GLIMPSES OF SUPREME COURT RULINGS

4.  Commissioner of Income Tax I vs. Virtual Soft Systems Ltd. (2018) 404 ITR 409 (SC)

Income – Real Income – Method of accounting followed, as derived from the ICAI’s Guidance Note, was a valid method of capturing real income based on the substance of finance lease transaction – The bifurcation of the lease rental was, by no stretch of imagination, an artificial calculation and, therefore, lease equalisation was an essential step in the accounting process to ensure that real income from the transaction in the form of revenue receipts only was captured for the purposes of income tax

The Respondent-Virtual Soft Systems Ltd., a company registered under the provisions of the Companies Act, 1956, filed return of income for the Assessment Year 1999-2000 declaring loss of Rs. 70,24,178/- while claiming an amount of Rs. 1,65,12,077/- as deduction for lease equalisation charges.

The Assessing Officer, in his Assessment Order disallowed deduction claimed as the lease equalisation charges amounting to Rs. 1,65,12,077/- and added the same to the income of the Respondent.

Being aggrieved with the said Assessment Order, the Respondent preferred an appeal before the Commissioner of Income Tax (Appeals). Learned CIT (Appeals), upheld the order of the Assessing Officer and dismissed the appeal. Being ssatisfied, the Respondent preferred an appeal before the ITAT, who allowed the appeal of the Respondent while setting aside the orders passed by Learned CIT (Appeals) and the Assessing Officer.

Being aggrieved, the Revenue took the matter before the High Court. The High Court dismissed the appeal at the preliminary stage while confirming the decision of the ITAT. Being aggrieved, the Revenue took the matter before the Supreme Court.

According to the Supreme Court, the short question that arose for its consideration was whether the deduction on account of lease equalisation charges from lease rental income could be allowed under the Income Tax Act, 1961, on the basis of Guidance Note issued by the Institute of Chartered Accountants of India (ICAI).

The Supreme Court after noting provisions of section 211 of the Companies Act, 1956 before and after the 1999 amendment observed that the purpose behind the amendment in section 211 of the Companies Act, 1956 was to give clear sight that the accounting standards, as prescribed by the ICAI, shall prevail until the accounting standards are prescribed by the Central Government under this Sub-section. The purpose behind the accounting standards was to arrive at a computation of real income after adjusting the permissible deprecation and that these accounting standards were made by the body of experts after extensive study and research.

The Supreme Court after going through the Guidance Note observed that at the first look, it appeared that the method of accounting provided in the Guidance Note of 1995, on the one hand, adjusted the inflated cost of interest of the assets in the balance sheet. Secondly, it captured “real income” by separating the element of capital recovery (essentially representing repayment of principal amount by the lessee, the principal amount being the net investment in the lease), and the finance income, which was the revenue receipt of the lessor as remuneration/reward for the lessor’s investment. As per the Guidance Note, the annual lease charge represented recovery of the net investment/fair value of the asset lease term. The finance income reflected a constant periodic rate of return on the net investment of the lessor outstanding in respect of the finance lease. While the finance income represented a revenue receipt to be included in income for the purpose of taxation, the capital recovery element (annual lease charge) was not classifiable as income, as it was not, in essence, a revenue receipt chargeable to income tax.

The Supreme Court held that the method of accounting followed, as derived from the ICAI’s Guidance Note, was a valid method of capturing real income based on the substance of finance lease transaction. The Rule of substance over form is a fundamental principle of accounting, and is in fact, incorporated in the ICAI’s Accounting Standards on Disclosure of Accounting Policies being accounting standards which is a kind of guidelines for accounting periods starting from 01.04.1991. According to the Supreme Court, it is a cardinal principle of law that the difference between capital recovery and interest or finance income is essential for accounting for such a transaction with reference to its substance. If the same was not carried out, the Respondent would be assessed for income tax not merely on revenue receipts but also on non-revenue items which was completely contrary to the principles of the IT Act and to its Scheme and spirit.

