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CASE NO.: Appeal (civil)  5315 of 2007

PETITIONER: Hero Exports,G.T. Road, Ludhiana

RESPONDENT: Commissioner of Income tax,(Central), Ludhiana

DATE OF JUDGMENT: 20/11/2007

BENCH: S.H. Kapadia & B. Sudershan Reddy

JUDGMENT: J U D G M E N T (Arising out of S.L.P. (C) No. 7411 of 2007) with

Civil Appeal No. 5317/2007 @ S.L.P.(C) No.7541/2007 Civil Appeal No. 5318/2007 @ S.L.P.(C) No.7613/2007 Civil Appeal No. 5319/2007 @ S.L.P.(C) No.7663/2007

KAPADIA, J.

                Leave granted.

2.      This batch of civil appeals is filed by the assessee for  assessment years 1994-95, 1995-96, 1996-97 and 1997-98. A  short question which arises for determination in this batch of  civil appeals is whether the A.O. and CIT(A) were right in  disallowing the claim of the assessee for adjustment of 10% of  export incentive against indirect cost of trading goods while  allowing deduction under section 80HHC of the Income-tax  Act as it stood at the relevant time. Facts in the Civil Appeal arising out of S.L.P. (C) No.  7411/2007 (lead matter):

3.      Assessee was engaged in the business of export of  \023trading goods\024. Under section 80HHC(3)(b), an exporter of  trading goods was entitled to deduction in respect of profits  derived from such export (export turnover) as reduced by the  direct costs and the indirect costs attributable to such export.  The smaller the figure of direct and indirect costs, the larger is  the profits derived from the export and, consequently, larger is  the deduction under section 80HHC. By attributing a part of  the indirect costs to the export incentives, interest etc. the  assessee sought to reduce the indirect costs attributable to  the export of trading goods so that it would be left with the  larger amount of export profits which it can deduct from the  gross total income. On the other hand, the attempt of the  Department was to prevent the aforestated claim of the  assessee by holding that expenses incurred for earning  incentives, commission etc. were not liable to be  reduced/deducted from Indirect Costs under section  80HHC(3)(c) read with clause (e) to the Explanation.

4.      The following example will clarify the position (figures  assumed):

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Rs.

Rs. FOB value of trading goods 6,50,000

Export incentives    80,000 }

Miscellaneous income & Brokerage     50,000

1,60,000 Interest Income 30,000

Direct cost 5,00,000

Indirect cost 50,000

Assessee\022s working of deduction under section 80HHC:

Rs.

Rs. FOB value of exports  

6,50,000 Less: Direct costs 5,00,000

                Proportionate indirect costs          (Rs. 50,000 minus 10% of            expenses attributable to export            incentives, miscellaneous           income & interest income           i.e. 10% of Rs.1,60,000           =Rs.16,000)

34,000

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5,34,000

Balance (export profits)

1,16,000

A.O\022s. working of deduction under section 80HHC:

Rs.

Rs.

FOB value of exports  

6,50,000 Less: Direct costs

5,00,000

        Indirect costs 50,000

5,50,000

Balance (export profits)

1,00,000

5.      The analysis of the aforestated example indicates that  assessee claims to reduce FOB value of exports amounting to  Rs. 6,50,000 by direct cost of Rs. 5,00,000 plus proportionate  indirect costs of Rs. 34,000, in all amounting to Rs. 5,34,000,  whereas the Department reduces the FOB value of exports of  Rs.6,50,000 by the direct cost of Rs.5,00,000 plus 100%  indirect cost of Rs.50,000, in all amounting to Rs.5,50,000,  which is sought to be reduced from FOB value of Rs.6,50,000.  In other words, according to the assessee, its export profits  should be Rs.1,16,000 whereas, according to the Department,  its export profit is Rs.1,00,000.

6.      According to the assessee, apart from export turnover, it  had earned income on account of export incentives,  miscellaneous income and interest income. According to the  assessee, it had two incomes, namely, export income and  income from export incentives. In the above example, assessee  had incurred direct cost of Rs.5,00,000 and indirect cost of  Rs.50,000. According to the assessee, the Department was  right in reducing Rs.5,00,000 from FOB value of exports  amounting to Rs.6,50,000, however, according to the  assessee, the Department had erred in reducing further the  FOB value of exports by Rs.50,000 instead of Rs.34,000  because, according to the assessee, although it had incurred  indirect cost of Rs.50,000, from that figure of Rs.50,000 it was  entitled to deduction of 10% of expenses attributable to export  incentives, miscellaneous income and interest  income

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amounting to Rs.1,60,000 (10% of Rs.1,60,000 is Rs.16,000)  as mentioned in the above example. Therefore, according to  the assessee, it was entitled to total deduction of only  Rs.5,34,000 and not Rs.5,50,000 from FOB value of exports  amounting to Rs.6,50,000.

