Sale of scrap — Whether income derived from industrial undertaking ?

1.2 The common requirement for all such incentive provisions
has been that the gross total income should include profits derived from such
eligible undertakings. Further, the deduction has always been a percentage of
the profits derived from such eligible undertakings. The quantum of the
deduction has therefore been linked to the profits of the eligible undertakings.

1.3 A question has arisen before the Courts as to whether
income from sale of scrap of the eligible undertaking can be regarded as profits
derived from such eligible undertaking, for the purpose of computing the
deduction under the incentive provisions. While the Madras High Court has
consistently taken the view that such income from sale of scrap would form part
of the profits derived from such eligible undertaking, the Madhya Pradesh High
Court has recently taken a contrary view that the income from such sale would
not form part of the profits derived from the eligible undertaking.

2. Fenner India’s case :

2.1 This issue had arisen before the Madras High Court in the
case of Fenner (India) Ltd. v. CIT, 241 ITR 803.

2.2 In this case the assessee was an industrial undertaking
in a backward area manufacturing V-belts, oil seals, O-rings, rubber moulded
products, etc. It was eligible for deduction u/s.80HH in respect of the profits
derived from such industrial undertaking. It claimed a deduction of 20% of the
net profits of such undertaking, including profit on sale of scrap.

2.3 The Assessing Officer disallowed the deduction in respect
of profit on sale of scrap. The Commissioner (Appeals) upheld the assessee’s
claim for deduction in regard to the profit on sale of scrap. The Tribunal
however allowed the Revenue’s appeal on further appeal by the Revenue.

2.4 The Madras High Court noted that there was no dispute
that the new industrial undertaking was set up to manufacture V-belts, oil
seals, O-rings, rubber moulded products, etc. and that in the process of
manufacture of the V-belts, oil seals, O-rings, rubber moulded products, certain
scrap resulted. The resulting product of scrap also had a market and was also
sold, such sale being reflected in the turnover of the industrial undertaking.

2.5 Before the Madras High Court, on behalf of the Revenue,
it was argued that profit on the sale of scrap materials could, by no stretch of
imagination, be stated to have been derived from the industrial undertaking, and
if at all, such profits were at best attributable to the industrial undertaking.
It was argued that profits on sale of the manufactured products of the
industrial undertaking alone could be stated to be profits or gains derived from
the industrial undertaking, in respect of which a deduction of 20% was
permissible.

2.6 The Madras High Court noted that an assessee must
establish that his profits and gains were derived from his industrial
undertaking. It was not sufficient if a commercial connection was established
between the profits earned and the industrial undertaking, and the law required
that such profits must have been derived from the industrial undertaking. The
industrial undertaking itself must be the source of that profit and the business
of the industrial undertaking must strictly yield that profit. It must be the
direct source of profit and not a means to earn any other profit.

2.7 The Madras High Court observed that to say that the scrap
materials had no direct link or nexus with the industrial undertaking could not
at all be expected to commend acceptance. The scrap materials came within the
manufacturing process of the industrial undertaking in the manufacture of its
products such as V-belts, oil seals, etc. Therefore, the Madras High Court was
of the view that the profits and gains from the sale of scrap materials were
eligible for deduction of an amount equal to 20% u/s.80 HH, inasmuch as such
gains or profits were derived from the industrial undertaking and includable in
the gross total income of the assessee.

2.8 A similar view had been taken by the Madras High Court in
the cases of CIT v. Wheels India Ltd., 141 ITR 745, CIT v. Sundaram
Clayton Ltd., 133 ITR 34 and CIT v. Sundaram Industries Ltd., 253 ITR
396.

3. Alpine Solvex‘s case :

3.1 The issue again came up for consideration before the
Indore Bench of the Madhya Pradesh High Court in the case of CIT v. Alpine
Solvex Ltd., 219 CTR (MP) 499.

3.2 In this case the assessee was a company which had a
solvent extraction plant where soya bean oil was manufactured from soya bean
seeds. The assessee claimed deduction u/s.80HH and u/s.80I on the amount
realised by it by sale proceeds of old gunny bags which were used as packing
material. The sale proceeds of such gunny bags were included in the total
turnover of the undertaking.

3.3 The Assessing Officer rejected the assessee’s claim,
holding that it was not an income derived by the assessee from an industrial
undertaking and that it was therefore not eligible for deduction u/s.80HH and
u/s.80I. The Commissioner(Appeals) allowed the assessee’s appeal. The Tribunal
dismissed the Revenue’s appeal and upheld the order of the Commissioner
(Appeals).

