Chapter VIA of the Income Tax Act, 1961 Provisions & Issues Vikram Naik 21 st March 2009

1. Chapter VIAof the Income Tax Act, 1961Provisions & IssuesVikram Naik21st March 2009

2. Contents Overview Introduction Deduction in Respect of Certain Payments Deduction in Respect of Certain Incomes Issues 80C 80G 80IA, 80IB, 80IC 80P

4. Introduction Chapter VIA Deductions to be made in computing total income Sections 80A to 80U 80A In computing the total income of the assessee, there shall be allowed from gross total income, in accordance with the provisions of this Chapter, the deductions specified in sections 80C to 80U

5. Introduction • 80A: Aggregate total deduction under sections 80C to 80U cannot exceed gross total income Essential rules governing deductions

6. Deductions in respect of certain Payments *80CCE prescribes an aggregate limit of INR 1,00,000 for 80C, 80CCC, 80CCD

7. Deductions in respect of certain Payments

8. Deductions in respect of certain Incomes

9. Deductions in respect of certain Incomes

10. Deductions in respect of certain Incomes

11. Deductions in respect of certain Incomes

13. Issues80C Deductions in respect of life insurance premia and others Issue: Whether investment out of borrowings are eligible Case:CIT vs. Ramesh Chandra Khandelwal (2005) 273 ITR 363 (All). Such investments are eligible for deduction u/s 80C Points: Source need not be currently taxable incomeearned. Assessee may well spend taxable income and invest borrowingsAll incomes are amalgamated and spent, so it is not possible to distinguish savings from borrowings80C is for the encouragement of thrift and its interpretation shouldn’t nullify that object In favor of: Assessee

14. Issues80G Donations to certain funds, charitable institutions, etc. Issue: Whether sums donated out of sources other than chargeable income are allowed Case:Infosys Technologies vs. JCIT (2007) 10 TTJ (Bang) 631 Points: No stipulation that donation has to be only out of income chargeable to taxDeduction available even when donations are out of ■ Capital or gifts received ■ Exempted Income ■ Income out of earlier years In favor of: Assessee

15. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by splitting up, or reconstruction, of a business already in existence” Case:Textile Machinery Corporation ltd vs. CIT (1977) 107 ITR 195 (SC) CIT vs. Hindustan General Industries Ltd (1982) 137 ITR 851 (Delhi) Points: Reconstruction involves ■ Substantially the same persons carrying on substantially the same business ■ Complete absorption and loss of identity into the old businessThe following is NOT reconstruction ■ Expansion of the existing undertaking (this would not deprive the assessee of the benefit) ■ New emergence of a separate unit which may exist on its own as a viable industrial unitSplitting up indicates ■ That the integrity of a business earlier in existence is broken up ■ Different sections of the activities previously carried out are carried on independently In favor of: Assessee - Textile Machinery Corporation ltd vs. CIT Assessee -CIT vs. Hindustan General Industries Ltd Issue: What constitutes reconstruction / splitting up?

16. Other Principles Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by splitting up, or reconstruction, of a business already in existence” Issue: What constitutes reconstruction / splitting up? Where there is • substantial investment in new plant & machinery, and • new employees are recruited substantially along with new services provided to new clients, then the new unit is not formed by splitting up of existing unit and is eligible for tax incentives on export profits To hold that a business is formed by reconstruction, there must be some material to hold that • Some assets of the existing business were diverted into another business • This other business was formed from such splitting up • The two business were the same and the business formed was an integral part of the earlier one ITO vs. DSM Soft P. Ltd. (unreported) (Chennai ITAT)

17. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings Issue: What constitutes reconstruction / splitting up? Case:CIT vs. M/s Mahaan foods Ltd. (2008) 177 Taxman 274 (Del) Points: 80-IA does not require the new industrial undertaking to be on a separate plot of land leaving the earlier undertaking totally untouchedDeduction allowed where the entire business is a new industrial undertaking with ■ Newly acquired technology for increased production capacity ■ A fresh dose of investment In favor of: Assessee

18. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by the transfer to a new business of machinery or plant previously used for any purpose” Explanations: Where the total value of transferred plant and machinery does not exceed 20% of the total plant and machinery of the business, the provision is deemed to be complied with Issue: Where the limit was exceeded in earlier years, can a subsequent reduction of old machinery below 20% secure deduction in a later year? Case 1 : Deduction allowed post-formation, if 20% condition is rectified Case:CIT vs. Satellite Engineering Co ltd (1978) 113 ITR 208 (Guj) Points: No additional limitation (to satisfy the condition on commencement) to be eligible for deduction in the subsequent yearsIf an undertaking satisfies the condition in the subsequent years, deduction is allowed In favor of: Assessee - CIT vs. Satellite Engineering Co ltd

19. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by the transfer to a new business of machinery or plant previously used for any purpose” Explanations: Where the total value of transferred plant and machinery does not exceed 20% of the total plant and machinery of the business, the provision is deemed to be complied with Issue: Where the limit was exceeded in earlier years, can a subsequent reduction of old machinery below 20% secure deduction in a later year? Case 2 : Deduction allowed only if 20% condition satisfied on formation Case:CIT vs. Nippon Electronics (India) Pvt Ltd (1990) 181 ITR 518 (Kar) Points: Deduction allowed for an undertaking not “formed” by transfer of plant and machineryEligibility for deduction has to be tested at the initial AY In favor of: Revenue- CIT vs. Nippon Electronics (India)

20. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by the transfer to a new business of machinery or plant previously used for any purpose” Explanations: Where the total value of transferred plant and machinery does not exceed 20% of the total plant and machinery of the business, the provision is deemed to be complied with Issue: Where the limit was exceeded in earlier years, can a subsequent reduction of old machinery below 20% secure deduction in a later year? Case 3 : Deduction allowed post-formation, even if 20% condition is not subsequently met Case:ITO v. Laxmi Packers [2007] 14 SOT 303 (Mum) Points: Legislature does not intend to keep the taxpayer (after formation of the undertaking) from purchasing second hand machinery to meet future demandsAdditional machinery beyond the 20% limit can be purchased post-formation In favor of: Assessee

21. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(3), 80IB(2), 80IC(4): “This section applies to an undertaking…not formed by the transfer to a new business of machinery or plant previously used for any purpose” Explanations: Where the total value of transferred plant and machinery does not exceed 20% of the total plant and machinery of the business, the provision is deemed to be complied with Issue: Where the limit was exceeded in earlier years, can a subsequent reduction of old machinery below 20% secure deduction in a later year? ? When considering the value of plant and machinery transferred, do we consider 20% of the book value, tax value, or market value? ?

22. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings Issue: Does leasing of property amount to formation by transfer? Case:Bajaj Tempo vs. CIT (1992) 196 ITR 188 (SC) Points: Undertaking established on premises taken on lease does not amount to formation by transfer of buildingTo amount to “formation by transfer”, it must be implied that but for the transfer, the undertaking would not have come into being In favor of: Assessee

23. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(5): “…the profits and gains of an eligible business … shall be computed as if such eligible business were the only source of income of the assessee during the previous year …” Illustration

24. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(5): “… the profits and gains of an eligible business … shall be computed as if such eligible business were the only source of income of the assessee during the previous year relevant to the initial assessment year …” Issue: What is the “initial assessment year”? Case:Mohan Breweries & Distilleries ltd vs. ACIT (2008) 114 TTJ 532 Points: It is at the option of the assessee to choose the initial AY from which deduction can be claimedInitial AY is the AY in which assessee has chosen to claim deduction under the section. It cannot be the year when operations beganProvisions of s. 80-IA(5) treating undertaking as a separate sole source of income cannot be applied to a year prior to the year in which assessee opted to claim relief for the first time. In favor of: Assessee

25. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(5): “…the profits and gains of an eligible business … shall be computed as if such eligible business were the only source of income of the assessee during the previous year …” Issue: Whether the profit from the eligible business has to be computed after deduction of the notional brought forward losses and depreciation of eligible business even though they have been allowed set off against other income in earlier years Case:ACIT vs. Goldmine Shares and Finance (P) Ltd. (2008) 116 TTJ 705 Points: 80IA(5) is an over-riding provision. A fiction is created for determining the quantum of deduction of the eligible unit as if such unit is the only source of income of the assessee Deduction would be computed after setting off carried forward losses of the eligible unit against profit of the eligible unit aloneLosses of earlier years, though already absorbed against other sources are once again to be notionally brought forward and set off against profits of the eligible unit to compute eligible deduction In favor of: Revenue

26. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA Explanation: “… nothing contained in this section shall apply to a person who executes a work contract entered into with an undertaking or enterprise…” 80IA(4)(i): “Any enterprise carrying on the business of developing….an infrastructure facility which fulfills the following conditions, namely…it is owned by a company registered in India…” Issue: Availability of benefit to a sub-contractor Case:Patel Engineering Ltd vs. DCIT (2005) 94 ITD 411 (Bom) Points: “Contractor”, as mentioned in a infrastructure development facility, is not necessarily contradictory to the term “developer”, who is eligible for deductionIncentive intended for entrepreneurs who undertake entrepreneurial and business risk, and not contractors who only undertake business risk In favor of: Assessee Note*: Considering the huge infrastructure funding requirement of about USD 300 billion in the next 5 years, the withdrawal of tax incentives to works contractors will need to be reconsidered *FICCI pre-budget memorandum

27. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA/IB/IC(1): “Where the gross total income….includes any profits and gains derived…from any business referred to…” Examples of income not derived from a business:Import / export entitlements from an Export Incentive SchemeLease money from leasing property to an eligible undertakingSale of scrapInterest earned on deposit with a State Electricity Board Issue: When is income “derived from” an eligible business? There has to be a direct nexus between the profit and gains and the undertaking “Derived from” cannot have a wide import, unlike the phrase “attributable to”

28. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(12): Deduction shall be available to any enterprise transferred in a scheme of amalgamation or demerger 80IA(12A): Nothing in sub-section 12 shall apply to any enterprise transferred in a scheme of amalgamation or demerger Issue: Is 80IA(12A) applicable to 80IB and 80IC? Points: 80IA(12A) inserted as 80-IA benefit was intended to provide incentive to take initial investment and entrepreneur risk80IA(5) and 80IA(7) to (12) apply to 80IB and 80IC. No mention of 80IA(12A) in 80IB and 80ICCBDT Circular 3 of 2008 confirms the above.

29. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(12): Deduction shall be available to any enterprise transferred in a scheme of amalgamation or demerger 80IA(12A): Nothing in sub-section 12 shall apply to any enterprise transferred in a scheme of amalgamation or demerger Issue: Is deduction available if there is transfer via slump sale or share sale? Points: Amalgamation, as defined u/s 2(1B), doesn’t include slump sale or share sale80IA(12) and 80IA(12A) do not mention transfer via slump sale or share saleDeduction u/s 80IA is for an “undertaking”. One possible view is that deduction will be available in the case of a slump sale as only ownership changes

30. Other Principles Issues80IA, 80IB, 80IC Deduction u/s 80IA allowed to well integrated new units with a separate and distinct identity. It is not very relevant that • The new units have the same management / premises • The new units produce similar goods, or procure raw materials from a common source – JCIT vs. Associated Capsules P. Ltd. (2008) 304 ITR (AT) 85 (Mum) Deduction u/s 80IB(10) is allowed to the developer, even if the developer is not the owner, as • The developer opted for the business risks associated, therefore could not be called a contractor • Deduction is not exclusively to a taxpayer, but to a developing undertaking, be it an owner or contractor – Radhe Developers & Ors vs. ITO (2008) 113 TTJ 300 (Ahm) Deduction u/s 80-IB(10) is allowed to units of a larger housing project, as • 80IB(10) uses the words ‘residential unit’, therefore deduction should be computed unit-wise • The provision should be construed liberally so as to advance its objective – DCIT vs. Brigade Enterprises (P.) Ltd. (2008) 119 TTJ 269 (Bangalore)