7.      Shri S. Ganesh, learned senior counsel appearing for the  assessee, submitted that under section 80HHC(3)(b) only  indirect costs which are \023attributable to such export\024 can be  deducted from export turnover. According to the learned  counsel, in the present case, assessee had export turnover  plus export incentives. According to the learned counsel, the  assessee had, under the circumstances, two incomes, namely,  incentives income and income from export sales for which it  had one Common Pool of expenses. According to the learned  counsel, clause (baa) of the Explanation to section 80HHC  specifically excludes 90% of incentive receipts from the  business profits leaving 10% of such receipts assumed to have  been incurred by the Legislature for earning such receipts  and, therefore, there is no reason why a similar assumption  cannot be validly made while interpreting clause (b) of sub- section (3) to section 80HHC read with clause (e) of the  Explanation to section 80HHC(3). Learned counsel submitted  that, every receipt has a corresponding expense. Learned  counsel submitted that, under clause (e) in the Explanation to  sub-section (3) of section 80HHC(3), indirect costs have been  defined to mean costs, not being direct costs, allocated in the  ratio of export turnover in respect of trading goods to the total  turnover. In this connection, it is submitted that the  Legislature has given recognition to the fact that 10% of  certain receipts had to be incurred  for earning them and,  therefore, it excluded only 90% of such receipts from the  purview of business profits. According to the learned counsel,  one has to read Explanation (e), which defines indirect costs  as applicable to apply to the entire section 80HHC and even if  that argument is not accepted, still there is no reason why the  assumption made by the Legislature of treating 10% of certain  receipts as expenditure under clause (baa) of the Explanation  to section 80HHC is not applicable to cases falling under  section 80HHC(3)(b) read with clause (e) to the Explanation to  sub-section (3) of section 80HHC.

8.      Mr. Vikas Singh, Additional Solicitor General, learned  counsel appearing on behalf of the Department submitted that  the modality under section 80HHC(3)(a) for computing  business profits was different from the modality for computing  export turnover in respect of trading goods under section  80HHC(3)(b). According to the learned counsel, nothing  contained in sub-section (3)(a) can be read into sub-section  (3)(b). According to the learned counsel, sub-section (3)(b) was  a stand alone sub-section. According to the learned counsel,  the two sub-sections operated in different spheres. In this  connection, learned counsel urged that in case of section  80HHC(3)(a), incentives are required to be deducted to the  extent of 90% by a deeming fiction from business profits  which methodology would not apply in computation of export  turnover reduced by direct and indirect costs as contemplated  by section 80HHC(3)(b), which, as stated above, applied only  to trader exporter. In the present case, we are concerned with  section 80HHC(3)(b) alone. According to the learned counsel,  the definition of the words \023direct costs\024 and \023indirect costs\024 in  the Explanation to sub-section (3) of section 80HHC, the  Legislature has indicated the ratio for allocation of costs  between export turnover and total turnover only in cases  where the tax payer is engaged in the business of exports and

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also in the business of making domestic sales. According to  the learned counsel, the word costs being attributable to  exports would attract the allocation ratio only in such cases  where the tax payer is engaged in earning income in foreign  exchange from exports and simultaneously earning income  from domestic sales and, that, such ratio is not applicable in  cases falling under section 80HHC(3)(b) because that sub- section categorically states that the profits derived from  exports shall be the export turnover minus direct and indirect  costs. Therefore, according to the learned counsel, the  methodology of section 80HHC(3)(a) should not be read into  section 80HHC(3)(b). In this connection, learned counsel also  urged that in the case falling under section 80HHC(3)(b),  export turnover and total turnover are identical and, therefore,  the allocation ratio contemplated by the definition of indirect  costs has no application to the cases falling under section  80HHC(3)(b). According to the learned counsel, in cases of  exports of trading goods, the methodology only indicates that  profits derived from export shall be export turnover minus  costs. Therefore, according to the learned counsel, the ratio of  allocation of costs in the definition of the words indirect costs  in the Explanation to sub-section (3) would apply only to  cases falling under section 80HHC(3)(a) and section  80HHC(3)(c)(i). Learned counsel further urged that in clause  (e) in the Explanation to sub-section 80HHC(3), which defines  the words indirect costs to be allocated in the ratio of export  turnover upon total turnover, the denominator, namely, total  turnover would not include incentives and, therefore, while  computing total turnover, one has to take the entire indirect  expense into account. In short, learned counsel submits that  the said ratio will not apply to cases falling under section  80HHC(3)(b).

