Initial assessment year for computation of profits eligible for tax holiday is the year in which taxpayer exercises the option to claim deduction

Velayudhaswamy Spinning Mills (P) Ltd. (Taxpayer), Madras High Court (HC) [38 DTR 57]

Under the Indian Tax Laws (ITL), a taxpayer carrying on the business of generation of electricity, which qualifies for income-linked deduction (eligible business), can opt to claim such deduction for a period of 10 assessment years (AYs) out of 15 years, beginning from the year in which the taxpayer commences generation of power.

The Madras HC held that the first AY in which the taxpayer opts to claim the deduction would be the ‘initial AY’ from when the eligible business would be treated as the only source of income of the taxpayer. In computing profits qualifying for the deduction in the initial AY, the taxpayer is not required to reduce the losses incurred by it in the AYs prior to the initial AY.

Background

Under the ITL, taxpayers engaged in infrastructure development are eligible for an income-linked deduction. The business of generation of electricity qualifies as infrastructure development and, therefore, is eligible for deduction. The taxpayer has an option of claiming deduction for any 10 consecutive AYs out of 15 years, beginning from the year in which the taxpayer commences generation of power. For the purpose of computing the quantum of deduction, the eligible business is fictionally treated as the only source of income of the taxpayer. The issue before the Madras HC was whether the eligible business should be treated as the only source of income from the AY in which the taxpayer exercises the option to claim deduction or the AY in which the taxpayer commences the eligible business.

Facts

The Taxpayer carried on the eligible business and claimed the income-linked deduction in respect of the profits derived from such business. In this case, the Taxpayer opted to claim deduction from the initial AY, under the relevant provisions of the ITL.

The Taxpayer had incurred losses in some of the AYs prior to the initial AY. In computing profits qualifying for deduction in the initial AY, the Taxpayer did not take into account losses incurred in the eligible business in AYs up to the initial AY, which were set off by the Taxpayer against its other income. The Tax Authority reduced the amount qualifying for deduction by the amount of unabsorbed depreciation incurred in the AYs prior to the initial AY, on the ground that the eligible business should be fictionally treated as the only source of income of the Taxpayer from the commencement of such business.

The first appellate authority reversed the Tax Authority’s order. It held that, as the unabsorbed depreciation pertaining to the earlier AYs had already been set off against other income of the Taxpayer in the respective

AYs, such unabsorbed depreciation cannot be notionally brought forward and considered for determining profits qualifying for deduction in the initial AY.

Placing reliance on the ruling of Ahmedabad Special Bench (SB) in the case of ACIT v. Goldmine Shares and Finance (P) Ltd. [116 TTJ 705] , the Income Tax Appellate Tribunal (ITAT) reversed the first appellate authority’s order.

Aggrieved, the Taxpayer appealed against the ITAT’s order.

Taxpayer’s contentions

The AY in which the option to claim deduction is exercised would be considered as the initial AY. The eligible business is fictionally treated as the only source of income of the Taxpayer only from the initial AY. This fiction does not extend to the AYs ending prior to the AY in which the

Taxpayer exercises the option to claim deduction.

Unabsorbed depreciation pertaining to the earlier AYs which had already been set off against other income of the Taxpayer in the respective AYs, should not be notionally brought forward and set off for determining profits of the initial AY to ascertain the amount qualifying for deduction.

Provisions under the ITL granting deduction are beneficial or incentive provisions and should be liberally construed.

In an unreported judgment (Tax Case (Appeal) No. 298 of 2004 dated 23 December 2009) of the Madras HC in the context of the erstwhile provisions allowing similar deduction under the ITL, it was held that for the purpose of claiming deduction, brought forward losses and unabsorbed depreciation need not be taken into consideration once they have been set off against other income in the earlier AYs.

Tax Authority’s contentions

Profits derived from the eligible business have to be computed after setting off notionally the brought forward losses and unabsorbed depreciation, irrespective of the same being set off against other income in the earlier AYs.

Memorandum explaining the Finance (No. 2) Bill, 1980, [123 ITR (St) 154 (1980)], in the context of the erstwhile provisions allowing similar deduction, indicates that losses, depreciation etc. of the earlier years have to be taken into account in determining the quantum of deduction admissible, even though the same have been set off against the profits of the taxpayer from other sources.

Madras HC’s decision

The AY in which a taxpayer exercises the option to claim deduction would be the initial AY for the purpose of reckoning the period of deduction. Once the option is exercised, the taxpayer is required to set off only those losses pertaining to the AYs beginning from the initial AY. The taxpayer is not required to set off losses pertaining to the earlier AYs if such losses have already been set off against other income of the taxpayer in the earlier AYs.

The fiction of treating the eligible business as the only source of income of the taxpayer is applicable only to the AYs beginning with the initial AY. This fiction does not extend to AYs ending prior to the initial AY. Hence, losses and unabsorbed depreciation pertaining to earlier AYs, which have been set off against other income of the taxpayer, cannot be notionally brought forward for determining quantum of profit eligible for deduction in the initial AY.

The Madras HC agreed with its own ruling referred to by the Taxpayer and the ruling of the Rajasthan HC in the case of CIT Vs. Mewar Oil and General Mills Ltd. [271 ITR 311], which were rendered in the context of similarly worded provisions allowing income-linked deduction under the ITL.

Comments

Under certain provisions of the ITL, which confer income-linked deduction in respect of profits derived from the business of infrastructure development, a taxpayer has the option to claim deduction for a period of 10 consecutive AYs out of 15 years (20 years in some cases). Also, such provisions mandate that the eligible business should be fictionally treated as the only source of income of the taxpayer. Such treatment would have consequences on claiming the set off of losses and unabsorbed depreciation incurred in the earlier years but set off against other income of the taxpayer, while determining the quantum of deduction from the eligible business in the subsequent AYs. There were contrary judicial decisions on the issue of set off of unabsorbed depreciation and losses. The Chennai ITAT, in the case of Mohan Breweries and Distilleries Ltd. [114 TTJ 532] had ruled that losses and depreciation pertaining to the AYs prior to the AYs selected for claiming income-linked deduction, should not be set off in determining the quantum of profits qualifying for deduction.

The present ruling provides guidance to taxpayers engaged in businesses qualifying for income-linked deduction, where the taxpayers have an option to claim deduction for a period of 10 AYs out of 15/ 20 years.

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