The SUPREME COURT vide its order Dated – August 31, 2009 in the case of M/s Liberty India Versus Commissioner of Income Tax was requested to determine the following question:-
“Whether profit from Duty Entitlement Passbook Scheme (DEPB) and Duty Drawback Scheme could be said to be profit derived from the business of the Industrial Undertaking eligible for deduction under Section 80-IB of the Income-tax Act, 1961 “
The SUPREME COURT vide its order Dated – August 31, 2009 in the case of M/s Liberty India Versus Commissioner of Income Tax has ruled that Deduction u/s 80-IB – in respect of profit from Duty Entitlement Passbook Scheme (DEPB) and Duty Drawback. should not be treated as adjustment (credited) to cost of purchase or manufacture of goods. – They should be treated as separate items of revenue or income and accounted for accordingly . For the purposes of AS-2, Cenvat credits should not be included in the cost of purchase of inventories .Duty drawback, DEPB benefits, rebates etc. cannot be credited against the cost of manufacture of goods debited in the Profit & Loss account for purposes of Sections 80-IA/80-IB as such remissions (credits) would constitute independent source of income beyond the first degree nexus between profits and the industrial undertaking – Duty drawback receipt/DEPB benefits do not form part of the net profits of eligible industrial undertaking for the purposes of Sections 80I/80-IA/80-IB of the 1961 Act.
Arguments by the Assessee
It was argued that the amount of duty drawback/DEPB was intended to neutralize the incidence of duty on inputs consumed/utilized in the manufacture of exported goods resulting into increased profits derived from the business of the industrial undertaking which profits qualified for deduction under Section 80-IB. Thus duty drawback/DEPB benefit received had to be credited against the cost of manufacture of goods/purchases debited to the Profit & Loss account and that such credit was not an independent source of profit. Reliance was placed on AS-2 issued by the ICAI on “valuation of inventories” according to which where excise duty paid was subsequently recoverable by way of drawback, the same would not form part of the manufacturing cost. The assessee contended that it had first degree nexus with the industrial activity of the eligible undertaking and consequently the reimbursement of the said amount cannot be treated as income of the assessee because the expense originally incurred by way of payment of duty. Consequently, according to the appellant , receipt of duty drawback/DEPB stood linked directly to the manufacture/production of goods and therefore had to be regarded as profits derived from eligible undertaking qualifying for deduction under Section 80-IB of the 1961 Act.
It was further contended that in the case of sale of import entitlements/REP license , the source was the Scheme framed by Government of India whereas in the case of DEPB/duty drawback, the source was the fact of payment of duty in respect of inputs consumed/utilized in the manufacture of goods meant for export and, therefore, there was a direct and immediate nexus between payment of duty on such inputs and receipt of duty drawback/DEPB. In his support the assessee further submitted that duty drawback regime required the industrial undertaking to pay in the first instance the duty on inputs and thereafter seek reimbursement on profit of goods manufactured using such duty paid inputs, having been exported. According to the appellant Section 80-IB is much wider as the Legislature intended to give benefit of deduction not only to profits derived from the undertaking but also to give benefit of deduction in respect of incomes having direct nexus with the profits of the undertaking, hence, all incomes that arose during the course of running of the eligible business would be eligible for deduction under Section 80-IB, which would include income arising on sale of DEPB at premium.
Arguments by the Department
The department submitted that merely because under the Scheme to encourage exports a certain amount was repaid as “duty drawback”, it cannot be regarded as profit “derived from” the industrial undertaking because its immediate and proximate source was not the industrial undertaking but the scheme for “duty drawback”. Duty drawback is a matter of policy, hence, the proximate and immediate source of duty drawback cannot be industrial undertaking.
Discussions and Findings:
The Income Tax Act 1961 Act broadly provides for two types of tax incentives, namely, investment linked incentives and profit linked incentives. Chapter VI-A which provides for incentives in the form of tax deductions essentially belong to the category of “profit linked incentives”. Therefore, when Section 80-IB refers to profits derived from eligible business, it is not the ownership of that business which attracts the incentives. What attracts the incentives under Section 80-IA/80-IB is the generation of profits (operational profits) and for this reason the Parliament has confined deduction to profits derived from eligible businesses and that each of the eligible business constitutes a stand-alone item in the matter of computation of profits. Sections 80-IB/80-IA are the Code by themselves as they contain both substantive as well as procedural provisions. That is the reason why the concept of “Segment Reporting” stands introduced in the Indian Accounting Standards (IAS) by the Institute of Chartered Accountants of India (ICAI).
