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TMI Blog2007 (1) TMI 86X X X X Extracts X X X X X X X X Extracts X X X X ..... a ofany goods or merchandise to which this Section applies, there shall, inaccordance with and subject to the provisions of this section, be allowed, incomputing the total income of the assessee, a deduction to the extent ofprofits, referred to in sub-section (1B), derived by the assessee from theexport of such goods or merchandise: . . . (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.. . . . . . . .. (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 am ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... port 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e comparative disadvantage faced by him in the international market. With a view to ensuring that the tax concession is not misused, sub-section (3) of section 80HHC of the Income-tax Act has been amended." 6. This Circular also clarifies certain other concepts that will be presently discussed. 7. A plain reading of the provision is indicative of the overall scheme which appears to be as follows : (a) The assessee has to be an Indian company engaged in the business of exports out of India of any goods or merchandise. (b) In computing the total income of such assessee, a deduction is allowed "to the extent of profits", referred to in sub-section (1B) "derived by the assessee from the export of such goods or merchandise". (c) Sub-section (1B) specifies the extent of deduction of profits. In a graded scale this has been progressively reduced by the legislature from 80 per cent for the Assessment Year 2001-02 to 30 per cent for the Assessment Year 2004-05, after which this deduction has been done away with. Effectively, therefore, the benefit under Section 80HHC is no longer available to an assessee after the beginning of the Assessment Year on April 1, 2005. (d) Where the busine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent, charges or any other receipts of a similar nature included in such profits [B] - Profits of any branch, office, warehouse or any other establishment of the assessee situate outside India [C] In other words, by using the symbols in the above equation, it can be further represented as under : POB = PAGBP - 90 per cent A - 90 per cent B - C Thus profits derived from exports would be: [PAGBP - 90 per cent A - 90 per cent B - C] x export turnover/Total turnover The use of the words computed under the head "profits and gains of business and profession" in clause (baa) is a direct reference to the exercise of computation of business income in accordance with Sections 28 to 44 of the Act. Questions and Issues 8. The questions that arise in this batch of appeals may be stated as under : (a) Does the expression "profits derived from such export" occurring in sub-section (3) read with Explanation (baa) restrict the profits available for deduction in terms of sub-section (1) to only those items of income directly relatable to the business of export ? (b) Does the expression "interest" in Explanation (baa) connote net interest, i.e. the gross interest income less the expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... from other sources" i.e., Section 56, the real issue is to find out the nature of the interest income in question. (b) even if interest income is assessed under the head "Income from other sources", if interest income is seen to have arisen from a business activity or, in other words, it has a close nexus with the business carried on by the assessee then it will bear the imprint of or have the quality of business income for limited purposes. © reliance is placed on the judgment of this Court in Snam Progetti S.P.A v. CIT [1981]132 ITR 70 which has been upheld by the Hon'ble Supreme Court by the dismissal of the Special Leave Petition in [1991] 189 ITR (St.) 116. Here it was held that the question to be examined is whether the interest income was derived from what may be described as a business activity. If it is so derived then the mere fact that it is taxed under a different section will make no difference. It was held that in that case the income earned by way of interest from deposits which represented the spare funds of the assessee, would nevertheless constitute business income. (d) reliance is placed on the Central Board Direct Taxes Circular No. 564 dated July 5, 1990 (s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h approach, it is urged that the Explanation "included in such profits" following the words "brokerage, commission, interest, rent, charges or any other receipts of a similar nature" is indicative of the fact that such amounts are the 'net' amounts and not the gross amounts because profits cannot be arrived at by any businessman without accounting for the expenditure incurred in earning such interest. Only such interest would be "included in the profits". 15. It is further urged that clause (baa) states that the "profits and gains of business or profession" have to be first "computed". This necessarily takes us to Sections 28 to 44 of the Act. The various stages in such computation, including Section 37, perforce envisage accounting for the expenditure incurred by an assessee for earning the income. The assessees further draw support from Circular No.621 dated December 19, 1991 and paragraph 30.11 thereof which states: "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 or such incomes is provided to account for these expenses". 