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Aurobindo Pharma Limited v. Income Tax
Structured Summary of the Opinion — Judgment (L.N.R., J.)
Factual and Procedural Background
The applicant is a pharmaceuticals company that both manufactures drugs for sale/use in India and manufactures items for export. In addition to producing its own products, the applicant undertakes contract processing (job work) of raw material supplied by other manufacturers and levies "conversion charges" for processing and handing over finished products to those customers.
Section 80HHC of the Income Tax Act, 1961 (inserted by the Finance Act, 1985) provides a deduction in respect of profits retained for export business. An Explanation (the Clause) to Section 80HHC(4C) prescribes computation of "profits of the business" and requires reduction of certain receipts (brokerage, commission, interest, rent, charges or similar receipts) to the extent of 90%.
For assessment year 1992-93, the Income Tax Officer proposed to deduct conversion charges from the profits and gains of business or profession for the purpose of determining the "profits of the business." An order was passed accordingly. The applicant's appeal to the Commissioner of Income-Tax (Appeals) was dismissed by order dated 20.03.1995. The applicant then appealed to the Income Tax Appellate Tribunal (ITA No.1103.Hyd/95), and the Tribunal dismissed the appeal by order dated 03.12.1997. On an application under Section 256(1) of the Act, the Tribunal referred two questions to this Court by order dated 24.01.2000.
Legal Issues Presented
- Whether on the facts and in the circumstances of the case the Tribunal was correct in law in its interpretation on the computation of relief under the provisions of Section 80HHC?
- Whether on the facts and in the circumstances of the case the Tribunal was right in law in holding that for the purposes of computation of deduction under Section 80HHC, 90% of the receipts on the sale of scrap and conversion charges were to be excluded?
Arguments of the Parties
Appellant's (Assessee's) Arguments — Sri S. Ravi, Senior Counsel
- Contended that the interpretation placed on Section 80HHC and the Clause by the Income Tax Appellate Commissioner and the Tribunal was contrary to law and settled principles.
- Argued that only amounts received by an assessee in activities unrelated to manufacture fall within the deductible category under the Clause; conversion charges are not unrelated but arise from processing/ manufacturing activity and therefore cannot be treated as deductible in the same category as brokerage, commission, interest, rent, etc.
- Submitted that any amount derived or earned through the process of manufacture — whether sold by the assessee or handed over to a customer — must be treated as part of the total turnover.
- Contended that Parliament's scheme in Section 80HHC balances benefits by linking export-derived profits to the proportion of export turnover to total turnover, and the view of the Tribunal disturbs that balance.
Respondent's (Revenue's) Arguments — Sri S.R. Ashok, Standing Counsel
- Submitted that by its description the conversion charges fall within the category referred to in the Clause (i.e., "charges" or receipts of a similar nature) and thus are deductible to the extent of 90%.
- Emphasized the objective of Section 80HHC: to differentiate the component of profit from unrelated accruals and permit appropriate deduction so that unrelated receipts do not inflate the profits eligible for export deduction.
- Argued that just as brokerage, commission, interest and rent mentioned in the Clause do not form part of the total turnover for the purpose of subsection (3) of Section 80HHC, conversion charges likewise should not form part of turnover.
- Noted that the Income Tax Officer, the Appellate Commissioner and the Tribunal had concurrently found on the facts that conversion charges were deductible under the Clause and that the questions framed by the Tribunal should be answered against the applicant.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income Tax v. Bangalore Clothing Company | Whether charges levied for job work (processing for others) can be treated on par with items mentioned in the Clause (brokerage, commission, interest, rent, charges of similar nature) and thus excluded from turnover. | The case held that job work charges cannot be treated on par with the items mentioned in the Clause (answer was in the negative). |
| Commissioner of Income Tax v. K. Ravindranathan Nair | Application to a processor (cashew nut processor) who processed both own and others' products and treatment of processing charges/ whether such charges should be added to turnover or deducted. | The Supreme Court affirmed the view that processing charges should be added to the turnover; the judgment included an observation at one place that such amount must be deducted along with other items in the Clause (the opinion notes this internal inconsistency in that judgment). |
| ACG Associated Capsules Pvt. Ltd. v. Commissioner of Income Tax | Clarification whether deductions under the Clause were under consideration in the K. Ravindranathan Nair case. | The Supreme Court held that the question of deductions to be made under the Clause did not fall for consideration in K. Ravindranathan Nair; the result indicated that the view expressed by the Bombay High Court in Bangalore Clothing Company's case "holds the field." |
Court's Reasoning and Analysis
The Court began by explaining the purpose and mechanism of Section 80HHC. Sub-section (3) operates to apportion profits derived from export by reference to the proportion of export turnover to total turnover. Because only profits "retained for export business" are deductible, the Section prescribes a method to segregate profits attributable to export from those of other activities.
