M/s. Starchik Specialities Ltd V. Dy.Commissioner of Incoem Tax

ITTA/46/2004

AI Insights

M/s. Starchik Specialities Ltd., the appellant, contested the inclusion of certain indirect costs in the calculation of profits derived from exports, which affected their tax liability under Section 80HHC of the Income Tax Act, 1961. The dispute centered on whether indirect costs should be limited to those related solely to export activities or include costs associated with manufacturing and other activities. The Assessing Officer and the Commissioner of Income Tax (Appeals) had affirmed a higher deduction of indirect costs than claimed by the appellant, leading to the appeal before the Tribunal and subsequently to the High Court. The court's decision clarified the interpretation of 'indirect costs' under the Act, supporting a broader inclusion that affected the taxable income calculation.

• Counselvise Citation: [2014] 140 COUNSELVISE.COM (IT) 695975 (HC-HYDERABAD)
• Appeal Type: Others
• Pronouncement Date: 02-12-2014
• Assessment Year: misc
• Laws Referred To: Income Tax Act, 1961
• Result in Favour of: Revenue
• Court: HIGH COURT
• Department Lawyers: S R ASHOK
• Assessee Lawyers: Y RATNAKAR
• Keywords: Book Profits; Direct costs; Export Profits; Income Tax; Indirect costs
• Section: 80HHC; 115JA; 260-A

