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Part of the direct cost is attributable to the value of DEPB license. To find out the direct cost relatable to trading export, one has to reduce that part of the direct cost attributable to earnings of DEPB from the value of total direct cost
May, 17th 2008

AIT-2008-174-ITAT

IN THE INCOME TAX APPELLATE TRIBUNAL

MUMBAI BENCH K MUMBAI

 

BEFORE SHRI R K GUPTA, JM & SHRI V K GUPTA, AM

 

ITA No: 5979/Mum/06

(Asst. Year: 2002-03)

 

M/s Glenmark Laboratories Ltd

601, 6th Floor, Chintamani Plaza Mohan Studio Compound, Andheri Kurla Road Andheri (E), Mumbai 99

PAN No AABCG3289R

 

 

V/s

The Dy. Commissioner of Income Tax Cen.Cir 33 Mumbai

(Appellant)

 

(Respondent)

 

Appellant by Shri Vijay Mehta

Respondent by Ms Ruby Srivastava & Vivek Batra

 

Part of the direct cost is attributable to the value of DEPB license. To find out the direct cost relatable to trading export, one has to reduce that part of the direct cost attributable to earnings of DEPB from the value of total direct cost. we restore this issue to the file of the Assessing Officer to ascertain the value of DEPB license on the date of receipt and reduce the same from total direct cost. We clarify that any difference in realization of DEPB license will be treated u/s 28(iiid) of the Act. Thereafter the Assessing Officer is directed to recompute the deduction u/s 80HHC. (Para 6)

 

O   R   D   E   R

 

PER R K GUPTA, JM;

 

This is an appeal by the assessee against the order of the CIT (A) relating to assessment year 2002-03.

 

2.         The assessee is objecting in holding that DEPB/DFRC income will not form part of business income for the purpose of computing deduction u/s 80 HHC of the Act.

 

3.         Briefly stated facts of the case are that the assessee is engaged in the business of export of Generic Pharmaceuticals, Formulations etc. During the year the assessee had carried out trading exports. The assessee has claimed deduction u/s 80 HHC amounting to Rs 76,80,735/-. The same was computed taking into consideration the DEPB income amounting to Rs 1,21,91,643/-. The A.O. did not consider DEPB income as eligible for deduction u/s 80 HHC of the Act. Further, after reducing the DEPB there was a loss and considering decision of Honble Supreme Court in the case of IPCA Laboratoreis (266 ITR 52), the deduction u/s 80 HHC was disallowed. The assessee filed an appeal before the CIT(A), which was rejected on the ground that the assessee had not fulfilled the additional conditions laid down vide Taxation Laws (Amendment) Act, 2005 which has amended the provisions of section 80 HHC. Now, the assessee is in appeal here before the Tribunal.

 

4.         The ld Counsel of the assessee, who appeared before the Tribunal argued at length. Written note as asked to file is also field. Through the written submission, it has been stated that the assessee was an exporter of trading goods during the year under consideration. Thus the assessee would be entitled to deduction under clause (3) (b) of s. 80 HHC of the Act. The ld Counsel then refereed to clause (3) (b) of sec 80 HHC which reads as under:

 

(b): "where the export out of India is of trading goods, the profits derived from such export shall be the export turnover in respect of such trading goods as reduced by the direct costs and indirect costs attributable to such export";

 

4.1       It was submitted that in the case of an exporter of trading goods, the export profits eligible for deduction shall be the export turnover in respect of trading goods as reduced by (i) the direct cost and (ii) the indirect cost. It was further submitted that as per the scheme of deduction u/s 80 HHC, the deduction so arrived is to be increased by the 90% of the sums referred to in clause (iiia), (iiib), (iiic), (iiid) or (iiie) of sec. 28 of the Act as the case may be. It was submitted that in the present case the assessee has availed of the DEPB and therefore clause (iiid) of sec. 28 would be applicable.

 

4.2       The ld counsel for the assessee referred to sec 28(iiid) and submitted that only the profits on sale/transfer of DEPB is covered under the said section. The ld Counsel then referred to clause (iiid) of section 28 dealing with DEPB which reads as under:

 

(iiid) any profit on the transfer of the Duty Entitlement Pass Book Scheme, being the Duty Remission Scheme under the export and import policy formulated and announced under section 5 of the Foreign Trade (Development and Regulation) Act, 1992 (22 of 1992):

 

4.3       The ld counsel referring to the above, submitted that only the profit arising on sale or transfer of DEPB is covered u/s 28(iiid) of the Act. Therefore, it was submitted that the provisions of sec. 28 (iii) clearly mention that only the profit is to be taken into account, which implies that the value of DEPB is not covered u/s 28(iiid) of the Act.

