Commissioner of Income Tax vs Elgi Rubber Products Ltd.

Thanikkachalam, J.—At the instance of the Department in the asst. yr. 1974-75, 1975-76 and 1976-77, the Tribunal referred the following

questions of law, said to arise out of the order of the Tribunal for our opinion, under s. 256(1) of the IT Act, 1961 :

Tax Cases Nos. 422 and 423 of 1982 (1974-75 and 1975-76) :

(i) Whether, on the facts and in the circumstances of the case and having regard to the provisions of s. 43A of the Act, the Tribunal was right in

law in holding that the fluctuation in the rate of exchange paid by the assessee to the Industrial Credit and Investment Corporation of India Ltd., is a

revenue expenditure and should accordingly be allowed ?

(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the excess payment made by the assessee to

the Industrial Credit and Investment Corporation of India Ltd., on account of fluctuation in the rate of exchange cannot be treated as part of the

cost of the capital assets imported by the assessee from West Germany ?

Tax Case No. 36 of 1983 (1976-77) :

(i) Whether, on the facts and in the circumstances of the case and having regard to the provisions of s. 43A of the Act, the Tribunal was right in

law in holding that the fluctuation in the rate of exchange paid by the assessee to the Industrial Credit and Investment Corporation of India Ltd., is a

revenue expenditure and should accordingly be allowed ?

(ii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the excess payment made by the assessee to

the Industrial Credit and Investment Corporation of India Ltd. on account of fluctuation in the rate of exchange cannot be treated as part of the

cost of the capital assets imported by the assessee from West Germany ?

(iii) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the provisions of s. 43A of the IT Act,

1961, would not apply to the assessee''s case ?

The assessee is a company, which imported machinery and equipment from West Germany for setting up a rubber reclamation plant. The

finance for payment of the price of the machinery purchased was arranged through the Industrial Credit and Investment Corporation of India Ltd.

(ICICI). Several suppliers of the machinery have paid the price of the machinery supplied between 15th Nov., 1971, and 7th Sept., 1972, and

spare parts supplied on 26th Feb., 1973. The amount paid comes to DM 5,22,935 = Rs. 12,38,332 at the rate of exchange prevailing at the time

of the purchase. The machinery was installed and production of the unit was commenced on 15th Oct., 1972. The ICICI had arranged for the

payment to the suppliers in DM by Kreditanstalt Furwiederaufbau (KFW) and, therefore, the agreement of the ICICI with the assessee provided

that the assessee should arrange not only the repayment of the loan in DM, but also to pay sufficient amount in rupees to purchase enough DM for

repayment to KFW. The loan was to be repaid only by instalments.

In view of the fluctuation in the rate of exchange for the previous year ended 31st March, 1974, corresponding to the asst. yr. 1974-75, the

assessee had to incur a sum of Rs. 25,004 over and above the amount originally anticipated, a sum of Rs. 1,22,144 required to be paid for the

instalment of 52,000 DM. Similarly for the asst. yr. 1975-76, corresponding to the previous year ended 31st March, 1975, the assessee incurred

a sum of Rs. 47,845 in addition to the anticipated amount of Rs. 1,26,690 required to be paid for 53,935.30 DM.

The assessee''s claim was that this extra expenditure was revenue expenditure and was deductible in computing the total income. The ITO rejected

this claim. On appeal, the AAC also held that the expenditure was capital in nature and had to be disallowed. The AAC relied on a decision of this

Court in Commissioner of Income Tax Vs. South India Viscose Ltd., .

Aggrieved, the assessee filed an appeal before the Tribunal and contended that, -

(i) The expenditure not related to the payment of the price but related only to a repayment of a loan, and, therefore, it was allowable as a revenue

expenditure.

(ii) That the decision in the case of Sivakami Mills Ltd. Vs. Commissioner of Income Tax, should be applied and not the decision in the case of

Commissioner of Income Tax Vs. South India Viscose Ltd., which was distinguishable on facts,

(iii) that s. 43A cannot be applied to the facts of the case. The contentions of the Revenue were that, (i) the extra expenditure must be regarded as

increasing the amount of the loan, and, therefore, the repayment of the principal amount of the loan should be considered as capital expenditure

and disallowed, (ii) in the alternative it was contended that s. 43A had to be applied even if it is treated as revenue expenditure so as to sustain the

disallowance without granting development allowance. The Revenue relied on the decision of the Calcutta High Court in the case of Union Carbide

India Ltd. Vs. Commissioner of Income Tax, .

