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CASE NO.: Appeal (civil)  3803-3808 of 2005

PETITIONER: Commissioner of Income Tax

RESPONDENT: Willamson Financial Services & Ors.

DATE OF JUDGMENT: 12/12/2007

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

JUDGMENT: J U D G M E N T With

Civil Appeal No.1021 of 2006,        Civil Appeal No.1825 of 2007, Civil Appeal No.1827 of 2007,        Civil Appeal No. 5827 of 2007 arising out  of S.L.P.(C) No.2275 of 2007, Civil Appeal Nos.6719-20 of 2004

KAPADIA, J.

1.      Leave granted in S.L.P. (C) No.2275 of 2007.           2.      The intricate question which arises for determination in this  batch of civil appeals is at what stage Section 80HHC Deduction  is to be allowed i.e. before the 60 : 40 apportionment under Rule  8(1) or from 40% profits on sales taxable as Business Income.

3.      Rule 8(1) of the said Rule provides that 40% of the  composite income from sale of tea, grown and manufactured,  arrived at on making of the apportionment \023shall be deemed to be  income liable to tax\024.

4.      Assessees exported tea in the accounting year.  They were  entitled to deduction under Section 80HHC of Income-tax Act,  1961 (for short, \0211961 Act\024) in respect of the export.  They were in  the business of growing and manufacturing tea.  Since they  earned Composite Income, their case stood covered by Rule 8(1)  of Income-tax Rules, 1962 (\0231962 Rule\024 for short).   

5.      For the sake of convenience we state the facts occurring in  Civil Appeal No.3803-3808 of 2005- Commissioner of Income  Tax v. Willamson Financial Services & ors.  In the returns, the  assessee claimed Section 80HHC Deduction against the entire  Composite Income before application of Rule 8(1).       6.      This working was rejected by the A.O. who took the view  that deduction under Section 80HHC can be allowed after 60 : 40  apportionment as 40% income was gross total income.  However,  in appeal, CIT (A) reversed the decision of the A.O. by holding  that the A.O. should have first granted Section 80HHC Deduction  against the entire tea income before applying Rule 8(1).         7.      In short, the controversy is : whether Section 80HHC  Deduction is admissible against the entire or part of the income  from tea (i.e. 40%).       8.      Against the said decision of CIT(A) the matter was carried in  appeal to the Tribunal who took the view that A.O. was right in  allowing Section 80HHC Deduction only against part of the

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income from tea which was taxable under the 1961 Act, namely,  40% of the income.  This view of the Tribunal stood reversed by  the impugned judgment of the High Court.  Hence this civil  appeal is filed by the Department against the judgment of the  Division Bench of the Guahati High Court.       SUBMISSIONS 9.      On behalf of the assessees learned senior counsel submitted  that Rule 8 of 1962 Rule which provides for computation of  composite income is made under the power conferred by section  295 of the 1961 Act and as such the said Rule has the effect as if  enacted in that Act.  Further, the definition of \023agricultural  income\024 is bound up with the Rules. Therefore, according to the  learned counsel, such composite income has to be computed in  the first instance as if it is income derived from business. The  income has to be computed in accordance with the provisions of  the Act which deals with computation of business income and,  therefore, any deduction permissible under the 1961 Act is to be  allowed while computing the composite income which is treated  as business income and, therefore, deduction admissible under  section 80HHC is to be computed on the basis of the proportion  which the export turnover bears to the total turnover, which  proportion is to be applied to the business profits to find out the  export profits derived from export business. According to the  learned counsel, when income is derived from profit computed  under the head \023profits and gains of business\024, all deductions  and allowances are to be allowed and, therefore, it is not possible  to compute the profit of the business by allowing only deduction  and allowances, which fall under Chapter IV but all other  deductions although they do not appear in Chapter IV but in  Chapter VIA, like deductions under section 80HHC, have also to  be allowed to compute business profits in accordance with the  provisions of the Act under the head \023profits of the business\024.  According to the learned counsel, if total profits from the sale of  tea cultivated and manufactured by the seller are to be included  in the computation of business profits, then, necessarily, any  deduction allowed in respect of the profits from tea export has  also to be allowed in computing the business income. In this  connection, learned counsel placed reliance on the definition of  \023total income\024 in section 2(45) and section 5 of the 1961 Act  which defines the scope of total income. According to learned  counsel, \023business income\024 is one of the Heads of Income under  Section 14 and such income is included in the total income of an  assessee.  According to assessees, Section 80A, which is in  Chapter VI-A, provides that in computing the total income, there  shall be allowed from gross total income, deductions specified in  sections 80C to 80U of the Act and, therefore, there is no  difference between deductions under Chapter IV and the  deductions under Chapter VI-A. Therefore, according to the  learned counsel, in computing the total income, it is not  permissible to restrict the deduction under Chapter IV and not to  allow deduction under Chapter VI-A. In this connection reliance  was placed by the learned counsel on the judgment of this Court  in the case of Cambay Electric Supply Industrial Company  Ltd. v. Commissioner of Income Tax \026 (1978) 113 ITR 84 (SC)  which had been approved by the Constitution Bench later on in  the case of Distributors (Baroda) Pvt. Ltd. v. Union of India  and Ors. \026 (1985) 155 ITR 120 (SC) in which it has been held  that though a deduction does not appear in Chapter IV, it has a  direct impact upon the computation of income under the head  \023business profit\024 and, therefore, even if the deduction does not  fall within the ambit of Sections 29 to 43A, still if the deduction  directly affects the computation of income under the head  business profits then such deduction has got to be taken into  account.  Placing reliance on the said judgments, learned counsel

