Bombay High Court High Court

The Commissioner Of Income Tax … vs M/S.Asian Star Co.Ltd on 18 March, 2010

Bombay High Court
The Commissioner Of Income Tax … vs M/S.Asian Star Co.Ltd on 18 March, 2010
Bench: Dr. D.Y. Chandrachud, J.P. Devadhar
                                             1

            IN THE HIGH COURT OF JUDICATURE AT BOMBAY
                             O. O. C. J.




                                                                                        
                    INCOME TAX APPEAL NO.200 OF 2009




                                                                
    The Commissioner of Income Tax City-III,
    Room No.607, 6th Floor, 
    Aayakar Bhavan, M.K.Road,




                                                               
    Mumbai-400 020.                                                  ...Appellant.
                            Vs.
    M/s.Asian Star Co.Ltd.,
    114-C, Mittal Court, Nariman Point,




                                                  
    Mumbai-400 021.                                                  ...Respondent.
                                    ....
                                  
    Mr.  Vimal Gupta with Mr.Suresh Kumar for the Appellant.
    Mr.J.B. Andhyarujina, Sr.Advocate with Dr.K.Shivram i/b. Mr.A.R. 
    Singh and Mr.P.S.Savla  for the Respondent.
                                 
                                    .....
                                    CORAM : DR.D.Y.CHANDRACHUD AND 
                                                   J.P.DEVADHAR,  JJ.

March 18/19, 2010.

ORAL JUDGMENT (PER DR.D.Y.CHANDRACHUD, J) :

The appeal by the Revenue under Section 260A of the

Income Tax Act, 1961 raises a question of law as regards the

interpretation of the provisions of Section 80HHC. The question of

law has been formulated as follows in the Memo of Appeal :

” Whether on the facts and in the circumstances of the
case and in law, the Hon’ble Tribunal was correct in
holding that net interest on fixed deposits in banks
received by the Assessee Company should be considered
for the purpose of working out the deduction u/s.80HHC
and not the gross interest?”

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The appeal was admitted on the aforesaid question.

The facts:

2. The assessee in the present case carries on the business

of the export of cut and polished diamonds. A return of income for

Assessment Year 2003-04 was filed on 28 November 2003,

declaring a total income of Rs. 13.91 crores, after claiming a

deduction of Rs. 13.22 crores under Section 80HHC. The return

was initially processed under Section 143(1), after which the case

was selected for scrutiny under Section 143(2) by the issuance of a

notice. The assessee had debited an amount of Rs. 21.46 crores as

interest paid/payable to the profit and loss account. The assessee,

however, stated that the interest charged to the profit and loss

account was net of interest received in the amount of Rs. 3.25

crores. The assessee was called upon to explain as to why the

deduction under Section 80HHC should not be recomputed by

excluding ninety per cent of the interest received in the amount of

Rs. 3.25 crores. By its explanation, the assessee submitted that

during the year, it received interest on fixed deposits. The assessee

stated that it had borrowed monies in order to fulfill its working

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capital requirements and the Bank had called upon it to maintain a

fixed deposit as margin money against the loans. The assessee

consequently contended that there was a direct nexus between the

deposits kept in the Bank and the amounts borrowed.

3. The Assessing Officer, while passing an order of

assessment dated 30 January 2006, found that the explanation of

the assessee could not be accepted since a plain reading of

Explanation baa to Section 80HHE would suggest that ninety per

cent of the receipts on account of brokerage, commission, interest,

rent, charges or receipts of a similar nature were liable to be

excluded while computing the profits of the business. In appeal,

the CIT (Appeals) held by his order dated 17 November 2006 that

from the Bank and fund flow statements, the assessee has

established a direct nexus between interest bearing fixed deposits

and the ‘interest charging’ borrowed funds. The CIT (Appeals)

directed the Assessing Officer to allow the netting of interest

income and interest expenses. The view of the CIT (Appeals) was

confirmed in appeal by the Income Tax Appellate Tribunal on 11

March 2008. The Tribunal held that the finding of the Appellate

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Authority was based on the existence of a nexus between

borrowed funds and fixed deposits. The Tribunal followed its

decision in the case of Lalsons Enterprises.1

The question :

4. The question of law which has been raised in the appeal

by the Revenue relates to whether netting of interest can be

allowed for the purpose of working out a deduction under Section

80HHC. The contention of the Revenue is that for computing the

profits and gains of the business for the purposes of Section

80HHC, ninety per cent of the receipts by way of interest has to be

reduced from the profits and gains of business or profession and

the receipts that have to be reduced are the gross receipts.

Consequently, it is the submission of the Revenue that gross

receipts by way of interest cannot be netted against expenditure

which is laid out for the earning of those receipts. On the other

hand, the contention of the assessee is that Section 80HHC must

have a purposive interpretation and the reduction that is to be

applied of ninety per cent of the receipts, must relate to the

1 (2004) 89 ITD 25

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inclusion of receipts in the profits and gains of business or

profession which is comprised both of receipts and the expenditure

which is incurred directly for the purpose of earning the receipts.