9.      Learned counsel further submitted that as a matter of  policy that the Government thought it fit to exclude only 90%  of the receipts from the business profits as per Explanation  (baa) instead of 100% and from this it cannot be inferred that  the Legislature has assumed that 10% of such receipts has to  be treated as costs or expenses to earn receipts by way of  incentives, commission, interest etc.. According to the learned  counsel, clause (baa) was inserted for an entirely different  purpose. It was not meant for interpreting clause (b) of section  80HHC(3) and, therefore, it cannot be assumed that 10% of  export incentives should be considered as costs or expenses  incurred to earn such receipts. According to the learned  counsel, the definition of \023indirect costs\024 as per clause (e) in  the Explanation below sub-section(3) does not exclude such  costs incurred for earning export incentives. Therefore, there  is no justification for excluding indirect costs, if any, incurred  for earning export incentives, commission etc.. According to  the learned counsel, the assessee in the present case is a  100% exporter and, therefore, the entire expenses, both direct  and indirect, can be only in respect of export turnover.  According to the learned counsel, the definition of \023indirect  costs\024 in clause (e) of the Explanation below sub-section (3)  was to apply only in cases where the tax payer had export  business plus domestic business, in which case, allocation  between export turnover and total turnover is contemplated.  According to the learned counsel, in the present case falling  under section 80HHC(3)(b), question of such apportionment  did not arise because in cases of the present type, export  turnover and total turnover are identical and in such cases  question of apportionment or allocation did not arise.  Therefore, the assumption on which the assessee is placing  reliance is not applicable to cases falling under section

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80HHC(3)(b).

10.     Before coming to the controversy in hand, we quote  hereinbelow section 80HHC(3) as it stood at the relevant time:                                          \023Deduction in respect of profits retained for export business 80HHC (3)  For the purposes of sub-section (1),-- (a) where the export out of India is of goods or merchandise  manufactured  or processed  by the assessee, the profits derived  from such export shall be the amount which bears to the profits of  the business, the same proportion as the export turnover in respect  of such goods bears to the total turnover of the business carried  on by the assessee; (b) where the export out of India is of trading goods, the profits  derived from such export shall be the export turnover in respect  of such trading goods as reduced by the direct costs and indirect  costs attributable to such export ; (c) where the export out of India is of goods or merchandise  manufactured  or processed  by the assessee and of trading goods,  the profits, derived from such export shall,-- (i) in respect of the goods or merchandise manufactured  or  processed  by the assessee, be the amount which bears to the  adjusted profits of the business, the same proportion as the  adjusted export turnover in respect of such goods bears to the  adjusted total turnover of the business carried on by the assessee;  and (ii) in respect of trading goods, be the export turnover in respect  of such trading goods as reduced by the direct and indirect costs  attributable to export of such trading goods : Provided that the profits computed under clause (a) or clause (b)  or clause (c) of this sub-section shall be further increased by the  amount which bears to ninety per cent of any sum referred to in  clause (iiia) (not being profits on sale of a licence acquired from  any other person), and clause (iiib) and (iiic) of section 28, the  same proportion as the export turnover bears to the total turnover  of the business carried on by the assessee. Explanations. \027 For the purposes of this sub-section,-- (a) \021adjusted export turnover\022 means the export turnover as  reduced by the export turnover in respect of trading goods; (b) \021adjusted profits of the business\022 means the profits of the  business as reduced by the profits derived from the business of  export out of India of trading goods as computed in the manner  provided in clause (b) of sub-section (3); (c) \021adjusted total turnover\022 means the total turnover of the  business as reduced by the export turnover in respect of trading  goods; (d) \021direct costs\022 means costs directly attributable to the trading  goods exported out of India including the purchase price of such  goods; (e) \021indirect costs\022 means costs, not being direct costs, allocated  in the ratio of the export turnover in respect of trading goods to  the total turnover; (f) \021trading goods\022 means goods which are not manufactured  or  processed  by the assessee.   (3A) \005  (4) \005  (4A) \005 Explanation.\027For the purposes of this section,-- (a) \021convertible foreign exchange\022 means foreign exchange which  is for the time being treated by the Reserve Bank of India as  convertible foreign exchange for the purposes of the Foreign  Exchange Regulation Act, 1973 (46 of 1973), and any rules made  thereunder; (aa) \021export out of India\022 shall not include any transaction by way  of sale or otherwise, in a shop, emporium or any other

