Windmills — Stormy issues

In recent times, companies have been installing windmills
mainly for two reasons (a) to garner green electrical energy from
non-conventional sources availing various incentives offered by the government,
and (b) as a tax planning measure due to availability of higher depreciation and
tax-free income for ten years u/s.80-IA. Many issues arise while availing tax
benefits u/s.80-IA. This article attempts to highlight the main issue of
notional carry forward and set-off of loss from eligible undertaking. Though
‘windmill’ is taken as the ‘eligible undertaking’ as an example, the discussion
is applicable for all other undertakings u/s.80-IA. The discussion is based on
the recent order of the Madras High Court in the case of
Velayudhaswamy
Spinning Mills (P) Ltd. v. ACIT, (2010) 38 DTR 57.

•  The assessee has a spinning mill division.

•  It has installed windmill (windmill division) which is eligible for deduction
  u/s.80-IA in A.Y. 2002-03 (first year of generation of power).

• The loss from windmill division has been set off against the profit of the
  spinning mill division for the first three years.

•  As there was loss from the windmill division, no deduction has been claimed
  u/s.80-IA for these three years i.e., till A.Y. 2004-05.

• When the operations of the windmill division resulted in profit after setting
  of its loss against the profit of the spinning mill division, the assessee
  claimed deduction u/s.80-IA from the fourth year i.e. A.Y. 2005-06
  (first year of claim).

    ii) Ten years out of twelve/fifteen years starting from the first year of commencement — like an undertaking engaged in the business of developing, maintaining and operating any infrastructure facility;

For undertakings falling under (i) above, the initial assessment year was defined as the first year of commencement of production or operation pursuant to the definition under erstwhile S. 80IA(12)(c)(1), (3), (4) and (5). For undertakings falling under above, the initial assessment year was defined to be the first year of claim under erstwhile S. 80-IA(12)(c)(2) which reads as under:

“Initial assessment year, in the case of an enterprise carrying on the business of developing infrastructure facility means the assessment year specified by the assessee at his option to be the initial assessment year not falling beyond twelfth assessment year starting from the previous year in which the enterprise begins operating and maintaining the infrastructure facility.” (Emphasis supplied)

Relevant contents of erstwhile S. 80-IA (12) are tabulated in Table 3.

Power-generating undertakings, namely, windmills are similar to category (2) of the above viz. infrastructure facilities and accordingly the initial assessment year in the case of windmills should be the first year of claim.

New S. 80-IA w.e.f. 1-4-2000:

The Finance Act, 1999, w.e.f 1-4-2000 substituted the erstwhile section S. 80-IA with two sections, namely, 80-IA and 80-IB. While doing so, the undertakings originally eligible for deduction for a fixed block of years like the one stated in clause (i) above, namely, the cold storage plant, ships, etc. are covered by S. 80-IB and undertakings which have the option to claim deduction for ten consecutive years within a block of twelve or fifteen years, like the infrastructure undertakings, are retained under the new S. 80-IA. A brief comparison is given in Table 4.

Contents of Form 10CCB:

Whenever a confusion of this kind arises, a reference to the form prescribed may at times throw more light to clarify the confusion. In the present case also, the contents and language of Form 10CCB are relevant. Relevant extracts from Form 10CCB, under the Rule 18BBB are reproduced below:

    Clause 8 — “Date of commencement of operation/activity by the undertaking”

    Clause 9 — “initial assessment year from when the deduction is being claimed”.

From the above clauses it is clear that the term the ‘initial assessment year’ under the present S. 80-IA is the first year of claim and not the first year of operation/commencement of production.

Issue 2: Applicability of the fiction u/s.80-IA(5):

There is no dispute that Ss.(5) creates a fiction. The fiction mandates a notional carry forward of loss from eligible business presuming that the eligible business is the only source of income. The moot issue is the year of applicability of the fiction.

