TMI Blog2013 (9) TMI 85X X X X Extracts X X X X X X X X Extracts X X X X ..... industrial undertaking so manufacturing precision equipments is a commercial venture for making profits, and exports or no exports, the industrial undertaking is in business anyway. In such a situation, in case the assessee is able to make some exports of the same product on the similar price, the duty drawback income is an incidental or standalone income. However, in another situation, in which, for example, the assessee is a one hundred percent exporter, and he is operating on the basis of costs duly adjusted by duty drawback, as evident from the fact that but for duty drawback receipts, he will have virtually no profits, the duty drawback receipts could as well have the first degree nexus since these cannot be viewed as incidental or ancillary profits or standalone income - What should have been really examined by the authorities below is whether or not, on the facts of this case, the duty drawback receipts can be said to have first degree nexus with the industrial undertaking or whether these profits can be said to be ancillary, incidental or standalone income. Everything thus hinges on the findings about the degree of nexus between duty drawback receipts and the indust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er section 80 IB in respect of entire business profits, including duty drawback receipts amounting to Rs 1,53,94,403. It was in this backdrop that the assessee was required to show cause as to why the duty drawback receipt not be excluded from the computation of deduction under section 80 IB, as it was, in the opinion of the Assessing Officer, not in the nature of business income derived from industrial undertaking. In response to this requisition, it was mainly contended by the assessee that the duty drawback refund is nothing but a refund of customs and central excise duty on the inputs used in manufacturing of its products. Elaborate submissions, on this aspect of the matter, were made by the assessee. Reliance was also placed judicial precedents in the cases of CIT Vs Madras Motors Ltd (257 ITR 60), CIT Vs Indian Gellative and Commercials Ltd (272 ITR 284) and CIT Vs Elteck SGS Pvt Ltd (300 ITR 6). None of these submissions, however, impressed the Assessing Officer. He was of the view that deduction under section 80 IB could be allowed only in respect of the profits from activities which are derived from industrial undertaking. It was also observed that "the deduction under sec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are de facto refund of excise duty and custom duty paid, and following the principle laid down by Hon'ble Delhi High Court in the case of CIT Vs Dharmpal Premchand Ltd (317 ITR 353), such a refund of duties is eligible for deduction under section 80 IB. Learned counsel submits Hon'ble Supreme Court has dismissed an SLP against this judgment of Hon'ble Delhi High Court , and, as such, Liberty India decision is to be read in harmony with the Dharmpal Premchand decision. Our attention is also invited to the order dated 29 th April 2011 passed by a coordinate bench in the case of J K Aluminum Co. Vs ITO, wherein, on the same lines, refund of excise duty is held to be eligible for deduction under section 80 IB. Learned counsel distinguishes Liberty India decision (supra) on the ground that at present we are dealing with a refund of duties, and, in support of this contention, he invites our attention to copi es of several purchase invoice, which were placed before us in the paperbook, disclosing separate charges for excise duty paid on purchases. It is his contention that the duty drawback receipt is nothing but refund of these, and other, duty payments. Learned counsel submits that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the matter. 7. Learned counsel indeed has an uphill task. No matter how convincing his argument seem to be on the first principles, and no matter how strong a conceptual support he can canvass for his claim, he has judicial precedents, including from the highest judicial forum in this country, which may dissuade many, and must have dissuaded many, from even attempting to argue i n support of this ambitious claim. Let us, therefore, begun by examining these judicial precedents and appreciate what has been said, and much more important than that in what context it has been so said, in these judicial precedents. 8. In the case of CIT Vs Sterling Foods (237 ITR 579), Hon'ble Supreme Court was in seisin of a situation in which the assessee, engaged in the business of processing and exporting prawns and other sea food, "earned some import entitlements granted by the Central Government under an export promotion scheme". The assessee was entitled to use the import entitlements itself or sell the same to others. It sold the import entitlements that it had earned to others. Its total income for the relevant assessment years included the sale proceeds of such import entitlements, and it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion as core question before the Court was that such income was derived from specified business, which reasoning is fully applicable to the present situation". On the matter being carried in further appeal, Hon'ble Supreme Court, speaking through Hon'ble Justice S H Kapadia for the division bench (in the case of Liberty India Vs CIT 317 ITR 218) also confirmed