Court rules on interest liability and export profits, clarifying tax deductions under Section 80 HHC.

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Case Name:

Commissioner of Income Tax vs. Purewal & Associates Ltd. (High Court of Himachal Pradesh)

ITA No.7 of 2009

Date: 30th November 2015

Key Takeaways

• The court clarified that interest income previously deducted while computing export profits does not become independent income when the liability ceases.
• The ruling emphasizes the importance of understanding the nature of income in relation to export profits under Section 80 HHC.
• The decision reinforces the principle that only net interest, after deducting related expenses, should be considered for deductions.

Issue

Does the income chargeable to tax under Section 41(1) of the Income Tax Act need to be excluded under clause (baa) of the Explanation to Section 80 HHC when computing deductions for the assessee?

Facts

• The assessee, Purewal & Associates Ltd., received a waiver of interest amounting to ₹2,24,46,466 as part of a one-time settlement with Punjab National Bank during the assessment year 2001-02.
• This amount was included in the return as income under Section 41(1) and the assessee claimed a deduction under Section 80 HHC on this entire amount.
• The Assessing Officer (A.O.) ruled that 90% of this deemed income should be reduced from the profits of the business, as it was not derived from exports.

Arguments

• For the Revenue: The A.O. argued that the interest income was of a similar nature to brokerage and commission, which should be excluded from the profits derived from exports.
• For the Assessee: The counsel contended that since the interest liability had been previously allowed as a deduction while computing export profits, it should not now be treated as independent income.

Key Legal Precedents

• K. Ravindranathan Nair vs. Commissioner of Income Tax [2007] 295 ITR 228 (SC): This case established that independent incomes not derived from export activities must be excluded from the profits for Section 80 HHC calculations.
• Commissioner of Income-Tax vs. Shri Ram Honda Power Equip [2007] 289 ITR 475 (Delhi): This case emphasized applying a nexus test to determine what constitutes profits derived from exports.

Judgement

The court ruled in favor of the assessee, stating that the interest liability previously allowed as a deduction would not change its nature to become independent income. The court clarified that only net interest, after deducting expenses incurred to earn that interest, should be considered for deductions under clause (1) of the Explanation (baa) to Section 80 HHC. The appeal was dismissed, affirming the ITAT’s decision.

FAQs

Q: What does this ruling mean for businesses claiming deductions under Section 80 HHC?

A: Businesses can continue to claim deductions for interest income that has been previously allowed as a deduction, as it does not become independent income when the liability ceases.

Q: How should interest income be treated for tax purposes?

A: Only the net interest, after deducting related expenses, should be considered for deductions under Section 80 HHC.

Q: What is the significance of the nexus test mentioned in the judgement?

A: The nexus test helps determine whether income is derived from export activities, ensuring that only relevant income is included in the calculation of export profits for tax deductions.

Tarlok Singh Chauhan, Judge.

1. This appeal under Section 260-A of the Income Tax Act, 1961, (for short ‘Act’) has been preferred by the Revenue against the order of Income Tax Appellate Tribunal (ITAT) Chandigarh Bench ‘B’, Chandigarh, passed in ITA No.211/Chandi/2006 dated 31.07.2008, Assessment Year 2001-02.

2. The brief facts are that during the previous year relevant to Assessment Year 2001-02, the assessee received a waiver of interest of `2,24,46,466/- as a result of one time settlement with Punjab National Bank. This amount was offered in the return as Whether the reporters of the local papers may be allowed to see the Judgment?

income under Section 41(1) of the Act and the assessee also claimed deduction under Section 80HHC on this entire amount of deemed income. However, the Assessing Officer (‘A.O.’) vide his order passed under Section 143(3) dated 29.06.2005 held that under clause (baa) of the Explanation to Section 80HHC, ninety percent of the amount of deemed income had to be reduced from the profits of business since such income was of a similar nature as brokerage, commission, interest etc. and was not derived from the exports made by the assessee.

3. The assessee filed an appeal against the assessment before the Commissioner of Income Tax (Appeals), Shimla (‘CIT (A)’, who vide his order dated 17.01.2006 passed in Appeal No.IT/169/2005-06/SML confirmed the assessment made by the A.O. holding that such deemed income is not derived from exports in view of the judgments of the Hon’ble Supreme Court in the cases of CIT vs. Sterling Foods (237 ITR 579) and Pandian Chemicals vs. CIT (262 ITR 278).

