Category: Direct Taxes

The assessee, a public sector undertaking, substantially
owned by the Government of India, was engaged in capital intensive exploration
and production of petroleum products for which it had to heavily depend on
foreign loan to cover its expenses, both capital and revenue, on import of
machinery on capital account and for payment to non-resident contractors in
foreign currency for various services rendered. The assessee had made three
types of foreign exchange borrowings : (i) in revenue account; (ii) in capital
account, and (iii) for general purposes, partly utilised in revenue account and
partly in capital account. As per terms and conditions of foreign exchange
borrowings, some of the loans became repayable in the year under consideration
but the date of repayment of some loans fell after the end of the relevant
accounting year. The assessee revalued in Indian currency all its foreign
exchange loans in revenue account, capital account as also in its general
purposes account, outstanding as on March 31, 1991 and claimed the difference
between their respective amounts in Indian currency as on 31st March, 1990 and
on March 31, 1991 as revenue loss u/s.37(1) of the Act in respect of loans used
in revenue account, and also took into consideration the similar difference in
foreign exchange on capital account loans as an increased liability u/s. 43A of
the Act for the purposes of depreciation. The foreign exchange loss incurred by
the assessee in the revenue account, on account of repayment of these loans made
in the year under consideration was allowed by the Assessing Officer as a
deduction u/s.37(1) of the Act, and he also took into consideration an increased
liability of foreign exchange loans taken in capital account and repaid in the
accounting year, for the purposes of depreciation, u/s.43A of the Act. He,
however, did not allow to the assessee its claim for foreign exchange loss
claimed on such foreign currency loans both in revenue account and in capital
account which were outstanding on the last day of the accounting year under
consideration and were as per the terms of borrowings repayable after the end of
the relevant accounting year. Similar treatment was given to the foreign
exchange loans for general purposes, used partly in revenue account and partly
in capital account. Thus, the assessee’s claim for foreign exchange
loss/increased liability on revaluation of these foreign exchange loans at the
end of the accounting year under consideration both in the revenue account and
capital account as also on loans used partly in revenue account and partly in
capital account, made on the ground that it had followed mercantile system of
accounting in this regards, was disallowed by the Assessing Officer. According
to the Assessing Officer, such a loss could be allowed to the assessee on
discharge of liability at the time of actual repayment of these loans.

Aggrieved, the assessee preferred appeal before the
Commissioner of Income-tax (Appeals). Inso-far as the assessee’s claim for
foreign exchange loss in revenue account was concerned, the Commissioner of
Income-tax (Appeals) affirmed the view taken by the Assessing Officer on the
ground that it was a notional liability and the same had not crystallised or
accrued in the relevant assessment year. However, as regards the adjustment for
increased liability made by the assessee for the purposes of S. 43A of the Act
in respect of foreign exchange loans in capital account, which were outstanding
as on March 31, 1991, the Commissioner accepted the stand of the assessee and
directed the Assessing Officer to allow the benefit of such increased liability
for computation of depreciation allowance on plant and machinery purchased out
of such foreign exchange loans for the assessment year under consideration.

Being dissatisfied, both the assessee as well as the Revenue
carried the matter in further appeal to the Income Tax Appellate Tribunal (for
short ‘the Tribunal’). The Tribunal observed that the method of accounting
adopted by the assessee right from the A.Y. 1982-83 is mercantile system; it has
been consistently claiming loss suffered by it on account of fluctuation in
foreign exchange rates on accrual basis; in respect of the A.Y. 1982-83 to
1986-87, the assessee’s claim on this account had been allowed by the Assessing
Officer himself; in respect of the A.Y. 1997-98, the assessee had shown a gain
of Rs.293.37 crores on account of fluctuation in foreign exchange because of the
Indian rupee had appreciated as compared to the foreign currency and that the
said amount was taxed as the assessee’s income. Taking all these factors into
consideration, the Tribunal held that the loss claimed by the assessee on
revenue account was allowable u/s.37(1) of the Act. The appeal preferred by the
Revenue on the question whether the assessee was entitled to adjust the actual
cost of imported assets acquired in foreign currency on account of fluctuation
in the rate of exchange, in terms of S. 43A of the Act, was also dismissed.