Section 80HHC:

5. Sub-section (1) of Section 80HHC provides that where

an assessee, being an Indian Company or a person residing in

India, is engaged in the business of export out of India of goods or

merchandise to which the section applies, there shall be allowed in

computing the total income of the assessee, a deduction to the

extent of profit referred to in sub-section (1B) derived by the

assessee from the export of such goods. Sub-section (1B) stipulates

the extent of the permissible deduction and the period during

which the deduction could be claimed. Sub-section (3) lays down

a formula with reference to which the profits derived by the

assessee from export have to be computed. In the present case,

clause (a) of sub-section (3) is of relevance and it provides as

follows:

“(3) For the purposes of sub-section (1), –

(a) where the export out of India is of goods or
merchandise manufactured or processed by the assessee,

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the profits derived from such export shall be the amount
which bears to the profits of the business, the same

proportion as the export turnover in respect of such
goods bears to the total turnover of the business carried

on by the assessee.”

The central focus of this appeal relates to the interpretation that is

to be placed on the provisions of clause (baa) of the Explanation.

Clause baa provides as follows:

“(baa) “profits of the business” means the profits of the
business as computed under the head “Profits and gains

of business or profession” as reduced by –

(1)ninety per cent of any sum referred to in clauses

(iiia), (iiib), (iiic), (iiid) and (iiie) of section 28 or
of any receipts by way of brokerage, commission,
interest, rent, charges or any other receipt of a
similar nature included in such profits; and

(2)the profits of any branch, office, warehouse or any
other establishment of the assessee situate outside

India.”

Hence, Clause (a) of sub-section (3) is applicable to an assessee

whose business consists of the export out of India of goods or

merchandise manufactured or processed by the assessee. In the

case of such an assessee, the profits derived from such export is the

amount which bears to the profits of the business, the same

proportion as the export turnover in respect of such goods bears to

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the total turnover of the business carried on by the assessee. The

expression “profits of the business” which has been used in clause

(a) of sub-section (3) is defined in clause baa of the Explanation.

For the purposes of clause baa, profits of the business have to be

first computed under the head ‘profits and gains of business or

profession’. That computation must necessarily be in accordance

with the provisions of Sections 28 to 44D of the Act. Once such a

computation has been arrived at, clause baa requires a reduction to

be carried out. The reduction is to be of (i) Ninety per cent of (a)

the export incentive referred to in clauses (iiia), (iiib), (iiic), (iiid)

and (iiie) of Section 28 or (b) any receipt by way of brokerage,

commission, interest, rent, charges or any other receipt of a similar

nature included in such profits; and (ii) Profits of a branch, office,

warehouse or any other establishment of the assessee situated

outside India. The issue which falls for determination in the

present case relates to the reduction factor of ninety per cent that

is to be applied in respect of any receipts by way of brokerage,

commission, interest, rent, charges or any other receipt of a similar

nature included in such profits. As noticed earlier, it is the

contention of the Revenue that the reduction factor of ninety per

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cent must be applied to the gross receipts, independent of any

expenditure that may be incurred in the earning of those receipts,

while according to the assessee, the use of the words “included in

such profits” must, in particular, result in the conclusion that the

reduction factor cannot be applied in isolation only to the gross

receipts without reference to the expenditure laid out directly for

the purpose of earning those receipts. It is in this background that

it would be necessary now to advert to the rival submissions.

Submissions :

6. Counsel appearing on behalf of the Revenue submitted

firstly that Explanation baa seeks to exclude ninety per cent of : (i)

Any sum by way of export incentives referred to in clause (iiia) to

(iiie) of Section 28; (ii) Receipts by way of brokerage, commission,

interest, rent, charges or other similar receipts; and the Profits of

any branch, office, or warehouse. The submission is that

Parliament has used three different expressions, namely, “any

sums”, “receipts” and “profits”. In so far as receipts are concerned,

it has been urged that ninety per cent of whatever receipts are

received of the description mentioned in the explanation must be

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excluded. Secondly, it has been submitted that Section 80HHC is a

statutory incentive provided to exporters and the object of the

provision is not to determine real income. The underlying object of

Explanation baa was to exclude receipts which do not have a nexus

with export turnover and ninety per cent of all such receipts would

have to be excluded in computing the deduction. Thirdly, reliance

was placed on a circular issued by the Central Board of Direct

Taxes on 19 December 1991 in order to contend that no netting of

receipts with the expenditure laid out in earning the receipts is

permissible since in mandating that a reduction of ninety per cent

shall be applied, Parliament has already taken into account, the

element of common expenses that may be incurred by the assessee.

In other words, the submission was that while the entire receipts

on account of brokerage, commission, interest, rent, charges or

other similar receipts would have to be excluded since they do not

bear a nexus with export turnover, nonetheless the Legislature has

taken notice of the fact that the assessee would have incurred

certain expenses towards those receipts and had consequently

applied a reduction factor of ninety per cent.

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7. The appeal before the Court has been placed for hearing

together with a batch of appeals where similar issues arise. Since

common issues of law arise in this batch of appeals, we have, while

hearing the arguments of the Revenue in the present appeal, also

heard Counsel appearing on behalf of the Assessees in the entire

batch on the question of interpretation. Submissions have been

urged before the Court by Mr.Andhyarujina, Mr.Shivram, Mr.Irani

and Mr.Nilesh Joshi. Counsel appearing on behalf of the Assessee

submitted that (i) The words “any receipts” denote the nature and

not the quantum of the receipt; (ii) The expression, therefore,

requires the nature of the receipts to be examined; (iii) Explanation

baa refers to any receipts of a similar nature “included in such

profits”. The words “such profits” would mean profits and gains of

business or profession computed under Sections 28 to 44D; (iv)

Profits can only be arrived at after the deduction of expenditure

from income and the net effect thereof would constitute profits; (v)

Explanation baa does not use the expression “gross or net”.

