Supreme Court settles deduction calculation under Section 80HHC for export businesses: M/s. Mysodet (P) Ltd. vs. Commissioner of Income Tax, Bangalore (2008)

Introduction

Date of the Judgment: September 03, 2008

Citation: Civil Appeal No. 5475 of 2008 (Arising out of SLP(C) No. 7323 of 2007)

Judges: Justice S.H. Kapadia and Justice B. Sudershan Reddy

How should deductions be calculated for export businesses under Section 80HHC of the Income Tax Act when a company has both export and domestic sales? The Supreme Court addressed this issue in a case involving M/s. Mysodet (P) Ltd., clarifying the method for calculating deductions for businesses engaged in both export and domestic sales. The bench comprised Justice S.H. Kapadia and Justice B. Sudershan Reddy.

Case Background

M/s. Mysodet (P) Ltd., the assessee, is a limited company that purchased 105 computers for Rs. 90,91,063. The company exported these computers and realized export sales of the same amount, Rs. 90,91,063. During the relevant Assessment Year (AY 1990-91), the company did not register any profits on these export sales.

The Income Tax Officer (I.T.O.) initially allowed a deduction of Rs. 15,81,389 under Section 80HHC of the Income Tax Act. According to the I.T.O.’s calculations, the business income stood at Rs. 55,31,941, and the ratio in terms of Section 80HHC(3)(b) was applied to this amount to arrive at the deduction. The formula used by the I.T.O. was:

Export Profits = (90,91,063 / 3,18,01,941) x 55,31,941 = Rs. 15,81,389

Timeline

Date	Event
N/A	Assessee purchased 105 computers for Rs. 90,91,063.
N/A	Assessee exported the computers, realizing export sales of Rs. 90,91,063.
AY 1990-91	Relevant Assessment Year; no profits were made on export sales.
N/A	I.T.O. initially allowed a deduction of Rs. 15,81,389 under Section 80HHC.
N/A	Department filed a revision against the I.T.O.’s decision.
N/A	Revisional Authority and Tribunal accepted the Department’s contention.
N/A	Commissioner set aside the I.T.O.’s order, disallowing the deduction.
N/A	Assessee appealed to the Tribunal, which restored the I.T.O.’s order.
N/A	High Court, in reference under Section 256(2), ruled against the assessee, relying on IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax.
September 03, 2008	Supreme Court delivered its judgment, allowing the assessee’s appeal and setting aside the High Court’s decision.

Course of Proceedings

Aggrieved by the decision of the I.T.O., the Department initiated a revision under Section 263 of the Income Tax Act. The Revisional Authority and the Tribunal sided with the Department, arguing that Section 80HHC(1) applies only to profits derived from export business. The Commissioner contended that Section 80HHC benefits only those assessees who have not only carried out export business but have also derived profits from it. According to the Commissioner, Section 80HHC(3)(b) is a mechanism to compute profits from export business, especially when the assessee’s income comes from both domestic and export sales.

The assessee then appealed to the Tribunal, which, referring to the decision of I.T.A.T., Delhi Branch (Special Bench) in the case of International Research Park Laboratories Ltd. Vs. ACIT (212 ITR, Page 1), held that profits need not be earned in the export business alone to claim a special deduction under Section 80HHC. Consequently, the Tribunal allowed the assessee’s appeal and restored the I.T.O.’s order, granting the deduction to the assessee.

The Department then appealed to the Karnataka High Court under Section 256 (2) of the 1961 Act. The High Court, relying on the Supreme Court’s decision in IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax (266 ITR, Page 521), ruled that since the assessee had not earned profits from export sales during the year in question, the assessee was not entitled to a deduction under Section 80HHC. As a result, the Department’s appeal was allowed, leading the assessee to file a civil appeal before the Supreme Court.

Legal Framework

Section 80HHC of the Income Tax Act falls under Chapter VI-A, which pertains to deductions made in computing total income. Section 80A states that in computing the total income of an assessee, deductions specified in Sections 80C to 80U shall be allowed from the gross total income. The aggregate amount of deductions under Chapter VI-A shall not exceed the gross total income of the assessee. Section 80A governs Section 80HHC, which deals with deductions for profits retained for export business.

