This Tax Alert summarizes a recent decision of the Special Bench (SB) of the Chennai Income Tax Appellate Tribunal (ITAT) [2010-TIOL-69-ITAT-MAD-SB] in the case of Scientific Atlanta India Technology Pvt. Ltd. (Taxpayer). The issue before the SB was that, while computing the amounts eligible for tax holiday under the Indian Tax Law (ITL), whether the losses of an undertaking of the Taxpayer which is not eligible for tax holiday (Non-eligible Undertaking), are required to be set off against the profits of another undertaking of the Taxpayer which is eligible for tax holiday (Eligible Undertaking).
The SB held that the amount eligible for tax holiday was specific to each undertaking of the Taxpayer. Further, for the purpose of determining the amount eligible for tax holiday under the ITL, the losses of a Non-eligible Undertaking are not required to be set off against the profits of an Eligible Undertaking.
Background and facts of the case
- The ITL provides tax holiday with respect to profits and gains derived from undertakings engaged in the export of articles or things or computer software for a period of 10 consecutive years, subject to conditions specified therein (Tax Holiday). Up to tax year 1999-00, the ITL provided for exemption of income derived from such undertakings i.e. income of Eligible Undertakings did not form part of the total income of a taxpayer. From tax year 2000-01, the ITL provides for a deduction of profit derived from Eligible Undertaking from its total income. Such profit forms part of the income of a taxpayer but is reduced later before arriving at the total income.
- The Taxpayer, a private limited company, carried on its business in 2 locations in India. One undertaking, engaged in the business of software development and registered with the Software Technology Parks of India, was an Eligible Undertaking for the purpose of Tax Holiday under the ITL. The other undertaking was engaged in carrying out trading activities of various products of the Taxpayer, hence a Non-eligible Undertaking. During the tax years 2002-03 and 2003-04, the Eligible Undertaking earned profits and the Non-eligible Undertaking reported a loss. The Taxpayer claimed the Tax Holiday for entire profits of the Eligible Undertaking without deducting losses incurred by the Non-eligible Undertaking. Such losses were carried forward to be set off in future years, as per the provisions of the ITL.
- The Tax Authority recomputed the amounts eligible for the Tax Holiday by reducing the losses incurred by the Non-eligible Undertaking from the profits earned by the Eligible Undertaking.
- The Taxpayer appealed to the first appellate authority which restricted the total amount eligible for the Tax Holiday to the extent of the total income of the Taxpayer i.e. aggregate of the income of both the undertakings along with income from any other sources. Total income was determined at Nil, after allowing benefit of the Tax Holiday.
- Aggrieved by the order of the first appellate authority, both the Taxpayer and the Tax Authority preferred an appeal before the ITAT. In view of the importance of the issue involved, an SB was constituted to adjudicate the issue referred under appeal.
Issue before the SB
Whether losses of the Non-eligible Undertaking are required to be set off against the profits of the Eligible Undertaking for computing the amount eligible for the Tax Holiday under the ITL.
Contentions of the Taxpayer
- The ITL provides the Tax Holiday by way of a deduction of the profits derived from the Eligible Undertaking, from the total income of a taxpayer. The Tax Holiday provided under the ITL is an exemption provision and, hence, the profits earned from the Eligible Undertaking should not be included in the computation of total income and should be computed separately.
- The placement of the Tax Holiday provisions in the ITL is along with the categories of incomes that are exempt from tax and this leads to an inescapable conclusion that the income from the enumerated sources should not be subject to income tax and is to be excluded at the threshold from the total income.
- The Tax Holiday provisions, including the Tax Holiday computation mechanism, indicate that the benefit of the Tax Holiday under the ITL is available in respect of each undertaking i.e. it is undertaking-specific. Hence, the amount of the Tax Holiday has to be computed undertaking-wise and not business-wise and it is available to the extent of profits derived from the Eligible Undertaking. In support of the above, reliance was placed on various circulars issued by the Central Board of Direct Taxes and certain earlier decisions given in the context of deductions claimed under the ITL.