Further, the bifurcation of the lease rental was, by no stretch of imagination, an artificial calculation and, therefore, lease equalisation was an essential step in the accounting process to ensure that real income from the transaction in the form of revenue receipts only was captured for the purposes of income tax. Moreover, there was no express bar in the IT Act which barred the bifurcation of the lease rental. This bifurcation was analogous to the manner in which a bank would treat an EMI payment made by the debtor on a loan advanced by the bank. The repayment of principal would be a balance sheet item and not a revenue item. Only the interest earned would be a revenue receipt chargeable to income tax. Hence, according to the Supreme Court there was no force in the contentions of the Revenue that whole revenue from lease should be subjected to tax under the IT Act.

The Supreme Court noted that in the present case, the relevant Assessment Year was 1999-2000. The main contention of the Revenue was that the Respondent could not be allowed to claim deduction regarding lease equalisation charges since there was no express provision regarding such deduction in the IT Act. The Supreme Court however held that the Respondent could be charged only on real income which could be calculated only after applying the prescribed method. The IT Act was silent on such deduction. For such calculation, it was obvious that the Respondent had to take recourse of Guidance Note prescribed by the ICAI if it was available. Only after applying such method which was prescribed in the Guidance Note, the Respondent could show fair and real income which was liable to tax under the IT Act.

Therefore, it was wrong to say that the Respondent claimed deduction by virtue of Guidance Note rather it only applied the method of bifurcation as prescribed by the expert team of ICAI. Further, a conjoint reading of section 145 of the IT Act read with section 211 (un-amended) of the Companies Act made it clear that the Respondent was entitled to do such bifurcation and there was no illegality in such bifurcation as it was according to the principles of law. Moreover, the Rule of interpretation says that when internal aid is not available then for the proper interpretation of the Statute, the Court may take the help of external aid. If a term is not defined in a Statute then it’s meaning could be taken as is prevalent in ordinary or commercial parlance. Hence, there was no force in the contentions of the Revenue that the accounting standards prescribed by the Guidance Note could not be used to bifurcate the lease rental to reach the real income for the purpose of tax under the IT Act.

The Supreme Court therefore dismissed the appeal.

5.  Commissioner of Income Tax, Chennai vs. S. Ajit Kumar (2018) 404 ITR 526 (SC)

Search and seizure – Block assessment – Words “and such other materials or information as are available with the Assessing Officer and relatable to such evidence” occurring in section 158BB of the Act – Any material or evidence found/collected in a Survey which has been simultaneously made at the premises of a connected person can be utilized while making the Block Assessment in respect of an Assessee u/s. 158BB read with section 158BH of the IT Act

A search was conducted by the officers of the Income Tax Department in the premises of the Assessee on 17.07.2002 which was concluded on 21.08.2002. On the same date, there was a survey in the premises of Elegant Constructions and Interiors Ltd. (hereinafter referred to as ‘ECIL’)-the builder and interior decorator who constructed and decorated the house of the Assessee at Valmiki Nagar. Pursuant to the same, the fact that the Assessee having engaged the above contractor for construction of the house came out. At the same time, from the survey in the builder’s premises, the fact of the Assessee having paid Rs. 95,16,000/- to ECIL in cash was revealed which was not accounted for.

The Assessing Officer, vide order dated 31.08.2004, after having regard to the facts and circumstances of the case, completed the block assessment and, inter alia, held that the said amount is liable to tax as undisclosed income of the block period.

Being aggrieved with the order dated 31.08.2004, the Assessee filed an appeal before the Commissioner of Income Tax (Appeals). Learned CIT (Appeals), vide order dated 15.02.2005, held that it was due to the search action that the Department had found that the Assessee had engaged the services of ECIL. Hence, the order of block assessment was upheld.

Being dissatisfied, the Assessee brought the matter before the Tribunal by way of an appeal. The Tribunal, vide order dated 28.04.2006, set aside the decisions of the Assessing Officer and learned CIT (Appeals) and allowed the appeal.

Being aggrieved, the Revenue filed an appeal before the High Court. The High Court, vide order dated 22.11.2006, dismissed the appeal.

According to the Supreme Court, the short point for its consideration in this appeal is as to whether in the light of present facts and circumstances of the instant case, the material found in the course of survey in the premises of the builder could be used in Block Assessment of the Assessee?

