Duty Drawback & sale of DEPB license not eligible for tax holiday – SC

This article  summarizes a recent ruling of the Supreme Court (SC) [2009-TIOL­100-SC-IT] in the case M/s Liberty India (Taxpayer), in which the SC held that the receipts, by way of Duty Drawback and sale of Duty Entitlement Pass Book (DEPB) licence by the Taxpayer, do not form part of the profits ‘derived from’ the industrial undertaking (IU), eligible for tax holiday under the Indian Tax Law (ITL). The SC further held that the Duty Drawback and sale of DEPB licence are incentives which flow from the schemes framed by the Government of India (G01) and do not have any direct nexus with the profits derived from the eligible IU of the Taxpayer.

Facts of the case

• The Taxpayer is engaged in the manufacturing of fabrics and various textile items. The Taxpayer is eligible for tax holiday in respect of the profits derived from the business of the eligible IU.

• For the tax year 2000-01, the Taxpayer claimed tax holiday in respect of the Duty Drawback and sale of DEPB licence, claiming it to be directly connected with the eligible IU.

• The Tax Authority denied the tax holiday claimed by the Taxpayer, treating the amounts received as export incentive, under the schemes framed by the GOI and not as profits derived from the eligible IU.

• The first appellate authority held that only the Duty Drawback, and not sale of DEPB licence, was linked to the profits derived from the eligible IU.

• The second appellate authority held that the Duty Drawback was not profit derived from the eligible IU.

• The High Court held that the amounts received were not eligible for tax holiday, as the Taxpayer failed to prove the nexus of the Duty Drawback and sale of DEPB licence with the eligible IU.

Contentions of the Taxpayer

• The Duty Drawback and sale of DEPB licence were meant to neutralize the incidence of duty paid on raw materials and other inputs used in the manufacture of goods intended for export, and thus, constituted an integral part of the profits derived from the eligible IU.

• The duty paid on raw materials and other inputs used in the manufacture of goods was inextricably linked to the eligible IU, as, without such payment of duty, the manufacturing operations could not have been undertaken. Receipts by way of Duty Drawback and sale of DEPB licence were, effectively, reimbursement of such duty paid and, hence, cannot be treated as an independent source of income, disregarding the payment of duty.

• The meaning of ‘income derived from the business of eligible IU’ is wider than that of ‘income derived from the eligible IU’. Hence, the benefit of tax holiday is not limited only to the ‘profits derived from’ the eligible IU, but also extend to incomes arising in the course of running of the eligible business.

Contentions of the Tax Authority

• The tax holiday is available in respect of profits ‘derived from’ the eligible IU. A direct nexus has to exist between the profits derived and the eligible IU.

• The receipts by way of Duty Drawback and sale of DEPB licence were pursuant to the schemes framed by the GOI to encourage exports and the immediate source of the receipts were the schemes and not the eligible IU. Hence, the receipts cannot be construed as profits ‘derived from’ the eligible IU.

• The Tax Authority placed reliance on an earlier SC decision where it was held that the amount received on sale of import entitlements, pursuant to the schemes framed by the GOI, did not constitute profits derived from the eligible IU.

Ruling of the SC

• The tax holiday benefit available to an eligible IU is a profit-linked incentive i.e. it is not the ownership of the IU, but the profits generated by it, which are eligible for the benefit. The profits are to be computed as if the eligible IU is the only source of income of the Taxpayer.

• Though the object behind Duty Drawback and DEPB is to neutralize the incidence of duty paid, the remission of duty is on account of the schemes framed by the GOI and cannot be regarded as the profits derived from the eligible IU.

• The phrase ‘derived from’ is narrower and is intended to cover only those receipts that have a direct nexus with the eligible IU. The receipts by way of Duty Drawback and sale of DEPB licence may constitute profits or gains of the business, but cannot be construed as profits or gains ‘derived from’ the eligible IU for tax holiday. The immediate and proximate source of these receipts is not the eligible IU, but the schemes framed by the GOI. The receipts are in the nature of ancillary profits of the eligible IU.

Comments:-The High Courts in India have taken conflicting views on the issue of eligibility for tax holiday on the receipts by way of Duty Drawback and sale of DEPB licence. The SC’s decision has set to rest the controversy, prevalent for quite some time, on the issue. The tax holiday will need to be worked out, without taking into account these receipts. The law laid down by the SC is the law of the land and is binding on all the Courts/appellate authorities.

NF