 

4.4       The ld Counsel for the assessee referring to the third provision to sec. 80 HHC(3) submitted that the same refers to clause (iiid) of s. 28 of the Act. It was submitted that only profit on sale or transfer of DEPB is covered u/s 28(iiid) of the Act as stated above. It was further submitted that the value of DEPB is covered u/s 28(iv) of the Act. Reliance was placed on the decision of Honble High Court in the case of Metal Rolling Works Pvt Ltd. V. Commissioner of Income Tax (142 ITR 170) wherein it was held that import entitlement were obtained by the assessee directly in the course of business and the value of the same constituted profits and gains of business of the assessee within the meaning of sec. 28(iv).

 

4.5       It was submitted that the CIT (A) dismissed the appeal of the assess on the ground that the assessee had not satisfied the additional conditions laid down under the third proviso to sec. 80HHC of the Act. It was submitted that in the case of the assessee, if the additional conditions laid down under the third provision are not fulfilled, the denial of deduction will be only to the extent o "profit" arising on sale/transfer of DEPB and not the value of DEPB which would fall with the provisions of s. 28(iv) of the Act.

 

4.6       The learned Counsel then referred to the definition of direct cost and indirect cost as given in clause (d) and (e) of Explanation to sub-section (3) of sec. 80HHC which reads as under:

 

"Direct Cost" means costs directly attributable to the trading goods Exported out of India including the purchase price of such goods. "Indirect Costs" means costs, not being direct costs, allocated in the ratio of the export turnover in respect of trading goods to the total turnover. It was submitted that the definition of direct cost includes all costs attributable to trading goods. The learned counsel emphasized on the use of the words "attributable" in the definition of direct cost. It was submitted that the term "attributable" has been considered by various Courts in the past. It was submitted that direct cost would thus only include the direct cost relatable to exports of goods.

 

4.7       The learned counsel submitted that in the case of most of the exporters, goods are exported at a price below the purchase price considering the entitlement of DEPB. It was submitted that an exporter who has incurred a cost of Rs 95/- on purchases and who is entitled to DEPB of say Rs 10/- would be readyh to export the goods at any price, say Rs 90/-. In such case also he would make a profit of Rs 5/- It was therefore, submitted that it would be unreasonable to say that the entire cost of Rs 95/- is attributable to the exports of Rs 90/- It was therefore, submitted that the cost of purchases net of value of DEPB only can be considered to be attributable to the export of Rs 90/-

 

4.8       It was further submitted that the assessee had incurred loss in trading exports as is evident from the assessment order. It was submitted that the assessee exported the goods at a lower price since he knew he would be entitled to DEPB. The learned counsel also submitted that any businessmen would never sell any of his products by incurring loss on the same. The fact that without considering DEPB there is a loss itself proves that the assessee had taken the value of DEPB into account while deciding the price of exported goods. The learned consul counsel then submitted that had the assessee not taken the DEPB income into account he would not have exported the goods at a lower price. Therefore, it was submitted that DEPB has a direct taxes to the determination of sales price of the exported goods and would thus form part of the cost of sales. It was submitted that if the value of DEPB is not considered as part of the cost of sales, it would always result into a loss thereby giving results countrary to the economies of trade.

 

4.9       It was submitted before us that like should always be compared with like. It was submitted that the exclusion of DEPB for the purpose of computing profit from exports would always give absurd result as the sales is at a price lower than the cost of purchase. It was further submitted that the aforesaid anomaly is as a result of not considering DEPB and ignoring the matching principle. In this regard, reliance was placed on the decision of Honble Supreme Court in the case of CIT v/s Lakshmi Machine Works (290 ITR 667) and Honble Bombay High Court in the case of Commissioner of Income Tax v. Sudarshan Chemicals Industries Ltd (245 ITR 769). Further, reliance was placed on the decision of Mumbai bench of the Tribunal in the case of Surendra Engg. Corpn v. Assistant Commissioner of Income-Tax (86 ITD 121) (SB). The learned counsel of the assessee emphasized the following observations of the Tribunal.

