EY Tax Alert. Full Bench of Karnataka HC rules incidental interest income earned by Taxpayer is eligible for export incentive scheme deduction

Transcription

1 2 November 2017 EY Tax Alert Full Bench of Karnataka HC rules incidental interest income earned by Taxpayer is eligible for export incentive scheme deduction Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. Executive summary This Tax Alert summarizes a recent Full Bench (FB) [1] decision of the Karnataka High Court (HC) in the case of CIT v. Hewlett Packard Global Ltd. [2] (Taxpayer) where the issue before the HC was whether interest income earned on short-term bank deposit and loans advanced to staff are eligible under Section (S.) 10A/10B (export incentive provisions) of the Income Tax Laws (ITL). The matter was decided by the FB of the HC in view of the conflicting views expressed by two divisional benches (DB) of the Karnataka HC. [1] High Court bench consisting of three judges [2] ITA No. 812 of 2017; order dated 30 October 2017

2 After considering the various judicial precedents relied by the Tax Authority (which dealt with income-linked deduction [3] under the ITL) the FB of the HC held that interest income earned by the Taxpayer on bank deposits and loans advanced to staff are eligible for deduction under the export incentive provision of the ITL on account of following: Export incentive provision is complete code in itself and are not comparable with those provisions of Chapter VI- A of the ITL. Export incentive provisions need a purposive interpretation and need to be interpreted liberally. Interest income earned form an integral part of export business and same cannot be delinked from profits derived from the undertaking engaged in export. Brief scheme of export incentive provision To promote export especially by the industry of software and information technology enabled services and to earn valuable foreign exchange, the ITL contain special provisions providing profit-linked deductions. Export incentive provisions provide for a 100% deduction of profits and gains derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive years. Deduction of profits is subject to various compliances and fulfilment of formative conditions. The deduction under export incentive provisions is available in respect of profits and gains as are derived by an undertaking. The present ruling deals with the meaning of such expression. Facts The Taxpayer is engaged in the business of export of computer software from four units set up under the scheme of Software Technology Parks of India. The Taxpayer is exclusively engaged in providing service from these export oriented units (EOUs) and had no other activity. It was an undisputed fact that the Taxpayer was eligible to claim 100% deduction in respect of profits and gains derived by the said EOUs as the Taxpayer had satisfied all the requisite conditions. The Taxpayer claimed deduction in respect of such interest income as profits and gains derived by an undertaking on the ground that these are incidental income earned by the eligible undertaking and, hence, forming part of profit and gains derived from such undertaking. The Tax Authority rejected the Taxpayer s claim and held that interest income is taxable under the head Income from other sources and, hence, are not entitled for deduction under the export incentive provisions. Reasons for referring the issue to FB of the HC In case of Motorola India [4], the DB of the Karnataka HC (Motorola ruling) held that the interest income earned from Exchange Earner s Foreign Currency Account constitutes business income if it is derived from an undertaking being a 100% EOU and in the business of export of software and is eligible for deduction under the export incentive provisions. Further, the DB of the HC held that the export incentive deduction is not only available for export of articles or things but is available in respect of income from the business of the said The Taxpayer s case was before another DB of the Karnataka HC. Before the DB, the Taxpayer cited the earlier Motorola ruling. However, after considering certain Supreme Court (SC) decisions, the DB in the Taxpayer s case, was not in agreement with the earlier DB ruling and took a contrary view. This difference of opinion arose between the two benches of the Karnataka HC on the deductibility of interest income under the export incentive provisions and accordingly, the matter was referred to the FB of the HC. Tax Authority s contention before the FB Before the HC, the Tax Authority placed reliance on various judicial precedents (listed below) rendered in the context of Chapter VI-A of the ITL [5] and contended that interest income earned by taxpayers from deposits, surplus funds parked in banks and loans advanced to staff members cannot be said to be profit and gains derived by an undertaking. During tax year , the Taxpayer earned interest income from short-term deposits, surplus funds parked in bank accounts and loans advanced to staff members. [4] CIT v. Motorola India Electronic (P.) Ltd. (ITA No. 428/2007; order [3] Deductions provided in Chapter VI-A of the ITL dated 11 December 2013) [5] Illustratively Ss. 80HH, 80HHC and 80IA of the ITL

