Rc/78/2000 Of M/S Aurobindo Pharma Ltd v. The Commisi0Ner Of Income Tax

*THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND*THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM+R.C.No.78 of 2000 % Dated 11.07.2014 M/s.Aurobindo Pharma Limited, Hyderabad. ….Applicant $ Commissioner of Income Tax. ….Respondent ! Counsel for the applicant : Sri S.Ravi^ Counsel for respondent : Sri S.R.Ashok < GIST: > HEAD NOTE: ? Cases referred:1 (2003) 260 ITR 371 (Bom)2 (2007) 295 ITR 228 (SC)3 (2012) 343 ITR 89 (SC) THE HON’BLE SRI JUSTICE L.NARASIMHA REDDYAND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAMR.C.No.78 of 2000 JUDGMENT: (Per LNR, J) The Income Tax Appellate Tribunal, Hyderabad Bench referred the following questionsto this Court, through its order, dated 24.01.2000: 1.Whether on the facts and in the circumstances of the case the Tribunal was correct in law inits interpretation on the computation of relief under the provisions of S.80HHC?its interpretation on the computation of relief under the provisions of S.80HHC? 2.Whether on the facts and in the circumstances of the case the Tribunal was right in law inholding that for the purposes of computation of deduction under S.80HHC, 90% of the receiptson the sale of scrap and conversion charges were to be excluded?holding that for the purposes of computation of deduction under S.80HHC, 90% of the receiptson the sale of scrap and conversion charges were to be excluded? Briefly stated, the facts are that the applicant is a pharmaceuticals company and apartfrom manufacturing drugs for being sold and used in India, it manufactures items for exportalso. In the ordinary course, the applicant acquires raw-material, manufactures drugsaccording to its own expertise and markets the products. In addition to such activity, theapplicant undertakes to process the raw-material supplied to it by the other manufacturingcompanies and hands over the end products to such companies, by levying, what are knownas “conversion charges”. The Parliament provided for incentive to the exporters of various products. Section80HHC of the Income Tax Act, 1961 (for short ‘the Act’) was added through Finance Act, 1985in this behalf. It provides for “deduction in respect of profits retained for export business”. Sub-section (3) thereof is to the effect that the profits of a manufacturing company, referable toexport of the merchandise or manufactured goods shall bear the same proportion, as does theexport turnover, to the total turnover of the business of the assessee. The profits of the assessee in the business become relevant in this context. Clause (baa) of the Explanation toSection 80HHC(4C) of the Act (for short ‘the Clause’) prescribes the procedure for computationof “profits of the business”, in this context. Certain amounts, such as brokerage, commission,interest are required to be reduced from “profits and gains of business or profession” to theextent of 90%. While processing the income tax returns of the applicant, submitted for the assessmentyear 1992-93, the Income Tax Officer proposed to deduct the “conversion charges” from the“profits and gains of business or profession” for the purpose of determining the “profits of thebusiness”. An order in this behalf was passed by the Income Tax Officer. The applicant filed an appeal before the Commissioner of Income-Tax (Appeals). Theappeal was dismissed through order, dated 20.03.1995. Thereupon, the applicant filedI.T.A.No.1103/Hyd/95 before the Tribunal. Through its order, dated 03.12.1997, the Tribunaldismissed the appeal. On an application submitted under Section 256(1) of the Act, theTribunal referred the two questions mentioned above: While processing the income tax returns of the applicant, submitted for the assessmentyear 1992-93, the Income Tax Officer proposed to deduct the “conversion charges” from the“profits and gains of business or profession” for the purpose of determining the “profits of thebusiness”. An order in this behalf was passed by the Income Tax Officer. The applicant filed an appeal before the Commissioner of Income-Tax (Appeals). Theappeal was dismissed through order, dated 20.03.1995. Thereupon, the applicant filedI.T.A.No.1103/Hyd/95 before the Tribunal. Through its order, dated 03.12.1997, the Tribunaldismissed the appeal. On an application submitted under Section 256(1) of the Act, theTribunal referred the two questions mentioned above: Sri S.Ravi, learned senior counsel appearing for the applicant submits that theinterpretation placed on Section 80HHC of the Act, by the Income Tax AppellateCommissioner and the Tribunal is contrary to law and settled principles. He submits that whatare deductible under Section 80HHC of the Act and the Clause are only the amounts that arereceived by an assessee in an activity unrelated to the manufacture and that there was nojustification in treating the “conversion charges”, as falling in that category. He submits thatmere use of the word “charges” to describe the amount levied for conversion of the rawmaterial supplied by a third party, into product and handing over the same, would not bring