These appeals are filed by the revenue challenging
the order passed by the Tribunal holding that the interest
payable on the fixed deposits constitutes profits of the
business of the undertaking. As such, the assessee is
entitled to the benefit under Sections 10A and 10B of
Income Tax Act, 1961 (hereinafter referred to as 'the Act'
for brevity).
2. The assessee had earned interest from the
following sources:-
1. Deposits lying in the EEFC account and
2. Advancing of inter-corporate loans out of the
funds of the undertaking.
The assessee had outstanding borrowings by way of
External Commercial Borrowings (ECBs in short)
obtained in earlier years. The assessee has to repay this
borrowing only in accordance with the repayment
schedule. It was stated that RBI has imposed restriction
on prepayment of instalments. The undisputed fact is
that the borrowings were for the business of STP
undertaking. Under the Exchange Control Regulation,
the assessee is prohibited from any pre-payment of
ECBs. For any pre-payment of the loan, the assessee
had to seek prior permission of the Central Government.
In the year 1999, the Government had formulated a
policy on pre-payment and the policy stated that
approval of pre-payment would be granted only to the
extent of 10% of the outstanding loan. Hence, even after
going through the regulation, the assessee would have to
repay a small portion of its outstanding loans, though it
had the liquidity to do so. Hence, it is required to
temporarily park the funds, until the date of repayment,
and also keep paying the interest on the loans. The
assessee took a business decision to place these funds
with various sister concerns as inter-corporate deposits.
The assessee claims that the interest derived from
deposits in the EEFC account and the interest income
earned on inter-corporate deposits, have to be assessed
under the head income from business. Further, the
assessee claimed that the interest income as derived from
the business of export of articles or things or computer
software and the same is eligible for exemption under
section 10A of the Act for the Assessment Years 1997-98
and 1998-99. For the Assessment Year 2001-02, he
submits that, since the Act has undergone a change, the
entire concept and basis of Section 10A have changed
and thus, as per the provisions of law as applicable to
the Assessment Year 2001-02, the interest income forms
part of profit from the business of industrial undertaking
and once the formula is applied as specified in sub-
section 4 of section 10A, the assessee would be entitled
for deduction, as the assessee is a 100% exporter, i.e. the
entire business of the assessee consists of development
and export of software. The assessing authority did not
agree with the said contention and therefore, he
disallowed the exemption claimed for the assessment
year 2001 - 02. Aggrieved by the said order, the assessee
preferred an appeal to the Commissioner of Income Tax
(Appeals), which came to be dismissed. Aggrieved by the
said order, the assessee preferred an appeal to the
Tribunal. The Tribunal insofar as the assessment year
1998 - 99 is concerned, held that the interest income
from EEFC account and the interest recovered on loans
advanced to the sister concern are admissible deduction
under the head Income from Business. It further held
that as per the predominant view of the various high
courts, the interest income arising from the transaction
connected with the business would be business income
and they affirmed the findings recorded by the appellate
authority. Hence, they extended the benefit under
Section 10 B of the Act, for the assessment year 1998-99.
3. However, while dealing with the very same
question for the assessment year 2001 - 02, they took
note of the change in the law. They extracted Section
10B(1) and (4) of the Act and held that it was an
exemption section and income from these undertakings,
which are covered by the section did not form part of the
total income. However, by virtue of the amendment, in
particular, introduction of Sub-section (4) to Section 10B
of the Act, the methodology of arriving at the export
profits of the business of the undertaking is given in a
formula. The terminology used in Sub-section 4 is
'profits of the business' of the undertaking in
contradiction to the word 'profits and gains derived by
the assessee "from a 100% export oriented undertaking'.
Finally, they held that the term "from the business of" is
much wider than the term "derived from industrial
undertaking". Keeping the said distinction in mind, they
held that the entire profits deriving from the business of
undertaking should be taken into consideration, while
computing the eligible deduction under Section 10B/10A
of the Act, by applying mandatory formula. After
introducing Section 80 HHC, it was observed, that the
legislature intended to exclude interest from the term
"profits of business of undertakings" under Sections 10A
and 10B of the Act and similar provision as in case of
Section (baa) would have been inserted. No such
explanation has been introduced in Sections 10A and
10B and therefore, it held that the interest income is
exempted from payment of tax and also their claim for
allowance of 5% on scientific basis should be allowed.
