By TIOL News Service

NEW DELHI, SEPT 23, 2013: THE issues before the Bench are - Whether ancillary profit like DEPB receipts can be said to be derived from an industrial undertaking for the purpose of claiming deduction u/s 80IC of the Act and Whether the Revenue can deny deduction u/s 80IC claimed by the assessee on the ground that the assessee has not carried out any manufacturing activity on the basis of assumption and suspicion and without laying its hands on any concrete material to prove the same. And verdict partly goes in favour of the assessee.

Facts of the case

Assessee filed its return of income on 26.9.2009 declaring an income at nil after claiming deduction u/s 80IC of the Act. AO noticed a total turnover of Rs.100,31,28,153 which has resulted net profit of Rs.36,68,35,903. Assessee has claimed deduction u/s 80IC and in support of its claim, it has submitted Form No. 3CD and Form No. 10CCB along with the return. AO has observed that assessee has been claiming deduction u/s 80IC on the ground that it has been engaged in the business of manufacturing and export of handmade, handcuffed carpet at its industrial undertaking situated at Plot No.11, Sector 4, Sidhcul Haridwar and has been claiming deduction u/s 80-IC since AY 2005-06. This is the 5th consecutive AY of such claim.

AO had a suspicion that a turnover of more than Rs. 100 crores cannot be achieved by the assessee. He observed that the department had made local inquiry on several occasions from which it was gathered that no manufacturing activity was done at the alleged industrial undertaking of the assessee. According to the AO, the huge turnover as claimed by the assessee was diverted from its factory at Partappur, Meerut. He further observed that assessee has been claiming deduction at 100% by camouflaging manufacture at its location at Haridwar.

AO directed the assessee to show the present status of the business at Sidhcul. It was contended that assessee firm was came into existence in January 2003 and it was dissolved w.e.f. Ist of April 2009. The factum of dissolution was duly intimated to the AO. AO has observed that it is quite unusual to close down a business concern which is showing huge turnover up to AY 2009-10. AO has further observed that ITO, Ward 2, Hardwar was deputed to visit the factory premises and furnished the factual report. He took note of the factual status report submitted by the ITO, Ward- 2, Hardwar and thereafter made an analysis of the material collected by the ITO, Ward-2, Hardwar. On such analysis, AO formed certain reasons which creates a doubt about the claim of the assessee. He issued a show-cause notice on 26.12.2011 wherein he has narrated 27 reasons for doubting the claim of the assessee.

On receipt of show-cause notice, assessee has filed detailed reply, whereby it has appraised its manufacturing activities, how it is entitled for deduction u/s. 80IC. The assessee highlighted the various statutory compliance made by it for fulfilling all the conditions required for grant of deduction u/s 80IC of the Act, the assessee has filed its comments on each observation of the AO in the alleged show-cause notice. AO thereafter held that the assessee did not manufacture carpet at Sidcul, rather it has achieved the turnover by diverting products from its factories at Partappur and Meerut. He disallowed the claim of the assessee u/s 80IC which includes deduction on DEPB receipts at Rs.12,90,26,728. CIT(A) dismissed the appeal of the assessee.

On further appeal by the assessee, the ITAT held that,

++ the primary issue required to be determined, is when assessee came into existence and whether geographically it is located with the notified area contemplated in sub-clause (ii) of sec. 80IC(2)(a) or (2) (b). It emerges out from the record that assessee partnership firm came into existence on 1st of December 2003. It is situated at Plot No.11 Sector 4, Sidcul, integrated industrial estate, Haridwar. It had commenced the production on 18th October 2004. The A.O. himself admitted that deduction u/s 80IC was granted to the assessee continuously since AY 2005-06;

++ the next step which is essential for examining the case of an assessee about the admissibility of deduction u/s 80-IC is whether it manufactures or produces any article or things. Expression "manufacture" has been defined in section 2(29BA). However, expression "production" has not been defined in the Act. The stand of the revenue authorities is that at the most activity carried out by the assessee is of latexing, binding, carving and embossing, clipping and finishing. The other actiity of weaving of the carpets is being done at Meerut and other localities;