However, having regard to the purpose and object of the provision

and the nature of the language used in the explanation, ninety per

cent of the receipts that is required to be excluded would have to

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be computed with reference to the inclusion of such receipts in the

profits and gains of business which in turn involves both the credit

and the debit sides of the profit and loss account; (vi) For the

purposes of Explanation baa, income from other sources would not

come within the purview of the explanation; Only business income

would have to be considered and interest in the nature of business

income would have to be taken into consideration; (vii) Receipts by

way of interest in Explanation baa denotes the nature of the

receipts and inclusion in ‘such profits’ would denote the quantum

of the receipts; (viii) The words which have been used by the

legislature suggest what is included in the total income or what has

gone into the computation of the total income. Consequently, both

the debit and the credit sides of the profit and loss account would

have to be considered; (ix) The words “such profits” can only mean

such profits as computed in accordance with the provisions of the

Act; (x) The words “receipt” and “income” in Explanation baa are

interchangeably used and consequently, receipts would have to be

read as income; (xi) The correct interpretation would be to take

into consideration netting and exclude all expenses which have a

direct nexus with the earning of the income; (xii) The provision

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being an incentive provision under Chapter VIA, it must be

beneficially construed in order to encourage exports; (xiii) The

word “profits” would denote profits in a commercial sense.

Another perspective of the submissions which have been urged on

behalf of the assessee is that the object of the exclusion contained

in Explanation baa is to sequester certain non-operational income

which does not bear a direct nexus with export income.

Consequently, the sequestration or exclusion cannot be confined

only to the credit side of the profit and loss account, but must

extend equally to the debit side subject to the rider that a clear

nexus has to be established. The Revenue, it has been urged, seeks

to exclude non-operational income on the one hand, because it has

no nexus with the export turnover while on the other hand, it

seeks to depress profits by including expenditure which has been

incurred for those very items. This, it has been submitted, would

lead to a consequence which could not have been intended by

Parliament having regard to the beneficial object underlying the

provision.

The rationale underlying the exclusion :

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8. Sub-section (3) of Section 80HHC was inserted by the

Finance Act of 1991, with effect from 1st April 1992. The principal

reason underlying the adoption of the formula in sub-section (3) of

Section 80HHC was to disallow a part of the concession when the

entire deduction claimed could not be regarded as being derived

from export. Section 80HHC had to be amended several times

since the formula had resulted in a distorted figure of export profits

where receipts such as interest, rent, commission and brokerage

which did not have a direct nexus with export turnover were

included in the profit and loss account and resultantly became a

subject of deduction. By the amendment, the position that

emerged was that receipts which do not have any element of or

nexus with export turnover would not become eligible for

deduction merely because they form part of the profit and loss

account. This aspect of the history underlying Section 80HHC, has

been elaborated upon in the judgment of Hon’ble Shri Justice

S.H.Kapadia, speaking for the Supreme Court, in CIT vs. Lakshmi

Machine Works.2

2 (2007) 290 ITR 667

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9. Explanation baa has to be read in the context of this

background underlying the exclusion of certain constituent

elements of the profit and loss account from the eligibility for

deduction under Section 80HHC. What Explanation baa

postulates is that, in computing the profits of business for the

purposes of Section 80HHC, the profits of business have to be first

computed under the head profits and gains of business or

profession, in accordance with the provisions of Sections 28 to

44D. Once that exercise is completed, those profits have to be

reduced to the extent provided by clauses (1) and (2) of

Explanation baa. Clause (1) to the explanation requires the

application of the ninety per cent deduction to two categories. The

first category consists of export incentives which are referred to in

clauses (iiia) to (iiie) of Section 28. The second category consists

of receipts by way of brokerage, commission, interest, rent, charges

or any other receipts of a similar nature included in such profits.

The importance of the second category lies in the fact that such

receipts by way of brokerage, commission, interest, rent, charges

or other receipts of a similar nature, though included in the profits

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and gains of business or profession, do not bear a nexus with the

export turnover. Consequently, though they are included in the

computation of profits and gains of business or profession, ninety

per cent of such receipts have to be excluded in computing the

profits of business for the purposes of Section 80HHC.

10. The reason for the exclusion is borne out by a circular

issued by the Central Board of Direct Taxes on 19 December 1991.

The circular issued by the Board noted that the existing formula

often presented a distorted figure of export profits when receipts

like interest, commission etc. which did not have an element of

turnover were included in the profit and loss account.

Consequently, a clarification had been introduced by which the

profits of business for the purposes of Section 80HHC would not

include receipts of a similar nature. However, as some

expenditure might have been incurred in earning these incomes

which in the generality of cases would be a part of common

expenditure, an ad-hoc deduction of ten per cent from such income

was provided to account for these expenses.

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11. Now, reading Explanation baa as it stands, the Court is

required to give a meaning to the provision consistent with the

underlying scheme, object and purpose of the statutory provision.