Analyzing Chapter VI-A, we find that Sections 80-IB/80-IA are the Code by themselves as they contain both substantive as well as procedural provisions. Therefore, we need to examine what these provisions prescribe for “computation of profits of the eligible business”. It is evident that Section 80-IB provides for allowing of deduction in respect of profits and gains derived from the eligible business. The words “derived from” is 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. Moreover that Sections 80I, 80-IA and 80-IB have a common scheme and if so read it is clear that the said sections provide for incentives in the form of deduction(s) which are linked to profits and not to investment hence, incentives profits are not profits derived from the eligible business under Section 80-IB. They belong to the category of ancillary profits of such Undertakings.
Analysis of AS-2 by the Supreme Court
AS-2 deals with Valuation of Inventories. Inventories are assets held for sale in the course of business; in the production for such sale or in form of materials or supplies to be consumed in the production. “Inventory” should be valued at the lower of cost and net realizable value (NRV). The cost of “inventory” should comprise all costs of purchase, costs of conversion and other costs including costs incurred in bringing the “inventory” to their present location and condition.
We are of the view that Department has correctly applied AS-2 as could be seen from the following. The cost of purchase includes duties and taxes (other than those subsequently recoverable by the enterprise from taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Hence trade discounts, rebate, duty drawback, and such similar items are deducted in determining the costs of purchase. Therefore, duty drawback, rebate etc. should not be treated as adjustment (credited) to cost of purchase or manufacture of goods. They should be treated as separate items of revenue or income and accounted for accordingly. Therefore, for the purposes of AS-2, Cenvat credits should not be included in the cost of purchase of inventories. Even Institute of Chartered Accountants of India (ICAI) has issued Guidance Note on Accounting Treatment for Cenvat/Modvat under which the inputs consumed and the inventory of inputs should be valued on the basis of purchase cost net of specified duty on inputs (i.e. duty recoverable from the Department at later stage) arising on account of rebates, duty drawback, DEPB benefit etc. Profit generation could be on account of cost cutting, cost rationalization, business restructuring, tax planning on sundry balances being written back, liquidation of current assets etc. Therefore, we are of the view that duty drawback, DEPB benefits, rebates etc. cannot be credited against the cost of manufacture of goods debited in the Profit & Loss account for purposes of Sections 80-IA/80-IB as such remissions (credits) would constitute independent source of income beyond the first degree nexus between profits and the industrial undertaking.
The following illustration will clarify the matter under question:
| Expenditure | Amount (Rs.) | Income | Amount (Rs.) |
| Opening stock | 100 | Sales | 1000 |
| Purchases (including customs duty paid | 500 | Duty Drawback received | 100
|
| Manufacturing overheads | 300 | Closing stock | 200 |
| Administrative, Selling and Distribution Exp. | 200 | ||
| Net profit | 200 | ||
| 1300 | 1300 |
Note: In above example, Department is allowing deduction on profit of Rs. 100 under Section 80-IB of the 1961 Act.
In the circumstances, the Supreme Court held that drawback receipt/DEPB benefits do not form part of the net profits of eligible industrial undertaking for the purposes of Sections 80I/80-IA/80-IB of the 1961 Act.
The above judgment will adversely affect those industrial units which are covered under scheme of industrial development and export business. The effect will be far reaching because all the assessed cases wherein the benefit of Export Incentive u/s 80I/80IA/80IB has been availed by the assessee will be reopened. The time limit for reopening of assessment is 4 to 6 years (Depending upon the escaped amount) . But do not rejoice under the impression that only cases from assessment year 2003-04 onwards can be reopened.
Hold your breath. The provisions of section 147 dealing with assessment of escaped income have been amended by the Finance Act 2009. The amendment is contained in Explanation-3 and the matter of the explanation is Draconian , Very severe and oppressive code of law of extreme severity because this explanation provides for reopening of all the assessment with effect from 1st day of April, 1989.
“Explanation 3.—For the purpose of assessment or reassessment under this section, the Assessing Officer may assess or reassess the income in respect of any issue, which has escaped assessment, and such issue comes to his notice subsequently in the course of the proceedings under this section, notwithstanding that the reasons for such issue have not been included in the reasons recorded under sub-section (2) of section 148.”.
As if the above amendment was not sufficient, the Central Board of Direct Taxes (CBDT) has directed re-opening of all cases under the search and seizure label, income-escaping assessments and deductions claimed from profits and gains on all eligible businesses with retrospective effect from 1st day of April, 1989.
In its plan for the year 2009-10 for boosting tax collection, discussed in the presence of the finance minister last week, the board feels its departments across India should reopen all such cases which attract provisions where amendments have been made in the Finance Bill, 2009, with retrospective effect.
The plan also requires the companies to furnish complete details of the latest balance sheet and bank accounts during their tax assessment, instead of the current practice of providing details pertaining to only that assessment year. Regular assessment is an exercise to find why there is gap between taxes paid by a company year on year.
Sources added the board has directed the department to assess cases for scrutiny not only for cases getting time-barred on March 31, 2010, but also to pick up cases which are to be assessed next year, where the department has noticed blatant violations through advance tax returns filed by the companies.