The Supreme Court noted that in the instant case, the office and residential premises of the Assessee was searched on 17.07.2002 and finally concluded on 21.08.2002. During the course of search, certain evidence were found which showed that the Assessee had indulged in understatement of his real income relating to the block period from 01.04.1996 to 17.07.2002. Consequently, a notice dated 25.02.2003, u/s. 158BC of the IT Act, was issued to the Assessee and he was asked to file block assessment. In reply to such notice, the Assessee filed return on 11.08.2003, admitting the undisclosed income as “NIL”.

The Supreme Court further noted that in the present case, it was an admitted position that the cost of investment was disclosed to the Revenue in the course of return filed by the Assessee. The Assessee also disclosed the detail of transaction between the Assessee and ECIL in the assessment year 2001-2002. However, he had not disclosed the payment of Rs. 95,16,000/- in cash made to ECIL.

According the Supreme Court, on a perusal of the provision of section 158BB, it was evident that for the purpose of calculating the undisclosed income of the block period, it could be calculated only on the basis of evidence found as a result of search or requisition of books of accounts or other documents and such other materials or information as are available with the Assessing Officer and relatable to such evidence. Section 158BB has prescribed the boundary which has to be followed. No departure from this provision is allowed otherwise it may cause prejudice to the Assessee. However, section 158BH of the IT Act has made all other provisions of the IT Act applicable to assessments made under Chapter XIV B except otherwise provided under that Chapter. The Supreme Court noted that Chapter XIV B of the IT Act, which relates to Block Assessment, came up for consideration before it in CIT vs. Hotel Blue Moon (2010) 321 ITR 362 (SC) wherein it has been held that the special procedure of Chapter XIV-B is intended to provide a mode of assessment of undisclosed income, which has been detected as a result of search. It is not intended to be a substitute for regular assessment. Its scope and ambit is limited in that sense to materials unearthed during search. It is in addition to the regular assessment already done or to be done. The assessment for the block period can only be done on the basis of evidence found as a result of search or requisition of books of accounts or documents and such other materials or information as are available with the assessing officer. Therefore, the income assessable in block assessment under Chapter XIV-B is the income not disclosed but found and determined as the result of search u/s. 132 or requisition u/s. 132-A of the Act.

The Supreme Court held that the power of survey has been provided u/s. 133A of the IT Act. Therefore, any material or evidence found/collected in a Survey which has been simultaneously made at the premises of a connected person can be utilised while making the Block Assessment in respect of an Assessee u/s. 158BB read with section 158BH of the IT Act. The same would fall under the words “and such other materials or information as are available with the Assessing Officer and relatable to such evidence” occurring in section 158BB of the Act. In the present case, the Assessing Officer was therefore justified in taking the adverse material collected or found during the survey or any other method while making the Block Assessment.

As a result, the appeal succeeded and was allowed. The impugned orders were set aside and the orders passed by the Assessing Officer making the Block Assessment were restored.

6.  Commissioner of Income Tax, Karnal (Haryana) vs. Carpet India, Panipat (Haryana) (2018) 405 ITR 469 (SC)

Exports – Special deduction – The question as to whether supporting manufacturer who receives export incentives in the form of duty draw back (DDB), Duty Entitlement Pass Book (DEPB) etc. is entitled for deduction under section 80HHC of the Income Tax Act, 1961 referred to a larger Bench

Carpet India (P) Ltd.-the Assessee, a partnership firm deriving income from the manufacturing and sale of carpets to IKEA Trading (India) Ltd. (Export House) as supporting manufacturer, filed a ‘Nil’ return for the Assessment Year (AY) 2001-2002 on 30.10.2001, inter alia, stating the total sales amounting to Rs. 6,49,83,432/- with total export incentives of Rs. 68,82,801/- as Duty Draw Back (DDB) and claimed deduction u/s. 80HHC amounting to Rs. 1,57,68,742/- out of the total profits of Rs. 1,97,10,927/- at par with the direct exporter.

On scrutiny, the Assessing Officer, allowed the deduction u/s. 80HHC to the tune of Rs. 1,08,96,505/- instead of 1,57,68,742/- as claimed by the Assessee while arriving at the total income of Rs. 57,18,040/-.

Being aggrieved, the Assessee preferred an appeal before the Commissioner of Income Tax (Appeals) which was allowed while holding that the Assessee was entitled to the deduction of export incentives u/s. 80HHC at par with the exporter.