Aggrieved by the said order, the revenue is in appeals.
4. Learned Counsel for the revenue assailing the
impugned order contended that having regard to the
Section 10B of the Act, what is to be taken into
consideration is profits and gains derived from the export
of articles or things or computer software and not the
profits of the business of the undertaking. The words
"derived from" is narrower in connotation and intends to
cover sources not beyond the first degree." Therefore,
when the interest from fixed deposits or interest from
loans advanced to the sister concern or interest from
EEFC account or the consideration received from sale of
the import entitlement cannot be construed as profits
and gains from export of computer software. Therefore,
the said account is liable to be taxed.
5. Per contra, learned Counsel for the assessee
submits 'that was the position prior to the amendment in
2001. That is why, for the assessment year 1998 - 99,
the Tribunal has declined to extend the said benefit and
the assessee has accepted the said finding. But in view
of the change in the law, he is entitled to the said benefit
and the Tribunal after taking note of the change in the
law, has extended the said benefit, which is in tune with
the legislative intention. Therefore, the impugned order
cannot be found fault with.' In the light of the aforesaid
facts and rival contentions, ITA No.428/2007 was
admitted on 19.11.2011 and ITA No.447/2007 was
admitted on 14.03.2008 to consider the following
substantial questions of law, which reads as under:
In ITA No.428/2007:
(1) Whether in the facts and
circumstances of the case the finding of
the appellate authorities that interest
received by the assessee out of surplus
funds and deposited in Banks and
other sister concerns should be brought
to tax under the head "Income from
Business" and not under the head
"Income from other sources", is
perverse, arbitrary and contrary to law?
2. Whether the finding of the
appellate authorities having regarding
to the facts and circumstances of the
case and the law that the interest
income deposited out of surplus funds
in Banks and sister concerns and EEFC
account should be treated as part of the
total income for the purpose of
computing deduction under Sections
10A and 10B of the Income Tax Act, is
perverse and arbitrary?
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In ITA No.447/2007:
1. Whether the Appellate Authorities
committed an error in holding that the
interest income deposited out of surplus
funds in Banks and sister concerns and
EEFC account should be treated as part
of the total income for the purpose of
computing deduction under Sections
10A and 10B of the Income Tax Act?
2. Whether the Appellate Authorities
were correct in holding that the
management expenses attributable to
the income earned by way of interest is
allowable at the rate of 5% and not at
the rate of 4% as computed by the
Assessing Officer without assessing
any cogent reasons for applying such
charges?"
6. Learned Counsel for the revenue in support of
his contentions relied on several judgments, which are as
under:
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The Apex Court in the case of PANDIAN
CHEMICALS LTD. VS.. COMMISSIONER OF INCOME
TAX reported in (2003) 262 ITR 278, while dealing with
Section 80HH of the Act has held as under:
6. xxxxxxxxxxx The word
'derived' is not a term of art. Its use in
the definition indeed demands an
enquiry into the genealogy of the
product. But the enquiry should stop as
soon as the effective source is
discovered. In the genealogical tree of
the interest land indeed appears in the
second degree, but the immediate and
effective source is rent, which has
suffered the accident of non-payment.
And rent is not land within the meaning
of the definition.
7. This definition was approved
and reiterated in 1955 by a Constitution
Bench of this court in the decision of
Mrs. Bacha F. Guzdar v. CIT . It is clear,
therefore, that the word "derived from"
in Section 80HH of the Income-tax Act,
1961, must be understood as something
which has direct or immediate nexus
with the appellant's industrial
undertaking. Although electricity may
be required for the purposes of the
industrial undertaking, the deposit
required for its supply is a step removed
from the business of the industrial
undertaking. The derivation of profits
on the deposit made with Electricity
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Board cannot be said to flow directly
from the industrial undertaking itself."
