M/S. J.B. ENTERPRISE vs. ASSTT. COMMISSIONER OF INCOME TAX.

These   appeals   involve   similar   questions   in   similar background involving the same assessee.   We may notice facts from Tax Appeal No.862/2007. 2. The assessee has challenged the judgment of the Income Tax Appellate Tribunal. Following questions were framed while admitting the appeal : “(1) Whether on the facts and circumstances of the case, the ITAT was right in holding that the appellant was not entitled to deduction under Section 10B of the Act? (2) Whether in the facts and circumstances of the case, the ITAT was right in holding that since there is no word as “for the removal of doubt” in Explanation 4 to Section 10B the said has to be held as prospective and not retrospective as claimed by the assessee?”

The appellant assessee is a registered partnership firm and is engaged in the business of import of rough diamonds and export of finished diamonds after cutting and polishing them. For the assessment year 2001­2002, the assessee had filed the return of income declaring total income of Rs.18.28   lacs   (rounded   off).   The   assessee   had   claimed deduction of Rs.68.74 lacs (rounded off) under section 10B of the Income Tax Act, 1961. The Assessing Officer framed scrutiny assessment under section 143(3) of the Act on 28.2.2003. In such order, he noted that the assessee firm has   its   manufacturing   unit   at   Surat,   Ahmedabad   and Visnagar.   It   had   also   started   a   separate   manufacturing unit at Surat which was a hundred percent export oriented unit. Income from such activity was claimed exempt under section 10B of the Act and that present one was a second year of such EOU. After completing such assessment, the Assessing   Officer   reopened   the   assessment   by   issuing notice under section 148 of the Act on the ground that section   10B   was   amended   by   which   explanation   4   was inserted by the Finance Act, 2003, providing that for the purposes   of   the   said   section   “manufacture   or   produce” would include cutting and polishing of precious stones and semi­precious stones. The Assessing Officer was therefore, of the opinion that such activity of cutting and polishing of diamonds would qualify for deduction under section 10B of the Act only after such amendment and not for the period prior   thereto.   The   assessee   appeared   and   opposed   the additions.   He   mainly   contended   that   the   explanation inserted in section 10B was merely clarificatory in nature. Heavy reliance was placed on the budget speech of the Finance Minister. An alternative argument was raised that being an export oriented unit, deduction would be available under section 80HHC in any case.

The Assessing Officer passed order under section 143(3) read   with   section   147   of   the   Act   on   27.10.2004. He confirmed his belief that deduction under section 10B of the Act to a diamond polishing or cutting unit would be available   only   with   effect   from   1.4.2004   i.e.   from   the assessment year 2004­2005 and not earlier. However, he accepted   the   assessee's   alternative   contention   and   held that the assessee would be eligible for deduction under section 80HHC of the Act.

The assessee carried the matter in appeal and reiterated the same contentions. CIT(Appeals) under his order dated 23.2.2005 was unable to accept the assessee's stand that the amendment in section 10B was merely clarificatory in nature. Reference was made to the budget speech of the Finance   Minister.   It   was   held   that   the   explanation   has prospective effect only. The assessee carried the matter in further appeal before the Tribunal.  The Tribunal  placed heavy reliance on the decision of Supreme Court in case of Commissioner   of   Income­tax   v.   Gem   India   Mfg.   Co. reported in (2001) 249 ITR 307 to come to the conclusion that the activity of cutting and polishing diamonds does not   amount   to   manufacture   or   production   of   article   or thing. In the view of the Tribunal therefore, in absence of explanation   4   to   section   10B,   deduction   would   not   be available.

Learned counsel Shri Soparkar for the appellant assessee raised the following contentions : (1)  Explanation 4 inserted in section 10B of the Act was merely   clarificatory   in   nature   and   would   apply   to   all pending cases. (2)  Even in absence of such explanation, what the section requires is that the assessee should have manufactured or produced article or thing. Cutting and polishing diamonds is a manufacturing activity. From the rough diamonds, the processed and polished diamond is brought into existence through a complex and sophisticated process. The original product i.e. rough diamond and the end product i.e. cut and   polished   diamonds   are   two   entirely   different commodities having different uses, different markets and different   values.   Uncut   and   unpolished   diamond   is   put only   to   industrial   uses.   Polished   diamond   is   principally used for gems and jewellery. (3)   Counsel pointed out that Bombay High Court in case of Commissioner of Income­tax v. Fateh Granite (P)  Ltd reported   in   (2009)   222   CTR   638   (Bombay),   held   that cutting and polishing of granites amount to manufacture or production of article or thing. It was observed that the expression “produce” is wider than “manufacture”. It was noticed   that   Section   10B   of   the   Act   uses   expression “manufacture or produce”.

