Dichotomy between Gross and Net amount - Analysis of Vijay Industries Judgment

By  Mahendra Singh

Introduction:
The Income-tax Act, 1961, under Chapter VI-A, provides for certain special deductions. These special deductions have been subject matter of litigation all along. One such provision is Section 80HH, which provides for deduction in respect of profits and gains from newly established industrial undertakings or hotel business in backward areas.

In a recent judgment in the case of Vijay Industries[See endnote 1], a three-judge bench of the Hon’ble Supreme Court decided the issue as to whether the deduction under Section 80HH is to be calculated after deducting ‘depreciation’ and ‘investment allowance’ from profits and gains or not. The Court held that the deduction under Section 80HH is to be allowed on the ‘profit and gains’ without applying the provisions of the Act (‘Gross amount’) and not on profits and gains computed as per the Act (‘Net amount’). The relevant assessment years in this case were assessment years 1979-80 and 1980-81.

In this case, the assessee had challenged the judgment of division bench of Hon’ble Supreme Court in Motilal Pesticides[See endnote 2], wherein in respect of same section 80HH and for the same assessment years, the Court had held that the deduction is to be allowed on the net amount and not on the gross amount. This ruling was being regularly followed by the department to compute deduction under 80HH on net amount.

This article tries to analyse the legal position existing prior to Vijay Industries judgment, and the change in position brought by this judgment.

Position of law before Vijay Industries:
The provisions relating to special deductions under chapter VI-A, heading “C- Deductions in respect of certain income” have been interpreted differently by the courts in India as discussed in the following paragraphs. This part of the article tries to discuss the interpretation given by the courts to other provisions of Chapter VI-A and its relevance in interpreting Section 80HH.

Interpretation of phrase “where the total income (as computed in accordance with the other provisions of this Act) includes any profits and gains”
In Cambay Electric Supply Industrial Co Ltd[See endnote 3], the Supreme Court interpreted the above-mentioned phrase in Section 80E, as it existed, and held that the deduction is to be allowed on the net amount, i.e. profits and gains after deducting unabsorbed depreciation and unabsorbed development rebate. The Court held that since the total income is required to be computed as per the provisions of the Act, unabsorbed depreciation and unabsorbed development rebate will have to be considered for arriving at the amount eligible for deduction.

Interpretation of the phrase “where the gross total income includes any income by way of…..”
In Cloth Traders[See endnote 4], the Supreme Court held that the deduction under Section 80M in respect of dividend is to be allowed on gross amount.  Court held that the opening words in the section, namely, "Where the gross total income of an assessee.......includes any income by way of dividends from a domestic company" refer only to the inclusion of the category of income by way of dividends and not to the quantum of the income included in the gross total income. Therefore, the deduction is to be calculated with reference to the whole amount of dividends. In this judgment, the Court referred to some other provisions such as 80-K, 80-MM, 80N-, 80-O, etc. and noted that deductions under these sections as well are on the whole amount. However, it is to be noted that the judgment of Cambay Electric Supply Industrial Co. Ltd. was not discussed in Cloth Traders.

Insertion of Section 80AA and 80AB
After the judgment of Cloth Traders, the legislature inserted Section 80AA (applicable to Section 80M) and 80AB (applicable to other deductions) in Chapter VIA of the Act. Both these sections provided that the deductions specified in the aforesaid sections will be calculated with reference to the net income as computed in accordance with the provisions of the Act (before making any deduction under Chapter VIA) and not with reference to the gross amount of such income.  Section 80AA was inserted with retrospective effect i.e. from 1^st April, 1968 whereas 80AB was prospective in operation from 1^st April, 1981 (from assessment year 1981-82 onwards).

Constitution bench in Distributors Baroda
The Constitution Bench of the Hon’ble Supreme Court in Distributors Baroda[See endnote 5] overturned the decision of Cloth Traders and held that the deduction in respect of Section 80M is to be allowed on net amount and not gross amount. The Supreme Court in this judgment did not discuss the retrospectivity of Section 80AA, as it was not necessary in view of its interpretation of Section 80M.

