Facts of the Case

The assessee, Vedanta Limited (successor to Cairn India Limited), filed appeals before the Delhi High Court challenging the order of the Income Tax Appellate Tribunal (ITAT) on multiple substantial questions of law arising under the Income Tax Act, 1961.

The primary controversy pertained to:

  1. Disallowance under Section 14A read with Rule 8D(2)(iii) concerning expenditure relatable to exempt income.
  2. Determination of Arm’s Length Price (ALP) under Section 92C in relation to transactions with Associated Enterprises (AEs).
  3. Interpretation of Section 32(1)(iia) regarding whether additional depreciation is mandatory even if the assessee withdraws such claim during assessment proceedings.

The assessee initially claimed depreciation of ₹503.24 crore and additional depreciation of ₹538.66 crore in its revised return. Subsequently, during assessment proceedings, it withdrew the additional depreciation claim through a letter, resulting in enhancement of deduction under Section 80IB. However, the Assessing Officer allowed the additional depreciation by applying Explanation 5 to Section 32(1), treating depreciation as mandatory. The Tribunal upheld this view.

Issues Involved

  1. Whether the disallowance under Section 14A read with Rule 8D(2)(iii) was legally sustainable.
  2. Whether transactions with Associated Enterprises could be disregarded for determining Arm’s Length Price under Section 92C.
  3. Whether additional depreciation under Section 32(1)(iia) is mandatory and cannot be voluntarily withdrawn by the assessee.
  4. Whether investment in redeemable preference shares constituted an international transaction requiring transfer pricing adjustment.

Petitioner’s Arguments (Assessee)

  • The assessee argued that additional depreciation under Section 32(1)(iia) is an incentive provision and not mandatory in nature.
  • It contended that Explanation 5 to Section 32 applies only to normal depreciation under Section 32(1)(ii) and not to additional depreciation under Section 32(1)(iia).
  • It was submitted that additional depreciation being a beneficial incentive provision cannot be forced upon the assessee against its intention.
  • The assessee relied upon judicial precedents including:
    • CIT v. Mahendra Mills (243 ITR 56, SC)
    • Goetze India Ltd. v. CIT (284 ITR 323, SC)
    • Patel Roadways Ltd. v. Prasad Trading Co.
      to support the proposition that deductions are claim-based and not compulsory.

Respondent’s Arguments (Revenue)

  • The Revenue contended that Explanation 5 to Section 32 clearly mandates depreciation allowance irrespective of whether claimed by the assessee.
  • It argued that additional depreciation under Section 32(1)(iia) is intrinsically linked to Section 32(1)(ii), and therefore falls within the scope of mandatory depreciation.
  • The Revenue maintained that allowing withdrawal of additional depreciation would distort the computation of taxable income and statutory deductions under Section 80IB.

Court Findings / Observations

The Delhi High Court examined the statutory framework of Section 32 and held:

1. Additional Depreciation is Part of Depreciation Scheme

The Court observed that Section 32(1)(iia) specifically provides that additional depreciation “shall be allowed as deduction under clause (ii).” Therefore, it is not independent of Section 32(1)(ii).

2. Explanation 5 Has Wider Applicability

The Court held that Explanation 5 to Section 32 uses the expression “this sub-section,” thereby covering the entirety of Section 32(1), including clause (iia).

3. Assessee Cannot Withdraw Mandatory Depreciation

The Court rejected the assessee’s attempt to withdraw additional depreciation merely to enhance Section 80IB deduction.

4. Transfer Pricing Issue Remanded

Regarding redeemable preference shares treated as international transactions, the Court modified the ITAT’s remand order and directed the Tribunal to independently adjudicate the issue on merits without waiting for another appellate decision.

Court Order / Decision

The Delhi High Court held that:

  • Additional depreciation under Section 32(1)(iia) is mandatory and cannot be declined by the assessee.
  • Explanation 5 to Section 32 applies to additional depreciation as well.
  • No substantial question of law arose on the depreciation issue.
  • The transfer pricing issue relating to redeemable preference shares was remitted to ITAT for fresh adjudication.

Important Clarification

This judgment clarifies that:

  • Additional depreciation is not merely an optional incentive but a statutory deduction once conditions are fulfilled.
  • Taxpayers cannot strategically withdraw depreciation claims to maximize deductions under other provisions like Section 80IB.
  • Explanation 5 to Section 32 ensures mandatory allowance of depreciation, preserving the integrity of taxable income computation.

Sections Involved

  • Section 14A – Expenditure incurred in relation to exempt income
  • Rule 8D(2)(iii) – Computation mechanism for disallowance
  • Section 32(1)(ii) – Depreciation on assets
  • Section 32(1)(iia) – Additional depreciation
  • Explanation 5 to Section 32 – Mandatory allowance of depreciation
  • Section 80IB – Deduction for profits from industrial undertakings
  • Section 92C – Computation of Arm’s Length Price

 Link to download the order -  https://delhihighcourt.nic.in/app/case_number_pdf/2018:DHC:1931-DB/SRB19032018ITA3032018.pdf

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