Sec 10A benefits cannot be denied on foreign exchange fluctuation gain linked to exports

Sanyo LSI Technology India Private Ltd. Vs. Deputy Commissioner of Income Tax

ITA No. 977/Bang/2010

Assessment year : 2004- 05

Asst. Commissioner of Income Tax Vs. Sanyo LSI Technology India Private Ltd.

ITA No. 1085/Bang/2010

Assessment year : 2004-05

Decided by – ITAT Bangalore

Decided on – 13.5.2011

O R D E R

Per A. Mohan Alankamony, Accountant Member

These two appeals instituted by (i) the assessee company as well as (ii) the Revenue are directed against the order of the Ld. CIT (A)-III, Bangalore in ITA NO: 183/DC 12(3)/ CIT (A)-III/06-07 dated: 9.6.2010 for the assessment year 2004-05.

I. ITA No: 977/10– [By the assessee company]

2. Though the assessee company has raised five grounds, a lone ground which survives for adjudication is extracted as under:

(i) that the CIT (A) erred in treating the foreign exchange gain of Rs. 4.94 lakhs in the nature of ‘income from Other Sources’; and that he further erred in not excluding the same for computation of deduction u/s 10A of the Act;

– without prejudice, if the foreign exchange gain were to be treated as ‘income from Other Sources’, then the foreign exchange loss of Rs.91.43 lakhs was to be treated as loss arising from O.S and not from ‘profit and gains from business’ and the foreign exchange should be allowed to be set off against such foreign exchange loss incurred during the same year.

II. ITA No: 1085/10 – [By the Revenue]

3.  Even though, the Revenue has raised four grounds, the substance of its grievance is confined to the effect that –

– the CIT (A) erred in excluding Rs.11.08 lakhs and Rs.1. 76 crores being telecommunication and traveling expenses respectively incurred in foreign currency from the total turnover for computation of deduction u/s 10A of the Act.

4. As the issues raised in these appeals being inter-linked pertaining to the same assessee, they were heard, considered together and disposed off, for the sake of clarity, in this common order.We shall now take up the assessee’s case for consideration. ITA No: 977/10– [By the assessee]

5. Briefly stated, the assessee company [‘the assessee’ in short] was in development of software registered under the Software Technology Park of India. During the year under challenge, the assessee had admitted its income at Rs.7.74 lakhs and claimed deduction u/s 10A of the Act to the extent of Rs.3.81 crores.

5.1. During the course of re-assessment proceedings u/s 143(3) r.w.s 147 of the Act, the AO, after due consideration of the assessee’s explanation, determined its total income at Rs.85.61 lakhs by excluding the telecommunication charges and travel expenses of Rs.11.08 lakhs and Rs.1 .76 crores respectively and foreign exchange gain of Rs.4.94 lakhs from the export turnover while computing the deduction u/s 1 0A of the Act.

6. Aggrieved, the assessee carried the issues to the Ld. CIT (A) for relief. After giving due weight-age to the contentions put-forth by the assessee, the Ld. CIT (A) had conceded to the assessee’s request in so far as expenses incurred towards (i) telecommunication and (ii) travel expenses were concerned. However, with regard to the foreign exchange gain of Rs. 4.94 lakhs, the Ld. CIT (A), by brushing aside the assessee’s forceful contentions, took a divergent view that –

“10.0. If the foreign exchange gain on realisation of sale proceeds has no nexus with the business of the appellant, it has to be assessed not under the head ‘profits & gains of business or profession’ but under the head ‘income from Other sources’. on the other hand, if the foreign exchange gain has nexus and connection with the business of the appellant, it has to be included under the head ‘profit & gains from business and profession.’ But it still has to be excluded in computing the deduction u/s 10A since it is not derived by the export business of the Industrial undertaking. The law on this issue is settled by the Apex Court in the case of CIT v. Sterling Foods Ltd. 237 ITR 571 (SC).

10.1. The Apex Court again considered the Legislative intent behind the use of the word ‘derived from’ in the case of Pandian Chemicals Ltd. v. CIT – 262 ITR 278 (SC) and reaffirmed its earlier decision in Sterling Foods Ltd. (supra). In that case the assessee made deposit with State electricity Board for the purpose of power connection to the industrial undertaking. The Apex court held that the interest on the deposit made with Electricity Board cannot be said to flow directly from the industrial undertaking itself, although electricity may be required for the purpose of the industrial undertaking. Hence, any controversy regarding the use of the word ‘derived’ in the Act should be treated as settled. What is eligible for the deduction is strictly the income derived by the undertaking and not on any other income that may be incidental or attributable to, even though such income is computed under the head ‘business. Hence, following the above decision of the S. C, I am of a considered view that, AO action is justified and, hence, this ground of appeal is dismissed.

