2009 (8) TMI 63 - SC - Income Tax

Duty drawback and DEPB benefits are separate revenue items, not cost adjustments for manufacturing

M/s Liberty India Versus Commissioner of Income Tax

M/s Liberty India Versus Commissioner of Income Tax - [2009] 317 ITR 218 ( SC), 2009 (241) E.L.T. 326 ( SC), 2009 AIR 2742, 2009 (9) SCC 328, 2009 (11) JT ... The core legal issue considered by the Court is whether profits arising from the Duty Entitlement Passbook Scheme (DEPB) and the Duty Drawback Scheme qualify as profits 'derived from the business of the industrial undertaking' for the purpose of claiming deduction under Section 80-IB of the Income-tax Act, 1961.In addressing this question, the Court examined the relevant statutory provisions, prior judicial precedents, and the nature of the DEPB and Duty Drawback benefits in relation to the industrial undertaking's business activities.Issue 1: Whether profits from DEPB and Duty Drawback constitute profits derived from the industrial undertaking eligible for deduction under Section 80-IBRs.Legal Framework and Precedents: Section 80-IB provides deductions in respect of profits and gains 'derived from' certain eligible businesses, including industrial undertakings. The phrase 'derived from' implies a direct, first-degree nexus between the profits and the industrial undertaking. The Court noted the common scheme of Sections 80-I, 80-IA, and 80-IB, emphasizing that these provisions provide profit-linked tax incentives, not investment-linked incentives. Prior judgments, notably the decision in Sterling Food, were relied upon by the revenue to argue that such export incentives do not qualify as profits derived from the industrial undertaking.Court's Interpretation and Reasoning: The Court analyzed the nature of DEPB and Duty Drawback schemes, concluding that both are export incentives granted under statutory schemes-the DEPB under the Foreign Trade (Development and Regulation) Act, 1992, and Duty Drawback under Sections 75 of the Customs Act, 1962 and Section 37 of the Central Excise Act, 1944. These incentives are designed to neutralize the incidence of customs and excise duties on inputs used in export products.The Court observed that while these incentives reduce the cost burden on the industrial undertaking, their source is the Government's export promotion schemes rather than the industrial undertaking itself. Therefore, the profits arising from these incentives are ancillary and not directly derived from the industrial undertaking's business operations.Key Evidence and Findings: The Court carefully examined the factual matrix, including the appellant's accounting treatment of DEPB and Duty Drawback receipts credited to the profit and loss account. The Assessing Officer initially denied deduction under Section 80-IB, viewing these receipts as export incentives unrelated to industrial profits. The Commissioner of Income Tax (Appeals) allowed deduction on Duty Drawback but denied it on DEPB, distinguishing the two schemes. The Tribunal and High Court ultimately denied deduction on both, relying on the absence of direct nexus.Application of Law to Facts: The Court held that the immediate and proximate source of the DEPB and Duty Drawback receipts is the Government's incentive schemes, not the industrial undertaking. Hence, these receipts do not qualify as profits 'derived from' the industrial undertaking under Section 80-IB. The Court underscored that the statutory language and scheme require profits to originate directly from the eligible business activity.Treatment of Competing Arguments: The appellant contended that these incentives neutralize duties paid on inputs, thus reducing manufacturing costs and increasing profits directly linked to the industrial undertaking. They relied on Accounting Standard 2 (AS-2) issued by the Institute of Chartered Accountants of India (ICAI), which treats duty drawbacks and similar rebates as adjustments to the cost of inventories. The appellant also distinguished the present case from Sterling Food, arguing that DEPB and Duty Drawback have antecedent cost links, unlike import entitlements which are gratuitous.The Court rejected these contentions, clarifying that AS-2 mandates that duty drawbacks and similar items should be treated as separate revenue or income items, not as adjustments to purchase or manufacturing costs. The Court emphasized that the accounting treatment does not override the statutory interpretation of 'profits derived from' an industrial undertaking. Furthermore, the Court held that the distinction drawn by the appellant between DEPB/Duty Drawback and import entitlements was not sufficient to alter the legal character of these receipts as incentive profits.Issue 2: Interpretation of the phrase 'profits derived from industrial undertaking' in Section 80-IB and its