Essel Shyam Communication Ltd. vs Commissioner Of Income Tax
2012 Latest Caselaw 3305 Del

*          IN THE HIGH COURT OF DELHI AT NEW DELHI

+           INCOME TAX APPEAL NO. 130/2011

                           Reserved on : 15th March, 2012.
%                       Date of Decision : 17th May, 2012.

ESSEL SHYAM COMMUNICATION LTD.            .... Appellant
             Through Mr. Ajay Vohra, Ms. Kavita Jha, Mr.
                     Somnath Shukla, Advocates.

                      VERSUS

COMMISSIONER OF INCOME TAX                  .....Respondent

            Through Mr. N.P.          Sahni, Sr. Standing
                     Counsel.

+           INCOME TAX APPEAL NOS 279/2011 & 284/2011

COMMISSIONER OF INCOME TAX                      .... Appellant
            Through Mr. N.P.          Sahni,   Sr. Standing
            Counsel.

                      VERSUS

ESSEL SHYAM COMMUNICATION LTD.           ...Respondent

Through Mr. Ajay Vohra, Ms. Kavita Jha, Mr. Somnath Shukla, Advocates.

CORAM:

HON'BLE MR. JUSTICE SANJIV KHANNA HON'BLE MR. JUSTICE R.V. EASWAR

SANJIVKHANNA, J.:

ITA 130/2011 preferred by Essel Shyam Communication

Ltd. and ITA Nos.284/2011 and 279/2011 preferred by the

Revenue arise out of the common order dated 31stMarch, 2010,

passed by the Income Tax Appellate Tribunal (for short, the

tribunal). The appeals pertain to the assessment year 2005-06.

We may note that the Revenue has preferred two appeals as

there were cross appeals by the Revenue and one by the

assessee before the tribunal against the order of the first

appellate authority.

2. By order dated 12th July, 2011, the following substantial

questions of law were framed in the respective ITAs:-

ITA 130/2011

"1. Whether on the facts and in the circumstances of the case, the Tribunal erred in law in holding that income earned by the appellant from development of software upgrades for Network Management Systems for smooth and trouble free working of VSAT service provided by the appellant, as part of business of telecommunication services, was not eligible for deduction under Section 80- IA(4(ii) of the Income Tax Act?

2. Whether on the facts and in the circumstances of the case, the Tribunal erred in law in not directing exclusion of only net interest income, i.e., gross interest income less expenditure incurred for earning such interest income, while computing deduction under Section 80-IA of the Income Tax Act?"

ITA No.279/2011

"Whether learned ITAT erred in law in holding that INSAT 2E is a domestic satellite within the meaning of sub-clause (ii) of Clause (4) of Section 80-IA of the Income

Tax Act, 1961, despite the fact that British Telecom has leased it to the assessee?"

ITA No.284/2011

"Whether learned ITAT erred in law in holding that income of Rs.50,42,764/- from trading activities is derived from Industrial undertaking within the meaning of Section 80-

         IA     of     the     Income     Tax     Act,
         1961?"

3. The assessee is a public limited company and was

providing satellite based telecommunication solutions including

VSAT services, up-linking services, play out services and

broadband service through satellite. It had earned income from

the said services, besides rental income and income from other

sources. In the return of income filed on 28th October, 2005, it

had claimed deduction under Section 80IA of the Income Tax

Act, 1961 (Act, for short) of Rs.4,88,29,013/- and after the

adjustment, had declared total taxable income of Rs.

5,45,89,013/-. The total taxable income under Section 115JB

was Rs.6,90,32,533/-.

4. As section 80IA is required to be interpreted and

examined, we deem it appropriate to reproduce the relevant

portion of the said provision, as it existed during the assessment

year period in question:-

"80-IA Deductions in respect of profit and gains from industrial undertakings etc., in certain cases.-(1) Where the gross total income of an assessee includes any profits and gains derived by an undertaking or an enterprise from any business referred to in sub-section (4) (such business being hereinafter referred to as the eligible business), there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction of an amount equal to hundred per cent of profits and gains derived from such business for ten consecutive assessment years.

