowable to the assessee for any assessment year commencing on or after the 1st day of April, 1988, as if the asset was the only asset in the relevant block of assets.]

Explanation 3.—Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the [Assessing] Officer is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income-tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the [Assessing] Officer may, with the previous approval of the 4[Joint Commissioner], determine having regard to all the circumstances of the case”.

“11. Now, the original cost of a particular asset is a question of fact which has to be determined on the evidence of the material produced before or available to the IT authorities. Any document or formal deed mentioning the consideration or the cost paid for the purchase of an asset by an assessee would be a piece of evidence and, prima facie, the statements or figures given therein would show how much the cost of the asset to the assessee is. But, if circumstances exist showing that a fictitious price has been put on the asset or there is fraud or collusion between the vendor and the vendee and there has been inflation or deflation of value for ulterior purposes it is open to the IT authorities to refuse to accept the price mentioned in the deed or alleged by the assessee and to ascertain what the actual original cost was: See Pindi Kashmir Transport Co. Ltd. v. CIT (1954) 26 ITR 595 (Lah-Pak) : TC29R.253 and Kalooram Govindram v. CIT (1965) 57 ITR 335 (SC) : TC29R.254. In this view of the matter it is open to the IT authorities to determine and to the assessee to show whether the goodwill of the business is or is not included in the consideration or the price paid for the acquisition of the asset. In other words, even if it is not expressly mentioned that goodwill has been sold, it can be shown and ascertained by evidence whether the same has been purchased or not by the assessee. The expression “goodwill” has been considered and explained by this Court in S.C. Cambatta & Co. P. Ltd. v. CEPT (1961) 41 ITR 500 (SC), and nothing more need be said about it. The principles stated by us are by no means exhaustive and are mainly illustrative.

12. Keeping in view the facts of the present case, we may make it clear that, if circumstances exist for going behind the valuation as also the allocation given in the deed of conveyance, it was and is open to the IT authorities to determine the valuation as well as the allocation between depreciable and non- depreciable assets.”

“11. We have heard the parties and given our utmost consideration to all the circumstances. As is clear from the narration of facts, in the books of Bhagwati Glass, the total expenditure incurred by it in the execution of the contract jobs was Rs. 3,11,954. As against that the assessee has paid Rs. 7,70,000 to it for execution of those jobs. This, on the face of it, appears to be a very high payment, specially when the Tribunal has noted that the jobs did not require any specialised or sophisticated skill. It was mostly a labour contract as the material was entirely supplied by the assessee. It is next also clear that the assessee and Bhagwati Glass were connected concerns indirectly owned by R. Dalmia, and that Bhagwati Glass had a carried forward loss of over Rs. 7 lakhs this year. The result has been that although Bhagwati Glass enjoyed a profit of about Rs. 4,58,000 in the execution of this contract, no tax liability ensued to it and the entire profit was wiped off against the large brought forward loss. At the same time, the assessee has claimed to be entitled to depreciation, etc., on the capital value of those works at Rs. 7,70,000. The I.T. authorities were, therefore, right in observing that there was considerable element of collusion in the entire affair which could not be treated as the result of normal commercial considerations. The capital cost has no doubt been inflated in the hands of the assessee to enable it to claim higher depreciation, etc.

12. We find that the term “actual cost” came up for consideration before the Supreme Court in the case of Guzdar Kajora C041 Mines Ltd. v. CIT 1972 CTR (SC) 231; (1972) 85 ITR 599. It was observed that the original cost of a particular asset is a question of fact which has to be determined on the evidence of the material produced before or available to the I.T. authorities. Any document or formal deed mentioning the consideration or the cost paid for the purchase of an asset by an assessee would be a piece of evidence and, prima facie, the statements or figures given therein would show how much the cost of the asset to the assessee is. But if circumstances exist showing that a fictitious price has been put on the asset or there is fraud or collusion between the vendor and the vendee and there has been inflation or deflation of value for ulterior purpose, it is open to the I.T. authorities to refuse to accept the price mentioned in the deed or alleged by the assessee and to ascertain what the actual cost was. These observations in our view render the approach adopted by the Tribunal in the present case as unsustainable when it observed that collusion and inflation would not entitle the I.T. authorities to substitute their own figure of actual cost.

13. In the case of Guzdar Kajora Coal Mines Ltd. (supra), the deed of conveyance executed in favour of the assessee purported to transfer certain assets for a consideration of Rs. 6 lakhs paid by the assessee. Those assets included machinery, plants, stores, buildings, etc. The I.T. authorities found that some of the directors and shareholders of the assessee and the vendorcompany were the same and connected, and there were certain inflations and deflations of the written down values of the assets. No provision had been made for goodwill of the business. The ITO, therefore, allocated part of Rs. 6 lakhs to goodwill. The value of the depreciable assets was computed at Rs. 33,973 only. The Tribunal then rejected the assessee’s claim holding, inter alia, that the allocation in the deed of conveyance was arbitrary. On a reference of the question whether the ITO was competent to go beyond the conveyance and fix a valuation of the assets on his own, the High Court answered the question in the affirmative. On appeal to the Supreme Court, it was held that there was no error or infirmity that would justify interference by the Supreme Court.

