1. This is an appeal by the assessee against the office of the CIT (Appeals) dated 30.11.2004. The following grounds have been raised in this appeal: 1. That the learned CIT (Appeals) Shimla has erred on facts and in law in sustaining the disallowance of deduction Under Section 80IB on the manufacture of 'case sets' by erroneously holding that the process-carried out by the appellant are not manufacturing process as no new characteristic or product comes into existence.
2. That the learned CIT (Appeals) Shimla has erred on facts and in law in sustaining the disallowance of deduction Under Section 801/VIB on lease rental income of Rs. 90,000/- and miscellaneous income of Rs. 10,258/- by erroneously holding that these are not derived from industrial undertaking.
That without prejudice to above the addition made/sustained by learned CIT (Appeals) is excessive and unreasonable.
3. That the appellant craves leave to add/amend or delete any ground of appeal before or during hearing of the appeal.
2. The first issue relates to sustaining of disallowance of deduction Under Section 80IB. The facts related to this issue in brief are that the assessee was engaged in the manufacture of watches, watch components, coil, ECB, plastic parts in its two manufacturing units.
During the year, it had earned Rs. 20,35,519/- and Rs. 7,06,254/- from job work in unit-I & II respectively. The Assessing Officer required the assessee to explain as to how deduction Under Section 80IB was available on the profit of job work and how the job work represented manufacture. The assessee vide written reply dated 22.10.2002 stated that it had undertaken some job work of welding of case and glass with its ultrasonic welding machine for which the components were supplied by the parties. It was further stated that the process resulted in manufacturing of new product i.e. case set and was available for deduction Under Section 80IA. The Assessing Officer did not accept contention of the assessee for two reasons. Firstlymere welding of a case and glass into a "case set" with the help of ultrasonic welding machine was not a manufacturing activity as no new product came into existence and secondly, even if for the sake of arguments, it was considered to be manufacturing activity, then also in view of the Hon'ble High Court's decisions reported in 130 ITR 477 and 113 ITR 718, deduction Under Section 80IB was not allowable to the assessee, as the Hon'ble High Court had held that the person who did the job work was merely a contractor and not manufacturer. The Assessing Officer pointed out that the assessee had stated that the profit involved in job work was in no case more than 15% although the net profit ratio was about 9.5% only. The Assessing Officer, accordingly computed profit on job work @15% which worked out to Rs. 305327/- and Rs. 1,05,938/- in unit-I & II respectively and disallowed deduction Under Section 80IB on such profit.
3. When the matter in the first appeal was to the learned CIT (Appeals), it was submitted that the assessee was having two independent units called Unit-I and Unit-II and separate books of accounts for each unit were being maintained. It was stated that unit-I started production on 1.10.93 and Unit-II on 16.6.97. It was further stated that in addition to manufacturing and sale of watches and watch parts, which included coil, ECB, plastic part, components etc., the assessee had also done job work in respect of which deduction Under Section 80IB and 80HHC had been claimed and that the assessee had carried out manufacturing activities of assembling of "watch cases" with the help of ultrasonic welding machine, using precision technology for bringing a new product passing through a highly technical, mechanized process. It was submitted that the other parts like glass and case lost their identity and merged into one item, they could not even be separated and could neither be used nor sold independently nor they were independent saleable products. It was further submitted that the percentage of job work to the total turnover of the assessee worked out to 2.9% and 0.29% for Unit-I and Unit-II respectively, It was argued that the assessee was in 'watch' industry and the product 'watch' is a composition of numerous components, all of which could not be produced by one assessee, as production of every part needs different machinery and technical know-how. The work was, thus, divided among various operators, who in themselves were also manufacturing an altogether independently marketable product and all of them had a significant contribution for the making of a complete watch. It was further stated that the assessee had machinery of Rs. 10,00,000/- (approximately) and Rs. 3,00,000/- (approximately) for manufacture of stator and case-set respectively. It was explained that both the machineries were hi-tech machineries and that was the reason, work was being entrusted to different manufacturers for different parts and for the above said two parts, the job was entrusted to the assessee. It was further stated that both those items were independently saleable items altogether different from the raw material supplied to the assessee.
