Prior period expenditure & it’s Set-off against prior period income

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Prior period expenditure & it’s Set-off against prior period income.

Conclusion: Once the prior period income was held to be taxable, the prior period expenditure also should be allowed to be set-off and the assessee was not obliged in law to indicate any direct or indirect nexus between the prior period income.

AO found that the assessee credited Rs. 3,39,534 being net period income, i.e., prior period income of Rs. 46,50,648 minus the period expenses of Rs. 43,11,114. The AO took the view that during the year under consideration the ‘prior period income’ was taxable, but the ‘prior period expenses’ were not allowable. In such circumstances, the AO made addition of Rs. 46,50,648 in respect of the ‘prior period income’ and denied the set-off of the prior period expenses against such prior period income. The AO denied the set-off on the basis that a different set of rules applied to such income and expenses. CIT(A) confirmed the addition on the basis that the prior period expenses cannot be adjusted against the prior period income in the absence of any corelation or nexus.  The Tribunal held that once the assessee offers prior period income, then the expenditure incurred under the different heads should be given set-off against that income and only the net income should be added. Held: Once the prior period income was held to be taxable, the prior period expenditure also should be allowed to be set-off and the assessee was not obliged in law to indicate any direct or indirect nexus between the prior period income and prior period expenditure.

Decision: In assessee’s favour.

Relied: CIT, Delhi v. Shri Ram Honda Power Equip (2007) 158 Taxman 474 (Delhi) : 2007 TaxPub(DT) 0899 (Del-HC), Pr. CIT-1 v. Adani Gas Ltd. [Tax Appeal No. 900 of 2016 decided on 11-1-2017], Pr. CIT-I v. Adani Enterprises Ltd. [Tax Appeal No. 566 of 2016 decided on 20-7-2016], CIT v. Excel Industries (2013) 358 ITR 295 (SC) : 2013 TaxPub(DT) 2414 (SC), Pr. CIT v. Adani Enterprises Ltd. [TA Nos. 566 of 2016 and 573 of 2016 decided on 20-7-2016], Pr. CIT v. Adani Gas Ltd. [Tax Appeal No. 900 of 2016 decided on 11-1-2017], CIT v. Exxon Mobile Lubricant (P) Ltd. (2010) 8 Taxmann.com 249 (Del) and Pr. CIT v. Adani Enterprises Ltd. [TA No. 573 of 2016 decided on 20-7-2016.

Income Tax Act, 1961, Section 10B

Deduction under section 10B—Profit derived from eligible undertaking—Nexus of income—Scope

Conclusion: Under section 10B any incidental income, in view of the definition of ‘income from profit and gains’ incorporated in sub-section (4) although it may not partake the character of profit and gain from the export of article, yet it could be termed as an income derived from the consideration realized by the export of articles. Accordingly, incidental income such as dividend income, other income, profit on sale of fixed assets, excess provision written back, profit on sale of investments, duty draw back income, interest income were eligible for deduction under section 10B.

AO held that profits eligible for deduction under section 10B should be derived by the undertaking from ‘exports’ of articles or things and should not be incidental to it. All the incomes, viz., Dividend income, other income, profit on sale of fixed assets, excess provision written back, profit on sale of investments, duty draw back income, interest income cannot be said to be ‘derived’ from ‘export of articles or things’. The source of income of each of these items is a step away from export of articles or things. Hence, these incomes cannot be considered to be eligible for deduction under section 10B.  CIT(A) affirmed the decision of the AO. ITAT allowed the claim of the assessee. Held: Basis of computation of the deductions enumerated under Chapter VIA is different from that set out for the special deductions like sections 10A and 10B. The relief under section 10B, is granted in respect of the profits derived from the eligible activity of export, computed as a proportion of the profits of the business of the undertaking. The said section allows deduction in respect of the profits and gains as are derived by a 100% EOU. Further, section 10B(4) stipulates specific formula for computing the profit derived by the undertaking from export. Even though sub-section (1) of section 10B refers to the profits and gains as are derived by a 100% EOU, yet the manner of determining such eligible profits had been statutorily defined in sub section (4) of section 10B. Both sub-sections (1) and (4) should be read together while computing the eligible deduction under section 10B. Sub-section (4) of section 10A/10B is a complete code providing the mechanism for computing the ‘profits of the business’ eligible for deduction under section 10B. Once an income forms part of the business of the income of the eligible undertaking of assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction under section 10B. The dividend income, profit on sale of fixed assets, profit on sale of investments, excess provision return back, duty drawback and interest income could be said to have direct nexus with the income of the business of the undertaking. Although it may not partake the character of profit and gain from the sale of article, yet it could be termed as an income derived from the consideration realized by the export articles. In view of the definition of ‘Income from profits and gains’ incorporated in sub-section (4), Tribunal committed no error in granting the benefit of exemption, as contemplated under section 10B.

Decision: In assessee’s favour.

Applied: Cambay Electrical Supply Industrial Co. Ltd. v. CIT (1978) 113 ITR 84 (SC) : 1978 TaxPub(DT) 947 (SC), Tuticorin Alkali Chemicals and fertilizers Ltd. v. CIT (1997) 227 ITR 172 (SC) : 1997 TaxPub(DT) 1304 (SC), CIT v. Motorola India Electronics (P) Ltd. [ITA No. 447 of 2007 (Kar HC) dated 11-12-2013].

Relied: CIT v. Hewlett Packard Global Soft Ltd. (2018) 403 ITR 453 (Karnataka) (FB) : 2017 TaxPub(DT) 4700 (Karn-HC), Riviera Home Furnishing v. Addl. CIT Range–15  (2016) 237 Taxman 520 : 2015 TaxPub(DT) 5292 (Del-HC),  CIT-IV v. Hritnik Exports (P) Ltd. (2015) 4 ITR-OL 267 (Del), CIT v. Hindustan Gum and Chemicals Ltd. ((2016) 72 Taxmann.com 90 (Cal) and Camiceria Apparels India (P) Ltd. v.  Asstt. CIT  (2019) 103 taxmann.com 238 (Mad).

Distinguished: Liberty India v. CIT (2019) 317 ITR 218 (SC) : 2009 TaxPub(DT) 2027 (SC).

Referred: Tuticorin Alkali Chemicals and Fertilisers Ltd. v. CIT (1997) 227 ITR 172 (SC) : 1997 TaxPub(DT) 1304 (SC), CIT v. Autokast Ltd. (2001) 248 ITR 110 (SC) : 2001 TaxPub(DT) 823 (SC), CIT v. Sterling (1999) 237 ITR 579 (SC) : 1999 TaxPub(DT) 1271 (SC), CIT v. Pandian Chemicals Ltd. (2003) 262 ITR 278 (SC) : 2003 TaxPub(DT) 1233 (SC) and Cambay Electrical Supply Industrial Co. Ltd. v. CIT (1978) 113 ITR 84 (SC) : 1978 TaxPub(DT) 947 (SC).

IN THE GUJARAT HIGH COURT

J.B. PARDIWALA & A.C. RAO, JJ.

Pr. v. Dishman Pharmaceuticals & Chemicals Ltd.

R/Tax Appeal No. 192 of 2019

24 June, 2019

Appellant(s) by: Mauna M. Bhatt (174)

Opponent(s) by: Tushar P. Hemani, with Vaibhavi K. Parikh with Aditi Sheth Advocates (3238)

ORAL JUDGMENT

J.B. Pardiwala, J.

This Tax Appeal under section 260­A of the Income Tax Act, 1961 (for short, “the Act, 1961”) is at the instance of the Revenue and is directed against the order passed by the Income Tax Appellate Tribunal, Ahmedabad ‘D’ Bench, Ahmedabad dated 23-5-2018 in the ITA No. 773/Ahd/2011 for the assessment year 2006-07.

  1. The Revenue has proposed the following questions of law :–

“(A) Whether the Appellate Tribunal has erred in law and on facts directing to add only net income after setting off prior period expenditure without appreciating that assessee has been unable to prove expenditure was incurred for earning the particular receipts offered under the head prior period income?

(B) Whether the Appellate Tribunal has erred in law and on facts in deleting the disallowance made under section 40(a)(i) of the Act amounting to Rs. 1,12,01,869 without appreciating that assessee had not filed any application under section 195 for non-deduction of TDS?

(C) Whether the Appellate Tribunal has erred in law and on facts in directing the assessing officer to exclude unrealised export from the total turnover, without appreciating that the formula adopted by the Appellate Tribunal would render the entire scheme of things non-workable in as much as the assessee would become entitled to section 10B deduction even in respect of turnover for which sales proceeds was not realised?

(D) Whether the Appellate Tribunal has erred in law and on facts in directing the assessing officer to consider other income as being eligible for deduction under section 10B of the Act?”

  1. It appears from the materials on record that the return of income for the assessment year 2006­-07 was filed by the assessee on 31-12-2006 declaring a total income of Rs. 9,55,84,979­. A report under section 92(E) of the Act relating to the international transaction in form No. 3CB was also filed. The return was processed under section 143(1) of the Act, 1961. Notice under section 143(2) of the Act was issued on 18-12-2007 and was duly served on the assessee.
  2. Essentially, the following four issues came up before the assessing officer :–

(i) Prior period expenditure and prior period income.

(ii) Disallowance made under section 40(a)(i) of the Act.

(iii) Section 10(B) deduction in respect of the turn over for which the sales proceeds were not realized.

(iv) The other income as being eligible for deduction under section 10(B) of the Act.

First Question Of Law:

  1. The assessing officer as regards prior period expenditures held as under :–

“5.3 While making the alternate plea, the assessee has itself conceded the requirement of taxing at least the prior period Income in excess of the expenditure. No dispute remains about this. Further, no proof was submitted regarding the crystallization of the expenditure in the current year. No bills, no vouchers, no reasoning for lack of provisioning for the expenses in the earlier year were submitted. The accounts are generally finalized after a sufficiently long period of time to make adequate \ provisions for all expenses. Hence, this general statement regarding crystallization is not acceptable.

5.4 Once it is held that the prior period expense cannot be allowed, it has to be considered whether the prior period income can be set off against it.

The treatment of the income would not be the same as the expense. While the expenditure is disallowable as not pertaining to the current year, the income has to be included in total income on the principle taxability on acctual or receipt. Since the same was not taxed in the earlier year on the basis of accrual, the same has to be taxed on the basis of receipt. Since a different set of rules applied to them, they cannot be netted.

5.5 In view thereof the claim for netting of prior period expenditure is denied, and set off of prior period income against prior period expenditure is not accepted. Hence a addition of Rs. 46,50,648 is made, being prior period income not offered for tax in this year or earlier years. As the assessee has not debited the prior period expenses in the profits offered for tax, no deduction is done to the income now computed. Penalty under section 271(1)(c) is separately initiated for furnishing inaccurate particulars of income.

  1. Thus, the assessing officer found that the assessee credited Rs. 3,39,534.­ being net period income i.e. prior period income of Rs. 46,50,648 minus the period expenses of Rs. 43,11,114­. The assessing officer took the view that during the year under consideration the “prior period income” was taxable, but the “prior period expenses” were not allowable. In such circumstances, the assessing officer made addition of Rs. 46,50,648 in respect of the “prior period income” and denied the set off of the prior period expenses against such prior period income. The assessing officer denied the set off on the basis that a different set of rules applied to such income and expenses.
  2. The Commissioner (Appeals), in the appeal preferred by the assessee, confirmed the addition on the basis that the prior period expenses cannot be adjusted against the prior period income in the absence of any corelation or nexus. The observations of the Commissioner (Appeals) are as follows :–

“3.5 I have considered the facts of the case, assessment order and appellant’s submission. Appellant did not account for complete prior period income on the ground that these are adjusted against prior period expenses. The details and nature of prior period income is not given therefore it cannot be said that prior period income is related to prior period expenses. In absence of any correlation, prior period expenses cannot be adjusted against prior period income. In any case any income accrued or received by the appellant is taxable unless the same is already taxed in earlier year. It is not in dispute that prior period income is not taxed in earlier year therefore the same has to be offered for tax during the year. Since there is no correlation of this income with prior period expenses, the same cannot be set off against this. Accordingly, I agree with the assessing officer that no adjustment of prior period expenses is permissible against prior period incomes which are taxable in this year.