10.2. Further, the Apex Court has considered the Legislative intent behind the use of the word ‘derived from’ in the case of liberty India and Ors. V. CIT – 317 ITR 218 (SC) and reaffirmed the words ‘derived from’ are narrower in connotation as compared to the words ‘attributable to’. In other words, by using the expression ‘derived from’ Parliament intended to cover sources not beyond the first degree.”

7. Dismayed with the findings of the first appellate authority, the assessee has come up with the present appeal. It was argued by the Ld.AR Shri Madhukar Dhakappa, that –

– S.10A(1) of the Act provides that subject to the provisions of the said section, a deduction of such profits and gains as are derived by an under-taking from the export of articles or things or computer software shall be allowed from the total income of the assessee;

– During the F. Y 2003- 04, the assessee had credited Rs. 4.94 lakhs to the P & L a/c as Foreign Exchange (FE) gain and debited Rs. 91.43 lakhs as FE loss. The said exchange gain and loss represents excess/deficit amount arising on account of exchange fluctuation relating to export sales made out of the STPI undertaking or exchange fluctuation relating to debit notes for reimbursement of expenses incurred for the purpose of business and, accordingly, was considered as part of profits of STPI undertaking for the purpose of computation of deduction u/s 10A of the Act;

-That in the case of export sales, export invoices was drawn in foreign currency. Also, in case of reimbursement of expenses, the debit notes were raised in foreign currency. The value of such invoices was recorded in the books of the assessee on the basis of the rate of exchange of foreign currency in terms of Indian rupees on the date of raising the invoice. The actual amount of such export invoice/ debit note was realized when such Foreign currency invoices were retired by the foreign buyer, that the assessee received was equivalent of the amount of foreign currency for which the export invoices/ debit notes were issued, that due to the day-to-day change in conversion rate between the Indian and foreign currencies, an assessee might be receiving higher or lower amount at a particular point of time in respect of same amount of export sales bills and the difference was recognised as exchange gain or loss as the case may be; further that the assessee was required to reinstate the outstanding amounts based on the exchange rates as on the close of the year in accordance with the provisions of AS – 11;

-That the assessee had made the above mentioned exchange gain in relation to the export sales made and reimbursement of expenses incurred in the course of the business carried on by the assessee from its STPI Under-taking; that the assessee had, accordingly, included the same as part of STPI undertaking’s profit while computing the tax deduction u/s 10A of the Act as the same arose in the course of business undertaken by the undertaking; and that the assessee had correspondingly also reduced the FE fluctuation loss from the profits of the STPI u/t while computing the tax deduction u/s 10A of the Act on the same premise;

– Rebutting the CIT (A) ’s theory that the FE gain does not have a direct nexus with the business of the assessee and therefore it has to be assessee under the head ‘income from OS’, the assessee relies on the ruling of the Hon’ble SC in the case of Pandian chemicals (2003) 262 ITR 278 (SC); THAT elaborating the said ruling, the assessee submitted that –

The facts of the case of Pandian chemicals were quite distinct from that of the assessee; that the assessee’s case was that the FE gain had arisen on account of export sales made by the STPI U/T that in other words, the source of the FE gain is the export sales made by the assessee, unlike the facts in the case of Pandian chemicals and, thus, the ruling of the SC does not squarely applicable to the case of the assessee;

– distinguishing the cases laws [CIT v. Sterling Foods Ltd. (237 ITR 579 – SC) & Liberty India and Ors v. CIT (317 ITR 218 – SC)] relied on by the Ld. CIT (A) to that of the assessee ’s case, it was contended that ‘Nonetheless, the principle laid down by the Apex Court that the words ‘derived from’ must be understood as something which has a direct or immediate nexus with the assessee’s industrial u/t is worth noting and actually supports the case of the assessee’;

– relies on the case law of CIT v. Sun Engineering Works (P) Ltd. 198 ITR 297 (SC);

Foreign Exchange fluctuation is part of ‘profits from business and profession’:

– relies on –

(i) CIT v. Woodward Governor India (P) Ltd (2009) 223 CTR 1 (SC);

(ii) Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC)

(iii) Hindustan Trading Corporation v. CIT 160 ITR 15 (Guj)

(iv) SAP Labs India Pvt. Ltd. v. ACIT (2010-TII-44-ITAT-BANG­TP)