Thus, simply supply of raw material would not make the manufacturing process of the assessee a non-manufacturing, i.e. to say job work by its nomenclature so is to disentitle the assessee from legally allowable deduction. It was further stated that in case, had the assessee purchased the raw material i.e. 'cut component' from the open market (instead having been supplied by the customer) and after processing in the hi-tech machinery sold it to the customer, then in that case, there would have been no denial of deduction, as the A.O.had not disputed the fact that the "Stator" as manufactured by the assessee was an independent saleable part and even being sold as an independent watch part in the international market by the customer who had supplied the assessee the 'cut component1 for heat treatment to make it capable of being used as a watch part. It was clarified that watch being a final finished product involved assembly/combination of about 105 parts which were being manufactured by different units in different parts of the world, wherein, in some cases, a particular item is so petty, not only in its specifications but even in cost, its value being less than a rupee, but the unit manufacturing it is independent manufacturing unit entitled for all enabling benefits/deductions. As regards to manufacture of "case-set", it was submitted that the assessee received two components namely glass and case, thereafter the process was carried out with the help of an ultrasonic welding machine and those two components were welded together to make a "case-set", which was ready for use in the process of making a watch. The "case-set" so made could not be reconverted into case and glass i.e.
the process was irreversible. It was further submitted that the carrying out of the process involved technical know-how including knowledge of the material being used vis-is temperature, pressure and time it would take to assemble into integrated 'watch case set'. It was argued that as a result of ultra-sonic welding, the case-set as produced was a water-proof case from the top and is so welded that the glass and case lost their individual identity as such and a new commercial saleable product i.e. "watch-case set" comes into existence.
Therefore, the process was essentially a manufacturing process and was eligible for deduction Under Section 80IB, It was, accordingly argued that the process, activities carried out for manufacture of stator and "watch-case set" termed as job work, irrespective of its nomenclature were essentially manufacturing activities. The reliance was placed on the following case laws: 4. Collector of Central Excise, Baroda, Appellant : M.M. Khambhatwala, Respondent .Philips India Ltd. and Ors. v. Union of India and Ors.
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4. The learned CIT (Appeals), after considering the submissions of the assessee observed that manufacturing process shall remain a manufacturing process irrespective of the fact whether raw material was supplied by some customer or purchased by the assessee himself i.e.
there is no difference between income from job work and the income from manufacturing activities carried out by the assessee provided the assessee carries on the same process for job work which have otherwise been carried out in the manufacturing activities. According to him, the assessee was engaged in manufacture of coils, ECB and plastic watches in Unit-I and watches and other parts in Unit-II and that the job work carried out by the assessee during the year was only in respect of two processes, first related to production of 'stator' which involve heat treatment in a controlled environment and second related to production of 'case set' from glass and case with the help of an ultrasonic welding machine. The learned CIT (Appeals) observed that it was not the case of the assessee that the watches, coils, electronic circuit board etc. were being manufactured on job work for the clients. He was of the view that the production of stator was an industrial activity as assessee through the process was converting the cut components into magnetic stator inserting in the material its essential character i.e.
'Magnetism' and thereby causing a transformation of the degree by which the output became commercially different from the input and its commercial identity was altogether different. As regards to the production of "case-set", the learned CIT (Appeals) was of the view that welding of glass into the 'case' did not involve any manufacture as no new characteristics were developed. He relied the judgment of Hon'ble Calcutta High Court in the case of CIT v. Hindustan Metal Refining Works Pvt. Ltd. 128 ITR 472 and held that the process of welding of glass and case did not bring into existence any new product, therefore, the assessee was not entitled to deduction Under Section 80IB in respect of profit from job work charged in production of "watch case-set".
4. The learned Counsel for the assessee reiterated the submissions made before the authorities below and further submitted that the clients supplied stator and case-set, coil, after receiving those, the assessee had done the magnetization and also fixed the glass in case with the help of ultrasonic welding machine., So it was a manufacturing because the "case-set" given by the clients before the job work was different from the "case-set" given by the assessee since quality of two were different, It was emphasized that the "case-set" after applying the process of ultrasonic welding with the help of hi-tech machinery was to be used in water-proof watches and without applying this process, the case-set would not become water-proof. So, there was change in the property of the commodity and a new waterproof case was developed, therefore, it was a manufacturing activity and the assessee was entitled to deduction for the profit earned on job work also. It was also emphasized that for the same activity in assessee's own business, it had been accepted that it was a manufacturing so different stand should not be taken for the activity conducted by the assessee on job work basis.
5. In his rival submissions, the learned DR strongly supported the orders of the authorities below and submitted that mere fixing of two things was not a manufacturing activity. The reliance was placed on the judgment of the Hon'ble Calcutta High Court in the case of CIT v.Hindustan Metal Refining Works Pvt. Ltd. reported at 128 ITR 472, wherein it has been held that the galvanization as an act or process of galvanizing or coating to protect it from rust does not bring into existence a different article and hence, does not result into manufacture or production of new good as such.
