Facts
The taxpayer filed its return of income for the assessment year 2002-03 by declaring a total loss of Rs.507.03 lakhs after claiming exemption of Rs.395.99 lakhs under section 10A of the Income-tax Act, 1961 (“the Act”) with regard to its STP unit .
The exemption under section 10A of the Act was computed before set off of brought forward business loss and unabsorbed depreciation by the taxpayer.
The Assessing Officer (“AO”) recomputed the section 10A benefit to adjust the brought forward business loss and unabsorbed depreciation of non-10A unit and the AO held that the taxpayer was not entitled to exemption under section 10A of the Act.
Against the order of the AO, the taxpayer preferred an appeal before the Commissioner of Income-tax (Appeals) [“CIT (A)”]. The CIT (A) held that income of the 10A unit has to be exempted at source level itself and would not enter into gross total income. The CIT (A) therefore directed the AO to allow exemption under section 10A without setting off of losses of non-10A unit and consequently allowed the carry forward of business losses and unabsorbed depreciation of non-10A unit.
The Revenue authorities preferred an appeal before the Income-tax Appellate Tribunal (“ITAT”) which also held in favor of the taxpayer.
The Revenue authorities preferred an appeal before the Honorable Karnataka High Court.
Issues before the Karnataka High Court
First substantial question of law
Whether the Tribunal did not consider that the amendment to section 10A by Finance Act 2000 with effect from 01.04.2001, which provided that the deduction of profits and gains of an undertaking from the export of articles or things or computer software is required to be allowed from the „total income‟ of the taxpayer and consequently the loss from non STP unit is required to be set off against the income of other STP unit before allowing deduction under section 10A of the Amended Act?
Second substantial question of law
Whether the Tribunal was right in holding that the deduction under section 10A or 10B of the Act during the current assessment year has to be allowed without setting off brought forward losses and depreciation from earlier assessment year or current assessment year either in the case of non-STP units or in the case of very same undertaking?
Observations and Ruling of the Karnataka High Court
First substantial question of law
The heading of Chapter III is “Incomes which do not form part of total income”. The second heading prior to amendment by Finance Act 2000 was “Special conditions in respect of newly established industrial undertakings in free Trade Zones”. Post amendment the heading read as “Special provisions in respect of newly established undertakings in a free Trade Zone etc.” with only a marginal addition of the word „etc‟.
While a literal reading of the provisions of section 10A/10B requires deduction from total income, there can only be a deduction in computing total income and not a deduction from total income which is the final result of the computation process. The computation of total income begins only with Chapter IV and as section 10A is covered in Chapter III, the phrase “total income” used in section 10A cannot be understood in the same sense as provided under section 2(45).
The deduction is undertaking specific and travels with the undertaking irrespective of who owns the same. The computation of deduction as provided in section 10A(4) is also with reference to the undertaking. The phrase “total income” used in section 10A (1) is, therefore, to be understood as the total income of the STP unit in its commercial sense.
The twin conditions of section 14 are that the income is subject to charge of income tax and is includible in the total income. As the deduction under section 10A is in the nature of exemption though termed as deduction and the same is in respect of commercial profits, the provisions of section14 providing for classification of income under various heads of income are not applicable. Thus, the deduction under section 10A would be given first and process of computation of “profits and gains of business or profession” would begin thereafter.
The amended section 10A continues to remain in Chapter III. The act of the Parliament in consciously retaining section 10A in Chapter III indicates its intention that the nature of relief continues to be an exemption.
The deductions under Chapter VIA are to be computed based on the “gross total income”. The term “gross total income” is defined in section 80B(5) to mean the total income computed in accordance with the provisions of this Act, before making any deduction under Chapter VIA. Thus, the other provisions of the Act will have to be first
given effect to and hence there is no reason why reference to the provisions of the Act should not include section 10A.
The income of 10A unit has to be excluded before arriving at the gross total income of the taxpayer. Hence, the income eligible for exemption under section 10A would not enter into computation as the same has to be deducted at source level itself.
Second substantial question of law
Per the insertion of the words “the year ending up to the first day of April 2001” in sub-section (6) of section 10A by the Finance Act 2003, it is clear that the intention of the legislature was to provide benefit of carry forward of depreciation and business loss relating to any year of tax holiday period and set off against income of any year post tax holiday. This is also supported by the Circular No. 7 of 2003 issued by the Central Board of Direct Taxes.
The aforesaid intention of the legislature is also clear from the fact that similar amendment has not been made with regard to relief provided under section 10C of the Act.
In order to give effect to the aforesaid intention, it is necessary that the normal computation of business income and the depreciation as per the provisions of the Act should be made for each year of tax holiday period. The amount of depreciation and business loss remaining unabsorbed at the end of tax holiday period should be determined so that the same may be set off against the income post tax holiday period.
It is permissible for a tax payer to opt in or opt out of section 10A. In the year the assessee has opted out, the normal provisions of the Act would apply. The profits derived by him from the STP undertaking would suffer tax in the normal course subject to various provisions of the Act including those of Chapter VIA. If in such a year, a taxpayer has suffered losses, such losses would be subject to inter source and inter head set off. The balance, if any, thereafter can be carried forward for being set off against profits of the subsequent assessment years in the normal course. Unabsorbed depreciation would also be subject to a similar treatment.
Since the income of 10A unit has to be excluded from the total income of the taxpayer, the question of unabsorbed business loss/depreciation being set off against such profit and gains of the undertaking would not arise.
Conclusion
The ruling rendered on the issue of set off of losses and depreciation against income of an STP unit with regard to manner of computing relief under section 10A/10B of the Act, would provide the clarity and precedence on the issue.
The observation of the High Court on significance of opting in and opting out of section 10A may also be crucial in determining the availability of losses incurred by 10A/10B unit for set off against income from non-STP units.
Source: Commissioner of Income-tax v. M/s.Yokogawa India Ltd & Ors. (ITA No.78 of 2011 – Karnataka High Court Order dated 9 August 2011)
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