21 December 2016 EY Tax Alert SC settles certain controversies on profit-linked deduction for export units Executive summary 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. This Tax Alert summarizes a recent ruling of the Supreme Court (SC) in a batch of cases, one of them being the case of Yokogawa India Ltd. [1] (Taxpayer). The SC dealt with multiples issues, the principal one being whether Section 10A (S.10A) of the Income Tax Law (ITL), which provides for profit-linked incentive to an exporter of software and other goods, is an exemption provision or a deduction provision. Furthermore, the SC was also required to adjudicate as to whether relief under S.10A, admissible in respect of an eligible unit, is to be allowed with respect to profits of an eligible unit before or after set off of losses of other units. The SC, after considering the amendment in 2001, held that, post the amendments.10a is a deduction provision, even though its placement in the ITL is along with other exemption provisions. The SC further held that the deduction under S.10A is attached to the eligible unit and is to be computed on a standalone basis, without reference to other eligible or non-eligible units of the Taxpayer. The SC also held that the deduction is to be availed of at the stage of computing the income of the eligible unit and not at the stage of computation of the Total Income (TI) of the Taxpayer. [1] [TS-661-SC-2016]
Facts and background S.10A [2] of the ITL provides for a profitlinked tax holiday in respect of income derived from export of articles or things or computer software for a period of 10 years to undertakings/units located in specified areas (such as free trade zones, electronic hardware technology parks, special economic zones), subject to conditions specified therein. The ITL is divided into various chapters. Chapter III covers income which does not form part of the TI of the taxpayer (Exemption Chapter). Chapter IV provides computation of income under various heads, including profits and gains of business or profession. Chapter VI is a chapter which provides for aggregation of income and set off or carry forward of loss. The process results in arriving at the Gross Total Income (GTI). Chapter VI- A provides for various deductions to be made from the GTI to arrive at the TI of the taxpayer (Deduction Chapter). The Deduction Chapter, amongst others, grants deductions which are profit-linked incentives in relation to the activity of export of goods, articles or things or computer software, wherever situated in India. Under the scheme of the ITL, the Exemption Chapter generally does not come up for the process of computation of TI under Chapters IV to VI-A and income covered by the Exemption Chapter is excluded from the commercial profits itself. However, if a deduction as profit-linked incentive is admissible under the Deduction Chapter, it undergoes the process of computation of TI under Chapters IV to VI-A. S.10A falls in the Exemption Chapter, which provided for exemption of profits before the amendment with effect from 1 April 2001. With the amendment in 2001, S.10A provides for an incentive which bears the nomenclature of a deduction of the profits and gains derived by a taxpayer engaged in the export of articles/things or computer software. (Amended S.10A). But, such deduction continues to be under Chapter III of the ITL. Prior to the amendment in 2003, S.10A provided for complete prohibition from carry forward of business losses and depreciation of unit beyond the tax holiday period. (S.10A was further amended by the Finance Act, 2003 with effect from April 2001, which lifted the bar and permitted the taxpayer to carry forward and set off unabsorbed business losses and depreciation of eligible unit beyond the tax holiday period). Karnataka High Court (Karnataka HC) ruling in the case of the Taxpayer [3] In the lead case of the Taxpayer, the Taxpayer had three units and claimed relief under the Amended S.10A in relation to one of its units located in a specified area, before setting off of brought forward business loss and depreciation which pertained to other units not eligible for deduction under S.10A. The Taxpayer claimed that its claim for exemption of profits from eligible units should not be diluted by set off of losses of non-eligible units. The Tax Authority, however, contended that relief under S.10A is allowed from the TI after setting off of all unabsorbed business losses and depreciation which pertains to other units. [2] S.10A was discontinued with effect from tax year 2011-12 [3] 341 ITR 385