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submitted that the deduction admissible under section 80HHC is  one of the items of deduction appearing in Chapter VI-A which  has to be taken into account in computing the business income  and, therefore, section 80HHC is a part of the provisions relating  to the computation of business income under the 1961 Act.  Before us, it was further submitted that the legal fiction under  Rule 8 became necessary because it was not possible for the ITO  to assess an assessee, who not only carries on business in selling  tea but also grows green tea leaves by agricultural process and  manufactures black tea from the same. Because of the said legal  fiction, the entire sale proceeds is treated as business income and  is computed as such after giving all allowances and deductions  admissible in computation of business income and, therefore,  according to the learned counsel, while computing business  income, the legal fiction under Rule 8 must be given effect by  computing the business income after taking into account the  deduction under section 80HHC. Learned counsel for the  assessee further submitted that Chapter VI-A has several  headings. Under heading \021C\022 we have \023deductions in respect of  certain incomes\024. That heading would cover \023incomes\024 which are  includible in the gross total income of the assessee and,  therefore, section 80AB which also falls in Chapter VI-A will  apply only to incomes which fall under heading \021C\022. In other  words, according to the learned counsel, section 80AB will not  have any application to incomes not falling under heading \021C\022.  Learned counsel for the assessee has relied upon the above  analyses of various deductions allowed under heading \021C\022 to show  that under certain provisions, deductions are allowed where the  gross total income includes profits or gains in respect of which  such deductions are admissible. For example, section 80HH  provides that where gross total income includes any profits  derived from an industrial undertaking, there shall be allowed, in  computing the total income, a deduction equal to twenty per cent  from such profits. Similar expression finds place in section  80HHB and section 80-IA. These illustrations have been given by  the learned counsel in support of his contention that where the  gross total income includes any business profits referred to under  the specific section, section 80AB would apply and the amount of  income specified in the given section as computed in accordance  with the provisions of the Act (before making any deduction  under Chapter VI-A) shall alone be deemed to be the amount of  income of the said nature which is derived or received by the  assessee and which is included in his gross total income.   However, the said scheme of sections 80HHB, 80-I and 80-IA etc.  is not applicable to the scheme of section 80HHC. According to  the learned counsel, section 80HHC is the separate code by itself.  That the said section cannot be confused or put on par with  sections 80HHB, 80-I or 80-IA. According to the learned counsel,  section 80HHC is different from other sections under Chapter VI- A because it provides that in computing the total income, the  profits and gains from export would be allowed a deduction of the  profits derived by the assessee from the export of such goods.  According to the learned counsel, in section 80HHC, the following  expression is not there, namely, \023where gross total income of an  assessee includes the profits derived from export business\024.  According to the learned counsel, the said expression is omitted  from section 80HHC because the deduction under section 80HHC  is strictly not computed in accordance with the provisions of the  1961 Act, relating to the computation of business income.  According to the learned counsel, the deduction under section  80HHC is only in respect of profit derived by the assessee from  export, which has been defined under section 80HHC(3). That  sub-section lays down that the profits derived from export shall  be the amount which bears to the profits of the business, as  computed under the head profits and gains of business, the same

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proportion as the export turnover bears to the total turnover of  the business. Therefore, according to the learned counsel, the  profits of the export business which are allowed deduction under  section 80HHC are not computed in accordance with the  provisions of the Act relating to the computation of business  income but is statutorily fixed under section 80HHC(3) of the Act  and that is the reason why section 80HHC does not use the  expression \023where gross total income includes any profits and  gains derived from export business\024. Therefore, according to the  learned counsel, section 80AB is not applicable to profits derived  from export business. Therefore, according to the learned  counsel, section 80AB will not govern section 80HHC.  Consequently, according to the learned counsel, the ITO should  have first granted Section 80HHC Deduction against the entire  tea income, i.e., before applying Rule 8(1) and, thereafter, the ITO  should have applied the said Rule and apportioned the income in  the ratio of 60:40.

Analysis of relevant provisions of the Constitution, Income-tax Acts, 1922 and 1961

10.     For the sake of convenience we quote hereinbelow relevant  sections, rules, articles and entries: 11.     Section 10 of I.T. Act, 1922 which reads as under:       10. (1) The tax shall be payable by an assessee under the head \023Profits and  gains of business, profession or vocation\024 in respect of the profits and  gains of any business, profession or vocation carried by him.

