Section 80IE deduction cannot be denied on unsubstantiated reconstruction allegations or notional expense allocations.

The respondent-assessee, M/s Sun Pharma Sikkim (“SPS”), was a partnership firm constituted on 15 January 2009, principally with Sun Pharmaceuticals Industries Ltd. (“SPIL”) as a 97.5% partner. It manufactured and sold pharmaceutical products at its Sikkim undertaking.

Plant, machinery and other assets of SPIL’s Sikkim unit were transferred to SPS under an assignment deed dated 16 January 2009, with the transaction being recorded through a debit note and journal entries on 5 March 2009.

SPS filed nil-income returns for assessment years 2010–11 and 2011–12 after claiming 100% deduction under Section 80IE of the Income-tax Act, 1961.

The Assessing Officer denied the deduction on the grounds that SPS had been formed by splitting up or reconstruction of SPIL’s existing business, had used more than 20% old or used machinery, and had overstated its eligible profits by failing to allocate various expenses incurred by SPIL, including selling and distribution, research and development, royalty, management and partner-remuneration expenses.

The Commissioner (Appeals) allowed the deduction and deleted the expenditure allocations. The Income Tax Appellate Tribunal affirmed those findings, relying substantially on the evidence, findings and orders concerning the group’s other units.

The Revenue challenged the Tribunal’s common order before the Gujarat High Court under Section 260A.

1. Whether SPS was formed by splitting up or reconstruction of SPIL’s existing business, thereby violating Section 80IE(3)(i).

2. Whether SPS had transferred or used old plant and machinery in excess of the permissible 20% limit under Section 80IE(3)(ii), read with the applicable Explanations to Section 80-IA(3).

3. Whether the Assessing Officer was justified in reducing SPS’s eligible profits under Section 80IE(6), read with Section 80-IA(10), by allocating selling and distribution, research and development, royalty and management expenses allegedly incurred by SPIL on SPS’s behalf.

4. Whether the central excise duty incentive was includible in the profits eligible for deduction under Section 80IE.

5. Whether the remuneration paid or payable to SPIL as the working partner could be disallowed or excluded from the eligible profits under Section 80IE(6) read with Section 80-IA(10).

6. Whether rejection of SPS’s books of account for assessment year 2011–12 was legally sustainable when the Assessing Officer proceeded under Section 143(3) rather than making a best-judgment assessment under Section 144.

Section 80IE grants a 100% deduction of profits derived from an eligible undertaking in the North-Eastern States for ten consecutive assessment years, subject to the conditions in Section 80IE(3), including that the undertaking must not be formed by splitting up or reconstruction of an existing business and must not be formed by transfer of previously used plant or machinery; the 20% machinery principle is applied through the Explanations to Section 80-IA(3).

Section 80IE(6) incorporates, so far as applicable, Sections 80-IA(5) and 80-IA(7)–(12), including Section 80-IA(10), which permits the Assessing Officer to recompute eligible profits where, because of a close connection or other reason, business arrangements produce more than ordinary profits; however, the existence of a close connection or high profitability alone is insufficient without evidence of an arrangement producing excessive profits.

Statements recorded during a survey under Section 133A, not having been made on oath, possess corroborative value but cannot, without supporting material, independently establish an adverse factual conclusion; this principle was applied with reference to Paul Mathews & Sons v. CIT and CIT v. S. Khader Khan & Sons.

For the excise incentive, the Court followed Shri Balaji Alloys v. CIT, as upheld by the Supreme Court, and the principles in Sahney Steel & Press Works Ltd. v. CIT and Ponni Sugars & Chemicals Ltd. v. CIT, under which an incentive granted to promote industrial development and employment is a capital receipt rather than a revenue receipt.

The Court found that the Commissioner (Appeals) and the Tribunal had concurrently determined, on the evidence, that SPS was a new undertaking transferred before commencement of commercial production and that the change was substantially one of ownership, not a splitting up or reconstruction of SPIL’s existing business.

The Assessing Officer’s inference of reconstruction was based on incorrect or incomplete facts, including an erroneous date in the manufacturing licence, construction activity that did not establish prior commercial production, and the existence of additional machinery installed after commencement; those circumstances did not prove that SPS had been formed from an existing operating business.

Similarly, duplicate or photocopied bills, missing transport documents and journal entries did not establish that the machinery was old or previously used. Since the Assessing Officer did not conduct independent enquiries with the suppliers, the finding that machinery exceeding 20% was old machinery was held to be presumptive and unsupported.

On the expenditure adjustments, the Assessing Officer relied principally on comparisons with SPIL’s profit and expense ratios and general survey statements of managerial personnel. The Court held that Section 80-IA(10) required material demonstrating an actual arrangement that generated more than ordinary profits; comparison with another group entity and general statements were insufficient, particularly when the assessee’s accounts were audited and no specific defect was identified.

The Tribunal therefore rightly rejected the notional allocation of selling, distribution, R&D, royalty and management expenses.

The Court also accepted the treatment of the central excise incentive as a capital receipt, which was consequently excluded both from taxable income and from the profits eligible for Section 80IE deduction, producing a tax-neutral result.

The disallowance of working-partner remuneration was also unsustainable because the supplementary partnership deed governed the remuneration arrangement and the amount had, in any event, been added back by the assessee in its revised return.

In light of these conclusions, the separate issue concerning rejection of books for assessment year 2011–12 no longer survived.

It held that SPS satisfied the conditions for deduction under Section 80IE, that the Revenue had failed to establish reconstruction of an existing business or use of old machinery beyond the statutory limit, and that the proposed allocations and disallowances under Section 80IE(6) read with Section 80-IA(10) were unsupported by evidence.

The substantial questions concerning eligibility, machinery and profit adjustments were answered against the Revenue; the books-of-account issue in Tax Appeal No. 184 of 2020 was held not to survive.

Both Tax Appeals Nos. 183 and 184 of 2020 were accordingly dismissed.