Friday 5 July 2013

Whether interest received for delayed payment from customers can be said to have direct nexus with sales of the Undertaking, and hence would be eligible for deduction u/s 80IA - YES: ITAT

THE issues before the Bench are - Whether the interest received by the assessee from delayed payment from customers can be said to have direct nexus with such sale and hence would be eligible for deduction u/s 80IA; Whether the provision of leave encashment is ascertained liability and therefore, need not to be added back to the book profits u/s 115JB of the Act; Whether interest on FDRs could not be said to have been derived from eligible business, and therefore, the assessee is not entitled to deduction u/s 80IA of the Act in respect of such interest and Whether scrap generated out of stores and from repair of plant cannot be said to have been generated during the process of manufacture for the purpose of deduction u/s 80IA. And the verdict partly goes in favour of the Revenue.
Facts of the case

Deduction
u/s 80IA - During assessment proceedings, the AO noticed that the assessee had received a sum of Rs.27,43,88,709/- which was received as interest from FDRs, Tariff filing fee from HPSEB, damage of transfer sale of scrap, interest received from staff and interest received from HPSEB etc. and deduction u/s 80IA of the Act was claimed on these amounts. It was held that these income items are not derived from eligible undertaking and accordingly deduction u/s 80IA was denied.

On appeal it was submitted that as far as interest amounting to Rs.24,18,42,351/- which was received from HPSEB on late payment of power sales dues. It was further pointed out that the said interest accrued from contract of sale of power dues and not from other separate contract and therefore, such interest should be treated as addition to the sale revenue. Such interest has a direct nexus with the sale of power and therefore, has direct nexus with the revenue derived from eligible business of power generation.

CIT(A) after examining the submissions observed that the interest was received from HPSEB on account of delayed payments of the power bills and therefore, such interest income is inextricable linked to the supply of power to HPSEB. Therefore, this receipt is distinctly part of sale revenue and is directly derived from the eligible business of generation of power. Accordingly the receipt of interest was held to be eligible for deduction u/s 80IA of the Act.

Book profit u/s 115JB – Assessee had made provision for leave encashment amounting to Rs.10,29,478/- (to AY 2007-08) and accordingly the assessee was asked to explain why this provision should not be treated as unascertained liability and added to the book profits u/s 115JB of the Act. In response it was mainly stated that provision was made as per actuarial valuation and therefore, it cannot be treated as unascertained liability. Reliance was placed on the decision of Hon'ble Supreme Court in case of Bharat Earth Movers v CIT (2002-TIOL-123-SC-IT) wherein it was observed that liability for leave encashment was certain though period in which the liability would incur, is not certain because leave encashment can be sought for by the employee either during the years of service or at the end of the service. The AO did not accept the submissions and added the amount to the book profit of the assessee u/s 115 JB of the Act. CIT(A) following the order for AY 2004-05 had held that provision for leave encashment cannot be held to be for unascertained liability.

In AY 2009-10, AO also made adjustments for working the book profit u/s 115JB of the Act by adding Advance Against Depreciation (for short AAD) to the book profits. On appeal the issue was decided in favour of the assessee by following the decision of Hon'ble Supreme Court in case of National Hydro Electric Power Corporation V CIT, 320 ITR 374.

Deduction u/s 80IA on account of interest income - During the assessment proceedings the AO held that the assessee has shown various items including interest on FDRs as business income and claimed deduction u/ s 80IA of the Act. It was held that interest on FDRs could not be said to have been derived from eligible business, therefore, the assessee was not entitled to deduction u/s 80IA of the Act.
On appeal, it was mainly submitted that the assessee was running a power project and therefore, under the category of industrial undertaking engaged in the infrastructure development. The project was financed by financial institution and assessee was required to execute the Trust and Retention Agreement so that financial institution can control and keep lien over cash flow of the assessee company. Out of various requirements of TRA agreement permitted investments made in FDRs etc. It is part of the financing arrangements under TRA agreement. Therefore, same should be treated as directly linked to the revenue from the eligible undertaking.

The CIT(A) did not accept the submissions and upheld the action of the AO in denying deduction u/s 80IA of the Act in respect of interest on FDRs.

Deduction u/s 80IA on sale of scrap - Various items of income which were included in the business profit to the tune of Rs.27,43,88,709/- were held to be not includible in the business profit for the purpose of deduction u/s 80IA of the Act because the same was not derived from eligible business. One of the item excluded is sale of scrap.

On appeal, it was mainly submitted that scrap was generated during the course of manufacture and therefore, same should be treated as derived from industrial undertaking. The CIT(A) did not find force in the submissions and rejected the claim.

On cross appeals by the Revenue and the assessee, ITAT held that,


++ Deduction u/s 80IA - in case of Pandian Chemicals Ltd. V. CIT, Supreme Court was concerned with the issue whether interest was received on deposits of electricity can be said to have been derived from industrial undertaking and it was observed that such interest income was a step removed from the business of the industrial undertaking and therefore, deduction was denied. However, this issue came up for consideration before various High Courts and it was pointed out that when the interest is received from delayed payment from customers then it would have direct nexus with such sale and would be eligible for deduction u/s Chapter VI. This view was accepted by Gujarat High Court in case of Nirma Industries Ltd. Vs. CIT;

++ from the juridical decisions, it becomes clear that when interest is received on account of delayed payments from customers then it would definitely constitute income from eligible business because such interest has direct nexus with the receipt from eligible business. Accordingly, there is nothing wrong in the order of the CIT(A) and confirm the same;