(2)     Such profits or gains shall be computed after making the following  allowances, namely:-

(i)     Any rent paid for the premises in which such business,  profession or vocation is carried on, provided that when  any substantial part of the premises is used as a dwelling- house by the assessee, the allowance under this clause shall  be such sum as the Income-tax Officer may determine  having regard to the proportional annual value of the part  so used;

(ii)    in respect of repairs, where the assessee is the tenant only  of the premises, and has undertaken to bear the cost of such  repairs, the amount paid on account thereof, provided that,  if any substantial part of the premises is used by the  assessee as a dwelling-house, a proportional part only of  such amount shall be allowed;

(iii)   in respect of capital borrowed for the purposes of the  business, profession or vocation, the amount of the interest  paid:

  12.     Rule 24 of the 1961 Act reads as under:

\02324. Income derived from the sale of tea grown  and manufactured by the seller in the taxable  territories shall be computed as if it were income  derived from business, and 40 per cent. of such  income shall be deemed to be income, profits and  gains liable to tax:

Provided that in computing such income an  allowance shall be made in respect of the cost of

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planting bushes in replacement of bushes that  have died or become permanently useless in an  area already planted, unless such area has  previously been abandoned.\024

 13.     Section 2(1A) of the 1961 Act reads as under:

\023Definitions.  2. In this Act, unless the context otherwise requires, - (1A)    \023agricultural income\024 means         (a)     any rent or revenue derived from land which is  situated in India and is used for agricultural  purposes;

       (b)     any income derived from such land by         (i)        agriculture; or         (ii)       the performance by a cultivator or  receiver of rent-in-kind of any process  ordinarily employed by a cultivator or  receiver of rent-in-kind to render the  produce raised or received by him fit to be  taken to market; or         (iii)   the sale by a cultivator or receiver of rent- in-kind of the produce raised or received by  him, in respect of which no process has  been performed other than a process of the  nature described in paragraph (ii) of this  sub-clause;

       (c)     any income derived from any building owned and  occupied by the receiver of the rent or revenue of  any such land, or occupied by the cultivator or  the receiver of rent-in-kind, of any land with  respect to which, or the produce of which, any  process mentioned in paragraphs (ii) and (iii) of  sub-clause (b) is carried on :

               Provided that         (i)     the building is on or in the immediate vicinity of  the land, and is a building which the receiver  of the rent or revenue or the cultivator, or the  receiver of rent-in-kind, by reason of his  connection with the land, requires as a  dwelling house, or as a store-house, or other  out-building, and         (ii)    the land is either assessed to land revenue in  India or is subject to a local rate assessed and  collected by officers of the Government as such  or where the land is not so assessed to land  revenue or subject to a local rate, it is not  situated -         (A)     in any area which is comprised within the  jurisdiction of a municipality (whether  known as a municipality, municipal  corporation, notified area committee, town  area committee, town committee or by any  other name) or a cantonment board and  which has a population of not less than  ten thousand according to the last  preceding census of which the relevant  figures have been published before the first  day of the previous year ; or         (B)     in any area within such distance, not being  more than eight kilometres, from the local

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limits of any municipality or cantonment  board referred to in item (A), as the Central  Government may, having regard to the  extent of, and scope for, urbanisation of  that area and other relevant  considerations, specify in this behalf by  notification in the Official Gazette:                 Explanation. \026 For the removal of doubts, it is hereby  declared that revenue derived from land shall not  include and shall be deemed never to have included  any income arising from the transfer of any land  referred to in item (a) or item (b) of sub-clause (iii) of  clause (14) of this section;\024          14.     Section 10(1) of the 1961 Act reads as under: \023CHAPTER III INCOMES WHICH DO NOT FORM PART OF TOTAL INCOME Incomes not included in total income. 10.     In computing the total income of a previous year of any  person, any income falling within any of the following clauses shall  not be included         (1)     agricultural income;\024       15.     Sections 80HHC(1) and 80HHC(3)(a) of the 1961 Act  read as under:       \023Deduction in respect of profits retained for export business 80HHC. (1) Where an assessee, being an Indian company or  a person (other than a company) resident in India, is engaged  in the business of export out of India of any goods or  merchandise to which this section applies, there shall, in  accordance with and subject to the provisions of this section,  be allowed, in computing the total income of the assessee, a  deduction of the profits derived by the assessee from the  export of such goods or merchandise : (1A) to (2A)    xxx             xxx             xxx (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;\024   16.     Rule 8(1) of the 1962 Rule reads as under: Income from the manufacture of tea. 8. (1) Income derived from the sale of tea grown  and manufactured by the seller in India shall be  computed as if it were income derived from  business, and forty per cent of such income shall  be deemed to be income liable to tax.   17.     Entry 46, List II (State List) of the Seventh Schedule to the  Constitution which reads as under:       \02346. Taxes on agricultural income.\024 18.     Article 245 of the Constitution reads as under: \023245. Extent of laws made by Parliament and  by the Legislatures of States.-

