Section 80IC deduction denied for interest income but allowed for scrap sales profits in manufacturing business

M/s. Reckitt Benckiser (India) Ltd. Versus The Addl. Commissioner of Income Tax

M/s. Reckitt Benckiser (India) Ltd. Versus The Addl. Commissioner of Income Tax - TMI The core legal questions considered by the Court revolve around the interpretation of the word 'derived' as used in Section 80-IC of the Income Tax Act, 1961, particularly in relation to two distinct issues: (1) whether interest income earned by an eligible industrial undertaking qualifies as income 'derived by' such undertaking for the purpose of claiming deduction under sub-section (2) of Section 80-IC; and (2) whether the Tribunal erred in allowing deduction of amounts received on account of scrap sales and T&M fees under Section 80-IC, with specific regard to the legislative intent behind the phrase 'derived by' as compared to the phrase 'attributable to' used elsewhere in the Income Tax Act.

Regarding the first issue, the relevant legal framework includes Section 80-IC of the Income Tax Act, which provides deductions to eligible industrial undertakings on profits and gains 'derived by' such undertakings from specified businesses. The Court examined authoritative precedents, notably the decisions of the Gauhati High Court in CIT vs. Meghalaya Steels Ltd. and the Karnataka High Court in CIT vs. Motorola India Electronics (P) Ltd., which took a broader view of 'derived by,' allowing deductions for interest income where a direct nexus to the industrial undertaking was established. The Gauhati High Court emphasized that operational subsidies, such as interest subsidies aimed at reducing working capital costs, establish a direct and first-degree nexus with the industrial activities, thus qualifying for deduction. Similarly, the Karnataka High Court recognized interest and other income related to export activities as income derived from the business of the undertaking.

However, the Court contrasted these views with a line of Supreme Court and High Court decisions interpreting 'derived' with a narrower connotation. The Supreme Court in Pandian Chemicals Ltd. held that 'derived from' implies a direct or immediate nexus with the industrial undertaking, distinguishing it from the broader term 'attributable to.' The Court relied on the principle that the enquiry into derivation should stop once the effective source of income is identified, which must be directly connected to the industrial undertaking's business. Subsequent High Court decisions in Andhra Pradesh (Globe Organics Ltd.), Delhi (Pyne Packaging Pvt. Ltd.), and Madras (Fenner (India) Ltd.) reinforced this interpretation, holding that income such as interest earned on deposits or intercorporate loans, which are steps removed from the manufacturing or production process, do not qualify as income 'derived from' the industrial undertaking.

Applying this narrower interpretation to the facts, the Court found that interest income earned on fixed deposits, which were profits and gains of the undertaking, did not have the requisite direct nexus with the business of manufacture or production. The interest income was thus not 'derived from' the industrial undertaking within the meaning of Section 80-IC. The Court rejected the argument that the absence of the word 'derived' in the quantification provision of Section 80-IC(3) indicated a broader legislative intent, noting that the eligibility criteria in sub-section (2) govern the scope of deduction and must be strictly construed.

On the second issue concerning the revenue's appeal about deduction on scrap sales and T&M fees, the Court referred to the decision of the Madras High Court in Fenner (India) Ltd., which held that profits and gains from the sale of scrap materials generated during the manufacturing process have a direct nexus with the industrial undertaking. The scrap materials arise as a natural by-product of the manufacturing process and thus qualify as income 'derived from' the industrial undertaking. The Court found this reasoning persuasive and ruled that such income is eligible for deduction under Section 80-IC.

In addressing competing arguments, the Court gave due consideration to the legislative language, the statutory scheme of Section 80-IC, and the authoritative judicial interpretations of the phrase 'derived.' It distinguished between income that is a direct product of the industrial undertaking's manufacturing or production activities and income that is merely incidental or remotely connected, such as interest on surplus funds. The Court emphasized the importance of maintaining the narrower connotation of 'derived' to preserve legislative intent and avoid unwarranted expansion of deductions.

Consequently, the Court concluded that the Tribunal erred in holding that interest income earned by the assessee's undertaking was income 'derived by' the undertaking for the purpose of claiming deduction under Section 80-IC. The Court answered the question in the revenue's favor and against the assessee on this point. Conversely, on the question raised by the revenue concerning the deduction of profits from scrap sales, the Court ruled in favor of the assessee, affirming that such profits are indeed 'derived from' the industrial undertaking and eligible for deduction.

Significant holdings include the Court's explicit reliance on the Supreme Court's articulation in Pandian Chemicals Ltd. that the expression 'derived from' has a narrower connotation than 'attributable to,' requiring a direct and immediate nexus with the industrial undertaking. The Court stated: '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.' This principle was pivotal in distinguishing income eligible for deduction under Section 80-IC.

The Court also upheld the principle that income arising as a direct consequence of manufacturing activities, such as profits from scrap sales, is within the scope of 'profits and gains derived by' the undertaking, thereby qualifying for deduction.

In final determinations, the Court dismissed both appeals, affirming the Tribunal's disallowance of deduction for interest income but allowing deduction for income from scrap sales. The appeals under ITAT No. 41 and 59 of 2014 were accordingly disposed of, with the questions framed answered as follows: (1) The interest income is not 'derived by' the eligible undertaking within the meaning of Section 80-IC; (2) The profits from scrap sales are 'derived from' the industrial undertaking and eligible for deduction under Section 80-IC.