iton par with the category of amounts mentioned under that provision. Learned senior counselfurther submits that any amount, which is derived or earned through the process ofmanufacture, irrespective of the fact whether the end product is marketed by the assessee orwas handed over to the customer, must be treated as part of the total turnover. He contendsthat the Parliament has evolved a complicated but balancing Act of enabling a company,undertaking export of products to get the benefit of making it dependable upon the proportionbetween the turnover of the exported goods on the one hand and the total turnover, on theother and that the view taken by the Tribunal and other authorities have the effect of disturbingthe balance. Sri S.R.Ashok, learned Standing Counsel for the Department, on the other hand, submitsthat by virtue of the very description, the “conversion charges” fall into the category, referred toin the Clause. He submits that the objective underlying Section 80HHC of the Act is to (a)differentiate, to the extent possible, the component of profit from unrelated accrual (b) to permitdeduction. According to the learned senior counsel, just as the amounts representingbrokerage, commission, interest, rent mentioned in the Clause do not form part of the totalturnover of the business referred to in sub-section (3) of Section 80HHC of the Act, the“conversion charges” also do not form part of the turn over. He submits that the Income TaxOfficer, the Appellate Commissioner and the Tribunal have concurrently held on facts, that theamount representing “conversion charges” is liable to be deducted under the Clause and thatthe questions framed by the Tribunal deserve to be answered against the applicant. Both the learned senior counsel placed reliance upon certain decided cases. Sections 80A to 80D of the Act were introduced through Fiancé Act, 1965, providing forcertain deductions from income. As and how the industrial and business activity has grown,categories of deductions have also increased. One just cannot state with precession, the totalcategories of deductions that are permissible under Chapter VI-A. The Chapter undergoesphenomenal change in every financial year. Both the learned senior counsel placed reliance upon certain decided cases. Sections 80A to 80D of the Act were introduced through Fiancé Act, 1965, providing forcertain deductions from income. As and how the industrial and business activity has grown,categories of deductions have also increased. One just cannot state with precession, the totalcategories of deductions that are permissible under Chapter VI-A. The Chapter undergoesphenomenal change in every financial year. Section 80HHC of the Act itself runs into six closely printed pages and it reflects almost acomprehensive code in the context of “deduction in respect of profits retained for exportbusiness”. One of the reasons for the bulk of the Section is that many manufacturing unitsundertake export of part of their products and a substantial part is marketed within the country. Since the profits, that are earned from export business alone are permitted to be deducted, a comprehensive procedure is prescribed to segregate the profits from export business, from thereturns of the remaining business. Sub-section (3) of Section 80HHC of the Act providesguidance in this behalf, which reads: (3) For the purposes of sub-section (1),-(a)where the export out of India is of goods or merchandise manufactured [or processed]by the assessee, the profits derived from such export shall be the amount which bearsto the profits of the business, the same proportion as the export turnover in respect ofsuch goods, bears to the total turnover of the business carried on by the assessee;(b)where the export out of India is of trading goods, the profits derived from such exportshall be the export turnover in respect of such trading goods as reduced by the directcosts and indirect costs attributable to such export;(remaining part of the provision is omitted, since it is not necessary) The expression “profits of the business’ employed in clause (a) of sub-section (3) ofSection 80HHC of the Act becomes relevant. A semblance of definition thereof is providedunder the Clause, which reads: “profits of the business” means the profits of the business as computed under the head “Profits andgains of business or profession” as reduced by – (1)ninety percent of any sum referred to in clauses (iiia), (iiib), (iiic), (iiid) and (iiie) of section28 or of any receipts by way of brokerage, commission, interest, rent, charges or any otherreceipt of a similar nature included in such profits; and(2)the profits of any branch, office, warehouse or any other establishment of the assesseesituate outside India. From a perusal of both the provisions referred to above, it becomes clear that the ratiobetween the turnover in respect of the exported goods on the one hand and the total turnoverof the business carried by the assessee on the other hand would reflect the ratio between theprofits of export and the rest of the business. This method appears to have been evolved witha