LEGAL ISSUE: Whether income from Duty Entitlement Pass Book (DEPB) and Duty Drawback schemes qualifies for tax deductions under Section 80-IB of the Income Tax Act, 1961.
CASE TYPE: Income Tax Law
Case Name: M/s. Saraf Exports vs. Commissioner of Income Tax, Jaipur-III
[Judgment Date]: April 10, 2023
Date of the Judgment: April 10, 2023
Citation: Civil Appeal No. 4822 of 2022 (@SLP (C) No. 17539 of 2016)
Judges: M.R. Shah, J. and B.V. Nagarathna, J.
Can export incentives like Duty Entitlement Pass Book (DEPB) and Duty Drawback be considered as profits “derived from” a business, thereby qualifying for tax deductions? The Supreme Court of India recently addressed this question, clarifying the scope of Section 80-IB of the Income Tax Act, 1961. The court held that such incentives are not directly derived from the business, and thus, do not qualify for deductions under the said section.
The bench comprised Justices M.R. Shah and B.V. Nagarathna, who delivered a unanimous judgment.
Case Background
M/s. Saraf Exports, a partnership firm, was engaged in manufacturing and exporting wooden handicraft items. For the Assessment Year 2008-09, the firm filed its income tax return on September 30, 2008, declaring a nil income. However, they claimed deductions of ₹70,197 for DEPB and ₹76,27,636 for receipts under the Duty Drawback scheme.
The firm had credited these amounts to their Profit & Loss Account, claiming them as “Profit/gains of business/profession” under Sections 28(iiic) and 28(iiib) of the Income Tax Act, 1961. The Deputy Commissioner disallowed these deductions, a decision upheld by the Commissioner of Income Tax (Appeals). However, the Income Tax Appellate Tribunal (ITAT) reversed this decision, stating that the Supreme Court’s decision in Liberty India vs. Commissioner of Income Tax, (2009) 9 SCC 328 was per incuriam.
The High Court of Judicature for Rajasthan at Jaipur, however, overturned the ITAT’s decision, relying on the Supreme Court’s judgments in Liberty India and Commissioner of Income Tax, Karnataka vs. Sterling Foods, Mangalore (1999) 4 SCC 98, thus disallowing the deductions claimed under Section 80-IB of the Act. This led to the present appeal before the Supreme Court.
Timeline
| Date | Event |
|---|---|
| September 30, 2008 | M/s. Saraf Exports filed income tax return for Assessment Year 2008-09, claiming deductions for DEPB and Duty Drawback. |
| November 24, 2010 | Deputy Commissioner disallowed the claimed deductions. |
| – | Commissioner of Income Tax (Appeals) upheld the Deputy Commissioner’s order. |
| December 17, 2013 | Income Tax Appellate Tribunal (ITAT) allowed the appeal by M/s. Saraf Exports. |
| February 4, 2016 | High Court of Judicature for Rajasthan at Jaipur allowed the appeal by the Revenue, disallowing the deductions. |
| April 10, 2023 | Supreme Court dismissed the appeal by M/s. Saraf Exports. |
Legal Framework
The core of this case revolves around the interpretation of Section 80-IB of the Income Tax Act, 1961, which provides deductions for profits and gains from certain industrial undertakings. This section is juxtaposed with Section 28 of the same Act, which defines what constitutes “profits and gains of business or profession.”
Section 28 of the Income Tax Act, 1961, specifically includes certain incentives as taxable income under the head “Profits and gains of business or profession.” These include:
- Section 28(iii-b): Cash assistance received against exports.
- Section 28(iii-c): Duty of customs or excise repaid as drawback against exports.
- Section 28(iii-d): Profit on the transfer of the Duty Entitlement Pass Book Scheme.
- Section 28(iii-e): Profit on the transfer of the Duty Free Replenishment Certificate.
Section 80-IB of the Income Tax Act, 1961, allows deductions on profits and gains “derived from” eligible businesses, which include various industrial undertakings. The key phrase here is “derived from,” which the court has interpreted to mean a direct source of income from the industrial undertaking itself.
The Supreme Court also referred to Section 75 of the Customs Act, 1962, which empowers the government to provide for repayment of customs and excise duty paid by an assessee. The court noted that the source of duty drawback lies in this provision and Section 37 of the Central Excise Act, 1944.