16. The further argument is that wherever the Legi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... omissus. In other words, the Court ought not to supply words when none exist. It is maintained that just as the assessees argue that in this behalf if the Legislature intended that these receipts like commission, brokerage, interest had to be net interest, then clearly the Legislature would have said so and in the absence of such a clear enunciation, the word "interest" has to be interpreted to mean "gross interest". Applying the strict rule of construction in interpreting the statutes, the Department urges that the expression 'interest' occurring in Clause (baa) can only mean gross interest. A comparison is sought to be drawn between clauses (a) and (b) of sub-section (3) to urge that the treatment in either case should be uniform. 21. It is urged that the Legislature has permitted the retention of 10 per cent of the interest income to compensate for the expenses laid out for earning such income and therefore a further deduction of the expenditure incurred for earning such interest, if permitted, would amount to a double deduction which clearly was not envisaged. Nature of Interest income : Is it Business Income or Income from Other Sources ? 22. The first issue that arises in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eld not to qualify for setting off against interest on loans borrowed. The other decisions on the same lines, in the context of Section 80HHC are CIT v. Sterling Foods [1999] 237 ITR 579 (SC) and Pandian Chemicals [2003] 262 ITR 278 (SC). In these decisions, the Hon'ble Supreme Court reiterated the nexus theory and declined to treat such interest earned as business income. Significantly, the provision of the Act involved in these cases do not contain a machinery clause similar to clause (baa) to the Explanation below sub-section (4C) of Section 80HHC. Still, if one were to draw an analogy, an assessee who is engaged in the business of exports and invests the surplus funds in fixed deposits 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. 24. On the distinction between the words "attributable to" and "derived from", the judgment of the Hon'ble Supreme Court in Cambay Electrical Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84 is illustrative. It was held (ITR Page 93) : "In our view, since the expression of wider import, namely "attributable to", has been used, the Legisla ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Hon'ble Supreme Court in CIT v. Karnal Co-operative Sugar Mills [2000] 243 ITR 2 was in the context of determining the nature of income earned by way of interest on the amounts deposited for opening a letter of credit for the purchase of machinery required for setting up a plant. It was held that the interest earned was a capital receipt since the deposit was incidental to the acquisition of assets. The decision of the Madras High Court in South India Shipping Corporation v. CIT [1999] 240 ITR 24 (Mad) was also rendered in the context of treating certain receipts not as business income but income from other sources for the purposes of Section 56 read with Section 57(iii) of the Act. 26. It is true that none of these cases considered or discussed a clause similar to clause (baa) of the Explanation below sub-section (4C) of Section 80HHC of the Act. If, as contended by counsels for both sides, Section 80HHC is a "stand-alone" provision that has to be construed on its own wording, then these judgments may not be particularly helpful. Moreover, the wording of clause (baa) of the Explanation incorporates the entire procedure for computing business income under Sections 28 to 44 of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 assessee 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 Hon'ble Supreme Court by the dismissal of the Special Leave Petition [order reported in [2004] 265 ITR (St) 38]. 31. In K. Ravindranathan Nair, in dealing with a similar issue, the Kerala High Court held (ITR page 673) : "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 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 rece ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , as regards the first of the categories, viz., the parking of surplus funds, there should be no difficulty at all. In view of the large number of the decisions of the Hon'ble Supreme Court in the context of Section 56 and Section 57 and those of the Kerala High Court in the context of Section 80HHC itself, we are unable to accept the contention of the assesses based on Snam Progretti [1981]132 ITR 70 that interest earned on parked surplus funds should qualify as business income. Clearly, Snam Progretti [1981] 132 ITR 70 was not rendered in the context of Section 80HHC and cannot but be confined to the facts of that case. Circular No. 564 dated April 5, 1990 can also not help in interpreting Section 80HHC which is a "stand alone" provision. We are therefore of