Amendment to section 80A: Another hammer on the unsuspecting assessees.
The next amendment made by the Finance Act by clause 29 is on the provisions for deductions. A new sub section 5 has been added to Section 80A which provides that if an assessee fails to make a claim in his return of income for any deduction under section 10A or section 10AA or section 10B or section 10BA or under any provision of this Chapter under the heading “C.—Deductions in respect of certain incomes”, no deduction shall be allowed to him thereunder.
This amendment is against the spirit of the law as many beneficial deductions have been provided by the Act in order to propel the development of undeveloped areas and to stimulate the export growth of the nation. Some of the observations made at different forum will bring out the importance of the deductions under Chapter VI.
The claim in return of income cannot be the sole criteria for deciding eligibility of deduction under the Act merely because the assessee has not claimed a certain eligible deduction, same cannot be held against him if otherwise the claim of the assessee is tenable under law. The provisions of IT Act alone can decide the eligibility of claim and not any other criteria. There have been instructions from the CBDT, particularly Circular No. 14, dt. 11th April, 1955, the relevant portions of which is as hereunder:
Circular No. 14(XL-35) of 1955, dt. 11th April, 1955.
“3. Officers of the Department must not take advantage of the ignorance of an assessee as to his rights. It is one of their duties to assist a taxpayer in every reasonable way, particularly in the matter of claiming and securing relief and in this regard the officers should take the initiative in guiding a taxpayer where proceedings or other particulars before them indicate that some refund or relief is due to him. This attitude would, in the long run, benefit the Department, for, it would inspire confidence in him that he may be sure of getting a square deal from the Department. Although, therefore, the responsibility for claiming refunds and relief rest with the assessees on whom it is imposed by law, officers should :
(a) draw their attention to any refunds or relief to which they appear to be clearly entitled but which they have omitted to claim for some reason or other;
(b) freely advise them when approached by them as to their rights and liabilities and as to the procedure to be adopted for claiming refunds and reliefs “
Further, the Delhi High Court in Continental Construction Ltd. vs. Union of India and Ors. (1990) 185 ITR 230 (Del), held that the IT Department should not stand on mere technicalities and must give an opportunity to the assessee to fulfill the requirements of the law and on such compliance within a reasonable time, it should grant the benefit to the assessee under that provision.
Moreover the Hon’ble Supreme Court has held in Bajaj Tempo Ltd. vs. CIT (1992) 196 ITR 188 (SC) that “a provision in a taxing statute granting incentives for promoting growth and development should be construed liberally, and since a provision for promoting economic growth has to be interpreted liberally, the restriction on it too has to be construed so as to advance the objective of the provision and not to frustrate it.” If the Department’s proposed rectification is accepted, it would only result in manifest anomalies and arbitrariness.
Further the Supreme Court in Navnit Lal C. Javer vs. K.K. Sen, AAC (1965) 56 ITR 198 (SC), held that though the responsibility for claiming refund and reliefs rested with the assessee, the ITO should draw the attention of the assessee to this relief in which the assessee appeared to be clearly entitled but which the assessee had omitted to claim.
In view of the above discussion the difficulties of the assessee are going to increase manyfold if they are covered by the amendment to section 147 or section 80A. The matter must be raised at the appropriate forum for redressal of the grievances of the assessment.
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Author Bio
The decision of the SC is well analysed one taking into all the arguments in full. The example cited by SC is the idealistic one; There are exporters who take a portion of the Duty drawback while working out the cost, where in, if we remove drawback, the profit will be in negative.(Imagine a figure of Rs.75/- as net profit and if we remove drawback of Rs.100, it is a loss of Rs.(-)25/).
Secondly, if we compare an exporter who has DEPB of same Rs.100/- instead of DDB, which he uses to import raw materials. In such case, his cost of purchase is 400(500-100). And while calculating 80HHC deduction, he will get full deduction on Rs.200. Another exporter who simply sold DEPB in the market for Rs.100 and credit the same to his P and L account which shows same profit of Rs.200/-. He will have the deduction on Rs.100/- only and sale of depb of Rs.100/- is not eligible for 80HHC deduction.
In the case of Duty Draw back, it is only a refund of customs/excise duty paid on purchases. Had it been possible to allocate the same to various purchases, it should have gone to reduce the cost of purchases only. Since it is not possible, DDB is credited as separate item in P and L account.
In the same example given in the judgement, if the draw back is credited to the only item of purchase item (there is no harm in reducing such cost as this is the purpose of DDB), entire profit would become eligible for 80HHC deduction as there is nothing to remove separately.
Another stark example is the exporter located in an EPZ. In his case, he would have purchased the item for Rs.400/-, ie.free of excise/customs duty; but not entitled for DDB/DEPB. He will also be eligible for full deduction on Rs.200/-
Therefore this anamoly will prevail. All other arguments are well conceived and dealt with.