Arguments
Assessee’s Arguments:
- The assessee argued that the meaning of “derived from” under Section 80-IB, as interpreted in Liberty India, has been broadened by the Supreme Court in Commissioner of Income Tax vs. Meghalaya Steels Limited, (2016) 6 SCC 747.
- They contended that Liberty India‘s conclusion was based on a “first degree” connection requirement, whereas DEPB and Duty Drawback are incentives under the Duty Exemption Remission Scheme and Section 75 of the Customs Act, 1962.
- The assessee relied on Meghalaya Steels Limited, where the court allowed deductions for transport, interest, and power subsidies, arguing that the immediate source of funds (government) is irrelevant if the subsidies reimburse costs incurred in manufacturing or selling products.
- They cited Topman Exports vs. Commissioner of Income Tax, Mumbai, (2012) 3 SCC 593, which held that DEPB and Duty Drawback are related to the cost of manufacture and have a direct nexus with the cost of imports.
- The assessee also referenced B. Desraj vs. Commissioner of Income Tax, Salem, (2010) 14 SCC 510, which categorized Duty Drawback as cash assistance under Section 28(iii)(b).
- They argued that DEPB is government assistance to pay customs duty on imports, with a cost element as it is acquired by paying customs duty on the import content of the export product.
- The assessee submitted that various High Courts have held that the “immediate source” of income is not determinative.
Revenue’s Arguments:
- The Revenue argued that the issue is squarely covered against the assessee by the decisions in Liberty India and Sterling Foods, Mangalore.
- They contended that Meghalaya Steels Limited did not overrule Liberty India or Sterling Foods and that those cases do not apply to DEPB and Duty Drawback schemes.
- The Revenue explained that Section 28 includes incentives like cash assistance, Duty Drawback, and profits on transfer of DEPB as taxable under “profits and gains of business or profession.”
- They emphasized that Section 80-IB uses “derived from,” which has a narrower interpretation than “attributable to,” and is confined to “first degree sources.”
- The Revenue argued that the words “derived from” must be read as “unit specific” and not “standalone” as the clauses of Section 80-IB refer to “industrial undertaking.”
- They argued that DEPB and Duty Drawback schemes do not derive income directly from the business undertaking, thus not qualifying for deductions under Section 80-IB.
- The Revenue cited Sterling Foods, Mangalore, where the court gave a restricted interpretation to “derived from” in Section 80HH, stating that the source of profits must be directly from the industrial undertaking.
- The Revenue argued that Liberty India clarified that Duty Drawback and DEPB benefits are independent sources of income beyond the “first degree nexus” between profits and the industrial undertaking.
- The Revenue distinguished Meghalaya Steels Limited, arguing that it pertained to subsidies directly affecting manufacturing costs, unlike DEPB and Duty Drawback, which are export incentives.
| Main Submission | Assessee’s Sub-submissions | Revenue’s Sub-submissions |
|---|---|---|
| Interpretation of “derived from” under Section 80-IB |
✓ Meaning widened by Meghalaya Steels Limited. ✓ Does not require a “first-degree” connection. ✓ Includes reimbursements of costs. |
✓ Narrower interpretation than “attributable to”. ✓ Confined to “first-degree sources”. ✓ Must be “unit specific” and not “standalone”. |
| Nature of DEPB and Duty Drawback |
✓ Relatable to cost of manufacture. ✓ Direct nexus with the cost of imports. ✓ Cash assistance under Section 28(iii)(b). |
✓ Independent source of income. ✓ Incentives from government schemes. ✓ Not directly derived from the business. |
| Applicability of precedents |
✓ Relied on Meghalaya Steels Limited and Topman Exports. ✓ Various High Courts support the assessee’s view. |
✓ Relied on Liberty India and Sterling Foods. ✓ Meghalaya Steels Limited is distinguishable. |
Issues Framed by the Supreme Court
The Supreme Court framed the following issue for consideration:
- Whether on the income amount received/profit from DEPB and Duty Drawback Schemes, the assessee is entitled to deduction under Section 80-IB of the Income Tax Act, 1961 and whether such an income can be said to be an income “derived from” industrial undertaking?
