Western Outdoor Interactive Ltd, a private company engaged in production, development and export of computer software, had one establishment in the Santa Cruz Electronics Export Processing Zone (SEEPZ) and another outside the SEEPZ area in Mumbai.

The company filed a return for assessment year 2000-01. Separate balance-sheet and profit and loss (P&L) accounts were maintained for the respective units.

The return was processed by the assessing officer (AO) under Section 143(3) of the I-T Act and deduction of Rs 5,21,74,398 was allowed in respect of the unit outside the SEEPZ against the claim of Rs 5,50,54,680 made in the return.

Audit objections were raised subsequently, questioning the deduction allowed. The audit pointed out that the turnover should have been taken as Rs 10,95,89,191, not Rs 9,85,43,319. This related to the computation of relief under Section 80HHE.

The company had claimed retainer fees at 18.30 per cent for the SEEPZ unit. According to the audit, it should have been only 8.86 per cent. Accepting the audit objection, the AO rectified the assessment under Section 154 of the I-T Act. On appeal, this debatable order was cancelled by the first appellate authority.

Reopening notice

In March 2006, the AO issued a reopening notice under Section 148. He pointed out that excess allowance of deduction was made under Section 80HHE. Expenses on account of retainer fees were misallocated in the original assessment between the two units at 18.3 per cent instead of the correct ratio of 8.86 on the export income under Section 10B of the Act. The company challenged the reopening and filed a writ petition before the Bombay High Court.

The company argued before the court that detailed calculations were given to support the claim for deduction under Section 80HHE. Income from services exports, domestic sales and exchange fluctuations were all given in the documents accompanying the return. The Department was mulling a change of opinion with regard to the allocation of expenses between the two units. It was a matter of looking at the same transaction from another point of view.

Clubbing the units

The Revenue argued that the company erred in applying Sections 80HHE and 10B separately to the two units and that the Department was right in clubbing the two units and insisting that the total turnover be taken as Rs 10,95,89,191.

Allocation of retainer fees between the two units was not done correctly. The Revenue specifically contended that a lesser percentage was allocated to the SEEPZ unit to take undue advantage of the exemption for income from the export processing zone (EPZ).

The Bombay High Court pointed out that this was a a clear case of applying a different yardstick on the same facts. Two views are possible in this case. In such a situation, to say that the view taken by the Department subsequently is correct and, therefore, the reopening of the assessment, is clearly an after-thought and beyond the provisions of Section 147. Reopening was not called for. The proliferation of special economic zones (SEZ) will mean that cases of the aforementioned type will have to be looked into more seriously by the Department and the TP regulations may have to be invoked even within the country in respect of units within and outside SEZs.

The Government has indicated that revenue loss because of SEZ tax sops under direct tax alone will be Rs 53,740 crore. The way companies seek to reduce the expenses in SEZ units will mean a much higher revenue loss than projected.

T. C. A. Ramanujam
(The author is a former Chief Commissioner of Income-Tax.)