1. Introduction: Currently, there has been a raging controversy between tax-payers and Income Tax Department on the nature and character of these sections, where the Income Tax Department consistently takes a position that these sections are deduction sections, while the tax-payers in some of the cases have taken an inconsistent position depending upon whether the 'eligible undertaking' makes a profit or incurs loss in a particular Assessment Year ("AY"). In case, the 'eligible undertaking' records profits in a particular AY, the tax-payers claim that these sections are exemption sections (akin to agricultural income), however, in case the said undertaking incurs loss in a particular AY, they argue that these sections are deduction sections (akin to section 80IA or the erstwhile section 80HHC). Legislative history of these sections, amendments to these sections, contradictory judicial precedents are some of the factors responsible for this state of affairs. Since there is a cleavage of opinion between High Courts, one has to wait for the last word from Supreme Court. Though, these sections have been omitted from the statute effective AY 2012-13, the litigation is likely to continue before different judicial fora for a number of years to come. Tax professionals are aware that although section 80HHC was omitted from the statute book with effect from AY 2005-06, courts and tribunal benches are still dealing with those matters. This article is a modest attempt to throw light on what should be the correct position in law.

2. Legislative history of sections 10A/10B:

2.1 Both of these sections when first introduced in the Income-tax Act, 1961 ("IT Act") were placed in Chapter III of the IT Act ("income which do not form part of total income") and were appropriately and unambiguously exemption sections (section 10A with effect from AY 1981-82 and section 10B with effect from AY 1989-90). Both of them provided complete exemption from income-tax to the profits of the 'eligible undertakings' for ten AYs. In other words, during the 'tax holiday' period, whether the 'eligible undertaking' made profit or incurred loss, those results got quarantined and segregated at source itself and did not at all enter the process of computation of 'total income' as defined under section 2(45) of the IT Act. As a result, the tax-payers' taxable income was computed only on the basis of all other sources of income ("ineligible undertaking") uninfluenced by the results, whether profit or loss, of the 'eligible undertaking'. Further, as a necessary consequence, when the 'eligible undertaking' came out of the tax holiday period, all deductions/ allowances of depreciation, investment allowance, development rebate, scientific research expenditure, unabsorbed business loss/ unabsorbed capital loss etc (sections 32, 32A, 33, 72, 74) were deemed to have been actually allowed during the tax holiday period, so that the 'eligible undertaking' would start its non-tax holiday journey with a clean slate and with no claim of unabsorbed depreciation, investment allowance, business loss etc.

2.2 Vide amendments carried out by Finance Act, 2000 and Finance Act, 2003 (both with effect from AY 2001-02 i.e. Finance Act, 2000 amendments with prospective effect and Finance Act, 2003 amendment with retrospective effect), both these sections, despite being retained in Chapter III, were amended to make them deduction sections akin to section 80I/80HHC placed in Chapter VIA of IT Act. CBDT Circulars No. 794 dated August 09, 2000, Circular No. 7/2003 dated September 5, 2003 and Circular No. 7/DV/2013 dated July 16, 2013 explained the object and purpose of the amendments.

2.3 In law, there is a fundamental distinction between exempt incomes included in Chapter III (incomes which do not form part of total income) and deductions lumped together in Chapter VIA (deductions from gross total income). While the former are treated as incomes from tax exempt source and therefore do not at all enter the process of computation of total income and get segregated at source itself; the latter are treated as incomes from taxable source and therefore enter the computation process (Sections 5, 14-59, 70-72); get subjected to intra-head and inter-head adjustments; and then get deducted from gross total income to the extent the eligible income forms a component part of gross total income as defined in section 80AB read with section 80B(5).

2.4 This distinction between Chapter III and Chapter VIA has been felicitously explained by Supreme Court of India in the case of CIT v. Williamson Financial Services [TS-5057-SC-2007-O] on page 34:

"……………..there is a vital difference between income not chargeable to tax and not includible in the total income (for example, agricultural income) and income which forms part of total income but which is made tax-free. Deductions under Chapter VI-A fall in the category of tax-free incomes. In fact, history shows that some of the incomes in Chapter VI-A have been transferred from Chapter VII to Chapter VI-A. Chapter VII has been deleted. However, at the relevant time Chapter VII referred to incomes forming part of total income on which no tax was payable. That is why we have stated that there is a difference between " exempted incomes" and " tax-free incomes" . This distinction is of some importance. As stated above, section 5 provides what the " total income" shall include. Chapter III refers to " incomes which do not form part of total income" . Chapter IV deals with " computation of total income" . It classifies the " income" under different heads and the deductions to be made in respect of each of the different heads of income. In the Income-tax Act, the expression " income includible in the total income" has a definite connotation. Similarly, the expression " deduction and allowances" have particular connotation. Therefore, on the one hand we have " agricultural income" which is neither chargeable nor includible in the total income and on the other hand we have " incomes" under Chapter VI-A which are part of total income but which are tax-free." (Emphasis supplied)