The Court held that the condition for applicability of Section 80M is that the gross total income must include the income by way of dividend. The deduction is to be made from 'such income by way of dividends', and therefore, it is elementary that 'such income by way of dividends' from which deduction has to be made must be part of the gross total income. The Court held that it is not the full amount of dividend which is included in the gross total income, but what is included would only be the amount of dividend as computed in accordance with the provisions of the Act. Accordingly, the deduction required to be made for computing the total income from the gross total income can only be from the amount of dividend computed. Therefore, the deduction was to be allowed on net amount and not gross amount. The court rejected the interpretation of Cloth Traders that the term ‘such income by way of dividends’ only refers to category of income and not to quantum of income.

After this judgment, section 80AA was rendered superfluous.

However, in Motilal Pesticides, the question came up whether the interpretation as provided in Distributors Baroda in respect of Section 80M is to be followed for the purposes of section 80HH or not.

The Court held that the language of Section 80HH and 80M was similar and following the judgment of Distributors Baroda, the deduction is to be allowed on the net amount. The Court held that the interpretation of Distributors Baroda is irrespective of Section 80AA. Further, the Court noted that though Section 80AB was to have prospective operation, similar to section 80 AA, even Section 80AB is to be understood to have been enacted to declare the law as it always stood.  Therefore, it was held that the deduction was to be allowed on net amount.

Judgment of Vijay Industries and analysis
In this judgment, the Court held that Chapter VI-A is a standalone chapter dehors Chapter IV of the Act. Therefore, provisions relating to various kinds of deductions mentioned therein have to be construed independent of Chapter IV of the Act. Further, the Court held that there is a distinction between the concept of ‘income’ on one hand and ‘profits and gains’ on the other hand.

The Court held that the scheme of Chapter VI-A which includes Sections 80C to 80U contain different subject matters and also specify particular percentage of deductions for a particular period. Further, different provisions from Sections 80C to 80U also specify as to how such a deduction is to be worked out. The court held that insofar as Section 80HH is concerned, it specifically mentions deduction at the rate of 20% of ‘profits and gains’.  On reading of Section 80HH along with Section 80A, it is clear that such a deduction has to be on gross profits and gains i.e. before computing the income as specified in Sections 30 to 43D of the Act.
The Court noted that the change in legal position was brought by Section 80AB which is prospective in operation and therefore not applicable to relevant assessment years.

It may be noted that the judgment of Cambay Electric Supply Industrial Co Ltd and Distributors Baroda were referred to and discussed. However, the same were distinguished on the ground that the language of Section 80HH was different from 80E and 80M.

The judgment of Distributor Baroda was distinguished on the basis that it was a decision on Section 80M which used the term ‘income by way of dividend’, whereas 80HH uses the term ‘profit and gains’ and does not use term ‘income’. However, one could always debate whether the judgment of Supreme Court in Distributors Baroda has been properly considered in Vijay Industries.
 
In Distributors Baroda, while holding that the deduction is to be allowed on net amount, the Court interpreted the condition for applicability of Section 80M, i.e. gross total income must include income by way of dividend. The Court held that it not only refers to category of income but also to quantum of income. The Court held that what is included in gross total income is the amount of dividends computed in accordance with the provisions of the Act. The judgment of Vijay Industries unfortunately does not discuss this point.
 
Be that as it may, section 80AB inserted with effect from 1^st April, 1981 seems to make it very clear that deductions specified in Chapter VIA will be calculated with reference to the net income as computed in accordance with the provisions of the Act (before making any deduction under Chapter VIA) and not with reference to the gross amount of such income. Therefore, the recent judgment in the case of Vijay Industries may not have any impact on Chapter VIA deductions for the period post 1^st April, 1981.
 
However, this judgment is likely to have an impact on the interpretation of various other sections which grants exemptions or deductions with reference to “profits and gains” of a business or activity rather than the “income” therefrom. May be the final verdict on this issue is yet to be pronounced.
 
[The author is an Associate, Direct Tax Team, Lakshmikumaran & Sridharan, Delhi]