         (2)       xxxxxxx

         (2A)      Notwithstanding anything contained in sub-

section (1) or sub-section (2), the deduction in computing the total income of any undertaking providing telecommunication services, specified in clause (ii) of sub-section (4Z), shall be hundred per cent of the profits and gains of the eligible business for the first five assessment years commencing at any time during the periods as specified in sub- section (2) and thereafter, thirty per cent of such profits and gains for further five assessment years.

(3) xxxxxxxx

(4) (ii) any undertaking which has started or starts providing telecommunication services whether basis or cellular, including radio paging, domestic satellite service, network of trunking, broadband network and internet services on or after the 1st day of April, 1995, but on or before the 31st day of March, 2005.

Explanation.- For the purpose of this clause, "domestic satellite" means a satellite owned and operated by an Indian company for providing telecommunication service."

(emphasis supplied)

5. Clause (ii) to Section 80IA (4) quoted above can be

bifurcated and divided into several parts. It applies to an

undertaking which had started or was providing; (i)

telecommunication services whether basic or cellular, (ii) radio

paging (iii) domestic satellite service (iv) network of trunking, (v)

broadband network and (vi) Internet service. The dates during

which the said services should be started/provided is stipulated.

Any company/assessee providing the said services was entitled

to claim benefit in respect of income earned i.e., profits and

gains derived from the said services. Therefore, the first and the

foremost requirement, when a deduction is claimed with

reference to clause (ii) of Section 80IA (4), is to determine and

decided whether activity undertaken by the assessee is covered

by any of categories mentioned in clause (ii) to Section 80IA(4).

This aspect has somehow escaped notice of the authorities as

well as the tribunal. This has resulted in confusion as the

Assessing Officer has made several additions including addition

for software sales, domestic satellite services etc. There is no

clear and direct finding on the precise nature of the activity

undertaken resulting in income earned and whether or not they

fall within one of the aforesaid specified categories. To some

extent, the assessee is also responsible for the said confusion

because of their reply in the course of the assessment

proceedings. The Assessing Officer had not appreciated and

understood the issue and the proper legal affect of clause (ii) of

Section 80IA (4). As we answer the questions, this aspect

becomes apparent.

6. Question No. 1 in ITA No. 130/2011 and the Questions

raised in ITA Nos. 279/2011 and 284/2011 are inter-related and

are being taken up first. Question No. 2 raised by the assessee

in ITANo. 130/2011 will be taken up in the end.

7. Question raised in ITA 279/2011 arises as the Assessing

Officer had treated Rs.1,42,34,278/- as income earned by the

assessee from domestic satellite service. The reasoning given

by the Assessing Officer is difficult to understand and somewhat

ingenious. The Assessing Officer referred to notes on accounts

in which the assessee had disclosed that payment of

Rs.13,42,288/- was made for space segment charges in foreign

currency. This payment was made to British Telecom

(Worldwide) for use of satellite service in the Indian Satellite

INSAT 2E. The Assessing Officer held that the said satellite

was not a „domestic satellite‟ as it was owned by Department of

Space, Government of India, which was not an Indian company

and was being operated by British Telecom (Worldwide), a

foreign company. The said view, however, was not accepted by

the CIT (Appeals), who held that British Telecom (Worldwide) or

INTELSAT did not have ownership right over the satellite.

Relying upon the letter dated 21stNovember, 2007, written by the

Director, ISRO, it was held that the satellite was owned by the

Department of Space, Government of India and, therefore, the

Assessing Officer was not justified in excluding the income

earned from the domestic satellite services. The view of the CIT

(Appeals) has been affirmed by the tribunal.

8. The Assessing Officer to compute and make the aforesaid

addition of Rs.1,42,34,278/- observed that the assessee had

made payment of Rs.13,42,288/- to British Telecom (Worldwide)

and had not shown any income or receipts earned from any third

party. The addition was made holding that the income included

income from satellite services not in the nature of domestic

satellite service as defined for purpose of the Section 80IA. The

profit/income disclosed by the assessee was notionally on

proportionate basis treated as profit/income earned from satellite

services, not being domestic satellite services.