On the other hand, learned counsel Shri Nikunt Raval for the department opposed the appeal contending that the issue   is   squarely   covered   by   the   judgment   of   Supreme Court in case of Gem India Mfg. Co.(supra). The Tribunal correctly   relied   on   the   said   provision.   Upholding   the contention   of   the   assessee   would   render   explanation   4 redundant. Such explanation is not clarificatory in nature and is only prospective. The assessee has not brought on record the process undertaken for cutting and polishing the   diamonds   to   establish   that   same   amounted   to manufacture or production of article or thing.

We may first consider whether this issue is covered by the judgment of the Supreme Court in case of Gem India Mfg. Co.(supra).   It   was   a   case   in   which   in   the   context   of deduction   under   section   80­I   of   the   Act,   the   question cropped   up   whether   cutting   and   polishing   diamonds amounted to manufacture or production of article or thing. The   Tribunal   and   the   High   Court   having   accepted   the assessee's stand, the Supreme Court reversed the same making the following observations :

Two things thus emerge from this judgment. One that the Supreme   Court readily accepted that the raw and uncut diamonds is subjected to a process of cutting and polishing which yields the polished diamond. However this would not be synonyms to saying that polished diamond is a new article   or   thing   which   is   the   result   of   manufacture   or production. In absence of any material on record, upon which, such a conclusion can be reached, the Supreme Court reversed the judgment of the High Court.

This position was explained by the Supreme Court in a later judgment in case of   Heaven Diamonds (P) Ltd (supra), relevant portion of which has been reproduced by the Tribunal in judgment in case of   Flawless Diamond (India) Ltd(supra) and reads as under : “15..... 'We  find   from  the   impugned   order   of   the   Tribunal   that there is no discussion on the process undertaken by the assessee, who claims benefit of section 80­IB of the Act. The assessee imports raw diamonds and applies thereon the process of sawing, turning, profiling, cutting, drilling, polishing,   etc.,   by   the   use   of   sophisticated   machineries resulting   in   production   of   a   superior   marketable commodity. Detailed procedure has been set out in the paper   book.   The   Tribunal   ought   to   have   examined   the process   as   to   whether   such   process   would   constitute "manufacture" under section 80­IB. That exercise has not been   undertaken.   The   reliance   on   the   judgment   of   this Court in the case of CIT v/s Gem India Mfg. Co. [2001] 249 ITR 307 may not be correct for the simple reason that in that case, the Revenue succeeded as Gem lndia Mfg. Co. was not able to demonstrate the process undertaken by it to   convert   raw   diamonds   into   a   superior   commodity. Moreover,   the   High   Court   has   also   not   gone   into   that aspect. The High Court should have remitted the case to the Tribunal to consider whether the process undertaken by   the   assessee   constituted   "manufacture".   Under   the above   circumstances,   the   impugned   order   of   the   High Court and the Tribunal are set aside and the matter is remitted to the Tribunal for de novo consideration in the light   of   what   we   have   stated   hereinabove.’   [Emphasis added]”

Thus judgment in case of Gem India Mfg. Co.(supra) was   explained   in   case   of    Heaven   Diamonds   (P)   Ltd (supra) observing that the Revenue succeeded in the said case since the assessee was not able to demonstrate the process undertaken by it to convert the raw diamond into superior   commodity.   Under   the   circumstances,   the Supreme   Court   remitted   the   matter   back   before   the Tribunal. Thus the Supreme Court in the later judgment in case   of  Heaven   Diamonds   (P)   Ltd  (supra)     limited   the findings and observations in case of Gem India Mfg. Co. (supra)   to   that   particular   case   since   the   assessee   was unable   to   demonstrate   the   process   undertaken   for conversion of diamond into a polished or cut diamond. We therefore, do not believe that by virtue of judgment in case of  Gem India Mfg. Co.(supra), any further discussion or inquiry is impermissible.