++ Book profit u/s 115JB – Supreme Court in case of Bharat Earth Movers v CIT Court was considering the issue where provision for leave encashment was allowable as admissible deduction referred to the another decision of Apex Court in case of Metal Box Company of India Ltd. V Their Workmen (1969) 73 ITR 53 (S.C) and held that the provision for leave encashment would constitute a liability and if the same has been determined on the basis of actuarial valuation then same cannot be considered as unascertained liability. Accordingly, there is nothing wrong in the order of the CIT(A) and confirm the same;

++ the issue regarding the nature of receipt in the form of AAD has already been decided by the Supreme Court in the case of NHPC Vs. CIT 320 ITR 374, wherein it has been held that AAD is ‘income received in advance’. It is a timing difference. It has been further held by the Supreme Court that in order to make an addition under clause (b) of Explanation 1 to section 115 JB, two conditions must be jointly satisfied: (a) there must be a debit of the amount to the profit and loss account, and (b) the amount so debited must be carried to the reserve. Since the amount of AAD is reduced from sales, there is no debit to the profit and loss account and the amount did not enter the stream of income for the purposes of determination of net profit at all. Hence clause (b) of the Explanation 1 is not applicable to AAD. Thus the court has clearly endorsed the method of accounting of the AAD by which it has been reduced from sales and represented as ‘deferred revenue’. It is thus accepted as an amount that is under obligation, right from inception, to get adjusted in future. The Court has also acknowledged the fact that the assessee cannot use the AAD for any other purpose except by way of its adjustment against future depreciation resulting in the reduction of tariff in future years. With the Supreme Court having accepted the position in principle regarding the exclusion of the AAD from the sales, the A.O. does not appear to be justified in still insisting that the non inclusion of AAD in the sale receipts vitiates the audited accounts of he assessee. This insistence of the A.O. is in clear contradiction of the ruling of the Supreme Court and hence his action of altering the net profit as per the audited accounts of the assessee by placing reliance on the decision of the Apex Court in the case of Dynamic Orthopedic (P) Ltd. Vs. CIT (2010-TIOL-12-SC-IT) is not found to be in order;

++ the above clearly shows that the issue has been decided on the basis of the decision of Supreme Court in case of National Hydro Electric Power Corporation V CIT. The decision is directly on the issue of advance against depreciation and whether the same is required to be added u/s 115JB of the Act to the book profits. Since the decision (or the law laid down) of Supreme Court is the Law of land and therefore, ITAT is bound to follow the same. Accordingly there is nothing wrong with the order of the CIT(A) which has been rendered on the basis of above decision;

++ Deduction u/s 80IA on account of interest income - The immediate and proximate source of interest income in the instant case is not the eligible business. The Supreme Court in the case of Pandian Chemicals Ltd. Vs. CIT (2003) 262 ITR 278 = (2003-TIOL-51-SC-IT), following the decision in the case of Cambay Electric Supply Industrial Co. Ltd. Vs. CIT (2002-TIOL-76-SC-IT) has dwelled upon the meaning of words "derived from" Quoting from the judgment of the Privy Council in CIT v. Raja Bahadur Kamakhaya Narayan Singh (2002-TIOL-677-SC-IT), the Court observed " ……. .The word 'derived’ is not a term of art. 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...." It was finally laid down by the Court that the word "derived from" must, be understood as something which has a direct, or immediate nexus with the appellant's industrial undertaking. It is further pertinent to note that the said judgment of the Supreme Court was in the context of interest income earned on such fixed deposits, the investment in which was mandatory by the assessee under a legal compulsion and for the operation of its business. In the instant case, even such compulsion or obligation does not exist. In view of the discussion above, the CIT(A) has held that the A. O was fully justified in excluding the interest income from the eligible profits u/s 80IA;

++ CIT(A) has correctly adjudicated the issue by following the decision of Apex Court in case of Pandian Chemicals Ltd. V. CIT. Further, if interest from deposit from electricity security which is directly related with the power connection without which an industrial unit cannot be operated, was held to be a step removed from industrial undertaking in case of Pandian Chemicals Ltd. V. CIT then how interest on FDRs made for obtaining loans from the bank, can be held to have direct nexus with the eligible industrial undertaking. This is not possible and the CIT(A) has correctly adjudicated the issue. No doubt that the decision in case of Pandian Chemicals Ltd. V. CIT (supra) has been rendered u/s 80HH of the Act, however, the judgment has been rendered mainly because of the expression used “derived from”. Perusal of Section 80IA(1) of the Act would show that in this provision also the expression has been used as “derived by an undertaking”, therefore, the same principle would be applicable in case of deduction u/s 80IA of the Act. Accordingly, the order of the CIT(A) was confirmed;

++ the assessee has raised other Cross-objections that the CIT(A) has erred in not allowing deduction of interest paid from the aforesaid interest income of Rs. 2,70,95,301/- while reducing the same from the profits of the eligible business for computing deduction u/s 8IA and accordingly as interest paid far exceeds interest income, as such too, no exclusion of interest income is warranted for computing deduction u/s 80IA;

++ whatever interest has been incurred or spent by the assessee, has already been allowed as business expenditure because same has been debited to the profit and loss account. Income on account of interest from FDR is totally a separate item and has to be taxed accordingly. It cannot be said that the amount in FDRs have been invested out of borrowed funds because borrowed funds have been utilized for purchase of assets. Therefore, there is no question of allowing deduction u/s 80IA of the Act simply because interest paid by the assessee, was more than the interest earned by the assessee;

++ Deduction u/s 80IA on sale of scrap – There is no force in the submissions of the assessee because the CIT(A) has clearly observed that admittedly scrap was generated out of stores and from repair of plant and therefore, same cannot be said to have been generated during the process of manufacture. In view of above discussion, assessee’s appeals as well as the Cross-objections are dismissed.

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