Depreciation claimed by a charitable institution should be allowed as a deduction in the computation of income under s. 11(1) of the I.T. Act, 1961, as it is a necessary outgoing and is recognized under the mercantile system of accounting.

Jagannatha Shetty, J.—The following question has been referred to this court under s. 256(1) of the I.T. Act, 1961 :

"Whether the Tribunal is correct in holding that the amount of depreciation debited to accounts of a charitable institution is to be deducted to arrive at the income available for application to charitable and religious purposes ?"

2. The assessee is a society known as "The Society of the Sisters of St. Anne, Bangalore". It is a charitable institution running a school. It was assessed as an association of persons for the assessment year 1977-78. The assessee filed a return of income on August 6, 1977, declaring "nil" income. The gross receipt as per income and expenditure statement was shown as Rs. 1,93,185. Expense claimed as allowance under s. 11(1) was shown as Rs. 1,37,389. While arriving at this figure, depreciation of Rs. 5,781 was claimed in the statement of accounts as a debit in respect of the school building. The ITO disallowed that claim stating that depreciation is required to be allowed only when the income is computed under the head "Business" falling under s. 28 of the I.T. Act, 1961. He also observed that what is contemplated u/s. 11(1) is actual application of the institution's income towards charitable objects and not an expenditure which has not been actually incurred to meet the expenses. The depreciation being a notional expenditure could not be said to have been incurred or applied for charitable purposes.

3. The assessee appealed to the AAC against the said disallowance. The AAC held that the assessee was entitled to the benefit of Rs. 5,781 in the computation of its income.

4. The ITO preferred an appeal to the Tribunal against allowing depreciation by the AAC. The Tribunal, while dismissing the appeal, upheld the order of the AAC, observing as follows :

"The income within the meaning of sec. 11(1) should be the income in the real sense which can be applied to charitable purposes and from which surplus can arise if a part thereof is not applied to the objects of the trust. Viewed from this angle, the Bombay Bench held that it was its considered opinion that the provisions of depreciation at 2 1/2 per cent. was not only prudent but was essential for the purpose of arriving at income available for distribution for application to charity. Following that order, I hold that the amount of depreciation was not the income available for application with the assessee. In that view of the matter, the departmental appeal is dismissed."

5. Being aggrieved by the said order, the Department has, in this reference, sought for the opinion of this court on the aforesaid question.

6. Mr. Srinivasan, learned counsel for the Revenue, while challenging the correctness of the order of the Tribunal, submitted that the word "income" in s. 11(1)(a) must represent the money that is available for being applied to charitable or religious purposes and that income should be construed as the actual receipts minus the actual expenses. The notional expenses like depreciation is not an expense that is relevant for arriving at the real income referred to in s. 11(1)(a).

7. Mr. Prasad, for the assessee, and Mr. Sarangan, as intervener, on the other hand, urged that the word "income" in s. 11(1)(a) cannot be understood to exclude the depreciation merely because the subsequent word "income" is succeeded by the word "applied". The income that is left in the hands of the society is the residue that is available for application after allowing all the expenditure, and depreciation is one such expenditure recognised under law and therefore, the benefit of that allowance cannot be denied to the assessee. They also urged that even the Board has approved the method of accounting in the commercial principle for determining the income derived from the trust and under that principle of accounting, the depreciation allowance is a necessary outgoing.

8. We may turn now to the relevant provisions of s. 11 of the Act. Section 11(1) p