Parliament considered it appropriate to exclude from the purview

of the deduction under Section 80HHC, certain receipts or income

which did not have a proximate nexus with export turnover. Such

items form part of the profit and loss account and form a

constituent element in the computation of the profits or gains of

business or profession under Sections 28 to 44D. The

interpretation which we place on the provisions of Section 80HHC

and on Explanation baa must be consistent with the law laid down

by the Supreme Court.

12. In Commissioner of Income Tax vs.

K.Ravindranathan Nair,3 the Supreme Court held that processing

charges, though a part of gross total income constituted an item of

independent income like rent, commission and brokerage and

consequently, ninety per cent of the processing charges would have

to be reduced from gross total income to arrive at business profits.

3 (2007) 295 ITR 228

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As a result, the processing charges would be includible in total

turnover in the formula under Section 80HHC(3). For the purpose

of this appeal, it would be appropriate to formulate the principles

which emerge from the decision in Ravindranathan Nair. These

may be summarized as follows:

-(i) Section 80HHC is not a charging section, but a provision

by way of an incentive and its object is not to ascertain real

income;

-(ii) The expression “derived from” in Sub-section (1) of

Section 80HHC is narrower than the expression “attributable to”

and consequently, it is only profits derived from export which can

become the basis for working out the formula in Section

80HHC(3);

-(iii) As a result of the amendment brought about from 1st

April 1992 by the Finance Act of 1991, the expression “profits of

the business” stands defined to mean profits of the business as

computed under the head profits and gains of the business under

Sections 28 to 44D;

-(iv) Before allowing a deduction under Sub-section (3) of

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Section 80HHC, the gross total income of an assessee, being profits

from business, has to be arrived at in terms of clause baa of the

explanation. Business profits have to be calculated in terms of

Sections 28 to 44D alone;

-(v) The deduction has to be from the profits as understood

in the commercial sense;

-(vi) Under clause (1) of Explanation baa, ninety per cent of

any amount referred to in clauses (iiia), (iiib), (iiic), (iiid) and

(iiie) of Section 28 or of any receipts by way of brokerage,

commission, interest, rent, charges or any other receipt of a similar

nature included in such profits has to be reduced. The expression

“included in such profits” indicates that such item which forms a

subject matter of the reduction also forms a part of gross total

income being business profits;

-(vii) Incentive profits and items like rent, commission, interest

and brokerage, though they form a part of the gross total income,

have to be excluded since they do not possess any nexus with

export turnover. The inclusion of such items in profits of the

business would result in a distortion of the figure of export profits;

-(viii) In the formula, there exist four variables namely,

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business profits, export turnover, total turnover and ninety per cent

of the sums referred to in Explanation baa. In the computation of

the deduction under Section 80HHC, all the four variables are

required to be taken into account;

-(ix) Section 80HHC(3) secures profits derived from the

export of eligible goods. Every receipt is not income and every

income would not necessarily include the element of export

turnover;

-(x) By Explanation baa ninety per cent of incentive profits or

receipts by way of brokerage, commission, interest, rent, charges or

any other receipts of like nature included in business profits have

to be deducted from business profits as computed under Sections

28 to 44D;

-(xi) In other words, receipts which result in an independent

income which has no nexus with export, are required to be reduced

from business profits under Explanation baa;

-(xii) Though receipts by way of brokerage, commission,

interest, rent, charges or any receipts of a similar nature form part

of the gross total income, yet for the purpose of working out the

formula and in order to avoid a distortion in arriving at export

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profits, Explanation baa has been inserted;

-(xiii) As a result of the insertion of Explanation baa incentive

profits and receipts which result in “independent income” have to

be excluded from the gross total income to the extent of ninety per

cent because such receipts have no nexus with the export turnover.

13. In Lakshmi Machine Works (supra), the issue before

the Supreme Court was whether excise duty and sales tax were

included in the total turnover for the purpose of working out the

formula contained in Section 80HHC(3). The Supreme Court held

that the object of the legislature in enacting Section 80HHC was to

confer benefit on profits accruing with reference to export

turnover. The Supreme Court observed that “commission, rent,

interest etc. did not involve any turnover” and “therefore, ninety

per cent of such commission, interest etc. was excluded from the

profits derived from the export.” Just as interest, commission etc.

did not emanate from export turnover, so also excise duty and sales

tax had to be excluded.

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The resultant position in law :

14. The deduction under Section 80HHC is available to an

assessee engaged in the export of goods or merchandise outside

India to the extent of the profits specified in sub-section (1B) of the

provision. Clause (a) of Sub-section (3) of Section 80HHC

provides that where the exported goods are manufactured by the

assessee, the deduction under sub-section (1) would be in

accordance with the formula stated therein. The formula is that

the profits derived from such export shall be the amount which

bears to the profits of the business, the same proportion as the

export turnover in respect of such goods bears to the total turnover

of the business carried on by the assessee. Explanation baa was

inserted by the Finance Act of 1991 with retrospective effect from

1st April 1987. Under Explanation baa, the expression “profits of

the business” means the profits of the business as computed under

the head “profits and gains of business or profession” as reduced by

ninety per cent of (a) Any sums referred to in clauses (iiia), (iiib),

(iiic), (iiid) and (iiie) of Section 28; or (b) Any receipts by way of

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brokerage, commission, interest, rent, charges or any other receipt

of a similar nature included in such profits. The profits of any

branch, office, warehouse or any other establishment of the

assessee situated outside India have also to be reduced. Since

receipts by way of brokerage, commission, interest, rent, charges or

other similar receipts have no nexus with the export activity, the

legislature thought it fit, for the purpose of deduction under

Section 80HHC to exclude such items from business profits.

