Amendments proposed for deductions in IT Act for Special Economic Zone units

Ranjeet Mahtani and Stella Joseph

One of the noteworthy proposals made in the Union Budget of 2017 is the proposal to rationalize Section 10AA of the Income-tax Act, 1961 (“IT Act”), which contains special provisions in respect of newly established Units in Special Economic Zones (“SEZ”).

The IT Act provides for the levy, collection and recovery of income tax in India. It is divided into various chapters governing separate aspects including exemptions, computation of total income, deductions, etc. Section 10AA of the IT Act is a provision contained in Chapter III of the IT Act which was inserted w.e.f. 10.02.2006 allowing for deduction of profits and gains derived from the export earned by an SEZ Unit. The Section specifically uses the word “deduction”. Further, Sections 10A and 10B, which deal with similar benefits to Free Trade Zones and Export Oriented Units respectively, also use the word “deduction” (with effect from 0.1.04.2001), and these provisions also fall within the ambit of Chapter III.

Chapter III of the IT Act deals with “incomes which do not form part of the total income” and Chapter VIA of the Act deals with “deductions to be made in computing total income”, and these two chapters operate differently and are for distinct objectives. If a particular income does not form part of the total income, it has to be excluded at the source itself and not after computing the gross total income of the assessee, while on the other hand, income to which deduction applies would form part of the gross total income of an assessee and before giving effect to the deduction, other provisions of the IT Act will have to be considered.

In the context of Sections 10A, 10B and 10AA, the benefit of excluding the income at the source itself is that there is no requirement of setting-off the losses of other units; therefore, only the profits of the concerned eligible unit is to be considered. However, if income is not excluded at the source itself and forms part of the gross total income then income would first be subjected to intra unit or intra head losses and brought forward losses and the resultant profits, if any, are to be considered for such benefit.

Since Sections 10A, 10B and 10AA of the IT Act use the word “deduction’, there has been considerable debate on how and at what level the benefits granted thereunder were to operate. Contrary views were taken on this issue by various courts. 

In December 2016, the matter was put to rest by the Hon’ble Supreme Court in CIT vs. Yokogawa [2017] 77 taxmann.com 41 (SC) case. While interpreting Section 10A, the Hon’ble Supreme Court held as follows:

• With effect from 01.04.2001, Section 10A had changed its colour from being an exemption section to a provision providing for deduction.
• Yet, the retention of Section 10A in Chapter III of the Act indicated some additional benefits to eligible units under Section 10A and not contemplated under provisions under Chapter VIA such as Sections 80HHC and 80HHE.
• The stage of deduction would be while computing the gross total income of the eligible undertaking under Chapter III of the Act and not at the stage of computation of the total income of the assessee.

Since the provision of Section 10A use similar words as the provisions under Sections 10B and 10AA, the judgement equally applies to these sections.

Now, under Union Budget of 2017, it is proposed that an explanation be added to Section 10AA to clarify two aspects:

• That the amount of deduction under this section shall be allowed from the total income of the assessee computed in accordance with the provisions of the IT Act, before giving effect to the provisions of this section; and
• That the deduction under this section shall not exceed such total income of the assessee.

The Memorandum to the Finance Bill of 2017 clarifies that the said amendment is proposed in light of the view of the Courts rendered in the context of Section 10A, thus hinting to the Yokagawa judgement that seemingly overrides the said judgement for the purposes of Section 10AA. This amendment will take effect from 1st April, 2018 and will, accordingly, apply in relation to the assessment year 2018-19 (i.e. Financial Year 2017-18) and subsequent assessment years.

In conclusion, to the manner in which deduction under Section 10AA will be computed gets altered, this is another instance of the legislature overcoming a judicial pronouncement.