80IA : Favor of revenue and against the assessee

Income Tax – benefit u/s 80IA, 80IB – initial year is the year in which commercial production starts, not trial production; Even if there was sale of only one water cooler and one air-conditioner, it amounts to commercial production: Madras HC

ITA Nos. 1154/2009 and 1204/2009 were heard on 25th November, 2009 and judgment reserved. Within few days other three ITAs were heard on 9th December, 2009. Though the assessees are different in the two sets of appeals, questions of law are common. In fact, ITA Nos. 1154/2009 and 1204/2009 are filed by the Revenue as the Income Tax Appellate Tribunal (ITAT) has decided the matter in favour of the assessee. On the other hand, in other appeals it is the assessee who is the appellant and is aggrieved by the order of the ITAT.

Both the sets of appeals are taken up together.

Both Revenue and the Assessee are in appeal before the High Court with the same question of law, but under different sets of facts and both lost.

First Set: ITA No. 1154/2009 and ITA No. 1204/2009

The assessee M/s Nestor Pharmaceuticals Limited is in the business of manufacturing of pharmaceuticals formulations in bulk drugs and supplying the drugs to the Government hospitals, institutions besides selling the product in domestic and foreign markets. It is claiming depreciation on plant and machinery for benefit under Section 80IA/80IB of the Income Tax Act. The assessee had carried out trial production from 20th March, 1998. On that basis the Assessing Officer treated assessment year 1998-99 as the initial year for benefit under the aforesaid provision. Since this benefit is allowable for five years, according to the Assessing Officer, this benefit as admissible from assessment years 1998-99 to assessment year 2002-03. The assessee on the other hand was claiming benefit from assessment year 1999-2000 to assessment year 2003-04. The ITA No. 1204/2009 refers to assessment year 2003-04. For this reason, in respect of this assessment year, the benefit was entirely disallowed.

The Commissioner of Income Tax (Appeals) confirmed the order of the Assessing Officer but the ITAT has reversed that order holding that since Section 80IA/80IB of the Act being beneficial legislation, the benefit should be extended to the assessee. It further held that as on 20th March, 1998 only trial production started which is different from commercial production and benefit of that Section would be allowed in the year in which commercial production started i.e. in the assessment year 1999-2000 and, therefore, would be extendable up to the assessment year 2003-04.

There is no quarrel that the assessee qualifies as the industrial undertaking as specified in the said Section for the purpose of deriving benefit of the said provision. This provision allows deduction from profits and gains of an amount equal to hundred per cent of profits and gains derived from such business for the first five assessment years commencing at the time during the periods as specified in Sub-section (2) and the dispute is as to which are the first five assessment years. These five years are to commence at any time during the periods as specified in Sub-section (2).

The initial assessment year, for the purpose of Section 80IA, is the assessment year relevant to previous year in which the "industrial undertaking begins to manufacture or produce articles or things. In the present case, the trial production began on 20th March, 1998 in its Goa plant as per the details given in the audit report furnished by the assessee along with its return of income for assessment year 2003-04 and 2004-05. According to the Assessing Officer this amounted to manufacture of its products on the date which means during the previous year relevant to assessment year 1998-99 and therefore that was the initial assessment year in which the assessee company was entitled to deduction under Section 80IA and the five years period expires on 2002-03. The assessee was, therefore, not entitled to deduction @ 100% of the profits of Goa unit and restricted the same to 30% of the profits from assessment year 2003-04.

The plea of the assessee was that trial production did not amount to manufacture of its products. It is only when commercial production commences, which according to the assessee commenced only in the assessment year 1999-2000, the assessee would become entitled to deduction under Section 80IA/80IB as per Clause(c) of Sub-section 12 of Section 80IA.

There is no dispute that first sale from Goa unit was made on 23rd April, 1998 which would be the period relevant to assessment year 1999-2000. The assessee had also produced evidence in the form of no objection certificate from local authority for manufacture operation in Goa unit as well as approval for release of HT power obtained by the assessee, which were granted only in the month of April, 1998. The assessee did not even have the requisite minimum number of employees employed in the previous year relevant to assessment year 1998-99. As against this, the plea of the Revenue is that closing stock of finished goods of given unit as on 31st March, 1998 was shown by the assessee-company at Rs.1,49,405/- and there was no commercial production as claimed by the assessee, how the closing stock of finished goods could be valued at the aforesaid figure.