the view that where surplus funds are parked with the bank and interest is earned thereon it can only be categorised as income from other sources. This 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. To give effect to this position, the Assessing Officer while compu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tep process in computing profits derived from exports. First, the Assessing Officer is required to apply Sections 28 to 44 in order to compute the profits and gains of business or profession. In doing so, the Assessing Officer may find that certain incomes, which have no nexus to the export business of the assessee, are not allowable and therefore ought to be treated as income from other sources. Once the Assessing Officer computes what is business income then he proceeds to the next step of deducting 90 per cent of the receipts referred in clause (baa) of the Explanation to Section 80HHC in order to arrive at the profits derived from profits. It is at this stage that the questions (b) and (c) arise. To recapitulate these are : (b) Does the expression "interest" in Explanation (baa) connote net interest, i.e. the gross interest income less the expenditure incurred by the assessee for earning such income, or does it connote gross interest ? (c) If the expression "interest" implies net interest, then should netting not be allowed where the interest income is computed to be business income? 40. The decision of the Supreme Court in Distributors (Baroda) P. Ltd. [1985] 155 ITR 120. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act is included in the gross total income or in other words, forms part of the gross total income, the condition specified in the opening part of sub-section (1) of Section 80M would be fulfilled and the provision enacted in that sub-section would be attracted." 43. The Hon'ble Supreme Court clarified (page. 134) that : "Now when an amount by way of dividend is received by the assessee from the paying company, the full amount of such dividend would have suffered tax in the assessment of the paying company and it is obvious, that, in order to encourage inter-company investments, the Legislature intended that this amount should not bear tax once again in the hands of the assessee either in its entirety or to a specified extent. But the amount by way of dividend which would otherwise suffer tax in the hands of the assessee would be the amount computed in accordance with the provisions of the Act and not the full amount received from the paying company. Therefore, it is reasonable to assume that in enacting Section 80M, the Legislature intended to grant relief with reference to the amount of dividend computed in accordance with the provisions of the Act and not with reference to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be giving to the word "such" its full meaning and effect. The word "such" in the context which it occurs can only mean that income by way of dividends from a domestic company which is included in the gross total income and that must necessarily be income by way of dividends computed in accordance with the provisions of the Act." 46. The expression "by way of" which qualified the word "income" in Section 80M is similar to the words "receipts by way of" occurring in Explanation (baa) of Section 80HHC of the Act. Further the words "included in such profits" occurs in both the provisions. Just as in Distributors (Baroda) [1985] 155 ITR 120 (SC) where it was explained by the Hon'ble Supreme Court that the words "such" profits can only be understood as "computed in accordance with the provisions of the Act", we are of the view that similar words in clause (baa) should partake of the same meaning. Applying the ratio of Distributors (Baroda), [1985] 155 ITR 120 (SC) we hold that the legislative intent in using the word "interest" in clause (baa) to the explanation in section 80HHC is indicative of "net interest, i.e. gross interest less the expenditure incurred by the assessee in earning ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of the assessees that an interpretation other than that suggested by them, i.e. interest in this context refers to net interest, might produce unintended or absurd results. A reference may be made to the decision of the Hon'ble Supreme Court in Keshavji Ravji and Co. v. CIT [1990] 183 ITR 1. 51. 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. 52. Once business income has been determined by applying accounting standards as well as the provisions contained in the Act, the assessee 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. 53. Support for this proposition is to be found from Circular No. 621 dated December 19, 1991 (see [1992] 195 ITR (St.) 154, 178) of the Central Board Direct Taxes. "32.10 The existing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the Profit and Loss account and will depress the profit to that extent. The idea of Section 80HHC is to ensure that the exporter gets the benefit of the profits derived from export and not to depress the profit further. Therefore, it can only be the net interest which can be included in the profits. If netting were not to be permitted the result would be that the profits of the exporter would be depressed by an item that is expenditure incurred on earning interest, which does not form part of the profit at all. This could not have been the intention of the legislature. 