++ broadly manufacture is a transformation of an article, which is commercially different from the one which is converted. It is a change of one object to another for the purpose of marketability. It brings something into existence, which is different from that, which originally existed. The new product is a different commodity physically as well as commercially. The broader test to determine whether manufacture is there or not, it is propounded that when a change or series of changes are brought out by application of processes which take the commodity to the point where, commercially, it cannot be regarded as the original commodity but is, instead recognized as a distinct and new article that has emerged as a result of the process;

++ as far as objections of the AO that binding latexing packing, tufting, leveling, embossing and finishing are to be considered as a manufacturing activity of the assessee. This activity was not even disputed by the AO himself since AY 2005- 06. In the last four years, deduction u/s 80IC has been granted to the assessee treating this activity as a manufacturing activity. AO did not dispute the fulfillment of other eligible criteria provided in sec. 80IC of the Act i.e. the geographical location of the assessee, employment of the number of employees etc. In this year, Revenue Authorities have erred in construing the concept of manufacturing in a restricted manner. Thus, as far as legal requirements are concerned, all have been fulfilled by the assessee. Even on the strength of principle of consistency, it was brought to our notice that deduction u/s 80IC of the Act was claimed for the first time in AY 2005-06 and it was allowed to the assessee. This is the 5th consecutive AY. The assessments have been made u/s 143(3) in AY 2005-06 to 2008-09. The Department has not reopened the assessment in these four AYs nor any action u/s 263 of the Act was taken. Thus, it is not necessary to go into the aspects whether assessee fulfilled the other conditions of sec. 80IC of the Act or not;

++ the limited issue required to be considered in this AY is, whether the department is able to lay its hands on a material which exhibits that assessee has not carried out any manufacturing activity and it is not entitled for deduction u/s 80IC of the Act? Whatever was granted in earlier years was granted on account of mistaken belief or misconstruction of the facts. It is also to be kept in mind that if no remedial action can be taken in those years on account of expiry of limitation etc. that does not mean that any error committed in earlier years would be perpetuated in the present year;

++ in the assessment order, AO has issued notice u/s 143(2) on Ist of September 2010, a questionnaire was issued u/s 142(1) almost after 10 months on 06th July 2011. Thereafter, the jurisdiction over the assessee was transferred from ACIT to the JCIT who had issued fresh notice u/s 143(2) and 142(1) on 12th September, 2011. It suggests that investigation process has been started after 6th July 2011 and effectively after 12th of September, 2011. The assessment has been passed on 30.12.2011 i.e. just within three and half months. The assessee firm was dissolved on Ist of April 2009. It closed down its business from this date. The alleged spot inquiry got conducted through ITO, OSD, Haridwar was conducted after the month of September, 2011 i.e. almost after two and half years of closure of the business. According to the assessee, AO has observed that on a local inquiry conducted through ITO, OSD, Haridwar, it was found that no such business was ever carried out at the said location. The assessee pointed out that during the course of assessment proceedings, assessee has asked the AO to disclose the basis of this observation. DR on the other hand pointed out that in the reasons stated by the AO, he has disclosed the basis. The objection of the assessee is that after the closure of the business, if the ITO made the inquiry from tea-vendors, rikshaw-pullers, it is meaningless. Had he approached the Pollution Authority, local sales-tax authorities, district industry office or other government agencies? It reveals from the record that no such exercise was carried out. In our opinion, the prosecuting agency needs not to explain the assessee the manner of investigation, but it is bound to confront the assessee with the material of investigation collected during the spot inquiry. If ITO, OSD was visiting the area in the capacity of a local commissioner, he should have issued a show-cause notice to the partners of the assessee, pointing out object of his visiting and associates them during his inquiry. He should have prepared a list of persons with whom he had interacted and on the basis of which AO has been observing that department made local inquiries on several occasions from which it was gathered that no manufacturing activity was done at the said location. No such material was ever confronted to the assessee or disclosed to the assessee. AO has been reproducing the factual position found by the ITO, OSD on page 2 of the assessment order (extracted by us in the order). According to the ITO, there were only 13 taping frames and three were in broken condition. ITO has narrated list of eleven items which were available on the premises and then concluded that on the basis of these items, it is not possible to achieve a turnover of Rs.100 crores. While putting reliance on this material, Revenue Authorities have totally lost sight that this is the remnant of a discontinued business. ITO has been visiting the place after two and half years of the closure of the business. Why the machinery etc. would be available in an intact position as was available at the time of running the business?;