14. Similarly, the Calcutta High Court in Jogta Coal Co. Ltd. v. CIT (1965) 55 ITR 89, observed that if the circumstances showed than an assessee had arranged to put a fictitious price on his assets in a contract or conveyance, it was open to the I.T. authorities to refuse to accept that price, go behind the contract or conveyance and ascertain what the original cost was. The Lahore High Court (Pakistan) has also in the case of Pindi Kashmir Transport Co. Ltd. (1954) 26 ITR 595 (Lah- Pak), observed that the I.T. authorities were justified in law in going behind the contract for determining the original cost to the company, for the purpose of making allowance of depreciation.

15. So far as the Explanations added to s. 43 of the Act, specially Expln. No. 3, under which alone the Tribunal has observed the interference by way of determination of actual cost can be made, we are of opinion that such Explanations are only elaborative and tend to bring out some of the circumstances in which the main provision of the law can operate. They can by no stretch be treated as exhaustive or to otherwise limit the wide scope which the provision of law may embrace. Rather the incorporation of some Legislature envisaged interference in given circumstances in the amount of purported actual cost.

16. We are further of opinion that the Tribunal was not justified in restricting the operation of the actuality of cost to cases where part of that consideration was not paid or ploughed back or covered some other items. In these cases, the cost would be what is in fact paid. What was not paid or was returned would never be considered as cost. This will be independent of the provisions contained in the IT Act. The provisions of this Act have not been introduced for this purpose. They have rather a special objective and is directed towards nullifying the malpractices, sometimes indulged in some quarters, of disproportionately inflating capital cost in order to earn high depreciation, and pass on in collusion substantial amounts to sister concerns or closely connected parties to whom those amounts may have little or negligible bearing on the incidence of tax. This is what appears to have happened in the present case. In our opinion, when the Legislature has prefixed the word “actual” to the word “cost”, it was to lay emphasis on the reality and genuineness thereof and exclude collusive, inflated, deflated or fictitious costs.”

“15. We cannot agree with the conclusion of the Tribunal that the revaluation of the assets on the eve of the dissolution of the firm was made bona fide for adjustment of the mutual rights of the firm. This is not a case where there is no written down value, which means, in the case of assets acquired in the previous year, the actual cost to the assessee and in the case of assets acquired before the previous year, the actual cost to the assessee less all depreciation actually allowed to him under the Act as defined under s. 43(6). Sec. 43(1) with Explanations thereof supersedes the general rule of law governing partnership, its assets and dissolution etc. The definition of ‘actual cost’ contained in s. 43(1) read with Explanations thereof affords a mechanism by which reduce the actual cost to a figure which is anything but real. When the asset was formally used by any other person for the purpose of his business and the main purpose of the transfer of the asset to the assessee is to claim a higher depreciation allowance so as to reduce the liability to pay incometax, the ‘actual cost’ shall be determined by the AO in the exercise of the power conferred on him as prescribed in Expln. 3 to s. 43(1) no matter what the general law prescribes for determining the costs of the assets on dissolution of partnership firms and transfer of its assets.

16. Both the contesting parties, assessee as well as the Revenue, placed reliance on the decision of the Bombay High Court in Ginners & Pressers P. Ltd. v. CIT 1978 CTR (Bom) 235 : (1978) 113 ITR 616 (Bom) : TC 29R.714, and the Tribunal said so in its impugned order. That was a case where s. 10(5)(a) of the 1922 Act corresponding to Expln. 3 to s. 43(1) of the present Act came up for discussion. The facts of that case narrated hereunder are more or loss similar to the facts on hand. The assessee, a private limited company, was a subsidiary of another private limited company. The object of formation of the assessee company was to take over some oil and ginning mills, factories and land belonging to and used in its business by the present company. These assets were taken over by the assessee-company at a cost of Rs. 13,50,000. Their written down value for the parent company was only Rs. 2,21,412 while their original purchase cost to the parent company was Rs. 5,52,475. The assessee paid for the assets by issuing fully paid up shares of that value. The ITO applied the proviso to s. 10(5)(a) and, with the previous approval of the IAC, he fixed the actual cost of the assets to the assessee at their written down value in the books of the transferor plus the balancing charge arising under s. 10(2)(vii). The Tribunal rejected the contention of the assessee that the assets had been transferred to the assessee by the parent company after they had been got valued by valuers, because the material on the basis of which the value had been fixed by the valuers for the assets in question had been withheld by the witness who was examined on behalf of the valuers before the ITO and the nonproduction of such material led to an adverse inference being drawn against the assessee company. On these facts, two questions arose for consideration before the High Court on reference. First question is whether the proviso to s. 10(5)(a) has been properly applied and the second question is, whether the Tribunal is justified in rejecting the valuation and drawing an adverse inference against the assessee. As far as the first question is concerned the Court found that the condition for attracting the proviso to s. 10(5)(a) was satisfied because the assets had been used by the parent company for their business before they were transferred to the assessee-company. On the second question the Court found that the Tribunal was justified in rejecting the valuation report and drawing an adverse inference against the assessee. The first question alone is relevant in the present case and on that question the Court said that the ITO proceeded to fix or determine the actual cost (written down value) of the assets transferred by adopting the written down value of those assets transferred in the books of the transferor of the assessee-company as on the date of transfer and added to that figure the balancing charge arising under s. 10(2)(vii) of the Act. The Court further observed:

