The manner of computation of allowance of deductions u/s 10A, 10AA, 10B and 10BA under Chapter III of the Income tax Act, 1961 often pose a challenge both for the Assessee and the Assessing Officer as each of the two try their best to formulate their own method of calculation as its suits them leading to growing number of interpretations from various High Courts. Some courts have taken sense from subsequent amendment in the law and some have not borrowed such means. So far ss. 10A and s. 10B have been rolled into controversies and s. 10AA and 10BA have yet to get testing at the High Courts. Since the new section 10AA and 10BA has been an off shoot of ss. 10A and 10B it would be a good idea do a round-robin the scheme of exemptions/deductions in their original order, after amendments and under the newly inserted provisions to freeze on the correct method once for all to end controversies.
Section 10AA which is latest in the row and relevant to the subject provides for allowance of a deduction in the computation of the total income of an assessee and read as below:
“10AA. Special provisions in respect of newly established units in Special Economic Zones.—(1) Subject to the provisions of this section, in computing the total income of an assessee, being an entrepreneur as referred to in clause (j) of section (2) of the Special Economic Zones Act, 2005, from his unit, who begins to manufacture or produce articles or things or provide any services during the previous year relevant to any assessment year commencing on or after the 1st day of April, 2006, a deduction of—
(i) hundred percent of profits and gains derived from the export, of such articles or things or from services for a period of five consecutive assessment years beginning with the assessment year relevant to the previous year in which the unit begins to manufacture or produce such articles or things or provide services, as the case may be, and fifty percent of such profits and gains for further five assessment years and thereafter;
(ii) for the next five consecutive assessment years, so much of the amount not exceeding fifty per cent. of the profit as is debited to the profit and loss account of the previous year in respect of which the deduction is to be allowed and credited to a reserve account (to be called the “Special Economic Zone Reinvestment Reserve Account”) to be created and utilised for the purposes of the business of the assessee in the manner laid down in sub-section (2).”
The words ‘in computing the total income of an assessee’ in the section necessitate the application of the provisions contained in Chapter IV viz., the manner of computation of total income under various heads of income. In other words, the process of computation will precede the stage of allowance of deduction and Chapter IV provisions cannot be given a go by. It is therefore utmost relevant to refer to the definition of the term “total income” which vide Apex Court decision in Commissioner of Income-tax v. Williamson Financial Services (2008) 297ITR17 involves two ingredients: firstly, the income must consist of the total amount of income referred to in section 5; and, secondly, it must be computed in the manner laid down in the Income-tax Act. At the same time it observed that Income covered by sections 10 and 11, which is not chargeable to tax, does not fall under section 14 and under the various computation sections under Chapter IV, section 15 to section 59.Following this definition, S.10AA which incidentally falls under Chapter III does not fall in the category of exempted incomes which are not includible in the total income namely incomes falling under section 10/11 for the sole reason that it provides for allowance of a deduction in the computation of total income as it is to be read with chapter IV and chapter VI the moment there is a reference of its relevance in computation of income. In other words the deduction will follow the computation principles which are elsewhere contained in Chapter IV (computation under each head) and Chapter VI (aggregation and set off/carry forward provisions) of the Act.
Judicial views on ‘deduction from total income’ and ‘deduction in computing total income’-
Previously, on the subject of manner of computation of deduction u/s 10A/10B various High Courts have held differently. For instance the Karnataka, Bombay and Delhi High Courts hold a view that the two sections confer an exemption and that same shall be allowed without setting off brought forward unabsorbed loss and depreciation from the earlier years or in the current assessment year. The Kerala High Court however taking into account the amended provisions of the Act held otherwise in CIT v. Patspin Ltd. (2011) 62DTR364. There the Kerala High Court concurred with a Karnataka High Court decision in CIT v. Himatasingike Seide Ltd. (2006) 286ITR255 which was in the context of A Y 1994-95 meaning prior to amendment in s. 10A provisions viz shift from exemption to deduction format. The assessee went for a review after a favorable pronouncement from Karnataka High Court in CIT v. Yokogawa India Ltd. (2012) 341ITR385 but the Kerala High Court dismissed the review petitions vide their decision dated 2.4.2012 in Patspin India Limited v. CIT (2012) 251CTR63 citing the amended provisions of the Act. To clear any doubt the Kerala High Court held as under:
“After hearing both sides, what we notice is that we have in our own way considered the scope of amended provisions and so much so the decision rendered by us is not based on the earlier decision of the Karnataka High Court. So much so, in effect, the review petitions are virtually another appeals against the judgment rendered in appeals, wherein we have confirmed the Tribunal‟s orders. We do not find any mistake or any other ground warranting interference in the judgment in review proceedings.”