(v) DCIT v. M/s.Lazard India Pvt. Ltd. 2010 41 SOT 72 (Mum)

Foreign Exchange gain is eligible for deduction u/s 10A of the Act:

-Countering the Ld. CIT(A) ’s finding that even if FE gain has a nexus and was earned in connection with the business of the assessee, the same would have to be excluded from the profits of the business from the computation of deduction u/s 10A of the Act as such gain is not ‘derived’ by the export business of the under-taking, it was contended that –

Foreign exchange fluctuation in the assessee ’s case had direct and immediate nexus with the export activities of the STPI U/T of the assessee and as such has to be considered as part of profits of the U/T for the purpose of computation of deduction u/s 10A of the Act;

Relies on the case laws:

(i) CIT v. M/s. Pentasoft Technologies Ltd. [2010- TIOL0525-HC-MAD-IT];

(ii) Renaissance Jewellery (P) Ltd. v. ITO 289 ITR 65 (Mumbai ITAT);

(iii) Change pond Technologies (P) Ltd. v. ACIT 119 TTJ 18 (Chennai ITAT)

(iv)   CIT v. Gem Plus Jewellery India Ltd. 233 CTR 248 (Bombay HC)

– without prejudice, if the foreign exchange gain was treated as income from ‘Other sources’ then the FE loss of Rs.91,43,586/- should also be treated as loss arising from OS and not from ‘profit and gains from business and profession’ and the FE gain should be allowed to be set off against such FE loss incurred during the same year

7.1. On the other hand, the Ld. D R was vehement in his urge that the authorities below have taken a stand after careful consideration of the issues and, therefore, it was pleaded that the finding of the Ld. CIT (A) requires no intervention at this stage.

8. We have scrupulously considered the rival submissions, diligently perused the relevant case records and also the various case laws on which the assessee had placed unstinted faith.

8.1. It was the stand of the Ld. CIT (A) that if the foreign exchange gain on realization of sale proceeds has no nexus with the business of the appellant, it has to be assessed NOT under the head ‘profits and gains of business or profession’ but ‘income from Other Sources. However, he conceded that if the foreign exchange gain has nexus with the business of the assessee, it has to be included under the head ‘profit and gains from business and profession but, with a rider that it still has to be excluded in computing the deduction u/s 10A of the Act by placing strong reliance on the ruling of the Hon’ble Apex Court in the cases of (i) CIT V. Sterling Foods Ltd and (ii) Pandian Chemicals Ltd. v. CIT cited supra.

8.1.1. In the case of Pandian Chemicals, the issue before the Hon’ble Supreme Court was that interest earned on the deposit made with the Electricity Board for supply of electricity to the assessee’s industrial U/T should be treated as income derived from the industrial U/T within the meaning of s.80HH. It was contended by that assessee that without the supply of electricity, the industrial U/T could not run and that electricity was an essential input for the U/T and that for the purpose of getting electricity, the assessee was required to meet the statutory requirement of making deposits for supply of electricity. It was, therefore, contended by the assessee that the interest accrued on such deposits should have been treated as income from the industrial U/T within the meaning of s.80HH. Based on the said submission, the Hon’ble Apex Court took a view that the word ‘derived from’ in s.80 HH must be understood as something which has direct or immediate nexus with the assessee’s U/T. In this context, it was held that although electricity was required for the purposes of industrial U/T, the deposit required for its supply was a step removed from the business of the industrial U/T and, thus, derivation of profits on the deposit made with the EB cannot be said to flow directly from the industrial U/T itself.

 8.1.2. With highest regards, we would like to point out that the issue on hand is quite on a different sphere in the sense that the foreign exchange gain had arisen on account of export sales made by its STPI U/T and, thus, the source of the foreign exchange gain was the export sales by the assessee which is dissimilar to the facts of Pandian chemicals case referred above. We are, therefore, of the firm view that the issue of Pandian Chemicals quoted above cannot be equated with that of the issue on hand.