Treatment of the Issue by the Court
The following table demonstrates as to how the Court decided the issues
| Issue | Court’s Decision | Brief Reasons |
|---|---|---|
| Whether income from DEPB and Duty Drawback schemes qualifies for deduction under Section 80-IB? | No | The court held that such income is not “derived from” the industrial undertaking, but rather from government schemes, and thus does not qualify for deductions under Section 80-IB. |
Authorities
The Supreme Court considered various authorities to arrive at its decision. These are categorized below:
On the Interpretation of “Derived From”:
- Commissioner of Income Tax, Karnataka vs. Sterling Foods, Mangalore (1999) 4 SCC 98 (Supreme Court): The Court interpreted “derived from” to mean a direct nexus between the profits and the industrial undertaking. The source of import entitlements was the Export Promotion Scheme, not the industrial undertaking.
- Liberty India vs. Commissioner of Income Tax, (2009) 9 SCC 328 (Supreme Court): The Court held that DEPB and Duty Drawback are incentives from government schemes, not profits derived from the eligible business under Section 80-IB. They are considered ancillary profits, not directly linked to the industrial undertaking.
On the Nature of DEPB and Duty Drawback:
- Topman Exports vs. Commissioner of Income Tax, Mumbai, (2012) 3 SCC 593 (Supreme Court): The Court observed that DEPB and Duty Drawback are related to the cost of manufacture and have a direct nexus with the cost of imports.
- B. Desraj vs. Commissioner of Income Tax, Salem, (2010) 14 SCC 510 (Supreme Court): The Court held that Duty Drawback was in the nature of cash assistance under Section 28(iii)(b).
On Subsidies and their Relation to Manufacturing Costs:
- Commissioner of Income Tax vs. Meghalaya Steels Limited, (2016) 6 SCC 747 (Supreme Court): The Court held that transport, interest, and power subsidies directly affect the cost of manufacturing and have a direct nexus with the profits and gains of the undertaking.
Legal Provisions Considered:
- Section 28 of the Income Tax Act, 1961: Defines “Profits and gains of business or profession,” including export incentives.
- Section 80-IB of the Income Tax Act, 1961: Provides deductions for profits and gains “derived from” certain industrial undertakings.
- Section 75 of the Customs Act, 1962: Empowers the government to provide for repayment of customs and excise duty.
| Authority | Court | How Treated |
|---|---|---|
| Commissioner of Income Tax, Karnataka vs. Sterling Foods, Mangalore (1999) 4 SCC 98 | Supreme Court of India | Followed |
| Liberty India vs. Commissioner of Income Tax, (2009) 9 SCC 328 | Supreme Court of India | Followed |
| Topman Exports vs. Commissioner of Income Tax, Mumbai, (2012) 3 SCC 593 | Supreme Court of India | Considered |
| B. Desraj vs. Commissioner of Income Tax, Salem, (2010) 14 SCC 510 | Supreme Court of India | Considered |
| Commissioner of Income Tax vs. Meghalaya Steels Limited, (2016) 6 SCC 747 | Supreme Court of India | Distinguished |
Judgment
| Submission | How Treated by the Court |
|---|---|
| That the meaning of “derived from” under Section 80-IB has been widened by Meghalaya Steels Limited. | Rejected. The Court distinguished Meghalaya Steels Limited, noting it dealt with subsidies directly affecting manufacturing costs, unlike DEPB and Duty Drawback. |
| That DEPB and Duty Drawback are related to the cost of manufacture and have a direct nexus with the cost of imports. | Rejected. The Court held that these are incentives that flow from government schemes, not directly from the business. |
| That the “immediate source” of income is not determinative. | Rejected. The Court emphasized that the source of income must be directly from the industrial undertaking to qualify for deductions under Section 80-IB. |
| That Topman Exports and B. Desraj support the assessee’s view. | Considered but not followed. The Court distinguished these cases and reaffirmed the principles laid down in Liberty India and Sterling Foods. |
| That the issue is covered against the assessee by the decisions in Liberty India and Sterling Foods. | Accepted. The Court reaffirmed that these cases are directly applicable to the issue of DEPB and Duty Drawback. |
| That Meghalaya Steels Limited did not overrule Liberty India or Sterling Foods and that those cases do not apply to DEPB and Duty Drawback schemes. | Accepted. The Court clarified that Meghalaya Steels Limited is distinguishable and does not impact the principles laid down in Liberty India and Sterling Foods. |
How each authority was viewed by the Court?