“It cannot be disputed that this method, if adopted, would clearly give the actual cost of the assets transferred to the transferor company as on the date of transfer, the determination would be irrational or unreasonable. If the ITO adopted this method of determining the actual cost of the transferred assets with the approval of the IAC, it will be difficult to say that the method adopted was unreasonable or irrational”.

17. Even if the assessee produces the valuation report, it cannot be said that the above conclusion would be different. Therefore, the drawing of adverse inference against the assessee has no impact on the question decided by the Court. The attempt of the Tribunal to distinguish the above decision on the basis that the assessee has furnished the revaluation report in the present case would not fructify.”

“6. The learned counsel for the assessee submitted that the value of the machineries which the assessee had adopted when it took over the assets at the time of dissolution was in accordance with what had been said in the case of A.L.A. Firm v. CIT (1991) 93 CTR (SC) 133 : (1991) 189 ITR 285 (SC) : TC 2R.453 wherein the Court approved the observation of this Court in the case of Md. Ussain v. Abdul Gaffoor AIR 1950 Mad 758. Counsel submitted that the formation of the company was only due to the insistence of the lenders that the business of the company, namely, the running of the cotton mill should be by an incorporated company before the financial institutions could lend money to it. However, there is no material on record to substantiate that claim.

7. The fact that the assessee had adopted the market value at the time of dissolution even when such value is much higher than the written down value, would afford sufficient basis for invoking Expln. 3 to s. 43(1) when the surrounding circumstances indicate that the purpose of the transfer of the assets directly or indirectly to the assessee where the assets had suffered depreciation prior to such transfer is such as to indicate that the main purpose of transfer was to enable the assessee to gain higher depreciation by taking a higher figure as it’s cost at the time of such transfer. Here the firm was dissolved within about 13 months of its formation. The two partners besides the assessee company were also the only two shareholders and directors of the company. The reality before and after the dissolution was the same. The same persons who enjoyed the benefits of the ownership of the assets and its uses continue to have such benefits, the two partners indirectly and the assessee itself directly. The findings recorded by the Tribunal in this background cannot be faulted. The question referred to us is, therefore, answered in favour of the Revenue and against the assessee.”

“36. At the outset, we may observe that AO has not considered the entire scheme as demerger under the Income-tax Act as contemplated u/s 2(19AA) of the Income-tax Act. Therefore, we do not consider it necessary to examine the observations of AO, and ld. CIT(A) and the submissions of both the parties on this count as it would only be of academic interest. This is evident from the fact that AO has invoked Explanation 3 to sec. 43(1) and not Explanation 7A to sec. 43(1). Further the contention of assessee that transferor company had also paid long term capital gain tax on the sale consideration is also not of much significance because tax liability is to be determined qua assessee. Therefore, the main issue for our consideration is whether AO was justified in invoking Explanation 3 to sec.43(1) by holding that the entire purpose of this scheme was reduction of tax liability by claiming higher depreciation in respect of those assets which were earlier used by transferor company by escalating the cost of the assets.

Explanation 3 has been incorporated in sec. 43(1) to counter the attempts of assessee to claim higher depreciation by purporting to purchase assets at more than their true or real cost. It is fundamental principle that department cannot question the wisdom of assessee in carrying out its business operations. Department cannot dictate as to how the assessee should conduct its business. However, legislature has made specific provisions in the Incometax Act when department can depart from this fundamental principle and ignore the apparent state of affairs and pearce the smoky-screen created by assessee in the transaction to find out the true intention. These sections provide circumstances in which department can impute its judgment to the assessee’s decision. The relevant provisions are to be found in section 40A(2), Explanation 3 to sec. 43(1), section 92C etc. But before these provisions can be invoked, legislature has required the AO to acquire necessary satisfaction in this regard which obviously has to be acquired judiciously and not arbitrarily. The AO should demonstrate that his satisfaction was rational and based on relevant factors. Explanation 3 to section 43(1) reads as under: –

43. “In sections 28 to 41 and in this section, unless the context otherwise requires-

(1) “actual cost ” means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority.

