S.H Kapadia, J.:— At the behest of the assessee, the Tribunal has referred the following question of law for out opinion under section 256(1) of the Income-tax Act. The Reference concerns Assessment Year 1976-1977. The question referred, is as follows:

“Whether on the facts and in the circumstances of the case, the Tribunal was justified in coming to the conclusion that depreciation allowance ought to be deducted while computing the total income for the purposes of deduction under section 80HH?”

FACTS:

2. In the Return for Assessment Year in question, the assessee claimed deduction under section 80-HH as follows:

Profits as per Profit and Loss Account Rs. 77,96,076 Less: Development Rebate Rs. 9,32,677 Rs. 68,63,399

3. On this amount of Rs. 68,63,399/-, the assessee claimed relief under section 80HH at the rate of 20%, amounting to Rs. 13,72,680/-.

4. The said computation of the assessee was made, by placing reliance on section 32(2) of the Income-tax Act. According to the assessee, in section 32(2) of the Act, the word “Chargeable” should be interpreted to signify the amount of profits and gains computed, after deducting therefrom the deductions permissible under sections 80HH and 80J. That, the effect would be that to the extent of deduction, the profits and gains would not be chargeable. In this connection the assessee relied upon the judgment of the Kerala High Court in the case of Indian Transformers Limited v. CIT, reported in 86 ITR Page 192.

5. This argument was rejected by the AO. The AO determined the allowable deduction under section 80HH as follows:

Profit as per Profit and Loss A/C. Rs. 77,96,076/- Less: Depreciation Rs. 87,76,690/- Development Rebate Rs. 9,92,677/- Rs. 97,09,367/- Nil

6. Being aggrieved, the assessee went in Appeal to the Commissioner. The First Appellate Authority rejected the contention of the assessee. It took the view that depreciation has got to be taken into account for determination of profits derived from Industrial Undertaking whether it is determination of profits of business in accordance with the Act or it is determination of true profits under proper principles of accountancy. In the circumstances, the assessee's claim for deduction under section 80HH, without taking into consideration current depreciation, came to be rejected. Being aggrieved, the asesssee carried the matter in Appeal to the Tribunal. Relying on the judgment of the Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT Gujarat-II reported in 113 ITR Page 84, the Tribunal took the view that the AO was justified in deducting depreciation and development rebate while computing the total income for the purposes of section 80HH. Being aggrieved, the assessee has come by way of Reference.

SCOPE OF THE Income-tax Act:

7. Before coming to the arguments advanced on behalf of the assessee, the following sections of the Income-tax Act needs to be looked into. Section 4(1) refers to charge of Income-tax. It states, inter alia, that Income-tax shall be charged in accordance with and subject to the provisions of the Act in respect of total income of the previous year. Section 5(1) refers to scope of total income. It states that the total income of any previous year includes all income from whatever source derived. Section 2(45) defined “Total-Income” to mean income computed as per the provisions of the Act. Chapter III refers to incomes which do not form part of total income. Section 10 states that in computing total income any income falling within any of the clauses in section 10 shall not be included. Chapter IV deals with computation of total income. Section 14 states inter alia, that all income shall, for purposes of computation, be classified under stipulated heads of income. In this case, we are concerned with the head “Profits and Gains of Business or Profession”. Section 28 refers to computation of income under the head “Profits and Gains of Business”. Section 29 states that the income under the head “Profits and Gains of Business” shall be computed in accordance with section 30 to section 43A. Section 32 refers to Depreciation. Section 32(1) states that in respect of depreciation of buildings, machinery, plant or furniture owned by the assessee and used for the purposes of the business, certain deductions shall be allowed. Section 32(2), which is heavily relied upon in this case by the assessee, inter alia, provides for carry forward of depreciation allowance in cases where it is not possible to set off such allowance against profits owing to absence of such profits or gains chargeable for the previous year or owing to such profits or gains chargeable, being less than the allowance [emphasis supplied]. section 70(1), inter alia, states that where the net result for any assessment year in respect of any source falling under any head of income other than “capital gains” is a loss, then the assessee shall be entitled to have such loss set off against his income from any other source under the same head. Section 72 refers to carry forward and set off of business losses. Section 72(1) states that where the net result of the computation under the head “Profits and Gains of Business” is a loss and such loss cannot be set off against income under any head then such loss could be carried forward to the following year and it could be set off against business profits, if any, accruing during that following Assessment Year.