4. The assessee thereafter filed further appeal before the ITAT and the ITAT vide impugned order passed in ITA No.211/Chandi/2006 dated 31.07.2008 allowed the assessee’s appeal.

5. It is against the aforesaid orders that the present appeal has been filed. Vide order dated 09.01.2009, the same was admitted on the following substantial question of law:-

“Whether income chargeable to tax under Section 41(1) of the Income Tax Act is to be excluded under clause (baa) of the Explanation to Section 80 HHC of the Act, for the purposes of computing the deduction allowable to the assessee under that section?”

6. It is vehemently argued by Shri Vinay Kuthiala, Senior Advocate, assisted by Ms.Ashima, Advocate, for the revenue that ITAT has misconstrued the decision of the Hon’ble Supreme Court in Commissioner of Income-Tax versus K.Ravindranathan Nair [2007] 295 ITR 228 (SC) wherein it has been held by the Hon’ble Supreme Court that under clause (baa) of the Explanation to Section 80HHC, incentive profits and certain independent incomes had to be excluded from the profits for the purpose of this Section, therefore, the receipts had no nexus with the export turnover as it is only the income derived from export that alone could be considered for deduction and not income from other sources.

7. On the other hand, Shri Vishal Mohan, learned counsel for the assessee, would contend that since the liability incurred by the assessee company in respect of interest had infact earlier been allowed as deduction while computing the profit of the export business and merely because such liability ceases to exist, the same will not undergo a change in its nature and become an independent income.

We have heard the learned counsel for the parties and have gone through the records of the case.

8. Section 80 HHC of the Act reads thus:- “Deduction in respect of profits retained for export business.

80HHC. (1) Where an assessee, being an Indian company or a person (other than a company) resident in India, is engaged in the business of export out of India of any goods or merchandise to which this section applies, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction to the extent of profits, referred to in sub-section (1B), derived by the assessee from the export of such goods or merchandise :

Provided that if the assessee, being a holder of an Export House Certificate or a Trading House Certificate (hereafter in this section referred to as an Export House or a Trading House, as the case may be) issues a certificate referred to in clause (b) of sub-section (4A), that in respect of the amount of the export turnover specified therein, the deduction under this sub-section is to be allowed to a supporting manufacturer, then the amount of deduction in the case of the assessee shall be reduced by such amount which bears to the total profits derived by the assessee from the export of trading goods, the same proportion as the amount of export turnover specified in the said certificate bears to the total export turnover of the assessee in respect of such trading goods.

(1A) Where the assessee, being a supporting manufacturer, has during the previous year, sold goods or merchandise to any Export House or Trading House in respect of which the Export House or Trading House has issued a certificate under the proviso to sub-section (1), there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of the assessee, a deduction to the extent of profits, referred to in sub-section (1B), derived by the assessee from the sale of goods or merchandise to the Export House or Trading House in respect of which the certificate has been issued by the Export House or Trading House.]

(1B) For the purposes of sub-sections (1) and (1A), the extent of deduction of the profits shall be an amount equal to—

(i) eighty per cent thereof for an assessment year beginning on the 1st day of April, 2001;

(ii) seventy per cent thereof for an assessment year beginning on the 1st day of April, 2002;

(iii) fifty per cent thereof for an assessment year beginning on the 1st day of April, 2003;

(iv) thirty per cent thereof for an assessment year beginning on the 1st day of April, 2004, and no deduction shall be allowed in respect of the assessment year beginning on the 1st day of April, 2005 and any subsequent assessment year.

(2)(a) This section applies to all goods or merchandise, other than those specified in clause (b), if the sale proceeds of such goods or merchandise exported out of India are received in, or brought into, India by the assessee (other than the supporting manufacturer) 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.—For the purposes of this clause, the expression "competent authority" means the Reserve Bank of India or such other authority as is authorised under any law for the time being in force for regulating payments and dealings in foreign exchange.

(b) This section does not apply to the following goods or merchandise, namely :—

(i) mineral oil ; and

(ii) minerals and ores (other than processed minerals and ores specified in the Twelfth Schedule).