 

"In the instant case, the assessee was undisputedly an exporter of "trading goods" exclusively and, therefore, clause (b) of sub section (3) applied. In the case of such an exporter, the export profits shall be the export turnover on respect of such trading goods as reduced by (1) the direct cost and (2) the indirect costs. Both these costs should, however, be attributable to such export;, which means the export of trading goods. By using these words in clause (b) of sub-section (3) and thereby introducing a condition that both the direct and indirect cost must be attributable to the exports of trading goods, the Legislature has manifested an intention that any costs which are attributable to receipts other than export turnover of trading goods must be left out of reckoning at the threshold itself. This condition, thus, forms the substratum or bedrock of the computation of the export profits. Therefore, it any part of the direct or indirect costs are attributable not to the exports of the trading goods in other words, the export turnover that part should be left and out of consideration".

 

4.10     The learned counsel of the assessee, relying upon the aforesaid decision argued that the principle that the export incentives are attributable to costs has been upheld by the Tribunal and following the same analogy, in the present case as well, the export incentives should be held to be attributable to exports and the cost of goods debited in profit and loss account be reduced to the extent of DEPB for purpose of computing deduction u/s 80 HHC (3) (b) of the Act.

 

4.11     It was submitted that in the instant case also DEPB income is directly attributable to the trading goods exported. Thus the direct cost comprising the cost of goods should be reduced to the extent of value of DEPB to arrive at profit from export of trading goods. It was further submitted that after availing DEPB, the assessee had two options i.e. either to utilize the said DEPB at the time of imports or to sale the same to a third party. The assessee selected the second option wherein it sold the DEPB to a third party. The learned counsel submitted that if the assesse had not transferred the said DEPB, then it would utilize the same for set off against subsequent imports, which in turn would reduce the cost of the goods imported. Thus by merely transferring the DEPB it cannot be said that the assessee is not entitled to reduce the cost of the goods exported by the value of DEPB. The value of DEPB is already factored in the cost of the goods which are imported by the assessee by paying duty which otherwise would not have been paid if the assessee choose to utilize DEPB for the said purpose.

 

4.12     The learned counsel of the assessee further submitted that DEPB is an export incentive and the purpose of giving the same is actually reimbursement of the taxes paid in relation to exports. Every exporter has an option to avail of refund of taxes and duties paid in relation to export of goods or avail of DEPB. Accordingly, it was submitted that DEPB is nothing but the re-imbursement of taxes and duties paid on purchase of goods, which are exported. It was submitted that since DEPB is re-imbursement of the taxes and duties, it should be set of f the against the duties and taxes paid which is part of the cost of goods.

 

Thus, in effect, the cost of goods should be considered without taxes and duties paid or in other words after setting off DEPB against such taxes and duties. It was submitted that DEPB credit in actual terms reduces the cost of goods, which are exported. It was further submitted that considering the above, the direct cost would mean cost of goods attributable to exports i.e. cost of goods as arrived at after setting off or reducing the value of DEPB. Further reliance was also placed on the decision of the Tribunal in the case of M/s Amar International decided in ITA No 613/Mum/06 for AY 02-03 vide order dated 26/9/2007. Copy of the order of the Tribunal is also filed.

 

4.13   The ld DR on the other hand firstly placed strong reliance on the orders of the authorities below. It was further submitted that direct cost means related to the attributable goods. Therefore, the entire cost shown in the Profit & Loss Account has to be taken into consideration and not the appointment of the cost as stated by the ld consul of the assessee. It was further submitted that there is no cost in respect of DEPB incentive; therefore, as per provisions of law, the cost shown in the P&L Account has to be taken into consideration.

 

4.14   The ld counsel, in reply again explained the provisions of law once again and invited the attention of the Bench on the decision of the Special Bench (supra) and it was submitted that some cost has to be attributed to the DEPB incentive as without any expense DEPB cannot be obtained. Ld Counsel of the assessee invited out attention to see 80HHC (3) (b), which states direct cost and indirect attributable to such export. He also drew our attention towards definition of direct cost contained in Explanation D according to which direct cost means cost directly attributable to trading goods exported. Thus, only that the most of direct cost is required to be reckoned which is attributable to trading goods exported. Therefore, the principle of attribution is inbuilt in the scheme of the section.

