By Subash Agarwal, advocate
It is a well-known fact that various incentives are provided to the exporters to make it easier for them to compete in the international market where the players from the developed economies are better placed in terms of infrastructural facilities and lower cost.
The benefits that the exporters are normally entitled to in regard to the payment of import/customs duty are as under –
(i) Duty Entitlement Pass Book Benefit (DEPB)
(ii) Duty Draw Back Benefit (DDB)
(iii) Duty Exemption Entitlement Certificate (DEEC) also known as Advance License Scheme
(iv) Duty Free Replenishment Certificate (DFRC)
Under the aforesaid schemes, an assessee is entitled to import entitlements on the basis of exports at zero or concessional rate. The said entitlements can be utilised either by way of actual import of raw material at zero or concessional rate or the said entitlement can be sold in the open market at a premium and the profit is pocketed. In the case of advance licence scheme, the exporter is entitled to the benefit on the basis of future export commitments but on failure to honour the commitment, the exporter has to make good the benefit wrongly availed to the government.
2. ENTITIES FOLLOWING MERCANTILE SYSTEM ARE ON THE HORNS OF DILEMMA IN CERTAIN SITUATIONS
In certain situations, the assessees following mercantile system are sitting on the horns of dilemma as to how to account for such benefits particularly when the benefit is merely notional and may not materialise in the subsequent year. Common instances of such cases are-
a) Actual entitlement earned but no import of raw material is made.
b) Actual import of raw material is made at zero or concessional rate but no corresponding sale is made.
c) Actual entitlement earned in year one but same is sold at a profit in year two.
For the followers of mercantile system, department also insists that the benefit on the basis of entitlement be offered to tax in the year one even if actual sale is made subsequently. The problem is compounded when the assessee himself takes credit of the estimated benefit in its accounts on the insistence/advise of the accountants/auditors.
3. LEGAL POSITION- NOTIONAL/CONTINGENT PROFITS CANNOT BE TAXED EVEN IF CREDITED IN ACCOUNTS.
Some of the reported judgements from the high courts and the apex court on the issue are analysed hereunder-
a) In the case of Indian Overseas Bank Ltd. vs. CIT 246 ITR 206 (Mad), it was held that even in the mercantile system of accounting, any contingent/estimated benefit cannot be brought to tax.
b) In CIT v. Shoorji Vallabhdas and Co.  46 ITR 144, 148 (SC) it has been laid down as under :
"Income-tax is a levy on income. No doubt, the Income-tax Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book-keeping, an entry is made about a hypothetical income, which does not materialise."
c) The above principle is applicable irrespective of whether the accounts are maintained on cash system or under the mercantile system. If the accounts are maintained under the mercantile system what has to be seen is whether income can be said to have really accrued to the assessee-company.
In CIT v. Birla Gwalior (P.) Ltd.  89 ITR 266 where the assessee maintained its accounts on the mercantile system, hon’ble Apex court after referring to the decision in Morvi Industries Ltd. v. CIT  82 ITR 835 (SC), which was also a case where the accounts were maintained on the mercantile system, has held:
"Hence, it is clear that this court in Morvi Industries' case  82 ITR 835 did emphasise the fact that the real question for decision was whether the income had really accrued or not. It is not a hypothetical accrual of income that has got to be taken into consideration but the real accrual of the income."
d) In Poona Electric Supply Co. Ltd. v. CIT  57 ITR 521, Supreme court held
"Income-tax is a tax on the real income, i.e., the profits arrived at on commercial principles subject to the provisions of the Income-tax Act."
e) Above view was also reiterated in Godhra Electricity Co. Ltd. V. Commissioner Of Income-tax 225 ITR 746 (SC)
4. SOME DIRECT CASE-LAWS ON THE ISSUE
Above mentioned principles have been adopted in regard to adjudication of the question of year of taxation of export license benefits in the following cases-
(i) Jamshri Rajitsinghji Spg. & Wvg. Mills Ltd. V. Inspecting Assistant Commissioner. 1992-(041)-ITD -0142 -TBOM
During the previous year relevant to the assessment year under appeal, the appellant had exported certain quantities of goods manufactured by them against which they were entitled to import 36,674.705 kgs. of fibre. No portion of this quantity was actually imported during the year. In the accounts for the relevant year, the appellant company calculated that if 36,674.705 kgs. of fibre were imported, it would be entitled to exemption from customs duty otherwise chargeable amounting to Rs. 31,75,231. This amount was taken to the credit of profit & loss account by reducing the material consumption account and the corresponding debit was raised to the material import entitlement account which appeared on the assets side of the balance-sheet. In return of income, it was claimed that by making these entries the appellant had taken into account a notional profit which it actually had not earned and which was not exigible to tax. He claimed that the book profits should, therefore, be reduced by a sum of Rs. 31,75,231.
