Notional interest not eligible for deduction u/s 10A: HC

Claim that notional interest on funds placed by the s. 10A eligible unit with the H.O. is allowable as a deduction to the H.O. and is exempt in the hands of the s. 10A unit is an “unsustainable view”

Facts of the case:

a. The Assessee is engaged in the business of running printing presses.

b. the Assessee’s undertaking at NEPZ Noida (hereafter referred to as the ‘eligible undertaking’) fulfilled the conditions as specified under section 10A(2) of the Act as it stood at the material time and, consequently, was eligible for exemption under Section 10A of the Act for a block of five years relevant to the AYs 1991-92 to 1994-95.

c. The Assessee filed its return of income for AY 1991-92 on 31st December, 1991 declaring a taxable income of Rs. 32,86,776/-.

d. This return was subsequently revised and the Assessee declared a total income of Rs. 1,45,73,443/-. The income derived by the Assessee from the eligible undertaking was excluded in computation of the declared income.

e. The CIT found that the eligible undertaking had accumulated profits of Rs. 98,05,560/- as on 31st March, 1991 and an interest of Rs. 8,13,651/- had been charged on the aforesaid surplus in the books of the eligible undertaking.

f. the separate books maintained in respect of the eligible undertaking reflected interest income of Rs. 8,13,651/- and the same was also deducted from the taxable income of the Assessee as being income derived by the Assessee from the eligible undertaking.

Issue put before (Delhi High Court):

Whether the Assessee could include notional interest as income in computation of profits and gains derived by its undertaking from export of articles or things, for the purposes of claiming deduction under Section 10A of the Act.

Contentions of Appellant:

a. The orders passed by the CIT were beyond the scope of Section 263 of the Act.

b. He submitted that in a case where two views were possible and the AO had taken one view, it was not open for the CIT to treat the order to be erroneous as prejudicial to the interest of the revenue only for the reason that he did not agree with the AO’s view.

c. He submitted that unless the view taken by the AO was unsustainable and patently erroneous, the CIT could not assume jurisdiction under Section 263 of the Act.

d. The eligible undertaking had debited interest amounting to Rs. 7,75,399/-, which had been accepted in an assessment framed under Section 143(3) of the Act.

e. His contention that where a view has been accepted in the preceding assessment years, CIT would have no occasion to take recourse to the revisional powers under Section 263 of the Act.

f. He argued that the deduction under Section 10A of the Act provided for a deduction in respect of incomes profit and gains derived by an Assessee from an industrial undertaking at the threshold and not as a deduction included in the gross income of an Assessee.

g. He submitted that in view of the said scheme the reasoning of the CIT and the Tribunal that no one could earn interest from oneself was not tenable as the eligible undertaking had for all practical purposes to be treated as a separate entity.

h. Section 10A provides for exemption of “income derived by an Assessee from its undertaking”. He submitted that this was different from the language used in Section 80HH or 80IA which referred to income “derived from an industrial undertaking”.

i. Unless a close nexus with the income by way of interest of the undertaking was established, the same could not be considered as a part of profit and gains derived by the Assessee from the eligible undertaking.

Contention by Revenue:

a. The CIT was of the view that the aforesaid deduction was erroneous as prejudicial to the interest of the revenue and, therefore, issued a show cause notice dated 5th February, 1996 under Section 263 of the Act in respect of the AY 1991-92.

b. A similar notice dated 5th February, 1996 was also issued in respect of the AY 1992-93, as in the Previous Year relevant to AY 1992-93, the Assessee had deducted a sum of `37,61,132 on account of notional interest credited in the books of the eligible undertaking.

c. The transaction of crediting interest by the Head office to the account of the eligible undertaking was between the two branches of the Assessee and did not give rise to any real expenditure or income.

d. He, accordingly, held that the expenditure could not be allowed in the hands of one unit and correspondingly, the question of enhancing income of the eligible unit by such notional income, did not arise.

Ruling of Honorable (Delhi High Court):

a. A plain reading of Section 10A(1) of the Act indicates that profits and gains derived by an Assessee from an industrial undertaking to which Section 10A applies is not included in the total income of the Assessee.

b. The expression “derived” followed by the word “from” refers to the source of profits and gains. The Oxford Dictionary defines the word “derived” as “obtained something from (a specified source)” and “arises from or originates in (a specified source)”. It is at once clear that in order for any profits and gains to be exempt under Section 10A of the Act, their source must be traced to “the industrial undertaking” to which Section 10A applies.

c. Only those profits and gains of an Assessee which have a direct nexus with an undertaking to which Section 10A of the Act applies would be excluded from the income of an Assessee.

d. In the present case, the interest credited by the Assessee in the books of the eligible undertaking is notional and practically unconnected with the eligible undertaking; the interest has been credited on the surplus generated, which has been transferred from the accounts of the eligible undertaking to the head office.

e. Concededly, the interest credited does not represent any real inflow of funds to the Assessee. The Assessee merely reflects inflow of funds in separate books maintained with respect to the eligible undertaking with a corresponding outflow of funds in the books maintained with respect to the head office (i.e. non-eligible undertaking).

f. In view of the aforesaid, the interest cannot be considered as profits and gains derived by the Assessee from the eligible undertaking as it does not bear a direct nexus with the activities of the eligible undertaking.

g. We are also in agreement that the deduction under Section 10A of the Act in respect of profits and gains derived from a specified source and the entire income of the eligible undertaking from the specified source is required to be excluded. However, the profits and gains must be real profits and gains derived by an Assessee and not notional or unreal income.

h. In the present case, the interest so credited and debited by the Assessee in the books maintained does not, in the first instance, represent any real profit or gain by the Assessee. The Assessee has not derived any real income. Therefore, the question of deriving such profits from the eligible undertaking does not arise.

i. In view of the aforesaid, the questions of law are answered in the affirmative; in favour of the Revenue and against the Assessee. The appeals are, accordingly, dismissed. The parties are left to bear their own costs.

Key Take Away

Claim that notional interest on funds placed by the s. 10A eligible unit with the H.O. is allowable as a deduction to the H.O. and is exempt in the hands of the s. 10A unit is an “unsustainable view”