Supreme Court Allows 100% Tax Exemption Post Substantial Expansion Under Section 80-IC: Aarham Softronics Case (2019)

Date of the Judgment: 20 February 2019

Citation: (2019) INSC 128

Judges: A.K. Sikri, J., S. Abdul Nazeer, J., M. R. Shah, J.

Can a business that initially received a 100% tax exemption for setting up a new industrial unit claim the same benefit again if they significantly expand their operations? The Supreme Court of India addressed this question, focusing on the interpretation of Section 80-IC of the Income Tax Act, 1961. This judgment clarifies the conditions under which businesses in specific states can avail tax benefits after substantial expansion.

The Supreme Court bench, comprising Justices A.K. Sikri, S. Abdul Nazeer, and M. R. Shah, delivered the judgment. The leading opinion was authored by Justice A.K. Sikri.

Case Background

The case revolves around several assessees who had established new industrial units in Himachal Pradesh. These units initially availed a 100% tax exemption under Section 80-IC of the Income Tax Act, 1961 for the first five years of operation. After this period, they undertook substantial expansion of their units. The assessees then claimed that the substantial expansion entitled them to another 100% tax exemption for the next five years, instead of the 25% (or 30% for companies) as stipulated for the subsequent five years after the initial five-year period. The Income Tax Department challenged this interpretation, leading to a legal dispute.

Timeline

Course of Proceedings

The High Court of Himachal Pradesh had initially ruled in favor of the assessees, holding that a substantial expansion of an existing industrial unit entitled the assessee to a fresh 100% tax exemption. The Income Tax Department appealed this decision to the Supreme Court. A Division Bench of the Supreme Court initially reversed the High Court’s decision. However, some assessees who were not represented in the initial proceedings filed miscellaneous applications for recall of the order. The Supreme Court allowed these applications, restored the appeals, and reheard them along with new appeals filed by the Revenue. The present judgment is the result of this fresh hearing.

Legal Framework

The core of this case lies in the interpretation of Section 80-IC of the Income Tax Act, 1961. This section provides special tax benefits to certain undertakings in specific states like Himachal Pradesh. Key provisions include:

• Section 80-IC(1): “Where the gross total income of an assessee includes any profits and gains derived by an undertaking or an enterprise from any business referred to in sub-section (2), 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 from such profits and gains, as specified in sub-section (3).” This section allows deductions for profits from businesses mentioned in sub-section (2).
• Section 80-IC(2): This subsection defines the types of undertakings eligible for the deduction, including those that manufacture or produce articles in specified areas, and those that undertake substantial expansion.
• Section 80-IC(3)(ii): “…one hundred per cent of such profits and gains for five assessment years commencing with the initial assessment year and thereafter, twenty-five per cent. (or thirty per cent. where the assessee is a company) of the profits and gains.” This clause specifies the deduction rate: 100% for the first five years and 25% (or 30%) for the next five years.
• Section 80-IC(6): “Notwithstanding anything contained in this Act, no deduction shall be allowed to any undertaking or enterprise under this section, where the total period of deduction inclusive of the period of deduction under this section, or under the second proviso to sub-section (4) of section 80-IB or under section 10C, as the case may be, exceeds ten assessment years.” This provision limits the total deduction period to ten years.
• Section 80-IC(8)(v): “Initial assessment year” means the assessment year relevant to the previous year in which the undertaking or the enterprise begins to manufacture or produce articles or things, or commences operation or completes substantial expansion;” This defines the ‘initial assessment year’ as the year when manufacturing starts or when substantial expansion is completed.
• Section 80-IC(8)(ix): “Substantial expansion” means increase in the investment in the plant and machinery by at least fifty per cent of the book value of plant and machinery (before taking depreciation in any year), as on the first day of the previous year in which the substantial expansion is undertaken.” This defines substantial expansion as an increase of at least 50% in plant and machinery investment.

The interplay of these provisions determines the extent and duration of tax benefits available to industrial units in special category states. The core issue was whether a ‘substantial expansion’ could trigger a new ‘initial assessment year,’ thus entitling the assessee to a fresh 100% deduction.

Arguments

Arguments by the Revenue (Income Tax Department):

• The Revenue argued that the 100% deduction under Section 80-IC(3)(ii) is only available for the first five years from the initial assessment year.
• They contended that the definition of ‘initial assessment year’ in Section 80-IB(14)(c) should be used, which does not allow for a second ‘initial assessment year’ within the 10-year period.
• The Revenue submitted that allowing a second 100% deduction after substantial expansion would defeat the purpose of Section 80-IC(6), which limits the total deduction period to 10 years.