 

5.         We have heard rival submissions and considered them carefully. We have considered the case laws on which reliance was placed by the ld counsel of the assessee. After considering all the relevant material, we find that there is no dispute that the value of DEPB incentive falls within the meaning of sec. 28(iv) of the Act. We also found that as per clause (iiid) only the profits on sale/transfer of DEPB can be taken into consideration. The language of sec. 28(iv) and 28(iiid) are very clear. In this regard we have also noted the decision in the case of Amar International on which reliance was placed by ld counsel of the assessee. Therefore, the value of license fall within sec. 28(iv) and only the profit on transfer of license fall with 28(iiid). The aspect that what is the value of the DEPB incentive on the date of receipt was neither examined at the end of the Assessing Officer or at the end of the CIT (A). The issue of apportionment of indirect cost has been examined by the Special Bench in the case of Surendra Engineering. In this case in respect of indirect cost attributable to trading export was discussed in detail and it was held that 10% of the indirect cost is to be attributable to the trading export. In a recent decision in the case of Hero Export decided in appeal no 5315 of 2007, the Honble Supreme Court as affirmed the identical view which was taken by the Special Bench. The argument of the department as well as the appellant was taken into consideration and after discussing the issue in detail, the Honble Supreme Court has given its findings in para 11 to 15 which are as under:

 

11. We have considered the rival submissions. It is not disputed by the department that the assessee, in addition to the income derived from export of trading goods, also derived income from Export Incentives etc. of Rs 1,60,000 against FOB value of exports amounting to Rs 6,50,000 in the above illustration. It is not the case of the department that the assessee could have earned Rs 1,60,000 without incurring any expenditure (Rs 50,000 in the above example). It is not in dispute that the case falls under section 80 HHC (3) (a). It is not the case of the department that assessee had not income by way of incentive, interest etc. (Rs 1,60,000 in the example). The basic case of the department was that the words "indirect costs" in clause (e) in the explanation did not provide for exclusion of expenses incurred for earning incentives, commission, rent etc, and, therefore, the entire amount of expenses (Rs 50,000 in the above example) spent for earning such other incomes did not fall within the meaning of the world indirect cost in clause (e). According to the department, section 80 HHC (3) (b) provides for a statutory formula to calculate export profits by deducting direct and indirect costs from export turnover, however, expenses incurred for earning incentives, commission etc. (other income) does not fall in the definition of indirect cost. That, the assessee was not entitled to claim 10% of the receipts from its other income (Rs 1,60,000 in the above example) as expense to be deduced from the indirect cost (Rs 50,000) in the above example). Accordingly, the Assessing Officer deducted full Rs 50,000 as indirect cost from the export turnover. Therefore, even according to the department, it is not in dispute that the assessee had incurred an expense of Rs 16,000 (in the above example) to earn other incomes of Rs 1,60,000 but it denied the proportionate deduction from Rs 50,000 on account of strict interpretation of the words indirect cost in clause (e). However, in the above stand of the department, there is a fallacy. Under Section 80 HHC (3)(b) which is the main section, the Legislature has provided that in case falling under section 80HHC (3)(b) direct and indirect costs attributable to such exports have to be deducted from the export turnover to arrive at Export Profits. Similar provision is made in clause (d) which defines the words direct costs to mean cots attributable to exports of trading goods. Moreover, clause (e) of the Explanation defines indirect costs as costs which is not direct costs as defined in clause (d). The word attributable is wider than the word derived. The department in this case, as can be seen from above example, itself says that Rs 50,000 in full is the indirect cost which has to be deducted in full as clause (e) does not provide for proportionate deduction. According to the department, the definition of indirect costs will not cover expenses incurred for earning other incomes. However, at the same time, department concedes that the assessee had earned export turnover of Rs 6,50,000 plus Rs 1,60,000 as other incomes. It also concedes that Rs 50,000 is the indirect expenses. If so, what should be the expense allocated to the earning of the two incomes and in what proportion is the question?

