2011 (5) TMI 575 - AT - Income Tax

Deduction u/s 10A - taxability of gain or deduction of loss arising on account of fluctuation in rate of foreign exchange - ECB s raised form its parent company for meeting its working capital requirements - Held that - section 10A(1) provides for connotation of such profit or gain as are derived from the export of articles or things or computer software. As reiterated in Liberty India (2009 (8) TMI 63 - SUPREME COURT) the contention of the words derived from is narrower as compared to that of words attributable . By using the expression derived from in S. 10A(1), the Parliament intended to cover sources not beyond the first degree. In the present case, gain is not on account of fluctuation in foreign exchange relating to assessee s export activities. The same is with respect to the external commercial borrowings. This cannot be termed as derived from the export activity of the assessee. The assessee s reliance in this regard on section 10A(4) does not come to its rescue, as the said sub-section only provides the formula for computing profits derived from the export activity. First, the income or gain has to be derived from export activity, only then the computation formula can be applied - against assessee.

Issues Involved:
1. Disallowance of claim of deduction under section 10A of the Income Tax Act.
2. Computation of income and denial of deduction under section 10A on foreign exchange fluctuation gain.

Detailed Analysis:

1. Disallowance of Claim of Deduction under Section 10A of the Income Tax Act:

The main issue raised by the Assessee was that the Commissioner of Income Tax (Appeals) erred in upholding the disallowance of the deduction under section 10A of the Income Tax Act amounting to Rs. 3,52,90,374/- made by the Assistant Commissioner of Income Tax. The Assessee argued that the foreign exchange fluctuation gain should be considered as business income eligible for deduction under section 10A. The Commissioner of Income Tax (Appeals) held that the income from foreign exchange gain was not derived from the export of articles or things or computer software, as required by section 10A. The Commissioner cited several case laws distinguishing the present case from others where deductions were allowed under different circumstances.

2. Computation of Income and Denial of Deduction under Section 10A on Foreign Exchange Fluctuation Gain:

The Assessee filed a return declaring NIL income for the assessment year 2004-05, but the regular assessment was completed at a taxable income of Rs. 27,58,30,556/-. The Commissioner of Income Tax found the assessment order erroneous and prejudicial to the interest of revenue because the Assessee had shown income from foreign exchange fluctuation gain under "other income" rather than "income from operation," which did not qualify for deduction under section 10A. The Assessing Officer observed that the Assessee had raised external commercial borrowings (ECBs) from its parent company, resulting in a notional foreign exchange gain, which was shown as "other income." The Officer rejected the Assessee's contention that the gain constituted business income eligible for deduction under section 10A.

Upon appeal, the Commissioner of Income Tax (Appeals) upheld the disallowance, stating that the foreign exchange gain was not derived from the export of articles or things or computer software. The Commissioner referred to several case laws, including the Hon'ble Supreme Court's decision in Woodward Governor India, which dealt with the recognition of exchange differences under Accounting Standard 11.

Additional Plea/Ground:

The Assessee also raised an additional ground, arguing that no real income had accrued as the gain was merely a book entry reflecting the difference in exchange rates. The Tribunal admitted this ground for adjudication but ultimately dismissed it, citing the Hon'ble Supreme Court's decision in Woodward Governor India, which recognized exchange differences as income or expenses in the period they arise.

Main Substantive Issue:

The Tribunal considered whether the Commissioner of Income Tax (Appeals) erred in upholding the disallowance of the deduction under section 10A. The Assessee argued that the foreign exchange gain was derived from its export activities and should qualify for the deduction. The Tribunal referred to several case laws, including the Hon'ble Madras High Court's decision in Menon Impex, which held that interest income from bank deposits did not have a direct nexus with the industrial undertaking and thus did not qualify for deduction under section 10A.

The Tribunal concluded that the foreign exchange gain was not derived from the Assessee's export activities but from external commercial borrowings, which did not meet the criteria for deduction under section 10A. The Tribunal upheld the order of the Commissioner of Income Tax (Appeals) and dismissed the Assessee's appeal.

Conclusion:

The appeal filed by the Assessee was dismissed, and the disallowance of the deduction under section 10A on the foreign exchange fluctuation gain was upheld. The Tribunal found no infirmity or illegality in the order of the Commissioner of Income Tax (Appeals). The decision was pronounced in the open court on 27.5.2011.

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