‘Set off’ a controversy

There is controversy surrounding the set-off or carry-forward of losses under Section 10A/10B/10BA/10AA (eligible units) of the income tax law, following an amendment in Section 10A/10B/10BA through Finance Act 2000. Earlier they were exempt sections. The amendment/ changed wording in 2000 suggests they are deduction sections although they remain under Chapter III (dealing with ‘income not forming a part of total income’).

It has been debated whether losses of non-eligible units should, or should not be set off against profits of eligible units when computing the deduction. The accompanying table uses a simple example to show the deduction position.

As seen from it, a difference in position impacts the carry-forward of losses that can be set off against income of future years and, accordingly, reduce the future tax impact.

The CBDT issued a circular dated July 16, 2013, to clarify that losses, if any, should be set off with respect to the profits of the eligible units before allowing deduction under Section 10A/10B/10BA/10AA. So, in effect, the CBDT has endorsed Scenario-1 (in the illustration table).

A few questions now arise in the wake of the circular.

How relevant is the circular?

Tax holiday under Section 10A/10B/10BA has ended. But this circular might impact pending assessments and, possibly, ongoing litigation too.

Section 10AA (related to special economic zones) deduction is alive and also grandfathered to a certain extent under the proposed Direct Taxes Code. The circular would clearly impact cases involving such tax-exempt units and with losses in other units within the same entity.

Does the circular carry binding force?

Circulars are generally binding on income tax officers even if the directives deviate from the Act. At the same time, it is known that circulars cannot bind any appellate authority, tribunal, courts or even the assessee.

What is the judicial position?

There are divergent views and contrary rulings from courts.

There are judicial precedents in which Bombay, Karnataka and Delhi High Courts have endorsed the view that losses of non-eligible units cannot be set off against the profits of eligible units before allowing deduction under the captioned sections, and the losses of non-eligible units can be carried forward to be set off against future income.

What position will the Tax Department take if the High Court rules contrary to the circular?

If the department view is in conflict with the High Court judgment, its view shall not be binding in that High Court jurisdiction. But such Court decisions are internally referred to the Central Technical Committee for appeal before the Supreme Court or for seeking legislative amendment in the Act and so on.

What stand should the taxpayer/ assessee take?

At the assessment stage, the Income-Tax Department would not accept a position contrary to the circular.

As the circular is not binding on the assessee, he/she can still rely on various High Court decisions to contest before appellate authorities issues related to Section 10A/10B and so on.

For future years, the assessee can take a conscious call, considering potential litigation. A cost-benefit analysis and an examination of the facts of each case to assess their strengths might be useful.

The author is a chartered accountant .

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