9. The assessee holds a VSAT license to establish, maintain

and operate closed users group, an Internet license to establish,

maintain and operate internet services and a license/permission

from the Ministry of Information and Broadcasting for providing

uplinking services. The case of the assesse is that they have

incurred an expenditure for utilization of space segment on a

satellite to provide the said services. It is not their case that they

are in the business of providing lease/ sale of space segment or

satellite services or that they were providing domestic satellite

services. Contention of the assessee was/is that as a

broadband/internet service provider etc. it had procured space

segment in the satellite and paid charges in foreign currency for

utilizing space segment. It was an expense, which was incurred

and not that any income was earned. The question is not

whether any expense was incurred in respect of the services

stipulated in clause (ii) of Section 80IA (4), but whether the

assessee has earned income derived from the specified

services. It is not the case of the assessee that it was providing

domestic satellite services and earning income from the said

activity. The term "domestic satellite" as defined in the

explanation means the satellite owned and operated by an

Indian company for providing telecommunication services. The

assessee is not an owner of the domestic satellite and nor is it

operating the satellite. On the other hand, it is apparent that the

assessee is claiming benefit/coverage under the said section on

the basis that it is providing broadband/internet services etc. As

long as it was providing the stipulated services and had received

payments for the specified services, the income earned would

qualify for deduction under Section 80IA(4)(ii). In case the

assessee incurs expenditure to buy and utilize space segment

on a satellite for providing the qualifying services, the

expenditure incurred cannot be disallowed and no notional

income can be computed or reduced from the income

earned/derived from the qualifying service. In view of the said

position and in the absence of details, we have no option, but to

remit the matter to the tribunal to examine the said aspect

afresh. The tribunal has to examine and clearly decide nature

and character of service rendered by the assessee to third

parties and whether the same qualifies and is a

prescribed/stipulated service under section 80IA. The order of

remit is also necessary in view of the ambiguous stand of the

assessee before the Assessing Officer and the appellate

authorities which has contributed to the confusion. The letter

written by the assessee to the Assessing Officer reads:-

"From the above, it is clear that though the payment to BT is made in USD, yet the same was paid for use of domestic Satellite which is owned and operated by Department of Space, Government of India but leased out by Department of Space (DOS) to INTELSAT, who in-turn have subleased part of it to BT and some of which is used by the assessee Company. Hence, this is no question of disallowance under Section 80IA in this regard."

10. The question raised in ITA 284/2011 again requires an

order or remit. The Assessing Officer noticed that the assessee

had shown sales of Rs.2,12,28,512/-. On scrutiny of details, it

was noticed that major sales were in respect of Antenna, RFT

and other miscellaneous items, which included computer printer,

UPS, CTV, air conditioner, hand camera, generator sets,

telephone instruments, video conferencing systems, monitor etc.

He held that the said equipments could be bought and procured

from the Original Equipment Manufacturers (OEMS, for short)

including the foreign vendors. Accordingly, Rs.50,42,717/- was

excluded from the deduction claimed under Section 80IA of the

Act as income not derived from specified services, after noticing

that the cost of material was Rs.1,61,85,795/-. The CIT

(Appeals) upheld the said addition holding that this was income

derived from trading in goods. The tribunal has deleted the said

addition, inter alia, holding :-

"11. Let us have a look on the nature of equipments. We have perused pages number 29-40 of the paper book. On page 29-31 the copy of the import license for import of C band redundant 1:1 Up Converter and Down Converter have been placed on record. These are the technical device. Similarly on page 32-33 are the import license on page 34 is the description of the items which are to be imported. At page 34 the description of the items is Codan 40 Wku Band BUC. According to the assessee these equipments are essential equipments for enabling, assessee to the telecommunication services. The Govt. has put up various restrictions on import of

such items because of security reasons. If the assessee is unable to provide these items to its customer then it might not be possible for it to provide telecommunication services. It was pointed out at the time of hearing that these equipments cannot be used for availing the services from any other service provider. The customer has to avail the telecommunication services through these items necessarily from the assessee only. Considering the nature of equipments and their relation to the nature of services provided by the assessee, in our opinion the receipt received by the assessee for supply of these items is inextricably links to the business of its telecommunication services. The AO is not justified in excluding these receipts. Therefore we direct the AO to include the receipt of Rs.5042717/- representing income from sale of equipment in the eligible receipt for grant of deduction u/s 80IA."

