Avoid, But Dont Evade

Sub section (2) of Section 41 provides that whenever the sale proceeds of a capital asset exceed the written down value, the excess amount that does not exceed the difference between the actual cost and the written down value, is chargeable to income tax as the income of the business or profession of the assessee in the previous year in which the asset was sold. This charge is popularly referred to as the balancing charge and represents the amount which the assessee got as depreciation allowance in earlier years and is now recouped in the enhanced sale price. Thus the entire concept of balancing charges under Section 41 (2), turns upon the depreciation allowed by virtue of provisions of Section 32.

Two recent Supreme Court judgements reveal that with proper planning, the impact of tax on such income can be avoided.

The facts of the case in CIT vs Artex Mfg Co (1997) 93 Taxman 357 (SC), reveal that a private limited company formed for the purpose of taking over the business of the assessee-firm, entered an agreement with the assessee, whereby the assessee sold the complete business as a going concern. The sale amount for consideration was Rs 11,50,400, paid by allotment of fully paid-up shares to the assessees partners. Accordingly, the business stood transferred to the company from the relevant accounting year.

For the purpose of determination of purchase, the assets were shown at Rs 41,73,973, out of which the valuer revalued the machinery and dead stock at Rs 15,87,296. The liabilities were shown at Rs 30,23,573 and the balance amount of Rs 11,50,400 was shown as the purchase consideration. While the assessee filed nil returns for the year in question, the ITO took the difference between the value of plant, machinery and dead-stock (Rs 15,87,296) as revalued and the written down value of the plant, machinery and dead-stock as per assessees book (Rs 4,36,896), which came to Rs 11,50,400 as taxable under Section 41(2).

The HCs decision went against the assessee. After reviewing earlier decisions concerning slump sales (CIT vs West Coast Chemicals & Industries (1962) 46 ITR 135, Mugneeram Baugur & Co (1965) 57 ITR 299 (SC) etc), the court reiterated that where there is a slump transaction and the business is sold as a going concern, it needs to be checked whether any portion of the slump price is attributable to the stock-in-trade. And if a particular price is found attributable to a particular item, then the excess amount would be taxed under Section 10(2) (vii), proviso (ii) of the IT Act, 1922 corresponding to Section 41(2) of the 1961 Act.

True, the agreement had no reference to the value of the plant, machinery and dead-stock but on the basis of the information that was furnished by the assessee to the ITO, it became evident that the amount Rs 11,50,400 had been arrived at by taking into consideration the value of the plant, machinery and dead-stock as assessed by the valuer at Rs 15,87,296. Therefore, it could not be said that the price attributed to the items transferred was not indicated and hence, Section 41(2) could apply. Thus the high courts view that Section 41(2) was not applicable, was incorrect.

The second case (CIT vs Electric Control Gear Mfg Co (1997) 93 Taxman 384) relates to a situation of slump sale. The assessee-firm entered into an agreement whereby, it transferred the entire assets of business together with liabilities as a going concern to a limited company for a consideration of Rs eight lakhs. The erstwhile partners of the assessee were allotted shares of the same value in their profit-sharing proportion. The as-sessing officer held that the depreciation allowed to the asse-ssee with respect to assets transferred was chargeable to tax und-er Section 41(2). Based on these facts, the court held that no inco-me under Section 41(2) is assessable in slump sale situations.

Referring to the decision in Artex Mfg Co (supra), the court held, that Section 41(2) was applicable since the price attributable to the plant, machinery and dead-stock which were transferred had been disclosed by the assessee to the assessing officer and that the said price was as per the value assessed by the valuer at the time of the execution of the agreement. In this case, there was nothing to indicate the price attributable like the machinery, plant or building out of the consideration amount of Rs 8 lakhs. Merely because depreciation had been allowed, it could not be stated that it was the excess amount between the price and the written down value. Section 41(2) was, therefore, not applicable to the assessee.

These two judgements prove that with proper planning within the frame work of the IT Act, profit arising due to application of Section 41(2) can be lawfully avoided. But care should be taken at the time of finalizing the agreements relating to sale, takeovers, amalgamations, etc. If the sale price is fixed itemwise, then tax under Section 41(2) will be applicable if any surplus arises consequent to the sale; on the other hand, if a consolidated i.e. slump price is fixed, there would be no liability for tax on recouped depreciation as no price in such a sale is attributed to the assets on which depreciation has been allowed.

Planning in this manner cannot be considered unethical. In the words of Justice Jagdishan of the Madras HC in the case Aruna Group of Estates vs State of Madras (1965) 55 ITR 642: Avoidance of tax is not tax evasion and it carries no ignominy with it, for it is sound law, and certainly not a bad morality for anybody to arrange his affairs as to reduce the brunt of taxation to a minimum.

Avoidance of tax is not tax evasion and it carries no ignominy with it, for it is sound law, and certainly not a bad morality for anybody to arrange his affairs as to reduce the brunt of taxation to a minimum.