The Apex Court in the case of LIBERTY INDIA VS.
COMMISSIONER OF INCOME TAX REPORTED IN (2009)
317 ITR 218, while interpreting Section 80IB of the Act,
which also allowed deduction in respect of profits and
gains derived from eligible business has held as under:
"14. xxxxxxxxxxxx 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."
That is the distinction between the words "derived from
industrial undertaking" as against "profits attributable to
industrial undertaking."
The Apex Court n the case of COMMISSIONER OF
INCOME TAX VS. STERLING FOODS REPORTED IN
(1999) 237 ITR 579 (SC), while dealing with Section
80HH has held as under:
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"There must be, for the application
of the words "derived from", a direct
nexus between the profits and gains
and the industrial undertaking."
In the case of COMMISSIONER OF INCOME TAX
VS. MENON IMPEX (P) LTD. REPORTED IN (2003) 259
ITR 403 (MAD), dealing with exemption under Section
10A of the Act, has held as under:
"It was pointed out that unless the
source of the income is from an
industrial undertaking, such income
cannot be regarded as "derived from"
industrial undertaking. It was held that
the income derived from sale of import
entitlement could only be said to be the
export promotion scheme and not the
industrial undertaking."
Following the aforesaid judgments, the Madras High
Court in the case of COMMISSIONER OF INCOME TAX
VS. THE MADRAS MOTORS LIMITED REPORTED IN
(2002) 257 ITR 60 (MAD) has held that the interest
which is earned by the assessee from the bank deposits
would not have a direct nexus with the industrial
undertaking of the assessee and would only be incidental
income thereto and, therefore, such interest has to be
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ignored from the allowable profits under Section 80 HH.
Following the aforesaid judgments, the Division Bench of
this Court in the Case of ANIL DANG VS. INCOME TAX
OFFICER REPORTED IN (2012) 344 ITR 143 (Karn)
has held that the primary condition to claim deduction
under Section 80HHC would be that the assessee should
have derived profits from export of goods or merchandise
and bailee. The assessee would not be allowed to
compute the total income by deducting profits derived
from export. The Bombay High Court in the case of
COMMISSIONER OF INCOME TAX VS. SHAH
ORIGINALS REPORTED IN (2010) 327 ITR 19 has held
that 'an assessee who is a exporter, is not under an
obligation of law to maintain the export proceeds in
EEFC account but, this is a facility which is made
available by the Reserve Bank of India. The transaction
of export is complete in all respects upon the repatriation
of the proceedings. It lies within the discretion of the
exporter as to whether the export proceeds should be
received in a rupee equivalent in the entirety or whether
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a portion should be maintained in convertible foreign
exchange in the EEFFC account. The exchange
fluctuation that arises, it must be emphasized, is after
the export transaction is complete and payment has been
received by the exporter. Upon the completion of the
export transaction, what the seller does with the
proceeds, upon repatriation, is a matter of his option.
The exchange fluctuation in the EEFC account arises
after the completion of the export activity and does not
bear a proximate and direct nexus with the export
transaction so as to fall within the expression "derived"
by the assessee is sub-section (1) of section 80hhc.
7. Relying on these judgments, it was contended
that the interest received or the consideration received
from sale of import entitlement has no direct nexus with
the profits and gains derived from the export of software
and therefore, the assessee is not eligible for exemption.