The relevance of sec 10A in the instant case is besought owing to Karnataka High Court decision in dealing with the expression „total income‟ used in sub-section (1) as under (pg 394-395):
“A literal reading of the above provision requires deduction from the total income. There can be a deduction in computing the total income. However, there cannot be deduction from the total income which is the final result of the computation process. The language adopted in section 10A is different from the one adopted in section 80A. Section 10A provides for deduction from the total income. In the scheme of the Act, while various deductions are allowed in computing the total income, once the total income is computed, no further adjustment to the total income is envisaged. The scheme of the Act provides for deduction in computing the total income but no mechanism for any deduction from the total income already computed is provided under the Act. Once the total income is computed, the next step is determination of tax by applying the applicable rates on the total income.
Section 2(45) defines “total income” to mean the total amount of income referred to in section 5 and computed in the manner laid down in the Income-tax Act. Section 5 defines the scope of total income and it is subject to the provisions of the Income-tax Act. Section 14 provides that “save as otherwise provided by the Income-tax Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income”. Therefore, the total income in its strict sense requires computation for the purpose of levy of tax. The computation of total income begins only with Chapter IV and as section 10A is covered in Chapter III, the phrase “total income” used in section 10A cannot be understood in the same sense as in section 2(45).
The phrase “total income” has been used in the Income-tax Act in several places with different connotations and shades. The phrase “total income” used in section 10A is one such variant. The phrase need not necessarily mean the total income as computed in accordance with the provisions of the Act. The relief under this section is with reference to the STP undertakings and not to the assessee. In other words, the relief travels with the undertaking irrespective of who owns the same. The computation of relief as provided in section 10A (4) is also with reference to the undertaking. A business might have several undertakings and section 28 does not envisage computation of income of each such undertaking. In other words, the profits of the business of the undertaking cannot be computed in isolation. The profits are computed under the head “Profits and gains of business or profession”, as under the above head, the income from business as a whole has to be computed. The phrase “total income” used in section 10A (1) is, therefore, to be understood as the total income of the STP unit. This is clear from the first proviso to section 10A (1) which makes a reference to the total income of the undertaking and not to the total income of the assessee. The definition of any term given in section 2 will apply only when the context does not otherwise require. The placement, language and setting of section 10A cannot mean the total income computed in accordance with the provisions of the Act. Instead, such a phrase in the context of section 10A means profits and gains of the STP undertaking as understood in its commercial sense.” (Unquote). On the basis of this decision „total income‟ in case of sec 10A is the income of the undertaking itself (Chapter III) and is not be confused with the income of the assessee (chapter IV and VI) and therefore is not be travelled to the computation of the „total income‟ of the assesse for such deduction.
Likewise, The Delhi High Court in CIT v. TEI Technologies (P) Ltd. (2012) 78DTR (Del) 225also held that the definition section 2 (45) would not apply if the context requires otherwise. As section 10A provide for a deduction from the total income and not a deduction in computing the total income the Court opined that s. 2 (45) or Chapter IV goes redundant as in no case a deduction is possible from the total income per se which is the final output. Thus the Court felt that the expression “total income” in s. 2(45) is out of context in the interpretation of sub-section (1) having regard to the context in which it is used therein. More particularly it observed as under (Pg 240-241):
“The position that emerges from a harmonious reading of these provisions is that the assessee is required to pay income tax on his total income of the previous year. The determination of the total income is the last point before the tax is charged and once the total income is determined or quantified, there is absolutely no scope for making any further deduction, having regard to the provisions referred to above. If this is the true legal position, as we think it to be, then it is not possible to understand sub-section (1) of Section 10A as providing for a “deduction” of the profits of the eligible unit “from the total income of the assessee“. The definition of the expression total income given in Section 2(45) cannot be imported into the interpretation of sub-section (1) having regard to the context in which it is used and the scheme of the Act relating to the charge of the tax. It has to be kept in mind that the definition section would not apply if the context requires otherwise; in other words, if the scheme of the Act relating to the charge of income tax clearly makes it impossible for any deduction to be allowed once the total income is determined, then it would be futile to still insist on applying the definition of the expression “total income” under Section 2 (45) to the interpretation of the sub-section. In other words the context in which the expression “total income” is used in the sub-section requires us to abandon the definition of that expression as per Section 2 (45).”
The High Court held that notwithstanding the amendment in the language of sub-section (1) of section 10A provisions it remains an exemption provision where neither the profit nor the loss enter the field of taxation. According to the Court the implication of an exemption provision is that the particular income which is exempt from tax does not enter the field of taxation and is not subject to any computation. The computation provisions of the Act do not get attracted at all to the exempted income.