Judgement Text

"* THE HONOURABLE SRI JUSTICE L. NARASIMHA REDDY and * THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM + I.T.T.A.No.46 of 2004 % 02.12.2014 # M/s. Starchik Specialities Ltd., Hyderabad. …. Appellant Vs. $ Dy. Commissioner of Income Tax, Circle – 3(1), Hyderabad. …. Respondent ! Counsel for the Appellant: SRI. Y. RATNAKAR Counsel for Respondent: SRI S.R. ASHOK, SC FOR INCOME TAX Head Note: ? Cases referred: THE HON’BLE SRI JUSTICE L.NARASIMHA REDDY AND THE HON’BLE SRI JUSTICE CHALLA KODANDA RAM I.T.T.A.No.46 of 2004 JUDGMENT: (per the Hon’ble Sri Justice L.Narasimha Reddy) This appeal filed under Section 260 A of the Income Tax Act, 1961 (for short ‘the Act’) by an assessee involves the interpretation of certain important portions of Sections 80HHC of the Act. The appellant is an assessee under the Act. It undertakes the activity of manufacturing and trading indigenously as well as outside the country. The exports made by it yield foreign exchange. Therefore, it is entitled to claim the deduction under Section 80HHC of the Act. Since it is a company, it reflects book profits in the profit and loss (P&L) accounts maintained under the provisions of the Companies Act. Section 115JA of the Act mandates that if the total income of a company, arrived at under the Act is less than 30% of the book profits in the P&L accounts of the previous year, the total income of such assessee company shall be deemed to equal to 30% of the book profit. The manner in which the book profit must be arrived at, is dealt with in the explanation to Section 115JA of the Act. For all practical purposes, the ‘book profit’ is nothing but the ‘net profit’ shown in the P&L account for the relevant previous year, as increased by the amounts mentioned in the entries in clauses (a) to (g), or as the case may be, reduced by those mentioned in clauses (i) to (viii) of explanation to sub-section (2) of Section 115JA of the Act. Clause (viii) provides for reduction, to the extent of the profits, eligible for deduction under Section 80HHC, computed under clauses (a), (b) and (c) of sub-section 3 or sub-section (3A) of the Act, subject to certain conditions. Since the appellant is undertaking the activities of manufacturing and trading, sub-section (3B) of Section 80HHC of the Act becomes relevant. That in turn provides for the deduction of direct as well as indirect costs incurred for the purpose of trading. In its return filed for the Assessment Year 1998-99, the appellant sought deduction of only Rs.1,84,471/- under the head “indirect costs”. The Assessing Officer, however, took the figure at Rs.14,57,292/-. In the appeal preferred by the appellant before the Commissioner of Income Tax (Appeals), Hyderabad, the view expressed by the Assessing Officer was affirmed. The appellant filed I.T.A.No.186/Hyd/2003 before the Hyderabad Bench ‘B’ of the Income Tax Appellate Tribunal (for short ‘the Tribunal’). The appeal was dismissed by the Tribunal through its order dated 22.07.2003. Hence, this further appeal. Sri Y. Ratnakar, learned counsel for the appellant, submits that Section 80HHC of the Act prescribes a separate procedure to be followed in arriving at the “profits derived from export” of trading goods under sub-section 3 (b) thereof and the indirect costs mentioned therein must be only those, that are referable to the activity of export and not other activity including manufacture. He contends that on account of the indiscriminate deduction of the amount under the heading of “indirect costs” from the profits derived from the export turnover, the book profits referable to Section 115 JA of the Act do not suffer the otherwise expected level of reduction, and thereby, the appellant is exposed to higher tax liability. Sri S.R. Ashok, learned Senior Standing Counsel for the respondent, on the other hand, submits that the method of calculation of profits derived from export is not restricted to the particulars relating to export alone, and those in relation to other activities are also liable to be taken into account. Section 80HHC of the Act itself poses almost a challenge for a proper understanding. Added to that, there is combination of Section 115JA of the Act, in this case. The complexity is not difficult to imagine. The manner in which, the returns of an assessee of this nature, are required to be processed, can be summed up as under: (a) Being a company, it maintains profit and loss account. It is not uncommon that the book profit is shown in an inflated figure unrelated to the ground reality obviously, to satisfy or to encourage the shareholders. (b) Taking into account, the fact that the book profits cannot be treated as the figures representing the true state of affairs, the Parliament introduced Section 115JA of the Act providing for levy of the income tax on 30% of the book profit, in case the amount arrived at under the income tax is less than that figure. The endeavour of an assessee would be to bring the taxable income arrived at under the Act, below 30% of the book profit, so that the Income Tax can be paid on the 30% of the book profits. The expression “book profit” is defined under Explanation to sub- section (2) of Section 115JA of the Act, which reads as under: “Explanation.—For the purposes of this section, \"book profit\" means the net profit as shown in the profit and loss account for the relevant previous year prepared under sub-section (2), as increased by— (a) the amount of income-tax paid or payable, and the provision therefor; or (b) the amounts carried to any reserves by whatever name called; or (c) the amount or amounts set aside to provisions made for meeting liabilities, other than ascertained liabilities; or (d) the amount by way of provision for losses of subsidiary companies; or (e) the amount or amounts of dividends paid or proposed; or (f) the amount or amounts of expenditure relatable to any income to which any of the provisions of Chapter III applies; (g) the amount or amounts set aside as provision for diminution in the value of any asset, if any amount referred to in clauses (a) to (g) is debited to the profit and loss account, and as reduced by,— (i)……………… (ii)……………. (iii) …………… (iv) ……………. (v) ……………. (vi)……………. (vii) ………….. (viii) the amount of profits eligible for deduction under Section 80HHC, computed under clause (a), (b) or (c) of sub-section (3) or sub-section (3A), as the case may be, of that section, and subject to the conditions specified in sub-sections (4) and (4A) of that section.” It is in this process that the determination of profits under Section 80HHC of the Act became relevant. Sub-section (3) of Section 80HHC of the Act reads as under: “(a) where the export out of India is of goods or merchandise manufactured or processed by the assessee, the profits derived from such export shall be the amount which bears to the profits of the business, the same proportion as the export turnover in respect of such goods bears to the total turnover of the business carried on by the assessee; (b) where the export out of India is of trading goods, the profits derived from such export shall be the export turnover in respect of such trading goods as reduced by the direct costs and indirect costs attributable to such export; (c) where the export out of India is of goods or merchandise manufactured or processed by the assessee and of trading goods, the profits derived from such export shall, — (i) in respect of the goods or merchandise manufactured or processed by the assessee, be the amount which bears to the adjusted profits of the business, the same proportion as the adjusted export turnover in respect of such goods bears to the adjusted total turnover of the business carried on by the assessee; and (ii) in respect of trading goods, be the export turnover in respect of such trading goods as reduced by the direct and indirect costs attributable to export of such trading goods : Many of the expressions employed in these provisions are defined in the Explanation, which is as follows: “Explanation.—For the purposes of this sub-section,— (a) \"adjusted export turnover\" means the export turnover as reduced by the export turnover in respect of trading goods ; (b) \"adjusted profits of the business\" means the profits of the business as reduced by the profits derived from the business of export out of India of trading goods as computed in the manner provided in clause (b) of sub-section (3) ; (c) \"adjusted total turnover\" means the total turnover of the business as reduced by the export turnover in respect of trading goods ; (d) \"direct costs\" means costs directly attributable to the trading goods exported out of India including the purchase price of such goods ; (e) \"indirect costs\" means costs, not being direct costs, allocated in the ratio of the export turnover in respect of trading goods to the total turnover ; (f) \"trading goods\" means goods which are not manufactured or processed by the assessee.” It is not necessary to deal with the detailed procedure to be followed in working out Section 80HHC of the Act. The limited purpose herein is to ascertain the profits of an exporter in trading covered by sub-section 3(b) of the Act. A perusal of the provision makes it clear that the profit from the export of trading goods is nothing but the export turnover as reduced by direct costs and indirect costs attributable to export. It reads. “where the export out of India is of trading goods, the profits derived from such export shall be export turnover in respect of such trading goods as reduced by the direct costs and indirect costs attributable to such export” The entire controversy is about the purport of the expression “indirect costs”. The same is defined under clause (e) of Explanation. The definition is exclusionary, in nature. The expression “direct costs” is defined in clause (d) and it takes in its fold, the costs attributable to export of trading, including purchase price. When it comes to the question of indirect costs, it is couched in residuary terms, namely, not being “direct costs”. The definition further makes an indication that the allocation of direct costs shall be in the ratio between export turnover and total turnover. Once the costs incurred by an assessee for export of trading is determined, the figure indirect costs, as defined under clause (e) of Explanation, can be derived, just by relating the direct costs to the total costs. It is too well known that the ratio between export turnover over and the total turnover is an important phenomenon that, cuts across the gamut of Section 80HHC of the Act. The argument that indirect costs must be only in relation to the export of trading goods and not of manufacture cannot be accepted, how so ever reasonable it may appear to be. The reason is that under Section 80HHC of the Act, the export profits are always determined by taking into account, the profits of the business, not only of the export activity, but also the profits of other activities of the assessee, multiplied by the resultant figure of division by the export turnover by the total turnover. In other words, the export profit is derived from the formula of profit of the business export turnover. total turnover When the section dissolves the difference between the export activity and non-export activity to such absolute levels, there is no reason why the indirect costs referred to in sub-section 3 (b) of Section 80HHC of the Act must be taken in a restrictive manner. The expression “indirect costs” occur only in sub-section 3(b) of the Act. We are convinced with the reason adopted by the Tribunal and do not find any basis to interfere with the order under appeal. The appeal is accordingly dismissed. There shall be no order as to costs. The miscellaneous petitions filed in this appeal shall also stand disposed of. ___________________________ L.NARASIMHA REDDY, J Date: 02.12.2014 ____________________________ CHALLA KODANDA RAM, J Note: L.R Copy to be marked B/o va "