Explanation 1.—The sale proceeds referred to in clause (a) 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.

Explanation 2.—For the removal of doubts, it is hereby declared that where any goods or merchandise are transferred by an assessee to a branch, office, warehouse or any other establishment of the assessee situate outside India and such goods or merchandise are sold from such branch, office, warehouse or establishment, then, such transfer shall be deemed to be export out of India of such goods and merchandise and the value of such goods or merchandise declared in the shipping bill or bill of export as referred to in sub-section (1) of section 50 of the Customs Act, 1962 (52 of 1962), shall, for the purposes of this section, be deemed to be the sale proceeds thereof.

(3) For the purposes of sub-section (1),—

(a) where the export out of India is of goods or merchandise manufactured or processed by the assessee, the profits derived from such export shall be the amount which bears to the profits of the business, the same proportion as the export turnover in respect of such goods bears to the total turnover of the business carried on by the assessee;

(b) where the export out of India is of trading goods, the profits derived from such export shall be the export turnover in respect of such trading goods as reduced by the direct costs and indirect costs attributable to such export;

(c) where the export out of India is of goods or merchandise manufactured or processed by the assessee and of trading goods, the profits derived from such export shall,—

(i) in respect of the goods or merchandise manufactured or processed by the assessee, be the amount which bears to the adjusted profits of the business, the same proportion as the adjusted export turnover in respect of such goods bears to the adjusted total turnover of the business carried on by the assessee; and

(ii) in respect of trading goods, be the export turnover in respect of such trading goods as reduced by the direct and indirect costs attributable to export of such trading goods :

Provided that the profits computed under clause (a) or clause (b) or clause (c) of this sub-section shall be further increased by the amount which bears to ninety per cent of any sum referred to in clause (iiia) (not being profits on sale of a licence acquired from any other person), and clauses (iiib) and (iiic) of section 28, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee :

Provided further that in the case of an assessee having export turnover not exceeding rupees ten crores during the previous year, the profits computed under clause (a) or clause (b) or clause (c) of this sub-section or after giving effect to the first proviso, as the case may be, shall be further increased by the amount which bears to ninety per cent of any sum referred to in clause (iiid) or clause (iiie), as the case may be, of section 28, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee :

Provided also that in the case of an assessee having export turnover exceeding rupees ten crores during the previous year, the profits computed under clause (a) or clause (b) or clause (c) of this sub-section or after giving effect to the first proviso, as the case may be, shall be further increased by the amount which bears to ninety per cent of any sum referred to in clause (iiid) of section 28, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee, if the assessee has necessary and sufficient evidence to prove that,—

(a) he had an option to choose either the duty drawback or the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme; and

(b) the rate of drawback credit attributable to the customs duty was higher than the rate of credit allowable under the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme :

Provided also that in the case of an assessee having export turnover exceeding rupees ten crores during the previous year, the profits computed under clause (a) or clause (b) or clause (c) of this sub-section or after giving effect to the first proviso, as the case may be, shall be further increased by the amount which bears to ninety per cent of any sum referred to in clause (iiie) of section 28, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee, if the assessee has necessary and sufficient evidence to prove that,—

(a) he had an option to choose either the duty drawback or the Duty Free Replenishment Certificate, being the Duty Remission Scheme; and

(b) the rate of drawback credit attributable to the customs duty was higher than the rate of credit allowable under the Duty Free Replenishment Certificate, being the Duty Remission Scheme.

Explanation.—For the purposes of this clause, "rate of credit allowable" means the rate of credit allowable under the Duty Free Replenishment Certificate, being the Duty Remission Scheme calculated in the manner as may be notified by the Central Government :

Provided also that in case the computation under clause (a) or clause (b) or clause (c) of this sub-section is a loss, such loss shall be set off against the amount which bears to ninety per cent of—

(a) any sum referred to in clause (iiia) or clause (iiib) or clause (iiic), as the case may be, or

(b) any sum referred to in clause (iiid) or clause (iiie), as the case may be, of section 28, as applicable in the case of an assessee referred to in the second or the third or the fourth proviso, as the case may be, the same proportion as the export turnover bears to the total turnover of the business carried on by the assessee.