8. Chapter VI-A refers to deductions to be made in computing total income. Chapter VI-A refers to special types of deductions. Chapter VI-A refers to special deductions to be made for computing Total Income. Section 80A(1) states that in computing the total income, there shall be allowed from gross total income, in accordance with and subject to the provisions of Chapter VI-A, the deductions specified in section 80C to section 80VV, which includes section 80HH, which arises for interpretation, once again, in this case. Section 80A(2) states that the aggregate amount of deductions under Chapter VI-A shall not exceed the gross total income of the assessee. Section 80B(5) defines “Gross Total Income” to mean total income computed in accordance with the provisions of the Act, before making any deduction under Chapter VI-A. Section 80HH comes under clause C to Chapter VI-A Deductions in respect of certain Incomes. Section 80HH refers to deduction in respect of profits and gains from newly established Industrial Undertakings in backward areas. It lays down that where gross total income of an assessee includes profits and gains derived from such Industrial Undertaking then, there shall be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to 20%. In other words, where the gross total income of an assessee includes certain types of Incomes falling in Clause C herein above then, while computing the total income of the assessee, a deduction of 20% is required to be made from profits of such Undertaking computed as per the Act. In this case, we are concerned with Income derived from Newly Established Industrial Undertaking in backward area. In other words, in cases where Gross Total Income includes profits from Newly Established Undertaking, one has to compute such profits and gains derived from Newly Established Undertaking in backward area in accordance with the provisions of the Act so as to form part of Gross Total Income and after so computing, one must deduct 20% thereof from Gross Total Income to arrive at Total Taxable Income. This is the ratio of the judgment of the Supreme Court also in the case of Cambay Electric Supply Industrial Company Limited v. CIT Gujarat-II, reported in 113 ITR Page 84.

9. The conspectus of the above sections show that Income tax is a charge on an assessee in respect of his Total Income computed in accordance with the provisions of the Act. However, in cases where the Total Taxable Income comprises of profits derived from Newly Established Undertaking under section 80HH, then such profits have got to be computed separately as laid down by the Supreme Court in the case of Cambay Electric Supply Co. (supra) as if it concerns a separate assessee. While calculating such profits, we must bear in mind sections 29 to 43-A of the Act. Hence, depreciation has got to be set off as an expense against Gross Income of the Newly Established Undertaking in order to arrive at profits and gains of Newly Established Undertaking. Hence Net Profits as per Profits and Loss Account of Newly Established Undertaking would be computed, after taking depreciation into account and 20% of such net profit would be deductible from the Gross Total Income of the assessee to arrive at Total Income of the assessee. It needs to be clarified that in this case, we are concerned with computation of Total Income of an assessee who seeks relief under section 80HH. In this case, the assessee has claimed depreciation allowance. It is important to note that in cases of computation of Normal Income, without seeking benefit of special deduction under Chapter VI-A, an assessee is free not to claim depreciation in view of the judgment of the Supreme Court in the case of CIT v. Mahendra Mills, reported in 243 ITR Page 56, but if the assessee claims depreciation, then such depreciation will be set off as any other expense against Gross Income. Further, if such an assessee claims deduction under Chapter VI-A, then to calculated profits and gains of Newly Established Undertaking, depreciation allowance has got to be set of against Gross Income of Newly Established Undertaking to arrive at Profits computed in accordance with the provisions of the Act, which profits would form part of Gross Total Income and which would be exigible to 20% deduction. The reason is that Chapter VI-A deals with special types of Income. The deduction of 20% is not to be equated with depreciation, which is an ordinary expense. The idea under the above formula is that the assessee should not claim more than what he is entitled to. Take the case of section 80HHC under which deduction is given in commensuration with the foreign exchange, which the assessee brings in. Therefore, if an assessee claims deduction under section 80HHC, depreciation has got to be set off against Gross Income. Our view is supported by the judgment of the Supreme Court in the case of Cambay Electric Supply Co. Ltd. v. CIT, reported in 113 ITR Page 84.

POINT AT ISSUE:

10. Before considering the arguments one must be clear on the nature of dispute, which is spelt out by the following Illustration.

11. ILLUSTRATION:

Computation of deduction under section 80HH according to AO.

Assessee has claimed depreciation of Rs. 75/-. Therefore, the AO has set off Rs. 75/- against the Gross Income of Rs. 100/- derived from Newly Established Undertaking, leaving a Balance Profit of Rs. 25/-. This sum of Rs. 25/- is exigible to 20% deduction [see the judgment of the Supreme Court in the case of Cambay Electric Supply Co. Ltd. (supra) under section 80HH. Consequently, the AO has computed deduction under section 80HH, which is reduced from Gross Total Income leaving the Taxable Profit at Rs. 20/-.

Computation of deduction under section 80HH by the assessee.

Assessee sets off Rs. 20/- (i.e 20% deduction under section 80HH) against Gross Income of Rs. 100/-, without depreciation. Hence assessee applies 20% benefit of Rs. 20/- under section 80HH leaving the Balance Profits at Rs. 80/- from which the assessee sets off Rs. 75/- as depreciation and returns Taxable Profit of Rs. 5/-.