This ground is therefore rejected.”

  1. In further appeal before the Tribunal, the ITAT held that the income was being assessed at the entity level. All the expenditure debited under the different heads cannot be decided qua a specific receipt. The ITAT took the view that once the assessee offers prior period income, then the expenditure incurred under the different heads should be given set off against that income and only the net income should be added.
  2. The observations of the ITAT in the aforesaid context are as follows :–

“We have duly considered rival contentions. We find that income of the assessee is being assessed at entity level. All the expenditure debited under different heads cannot be decided qua a specific receipt. Once the assessee has been offering income of prior period as an entity, then its prior period expenditure cannot be disallowed simply by observing that it is not ascertainable whether this expenditure was incurred for earning a particular receipts offered under the prior period income. To our mind, if an assessee is offering prior period income, then the expenditure which was incurred under different heads ought to be set off against that income.

Therefore, we are of the view that net differential amount of Rs. 3,39,534 ought to be assessed as income of the assessee. We allow both these grounds of appeal statistical purpose and direct the assessing officer to allow set off prior period expenditure against prior period income and only net income is to be added to the total income of the assessee.”

  1. Mr. Manish Bhatt, the learned senior standing counsel appearing for the Revenue vehemently submitted that the decision of the Appellate Tribunal as regards the prior period expenditure is erroneous. Mr. Bhatt pointed out that it was noticed by the assessing officer, in the course of the assessment proceedings, that the assessee had credited an amount of Rs. 3,39,534 below the PBT net figure. The assessee accepted that the same pertained to the earlier years and having regard to the volume of the business, it had likely to have debit and credit pertaining to the earlier years. Mr. Bhatt submitted that there is no proof or evidence relating to the crystallization of the expenditure in the current year.

According to Mr. Bhatt, once the assessing officer came to the conclusion that prior period expenditure cannot be allowed, then the same could not have been given set off against the prior period income. While the expenditure was disallowable as not pertaining to the year in question, the income should have been included in the total income of taxability on accrual or receipt.

  1. On the other hand, Mr. Tushar Hemani, the learned counsel appearing for the assessee submitted that the only reason assigned by the assessee and the Commissioner (Appeals) to confirm the addition is that the prior period income and the expenditure do not have any nexus, or in other words, any correlation, and therefore, the set off was declined.

According to Mr. Hemani, there is no legal obligation to demonstrate any nexus to claim the business expenditure. Mr. Hemani placed reliance on sections 37(1) and 57 of the Act, 1961. According to Mr. Hemani, the ITAT committed no error much less an error of law in taking the view that once the prior period was taken into account, the expenses should also be accepted.

Concept of “Prior Period” and its Accounting Treatments :–

  1. As per section 209 of the Companies Act, 1956, every company is required to prepare and maintain its books of accounts, following the double entry system and the accrual method. At the end of the accounting year/financial year, the financial statements are prepared which furnishes the financial information relating to the financial position. As per section 211 of the Companies Act, 1956, every company while preparing its profit and loss account and balance-sheet has to comply with the Accounting Standards recommended by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act 1949 (38 of 1949), or the Accounting Standards prescribed by the Central Government in consultation with the National Advisory Committee on the Accounting Standards established under sub-section (1) of section 210A of the Companies Act, 2013). The Accounting Standard 5 “net profit or Loss for the period, prior period Items and changes in the accounting policies”, deals with the issue of prior period items. Vide Para 4.3, it defines the prior period the items as items of income or expenses which arise in the current period as a result of the errors or omissions in the preparation of the financial statements of one or more prior periods. The same read as follows :–

“4.3 Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”

The para 15 of the Accounting Standard indicates that the nature and amount of prior period items, should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived. Para 16 of the standard, restricts itself to those items of income or expenses which arise in the current period as a result of the errors or omissions in the preparation of the financial statements of one or more prior periods. Some of the examples of prior period items are as under :–

–Error in calculation in providing expenditure or income.

–Omission to account for income or expenditure.

–Non­provision of travelling expenses for travel already undertaken.

–Non­provision for salary already due in earlier year.

–Applying incorrect rate of depreciation.

–Treating operating lease as finance lease.

–Capitalisation of borrowing cost on working capital.

  1. Section 37(1) of the Act is as follows :–

“37. General (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 a (x x) and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”.

Hence, the only requirement under section 37 of the Act is that the expenses (not capital or personal) should be incurred for the purposes of the business or profession. There is no need to demonstrate that a certain expense relates to a particular income in order to claim such expense. Moreover, if the Legislature intended to have such a condition, it would have worded the section accordingly as was done in section 57(iii) of the Act.

  1. Section 57 of the Act is as follows :–

“57. Deductions­ The income chargeable under the head “Income from other sources” shall be computed after making the following deductions, namely

*** *** ***

(iii) any other expenditure (not being in the nature of capital expenditure) laid out or expended wholly and exclusively for the purpose of making or earning such income.”

  1. We are of the view that once the prior period income is held to be taxable, the prior period expenditure also should be allowed to be set off.
  2. In the aforesaid context, we may refer to and rely upon a decision of the Delhi High Court in the case ofCIT, Delhi v. Shri Ram Honda Power Equip (2007) 158 Taxman 474 (Delhi) : 2007 TaxPub(DT) 0899 (Del-HC). We quote the following observations :–

“25.5 The underlying principle of netting appears to logically get attracted as no prudent businessman would allow taxation of the interest income de hors the expenditure incurred for earning such income. The words ‘included any such profits’ following the words receipts by way of interest, commission, brokerage etc., is a clear pointer to the fact that only net interest would be includable in arriving at the business profit.

25.6 Once business income has been determined by applying accounting standards as well as the provisions contained in the Act, the assessed would be permitted to, in terms of section 37 of the Act, claim as deduction, expenditure laid out for the purposes of earning such business income.

25.7 Support for this proposition is to be found from Circular No. 621, dated 19-12-1991 of the CBDT.

“32.10 The existing formula often gives a distorted figure of export profits when receipts like interest, commission, etc., which do not have element of turnover are included in the profit and loss account.

32.11 It has, therefore, been clarified that “profits of the business” for the purpose of section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10 per cent deduction from such incomes is provided to account for these expenses.””

  1. Mr. Hemani, the learned counsel placed reliance on the decision of this Court in the case ofPr. CIT-­1 v. Adani Gas Ltd. (Tax Appeal No. 900 of 2016 decided on 11-1-2017) wherein two questions fell for consideration of this Court. Those are as under;

“A. Whether the Appellate Tribunal has erred in law and in facts in deleting the disallowance of Rs. 10,28,028 being the preliminary expenditure under section 35 D of the Act ?

  1. Whether the Appellate Tribunal has erred in facts and circumstances in directing the assessing officer to set off prior period expenditure of Rs. 15,25,746 without considering the merit of the issue?”

This Court held as under :–

“3. So far as proposed question no.–A is concerned, it is with respect to deletion of disallowance of Rs. 10,28,028 being preliminary expenditure under section 35 D of the Act. The learned Tribunal has dealt with the same in para 4 and considering the fact that the very expenditure stand accepted in the preceding assessment year and therefore, thereafter it will not be open for the department in the subsequent year to disallow the preliminary expenditure under section 35 D of the Act, the learned Tribunal has deleted the disallowance of Rs. 10,28,028 being preliminary expenditure under section 35 D of the Income Tax Act. It is not in dispute that in the preceding assessment year, very expenditure stand accepted. The issue is squarely covered against the revenue in light of the decision of the Hon’ble Supreme Court in the case of Shasun Chemicals & Drugs Ltd. v. CIT­ II, Chennai reported in (2016) 243 Taxman 47 (SC) : 73 taxman.com 293 (SC) : 2016 TaxPub(DT) 4252 (SC). In the said decision also, the issue was with respect to claim under section 35 D of the Act and it was found that expenses claimed by the assessee for first two assessments years were allowed by the assessing officer, the assessing officer in the subsequent assessment year could not have disallowed the same. Under the circumstances, no error has been committed by the learned Tribunal in deleting the disallowance of preliminary expenditure under section 35 D of the Act. We are in complete agreement with the view taken by the learned Tribunal. Under the circumstances, question No. 1 A is answered against the revenue and in favour of assessee.”

“5. The aforesaid issue is also as such concluded by the decision of the Division Bench of this Court in the case of Associate Company of the very assessee i.e. in the case of Pr. CIT-I v. Adani Enterprises Ltd. in Tax Appeal No. 566 of 2016. Even the said issue is also directly covered by the decision of the Delhi High Court in the case of CIT v. Exxon Mobil Lubricant (P) Ltd. reported in (2010) 328 ITR 17 (Delhi) : 2010 TaxPub(DT) 2236 (Del-HC). No error has been committed by the learned Tribunal in accepting the alternative plea and directing the assessing officer to set off prior period of expenditure of Rs. 15,25,746­. The learned Tribunal has directed the assessing officer to set off assessees prior period of expenditure and income as per the law.

Therefore, necessary consequence shall follow. Under the circumstances, we see no reason to interfere with the impugned judgment and order passed by the learned Tribunal. Question B is also held against the revenue and in favour of assessee. No substantial question of law arise in the present appeal. Hence, present appeal deserves to be dismissed and is accordingly dismissed.”

  1. Mr. Hemani also placed reliance on the decision of this Court in the case ofPr. CIT-­I v. Adani Enterprises Ltd. (Tax Appeal No. 566 of 2016 decided on 20-7-2016) wherein one of the questions was as under :–

“(A) Whether on the facts and in the circumstances of the case and in law, the Tribunal was right in deleting the disallowance of Prior Period expenditure of Rs. 67,88,591­?”

The Court, ultimately, held as under :–

“2. Main question is sum of Rs. 67.88 lacs(rounded off) which the assessing officer and Commissioner (Appeals) disallowed treating the expenditure as a prior period expenditure. The Tribunal reversed the findings of the Revenue authorities primarily on two grounds. Firstly, that the assessee being a company was charged uniformly for all years and would therefore, have no revenue implication of whether the expenditure was recognised in this assessment year or earlier year. The second ground was that in any case, the Revenue had recognised the prior period income. If that be so, according to the Tribunal, it would be unfair not to recognise the expenditure also of the prior period.

  1. Having heard learned counsel for the parties and having perused the documents on record, we see no reason to interfere. Firstly, the expenditure of Rs. 67.88 lacs is a fraction of the total income of the assessee-company declared at Rs. 105.88 crores. Further, even the Revenue does not dispute that the company would be taxed at the same rate in the present assessment year or during earlier year. It is also not disputed that prior period income was declared by the assessee during the current year which is also accepted by the Revenue. No question of law therefore, arises.”
  2. In the aforesaid context, Mr. Hemani submitted that even otherwise, there is no loss to the Revenue as the respondent being a corporate entity, the rate of tax has remained the same and on this count also, the set off is to be allowed. Mr. Hemani placed reliance on a decision of the Supreme Court in the case ofCIT v. Excel Industries (2013) 358 ITR 295 (SC) : 2013 TaxPub(DT) 2414 (SC), wherein the following has been observed :–

“32. Thirdly, the real question concerning us is the year in which the assessee is required to pay tax. There is no dispute that in the subsequent accounting year, the assessee did make imports and did derive benefits under the advance licence and the duty entitlement pass book and paid tax thereon. Therefore, it is not as if the Revenue has been deprived of any tax.