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establishment situate in India, not involving clearance at any  customs station as defined in the Customs Act, 1962 (52 of  1962);  (b) \021export turnover\022 means the sale proceeds, received in, or  brought into, India  by the assessee in convertible foreign  exchange  in accordance with clause (a) of sub-section (2)  of any  goods or merchandise to which this section applies and which are  exported out of India, but does not include freight or insurance  attributable to the transport of the goods or merchandise beyond  the customs station as defined in the Customs Act, 1962 (52 of  1962);  (ba) \021total turnover\022 shall not include freight or insurance  attributable to the transport of the goods or merchandise beyond  the customs station as defined in the Customs Act, 1962 (52 of  1962) : Provided that in relation to any assessment year commencing on  or after the 1st day of April, 1991, the expression \023total turnover\024  shall have effect as if it also excluded any sum referred to in  clauses (iiia), (iiib) and (iiic) of section 28;  (baa) \021profits of the business\022 means the profits of the business as  computed under the head \021Profits and gains of business or  profession\022 as reduced by\027 (1) ninety per cent of any sum referred to in clauses (iiia),  (iiib) and (iiic) of section 28 or of any receipts by way  of brokerage, commission, interest, rent, charges or any  other receipt of a similar nature included in such profits;  and (2) the profits of any branch, office, warehouse or any other  establishment of the assessee situate outside India;  (c)  \021Export House Certificate\022 or \021Trading House Certificate\022  means a valid Export House Certificate or Trading House  Certificate, as the case may be, issued by the Chief Controller of  Imports and Exports, Government of India; (d)  \021supporting manufacturer\022 means a person being an Indian  company or a person (other than a company) resident in India,   manufacturing (including processing) goods  or merchandise and  selling such goods or merchandise to an Export House or a  Trading House for the purposes of export.\024

11.     We have considered the rival submissions. It is not  disputed by the Department that the assessee, in addition to  the income derived from export of trading goods, also derived  income from Export Incentives etc. of Rs.1,60,000 against  FOB value of exports amounting to Rs.6,50,000 in the above  illustration. It is not the case of the Department that the  assessee could have earned Rs.1,60,000 without incurring  any expenditure. (Rs.50,000 in the above example). It is not in  dispute that the case falls under section 80HHC(3)(a). It is not  the case of the Department that assessee had no income by  way of incentive, interest etc. (Rs.1,60,000 in the example).  The basic case of the Department was that the words \023indirect  costs\024 in clause (e) in the Explanation did not provide for  exclusion of expenses incurred for earning incentives,  commission, rent etc. and, therefore, the entire amount of  expenses (Rs.50,000 in the above example) spent for earning  such Other Incomes did not fall within the meaning of the  word \023indirect cost\024 in clause (e). According to the  Department, section 80HHC(3)(b) provides for a statutory  formula to calculate export profits by deducting direct and  indirect costs from export turnover, however, expenses  incurred for earning incentives, commission etc. (other  incomes) does not fall in the definition of \023indirect cost\024. That,  the assessee was not entitled to claim 10% of the receipts from  its Other Income (Rs.16,000 in the above example) as expense

