TMI Blog2008 (9) TMI 3X X X X Extracts X X X X X X X X Extracts X X X X ..... ct (PSC) with Government of India. EOGIL was entitled to a participating interest of 30% in the rights and obligations arising under the PSC. RIL was also entitled to participating interest of 30%. ONGC was entitled to a participating interest of 40%. EOGIL was designated as the Operator under the said PSC. 3. Vide Notification No. 9997 dated 8.3.1996 under Section 293A of the Income Tax Act, 1961 ("1961 Act"), each co-venturer was liable to be assessed for his own share of income. They were not to be treated as an AOP. 4. EOGIL filed his return of income for Assessment Year 1999-00 declaring its taxable income of Rs. 71,19,50,013 under Section 115JA. 5. During the year, EOGIL debited its P L account by exchange loss of Rs. 38,63,38,980. The A.O. disallowed this loss on the ground that it was a mere book entry and actually no loss stood incurred by the assessee. 6. The decision of the A.O. was challenged in appeal by EOGIL before CIT(A), who after analyzing the PSC held that each co-venturer in this case had made contribution at a certain rate whereas the expenditure incurred out of the said contribution stood converted on the basis of the previous month's average daily ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he exchange of currency. According to the Tribunal, the assessee was maintaining its accounts in rupees and such accounts had to reflect the loan liability under consideration as the loan had been taken for the Indian activity. Therefore, according to the Tribunal, the liability arising as a consequence of depreciation of the rupee had to be considered both for accounting and tax purposes. Accordingly, the Tribunal refused to interfere with the findings returned by CIT(A). 8. The above concurrent finding stood confirmed by the impugned judgment delivered by the Uttrakhand High Court in ITA No. 74/07 along with ITA No. 76/07 and ITA No. 77/07 decided on 17.1.2008. Hence, this civil appeal. 9. The only question which needs to be considered in this civil appeal is whether the assessee was entitled to claim deduction for foreign exchange losses on account of foreign currency translation? In other words, whether loss arising on account of foreign currency translation is allowable as deduction or not and conversely whether the gains on account of foreign currency translation is to be treated as a receipt liable to tax. 10. At the outset, we quote hereinbelow Section 42(1) of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ernments to maximize their gains from oil exploration by private corporations. PSC is a regime. 12. Prior to the PSC regime, Governments recovered royalty and imposed tax on revenues from oil exploration. However, in countries like India, where there is a great demand for oil, PSC was devised to give the Governments a stake in oil exploration and development- virtually making it a partner in the process. Under the PSC, Government or its nominee becomes a party. The private parties either single company or a consortium are the other parties to the contract. The consortium consists of an Indian partner and a foreign company. The private parties are generally called as Contractors. These contractors have a defined share which is called as "Participating Interest". One of the Contractors would be designated as an "Operator", who would have a control over day to day operations. Upfront investments are made generally by the Contractors. For this purpose, the Operator "in this case being M/s EOGIL" would make "cash calls". The operating expenses are also similarly funded. In these Contracts, generally there are three types of costs, namely, exploration costs, which is a capital expendi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... penses; some of the expenses stood incurred in USD whereas some to be incurred in INR; the sale price of oil was in USD whereas the accounts were drawn up in USD. When some of the expenses were incurred in USD and some incurred in INR, conversion had to be made at the prevalent rates of exchange to bring them all to the contract currency, i.e., USD. Similarly, as stated above, the sale price of oil was in USD. At the time of sale, the INR - USD rate would change from that on the date of the cash calls. Similarly, as stated above, the accounts were required to be drawn up in USD. For that purpose also one had to reconvert the costs from barrels to monetary terms. For the said reasons, clauses 1.6.1 and 1.6.2 of appendix `C' to the PSC envisaged booking of all currency gains and losses irrespective of whether such gains/losses stood realized or remained unrealized. In case of gains, a part of the credit would go to the Government, and taxes would be payable on the income to the extent of such gains credited. Therefore, in our view, currency gains and losses constituted an inextricable part of the accounting mechanism for expenses incurred on the development and production of oil. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . In short, an assessee is entitled to allowances which are mentioned in the PSC. According to the Department, translation losses claimed by EOGIL are not specified in the PSC, hence they cannot be claimed as deduction under Section 42(1). 20. The question which this Court needs to answer is - are the translation losses within the scope of Section 42? 21. In order to answer the above question, we are required to analyse certain provisions of the PSC in question. Article 1 deals with definitions. Under Article 1.21 "Contract Costs" means exploration costs, development costs, production costs and all other costs related to petroleum operations. Similarly, "Cost Petroleum" is defined to mean the portion of the total volume of petroleum produced which the contractor is entitled to take for the recovery of Contract Costs as specified in Article 13. Under Article 13 the Contractor is entitled to recover Contract Costs out of the total volume of petroleum produced. That costs include development and exploration costs. Similarly, Article 1.69 defines "Profit Petroleum" to mean all petroleum produced and saved from the Contract Area in a particular period as reduced by Cost Petroleum ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nsure a fair "take" to the Government. The said "take" comprised of profit oil, royalty, cesses and taxes. The said PSC prescribed a special manner of accounting which was at variance with the normal accounting standards. The said "PSC accounting" obliterated the difference between capital and revenue expenditure. It made all kinds of expenditure chargeable to P L account without reference to their capital or revenue nature. But for the PSC Accounting there would have been disputes as to whether the expenses were of revenue or capital nature. In view of the special accounting procedure prescribed by the PSC, Accounting Standard 11 had to be ruled out. 23. The question before us still remains as to whether the PSC talks of translation, and if so, whether translation losses could be claimed by EOGIL. In this connection, we need to consider Article 20.2 which inter alia states that the rates of exchange for the purchase and sale of currency by the Contractor shall be the prevailing rates as determined by the State Bank of India and for accounting purposes under the PSC such rates shall apply as provided for in clause 1.6 of Appendix `C' to the PSC. Appendix is a part of PSC. The pu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... anslated on the basis of accounting procedure mentioned in Appendix `C' to the PSC. Cash call in other words was not a loan. A wrong illustration has been given in the impugned judgment. Cash call was a contribution. It was made by each co-venturer at a certain rate whereas the expenditure against it had to be converted on the basis of the exchange rates as provided for in the PSC, which, as stated above, stated that the same had to be converted on the basis of the previous month's average of the daily means of buying and selling rates of exchange (see clause 1.6.1 of Appendix `C' to PSC). 27. The above analysis shows that the capital contribution had to be converted under the PSC at one rate whereas the expenditure had to be converted at a different rate. This exercise resulted into loss/profit on conversion. Under the PSC, the respondent had to convert revenues, costs, receipts and incomes. If EOGIL had a choice to prepare its accounts only in USD, there would have been no loss/profit on account of currency translation. It is because of the specific provision in the PSC for currency translation that loss/profit accrued to EOGIL. Moreover, under clause 1.6.2 of Appendix `C' to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e costs have been recovered, the remaining "profit oil" is divided between the State and the company in agreed proportions. The company is taxed on its profit oil. Sometimes, the State participates either itself or through its nominee as a commercial partner in the contract, operating in joint venture with foreign oil companies. In such cases, the State provides its percentage share of capital investment, and directly receives the percentage share of cost oil and profit oil. 31. As stated above, in PSC, the foreign company provides the capital investment and cost and the first proportion of oil extracted is generally allocated to the company which uses oil sales to recoup its costs and capital investment. The oil used for that purpose is termed as "cost oil". Often a company obtains profit not just from the "profit oil", but also from "cost oil". Such profits cannot be ascertained without taking into account translation losses. Moreover, as stated above, taxes are embedded in the profit oil. If these concepts are kept in mind then it cannot be said that "translation losses" under the PSC are illusory losses. 32. Before concluding, we may point out that on behalf of the Depart ..... X X X X Extracts X X X X X X X X Extracts X X X X
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