We are told that the rate of tax remained the same in the present assessment year as well as in the subsequent assessment year. Therefore, the disptue raised by the Revenue is entirely academic or at best may have a minor tax effect. There was, therefore, no need for the Revenue to continue with this litigation when it was quite clear that not only was it fruitless (on merits) but also that it may not have added anything much to the public coffers.”

  1. This Court inPCIT v. Adani Enterprises Ltd. (Tax Appeals Nos. 566 of 2016 and 573 of 2016 decided on 20-7-2016) has taken such a stance while allowing the set off of the prior period expenses against the prior period income.
  2. This Court inPCIT v. Adani Gas Ltd. (Tax Appeal No. 900 of 2016 decided on 11-1-2017) allowed the set off by following the decision of the Delhi High Court in CIT v. Exxon Mobile Lubricant (P) Ltd. ((2010) 8 Taxmann.com 249 (Delhi). It was held that if the assessing officer had not excluded the prior period income while working out the current year taxable income, there was no reason to disallow only a part of the prior period adjustment.
  3. This Court inPCIT v. Adani Enterprises (Tax Appeal No. 566 of 2016 decided on 20-7-2016) noted that the prior period income was declared by the assessee in the current year and accepted by the Revenue. Hence, this Court declined to interfere with the order of the ITAT holding that it would be unfair not to recognise the prior period income. It further took into account the fact that the company would be taxed at the same rate in the present assessment year or during the earlier year.
  4. This Court inPCIT v. Adani Enterprises Ltd. (Tax Appeal no.573 of 2016 decided on 20-7-2016) followed its order in the Tax Appeal No. 566 of 2016, dated 20-7-2016 to dismiss the Tax Appeal.
  5. Thus, in view of the aforesaid discussion, we are of the view that the ITAT committed no error in holding that once the prior period income is held to be taxable, the prior period expenditure also should be allowed to be set off and the assessee is not obliged in law to indicate any direct or indirect nexus between the prior period income and prior period expenditure.

Second Question of Law :–

  1. The assessing officer made disallowance of Rs. 1,12,01,869 under section 40(a)(i) on account of the non-deduction of TDS under section 195 while remitting such payments to the non­residents. The break up of the same is as under :–
–Professional service expenditure : Rs. 6,70,674
–Reimbursement of administrative services : Rs. 81,02,625
–Reimbursement of insurance and foreign travel expenses : Rs. 24,28,570
  1. The assessee submitted before the assessing officer that the payees were not liable to pay taxes in India as the services were rendered outside India. However, the assessing officer relied upon a decision of the High Court of Karnataka in theCIT (International Taxation) v. Samsung Electronics Co. Ltd. (2010) 320 ITR 209 (Karn) : 2010 TaxPub(DT) 0832 (Karn-HC) to make the disallowance on the basis that no application was filed under section 195(2) of the Act. The said disallowance came to be affirmed by the Commissioner (Appeals) as well on the basis of the aforesaid decision of the High Court of Karnataka. The ITAT noted that the decision relied upon by the lower authorities in the case of Samsung Electronics (2010) 320 ITR 209 (Karn) : 2010 TaxPub(DT) 0832 (Karn-HC) had been reversed by the Supreme Court in the GE India Technology (2010) 327 ITR 456 (SC) : 2010 TaxPub(DT) 2241 (SC) by holding that the TDS has to be deducted under section 195 of the Act only if the element of income is involved. The ITAT held that the assessing officer had failed to bring on record any material to indicate that the recipient is taxable in India. The ITAT also held that the reimbursement of expenses did not involve any income element, and therefore, the TDS was not required to be deducted. The only reason for the assessing officer and the Commissioner (Appeals) to make the disallowance was the decision of the Karnataka High Court in Samsung Electronics. The said decision has now been reversed by the Supreme Court of India in GE India Technology (supra) wherein it was held that an assessee paying any sum to a non­resident is not liable to deduct tax if the sum is not chargeable to tax under the Act, as the expression in section 195(1) of the Act is “chargeable under the provisions of the Act.”
  2. The decision in GE India (supra) has been followed by this Court inPCIT v. Nova Technology (P) Ltd. (Tax Appeal No. 290 of 2018 decided on 9-4-2018). It was held therein that the payment does not enter the tax liability of the payee under the Act. Section 195 would not apply. The fundamental principle of deducting tax at source in connection with the payment only where the sum is chargeable to tax under the Act continues to hold the field even after the retrospective insertion of Explanation 2 to sub-section (1) of section 195 of the Act.
  3. Thus, where the payment is in the nature of reimbursement, there is no element of income involved, and therefore, no tax is required to be deducted at source. Having regard to the settled position, the assessee was not liable to deduct the tax at source on such payments and hence, the ITAT committed no error in answering the second question as proposed by the Revenue in favour of the assessee.

Third Question of Law :–

  1. The assessing officer, while working the eligible profit for deduction under section 10B of the Act, held that the “unrealized export turnover” is to be excluded from the “export turnover”, but refrained from excluding the same from the “total turnover”. The said action was confirmed by the Commissioner (Appeals) on the basis that there is no provision to reduce the same from the total turnover the profit on the unrealised turnover would get unintended deduction and that the decisions relied on by the assessee pertained to the sales tax, excise duty etc. The ITAT held that if an item does not fall in the export turnover, then it has to be excluded from the total turnover also for computing deduction admissible under section 10B of the Act. Mr. Hemani submitted that as per section 10B(4) of the Act, the formula for determining the “profits derived from export of articles or things or computers software” i.e. the amount of deduction is:–
Export Turnover x profits of the business of the undertaking
Total Turnover

Hence, for the purpose of parity, if “unrealized export turnover” is excluded from “export turnover” (numerator), then the same must be excluded from “total turnover” (denominator).

The aforesaid issue is now settled by the decisions of the Supreme Court. In CIT v. HCL Technologies Ltd. (2018) 404 ITR 719 (SC) : 2018 TaxPub(DT) 2138 (SC), it was held as follows :–

“19. In the instant case, if the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under section 10A of the Income Tax Act are allowed only in Export Turnover but not from the Total Turnover then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the Respondent which could have never been the intention of the legislature.”

In PCIT v. Tesco Hindusthan Service Centre Ltd. (2018) 257 Taxman 92 (SC) : 2018 TaxPub(DT) 4426 (SC), the Supreme Court dismissed the SLP against the decision of the High Court of Karnataka holding that while computing deduction under section 10A of the Act, if the export turnover in numerator is arrived at after excluding certain expenses, the said expenses should also be excluded from the total turnover in denominator.

  1. Thus, the third question, as proposed by the Revenue being no longerres integra, cannot be termed as a substantial question of law.

Fourth Question of Law :–

  1. The assessing officer, by placing reliance on the decision of the Supreme Court in the case ofLiberty India Ltd. v. CIT (2009) 317 ITR 218 (SC) : 2009 TaxPub(DT) 2027 (SC) held as follows :–

“16.9 Thus, as per the provision of the section the profits should be derived by the hundred per cent export ­oriented undertaking from the export of articles or things. As has been held by the Hon’ble Supreme Court above, it is not the ownership of that business which attracts the incentives. What attracts the incentives under section 80­IA/80­IB is the generation of profits (operations profits). Thus, the profits eligible for deduction under section 10B should be derived by the undertaking from ‘exports’ of articles or things and should not be incidental to it. All the incomes viz. Dividend income, other income, profit on sale of fixed assets, excess provision written back, profit on sale of investments, duty draw back income, interest income cannot be said to be ‘derived’ from ‘export of articles or things’. The source of income of each of these items is a step away from export of articles or things. Hence, these incomes cannot be considered to be eligible for deduction under section 10B.”

  1. The Commissioner (Appeals), in the appeal preferred by the assessee, affirmed the decision of the assessing officer holding as under :–

“Assessing officer excluded other income for computing deduction under section 10B on the ground that these incomes are not derived from the EOU. In other income are in the nature of dividend, duty drawback, etc which are not derived from EOU and therefore should not be eligible for deduction. I agree with the assessing officer that these items are not derived from EOU and hence in view of the decisions of Honourable Supreme Court in the case of Sterling Foods, Liberty India and Pandian Chemicals, these other incomes are not eligible for deduction under section 10B. Assessing officers action to this extent is confirmed.”

  1. The ITAT allowed the claim of the assessee by following the decision in the case ofSonic Technology (P) Ltd. (ITA No. 2665 and 2720/Ahd/2011 (Ahmedabad ITAT) which in turn followed the decision of the Special Bench of the Indore ITAT in Maral Overseas Ltd. v. CIT (2012) 136 ITD 177 IInd) : 2012 TaxPub(DT) 2211 (Ind-Trib) as upheld by the High Court of Delhi in Hritnik Export (P) Ltd. (ITA Nos. 219 and 239 of 2014 respectively dated 13-11-2014).
  2. In the case on hand, we are concerned with the following heads of income :–

(i) Dividend Income

(ii) Profit on sale of fixed assets

(iii) Profit on sale of investments

(iv) Excess provision return back

(v) Duty drawback

(vi) Interest income

  1. Section 10B of the Act, relevant for our purpose, reads thus :–

“10B. Special provision in respect of newly established hundred per cent export ­oriented undertakings

(1) Subject to the provisions of this section, a deduction of such profits and gains derived by a hundred per cent export ­oriented undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee :–

Provided that where in computing the total income of the undertaking for any assessment year, its profits and gains had not been included by application of the provisions of this section as it stood immediately before its substitution by the Finance Act, 2000, the undertaking shall be entitled to the deduction referred to in this sub-section only for the un-expired period of aforesaid ten consecutive assessment year :–

Provided further that for the assessment year beginning on the 1-4-2003, the deduction under this sub-section shall be ninety per cent of the profits and gains derived by an undertaking from the export of such articles or things or computer software.

Provided also that no deduction under this section shall be allowed to any undertaking for the assessment year beginning on the 1-4-2012 and subsequent years :

Provided also that no deduction under this section shall be allowed to an assessee who does not furnish a return of his income on or before the due date specified under sub-section (1) of section 139.

(2) This section applies to any undertaking which fulfils all the following conditions, namely :–

(i) it manufactures or produces any articles or things or computer software;

(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence :–

Provided that this condition shall not apply in respect of any undertaking which is formed as a result of the re­establishment, reconstruction or revival by the assessee of the business of any such undertaking as is referred to in section 33B, in the circumstances and within the period specified in that section :–

(iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose.

Explanation.–The provisions of Explanation (1) and Explanation 2 to sub-section (2) of section 80­I shall apply for the purposes of clause (iii) of this sub-section as they apply for the purposes of clause (iz) of that sub-section.

(3) This section applies to the undertaking, if the sale proceeds of articles or things or computer software exported out of India are received in, or brought into, India by the assessee in convertible foreign exchange, within a period of six months from the end of the previous year or, within such further period as the competent authority may allow in this behalf.

Explanation I.–­For the purposes of this sub-section, the expression “competent authority” means the Reserve Bank of India or such other authority as is authorised under any law for the time being to force for regulating payments and dealings in foreign exchange.

Explanation 2.–The sale proceeds referred to in this sub-section shall be deemed to have been received in India where such sale proceeds are credited to a separate account maintained for the purpose by the assessee with any bank outside India with the approval of the Reserve Bank of India.

(4) For the purposes of sub-section (1), the profits derived from export of articles or things or computer software shall be the amount which bears to the profits of the business of the undertaking the same proportion as the export turnover in respect of such articles or things or computer software bears to the total turnover of the business carried on by the undertaking.”