The Court then analyzed the Clause's definition of "profits of the business," which requires reduction of 90% of any sums referred to in certain clauses of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in profits. The Clause also reduces profits of any establishment of the assessee outside India.
The Court identified the practical difficulty: indiscriminate posting or exclusion of items could distort the apportionment between export and non-export activities and thereby produce an incorrect deduction under Section 80HHC. To avoid such distortions, the Clause mandates deduction of items mentioned to the extent of 90%, but only where those items are unrelated to the manufacturing activity of the assessee.
The Court's central analytical proposition is that the common factor justifying grouping the items in the Clause is that they are unrelated to the activity of manufacture (whether exclusively or partly for export). If an amount has anything to do with the activity of manufacturing, even if the manufacture was for the benefit of other customers (i.e., job work/processing), that amount cannot be deducted under the Clause when arriving at the "profits of the business" for Section 80HHC purposes because doing so would disturb the proportionate relationship between export turnover and total turnover.
The Court reviewed prior decisions: Bangalore Clothing Company (held job work charges could not be treated as deductible like the Clause items), K. Ravindranathan Nair (processing charges were to be added to turnover, with an observation in that judgment suggesting otherwise at one place), and ACG Associated Capsules (held that deductions under the Clause were not in issue in K. Ravindranathan Nair, leaving the Bombay High Court view intact). The Court concluded that the amounts falling within the Clause are only those unrelated to the manufacturing activity; conversion charges earned through manufacturing (even when performed for others) are part of the total turnover and therefore not deductible under the Clause.
Holding and Implications
HOLDING: The Court answered the referred questions in favour of the applicant (the assessee). Specifically, the Court held that conversion charges earned by the applicant through processing/manufacturing for others are not deductible under the Clause for the purpose of computing "profits of the business" under Section 80HHC; such conversion charges form part of the total turnover.
Implications:
- Direct effect on the parties: The deduction of conversion charges under the Clause (i.e., excluding 90% of such receipts from the profits for Section 80HHC computation) is not permissible. Conversion charges must be treated as part of total turnover when applying the apportionment in Section 80HHC.
- On precedent: The Court's conclusion aligns with the view expressed in Commissioner of Income Tax v. Bangalore Clothing Company and the treatment affirmed by subsequent consideration in the cited Supreme Court decisions; the opinion does not purport to create a novel rule beyond applying those authorities to the facts before it.
This summary has been prepared strictly from the content of the provided opinion. No information beyond the text has been added or inferred.
Judgment: (L.N.R, J.)
The Income Tax Appellate Tribunal, Hyderabad Bench referred the following questions to 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 in 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 in holding that for the purposes of computation of deduction under S.80HHC, 90% of the receipts on the sale of scrap and conversion charges were to be excluded?
Briefly stated, the facts are that the applicant is a pharmaceuticals company and apart from manufacturing drugs for being sold and used in India, it manufactures items for export also. In the ordinary course, the applicant acquires raw-material, manufactures drugs according to its own expertise and markets the products. In addition to such activity, the applicant undertakes to process the raw-material supplied to it by the other manufacturing companies and hands over the end products to such companies, by levying, what are known as conversion charges.
The Parliament provided for incentive to the exporters of various products. Section 80HHC of the Income Tax Act, 1961 (for short the Act) was added through Finance Act, 1985 in 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 to export of the merchandise or manufactured goods shall bear the same proportion, as does the export 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 to Section 80HHC(4C) of the Act (for short the Clause) prescribes the procedure for computation of 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 the extent of 90%.
While processing the income tax returns of the applicant, submitted for the assessment year 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 the business. An order in this behalf was passed by the Income Tax Officer.
