Supreme Court clarifies deduction under Section 80HH of Income Tax Act: Vijay Industries vs. Commissioner of Income Tax (2019)

Date of the Judgment: March 01, 2019

Citation: (2019) INSC 176

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

When calculating tax deductions for businesses in backward areas, should depreciation and investment allowances be factored in? The Supreme Court of India addressed this question in a recent judgment, clarifying the scope of Section 80HH of the Income Tax Act, 1961. This case revolved around whether deductions should be applied to ‘profits and gains’ or ‘income’ after accounting for depreciation and investment allowances. The three-judge bench, composed of Justices A.K. Sikri, S. Abdul Nazeer, and M. R. Shah, delivered the judgment.

Case Background

The dispute arose from the interpretation of Section 80HH of the Income Tax Act, 1961, which provides deductions for industrial undertakings in backward areas. The core issue was whether the 20% deduction should be calculated on the gross ‘profits and gains’ or on the ‘income’ after deductions like depreciation and investment allowance. The assessees argued that the deduction should be based on gross profits, while the Income Tax Department contended it should be on net income after all deductions.

The case specifically concerned the Assessment Years 1979-80 and 1980-81. The assessees, M/s. Vijay Industries, and other similar entities, were claiming deductions under Section 80HH based on their gross profits. The Income Tax Department, however, insisted that the deductions should be calculated after accounting for depreciation, unabsorbed depreciation, and investment allowances, as per Sections 28 to 44DB of the Income Tax Act, which deal with the computation of income under the head ‘profits and gains of business or profession’.

Timeline

Course of Proceedings

The High Court had previously ruled in favor of the Income Tax Department, following the Supreme Court’s decision in Motilal Pesticides (I) Pvt. Ltd. vs. Commissioner of Income Tax, Delhi-II. This earlier ruling supported the view that deductions under Section 80HH should be computed on net income after accounting for depreciation and investment allowances.

The assessees appealed to the Supreme Court, arguing that the Motilal Pesticides case was incorrectly decided and needed a re-look. A Division Bench of the Supreme Court, after hearing the arguments, noted the conflict and referred the matter to a larger bench for a conclusive decision.

Legal Framework

The core of the dispute lies in the interpretation of Section 80HH of the Income Tax Act, 1961. This section states:

“80HH. Deduction in respect of profits and gains from newly established industrial undertakings or hotel business in backward areas. (1) Where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking, or the business of a hotel, 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 from such profits and gains of an amount equal to twenty per cent thereof.”

Section 4 of the Act is the charging section, which makes the total income of the previous year chargeable to tax. Section 14 enumerates different heads of income, including ‘profits and gains of business or profession’, which is governed by Sections 28 to 44DB. These sections provide for various deductions, including depreciation under Section 32 and investment allowance under Section 32AB.

Chapter VIA of the Act contains provisions for certain deductions in computing total income, including Section 80HH. Section 80A stipulates that deductions specified in Sections 80C to 80U are allowed from ‘gross total income’. The court noted that Chapter VIA is a stand-alone chapter, separate from Chapter IV, which deals with computation of income under various heads.

Arguments

The appellants, represented by Mr. Bagaria, argued that the term ‘profits and gains’ in Section 80HH is distinct from ‘income’. They contended that the deduction should be calculated on the gross profits and gains of the industrial undertaking, without factoring in depreciation and investment allowances. They highlighted that Section 80HH specifically uses the term ‘profits and gains’ and not ‘income’, which is defined differently under the Act.

The appellants further argued that the restrictive clause in Section 80AB, which applies to provisions based on ‘income’ or ‘gross total income’, is inapplicable to provisions like 80HH, 80I, 80IA, and 80J, which are intended to promote specific activities and are calculated on ‘profits and gains of business’.

The Income Tax Department, represented by Ms. Vibha Datta Makhija, argued that the legislative intent was to compute deductions with reference to ‘income’ included in the gross total income. They relied on the insertion of Section 80AB, which, according to them, clarified that deductions should be computed after considering all other deductions under the Act. They also cited the judgment in Distributors (Baroda) Pvt. Ltd. v. Union of India & Ors., which overruled M/s. Cloth Traders (P) Ltd., to support their argument that deductions should be based on net income.