  1. The Parliament intended to encourage the entrepreneurs to export the products from India. As part of that, it incorporated section 10B of the Act. On perusal of section 10B discloses that the profits and gains derived from a 100% export oriented undertaking, shall not be included in the total income of an assessee. This almost falls into the category of the deduction provided for under Chapter VI A, except that the exemption or deduction is in its entirety. However, the basic principle, namely, that the profit and gain must be derived from the concerned activity, is common to both the provisions. It is not in dispute that the assessee herein is a 100% export–oriented unit. The provisions of section 10B of the Act, in terms of which relief is sought, provides for a deduction of such profits and gains as are derived by a 100% export­ oriented unit from the export of articles, things or computer software for a period of 10(ten) consecutive assessment years commencing with the assessment year relevant to the previous year in which eligible activity commences. The methodology for computation as envisaged in sub-section (1) of section 10B is by way of a mathematical formula set out in sub-section (4) whereby the profits derived from the exports of articles or things or computer software is stated to be the amount which bears to the profits of the business of the undertaking, the same proportion as the export turnover in respect of such articles/things/computer software bears to the total turnover of the business carried on by the undertaking.
  2. Export reliefs such as Duty Drawback, REP Licences and DEPB have been brought within the ambit of business income in terms of sub-sections (iiia) to (iiie) of section 28 of the Act, vide Finance Act, 1990 with retrospective effect from 1-4-1962. Income from sale of export quota thus falls under the head ‘business income’ to be included in the computation of ‘Profit and Gains of business or profession’ entitled to relief under section 10B. It is relevant to note that there is no restriction whatsoever placed on what constitutes profits of the business of the eligible undertaking.
  3. One may contrast in this context, the provisions of clause (baa) under the Explanation to section 80 HHC of the Act that provides for a deduction in respect of the income derived from the business of export of goods or merchandise. Section 80 HHC also provides for the computation of the deduction by way of a formula, similar to section 10 B of the Act. However, in computing the component of ‘profits of the business’, Clause (baa) stipulates that 90% of all receipts from the enumerated categories including the export entitlements such as the Duty Drawback and similar reliefs, that are part of the business income be excluded from the computation of ‘profits of the business’ in the computation of relief under 80HHC. Such restriction is conspicuous by its absence in section 10B.
  4. The important words in section 10B are “derived from”.
Section 80HH It uses the term “derived from”.

It does not prescribe a formula to arrive at the eligible profit in the ratio of turnover unlike 80HHC(3) or 10B(4).

It does not define “profit of business” unlike 80HHC (4C)(baa).

Section 80HHC It uses the term “derived from”.

Section 80HHC(3) prescribes a formula to arrive at the eligible profit in the ratio of turnover (export/total).

Section 80HHC(4C)(baa) defines “profits of business” : expressly excludes interest from the profit.

Section 10B It uses the term “derived from”.

Section 10B(4) prescribes a formula to arrive at the eligible profit in the ratio of turnover (export/total).

It does not define “profits of business” unlike 80HHC(4C)(baa).

  1. We looked into few decisions of the various High Courts and the Honourable Supreme Court in context with section 80HH and section 80HHC of the Act. The approach in all the decisions which we would like to refer to hereinafter is that where the statutory provision talks about the “income derived from the business activity in question”, the nexus theory should be applied in order to determine whether a particular item of income is business income or not.
  2. The Supreme Court inTuticorin Alkali Chemicals and Fertilisers Ltd. v. CIT (1997) 227 ITR 172 (SC) : 1997 TaxPub(DT) 1304 (SC) took the view that the interest earned on the deposits placed for the purposes of obtaining loans for business cannot be treated as business income, but only as the income from other sources. The decision in Tuticorin (supra) was rendered in the context of sections 56 and 57 of the Act and came to be followed in the CIT v. Autokast Ltd. (2001) 248 ITR 110 (SC) : 2001 TaxPub(DT) 0823 (SC).
  3. The Supreme Court inCIT v. Dr. V. Gopinathan (2001) 248 ITR 449 (SC) : 2001 TaxPub(DT) 1197 (SC) took the view that the interest on the fixed deposits would not qualify for setting off against the interest on the loans borrowed. The other two decisions on the same line in the context of section 80HHC are CIT v. Sterling (1999) 237 ITR 579 (SC) : 1999 TaxPub(DT) 1271 (SC) and CIT v. Pandian Chemicals Ltd. (2003) 262 ITR 278 (SC) : 2003 TaxPub(DT) 1233 (SC). In these two decisions, the Supreme Court reiterated the nexus theory and declined to treat such interest earned as business income. The Revenue seeks to draw an analogy even for the purpose of section 10B of the Act that an assessee who is engaged in the business of exports and invests the surplus funds in fixed deposits or earns dividend income or income from sale of its assets will not be able to treat the interest earned thereon as business income since it does not bear any direct nexus with the export business of the assessee.
  4. The Supreme Court inCambay Electrical Supply Industrial Co. Ltd. v. CIT (1978) 113 ITR 84 (SC) : 1978 TaxPub(DT) 0947 (SC) drew a fine distinction between the words “attributable to” and “derived from”. It was held :–

“In our view, since the expression of wider import, namely ‘attributable to’, has been used, the Legislature intended to cover receipts from sources other than the actual conduct of the business of generation and distribution of electricity. It was explained that the expression ‘derived from’ is a narrower concept and therefore unless nexus is shown between the income earned and the immediate and direct activity of the assessed, such income would not qualify as business income. This decision was followed in CIT v. Cochin Refineries Ltd. in the context of section 80I and subsequently by the Hon’ble Supreme Court itself in Vellore Electric Corporation Ltd. v. CIT. The latter decision was rendered in the context of section 80I which uses the words “profits and means attributable to any priority industry.”

The question that arose was whether the assessed was entitled to the relief under section 80I even in respect of income earned by way of interest on the investment in securities of the amounts appropriated to the contingencies reserve, which was mandatorily required to be maintained by it in terms of the Electricity (Supply) Act, 1948. Answering the question in the affirmative, the Hon’ble Supreme Court held that the creation of the contingency reserve, being a condition statutorily incorporated “is incidental to the carrying on of the business of generation and distribution of electricity by the assessed.”

  1. The Calcutta High Court inConsolidated Fibers and Chemicals Ltd. v. CIT (2005) 273 ITR 353 (Cal) : 2005 TaxPub(DT) 0974 (Cal-HC) was called upon to consider the question in context of sections 56 read with 57 (iii), whether the interest paid on the borrowed capital could go to reduce the income from the short-­term deposits the relevant assessment year when the assessee had not commenced business. It was held therein that the interest income was income from other sources and therefore the interest paid on the borrowed capital could not be said to have been laid out or expended for the purposes of earning such income and therefore would not come within the purview of section 57(iii).
  2. In the context of section 80HHC itself, the Madras High Court inK.S. Subbiah Pillai v. CIT (2003) 260 ITR 304 (Mad) : 2003 TaxPub(DT) 0475 (Mad-HC) has held that if an assessee engaged in the business of exports, invests surplus funds in the fixed deposits and earns interest thereon, such income cannot be treated as business income since it does not bear any direct nexus with the export business of the assessed.
  3. InUrban Stanislaus Co. v. CIT (2003) 263 ITR 10 (Ker) : 2003 TaxPub(DT) 1121 (Ker-HC) the assessee had contended that as a condition for obtaining a loan from the bank, 20% of the sale receipts had to be deposited by way of security. It was claimed that the interest earned on such deposit was business income for the purpose of section 80HHC. This was negatived by the Kerala High Court by observing (ITR Page 12) that “the assessed can claim deduction in respect of the profits derived from the export of goods only when it is established that the income is solely related to the export. The obvious intention behind the provision in section 80HHC is to promote exports.

However, the income earned by way of interest from fixed deposit is not an income from exports. Thus, it was rightly taken into account as income from other sources.” This decision has been affirmed by the Supreme Court by the dismissal of the Special Leave Petition (order reported in 265 ITR (Statutes) 38).

  1. InK. Ravindranathan Nair v. CIT (2003) 262 ITR 669 (Ker) : 2003 TaxPub(DT) 0658 (Ker-HC), in dealing with a similar issue, the Kerala High Court held :–

“…The interest from short term deposits received by the appellant is not the direct result of any export of any goods or merchandise. The fixed deposit was made only for the purpose of opening letters of credit and Page 0518 for getting other benefits which are necessary requirements to enable the appellant to make the export. From the above it is clear that the interest income received on the short-term deposits though it can be attributed to the export business cannot be treated as income which is derived from the export business. In the above circumstances, even assuming that the bank had insisted for making short-term deposits for opening letters of credit and for other facilities, it cannot be said that the income is derived from the export business.”

  1. Our High Court followingPandian Chemicals (supra) and Sterling Foods (supra) in the case of Gaskets and Radiators Distributors (2008) 296 ITR 440 (Guj) : 2008 TaxPub(DT) 0315 (Guj-HC) held that the Tribunal was not right in allowing the assessee’s claim regarding rebate under section 80HHC by holding that the receipts such as interest on deposits export incentive, octroi refund and sales in India would form part of the total profits to work out the total turnover and qualifying profits.
  2. Our High Court inCIT v. Priyanka Gems (2014) 367 ITR 575 (Guj) : 2014 TaxPub(DT) 1612 (Guj-HC) examined the treatment of foreign exchange fluctuation gains and held that the same are not similar to interest etc. as prescribed in 80HHC (4C) (bba) and therefore will form part of the export profit and not be excluded from it.
  3. InPr. CIT v. Asahi Songwon Colors Ltd. (2018) 400 ITR 138 (Guj) : 2017 TaxPub(DT) 5315 (Guj-HC), this Court observed :–

“8. Section 10B of the Act provides for deduction of such profits and gains as are derived by a hundred per cent export oriented undertaking from the export of articles or things or computer software for the period and subject to the conditions stipulated there under. Therefore, the deduction is permissible if such profits and gains as are derived from the export of articles and things. As held in the above decision, the exact remittance in connection with such export would depend on the precise exchange rate at the time when the amount is remitted. The receipt would be on account of the export made and therefore, the fluctuation thereof must also be said to arise out of the export business. Merely because of fluctuation in the international currencies, the income does not get divested of the character of income from export business. The Tribunal, therefore, did not commit any error in deleting the addition made on account of fluctuation in foreign exchange rates from the deduction under section 10B of the Act.”

  1. We are of the view that the basis of computation of the deductions enumerated under Chapter VIA is different from that set out for the special deductions like section 10A and 10B. Section 80IA provides for a deduction of profits and gains derived by an undertaking or an enterprise from an eligible business. The provisions of section 80IA(1) state that where the gross total income of an assessee includes profits and gains derived by an undertaking or an enterprise from any eligible business, there shall, in accordance with and subject to the provisions be allowed, in computing the total income of the assessee, a deduction of an amount equal to 100% of the profits and gains derived from such business for a demarcated period. The relief under section 10B, on the other hand, is granted in respect of the profits derived from the eligible activity of export, computed as a proportion of the profits of the business of the undertaking.
  2. The aforesaid distinction has been noted by the Full Bench of the Karnataka High Court in the case ofCIT v. Hewlett Packard Global Soft Ltd. (2018) 403 ITR 453 (Karnataka) (FB) : 2017 TaxPub(DT) 4700 (Karn-HC). The Full Bench of the Karnataka High Court was called upon to answer the following two questions of law :–

“(i) Whether in the facts and in the circumstances of the case, Tribunal was justified in holding that interest from Fixed Deposits, accrued interest on Fixed Deposits, interest received from Citibank, Hong Kong and interest on staff loans should be treated as business income of the assessee even though the assessee is not carrying any banking/financial activity?

(ii) Whether the assessing officer was correct in holding that the interest income cannot be held to be derived from eligible business of the assessee (software development) for the purpose of claiming deduction under section 10A of the Income Tax Act, 1961?”