The applicant filed an appeal before the Commissioner of Income-Tax (Appeals). The appeal was dismissed through order, dated 20.03.1995 Thereupon, the applicant filed I.T.A No. 1103.Hyd/95 before the Tribunal. Through its order, dated 03.12.1997, the Tribunal dismissed the appeal. On an application submitted under Section 256(1) of the Act, the Tribunal referred the two questions mentioned above:
Sri S. Ravi, learned senior counsel appearing for the applicant submits that the interpretation placed on Section 80HHC of the Act, by the Income Tax Appellate Commissioner and the Tribunal is contrary to law and settled principles. He submits that what are deductible under Section 80HHC of the Act and the Clause are only the amounts that are received by an assessee in an activity unrelated to the manufacture and that there was no justification in treating the conversion charges, as falling in that category. He submits that mere use of the word charges to describe the amount levied for conversion of the raw material supplied by a third party, into product and handing over the same, would not bring it on par with the category of amounts mentioned under that provision. Learned senior counsel further submits that any amount, which is derived or earned through the process of manufacture, irrespective of the fact whether the end product is marketed by the assessee or was handed over to the customer, must be treated as part of the total turnover. He contends that 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 proportion between the turnover of the exported goods on the one hand and the total turnover, on the other and that the view taken by the Tribunal and other authorities have the effect of disturbing the balance.
Sri S.R Ashok, learned Standing Counsel for the Department, on the other hand, submits that by virtue of the very description, the conversion charges fall into the category, referred to in 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 permit deduction. According to the learned senior counsel, just as the amounts representing brokerage, commission, interest, rent mentioned in the Clause do not form part of the total turnover 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 Tax Officer, the Appellate Commissioner and the Tribunal have concurrently held on facts, that the amount representing conversion charges is liable to be deducted under the Clause and that the 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 Fianc Act, 1965, providing for certain 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 total categories of deductions that are permissible under Chapter VI-A. The Chapter undergoes phenomenal change in every financial year.
Section 80HHC of the Act itself runs into six closely printed pages and it reflects almost a comprehensive code in the context of deduction in respect of profits retained for export business. One of the reasons for the bulk of the Section is that many manufacturing units undertake 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 the returns of the remaining business. Sub-section (3) of Section 80HHC of the Act provides guidance 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 bears to the profits of the business, the same proportion as the export turnover in respect of such 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 export shall be the export turnover in respect of such trading goods as reduced by the direct costs 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) of Section 80HHC of the Act becomes relevant. A semblance of definition thereof is provided under the Clause, which reads:
profits of the business means the profits of the business as computed under the head Profits and gains of business or profession as reduced by
(1) ninety percent of any sum referred to in clauses (iiia), (iiib), (iiic), (iiid) and (iiie) of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and
(2) the profits of any branch, office, warehouse or any other establishment of the assessee situate outside India.
From a perusal of both the provisions referred to above, it becomes clear that the ratio between the turnover in respect of the exported goods on the one hand and the total turnover of the business carried by the assessee on the other hand would reflect the ratio between the profits of export and the rest of the business. This method appears to have been evolved with a view to cushion the uncertainity in one sector, with the profits earned in the other sector and vice 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 total profit 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 earned through 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 the investment 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 or profession, the Clause mandates that the items mentioned therein must be deducted to the extent of 90%. The effort is only to ensure that the benefit of deduction provided in respect of profits, retained for export business is not claimed vis-vis the unrelated items. To the extent, the items are mentioned in the provision, there does not exist any difficulty for deduction from the total profits in the ordinary parlance. To arrive at the profits of business which is an expression coined specifically for the purpose of the Section, not only the items mentioned therein i.e, brokerage, commission, interest and rent, but also charges or any other receipt of similar nature are to be deducted. The whole controversy is as to whether the conversion charges 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 the Clause is their being unrelated to the activity of the business of manufacture, which is exclusively or partly of export items. In other words, if the amount has anything to do with the activity 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 v. Bangalore Clothing Company 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 the charges levied for job work can be treated, on par with the items mentioned in the Clause. The answer was in the negative. In The Commissioner of Income Tax v. K. Ravindranathan Nair, the Supreme Court affirmed that view. In that case, the assessee was a processor of cashew nuts and apart from processing its own product, it has undertaken the products of others also. The assessee did not add the processing charges to the turnover at all. It was held that such amount is liable to be added to the turnover. However, at one place of the judgment, it was mentioned that such amount must be deducted along with other items mentioned in the Clause. In the subsequent judgment in ACG Associated Capsules Pvt. Ltd. v. Commissioner of Income Tax, the Honble Supreme Court held that the question as to the deductions to be made under the Clause did not fall for consideration in K. Ravindranathan Nairs case (2 supra). The 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 the category of brokerage, commission, interest, rent, charges occurring in the Clause are only those items, which are unrelated to, and other than the amounts forming part of total turn over of the business carried on by the assessee occurring in sub-section (3) of Section 80HHC of the 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 general profits, 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.
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