Assessee entitled to deduction under Section 80IB(2) as activity held manufacturing with new machinery and requisite employees

ITAT, Chennai allowed the appeal and held the assessee entitled to deduction under section 80IB(2). The Tribunal found the activity constituted manufacturing, the plant and machinery were new, and the undertaking engaged ten or more workers while using power. The Tribunal concluded the AO's and CIT(A)'s disallowance was based on incorrect appreciation of facts, set aside their orders, and directed the AO to delete the impugned addition.

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ISSUES PRESENTED AND CONSIDERED

1. Whether the assessee's activities of combining chemicals to produce varnish, thinners and similar products constitute "manufacture" for the purposes of section 80IB(2)(iii) (i.e., the requirement that the industrial undertaking "manufactures or produces any article or thing").

2. Whether plant and machinery used by the undertaking are "previously used" so as to attract exclusion under section 80IB(2)(ii).

3. Whether the requirement of employing ten or more workers in a manufacturing process carried on with the aid of power under section 80IB(2)(iv) is satisfied by counting contractual/outsourced workers engaged through a contractor and whether those contractual workers must be shown to take part in the manufacturing process.

4. Whether the assessment addition denying deduction under section 80IB(2) (amounting to the specified sum) was justified on the facts and law after remand proceedings.

ISSUE-WISE DETAILED ANALYSIS

Issue 1 - Characterisation as "manufacture"

Legal framework: Section 80IB(2)(iii) requires the industrial undertaking "manufactures or produces any article or thing" (subject to Eleventh Schedule exceptions). The Court also refers to statutory/authoritative definitions of "manufacture" and judicial tests for alteration in nature or character of goods.

Precedent treatment: The Court considered higher-court authorities that discuss the scope of "manufacture," including decisions holding that manufacture requires an alteration in the nature/character of inputs (e.g., blending that produces a commercially distinct commodity qualifies; mere mixing that leaves goods essentially the same may not).

Interpretation and reasoning: The Court adopts a functional test: if two or more independent chemicals/raw materials are combined using labour and/or machines and the end product is chemically or physically different from the inputs (a commercially distinct commodity), the process is manufacturing. The Court expressly rejects the Assessing Officer's narrow conclusion that simple mixing cannot be manufacturing merely because it requires no "expert knowledge." The Court explains that manufacture may be simple or complex, and the essential requirement is that the resultant product is fundamentally different from the ingredients.

Ratio vs. Obiter: Ratio - application of the test that combining chemicals producing a chemically/physically different and commercially distinct product amounts to "manufacture" for section 80IB(2)(iii). Obiter - observations on the irrelevance of "expert knowledge" to the concept of manufacture (supporting reasoning but ancillary).

Conclusion: The first limb of section 80IB(2) (that the undertaking manufactures) is satisfied on the facts - the assessee's process of mixing chemicals produced varnish/thinners that are different from the raw materials and therefore amounts to manufacture.

Issue 2 - Use of "previously used" plant and machinery

Legal framework: Section 80IB(2)(ii) excludes undertakings formed by transfer to a new business of machinery/plant previously used for any purpose; statutory explanations provide exceptions for imported machinery and a de minimis 20% rule for transferred used machinery.

Precedent treatment: The Court relied on the Assessing Officer's remand report findings as to whether machinery was previously used.

Interpretation and reasoning: The Assessing Officer's remand report recorded a categorical finding that the assessee used new plant and machinery and that no case of previously used plant and machinery was made out. The Court accepts that factual finding and treats the second limb as satisfied.

Ratio vs. Obiter: Ratio - acceptance of factual finding that machinery is new negates the applicability of the "previously used" exclusion under section 80IB(2)(ii).

Conclusion: The second limb of section 80IB(2) is satisfied on record because the undertaking used new plant and machinery.

Issue 3 - Counting contractual/outsourced workers for the 10-worker threshold and participation in manufacturing

Legal framework: Section 80IB(2)(iv) conditions deduction on employing ten or more workers where manufacturing is carried on with the aid of power. The statute does not define "worker." The Court invokes the Factories Act definition and prior judicial authority addressing whether workers employed through an agency/contractor are to be counted.

Precedent treatment: The Court places respectful reliance on higher-court authority holding that the expression "worker" should include persons employed directly or by or through an agency (including a contractor) where they are engaged in the manufacturing process, and on authorities holding that the aggregate actual number of workers (regular plus casual/contractual) is relevant. Distinguishing authorities that treated artisan/karigar arrangements as contracts for service (not employees) on their particular facts.

Interpretation and reasoning: The Court concludes that the statutory language of section 80IB(2)(iv) does not restrict "worker" to directly employed persons; therefore contractual workers supplied through a contractor who work under the control/supervision of the undertaking in the manufacturing process are to be aggregated for the 10-worker test. The Court examines the accounts and production/sales figures, observing that sales volumes were such that it is implausible manufacturing could be carried out by only the two on-roll factory staff; the existence of a wages register for contractual workers and the practical realities support inclusion of contractual workers. The Court also addresses the contention that contractual workers were employed only for gardening/housekeeping, noting that the contractor agreement's description of activities does not exclude their engagement in manufacturing and that the factual matrix supports their participation in industrial activity.

Ratio vs. Obiter: Ratio - contractual/outsourced workers engaged in the manufacturing process and working under the undertaking's control are to be included in the numerical requirement of section 80IB(2)(iv); the undertaking meets the 10-worker threshold if the aggregate employed (direct and contractual) reaches ten. Obiter - critiques of contrary High Court decisions were made with respect to their factual matrices (distinguishing those authorities).

Conclusion: The third limb of section 80IB(2) is satisfied on the facts: contractual workers engaged by the undertaking are properly counted, and material on record (sales volumes, wages register, and practical considerations) establishes participation of contractual workers in manufacturing.

Issue 4 - Validity of the assessment addition after remand and entitlement to deduction under section 80IB(2)

Legal framework: The Assessing Officer's subsequent remand report and the First Appellate Authority upheld the addition denying section 80IB(2) deduction; the Tribunal must assess whether those conclusions conform to law and facts on the remand record.

Precedent treatment: The Court considered the coordinate bench's earlier direction to re-examine the manufacturing claim and machinery/workers evidence, and applied relevant judicial authorities on manufacture and worker counting (see Issues 1-3 above).

Interpretation and reasoning: Having evaluated the remand reply, remand report, accounts, wages registers and contractor agreement, the Court finds that the Assessing Officer's reliance on the purported simplicity of the process and on the contractor agreement's wording was an incorrect appreciation of facts and law. The Court holds the addition is not based on correct appreciation - manufacture is established, machinery is new, and the workforce threshold is satisfied including contractual workers engaged in manufacturing. The Court therefore sets aside the addition and directs deletion of the impugned amount.

Ratio vs. Obiter: Ratio - the addition disallowing deduction under section 80IB(2) is unsustainable where (i) the activity amounts to manufacture, (ii) machinery is new, and (iii) the undertaking employs the requisite number of workers including contract labour engaged in manufacturing. Obiter - observations on res judicata and precedential reliance across assessment years (not determinative of the present statutory requirement).

Conclusion: The assessment addition is quashed; deduction under section 80IB(2) is allowable for the relevant assessment year(s) on the established facts. The Tribunal directs deletion of the impugned addition and allows the appeal(s), applying the decision mutatis mutandis to the related assessment year.

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