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to be deducted from the indirect cost (Rs.50,000 in the above  example). Accordingly, the A.O. deducted full Rs.50,000 as  indirect cost from the export turnover. Therefore, even  according to the Department, it is not in dispute that the  assessee had incurred an expense of Rs.16,000 (in the above  example) to earn Other Incomes of Rs.1,60,000 but it denied  the Proportionate Deduction from Rs.50,000 on account of  strict interpretation of the words \023indirect cost\024 in clause (e).  However, in the above stand of the Department, there is a  fallacy. Under section 80HHC(3)(b) which is the main section,  the Legislature has provided that in cases falling under  section 80HHC(3)(b) direct and indirect costs attributable to  such exports have to be deducted from the export turnover to  arrive at Export Profits. Similar provision is made in clause (d)  which defines the words \023direct costs\024 to mean costs  attributable to exports of trading goods. Moreover, clause (e) of  the Explanation defines \023indirect costs\024 as costs which is not  direct costs as defined in clause (d). The word \023attributable\024 is  wider than the word \023derived\024. The Department in this case,  as can be seen from above example, itself says that Rs.50,000  in full is the Indirect Cost which has to be deducted in full as  clause (e) does not provide for proportionate deduction.  According to the Department, the definition of \023indirect costs\024  will not cover expenses incurred for earning Other Incomes.  However, at the same time, Department concedes that the  assessee had earned export turnover of Rs.6,50,000 plus  Rs.1,60,000 as Other Incomes. It also concedes that  Rs.50,000 is the indirect expense. If so, what should be the  expense allocated to the earning of the two incomes and in  what proportion is the question?       12.     According to the Department, the question of allocation  does not arise in cases falling under section 80HHC(3)(b). We  do not find merit in this contention. Firstly, clause (e) to the  Explanation which refers to allocation of costs applies to  sections 80HHC(3)(a), 80HHC(3)(b) and 80HHC(3)(c). Secondly,  section 80HHC(3)(b) equates export profits to export turnover  less direct and indirect costs attributable to the exports  of   trading goods. Therefore, the principle of attribution is  retained. Thirdly, keeping in mind the provisions of section  80HHC(3)(b) read with clauses (d) and (e) of the Explanation  it  is clear that Legislature intended allocation of costs between  export turnover and  total turnover. It is urged that the  apportionment would not apply to cases under section  80HHC(3)(b). It is true that, in most cases, it may not. But in  certain cases falling under section 80HHC(3)(b), ratio still  applies. For example, in the case where the assessee exports  all bought-out items but brings back only a part of the export  proceedings into India, in such cases, the ratio will apply and,  therefore, if one is to read clause (e), it retains the words  indirect costs to be allocated in the ratio of export turnover to  total turnover.       13.     The question which, however, needs to be decided is  whether, in the above example, the assessee is entitled to  reduction of Rs.16,000 from Rs.50,000 being the total indirect  expenses for earning both the incomes. Department reduces  the FOB value by Rs.50,000 whereas assessee contends that it  should be reduced by Rs.34,000 (Rs.50,000 \026  Rs.16,000).  Assessee claims apportionment at the rate of 10% of Other  Income of Rs.1,60,000 (in the above example). This is opposed  by the Department saying that since apportionment does not  apply to section 80HHC(3)(b), there is no question of applying  the yardstick of 10%. According to the Department, the words  \023indirect costs\024 does not take into account the expenses to

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earn Other Incomes. In this case, reliance is placed on clause  (e). However, the Department has failed to notice the words  \023attributable to exports\024 in section 80HHC(3)(b).       14.     As stated above, in our opinion, the words \023attributable\024  in section 80HHC(3)(b) in the main section itself indicates that  apportionment (principle of attribution) is not omitted from  the said provision of section 80HHC(3)(b). As stated above,  assessee has earned Other Income of Rs.1,60,000 apart from  FOB value of exports of Rs.6,50,000. Therefore, some expense  has to be attributed to earning of Rs.1,60,000. If so, the next  question which arises is how to allocate the costs? As stated  above, assessee has two incomes with one Common Pool of  expenses and since \023principle of attribution\024 has been retained  in the scheme of section 80HHC, both in terms of section  80HHC(3), clause (e) to the Explanation to section  80HHC(3)(a), (b) and (c) and in clause (baa) to the Explanation  to section 80HHC, instead of going into lengthy exercise of  dividing such Common Expenses, the assessee has estimated  the reduction of export turnover by 10% of the other income of  Rs.1,60,000 (in the above example). Ultimately, clause (baa) to  the Explanation is itself based on the assumption that 10% of  the income would be an expense. We make it clear that we are  not reading Explanation (baa) into section 80HHC(3)(b). What  we say is as a Guidance Value/Factor, 10% of the total Other  Income of Rs.1,60,000 would be fair estimate. This guidance  value is not flowing from clause (baa) but from the scheme of  section 80HHC read with the Memorandum to the Finance Act  of 1991. Take a reverse case, if allocation of expenses is to be  done on Actual Basis, it would not only be very difficult but in  some cases actual apportionment may not be in the interest  even of the Department.

15.     In conclusion, we may state that under section  80HHC(3)(b) one has to balance the \023principle of attribution\024  with the concept of \023allocation\024. The concept of allocation is  meant to reduce the incentive. However, when \023allocation\024 has  to be balanced with the \023principle of attribution\024, the object is  to reduce the incentive and not to eliminate it.

16.     For the above reasons, we set aside the impugned  judgments of the High Court dated 22.12.2006 and restore the  orders of the Income Tax Appellate Tribunal dated 30.9.2003,  24.10.2003, 13.2.2004 and 26.8.2004.       17.      Accordingly, the civil appeals filed by the assessee stand  allowed with no order as to costs.