“What the appellant had accounted for in its books was a future duty benefit which it would get in respect of imports of fibre if and when such imports were to be effected. Then again, the materials imported against licences under the scheme were to be utilized for the manufacture of the resultant products specified in the Duty Exemption Entitlement Certificate and clause 30 of the Scheme provided that such materials shall not be loaned, sold or transferred, disposed of otherwise under any circumstances. In the present case, the appellant had acquired advance licences on two occasions in respect of two instances of exports referred to above on 29-10-1984 and 23-3-1985 and had applied for further licences in respect of cloth exported and yarn exported; but the benefit by way of Duty Exemption in respect of advances, which are received or due to be received by the assessee, had not accrued to the assessee because no imports had been effected. The contingency on which such benefit could be said to have accrued was the import of the fibres which the appellant could effect duty-free as a consequence of the exports effected by it under this scheme. The fact that in the accounts this was shown as a material import entitlement does not ipso facto clothe it with the nature of income. The considerations which weighted with the company in making such entries in the books to show a figure of book profits may be different and we are not aware under what circumstances this item came to be included in the books. Judging purely from the point of view of liability to income-tax, we are of the view that this item of duty exemption was neither income on accrual basis nor had it actually been received nor did it afford any tangible benefit to the appellant in the form of concession of duty in the year of account for the simple reason that the liability to pay duty did not exist during this year since no goods were imported. It can happen that even in cases where export is made, for some reason or the other, the appellant fails to obtain the advance licence or fails to effect imports in to accounting year. In such an eventuality, the benefit of duty exemption cannot be said to arise and there is, therefore, no question of taking credit for DEEC. The amount of Rs. 31,75,231 can at best be described as an estimated value of concession or saving in import duty that the appellant expected to earn at the time of importing raw material. Such concession or such benefit can only be accounted for in the year in which the imports are effected. It is not a benefit in praesenti but in futuro. No profit or reduction in liability has actually been earned by the appellant during this year. Such concession in duty or what is called duty exemption is anticipated but not actually realised. It can be realised only in subsequent years if and when the appellant effects imports. In our opinion, no income can be said to have accrued or arisen in respect of advance licences received in the current period on the goods exported because no income in real terms had accrued. The cases cited by the learned counsel, to which detailed reference has been made in the preceding paragraphs, would seem to support this view. We need refer to only one more case of the Madras High Court in the case of CIT v. Indian Overseas bank  151 ITR 446. In that case, the Bank dealing in foreign currencies on behalf of its customers had certain foreign exchange contracts entered into by it which were not settled on the close of the accounting period ended December 31, 1967. As the contracts were in different foreign currencies, the loss or profit arising on outstanding contracts was estimated based on the rate of exchange as on the closing day. In view of the devaluation of Sterling in November 1967, the loss arising on account of outstanding foreign exchange amounted to Rs. 9,20,125. The assessee-bank made provision for this in its accounts on the ground that this amount had to be provided for before ascertaining the profit. The ITO estimated the loss as purely anticipated and uncertained. The AAC reversed the order which was confirmed by the Tribunal. The Madras High Court, on these facts, held that only the actual loss incurred can be deducted but not any probable or possible loss. As there was no settlement of the outstanding contracts, the amount claimed could only be considered to be notional or anticipated loss and such notional or anticipated loss could not be allowed as a deduction. The same principle on a parity of reasoning would apply to the taxability of anticipated profit or concession in excise duty which the appellant expected to get in the event of import of raw material. Since such event had not taken place during the year of account, the benefit, if any, was inchoate, incapable of actual determination and had, in effect, not accrued during the year of account. We are, therefore, inclined to accept the stand of the appellant that this was not an income of the appellant during the year. All the principles laid down by the various judicial pronouncements, to which we have referred in the earlier paragraphs, have accepted the theory of real income and whatever has been stated in these judgments would seem to apply in a case of this type. No real income had accrued to the appellant by virtue of getting or expecting to get advance licences irrespective of the fact that such estimated benefit was accounted for in the books of the appellant. This fact, as we have pointed out earlier, is not determinative of the issue of the taxability of this amount. We would, therefore, hold that the amount of Rs. 31,75,231, being the value of material import entitlement receivable by the appellant, does not constitute the income of the appellant for the year under appeal since it had neither accrued nor arisen during the year of account. This ground of appeal is, therefore, allowed.”