For the A.Ys. 1992-93, 1993-94, 1994-95 and 1997-98 similar
findings were given by the Tribunal. The Revenue took the matter in further
appeal to the High Court. By a common judgment pertaining to the A.Ys. 1991-92
to 1994-95 and 1997-98, the High Court reversed the decision of the Tribunal on
both the issues. Terming the order of the Tribunal as perverse, having been
passed without any material on record and against the statutory provisions, the
High Court held that the foreign exchange loss by the assessee being only a
contingent and notional liability, it was not allowable as deduction u/s.37(1)
of the Act. Insofar as the applicability of S. 43A of the Act was concerned, the
High Court observed that the said provision is confined only to those
liabilities which have become due as per the terms and conditions of written
agreement between the assessee and the foreign creditors but since in the
present case, no such agreement was made available by the assessee at any stage
of the proceedings, the claim of the assessee was not justified. According to
the High Court, the variation in foreign exchange was neither quantified, nor
had it become due or repaid and, therefore, deductions on that account had been
allowed by the Tribunal without application of mind and were, therefore,
illegal.

On an appeal by the assessee, the Supreme Court was of the
opinion that the ratio of the decision in CIT v. Woodward Governor of India P.
Ltd., (2009) ITR 254 (SC) squarely applied to the facts at hand and, therefore,
the loss claimed by the assessee on account of fluctuation in the rate of
foreign exchange as on the date of balance sheet was allowable as expenditure
u/s.37(1) of the Act.

The assessee was engaged in the manufacture of gears and
mechanical handling equipment. It procured a foreign currency loan for expansion
of existing business. Since the repayment of loan was stipulated in instalments,
the assessee wanted to ensure that foreign currency required for repayment of
the loan be obtained at a pre-determined rate and cost. Accordingly, the
assessee booked forward contracts with Citibank for delivery of the required
foreign currency on the stipulated dates. The contract was entered into for the
entire outstanding amount and the delivery of foreign currency was obtained
under the contract for instalment due from time to time. The balance value of
the contract, after deducting the amount withdrawn towards repayment, was rolled
for a further period up to the date of the next instalment. The assessee filed
its return of income for the A.Y. 1986-87 on June 30, 1986. A revised return was
filed by it on March 27, 1989, declaring a total income of Rs.2,10,08,640. The
Assessing Officer disallowed an amount of Rs.8,86,280, being the roll-over
premium charges paid by the assessee in respect of foreign exchange forward
contracts to Citibank N.A. on the ground that the said charges were incurred in
connection with the purchase of a capital asset (plant and machinery), hence, it
was not admissible for deduction u/s.36(1)(iii) or u/s.37 of the Act. On appeal,
the Commissioner of Income-tax (Appeals) held that the roll-over premium charges
incurred by the assessee were allowable as they were incurred by the assessee to
mitigate the risk involved in higher payment because of adverse fluctuation of
rate of exchange. According to the Commissioner of Income-tax (Appeals),
roll-over premium charges constituted an expenditure incurred for raising loans
on revenue account, hence, the said expenditure was allowable under the Act.

The Tribunal held that roll-over premium charges (carry
forward charges) were required to be paid to the authorised dealer as
consideration for permitting the unutilised amount of the contract (balance
value of the contract) to be availed of at a later date and in the circumstances
the roll-over premium charges had to be capitalised under Explanation 3 to S.
43A of the said Act. Consequently, the Tribunal upheld the order of the
assessment.

The High Court came to the conclusion that the roll-over
premium charges paid by the assessee were in the nature of interest or committal
charges, hence, the said charges were allowable u/s.36(l)(iii) of the said Act.

