Is value of DEPB licence attributable to ‘direct cost’ of trading exports? – Is it eligible for deduction u/s 80HHC of Income Tax Act? – Tribunal clears clouds over the issue

MUMBAI, JAN 08, 2008 : IT is not only the Ministry of Commerce which is struggling to sculpt a perfect substitute for the most popular exports incentive scheme of DEPB, even the Income Tax Department has been breaking its head against multiple possibilities as to how to treat the value of DEPB. And the very same question came before the Tribunal in a recent case. The merchant exporter had computed its Sec 80HHC benefits by taking into consideration the DEPB income whereas the A.O. did not consider DEPB income as eligible for deduction u/s. 80HHC of the Act. Let’ take a quick stroll through the various arguments and the recent judicial pronouncements which enabled the Tribunal to form a concrete opinion on this contentious issue.

Brief facts of the case :

The assessee is engaged in the business of export of Generic Pharmaceuticals and Formulations. During the relevant year the assessee had carried out trading exports. The assessee claimed deduction u/s. 80HHC. The same was computed taking into consideration the DEPB income. The A.O. did not consider DEPB income as eligible for deduction u/s. 80HHC of the Act. Further, after reducing the DEPB there was loss and considering decision of Supreme Court in the case of Ipca Laboratories (2004-TIOL-26- SC-IT), the deduction u/s 80HHC was disallowed. The assessee filed an appeal before the CIT(A), which was rejected on the ground that the assessee had not fulfilled the additional conditions laid down vide Taxation Laws (Amendment) Act, 2005 which has amended the provisions
of section 80HHC. Now, the assessee is in appeal here before the Tribunal.

Through a written submission, the counsel for the assessee argued that the assessee was an exporter of “trading goods” during the year under consideration. Thus the assessee would be entitled to deduction under clause (3) (b) of s. 80HHC of the Act. The ld counsel then referred to clause (3) (b) of sec. 80HHC – the export profits eligible for deduction shall be the export turnover in respect of trading goods as reduced by (i) the direct cost and (ii) the indirect cost. It was further submitted that as per the scheme of deduction u/s 80HHC, the deduction so arrived is to be increased by the 90% of the sums referred to in clause (iiia), (iiib), (iiic), (iiid), or (iiie) of sec.28 of the Act as the case may be. It was submitted that in the present case of the assessee has availed of the DEPB and therefore clause (iiid) of sec.28 would be applicable.

The counsel further referred to sec. 28(iiid) and submitted that only the profits on sale/transfer of DEPB is covered under the said section. Rreferring to the third proviso to sec. 80HHC(3) the counsel submitted that only profit on sale or transfer of DEPB is covered u/s. 28(iiid) of the Act. It was further submitted that the value of DEPB is covered u/s. 28(iv) of the Act. It was submitted that the definition of direct cost includes all costs attributable to trading goods. The learned counsel emphasized on the use of the words “attributable” in the definition of direct cost. The term “attributable” has been considered by various Courts in the past. It was submitted that direct cost would thus only include the direct relatable to export of goods.

He further submitted that in the case of most of the exporters, goods are exported at price below the purchase price considering the entitlement of DEPB. It was submitted that an exporter who has incurred a cost of Rs. 95/- on purchases and who is entitled to DEPB of say Rs 10/- would be ready to export the goods at any price, say Rs 90/-. In such case also he would make a profit of Rs. 5/-. It was
therefore, submitted that it would be unreasonable to say that the entire cost of Rs 95/. is attributable to the exports of Rs.90/. It was therefore, submitted that the cost of purchases net of value of DEPB only can be considered to be attributable to the export of Rs. 90/-.

It was further submitted that the assessee had incurred loss in trading exports as is evident from the assessment order. It was submitted that the assessee exported the goods at a lower price since he knew he would be entitled to DEPB. The learned counsel also submitted that any business would never sell any of his products by incurring loss on the same. The fact that without considering DEPB there is a loss itself proves that the assessee had taken the value of DEPB into account while deciding the price of exported goods. Therefore, it was submitted that DEPB has direct nexus to the determination of sales price of the exported goods and would thus from part of the cost of sales. It was submitted that if the value of DEPB is not considered as part of the cost of sales, it would always result into a loss thereby giving results contrary to the economics of trade.