All the judgments were rendered prior to the amendment
in the year 2001 and therefore, there cannot be any
quarrel with the law laid down in these cases. All the
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judgments are rendered in the context of Section 80
HHC. Therefore, the judgment of the Tribunal for the
assessment year 1998 - 99, where it has declined the
benefit to the assessee cannot be found fault with. But
there is change in the law for the assessment year 2001 -
02. Section 10(B)(1) and (4) reads as under:-
"Section 10B : Special
provisions in respect of newly
established hundred per cent
export-oriented undertakings.-
(1) Subject to the provisions of this
section, a deduction of such profits and
gains as are derived by a hundred per
cent export-oriented undertaking from
the export of articles or things or
computer software for a period of ten
consecutive assessment years
beginning with the assessment year
relevant to the previous year in which
the undertaking begins to manufacture
or produce articles or things or computer
software, as the case may be, shall be
allowed from the total income of the
assessee :
Provided that where in computing the
total income of the undertaking for any
assessment year, its profits and gains
had not been included by application of
the provisions of this section as it stood
immediately before its substitution by
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the Finance Act, 2000, the undertaking
shall be entitled to the deduction
referred to in this sub-section only for
the unexpired period of aforesaid ten
consecutive assessment years :
Provided further that for the assessment
year beginning on the 1st day of April,
2003, the deduction under this sub-
section shall be ninety per cent of the
profits and gains derived by an
undertaking from the export of such
articles or things or computer software:
Provided also that no deduction under
this section shall be allowed to any
undertaking for the assessment year
beginning on the 1st day of April, 2012
and subsequent years :
Provided also that no deduction under
this section shall be allowed to an
assessee who does not furnish a return
of his income on or before the due date
specified under sub-section (1) of section
139.
(4) For the purposes of sub-section
(1), the profits derived from export of
articles or things or computer software
shall be the amount which bears to the
profits of the business of the
undertaking, the same proportion as the
export turnover in respect of such
articles or things or computer software
bears to the total turnover of the
business carried on by the
undertaking."
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By Finance Act, 2001, with effect from 01.04.2001, the
present Subsection (4) is substituted in the place of old
Subsection (4). No doubt Subsection 10(B) speaks about
deduction of such profits and gains as derived from
100% EOU from the export of articles or things or
computer software. Therefore, it excludes profit and
gains from export of articles. But Subsection (4) explains
what is the profit derived from export of articles as
mentioned in Subsection (1). The substituted Subsection
(4) says that profits derived from export of articles or
things or computer software shall be the account which
bares to the profits of the business of the undertaking
and not the profits and gains from export of articles.
Therefore, profits and gains derived from export of
articles is different from the income derived from the
profits of the business of the undertaking. The profits of
the business of the undertaking includes the profits and
gains from export of the articles as well as all other
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incidental incomes derived from the business of the
undertaking. It is interesting to note that similar
provisions are not there while dealing with computation
of income under Section 80HHC. On the contrary, there
is specific provisions like Section 80HHB which expressly
excludes this type of incomes. Therefore, in view of the
aforesaid provisions, it is clear that, what is exempted is
not merely the profits and gains from the export of
articles but also the income from the business of the
undertaking.
8. In the instant case, the assessee is a 100% EOU,
which has exported software and earned the income. A
portion of that income is included in EEFC account. Yet
another portion of the amount is invested within the
country by way of fixed deposits, another portion of the
amount is invested by way of loan to the sister concern
which is deriving interest or the consideration received
from sale of the import entitlement, which is permissible
in law. Now the question is whether the interest received
and the consideration received by sale of import
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entitlement is to be construed as income of the business
of the undertaking. There is a direct nexus between this
income and the income of the business of the
undertaking. Though it does not par take the character
of a profit and gains from the sale of an article, it is the
income which is derived from the consideration realized
by export of articles. In view of the definition of 'Income
from Profits and Gains' incorporated in Subsection (4),
the assessee is entitled to the benefit of exemption of the
said amount as contemplated under Section 10B of the
Act. Therefore, the Tribunal was justified in extending
the benefit to the aforesaid amounts also. We do not find
any merit in these appeals. Therefore, the first
substantial question of law raised in ITA No.428/2007 is
answered in favour of the revenue and against the
assessee and the first substantial question of law in ITA
No.447/2007 is answered in favour of the assessee and
against the revenue.
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In the light of the aforesaid findings, the second
substantial question of law in both the appeals do not
arise for consideration.
Parties to bear their own costs.
Sd/-
JUDGE
Sd/-
JUDGE
nvj