Parliament was, however, conscious of the fact that the

expenditure incurred in earning the items which were liable to be

excluded had already gone into the computation of business

profits. This was because the computation of business profits

under Chapter IV is made by amalgamating the receipts as well as

the expenditure incurred in carrying on the business. Since the

expenditure incurred in earning the income by way of interest,

brokerage, commission, rent, charges or other similar receipts had

also gone into the computation of business profits, Parliament

thought it fit to exclude only ninety per cent of the receipts

received by the assessee in order to ensure that the expenditure

which is incurred by the assessee in earning the receipts which has

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gone into the computation of the business profits is taken care of.

15. The reason why Parliament confined the reduction factor

to ninety per cent of the receipts is stated in the Memorandum

explaining the provisions of the Finance Bill of 1991. In so far as it

is relevant, the Memorandum states thus:

“The existing formula may also give a distorted
figure of export profits when receipts like interest,

commission, etc., which do not have an element of
turnover are included in the profit and loss account.

It is, therefore, proposed to clarify that “profits
of the business” for the purpose of section 80HHC will
not include receipts by way of brokerage, commission,
interest, rent, charges or any other receipt of a similar

nature. As some expenditure might be incurred in
earning these incomes, which in the generality of cases is

part of common expenses, it is proposed to provide ad
hoc 10 per cent deduction from such incomes to account
for these expenses.”

Parliament, therefore, confined the reduction to the extent of

ninety per cent of the income earned through such receipts since it

was cognizant of the fact that the assessee would have incurred

some expenditure in earning those incomes. Parliament provided

an ad-hoc deduction of ten per cent from such incomes to account

for the expenses incurred in earning the receipts. The explanatory

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statement which is contained in the Memorandum explaining the

provisions of the Finance Bill of 1991 has also been reflected in the

explanatory circular issued by the Central Board of Direct Taxes on

19 December 1991 (Circular No.621). The distortion of the profits

that would take place by excluding the receipts received by the

assessee which were unrelated to export turnover and not the

expenditure incurred by the assessee in earning those receipts was

factored in by Parliament by excluding only ninety per cent of the

receipts received by the assessee. In a given case, the expenditure

incurred by the assessee in earning the receipts, which is to be

excluded, may be more than ten per cent or less than ten per cent.

Parliament, however, thought it fit to adopt a uniform formula

envisaging a reduction of ninety per cent to make due allowance

for the expenditure which would have been incurred by the

assessee in earning the receipts. Parliament regarded the element

of expenditure computed at ten per cent of the receipts to be a

reasonable parameter of what would have been expended by the

assessee. It is in this background that in Explanation baa,

Parliament has thought it fit to exclude ninety per cent of the

receipts received by the assessee which have no nexus with the

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export activity. Ordinarily, the sums, receipts and profits set out in

clause baa would have been required to be excluded completely

from the profits of the business, being unrelated to export turnover.

Yet, since the expenditure incurred in earning such sums, receipts

and profits has already been taken into account on the debit side,

in computing profits of the business, it is only ninety per cent of

these sums, receipts and profits referred to therein which would

have to be excluded from the profits of the business in order to off

set the expenditure taken into account while computing the

business profits. In other words, the distortion in the profits of

business that would take place by excluding only the sums, receipts

and profits from the credit side, but not the expenditure from the

debit side, is off set by excluding only ninety per cent of such sums,

receipts and profits to represent the expenditure incurred on

earning them. As stated earlier, it may well be that the actual

expenditure incurred in a case may be more or less than the

statutory factor of ten per cent enacted by Parliament, but in order

to simplify the application of the law, Parliament treated a uniform

expenditure computed at ten per cent to be applicable in order to

ensure that there is no distortion of profits by exclusion of income

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which is not relatable to export profits.

Distributors Baroda :

16. In Distributors (Baroda) P. Ltd. vs. Union of India,4

what was in issue before the Supreme Court was the deduction

provided for in Section 80M. Section 80M provided that where the

gross total income of an assessee, being a company includes any

income by way of dividends received from a domestic company, in

computing the total income of the assessee, there shall be allowed

a deduction from such income by way of dividends of a certain

amount. The extent of the deduction varied between sixty to

eighty per cent. The Supreme Court observed that ‘income by

way of dividend from a domestic company included in the gross

total income’ would be the income computed in accordance with

the provisions of the Act, that is after deducting interest on monies

borrowed for earning such income. While interpreting the words

“included in the gross total income” and, emphasizing words “a

deduction from such income by way of dividend”, the Supreme

Court held thus:

4 (1985) 155 ITR 120

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“Now, when in computing the total income of the
assessee, a deduction has to be made from “such income

by way of dividends, it is elementary that “such income
by way of dividends” from which deduction has to be

made must be part of gross total income. It is difficult to
see how the language of this part of sub -s.(1) of s. 80M
can possibly fit in if “such income by way of dividends”
were interpreted to mean the full amount of dividend

received by the assessee. The full amount of dividend
received by the assessee would not be included in the
gross total income. What would be included would only
be the amount of dividend as computed in accordance

with the provisions of the Act. If that be so, it is difficult
to appreciate how for the purpose of computing the total

income from the gross total income, any deduction
should be required to be made from the full amount of
the dividend. The deduction required to be made for

computing the total income from the gross total income
can only be from the amount of dividend computed in
accordance with the provisions of the Act which would
be forming part of the gross total income.”

