TMI Blog2004 (3) TMI 345X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee borrowed funds in US Dollars and Pound Sterling from US Exim Bank and Commonwealth Development Corporation (CDC, for short). The amount of loan disbursed till the year under reference amounted to US $ 35,83,839 from Exim Bank and 35,58,074 and 11,15,000 from CDC. As per the agreement with the Exim Bank, the repayment of loan was to commence on15-4-1992and to be made in 10 equal six monthly instalments. Similar terms of repayment were stipulated in respect of loan from CDC. 3. The assessee company entered into forward contracts in foreign currency with the Indian Bank on different dates in June October, 1990 and July, 1991 to cover its liability on foreign currency loans against fluctuations in currency rates. These forward contracts; brought forward from the preceding year, were however cancelled on30-4-1992resulting into a gain of Rs. 14.06 crores. Reserve Bank ofIndiahad issued revised instructions on27-3-1992permitting the cancellation of the forward contracts in foreign currency. These instructions were issued in pursuance of the introduction of the Liberalized Exchange Rate Management System (LERMS) and with a view to creating greater depth in the foreign exch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -94 Surplus on cancellation of contracts Rs. 27,60,463 taken in financial year 1992-93 and cancelled during the very financial year ------------------------- Rs. 14,28,08,788 ------------------------- Less :- 1. Surplus on these amounts that relates Rs. 3,03,19,957 to interest payable on foreign loan conceded and assessed as Revenue receipt. 2. Calculation error by Citibank Rs. 18,39,092 discovering that more of it was paid by mistake and accepted by the assessee ------------------------- Rs. 11,06,49,739 ------------------------- The treatment of the aforesaid gains received as well as the roll over charges paid as per the books of account is as under: (i) Rs. 11,06,49,739 received, on account of cancellation of contract for forward cover attributed to proposed repayment of principal amount of loans, were credited to the Plant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofIndiasince the assessee felt that the Dollar rate of exchange would remain stable and the Rupee would not depreciate. Ld. Counsel submitted that cancellation of the contract is not determinative of the factum of carrying out business or adventure in the nature of trade. It is further argued that the transactions of entering into foreign exchange forward contracts and subsequently cancelling them cannot be classified as business carried on by the assessee per se since no activity is involved in signing or cancelling these contracts. It is further contended that there is, in any case, no direct nexus between the business carried on by the assessee which is the production and sale of tyres and tubes etc. and the entering into and cancellation of the foreign exchange forward contract. Ld. Counsel further added that the assessee is not an authorized dealer in foreign exchange and has not carried out any business of buying and selling foreign currency. Any such activity would in fact be violative of the Foreign Exchange Regulation Act. In support of his contention, reliance is placed by the learned counsel on the following decisions: (i) G. Venkataswami Naidu Co. v. CIT [1959] 35 I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ofits of Rs. 11.06 crores, He submitted that the assessee again entered into forward contracts in the months of May and June, 1992 for the Dollar loans and these contracts were not utilized for making remittances on 15-10-1992. The assessee in fact again proceeded to cancel two contracts on26-2-1993resulting in profits. Ld. DR contended that the entire conduct of the assessee, as evidenced by the aforesaid facts dearly indicate that the contracts were motivated by commercial considerations of profits and not for securing forward cover against enhanced liability of foreign loans due to exchange rate fluctuations. According to the ld. CIT (DR), the set of initial contracts entered into in the preceding years were admittedly intended as covers against exchange rate fluctuations and there was no profit motive in these contracts. However, subsequent conduct of the assessee amply demonstrates that the entire activity of cancellation and execution of fresh contracts followed by cancellation was motivated by business considerations. In support of his arguments, ld. CIT (DR) placed reliance on the following decisions: (i) CIT v. Rai Bahadur Jairam Valji [1959] 35 ITR 148 (SC); (ii) A.K. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts entered into by the assessee initially were by way of hedging transactions against the enhancement of the liability of foreign loans due to exchange rate fluctuations, the conduct of the assessee after 27-3-1992 clearly indicate that what was initially a hedging mechanism has been used by the assessee for commercial gain. In the written submissions, Shri Salil Gupta, ld. DR, stated that the assessee was a holder of certain forward contracts at the beginning of the previous year on1-4-1992. Consequent to the change in the RBI Policy on27-3-1992, all these forward contracts were cancelled on30-4-1992and fresh forward, contracts obtained. The assessee had a liability to make repayment of half-yearly instalments to its lender Exim Bank on15-4-1992and 15-101992. Shri Salil Gupta submitted that all the forward contracts available with the assessee on1-4-1992were actually cancelled on30-4-1992and none were utilized for discharging the actual foreign exchange liability on15-4-1992and15-10-1992. Therefore, the purported purpose for taking forward contracts to hedge against the exchange rate fluctuations was defeated by the assessee's conduct as it engaged in a trading activity in the for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e added or reduced from the cost of the asset on the actual date of repayment of the instalment of loan obtained for the purpose. Shri Gupta further added that in the instant case, the assessee has chosen to