(1)     Subject to the provisions of this  Constitution, Parliament may make laws for  the whole or any part of the territory of  India, and the Legislature of a State may  make laws for the whole or any part of the  State. (2)     No law made by Parliament shall be deemed

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to be invalid on the ground that it would  have extra-territorial operation.\024               19.     Entry 82, List I (Union List) of the Seventh Schedule to the  Constitution reads as under: \02382. Taxes on income other than agricultural  income.\024             20.     Article 366(1) of the Constitution reads as under: \023366. Definitions.- In this Constitution, unless  the context otherwise requires, the following  expressions have the meanings hereby respectively  assigned to them, that is to say-              (1) \023agricultural income\024 means agricultural  income as defined for the purposes of the  enactments relating to Indian income-tax;\024        21.     On analysis of the above provisions the position which  emerges is as follows.  Section 10(1) of 1961 Act exempts  \023agricultural income\024 not only from taxable income but also from  the \023total income\024 of the assessee.  These incomes are different  from tax-free incomes under Chapter VIA.  The exemption of  agricultural income from central taxation is based on the  provisions in the Constitution according to which Parliament has  exclusive power to make laws with respect to taxes on income  other than agricultural income, whereas State Legislature has  exclusive power to make laws with respect to taxes on  agricultural income, under Article 246(1) of the Constitution read  with Entry 82 of List I in the Seventh Schedule and Article 246(3)  read with Entry 46 of List II in the Seventh Schedule.       22.     The expression \023agricultural income\024, for the purpose of  above-mentioned entries, means agricultural income as defined  for the purpose of the enactments relating to Indian Income-tax  vide Article 366(1) of the Constitution.  Therefore, the definition of  \023agricultural income\024 in Article 366(1) indicates that it is open to  the income-tax enactments in force from time to time to define  \023agricultural income\024 in any particular manner and that would be  the meaning not only for tax enactments but also for the  Constitution.  This mechanism has been devised to avoid a  conflict with the legislative power of States in respect of  agricultural income.  From the said definition of \023agricultural  income\024 in Article 366(1) it becomes clear that Rule 8 of 1962  Rule (corresponding to Rule 24 framed under I.T. Act, 1922)  pertains to and is integrated with the definition of the expression  \023agricultural income\024 for the purposes of laws pertaining to  Indian Income-tax and, therefore, the said rule has to be taken  into account in considering the meaning of the expression  \023agricultural income\024 in Article 366(1) of the Constitution.  It is  significant to note that the words used in Article 366(1) of the  Constitution are not \023as defined by the enactments relating to  Indian Income-tax\024 but \023as defined for the purposes of the  enactments relating to Indian Income-tax\024.  Therefore, it is clear  from the definition in Article 366(1), that Rule 8 of 1962 Rule  (Rule 24 of I.T. Rules, 1922), defines the term \023agricultural  income\024 for the purposes of laws pertaining to Indian Income-tax  and, therefore, the said rule has to be taken into account in  considering the meaning of the term \023agricultural income\024 under  Article 366(1) of the Constitution.  [See: Tata Tea Ltd. v. State  of West Bengal \026 (1988) 173 ITR 18 (SC) ].         23.     In short, whatever definition is given in the I.T. Act shall be

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deemed to be adopted under the Constitution by virtue of Article  366(1) of the Constitution of India.         24.     It is in the above context that one has to examine the scope  of Rule 8 of 1962 Rule.  Rule 8 refers to cases of integrated  income.  Where the income of the assessee is partly from  agriculture and partly from manufacture \026 example, where the  assessee grows tea and subjects it to a manufacturing process,  and sells the manufactured product \026 the profits on the sales  have to be apportioned, and the elements in the profits referable  to agricultural activities may be exempted as being agricultural  income.  In such cases, the task of apportionment is simplified by  Rules 7 and 8 framed in exercise of powers conferred by Section  295(2)(b).  Under Rule 7 the market value of the agricultural  produce used as raw material in the business is deductible from  the business profits, as representing agricultural income.  Under  Rule 8, which applies only in cases where the assessee himself  grows tea-leaves and manufactures tea in India, 40% of the  profits on sales is taxable as business income, while the balance  is exempt as representing agricultural income.  If an income  receipt, comprises of both agricultural and non-agricultural  elements, it has to be disintegrated \026 and that portion which  represents agricultural income should be exempted from tax.   Thus, composite revenue derived from land may be apportioned.   In cases where a person subjects agricultural produce to a  manufacturing process before selling it, the profits on the sale  has to be disintegrated and the portion representing agricultural  income would be exempt from tax but the portion attributable to  the manufacturing process would be taxable as business profits.   This is the basic scheme of Rule 8.  Therefore, the position which  emerges is that income derived from the sale of tea grown and  manufactured by the seller in India shall be computed as income  derived from business and 40% of such income shall be deemed  to be liable to tax under the I.T. Act.  Only the balance 60% of  such income would be deemed to be agricultural income on  which the State Legislature would have the power to levy  agricultural income-tax under Article 246(3) r/w Entry 46, List II  of the Seventh Schedule to the Constitution.  However, the State  Legislature would have no power to make any law which would  have the effect of levying tax on the aforestated 40% of such  income on which tax is payable under the I.T. Act by virtue of the  provisions of the I.T. Act.  The computation of income from tea  has to be in accordance with the relevant provisions of the  enactments relating to the Indian Income-tax and the deductions  towards various expenses incurred for earning the income shall  be liable under the said enactments relating to Indian Income- tax.  Thus, where computation of income from cultivation,  manufacture and sale of tea is made in accordance with the  provisions of the I.T. Act, the Agricultural Income-tax Officer  would have no option but to accept the computation by the A.O.  under 1961 Act and treat 40% of such income, as business  income and the balance 60%, as agricultural income.       25.     To the above extent there is no dispute.  The question before  us is whether computation of Section 80HHC Deduction could be  said to be part of computation provision under the 1961 Act,  particularly, provisions dealing with computation of income  under the head \023Business Income\024 and particularly when the  said Deduction has to be made from \023gross total income\024 under  Chapter VIA       26.     The term \023agricultural income\024 has been defined under  Section 2(1A) of the 1961 Act.  It is exempted from tax under  1961 Act because Parliament has no power under the  Constitution to levy tax on agricultural income.  The word