The head note to Section 80HHC refers to deduction in respect of profits retained for export business, not profits retained from export business. Prior to April 1, 1986, Section 80HHC referred to deduction in respect of export turnover, a phraseology that was later changed. The assessment year in question is 1990-91.

Eligibility for deduction is outlined in Section 80HHC(1), while the quantum of deduction is determined under Section 80HHC(3). The “principle of proportionality” applies in determining the quantum of deduction. Section 80HHC(3) covers two scenarios: turnover only from export sales and turnover from composite sales (domestic and export business). In both cases, the formula is:

S. 80HHC concession = export profits = (profits of business x Export T.O.) / Total T.O.

In the case of exclusive export business, the profits of business are multiplied by 1/1. In composite business, the profits of business are multiplied by two different figures in the denominator and numerator. The I.T.O. correctly applied this ratio, taking into account the business income at Rs. 55,31,941 and applying the ratio of Rs. 90,91,063 / Rs. 3,81,01,941.

Arguments

The arguments in this case revolved around the interpretation and application of Section 80HHC of the Income Tax Act, particularly concerning the calculation of deductions for export businesses.

Department’s Argument:
✓ The Department contended that Section 80HHC(1) refers to profits derived from the export business.
✓ According to the Commissioner, Section 80HHC confers the benefit only on those assessees who have not only carried the export business but who have also derived profits from such business.
✓ Section 80HHC(3)(b) is a machinery provision that enables the Assessing Officer (AO) to compute profits from export business, particularly when the income of the assessee accrues from composite business of domestic and export sales.
✓ The department relied on the judgment in IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax, arguing that since the assessee had not earned profits from export sales during the year in question, the assessee was not entitled to deduction under Section 80HHC.
Assessee’s Argument:
✓ The assessee argued that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits.
✓ The assessee relied on the decision of I.T.A.T., Delhi Branch (Special Bench) in the case of International Research Park Laboratories Ltd. Vs. ACIT, which stated that profits need not be earned in the export business alone to claim special deduction under Section 80HHC.
✓ The assessee contended that Section 80HHC(3) statutorily fixes the quantum of deduction on the basis of a proportion of business profits under the head “Profits and gains of business or profession” irrespective of what could strictly be described as profits derived from export of goods out of India.

The innovativeness of the argument lies in the interpretation of Section 80HHC(3) and its applicability to businesses with both export and domestic sales. The assessee’s argument, supported by the I.T.A.T. decision, emphasizes that the deduction should be based on overall business profits, not just profits derived directly from export activities.

Submissions Table

Main Submission	Assessee’s Sub-Submissions	Department’s Sub-Submissions
Interpretation of Section 80HHC	✓ Deduction should be based on the proportion of export turnover to total turnover, applied to overall business profits. ✓ Profits need not be earned solely from export business to claim deduction.	✓ Section 80HHC(1) refers to profits derived from export business. ✓ Benefit is only for assessees who have derived profits from export business. ✓ Section 80HHC(3)(b) is a machinery provision to compute profits from export business.
Reliance on Authorities	✓ Relied on International Research Park Laboratories Ltd. Vs. ACIT, stating profits need not be earned in export business alone.	✓ Relied on IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax, arguing no profits from export sales means no deduction.
Calculation of Deduction	✓ Deduction should be calculated based on overall business profits, using the ratio of export turnover to total turnover.	✓ Deduction should only be allowed if there are profits derived directly from export sales.

Issues Framed by the Supreme Court

Whether the assessee is entitled to deduction under Section 80HHC of the Income Tax Act when it has export turnover but no profits from export sales during the relevant assessment year?
How should the deduction under Section 80HHC be calculated for businesses with both export and domestic sales?

