TMI Blog2006 (7) TMI 551X X X X Extracts X X X X X X X X Extracts X X X X ..... ch 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 the deduction under section 80HHC, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eing 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 the margi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re). The Circular 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 busi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the bank. Two rights flow 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ourt. 11. The learned counsel 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... introduced from the assessment year 1983-84, relief was granted on 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ngalore Clothing Co. [2003] 260 ITR 371 has laid down the principle of determining whether the 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 g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as profits and gains of business, has to be taken for the purpose of section 80HHC [followed in the decisions in the case of CIT. v. S.S.C Shoes Ltd. [2005] 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 no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... red opinion, the law laid down in the case of Lalsons Enterprises ( supra ) does not call for any nexus between interest received and interest paid in cases where net profit is the criterion. What has to be looked into under section 80HHC is "business profits" 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on this count against the assessee." It is seen that this issue relates to deduction under section 80HH. As regards decision of CIT v. Sharp Industries ( supra ) cited by the learned counsel of the assessee, the learned Departmental Representative took us through the last two paragraphs of the judgment 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." ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profits of the business will be determined by deducting from the profits as computed under the head Profits and gains of business or profession the following, ( a )90 per cent of receipts by way of brokerage, commission, interest, rent, etc., included in the profits; and ( b )profits of any foreign branch, office, warehouse, etc. 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ( baa ) in every matter involving receipts by way of brokerage, commission, interest, rent, labour chares, etc. These items of income have got to be seen in the context of the business 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. 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, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceipt is by way of labour charges, Explanation ( baa ) stood attracted. As stated above, each case will have to be examined by the Assessing Officer. As stated above, in each case of receipt of labour charges, rent, interest, commission, etc., the Assessing Officer will have to ascertain whether the element of turnover existed. In the present case, the Tribunal has found, on the facts, that there was 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, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or to the amendment of section 80HHC with effect from 1-4-1992 where Explanation ( baa ) was brought on statute book by the Finance (No. 2) Act, 1991. Even in the case of Madras Motors Ltd. ( supra ), the jurisdictional High Court has gone into the nature of interest income and given a finding after holding discussion as under : "Interest receipts : The interest receipts are also of two descriptions. Firstly interest received on 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 suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n para 11 in the following words (page 584 of 237 ITR) : The use of words derived from in item 11-AA(2) suggests that the original source of the product has to be found. Thus, as a matter of plain English, when it is said that one word is derived from another, often in another language, what is meant is that the source of that word is another word, often in another language. As an illustration, the word democracy is derived from the Greek 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om industrial undertaking. The Court further held that the immediate and effective source of the interest was the deposit and hot the industrial undertaking. Relying upon a number of other decisions, the Court observed as follows (p. 504) : :...the word derived is not a term of art and its use in the definition indeed demands an enquiry into the genealogy of the product, but the enquiry should stop as soon as the effective source is discovered 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 assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uses ( iiia ), ( iiib ) and ( iiic ) of section 28 or of any receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits; and (2) the profits of any branch, office, warehouse or any other establishment of the assessee situate outside India; 31. The learned counsel of the assessee has relied on the decision in Bokaro Steel Ltd. ( supra ). The Hon ble Apex Court has dealt with this issue entirely 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-operati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om. A plain reading of clause ( baa ) of Explanation to section 80HHC of the Act makes this aspect quite clear and we are of the view that the Tribunal was right in disallowing the claim of the assessee in this regard." In the above decision, the Hon ble High Court has given a plain meaning of clause ( baa ) to Explanation to section 80HHC of the Act, which means, clause ( baa ) is very clear that 90 per cent of the interest that was deductible for the claim under section 80HHC was from the 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n, the Hon ble jurisdictional High Court has answered in the case of A.S. Nizar Ahmed Co. ( supra ). 35. The Hon ble jurisdictional High Court in the case of Chinnapandi ( supra ) has very categorically and clearly held as under : "The above two judgments support the case of the revenue. The appellant in the present case had received interest of Rs. 2,65,019 and hence the receipt of interest is alone relevant and the same is to be taken into consideration for the purpose of deduction for the claim under 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supra ). The Hon ble High Court in this case has clearly held that the true character of income is interest income and not business income, the fact that the assessee had claimed it to be business income will not make it so and this will be treated as income from other sources. Even the Bombay High Court in the case of Bangalore Clothing Co. ( supra ) very clearly stated about the applicability of Explanation ( baa ) in the following words at page 379 of 260 ITR: "These items of income have got to be seen in the context of the business 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 inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arned, counsel of the assessees, the learned Departmental Representative and the case laws relied on by both the sides on the Hon ble apex Court, as well as jurisdictional High Court and various other High Courts, we are of the view that according to the newly inserted clause ( baa ) to Explanation to section. 80HHC, the expression profits of the business for the purposes of computation of deduction under section 80HHC means profits of the business as computed under the head "Profits and gains of business or profession" as reduced by 90 per cent of any receipt 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 tha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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