31. Other Principles Issues80IA, 80IB, 80IC Deduction u/s 80IB is available even if, once the requirements are met, the services provided by the eligible unit are used by the taxpayer itself or a third party – Sanchita Marine Products (P.) Ltd. vs. DCIT 15 SOT 280 (Mum) Mere facilitation from the head office of an eligible unit would not disentitle the eligible unit from claiming deduction – DCIT vs. Tribhovandas Bhimji Zaveri (2007) 110 TTJ 942 (Mum) • Providing installation, testing, commissioning facilities etc. of the cranes to a port in a BOLT scheme is an infrastructure facility u/s 80IA – DCIT vs. ABG Heavy Industries Ltd. (2008) 20 SOT 525 (Mum)

32. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IA(12): Deduction shall be available to any enterprise transferred in a scheme of amalgamation or demerger 80IA(12A): Nothing in sub-section 12 shall apply to any enterprise transferred in a scheme of amalgamation or demerger Issue: Should 80IA(12A) be reconsidered? Thoughts*:Companies’ need to reposition themselves quickly, especially in the current economic environmentMergers / demergers crucial to companies’ global competitivenessEarlier position of 80IA(12) to be continued and benefit to be available to the amalgamated or resulting company *FICCI pre-budget memorandum

33. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IB(9): Deduction to an undertaking which begins commercial production of mineral oil Issues: Undertakings unable to avail benefit for the full 7 years due to the huge depreciation claims in the initial 3-4 yearsCommercial viability of upcoming refineries affected by the Sunset Clause (tax holiday not available for undertaking beginning refining on or after 1st April 2009)The term ‘mineral oil’ does not include petroleum and natural gas, unlike other sections of the Act Thoughts*: 100 % tax holiday for a period of any 10 consecutive years out of 15 years under section 80-IA instead of 80-IBFlexibility to be provided of choosing any 7 consecutive years out of 15 years Drop the sunset clause or extend to 31st March 2012 for private sector undertakings, to be on par with public sector undertakings *FICCI pre-budget memorandum

34. Issues80IA, 80IB, 80IC Deduction in respect of profits and gains from industrial undertakings 80IB(9): Deduction to an undertaking with profits from operating and maintaining a hospital Issues: Current 5 year tax holiday is very short. Entrepreneurs would hardly reach the break even point in the first 5 years Thoughts*: 5 year holiday to be extended to 10 yearsInfrastructure status to be granted to the healthcare industryCompanies creating the following training and educational facilities to be eligible for exemption ■ Medical ■ Dental ■ Nursing ■ Midwifery ■ Paramedical ■ Lab Technicians ■ Biomedical Engineering *FICCI pre-budget memorandum

35. Issues80P Deduction in respect of income of co-operative societies Issue: When a co-operative society (other than a credit co-operative) provided credit facilities to its members, is the interest earned eligible for deduction? Case:CIT vs. Krishak Sahkari Ganna Samiti (2002) 258 ITR 594CIT vs. Madras Autorickshaw Drivers Co-operative Society (1983) 143 ITR 981 Points: Income “attributable to” an activity includes income from sources other than the main activity of the societyInterest from statutory investment in government securities deductible HoweverInterest earned from goods sold on credit not deductible as the element of sale predominates the element of financing In favor of: Assessee - CIT vs. Krishak Sahkari Ganna Samiti Revenue - CIT vs. Madras Autorickshaw Driver’s Co-op

36. Issues80P Deduction in respect of income of co-operative societies Issue: Whether income from activities of a co-operative housing society is eligible for deduction u/s 80P(2)(c ) Case:CIT vs. Film Nagar Co-operative Housing Society Ltd (2004) 91 ITD 27Maker Tower A & B Co-op. Hsg. Society vs. ITO (2008) 20 SOT 253 Points: Income of a co-operative housing society is eligibleas a case of “other co-operative societies” (80P(2)(c ) Profit and gains are not from “business” but from “activities” carried out In favor of: Assessee - CIT vs. Film Nagar Co-operativeAssessee - Maker Tower A & B Co-op.

37. Issues80P Deduction in respect of income of co-operative societies Issue: Whether a co-operative bank needs to carry on business only with members to be eligible for exemption Case:Milli Co-op Urban Bank vs. ITO (2007) 106 ITD 151 (Hyd) Points: Co-operative bank can do business with non-members and be eligible for deduction u/s 80P(2)(i)The section should be read as income to a co-operative society carrying on the business of“banking” or “providing credit facilities to its members” In favor of: Assessee

38. Questions?

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