11. Learned counsel for the Revenue, during the course of

hearing before us, has drawn our attention to the assessment

order and the stand taken by the assessee. It was submitted

that the assessee had stated and accepted that the customers

could buy the equipment from them or from third parties and had

pleaded that entire income, which was inextricably related to

business of telecommunication and was exempt. Sale of

equipment etc., had close and direct nexus with profit and gains

of the stipulated industrial undertaking.

12. The legal contention of assessee is substantially correct.

However, what was relevant and required examination was the

contracts under which the sales were made. Sale of TV Camera,

Air Conditioner, generator sets per se or on standalone basis

would not qualify for deduction 80IA read with sub-section (4)

clause (ii). On the other hand, in case the assessee has been

awarded a contract for providing telecommunication service,

network of trunking and broadband/internet services and while

and for executing the said contract, generator sets, air

conditioner etc. were sold as a part of a complete package, then

the income earned may qualify for deduction under Section

80IA. Therefore, each contract and nature thereof has to be

examined. It has to be ascertained whether it was a case of

supply of goods or it was a case where the assessee was

providing qualifying services which mandated and required

inextricably or as an necessary requirement, (under the same

contract or under a different contract), sale/supply goods to

operationalize and use/provide the telecommunication services.

In case, the sale of goods was inextricably linked, had nexus

and was connected with the primary purpose of providing or

starting telecommunication services, the assessee will be

entitled to benefit under Section 80IA. Otherwise, the assessee

will not be entitled to exemption under Section 80IA on the

transaction. Whether the commodities/goods could have been

also purchased from a third party may not relevant and the

determinative factor in many a case. It is the predominant or

primary reason or purpose why the contract was entered into,

and whether it has direct nexus and is inextricably linked with

providing the qualifying activities, is and would be the

determinative factor. The substantial question of law is

accordingly answered. An order of remit is passed, with a

direction to the tribunal to decide the issue/question afresh in the

light of the above observation/ratio.

13. The question No.1 raised in the appeal of assessee i.e.

ITA 130/2011 relates to income earned from development and

sale of software and whether the said amount qualifies for

deduction under Section 80IA. The tribunal has not treated the

proceeds from sale of software declared by the assessee as

eligible for deduction under Section 80IA on the ground that the

income derived from the sale of software was not derived from

qualifying business i.e. telecommunication services. It has been

observed that development of software was a separate source

of business income. Accordingly, the total receipt of

Rs.61,58,000/- from the sale of software should be excluded

from the deduction claimed under Section 80IA of the Act.

14. The contention of the assessee, which is recorded in the

order passed by the tribunal, is that the software developed was

for upgrading the Network Management System (NMS, for

short), to enable smooth working of VSAT service under the

technology from Via Sat and HSN at the request and on

confirmed purchase orders from TVC India Pvt. Ltd. The

justification given by the assessee to treat and regard the said

income as eligible for deduction under Section 80IA, reads as

under:-

"............The Hub controls the entire operations of the communication network through a NMS, which continuously accumulates data on the system so as to provide regular „health checks‟ for the remotes and determine the level of activity for billing purpose. The NMS, which is principally a software, is an integral part of Hub station for running VSAT services at various remotes. The NMS needs to be regularly updated and maintained for a smooth and trouble free service. Since TVC could not have the upgrades of these NMS‟s through the OEMs, the appellant provided the upgrades so that a smooth and uninterrupted service on the VSATs located at various remotes could be provided, it was argued that the software developed by the appellant is a part of the satellite based telecommunication services rendered by it. The appellant had the requisite expertise for the software development. The appellant under the impugned software developed four modules for TVC. Each module was developed to provide wide time window for packet transfers between TVC and Bank of Tokyo & Mitsubishi, Ludhiana Stock Exchange, EIH and BNP respectively. Without this software, the client of the appellant (TVC) could not have satellite connection with the abovementioned companies and the signal could not be transmitted thereto. The sole motive of developing the software was to further its telecommunication operations and was thus, inextricably linked to the business of the appellant of providing telecommunication services."