12. This Illustration shows that the assessee has not disclaimed depreciation.

13. This Illustration illustrates the basic controversy.

ARGUMENTS:

14. Mr. Mistry learned counsel appearing on behalf of the assessee firstly contended that deduction under section 80HH should be calculated with reference to income net of depreciation. That, the said deduction should be with reference to the profits of the newly established undertaking before charging depreciation. That, under section 32(2) if, in a given case, there were no profits and gains chargeable, then depreciation was required to be carried forward. That the words “chargeable” in section 32(2) refers to profits and gains computed after deducting therefrom special deductions under Chapter VI-A, which included section 80HH because the effect of such deductions was that, to the extent of such deductions, profits and gains were not chargeable. He also relied upon section 4 of the Income-tax Act. He submitted that if the one reads section 32(2) with section 4 of the Income-tax Act then it is clear that deduction under section 80HH should be first made from profits and gains of the concerned Newly Established Undertaking, without depreciation. In this connection, he invited our attention also to section 80B(5) which defines gross total income to mean total income computed in accordance with the provisions of the Act. Mr. Mistry contended that section 4 of the Income-tax Act imposes a charge of tax in respect of the total income. That the word “total income” has been defined under section 2(45) to mean total amount of Income computed in the manner laid down in the Act. Therefore, he contended that if one reads section 80HH, which provides for computation of deduction at 20%, it is clear that open must take into account the total profits of the Unit, without depreciation and apply to it the special rate of 20%. He contended that only by such methodology one can give effect to the special provisions of Chapter VI-A. Mr. Mistry, in the alternative submitted that in several cases decided by this Court dealing with computation of deductions under Chapter VI-A, it has been held that profits and gains of newly established Undertaking shall be computed in accordance with the provisions of the Act. In this connection, he cited the following judgments of the Bombay High Court to which one of us [Kapadia, J.] was a party, in the case of CIT v. Gannon Dunkerley and Co. Ltd., reported in 216 ITR Page 708, in the case of CIT v. Albright Morarji and Pandit Ltd., reported in 236 ITR Page 914 and in the case of Grasim Industries Ltd. v. Asstt. CIT, reported in 245 ITR page 677. However, Mr. Mistry contended that all these judgments were delivered prior to the judgment of the Supreme Court in the case of CIT v. Mahendra Mills, reported in 243 ITR Page 56. He contended that in the case of Mahendra Mills (supra), it has been held by the Apex Court now that business profits can be computed, net of depreciation if the assessee disclaims such depreciation allowance. Mr. Mistry, therefore, contended that one has to read section 80HH in the light of the judgment of the Supreme Court in Mahendra Mill's case (supra) and if so read, he contended that it is clear that deduction under section 80HH should be made from profits and gains of the concerned Units computed in accordance with the provisions of the Act which covers section 29 to section 43A of the Income-tax Act as it stood at the relevant time and since section 32(2) is a part of those provisions, the computation of profits of newly established Undertakings could be made, net of depreciation provided the assessee opts not to claim depreciation allowance.

15. Mr. R.V Desai, learned senior counsel appearing on behalf of the department has relied upon the above judgments of the Bombay High Court and submitted that the arguments of the assessee had no merits. He contended that in view of the judgment of the Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT-Gujarat-II reported in 113 ITR Page 84 the point at issue has been resolved. He submitted that in the said judgment of the Supreme Court it has been unequivocally laid down that items like depreciation and development rebate have to be deducted in arriving at the figure which would be exigible to deduction at 20% under section 80HH. He clarified that the judgment of the Supreme Court was dealing with section 80E, which was also a special deduction under Chapter VI-A for which the rate prescribed was 8% and not 20%. However, the principle laid down by the Supreme Court in Cambay Electric Supply Company's case would equally apply to the facts of this case. Mr. R.V Desai further submitted that the judgment of the Supreme Court in the case of Mahendra Mills (supra) had no application to the facts of this case. He contended that the only argument advanced before the Supreme Court in that matter was whether the assessee was free to disclaim/not to claim depreciation allowance while computing profits and gains of business. It is in that light that the Supreme Court has held, after considering the provisions of sections 28, 29, 32 and 34 with the Circulars issued by C.B.D.T that the AO cannot grant depreciation allowance when the same is not claimed by the assessee. Mr. Desai contended that in the case of Mahendra Mills (supra), applicability of special deductions under Chapter VI-A was not in issue. He, therefore, contended that Mahendra Mill's case did not apply to the present controversy. Mr. R.V Desai further pointed out that in any event in this case the assessee has not disclaimed depreciation. He submitted that on the contrary the assessee claims deduction of Rs. 75/- in its entirety and he also claims full deduction at 20% under section 80HH as could be seen from the example given hereinabove. In the circumstances, he submitted that the entire attempt of the assessee was to maximize the deduction under section 80HH at the cost of distorting the computation of true profits.

