Prior period Expenses not allowable
There the Assessee had earned interest on the deposits lying in the EEFC account as well as interest earned on intercorporate loans given to sister concerns out of the funds of the undertaking. There was a restriction on the Assessee in that case from making prepayment of its external commercial borrowings (‘ECB’). It could repay only to the extent of 10% of the outstanding loan in a year. This made the Assessee temporarily park the balance funds as deposits or with various sister concerns as inter corporate deposits until the date of repayment. The Assessee contended that the interest derived from the business of the industrial undertaking was eligible for exemption within the meaning of Section 10B and applied the formula under Section 10B of the Act for determining the profits from exports.
In view of the definition of income from Profits and Gains incorporated in Subsection , the assessee is entitled to the benefit of exemption of the said amount as contemplated under Section 10B of the Act. Therefore, the Tribunal was justified in extending the benefit to the aforesaid amounts also. We do not find any merit in these appeals.
As per the formula stated above, the entire profits of the business are to be taken which are multiplied by the ratio of the export turnover to the total turnover of the business. Subsection does not require an assessee to establish a direct nexus with the business of the undertaking and once an income forms part of the business of the undertaking, the same would be included in the profits of the business of the undertaking. Thus, once an income forms part of the business of the eligible undertaking, there is no further mandate in the provisions of Section 10B to exclude the same from the eligible profits. The mode of determining the eligible deduction U/S 10B is similar to the provisions of Section 80HHC inasmuch as both the sections mandates determination of eligible profits as per the formula contained therein.
In view of the definition of ‘income from Profits and Gains’ incorporated in Subsection , the assessee is entitled to the benefit of exemption of the said amount as contemplated under Section 10B of the Act. The relevant discussion as found in paragraph 16 of the judgment is quoted below for ready reference. The assessee earned during the said Assessment Year 2001-02, interest income of `4,68,037/ on the Short Term Deposits made by it to the tune of `6,46,88,606/ out of its Surplus Funds temporarily parked in the Current Account held in Citi Bank, Hong Kong and also earned interest of `6,02,309/ from the Advances of loans to its staff members. The deduction in respect of both the said interest income was claimed as a 100% deduction under Section 10A of the Act during the said relevant year as income from “Profits and Gains” of export business.
Where are prior period adjustments reported?
Definition: A prior period adjustment is the correction of an accounting error that occurred in the past and was reported on a prior year’s financial statement, net of income taxes. In other words, it’s a way to go back and fix past financial statements that were misstated because of a reporting error.
In case of Liberty India (supra), the Supreme Court dealt with the provisions of Section 80IA of the Act wherein no formula was laid down for computing the profits derived by the undertaking which has specifically been provided under subsection of Section 10B while computing the profits derived by the undertaking from the export. Thus, the decision of the Supreme Court in Liberty India (supra) is of no help to the revenue in determining the claim of deduction u/s 10B in respect of the export incentives. We are of the view that the basis of computation of the deductions enumerated under Chapter VIA is different from that set out for the special deductions like Section 10A and 10B. Section 80IA provides for a deduction of profits and gains derived by an undertaking or an enterprise from an eligible business.
In Totgars Cooperative Sale Society Ltd. The relevant extract of the Supreme Court judgment is quoted below for ready reference.
Prior period adjustment
The Assessee’s contention that the expression “profits of the business of the undertaking” in Section 10B was wider than the expression “profits and gains derived by” the Assessee from a 100% EOU occurring in Section 10B was accepted by the ITAT. The ITAT noticed that unlike Section 80 HHC, where there was an express exclusion of the interest earned from the ‘profits of business of undertaking’, there was no similar provision as far as Sections 10A and 10B were concerned. The Parliament intended to encourage the enterpreneurs to export the products from India. As part of that, it incorporated Section 10B of the Act. On perusal of Section 10B discloses that the profits and gains derived from a 100% export oriented undertaking, shall not be included in the total income of an assessee.
The relief under Section 10B, on the other hand, is granted in respect of the profits derived from the eligible activity of export, computed as a proportion of the profits of the business of the undertaking. Thus, subsection of Section 10B stipulates that deduction under that section shall be computed by apportioning the profits of the business of the undertaking in the ratio of turnover to the total turnover. Thus, notwithstanding the fact that subsection of Section 10B refers the profits and gains as are derived by a 100% EOU, yet the manner of determining such eligible profits has been statutorily defined in subsection of Section 10B of the Act.
Both subsections and should be read together while computing the eligible deduction u/s 10B of the Act. We should not ignore subsection of Section 10B which provides the specific formula for computing the profits derived by the undertaking from export. As per the formula so laid down, the entire profits of the business are to be determined which are further multiplied by the ratio of export turnover to the total turnover of the business.
What is a prior period error How and when is it corrected?
Definition: A prior period adjustment is the correction of an accounting error that occurred in the past and was reported on a prior year’s financial statement, net of income taxes. In other words, it’s a way to go back and fix past financial statements that were misstated because of a reporting error.
