T N Pandey: Taxing times for IT firms

Recently, there have been reports in the print media on tax demand being slapped on information technology (IT) companies "" Wipro, Tata Consultancy Service (TCS) and others "" by the income-tax department.

Although the exact nature of differences on this matter between the finance ministry and the IT companies has not been clearly stated, reports covering a recent press conference by revenue officers ("No tax respite for IT firms", Business Standard, April 21) show that the dispute concerns the denial of exemption to company units under Sections 10A/10B of the Income Tax Act, 1961, on grounds that the assessees did not obtain separate licences from the Software Technology Parks of India (STPI) and did not keep a separate set of accounts for the units for which exemption of income was claimed.

The tax demands that have been slapped on various companies are huge "" Wipro alone has to pay Rs 261.4 crore. Central Board of Direct Taxes (CBDT) Chairman P L Singh reportedly said at the press conference that there is no plan to change the stand taken and the issue can now only be decided by the appellate forums under the Act.

Section 10A was first enacted by the Finance Act, 1981, for newly-established industrial undertakings in free trade zones (FTZs).

It was extended to units commencing operations in any software technology park (STP) and electronic hardware technology park (EHTP) with effect from April 1, 1994, and accordingly, applies in relation to assessment year (AY) 1994-95 and subsequent years.

On satisfaction of the prescribed conditions, the income of units, established in such places, is exempt from tax for 10 years. In notification SO-3231 dated September 29, 1987, notifying FTZs , the object for which the Section was enacted has been mentioned as "to attract investment for industrial growth by offering substantial tax concessions, including a complete tax holiday for a specified number of years". This objective is valid even today.

The conditions required to be complied with for getting exemption are:

• The undertaking must begin production in the FTZ, EHTP or STP during the previous year relevant to AY 1994-95 or any subsequent year.
• It should not be formed by splitting/reconstruction of a business already in existence.
• It should not be formed by transfer of old machinery.
• There must be repatriation of sales proceeds in India according to the stipulated conditions in convertible foreign exchange.
• Audit certificate in form number 56F should be filed while making the claim.
• The ownership of the unit or beneficial interest therein should not be transferred.

The income-tax department's view is that new units, formed under one original registration (licence) after the first unit, are in the nature of expressions. Accordingly, only the first unit is considered for the purpose of Section 10A. This has the following consequences:

• If the first unit is formed in the previous year, relevant to AY 1993-94 or earlier assessment years, then no deduction under Section 10A can be allowed, even if the subsequent units are formed in the previous year, relevant to AY 1994-95 or subsequent years.
• If the first unit is formed in the previous year, relevant to AY 1994-95 or thereafter, the deduction will be allowed for a maximum period of 10 years from the year in which the first unit is formed.

Thus, if the first unit is formed under a licence dated April 1,1995 and the second unit is formed on April 1, 2002 under the same licence, the second unit will get the deduction under Section 10A only up to 2004-05 (that is, only for three years) for the reason that the second unit is formed under the same licence even though it should be eligible till AY 2012-13.

Apparently, such a view is far-fetched. Section 10A ceases to apply if the unit is formed by "splitting or reconstruction of a business already in existence".

Obviously, setting up of new units cannot be covered by the handicap mentioned earlier. If the existing licence permits setting up of new units, this cannot be held against an assessee as a ground for denying the benefit. At best, it could be merely a technical non- compliance.

There are umpteen decisions in the context of Sections 80-I, 80-IA and 80J, where it has been held that establishment of a new industrial unit, as a part of an already existing industrial establishment, would be entitled to the exemption benefit if the newly-established unit is an integrated independent unit in which new plant and machinery are put up and are themselves independent of the old unit, capable of production of goods, and so on. In such a situation, a unit of this nature can be classified as a newly-established industrial undertaking [CIT vs Associated Cement Co Ltd (1979), 118 ITR 406 (bom)].

As far as separate accounts are concerned, no such requirement has been laid down by Section 10A. In any case, this is not such a vital requirement, for which exemption need to be denied.

The issue has apparently emerged from the decision of the Income Tax Appellate Tribunal, Hyderabad Bench (ITAT) reported in 85 ITD 325. The appellant company, in this case, had two units; the first was formed in 1991 and the second in 1997.

The ITAT in that case was to decide the issue whether a unit, formed with the approval of STPI before April 1,1994, can claim a deduction under Section 10B as a 100 per cent export-oriented unit.

While addressing the issue, the ITAT made an uncalled-for observation that the second unit, formed in 1997, is only an extension of the first unit and, hence, the second unit is also not eligible for the deduction under Section 10A.

This observation was made even though the appellant company had not solicited decisions on this ground and neither the appellant nor the respondent had an opportunity of being heard on this issue.

The ITAT had stated that it was not required to address the original grounds in the appeal before it because the appellant company had not pressed them. Hence, the obiter dictum of the ITAT in this decision cannot be held against the IT companies in general.

The CBDT's decision ignores the following well-established legal principles:

• It is contrary to the rules of interpretation of the statutes and against the view expressed by the Supreme Court expressed in (1988) 173 ITR 216 (Guj), where it has said that it is an elementary duty of the court to give effect to the intention of the legislature as evident from the words used.

According to Lord Denning (quoted with approval by the Supreme Court in AIR, 1961, SC 107), a judge must set to work on the constructive task of finding the intention of Parliament and must supplement the written words so as to give force and life to the intention of the legislature.

Ordinarily, a provision in a taxing statute, granting incentives for promoting growth and development, has to be construed liberally, and since a provision for promoting economic growth has to be interpreted liberally, the restriction on it, too, has to be construed so as to advance the objective of the provision and not to frustrate it [Bajaj Tempo Ltd vs CIT (1992) 196 ITR 188 (SC); CIT vs UP State Agro Industrial Corporation (1991) 188 ITR 370 (All)].

The CBDT's view would proliferate unnecessary litigation.

The IT industry is registering a phenomenal growth. The restricted view being adopted by the CBDT concerning Sections 10A and 10B, on mere hyper-technical grounds, is bound to set back such growth.

Hence, the decision of the finance ministry need to be urgently reviewed. Relief can be provided by issuing a circular under Section 119 of the IT Act.

In UCO Bank vs CIT (1999) 237 ITR 889, the Supreme Court has said that the CBDT has power, inter-alia, to tone down the rigour of the law and ensure a fair enforcement of its provisions by issuing circulars in exercise of its statutory powers under Section 119.

(The writer is former chairman, Central Board of Direct Taxes)