6. We have considered the rival submissions and carefully gone through the material available on the record.
Before us, the Issue to be decided is whether the assessee is eligible for deduction Under Section 80IB claimed on the manufacture of 'case-sets'. The deduction Under Section 80IB is available to an Industrial Under taking if it manufactures or produces any article or thing not being any article or thing specified in the list in the Eleventh Schedule. The word 'Industrial Undertaking' has not been defined in the Income-tax Act, however, cropped up many a time before the Hon'ble Supreme Court and various High Courts. In the present case, interpretation of the word 'Industrial Undertaking' does not pose much difficulty before us because nobody has disputed that the assessee is an industrial undertaking. As such, we do not find any reason to hold otherwise than that the establishment of the assessee is 'Industrial Undertaking'. It is true that each and every industrial undertaking would not be eligible for the deduction Under Section 80IB of the Income-tax Act because it is only the) industrial undertaking that specifies test indicated in Section 80IB, would only be eligible and qualified for such deduction. An 'industrial undertaking' which is engaged in manufacture and production of an article or thing would be eligible for the deduction Under Section 80IB. Now, the question to be decided is whether the welding of glass and case to make 'case-sets' can be considered as manufacturing. Admittedly, the assessee had undertaken job work of welding of case and glass with its ultrasonic welding machine for which the components were supplied by the parties, whether this job work undertaken by the assessee can be considered as manufacturing, so that the deduction Under Section 80IB could be allowed, it is necessary to understand the meaning of the word "manufacture". The word 'manufacture' used as a verb is generally understood to mean as that bringing into existence a new substance and does not mean merely to produce some change in a substance, however, minor in a consequence the change may be. In the case of B.S. Bajaj & Sons v. CIT reported at 222 ITR 418, the Hon'ble jurisdictional High Court interpreted the word 'manufacture' and observed that the distinction between processing and manufacturing is well brought about in a passage quoted in Permanent Eddition of Words and Phrases Vol. 26 the passage runs thus: "Manufacture" implies a change, but every change is not manufacture and yet every change of an article is the result of treatment, labour and manipulation. But something more is necessary and there must be transformation; a new and different article must emerge having a distinctive name, character or use.
The Hon'ble jurisdictional High Court had also considered and opined on the word 'manufacture' in the case of Sidhu Ram Atam Parkash (1974) 34 STC 344 (at page 346) as under: Applying the above definition to the instant case, the question is when the logs are converted into planks and rafters, does it mean that a manufacturing process has been gone into? In other words, has a new substance has occurred? As we look at the matter, when a log, either by manual labour or mechanical process, is converted into a plank or a rafter, a new substance does not come into being and this process is not covered; by the definition of the word 'manufacture' as given by the Supreme Court.
6.1 I.T.A.T. Calcutta Special Bench in the case of Shah Escort Distillery Pvt. Ltd. v. ACIT (2002) 255 ITR 14 (A.T.) also interpreted the meaning of the word 'manufacturing' in the following words: Manufacturing normally involves consumption of a particular commodity in the process of manufacturing of another commodity. The goods purchased should be consumed, the consumption should be in the process of manufacture and the result must be the manufacture of other goods. There are several criteria for determining whether a commodity is consumed in the manufacture of another. The generally prevalent test is whether the article produced is regarded in the trade, by those who deal in it, as distinct in identity from the commodity involved in its manufacture. Commonly, manufacture is the end result of one or more processes through which the original commodity is made to pass. The nature and extent of processing may vary from one case to another, and indeed there may be several stages of processing and perhaps a different kind of processing at each stage, With each process suffered, the original commodity experiences a change. But it is only when the change, or a series of changes take the commodity to the point where commercially it can no longer be regarded as the original commodity but instead is recognized as a new and distinct article that a manufacture can be said to take place.
6.2 It is also relevant to point out that under Clause (iii) to Sub-section 2 of Section 80IB, the legislature has used two separate words i.e. 'manufactures' and 'produces' any article with an 'or' in between. Thus, both have to be read separately and the meaning assigned to them. These two words can not have the same meaning. The word 'produce' an article has a wider connotation than 'manufacture', every manufacture can be said to be production but not vice-versa. Their Lordships of the Hon'ble Apex Court in the case of CIT v. N.C.Budhiraja & Co. while considering the provisions of Section 80HH of the Income-tax Act and had held as under: That the word "production" has a wider connotation than the word "manufacture". Every "production" may not amount to "manufacture" whereas every "manufacture" can be termed as "production".