17. The principle which has been laid down by the Supreme

Court in the context of Section 80M was sought to be extrapolated

by Counsel appearing on behalf of the Assessees in the present

case, in their submission, in relation to the correct interpretation of

Explanation baa to Section 80HHC. Now, undoubtedly, as already

noted earlier, Explanation baa provides first for the computation of

the profits of the business which are defined to mean the profits

and gains of business or profession as reduced under clauses (1)

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and (2). For the purpose of clause (1) of Explanation baa, the

words “included in such profits” would clearly evince the intent of

Parliament that such receipts ought to have formed a part of the

profits and gains of business or profession as computed in

accordance with the provisions of Sections 28 to 44D. The

distinguishing aspect of Explanation baa is that the profits of the

business as computed under the head of profits and gains of

business or profession are subject to a reduction factor of ninety

per cent. The rationale for the exclusion which has been provided

for by Parliament in Explanation baa is that items which are

unrelated to export turnover have to be excluded in computing the

profits of business. Including items which are unrelated to export

turnover in computing the profits of business would result in a

distortion of the formula which is to be applied in construing the

provisions of Section 80HHC. The reason for exclusion, therefore,

is that in computing the profits of business items which are

unrelated to export turnover must be excluded because the basis of

Section 80HHC is to provide an incentive for export. The extent of

the exclusion which is statutorily mandated by Parliament is ninety

per cent of the total receipts. Though the entire quantum of

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receipts unrelated to export turnover would ordinarily have to be

excluded, the extent of the exclusion has been confined to ninety

per cent. This is because the expenditure which is incurred by the

assessee in earning these receipts would have gone into the

computation of the profits and gains of business or profession and

a distortion would be caused if the entirety of the income

generated from the receipts alone were to be excluded. It is in

order to obviate such a distortion that Parliament mandated that

ninety per cent of the receipts would be excluded. Consequently,

while the principle which has been laid down by the Supreme

Court in Distributors (Baroda) must illuminate the interpretation

of the words “included in such profits”, the Court cannot, at the

same time, be unmindful of the reduction which is postulated by

explanation baa, the extent of the reduction and the rationale for

effecting the reduction.

Decisions of the High Courts :

18. Several High Courts had occasion to deal with the

provisions of Section 80HHC including explanation baa. The

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Madras High Court considered the interpretation of Section 80HHC

in K.S.Subbiah Pillai & Co.(India) Pvt.Ltd. vs. CIT.5 The

questions of law which were referred to the High Court were as

follows :

“1. Whether on a true construction of the Explanation
(baa) to Section 80HHC of the Income-tax Act, 1961,
interest, rent and commission are to be deducted from
export profits or only net receipts, if any, after taking

into account the payments?

-2. Whether on a true construction of the Explanation
(baa) to section 80HHC of the Income-tax Act all the net
receipts by way of interest, rent and commission should

be aggregated before deduction and only the net
balance, if any, should be deducted from export profits?”

The High Court held that the second question of law did not arise

on the order of the Tribunal and only the first question was

required to be addressed. Dealing with the first question,

Mr.Justice R.Jayasimha Babu, speaking for the Division Bench held

as follows:

The clause does not refer to net interest. It refers, inter
alia, to the interest included in the profits and gains of
the business or profession. .. The reference to “such
profits” in sub-clause (1) of clause (baa) can only be to
the profits of the business computed under the head
“Profits and gains of business or profession”. Addition of

5 (2003) 260 ITR 304

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prefix “the” to “profits” in clause (baa), while referring to
the profits and gains of business or profession makes it

clear that it is only the amounts already included in that
computation which are now to be reduced to the extent

of 90 per cent., if those items are included in sub-clause
(1) of that definition.”

The High Court held that interest paid and claimed as a deduction

in the computation of profits and gains for business could not be

set off against interest received and paid under income from other

sources. The judgment in Subbiah Pillai was followed by another

Division Bench in CIT vs. V.Chinnapandi.6 In the case before the

Madras High Court, the assessee had paid interest of Rs.9.24 lakhs

and had received interest of Rs.2.65 lakhs and the net interest of

Rs.6.59 lakhs came to be debited. The Assessing Officer held that

under Section 80HHC, ninety per cent of the receipts had to be

excluded and consequently the deduction was confined to ninety

per cent of the income of Rs.2.65 lakhs received on account of

interest. The order of the Assessing Officer was confirmed by the

Appellate Authority. The Income Tax Tribunal, however, held that

the net figure of interest was Rs.6.59 lakhs which was not a receipt

and hence, there was no question of removing any amount while

6 (2006) 282 ITR 389

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computing the deduction under Section 80HHC. The Division

