2018 (4) TMI 1634 - HC - Income Tax

Entitlement to deduction u/s 10B - proof of manufacture - ITAT held that since there is no word as for the removal of doubt in Explanation 4 to Section 10B the said has to be held as prospective and not retrospective as claimed by the assessee - Held that - Referring to Article by one Akiva Caspi titled as Modern Diamond Cutting And Polishing gives detailed process undertaken for cutting and polishing of raw diamonds. Essentially this Article aims to explain the complexities involved in the process and the sophistication required to carry out such process in order to optimize the value and quantity of the polished diamonds that may emerge out of such process. Whether carried out manually or through sophisticated machines, it is impossible to deny that the process of cutting and polishing diamonds is a complex one requiring specialized knowledge and expertise at every step. Rough unpolished diamond on one hand and cut and polished diamond on the other differ completely in appearance, value and uses. Thus this process of cutting and polishing diamonds brings into existence a new product which has totally different marketable commodity. From such Article, we gather that cutting and polishing diamonds have sparkle and definite desired shapes. Through this process thus a completely new commodity having a different market is brought into existence. In the result, question no.1 is answered in favour of the assessee. Though question no.2 is answered against the assessee, Tax Appeal is allowed in view of answer of the first question. Judgment of the Tribunal confirming the view of the revenue authorities is set aside. The assessee is held entitled to deduction under section 10B

Summary

Issues Involved:
1. Entitlement to deduction under Section 10B of the Income Tax Act.
2. Retrospective or prospective application of Explanation 4 to Section 10B.

Issue-wise Detailed Analysis:

1. Entitlement to Deduction under Section 10B:

The assessee, a registered partnership firm engaged in the import of rough diamonds and export of finished diamonds, claimed a deduction under Section 10B of the Income Tax Act for the assessment year 2001-2002. The Assessing Officer (AO) initially allowed the deduction but later reopened the assessment, citing the amendment to Section 10B by the Finance Act, 2003, which inserted Explanation 4. This explanation clarified that "manufacture or produce" includes cutting and polishing of precious and semi-precious stones, leading the AO to believe that such activities qualified for deduction only post-amendment, i.e., from assessment year 2004-2005.

The assessee argued that Explanation 4 was merely clarificatory and should apply to all pending cases, asserting that cutting and polishing diamonds is a manufacturing activity. They cited various judicial precedents, including the Supreme Court's judgment in Commissioner of Income-tax v. Gem India Mfg. Co., which was later explained in Heaven Diamonds (P) Ltd., and other High Court judgments supporting the view that such activities amount to manufacturing.

The Tribunal initially ruled against the assessee, relying on Gem India Mfg. Co. However, the High Court found that the Tribunal did not thoroughly examine the process undertaken by the assessee. The High Court emphasized that cutting and polishing diamonds involve complex processes resulting in a new product with different marketability, thereby qualifying as manufacturing.

2. Retrospective or Prospective Application of Explanation 4:

The High Court examined whether Explanation 4 to Section 10B was clarificatory or prospective. The plain language of the provision, the budget speech of the Finance Minister, and the memorandum explaining the Finance Bill, 2003, indicated that the provision was prospective, applicable from 1.4.2004. The Court concluded that the insertion of Explanation 4 was not intended to be retrospective.

Conclusion:

The High Court held that even if Explanation 4 was prospective, the assessee's activity of cutting and polishing diamonds amounted to manufacturing, entitling them to deduction under Section 10B for the period before the insertion of Explanation 4. The Tribunal's judgment was set aside, and the assessee was granted the deduction.

Disposition:

The Tax Appeals were allowed in favor of the assessee, with the Tribunal's judgment confirming the revenue authorities' view being set aside. The assessee was held entitled to deduction under Section 10B of the Income Tax Act.