15. We find that the tribunal has not examined the said aspect

and question with reference to the contention raised by the

assessee, on the nature and character of the software, which

was developed and sold. The exact reasoning given by the

tribunal reads as under:-

"4.8 In regard to income from software, the development of software is certainly a separate source of business income of the appellant different from providing Telecommunication services. Thus, this income cannot be said to the income derived from the eligible business of providing Telecommunication service. The appellant has shown total receipts of Rs.61,58,000/- from development and selling of software. The A.O. has allowed expenses on account of salary paid to employees and other administrative expenses of Rs.4,00,000/- and calculated the net profit from software development at Rs.57,58,000/-. The A.R. of the appellant submitted that the appellant had incurred higher amount of expenses than Rs.4,00,000/- on the development of software because apart from personnel/staff, the appellant had incurred various other overhead charges also. But the appellant had not furnished any details of expenses in excess of 4,00,000 incurred for the development of software. In these circumstances, the calculation made by the A.O. does not warrant any interference. Since the income earned from development of software was not profit and gains derived from the eligible business of providing Telecommunication service, the A.O. was justified in excluding the income from software development for computing deduction u/s 80IA."

16. We find that the Assessing Officer as well as the appellate

authorities have not examined the issue/question keeping in

mind the mandate of the section and contention of the assessee.

Nature, character and type of the software and whether or not it

could be treated and regarded as income earned from the

business referred to in sub-section (4) clause (ii) to Section 80IA

has not been examined and considered. Without examining the

said aspect and the factual position regarding nature and type of

software, the Assessing Officer and the appellate authorities

were not justified in excluding the sale proceeds from

computation of deduction under Section 80IA. The Assessing

Officer has merely recorded that the assessee had furnished

copy of the work orders as well as the bill raised and in view of

the judicial pronouncements, income from selling of software

cannot be considered as income earned or derived from the

activities specified in Section 80IA(4)(ii) of the Act. This issue is

accordingly remitted to the tribunal for a fresh decision. The

tribunal will examine the nature, type and character of the

software or whether it was inextricably and directly connected

with the activities/services stipulated in clause (ii) to sub-section

(4) of Section 80IA. This is a technical aspect and if required,

the tribunal can take help and/or opinion of experts. The

assessee will be also at liberty to justify and establish their claim

by filing opinion from the experts. Question No.1 is accordingly

answered with an order of remit.

17. The last question is question No.2 in ITA No.130/2011.

The findings recorded by the tribunal in this regard are that the

assessee had earned interest income on FDRs of Rs.7,61,584/-

and other interest of Rs.77,042/-. It has been observed by the

tribunal that the aforesaid receipts cannot be included in the

income derived from the specified activities in view of the

decision of this Court in CIT Vs. Shri Ram Honda Power Equip

(2007) 289 ITR 475.

18. The assessee has submitted that they had earned this

interest of Rs.8,38,626/- on FDRs pledged with the banks for

availing non- fund based credit limits but they had paid interest

of Rs.1,70,99,277/- and, effectively the net interest paid was the

expense. Interest earned was business income directly

connected with the qualifying service and therefore should be

set off from the interest paid. It was stated that the interest

earned had direct nexus with the business of the assessee since

the FDRs were pledged as margin money for availing credit

limits. The Assessing Officer, however, did not agree with the

said contention. The CIT (Appeals) agreed with assessee and

held that the interest on deposit was taxable as "business

income" and not under the head "income from other sources"

and therefore the assessee was entitled to deduction under

Section 80IA(4)(ii). As noticed above, the tribunal has reversed

the findings of the CIT(Appeals) and agreed with the Assessing

Officer.