It was submitted that the exclusion of DEPB for the purpose of computing profit from exports would always give absurd result as the sales is at price lower than the cost of purchase. It was further submitted that the aforesaid anomaly is as a result of not considering DEPB and ignoring the matching principle. In this regard, reliance was placed on the decision of Supreme Court in the case of CIT Vs Lakshmi Machine Works (2007-TIOL-72- SC-IT) and Bombay High Court in the case of Commissioner of Income Tax v. Sudarshan Chemicals Industries Limited (2003-TIOL-95- HC-MUM-IT) .

It was further submitted that after availing DEPB, the assessee had two options i.e. either to utilize the said DEPB at the time of imports or to sale the same to the third party. The assessee selected the second option wherein it sold the DEPB to a third party. The learned counsel submitted that if the assessee had not transferred the said DEPB, then it would utilise the same for set off against subsequent imports, which in turn would reduce the cost of the goods imported. Thus by merely transferring the DEPB it cannot be said that the assessee is not entitled to reduce the cost of the goods exported by the value of DEPB. The value of DEPB is already factored in the cost of the goods which are imported by the assessee by paying duty which otherwise would not have been paid if the assessee chooses to utilize DEPB for the said purpose.

The counsel of the assessee further submitted that DEPB is an export incentive and the purpose of giving the same is actually reimbursement of the taxes paid in relation to exports. Every exporter has an option to avail of refund of taxes and duties paid in relation to exported goods or avail of DEPB. Accordingly, it was submitted that DEPB is nothing but the re-imbursement of taxes and duties paid on purchase of goods, which are exported. It was submitted that since DEPB is re-imbursement of the taxes and duties, it should be set-off against the duties and taxes paid which is part of the cost of goods. Thus, in effect, the cost of goods should be considered without taxes and duties paid or in other words after setting off DEPB against such taxes and duties. It was submitted that DEPB credit in actual terms reduces the cost of goods, which are exported. It was further submitted that considering the above, the direct cost would mean cost of goods attributable to exports.

Having heard the DR, the Tribunal observed that,

++ there is no dispute that the value of DEPB incentive falls within the meaning of sec. 28(iv) of thc Act. As per clause (iiid) only the profits on sale/transfer of DEPB can be taken into consideration. The language of sec. 28(iv) and 28(iiid) are very clear. Therefore, the value of licence falls within sec. 28(iv) and only the profit on transfer of licence falls within 28(iiid);

++ However, the aspect that what is the value of the DEPB incentive on the date of receipt, was neither examined at the end of the Assessing Officer or at the end of the CIT(
A). The issue of apportionment of indirect cost has been, examined by the Special Bench in the case of Surendra Engineering. In this case in respect of indirect cost attributable to trading export was discussed in detail and it was held that 10% of indirect cost is to be attributable to the trading export. In a recent decision in the case of Hero Export decided (2007-TIOL-208- SC-IT), the Supreme Court has affirmed the identical view which was taken by the Special Bench.

++ The Apex Court has held that under section 80HHC (3)(b) one has to balance the ‘principle of attribution’ with the concept of ‘allocation’ . The concept of allocation is meant to reduce the incentive. However, when ‘allocation’ has to be balanced with the ‘principle ‘of attribution’ , the object is to reduce the incentive and not to eliminate it.

In this background, the Tribunal held that part of the direct cost is attributable to the value of DEPB licence. To find out the direct cost relatable to trading export, one has to reduce that part of the direct cost attributable to earning of DEPB from the value of total direct cost. However, this aspect has not been examined by the AO or by the CIT(A). Therefore, the Bench restored this issue to the file of the Assessing Officer to ascertain the value of DEPB licence on the date of receipt and reduce the same from total direct cost. It also clarified that any difference in realization of DEPB licence will be treated u/s 28(iiid) of the Act.

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