"Manufacture" does not imply only a change but something more is necessary. A new and different article must emerge having a distinct name, character or use to bring it within the meaning of the word "manufacture". The word "produce an article" may not amount to a "manufacture" but it would include all the by-products, intermediate products and residual products which emerge in the course of manufacture of goods. It was held as under (at page 423): The words 'manufacture' and 'production' have received extensive judicial attention both under this Act as well as the Central Excise Act and the various sale tax laws. The word "production has a wider connotation than the word 'manufacture'. While every manufacture can be characterized as production, every production need not amount to manufacture. The meaning of the expression 'manufacture' was considered by this Court in Deputy CST v. Pio Food Packers (1980) 46 STC 63 among other decisions. In the said decision, the test evolved for determining whether manufacture can be said to have taken place is, whether the commodity which is subjected to the process of manufacture can no longer be regarded as the original commodity but is recognized in the trade as a new and distinct commodity. Pathak J., as he then was, stated the test in the following words (at page 65): Commonly, manufacture is the end result of one or more process through which the original commodity is made to pass. The nature and extent of processing may vary from one case to another, and indeed there may be several stages of processing and perhaps a different kind of processing at each stage. With each process suffered, the original commodity experiences a change. But it is only when the change, or a series of changes, take the commodity to the point where commercially it can no longer be regarded as the original commodity but instead is recognized as a new and distinct article that a manufacture can be said to take place. The word 'production' or 'produce' when used in justaposition with the word 'manufacture' takes in bringing into existence new goods by a process which may or may not amount to manufacture. It also takes in all the by-products, intermediate products and residual products which emerge in the course of manufacture of goods.
6.3 From the combined reading of the ratios laid down in the aforesaid referred to cases, it can be concluded that when the change or a series of changes takes one commodity to the point where commercially it can no longer be regarded as the original commodity, but instead is recognized as a new and distinct article, then it can be said that 'manufacture' takes place. In the present case, the assessee while doing the job work applied the process of welding on glass and case with the ultrasonic welding machine, so that the "case-set" becomes waterproof. However, there was no change in the composition of the glass and it was merely affixed to the case, no new article came into existence and there was no change in the composition of the raw materials used i.e. the glass and case. So, it can not be considered a manufacturing. The Hon'ble Calcutta High Court in the case of CIT v.Hindustan Metal Refining work Pvt. Ltd. (supra) held as under: Galvanization is an act or process of galvanizing or coating by which iron or steel is coated with zinc to protect it from rust. The process of galvanizing does not result in the manufacture or production of new goods as such.
In the present case also the assessee was doing the job work on behalf of its clients and the 'case-set' became waterproof so that the watch would be protected from water. However, no new article was manufactured or produced. Therefore, the process of welding of glass and case does not amount to manufacturing and the assessee was not entitled to deduction Under Section 80IB in respect of job work. In that view of the matter, we do not see any merit in the appeal of the assessee on this issue.
That the learned CIT (Appeals) Shimla has erred on facts and in law in sustaining the disallowance of deduction Under Section 80IA/IB on lease rental income of Rs. 90,000/- and miscellaneous income of Rs. 10,258/- by erroneously holding that these are not derived from industrial undertaking.
That without prejudice to above the addition made/sustained by learned CIT (Appeals) is excessive and unreasonable.
During the course of hearing, the learned Counsel for the assessee did not press the issue related to the miscellaneous income of Rs. 10,258/-. As regards to the issue related to the lease rental income of Rs. 90,000/- is concerned, the facts in brief are that the assessee claimed deduction Under Section 80IA/IB of Income-tax Act on lease rent amounting to Rs. 90,000/- in Unit-II. The Assessing Officer did not allow the deduction by stating that the lease rent had nothing to do with the profit from manufacturing activity.