Explanation.—For the purposes of this sub-section,—

(a) "adjusted export turnover" means the export turnover as reduced by the export turnover in respect of trading goods;

(b) "adjusted profits of the business" means the profits of the business as reduced by the profits derived from the business of export out of India of trading goods as computed in the manner provided in clause (b) of sub- section (3) ;

(c) "adjusted total turnover" means the total turnover of the business as reduced by the export turnover in respect of trading goods ;

(d) "direct costs" means costs directly attributable to the trading goods exported out of India including the purchase price of such goods ;

(e) "indirect costs" means costs, not being direct costs, allocated in the ratio of the export turnover in respect of trading goods to the total turnover ;

(f) "trading goods" means goods which are not manufactured or processed by the assessee.

(3A) For the purposes of sub-section (1A), profits derived by a supporting manufacturer from the sale of goods or merchandise shall be,—

(a) in a case where the business carried on by the supporting manufacturer consists exclusively of sale of goods or merchandise to one or more Export Houses or Trading Houses, the profits of the business ;

(b) in a case where the business carried on by the supporting manufacturer does not consist exclusively of sale of goods or merchandise to one or more Export Houses or Trading Houses, the amount which bears to the profits of the business the same proportion as the turnover in respect of sale to the respective Export House or Trading House bears to the total turnover of the business carried on by the assessee.

(4) The deduction under sub-section (1) shall not be admissible unless the assessee furnishes in the prescribed form, along with the return of income, the report of an accountant, as defined in the Explanation below sub-section (2) of section 288, certifying that the deduction has been correctly claimed in accordance with the provisions of this section:

Provided that in the case of an undertaking referred to in sub- section (4C), the assessee shall also furnish along with the return of income, a certificate from the undertaking in the special economic zone containing such particulars as may be prescribed, duly certified by the auditor auditing the accounts of the undertaking in the special economic zone under the provisions of this Act or under any other law for the time being in force.

(4A) The deduction under sub-section (1A) shall not be admissible unless the supporting manufacturer furnishes in the prescribed form along with his return of income,—

(a) the report of an accountant, as defined in the Explanation below sub-section (2) of section 288, certifying that the deduction has been correctly claimed on the basis of the profits of the supporting manufacturer in respect of his sale of goods or merchandise to the Export House or Trading House; and

(b) a certificate from the Export House or Trading House containing such particulars as may be prescribed and verified in the manner prescribed that in respect of the export turnover mentioned in the certificate, the Export House or Trading House has not claimed the deduction under this section :

Provided that the certificate specified in clause (b) shall be duly certified by the auditor auditing the accounts of the Export House or Trading House under the provisions of this Act or under any other law.

(4B) For the purposes of computing the total income under sub- section (1) or sub-section (1A), any income not charged to tax under this Act shall be excluded.

(4C) The provisions of this section shall apply to an assessee,—

(a) for an assessment year beginning after the 31st day of March, 2004 and ending before the 1st day of April, 2005;

(b) who owns any undertaking which manufactures or produces goods or merchandise anywhere in India (outside any special economic zone) and sells the same to any undertaking situated in a special economic zone which is eligible for deduction under section 10A and such sale shall be deemed to be export out of India for the purposes of this section.

Explanation.—For the purposes of this section,—

(a) "convertible foreign exchange" means foreign exchange which is for the time being treated by the Reserve Bank of India as convertible foreign exchange for the purposes of [the Foreign Exchange Management Act, 1999 (42 of 1999)], and any rules made thereunder ; (aa) "export out of India" shall not include any transaction by way of sale or otherwise, in a shop, emporium or any other establishment situate in India, not involving clearance at any customs station as defined in the Customs Act, 1962 (52 of 1962) ;]

(b) "export turnover" means the sale proceeds, received in, or brought into, India by the assessee in convertible foreign exchange in accordance with clause (a) of sub- section (2)] of any goods or merchandise to which this section applies and which are exported out of India, but does not include freight or insurance attributable to the transport of the goods or merchandise beyond the customs station as defined in the Customs Act, 1962 (52 of 1962) ;