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\023income\024 has been defined in Section 2(24) of the said Act to  include profits and gains.  The term \023total income\024 is defined in  Section 2(45) of the said Act.  The definition of the term \023total  income\024 involves two ingredients \026 firstly, that 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.  Therefore, the manner of computation laid down  by the I.T. Act forms an integral part of the definition \023total  income\024.  The correct method of approach is to treat nothing as  being charged to tax until by the process of computation laid  down by the said Act, the status of income, profits and gains,  emerges.  This principle is very important for deciding the present  case.  We repeat that computation laid down by the said Act  forms an integral part of the definition of \023total income\024.  Section  4 charges the total income of an assessee to income-tax.  Section  5 of the I.T. Act defines \023total income\024.       27.     At this stage we have to analyse Chapter III which deals  with Incomes which do not form part of total income.  Section 10  groups in one place various incomes which are exempt from tax.   The incomes enumerated in Section 10 are not only excluded  from the taxable income of the assessee but also from his total  income.  The exemption embodied in Section 10 can be divided  into two categories, namely, exemption to which certain classes of  income from their very nature are entitled to exemption and the  second category concerns exemption to which the character of  the assessee entitles him to claim exemption.  In the first  category is agricultural income whereas in the second category of  exempted income is the income of local authorities and  diplomatic officers.  We are concerned with the first category.         28.     In addition to the above two categories there is a third kind  of income.  These incomes are wholly or partly tax-free incomes  on account of special deductions under Chapter VIA.  We are  essentially concerned with these \023tax-free incomes\024.         29.     In the present matter we are required to adjudicate upon  the fiction in Rule 8 vis-‘-vis the computation contemplated by  Chapter VIA in which Section 80B(5) finds place and which  defines the expression \023gross total income\024 as total income  computed in accordance with the provisions of the said Act before  making any deduction under Chapter VIA.  Section 10(1) inter  alia provides that agricultural income is not includible in the  total income of the assessee.  The result is that agricultural  income is not only exempt from tax but, under the scheme of the  I.T. Act, is also to be excluded from computation of the total  income.  Exemptions granted under the I.T. Act covers \023incomes\024  which are exempt from Charge and also from total income of the  assessee whereas there are \023incomes\024 which are exempted from  income-tax but they are to be included in the total income of the  assessee.  In the first case, we have agricultural income which is  exempt from Charge as also from total income whereas in the  second case we have incomes which are exempted from the  Charge but they are included in the total income of the assessee,  for example, at one point of time certain incomes were exempted  under Sections 86 and 86A but expressly declared by Section 66  to be included in the total income.  Section 110 indicates incomes  which are free from the Charge but which are required to be  included in the total income of the assessee.  The effect of  including exempted income in the total income of the assessee is  of two-fold.  Firstly, the rate of tax is determined with reference to  the total income and, therefore, exempted income which is  included in the total income would affect the rate of tax  applicable to the chargeable portion of total income.  Secondly,  calculations in several cases have to be made with reference to

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total income.  For example, tax relief under Section 80HH is  restricted to the ceiling limit determined by reference to gross  total income of the assessee which expression, as stated above, is  defined in Section 80B(5) of the I.T. Act. It is also important to  bear in mind that under Section 4 the levy is on \023total income\024 of  the assessee computed in accordance with and subject to the  provisions of the I.T. Act.  What is chargeable to tax under the  I.T. Act is the profits and gains of a year.  What is chargeable to  tax under the I.T. Act is not gross receipts but income.  Under the  I.T. Act the tax is on income and not on gross receipts.  Section 4  is the charging section.  Section 5 defines gamut of \023total  income\024.  Section 4 charges every person in respect of his total  income, however, income cannot be taxed unless it falls within  Section 5 subject to it being saved by any other section from  taxation.  The ambit of taxation, being subject to the provisions of  the I.T. Act, involves two consequences.  Firstly, provisions of the  I.T. Act, example, Section 10 to Section 12 and various sections  under Chapter VIA, may have the effect of exempting income  which would otherwise be chargeable under Section 5.  Secondly,  the amount of income from whatever sources derived is to be  ascertained subject to the provisions of particular sections  dealing with the sources, namely, Section 15 to Section 59.         ASSUMPTION 30.     Before coming to the reasons in support of our findings we  would like to explain the claim of the assessees.  For that  purpose we need to give a mathematical illustration based on  certain assumptions.