The department contended that although Section 80AB was inserted with effect from 01.04.1981, it was clarificatory in nature and should apply retrospectively. They also relied on the judgment in Commissioner of Income Tax, T.N.-V, Madras v. Kotagiri Industrial Cooperative Tea Factory Ltd., Kotagiri, to argue that deductions under Section 80P should be allowed only after setting off unabsorbed losses of earlier years.

Issues Framed by the Supreme Court

The Supreme Court framed the following issue for consideration:

1. Whether the deduction under Section 80HH of the Income Tax Act, 1961, should be allowed on the gross profits and gains or on the net income after accounting for depreciation and investment allowances?

Treatment of the Issue by the Court

Authorities

Judgment

What weighed in the mind of the Court?

The Supreme Court’s decision was primarily influenced by the specific language used in Section 80HH, which refers to ‘profits and gains’ rather than ‘income’. The Court emphasized that Chapter VIA, where Section 80HH is located, is a stand-alone chapter, and deductions under it should be interpreted independently of Chapter IV, which deals with the computation of income under various heads. The Court also noted that the term ‘profits and gains’ is conceptually different from ‘income’, and the deductions under Section 80HH are in the nature of incentives, not expenses.

The Court also considered the legislative intent behind Section 80HH, which is to encourage industrial development in backward areas. It recognized that providing deductions on gross profits and gains would better serve this purpose. The Court also acknowledged that Section 80AB, which was inserted to clarify that deductions should be computed with reference to net income, was prospective and did not apply to the assessment years in question.

The Court rejected the argument that Section 80AB was clarificatory in nature, emphasizing that it was a prospective amendment. It also distinguished the cases relied upon by the Income Tax Department, noting that they were either related to different sections or had different contexts.

The final decision was that the deduction under Section 80HH should be allowed on the gross profits and gains of the industrial undertaking, without deducting depreciation and investment allowance.

The Court quoted the following from the reference order: “Conceptually, “any income” and “profits and gains” are different under the Income Tax Act. (See Section 80-M read with Sections 80-AA & AB, Section 80-T which speak of “any income” and Section 28 which speaks of “income from profits and gains” showing thereby that conceptually the two expressions are understood as distinct in law).”

The Court also quoted the following from Section 80HH: “80HH. Deduction in respect of profits and gains from newly established industrial undertakings or hotel business in backward areas. (1) Where the gross total income of an assessee includes any profits and gains derived from an industrial undertaking, or the business of a hotel, 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 from such profits and gains of an amount equal to twenty per cent thereof.”

The Court also quoted the following from the circular issued by the Central Board of Direct Taxes: “The new section 80AB will take effect from 1st April, 1981, and will accordingly apply in relation to the assessment year 1981-82, and subsequent years. It should be carefully noted that the new section 80AB, unlike section 80AA, will not have any retrospective operation.”

Key Takeaways

• ✓ Deductions under Section 80HH of the Income Tax Act, 1961, for industrial undertakings in backward areas should be calculated on gross profits and gains, without deducting depreciation and investment allowance.
• ✓ The terms ‘profits and gains’ and ‘income’ are conceptually different under the Income Tax Act.
• ✓ Section 80AB of the Income Tax Act, which specifies that deductions should be computed with reference to net income, is prospective and does not apply to the assessment years 1979-80 and 1980-81.
• ✓ This judgment overrules the previous decision in Motilal Pesticides (I) Pvt. Ltd. vs. Commissioner of Income Tax, Delhi-II, providing clarity on the interpretation of Section 80HH.

Directions

The Supreme Court did not give any specific directions other than allowing the appeals.

Development of Law

The ratio decidendi of this case is that deductions under Section 80HH of the Income Tax Act, 1961, should be calculated on the gross profits and gains of the industrial undertaking, without deducting depreciation and investment allowance. This decision changes the previous position of law as established in Motilal Pesticides (I) Pvt. Ltd. vs. Commissioner of Income Tax, Delhi-II, which was overruled by this judgment.

Conclusion

In conclusion, the Supreme Court’s judgment in M/S. VIJAY INDUSTRIES VERSUS COMMISSIONER OF INCOME TAX clarifies that deductions under Section 80HH of the Income Tax Act, 1961, should be calculated on the gross profits and gains of the industrial undertaking, without deducting depreciation and investment allowance. This decision overrules the earlier judgment in Motilal Pesticides and provides much-needed clarity on the interpretation of Section 80HH for the assessment years 1979-80 and 1980-81.