• Investment World
• eWorld
• Catalyst
• Mentor
• Life
• Canvas
• Praxis
• Urban Pulse
• Brand Quest

R. Anand

R Anand on a case dealing with determination of profits from new undertakings

ONE OF the various deductions in Chapter VIA of the Income-tax Act, 1961 (the Act) relates to deduction in respect of profits from newly-established undertakings. This is contained in Section 80HH of the Act, which grants 20 per cent deduction from profits and gains derived from an industrial undertaking in a backward area. The section lists several conditions to be specified before conferring a deduction.

Like all other provisions granting deductions/concessions, this provision has also had its fair quota of judicial interpretation. One of the interpretations deals with how to determine profits derived from a new industrial undertaking. This pointed issue has been decided by the Supreme Court in the Pandian Chemicals Ltd vs CIT (2003 262 ITR 278) case.

Facts, issues

The assessee, a private limited company engaged in the manufacture and sale of potassium chlorate used in the manufacture of matches, claimed deduction under Section 80HH for the assessment year 1979-80 on interest earned in respect of deposits placed with the Tamil Nadu Electricity Board. The assessee claimed that the interest received on deposits formed part of profits derived from newly established industrial undertakings in a backward area.

The assessing officer (AO) rejected the claim stating in simple terms that interest income cannot be equated with business profits. The issue travelled through various chains of appellate authorities and finally landed in the Supreme Court.

Incidentally the Madras High Court held that interest could not be treated as part of business profit for relief under Section 80HH. The assessee took the matter to the apex court.

The issue here was what sort of interpretation one would give to the expression "derived from an industrial undertaking" occurring in Section 80HH. Can one stretch the expression "derived" to take within its scope and ambit even extraneous income, which are indirectly attributable to earning business profits of the assessee? If that were so, various components of other income such as interest on deposits, surplus on sale of assets, and so on, would qualify for deduction under Section 80HH. The ancillary issue flowing out of this is how liberally does one interpret such expressions, particularly in dealing with provisions dealing with exemptions/deductions.

Arguments and decision

The Supreme Court held that the assessee was not entitled to claim Section 80HH deduction in respect of interest income. The court held that Section 80HH grants deduction in respect of profits and gains "derived from" an industrial undertaking.

The appellant had argued that interest earned on deposit made with the Electricity Board for the supply of electricity to the appellant's industrial undertaking should be treated as income derived from the industrial undertaking within the meaning of Section 80HH.

It was highlighted that without the supply of electricity the industrial undertaking could not run . Further, it was pointed out that for getting this essential input, the statutory requirement was that the deposit must be made as a pre-condition for the supply of electricity. Consequently, according to the appellant, the interest on deposit should be treated as income derived from the industrial undertaking within the meaning of Section 80HH.

The Madras High Court rejected this argument of the appellant by relying heavily on the decision of the apex court in the Cambay Electric Supply Industrial Co. Ltd vs CIT (1978 113 ITR 84) case, where the court had clearly stated that the expression "derived from" had an narrower connotation than the expression "attributable to".

"In this connection, it may be pointed out that whenever the Legislature wanted to give a restricted meaning in the manner suggested it has used the expression `derived from', as, for instance, in Section 80J. In our view, since the expression of wider import, namely, `attributable to', has been used, the legislature intended to cover receipts from sources other than the actual conduct of the business of generation and distribution of electricity."

The word `derived' has been construed as far back in 1948 by the Privy Council in CIT vs Raja Bahadur Kamakhaya Narayan Singh (1948 16 ITR 325) when it said:

"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."

This definition was approved and reiterated in 1955 by a Constitution Bench of this court in the Mrs Bacha F. Guzdar vs CIT (1955 27 ITR 1, page 7) case. It is clear, therefore, that the word "derived from" in Section 80HH of the I-T Act 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 deposits made with the Electricity Board cannot be said to flow directly from the industrial undertaking itself.

The question of the court giving a liberal interpretation to a provision granting a deduction was also rejected on the ground that the rules of interpretation will come into play only if there is doubt on the express language used. Accordingly, the Supreme Court held that the appellant was not entitled to Section 80HH deduction in respect of interest on deposits.

One cannot help get the feeling that the Supreme Court has laid down the correct principle of law in the Pandian Chemicals Ltd case.

There have been repeated disputes of quantification of deduction relating to incentives. The best example is the varied nature of cases that have gone to courts for calculating export deduction under Section 80HHC of the Act.

No legislation can take care of every possible practical situation when the law is framed. There is also the ingenious assessee on one side trying to get maximum deduction by stretching the language of a provision to his advantage.

With the lowering of the tax rates, disputes such as this will slowly get eclipsed, but till then one has no other choice but to wait for the Supreme Court's decision for a final confirmation of any stand taken in the matter.

Article E-Mail :: Comment :: Syndication

Stories in this Section
Let brokers migrate

Copyright © 2003, The Hindu Business Line. Republication or redissemination of the contents of this screen are expressly prohibited without the written consent of The Hindu Business Line