8. The assessee carried the matter to the learned CIT (Appeals) and submitted that the Assessing Officer himself had treated the lease rent at business income and not as income from other sources, whereas, while calculating the deduction Under Section 80IA, it had not been treated as income from business. It was further stated that the lease rent of Rs. 90,000/- had been received by the assessee on lease of EDM machine to M/s Purewal & Associates Ltd. and this machinery was purchased as part of plant & machinery of the assessee. It was further stated that the machinery could not be properly utilized by the assessee for its own purpose and was given temporarily on lease to another organization to optimize profit of the organization. Hence, the intention of the company was not to part with the assets but to lease them out for a temporary period as a part of the exploitation of the assets. The reliance was placed on the following case laws: 9. Learned CIT (Appeals), after considering the submissions of the assessee observed that the expression 'profit and gain' derived from industrial undertaking implies that such profits and gains must have direct nexus with the industrial undertaking and if such nexus is incidental only, such income would not be a profit derived from the industrial undertaking and the same would not qualify for deduction.
The reliance was placed on the judgment of Hon'ble Supreme Court in the case of Cambay Electrical Supply Industrial Co. v. CIT reported at 113 ITR 84. Learned CIT (Appeals) further observed that there must be a direct nexus between the profit and gains and industrial undertaking and if such nexus was not direct but only incidental, the profit derived from such incidental activities would not be considered profit and gains derived from the assessee's industrial undertaking. The reliance was placed on the following case laws: The CIT (Appeals) observed that even if it was to be admitted that income from leasing of EDM machines was established as business income still, the assessee should not be entitled to deduction Under Section 80IB as the immediate source of income was leasing of machinery and not any industrial activity. Accordingly, the learned CIT (Appeals) upheld the findings of the Assessing Officer. 10. Before us, the learned Counsel for the assessee reiterated the submissions made before the authorities below and submitted that the lease rent has been assessed as business income and not income from other sources. Therefore, the deduction was allowable to the assessee since there was direct nexus of the machinery and the business activity of industrial undertaking.
11. In her rival submissions, the learned DR strongly supported the orders of the authorities below and submitted that there was no direct nexus between the lease rent and the profits and gains derived by the industrial undertaking.
12. We have given our careful thought to the rival contentions, In the instant case the assessee was the owner of the machinery to be used for the business purpose. The assessee could not utilize the machinery for its own purpose and had given that temporarily on lease to optimize the profits of industrial undertaking. Neither the Assessing Officer nor the learned CIT (Appeals) had stated that it was a business of the assessee to give machinery on lease. On the contrary, the machineries were purchased by the industrial undertaking for business purposes.
However, it is not brought on record whether the machinery given on lease by the assessee was used by the lessee or not. The Hon'ble Madras High Court in the case of CIT v. Universal Radiators Pvt. Ltd. has held as under.
There is nothing in Section 80-1 of the I.T. Act, 1961, which requires that the assessee alone should run the priority industry.
So long as the factory manufactures the products coming within the list of articles and things in Schedule VI, the assessee would be eligible for the relief under Section 80-1, as the profits derived from the factory either by lease or otherwise would be attributable to the priority industry. If the assessee has something to do with the factory and the income earned has a nexus with the priority industry the assessee would be eligible for the relief under Section 80-1.
In the said case the assessee leased out certain machinery belonging to it to another company to enable the latter company to manufacture certain component parts which were automobile accessories. The products so manufactured by the other company were made available to the assessee. The assessee's claim that the rent received by it from the lease of the machinery was to be treated as profits attributable to the priority industry and hence would qualify for deduction under Section 80-1 of the I.T. Act, 1961, was accepted by the ITO. The Addl. Commissioner, however, held that the assessee was not entitled to the relief and revised the order of the ITO. The Tribunal, in the appeal by the assessee, restored the order of the ITO.Hon'ble High Court held that the "Tribunal was right in its conclusion that the amount received from the lease of machinery would qualify for deduction Under Section 80-1".
12.1 Although the facts of the present case are similar to the facts involved in the case of CIT v. Universal Radiators Pvt. Ltd. (supra), therefore, the ratio laid down in the said case may be applicable to the facts of the present case. In the aforesaid referred to case, the assessee manufactured certain component parts with the help of the machinery taken on lease and those components were supplied to the lesser but, in the present case, the facts are not brought on record either by the Assessing Officer or by the learned CIT (Appeals) as to whether the machineries given on lease were used by the lessee for the purpose of manufacturing for the assessee. We, therefore, deem it proper to set aside this issue back to the file of the Assessing Officer for fresh adjudication. The Assessing Officer should give an opportunity of being heard to the assessee and if the assessee would be able to prove that the lessee had used the machineries for the purposes of manufacturing for the assessee than the deduction claimed may be allowed. Accordingly, this issue is remanded back to the Assessing Officer for fresh adjudication in. accordance with law after providing due and reasonable opportunity of being heard to the assessee.