2.5 As opposed to exemptions, the process of computation of deduction from gross total income to arrive at total income has been explained by Supreme Court in Synco Industries Ltd. v. Assessing Officer [TS-127-SC-2008-O] as follows:

"………………Sub-section (1) of sections 80A lays down that while computing the total `income of an assessee, deductions specified in sections 80C to 80U shall be allowed from his gross total income. This section has introduced a new concept of "gross total income" as distinguished from the "total income" i.e., the net or taxable income. Clause (5) of section 80B defines the expression " gross total income" to mean the total income computed in accordance with the provisions of the Act before making any deductions under Chapter VI-A of the Act. It follows, therefore, that deductions under Chapter VI-A can be given only if the gross total income is positive and not negative.

9. If the gross total income of the assessee is determined as " nil" then there is no question of any deduction being allowed under Chapter VI-A in computing the total income. The Assessing Officer has to take into account the provisions of section 71 providing for set off of loss from one head against income from another and section 72 providing for carry forward and set off of business losses. Section 32(2) makes provisions for carry forward and set off of the unabsorbed depreciation of a particular year. The effect of the abovementioned provisions is that while computing the total income, the losses carried forward and depreciation have to be adjusted and thereafter the Assessing Officer has to work out the gross total income of the assessee. Sub-section (2) of section 80A specifically enacts that the aggregate of deductions under Chapter VI-A should not exceed the gross total income of the assessee. If the gross total income is found to be a net loss on account of the adjustment of losses of the earlier years or "nil", no deduction under this Chapter can be allowed. As noticed earlier clause (5) of section 80B defines the expression "gross total income" to mean the total income computed in accordance with the provisions of the Act without making any deductions under Chapter VI-A. The effect of clause (5) of section 80B of the Act is that "gross total income" will be arrived at after making the computation as follows:

(i) making deductions under the appropriate computation provisions;

(ii) including the incomes, if any, under sections 60 to 64 in the total income of the individual;

(iii) adjusting intra-head and/or inter-head losses; and

(iv) setting off brought forward unabsorbed losses and unabsorbed depreciation, etc.

……………………….." (Emphasis supplied)

2.6 In a practical sense, the distinction between exempt incomes and deductions can be understood by the following examples arising in day to day tax litigation:

(i) Disallowances under section 14A are applicable to exempt incomes; but not to deductions (Delhi High Court in CIT V. KRIBHCO [TS-5475-HC-2012(Delhi)-O].

(ii) Exemptions can be availed even if gross total income is NIL, but deductions are lost if gross total income is NIL (See Supreme Court in Synco Industries supra).

2.7 So far it is evident that Chapter VIA deductions are made from gross total income as defined in section 80B(5) to arrive at total income, which is the final figure of taxable income on which tax is to be paid. To emphasize, total income is the income on which tax is to be paid, and no further deduction is possible from total income. Here it is important to note the language of amended section 10A(1), which provides for deduction from total income:

"Special provision in respect of newly established undertakings in free trade zone, etc.

10A.(1) Subject to the provisions of this section, a deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software for a period of ten consecutive assessment years beginning with the assessment year relevant to the previous year in which the undertaking begins to manufacture or produce such articles or things or computer software, as the case may be, shall be allowed from the total income of the assessee :

………………………" (Emphasis supplied)

2.8 This apparent drafting error in section 10A(1) of providing deduction from total income, not from gross total income as per the normal scheme of IT Act, was noted by Karnataka High Court in Commissioner of Income-tax v. Yokogawa India Ltd. [TS-641-HC-2011(KAR)-O] as follows:

"….13. A literal reading of the above provision requires deduction from the total income. There can be a deduction in computing the total income. However, there cannot be deduction from the total income which is the final result of the computation process. The language adopted in section 10A is different from the one adopted in section 80A. Section 10A provides for deduction from the total income. In the scheme of the Act, while various deductions are allowed in computing the total income, once the total income is computed, no further adjustment to the total income is envisaged. The scheme of the Act provides for deduction in computing the total income but no mechanism for any deduction from the total income already computed is provided under the Act. Once the total income is computed, the next step is determination of tax by applying the applicable rates on the total income.

