2021 (5) TMI 466 - HC - Income Tax

High Court affirms 'manufacture' status, directs AO on iron ore value, deletes disallowance under section 14A.

The High Court upheld the Tribunal's findings that the Assessee's activities constituted 'manufacture' under the IT Act, directed the AO to determine ... Eligibility of Deduction u/s 10AA - manufacture u/s 2(29BA) - Has the Tribunal correctly applied the definition of ‘manufacture’ given in SEZ Act 2005, which is applicable only for section 10AA of the IT Act and which imposes various conditions for the utilisation of profits? - Do the Assessee’s Units manufacture or produce any product? - HELD THAT:- Definition of “manufacture” was removed when sections 10A and 10B of the Act were amended by the Finance Act, 2001. These two provisions suffered a further amendment through the Finance Act, 2003. Explanation (iv) is merely inclusive as it declares that “manufacture or produce” shall include the cutting and polishing of precious and semi-precious stones. On the other hand, clause (iii) of Explanation to section 10AA adopts the definition of 'manufacture' clause (r) of section 2 of the SEZ Act, 2005. As defined under clause (r) of section 2 of the SEZ Act, “manufacture” means “to make, produce, fabricate, assemble, process or bring into existence, by hand or by machine, a new product having a distinctive name, character or use and shall include processes such as refrigeration, cutting, polishing, blending, repair, remaking, reengineering and includes agriculture, aquaculture, animal husbandry, floriculture, horticulture, pisciculture, poultry, sericulture, viticulture and mining”. This definition is both exhaustive (“means”) and inclusive (“shall include”), too. The inclusive part is merely clarificatory, though. Later, through the Finance Act, 2009, clause (29BA) was inserted in section 2 of the IT Act, defining the expression 'manufacture”: On facts, Chowgule [1980 (11) TMI 61 - SUPREME COURT]has held that diverse quantities of ore possessing different chemical and physical compositions are blended to produce ore of the requisite chemical and physical composition demanded by the foreign purchaser. And obviously, as a result of this blending, the quantities of ore mixed in the course of loading through the mechanical ore handling plant experience change in their respective chemical and physical compositions. Thus, what is produced by such blending is ore of a different chemical and physical composition. In other words, when the chemical and physical composition of each kind of ore which goes into the blending is changed, “there can be no doubt that the operation of blending would amount to ‘processing’ of ore. After relying on Chowgule, the Tribunal has concluded that even blending of iron ore for export involves change in the chemical and physical composition of iron ore. It has, then, gone one step ahead and observed that the Assessee is not only blending iron ore but also carrying out various processes to make the crude ore usable. In this context, it has referred to clause (b) of section 2 (29BA) of the Act-that bringing into existence a new and distinct object or article or thing with a different chemical composition or integral structure is tantamount to ‘manufacture’. We do accept that Chowgule was rendered in a different statutory backdrop. But under the CST Act, too, the term ‘processing’ has not been defined. Then, applying the common parlance meaning of ‘processing’ Chowgule ruled. Does the processing of the original commodity bring into existence a commercially different and distinct commodity? In fact, Pio Food Packers[1980 (5) TMI 30 - SUPREME COURT] has answered that question affirmatively. If we interpret section 2 (29BA) in the context of the case-holdings of both Chowgule and Pio Food Packers, the inevitable conclusion is that for the purposes of Income Tax Act, both ‘manufacture’ and ‘process’ are synonymous. Thus we hold that on the first substantial question of law, the Tribunal has rightly rendered its findings and those findings require no interference. Determination of price - Has the Tribunal correctly directed the AO to restrict the open market right of the iron ore to average purchase value by applying section 10B (7) read with section 80 IA (8) of the IT Act though there are differences in grade/quality and though it was not at arm’s length price? - Is Tribunal right in not considering pro rata overhead costs in determining profits from EVUs? - HELD THAT:- It is a fact that the Assessee has also purchased crude ore, ROM, from outside parties, that is from the mines belonging to other parties. The price paid by the Assessee to these outside parties, according to the Tribunal, can be regarded as the best evidence for determining the market value of the crude ore the Assessee extracted from its own mine and used. Tribunal has felt that “the determination of market value requires verification” by the Revenue. So, it has restored this issue. That restoration or remand is to enable the AO to determine the market value of the crude ore the Assessee consumed, based on the value paid by the assessee for the crude ore from the third parties during the year. Thus, there should be re-computation of the profit the Assessee derived from the 100% EOU units eligible for exemption u/s 10B. Tribunal has directed the AO “to recompute the