Gwalior Rayon Silk Mfg. (Wvg.) Co. Ltd. v. Commissioner Of Income-Tax, Madhya Pradesh-I, Bhopal

1. This is a reference under Section 256(1) of the I.T. Act, 1961.

2. The assessee is a company. The relevant assessment year is 1962-63 for which the previous year is the financial year 1961 -62. The company carries on the business of manufacturing, inter alia, staple fibre and art silk fabrics and of exporting its goods outside India. The questions in this reference relate to calculation of tax deduction allowance under Section 2(5) of the Finance (No. 2) Act, 1962. The ITO in calculating the value of the turnover of exports for computation of qualifying income, under Rule 2(3) of the Income-tax (Determination of Export Profits) Rules, 1962, took into account only the value of goods exported as per invoice amounting to Rs. 8,25,668. The assessee-company submitted before the ITO that three further items should be taken into account in calculating the value of the turnover of exports. These items are: (i) Rs. 1,41,402, being drawback of customs duty, (ii) Rs. 86,526, being refund of excise duty, and (iii) Rs. 28,81,308, being value of import entitlements. The ITO refused to take into account these items on the ground that the word "turnover" as used in Rule 2(3) should be construed in its ordinary commercial usage to mean sale price of goods and, therefore, other benefits arising from exports cannot be added to the invoice value of sales for calculating the value of turnover of exports. The view taken by the ITO was affirmed in appeal by the AAC and the Tribunal. The Tribunal also, observed that the items which the assessee wanted to get included in the value of turnover of exports were indirect benefits and that the assessee would be getting double advantage as these indirect benefits have already formed part of the total profits of the company in the assessment of income-tax.

3. On an application made by the assessee, the Tribunal has referred for our answer the following questions of law :

"(1) On the facts and in the circumstances of the case, whether the Tribunal was right in rejecting the applicant's claim that for the purpose of computing the tax deduction Under Section 2(5) of the Finance (No. 2) Act, 1962, in accordance with Rule 2(3) of the Income-tax (Determination of Export Profits) Rules, 1962, the direct incentives and benefits to which the applicant-company is entitled on exports, should be added to the invoice prices of the exported goods, to arrive at the ' export turnover ' ?

(2) On the facts and in the circumstances of the case, whether the Tribunal in arriving at its conclusion, was right in holding that if the benefits in the form of drawback of customs duty, refund of excise duty and premium gain on value of yarn entitlements to which the applicant-company is entitled are added to the invoice prices of the exported goods, the ussessee would be getting double advantages as these indirect benefits have already formed part of the total profits of the applicant-company and erred in concluding that the applicant-company wanted them to be included again in the turnover of such export ? "

4. Section 2(5)(i) of the Finance (No. 2) Act, 1962, reads as follows :

"2. (5)(i) An assessee being an Indian company or any other company which has made the prescribed arrangements for the declaration and payment of dividends within India or an assessee other than a company, whose total income includes any profits and gains derived from the export of any goods or merchandise out of India, shall be entitled to a deduction, from the amount of income-tax and super-tax with which he is chargeable for the assessment year commencing on the 1st day of April, 1962, of an amount equal to the income-tax and super-tax calculated respectively at one-tenth of the average rate of income-tax and of the average rate of supertax on the amount of such profits and gains included in the total income."

5. Rules have been made by the CBR under Section 2(5)(ii) which are known as the Income-tax (Determination of Export Profits) Rules, 1962. Rule 2 of these Rules, in so far as relevant, reads as follows :

"2. Computation of qualifying income.--(1) Where an assessee referred to in Clause (i) of Sub-section (5) of Section 2 of the Finance (No. 2) Act, 1962 (XX of 1962), carries on any business of exporting goods or merchandise out of India, the amount of the profits and gains of such business with reference to which deduction of tax is admissible under that Sub-section (hereinafter referred to as the 'qualifying income') shall be computed in accordance with the provisions of Sub-rule (2) or Sub-rule (3) or Sub-rule (4) of this rule, as the case may be...

(3) Where in the opinion of the Income-tax Officer the profits and gains on such exports cannot be ascertained, the amount of qualifying income shall be taken as a fraction of the profits and gains of the whole business of which such exports form a part and included in the total income (as reduced by the aggregate of the amount of any portion thereof on which income-tax or super-tax is not payable and the amount in respect of which a deduction of income-tax or super-tax has been granted under any provision of the Act), the fraction being proportional to the value of the turnover of such exports in relation to the total turnover of the business of which such exports form a part....."

6. The entitlement of an assessee-company for a deduction from the amount of income-tax and super-tax tinder Section 2(5) of the Finance (No. 2) Act is of an amount equal to the income-tax and super-tax calculated respectively at one-tenth of the average rate of income-tax and of the rate of super-tax on the amount of "profits and gains derived from the export of any goods or merchandise out of India" which are included in the total income. Rule 2 of the Rules made by the CBR under Section 2(5)(ii) is for computing the amount of profits and gains derived from the export business, which is referred to as the qualifying income in that rule. The rule must, therefore, be construed in the light of this object. If the amount of profits and gains on exports cannot be ascertained in accordance with Rule 2(2), the ITO has to apply Rule 2(3), as has been done in the present case. The amount of qualifying income under Rule 2(3) is computed as a fraction of the profits and gains of the whole business of which such exports form a part and included in the total income, the fraction being proportional to the value of the turnover of such exports in relation to the total turnover of the business of which such exports form a part. The I.T. authorities came to the conclusion that the word " turnover " in Rule 2(3) was restricted to the invoice value of sales and no other item could be added in the calculation of the turnover of exports. We are unable to agree that the word " turnover " which is not defined in the Act or the Rules, can be given such a restricted meaning. In Aris Bainbridge v.