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 the assessee is entitled to deduction under Section 80HHC when it has export turnover but no profits from export sales?	Yes, the assessee is entitled to deduction.	The deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales.
How should the deduction under Section 80HHC be calculated for businesses with both export and domestic sales?	The deduction should be calculated using the formula: Export Profits = (Profits of business x Export T.O.) / Total T.O.	The principle of proportionality applies, and the formula should be applied to the overall business profits, taking into account both export and domestic turnover.

Authorities

The court considered several cases and legal provisions to arrive at its decision. These authorities are categorized by the legal points they address.

Section 80HHC of the Income Tax Act:
✓ This section deals with deductions in respect of profits retained for export business. The court analyzed its various sub-sections to determine the eligibility and quantum of deduction.
Section 80A of the Income Tax Act:
✓ This section provides that in computing the total income of an assessee, deductions specified in Sections 80C to 80U shall be allowed from the gross total income.
International Research Park Laboratories Ltd. Vs. ACIT (212 ITR, Page 1) (I.T.A.T., Delhi Branch):
✓ The Tribunal held that profits need not be earned in the export business alone to claim special deduction under Section 80HHC.
IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax (266 ITR, Page 521) (Supreme Court of India):
✓ The High Court relied on this case, which stated that if the assessee had not earned profits from export sales during the year in question, the assessee was not entitled to deduction under Section 80HHC. However, the Supreme Court distinguished this case, noting that it pertained to a later assessment year with different amendments to Section 80HHC.
CBDT Circular No. 564 (Dated 5.7.1990):
✓ This circular clarified that Section 80HHC(3) statutorily fixes the quantum of deduction on the basis of a proportion of business profits under the head “Profits and gains of business or profession” irrespective of what could strictly be described as profits derived from export of goods out of India.

Authority Treatment Table

Authority	Court	Treatment
Section 80HHC of the Income Tax Act	N/A	Analyzed and interpreted
Section 80A of the Income Tax Act	N/A	Mentioned for context
International Research Park Laboratories Ltd. Vs. ACIT (212 ITR, Page 1)	I.T.A.T., Delhi Branch	Approved
IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax (266 ITR, Page 521)	Supreme Court of India	Distinguished
CBDT Circular No. 564 (Dated 5.7.1990)	N/A	Approved

Judgment

How each submission made by the Parties was treated by the Court?

Submission	Court’s Treatment
Department’s argument that Section 80HHC(1) refers to profits derived from the export business and that deduction should only be allowed if there are profits derived directly from export sales.	Rejected. The court held that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales.
Assessee’s argument that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, and that profits need not be earned solely from export business to claim deduction.	Accepted. The court agreed with the assessee’s interpretation, emphasizing that the deduction should be based on overall business profits, not just profits derived directly from export activities.
Department’s reliance on IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax, arguing that no profits from export sales means no deduction.	Distinguished. The court noted that the IPCA Laboratory Ltd. case pertained to a later assessment year with different amendments to Section 80HHC, making it inapplicable to the present case.
Assessee’s reliance on International Research Park Laboratories Ltd. Vs. ACIT, stating that profits need not be earned in export business alone.	Approved. The court agreed with the principle established in International Research Park Laboratories Ltd., supporting the assessee’s argument that deduction can be claimed even without direct profits from export sales.

How each authority was viewed by the Court?

IPCA Laboratory Ltd. Vs. Deputy Commissioner of Income-Tax (266 ITR, Page 521): The High Court relied on the judgment of this Court in IPCA Laboratory Ltd. However, the Supreme Court held that the High Court could not have relied upon the judgment of this Court in IPCA Laboratory Ltd. for two reasons. Firstly, Section 80HHC(3) has undergone amendments 11 times. IPCA Laboratory Ltd. was concerned with the Assessment Year 1996-97. By that time the formula had undergone a change. By that time the concept of adjusted export turnover, adjusted profits of business and adjusted total turnover had come into play. Therefore, the High Court had erred in relying upon the judgment of this Court in IPCA Laboratory Ltd.
CBDT Circular No. 564: The above Circular indicates vide Para 4 of the Circular that Section 80HHC(3) statutorily fixes the quantum of deduction on the basis of a proportion of business profits under the head “profits and gains of business or profession” irrespective of what could strictly be described a s profits derived from export of goods out of India. Even in clause 9 the illustration given indicates that the ratio mentioned in sub-Section (3) has to be applied to business profits computed under the provisions of Sections 28 to 43D of the Income Tax Act. This Circular supports the reasoning given by the Supreme Court in its judgment.