exemption available u/s 10B to the assessee in respect of Amona as well as Chitradurga units after ascertaining the market value of the crude ores transferred by the assessee to these units from its extraction divisions. It must be based on the average market value as the assessee has paid to the third-party suppliers the crude ore. And the determination must be after the AO’s giving proper and sufficient opportunity to the assessee to adduce material evidence in this regard. We reiterate that the remand or the restoration of the issue is complete, and the AO shall determine the price untrammelled by the Tribunal’s observations, if any. And that determination is in accordance with law and only after accounting for the quality or grade of the iron ore supplied. Disallowance u/s 14A - Tribunal deleted the disallowance u/s 14A in accordance with Rule 8D of IT Rules as held in ITO v. Daga Capital Management Pvt. Ltd [2008 (10) TMI 383 - ITAT MUMBAI] - HELD THAT:- In Daga Capital Management, the question was whether section 14A of the IT Act, 1961 applies to dividend income earned by the assessee “engaged in the business of dealing in shares and securities, on the shares held as stock-in-trade and when earning of such dividend income is, therefore, incidental to trading in shares”. Given the factual disparity, we need not examine the Tribunal’s decision in Daga Capital Management. We may rely on this Court’s earlier decision M/S. SOCIEDADE DE FOMENTO INDUSTRIAL PVT. LTD., [2020 (11) TMI 277 - BOMBAY HIGH COURT] only issue was whether the respondent incurred any expenditure while earning that exempted income and whether it included that expenditure in the common indirect expenditure of its own. The Court ruled in the respondent-assessee’s favour. First, unlike Sociedade De Fomento, the AO accepted that the Assessee had not borrowed funds. Second, the Assessee has deducted certain proportionate expenditure, which the AO has not disbelieved or disputed. Finally, given the volume of investment, the Assessee is said to have received charge-free services from the banks and other financial institutions with whom they have invested. So there is said to be no expenditure. We reckon the ratio Sociedade De Fomento squarely applies to this case. And, thus, the third substantial question of law, too, shall stand answered against the Revenue. Issues Involved:1. Definition and application of 'manufacture' under SEZ Act and IT Act.2. Direction to AO regarding market value and overhead costs for EOUs under section 10B(7) read with section 80 IA (8) of the IT Act.3. Deletion of disallowance under section 14A of the IT Act.Detailed Analysis:1. Definition and Application of 'Manufacture':The primary issue was whether the Tribunal correctly applied the definition of 'manufacture' given in the SEZ Act 2005 to section 10B of the IT Act. The Revenue argued that the SEZ Act's definition applies only to section 10AA of the IT Act and that the Tribunal misinterpreted section 2(29BA) of the IT Act. The Tribunal had relied on the Supreme Court's decision in Chowgule & Co. Pvt. v. Union of India, which defined 'processing' under the CST Act. The Tribunal concluded that the Assessee's activities, including blending and processing of iron ore, amounted to 'manufacture' under section 2(29BA) of the IT Act. The High Court upheld the Tribunal's findings, noting that both 'manufacture' and 'process' are synonymous for the purposes of the IT Act and that the Assessee's activities resulted in a commercially distinct product.2. Direction to AO Regarding Market Value and Overhead Costs:The second issue was whether the Tribunal correctly directed the AO to restrict the open market rate of iron ore to the average purchase value, applying section 10B(7) read with section 80 IA (8) of the IT Act. The Revenue contended that the Tribunal misapplied these sections and that the remand was restrictive. The Tribunal had directed the AO to determine the market value of crude ore based on the price paid by the Assessee to third parties, ensuring that the computation accounted for the quality or grade of the iron ore. The High Court upheld the Tribunal's direction, clarifying that the remand was complete and the AO should determine the price untrammeled by the Tribunal’s observations.3. Deletion of Disallowance Under Section 14A:The third issue was whether the Tribunal correctly deleted the disallowance of Rs. 12.29 crore under section 14A of the IT Act, in accordance with Rule 8D of IT Rules. The Assessee claimed it had not borrowed funds for investment in mutual funds and had disallowed a reasonable amount of expenditure. The AO, however, applied Rule 8D and made a disallowance based on the average amount of investments. The Tribunal reversed the AO's findings, noting that the Assessee's primary business required more manpower than the insignificant activity of investing surplus funds. The High Court upheld the Tribunal's decision, referencing its own earlier judgment in CIT v. Sociedade De Fomento, which dealt with similar facts and concluded in favor of the Assessee.Result:All substantial questions of law were answered against the Revenue and in favor of the Assessee. The appeals TXA No.13 of 2013 and TXA No.25 of 2013 were dismissed, and TXA No.14 of 2013 required no adjudication due to the comprehensive challenge in TXA No.13 of 2013 being repelled.