Explanation 3 – Where, before the date of acquisition by the assessee, the assets were at any time used by any other person for the purposes of his business or profession and the AO is satisfied that the main purpose of the transfer of such assets, directly or indirectly to the assessee, was the reduction of a liability to income tax (by claiming depreciation with reference to an enhanced cost), the actual cost to the assessee shall be such an amount as the AO may, with the previous approval of the [Joint Commissioner], determine having regard to all the circumstances of the case. ”

Thus, the basic ingredients of Explanation 3 are as under: –

(i) an asset was already in use in a business in the hands of one persons;

(ii) that person transfers the asset to assessee;

(iii) the A.O. is satisfied that the main purpose of transfer of such assets was the reduction of liability to Income-tax by claiming depreciation with reference to an enhanced cost;

(iv) the A.O. can refuse to accept the sale price as the actual cost to the purchaser (assessee) in the purchasers assessments.

37. The legislature has prefixed the word “actual” to the word “cost” which clearly signifies that emphasis is on the reality and genuineness of the cost so as to exclude collusive, inflated, deflated or fictitious cost. As already pointed out that the AO is required to judiciously acquire the necessary satisfaction regarding the object of transfer. It is not to be understood that every case wherever assessee acquires a used asset from other person then the object would only be reduction of tax liability. There may be genuine cases also where the asset has appreciated in value since its original purchase and consequently, the market value on the date of the sale is greater than written down value in the AO’s chart. In the absence of any finding, that the main purpose of the transfer is to reduce the tax liability with reference to enhanced cost, it is not permissible to the AO to reject the cost paid for the transfer. The AO cannot substitute his own estimate of the value rejecting the assessee’s estimate as was held in by Hon’ble Supreme Court in Joyta Coal Company Ltd. v. CIT, 36 ITR 521. Thus, where at the time of partition of a family, as was the case in Kalu Ram Govind Ram v. CIT, 57 ITR 335, the assets were allotted among the members at a valuation arrived at in a reasonable manner, there being no allegation of inflated cost by reason of fraud, collusion, subterfuge, devise or false transaction made with an ulterior purpose, the department was held to be precluded from going behind the agreement between the purchaser and the seller in determining the purchase price. The thresh hold condition is that the transfer should be with intent to get the benefit of enhanced value of asset. Therefore, before invoking Explanation 3, the AO is required to record his satisfaction that entire transaction was undertaken with a view to reduce the tax liability by claiming higher depreciation. Before we embark upon for detailed discussion regarding actual cost to the assessee in terms of Explanation 3, we first decide some objections of both the sides. The assessee’s objection is that AO has not recorded his requisite satisfaction for invoking Explanation 3: we are not in agreement with ld. Sr. Counsel’s argument because, as rightly pointed out by ld. DR, a holistic view is to be taken. The entire discussion by AO proceeds on the premise that assessee was trying to claim higher depreciation on enhanced cost. The next objection of ld. Sr. Counsel is that AO did not determine the actual cost as required in Explanation 3. We are not in agreement with this argument also of ld. Sr. Counsel because, as rightly demonstrated by ld. DR, AO had made all out efforts to find out the actual cost. We do not find any substance in this plea of the assessee because AO had taken into consideration different valuation reports and WDV of assets before arriving at the conclusion that WDV as per Income-tax records was the actual cost of assets.”

“.Therefore, considering the totality of the facts and circumstances we are of the view that as the impact of acquisition of 39% of equity shares by M/s Equator Trading Enterprises Pvt. Ltd. has not at all been examined by AO at the time of assessment proceeding or by the learned CIT(A) while disposing of assessee’s appeal and further as the additional evidences produced before us were not examined either by the AO or by CIT(A), which certainly have a crucial bearing on the issue as to whether the payment of non-compete fee is genuine and necessary, we are inclined to remit the matter back to the file of AO for deciding afresh. Only after the issue relating to genuineness of non-compete fee paid and necessity to pay such fee is resolved, AO will decide the allowability of depreciation claimed on such noncompete fee by keeping in view the statutory provision as well as the ratio laid down in the decisions referred to hereinabove and any other decision brought to his notice. It is needless to mention that AO must afford a fair opportunity of hearing to assessee in the matter before deciding the issue. This ground is considered to be allowed for statistical purposes.”