We   may   now   test   the   assessee's   contention   that explanation  4 to  section  10B was  either  clarificatory   or having retrospective effect. Section 10B of the Act, as is well­known,   provides   for   deduction   of   profits   and   gains derived by a hundred per cent export­oriented undertaking from export of articles or things for a specified period from the time undertaking begins to manufacture or produce articles or things. Explanation 4  which was added to the said section with effect from 1.4.2004 provides that for the purposes of this section, “manufacture or produce' shall include the cutting and polishing of precious and semi­ precious stones. In plain terms, this provision has been made applicable without any retrospectivity. The language of the provision also does not make it clarificatory. The budget   speech   of   the   Finance   Minister   explaining introduction of the said provision would also not help the assessee. In such speech, while allying the fears of gem and jewellery industry about withdrawal of benefits under section 10A and 10B of the Income­tax Act, it was further stated that “ Keeping in view the substantial value addition that takes place in cutting and polishing of diamond and gems, it is also proposed to extend the benefits u/s.10A & 10B of the Income­tax Act to these activities. It is also proposed to insert explanation 4 at the end so as to provide that   for   the   purpose   of   this   section,   “manufacture   and produce”   shall   include   the   cutting   and   polishing   of precious and semi­precious stones.” It was   stated that these   amendments   will   take   place   from   1.4.2004     and would accordingly apply in case of assessment year 2004­ 2005 and subsequent years.  Like­wise, the memorandum explaining   the   provision   of   the   Finance   Bill,   2003,   also provides   that   with   a   view   to   give   fiscal   support   to   the exporter   of   precious   and   semi­precious   stones,   it   is proposed to insert a new explanation 4 at the end so as to provide that for purposes of this section, the expression “manufacture and produce” shall include the cutting and polishing of precious and semi­precious stones. There is nothing in the budget speech or memorandum explaining the relevant provisions of the Finance Bill to indicate that insertion of explanation 4 to section 10B was either an exercise   of   clarification   or   meant   to   be   applied retrospectively. In fact, every indication is to the contrary. The Finance Minister made it clear that the provision is prospective and would apply to the period post 1.4.2004. The   assessee   would   therefore,   not   be   correct   in   basing reliance on the said provision or the budget speech of the Finance Minister explaining the reason for introduction of the provision.

Even if explanation 4 to section 10B was meant to be prospective, in absence of any such provision, the assessee succeeds   in   establishing   that   activity   of   cutting   and polishing   diamonds   amounted   to   manufacture   or production   of   article   or   thing,   it   would   automatically qualify for deduction under section 10B of the Act. In other words, we have to ascertain the eligibility of the assessee for deduction under section 10B of the Act for the period prior to insertion of explanation 4 without the aid of the said explanation and come to a conclusion whether the assessee satisfied the requirement of the said section. It is in this context, the question arises whether the activity of cutting and polishing diamonds amounts to manufacture or production of article or thing.

The question whether a particular process amounts to manufacture has occupied the attention of the  Courts on numerous occasions. Such a question typically arises in the   background   of   exciseability   of   the   product.   The Supreme   Court   has   laid   down   certain   principles   and guidelines   to   ascertain   whether   a   particular   activity amounts to manufacture. In case of India Cine Agencies v. Commissioner of Income­tax  reported in (2009) 308 ITR 98(SC), the Supreme Court considered the question whether conversion of jumbo rolls of photographic films into   small   flats   and   rolls   of   desired   sizes   amounted   to production. In this background, it was observed as under :

‘Manufacture’ is a transformation of an article, which is commercially different from the one, which is converted. The essence of manufacture is the change of one object to another   for   the   purpose   of   making   it   marketable.   The essential point thus is that, in manufacture something is brought into existence, which is different from that, which originally existed in the sense that the thing produced is by itself a commercially different commodity whereas in the case   of   processing   it   is   not   necessary   to   produce   a commercially different article. (See M/s. Saraswati Sugar Mills and others v. Haryana State Board and others (1992 (1) SCC 418).

The prevalent and generally accepted test to ascertain that there is ‘manufacture’ is whether the change or the series   of   changes   brought   about   by   the   application   of processes   take   the   commodity   to   the   point   where, commercially, it can no longer be regarded as the original commodity but is, instead, recognized as a distinct and new article that has emerged as a result of the process. There might be borderline cases where either conclusion with equal justification can be reached. Insistence on any sharp   or   intrinsic   distinction   between   ‘processing   and manufacture’, results in an oversimplification of both and tends to blur their interdependence. (See Ujagar Prints v. Union of India (1989 (3) SCC 488).