  1. The Full Bench of the Karnataka High Court, after an exhaustive review of the Supreme Court decisions in theLiberty India Ltd. (supra) as well as Pandian Chemicals (supra), ultimately, held as under :–

“9. The Scheme of the Income Tax Act, 1961 is that the said Act is divided into XXIII Chapters, comprising of section 1 to section 298 and Fourteen Schedules to the Act. We are mainly concerned with Chapter II (Basis of Charge–Section 4 to section 9­A); Chapter III (Incomes which do not form part of Total Income–Section 10 to section 13­B) Chapter IV (Computation of Total Income, providing for different Heads of Income–Part ­D–Profits and Gains of Business or Profession–(Section 28 to section 44DB) and Chapter VI­A (Deductions to be made in computing Total Income, Part A–General, comprising of section 80­A to 80­B and Part B–Deductions in respect of certain payments, comprising of section 80C to 80GGC and Part C–Deductions in respect of certain incomes–comprising of section 80H to section 80TT.

  1. Out of this broad scheme of the Act, since the cited cases before us mostly pertain to Part C of Chapter VI­A which deals with the deductions to be made in computing Total Income under section 80­H, 80HH, 80HHC etc, we would deal with these provisions when relevant case laws are discussed by us.
  2. As against the Chapter VI­A relating to Deductions from Gross Total Income as provided in Chapter VI­A of the Act, section 10­A and 10B contained in Chapter III of the Act provide for exemptions or 100% deduction in Chapter III which deals with “Incomes which do not form part of the Total Income” and section 10­A deals with “Special provisions in respect of the newly established Undertakings in Free Trade Zone, etc. (FTZ)” and section 10­AA deals with “Special provisions in respect of newly established Units in Special Economic Zones (SEZs)” and section 10­B deals with “Special provisions in respect of newly established 100% Export Oriented Units (100% E.O.Us)”.
  3. Before coming to the crux of the controversy, let us have a look at the brief factual background of the Respondent assessee for the assessment year 2001-­02 in question.
  4. The Respondent assessee during the relevant year operated four Units set up under the Scheme formulated by the Government in the name of Software Technology Parks of India (STPI) for 100% Export of the Computer Software Units. The Government of India to promote the fast growing Industry of Software and Software Technology in our country, made a special provision for providing incentive in the form of Tax Exemption by inserting section 10­A in Chapter III of the Act which provision is quoted herein below and the same provided for a 100% deduction of Profits and Gains derived by an Undertaking from the export of articles or things or Computer Software for a period of ten consecutive assessment years from the beginning of its setting up, if such Undertaking begins to manufacture or produce such Articles or things or Computer Software in its Export Undertaking. The said provision was substituted by Finance Act, 2000, with effect from 1-4-2001 in place of the earlier section 10­A, which was inserted by Finance Act, 1981.
  5. Section 10­B of the Act was also substituted by the Finance Act, 2000, with effect from 1-4-2001 in place of earlier provisions of section 10­B of the Act inserted by Finance Act, 1988 with effect from 1-4-1989 and it provided for such 100% deduction of profits and gains derived by a 100% Export Oriented Undertaking set up in specified Zones like STPI etc. from the export of articles or things or Computer Software for a period of Ten consecutive assessment years, beginning with the assessment year relevant to the previous year in which the Undertaking begins to manufacture or produce such Articles.
  6. There is no dispute of facts before us as found by the Income Tax Tribunal with the Respondent–assessee, as a 100% Export Oriented Unit had four Units set up in the Software Technology Park of India (STPI) Scheme and it had no other Units from which it carried on any other activity other than the 100% export of Software projects during the assessment year 2001-02 under consideration.
  7. The assessee earned during the said assessment year 2001-02, interest income of Rs. 4,68,037 on the Short Term Deposits made by it to the tune of Rs. 6,46,88,606 out of its Surplus Funds temporarily parked in the Current Account held in Citi Bank, Hong Kong and also earned interest of Rs. 6,02,309 from the Advances of loans to its staff members. The deduction in respect of both the said interest income was claimed as a 100% deduction under section 10­A of the Act during the said relevant year as income from “Profits and Gains” of export business. But, the Assessing Authority under the Act held that such interest income was not entitled to 100% deduction under section 10­A of the Act, but such interest income was taxable under section 56 of the Act, as ‘Income from Other Sources’ and that is the bone of contention between the assessee and the Revenue before us.
  8. The learned counsel for the Revenue, Mr. Aravind relying upon the following judgments under sections 80­HH, 80­HHC and 80­I of the Act which scheme of Deductions under Chapter VI­A of the Act is different from the scheme of Exemptions from tax under sections 10­A and 10­B in Chapter III of the Act, submitted that the interest income derived by the Respondent assessee cannot be said to be “Profits and Gains” as derived by an Undertaking from the export of articles and therefore such interest income earned from Banks and staff loans has to be taxed under section 56 of the Act as “Income from other Sources” and 100% deduction treating them as “profits and gains of business” is not allowable under 80A of the Act.
  9. The relevant extracts of the judgments mainly relied upon by the learned counsel for the Revenue are quoted below for ready reference.
  10. InPandian Chemicals Ltd. v. CIT (2003) 262 ITR 278 (SC) : 2003 TaxPub(DT) 1233 (SC), the Hon’ble Supreme Court dealing with a controversy with regard to interest on deposits with Electricity Board held that the same could not be treated as ‘Profits and Gains derived from Industrial Undertaking” for the purposes of section 80­HH of the Act. The relevant paragraphs 4 and 6 of the judgment are quoted below for ready reference.

“4. Section 80HH of Income Tax Act grants deduction in respect of profits and gains “derived from” an industrial undertaking. The contention of the appellant before us is that interest earned on the deposit made with the Electricity Board (assessee) for the supply of electricity to the appellants industrial undertaking should be treated as income derived from the industrial undertaking within the meaning of section 80HH. It is submitted that without the supply of electricity the industrial undertaking could not run and since electricity was an essential requirement of the industrial undertaking, the industrial undertaking could not survive without it. It is further pointed out that for the purpose of getting this essential input, the statutory requirement was that the deposit must be made as a precondition for the supply of electricity.

Consequently, according to the appellant, the interest on the deposit should be treated as income derived from the industrial undertaking within the meaning of section 80HH.

  1. ……
  2. The word “derived” has been construed as far back in 1948 by the Privy Council inCIT v. Raja Bahadur Kamakhaya Narayan Singh (1948) 16 ITR 325 (PC) : 1948 TaxPub(DT) 0047 (Privy Council)when it said :–

“The word derived is not a term of art. Its use in the definition indeed demands an enquiry into the genealogy of the product. But the enquiry should stop as soon as the effective source is discovered. In the genealogical tree of the interest land indeed appears in the second degree, but the immediate and effective source is rent, which has suffered the accident of non­payment. And rent is not land within the meaning of the definition.”

This definition was approved and reiterated in 1955 by a Constitution Bench of this Court in the decision of Mrs. Bacha F. Guzdar v. CIT (1955) 27 ITR 1 (SC) : 1955 TaxPub(DT) 0064 (SC). It is clear, therefore, that the words ‘derived from’ is s.80HH of the Income Tax Act, 1961 must be understood as something which has direct or immediate nexus with the appellant’s industrial undertaking. Although electricity may be required for the purposes of the industrial undertaking, the deposit required for its supply is a step removed from the business of the industrial undertaking. The derivation of profits on the deposit made with Electricity Board cannot be said to flow directly from the industrial undertaking itself.”

  1. InLiberty India v. CIT ((2009) 317 ITR 218 (SC) : 2009 TaxPub(DT) 2027 (SC)), the Hon’ble Supreme Court dealing with the controversy of profit from Duty Exemption Payback Scheme (DEPB), Duty drawback incentives dealing with deduction under 80­IB of the Act held that the profit derived on sale of such DEPB and Duty draw back Entitlements by the assessee could not be said to be Profits and Gains “derived from” which are “ancillary” as compared with the words “attributable to” and therefore such profits on sale of DEPB/Duty drawback Entitlements was not deductible under section 80­IB of the Act. The relevant discussion as found in paragraph 16 of the judgment is quoted below for ready reference.

“16. DEPB is an incentive. It is given under Duty Exemption/Remission Scheme. Essentially, it is an export incentive. No doubt, the object behind DEPB is to neutralize the incidence of customs duty payment on the import content of export product.

This neutralization is provided for by credit to customs duty against export product. Under DEPB, an exporter may apply for credit as percentage of FOB value of exports made in freely convertible currency. Credit is available only against the export product and at rates specified by DGFT for import of raw materials, components etc. DEPB credit under the Scheme has to be calculated by taking into account the deemed import content of the export product as per basic customs duty and special additional duty payable on such deemed imports. Therefore, in our view, DEPB/duty drawback are incentives which flow from the Schemes framed by Central Government or from section 75 of the Customs Act, 1962, hence, incentive profits are not profits derived from the eligible business under S.80­IB. They belong to the category of ancillary profits of such undertakings.”

  1. Likewise, inCIT v. Sterling Foods ((1999) 237 ITR 579 (SC) : 1999 TaxPub(DT) 1271 (SC)) again the Hon’ble Supreme Court in a case arising under section 80­HH of the Act held that the nexus between the sale consideration of Import Entitlements and the Industrial Undertakings was not direct but only incidental and therefore the same would not constitute “profits and gains” derived from assessee’s Industrial Undertaking for the purpose of computing deduction under section 80­HH of the Act. The observations made in paragraph 9 of the judgment are quoted below :–

“9. We do not think the source of the import entitlements can be said to be the industrial undertaking of the assessee. The source of the import entitlements can in the circumstances, only be said to be the export promotion scheme of the Central Government whereunder the export entitlements become available. There must be, for the application of the words “derived from”, a direct nexus between the profits and gains and the industrial undertaking. In the instant case the nexus is not direct but only incidental. The industrial undertaking exports processed sea food. By reason of such export, the export promotion scheme applies. Thereunder, the assessee is entitled to import entitlements, which it can sell. The sale consideration therefrom cannot, in our view, be held to constitute a profit and gain derived from the assessee’s industrial undertaking.”

  1. InTotgars Co­operative Sale Society Ltd. v. ITO ((2010) 322 ITR 283 (SC) : 2010 TaxPub(DT) 1466 (SC)), which judgment was relied upon by the Division Bench of this Court for the later years also while decidingITA No. 100066/2016 (Pr. CIT v. The Totagar’s Co­operative Societies Sales Ltd. Sirsi, Karnataka) on 16-6-2017, the Hon’ble Supreme Court held that the profits and gains of business attributable to one of the activities specified in section 80­P(2)(a) of the Act which gave 100% deduction from tax to the Co­operative Societies engaged in specified types of activities did not include the interest earned by it by investing Surplus Funds in Short Term Deposits and Government Securities which would be taxable under section 56 of the Act as “Income from other Sources”. The relevant extract of the Supreme Court judgment is quoted below for ready reference.

“To say that the source of income is not relevant for deciding the applicability of s.80P would not be correct because weight-age has to be given to the words “the whole of the amount of profits and gains of business” attributable to one of the activities specified in s.80P(2)(a). An important point needs to be mentioned. The words “the whole of the amount of profits and gains of business” emphasise that the income in respect of which deduction is sought must constitute the operational income and not the other income which accrues to the society. In this particular case, the evidence shows that the assessee-­society earns interest on funds which are not required for business purposes at the given point of time.

Therefore, on the facts and circumstances of this case, such interest income falls in the category of “other income” which has been rightly taxed by the Department under section 56.­The Totgars Cooperative Sale Society Ltd. v. ITO (2010) 228 CTR (Kar) 526 : 2010 TaxPub(DT) 0216 (Karn-HC) affirmed.