For easy analysis, Ss.(5) is divided into phrases as below:

    a) for the purpose of determining the quantum of deduction;

    b) for the assessment year immediately succeeding the initial assessment year;

    c) eligible business was the only source of income;

    d) during the previous year relevant to the initial assessment year;
    e) and to every subsequent assessment year up to and including the assessment year for which the determination is to be made;

Phrase (c) introduces the fiction ‘eligible business was the only source of income’ and phrase (d) provides for its applicability ‘during the previous year relevant to the initial assessment year’. Phrases (c) and (d) collectively mean that the loss of the years commencing from the initial assessment year (i.e., the first year of claim) alone is to be notionally carried forward and not losses of the years prior to the initial assessment year.

Phrases (a) and (b) provide that when the determination of quantum of deduction is to be made for any year from the second year of the claim (year after the initial assessment year), it is only the loss of that year and subsequent years that is required to be set off against the profit of the eligible business and not the loss for any earlier year including the initial assessment year.

Therefore, loss from the eligible business in the years prior to the initial assessment year absorbed against the profits of other businesses need not be notionally brought forward and has no effect on the deduction claimed.

Accordingly, the fiction u/s.80-IA(5) is applicable only from the second year of claim and not prior to it. The true intention of Ss.(5) can be easily understood by imagining the absence of it. For example, where the assessee has claimed deduction u/s.80-IA for three years and there is a loss in the 4th year of claim in a block of ten years, in the absence of Ss.(5), the assessee can continue to claim full deduction on the profit from the 5th year ignoring loss incurred in the 4th year if it has been set off against any other income. By virtue of the fiction in Ss.(5), the loss of the 4th year is to be set off against the income before claiming deduction for the 5th year. Therefore, Ss.(5) will operate only during the period of ten years of claim and only from the second year of the claim. Ss.(5) is thus not rendered redundant.

Further grounds to support the above view are:

    i) In the example above, the year in which the eligible undertaking u/s.80-IA began generation of power is the year A.Y. 2002-03. But the assessee exercised the option to claim deduction u/s. 80-IA(2) in the A.Y. 2005-06. This is the year from which the assessee is governed by S. 80-IA. Prior to that, the provisions of the Section had no applicability in the assessee’s case.

    ii) The expression ‘initial assessment year’ is not defined in the present S. 80-IA. Even so, logically it has to be the previous year in which the assessee is first governed by S. 80-IA i.e., the year in which the option is exercised u/s.80-IA(2). As a corollary, it will be illogical to state that the year of commencement of operation or set up of infrastructure, or generation of power, as the case may be, referred to in Ss.(2) is the ‘initial assessment year’.

    iii) The Legislature has consciously used different and contrasting expressions in the different sub-sections of S. 80-IA. Ss.(2) inter alia, speaks of any ‘ten consecutive assessment years’ out of fifteen years beginning from the year in which the undertaking or the enterprise develops and begins to operate any infrastructure facility or starts providing telecommunication service or develops or generates power.

S. 80-IA(5) refers to the year of exercise of option. It is referred to as ‘the initial assessment year’. It uses the words ‘during the previous year relevant to the initial assessment year’. U/ss.(5), the eligible business has to be one “to which the provisions of Ss.(1) apply”. Further, the words are “for the purposes of determining the quantum of deduction under that sub-section for the assessment year immediately succeeding the initial assessment year”. When words of import are used in the provisions of the statute, they are intended to convey different senses. (AIR 1956 SC 35 AIR 1989 SC 836)

iv) U/ss.(5), there is no ‘initial assessment year’ unless the provisions of Ss.(1) apply, i.e., unless the option has been exercised U/ss.(2). The determination of quantum of deduction U/ss.(1) is for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year and every sub-sequent year. Therefore, ‘initial assessment year’ employed in Ss.(5) is different from the year ‘beginning from the year’ referred to in Ss.(2).