3.4 Before the Madhya Pradesh High Court, on behalf of the Revenue it was contended that the amount earned by the assessee from sale of certain gunny bags lying in the factory could not be said to be the business, much less regular business activity and hence the income derived from sale of such gunny bags could not be said to be an income derived from the industrial undertaking eligible for the benefit of special deduction u/s.80HH/80I. It was argued that the expression ‘income derived from industrial undertaking’ has to be interpreted in a restricted/narrower sense, and hence only income earned directly from the business carried on by the industrial undertaking can be taken into consideration for calculating total income and deduction available under these Sections. Nobody appeared on behalf of the assessee before the Madhya Pradesh High Court.

3.5 The Madhya Pradesh High Court, relying on the decision of the Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT, 113 ITR 84, noted that the expression’ derived from’ was more restricted than the term ‘attributable to’, which was a comparatively broader expression. It further placed reliance on the decision of the Supreme Court in the case of Pandian Chemicals Ltd. v. CIT, 262 ITR 278, to the effect that the words ‘derived from’ used in S. 80HH must be understood as something which had direct or immediate nexus with the appellant’s industrial undertaking.

3.6 According to the Madhya Pradesh High Court, the main business of the assessee was to manufacture and sell soya oil by extracting it from soya bean seeds in their extraction plant. Therefore, according to the High Court, all income is derived from sale of soya oil has to be held as income derived from industrial undertaking, and so far as income earned out of sale of gunny bags was concerned, it could not be kept at par with the income derived from sale of soya oil. The High Court was of the view that sale of gunny bags was not the main or even ancillary business activity of the assessee, was not even regular or continuous business activity of the assessee, and that no investment was made by the assessee for sale of gunny bags, inasmuch as no industrial undertaking was established for manufacture and sale of gunny bags. Further, according to the Court the gunny bags were not manufactured by the assessee in its plant, which was established only for production of soya oil. According to the High Court, merely because some gunny bags were lying in the factory as surplus or unused or as waste material and were sold to earn some income, it could not be regarded as an income directly derived from the industrial undertaking.

3.7 The Madhya Pradesh High Court expressed the view that in order to derive income from the industrial undertaking, it must be shown that it was so earned by sale of those goods which were manufactured in the industrial undertaking as a part of the main and day-to-day business activity. The Madhya Pradesh High Court therefore held that the sale of gunny bags did not have a direct or immediate nexus with the industrial undertaking. While placing reliance on the decision of the Supreme Court in CIT v. Sterling Foods, 237 ITR 579, the Madhya Pradesh High Court expressed its disagreement with the decision of the Madras High Court in the case of Fenner (India) Ltd., noting that the Madras High Court decision did not take into consideration any decision of the Supreme Court.

3.8 The Madhya Pradesh High Court therefore held that the profit on sale of gunny bags was not part of the profits derived from the industrial undertaking eligible for deduction u/s.80HH/80I.

4. Observations:

4.1 It is significant to note that the nature of scrap dealt with by the Madras High Court was quite different from the scrap dealt with by the Madhya Pradesh High Court. The Madras High Court was dealing with a situation where the scrap arose directly out of the manufacturing process, and was an incidental part (though insignificant in value) of the very manufacturing process itself. The Madhya Pradesh High Court, on the other hand, was dealing with a case where the scrap was incidental to the acquisition of raw materials (being packed in gunny bags) or to the packing of manufactured goods. The scrap was therefore not a direct outcome of the manufacturing process, but was incidental to activities associated with the manufacture of the goods. Therefore, on facts, it is possible to distinguish between the nature of the scrap resulting in two different views being taken by the High Courts.

4.2 On a broader level, however, the question that arises is whether the business of an industrial undertaking encompasses only the manufacturing process simpliciter or covers the entire business of manufacture. Can the business of manufacture be said to commence only when the raw material is subjected to the physical process of manufacture, or does it also cover the incidental processes of preparation for manufacture, finishing and ‘Packing? If one takes a view that the business of manufacture involves all these steps as well, then the waste gunny bags clearly arise directly out of the business of manufacture, and should be regarded as the profits of the industrial undertaking.

4.3 The decision of the Supreme Court in the case of Pandian Chemicals (supra) is clearly distinguishable, as it related to interest on electricity deposit, which as the Supreme Court noted:

“Although electricity may be required for the purposes of the industrial undertaking, the deposit required for its supply is a step removed from the business of the industrial undertaking.”

Similarly, the case of Sterling Foods (supra) involved sale of import entitlements, which process was not part of the manufacturing business at all.

4.4 Viewed in this manner, it appears that the Madhya Pradesh High Court took too technical a view of the matter in holding that the waste gunny bags did not arise out of the manufacturing process. It ought to have considered that any income arising from a process which was directly associated with the business of manufacture, and not only the sale of the finished products, was profits derived from the industrial undertaking. Therefore, the view taken by the Madras High Court that sale of scrap forms part of the profits derived from the industrial undertaking, seems to be the better view of the matter.