distinction from related provisions.Legal Framework and Precedents: The Court examined Sections 80-I, 80-IA, and 80-IB as a cohesive scheme providing profit-linked tax incentives. It noted that the phrase 'derived from' used in these sections is narrower in scope than 'attributable to,' implying that only profits with a direct, first-degree nexus to the eligible business qualify for deduction.Court's Interpretation and Reasoning: The Court observed that Section 80-IB applies to profits 'derived from' eligible industrial undertakings and that sub-section (13) of Section 80-IB incorporates provisions of Section 80-IA relating to computation of profits. This includes the principle that profits of the eligible business must be computed as if it were the sole source of income, precluding artificial inflations or reductions. The Court reasoned that this framework excludes ancillary or indirect receipts such as export incentives from qualifying as profits derived from the industrial undertaking.Key Evidence and Findings: The Court highlighted that the legislative intent underlying Sections 80-I, 80-IA, and 80-IB is to incentivize operational profits of eligible businesses, not to extend benefits to profits arising from government incentive schemes that are not integrally linked to the business operations.Application of Law to Facts: Applying this interpretation, the Court concluded that DEPB and Duty Drawback receipts, being incentives granted under separate statutory schemes, do not meet the statutory requirement of being profits 'derived from' the industrial undertaking.Treatment of Competing Arguments: The appellant argued for a broader interpretation of Section 80-IB, emphasizing that it covers all incomes having a direct nexus with the profits of the undertaking, including income from sale of DEPB licenses. The Court rejected this expansive view, holding that the statutory language and scheme do not support such an interpretation.Issue 3: Applicability of Accounting Standard 2 (AS-2) on Valuation of Inventories in the context of DEPB and Duty Drawback receipts.Legal Framework and Precedents: AS-2 requires inventories to be valued at the lower of cost and net realizable value, with cost including purchase price, conversion costs, and other costs incurred in bringing inventories to their present location and condition. Trade discounts, rebates, and duty drawbacks are to be deducted in determining the cost of purchase.Court's Interpretation and Reasoning: The Court noted that AS-2 treats duty drawback and similar items as separate revenue or income items rather than adjustments to manufacturing cost. The Court referred to the ICAI's Guidance Note on Accounting Treatment for Cenvat/Modvat, which supports this approach.Key Evidence and Findings: The Court illustrated the accounting treatment with an example showing that duty drawback receipts are accounted for separately and not as part of cost of manufacture. This treatment aligns with the statutory scheme that requires profits 'derived from' the industrial undertaking to exclude such incentive receipts.Application of Law to Facts: The Court held that the appellant's attempt to treat DEPB and Duty Drawback receipts as cost adjustments to increase profits derived from the industrial undertaking was inconsistent with AS-2 and statutory provisions.Treatment of Competing Arguments: The appellant's reliance on AS-2 to argue that duty drawback and DEPB reduce cost and thus increase profits derived from the industrial undertaking was rejected. The Court clarified that accounting standards do not override the legal interpretation of tax statutes.Significant Holdings:'DEPB/Duty Drawback are incentives which flow from the Schemes framed by Central Government or from Section 75 of the Customs Act, 1962, hence, incentive profits are not profits derived from the eligible business under Section 80-IB. They belong to the category of ancillary profits of such Undertakings.''The words 'derived from' is narrower in connotation as compared to the words 'attributable to'. In other words, by using the expression 'derived from', Parliament intended to cover sources not beyond the first degree.''Duty drawback, rebate etc. should not be treated as adjustment (credited) to cost of purchase or manufacture of goods. They should be treated as separate items of revenue or income and accounted for accordingly.''Profits derived by way of such incentives do not fall within the expression 'profits derived from industrial undertaking' in Section 80-IB.'The Court ultimately dismissed the appeals, holding that profits arising from DEPB and Duty Drawback schemes do not qualify for deduction under Section 80-IB as they are not profits derived directly from the industrial undertaking but are ancillary profits arising from government incentive schemes.