The High Court was of the opinion that merely because some closing stock was shown as on 31st March, 1998, would not lead to the conclusion that there was commercial production as well. Naturally, even for the purpose of trial production material would be needed and there would be production which will result in stock of finished goods. Otherwise, there is overwhelming evidence produced by the assessee, and accepted by the Tribunal as well, from which it is clear that there was only a trial production in the assessment year 1998-99 and commercial and full-fledged production commenced only in the year 1999-2000.

The controversy, thus, boils down to the limited sphere namely whether, even with the start of trial production, with no commercial production in a particular year, it will be treated as "initial year" for the purpose of Section 80IA/80IB. The CIT(A) held so and this opinion of the CIT(A) did not found favour with the ITAT.

Challenging this decision of the Tribunal, present appeal is preferred and the question of law which arises is as under:

"Whether the Ld. ITAT erred in allowing benefit of deduction u/s 801A/802B of the Act from the AY 98-99 (by treating the same as initial year of production) to AY 2003-04."

In view of consistent view taken by various High Courts, the High Court did not find any reason to take a different view and are in respectful agreement with the dicta laid down in the judgments. It is more so when even this Court, way back in the year 1984, in Commissioner of Income Tax vs. Food Specialities Ltd., followed the ratio of Hindustan Antibiotics Ltd as is clear from the following:

"As regards the year of manufacture, on the question whether there can be an experimental period, a reference was made to the case of CIT v. Hindustan Antibiotics Limited, 93 ITR 548 and Madras Machine Tools Manufacturers Ltd. v. CIT, 98 ITR 119 in both of which it was held that manufacturing for the purpose of section 15C of the 1922 Act and section 84 of the 1961 Act was the date of "commercial" manufacture and the period during which experimental work, particularly manufacture, was effected had to be disregarded."

The High Court answered the question against the Revenue and in favour of the assessee and as consequence dismissed these appeals.

The second Set: ITA No. 160/2008, ITA No. 161/2008 & ITA No. 793/2009

Question involved in all these three appeals is same discussed earlier. It also arises under Section 80IA of the Act. The Tribunal has even taken note of judgment of Bombay High Court, Allahabad High Court as well as Madras High Court, holding that there should be regular production and not the trial production. However, on facts, the Tribunal decided the case against the assessee. What weighed with the Tribunal was that the assessee had not only produced the goods for trial purposes but there was, in fact, sale of one water cooler and air-conditioner in the assessment year 1998-99 relevant to the previous year/financial year 1997-98. The explanation of the assessee that this was done to file the registration under the Excise Act as well as the Sales Tax Act. This did not find favour with the ITAT.

Thus, the distinguishing feature is that after the production, commercial sale also took place as well before on 31st March, 1998. In this factual scenario following question of law was framed in these appeals:

"Whether the ITAT was correct in law and on facts to hold that sale of one water cooler and one air-conditioner as on 31.03.1998 for the purposes of obtaining registration of excise ad sales tax was `manufacturing' within the meaning of Section 80IA?"

The High Court observed, "When we carefully examine the ratio laid down in various judgments while dealing with ITA No. 1154/2009, we arrive at irresistible conclusion that the decision rendered by the Tribunal is without blemish and does not call for any interference. The provisions of Income Tax Act use the word "manufacture". Trial production is not regarded as beginning to manufacture or to produce articles because of the reason that the assessee has to produce trial production to verify whether it can be used ultimately in the manufacture of the final article. These are, therefore, "trial runs". The article is tested to find out as to whether it can be launched as a final product in the market or not. Therefore, with mere trial production, the manufacture for the purpose of marketing the goods has not started which starts only with commercial production namely when final product to the satisfaction of the manufacturer has been brought into existence and is now fit for marketing."

In the present case, the assessee had sold one water cooler and one air-conditioner before April, 1998. Thus, the stage of trial production had been crossed over and the assessee had come out with the final saleable product which was in fact sold as well. The quantum of commercial sale would be immaterial. With sale of those articles marketable quality was established, more particularly when assessee failed to show that the dealer returned those goods on the ground that there was any defect in the water cooler or air-conditioner produced and sold by the assessee to the dealer. Things would have been different if that had happened. The Tribunal, in the circumstances, is right that the two types of conditions stipulated in Section 80IA were fulfilled with the commercial sale of the two items in that assessment year. Whether the purpose of that sale was to obtain registration of excise or sales tax would be immaterial.

This question is answered against the assessee and in favour of the Revenue and the appeals are dismissed.

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