Assessee, a co­operative society, being engaged in providing credit facilities to its members and marketing the agricultural produce of the members, interest earned by it by investing surplus funds in short-term deposits and Government securities fell under the head “Income from other sources” taxable under s.56 and it cannot be said to be attributable to the activities of the society and, therefore, the interest income did not qualify for deduction under section 80P(2)(a) (I).”

  1. The Division Bench following the aforesaid judgment later again held that the said judgment of the Hon’ble Supreme Court will apply to the same Assessee even for subsequent assessment years despite the amendment in law and even if the interest income was earned by the assessee Co­operative Society from the deposits made with the Co operative Banks and not with the other Scheduled or Nationalized Banks as was done in the earlier years involved before the Hon’ble Supreme Court and such 100% deduction would not be available to the assessee Society even with reference to section 80­P(2)(a) or (d) of the Act for those subsequent assessment years as well.
  2. Before adverting to the judgments cited by the learned counsel for the Respondent assessee and his contentions in brief, let us extract the relevant portion of the section 10­A applicable in the facts and circumstances of the present case to its relevant extent herein below.

10A (Special provision in respect of newly established undertakings in free trade zone, etc.

10A. (1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee :–

….

….

10­A(2) This section applies to any undertaking which fulfils all the following conditions, namely :–

(i) it has begun or begins to manufacture or produce articles or things or computer software during the previous year relevant to the assessment year–

(a) commencing on or after the 1-4-1981, in any free trade zone; or

(b) commencing on or after the 1-4-1994, in any electronic hardware technology park, or, as the case may be, software technology park;

(c) commencing on or after the 1-4-2001 in any special economic zone;

(ii) it is not formed by the splitting up, or the reconstruction, of a business already in existence :–

Provided that this condition shall not apply in respect of any undertaking which is formed as a result of the re­establishment, reconstruction or revival by the assessee of the business of any such undertakings as is referred to in section 33B, in the circumstances and within the period specified in that section;

(iii) it is not formed by the transfer to a new business of machinery or plant previously used for any purpose.

…….

10­A(4) For the purposes of (sub-section (1) and (1A)), the profits derived from export of articles or things or computer software shall be the amount which bears to the profits of the business of the undertaking, the same proportion as the export turnover in respect of such articles or things or computer software bears to the total turnover of the business carried on by the undertaking.”

  1. The learned counsel for the Respondent assessee, Mr. T. Suryanarayana submitted that the entire profits and gains of the Undertaking of the Respondent assessee who was exclusively engaged in the business of manufacture and export of Software Programmes and projects was entitled to exemption or 100% deduction under section 10­A of the Act as the entire income earned by such Undertaking including the interest earned from Banks and staff loans which was just incidental to the normal business activity of export of software and such interest would also therefore constitute part of the profits and gains of the Undertaking and would be entitled to such exemption.
  2. The learned counsel for the Respondent assessee also urged that in fact, the question of applying the formula under section 10­A(4) for giving proportionate deduction would not arise in such circumstances where the assessee was engaged wholly in 100% export of its Software Programmes and would not apply to exclude such exemption in respect of the interest income because the interest income of the Undertaking does not form part of ‘Total Turnover of the assessee’ in contra­distinction with ‘export turnover of the assessee’ because the assessee is engaged in 100% export of articles and the assessee admittedly satisfies all other relevant conditions for applicability of section 10­A of the Act to the respondent assessee.
  3. He submitted that the judgment of the Division Bench in the case ofM/s. Motorola India Electronics (P) Ltd.(supra) of this Court which has been differed with by the subsequent Division Bench giving rise to the present Reference to the Full Bench gives the correct interpretation of section 10­A/10­B of the Act and the same has been consistently followed at later stages by the other High Courts.
  4. The learned counsel for the Respondent assessee relied upon the following decisions in this regard.
  5. InRiviera Home Furnishing v. Addl. CIT, Range 15 ((2016) 65 Taxmann.com 287(Delhi)), the Division Bench of Delhi High Court dealing with a case of Export Oriented Undertaking, for the assessment year 2008­09, in respect of interest received by an assessee on Fixed Deposit Receipts (FDRs.) which were under lien with Bank for facilitating Letter of Credit and Bank Guarantee facilities held that such interest received on FDRs would qualify for deduction under section 10­B of the Act. The relevant paragraphs 9 and 15 of the said decision are quoted below.

“9. The question as to what can constitute as profits and gains derived by a 100% EOU from the export of articles and computer software came for consideration before the Karnataka High Court in CIT v. Motorola India Electronics (P) Ltd. (2014) 46 Taxmann.com 167 (Kar). The said appeal before the Karnataka High Court was by the Revenue challenging an order passed by the ITAT which held that the interest payable on FDRs was part of the profits of the business of the undertaking and therefore includible in the income eligible for deduction sections 10A and 10B of the Act. There the Assessee had earned interest on the deposits lying in the EEFC account as well as interest earned on inter­-corporate loans given to sister concerns out of the funds of the undertaking.

There was a restriction on the Assessee in that case from making pre­payment of its external commercial borrowings (‘ECB’). It could repay only to the extent of 10% of the outstanding loan in a year.

This made the Assessee temporarily park the balance funds as deposits or with various sister concerns as inter corporate deposits until the date of repayment. The Assessee contended that the interest derived from the business of the industrial undertaking was eligible for exemption within the meaning of section 10B and applied the formula under section 10B(4) of the Act for determining the profits from exports. The Assessee’s contention that the expression “profits of the business of the undertaking” in section 10B(4) was wider than the expression “profits and gains derived by” the Assessee from a 100% EOU occurring in section 10B(1) was accepted by the ITAT. The ITAT noticed that unlike section 80 HHC, where there was an express exclusion of the interest earned from the ‘profits of business of undertaking’, there was no similar provision as far as sections 10A and 10B were concerned.

  1. In the considered view of the Court, the submissions made on behalf of the Revenue proceed on the basic misconception regarding the true purport of the provisions of Chapter VIA of the Act and on an incorrect understanding of section 80A(4) of the Act. The opening words of section 80A(4) read “Notwithstanding anything to the contrary contained in section 10A or section 10AA or section 10B or section 10BA or in any provisions of this Chapter…..”. What is sought to be underscored, therefore, is that section 80A, and the other provisions in Chapter VIA, are independent of sections 10A and 10B of the Act. It appears that the object of section 80A(4) was to ensure that a unit which has availed of the benefit under section 10B will not be allowed to further claim relief under section 80IA or 80IB read with section 80A(4). The intention does not appear to be to deny relief under section 10B(1) read with section 10B(4) or to whittle down the ambit of those provisions as is sought to be suggested by Mr. Manchanda. Also, he is not right in contending that the decisions of the High Courts referred to above have not noticed the decision of the Supreme Court in Liberty India. The Karnataka High Court inCIT v. Motorola India Electronics (P) Ltd.(supra) makes a reference to the said decision. That decision of the Karnataka High Court has been cited with approval by this Court in Hritnik Exports (supra) and Universal Precision Screws (supra). In Hritnik Exports (supra) the Court quoted with approval the observations of the Special Bench of the ITAT in Maral Overseas Ltd. (supra) that “Section 10A/10B of the Act is a complete code providing the mechanism for computing the ‘profits of the business’ eligible for deduction under section 10B of the Act. Once an income forms part of the business of the income of the eligible undertaking of the assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction under section 10B of the Act.”
  2. The said judgment, in our opinion, rightly distinguishes the judgments on the interpretation of section 80­HH, 80­IA etc. under Chapter VI­A of the Act in view of section 80­A (4) of the Act which, with anon obstanteclause which starts with “Notwithstanding anything to the contrary contained in section 10­A or section 10­AA or section 10­B or section 10­BA or in any provisions of this Chapter” proceeds to enumerate the various deductions under Chapter VI­A of the Act.
  3. Similarly the Division Bench of the Calcutta High Court inCIT, Kolkata­-IV v. Hindustan Gum & Chemicals Ltd. ((2016) 72 Taxmann.com. 90 (Calcutta))again held that interest earned on Surplus Business Funds deposited with Banks for short periods will be part of profits of business for the purposes of section 10­B of the Act. The relevant portion of the judgment in para.3 relied upon in the decision of the Division Bench of this Court in the case of M/s. Motorola India Electronics (P) Ltd. (supra) is quoted below for ready reference.

“3. A bare reading of sub-section (1) suggests that 100 % export oriented undertakings are entitled to a deduction of profits and gains derived from the export of articles for a period of 10 years.

The aforesaid entitlement is, however, subject to the provisions of section 10B. In other words, subject to the provisions contained in the other parts of the section 10B, the benefit is available to an assessee. It was not disputed that the only relevant provision to be taken into account is sub-section (4) which we already have quoted. Sub-section (4) provides the quantum of deduction which can be availed by an assessee. The quantum of deduction is dependent upon the total turnover of the business of the undertaking and the export turnover of the undertaking. Once these two figures are available, one has to divide the total turnover by the export turnover in order to work out the percentage of the export turn over, vis-a-­vis the total turn over. Suppose total turn over is Rs. 100 and total export turn over is for Rs. 10­, then the export turn over is 10 % of the total turnover. Then one has to find out the total profit of the business of the undertaking. Suppose the total profit of the business of the undertaking is Rs. 100, in that case, deduction available to the assessee under section 10 sub-section (1) of section 10B shall be 10% of Rs. 100, i.e. to say Rs. 10­. This is the formula which has been provided by sub-section (4) for the purpose of working out the benefit or deduction under sub-section (1). Total turnover shall naturally include receipt on account of interest. The legislature does not appear to have provided for excluding the amount of interest from the total turnover as has been done in the case of 80HHC by explanation (baa) of sub-section (4C) thereof. In that case, 90% of the income arising out of interest has to be excluded from the profits of the business for the purpose of arriving at deduction available under section 80HHC. But an identical provision is not there. Therefore, that provision cannot be imported by implication. The submission that the amount earned from interest was not intended to be taken into account for the purpose of giving benefit under sub-section (1) of section 10B may be correct. But the amount of deduction available to a 100% export oriented undertaking is necessarily dependent upon the formula provided in sub-section (4). There is, as such, no scope for any controversy that part of the money was earned from interest and not from export. This question came up before the Karnataka High Court and was answered in the case of CIT v. Motorola India Electronics (P) Ltd. (2014) 46 taxmann.com 167 (Kar) : 225 Taxman 11 (Kar.)(Mag.) as follows :–

“In the instant case, the assessee is a 100% EOU, which has exported software and earned the income. A portion of that income is included in EEFC account. Yet another portion of the amount is invested within the country by way of fixed deposits, another portion of the amount is invested by way of loan to sister concern which is deriving interest or the consideration received from sale of the import entitlement, which is permissible in law. Now the question is whether the interest received and the consideration received by sale of import entitlements is to be construed as income of the business of the undertaking. There is a direct nexus between this income and the income of the business of the undertaking. Though it does not partake the character of a profits and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles. In view of the definition of income from Profits and Gains incorporated in sub-section (4), the assessee is entitled to the benefit of exemption of the said amount as contemplated under section 10B of the Act. Therefore, the Tribunal was justified in extending the benefit to the aforesaid amounts also. We do not find any merit in these appeals. Therefore, the first substantial question of law raised in ITA No. 428/2007 is answered in favour of the revenue and against the assessee and the first substantial question of law in ITA No. 447/2007 is answered in favour of the assessee and against the revenue.

In the light of the aforesaid findings, the second question of law in both the appeals do not arise for consideration.”

  1. The Division Bench of Bombay High Court inCIT­-IV v. Symantee Software India (P) Ltd. (MANU/MH/2575/2014)rightly held, in our opinion, that the provisions of Chapter VI­A in the context of ‘Deductions’ cannot be allowed to be telescoped in section 10­A and the deduction under section 10­A has to be given effect to at the prior stage of computing the profits and gains of the business, whereas Chapter VI­A comes in for application after the Gross Total Income is determined by adding the income under various independent Heads of Income in Chapter IV comprising of sections 14 to 59 of the Act.
  2. The relevant extract from paragraphs 19 to 21 of Bombay High Court decision is also quoted below for ready reference.