The Karnataka HC, in the Taxpayer s case, ruled that S.10A, though called a deduction provision after the amendment with effect from 1 April 2001, is in the nature of an exemption provision and income of a S.10A unit is to be excluded at the source itself before arriving at the GTI. Basis this, the Karnataka HC held that the question of settling off of past losses of non-eligible units does not arise. Other developments Certain other HCs have taken a view that, post its amendment in 2001, S.10A has become a deduction provision even if the Section continues to be part of the Exemption Chapter. The HCs further held that despite S.10A being a deduction provision, deduction is to be allowed at the stage of computation of profits and gains of the unit itself, without taking into consideration set off of losses of non-eligible units. Issues under consideration Substantial questions of law considered by the SC were based on issues involved in a batch of cases. The following is a summary of questions considered by the SC: Whether, even after the amendment which was effected from 1 April 2001, S.10A continues to remain an exemption provision and not a deduction provision. Whether the income eligible for relief under the Amended S.10A is to be excluded before the stage of computation of the GTI of the Taxpayer. Whether, in computing deduction under S.10A, the losses (current year/brought forwards from earlier years) of other units (eligible/not eligible) can be set off against the profits of the eligible unit. SC s ruling On whether amended S.10A is an exemption provision or a deduction provision The Central Board of Direct Taxes (CBDT), the apex body administrating direct taxes in India, issued a Circular [4] (Circular No. 7) which provided that losses of eligible and non-eligible units, if any, should be set off against the profits of the eligible units before allowing deduction under S.10A. Tax return forms for the taxpayer were also amended to align the columns of the return form with the understanding in Circular No. 7. The SC ruled that S. 10A, post its amendment, is a deduction provision, on the following grounds: Introduction of the word deduction in the Amended S.10A, as also other amendments including permitting a taxpayer to carry forward and set off of losses of eligible units in the absence of any contrary material, embodies a clear enunciation of the legislative intention to alter the nature of S.10A from an exemption provision to a deduction provision. Retention of the Amended S.10A in the Exemption Chapter is not decisive. The true and correct purport and effect of the Amended S.10A is to be construed from the language used. [4] Circular No. 7 dated 17 January 2013
[5] Circular No. 794 dated 9 August 2000 [6] Sections 10B, 10AA, etc. On the stage of grant of deduction under S.10A The SC ruled that deduction under S.10A is qua eligible unit to the exclusion of other eligible or non-eligible units. Furthermore, deduction is to be allowed at the stage of determination of profits of the eligible unit itself under Chapter IV and without considering the provisions of Chapter VI relating to set off of losses, on the following reasoning: The SC noted that in addition to incentives provided in S.10A, there are separate provisions embedded in the Deduction Chapter, which also provide for tax relief on export of articles/goods or computer software. The presence of parallel provisions under two different chapters is indicative of the legislative intent to provide certain additional benefits to S.10A, as compared to provisions in the Deduction Chapter. These additional benefits to S.10A are as under: Deduction of S.10A is attached to the eligible unit. Deduction is to be computed on a standalone basis, without reference to other eligible or non-eligible units of the Taxpayer. Deduction is to be allowed at the stage of determination of profit and gains of an eligible unit under Chapter IV and without aggregating results, including losses of other units (eligible or noneligible units) of the Taxpayer. The expression total income, as used in S.10A, is to be understood as total income of the unit computed at the stage of determination of profits of the unit under Chapter IV, and not as total income of the Taxpayer. The SC further drew support from a CBDT Circular [5] explaining the Amended S.10A, which had clarified that while working out deduction under S.10A, the export turnover and the total turnover of units eligible to S.10A is to be computed separately, without any reference to other units of the taxpayer. Comments The issue of whether S.10A is a deduction or exemption provision and whether, in computing deduction under S.10A, set off of business loss or depreciation of other eligible or non-eligible units is to be considered, had engaged the attention of Indian Courts for quite some time. The present ruling puts at rest the various controversies. The SC ruled that S.10A is a deduction provision. This ruling upholds that deduction in respect of an eligible unit is to be computed on a standalone basis, without reference to other eligible or non-eligible units of the Taxpayer. The SC further ruled that deduction is allowed at the stage of determination of profits and gains of an eligible unit under Chapter IV and without aggregating results, including losses of other units (eligible or non-eligible units), of the Taxpayer. In view of this SC ruling, Circular No. 7, which provides for a contrary position, will have no legal effect. This ruling, though rendered in the context of S.10A may also have a binding effect in relation to the other provisions [6] in the Exemption Chapter, which are on similar lines.
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