this stand and observed as follows: .......The words "derived from" is narrower in connotation as compared to the words "attributable to". In other words, by using the expression "derived from", Parliament intended to cover sources not beyond the first degree. In the present batch of cases, the controversy which arises for determination is: whether the DEPB credit/ Duty drawback receipt comes within the first degree sources? According to the assessee(s), DEPB credit/duty drawback receipt reduces the value of purchases (cost neutralization), hence, it comes within first degree source as it increases the net profit proportionately. On the other hand, according to the Department, DEPB credit/duty drawback receipt do not come within first degree source as the said incentives flow from Incentive Schemes enacted by the Government ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bt, the object behind DEPB is to neutralize the incidence of customs duty payment on the import content of export product. This neutralization is provided for by credit to customs duty against export product. Under DEPB, an exporter may apply for credit as percentage of FOB value of exports made in freely convertible currency. Credit is available only against the export product and at rates specified by DGFT for import of raw materials, components etc.. DEPB credit under the Scheme has to be calculated by taking into account the deemed import content of the export product as per basic customs duty and special a dditional duty payable on such deemed imports. Therefore, in our view, DEPB/Duty Drawback are incentives which flow from the Schemes framed by Central Government or from Section 75 of the Customs Act, 1962, hence, incentives profits are not profits derived from the eligible business under Section 80-IB. They belong to the category of ancillary profits of such Undertakings. 17. The next question is - what is duty drawback? Section 75 of the Customs Act, 1962 and Section 37 of the Central Excise Act, 1944 empower Government of India to provide for repayment of customs and ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee, and, in coming to this conclusion, held as follows: In the case of CIT vs. Sterling Foods (supra), the Supreme Court was interpreting the provisions of s. 80HH of the Act. The Supreme Court was called upon to adjudicate income derived from the sale of import entitlements granted by the Central Government under the Export Promotion Scheme which the assessee could use itself or sell the same to others. The issue before the Supreme Court was whether the income from such import entitlements could be included in the total income for the purposes of claiming relief under s. 80HH of the Act. The S upreme Court came to the conclusion in the said case that the source of import entitlements was not the industrial undertaking of the assessee. According to the Supreme Court, the source of import entitlement in the circumstances was Export Promotion Scheme of the Central Government whereunder the export entitlements became available. The Supreme Court further went on to hold that the expression 'derived from' entailed a direct nexus between profit and gains and the industrial undertaking. In that case, the Supreme Court found that the nexus was not direct but only incidental. According ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n sought to be made by learned counsel for the assessee, in income derive d from duty drawback and sale of import entitlements, could not be accepted as relevant distinction since "core question before the Court was that such income was derived from specified business, which reasoning is fully applicable to the present situation". What was thus implicitly held was that the duty drawback receipts were not from core activities of specified business - something which was upheld by Hon'ble Supreme Court as well. Hon'ble Supreme Court did hold that DEPB/ duty drawback receipts would "constitute independent source of income beyond the first degree nexus between profits and the industrial undertaking". Even in the illustration taken by Hon'ble Supreme Court, in the case of Liberty India (supra), overall profit is Rs 200, out of which Rs 100 is profit by way of receipt of duty drawback receipts and the other Rs 100 is profit by way of normal business profits. Such examples, however, hold good on the premises that duty drawback receipt is an additional, ancillary or supplemental profit. There can, on the other extreme, be situations in which duty drawback itself could be more than the overa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... direct but only incidental. According to us, the ratio of this judgment has no application to the case in the instant case. In the instant case both the CIT(A), as well as, the Tribunal found that the refund of excise duty had a direct nexus with the manufacturing activity carried out by the assessee". The views expressed in Sterling Food (supra) which is the basic foundation of revenue's case, therefore, remain confined to the those facts. When facts can shown to be materially different and when a receipt can be shown to have direct nexus with the manufacturing activity, such a receipt can indeed be included in computation of deduction under section 80 IB. 12. It is thus the nexus which was found to be missing in the case of Liberty India's case, but when nexus was found to be existing, as in Premchand Lakhanpal's case, the amounts were held to be eligible for deduction 80 IB. The true test, therefore, is not the nexus that the duty drawback has with the operations of business. 