56. There is also no merit in the contention of the Department that the treatment of clause (a) of Section 80HHC (a) should be no different from clause (b) of the same sub-section. Explanation (baa) is relatable only to clause (a) of Section 80HHC (3) and not to clause (b) thereof. These operate in distinct areas and no inter-mixing is contemplated. For all of these reasons, we hold that the word "interest" in clause (baa) to the Explanation in Section 80HHC is indicative of "net interest, i.e. gross interest less the expenditure incurred by the assessee in earning such interest. 57. The Tribunal's decision in L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tead of the entire receipts, has been given for common expenses, according to the circular. Such common expenses are generally the indirect or fixed expenses which every businessman has to incur to continue in business, such as salaries and wages, other administrative expenses and so on. In addition to such common expenses, there may be expenses which have a direct bearing or nexus with the receipts by way of interest, commission, brokerage, rent etc. If such receipts are to be taken out of profits of the business on the footing that they have no connection with the business profits or the turnover, it seems only fair and reasonable to hold that the expenditure having a nexus with such receipts should also be taken out of the business profits on the same footing. This conclusion is warranted, in our humble opinion, even on the language of clause (1) of the Explanation. The receipts that are to be excluded from the business profits are those which are "included in such profits". The word "receipts" used in the clause does not, in our view, refer to gross receipts merely because the word "net" is not used before it: nor does it mean, as was suggested on behalf of the Department, to d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Income-tax Appellate Tribunal in Lalsons Enterprises [2004] 89 ITD 25 (Delhi) that the expression "interest" in clause (baa) of the Explanation to Section 80HHC connotes "net interest" and not "gross interest". 66. Question (b) is answered accordingly by holding that the word "interest"in clause (baa) of the Explanation connotes "net interest" and not "gross interest" 67. Question (c): Is netting allowable on business income" 68. The last submission of the Department is that even if the interest earned is to be construed as part of the business income, the netting should not be permitted since the statute does not specifically say so. Reliance was placed on the judgment in IPCA Laboratory Ltd. v. Deputy CIT [2004] 266 ITR 521(SC) ; CIT v. Chinnapandi [2006] 282 ITR 389 and Rani Paliwal v. CIT [2004] 268 ITR 220 (P & H). 69. In Rani Paliwal [2004] 268 ITR 220 (P & H).the High Court, without any detailed discussion simply held as follows (page 222) : "A plain reading of clause (baa) of Explanation to section 80HHC of the Act makes this aspect quite clear and we are of the view that the Tribunal was right in disallowing the claim of the assessee in this regard." We are afraid t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ded from business profits." 71. To the above, we may add a few lines by way of clarification. It will bear examination whether obtaining the loan and paying interest thereon (laying out the expenditure by way of interest) was "wholly and exclusively"for the purpose of earning the interest on the fixed deposit, to draw an analogy from Section 37. This nexus will have to be shown by the assessee for application of the netting principle. 72. For all of the above reasons we respectfully differ from the views expressed by the Punjab and Haryana High Court in Rani Paliwal [2004] 268 ITR 220. and the Madras High Court in Chinnapandi [2006] 282 ITR 389. 73. We accordingly hold that 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. Question (c) is answered accordingly. Conclusions 74. To summarise our conclusions : (i) In computing what the profits derived from exports for the purposes of 80HHC(1) read with 80HHC ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ives; (b) 90 per cent. 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 assessee 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 Assessing Officer 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 Income-tax Appellate Tribunal in Lalsons [2004] 8 ITR 25 (Delhi) to this effect is affirmed. In holding as above, we differ from the judgments of the Punjab and Haryana High Court in Rani Paliwal [2004] 268 ITR 220and the Madras High Court in Chinnapandi [2006] 268 ITR 389 and affirm the ruling of the Special Bench of the ITAT in Lalsons. (ix) Where, as a result of the computation of profits and gains of business and profession, the Assessing Officer treats the interest receipt as business income, then deduction should be permissible, in terms of Explanation (baa) of the net i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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