“19. There is some substance in the contention of Mr. Kaka that if the deduction shall be allowed from the total income of the Assessee in the manner set out by section 10A and the computation is also provided in that provision itself namely sub-section (4), then there is a complete Code which is evolved and formulated by the Legislature.

  1. In relation to this, we also find support in the judgment of this Court in the case ofBlack and Veatch Consulting (P) Ltd.This Court has observed and held as under :–

“Section 10A is a provision which is in the nature of a deduction and not an exemption. This was emphasized in a judgment of a Division Bench of this Court, while construing the provisions of section 10B, in Hindustan Unilever Ltd. v. Dy. CIT MANU/MH/0417/2010: (2010) 325 ITR 102 (Bom) : 2010 TaxPub(DT) 1767 (Bom-HC) at paragraph 24. The submission of the Revenue placed its reliance on the literal reading of section 10A under which a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years is to be allowed from the total income of the assessee. The deduction under section 10A, in our view, has to be given effect to at the stage of computing the profits and gains of business. This is anterior to the application of the provisions of section 72 which deals with the carry forward and set off of business losses. A distinction has been made by the Legislature while incorporating the provisions of Chapter VI­A. Section 80A(1) stipulates that in computing the total income of an assessee, there shall be allowed from his gross total income, in accordance with and subject to the provisions of the Chapter, the deductions specified in sections 80C to 80U. Section 80B(5) defines for the purposes of Chapter VIA “gross total income” to mean the total income computed in accordance with the provisions of the Act, before making any deduction under the Chapter. What the Revenue in essence seeks to attain is to telescope the provisions of Chapter VI­A in the context of the deduction which is allowable under section 10A, which would not be permissible unless a specific statutory provision to that effect were to be made.

In the absence thereof, such an approach cannot be accepted. In the circumstances, the decision of the Tribunal would have to be affirmed since it is plain and evident that the deduction under section 10A has to be given at the stage when the profits and gains of business are computed in the first instance.”

  1. Therefore, when this Court has held that Chapter VIA provides for deduction to be made in computing the total income and section 80HH deals with deduction in respect of profit and gains from the newly established undertaking or Hotel business in backward areas, then the attempt of the Revenue to telescope Chapter VIA in the context of the deduction, which is permissible under section 10A falling in Chapter III, cannot be countenanced.”
  2. We are of the considered opinion that the above referred decisions relied upon by the learned counsel for the Revenue, Mr. Aravind do not cover the cases under sections 10­A and 10­B of the Act which are special provisions and complete code in themselves and deal with profits and gains derived by the assessee of a special nature and character like 100% Export Oriented Units (EOUs.) situated in Special Economic Zones (SEZs), STPI, etc., where the entire profits and gains of the entire Undertaking making 100% exports of articles including software as is the fact in the present case, the assessee is given 100% deduction of profit and gains of such export business and therefore incidental income of such undertaking by way of interest on the temporarily parked funds in Banks or even interest on staff loans would constitute part of profits and gains of such special Undertakings and these cases cannot be compared with deductions under sections 80­HH or 80­IB in Chapter VI­A of the Act where an assessee dealing with several activities or commodities mayinter aliaearn profits and gains from the specified activity and therefore in those cases, the Hon’ble Supreme Court has held that the interest income would not be the income “derived from” such Undertakings doing such special business activity.
  3. The Scheme of Deductions under Chapter VI­A in sections 80­HH, 80­HHC, 80­IB, etc from the ‘Gross Total Income of the Undertaking’, which may arise from different specified activities in these provisions and other incomes may exclude interest income from the ambit of Deductions under these provisions, but exemption under section 10­A and 10­B of the Act encompasses the entire income derived from the business of export of such eligible Undertakings including interest income derived from the temporary parking of funds by such Undertakings in Banks or even Staff loans. The dedicated nature of business or their special geographical locations in STPI or SEZs. Etc. makes them a special category of assessees entitled to the incentive in the form of 100% Deduction under section 10A or 10­B of the Act, rather than it being a special character of income entitled to Deduction from Gross Total Income under Chapter VI­A under section 80­HH, etc. The computation of income entitled to exemption under section 10­A or 10­B of the Act is done at the prior stage of computation of Income from Profits and Gains of Business as per sections 28 to 44 under Part-­D of Chapter IV before ‘Gross Total Income’ as defined under section 80­B(5) is computed and after which the consideration of various Deductions under Chapter VI­A in section 80HH etc. comes into picture. Therefore analogy of Chapter VI Deductions cannot be telescoped or imported in section 10­A or 10­B of the Act. The words ‘derived by an Undertaking’ in section 10­A or 10­B are different from ‘derived from’ employed in section 80­HH etc. Therefore all Profits and Gains of the Undertaking including the incidental income by way of interest on Bank Deposits or Staff loans would be entitled to 100% exemption or deduction under section 10­A and 10­B of the Act. Such interest income arises in the ordinary course of export business of the Undertaking even though not as a direct result of export but from the Bank Deposits etc., and is therefore eligible for 100% deduction.
  4. We have to take a purposive interpretation of the Scheme of the Act for the exemption under section 10­A/10­B of the Act and for the object of granting such incentive to the special class of assessees selected by the Parliament, the play­ in­ the ­joints is allowed to the Legislature and the liberal interpretation of the exemption provisions to make a purposive interpretation, was also propounded by Hon’ble Supreme Court in the following cases :–

(I) In Bajaj Tempo Ltd., Bombay v. CIT, Bombay, ((1992) 3 SCC 78), the Hon’ble Supreme Court held that :–

“5. …..Since a provision intended for promoting economic growth has to be interpreted liberally, the restriction on it, too, has to be construed so as to advance the objective of the section and not to frustrate it. But that turned out to be the, unintended, consequence of construing the clause literally, as was done by the High Court for which it cannot be blamed, as the provision is susceptible of such construction if the purpose behind its enactment, the objective it sought to achieve and the mischief it intended to control is lost sight of. One way of reading it is that the clause excludes any undertaking formed by transfer to it of any building, plant or machinery used previously in any other business. No objection could have been taken to such reading but when the result of reading in such plain and simple manner is analysed then it appears that literal construction would not be proper. …”

(II) In R.K. Garg v. Union of India, ((1981) 4 SCC 675) = (1982 SCC (Tax) 30 p.690), the Hon’ble Apex Court has held as under :–

“8. Another rule of equal importance is that laws relating to economic activities should be viewed with greater latitude than laws touching civil rights such as freedom of speech, religion etc. It has been said by no less a person than Holmes, J., that the legislature should be allowed some play in the joints, because it has to deal with complex problems which do not admit of solution through any doctrinaire or strait­jacket formula and this is particularly true in case of legislation dealing with economic matters, where, having regard to the nature of the problems required to be dealt with, greater play in the joints has to be allowed to the legislature. The court should feel more inclined to give judicial deference to legislative judgment in the field of economic regulation than in other areas where fundamental human rights are involved. Nowhere has this admonition been more felicitously expressed than in Morey v. Doud (351 US 457 : 1 L Ed 2d 1485 (1957)) where Frankfurter, J., said in his inimitable style :–

“In the utilities, tax and economic regulation cases, there are good reasons for judicial self­-restraint if not judicial deference to legislative judgment. The legislature after all has the affirmative responsibility. The courts have only the power to destroy, not to reconstruct. When these are added to the complexity of economic regulation, the uncertainty, the liability to error, the bewildering conflict of the experts, and the number of times the judges have been overruled by events–self ­limitation can be seen to be the path to judicial wisdom and institutional prestige and stability.”

The Court must always remember that “legislation is directed to practical problems, that the economic mechanism is highly sensitive and complex, that many problems are singular and contingent, that laws are not abstract propositions and do not relate to abstract units and are not to be measured by abstract symmetry”; “that exact wisdom and nice adoption of remedy are not always possible” and that “judgment is largely a prophecy based on meagre and un-interpreted experience”. Every legislation particularly in economic matters is essentially empiric and it is based on experimentation or what one may call trial and error method and therefore it cannot provide for all possible situations or anticipate all possible abuses. There may be crudities and inequities in complicated experimental economic legislation but on that account alone it cannot be struck down as invalid.”

  1. On the above legal position discussed by us, we are of the opinion that the Respondent assessee was entitled to 100% exemption or deduction under section 10­A of the Act in respect of the interest income earned by it on the deposits made by it with the Banks in the ordinary course of its business and also interest earned by it from the staff loans and such interest income would not be taxable as ‘Income from other Sources’ under section 56 of the Act. The incidental activity of parking of Surplus Funds with the Banks or advancing of staff loans by such special category of assessees covered under section 10­A or 10­B of the Act is integral part of their export business activity and a business decision taken in view of the commercial expediency and the interest income earned incidentally cannot be de­linked from its profits and gains derived by the Undertaking engaged in the export of Articles as envisaged under section 10­A or section 10­B of the Act and cannot be taxed separately under section 56 of the Act.”
  2. The Delhi High Court in the case ofRiviera Home Furnishing v. Addl. CIT Range–15 reported in (2016) 237 Taxman 520 : 2015 TaxPub(DT) 5292 (Del-HC), following its earlier decision in CIT-IV v. Hritnik Exports (P) Ltd. (2015) 4 ITR-OL 267 (Delhi), has taken the identical view as follows :–

“In the considered view of the Court, the submissions made on behalf of the Revenue proceed on the basic misconception regarding the true purport of the provisions of Chapter VIA of the Act and on an incorrect understanding of section 80A (4) of the Act. The opening words of section 80A (4) read “Notwithstanding anything to the contrary contained in section 10A or section 10AA or section 10B or section 10BA or in any provisions of this Chapter…..”. What is sought to be underscored, therefore, is that section 80A, and the other provisions in Chapter VIA, are independent of sections 10A and 10B of the Act. It appears that the object of section 80A (4) was to ensure that a unit which has availed of the benefit under section 10B will not be allowed to further claim relief under section 80IA or 80IB read with section 80A (4). The intention does not appear to be to deny relief under section 10B (1) read with section 10B (4) or to whittle down the ambit of those provisions as is sought to be suggested by Mr. Manchanda. Also, he is not right in contending that the decisions of the High Courts referred to above have not noticed the decision of the Supreme Court in Liberty India. The Karnataka High Court in CIT v. Motorola India Electronics (P) Ltd. (supra) makes a reference to the said decision. That decision of the Karnataka High Court has been cited with approval by this Court in Hritnik Exports (supra) and Universal Precision Screws (supra). In Hritnik Exports (supra) the Court quoted with approval the observations of the Special Bench of the ITAT in Maral Overseas Ltd. (supra) that “Section 10A/10B of the Act is a complete code providing the mechanism for computing the ‘profits of the business’ eligible for deduction under section 10B of the Act. Once an income forms part of the business of the income of the eligible undertaking of the assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction under section 10B of the Act.”

  1. A similar view has also been taken by the Calcutta High Court in the case ofCIT, Kolkata­IV v. Hindustan Gum and Chemicals Ltd. ((2016) 72 Taxmann.com 90 (Calcutta)). We quote the following observations made in paras 4 and 5 as under :–

“4. Mr. Dudhoria, learned Advocate appearing for the revenue drew our attention to a judgment of the Madras High Court in the case of International Components India Ltd. v. Asstt. CIT reported in (2015) 372 ITR 190 (Mad) : 2015 TaxPub(DT) 1239 (Mad-HC) Madras wherein the following view was taken :–

“In the light of the above said decision, we are of the firm view that the interest earned from deposits with Corporation Bank, Electricity Board and on staff advances does not have direct or immediate nexus with the business of the assessee’s undertaking and, consequently, they are not eligible for grant of deduction under section 10B of the Act, which is akin to section 80HH of the Act dealt with in the decision referred supra.”