To put it differently, the test to determine whether a particular activity amounts to ‘manufacture’ or not is: Does a new and different good emerge having distinctive name, use and character. The moment there is transformation into a new commodity commercially known as a distinct and separate commodity having its own character, use and name, whether be it the result of one process or several processes ‘manufacture’ takes place and liability to duty is attracted. Etymologically the word ‘manufacture’ properly construed would doubtless cover the transformation. It is the transformation of a matter into something else and that something   else   is   a   question   of   degree,   whether   that something else is a different commercial commodity having its   distinct   character,   use   and   name   and   commercially known   as   such   from   that   point   of   view,   is   a   question depending upon the facts and circumstances of the case. (See Empire Industries Ltd. v. Union of India (1985 (3) SCC 314).”

In case of  Grasim Industries Limited v. Union of India reported in (2011) 10 Supreme Court Cases 653, it was observed that term 'manufacture' includes any process incidental   or   ancillary   to   completion   of   manufactured product. Same can be a process in manufacture or process in   relation   to   manufacture   of   the   end   product,   which involves bringing some kind of change to raw material at various stages by different operations. Process must have effect of bringing change or transformation in raw material and   also   lead   to   creation   of   any   new   and   distinct   and excisable product.

In   case   of  Servo­Med   Industries   Pvt.   Ltd   v. Commissioner of C. Ex. Mumbai  reported in 2015 (319) ELT 578 (SC) in a detailed analysis of the case law, it was held   that   sterilization   of   syringes   and   needles   though involved process of removal of foreign matter from goods and   unsterilized   syringes   and   needles   were   of   no commercial   use   without   sterilization,   the   process   of sterilization did not amount to manufacture.

It   is   undisputable   that   the   rough   diamonds   are subjected to the process of cutting and polishing to bring into existence the polished diamonds. Such process has been noted by the Tribunal in the judgment in case of Flawless Diamond (India) Ltd(supra) as under : “'

As far as the issue whether cutting and polishing of diamonds would constitute manufacturing or not, before us   ld.   Counsel   of   the   assessee   had   produced   rough diamonds   which   are   just   like   ordinary   stones   or   more precisely coloured glass type with uneven surface and were of uneven shape. All the samples were of dark brownish / greenish/bluish colour measuring about 1 c.m. To 2½ c.m. ld.   Counsel   of   the   assessee   produced   cut   and   polished diamonds in the size of 10 cents to l carat, which were looking sparkling white. lt was explained before us with reference   to   the   procedure   for   cutting   and   polishing   or processing   of   the   diamonds   as   listed   out   by   one   Mr. Kantilal Chhotalal in the book titled as 'Diamonds From Mines To Markets'. In this book after stating that diamond cutting is a labour incentive industry and India was one of the main centres for the cutting. The process has been briefly discussed as under: "The ultimate value of a diamond depends, among other factors, on its make, that is, the quality of the finished product. A "good make" refers to a stone that is of fine proportions, symmetrical, and well­polished. The purpose of cutting, faceting and polishing is to bring out the best in a diamond in terms of brilliance and purity, which results from   the   refraction   and   reflection   of   light.   It   is   also necessary to preserve as much of the original weight as possible.

