Gujarat High Court upholds Sun Pharma Sikkim’s Section 80IE claim and dismisses Revenue appeals

1. Background and procedural history

The Gujarat High Court adjudicated two connected appeals filed by the Revenue, being R/Tax Appeal No. 183 of 2020 and R/Tax Appeal No. 184 of 2020, arising out of common issues relating to Section 80IE of the Income Tax Act, 1961 (“the Act”) in the case of PCIT Vs Sun Pharma Sikkim. The relevant assessment years were 2010-2011 and 2011-2012.

Both appeals challenged the common order dated 16.05.2019 passed by the Income Tax Appellate Tribunal, Ahmedabad Bench (“the Tribunal”) in ITA No.3541/MUM/2015 and ITA No.212/Mum/2017, where the Tribunal had substantially affirmed the order of the Commissioner of Income Tax (Appeals) [“CIT(A)”] granting Section 80IE deduction to M/s. Sun Pharma Sikkim and deleting multiple disallowances made by invoking Section 80IE(6) read with Section 80IA(10).

The assessee is a partnership firm constituted by partnership deed dated 15.01.2009 with the following partners and profit-sharing ratios:

  • M/s. Sun Pharmaceuticals Industries Ltd. (SPIL) – 97.50%
  • Sun Pharmaceuticals Key Employees Benefit Trust (SPIKEBT) – 2.00%
  • M/s. Sun Pharma Advanced Research Co. Ltd., Key Employees Benefit Trust (SPARCKEBT) – 0.50%

The firm is engaged in manufacturing and sale of pharmaceutical formulations through its Sikkim unit.

By an assignment deed dated 16.01.2009, the plant, machinery and other assets of the Sikkim unit of M/s. Sun Pharmaceutical Industries Ltd. were transferred to the assessee at a net value of Rs.41,61,35,690/-. The corresponding debit note giving accounting effect to this transfer was raised on 05.03.2009.

For both assessment years 2010-2011 and 2011-2012, the assessee filed returns declaring NIL income after claiming deduction under Section 80IE. The Assessing Officer (“AO”), however, denied the deduction and, in the alternative, recomputed the profits of the Sikkim unit by making notional allocations of common/group expenses and other items.

The CIT(A) allowed the assessee’s claim and deleted the allocations and related disallowances. The Tribunal upheld the CIT(A)’s findings and dismissed the Revenue’s appeals, while partly allowing the assessee’s appeal for A.Y. 2010-2011 on an unrelated scrap issue and dismissing the assessee’s appeal for A.Y. 2011-2012. The Revenue then brought the matter before the High Court under Section 260A.

2. Substantial questions of law before the High Court

2.1 Questions in Tax Appeal No. 183 of 2020

The Court admitted Tax Appeal No. 183 of 2020 on a set of substantial questions of law. In essence, they covered the following themes:

  • Eligibility under Section 80IE
    Whether the Tribunal erred in allowing deduction under Section 80IE despite:

    • the AO’s conclusion that M/s. Sun Pharma Sikkim was formed by splitting up or reconstruction of the existing business of M/s. Sun Pharma Industries, and
    • the allegation that more than 20% of the plant and machinery consisted of old/used machinery, contrary to Section 80IE(3) read with the Explanations to Section 80IA(3).

  • Application of Section 80IE(6) read with Section 80IA(10)
    Whether the Tribunal erred in deleting disallowances of deduction under Section 80IE(6) r.w.s. 80IA(10) on notional apportionment of:

    • selling and distribution expenses,
    • research and development expenses,
    • royalty expenses,
    • management fees,
    • treatment of central excise duty incentive, and
    • remuneration to working partner, including the effect of a supplementary partnership deed.

2.2 Questions in Tax Appeal No. 184 of 2020

Tax Appeal No. 184 of 2020 involved similar questions as in Appeal No. 183 of 2020, with one additional issue:

  • Rejection of books under Section 145(3)
    Whether the Tribunal was right in upholding the CIT(A)’s view that rejection of books of account was not legally tenable merely because the AO, after invoking Section 145(3), did not proceed to complete assessment in the manner prescribed under Section 144.

Apart from this, the appeal repeated the challenges to Section 80IE eligibility and the disallowances under Section 80IE(6) r.w.s. Section 80IA(10) on the same categories of expenditure and items as in Appeal No. 183 of 2020.

3. Facts relevant to Section 80IE eligibility

3.1 Incorporation and business of the assessee

The assessee firm came into existence on 15.01.2009. Its business is the manufacture and sale of pharmaceutical products from the Sikkim unit. As noted, the Sikkim undertaking’s tangible assets were assigned by M/s. Sun Pharmaceutical Industries Ltd. to the assessee on 16.01.2009, with a net asset value of Rs.41,61,35,690/- and corresponding debit note dated 05.03.2009.

Returns for A.Y. 2010-2011 (filed on 15.10.2010) and A.Y. 2011-2012 (filed on 29.09.2011) both declared NIL income after claiming the full deduction under Section 80IE.

3.2 AO’s reasons for denying Section 80IE deduction

For both assessment years, the AO framed assessments under Section 143(3) by orders dated 19.03.2013 (A.Y. 2010-2011) and 12.03.2014 (A.Y. 2011-2012). For A.Y. 2011-2012, the AO also purported to reject the books of account and then concluded that:

  1. Conditions in Section 80IE(3) were not satisfied

    • According to the AO, the firm had been formed by splitting up and reconstruction of the existing business of M/s. Sun Pharmaceuticals Industries Limited (SPIL).
    • The AO alleged that old/used machinery in the Sikkim unit exceeded the 20% ceiling envisaged in the Explanations to Section 80IA(3), read with Section 80IE(3).

  2. Alternative disallowance through reallocation of expenses
    Even assuming eligibility, the AO held that:

    • the assessee’s computation of eligible profit was excessive, and
    • various common expenses and other charges booked entirely in the accounts of Sun Pharma Industries Ltd. (SPIL) or other group entities should have been proportionately allocated to the Sikkim unit, thereby reducing its profit for Section 80IE purposes.

The AO also placed reliance on certain survey materials under Section 133A, impounded documents, and comparative figures of production and sales of SPIL before and after the formation of the Sikkim firm to support the theory of splitting up/reconstruction and inflated profits.

4.