TaxTMI 
TaxTMI 
2006 (7) TMI 551
X X X X Extracts X X X X
X X X X Extracts X X X X
....lar nature is to be excluded net or gross from such profits for the purpose of computation of deduction under Explanation (baa) to section 80HHC of the Income-tax Act, 1961." 2. On this issue, first of all Shri K. Ravi, learned senior counsel of the assessee argued that the issue was whether interest on deposit in lien with the bank as a precondition for sanction of loan, be netted off against the interest paid to the bank? He submitted why the ratio of the Hon'ble jurisdictional High Court in the case of CIT v. V. Chinnapandi [2006] 282 ITR 389 (Mad.) is not applicable to the present case. He submitted that there are two streams of cases which have to be considered, that have evolved based on two different factual dispositions. Stream A is a case where the income is computed by reducing certain expenses from the gross receipt and whether the gross receipt is to be taken or net receipt, would be an issue of contention. For instance, the issue of gross interest or net interest for the purpose of section 80M, where there were expenses for earning a dividend income. The decision of the Madras High Court, in the case of V. Chinnavandi (supra) considers only the case of whether for t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....income stream being inextricably linked to the expense, the income has to be netted off against the expense. This is the precise case of the assessee in this appeal. Therefore, the ratio laid down in the case of V. Chinnapandi (supra) will not apply to the case of the assessee. 4. Shri K. Ravi, the learned counsel of the assessee, further submitted that the Hon'ble jurisdictional High Court in the case of CIT v. A.S. Nizar Ahmed & Co. [2003] 259 ITR 244 (Mad.) has held that the deposit is made in pursuance of a precondition for enjoying a credit facility. At p. 247 of the report, it was held as under : "In cases where security deposit is required to be given before enjoying a facility as in the case of supply of electricity or in a case where the deposit is a precondition for enjoying a credit facility essential for running the business, the making of the deposit would be regarded as being inextricably linked to the running of the business of the assessee, so as to enable the assessee to regard the interest derived on deposit as being part of its business income." He submitted that it is absolutely clear that the jurisdictional High Court has held that in all cases where t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r No. 621 explaining the provisions of Explanation (baa) [(1992) 101 CTR (St) 1 : (1992) 195 ITR (St) 154] recognizes that there may be some common expenses and estimates an ad hoc 10 per cent of such common expenses to be allowed as deduction against the receipts such as interest, brokerage, commission, etc., But this deduction is only for common expenses. Deduction in respect of expenditure which has a nexus with the receipts of the nature referred to in the Explanation has to be allowed further, which is not prohibited. Such common expenses are generally the indirect or fixed expenses which every businessman has to incur to continue in business, such as salaries and wages, other administrative expenses and so on. In addition to such common expenses there may be expenses which have a direct bearing or nexus with the receipts by way of interest, commission, brokerage, rent, etc. If such receipts are to be taken out of profits of the business on the footing, that they have no connection with the business profits or the turnover, it seems only fair and reasonable to hold that the expenditure having a nexus with such receipts should also be taken out of the business profits on the sa....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... out of the relationship of debtor and creditor, viz., (1) the right of the customer to demand repayment of the amounts due to him if and when he so desires, and (2) the right of the bank to appropriate the monies, funds and securities of the customer coming into its possession in the course of their dealings for repayment of the customer's indebtedness. This latter right is known as banker's lien and it rests on the principle of the law merchant that any credit given by bank to a customer is given on the faith that sufficient monies and securities belonging to the customer will come into the possession of the bank in the due course of further transactions. The right is akin to the right of set off which obtains between persons occupying the relation to debtor and creditor and between whom there exist mutual demands. As mutuality is essential to the validity of a set off, it is necessary that before one demand can be set off against another, both must mutually exist between the same parties and between them in the same capacity. It has been held in the case of Brahmawa & Co. v. K.P. Thangavelu Nadar AIR 1956 Mad. 570 that a lien under section 171 can be exercised only over property....