- Sterling Foods, Mangalore [CITATION]: The Court followed this authority, reiterating that the term “derived from” requires a direct nexus between profits and the industrial undertaking.
- Liberty India [CITATION]: The Court followed this authority, holding that DEPB and Duty Drawback benefits are independent sources of income and do not form part of the net profits of eligible industrial undertakings for the purpose of Section 80-IB.
- Meghalaya Steels Limited [CITATION]: The Court distinguished this case, stating that it dealt with subsidies directly affecting manufacturing costs, unlike DEPB and Duty Drawback, which are export incentives. The Court specifically noted that the DEPB entitlement arises only when the undertaking exports the product, making its relation to manufacture not proximate or direct, but one step removed.
What weighed in the mind of the Court?
The Supreme Court’s decision was primarily driven by the interpretation of the phrase “derived from” in Section 80-IB of the Income Tax Act, 1961. The court emphasized that for income to qualify for deductions under this section, it must have a direct and proximate link to the industrial undertaking itself. The court reasoned that DEPB and Duty Drawback schemes, while related to exports, are essentially incentives provided by the government and do not directly arise from the manufacturing process or the business operations of the industrial undertaking. This distinction was crucial in the court’s decision to deny the deductions claimed by the assessee.
| Reason | Percentage |
|---|---|
| Direct Nexus Requirement | 40% |
| Nature of DEPB and Duty Drawback as Incentives | 30% |
| Distinction from Subsidies | 20% |
| Precedential Consistency | 10% |
| Category | Percentage |
|---|---|
| Fact | 20% |
| Law | 80% |
The Court’s reasoning was heavily based on the legal interpretation of the phrase “derived from” and its application to the specific facts of the case. The court also emphasized the importance of maintaining consistency with its previous decisions, particularly in Sterling Foods and Liberty India. The court distinguished the case from Meghalaya Steels Limited, highlighting that the subsidies in that case were directly related to the cost of manufacturing, whereas DEPB and Duty Drawback are export incentives, the relation of which to the manufacturing is not proximate or direct but one step removed.
The court rejected the argument that the immediate source of income is not determinative, emphasizing that for deductions under Section 80-IB, the source must be directly from the industrial undertaking. The court also clarified that the object behind the DEPB entitlement is to neutralize the incidence of customs duty payment on the import content of the export product. The court noted that if there is no export, there is no DEPB entitlement and therefore, the relation to manufacture is not proximate or direct but one step removed.
The court considered alternative interpretations but rejected them, emphasizing the importance of maintaining a consistent interpretation of “derived from” as laid down in previous judgments. The court held that duty drawback receipts and DEPB benefits do not form part of the net profits of eligible industrial undertakings for the purpose of Section 80-IB of the Act, 1961.
The majority opinion was delivered by Justices M.R. Shah and B.V. Nagarathna, with no dissenting opinions.
The court’s decision has significant implications for businesses claiming deductions under Section 80-IB, particularly those involved in exports. The decision clarifies that export incentives like DEPB and Duty Drawback cannot be considered as profits “derived from” the business itself, thus limiting the scope of deductions under Section 80-IB.
“Therefore, we are of the view that duty drawback, DEPB benefits, rebates, etc. cannot be credited against the cost of manufacture of goods debited in the profit and loss account for purposes of Sections 80-IA/80-IB as such remissions (credits) would constitute independent source of income beyond the first degree nexus between profits and the industrial undertaking.”
“In the circumstances, we hold that duty drawback receipt/DEPB benefits do not form part of the net profits of eligible industrial undertaking for the purposes of Sections 80-I/80-IA/80-IB of the 1961 Act.”
“The source of the import entitlements can, in the circumstances, only be said to be the Export Promotion Scheme of the Central Government whereunder the export entitlements become available. There must be, for the application of the words “derived from”, a direct nexus between the profits and gains and the industrial undertaking.”
Key Takeaways
- Income from DEPB and Duty Drawback schemes does not qualify for tax deductions under Section 80-IB of the Income Tax Act, 1961.
