Whether interest income arising out of deposits with banks and EEFC account is eligible for deduction u/s 10A - YES: HC

THE issues before the Bench are - Whether interest income arising out of deposits with banks and EEFC account is eligible for deduction u/s 10A. And the answer goes in favour of the assessee.

Facts of the case

The assessee is a 100% EoU, engaged in exports of computer software. It earned interest income

from deposits lying in the EEFC account and advancing of inter-corporate loans out of its own fund. The assessee had outstanding borrowings by way of External Commercial Borrowings (ECBs) obtained in earlier years. The assessee had to repay this borrowing only in accordance with the repayment schedule. It was stated that RBI had imposed restriction on prepayment of instalments. The borrowings were for the business of STP undertaking. Under the Exchange Control Regulation, the assessee was prohibited from any pre-payment of ECBs. For any pre-payment of the loan, the assessee had to seek prior permission of the Central Government. In the year 1999, the Government had formulated a policy on pre-payment and the policy stated that approval of pre-payment would be granted only to the extent of 10% of the outstanding loan. Hence, even after going through the regulation, the assessee would have to repay a small portion of its outstanding loans, though it had the liquidity to do so. Hence, it was required to temporarily park the funds, until the date of repayment, and also keep paying the interest on the loans. The assessee took a business decision to place these funds with various sister concerns as inter-corporate deposits. The assessee claimed that the interest derived from deposits in the EEFC account and the interest income earned on inter-corporate deposits, had to be assessed under the head income from business. Further, the assessee claimed that the interest income as derived from the business of export of articles or things or computer software and the same was eligible for exemption under section 10A of the Act for the Assessment Years 1997-98 and 1998-99. For the Assessment Year 2001-02, he submitted that, since the Act had undergone a change, the entire concept and basis of Section 10A had changed and thus, as per the provisions of law as applicable to the Assessment Year 2001-02, the interest income formed part of profit from the business of industrial undertaking and once the formula was applied as specified in subsection 4 of section 10A, the assessee would be entitled for deduction, as the assessee was a 100% exporter, i.e. the entire business of the assessee consisted of development and export of software. The assessing authority did not agree with the said contention and therefore, he disallowed the exemption claimed for the assessment year 2001–02.

Aggrieved by the said order, the assessee preferred an appeal to the Commissioner of Income Tax (Appeals), which came to be dismissed. Aggrieved by the said order, the assessee preferred an appeal to the Tribunal. The Tribunal insofar as the assessment year 1998 – 99 was concerned, held that the interest income from EEFC account and the interest recovered on loans advanced to the sister concern were admissible deduction under the head Income from Business. It further held that as per the predominant view of the various high courts, the interest income arising from the transaction connected with the business would be business income and they affirmed the findings recorded by the appellate authority. Hence, they extended the benefit under Section 10 B of the Act, for the assessment year 1998–99.

However, while dealing with the very same question for the assessment year 2001 – 02, they took note of the change in the law. They extracted Section 10B(1) and (4) of the Act and held that it was an exemption section and income from these undertakings, which are covered by the section did not form part of the total income. However, by virtue of the amendment, in particular, introduction of Sub-section (4) to Section 10B of the Act, the methodology of arriving at the export profits of the business of the undertaking was given in a formula. The terminology used in Sub-section 4 is ‘profits of the business’ of the undertaking in contradiction to the word ‘profits and gains derived by the assessee “ from a 100% export oriented undertaking’. Finally, they held that the term “from the business of” had much wider than the term “derived from industrial undertaking”. Keeping the said distinction in mind, they held that the entire profits deriving from the business of undertaking should be taken into consideration, while computing the eligible deduction under Section 10B/10A of the Act, by applying mandatory formula. After introducing Section 80 HHC, it was observed, that the legislature intended to exclude interest from the term “profits of business of undertakings” under Sections 10A and 10B of the Act and similar provision as in case of Section (baa) would had been inserted. No such explanation had been introduced in Sections 10A and 10B and therefore, it held that the interest income was exempted from payment of tax and also their claim for allowance of 5% on scientific basis should be allowed.

In appeal before the HC, the counsel for the Revenue contended that having regard to the Section 10B of the Act, what was to be taken into consideration was profits and gains derived from the export of articles or things or computer software and not the profits of the business of the undertaking. The words “derived from” was narrower in connotation and intended to cover sources not beyond the first degree.” Therefore, when the interest from fixed deposits or interest from loans advanced to the sister concern or interest from EEFC account or the consideration received from sale of the import entitlement cannot be construed as profits and gains from export of computer software. Therefore, the said account is liable to be taxed.

Per contra, the Counsel for the assessee submitted that that was the position prior to the amendment in 2001. That is why, for the assessment year 1998–99, the Tribunal had declined to extend the said benefit and the assessee had accepted the said finding. But in view of the change in the law, he was entitled to the said benefit and the Tribunal after taking note of the change in the law, had extended the said benefit, which was in tune with the legislative intention. Therefore, the impugned order cannot be found fault with.

Having heard the parties, the Bench held that,

++ in the instant case, the assessee is a 100% EOU, which has exported software and earned the income. A portion of that income is included in EEFC account. Yet another portion of the amount is invested within the country by way of fixed deposits, another portion of the amount is invested by way of loan to the sister concern which is deriving interest or the consideration received from sale of the import entitlement, which is permissible in law. Now the question is whether the interest received and the consideration received by sale of import entitlement is to be construed as income of the business of the undertaking. There is a direct nexus between this income and the income of the business of the undertaking. Though it does not partake the character of a profit and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles;

++ in view of the definition of ‘Income from Profits and Gains’ incorporated in Subsection (4), the assessee is entitled to the benefit of exemption of the said amount as contemplated under Section 10B of the Act. Therefore, the Tribunal was justified in extending the benefit to the aforesaid amounts also. We do not find any merit in these appeals. Therefore, the first substantial question of law raised in ITA No.428/2007 is answered in favour of the revenue and against the assessee and the first substantial question of law in ITA No.447/2007 is answered in favour of the assessee and against the revenue.

++ in the light of the aforesaid findings, the second substantial question of law in both the appeals do not arise for consideration.