  1. Mr. R.N. Bajoria, Learned senior advocate rightly pointed out that the judgment of the Madras High Court is of no relevance for the simple reason that sub-section (4) of section 10B was not taken into account by the Hon’ble Madras High Court. Therefore, this judgment is of no assistance in deciding the issue. The learned Tribunal has passed the following order :–

“There is no requirement for the purposes of section 10B to establish direct nexus between the income and the undertaking. The entire business income of the 100% EOU will be the “profits of the business of the undertaking”. It has been held above that the interest earned on temporarily surplus business funds of the 100% EOU deposited with banks for short periods is business income and has in fact been so assessed. It is not in dispute that the surplus funds were of the 100% EOU. As such, the interest earned thereon has to be regarded as part of the “profit of the business of the undertaking”. We further find that the Tribunal in the case of Cheviot Co. Ltd. for assessment years 2003-04 and 2004-05, relied upon by the assessee, has dealt with similar issue. In those cases, the difference between the provisions of section 10B and 80HH was noted and after considering the judgments of the Hon’ble Supreme Court in Sterling Foods (supra) and in P.R. Prabhakar v. CIT (2006) 284 ITR 548 (SC) : 2006 TaxPub(DT) 1754 (SC) approving the Special Bench decision of the Tribunal in International Research Park Laboratories Limited v. Assistant C.I.T. (1995) 212 ITR (AT) 1 (Delhi) (SB) : 1995 TaxPub(DT) 0466 (Del-Trib), it was held that the profits of the business of the undertaking would include its entire business income. Keeping in view the above decision and the decision of the Tribunal, we are of the considered opinion that the assessee has to succeed. The assessing officer is directed to treat the interest of Rs. 28,74,473 as part of the profits of the business of the 100% EOU eligible for deduction under section 10B and compute the deduction accordingly. The assessing officer should deduct the sum of Rs. 8,01,30,294 (Rs. 7,72,54,821 + Rs. 28,74,473­) and not only Rs. 7,72,54,821 from the profit as per profit and loss account for the purpose of separate consideration under section 10B Ground Nos. 3, 4 and 5 of the assessee’s appeal are thus allowed.”

  1. The Madras High Court in the case ofM/s. Camiceria Apparels India (P) Ltd. v. The Asstt. CIT reported in (2019) 103 taxmann.com 238 (Madras), after referring to the Full Bench decision of the Karnataka High Court in the case of Hewlett Packard (supra), held as under :–

“19. The relief provided for in terms of sections 10A, 10B and other special provisions addresses relief to be granted to specified categories of undertakings, specified either by the activities carried on by them or their location (in STPI/FTZ/EOU). The provision is attracted to the entire income derived from the ‘business of the eligible undertaking’, as contradistinguished from the provisions of section 80 IA falling under Chapter VI A, which provides for a deduction only in respect of the income ‘derived from/by the eligible undertakings’. The use of the word ‘business’ in the context of the grant of the relief widens the scope of such benefit encompassing all incomes generated by such business activities.

  1. Such special deduction is intended as a benefit to a special class of undertakings and as stated by the Supreme Court in the case ofBajaj Tempo LTD. v. CIT, Bombay ((1992) 3 SCC 78), ‘Since a provision intended for promoting economic growth has to be interpreted liberally, the restriction on it, too, has to be construed so as to advance the objective of the section and not to frustrate it’.”
  2. Mr. Bhatt, the learned senior counsel appearing for the Revenue has placed strong reliance on the decision of the Supreme Court in the case ofLiberty India v. CIT (2019) 317 ITR 218 (SC) : 2009 TaxPub(DT) 2027 (SC). In Liberty India, the issue before the Supreme Court for consideration was :–

“whether profit from Duty Entitlement Passbook Scheme (DEPB) and Duty Drawback Scheme could be said to be profit derived from the business of the Industrial Undertaking eligible for deduction under section 80­IB of the Income Tax Act, 1961 (1961 Act)?”

The Supreme Court, after due analysis of sections 80I/80­IA/80IB of the Act, ultimately, took the view that the duty drawback receipts/DEPB benefits would not form part of the net profits of eligible industrial undertaking for the purposes of sections 80I/80­IA/80­IB of the Act.

  1. It is clear from the plain reading of section 10B(1) of the Act that the said section allows deduction in respect of the profits and gains as are derived by a 100% EOU. Further, section 10B(4) of the Act stipulates specific formula for computing the profit derived by the undertaking from export. Thus, the provisions of sub-section (4) of section 10B of the Act mandate that the deduction under that section shall be computed by apportioning the profits of the business of the undertaking in the ratio of export turnover by the total turnover. Thus, even though sub-section (1) of section 10B refers to the profits and gains as are derived by a 100% EOU, the manner of determining such eligible profits has been statutorily defined in, sub­ section (4) of that section. Both sub-sections (1) and (4) should be read together while computing the eligible deduction under section 10B of the Act. We should not ignore sub-section (4) of section 10B which provides the specific formula for computing the profits derived by the undertaking from export. As per the formula so laid down, the entire profits of the business are to be determined which are further multiplied by the ratio of export turnover to the total turnover of the business. In case of Liberty India (supra), the Supreme Court dealt with the provisions of section 80IA of the Act wherein no formula was laid down for computing the profits derived by the undertaking which has specifically been provided under sub-section (4) of section 10B while computing the profits derived by the undertaking from the export. Thus, the decision of the Supreme Court in Liberty India (supra) is of no help to the revenue in determining the claim of deduction under section 10B in respect of the export incentives.
  2. Section 10B(4) lays down the special formula for computing the profits derived by the undertaking from export. The formula is as under :–

“Profit of the business of the Undertaking X Export turnover Total turnover of business carried out by The undertaking”

  1. Thus, sub-section (4) of section 10B stipulates that deduction under that section shall be computed by apportioning the profits of the business of the undertaking in the ratio of turnover to the total turnover.

Thus, notwithstanding the fact that sub-section (1) of section 10B refers the profits and gains as are derived by a 100% EOU, yet the manner of determining such eligible profits has been statutorily defined in sub-section (4) of section 10B of the Act. As per the formula stated above, the entire profits of the business are to be taken which are multiplied by the ratio of the export turnover to the total turnover of the business.

Sub-section (4) does not require an assessee to establish a direct nexus with the business of the undertaking and once an income forms part of the business of the undertaking, the same would be included in the profits of the business of the undertaking. Thus, once an income forms part of the business of the eligible undertaking, there is no further mandate in the provisions of section 10B to exclude the same from the eligible profits. The mode of determining the eligible deduction U/S 10B is similar to the provisions of section 80HHC inasmuch as both the sections mandates determination of eligible profits as per the formula contained therein. The only difference is that section 80HHC contains a further mandate in terms of Explanation (baa) for exclusion of certain income from the ”profits of the business which is, however, conspicuous by its absence in section 10B. On the basis of the aforesaid distinction, sub-section (4) of section 10A/10B of the Act is a complete code providing the mechanism for computing the “profits of the business” eligible for deduction under section 10B of the Act. Once an income forms part of the business of the income of the eligible undertaking of assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction under section 10B of the Act.

  1. We take notice that the Karnataka High Court inCIT v. Motorola India Electronics (P) Ltd. (ITA No. 447 of 2007 (Kar HC) dated 11-12-2013) makes a reference to the decision of the Supreme Court of Liberty India (supra). We would like to look into Motorola India (supra) in details. In Motorola India (supra), the assessee had the outstanding borrowings by way of External Commercial Borrowings. The borrowings were for the business of STP undertaking. The Government had formulated a policy on pre­payment and the policy stated that the approval of pre­payment would be granted only to the extent of 10% of the outstanding loan. In such circumstances, it was required to temporarily park the funds, until the date of repayment, and also keep paying the interest on the loans. The assessee took a business decision to place these funds with its various sister concerns as inter-corporate deposits. The assessee claimed that the interest income as derived from the business of export of articles or things or computer software was eligible for exemption under section 10A of the Act. The assessing officer disallowed the exemption claimed with respect to the respect income. The ITAT’s ruling :–

–ITAT held that the terminology used in sub-section 4 is ‘profits of the business’ of the undertaking in contradiction to the word profits and gains derived by the asssessee “from a 100% export oriented undertaking.

–It was held that the term “from the business of” is much wider than the term “derived from industrial undertaking”.

–Considering section 80 HHC, it was observed, that if the legislature intended to exclude interest from the term “profits of business of undertakings” under sections 10A and 10B of the Act a similar provision as in the case of section (baa) would have been inserted.

–No such explanation has been introduced in sections10A and 1OB and therefore, it held that the interest income is exempted from payment of tax and also their claim for allowance of 5% on scientific basis should be allowed.)

The High Court took the view as follows :–

–Sub-section (4) says that the profits derived from export of articles or things or computer software shall be the account which bares to the profits of the business of the undertaking and not the profits and gains from the export of articles.

–Therefore, profits and gains derived from the export of articles is different from the income derived from the profits of the business of the undertaking.

–The profits of the business of the undertaking includes the profits and gains from the export of the articles as well as all other incidental incomes derived from the business of the undertaking.

–It is interesting to note that similar provisions are not there while dealing with computation of income under section 80HHC. On the contrary, there is a specific provision like section 80HHB which expressly excludes this type of incomes.

–In the instant case, the assessee is a 100% EOU, which had exported software and earned the income. A portion of that income is included in EEFC account. Yet another portion of the amount is invested within the country by way of fixed deposits, another portion of the amount is invested by way of loan to the sister concern which is deriving interest or the consideration received from sale of the import entitlement, which is permissible in law.

–There is a direct nexus between this income and the income of the business of the undertaking. Though it does not partake the character of a profit and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles. In view of the definition of ‘income from Profits and Gains’ incorporated in sub-section (4), the assessee is entitled to the benefit of exemption of the said amount as contemplated under section 10B of the Act.

In taking the aforesaid view, the Karnataka High Court distinguished the following decisions relied upon by the Revenue authorities :–

(1) Pandian Chemicals Ltd. v. CIT (2003) 262 ITR 278 (SC) : 2003 TaxPub(DT) 1233 (SC)

(2) Liberty India v. CIT (2009) 317 ITR 218 (SC) : 2009 TaxPub(DT) 2027 (SC)

(3) CIT v. Sterling Foods (1999) 237 ITR 579 (SC) : 1999 TaxPub(DT) 1271 (SC)

(4) CIT v. Menon Impex (P) Ltd. (2003) 259 ITR 403 (Mad) : 2003 TaxPub(DT) 0454 (Mad-HC)

(5) Anil Dang v. ITO (2012) 344 ITR 143 (Karn) : 2011 TaxPub(DT) 1618 (Karn-HC)

(6) CIT v. Shah Originals (2010) 327 ITR 19 (Bom) : 2010 TaxPub(DT) 1852 (Bom-HC)

  1. In view of the aforesaid discussion, we hold that the dividend income, profit on sale of fixed assets, profit on sale of investments, excess provision return back, duty drawback and interest income could be said to have direct nexus with the income of the business of the undertaking. Although it may not partake the character of profit and gain from the sale of article, yet it could be termed as an income derived from the consideration realized by the export articles. In view of the definition of “income from profits and gains” incorporated in sub-section (4), the Tribunal committed no error in granting the benefit of exemption, as contemplated under section 10B of the Act.
  2. In view of the aforesaid, the fourth question is answered in favour of the assessee and against the Revenue.
  3. In the result, this Tax Appeal fails and is hereby dismissed.

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