++ thus, the alleged inspection report of ITO is neither here nor there, it cannot goad any adjudicating authority to any conclusion, more so, when in the last four AYs passed u/s 143(3) existence of assessee's business was not disputed by the ITO. The right time to raise this suspicion about the nature of business was the time when it was in existence;

++ AO has alleged that statement of Mr. Ashis Gupta was recorded. In his statement, he claimed that latexing, binding, embossing and finishing was done at Haridwar but the production activity data furnished by the firm does not reflect any activity of this type being done at Haridwar. For this conclusion, he was harping upon the replies of the job workers obtained u/s 133(6) who have alleged that they were doing the job work at their premises outside Haridwar. The reply qua reasons No. 9 of the assessee is available on page 18 of the assessment order. The assessee has alleged that these replies were received during the AY 2005-06. The vendors have no where said that these services are not given by them at Haridwar. AO has drawn incorrect inference from the replies. AO has considered this reply and made analysis on page 24 of the order. He observed that letters were issued to different persons u/s 133(6) of the Act, who have done job work for the assessee. 25 letters have been received back undelivered. 7 concerns have responded to the letters. They have confirmed the job work done for the assessee. AO did not consider their replies as worthy of credence on the ground that they have sent the copies of their replies to the assessee. Their replies are similarly worded. On an analysis of this detail, we fail to understand the approach of the AO. He is using this material against the assessee. When assessee explained its position he excluded this material but considered it as a negative evidence. In the reasons, he has observed that job workers have denied for carrying out the job work for the assessee. When assessee explained its position and pointed out that seven parties have confirmed about doing the job work then AO has observed that such reply must be a tutored reply on the asking of the assessee otherwise they would have not sent these letters to the assessee. This will only suggest that this material cannot be used against the assessee, at the most for its prosecution. It is not the evidence of the assessee. It is the evidence of the AO who failed to prove against the assessee but still relying upon it in a negative sense;

++ similar are the other reasons assigned by the AO. The assessee has explained its position and on an analysis of the material, except observing philosophically for raising a suspicion, AO was unable to lay his hands on any concrete material for doubting the activity of the assessee;

++ during the course of appellate proceedings, a survey u/s 133A of the Act was carried out on the new business premises of erstwhile partner on 23.2.2012 at Meerut and Haridwar. AO has submitted a report dated 4.5.2012 to the CIT(A) which includes the material collected during the course of survey. Before considering this report on merit, let us consider the procedural aspect whether it is cognizance could be taken by the CIT(A) or not, on asking of the AO? Rule 46A of the Income-tax Rules, 1962 is a rule which provide the procedure for production of additional evidence before the DCIT(Appeals) and CIT(A);

++ a bare perusal of rule 46A from clause Nos. 1 to 3 would suggest that additional evidence could be produced by the appellant only. It nowhere provide a remedy to the AO to strength his assessment order by supplementing the material in the shape of additional evidence. No doubt, sub-rule(4) gives powers to the CIT(A) to direct the production of any document or the examination of any witness to enable him to dispose of the appeal. CIT(A) in the impugned order did not disclose how he came to know about the survey and whether he has issued notice to the assessee for production of the survey material or not. AO cannot be an applicant for production of the additional evidence in an appellate proceeding. The rule does not empower the AO because, if some income has escaped assessment, he can take action under sections 147, 154 or the CIT can take action u/s 263 of the Income-tax Act, 1961. CIT(A) can exercise its coterminus powers of the AO and then calls for any evidence. But we find that the report has been entertained on the request of the AO which is not permissible under the Rule;