(ba) "total turnover" shall not include freight or insurance attributable to the transport of the goods or merchandise beyond the customs station as defined in the Customs Act, 1962 (52 of 1962) :

Provided that in relation to any assessment year commencing on or after the 1st day of April, 1991, the expression "total turnover" shall have effect as if it also excluded any sum referred to in clauses (iiia), (iiib), (iiic), (iiid) and (iiie) of section 28;

(baa) "profits of the business" means the profits of the business as computed under the head "Profits and gains of business or profession" as reduced by—

(1) ninety per cent of any sum referred to in clauses (iiia), (iiib), (iiic), (iiid) and (iiie) of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits ; and

(2) the profits of any branch, office, warehouse or any other establishment of the assessee situate outside India ;

(c) "Export House Certificate" or "Trading House Certificate" means a valid Export House Certificate or Trading House Certificate, as the case may be, issued by the Chief Controller of Imports and Exports, Government of India ;

(d) "supporting manufacturer" means a person being an Indian company or a person (other than a company) resident in India, manufacturing (including processing) goods or merchandise and selling such goods or merchandise to an Export House or a Trading House for the purposes of export;

(e) "special economic zone" shall have the meaning assigned to it in clause (viii) of the Explanation 2 to section 10A.]”

9. In K.Ravindranathan Nair’s case (supra) which has been heavily relied upon by the learned Senior Counsel for the revenue, we find that while interpreting explanation (baa) to section 80HHC of the Act, it was held that the formula in section 80HHC(3) provided for a fraction of export turnover divided by the total turnover to be applied to business profits calculated after deducting 90 per cent of the sums mentioned in clause (baa) of the explanation. Profit incentives like rent, commission, brokerage charges, etc., though formed part of the gross total income, had to be excluded as these were "independent incomes" which had no element of export turnover. All the four variables in the section were required to be kept in mind and if all the four variables are kept in mind, it becomes clear that every receipt is not income and every income would not necessarily include the element of export turnover. It was further observed that clause (baa) of the Explanation states that 90 per cent of the incentive profits or receipts by way of brokerage, commission, interest, rent, charges or any other receipt of like nature included in business profits have to be deducted from business profits computed in terms of sections 28 to 44D. In other words, receipts constituting independent income having no nexus with exports were required to be deducted from business profits under clause (baa).

10. The Hon'ble Supreme Court observed that a bare reading of clause (baa)(1) indicates that receipts by way of brokerage, commission, interest, rent charges, etc., formed part of the gross total income being business profits. But for the purpose of working out of formula and in order to avoid distortion in arriving at the export profits clause (baa) stood inserted to say that although incentive profits and "independent incomes" constituted part of the gross total income, these had to be excluded from gross total income because such receipts had no nexus with the export turnover.

11. The Hon'ble Apex Court further observed that processing charges, which are part of gross total income, form an item of independent income like rent, commission, brokerage, etc., and, therefore, 90% of the processing charges have also to be reduced from the gross total income to arrive at the business profits and, therefore, it has also to be included in the total turnover in the formula for arriving at the business profits in terms of the clause (baa) of the Explanation to section 80HHC(3). It was further held by the Hon'ble Supreme Court that:-

"In the above formula there existed four variables, namely, business profits, export turnover, total turnover and 90 per cent. of the sums referred to in clause (baa) to the said Explanation. In the computation of deduction under section 80 HHC all four variables had to be taken into account. All four variables were required to be given weightage. The substitution of section 80 HHC(3) secures profits derived from the exports of eligible goods. Therefore, if all the four variables are kept in mind, it becomes clear that every receipt is not income and every income would not necessarily include element of export turnover. This aspect needs to be kept in mind while interpreting clause (baa) to the said Explanation. The said clause stated that 90 per cent of incentive profits or receipts by way of brokerage, commission, interest, rent, charges or any other receipt of like nature included in business profits, had to be deducted from business profits computed in terms of sections 28 to 44D of the Income-tax Act. In other words, receipts constituting independent income having no nexus with exports were required to be reduced from business profits under clause (baa). A bare reading of clause (baa)(1) indicates that receipts by way of brokerage, commission, interest, rent, charges, etc., formed part of gross total income being business profits. But for the purposes of working out the formula and in order to avoid distortion of arriving at the export profits, clause (baa) stood inserted to say that although incentive profits and "independent incomes" constituted part of gross total income, they had to be excluded from gross total income because such receipts had no nexus with the export turnover. Therefore, in the above formula, we have to read all the four variables. On reading all the variables it becomes clear that every receipt may not constitute sale proceeds from exports. That, every receipt is not income under the Income-tax Act and every income may not be attributable to exports. This was the reason for this court to hold that indirect taxes like excise duty which are recovered by the taxpayers for and on behalf of the Government, shall not be included in the total turnover in the above formula."