8.1.3. At this juncture, it would be more appropriate to recall the observations of the Hon’ble Highest judiciary of the land in the case of CIT v. Sun Engineering Works (P) Ltd reported in 198 ITR 297 (SC) wherein it was held that –

“It is neither desirable nor permissible to pick out a word or a sentence from the judgement of this court, divorced from the context of the question under consideration and treat it to be the complete “law” declared by this court. The judgement must be read as a whole and the observations from the judgement have to be considered in the light of the questions which were before this court. A decision of this court takes its colour from the questions involved in the case in which it is rendered and, while applying the decision to a later case, the courts must carefully try to ascertain the true principle laid down by the decision of this court and not to pick out words or sentences from the judgement, divorced from the context of the questions under consideration by this court, to support their reasoning. In Madhav Rao Jivaji Rao Scindia Bahadur v. Union of India [1971] 3 SCR 9; AIR 1971 SC 530, this Court cautioned (at page 578 of AIR 1971 SC)

“It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgement. “

8.1.4. Reverting back to the issue under consideration, on the facts and circumstances of the issue, we are of the considered view that the foreign exchange fluctuation gain was directly related to the export activity of the assessee. Assuming that the assessee had not ventured to do any export sales, the question of foreign exchange gain didn’t arise. As such, the foreign exchange fluctuation had direct nexus with the STPI U/T of the assessee which has been rightly included by the assessee as part of profits of the U/T for the purpose of computation of deduction u/s 10A of the Act. Our finding is in consonance with various judicial precedents, a few of which are discussed, in brief, here-below:

(i) The Hon’ble Madras High court in the case of CIT v. M/s. Pentasoft Technologies Ltd. reported in 2010-TIOL-525-HC-MAD-IT, had held that –

“The exchange value based on upward or downward of the rupee value is not in the hands of the assessee. The assessee does not determine the exchange value of the Indian rupee; that when the fluctuation in foreign exchange rate was solely relatable to the export business of the assessee and the higher rupee value was earned by virtue of such exports carried out by the assessee, there was no reason why the benefit of s.10A should not be allowed to the assessee.”

(ii) In the case of CIT v. Gem Plus Jewellery India Ltd. reported in (2010) 233 CTR (Bom) 248, the Hon’ble High Court of Bombay has ruled that –

“Gain from fluctuation of foreign exchange is directly related with the export activities and should be considered as income derived from export in the year in which the export took place for the purpose of deduction u/s 10A of the Act.

(iii) With regard to the foreign exchange fluctuation is a part of ‘profits from business and profession, the Hon’ble Apex Court in its ruling in the case of Sutlej Cotton Mills Ltd. v. CIT cited supra, had held thus –

“The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.”

In consonance with the above ruling, the Hon’ble Supreme Court in its subsequent verdict in the cases of (i) CIT v. Woodward Governor India (P) Limited and (ii) in CIT v. Honda Siel Power Products Limited reported in (2009) 312 ITR 254 (SC) observed thus –

“15. For the reasons given hereinabove, we hold that, in the present case, the “loss” suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure under s. 37(1) of the 1961 Act.

8.1 .5. Taking into account the facts of the issue and also in conformity with the legal position of various judiciaries referred in the fore-going paragraphs, we observe that –

(i) the foreign exchange gain was income derived by export business of the assessee, and, hence, eligible for deduction u/s 10A of the Act; &

(ii) the foreign exchange gains has to be taxed under the head ‘income from business and profession’.

It is ordered accordingly.

8.2. We have since conceded to the assessee’s request to treat the foreign exchange gain of Rs.4.94 lakhs earned was in the course of business and in the nature of ‘profits and gains from business and profession’, the assessee’s other plea – without prejudice, if the foreign exchange gain were to be treated as ‘income from Other Sources’, then the foreign exchange loss of Rs.91.43 lakhs was to be treated as loss arising from O.S etc.,” has become obsolete and, thus, it has not been addressed to.

ITA No: 1085/10 – [By the Revenue]

9.Let us now turn our attention to address to the Revenue’s grievance that “the CIT (A) erred in excluding Rs.11.08 lakhs and Rs.1.76 crores being telecommunication and traveling expenses respectively incurred in foreign currency from total turnover for computing deduction u/s 10A of the Act.”

9.1. We have duly taken cognisance of the rival submissions on the issue and also glanced at the relevant records.

9.1 .1. At the out-set, we would like to point out that this Bench in its earlier finding in the case of the assessee for the assessment year 2005-06 (in ITA No: 786/Bang/2009 dated: 23.12.2009) had deliberated the identical issues – Telecommunication charges, travel expenses etc., – at a greater length, also quoting extensively the various decisions of the Hon’ble Tribunals including in the cases of (i) ITO v. M/s. Sak Soft Ltd – (2009) 313 ITR (AT) 353 (Chennai – SB); (ii) M/s. Tata Elexsi Limited v. ACIT – ITA NO:315/Bang/2006; (iii) CIT v. Bharat Earth Movers Ltd. – 268 ITR 232 (Kar), (iv) CIT v. Lakshmi Machine Works – 290 ITR 667 (SC) etc., and arrived at a conclusion that –