++ the assessee has explained each page and each objections raised by the AO. The survey has not been carried out on the premises of the assessee because it has already discontinued the business. In paragraph 4.2 of the First Appellate Authority has observed that as far as the material available in report at Sr. Nos. 1 to 4, 6 to 9, 11 to 13, 15 to 71, 73 to 83, 93, 94 & 97 are concerned, the assessee has given a common reply that these documents are not related to the assessee firm because, it has closed the business. Assessee has placed on record its reply on all the issues. In the report of the AO, Sr. No. 1 talks about register pertaining to dying unit. It is annexure 63. The conclusion derived by the AO is that this register has been found at the Gogal Road, Meerut Unit of the assessee, therefore, it may be concluded that dying operation is being performed at Meerut rather then Haridwar as claimed by the assessee. It submitted that on page Nos. 1 and 2, dates mentioned are January 2012. Therefore, it is a register for dying unit. It does not relate to the business of the assessee which discontinued w.e.f. Ist of April 2009. CIT(A) has simply ignored this reply on the ground that it is a stock reply. When a business was discontinued in 2009 and the department is trying to co-relate the entries of 2012 with 2009, it is totally misapplication of mind. In the survey, the department ought to have collected the material for the period relevant to this AY. It should not have drawn the inference from the latest material found at the premises of new concern and then assumed that it must belong to the assessee in 2009. During the course of hearing, we have confronted the DR to pin point the material which pertains to the period of the accounting year involved in the present AY and then point out how that material suggests that assessee has not carried out any manufacturing activity. He drew our attention towards Sr. No. 96, or No. 86, Sr. No. 10 and Sr. No. 14 of the report. We have duly considered these material but they do not suggest that assessee has not carried out any manufacturing activity;

++ apart from these aspects, assessee took us through the assessment order passed by Dy. Commissioner, Central Excise u/s 9(2) available and through the sales-tax assessment order passed by Dy. Commissioner Sales tax, Haridwar. These are scrutiny assessments. For AY 2008-09, these authorities have accepted the business turnover of the assessee. Revenue Authorities have totally ignored these material on the record. It is true that whenever a conclusion has to be reached on an appreciation of a number of facts established by evidence, whether that was sound or not must be determined not by considering the weight to be attached to each single fact in isolation but by assessing the cumulative effect of all the facts in their setting as a whole. The efforts of the CIT(A) is to reach the conclusion on the basis of circumstantial evidence but to our mind the inferences drawn by the Revenue Authorities are not supported by the material or the circumstances. They are just on assumption and suspicion. Therefore, the assessee has carried out the manufacturing activity. It has been granted deduction u/s 80IC of the Act from the last four AYs. The department is unable to lay its hands on any concrete material which can force us to take a different view then the stand of the AO in earlier four AYs. Assessee is entitled for deduction u/s 80IC of the Act;

++ in the computation for deduction u/s 80IC, assessee has included a sum of Rs.12.90 crores which represents the DEPB receipts. The assessee has placed on record a note as to how deduction on DEPB receipts u/s 80IC are admissible. However, this issue is squarely covered against the assessee by the decision of Supreme Court in the case of Liberty India vs. CIT. The Supreme Court has held that DEPB receipts are not derived from an industrial undertaking rather their genesis is from the beneficiary scheme formulated under Central Excise Act etc. They are the ancillary profit. The assessee submitted that the Supreme Court has not taken into consideration the amendment in sec. 28 which has been given effect from 1st of April 1998. This amendment suggests that on sale of DEPB receipts, if there is any profit, then it will be a revenue receipts. This amendment was brought by Act of 2005, w.e.f. 01.04.1998. The decisions of the Supreme Court is dated 31.09.2009. Thus, the decision of Supreme Court is subsequent to the amendment, hence, the decision cannot be distinguished on this argument. In view of the above discussion, the AO was directed to allow the deduction u/s 80IC of the Act as per law excluded on the DEPB receipts.

(See 2013-TIOL-817-ITAT-DEL)