- The entire profits derived from the Eligible Undertaking would be entitled for the Tax Holiday as the ITL does not provide any restriction or qualification with regard to the Tax Holiday. The Tax Holiday provision is a special code in respect of which no restriction is permissible, except in special cases that have been demarcated by the Legislature.
- The amount eligible for the Tax Holiday is deducted while computing the total income under the ITL. The phrase ‘total income’ used in the Tax Holiday provision is to be understood as total income of the Eligible Undertaking. The deduction under the Tax Holiday is provided at the source level only. Any other view may not make the provision workable as the ITL does not provide any mechanism for deduction from the total income already computed.
- The forms specified for filing the return of income also provide that the deduction under the Tax Holiday has to be granted at the time of computing the business income of a taxpayer.
- The ITL provides for the mechanism for computation of business income of a taxpayer and, separately, for the set off of losses from one source of income against another source. Therefore, the loss of the Non-eligible Undertaking cannot be set off before allowing the deduction of the Tax Holiday under the ITL.
- The Tax Holiday is an incentive provision introduced to benefit certain sectors of the industry and the same should be construed beneficially to arrive at the intended object.
Contentions of the Tax Authority
- The Tax Holiday was originally enacted as providing an exemption and, hence, the amounts eligible for the Tax Holiday did not form part of the total income of a taxpayer. Exclusion of profit at the threshold of computation of income was earlier possible. Post an amendment, the Tax Holiday is allowed as a deduction of the eligible amount from the total income. Being a deduction section, it has to necessarily undergo the process of computation of total income.
- Total income is determined by setting off the loss incurred in any undertaking against the profit of the Eligible Undertaking. It is a settled law that when a deduction is granted for any profits or gains from the total income, such a profit or gain can only refer to a positive figure arrived at after setting off the losses of other undertakings.
- When the intention of the provision of the ITL is clear, the form specified for filing the return of income cannot be relied upon to determine the method of computation of the amount eligible for the Tax Holiday.
Ruling of the SB
- From the language of the Tax Holiday provision, as applicable to the relevant tax years, as also from the placement of the Tax Holiday provision in the ITL, what is contemplated is only the deduction of profits and gains derived by an undertaking from export of articles or things or computer software. The intention of the Legislature is only to give deduction from total income and not to provide exclusion from total income at the threshold.
- Even though the Tax Holiday provision is placed with the incomes exempted from tax under the ITL, what is given by the Tax Holiday provision is only a deduction and not an exemption. The Legislature has consciously placed the Tax Holiday provision separately from other deduction provisions, only with the idea of varying the percentage of deduction from year to year or whenever necessary.
- The deduction of amount eligible for the Tax Holiday is to be made at the stage of arriving at the business income of a taxpayer and not while computing total income.
- The ITL does not specifically restrict the amount of the Tax Holiday to the total income of a taxpayer. Wherever the Legislature wants to restrict the deduction, it has specifically provided such a restriction.
- The SB held that the Tax Holiday is undertaking-specific. In computing the amount eligible for the Tax Holiday, total income in respect of that undertaking is to be determined and such an amount is reduced from the total income of a taxpayer.
- Since the deduction under the Tax Holiday provision is undertaking-specific, the business losses of the Non-eligible Undertaking of the Taxpayer cannot be set off against the profits of the Eligible Undertaking.
- The SB, however, clarified that this decision will have application to the facts before it. The SB observed that if there are more than one Eligible Undertakings and if some of the undertakings have profit and others have loss, it would be an entirely different case.
Under the provisions of the ITL, a special bench of a tribunal consisting of 3 or more members may be constituted for disposal of any particular case. Such benches are generally constituted when there are conflicting decisions or the matter pending for adjudication is of considerable importance. It is also a well-settled judicial convention to consider a decision of a special bench as binding on the other benches of the tribunal.
For the purpose of the computation of the amount eligible for the Tax Holiday under the ITL, the aspect of set off of losses of non-eligible undertaking of a taxpayer had been a contentious issue. The Tax Authority had generally taken an approach which resulted in the Tax Holiday being computed in a manner which truncated the amount qualifying for the Tax Holiday. This had also led to conflicting decisions by various benches of the tribunals. The present decision of the SB which has decided the controversy in favor of the Taxpayer, should bring greater clarity to all taxpayers.