       (a) Calculation according to assessees: Composite Income as business  profits : Rs.16.05 crores Total turnover : Rs.52.20 crores FOB Value of Export Sales : Rs.64.08 lakhs

Thus, Deduction under Section 80HHC = 64.08 lakhs x16.05 crores = Rs.19.70 lacs (Apprx.) (Rounded off to Rs.20Lacs)             52.20 crores

       After deducting Rs.20 lacs from Rs.16.05 crores  the total income will come to Rs.15,85,00,000/-  (Approx.) to which apportionment of 60:40 under  Rule 8(1) will be applied to arrive at income liable to  tax.

(b) Calculation according to A.O. Composite Income as  business profits : Rs.16.05 crores 40% of composite income : Rs.6.42 crores (Approx.) Total turnover : Rs.52.20 crores FOB Value of Export Sales : Rs.64.08 lakhs

Thus, Deduction  = 64.08 lakhs    x 6.42 crores = Rs.7.88 lacs (approx.)                                      52.20 crores

NB : The main difference is on the amount of deduction i.e.

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between Rs.19.70 lacs (approx.) in the former case and  Rs.7.88 lacs (approx.) according to A.O.

ISSUE 31.     As stated, the case of the assessees is that 80HHC  Deduction should be granted against the entire tea income before  applying Rule 8(1).         32.     To put it simply, if the business profit is Rs.50 lacs, the total  turnover is Rs.200 lacs and  export turnover is   Rs.100 lacs   then  Section   80HHC  Deduction  will   be: 50  x  100   = Rs. 25 lacs          and                                                                                200 accordingly assessee would claim deduction of Rs.25 lacs from  business profits of Rs.50 lacs to arrive at the total income of  Rs.25 lacs which would be liable to be apportioned in the ratio of  60 : 40 and consequently Rs.10 lacs would be liable to income- tax.   

33.     On the other hand, according to Department, applying the  apportionment of 60 : 40 in Rule 8(1) to Rs.50 lacs the business  profit would come to Rs.20 lacs which would be allocated  between  export  turnover : total  turnover  to  arrive  at   Section  80HHC Deduction which will be : 20  x  100    = Rs.10 lacs.                                                                                       200         34.     In short, assessee claims 80HHC Deduction at Rs.25 lacs  whereas Department calculates 80HHC Deduction at Rs.10 lacs  to arrive at the \023total income\024.         FINDINGS  35.     The word \023income\024 is defined in Section 2(24) of the 1961  Act.  That word finds place in Rule 8(1).  The word \023income\024 in  Section 2(24) includes \023profits and gains\024.  The term \023total  income\024 is defined in Section 2(45) to mean the total amount of  income referred to in Section 5, computed in the manner laid  down in the I.T. Act.  The word \023total income\024 is not there in Rule  8.         36.     The word \023income\024 is an expression of elastic ambit.  It is  not exhaustive.  That is why Section 2(24) defines \023income\024 as  including a particular category of receipts.  Mere gross receipt  cannot be taxed as income.         37.     Section 80HHC inter alia  states that in computing the \023total  income\024 a deduction, to the extent of profits derived by the  assessee from exports has to be taken into account.  The  important words are \023profits derived from the export\024.  The word  \023derived\024 would mean \023derived from the source\024.  That source has  to be in Section 14.  Income covered by Section 10(1) i.e.  agricultural income, which is not chargeable to tax, does not fall  in Section 14 and, therefore, it will not fall under various  computation sections commencing from Section 15 to Section 59.   Section 14 classifies \023all income\024 into five enumerated heads for  the purpose of charge of income-tax and computation of total  income.  As stated hereinabove, \023exempted income\024 is different  from \023tax-free income\024.  In the present case, we are concerned  with both these types of income.  \023Agricultural income\024 falls in  the category of exempted income.  It is neither chargeable nor  includible in the total income.  On the other hand, deduction  under Chapter VIA is for \023income\024 which forms part of total