3 Pandian Chemicals Ltd. v. CIT [6] : The SC held that interest income earned on electricity deposit cannot be treated as profit and gains derived from industrial undertaking for the purpose of S. 80HH of the ITL. The word derived from must be construed as something which has direct or immediate nexus with the industrial Liberty India v. CIT [7] : In this case, the SC dealt with the controversy whether profit earned from duty drawback incentives can be claimed as deduction under S. 80-IB of the ITL. The SC held that the profit derived on sale of duty drawback entitlements could not be said to be profit and gains derived from the The income may be ancillary in nature and not attributable to the CIT v. Sterling Foods [8] : In this case, the SC dealt with the controversy that whether a consideration received on sale of import entitlements will be eligible for deduction under S. 80-HH of the ITL. The SC held that there was no direct nexus between the sale consideration of import entitlement and the industrial Income earned on sale of import entitlements arose from the export subsidy scheme of the Government of India and, therefore, would not constitute profit and gains derived from the industrial Totgars Co-operative Sale Society Ltd. v. ITO [9] : In this case, the question before the SC was whether interest earned by co-operative societies from investing surplus funds in short-term deposits and government securities is deductible under S. 80-P of the ITL which allowed 100% deduction to the co-operative societies engaged in specified activities. The SC held that the expression the whole of the amount of profits and gains of business appearing in S. 80P of the ITL would include operational income alone, and not income earned from deployment of surplus funds. Taxpayer s contention before the FB The Taxpayer was exclusively engaged in the business of manufacture and export of software program. Accordingly, the entire income earned from all undertakings, including interest income, constitute part of the profits and gains of the undertaking and are eligible for deduction under the export incentive provision. The normative formula provided to compute the deduction under the export incentive provision for the proportionate deduction in relation to export turnover to the total turnover is not applicable in absence of any domestic turnover. Thus, even in terms of normative formula, in absence of any domestic turnover, 100% deduction is admissible. The Motorola ruling is correct and has been consistently followed by various High Courts (discussed below) on which the Taxpayer placed reliance. Riveria Home Furnishing v. Additional CIT [10] : In this case, the issue before the Delhi HC was whether the taxpayer, which was a 100% EOU will be eligible to claim deduction in respect of interest income earned on fixed deposits which were under the lien with a bank for facilitating letter of credit and bank guarantee under the export incentive provisions. The Delhi HC referred to Motorola ruling and held that: Export incentive provisions are independent of Chapter VI-A of the ITL. Provisions of export incentive provisions is a complete code providing for deduction. Once an income form part of the business of the eligible undertaking, the same cannot be excluded in computing deduction. CIT v. Hindustan Gum & Chemicals Ltd. [11] : The Calcutta HC held that the interest earned on surplus business funds deposited with banks for short periods will form part of business profits for the purpose the export incentive provisions. [6] I[(2003) 262 ITR 278 (SC)] [7] [(2009) 317 ITR 218 (SC)] [8] [(1999) 237 ITR 579 (SC)] [9] [(2010) 322 ITR 283 (SC)] [10] [(2016) 65 taxmann.com 287 (Delhi)] [11] [(2016) 72 Taxmann.com 90 (Cal HC)]

