Supporting development in backward regions should not be at the expense of simplicity of the tax law.
T. C. A. Ramanujam
The Government is giving serious thought to the question of reducing or abolishing exemptions, incentives and subsidies under the income tax law. The three-year old special economic zones are now seen to be white elephants as far as fiscal prudence goes. Loss of revenue foregone will be of the order of Rs 1,75,000 crore over a three-year period.
SEZs are governed by a special enactment of Parliament and came to be mentioned in 10AA of the Income tax Act, 1961 with effect from February 10, 2006. The Income Tax Act grants incentives on the basis of certain backward areas and profits are exempt for units located in these areas. This gives rise to litigation and difficulties in implementation of the policy.
CIT vs. Dewan Kraft System (P) Ltd 296 ITR 305 (Delhi)
The company in this case was engaged in the business of fabrication and supply of equipment. It had units located in Kalamb in Himachal Pradesh and also units in Delhi and Noida. Himachal Pradesh was notified as a backward area and the profits from the unit in Kalamb was eligible for exemption under Section 80-IA of the Income Tax Act, 1961. The Kalamb unit earned a profit of Rs 20,92,221. The gross total income was declared in the return as Rs 21,91,102. The company claimed deduction under Section 80IA for the 100 per cent profits from the Kalamb Unit. It showed an assessable income of Rs 98,880.
The Delhi unit had suffered a loss of Rs 9,11,270. The Assessing Officer adjusted this loss against the profit from the Kalamb Unit and restricted the deduction under Section 80IA to Rs 11,80,952. The first two appellate authorities decided the matter in favour of the company. Revenue went up in appeal before the Delhi High Court. It was argued that where the gross total income included profits derived from any eligible business of an industrial undertaking, the whole of the profits of such eligible business is to be allowed as deduction under Section 80-IA.
The company disputed the computation made by the Assessing Officer. It pointed out that in adjusting the loss from Delhi against the profits from Kalamb, the Assessing Officer had mixed up the profits and this resulted in the restriction of the eligible deduction to the extent of business income.
The High Court found that the only unit eligible for exemption under Section 80-IA was located in Kalamb. Section 80-IA(7) lays down that the eligible unit will be governed by a distinct and separate deeming provision and the profits will be computed by a special method. The provision is of overriding nature.
During the tax holiday period, the exemption will apply to the profits in the industrial unit treating it as an independent unit and the one and only source of income possessed by the company. Mixing up of the profits of the Kalamb unit with the results of the units at Delhi and Noida resulted in erroneous restriction of the eligible deduction and this is against the provisions of Section 80-IA (5) and (7). The Kalamb unit is to be treated as independent unit. The deduction claimed by the company was found to be in accordance with Section 80-IA. Revenues appeal was dismissed.
Our income tax law allows incentives product-wise. Products mentioned in the 11th Schedule are not eligible for benefits under Section 32A, 32AB and Section 80-I(2). Certain categories of processed minerals and ores are listed in the 12th Schedule for relief under Section 80HHC. There is a separate Schedule for Sikkim, another for Himachal and Uttarakhand. The 14th Schedule governs the North Eastern States. The income-tax law makes distinction between the forms of business organisations, namely whether it is a corporate entity or a co-operative society, etc.
The size of the entity also matters in the computation. It has been forgotten that in this maze of deductions and incentives, taxable entities can manipulate profit from one unit to another unit as has been witnessed in the application of the transfer pricing law.
Backward regions need to be supported. This should not be at the expense of simplicity of the tax law. Economic growth is fostered more by physical incentives like infrastructure development, talent promotion, development of a marketing network and technology upgradation. It is easy to offer tax incentives. This will not help us in the long term.
Once incentives are built into the code, vested interests develop and it is not easy to abolish such incentives. Sun-set clauses can be utilised for abolishing unwanted tax exemption provisions. This is already in vogue with reference to Section 10A, 10B 80HHC etc.
There is already a clamour for extending the life of the special provisions in respect of newly established undertakings in the free trade zone. The Finance Bill 2008 will provide answers to the nagging question of reducing or abolishing the incentives provisions in the tax law.
(The author is former Chief Commissioner of Income Tax.)