(ii) Joint Commissioner Of Income-tax Spl. Range V. Deva Singh
Sham Singh.2005-(095)-ITD -0235 -TASR
“In the present case, we are concerned with section 28(iiia) read with section 2(24)(va) which were inserted with retrospective effect from 1-4-1962. The effect of this insertion is that the "profit on sale of a licence granted under the Imports (Control) Order, 1955, made under the Imports and Exports (Control) Act, 1947" became chargeable to tax under the head 'Profits and gains of business or profession' and the earlier controversy regarding such item being capital or revenue receipt was set to rest.
Considering the facts of the present case, we find that the assessee credited a sum of Rs. 62,85,884 to the profit and loss account being the consideration received/receivable for transfer of material import entitlements during the year and offered it for taxation. Apart from that a sum of Rs. 125.08 lakhs was also credited to the profit and loss account
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Break-up of this amount has been appended at page 41 of the paper book which shows that Rs. 45.08 lakhs is the estimated value of material import entitlement in the shape of advance licence, whereas the other item, namely Rs. 80 lakhs is the amount of special import licence. At this stage, it would be appropriate to appreciate the concept of "Material import entitlements". In simple terms, it is an authorization to import goods at concessional custom duty or make duty-free import. Whereas the Special import licence is issued pursuant to the making of actual exports, the advance licence is issued in anticipation of export and is coupled with the export obligation. If the exporter fails in discharging its obligation of making the requisite exports, he becomes liable to reimburse the Government with the concession in duty availed by it through such advance licence. By virtue of holding the Import Entitlement (Special Import Licence or Advance Licence), an exporter becomes entitled to make imports itself. Alternatively, he can also sell Import Entitlement in the market and earn a profit therefrom. In the instant case, the assessee valued the profit from advance licence at Rs. 45.08 lakhs and the profit from sale of Special Import Licence at Rs. 80 lakhs and did not offer it for taxation. Besides these two figures, the actual amount realised by way of sale of import entitlements at Rs. 62.85 lakhs was duly credited to the profit and loss account and shown as taxable. The question for our consideration is to decide as to whether the sum of Rs. 125.08 lakhs is taxable or not which represents the notional value of the estimated benefit that the assessee may get in future. As noted above, there can be two ways of exploiting Import entitlements. The first, being the case where the exporter actually imports the goods at concessional rate of duty. In such circumstances, the imported goods becomes purchases and the question of profit can arise only when these are actually sold. To put in simple term, if the concessional purchase cost is Rs. 100 (Rs. 120 without import entitlements) and the goods are actually sold for Rs. 130. The event of accrual of income due to import entitlement can be said to take place when the sales are made which results into profit of Rs. 30. It can neither be at the threshold of acquiring the import entitlements nor at the time of making concessional or duty-free imports because the income does not accrue at the time of making purchases but when such goods are sold and income is realized after adjusting cost price against the sales consideration. The other situation may be where the imports are not directly made by the holder of Import Entitlement and the licences are actually transferred to the outside parties at premium. Our case falls in this category when the assessee acquired import licences in the year under consideration and sold them on premium in subsequent years, but the Assessing Officer proceeded to tax the estimated profit on the import entitlements in the hands of the assessee at the year end.
The Legislature by inserting section 28(iiia) has settled the position by providing that profit on sale of a licence granted under Import (Control) Order would be charged to Income-tax. The expression "profit on sale" is employed in this sub-section in contradistinction to the cash assistance "received or receivable" as incorporated in section 28(iiib) and the duty of customs or excise "repaid or repayable" as contained in section 28(iiic). The intention is very clear that insofar as the import entitlements are concerned, the profit has to be recognised only when such licences are sold and the profit is, in fact, realised. Mere holding of licence as at the year end does not result into accrual of income. If the view of the department is accepted, it would amount to double taxation because not only the profit on acquisition of such import licences as is the case in hand, would be taxable but the actual profit realized on the sale of such licences would again become subject-matter of taxation in view of the specific provision contained in section 28(iiia). It is a matter of record that a sum of Rs. 62.85 lakhs, being the profit realized on sales of import entitlements in this year was voluntarily offered for taxation and as against the estimated income of Rs. 45.08 lakhs against Advance Licence recognized in accounts, only a sum of Rs. 6.64 lakhs was realized after the close of the year which was also declared for taxation in the succeeding years. In view of these facts, we hold that the income accrues at the time when the assessee transfers/surrenders import entitlements in favour of the outside party and not when such import entitlements are acquired or held by it. The order of the CIT(A) being in conformity with the statutory provisions, does not warrant any interference on this score. This ground is, therefore, not allowed.”
It is surprising that inspite of the settled law as explained above, the deparment is breathing down the assessee’s neck , still hauling the assessees over the coals on the issue leading to avoidable litigation.