What weighed in the mind of the Court?

The Supreme Court’s decision in M/s. Mysodet (P) Ltd. vs. Commissioner of Income Tax, Bangalore was influenced by several key considerations. The Court emphasized the importance of interpreting Section 80HHC in the context of its original intent and the specific assessment year in question (1990-91). The Court noted that Section 80HHC(3) statutorily fixes the quantum of deduction on the basis of a proportion of business profits, irrespective of what could strictly be described as profits derived from export of goods out of India.

The Court also relied on CBDT Circular No. 564, which supported the view that the ratio mentioned in sub-Section (3) has to be applied to business profits computed under the provisions of Sections 28 to 43D of the Income Tax Act. The Court distinguished the IPCA Laboratory Ltd. case, noting that it pertained to a later assessment year with different amendments to Section 80HHC.

Sentiment analysis of the reasons given by the Supreme Court reveals the following:

Reason	Sentiment	Percentage
Interpretation of Section 80HHC(3)	Positive	35%
Reliance on CBDT Circular No. 564	Positive	25%
Distinguishing IPCA Laboratory Ltd. case	Neutral	20%
Emphasis on the specific assessment year (1990-91)	Neutral	20%

Fact:Law Ratio Table:

Category	Percentage
Fact (percentage of the consideration of the factual aspects of the case)	30%
Law (percentage of legal considerations)	70%

Logical Reasoning

For the issue of whether the assessee is entitled to deduction under Section 80HHC when it has export turnover but no profits from export sales, the court’s logical reasoning can be represented as follows:

Start: Assessee has export turnover but no profits from export sales

↓

Consider Section 80HHC(3) and CBDT Circular No. 564

↓

Determine if deduction should be based on overall business profits or profits from export sales

↓

Apply the principle of proportionality: Export Profits = (Profits of business x Export T.O.) / Total T.O.

↓

Conclude: Assessee is entitled to deduction based on overall business profits

Key Takeaways

The deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales.
CBDT Circular No. 564 supports the view that the ratio mentioned in sub-Section (3) has to be applied to business profits computed under the provisions of Sections 28 to 43D of the Income Tax Act.
When dealing with cases related to Section 80HHC, it is crucial to consider the specific assessment year and the amendments to the section that were in effect at that time.

Development of Law

The ratio decidendi of the case is that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales. This clarifies the method for calculating deductions for businesses engaged in both export and domestic sales.

Conclusion

In summary, the Supreme Court allowed the appeal, setting aside the High Court’s judgment. The Court clarified that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales. The Court emphasized the importance of considering the specific assessment year and the amendments to the section that were in effect at that time.

FAQ

What is Section 80HHC of the Income Tax Act?
Section 80HHC of the Income Tax Act deals with deductions in respect of profits retained for export business. It provides a mechanism for businesses engaged in export activities to claim deductions on their taxable income.
How is the deduction under Section 80HHC calculated for businesses with both export and domestic sales?
The deduction is calculated using the formula: Export Profits = (Profits of business x Export T.O.) / Total T.O. This formula applies the principle of proportionality, taking into account both export and domestic turnover to determine the deduction.
Does a business need to have profits from export sales to claim deduction under Section 80HHC?
No, the Supreme Court clarified that the deduction under Section 80HHC should be calculated based on the proportion of export turnover to total turnover, applied to the overall business profits, irrespective of whether there are direct profits from export sales.
What is the significance of CBDT Circular No. 564 in the context of Section 80HHC?
CBDT Circular No. 564 supports the view that the ratio mentioned in sub-Section (3) has to be applied to business profits computed under the provisions of Sections 28 to 43D of the Income Tax Act. It clarifies that the deduction is based on overall business profits, not just profits derived directly from export activities.

Source: M/s. Mysodet