The Tribunal accepted the submissions made by the assessee and held that the amounts paid due to fluctuation in the exchange rate in the

assessment year, are revenue in nature and, therefore, the additional amounts paid are deductible from the reported income. The Tribunal also held

that s. 43A of the Act would not be applicable to the facts of the case.

Learned standing counsel appearing for the Department submitted that the assessee is in fact the purchaser of the machinery from the German

company. The finance was arranged through the ICICI for the purpose of purchasing the machinery. The ICICI was repaying the amount in

instalments. During the assessment year, there was fluctuation in foreign exchange and on that account, the assessee has got to pay more to the

ICICI over and above the originally anticipated sum. When the original amount paid to acquire the machinery was capital in nature, additional

amounts paid towards the cost price of the machinery would also be in the nature of capital expenditure. The assessee cannot disconnect the

purchase of machinery and the payment of excess amount on account of fluctuation in foreign exchange. The excess amount paid by the assessee

would definitely go towards the cost of the machinery. It is not correct on the part of the assessee to state that the entire price money was paid to

the foreign company and, therefore, what was paid by the assessee by way of excess amount to the ICICI is only in the nature of revenue

expenditure. Even though the said expenditure was incurred after the commencement of the production of unit, the excess payment was only

towards the cost price of the machinery purchased. When the original liability due to the foreign company payable through the financier is capital in

nature, the additional amount paid due to fluctuation in the foreign exchange should also be considered as capital in nature. The financier ICICI

paid the amount towards the purchase of the machinery on behalf of the assessee. Therefore, the additional amount paid due to fluctuation in the

exchange rate which was paid by the financier, viz., ICICI, is in fact the liability of the assessee. Therefore, the additional amount paid by the

assessee due to fluctuation in the exchange rate would also be in the nature of capital expenditure. It was alternatively contended that if the

provisions of s. 43A of the Act had to be applied, the additional amount paid due to fluctuation in the exchange rate would also go to add for the

purpose of granting development allowance. Therefore, the Tribunal was not correct in holding that s. 43A would not be applicable to the facts of

this case.

On the other hand, learned counsel appearing for the assessee, submitted that the additional amount paid was not only related to the payment of

price of the machinery but also related to the repayment of loan and hence, it was allowable as a revenue expenditure. There is no connection

between the purchase of the machinery and the payment of the additional amount to the ICICI due to fluctuation in the exchange rate. The

additional amount paid was in the nature of payment of interest on the principal amount or like the payment for the guarantee given by the ICICI

for the repayment of the loan. The provision of s. 43A will not be applicable to the facts of this case. The provision of s. 43A would be applicable

where the finance arrangement was made prior to the production since it recognised the principle that such expenses are to be added to the cost of

the assets purchased. There is nothing in s. 43A to treat what is generally accepted as revenue expenditure also as part of the cost of the asset for

the purpose of that section except the non obstante clause. Therefore, the Department cannot contend that s. 43A could be applied to an

expenditure which no businessman would treat as part of the cost of the asset. It was, therefore, pleaded that the Tribunal was correct in holding

that the additional amount paid by the assessee to the ICICI due to fluctuation in the exchange rate is only revenue expenditure and, therefore,

allowable as deduction under s. 37 of the Act.

We have heard learned standing counsel as well as learned counsel appearing for the assessee.

A similar question came up for consideration before a Division Bench of this Court in the case of CIT vs. South India Viscose Ltd. (supra). In

the abovesaid case, the following question was referred for its opinion : ""Whether, on the facts and in the circumstances of the case, the amounts of

Rs. 1,93,509 and Rs. 1,08,302 paid in excess by the assessee to the Italian company while honouring the bills of exchange drawn in connection

with purchase of the machinery by the assessee, due to fluctuation in exchange rate, during the accounting years ending with 31st Dec., 1962, and

31st Dec., 1964, are allowable as revenue expenditure for the asst. yr. 1963-64 and 1965-66, respectively ?

While answering such question, this Court held that as the price fixed under the agreement was only a tentative price which had to be discharged at

the prevailing rates of exchange at the time of respective payments, the payments related only to the purchase price of the machinery, the difference

was on capital account and not allowable as business expenditure.