Bench of the Madras High Court held that “on a plain reading of

the provision”, it was clear that what the provision stipulates is that

the profits of business would be the profits as computed under the

head of profits and gains of business or profession. While

computing such profits under the head of profits and gains of

business or profession, if any receipts by way of brokerage,

commission, interest, rent, charges or a receipt of a similar nature

was included in such profits that would have to be reduced by

ninety per cent from the profits so computed. The Division Bench

held that no reference to net interest is mentioned in Explanation

baa and what had to be seen is only the nature of the receipts as

contemplated by the clause. Once the receipt of interest was

known, ninety per cent of it would have to be reduced from the

profits without deducting any amount. The Division Bench held as

follows:

“No expenditure or any other deduction is permissible
from the receipt of interest income. Section 80HHC
stipulates a deduction in respect of export profits.
Instead of enjoining the Assessing Officer to compute
such export profits from out of the consolidated amount
of the assessee, which may involve income by way of
interest, rent, commission etc., the Legislature has

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provided a simple procedure under which 90 per cent of
the receipts such as interest, rent, commission,

brokerage, etc., shall be excluded as profits not
attributable to exports. The intention is, therefore, clear

that there should be no attempt to deduct any
expenditure from the receipts, however, related, such
expenditure may be to the receipts. It is in this view of
the matter that the expression “receipt by way of” has

been used in the section and not “income” of that
nature.”

The same view has been taken by a Division Bench of the Punjab

and Haryana High Court in Rani Paliwal vs. CIT.7 In that case,

the total interest received by the assessee during the relevant

Assessment Year was Rs.6.33 lakhs while the total interest paid was

Rs.4.12 lakhs. The Assessing Officer was of the view that ninety

per cent of the receipts on account of interest in the amount of Rs.

6.33 lakhs was liable to be deducted from the profits of the

business for the purposes of deduction under Section 80HHC. The

CIT (Appeals) however, took the view that the interest would have

to be netted. The Income Tax Appellate Tribunal, on appeal,

confirmed the view of the Assessing Officer by holding that ninety

per cent of the interest that was deductible for the claim under

Section 80HHC was from the gross interest received by the assessee

7 (2004) 268 ITR 220

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and that the amount of the interest paid by the assessee could not

be deducted therefrom. The Division Bench held that “a plain

reading of clause baa of Explanation to Section 80HHC .. makes

this aspect quite clear” and the Tribunal was right in disallowing

the claim of the assessee. A subsequent decision of the Punjab and

Haryana High Court in CIT vs. Liberty Footwears,8 also adopts

the same position.

19. Reliance is, however, sought to be placed on behalf of

the assessee upon the judgment of a Division Bench of the Delhi

High Court in CIT vs. Shri Ram Honda Power Equip.9 One of the

issues which came up for decision in the appeal was whether the

expression “interest” in Explanation baa connotes net interest as

gross income less expenditure incurred by the assessee for earning

such income. The Delhi High Court held that the judgment of the

Supreme Court in Distributors (Baroda) (supra) would fully cover

the question as to whether the deduction which is to be effected

under Explanation baa was of the entire interest received or of the

interest less the expenditure incurred by the assessee for earning

8 (2006) 287 ITR 279
9 (2007) 289 ITR 475

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such income. Observing that the words used in Section 80HHC

were similar to those in Section 80M, the Delhi High Court held

thus:

“The expression “by way of” which qualified the word
“income” in section 80M is similar to the words “receipts

by way of” occurring in the Explanation (baa) of section
80HHC of the Act. Further the words “included in such
profits” occurs in both the provisions. Just as in
Distributors (Baroda) [1985] 155 ITR 120 (SC) where it

was explained by the Hon’ble Supreme Court that the
words “such” profits can only be understood as

“computed in accordance with the provisions of the Act”,
we are of the view that similar words in clause (baa)
should partake of the same meaning. Applying the ratio

of Distributors (Baroda) [1985] 155 ITR 120 (SC), we
hold that the legislative intent in using the word
“interest” in clause (baa) to the Explanation in section
80HHC is indicative of “net interest”, i.e., gross interest

less the expenditure incurred by the assessee in earning
such interest.”

The Delhi High Court was of the view that where the plain or

literal interpretation of a statute would produce an unintended or

absurd result, the literal construction should not be adopted.

According to the Delhi High Court, the words “included any such

profits” was a clear pointer to the fact that only net interest would

be includible in arriving at the business profit. The Delhi High

Court also held that unless netting were to be permitted, it would

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not be in ‘sync’ with the entire section. The contention of the

assessee was that if the deduction of ninety per cent is of gross

interest itself, the amounts spent in earning such interest will

remain on the debit side of the profit and loss account and will

depress the profits to that extent. This submission was accepted

with the observation that the idea of Section 80HHC was to ensure

that the exporter gets benefit from the profits derived from export

and not to depress the profits further. Hence, according to the

High Court, it can only be net interest which can be included in

the profits and if netting were not to be permitted, the result

would be that the profits of the exporter would be depressed by an

item that is expenditure incurred on earning interest which does

not form part of the profits at all.