v) The fiction u/s.80-IA(5) to the effect that “as if such eligible business was the only source of income of the assessee during the previous year relevant to the initial assessment year and every subsequent year” is to be confined to ten consecutive years beginning from the initial assessment year and to every subsequent year. The word ‘during’ connotes a period of time. Fiction U/ss.(5) operates in the ‘initial assessment year’ i.e., the year of option and runs for ten consecutive years. Without the option, there is no initial assessment year for S. 80-IA.

vi) To support the other interpretation of Ss.(5), the sub-section should have read as under: [blending Ss.(5) and Ss.(2)]

“Notwithstanding anything contained in any other provision of this Act, the profits and gains of an eligible business to which the provisions of Ss.(1) apply shall, for the purposes of determining the quantum of deduction under that sub-section for the assessment year immediately succeeding the initial assessment year or any subsequent assessment year, be computed as if such eligible business was the only source of income of the assessee for ten consecutive assessment years out of fifteen years beginning from the year in which the undertaking or the enterprise develops and begins to operate any infrastructure facility or starts providing telecommunication service or develops an industrial park or develops a special economic zone referred to in clause (iii) of Ss.(4) or generates power or commences transmission or distribution of power or under-takes substantial renovation and modernisation of the existing transmission or distribution lines” [Adopting the lines in Ss.(2)].

    vii) The fiction in Ss.(5) is limited to assuming that, during the previous year relevant to the initial assessment year, the eligible business is the only source of income. The provision looks forward to a period of ten years from the initial assessment year (year of option). The fiction does not look backwards to the year beginning, referred to in Ss.(2). In construing a fiction, it is impermissible to invoke a further fiction or enlarge the same.

[AIR 1966 SC 870; AIR 1963 SC 448 1996 (2) SCC 449]

Judicial precedents:

Mohan Breweries v. ACIT, 116 ITTD 241 (Chennai) — This case pertains to A.Y. 2004-05 (i.e., after the amendment of S. 80-IA by the Finance Act 1999), In this case, the Madras Tribunal has held that the initial assessment year is the first year of claim and 80-IA itself becomes applicable only when the assessee makes the claim for the first time and not before that.

ACIT v. Goldmine Shares and Finance P Ltd., 113 ITD 209 (Ahd.) (SB) — In this case, the undertaking had been set up prior to 31-3- 2000. The Special Bench held that before claiming deduction, the losses of the earlier years (i.e., the first year of commencement of business being the initial assessment year) are to be brought forward notionally and set off against the income of the current year. It placed reliance on the Circular 281, dated 22-9-1980. How-ever, the ratio of this decision and the said Circular are relevant for undertakings set up till 31-3-2000 and not for those set up on or after 1-4-2000. When the Mohan Breweries case was referred before the Special Bench, the Tribunal distinguished it on facts. It pointed out that the assessee, Goldmine Shares had claimed deduction in the year of setting up of undertaking itself and whereas in Mohan Breweries case, the year of claim was after the year of setting up of the undertaking.

Velayudhaswamy Spinning Mills (P) Ltd. Vs. ACIT (2010 38 DTR (Mad) 57)

The Madras High Court considered both the above decisions. It held that provision of S. 80-IA(5), treating eligible undertaking as a separate sole source of income, is applicable only when the assessee chooses to claim deduction under S. 80-IA and same cannot be applied to a year prior to the year in which assessee opted to claim relief under S. 80-IA for the first time. As initial year is not defined in S. 80-IA, the year of option has to be treated as the initial assessment year for the purpose of S. 80-IA.

To sum up:

    1. The initial assessment year in the case of an eligible undertaking is the first year of claim of deduction u/s.80-IA and not the first year of operation of the undertaking.

    2. The fiction of notional carry forward of loss u/s.80-IA(5) does exist, but operates only from the initial assessment year, i.e., from the first year of claim and thereafter and is not applicable in the earlier years.

    3. The Special Bench decision in the case of Goldmine Shares is clearly distinguishable given the fact that it was rendered in the context of erstwhile 80-IA which ceased to be effective from 1-4-2000.