X X X X Extracts X X X X
X X X X Extracts X X X X
....of the assessee further submitted that in the case of Bhanu Constructions Co. Ltd. v. Dy. CIT [2001] 119 Taxman 31 (Hyd.) (Mad.), a guarantee extended by the bank was invoked and the bank instead of paying off the margin money deposit, continued to hold the deposit as it is and debited the payout by debiting the cash credit account thereby increasing the interest payable by the assessee as well as paying interest to the assessee. The Hyderabad Bench of the Tribunal held that though for the purpose of accounting, the transactions may appear to be independent transactions, one by way of FDR as margin and another by way of loan taken by the assessee, yet in truth and reality, there was only one transaction, more particularly in view of the fact that the guarantee was invoked and guarantee money paid formed part of the total loans. Interest on FDR which was kept as margin money for giving guarantee could not be seen de hors the inaction of the bank to adjust the margin against the guarantee invoked. On the other hand, interest was payable on the loan amount including the guarantee amount, yet, on the other hand, interest on margin FDR was taxed, a fact which could not be said to be jus....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the basis of export turnover as well as the incremental turnover over the earlier period. Relief under section 80HHC was later on changed to profits derived from export from the assessment year 1986-87. Here also the Government did not require the profits from export to be separately computed. The legislature put forth a thumb-rule of determining the profits from export. The profits and gains of the entire business of the assessee was divided by the total turnover which, will give the average rate of profit per rupee of turnover of the business. This average rate of profit is to be multiplied by the export turnover, which will give the deemed profits of the business from the export at the same rate of profitability for the entire business. It was immaterial whether exports actually yielded profits. 14. The learned counsel of the assessee further submitted that the profits and gains for the entire business have to be taken and no part of it is to be excluded therefrom, as not relating to exports or otherwise (CBDT Circular No. 564, dated 5-7-1990 [(1990) 85 CTR (St) 53 : (1990) 184 ITR (St) 37]. Such exclusion is not contemplated in view of the fact that such profits or gain is ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e receipt should be excluded under clause (baa) or not. It is held that if the receipt is part of the operational activity, the same cannot be excluded. The word "operational activity" referred to in this decision does not mean that it should be a manufacturing activity but means main line of business employing resources of the assessee. In fact the Bombay High Court has also concluded that interest earned from money lending activity cannot be excluded under clause (baa). 16. He submitted that, therefore, it is essential to examine each receipt to see whether it is a receipt arising from or connected with the business activity or it is a sundry receipt which has no connection whatsoever with the business activity. If the receipt is connected with the business activity then the same cannot be excluded from profits and gains under Explanation (baa ). Whether a receipt is connected with business activity is to be decided on the facts of each case. But it may be useful to consider the decisions rendered under section 80-I, 80E, wherein profits "attributable" to an undertaking was given relief under that section. While Courts have held that "profits attributable to" is wider than "pr....
X X X X Extracts X X X X
X X X X Extracts X X X X
....] 275 ITR 46 (Mad.). The Madras High Court in a most recent case for the assessment year 1993-94 has held that interest income should be taken into account for computing relief under section 80HHC. This being the latest decision of the Madras High Court is binding on the lower authorities and therefore this has to be followed. In the case of V. Chinnapandi (supra), the Madras High Court was concerned with interpretation of Explanation (baa) and whether the gross receipts were to be considered or the net receipts. In that case the High Court was not considering what are the various receipts that are to be excluded under Explanation (baa). A decision of the High Court cannot be an authority for an issue which was not before it or was not considered by it, CIT v. Sun Engineering Works (P.) Ltd. [1992] 198 ITR 297 (SC) p. 320]. But in the latter case of Sharp Industries (supra), specific issue before the High Court was whether interest income can be excluded under Explanation (baa). Thus the decision not only is on the specific issue and is the latest decision of the jurisdictional High Court on the issue. The High Court has not decided on jurisdiction alone but has clearly spelt out t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....fits" and this is not the same as in section 80-I where the concept of "derived from an undertaking" is considered. There is no concept of "derived from" under section 80HHC. All that is to be seen is whether the interest in question is assessed as "business profits" and if so the interest component included in such business profits should be excluded in terms of Explanation (baa) to section 80HHC and the formula applied. There seems to be confusion on the concept of "profits of business" as contemplated under section 80HHC and the concept of "income derived from" contemplated under section 80-I. All that is to be seen under section 80HHC is whether it is "profit from business" or not and then, if it is so, apply the formula. Looking at the matter from any angle, the order of the first appellate authority has to he upheld, by following the order of the Tribunal in the case of the assessee for the earlier years." 19. On the other hand, the learned Departmental Representative, Shri Shaji P. Jacob, first of all argued that clause (baa) to Explanation to section 80HHC was brought on statute book with effect from 1-4-1992 by the Finance (No. 2) Act, 1991. He argued that Notes on Clau....
