By TIOL News Service

NEW DELHI, NOV 25, 2008 : REGULAR power is the lifeline for industry. But, given the hiatus between what India produces and what is demanded, a decision to go for a captive power generation unit has of late become a common management tool. But the major question is: In the absence of a third party sale, what would be the acceptable sale price to calculate the profit and whether it would constitute business within the meaning of Explanation (iv) of to Sec 115JA as the main line of activity of the assessee is not the business of power generation? To find their answers let's go to the latest decision of the Delhi High Court.

First, the matrix of facts

The assessee has four divisions namely Shriram Fertilisers and Chemicals, Shriram Cement Works, Shriram Alkalies and Chemicals and the textile division. In addition, the assesses also has four industrial undertakings which are engaged in captive power generation (CCPs). Three out of the four CPPs are situated at Kota, which generate power equivalent 10 MW, 30 MW and 35 MW respectively. The fourth CPP, at Bharuch, which is situated in the State of Gujarat, generates 18 MW power. For the purposes of setting up CPPs the assesses has taken requisite permission from the Rajasthan State Electricity Board as well as the Gujarat State Electricity Board. These permissions have been referred to by the authorities below. A reference in this regard has been made to the orders issued by the RSEB dated 23.4.1967, 18.6.1982 and 16.2.1993 and the orders of GSEB dated 22.11.1995 as modified by its letter dated 31.1.1996.

It is in this background that on 29.11.1997 the assessee had filed a return declaring a loss of Rs 43,31,74,077/-. It is important to bring to the fore at this stage that, in a note attached to the return the assessee had disclosed the profit and loss derived from each of the CPPs, and also, indicated the formula adopted for computation of the profit derived from the respective CPPs. Briefly, the method for computation of profit and loss indicated in the note appended to the return was-the rate per unit as charged by the respective State Electricity Board for transfer of power, reduced by 7%, on account of absence of transmission and distribution losses (wheeling charges). From the figure obtained by applying the reconfigured rate per unit, deduction was made towards specific expenses, as well as, common expenses attributable to each CPP so as to arrive at the figure of profit/loss of each CPP. In the note appended to the return of the assessee the break up of total profit in the sum of Rs.41,88,50,862/- is detailed out in the following manner:-

The assessee however, for the purposes of provisions of Section 115JA of the Act based on its books of accounts, disclosed income in the sum of Rs 86,33,382/-. By an intimation dated 07.07.1998, the Revenue processed the return filed by the assessee under the provisions of Section 143(1)(a) of the Act. On 30.3.1999, the assessee filed revised return declaring a loss of Rs 39,36,71,056/-. Interestingly though, for the purposes of Section 115JA of the Act, the assessee continued to show its income as Rs 86,33,382/-. The case of the assessee was taken up by the Assessing Officer for scrutiny. A notice under Section 143(2) of the Act was issued. During the course of scrutiny, the Assessing Officer raised a query with regard to the deduction of a sum of Rs 41,88,50,862/- from book profit by the assessee while, computing tax under Section 115JA of the Act. In response to the query, the assessee informed that the said amount has been reduced from the book profit as this amount was profit derived from CPPs set up by the assessee with the permission of the RSEB and the GSEB. The deduction from book profit was justified by taking resort to explanation (iv) to Section 115JA of the Act.

The AO rejected the claim of the assessee and added back the deduction claimed, by the assessee, from book profit, broadly on the following grounds:-

(i) the Memorandum and Articles of Association did not permit the assessee to engage in the business of generation of power;

(ii) the permission granted by the State Electricity Boards prohibited sale of energy so generated or supply of energy free of cost to others;

(iii) the sanction given by RSEB was only for setting up of turbo generator and not for parallel generation and;

