Court Upholds Business Income Inclusion for Tax Deduction

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Case Name:

Priviera Home Furnishing vs. Additional Commissioner of Income Tax (High Court of Delhi)

ITA 459/2015

Date: 19th November 2015

Key Takeaways:

• The court emphasized that once an income forms part of the business of the eligible undertaking, it cannot be excluded from the eligible profits for deduction under Section 10B (of Income Tax Act, 1961).
• The decision clarifies that interest on fixed deposits, customer claims, and freight subsidies are considered part of the business income if they have a nexus to the business activities.
• The ruling reinforces the interpretation of Section 10B (of Income Tax Act, 1961) as a complete code for computing eligible business profits, distinct from other sections like 80IA or 80IB.

Issue:

The central legal question was whether the income from customer claims, freight subsidies, and interest on fixed deposits should be included in the profits eligible for deduction under Section 10B (of Income Tax Act, 1961).

Facts:

Priviera Home Furnishing, a private limited company engaged in manufacturing and exporting home furnishings, claimed deductions under Section 10B (of Income Tax Act, 1961) for various incomes, including deemed export drawbacks, customer claims, freight subsidies, and interest on fixed deposits. The Assessing Officer excluded these from eligible income, leading to an appeal by the Assessee.

Arguments:

• Assessee’s Argument: The Assessee argued that the incomes in question were integral to the business operations and should be included in the eligible profits for deduction under Section 10B (of Income Tax Act, 1961).
• Revenue’s Argument: The Revenue contended that these incomes did not directly derive from the export of goods and should not be included in the eligible profits.

Key Legal Precedents:

• CIT v. Motorola India Electronics Pvt. Ltd.: This case was cited to support the inclusion of interest income as part of business profits eligible for deduction.
• Liberty India v. Commissioner of Income Tax: Referenced to discuss the scope of deductions under different sections of the Income Tax Act.

Judgement:

The court ruled in favor of the Assessee, allowing the inclusion of the disputed incomes in the eligible profits for deduction under Section 10B (of Income Tax Act, 1961). The court found that these incomes were part of the business of the undertaking and had a sufficient nexus to the business activities.

FAQs:

Q1. Why was the interest on fixed deposits included in the business income?

A1. The court found that the interest on fixed deposits had a direct nexus to the business activities, as it was related to the utilization of bank facilities necessary for business operations.

Q2. What does this decision mean for other businesses?

A2. This decision sets a precedent that similar types of income can be included in the business profits eligible for deduction under Section 10B (of Income Tax Act, 1961), provided they are integral to the business operations.

Q3. How does this ruling affect the interpretation of Section 10B (of Income Tax Act, 1961)?

A3. The ruling reinforces the interpretation of Section 10B (of Income Tax Act, 1961) as a comprehensive code for computing eligible business profits, distinct from other sections that might have different criteria for deductions.

1. The present appeal by the Appellant Assessee under Section 260A (of Income Tax Act, 1961) (‘Act’) is directed against the impugned order dated 27th February 2015 passed by the Income Tax Appellate Tribunal (‘ITAT’) in ITA No.1191/Del/2012 for the Assessment Year (‘AY’) 2008-09.

2. Admit.

3. The following questions of law are framed for consideration:

“(i) Whether in the facts and circumstances of the case, ITAT

is correct in law in not allowing the exemption of

Rs.28,27,224/-, on account of customer claim, ignoring the

express provision of Section 10B(4) (of Income Tax Act, 1961), whereby

profit of business of the undertaking are eligible for deduction.

(ii) Whether in the facts and circumstances of the case, ITAT

is correct in law in not allowing the exemption of

Rs.29,24,405/- on account of freight subsidy, ignoring the

express provision of section l0B(4) of the Act, whereby profit

of business of the undertaking are eligible for deduction.

(iii) Whether in the facts and circumstances of the case, ITAT

is correct in law in not allowing the exemption of Rs.43,287/-,

on account of interest on FDR, ignoring the express provision

of section 10B(4) (of Income Tax Act, 1961), whereby profit of business of the

undertaking are eligible for deduction.”

4. The Assessee is a private limited company engaged in the business of

manufacture and sale of home furnishings such as rugs, bath mats, blankets etc. The Assessee set up a 100% Export Oriented Undertaking ('EOU')which was an 'eligible unit' for the purposes of deductions under Section 10B (of Income Tax Act, 1961). The Assessee commenced operations on 1st October 2002.