FINDINGS:

16. The only question which arises for determination in this case is the amount of depreciation which should be set off while computing profits and gains derived by the assessee from Newly Established Undertaking covered by section 80HH.

17. The point at issue in amply clear from the Illustration given hereinabove under the caption “Point at issue”. The Illustration indicates that the assessee has not disclaimed depreciation. The point, therefore, to be noted is that the assessee has also claimed depreciation, but at a later stage and, therefore, the judgment of the Supreme Court in Mahendra Mills' case has no application. According to the assessee the profits derived from the Unit was Rs. 100/- because under section 32(2) read with section 4 of the Income-tax Act, the chargeability was in respect of the total income and, therefore, the rate of 20% was applicable to the total income of Rs. 100/- without deducting depreciation. Secondly, in any event, the controversy in Mahendra Mill's case was not concerning deductions under Chapter VI-A of the Income-tax Act. Therefore, that judgment would not apply to this case. The important distinction, which is required to be noticed in this case, is that we are required to compute total taxable income of the assessee who has claimed special deduction under Chapter VI-A. For that purpose, one has to keep in mind provisions of section 80b(5) and 80ab. consequently, section 80hh, inter alia, lays down that if the Gross Total Income includes profits from Newly Established Undertaking then 20% of such profits would be deductible from Gross Total Income in order to arrive at total taxable income. That, in such a case, profits derived from Newly Established Undertaking shall be computed in accordance with the provisions of the Act i.e section 29 to section 43A. Therefore, Net Profit will have to be computed in accordance with the provisions of the Act. The argument of the assessee is that in view of the Judgment of the Supreme Court in Mahendra Mill's case (supra), it is open to the assessee not to claim depreciation allowance under section 32 and consequently it is argued that 20% rate of deduction should be applied to Rs. 100/- in the above Illustration, without taking into account the depreciation. We do not find any merit in this argument. The Scheme of section 4 and section 5 of the Income Tax Act does indicate that income tax is a tax in respect of income computed as per the provisions of the Act. There is a distinct dichotomy between cases of computation of normal income under the Act de hors Chapter VI-A and computation of taxable income where the assessee claims the benefit of deduction under Chapter VI-A because the legislature has intended that these special deductions should be restricted to the profits derived from Newly Established Undertaking. To give an Illustration, export profits under section 80HHC are required to be restricted to the receipt of foreign exchange. If this object is kept in mind, then it is clear that the analogy of section 32(2) given by the assessee will not apply in cases where an assessee claims special deduction under Chapter VI-A. The matter can be looked at from another angle. While computing normal income, an assessee may set off depreciation against its Gross income. In such cases, depreciation is like any other ordinary expense. However, such depreciation cannot be equated with special deduction under Chapter VI-A. In any event, in this case, on facts, the assessee claims depreciation of Rs. 75/- from the balance income of Rs. 80/- and, therefore, the judgment of the Supreme Court in Mahendra Mill's case (supra) has no application.

18. In the above judgments of the Bombay High Court to which one of us (Kapadia, J.) was a party it has been held inter alia, that Chapter VI-A of the Income-tax Act deals with special deductions. That, Chapter VI-A, for the purposes of computing such deductions, constituted a separate code by itself. In order to compute the total taxable income of the assessee, deductions computed under section 80HH have to be reduced from Gross Total Income of the assessee. The question basically in this matter is concerning computation of deduction under Chapter VI-A in which section 80HH falls. Profits and Gains of newly established Undertaking, therefore, have got to be computed as per the provisions of section 29 to section 43-A and if the assessee claims relief under Chapter VI-A of the Act, then it is not open to the assessee to disclaim depreciation allowance. This is because Chapter VI-A is an independent code by itself for computing these special types of deductions. In other words, one must first calculate the Gross Total Income from which one must deduct a percentage of Incomes contemplated by Chapter VI-A. That such special Incomes were required to be computed as per the provisions of the Act viz. Section 29 to section 43-A, which included section 32(2). Therefore, one cannot exclude depreciation allowance while computing profits derived from newly established Undertaking for computing deductions under Chapter VI-A. Therefore, the appellants claim for allowance of deduction under section 80HH, without taking into consideration the current depreciation will have to be rejected.

CONCLUSION:

19. For the above reasons, we answer the above question in the affirmative i.e in favour of the department and against the assessee.

20. Accordingly, the Income-Tax Reference is disposed of with no order as to costs.

Reference answered in favour of Department.