19. Decision of this Court in Shri Ram Honda (supra) consists

of two parts. In the first part it has been held that interest

income is not income derived from exports as it is not a part of

export proceeds and is not a direct and proximate result of

exports earning but earning made from deposit of money and

payment by the bank. The second part of the said judgment

deals with computation under Explanation (bba) to Section

80HHC. For the purpose of the said explanation, it has been

held that interest refers to and means net interest and not gross

interest, provided the interest earned is taxable under the head

"income from business" and not under the head "income from

other sources." This view has been upheld by the Supreme

Court in its recent decision in ACG Associated Capsules

Private Limited. Vs. Commissioner of Income Tax (2012) 3

SCC 321. The Supreme Court approving the said judgment has

referred to their earlier Constitution Bench‟s decision in

Distributors (Baroda) (P) Ltd. Vs. Union of India (1986) 1

SCC 43 and observed as under:-

"11. Before we deal with the contentions of Learned Counsel for the parties, we may extract Explanation (baa) to Section 80HHC of the Act.

Explanation: For the purposes of this section,-

* * *

(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-

1300 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.

12. Explanation (baa) extracted above states that "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 the receipts of the nature mentioned in Clauses (1) and (2) of the Explanation (baa). Thus, profits of the business of an Assessee will have to be first computed under the head "Profits and Gains of Business or Profession" in accordance with provisions of Sections 28 to 44D of the Act. In the computation of such profits of business, all receipts of income which are chargeable as profits and gains of business under Section 28 of the Act will have to be included. Similarly, in computation of such profits of business, different expenses which are allowable under Sections 30 to 44D have to be allowed as expenses. After including such receipts of income and after deducting such expenses, the total of the net receipts are profits of the business of the Assessee computed under the head "Profits and Gains of Business or Profession" from which deductions are to made under Clauses (1) and (2) of Explanation (baa).

         13.           xxxxxxx

         14.          xxxxxxx

         15.      Section 80M of              the Act provided for
         deduction in respect of                certain intercorporate
         dividends and it provided             in Sub-section (1) of
         Section 80M that "where the          gross total income of an

Assessee being a company includes any income by way of dividends received by it from a domestic company, there shall, in accordance with and subject to the provisions of this Section, be allowed, in computing the total income of the Assessee, a deduction from such income by way of dividends an amount equal to" a certain percentage of the income mentioned in this Section. The Constitution Bench held that the Court must construe Section 80M on its own language and arrive at its true interpretation according to the plain natural meaning of the words used by the legislature and so construed the words "such income by way of dividends" in Sub-section (1) of Section 80M must be referable not only to the category of income included in the gross total income but also to the quantum of the income so included.

16. Similarly, Explanation (baa) has to be construed on its own language and as per the plain natural meaning of the words used in Explanation (baa), the words "receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature included in such profits" will not only refer to the nature of receipts but also to the quantum of receipts included in the profits of the business as computed under the head "Profits and Gains of Business or Profession" referred to in the first part of the Explanation (baa). Accordingly, if any quantum of any receipt of the nature mentioned in Clause (1) of Explanation (baa) has not been included in the profits of business of an Assessee as computed under the head "Profits and Gains of Business or Profession", ninety per cent of such quantum of the receipt cannot be deducted under Explanation (baa) to Section 80HHC."

20. The Supreme Court in ACG Associated Capsules

(supra), did not approve the view of the Bombay High Court in

CIT Vs. Asian Star Company Ltd.(2010) 326 ITR 56 (Bom.).