Intervention of Board to exterminate the controversies:
It is in keeping with these conflicting judgments that the CBDT vide their Circular No. 7/DV/2013 [File No.279/Misc./M-116/2012-ITJ], Dated 16-7-2013explicitly pointed out that the provisions of Chapter IV and Chapter VI shall apply in computing the income for the purpose of deduction under sections 10A/10AA/10B/10BA of the Act subject to the conditions specified in the said sections. As regard aggregation or set off of losses the Board explained that the income computed under various heads of income in accordance with the provisions of Chapter IV of the IT Act shall be aggregated in accordance with the provisions of Chapter VI of the IT Act, 1961. This means that first the income/loss from various sources i.e. eligible and ineligible units under the same head are aggregated in accordance with the provisions of section 70 of the Act. Thereafter, the income from one ahead is aggregated with the income or loss of the other head in accordance with the provisions of section 71 of the Act. If after giving effect to the provisions of sections 70 and 71 of the Act there is any income (where there is no brought forward loss to be set off in accordance with the provisions of section 72 of the Act) and the same is eligible for deduction in accordance with the provisions of Chapter VI-A or sections 10A, 10B etc. of the Act, the same shall be allowed in computing the total income of the assessee. If after aggregation of income in accordance with the provisions of sections 70 and 71 of the Act, the resultant amount is a loss (pertaining to assessment year 2001-02 and any subsequent year) from eligible unit it shall be eligible for carry forward and set off in accordance with the provisions of section 72 of the Act. Similarly, if there is a loss from an ineligible unit, it shall be carried forward and may be set off against the profits of eligible unit or ineligible unit as the case may be, in accordance with the provisions of section 72 of the Act.
The Board in their Circular have clarified that the deduction under sections 10A/10B is to be allowed in computing the total income of the assessee notwithstanding their continued placement in Chapter III in the light of amended provisions as these now only provide for deduction of the profits and gains derived from the export of articles or things or computer software and not designate incomes from any exempted source.
Sub-section (1) of s. 10AA is materially different from section 10A and 10B as they use the expression „deduction from the total income‟ as against the expression „in computing the total income‟ in s. 10AA. Further sub-section (6) of s. 10AA provide for allowance of set off or carry forward of loss of SEZ unit. At the same time sub-section (8) which imports application of the provisions of section 10A (6) provide that all losses/unabsorbed depreciation for A Y 2006-07 or subsequent years of SEZ unit would be available for carry forward and set off in accordance with the provisions of section 72 during the holiday period.
By the Board Circular it is thus widely clear that loss incurred in a SEZ unit is not a loss from any non-taxable source. In other words it is available for carry forward and set off against taxable profits in the same year or in the subsequent period. Section 72 provide for allowance of carry forward and set off of a business loss. In the matter of carry forward and set off scheme the Supreme Court in Commissioner of Income-tax v. Harprasad and Co. P. Ltd. (1975) 99ITR118 held that the concept of carry forward of loss does not stand in vacuo. It involves the notion of set off. Its sole purpose is to set off the loss against the profits of a subsequent year. It presupposes the permissibility and possibility of the carried forward loss being absorbed or set off against the profits and gains, if any, of the subsequent year. Set off implies that the tax is exigible and the assessee wants to adjust the loss against profit to reduce the tax demand. It follows that if such set off is not permissible of possible owing to the income or profits of the subsequent year being from a non-taxable source, there would be no point in allowing loss to be ” carried forward “. Conversely, if the loss arising in the previous year was under a head not chargeable to tax, it could not be allowed to be carried forward and absorbed against income in a subsequent year, from a taxable source.
In that case, during the accounting period ending April 30, 1954, relevant to the assessment year 1955-56, the assessee sold certain shares at a loss of Rs. 28,662 which it claimed as a revenue loss. Both the Income-tax Officer and the Appellate Assistant Commissioner rejected the claim on the ground that the loss was a capital loss. On appeal, the Tribunal accepted the contention of the respondent raised for the first time that the capital loss of Rs. 28,662 should be carried forward and set off against capital gains, if any, in the future, even though tax was not chargeable under section 12B of the Indian Income-tax Act, 1922, on capital gains derived during April 1, 1948, to March 31, 1956. On a reference, the High Court held that if capital loss was incurred in a year in which capital gains did not attract tax under section 12B such loss would still be loss under the head “Capital gains” and it could be carried forward and set off against capital gains in a subsequent year. On appeal to the Supreme Court by the Commissioner the decision of the High Court was reversed and it was held that the capital loss could not be determined and the respondent was not entitled to the carry forward of the loss of Rs. 28,662.