X X X X Extracts X X X X
X X X X Extracts X X X X
....udgment which read as under : "It is fairly submitted by the learned counsel for the revenue that the issue raised in the question is covered against the revenue by the decision of this Court in CIT v. N.S.C. Shoes [2003] 179 CTR (Mad.) 524 : (2002) 258 ITR 749 (Mad), wherein it is held that the interest income is also eligible for deduction provided it is included in the computation of profits and gains of the business. Applying the ratio laid down by this Court in the decision cited supra, we hold that, the Tribunal was right in holding that the claim of the assessee could not be disallowed in a proceeding under section 154, especially when the interest income was included in the profit of the business. Hence, there is no error in the order of the Tribunal and no substantial question of law arises for consideration for this Court. Hence, the appeal is dismissed. No costs." He argued that this case law is purely on a debatable issue, whether rectification proceedings under section 154 can be carried out on debatable issue or not. This case law is not at all applicable to the facts of the present cases. 21. As per clause (baa ) to Explanation to section 80HHC, profits o....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Item (iii) of sub-clause (e) seeks to omit clause (bb) of the Explanation relating to definition of 'total turnover'. This amendment is consequential to the amendment proposed under sub-clause (e)( ii)(1) relating to new definition of this expression." The Memorandum explaining provisions in the Finance (No. 2) Bill, 1991 reads as under : "..........The existing formula may also give a distorted figure of export profits when receipts like interest, commission, etc., which do not have an element of turnover are included in the P & L a/c. It is, therefore, proposed to clarify that "profits of the business" for the purpose of section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, it is proposed to provide ad hoc 10 per cent deduction from such incomes to account for these expenses. It is also proposed to clarify that "profits of the business" for the purpose of section 80HHC will not include profits of any branch, warehouse, etc., situated overseas. These amendme....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ey do not have the element of turnover and consequently Explanation (baa) will apply. However, that will not be the case if the assessee is carrying on the business of financing because in the case of financing, the interest income which accrues to the assessee, will have the element of turnover and in such a case, receipts like interest, will not attract Explanation (baa). The point which we would like to make, therefore, is that in every matter the Assessing Officer will have to ascertain whether receipt of interest, commission, labour charges, etc., were a part of operational income. We cannot lay down any standard test for deciding what would constitute operational income. Broadly, the Department will have to consider the memorandum and articles of association of the company, the nature of the business, the nature of the activity and such other tests. The Department will also have to ascertain as to what is the dominant business of the company and whether receipts like interest, commission, etc., accrue as a part of the main business activity or whether they accrue out of incidental business. In the case of CIT v. K.K. Doshi & Co. [2000] 163 CTR (Bom) 472 : (2000)245 TTR 849 (B....