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income but which is tax-free.  In the present case, we have to  balance both these types of income, namely, exempted income  vis-‘-vis tax-free income.  Thus, it is clear that \023income\024, covered  under Section 10 and Section 11 which is not chargeable to tax,  does not fall under Section 14 and under various computation  sections from Section 15 to Section 59.  However, on account of  legal fiction built into Rule 8(1), which applies to composite  income, a part of the composite income/integrated income is  agricultural income and the balance is the business income.  The  object of Rule 8(1) is to disintegrate the two.  If the income from  agriculture cannot be computed under 1961 Act then the income  from agriculture has to be arrived at in a normal commercial  manner.  There is no scope for computing such income by  complying with the computation section under the I.T. Act.  In  other words, the real income has to be taken into account for the  purpose of considering the exemption under Section 10(1).  This  position emerges in a case where we have to deal solely with  agricultural income.  However, as stated above, in this case we  are concerned with the composite income.  Therefore, we have to  interpret Rule 8(1) of the1962 Rule.       38.     At the outset, it may be noticed that Rule 8(1) uses the word  \023income\024.  In the entire rule the word \023total income\024 is not  mentioned.  Further, Rule 8(1) refers to income derived from the  sale of tea cultivated and manufactured.  In the case of an  assessee deriving income, not from composite activity, one has to  calculate agricultural income in the commercial sense.  However,  when we come to composite income under Rule 8(1) a part of the  composite income is business profit, which is one of the  source/head of income under Section 14, and therefore to that  extent alone chargeability and computation would arise and that  too only to the extent of computation of income under the head  \023profits and gains from business\024.  Therefore, the charging  provision and computation provision will apply only to that  limited extent.  That is why in Rule 8 a legal fiction is  incorporated.         39.     It is well-settled that chargeability and computation under  1961 Act, constitutes one integral Code.  Rule 8(1), therefore,  states that composite/integrated income shall be computed as if  it was income derived from business.  The words \023as if\024 stand for  legal fiction.  Therefore, the composite income had an element of  agricultural and business incomes which needed to be separated  by applying the rule of apportionment under Rule 8.  That is  because, agricultural income has no linkage with any of the  enumerated heads in Section 14 though the non-agricultural  element has such linkage.  Rule 8(1) says that when income is  derived from composite activity such income shall be chargeable  to income-tax as \023business income\024.  In other words, in the case  of composite income, by legal fiction, chargeability is assigned  only to non-agricultural part of the composite income which has  linkage with one of the enumerated heads in Section 14, namely,  \023business income\024.  Therefore only to that extent, the  computation provisions, mentioned in Section 15 to Section 59 of  the I.T. Act, stand attracted.  Therefore, Rule 8(1) makes it clear  that chargeability and computability shall be confined to 40% of  such income which shall be deemed to be income liable to tax.   We have to confine the legal fiction in Rule 8(1) to that rule alone.   We cannot extend the legal fiction in Rule 8(1) to Section  80HHC(3)(a).  As stated above, there is a vital difference between  income not chargeable to tax and not includible in the total  income (for example, agricultural income) and income which  forms part of total income but which is made tax-free.   Deductions under Chapter VIA fall in the category of tax-free  incomes.  In fact, history shows that some of the incomes in

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Chapter VIA have been transferred from Chapter VII to Chapter  VIA.  Chapter VII has been deleted.  However, at the relevant time  Chapter VII referred to incomes forming part of total income on  which no tax was payable.  That is why, we have stated that there  is a difference between \023exempted incomes\024 and \023tax-free  incomes\024.  This distinction is of some importance.  As stated  above, Section 5 provides what the \023total income\024 shall include.   Chapter III refers to \023incomes which do not form part of total  income\024.  Chapter IV deals with \023computation of total income\024.  It  classifies the \023income\024 under different heads and the deductions  to be made in respect of each of the different heads of income.  In  the Income-tax Act, the expression \023income includible in the total  income\024 has a definite connotation.  Similarly, the expression  \023deduction and allowances\024 have particular connotation.   Therefore, on one hand we have \023agricultural income\024 which is  neither chargeable nor includible in the total income and on the  other hand we have \023incomes\024 under Chapter VIA which are part  of total income but which are tax-free.         40.     In this case, however, we are concerned with composite  income which is partly agricultural and partly business.   Therefore, Rule 8(1) segregates agricultural income which is  exempted income from business income which is chargeable to  tax.  For that purpose we need to apply the ratio of 60 : 40.   Therefore, to the extent of 40% only we have chargeability and  computability.  If this distinction is kept in mind we are of the  view that the assessee cannot claim 80HHC(3)(a) Deduction  against the entire tea composite income.  It can be claimed only  against proportionate income.  Therefore, in the above example,  80HHC Deduction can be claimed not against the entire  composite income of Rs.50 lacs but it can be claimed only against  a part thereof which is Rs.20 lacs.  Similarly, in the other  example, 80HHC Deduction can be claimed not against  composite income of Rs.16.05 crores, it can be claimed only  against the composite income of Rs.6.42 crores.  For the above  reasons, we are of the view that Section 80HHC Deduction  cannot be allowed against the entire tea income.