4 CIT v. Symantee Software India (P.) Ltd. [12] : The Bombay HC held that provisions of Chapter VI- A of the ITL cannot be telescoped in the export incentive provisions; since the latter are to be applied before computing profit and gains of the business whereas Chapter VI-A of the ITL comes into effect after the computation of gross total income. FB decision: The FB held that the judicial precedents referred by the Tax Authority are not in the context of the export incentive provision which is a complete code in itself. The decisions relied upon by the Tax Authority are in the context of Chapter VI-A of the ITL which provides for deduction from gross total income which may not include other income (interest income) for the purpose of computing deduction. On the other hand, deduction under the export incentive provisions encompasses the entire income derived from the business of export of article or thing or computer software from such eligible Hence, the deduction may include interest income derived from temporary parking of funds in bank or loans advanced to staff members. Comments The FB has applied purposive interpretation while interpreting the export incentive provisions and has construed the export incentive provisions liberally. The FB ruling provides welcome relief for taxpayers in litigation. Further, the FB ruling will be binding on lower appellate authorities within the jurisdiction of the Karnataka HC. Though the FB has made distinction between the language employed in the export incentive provisions and the provisions of Chapter VI-A of the ITL, litigation on the issue whether the incidental income earned by the eligible export units can be said to be derived by an undertaking cannot be ruled out. The deduction under the export incentive provisions is computed prior to computing income under the head profit and gains of business. However, deduction under Chapter VI-A of the ITL comes into play only after the computation of gross total income. Therefore, analogy of Chapter VI-A of the ITL deductions cannot be imported in computing deduction under the export incentive provision. The words derived by an undertaking in the export incentive provisions is different from derived from employed in the provisions of Chapter VI-A of the ITL. Parking of surplus funds was an integral part of export business activity and business decisions taken in view of the commercial expediency and interest income earned cannot be delinked from the profits and gains derived by the Export incentive provisions need a purposive interpretation and need to be interpreted liberally. Reliance for this proposition was placed on the decisions of the SC in the case of Bajaj Tempo Ltd. v. CIT [13] and R. K. Garg v. UOI [14]. Accordingly, the Taxpayer was eligible for 100% deduction in respect of interest income earned from fixed deposits, parking of surplus funds with banks and loans made to staff. Further, such interest income will not be taxed under the head Income from other sources. [12] [(MANU/MH/2575/2014) (Bom HC)] [13] [(1992) 3 SCC 78] [14] [(1981) 4 SCC 675]

5 Our offices Ahmedabad 2nd floor, Shivalik Ishaan Near C.N. Vidhyalaya Ambawadi Ahmedabad Tel: Fax: Bengaluru 6th, 12th & 13th floor UB City, Canberra Block No.24 Vittal Mallya Road Bengaluru Tel: Fax: Ground Floor, A wing Divyasree Chambers # 11, O Shaughnessy Road Langford Gardens Bengaluru Tel: Fax: Chandigarh 1st Floor, SCO: Sector 9-C, Madhya Marg Chandigarh Tel: Fax: Chennai Tidel Park, 6th & 7th Floor A Block (Module 601, ) No.4, Rajiv Gandhi Salai Taramani, Chennai Tel: Fax: Delhi NCR Golf View Corporate Tower B Sector 42, Sector Road Gurgaon Tel: Fax: rd & 6th Floor, Worldmark-1 IGI Airport Hospitality District Aerocity, New Delhi Tel: Fax th & 5th Floor, Plot No 2B Tower 2, Sector 126 NOIDA Gautam Budh Nagar, U.P. Tel: Fax: Hyderabad Oval Office, 18, ilabs Centre Hitech City, Madhapur Hyderabad Tel: Fax: Jamshedpur 1st Floor, Shantiniketan Building Holding No. 1, SB Shop Area Bistupur, Jamshedpur Tel: BSNL: Kochi 9th Floor, ABAD Nucleus NH-49, Maradu PO Kochi Tel: Fax: Kolkata 22 Camac Street 3rd Floor, Block C Kolkata Tel: Fax: Mumbai 14th Floor, The Ruby 29 Senapati Bapat Marg Dadar (W), Mumbai Tel: Fax: th Floor, Block B-2 Nirlon Knowledge Park Off. Western Express Highway Goregaon (E) Mumbai Tel: Fax: Pune C-401, 4th floor Panchshil Tech Park Yerwada (Near Don Bosco School) Pune Tel: Fax: Ernst & Young LLP EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is one of the Indian client serving member firms of EYGM Limited. For more information about our organization, please visit Ernst & Young LLP is a Limited Liability Partnership, registered under the Limited Liability Partnership Act, 2008 in India, having its registered office at 22 Camac Street, 3rd Floor, Block C, Kolkata Ernst & Young LLP. Published in India. All Rights Reserved. This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young LLP nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. Join India Tax Insights from EY on Download the EY India Tax Insights App Logo