The Assessee filed its return of income for AY 2008-09 on 27th September

2008 declaring an income of Rs. 10,34,24,340. Inter alia, the Assessee

claimed deduction in respect of the income earned from the following

receipts:

(a) Deemed Export Drawback (Export Incentives) Rs. 1,22,25,214/-

(b) Customer Claims Rs. 28,27,224/-

(c) Freight Subsidy Rs. 29,24,405/-

(d) Interest on Fixed Deposit Receipts (FDRs) made for business purposes:

Rs.43,287/-.

5. The return of the Assessee was picked up for scrutiny and notice under Section 143(2) (of Income Tax Act, 1961) was issued. The Assessing Officer (‘AO’) by order dated 3rd December 2010 excluded the above receipts from the computation of eligible income under Section 10B(4) (of Income Tax Act, 1961). The AO was of the view that the above receipts did not fall within the expression ‘profit derived’from the export of articles.

6. The appeal of the Assessee was dismissed by the Commissioner of

Income Tax (Appeals) [‘CIT (A)’] on 11th January 2012. The Assessee

thereafter filed an appeal before the ITAT which came to be decided by the impugned order.

7. The ITAT in the impugned order agreed with the contention of the

Assessee as regards the deemed export drawback forming part of the income eligible for deduction under Section 10B (of Income Tax Act, 1961). However, as regards other three items, viz., customer claims, freight subsidy and interest on FDRs made for business purposes, the ITAT concurred with the view of the AO and the CIT (A). This is how the Assessee is in appeal before this Court.

8. This Court has heard the arguments of Mr. Ved Jain, learned counsel for the Assessee and Mr. Ashok Manchanda, Senior standing counsel for the Revenue.

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 Pvt. 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 ad 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 pre-payment 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 (of Income Tax Act, 1961) and applied the formula under Section 10B(4) (of Income Tax Act, 1961) for determining the profits from exports. The Assessee’s contention that the expression “profits of the business of the undertaking" in Section 10B(4) (of Income Tax Act, 1961) was wider than the expression "profits and gains derived by” the Assessee from a 100% EOU occurring in Section 10 (of Income Tax Act, 1961) B (1) was accepted by the ITAT. The ITAT noticed that unlike Section 80 (of Income Tax Act, 1961) 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.

10. In CIT v. Motorola India Electronics Pvt. Ltd. (supra) reference was

made to the decision of the Supreme Court in Pandian Chemicals Ltd. v.

Commissioner of Income Tax (2003) 262 ITR 278 which dealt with Section

80HH and Liberty India v. Commissioner of Income Tax (2009) 317 ITR

218, which interpreted Section 801B (of Income Tax Act, 1961). Reference was also made

to the decision of CIT v. Sterling Foods (1999) 237 ITR 579 (SC), which

interpreted Section 80HH (of Income Tax Act, 1961) and the decision of the Madras High Court in CIT v. Menon Impex P Ltd. (2003) 259 ITR 403(Mad.) which interpreted

Section 10A (of Income Tax Act, 1961). The Karnataka High Court in CIT v. Motorola

India Electronics Pvt. Ltd. (supra), after noticing the above decisions, held that “it is clear that, what is exempted is not merely the profits and gains from the export of articles but also the income from the business of the undertaking”. Specific to the question of interest earned by the EOU on the FDRs placed by it and interest earned from the loans given to sister concerns, it was held that although it did not partake the character of profit and gains from the sale of an article “it is income which is derived from the consideration realized by export of articles.”

11. The decision of the Karnataka High Court in CIT v. Motorola India

Electronics Pvt. Ltd. (supra) was followed by this Court in its decision in CIT v. Hritnik Exports Pvt. Ltd. (decision dated 13th November 2014 in ITA Nos. 219 and 239 of 2014). This Court also referred to its earlier decision dated 1st September 2014 in ITA No. 438 of 2014 (CIT v. XLNC Fashions). While declining to frame a question of law in the Revenue’s appeal, this Court in CIT v. Hritnik Exports Pvt. Ltd. (supra) quoted with approval the observations of the Special Bench of the ITAT in Maral Overseas Ltd. v. ACIT (decision dated 20th March 2012) on the interpretation of Section 10B(4) (of Income Tax Act, 1961) as under:

“79. Thus, sub-section (4) of section 10B (of Income Tax Act, 1961) stipulated 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, not-with-standing the fact

that sub-section (1) of section 10B (of Income Tax Act, 1961) 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 Income Tax Act, 1961). 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 (of Income Tax Act, 1961) to exclude the

same from the eligible profits. The mode of determining the

eligible deduction u/s 10B (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961) 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 (of Income Tax Act, 1961). On the basis of the aforesaid

distinction, sub-section (4) of section 10A (of Income Tax Act, 1961)/10B of the Act is a

complete code providing the mechanism for computing the

"profits of the business" eligible for deduction u/s 10B (of Income Tax Act, 1961) 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 u/s 10B (of Income Tax Act, 1961). As per the computation made by

the Assessing Officer himself, there is no dispute that both these

incomes have been treated by the Assessing Officer as business

income. The CBDT Circular No. 564 dated 5th July, 1990

reported in 184 ITR (St.) 137 explained the scope and ambit of

section 80HHC (of Income Tax Act, 1961) and the mode of determination of profits

derived by an assessee from the export of goods. I.T.A.T.,

Special Bench in the case of International Research Park

Laboratories v. ACIT, 212 ITR (AT) 1, after following the

aforesaid Circular, held that straight jacket formula given in

sub-section (3) has to be followed to determine the eligible

deduction. The Hon'ble Supreme Court in the case of P.R.

Prabhakar; 284 ITR 584 had approved the principle laid down

in the Special Bench decision in International Research Park

Laboratories v. ACIT (supra). In the assessee's own case the

I.T.A.T. in the preceding years, after considering the decision in

the case of Liberty India held that provisions of section 10B (of Income Tax Act, 1961) are

different from the provisions of section 80IA (of Income Tax Act, 1961) wherein no

formula has been laid down for computing the eligible business

profit.”

12. Recently, in a decision dated 6th October 2015 in ITA NO. 392 of 2015(Principal Commissioner of Income Tax v. Universal Precision Screws),this Court had occasion to again consider whether interest earned on fixed deposits kept by an Assessee which was eligible under Section 10B (of Income Tax Act, 1961), as a condition for utilization of letter of credit and bank guarantee limits, would qualify for deduction. That question was decided in favour of the Assessee and against the Revenue. The Court held as under:

"9. On the question of interest on the FDRs, the ITAT has referred to

Section 10B(4) (of Income Tax Act, 1961) which states that for the purposes of Section 10B(1) (of Income Tax Act, 1961),

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.’ As noted by this Court in CIT v. Hritnik Exports Pvt.

Ltd. (decision dated 13th November, 2014 in ITA No.219 & 239 of

2014), Section 10B(4) (of Income Tax Act, 1961) andates the application of the formula for

determining the profits derived from exports for the purposes of

Section 10B(1) (of Income Tax Act, 1961). In other words, the formula would read thus:

Profits derived = profits of the business x export turnover

from export of the undertaking total turnover

9A. In terms of the above formula, the question that would arise

is whether the interest on the FDRs could form part of the

‘profits of the business of the undertaking’. The attention of the

Court has been drawn to the decision of the Karnataka High

Court in CIT v. Motorola India Electronics Pvt. Ltd. (2014) 46

Taxmann.com 167 (Kar.) which held that there was a direct

nexus between the interest received from the FDRs created by a

similarly placed Assessee from the amounts borrowed by it.

The High Court approved the order of the ITAT in that case

which held that the entire profits of the business of the

undertaking should be taken into consideration while

computing the eligible deduction under Section 10B (of Income Tax Act, 1961)

by ITA 392/2015 applying the mandatory formula.

10. In the present case, the Assessee has stated that the interest

on FDRs was received on “margin kept in the bank for

utilization of letter of credit and bank guarantee limits”. In

those circumstances, the decision of the ITAT that such interest

bears the requisite characteristic of business income and has

nexus to the business activities of the Assessee cannot be

faulted. In other words, interest earned on the FDRs would form

part of the “profits of the business of the undertaking” for the

purposes of computation of the profits derived from export by

applying formula under Section 10B(4) (of Income Tax Act, 1961)”

13. Mr. Ashok Manchanda, learned Senior standing counsel for the Revenue,urged that none of the earlier decisions of the High Courts have considered the effect of Sections 80I, 801A and 801B of the Act which occur in Chapter VIA of the Act. He referred in particular to Section 80A(4) (of Income Tax Act, 1961),which reads as under:

“4) Notwithstanding anything to the contrary contained in section

10A or section 10AA (of Income Tax Act, 1961) or section 10B (of Income Tax Act, 1961) or section 10BA (of Income Tax Act, 1961) or in any

provisions of this Chapter under the heading “C—Deductions in

respect of certain incomes”, where, in the case of an assessee,

any amount of profits and gains of an undertaking or unit or

enterprise or eligible business is claimed and allowed as a

deduction under any of those provisions for any assessment year,

deduction in respect of, and to the extent of, such profits and

gains shall not be allowed under any other provisions of this Act

for such assessment year and shall in no case exceed the profits

and gains of such undertaking or unit or enterprise or eligible

business, as the case may be.”