The Supreme Court observed that S. 43A, before its
substitution by a new S. 43A vide the Finance Act, 2002, was inserted by the
Finance Act, 1967, with effect from April 1, 1967, after the devaluation of the
rupee on June 6, 1966. It applied where as a result of change in the rate of
exchange there was an increase or reduction in the liability of the assessee in
terms of the Indian rupee to pay the price of any asset payable in foreign
exchange or to repay moneys borrowed in foreign currency specifically for the
purpose of acquiring an asset. The Section has no application unless an asset
was acquired and the liability existed, before the change in the rate of
exchange. When the assessee buys an asset at a price, its liability to pay the
same arises simultaneously. This liability can increase on account of
fluctuation in the rate of exchange. An assessee who becomes the owner of an
asset (machinery) and starts using the same, becomes entitled to depreciation
allowance. To work out the amount of depreciation, one has to look to the cost
of the asset in respect of which depreciation is claimed. S. 43A was introduced
to mitigate hardships which were likely to be caused as a result of fluctuation
in the rate of exchange. S. 43A lays down, firstly, that the increase or
decrease in liability should be taken into account to modify the figure of
actual cost and, secondly, such adjustment should be made in the year in which
the increase or decrease in liability arises on account of fluctuation in the
rate of exchange. It is for this reason that though S. 43A begins with a non
obstante clause, it makes S. 43(1) its integral part. This is because S. 43A
requires the cost to be recomputed in terms of S. 43A for the purpose of
depreciation [S. 32 and 43(1)]. A perusal of S. 43A makes it clear that insofar
as the depreciation is concerned, it has to be allowed on the actual cost of the
asset, less depreciation that was actually allowed in respect of earlier years.
However, where the cost of the asset subsequently increased on account of
devaluation, the written down value of the asset has to be taken on the basis of
the increased cost minus the depreciation earlier allowed on the basis of the
old cost. U/s.43A, as it stood at the relevant time, it was, inter alia,
provided that where an assessee had acquired an asset from a country outside
India for the purpose of his business, and in consequence of a change in the
rate of exchange at any time after such acquisition, there is an increase or
reduction in the liability of the assessee as expressed in Indian currency for
making payment towards the whole or part of the cost of the asset or for
repayment of the whole or part of the moneys borrowed by him for the purpose of
acquiring the asset, the amount by which the liability stood increased or
reduced during the previous year shall be added to or reduced from the actual
cost of the asset as defined in S. 43(1). This analysis indicated that during
the relevant assessment year adjustment to the actual cost was required to be
done each year on the closing date, i.e., year end. Subsequently, S. 43A
underwent a drastic change by virtue of a new S. 43A inserted vide the Finance
Act, 2002. Under the new S. 43A, such adjustment to the cost had to be done only
in the year in which actual payment is made. The Supreme Court noted that in
this case, it was not concerned with the position emerging after the Finance
Act, 2002. Under Explanation 3 to S. 43A, if the assesse had covered his
liability in foreign exchange by entering into forward contract with an
authorised dealer for the purchase of foreign exchange, the gain or loss arising
from such forward contract was required to be taken into account.

According to the assessee, S. 43A was not applicable in this
case as there was no increase or reduction in liability because such roll-over
charges were paid to avoid increase or reduction in liability consequent upon
change in the rate of exchange.

The assessee, a Japanese organisation set up for transmission
of news and broadcasting, paid salary to its employees. It also paid some
housing allowance.

The Assessing Officer included citizens tax as a part of the
income of the expatriates employed by the assessee-company in India as part of
the employee’s income on the ground that it was an amount paid by the assessee
to its employees. According to the Assessing Officer, the assessee ought to have
deducted tax at source at the time of payment.

On appeal, the Commissioner of Income-tax (Appeals) held that
citizen tax was a statutory levy in Japan on the Japanese citizens and such tax
constituted an overriding charge on the salary income and, therefore, the same
had to be excluded in computation of taxable income. This view of the
Commissioner (Appeals) was upheld by the Tribunal.

The High Court took the view that in view of the concurrent
finding of fact, no interference was called for and the appeal was dismissed
accordingly.