capitalize the gain in exchange rate fluctuation and such gain would, therefore, be not covered under Explanation 3 to section 43A. 13. We have given our thoughtful consideration to the rival submissions as well as string of judicial authorities cited by ld. Representatives on both sides. The basic question which falls for determination before us is whether gains arising from cancellation of forward foreign exchange contracts are in the nature of capital receipts or revenue receipts. Ld. Representatives on both sides took up the position that such receipts are not covered under Explanation 3 to section 43A. It appears to us that ld. Counsel for the assessee-company, even while arguing that the foreign exchange contracts related to repayment of foreign loans taken for acquisition of plant and machinery and constituted capital receipt went on to argue that Explanation 3 did not apply so that gains would not be set off against the cost of plant and machinery. On the other hand, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness of manufacture of tyres carded out by it is not connected with dealings in foreign exchange. 15. Insofar as 13 forward contracts brought forward from the preceding year are concerned, these have admittedly been entered into to guard against foreign currency losses due to exchange rate variation in relation to repayment of foreign loans taken by the assessee for purchase of machinery. It is not disputed on behalf of the revenue before us that these Contacts were entered into by the assessee to secure foreign exchange cover against exchange rate variation and there was no intention on the part of the assessee to carry out any commercial dealings in foreign exchange in the revenue account. However, the case of the revenue is that after27-3-1992, the assessee cancelled these contracts with the intention to earn profits and subsequent contracts entered into by the assessee and cancelled in succession were guided by the profit motive. On behalf of the assessee company, however, it is pleaded that forward contracts were meant for guarding against enhancement of foreign liabilities due to exchange rate variation and since such liabilities were connected with the acquisition of capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Whether it is in the nature of trade will depend on the facts and circumstances. Where the purchase of any article or of any capital investment is made without the intention to resell at a profit, a resale under changed circumstances would only be a realization of capital and would not stamp the transaction with a business character. In Sutlej Cotton Mills Supply Agency Ltd. case, the Supreme Court, after detailed review of case law, observed that where a purchase is made with the intention of resale, it depends upon the conduct of the assessee and the circumstances of the case whether the venture is on capital account or in the nature of trade. A transaction is not necessary in the nature of the trade because the purchase was made with the intention of resale. The Court further held at page 712, as under: "A capital investment and resale do not lose their capital nature merely because the resale was foreseen and contemplated when the investment was made and the possibility of enhanced values motivated the investment and also the decisions of this court in Saroj Kumar Majumdar v. CIT 37 ITR 242 (SC) and Janki Ram Bahadur Ram v. CIT 57 ITR 21 (SC): An accretion to capital d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... regard to these contracts profit motive possibly cannot be attributed t6 the assessee. Even with regard to contracts entered into and cancelled after27-3-1992, we noticed that the transactions are a few in number and looking to the magnitude of the outstanding Dollar loan, the contracts entered into are only 6 in number out of which 2 have been cancelled during the year. Gains arising from these 2 contracts have been shown by the assessee as revenue receipt since these contracts relate to payment of interest liabilities on Dollar loans. The entire factual matrix of the case concerning the execution and cancellation of forward contracts does not in our opinion stamp the transaction with a business character. Merely because the assessee-company did not choose to roll over the contracts beyond30-4-1992would not alter the intrinsic nature of the contracts being in the capital field. If the contracts brought forward from the preceding year are accepted and acknowledged by the revenue authorities as being in capital account, mere cancellation on 30-4-1992 would not have 'denaturing' effect and divest them of inherent capital nature particularly when cogent reasons have been cited by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Tata Locomotive Engg. Co. Ltd.'s case relied upon by the learned counsel for the assessee. In this case, the assessee, which was a limited company carrying on business of locomotive boilers and locomotives had for the purpose of its manufacturing activity to make purchases of plant andl11achinery in theUnited States. The assessee remitted a sum of $ 33,850 to theUnited Stateswith the sanction of the Exchange Control Authorities, for the aforesaid, purpose of purchasing capital goods. The assessee also earned a commission of$ 36,123 as selling agent in the Unite" States and the amount was retained in theUnited Statesfor capital purposes after obtaining the sanction of the Reserve Bank ofIndia. The court held that even though the amount of $ 36,123 was a revenue receipt in the assessee's business of commission agency, retention of this amount in the United States with the sanction of the Reserve Bank of India for buying capital goods fall in the capital field and any profit accruing on subsequent repatriation of this amount on account of exchange variation was a capital profit. 