Arguments by the Assessees:

• The assessees argued that the definition of ‘initial assessment year’ in Section 80-IC(8)(v) is applicable, which includes the year of substantial expansion.
• They submitted that a substantial expansion triggers a new ‘initial assessment year’, entitling them to a fresh 100% deduction for the next five years.
• The assessees contended that Section 80-IC(6) only limits the total period of deduction to 10 years, not the number of times a 100% deduction can be claimed.
• They argued that the purpose of Section 80-IC was to encourage industrial growth in special category states, and denying a fresh 100% deduction after substantial expansion would discourage such investments.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. “Whether an assessee who sets up a new industry of a kind mentioned in sub-section (2) of Section 80-IC of the Act and starts availing exemption of 100 per cent tax under sub-section (3) of Section 80-IC (which is admissible for five years) can start claiming the exemption at the same rate of 100% beyond the period of five years on the ground that the assessee has now carried out substantial expansion in its manufacturing unit?”

Treatment of the Issue by the Court

Authorities

The Supreme Court considered the following authorities:

Judgment

How each authority was viewed by the Court?

• Section 80-IC of the Income Tax Act, 1961: The court interpreted various sub-sections of Section 80-IC, particularly the definition of ‘initial assessment year’ and ‘substantial expansion’, to conclude that a substantial expansion triggers a new ‘initial assessment year’, entitling the assessee to a fresh 100% deduction.
• Section 80-IB of the Income Tax Act, 1961: The court distinguished the definition of ‘initial assessment year’ in Section 80-IB from that in Section 80-IC, noting that the former does not apply to the case at hand.
• Commissioner of Income Tax vs. M/s. Classic Binding Industries [CITATION]: The court overruled this judgment, acknowledging that it had erred in applying the definition of ‘initial assessment year’ from Section 80-IB to Section 80-IC, and that the definitions of ‘initial assessment year’ in the two sections are materially different.
• Mahabir Industries v. Principal Commissioner of Income Tax [CITATION]: The court found that this case supported the assessee’s position, as it held that there can be two initial assessment years, one for Section 80-IB and another for Section 80-IC.
• Commissioner of Customs (Import), Mumbai vs. Dilip Kumar and Company and Others [CITATION]: The court quoted this case to emphasize the importance of interpreting a statute based on the intention of the legislature, and that strict interpretation does not encompass such literalism, which lead to absurdity and go against the legislative intent.

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the following factors:

• The plain language of Section 80-IC(8)(v) which defines “initial assessment year” to include the year in which substantial expansion is completed.
• The intention of the legislature to promote industrial growth in special category states by incentivizing substantial expansion.
• The fact that substantial expansion involves significant investment, which should be rewarded with tax benefits.
• The understanding that Section 80-IC(6) only limits the total period of deduction to 10 years, not the number of times a 100% deduction can be claimed.

Fact:Law Ratio

The court’s decision was primarily driven by legal interpretation (80%), with a lesser emphasis on the factual aspects (20%) of the case.

Logical Reasoning:

The court rejected the interpretation that there can be only one ‘initial assessment year’ and held that the definition of ‘initial assessment year’ in Section 80-IC(8)(v) allows for a new initial assessment year upon substantial expansion.

The court observed, “When we keep in mind these objectives for which Section 80-IC was enacted, an irresistible conclusion would be to grant 100% deduction of the profits and gains even from the year when there is substantial expansion in the existing unit.”

The court further noted, “With an expansion of such a nature not only there would be increase in production but generation of more employment as well, which would benefit the local populace. It is for this reason, carrying out substantial expansion by itself is treated as ‘initial assessment year’.”

The court also stated, “As per sub-section (6), cap is on the 10 assessment years. It is not on quantum.”

Key Takeaways

• Businesses in Himachal Pradesh that initially availed a 100% tax exemption under Section 80-IC can claim the same benefit again if they undertake substantial expansion.
• A ‘substantial expansion’ triggers a new ‘initial assessment year’, entitling the unit to a fresh 100% deduction for five years, subject to the overall 10-year limit.
• The total deduction period under Section 80-IC is capped at 10 years, but there is no restriction on the number of times a 100% deduction can be claimed within this period.
• This judgment promotes industrial growth in special category states by incentivizing substantial investments.

Directions

The Supreme Court dismissed all appeals of the Revenue and allowed the appeals filed by the assessees.

Development of Law

The ratio decidendi of this case is that the definition of ‘initial assessment year’ in Section 80-IC(8)(v) allows for a new initial assessment year upon substantial expansion, thereby entitling the assessee to a fresh 100% deduction for five years, subject to the overall 10-year limit. This judgment overrules the previous position of law laid down in Commissioner of Income Tax vs. M/s. Classic Binding Industries, which had erroneously applied the definition of ‘initial assessment year’ from Section 80-IB to Section 80-IC.

Conclusion

The Supreme Court’s judgment in the Aarham Softronics case clarifies that businesses in special category states like Himachal Pradesh can avail a fresh 100% tax exemption under Section 80-IC after undertaking substantial expansion, subject to the overall 10-year limit. This decision promotes industrial growth by incentivizing significant investments in plant and machinery. The court’s interpretation of Section 80-IC(8)(v) provides clarity on the definition of ‘initial assessment year’ and its implications for tax benefits.