21. We have quoted Section 80IA (1) and (2A) above. For

determining the income derived by an undertaking or enterprise,

we have to compute the total income of the assessee from the

business referred in sub-section (4) to Section 80IA. The words

used in Section 80IA(1) and (2A) are "profit and gains of eligible

business". On the basis of same logic and reasoning, we have

to first find out the profit and gains of business from the specified

activities. Section 80IA was interpreted and elucidated in

Liberty India v. Commissioner of Income Tax, (2009) 9 SCC

328.It was highlighted Section 80IA is a profit linked incentive

and only profits "derived from" eligible business are entitled to

deduction. The expression "derived from" covers sources not

beyond the first degree. Devices to inflate or reduce profits from

eligible business should be rejected. On DEPB utilization and

duty drawback it was held:-

"39. Analysing the concept of remission of duty drawback and DEPB, we are satisfied that the remission of duty is on account of the statutory/policy provisions in the Customs Act/Scheme(s) framed by the Government of India. In the circumstances, we hold that profits derived by way of such incentives do not fall within the expression "profits derived from industrial undertaking" in Section 80-IB."

22. Reliance was placed by the assessee on AS 2 and

explaining the same in Liberty India (supra), it was held;-

"40. Since reliance was placed on behalf of the assessee(s) on AS-2 we need to analyse the said standard. AS-2 deals with valuation of inventories. Inventories are assets held for sale in the course of business; in the production for such sale or in the form of materials or supplies to be consumed in the production. "Inventory" should be valued at the lower of cost and net realisable value (NRV). The cost of "inventory" should comprise all costs of purchase, costs of conversion and other costs including costs incurred in

bringing the "inventory" to their present location and condition.

41. The cost of purchase includes duties and taxes (other than those subsequently recoverable by the enterprise from taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Hence trade discounts, rebate, duty drawback, and such similar items are deducted in determining the costs of purchase. Therefore, duty drawback, rebate, etc. should not be treated as adjustment (credited) to cost of purchase or manufacture of goods. They should be treated as separate items of revenue or income and accounted for accordingly (see p. 44 of Indian Accounting Standards & GAAP by Dolphy D‟Souza).

42. Therefore, for the purposes of AS-2, CENVAT credits should not be included in the cost of purchase of inventories. Even the Institute of Chartered Accountants of India (ICAI) has issued Guidance Note on Accounting Treatment for CENVAT/MODVAT under which the inputs consumed and the inventory of inputs should be valued on the basis of purchase cost net of specified duty on inputs (i.e. duty recoverable from the Department at a later stage) arising on account of rebates, duty drawback, DEPB benefit, etc. Profit generation could be on account of cost cutting, cost rationalisation, business restructuring, tax planning on sundry balances being written back, liquidation of current assets, etc.

43. Therefore, we are of the view that duty drawback, DEPB benefits, rebates, etc. cannot be credited against the cost of manufacture of goods debited in the profit and loss account for purposes of Sections 80-IA/80-IB as such remissions (credits) would constitute independent source of income beyond the first degree nexus between profits and the industrial undertaking.

44. We are of the view that the Department has correctly applied AS-2 as could be seen from the following illustration:

      Expenditure             Amount(Rs)     Income             Amount(Rs)

      Opening stock                   100    Sales                   1000

      Purchases
      (including customs duty paid)   500    Duty drawback received 100
      Manufacturing overheads         300    Closing stock          200

      Administrative, selling and

      Net profit                      200                            ____
                                      1300                           1300

Note: In the above example, the Department is allowing deduction on profit of Rs 100 under Section 80-IB of the 1961 Act."

(emphasis supplied)

23. In view of the aforesaid observations in the case of Liberty

India (supra), the aforesaid second question of law in ITA No.

130/2011 is answered in negative with an order of remand to the

tribunal. In the absence of details, it is directed that the tribunal

will examine the factual matrix of the present case including the

balance-sheet and accounts of the assessee, to decide the

question. It will be open to the tribunal to examine and consider

the contention of the assessee, if raised and supported by facts,

the quantum of expenditure incurred/attributed to earning of

exempt income under Section 80IA of the Act.

24. The appeal is accordingly disposed of. There will be no

order as to costs.

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(SANJIV KHANNA) JUDGE

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(R.V. EASWAR) JUDGE May 17th, 2012 NA