Chaturvedi and Pithisaria‟s Treatise on Income tax Law also reads the following dictum in the Supreme Court laid principle in Harprasad case (supra): “It follow that if such set-off is not permissible or possible owing to income or profits of the subsequent year being from a non-taxable source, there would be no point in allowing loss to be „carried forward‟. Conversely, if the loss arising in the previous year was under a head not chargeable to tax, it could not be allowed to be carried forward and absorbed against income in a subsequent year, from a taxable income.“
On the set off of loss incurred by the eligible unit against normal business income the Bombay High Court in Hindustan Unilever Ltd. v. Deputy Commissioner of Income-tax (2010) 325ITR102 held that plainly, section 10B is not a provision in the nature of an exemption but provides for a deduction. Section 10B was substituted by the Finance Act of 2000 with effect from April 1, 2001. Prior to the substitution of the provision, the earlier provision stipulated that any profits and gains derived by an assessee from a 100 percent export oriented undertaking, to which the section applies “shall not be included in the total income of the assessee”. The provision, therefore, as it earlier stood was in the nature of an exemption. After the substitution of section 10B by the Finance Act of 2000, the provision as it now stands provides for a deduction of such profits and gains as are derived by a 100 percent export oriented undertaking from the export of articles or things or computer software for ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce. Consequently, it is evident that the basis on which the assessment has sought to be reopened is belied by a plain reading of the provision.
The Assessing Officer was plainly in error in proceeding on the basis that because the income is exempted, the loss was not allowable. All the four units of the assessee were eligible under section 10B. Three units had returned a profit during the course of the assessment year, while the Crab Stick unit had returned a loss. The High Court held that the assessee was entitled to a deduction in respect of the profits of the three eligible units while the loss sustained by the fourth unit could be set off against the normal business income.
In the opposite in the context of losses from non-eligible units the special bench in Scientific Atlanta India Technology P. Ltd. v. Assistant Commissioner of Income-tax (2010) 2ITR (CheTrib) 66 in regard to parallel s. 10A provisions held a view that the deduction under section 10A was undertaking specific. It was accordingly held that the losses from non-eligible units cannot be set off against the profit of the undertaking eligible for deduction under section 10A for the purpose of computation of deduction under section 10A. The view taken by the Special Bench has been upheld by the Bombay High Court in Black and Veatch Consulting P. Ltd.  348 ITR 72.The Karnataka High Court in Commissioner of Income-tax v. Yokogawa India Ltd. (2012) 341ITR385 also held as the deduction under section 10A has to be excluded from the total income of the assessee, the question of unabsorbed business loss being set off against such profit and gains of the undertaking would not arise.
The two views pronounced by the same High Court viz one for possibility of set off of losses of eligible unit against profits of non-eligible unit and on the other side citing a view that losses from non-eligible units cannot be set off against the profit of eligible unit are contradicting each other and may get self-defeating at some point in time.
Section 10AA is in a different setting than section 10A and it is for this very reason that the provisions under Chapter IV and Chapter VI shall become active in computing the income for the purpose of deduction under sections 10AA. S. 10AA (1) provide for allowance of deduction in the computation of total income. The total income of the assessee would mean total income from all sources and head of income combined together after applying the various provisions of intra and inter set off and carry forward of losses. Further from the clarification issued by the Board it is evident that the SEZ unit losses shall be set off against non-SEZ profits in the current year.
The Karnataka/Delhi High Court‟s pointing that a deduction cannot be given from the total income which is a final figure is a misconstrue of Act provisions and in any case gets relevant to section 10A/10B provisions and do not have any relevance to section 10AA which uses the expression „in computing the total income‟. The judgements only proceed on a rationale that since section 10A is placed under Chapter III heading its scope would not get off to Chapter IV or VI. Whereas, the Supreme Court in Chandroji Rao v. Commissioner of Income-tax (1970) 77ITR743 held that the marginal heading to a section cannot control the interpretation of the words of the section particularly where the language of the section is clear and unambiguous.
The Central Board of Direct Taxes has the requisite jurisdiction to interpret the provisions of the Income-tax Act. The interpretation of the Central Board of Direct Taxes being in the realm of executive construction should ordinarily be held to be binding, save and except where it violates any provisions of law or is contrary to any judgment rendered by the courts.
The Supreme Court in R & B Falcon (A) Pty. Ltd. v. Commissioner of Income-tax (w2008) 301ITR309 (pg 322) held that the Central Board of Direct Taxes has the requisite jurisdiction to interpret the provisions of the Income-tax Act. The interpretation of the Central Board of Direct Taxes being in the realm of executive construction should ordinarily be held to be binding, save and except where it violates any provisions of law or is contrary to any judgment rendered by the courts. Though the Board interpretation is contrary to some judgments rendered by the Courts these may not be binding in nature viz a viz 10A/10B provisions but it certainly has a binding effect over the application of the provisions of section 10AA which is differently worded and on which no contrary view is available from any High Court. The Kerala High Court decision which favors the revenue may call it binding even.