(iv) lastly, the assessee was in the business of manufacturing fertilizer, for which purpose, it had received a subsidy as the urea manufactured was a controlled and consequently, a licensed item being, subject to the Retention Price Scheme of Government of India which, mandated that since, sale price and the distribution of urea was fully controlled the manufacturer would be allowed a subsidy in a manner which permitted him to earn a return of 12% on his net worth after taking into account the cost of raw material and capital employed, which included both the fixed and variable cost. From this it was concluded that as the assessee had received a subsidy from the Government of India for manufacture of urea and, as was, apparent from the balance sheet and profit and loss account filed by the assessee, the CPPs, were a part of the fertilizer, cement, and caustic soda plants. The CPPs were included in the aforesaid plants and thus, it could not be said that the income derived from the said plants, keeping in view the subsidy received by the assessee under the Retention Price Scheme, was in any way, income derived from generation of power and;

(v) lastly, the assessee is not in the business of generation of power and that the assessee is not deriving any income from business of generation of power. A distinction was drawn between an industrial undertaking generating power and one which was in the business of generating power. The assessee's case was likened to an undertaking which is generating power but is not in the business of generating power, and hence not deriving income from generation of power.

The assessee being aggrieved, preferred an appeal to the Commissioner of Income Tax (Appeals). The CIT(A) allowed the appeal and the Tribunal simply upheld the CIT(A) order.

Now the issue is before the High Court which has observed that,

++ The fallacy in the Revenue's argument is self evident as it has proceeded on the basis that the words and expressions used in Explanation (iv) to Section 115JA are to be confined to a situation which involves a commercial transaction with an outsider.

++ The profit derived by the assessee on transfer of energy from its CPPs to its other units was "embedded" in the ultimate profit earned on sale of its final products. The assessees by taking resort to Explanation (iv) to Section 115JA has sought to apportion, and consequently, reduce that part of the profit which is derived from transfer of energy from its CPPs in arriving at book profits amenable to tax under Section 115JA of the Act.

++ assessee's CPPs can as a matter of principle derive profits which is in point of fact embedded in the ultimate profit earned on the sale of the final product.

++ Is assessee engaged in the business of power generation: Based on the findings returned both by the CIT(A), as well as, the Tribunal, it cannot be said that the assessee is not engaged in the business. As rightly held by the Tribunal, the assessee had been authorised by the State Electricity Boards to generate electricity. The generation of electricity has been undertaken by the assesses by setting up a fully independent and identifiable industrial undertaking. These undertakings have separate and independent infrastructures, which are managed independently and whose accounts are prepared and maintained separately and subjected to audit.

++ The term ''business" which prefixes generation of power in Clause (iv) of the Explanation to Section 115JA is not limited to one which is prosecuted only by engaging with an outside third party. The meaning of the word 'business' as defined in Section 2(b) of the Act includes any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture. The definition of 'business', which is inclusive, clearly brings within its ambit the activity undertaken by the assesses, which is, captive generation of power for its own purposes.

++ The approach of the CIT(A) and, consequently the Tribunal, both in law and on facts cannot be faulted with. Wa are of the opinion that the Assessing Officer clearly erred in holding that, since the main business of assessee is of manufacture and sale of urea it could not be said to be in the business of generation of power in terms of Explanation (iv) to Section 115JA of the Act.

++ the assessee is entitled to reduce from its book profits, the profits derived from its CPPs, in determining tax payable for the purposes of Section 115JA of the Act.

The Bench also concurs with the line of reasoning adopted both by the CIT(A), as well as, the Tribunal as regards computation of sale price and consequent profits in terms of Explanation (iv) of Section 115JA of the Act. Since the CIT(A) has categorically recorded the facts with regard to computation. It would be neither fair nor would it be in the interest of justice if we were to remand the matter as requested by the Revenue, at this stage, for the purposes of computation of profits in terms of Explanation (iv) under Section 115JA of the Act.

(See 2008-TIOL-576-HC-DEL-IT in 'Income Tax' + 2008-TIOL-576-HC-DEL-IT in 'Legal Corner')