S.H. Kapadia, J.
1. Both the above appeals raise a common question of law and fact. Hence, they are disposed of by this common judgment.
2. The short point which arises for consideration in the above two appeals is whether service charges constituted business income for the purposes of computing export profits under Section 80HHC.
3. The assessee credited in the profit and loss account for the assessment year 1990-91, service charges while working out deduction under Section 80HHC by considering the said service charges as part of business profit. The assessee applied the formula under Section 80HHC(3)(b) and worked out the deduction at Rs. 90,54,447. The assessee-firm are diamond merchants. The Assessing Officer held that service charges cannot be treated as profit relating to export business. The Assessing Officer reduced the service charges from business profits and worked out the deduction at Rs. 77,18,329. The Assessing Officer held that deduction under Section 80HHC was only meant for assessees who earned profits from exports and any business profit other than from export activity was not eligible for deduction under Section 80HHC. The first appellate authority and the Tribunal allowed the claim of the assessee. Hence, this appeal by the Department under Section 260A of the Income-tax Act.
4. On behalf of the Department it was contended that the word 'derived' in Section 80HHC(1) clearly indicated that any income which does not accrue from export activities of the assessee should be excluded while determining the deduction under Section 80HHC(3). It was contended that service charges did not relate to the export activities of the assessee and, accordingly, the Assessing Officer was right in delinking the service charges from the business profits. It was contended that the assessee-firm undertook the work of polishing diamonds for which they charged service charges. Reliance was placed on the judgment of the Gujarat High Court in the case of Ahmedabad . v. CAT : [1982]137ITR616(Guj) . It was contended that the work was undertaken by the assessee on job-work basis. Hence, the service charges did not accrue to the assessee from export activity. It was contended that Section 80HHC applied only to profits derived from exports.
5. On the other hand, it was contended by the assessee that they provided services by way of grading, assorting and dividing polished diamonds. It was further contended that service charges accrued to the assessee as a receipt which was very small as compared to the business of exporting diamonds. It was, therefore, contended that service charges were part of the business income. It was urged that this was a finding of fact recorded by the first appellate authority and the Tribunal. It was contended that in the circumstances, this court should not interfere with the said findings.
6. We find merit in this appeal. The Assessing Officer has found on facts that the assessee was engaged in the manufacture and export of polished diamonds out of India. During the period, when the assessee-firm did not engage itself in the business activity of exports and manufacture, the assessee-firm offered its services on job-work basis to outsiders to polish rough diamonds for which the assessee received service charges. The Assessing' Officer found, on the facts, that the assessee earned gross profits by way of service charges of Rs. 19.60 lakhs during' the assessment year in question. The Assessing Officer on the facts, found that service charges constituted a separate head of income in the sense that it was not linked to export activities of the assessee. Hence, the Assessing Officer de-linked the service charges from business profits and then computed the export profits for the purposes of calculating the deduction under Section 80HHC. No reasons have been given by the first appellate authority for setting aside the above finding of fact recorded by the Assessing Officer. The only reason given by the Tribunal is that the judgment of the Gujarat High Court has no application to the facts of the case and that the first appellate authority had rightly allowed the claim of the assessee. Section 80HHC was intended to provide incentives to promote exports to earn foreign exchange for the country. The incentive provided was in the form of exemption of profits relatable to exports. In the present matter, on facts, the Department has clearly established that the assessee-firm exported polished diamonds out of India. However, during the lean season, the assessee-firm undertook work of polishing on job-work/contract basis for third parties in India. For this job work, the assessee charged service charges. The object of Section 80HHC is to ascertain the export profits. It may be mentioned that in this case we are concerned with the law prior to the assessment year 1992-95. Under Section 80HHC(3), as it stood before April 1, 1992, profits derived from exports were computed in the following manner :
Business profits X Export turnover
total turnover
7. The said formula, however, gave a distorted figure of export profits when receipts like interest, commission, etc., which do not have an element of turnover came to he included in the profit and loss account. Every assessee tries to inflate, in the above formula, the business profits and correspondingly, he tries to reduce the denominator, viz., total turnover. It is for this reason that the Legislature amended the above formula by amending the law from the assessment year 1992-93 by clarifying that in the above formula the business profits will not include receipts by way of brokerage, commission, interest, rent charges or any other receipt of a similar nature. However, as some expenditure might be incurred in earning the above income by way of brokerage, commission, etc., an ad hoc 10 per cent. deduction from such income was provided for to account for the expenses. Similarly, under Explanation (ba) to Section 80HHC, the Legislature has explained that the words 'total turnover' shall not include freight or insurance. On the other hand, vide Clause (b) to the Explanation to Section 80HHC, the Legislature has defined the words 'export turnover' to mean the sale proceeds, but not freight or insurance. The combined meaning of Clauses (b) and (ba) to the Explanation shows that the business profits in the above formula shall not include receipts by way of brokerage, commission, interest, rent charges or any other receipt of a similar nature as they do not have any nexus with the sale proceeds from export activities. Therefore, the service charges cannot be considered as part of the business profits while working out deductions under Section 80HHC. The judgment of the Supreme Court in the case of CIT v. Sterling Foods : 1999ECR481(SC) , dealt with the provisions of Section 80HH. In that judgment, the Supreme Court was required to construe the expression 'derived from' in Section 80HH. In that matter, the assessee was engaged in processing prawns. It earned import entitlements from the Central Government under an Export Promotion Scheme. The assessee was entitled to sell the same. The assessee sold the said entitlements. In its total income for the assessment year 1979-80, the assessee included the sale proceeds and claimed relief under Section 80HH. The High Court held that the income which the assessee made by selling the import entitlements was not a profit and gain which the assessee had derived from industrial undertaking. The Division Bench held in favour of the assessee on the basis of the retrospective amendment to Section 28 of the Act by the Finance Act, 1990, making such receipts taxable as business profits. It was held by the Supreme Court that the word 'derived' is followed by the word 'from' which meant arising from a source. The Supreme Court held on the facts of that case that import entitlements did not originate from the industrial undertaking of the assessee, but it came from the Export Promotion Scheme of the Government. The Supreme Court held that the words 'derived from' indicated a direct nexus between the profits and gains on the one hand and the industrial undertaking on the other hand since under Section 80HH the expression used is 'derived from the industrial undertaking'. In that matter, on the facts, the Supreme Court held that since the export entitlements were made available under the Scheme of the Government, the nexus between the profits and the industrial undertaking was only incidental and not direct. Accordingly, the Supreme Court allowed the appeal of the Department. This judgment helps the case of the Department in this matter. Section 80HHC(1) clearly states that in computing the total income of the assessee, there shall be a deduction of the profits derived by the assessee from the export of goods. In other words, there should be a direct nexus between the profits on the one hand and the export activity on the other hand. Applying the ratio of the judgment of the Supreme Court to the facts of our case, the profits earned by the assessee on account of service charges cannot be said to have a direct nexus with the export activities of the assessee. Hence, to that extent, the assessee was not entitled to claim deduction under Section 80HHC.
8. Accordingly, the impugned judgment of the Tribunal is set aside. Both the above appeals are allowed with costs.