The Supreme Court was however of the view that the
Commissioner of Income-tax (Appeals) ought to have examined the provisions of
the Citizen Individual Inhabitant Tax Act which was a Japanese law and it ought
to have analysed the provisions of that law, particularly when it was required
to decide the question as to the nature of the levy being an overriding charge
on the salary income, as stated hereinabove. The controversy in the present case
was that whether citizens tax was a statutory levy in Japan on the Japanese
citizens constituting an overriding charge. If it was an overriding charge, then
of course the Commissioner of Income-tax (Appeals) was right in saying that it
would not be an income. However, according to the Supreme Court, since the
provisions of the Act had not been examined, the matter needed to be considered
afresh by the Tribunal. Accordingly, the Supreme Court remitted the matter to
the Tribunal for fresh consideration in accordance with law. The Supreme Court
did not express any opinion on the merits of the case.

[CIT v. NHK Japan Broadcasting Corporation, (2010) 322
ITR 628 (SC)]

The assessee, a co-operative credit society, which provides
credit facilities to its members and also markets the agricultural product of
its members, during the relevant assessment years in question, had surplus funds
which it invested in short-term deposits with banks and in Government
securities. Interest accrued to the assessee on such investments.

The Assessing Officer held that the interest income which the
assessee had disclosed under the head ‘Income from business’ was liable to be
taxed under the head ‘Income from other sources’. According to the Assessing
Officer the assessee-society had invested the surplus funds as and by way of
investment by an ordinary investor, hence, interest on such investment has got
to be taxed under the head ‘Income from other sources’. Before the Assessing
Officer, it was argued by the assesssee that it had invested the funds on
short-term basis as the funds were not required immediately for business
purposes and, consequently, such act of investment constituted a business
activity by a prudent businessman; therefore, such interest income was liable to
be taxed u/s.28 and not u/s.56 of the Act, and, consequently, the assessee was
entitled to deduction u/s.80P(2)(a)(i) of the Act. This argument was rejected by
the Assessing Officer as also by the Tribunal and the High Court, hence, the
civil appeal was filed by the assessee before the Supreme Court.

The Supreme Court held that the assessee-society regularly
invested funds not immediately required for business purposes. Interest on such
investments, therefore, could not fall within the meaning of the expression
‘profits and gains of business’. Such interest income cannot be said also to be
attributable to the activities of the society, namely, carrying on the business
of providing credit facilities to its members or marketing of the agricultural
produce of its members. The Supreme Court was of the view that such interest
income would come in the category of ‘Income from other sources’, hence, such
interest income would be taxed u/s.56 of the Act.

The Supreme Court further held that to say that the source of
income is not relevant for deciding the applicability of S. 80P of the Act would
not be correct because weightage need to be given to the words ‘the whole of the
amount of profits and gains of business’ attributable to one of the activities
specified in S. 80P(2)(a) of the Act. The words ‘the whole of the amount of
profits and gains of business’ emphasise that the income in respect of which
deduction is sought must constitute the operational income and not the other
income which accrues to the society. In this particular case, the evidence
showed that the assessee-society earned interest on funds which were not
required for business purposes at the given point of time. Therefore, on the
facts and circumstances of this case, the Supreme Court was of the view, such
interest income fell in the category of ‘Other Income’ which had been rightly
taxed by the Department u/s.56 of the Act.

[Totgar’s Co-operative Sale Society Ltd. v. ITO, (2010)
322 ITR 283 (SC)]

The assessee was an exporter. The Tribunal held that the
interest income was generated by way of keeping the ‘advances’ received by the
assessee in the course of its regular business activity. According to the
Department, it was the case of surplus being invested in FDR, whereas according
to the assessee it was the case of advance having been received from the
exporter which was in FDR for short duration.

The Supreme Court observed that in the present case there was
no factual data to decide the aforesaid issue. The nature of the receipt was not
discussed. The High Court while disposing of the matter had also not examined
the factual basis. In view of the absence of factual matrix the Supreme Court
was of the view that to decide the question as to whether the receipt fell
u/s.28 or u/s.56, the matter was required to be remitted to the Tribunal for
fresh consideration in accordance with law.

[CIT v. Producin Pvt. Ltd., (2010) 322 ITR 270 (SC)]