The question as to what can constitute as profits and gains derived by a 100% EOU from the export of articles and computer software came for consideration before the Karnataka High Court in CIT v. Motorola India Electronics Pvt. Ltd. 46 taxguru.in 167 (Kar). The said appeal before the Karnataka High Court was by the Revenue challenging an order passed by the ITAT which held that the interest payable on FDRs was part of the profits of the business of the undertaking and therefore includible in the income eligible for deduction Sections 10A and 10B of the Act.
- Ltd. 46 taxguru.in 167 (Kar).
- The question as to what can constitute as profits and gains derived by a 100% EOU from the export of articles and computer software came for consideration before the Karnataka High Court in CIT v. Motorola India Electronics Pvt.
Therefore, the first substantial question of law raised in ITA No.428/2007 is answered in favour of the revenue and against the assessee and the first substantial question of law in ITA No.447/2007 is answered in favour of the assessee and against the revenue. Mr. Manish Bhatt, the learned senior standing counsel appearing for the Revenue vehemently submitted that the decision of the Appellate Tribunal as regards the prior period expenditure is erroneous. Mr. Bhatt pointed out that it was noticed by the Assessing Officer, in the course of the assessment proceedings, that the assessee had credited an amount of Rs.3,39,534/ below the PBT net figure.
There is a direct nexus between this income and the income of the business of the undertaking. Though it does not partake the character of a profits and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles.
What Does Prior Period Adjustment Mean?
The assessee accepted that the same pertained to the earlier years and having regard to the volume of the business, it had likely to have debit and credit pertaining to the earlier years. Mr. Bhatt submitted that there is no proof or evidence relating to the crystallization of the expenditure in the current year. According to Mr. Bhatt, once the Assessing Officer came to the conclusion that prior period expenditure cannot be allowed, then the same could not have been given set off against the prior period income.
Does a Prior Period Adjustment Affect the Statement of Cash Flow?
This almost falls into the category of the deduction provided for under Chapter VI A, except that the exemption or deduction is in its entirety. However, the basic principle, namely, that the profit and gain must be derived from the concerned activity, is common to both the provisions. It is not in dispute that the assessee herein is a 100% export – oriented unit.
It is clear from the plain reading of Section 10B of the Act that the said section allows deduction in respect of the profits and gains as are derived by a 100% EOU. Further, Section 10B of the Act stipulates specific formula for computing the profit derived by the undertaking from export. Thus, the provisions of subsection of Section 10B of the Act mandate that the deduction under that section shall be computed by apportioning the profits of the business of the undertaking in the ratio of export turnover by the total turnover. Thus, even though subsection of Section 10B refers to the profits and gains as are derived by a 100% EOU, the manner of determining such eligible profits has been statutorily defined in, sub section of that section.
In view of the definition of “income from profits and gains” incorporated in subsection , the Tribunal committed no error in granting the benefit of exemption, as contemplated under Section 10B of the Act. The relevant paragraphs 9 and 15 of the said decision are quoted below.
While the expenditure was disallowable as not pertaining to the year in question, the income should have been included in the total income of taxability on accrual or receipt. Though it does not partake the character of a profit and gains from the sale of an article, it is the income which is derived from the consideration realized by export of articles.
Once an income forms part of the business of the income of the eligible undertaking of assessee, the same cannot be excluded from the eligible profits for the purpose of computing deduction u/s 10B of the Act. The dedicated nature of business or their special geographical locations in STPI or SEZs.
A portion of that income is included in EEFC account. Yet another portion of the amount is invested within the country by way of fixed deposits, another portion of the amount is invested by way of loan to sister concern which is deriving interest or the consideration received from sale of the import entitlement, which is permissible in law. Now the question is whether the interest received and the consideration received by sale of import entitlements is to be construed as incomeof the business of the undertaking.
Etc. makes them a special category of assessees entitled to the incentive in the form of 100% Deduction under Section 10A or 10B of the Act, rather than it being a special character of income entitled to Deduction from Gross Total Income under Chapter VIA under Section 80HH, etc. Therefore analogy of Chapter VI Deductions cannot be telescoped or imported in Section 10A or 10B of the Act. The words ‘derived by an Undertaking’ in Section 10A or 10B are different from ‘derived from’ employed in Section 80HH etc. Therefore all Profits and Gains of the Undertaking including the incidental income by way of interest on Bank Deposits or Staff loans would be entitled to 100% exemption or deduction under Section 10A and 10B of the Act. “In the instant case, the assessee is a 100% EOU, which has exported software and earned the income.
But, the Assessing Authority under the Act held that such interest income was not entitled to 100% deduction under Section 10A of the Act, but such interest income was taxable under Section 56 of the Act, as ‘Income from Other Sources’ and that is the bone of contention between the assessee and the Revenue before us. The Respondent assessee during the relevant year operated four Units set up under the Scheme formulated by the Government in the name of Software Technology Parks of India (STPI) for 100% Export of the Computer Software Units. The said provision was substituted by Finance Act, 2000, with effect from 01/04/2001 in place of the earlier Section 10A, which was inserted by Finance Act, 1981. In view of the aforesaid discussion, we hold that the dividend income, profit on sale of fixed assets, profit on sale of investments, excess provision return back, duty drawback and interest income could be said to have direct nexus with the income of the business of the undertaking. Although it may not partake the character of profit and gain from the sale of article, yet it could be termed as an income derived from the consideration realized by the export articles.