14. Mr. Manchanda’s attempt was to show that Section 80A(4) (of Income Tax Act, 1961), which inter alia stated that any deduction allowable under Section 10B (of Income Tax Act, 1961) cannot in any case “exceed the profits and gains of such undertaking or unit or enterprise or eligible business, as the case may be” made it clear that a unit seeking deduction under Section 10B (of Income Tax Act, 1961) would be eligible to do so only in so far as such income was directly attributable to the business of export. Any income that might be merely incidental to the business of the undertaking, not directly related to the activity of export, would not be eligible for such deduction. He also took the Court again through the decision of the Supreme Court in Liberty India (supra) and submitted that the earlier decisions of this Court in Hritnik Exports (supra) and Universal Precision Screws (supra) might require to be reconsidered. When a question was posed to him as to whether the Revenue had challenge the aforementioned decisions of this Court, and of the ITAT in the present case to the extent it has allowed the plea of the Assessee as regards ‘deemed export drawback’, Mr. Manchanda stated that the Revenue ought to have challenged the above decisions as well as the impugned order of the ITAT in the present case and perhaps he would

advise it to do so hereafter. He has also handed over a written note of

submissions, reiterating the above submissions.

15. 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 Income Tax Act, 1961). The opening words of Section 80A(4) (of Income Tax Act, 1961) read “Notwithstanding anything to the contrary contained in section 10A (of Income Tax Act, 1961) or section 10AA (of Income Tax Act, 1961) or section 10B (of Income Tax Act, 1961) or section 10BA (of Income Tax Act, 1961) or in any provisions of this Chapter.....”. What is sought to be underscored, therefore, is that Section 80A (of Income Tax Act, 1961), 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) (of Income Tax Act, 1961) was to ensure that a unit which has availed of the benefit under Section 10B (of Income Tax Act, 1961) will not be allowed to further claim relief under Section 80IA (of Income Tax Act, 1961) or 80IB (of Income Tax Act, 1961) read with Section 80A(4) (of Income Tax Act, 1961). The intention does not appear to be to deny relief under Section 10B(1) (of Income Tax Act, 1961) read with Section 10B(4) (of Income Tax Act, 1961) 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 Pvt. 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 (of Income Tax Act, 1961)/10B of the Act is a complete code providing the mechanism for computing the ‘profits of the business’ eligible for deduction u/s 10B (of Income Tax Act, 1961). 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 u/s 10B (of Income Tax Act, 1961).”

16. This then brings us to the questions framed for consideration in the

present case and the decision of the ITAT in not accepting the Assessee’s plea in regard to ‘customer claims’ ‘freight subsidy’ and ‘interest on fixed deposit receipts’ even while it accepted the Assessee’s case as regards ‘deemed export drawback’.

17. The contention of the Assessee as regards customer claims was that it had received the claim of Rs. 28,27,224 from a customer for cancelling the export order. Later on the cancelled order was completed and goods were exported to another customer. The sum received as claim from the customer was non-severable from the income of the business of the undertaking. The Court fails to appreciate as to how the ITAT could have held that this transaction did not arise from the business of the export of goods. Even as regards freight subsidy, the Assessee’s contention was that it had received the subsidy in respect of the business carried on and the said subsidy was part of the profit of the business of the undertaking. If the ITAT was prepared to consider the deemed export draw back as eligible for deduction then there was no justification for excluding the freight subsidy. Even as regards the interest on FDR, the Court has been shown a note of the balance

sheet of the Assessee [which was placed before the AO] which clearly states that “fixed deposit receipts (including accrued interest) valuing Rs.15,05,875 are under lien with Bank of India for facilitating the letter of credit and bank guarantee facilities.” In terms of the ratio of the decisions of this Court both in Hritnik Exports (supra) and Universal Precision Screws (supra), the interest earned on such FDR ought to qualify for deduction under Section 10B (of Income Tax Act, 1961).

18. Accordingly, the questions are answered in favour of the Assessee and against the Revenue. The impugned order of the ITAT to the extent it

answered the said questions against the Assessee is hereby set aside.

19. The appeal is allowed in the above terms, but with no order as to costs.

S. MURALIDHAR, J

VIBHU BAKHRU, J

NOVEMBER 19, 2015