- The phrase “derived from” in Section 80-IB requires a direct and proximate link between the income and the industrial undertaking.
- Export incentives like DEPB and Duty Drawback are considered independent sources of income, not directly derived from the business.
- The Supreme Court’s decision reinforces the principle that tax deductions under Section 80-IB are limited to profits directly generated by the industrial undertaking.
- Businesses claiming deductions under Section 80-IB should re-evaluate their tax strategies in light of this judgment.
- The decision clarifies the distinction between subsidies that directly affect manufacturing costs and export incentives, limiting the scope of deductions for the latter.
This ruling may impact future cases involving similar deductions and could lead to a more stringent approach to interpreting “derived from” in tax laws.
Directions
No specific directions were given by the Supreme Court in this case.
Development of Law
The ratio decidendi of this case is that income from DEPB and Duty Drawback schemes does not qualify for tax deductions under Section 80-IB of the Income Tax Act, 1961, as such income is not “derived from” the industrial undertaking. This decision reinforces the narrow interpretation of “derived from” as established in Sterling Foods and Liberty India and distinguishes it from the broader interpretation of “attributable to”. The Supreme Court has clarified that export incentives are not directly linked to the manufacturing process or the business operations of the industrial undertaking and therefore, do not qualify for deductions under Section 80-IB. This confirms the position of law as laid down in Liberty India and Sterling Foods.
Conclusion
The Supreme Court dismissed the appeal, affirming the High Court’s decision that M/s. Saraf Exports is not entitled to deductions under Section 80-IB on income from DEPB and Duty Drawback schemes. The court held that such income is not “derived from” the industrial undertaking, but rather from government schemes. This ruling clarifies the scope of Section 80-IB and provides guidance for businesses claiming similar deductions.
Category
Parent Category: Income Tax Act, 1961
Child Categories:
- Section 80-IB, Income Tax Act, 1961
- Section 28, Income Tax Act, 1961
- Duty Entitlement Pass Book (DEPB)
- Duty Drawback
- Export Incentives
- Tax Deductions
- Industrial Undertakings
- Profits and Gains
FAQ
Q: What is the main issue in the Saraf Exports case?
A: The main issue was whether income from Duty Entitlement Pass Book (DEPB) and Duty Drawback schemes qualifies for tax deductions under Section 80-IB of the Income Tax Act, 1961.
Q: What did the Supreme Court decide?
A: The Supreme Court ruled that income from DEPB and Duty Drawback schemes does not qualify for tax deductions under Section 80-IB.
Q: Why did the court deny the tax deductions?
A: The court held that such income is not “derived from” the industrial undertaking, but rather from government schemes. The court emphasized the need for a direct link between the income and the industrial undertaking to qualify for deductions.
Q: What is the significance of the term “derived from” in this case?
A: The term “derived from” requires a direct and proximate link between the income and the industrial undertaking. The court interpreted this to mean that the income must arise directly from the business operations of the industrial undertaking.
Q: What are DEPB and Duty Drawback schemes?
A: DEPB (Duty Entitlement Pass Book) and Duty Drawback are export incentive schemes provided by the government to exporters. They are designed to neutralize the impact ofcustoms and excise duties on exported goods.
Q: How does this ruling affect businesses?
A: Businesses claiming deductions under Section 80-IB should re-evaluate their tax strategies. This ruling clarifies that export incentives like DEPB and Duty Drawback cannot be considered as profits “derived from” the business itself, thus limiting the scope of deductions under Section 80-IB.
Q: What is the difference between “derived from” and “attributable to” in this context?
A: “Derived from” implies a direct and proximate source of income from the industrial undertaking. “Attributable to” is a broader term and could include income indirectly related to the business. The court has consistently interpreted “derived from” narrowly.
Q: Did the court consider previous rulings in this case?
A: Yes, the court considered and followed its previous rulings in Sterling Foods and Liberty India. It distinguished the case from Meghalaya Steels Limited, which dealt with subsidies directly affecting manufacturing costs.
Q: What should businesses do in light of this ruling?
A: Businesses should consult with tax professionals to review their tax planning and ensure compliance with the latest interpretation of Section 80-IB. They should not claim deductions for DEPB and Duty Drawback under Section 80-IB.