"Before concluding we state that the nature of every receipt needs to be ascertained in order to find out whether the said receipt forms part of/or that it has an attribute of an export turnover. When an indirect tax is collected by the taxpayer on behalf of the Government the tax recovered is for the Government. It may be an income in the conceptual sense or even under the Income-tax Act but while working out the formula under section 80HHC(3) of the Income-tax Act and while applying the four variables one has to ascertain whether the receipt has an attribute of export turnover."

12. What can be deduced from the judgment in K. Ravindranathan Nair’s case (supra) is that any independent income which is not derived from the export activities in terms of Section 80 HHC (2) of the Act but is otherwise assessed as business income, 90% of such receipts have to be reduced from the profits of the business in terms of Explanation (baa) to Section 80 HHC of the Act.

13. Now, we proceed to deal with the precedents as relied upon by learned counsel for the assessee to canvass that since all liability incurred by the assessee-company in respect of the interest had infact earlier been allowed as deduction while computing the profit of the export business, then merely because such liability ceases to exist, the same will not undergo a change in its nature and become an independent income.

14. In Commissioner of Income-Tax versus Shri Ram Honda Power Equip [2007] 289 ITR 475 (Delhi), after taking into consideration the entire law on the subject, the learned Division Bench of Delhi High Court summarized the legal position as follows:-

“To summarise our conclusions:

(i) In computing what the profits derived from exports for the purposes of 80HHC(1) read with 80HHC(3) are, the nexus test has to be applied to exclude that which does not partake of profits that can be said to have been derived from the business of exports.

(ii)In the specific context of Clause (baa) of the Explanation to Section 80HHC, while determining the 'profits of the business', the AO has to undertake a two-step exercise in the following sequence. He has to first 'compute' the profits of the business under the head "profits and gains of business or profession." In other words, he will have to compute business profits, in terms of the Act, by applying the provisions of Sections 28 to 44 thereof.

(iii) In arriving at profits of the business by the above method, the AO will exclude all such incomes which partake the character of 'income from other sources' which in any event are treated under Sections 56 and 57 of the Act and are therefore not to be reckoned for the purposes of Section 80HHC. The AO will apply the law as explained in the judgments of the Kerala High Court referred to above which have been affirmed by the Hon'ble Supreme Court in Ravindra Nathan’s case supra.

(iv) Where surplus funds are parked with the bank and interest is earned thereon it can only be categorised as income from other sources. This Page 0528 receipt merits separate treatment under Section 56 of the Act which is outside the ring of profit and gains from business and profession. It goes entirely out of the reckoning for the purposes of Section 80HHC.

(v) Interest earned on fixed deposits for the purposes of availing credit facilities from the bank, does not have an immediate nexus with the export business and therefore has to necessarily be treated as income from other sources and not business income.

(vi) 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.

(vii) In the second stage, the AO will deduct from the profits of the business computed under the head profits and gains of business or profession the following sums in order to arrive at the 'profits of the business' for the purposes of Section 80HHC(3):

(a) 90% of any sum referred to in Clauses (iiia), (iiib) and (iiic) of Section 28 i.e. export incentives;

(b) 90% of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and

(c) profits of any branch, office, warehouse or any other establishment of the assessed situate outside India.

(viii) The word “interest” in clause (baa) of the Explanation connotes “net interest” and not “gross interest”. Therefore, in deducting such interest, the AO will take into account the net interest i.e. gross interest as reduced by expenditure incurred for earning such interest. The decision of the Special Bench of the ITAT in Lalsons [2004] 8 ITR 25 (Delhi) to this effect is affirmed. In holding as above, we differ from the judgments of the Punjab & Haryana High Court in Rani Paliwal [2004] 268 ITR 220 and the Madras High Court in Chinnapandi [2006] 282 ITR 389 and affirm the ruling of the Special Bench of the ITAT in Lalsons [2004] 8 ITR 25 (Delhi).

