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?”