 

12         According to the department, the question of allocation does not arise in cases falling under section 80 HHC (3(b). We do not find merit in this contention. Firstly, clause (e) to the Explanation which refers to allocation of costs applies to sections 80 HHC (3) (a), 80 HHC (3) (b) and 80 HHC (3) (c). Secondly, section 80HHC (3)(b) equates export profits to export turnover less direct and indirect costs attributable to the exports of trading goods. Therefore, the principle of attribution is retained. Thirdly, keeping in mind the provisions of section 80HHC(3)(b) read with clauses (d) and (e) of the Explanation it is clear that Legislature intended allocation of costs between export turnover and total turnover. It is urged that the apportionment would not apply to cases under section 80HHC (3) (b). It is true that, in most cases, it may not. But in certain cases falling under section 80HHC (3) (b), ratio still applies. For example, in the case where the assessee exports all bought-out items, but brings back only a part of the export proceedings into India, in such cases, the ratio will apply and, therefore, if one is to read clause (e), it retains the words indirect costs to be allocated in the ratio of export turnover to the turnover.

 

13         The question, which, however, needs to be decided, is whether, in the above example, the assessee is entitled to reduction of Rs 16,000 from Rs 50,000 being the total indirect expenses for earning both the incomes. Department reduces the FOB value by Rs 50,000 whereas assessee contends that it should be reduced by Rs 34,000 (Rs 50,000 - Rs 16,000), assessee claims apportionment at the rate of 10% of other income of Rs 1,60,000 (in the above example).This is opposed by the department saying that since apportionment does not apply to sec 80HHC (3) (b), there is no question of applying the yardstick of 10%. According to the department, the words, indirect costs does not take into account the expenses to earn other incomes. In this case, reliance is placed on clause (e). However, the department has failed to notice the words attributable to exports in sec 80HHC (3)(b).

 

14.        As stated above, in our opinion, the words attributable in section 80HHC(3) (b) in the main section itself indicates that apportionment (principle of attribution) is not omitted from the said provision of section 80HHC (3)(b). As stated above, assessee has earned other income of Rs 1,60,000 apart from FOB value of exports of Rs 6,50,000. Therefore, some expenses has to be attributed to earning of Rs 1,60,000. If so, the next question which arises is how to allocate the costs? As stated above, assessee has two incomes with one common pool of expenses and since principle of attribution has been retained in the scheme of section 80HHC, both in terms of section 80HHC (3), clause (e) to the Explanation to section 80HHC (3)(a), (b) and (c) and in clause (baa) to the Explanation to section 80HHC, instead of going into lengthy exercise of dividing such common expenses, the assessee has estimated the reduction of export turnover by 10% of the other income of Rs 1,60,000 (in the above example). Ultimately, clause (baa) to the Explanation is itself based on the assumption that 10% of the income would be an expenses. We make it clear that we are not reading Explanation (baa) into section 80HHC (3)(b).

 

What we say is as a guidance value/factor, 10% of total other income of Rs 1,60,000 would be fair estimate. This guidance value is not flowing from clause (baa) but from the scheme of section 80HHC read with the Memorandum to the Finance Act of 1991. Take a reverse case, if allocation of expenses is to be done on actual basis, it would not only be very difficult but in some cases actual apportionment may not be in the interest even of the department.

 

15.        In conclusion, we may state that under section 80HHC (3)(b) one has to balance the principle of attribution with the concept of allocation. The concept of allocation is meant to reduce the incentive. However, when allocation has to be balance with the principle of attribution, the object is to reduce the incentive and not to eliminate it.

 

6.         The above findings of the Honble Supreme, which are binding on us, are very relevant to the present issue. In view of the judgment of the Special Bench and in view of the recent judgment of the Supreme Court, we hold that part of the direct cost is attributable to the value of DEPB license. To find out the direct cost relatable to trading export, one has to reduce that part of the direct cost attributable to earnings of DEPB from the value of total direct cost. However, this aspect has not been examined by the Assessing Officer or by the CIT (A). Therefore, we restore this issue to the file of the Assessing Officer to ascertain the value of DEPB license on the date of receipt and reduce the same from total direct cost. We clarify that any difference in realization of DEPB license will be treated u/s 28(iiid) of the Act. Thereafter the Assessing Officer is directed to recompute the deduction u/s 80HHC. We order accordingly.

 

7.         Ground No 2 relate to imitation of penalty u/s 27 1(1)(C) This ground is pre-mature, therefore, does not require any adjudication upon. Accordingly, this ground is dismissed.

 

8.         Ground No 3 is against levy of interest u/s 234C and D which are consequential in nature. Accordingly, the Assessing Officer is directed to adjudicate the same afresh by passing a speaking order.

 

9.         In the result, the appeal filed by the assessee is partly allowed for statistical purpose.

 

Order pronounced on 27/12/2007

 
 
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