Turner Manufacturing Co. Ltd. [1951] 1 KB 563; [1950] 2 All ER 1178 (KB), McNair J., held that the expression " turnover of the company's annual business " did not merely include their net invoice sales but also all sums received and receivable as a result of the company's trading, whether normal or abnormal. On this view, various lump sums received by the company in discharge of war-time contracts from Government departments representing payment by them for articles taken over and for hardship suffered by the company as a result of the termination of the contracts were held to be part of the turnover of the company's annual business. It is not in dispute before us that the amounts received by the assessee-company as drawback of the customs duty and as refund of excise duty have been included in the computation of profits and gains of business of the assessee. It is also not in dispute that these items were received by the company only because of the export business carried on by it. The items are not referable to any other business carried on by the assessee. Once it is held that these items constitute income, they must have their source and as these items could not have been received by the assessee but for the export business carried on by it, a direct relationship between the receipt of these items and the export business is established.

There cannot be a neutral source of income or nondescript business :

[Rajputana Trading Co. Ltd. v. CIT [1969] 72 ITR 286 (SC), at pp. 288, 290].

As these items are not relatable to any other source, it must be held that they are derived from the export business carried on by the assessee and they must thus form a part of the turnover of the export business of the assessee. These items ought to have been included in the calculation of turnover of exports for purposes of Rule 2(3).

7. Now we come to the item of Rs. 28,81,308. This represents the income arising from import entitlements which were non-transferable.

The company was permitted to import yarn which was used by it in the manufacture of textiles. Had the company purchased the yarn in the open market in India, it would have been required to pay much higher price than what it paid on import purchases and the difference resulted in the income of the above amount. The argument of the learned counsel for the assessee is that the assessee got import licences only because it exported goods with a view to compensate it against loss which it may have otherwise incurred in export business and the value of import entitlements must, therefore, be added in the calculation of the value of the turnover of exports. Now import entitlements are of two varieties, transferable and non-transferable. In the case of transferable import licences, the goods imported can be sold in the market by the importer.

In the case of non-transferable import licences, the goods have to be utilised by the importer himself. But, on principle, there is hardly any difference. The profits and gains resulting in both the cases would be included in the total income. The question before us is whether the source of such income can be said to be the export business. In other words, whether the income resulting from import entitlements can be said to be profits and gains derived from the export business within the meaning of section 2(5)(i). Now the word " derived " was construed by the Privy Council in CIT v. Raja Bahadur Kamakhaya Namyan Singh [1948] 16 ITR 325. In that case it was held that interest on rent was not agricultural income as it was not revenue derived from land. In holding so, the Privy Council observed (p. 328):

" The word ' derived ' is not a term of Article Its use in the definition (Section 2(1) of the Indian I.T. Act, 1922) 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."

8. This decision of the Privy Council was applied by the Supreme Court in Mrs. Bacha F. Guzdar v. CIT [1955] 27 ITR 1, at p. 7. The word "derived" in Section 2(5)(i) of the Finance Act must be similarly construed. Applying the test laid down by the Privy Council, let us examine as to what is the source of the profits resulting from the import entitlements. In the genealogical tree of this income, import comes first and export appears in the second degree. The income arising from import entitlements is directly related to the import activities or the import business of the assessee. It may be that it was because of the export business that the assessee got import licences, yet the connection of the income resulting from import entitlements to the export business is indirect and the direct, source, of this income is the import business. The amount of Rs. 28,81,308, being profits arising from import entitlements cannot, therefore, be included in the value of the turnover of exports under Rule 2(3). It is true that neither Rule 2(1) nor Rule 2(3) uses the word "derived", but the rule has to. be construed, as earlier stated, in the light of the object of Section 2(5)(i). A rule made under Section 2(5)(ii) for a computation of the qualifying income cannot enlarge the tax deduction allowance by widening the scope of the profits and gains of export business. The expressions "profits and gains of such business" and " profits and gains on such exports " as they occur in Rule 2(1) and Rule 2(3) respectively have to be given the same meaning as the expression "profits and gains derived from the export of any goods", which occurs in section 2(5)(i). So construed, there is no room for including the value of import entitlements in the turnover of exports under Rule 2(3). This conclusion is fully supported by the decision of the Bombay High Court in Hindustan Lever Ltd. v. CIT [1980] 121 ITR 951 and by the decision of the Kerala High Court in Cochin Co. v. CIT [I978] 114 ITR 822. We respectfully agree with the view taken in these cases. Learned counsel for the assessee has relied upon the decision of the Madras High Court in CIT v. Wheel & Rim Co. of India Ltd. [1977] 107 ITR 168, in which a contrary view was taken. The Madras case has been expressly, dissented from by the Bombay High Court in the case referred to above. The Madras High Court has not taken notice of the decision of the Privy Council in Kamakhaya Narayan Singh's case [1948] 16 ITR 325, and we respectfully differ from the view taken in the Madras case.

9. The observations of the Tribunal about double advantage in respect of the items in question are wholly irrelevant and the learned standing counsel has also not supported the said observations.

10. For the reasons given above, we answer the questions as follows :

(1) The Tribunal was not right in not including Rs. 1,41,402, being drawback of customs duty, and Rs. 86,526, lining refund of excise duty in calculation of turnover of profits from exports, within Rule 2(3) for computation of qualifying income. The Tribunal was, however, right in excluding the item of Rs. 28,81,308 representing profits from import entitlements in the calculation of turnover of exports under the said rule.

(2) The question of double advantage is irrelevant. There will be no order as to costs of this reference.