We also used Inter net to find out scientific information on the process involved in making out fine diamond. We could get Wikepedia encyclopedia on 'Net' in which various stages involved in making of a ’diamond‘ are described. The process of cutting and polishing of diamonds as described in the Wikepedia encyclopedia is as under: Diamond cutting is the art, skill and, increasingly. science of changing a diamond from a rough stone into a faceted gem.   Cutting   diamond   requires   specialized   knowledge, tools, equipment, and techniques because of its extreme hardness. The   first   guild   of   diamond   cutters   and   polishers (diamantaire) was formed in 1375 in Nuremberg, Germany, and led to the development of various types of 'Cut'. This has two meanings in relation to diamonds. The first is the shape: square, oval, and so on. The second relates to the specific quality of cut within the shape, and the quality and price will vary greatly based on the cut quality. Since diamonds are  very hard to  cut, special  diamond­bladed edges are used to cut them. The first major development in diamond   cutting   came   with   the   "Point   Cut"   during   the latter half of the 14th century: the Point Cut follows the natural   shape   of   an   octahedral   raw   diamond   crystal, eliminating some waste in the cutting process. Further, various tests have been explained as under: Planning Diamond manufacturers analyze diamond rough from an economic perspective, with two objectives steering decisions made about how a faceted diamond will be cut. The   first   objective   is   that   of   maximum   return   on investment for the piece of diamond rough. The second is how quickly the finished diamond can be sold. Scanning devices are used to get 3­dimensional computer model of the rough stone. Also, inclusions are photographed and placed on the 3D model, which is then used to find an optimal way to cut the stone. Maximizing value The process of maximizing the value of finished diamonds, from a rough diamond into a polished gemstone, is both an art and a science. The choice of cut is influenced by many factors. Market factors include the exponential increase in value   of   diamonds   as   weight   increases,   referred   to   as Weight   retention,   and   the   popularity   of   certain   shapes amongst consumers. Physical factors include the original shape of the rough stone, and location of the inclusions and flaws to be eliminated. Weight retention The weight retention analysis studies the diamond rough to find the best combination of finished stones as it relates to per carat value. For instance, a 2.20 carat (440 mg) octahedron may produce (i) either two half carat (l00 mg) diamonds whose combined value may be higher than that of (ii) a 0.80 carat (I60 mg) diamond + 0.30 carat (60 mg) diamond that could be cut from the same rough diamond. The   round   brilliant   cut   and   square   brilliant   cuts   are preferred when the crystal is an octahedron as often two stones may be cut from one such crystal. Oddly shaped crystals,   such   as   macles   are   more   likely   to   Weight retention   The   weight   retention   analysis   studies   the diamond rough to find the best combination of finished stones as it relates to per carate value. For instance. a 2.20 carat (440 mg) octahedron may produce (i) either two half carat (100 mg) diamonds whose combined value may be higher than that of (ii) a 0.80 carat (160 mg) diamond + 0.30 carat (60 mg) diamond that could be cut from the same rough diamond. The   round   brilliant   cut   and   square   brilliant   cuts   are preferred when the crystal is an octahedron, as often two stones may be cut from one such crystal. Oddly shaped crystals, such as macles are more likely to be cut in a fancy cut­that   is, a cut  other  than the round brilliant­ which  the  particular  crystal  shape lends itself to.  Even with modern techniques, the cutting and polishing of a diamond   crystal   always   results   in   a   dramatic   loss   of weight,   about   50%.   Sometimes   the   cutters   compromise and accept lesser proportions and symmetry in order to avoid   inclusions   or   to   preserve   the   weight.   Since   the percarat price of a diamond shifts around key milestones (such as 1.00 carat), many one­carat (200 mg) diamonds are   the   result   of   compromising   Cut   quality   for   Carat weight. Some jewelry experts advise consumers to buy a 0.99 carat (198 mg) diamond for its better price or buy a 1.10 carat (220 mg) diamond for its better cut, avoiding a 1.00 carat (200 mg) diamond, which is more likely to be a poorly cut stone.

Counsel for the assessee also placed reliance on the Article   by   one   Akiva   Caspi   titled   as   “Modern   Diamond Cutting And Polishing”. This Article gives detailed process undertaken   for   cutting   and   polishing   of   raw   diamonds. Essentially   this   Article   aims  to  explain  the   complexities involved in the process and the sophistication required to carry out such process in order to optimize the value and quantity of the polished diamonds that may emerge out of such process.   Whether carried out manually or through sophisticated machines, it is impossible to deny that the process of cutting and polishing diamonds is a complex one requiring specialized knowledge and expertise at every step. Rough unpolished diamond on one hand and cut and polished   diamond   on   the   other   differ   completely   in appearance, value and uses. Thus this process of cutting and   polishing   diamonds   brings   into   existence   a   new product which has totally different marketable commodity. From such Article, we gather that cutting and polishing diamonds   have   sparkle   and   definite   desired   shapes. Through this process thus a completely new commodity having a different market is brought into existence.

In the result, question no.1 is answered in favour of the assessee. Though question no.2 is answered against the assessee, Tax Appeal is allowed in view of answer of the first question. Judgment of the Tribunal   confirming the view of the revenue authorities is set aside. The assessee is held entitled to deduction under section 10B of the Act.

Tax Appeals are disposed of. (AKIL KURESHI, J) (B.N. KARIA, J) raghu