(ix) Where, as a result of the computation of profits and gains of business and profession, the AO treats the interest receipt as business income, then deduction should be permissible, in terms of Explanation (baa) of the net interest i.e. the gross interest less the expenditure incurred for the purposes of earning such interest. The nexus between obtaining the loan and paying interest thereon (laying out the expenditure by way of interest) for the purpose of earning the interest on the fixed deposit, to draw an analogy from Section 37, will require to be shown by the assessed for application of the netting principle.”

15. In Commissioner of Income-Tax versus Bhansali Engineering Polymars Ltd. [2008) 306 ITR 194 (Bom), it was held by a learned Division Bench of the Bombay High Court that the interest received on delayed payments from sundry debtors to whom the industrial unit of the assessee had sold goods could be treated as interest income derived from such industrial undertaking even though the assessee had realised income from other sources.

16. In Commissioner of Income-Tax versus Sociedade De Fomento Industrial Ltd. [2011] 335 ITR 472 (Bom) a learned Division Bench of the Bombay High Court held that though the main object of the assessee was to extract iron ore and export the same, the interest received from the bank and intercorporate deposits earned out of surplus funds by the assessee could not be said to be an activity which was not includible in the business profits for the purpose of Section 80 HHC. In such a situation, it could not be said that the assessee had not carried out the business of placing various deposits and earning interest therefrom. It was further held that the activity carried out could be definitely held business activity and hence an income earned therefrom was to be taxed business income only. The interest income had to be taken into account for the purpose of Section 80 HHC.

17. In ACG Associated Capsules Pvt. Ltd. versus Commissioner of Income-Tax (2012) 3 SCC 321 while affirming the view taken by the Delhi High Court in Shri Ram Honda’s case (supra), it was held by the Hon’ble Supreme Court that the profits of business “as contemplated under Explanation (baa) means the profit of business as computed under the head “profits and gains of business or profession” as reduced by the receipts of the nature mentioned in clauses (1) and (2) of Explanation (baa). Thus, profits of the business of an assessee will have to be first computed under the head “profits and gains of business or profession” in accordance with the provisions of Sections 28 to 44-D of the Act. In the computation of such profits of business, all receipts of income which are chargeable as profits and gains of business under Section 28 of the Act will have to be included. Similarly, in computation of such profits of business, different expenses which are allowable under Sections 30 to 44-D have to be allowed as expenses. After including such receipts of income and after deducting such expenses, the total of the net receipts are profits of the business of the assessee computed under the head “ profits and gains of business or profession” from which deductions are to be made under clauses (1) and (2) of Explanation (baa).

18. It was held that under clause (1) of Explanation (baa), ninety per cent of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in any such profits are to be deducted from the profits of the business as computed under the head "profits and gains of business or profession". The expression "included any such profits" in clause (1) of the Explanation (baa) would mean only such receipts by way of brokerage, commission, interest, rent, charges or any other receipt which are included in the profits of the business as computed under the head "profits and gains of business or profession". Therefore, if any quantum of the receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature is allowed as expenses under Sections 30 to 44D of the Act and is not included in the profits of business as computed under the head "profits and gains of business or profession", ninety per cent of such quantum of receipts cannot be reduced under Clause (1) of Explanation (baa) from the profits of the business. In other words, only ninety per cent of the net amount of any receipt of the nature mentioned in clause (1) which is actually included in the profits of the assessee is to be deducted from the profits of the assessee for determining "profits of the business" of the assessee under Explanation (baa) to Section 80HHC.

19. It was further held that Explanation (baa) has to be construed on its own language and as per the plain natural meaning of the words used in Explanation (baa), the words "receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits" will not only refer to the nature of receipts but also the quantum of receipts included in the profits of the business as computed under the head "profits and gains of business or profession" referred to in the first part of the Explanation (baa). Accordingly, if any quantum of any receipt of the nature mentioned in clause (1) of Explanation (baa) has not been included in the profits of business of an assessee as computed under the head "profits and gains of business or profession", ninety per cent of such quantum of the receipt cannot be deducted under Explanation (baa) to Section 80HHC.