13. As we deal with this aspect of the matter, let us not lose sight of the fact that the expression 'first degree nexus between profits and industrial undertaking' has been used, by Hon'ble Supreme Cou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of profits, in view of the position that de-hors such export incentives also the industrial undertakings make commercial sense. 15. To up a question to ourselves, what are the options open to us in this situation and on the facts of this case. On the one hand, the words employed in Hon'ble Supreme Court's judgment in Liberty India's case (supra) leave little doubt about the fact that, in the esteemed views of Hon'ble Supreme Court, the duty drawback receipts donot have first degree nexus with the profits of the industrial undertaking, but then there is no warrant for the assumption that this approach must remain valid in all factual situations. Of course, it is tempting to proceed on the basis that this lack of first degree nexus is a legal principle, but then an issue like that o f degree of nexus between nature of receipts vis-a-vis the industrial undertaking cannot be decided in vacuum; it has to depend on the facts, and business situations can never be so static or uniform that lack of nexus in one factual matrix must essentially imply lack of that nexus in all factual matrixes. On the other hand, on the peculiar facts of this case, duty drawback receipts, at least at the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g highly as subjective as it is, it is perhaps incapable of unanimity in approach, but then that cannot be a ground enough to deal with the matters at a superficial level . 16. The question that we must, therefore, deal with, to ascertain whether or not duty drawback receipt in includible in computation of deduction under section 80 IB, is whether this particular receipt is an ancillary or additional profit and can be seen as an income on standalone basis or whether it is an integral part of the profits of the industrial undertaking. In our humble understanding, the answer to this question does depend more on the factual matrix of a case essentially because whether or not duty drawback receipts are additional incentive receipt or an integral part of the business receipt may vary on several factual factors. In a situation in which the duty drawback receipts are nothing but additional or incidental profits, and when even in the absence of duty drawback receipts, operations of industrial undertaking make business sense, as was the case before Their Lordships in Liberty India or as was visualized or perceived by Their Lordships, the situation will be different. However, the same may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ccounting Standard 1) issued by the Institute of Cost Accountants of India, which deals with the question as to how the costs should be recognised, which states as follows: 6.1.2 Material Cost is the cost of material of any nature used for the purpose of production of a product or a service. 6.1.3 Material cost includes cost of procurement, freight inwards, taxes and duties, insurance etc directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks, refunds on account of modvat, cenvat, salex tax and other similar items are deducted in determining the costs of material. http://casbicwai.org/CASB/casb-resources-download.asp (Emphasis by underlining supplied by us) 17. It is thus clear that in a particular fact situation, even material cost may be required to be adjusted for duty drawback. Of course, the crucial question is whether the duty drawback is an incidental profit or a p rofit of the first degree which, in turn, depends on the business models. Take for example a situation in which an assessee is manufacturing precision equipments and selling the same in domestic as well as international markets. The industrial undertaking so manufacturing prec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . We, therefore, remit the matter to the file of the CIT(A) for adjudication de novo by way of a speaking order, in the light of our above observations, in accordance with the law, and, after giving yet another opportunity of hearing to the assessee. While doing so, learned CIT(A) will also deal with alternate contention of the assessee to the effect that, in any event, to the extent the duty drawback receipts represent refund of duties by the assessee, which assessee can demonstrate and establish, the same shall be includible in profits of the assessee eligible for deduction under section 80 IB. In the event, however, of the basic plea being accepted, this aspect of the matter will be rendered academic. 19. To the extent above, grievance of the assessee is upheld to the extent that the matter regarding the duty drawback receipts being includible in computation of deduction under section 80 IB deserves to be re-examined by the CIT(A) as directed above. What we have decided for the assessment year 2006-07, learned representatives fairly agree, will also apply mutatis mutandis for the three other assessment years, i.e. assessment year2002-03, 2003-04 and 2004-05. No other issues we ..... 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