The Revenue went in appeal before the Income Tax Appellate Tribunal as well as before the High Court but the same got dismissed leaving it to take recourse of the Supreme Court by way of special leave.

According to the Supreme Court, the short but important question of law that arose before it was whether in the facts and circumstances of the present case, supporting manufacturer who receives export incentives in the form of duty draw back (DDB), Duty Entitlement Pass Book (DEPB) etc., is entitled for deduction under section 80HHC of the IT Act at par with the direct exporter?

The Supreme Court noted that in the case at hand, it was evident that the total income of the Assessee for the concerned Assessment Year was Rs. 1,97,10,927/- out of which it claimed deduction to the tune of Rs. 1,57,68,742/- u/s. 80HHC of the IT Act which was partly disallowed by the Assessing Officer and deduction was allowed only to the tune of Rs. 1,08,96,505/-. However, the Assessee claimed the deduction at par with the direct exporter u/s. 80HHC of the IT Act which has been eventually upheld by the High Court.

According to the Supreme Court, in the instant case, the whole issue revolved around the manner of computation of deduction u/s. 80HHC of the IT Act, in the case of supporting manufacturer. On perusal of various provisions of the IT Act, it was clear that section 80HHC of the IT Act provides for deduction in respect of profits retained from export business and, in particular, s/s. (1A) and s/s. (3A), provides for deduction in the case of supporting manufacturer. The “total turnover” has to be determined as per clause (ba) of the Explanation whereas “Profits of the business” has to be determined as per clause (baa) of the Explanation. Both these clauses provide for exclusion and reduction of 90% of certain receipts mentioned therein respectively. The computation of deduction in respect of supporting manufacturer, is contemplated by section 80HHC(3A), whereas the effect to be given to such computed deduction is contemplated u/s. 80HHC(1A) of the IT Act. In other words, the machinery to compute the deduction is provided in section 80HHC(3A) of the IT Act and after computing such deduction, such amount of deduction is required to be deducted from the gross total income of the Assessee in order to arrive at the taxable income/total income of the Assessee, as contemplated by section 80HHC(1A) of the IT Act.

The Supreme Court observed that in CIT vs. Baby Marine Exports (2007) 290 ITR 323 (SC), the question of law involved was “whether the export house premium received by the Assessee is includible in the “profits of the business” of the Assessee while computing the deduction under section 80HHC of the Income Tax Act, 1961?”. The said case mainly dealt with the issue related with the eligibility of export house premium for inclusion in the business profit for the purpose of deduction u/s. 80HHC of the IT Act. Whereas in the instant case, the main point of consideration was whether the Assessee-firm, being a supporting manufacturer, was to be treated at par with the direct exporter for the purpose of deduction of export incentives u/s. 80HHC of the IT Act, after having regards to the peculiar facts of the instant case.

The Supreme Court noted that while deciding the issue in Baby Marine Exports (supra), it held that on plain construction of section 80HHC(1-A), the Respondent was clearly entitled to claim deduction of the premium amount received from the export house in computing the total income. The export house premium could be included in the business profit because it was an integral part of business operation of the Respondent which consisted of sale of goods by the Respondent to the export house.

The Supreme Court also noted that the aforesaid decision had been followed by it in Special Leave to Appeal (Civil) No. 7615 of 2009, Commissioner of Income Tax Karnal vs. Sushil Kumar Gupta. 

The Supreme Court however was of the view that both these cases were not identical and could not be related with the deduction of export incentives by the supporting manufacturer u/s. 80HHC of the IT Act.

As Explanation (baa) of section 80HHC specifically reduces deduction of 90% of the amount referable to section 28(iiia) to (iiie) of the IT Act, hence, the Supreme Court was of the view that these decisions required re-consideration by a larger Bench since this issue has larger implication in terms of monetary benefits for both the parties. After giving thoughtful consideration, the Supreme Court was of the view that the following substantial question of law of general importance arose for its re-consideration:

“Whether in the light of peculiar facts and circumstances of the instant case, supporting manufacturer who receives export incentives in the form of duty draw back (DDB), Duty Entitlement Pass Book (DEPB) etc. is entitled for deduction under section 80HHC of the Income Tax Act, 1961?”