20. Finally, after interpreting the provisions of Explanation (baa), it was held that if the rent or interest is a receipt chargeable as profits and gains of business and chargeable to tax under Section 28 of the Act and if any quantum of the rent or interest of the assessee is allowable as an expense in accordance with Sections 30 to 44-D of the Act and is not to be included in the profits of the business of the assessee as computed under the head “profits and gains of business or profession”, 90% of such quantum of the receipt of interest or rent will not be deducted under clause (1) of Explanation (baa) to Section 80 HHC. In other words, 90% of not the gross rent or gross interest but only the net interest or net rent which has been included in the profits of business of the assessee as computed under the head “profits and gains of business or profession” is to be deducted under clause (1) of Explanation (baa) to Section 80 HHC for determining the profits of the business.

21. Now what emerges from the aforesaid exposition of law is that as per Section 80 HHC deduction is to be allowed from the profits derived by the assessee from the exports of goods or merchandise while computing the gross total income and the object of this Section is to grant an incentive to earners of foreign exchange and the matter, therefore, essentially has to be considered with reference to that object. Under sub-section (3) of Section 80 HHC, the mechanism for determination of profits derived from export of goods or merchandise has been prescribed for the purposes of sub-section (1). Clause (a) thereof deals with an assessee where the business is export of goods or merchandise manufactured by the assessee. Clause (b) relates to an assessee whose business is of export outside India of trading goods, whereas, clause (c) applies to an assessee whose business comprised both export of manufactured goods and also of trading goods. The computation referred to above is to be made having regard to the “profits of the business” which are determined in terms of clause (baa) of the Explanation to Section 80 HHC of the Act. The said Explanation provides that the expression “profits of the business” means, the profits as computed under the head “profits and gains of business or profession”, as reduced by 90% of the sums referred to in clauses (iiia), (iiib) and (iiic) of Section 28 or any receipt by way of brokerage, commission, interest, rent, charges and any other receipt of the similar nature included in such profits.

22. It would also be noticed that Section 41(1) creates a legal fiction and can be extended for the purpose of allowing deduction from “profits of the business” as referred to in Section 80 HHC of the Act. The income chargeable to tax under Section 41(1) of the Act is from reversal of any loss, expenditure or trading liability which had extinguished or ceased to exist. The legal fiction can only be extended to the extent that the provisions of Section 80 HHC have to be understood excluding the legal fiction created by deeming provisions contained in Section 41(1) of the Act as the source of income which is chargeable cannot be related to export of goods or merchandise because if any other meaning is assigned to the aforesaid fiction created with respect to Section 41(1), it would be against the basic purpose and object of Section 80 HHC of the Act. If that be so, then the exclusion of 90% of the deemed income under Section 41(1) of the Act is not in accordance with the correct interpretation of Explanation (baa) to Section 80 HHC of the Act and, therefore, the ITAT, in such circumstances, has rightly allowed the appeal of the assessee.

23. That apart, it would also be noticed that the liability incurred by the assessee company in respect of the interest had infact been earlier allowed as deduction while computing the profits of the export business, the same will not now undergo a change in its nature and become an independent income. However, in terms of the judgment passed by the Hon’ble Supreme Court in ACG Associated’s case (supra), the benefit would only be available on the net interest which had been included in the profits of the business of the assessee as computed under the head “profits and gains of business or profession” that alone will be deducted under clause (1) of the Explanation (baa) to Section 80 HHC of the Act for determining the profits of the business and not the gross interest.

24. The question is accordingly answered in the aforesaid terms. However, it is once again clarified that while computing the interest under clause (baa) of the Explanation, the Assessing Officer will take into account the net interest i.e. gross interest as reduced by expenditure incurred for earning such interest.

25. In view of the aforesaid discussion, there is no merit in this appeal and the same is dismissed with the aforesaid clarification, leaving the parties to bear their own costs. Pending application, if any, also stands disposed of.

(Mansoor Ahmad Mir),

Chief Justice.

( Tarlok Singh Chauhan),

November 30, 2015. Judge.