20. Having given a careful consideration to the judgment of

the Delhi High Court, we are not inclined to follow the view for a

number of reasons. The substratum of the judgment of the

Delhi High Court proceeds on the basis that the question as to

whether netting should be permissible stands concluded by the

judgment of the Supreme Court in Distributors (Baroda). In

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Distributors (Baroda), while considering the provisions of Section

80M, the Supreme Court interpreted the words “where the gross

total income of the assessee being a company included any income

by way of dividend received” and the words which provided that in

computing the total income of the assessee “a deduction from such

income by way of dividend” shall be allowed to the extent specified

in the provision. While applying the ratio of the judgment in

Distributors (Baroda), we have observed that the expression

“receipts of a similar nature included in such profits” in

Explanation baa to Section 80HHC must refer to receipts which

form a part of the computation under the head of profits and gains

of business or profession under Sections 28 to 44D of the Income

Tax Act, 1961. The expression “such profits” therefore, following

the rationale in Distributors Baroda, must refer to the

computation of profits and gains of business or profession in

accordance with the aforesaid provisions of the Act. But, the

similarity between the provisions of Sections 80HHC and 80M

which is relied upon in the judgment of the Delhi High Court

would miss the comprehensive position as it obtains under Section

80HHC. The similarity of the provisions should not result into an

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assumption that the provisions are identical, when they are not.

Section 80 HHC is a provision which is intended to provide an

incentive for export. Parliament, therefore, expressed a legislative

intent to exclude items which were unrelated to export turnover

from the computation of the deduction and the application of the

formula. While excluding such items which are unrelated to

export for the purposes of Section 80HHC, Parliament has taken

due note of the fact that the exporter assessee would have incurred

some expenditure in earning the receipts. The expenditure would

have gone into the computation of profits and gains of business or

profession since the computation of business profits under

Chapter IV of the Act is made by amalgamating the receipts as well

as expenditure incurred in carrying on the business. Parliament,

however, legislated that in order to remove a cause for distortion,

the reduction to be effected of receipts such as brokerage,

commission, and interest should be confined to ninety per cent of

those receipts. In providing a simplified formula in these terms,

Parliament evidently adopted a fair and reasonable statutory basis

of what may be regarded as expenditure incurred for the earning of

the receipts. Once Parliament has legislated both in regard to the

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nature of the exclusion and the extent of the exclusion, it would

not be open to the Court to order otherwise by rewriting the

legislative provision. The task of interpretation is to find out the

true intent of a legislative provision. Undoubtedly, in dealing with

a provision by way of an incentive, the Court must adopt a broad

and liberal interpretation which would advance the purpose. While

doing so, the Court is duty bound to iron out the creases but, it is

clearly not open to the Court to legislate by substituting a formula

or provision other than what has been legislated by Parliament.

The Delhi High Court, with respect, has not adequately emphasised

the entire rationale for confining the deduction only to the extent

of ninety per cent of the excludible receipts. While the judgment of

the Delhi High Court referred to the C.B.D.T. Circular dated 19

December 1991, as noted earlier, we have also adverted to the

Memorandum explaining the clauses of the Finance Bill of 1991.

The Memorandum can be relied upon as a legitimate instrument of

statutory interpretation and to shed light upon the provisions of

Explanation baa.

21. Before concluding, it would be necessary to note that the

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Delhi High Court affirmed the judgment of a Special Bench of

Income Tax Appellate Tribunal in the case of Lalsons. The

Tribunal in the course of its decision, adverted to the deduction of

ten per cent allowed by Parliament in Explanation baa while

legislating that only ninety per cent of the receipts unrelated to

export turnover would be excluded from the profits of business.

The Tribunal, observed that the allowance of ten per cent had

been made by Parliament only for meeting common expenses,

according to Circular 621 dated 19 December 1991 of the C.B.D.T.

In Lalsons, the Tribunal observed that in addition to such common

expenses, there may be other expenses which have a direct bearing

on excludible receipts. The Tribunal held that if such receipts were

to be taken out of the business profits on the footing that they had

no connection with the business profits or turnover, it would only

be reasonable to hold that expenditure having nexus with such

receipts should also be taken out of the business profits on the

same footing. The Tribunal noted that the use of the word

“receipts” would not refer to gross receipts because the legislature

had not used the words “gross” nor “net”. We are affirmatively of

the view that in its discussion on the issue of netting, the Tribunal

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in its Special Bench decision in Lalsons has transgressed the

limitations on the exercise of judicial power. The Tribunal has in

effect, legislated by providing a deduction on the ground of

expenses other than in the terms which have been allowed by

Parliament. That is impermissible. In the present case, it is

necessary to emphasize that the question before the Court relates

to the deduction under Section 80HHC. An assessee may well be

entitled to a deduction in respect of the expenditure laid out wholly

and exclusively for the purpose of business in the computation of

the profits and gains of business or profession. However, for the

purposes of computing the deduction under Section 80HHC, the

provisions which have been enacted by Parliament would have to

be complied. A deduction in excess of what is mandated by

Parliament cannot be allowed on the theory that it is an incentive

provision intended to encourage export. The extent of the

deduction and the conditions subject to which the deduction

should be granted, are matters for Parliament to legislate upon.

Parliament having legislated, it would not be open to the Court to

deviate from the provisions which have been enacted in Section

80HHC.

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22. In the circumstances, we allow the appeal by holding

that the Tribunal was not justified in coming to the conclusion that

the net interest on fixed deposits in the Bank received by the

assessee should be considered for the purposes of working out the

deduction under Section 80HHC and not the gross interest. The

question of law would accordingly stand answered in the aforesaid

terms in favour of the Revenue and against the assessee. There

shall be no order as to costs.

( Dr.D.Y.Chandrachud, J.)

( J.P.Devadhar, J.)

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