Vivad se Vishwas: Interplay with section 80HHC on conversion charges

Background

Deduction u/s 80HHC was introduced in Indian Income Tax Act to incentivize exporters by offering a deduction on profits of business.

The formula: Profits of Business*Export Turnover = Deduction u/s 80HHC Total turnover Profits of business (“POB”) are the profits of the business as computed under the Act and reduced by 90% of (interest, rent, commission, brokerage, charges, etc ).

Illustration 11: ExpenditureAmount (Rs)RevenueAmount (Rs)Direct and indirect expenses103Export turnover100 Domestic turnover100Net profit127Commission (no conversion charges)30Total230Total230 Deduction u/s 80HHC Profits of business (assumed to be same as Income Tax Act for ease of computation): 127 less [90% * (Rs 30)] = 100 Export turnover: 100 Total turnover: 200 (100+100) ie export and domestic turnover Deduction = 100/200*100 = Rs 50 The Issue The exclusions from POB include rent, brokerage, interest, other charges. Whether Conversion charges (also called job work charges – where main material is received from customer and labour or machine hours are expended to get finished product. E.g a tailor who is given a cloth by customer and he expends labour only in converting such cloth into a shirt) are to be deducted from Profits of business? CBDT view In circular 572 dated 03-Aug-1990, the CBDT has said “The benefit of deduction under section 80HHC has now been extended to processors who sell their goods or merchandise to Export Houses or Trading Houses for export purposes. The condition for obtaining the benefit is the same as already applicable to supporting manufacturers, namely, that of obtaining a disclaimer certificate from the Export House or Trading House”. 2 Further, in circular 621 dated 19-Dec-1991, in para 32.11, it is stated that “profits of the business” for the purpose of section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10 per cent deduction from such incomes is provided to account for these expenses.” Decided cases of Supreme Court The exclusions like rent, charges etc mentioned above in definition of Profits of Business pertain to independent incomes, which, if included in POB, need to be reduced. They can on no account be considered as part of total turnover (denominator in above formula). However, in Ravindranath Nair 295 ITR 228, the Supreme Court ruled that conversion charges are to be included in Total turnover and also excluded from profits of business. The Affront This is a double whammy for the assessee. Firstly, by including conversion charges in Total turnover, the denominator increases and the percentage of POB eligible for deduction reduces. Secondly, if the profits of business are to be further reduced by conversion charges, the result will most likely be negative. The impact of Supreme Court ruling is explained in below illustration. Illustration 2: If domestic turnover in Illustration 1 above is replaced by conversion charges, the deduction would be as below (as per Supreme court in Ravindranathan Nair above): Profits of business: 127 less [90% * (Rs 30+Rs 100 conversion charges)] = Rs 10 Export turnover: 100 Total turnover: 200 ie (100+100) ie export and conversion charges Deduction = 10/200*100 = Rs 5 It is apparent that the working in illustration 2 is manifestly unjust and against all rules of mathematics and accounting. While logic and law are not close friends, they certainly cannot be enemies. The above decision in Ravindranath Nair’s case deserves to be reviewed.3 Question of law: The law laid down by Supreme Court is the law of the land.4 It may be noted that in Ravindranathan Nair’s case, the question raised was whether conversion charges are part of total turnover. However, while answering in the affirmative, Supreme Court made an observation that the con version charges are to be reduced from profits of business which was not even a part of the question raised. Can a view be taken that the same is in the nature of a passing remark, not having binding effect? Our view: In our view, the treatment of conversion charges on same lines as domestic revenue (ie include in total turnover but do not reduce from profits of business) will suppress the mischief and advance the remedy. Whether these assesses should take the VSVS scheme and pay demands raised? The cases in appeal pending before Supreme Court on this issue of conversion charges includes the lead case of M/S MAINI PRECISION PRODUCTS PVT. LTD vs JCIT, SLP(C) No. 018966 - 018970 / 2012, Registered on 03-12-2012. With an unfavourable tax ruling at Supreme Court and subsequent rulings toeing the line of the Supreme Court (as they must), the future looks bleak for pending cases, and it is likely that Supreme Court will confirm its mathematically unjust ruling. While VSVS scheme is a costly option (as assessee has to pay the demand, excluding interest and penalty), it is hoped that high thinking will prevail and the Hon’ble Finance Minister will provide a suitable ordinance to amend the law on section 80HHC retrospectively and withdraw needless litigation on this aspect of conversion charges. This would be an effective tool to reverse tax terrorism and provide much needed relief to assesses in these troubled times.

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11 Based on illustration in circular No. 564 dated 05-July-1990, para 9, case III, as suitably modified 2 Refer para 28.3 3 In subsequent rulings , the rigor of Ravindranath Nair case (supra) was somewhat reduced where the Court held that the “net conversion charges” are to be reduced from profits of Business. Refer ACG Associated Capsules 67 DTR 0205 where the Supreme Court ruled that the “net” rent, interest, etc is to be deducted from POB and not “gross” rent, interest etc on the ground that POB is arrived at after deducting all expenses and only the net amounts of rent, etc will be included in POB. 4 Article 141 of the Constitution