14. Section 2(45) defines "total income" to mean the total amount of income referred to in section 5 and computed in the manner laid down in the Income-tax Act. Section 5 defines the scope of total income and it is subject to the provisions of the Income-tax Act. Section 14 provides that "save as otherwise provided by the Income-tax Act, all income shall, for the purposes of charge of income-tax and computation of total income, be classified under the following heads of income". Therefore, the total income in its strict sense requires computation for the purpose of levy of tax. The computation of total income begins only with Chapter IV and as section 10A is covered in Chapter III, the phrase "total income" used in section 10A cannot be understood in the same sense as in section 2(45).

………………………………" (Emphasis supplied)

3. Having seen the legal problem in the amended sections, now it is important to take stock of some sample judicial precedents; which have taken a divergent view:

3.1 Precedents holding these sections as exemption sections:

- Karnataka High Court in Commissioner of Income-tax v. Yokogawa India Ltd. (Supra);

- Karnataka High Court in Cheslind Textiles Ltd [TS-5198-HC-2013(Karnataka)-O];

- Delhi High Court in Commissioner of Income-tax v. TEI Technologies (P.) Ltd. [TS-665-HC-2012(DEL)-O];

- ITAT Bangalore Bench in Biocon Ltd. [TS-382-ITAT-2014 (Bang)].

3.2 Precedents holding these sections as deduction sections:

- Bombay High Court in Hindustan Lever Ltd. V DCIT [TS-5277-HC-2010(Bombay)-O];

- Bombay High Court in CIT V. Black & Veatch Consulting P Ltd. [TS-260-HC-2012(BOM)-O];

- ITAT Bangalore Bench in Mindteck (India) Ltd. [TS-554-ITAT-2014 (Bang)] = [TS-6265-ITAT-2014(Bangalore)-O];

- ITAT Pune Bench in Patni Computer Systems P. Ltd. [TS-5331-ITAT-2011(Pune)-O].

4. The tax impact of treating the said sections as exemption versus deduction sections is explained in the following examples by adopting illustrative numbers:

4.1 The table below analyses a situation wherein, these sections are treated as exemption sections i.e. the results of eligible undertaking, whether profit or loss, are segregated in the beginning itself without taking them into the total income computation process:

Total Income = 300

* (Figures in bracket indicate loss)

4.2 It can be seen that, in the exemption scenario, the tax-payer pays tax on the Total Income of ineligible undertaking amounting to 300 over the tax holiday period, while the overall profit of eligible undertaking of 1750 (profit in some years/ loss in other years) does not at all enter the total income computation process and is thus completely exempted from tax.

5. In contrast, the table below analyses the impact in a deduction scenario by adopting the same set of numbers:

Total Income = 550

5.1 As discussed earlier, in this scenario, the results of both; eligible and ineligible undertakings are aggregated together as per sections 70, 71, 72 etc to arrive at Gross Total Income and therefrom deduction of eligible profits (if included therein) is allowed to arrive at total income. It can be seen that in this scenario, numbers remaining same, the tax-payer pays tax on total income of 550 (as against 300 in exemption scenario). As a result, the income not suffering tax, in this scenario, is reduced to 1500 as against the figure of 1750 in exemption scenario.

6. The table below analyses the situation where a tax-payer takes an inconsistent position i.e. exemption in case of profits in the case of eligible undertaking and deduction in case of loss in eligible undertaking.

Total Income = 50

6.1 It can be noted that out of the three possible situations outlined above, in this scenario, the result is most beneficial for the tax-payer. Here, effectively both the incomes whether of eligible undertaking or of ineligible undertaking; do not suffer tax (1750+ 300= 2050) as the tax paid on 50 (Column G) is effectively recovered by a carry-forward of loss of 50 for subsequent years.

7. It is important to note that Chapter III incomes are considered incomes from an exempt source as against Chapter VIA deductions which are considered to be incomes from taxable source. The Supreme Court in the case of Harprasad & Co. (P.) Ltd. [TS-4-SC-1975-O], has clarified that losses of exempt source can not be set-off against profits of taxable source:

"….if the loss arising in the previous year was under a head not chargeable to tax, it could not be allowed to be carried forward and absorbed against income in a subsequent year from a taxable source. …………."

8. The foregoing paras amplify the position of prevalent confusion. As stated earlier, the last word has yet to come from Supreme Court. The Supreme Court will hold them either exemption sections or deduction sections, in no case a mix and match position of exemption in some years and deduction in others. Therefore, the tax-payers will be well-advised to take a consistent position to avoid the possible burden of interest and penalties, till the legal situation attains clarity and finality.