Is Section 80HHC a part of the provisions of the 1961 Act  which deals with computation under the head \023Profits and  Gains from Business\024?       41.     The contention of the assessees cannot be accepted for one  more reason.  The tea income consists of two parts : (i)  \023agricultural income\024 upto the stage of growing the tea; and (ii)  \023business income\024 from the manufacture and sale of tea grown by  the assessee.  Under the Constitution, \023agricultural income\024 can  be taxed only by the State Governments.  Rule 8(1), therefore,  provides that only 40% of the composite income can be taxed  under the 1961 Act.  Power of the State Governments to levy tax  extends to the balance, namely, 60% of the composite income.   This part of the composite income (60%) cannot be taxed under  the 1961 Act (See: Section 10(1) of the 1961 Act).  As stated  above, Rule 8(1) provides for the method in which composite  income is to be computed.  Rule 8(1) says that income shall be  computed as if it were income derived from business.  Rule 8(1)  uses the word \023income\024 and not \023total income\024.  The 1961Act  contains provisions for computation of income under the head  \023Business\024.  The question is whether Section 80HHC is part of  the provisions in the 1961 Act which deals with computation of  income under the head \023profits and gains from business\024?  If it is,  then apportionment prescribed by Rule 8(1) can be applied only  after deducting the allowance under Section 80HHC from the  composite income as contended by the assessees.  However, in  our view computation in Rule 8(1) in respect of composite

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income, by reason of legal fiction in-built in Rule 8, cannot be  read in entirety into computation of income under the head  \023Business\024.  If the contention of the assessees is accepted,  namely, that the entire computation of composite income under  Rule 8(1) is part of computation provisions under the head  \023Business\024 then it would amount to granting deduction under  Section 80HHC even with reference to income which is exempt  under Section 10(1) of the 1961 Act, namely, agricultural income.   Such a result would be opposed to the basic scheme of the 1961  Act.  In this connection, it is also important to note that under  Section 80A which falls in Chapter VIA, deductions are allowed  only from \023gross total income\024.  The object for making such  provision is to limit the amount of 80HHC Deduction.  It is true  that Section 80HHC provides for deduction of a percentage of the  export profits.  The percentage is calculated with reference to the  export profits, but the deduction is only from \023gross total income\024  as defined under Section 80B(5) of the 1961 Act.  Therefore, the  very scheme of 1961 Act is to treat the deductions under Chapter  VIA as deductions only from \023gross total income\024 in order to  arrive at the \023total income\024.  In other cases falling under Section  28 where computation of income falls under the head \023Business\024,  allowances are deductible from the income but not from \023gross  total income\024.  It is, therefore, not possible to accept the  contention that Section 80HHC is part of the provisions for  computation of business income.  Section 80HHC does not have  any direct impact on the computation of business income in the  manner in which, for example, Section 72 affects the  computation of business income.  On behalf of the assessees  heavy reliance was placed on the judgment of this Court in the  case of Cambay Electric Supply Industrial Company Ltd.  (supra).  That was a case where this Court held that Section 72  provides for the business loss, not set-off fully against the other  heads of income under Section 71, to be carried forward and  adjusted against the profits of the same business in the next  year.  Inter-head and intra-head adjustments and carry-forwards  are part of the computation provisions.  However, Section 72  cannot be compared with Section 80HHC because Section  80HHC provides for deduction only from \023gross total income\024.     Therefore, the judgment of this Court in Cambay Electric  Supply Industrial Company Ltd. (supra) has no application.         42.     Reliance was also placed by the assessees on the judgment  of this Court in the case of The Karim Tharuvi Tea Estates  Ltd., Kottayam and Anr. v. State of Kerala and Ors. \026 (1963)  48 ITR 83 (SC).  In that decision this Court referred to the  provisions of Section 10 of I.T. Act, 1922 and to the deduction  available thereunder as being deductible while computing the  composite income.  It was not concerned with Section 80HHC  Deduction.  Therefore, that judgment has no application to the  present case.         43.     Even in the case of Tata Tea Ltd. v. State of West Bengal  \026 (1988) 173 ITR 18 (SC), there is no reference to the deductions  under Chapter VIA.         44.     In short, deductions under Chapter VIA are deductions not  from a particular head of income but from gross total income.  Therefore, Section 80HHC is not part of the computation of  income under the head \023Business\024.       45.     For the aforestated reasons, we hold that 80HHC Deduction  of the 1961 Act is required to be allowed after apportionment of  income under Rule 8(1) of the 1962 Rule.                        46.     For the aforestated reasons, we set aside the impugned

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judgments of the Guahati High Court in Civil Appeal Nos. 3803- 3808 of 2005, Civil Appeal No.1021 of 2006, Civil Appeal No.1825  of 2007, Civil Appeal No. 1827 of 2007 and Civil Appeal  No..........of 2007 arising out of S.L.P.(C) No.2275 of 2007 and  affirm the impugned judgment of the Calcutta High Court in Civil  Appeal Nos.6719-20 of 2004 \026 Warren Tea Ltd. & Anr. etc. v.  Union of India & Ors. etc.  Accordingly, the above issue is  answered in favour of the Department and against the assessees.   Civil appeals are, accordingly, disposed of with no order as to  costs.