view to cushion the uncertainity in one sector, with the profits earned in the other sector andvice versa. For instance, if the total turnover of the business of an assessee is Rs.10,00,000/-,the turnover in respect of exported goods is Rs.4,00,000/- and the company has earned totalprofit of Rs.3,00,000/-, the profit earned through export shall be deemed to be 40% thereof,amounting to Rs.1,20,000/-. This is irrespective of the actual profit that has been earnedthrough export. The actual difficulty is experienced in arriving at the “profits of the business”. Indiscriminate posting of profits may result in loss to the revenue, since the proportion of theinvestment for export goods would have a bearing upon the profits also. The actual difficulty is experienced in arriving at the “profits of the business”. Indiscriminate posting of profits may result in loss to the revenue, since the proportion of theinvestment for export goods would have a bearing upon the profits also. With a view to avoid the indiscriminate addition to the profits and gains of business orprofession, the Clause mandates that the items mentioned therein must be deducted to theextent of 90%. The effort is only to ensure that the benefit of deduction provided in respect ofprofits, retained for export business is not claimed vis-à-vis the unrelated items. To the extent,the items are mentioned in the provision, there does not exist any difficulty for deduction fromthe total profits in the ordinary parlance. To arrive at the “profits of business” which is anexpression coined specifically for the purpose of the Section, not only the items mentionedtherein i.e., brokerage, commission, interest and rent, but also “charges or any other receipt ofsimilar nature” are to be deducted. The whole controversy is as to whether the “conversioncharges” earned by the applicant can be deducted from the “profits and gains of the business”,to arrive at the “profits of the business” mentioned under the Clause. To our mind, the common factor that warrants the grouping of the items mentioned in theClause is their being unrelated to the activity of the business of manufacture, which isexclusively or partly of export items. In other words, if the amount has anything to do with theactivity of manufacturing, though not of export goods, deduction thereof cannot be made. Otherwise, the proportion of the profit earned through export to the total profit gets disturbed. The Commissioner of Income Tax vs. Bangalore Clothing Company[[1]]was a case, in which the assessee not only carried out the activity of manufacture and export of its own,but also took up the job work of other manufactures. The question arose as to whether thecharges levied for job work can be treated, on par with the items mentioned in the Clause. The answer was in the negative. I n The Commissioner of Income Tax vs. K.Ravindranathan Nair[[2]], the Supreme Court affirmed that view. In that case, the assesseewas a processor of cashew nuts and apart from processing its own product, it has undertakenthe products of others also. The assessee did not add the processing charges to the turnoverat all. It was held that such amount is liable to be added to the turnover. However, at oneplace of the judgment, it was mentioned that such amount must be deducted along with otheritems mentioned in the Clause. In the subsequent judgment in ACG Associated Capsules Pvt. Ltd. vs. Commissioner of Income Tax[[3]], the Hon’ble Supreme Court held that thequestion as to the deductions to be made under the Clause did not fall for consideration inK.Ravindranathan Nair’s case (2 supra). result is that the view expressed by the Bombay High Court in Bangalore Clothing Company‘s case (1 supra) holds the field. Therefore, We are of the view that the amounts that can be treated as falling in thecategory of brokerage, commission, interest, rent, charges occurring in the Clause are onlythose items, which are unrelated to, and other than the amounts forming part of “total turn overof the business carried on by the assessee” occurring in sub-section (3) of Section 80HHC ofthe Act. Sine the “conversion charges” are earned through the activity of manufacturing,though for the benefit of other customers, the question of deducting the same from the generalprofits, in the context of arriving at “profits from business” under the Clause does not arise. Therefore, the questions are answered in favour of the applicant i.e., the assessee. ____________________ L.NARASIMHA REDDY, J ______________________ CHALLA KODANDA RAM, J Date: 11.07.2014Note: L.R.Copy to be marked.JSU THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM R.C.No.78 of 2000 Date: 11.07.2014 JSU [1](2003) 260 ITR 371 (Bom) Therefore, the questions are answered in favour of the applicant i.e., the assessee. ____________________ L.NARASIMHA REDDY, J ______________________ CHALLA KODANDA RAM, J Date: 11.07.2014Note: L.R.Copy to be marked.JSU THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM R.C.No.78 of 2000 Date: 11.07.2014 JSU [1](2003) 260 ITR 371 (Bom) [2](2007) 295 ITR 228 (SC) [3](2012) 343 ITR 89 (SC)