X X X X Extracts X X X X
X X X X Extracts X X X X
....as an element of job work turnover and therefore, the Tribunal concluded on the facts of this case that the receipt of labour charges was not in the nature of brokerage, commission, rent, interest or charges as mentioned in Explanation (baa) to section 80HHC. Further, the assessee received Rs. 66.35,083 as processing charges. This can be seen from the P & L a/c. The company is engaged in manufacture and sale of garments, both domestically and by way of exports. The processing charges earned was by using the entire undertaking of the company which also manufactured garments for domestic sales and export sales and which processing charges were earned by incurring expenditure for the factory like wages, electricity charges, etc., debited in the P & L a/c. That, the income of Rs. 66,35,083 was only an income from business and the expenditure for earning this income is included in several items of expenditure debited in the P & L a/c. In these circumstances, we do not wish to interfere with the finding of fact recorded by the Tribunal. As.stated above, if the receipt of labour charges (job work charges), interest, commission, etc., accrues by way of operating income then it falls outsid....
X X X X Extracts X X X X
X X X X Extracts X X X X
....account of deposit made by the assessee-company with the banks for obtaining letters of credit and, secondly, interest earned by the assessee-company on the deposit of margin money for letters of credit. Mrs. Chitra Venkataraman, learned senior standing counsel for the Department, very heavily criticized the deduction granted to the assessee-company on account of this interest receipts. She points out that the words used in section 80HH are : 'Where the gross total income of an assessee includes any profits and gains derived from the industrial undertaking.....to which this section applies there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction from such profits and gains of an amount equal to twenty per cent thereof'. Learned counsel invites our attention that the emphasised words would suggest that the deductible income must have been 'derived' from the industrial undertaking. Learned counsel claims that the words 'derived from the industrial undertaking' would suggest that the said income must be solely relatable to the industrial undertaking and the interest earned by the asse....
X X X X Extracts X X X X
X X X X Extracts X X X X
....reek word 'demos' the people, and most dictionaries will so state. That is the ordinary meaning of the words 'derived from' and there is no reason to depart from that ordinary meaning here'. The Apex Court further observed in para 12 as follows (page 584 of 237 ITR) : 'There must be, for the application of the words 'derived from', a direct nexus between the profits and gains and the industrial undertaking.' As regards the facts of the case concerned, the apex Court held in that case that the nexus was not direct but only incidental. There the apex Court was considering the case of an assessee who was engaged in processing prawns and other seafood which it exported and in that it also earned some import entitlements granted by the Central Government under the Export Promotion Scheme. Such import entitlements could be used by the assessee itself or could also be sold to others. The assessee had sold the import entitlements which it had earned to others and the total income for the assessment included the sale proceeds of such import entitlements in respect of which relief was granted under section 80HH of the Income-tax Act. The High Court had held in favour of the assessee....
X X X X Extracts X X X X
X X X X Extracts X X X X
....iscovered and the profit or gain can be said to have been 'derived' from an activity carried on by a person, if the said activity is the immediate and effective source of the said profit or gain. ...there must be a direct nexus between the activity and the earning of the profit or gain and the income, profit or gain cannot be said to have been derived from an activity merely by reason of the fact that the said activity may have helped to earn the said income or profit in an indirect or remote manner.' We agree with this decision, which is binding on us. The aforementioned decision has only been further strengthened by the subsequent decision of the apex Court. We are, therefore, of the clear opinion that the interest which is earned by the assessee from the bank deposits would not have a direct nexus with the industrial undertaking of the assessee and would only be incidental income thereto and, therefore, such interest has to be ignored from the allowable profits under section 80HH. We answer the reference on this count against the assessee. Let us now consider the interest earned by the assessee on belated payments. There can be no doubt that this interest would, however, b....