19. The other decision to which we must refer is the one in Canara Bank Ltd.'s case relied upon by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of section 43A in the Income-tax Act, 1961 by the Finance (No.2) Act, 1967, with effect fromApril 1, 1967. The second statutory provision was an amendment to Schedule VI of the Companies Act, 1956 in the form of a balance-sheet prescribed for companies. On perusal of the aforesaid provisions, it is clear that where an assessee had borrowed money for acquisition of any asset from a country outside India and in consequence of the change in the rate of exchange at any time after the acquisition of such asset there is an increase in the liability of the assessee as expressed in Indian currency in repayment of the whole or a part of the moneys borrowed by him from any person in any foreign currency specifically for the purpose of acquiring such asset, the amount by which the liability is so increased shall be added to the actual cost of the asset as defined in clause (1) of section 43 of the Act. This section specially provides for the treatment of increased liability of the assessee as expressed in Indian currency for repayment of the moneys borrowed by him from any person in foreign currency specifically for the purposes of acquiring the asset. In the present case, the assessee had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee (as expressed in Indian currency) for repayment of the whole or part of the monies borrowed by him from any person, directly or indirectly, in any foreign, currency specifically for the purposes of acquiring the asset. It is a. moot question as to whether, in such a case, on general principles, the actual cost of the assessee's plant or machinery would be the revised liability or the original liability. This is also a situation which is specifically provided for in the section....As we had said earlier, there is no need to speculate on all the problems that might have arisen if section 43A has not been there because the statute has resolved these problems. It lays down, firstly, that the increase or decrease in liability should be taken into account to modify the figure of actual cost and secondly that such adjustment should be made in the year in which the increase or decrease in liability arises on account of the fluctuation in the rate of exchange." 24. From the facts in the instant case before us, it is manifestly clear that the assessee had entered into foreign exchange contracts with a view to secure protection against enhancement of foreign loan liability and Explana ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are not persuaded to accept the argument of the ld. Counsel for the assessee that the forward contracts have been cancelled by the assessee and are not covered under Explanation 3 to section 43A. As we have already mentioned above, forward contracts have been initially entered into by the assessee against repayment of foreign loan inSterlingas well as US Dollars and have been rolled over upto30-4-1992when the same were cancelled in pursuance of relaxation of restriction against cancellation by the Reserve Bank ofIndia. The fact that contracts were not rolled over beyond30-4-1992and the assessee consciously decided not to extend the security cover on maturity of the contracts would not by itself take these contracts out of the purview of Explanation 3. Admitted, facts are that these contracts have been entered into for providing the assessee with foreign currency on or after a stipulated future date at the fixed exchange rate. The contracts are thus fully in conformity with the letter and spirit of Explanation 3. If the assessee has not opted for roll over of the contracts, this would not ipso facto make Explanation 3 inapplicable. The language of Explanation 3 does not contain any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s taken note of the circular issued by the Central Board of Direct Taxes explaining the provisions of section 43A and extracted the following paragraph at page 266 of the report: "The above mentioned adjustment to the original actual cost of the assessee to be imported capital asset is to be made in respect of the previous year in which there is an increase or reduction in the assessee's liability in terms of Indian currency for payment of the whole or part of the cost of the asset or for repayment of the foreign loan against which the asset has been acquired. With reference to the recent devaluation of the rupee, this will be the previous year in which the date of devaluation, viz.,6th June, 1966falls. The Supreme Court, analyzing the provisions of section 43A, held that increase or decrease in liability in the repayment of foreign loan should be taken into account to modify the figure of actual cost in the year in which the increase or decrease in liability arises on account of the fluctuation in the rate of exchange. Thus, the adjustment in the actual cost are to be made irrespective of date of actual payment in foreign currency made by the assessee. Reference may further be m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ense over the life of the contract. The only exception is in respect of forward exchange contracts related to liabilities in foreign currency incurred for acquisition of fixed assets. 15. Any profit or loss arising on cancellation or renewal of a forward exchange contract should be recognized as income or as expense for the period, except in case of a forward exchange contract relating to liabilities incurred for acquiring fixed assets, in which case, such profit or loss should be adjusted in the carrying amount of the respective fixed assets." 28. From the aforesaid rules as laid down in the Accounting Standard 11, it clearly emerges that in case of a foreign exchange contract relating to foreign liability incurred for acquiring fixed assets, any profit or loss on cancellation or renewal of a foreign exchange contract should be adjusted in the cost of the respective fixed assets. Since, in the case of the present assessee, forward contracts relating to foreign loan liabilities incurred for acquiring plant and machinery from abroad have been cancelled, profits arising therefrom are required to be adjusted in the cost of the plant and machinery purchased by the assessee. It is t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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