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ly on different principle and held as under : "In case money is borrowed by a newly started company which is in the process of constructing and erecting its plant, the interest incurred before the commencement of production on such borrowed money can be capitalised and added to the cost of the fixed assets created as a result of such expenditure. By the same reasoning if the assessee receives any amounts which are inextricably linked with the process of setting up its plant and machinery, such receipts will go to reduce the cost of its assets. These are receipts of a capital nature and cannot be taxed as income." Further, in the decision cited by the Id, counsel of the assessee in the case of Kamal Co-operative Sugar Mills Ltd. (supra), the apex Court held that the assessee had deposited money to open a letter of credit for the purchase of machinery required for setting up its plant in terms of assessee's agreement with the supplier It was on the money so deposited that some interest had been earned. This was, therefore, not a case where any surplus share capital money which was lying idle had been deposited in the bank for the purpose of earning interest. The deposit of mone....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e gross interest received by the assessee and the amount of interest paid by the assessee could not be deducted therefrom. Therefore, the reliance placed by the learned counsel of the assessee on the Punjab & Haryana High Court decision is misplaced. 33. Further, the Hon'ble jurisdictional High Court in the case of A.S. Nizar Ahmed & Co. (supra) has clearly held as under: "That view of the Tribunal cannot be sustained. The CIT has rightly pointed out that the deposits kept by the assessee in the bank in a large sum of over Rs. 130 lakhs were to the assessee's own advantage, inasmuch as they provided a return at the rate of 10 per cent. That was in the nature of an additional source of income to the assessee which was not in any way linked to the business that it was carrying on. The credit facilities enjoyed by the assessee from the bank had been extended to it by charging interest at a rate lower than the one which the assessee was receiving on its deposits. The assessee, therefore, had found it advantageous to borrow money from the bank and.have those borrowed funds used in the business. The interest income that the assessee received on its own funds kept in deposit with th....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nder section 80HHC of the Act. No expenditure or any other deduction is permissible from the receipt of interest income. Section 80HHC stipulates a deduction in respect of export profits. Instead of enjoining the Assessing Officer to compute such export profits from out of the consolidated amount of the assessee, which may involve income by way of interest, rent, commission, etc., the legislature has provided a simple procedure under which 90 per cent of the receipts such as interest, rent, commission, brokerage, etc., shall be excluded as profits not attributable to exports. The intention is, therefore, clear that there should be no attempt to deduct any expenditure from the receipts, however related such expenditure may be to the receipts". It is in this view of the matter that the expression "receipt by way of has been used in the section and not 'income' of that nature. In view of the above, we are of the view that 90 per cent of the interest that is deductible for the claim under section 80HHC of the Act is from the gross interest received by the assessee and that the amount of interest paid by the assessee should not be deducted therefrom and, hence, we answer the above qu....
X X X X Extracts X X X X
X X X X Extracts X X X X
....s activity of the assessee. To give an example, in the case of a manufacturing company which undertakes exports, receipt of interest or commission may not be operational income because they do not have the element of turnover and consequently Explanation (baa) will apply." 37. As far as netting is concerned, the Hon'ble jurisdictional High Court in the case of K.S. Subbiah Pillai & Co. (India) (P.) Ltd. (supra) has very categorically held that if receipt is in the nature of brokerage, commission, interest, rent, charges, etc., netting is not possible. The Hon'ble High Court has held as under: "The clause does not refer to net interest. It refers, inter alia, to the interest included in the profits and gains of the business or profession. Regarding the first question there is considerable confusion. The Assessing Officer, according to counsel for the revenue, has not deducted the amount of interest assessed under the head "Income from other sources". The appellate order proceeds on the basis that there has in fact been such deduction and that such deduction could be made from the profits even though the interest received is not assessed under the head 'Profits and gains of ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profit. In view of the decision of the Hon'ble jurisdictional High Court in the case of Chinnapandi (supra), the legislature has provided a simple procedure under which 90 per cent of the receipts like interest, rent, brokerage, commission, etc. shall be excluded as profits not attributable to exports while computing deduction in respect of export profits. The intention of the legislature is very clear that no further deduction of any expenditure from the receipt whether such expenditure is related to that receipt will be allowed. In clause (baa), the expression "receipt by way of" means the gross receipt and here the word "income" has not been used by the legislature: Accordingly, 90 per cent of the gross receipts of such nature will be excluded while computing the export profit for the purpose of computation of deduction from the profits of the business and this clause (baa) does not speak about netting of the receipt of the types mentioned therein. Clause (baa) to Explanation to section 80HHC speaks about profits of the business but does not include receipts which....