The fact that Parliament provided for fluctuation in the exchange rates being taken into account in arriving at the cost of the asset by inserting s.

43A in the IT Act, 1961, by s. 17 of the Finance (No. 2) Act, 1967, w.e.f. 1st April, 1967, would not in any way affect the point in issue which

has to be considered in the light of the actual nature of the payment that had to be made and in the light of the provisions in force.

The SLP filed against this judgment was rejected by the Supreme Court as can be seen from Lucknow Producers'' Co-operative Milk Union Ltd.

Vs. Commissioner of Income Tax, . The Tribunal distinguished this decision on facts stating that it related to payment of the purchase price directly

to the supplier when the exchange fluctuation in fact increased the cost of the machinery purchased. It was further pointed out that this decision is

concerned with the guarantee commission paid by the assessee to the State Bank of India which stood as a guarantor for the repayment of the

purchase money. But it remains to be seen that what was paid by way of additional amount by the assessee to the company was for the purchase

of machinery. The fact that in the present case the assessee had paid the additional amount due to fluctuation in the exchange rate to the financier

ICICI would also go towards the cost of the purchase of the machinery since the ICICI in turn paid the additional amount to the seller through the

foreign financier. Therefore, it cannot be said that the decision in the case of CIT vs. South India Viscose Ltd. (supra), cannot be made applicable

to the facts of this case.

In the case of Union Carbide India Ltd. Vs. Commissioner of Income Tax, , the following question was referred to the Calcutta High Court for its

opinion viz., :

Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the increase in liability of Rs. 1,75,99,854 due

to devaluation was not deductible in computing the assessee''s business income ?

While answering the question, the Calcutta High Court held that in view of the fact that the loan had been utilised for purchase of capital assets, the

increase in liability due to the devaluation of the rupee was on capital account. The amount of Rs. 1,75,99,854 was not, therefore, deductible as

business expenditure.

In the case of Union Carbide India Ltd. Vs. Commissioner of Income Tax, , before the Division Bench of the Calcutta High Court, the following

question was referred for its opinion :

Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the excess payment of Rs. 8,721 made on account of

fluctuations in the exchange rate of dollars, at the time of repayment of the dollar loan, raised from the ICICI for purchasing machinery from abroad

was a capital expenditure and not an allowable revenue expenditure ?

While answering this question, the Calcutta High Court held that there is no qualitative difference in the additional expenditure incurred due to

devaluation or fluctuation in the rate of exchange. In both the cases, an additional liability is imposed but whether the expenditure involving the

additional liability will be a revenue expenditure will depend on whether the expenditure is on capital account or on revenue account. In this case, it

had not been contested by the assessee that the loan represented the price of the capital assets purchased and the repayment was the instalment

payment of the consideration. Hence, the excess payment made on account of fluctuation in the exchange rate of dollars was of capital nature. It

was not deductible.

So also the Calcutta High Court in the case of Kesoram Industries and Cotton Mills Ltd. Vs. Commissioner of Income Tax, , by considering a

question similar in nature, held that the additional expenditure incurred in payment of instalment of foreign loan liability due to exchange fluctuation

was capital expenditure.

Similarly, the Andhra Pradesh High Court had an occasion to consider a question similar in nature in the case of Vazir Sultan Tobacco Co. Ltd.

Vs. Commissioner of Income Tax, , wherein the Andhra Pradesh High Court held that s. 43A(1) of the IT Act makes it clear that any amount

expended to acquire any asset from a country outside India for the purpose of the business and any amount paid either in whole or in part towards

the amount borrowed by an assessee from any person directly or indirectly in any foreign currency specifically for the purpose of acquiring assets

should be treated as capital in nature. The fluctuation was one of the factors to be taken into account to determine the value of the capital asset.

Therefore, the mere fluctuation in the rate of exchange was not a ground for the assessee to claim the allowance as a revenue expenditure. Sec.

43A of the Act itself provides for fluctuation in the exchange rate. Therefore, the loss of Rs. 10,485 incurred by the assessee due to the exchange

fluctuation was not allowable as revenue expenditure.

In Mopeds India Ltd. Vs. Commissioner of Income Tax, , the following question of law has been referred to the Hon''ble Judges :

Whether, on the facts and in the circumstances of the case, the sum of Rs. 10,558 paid by the assessee as exchange difference cannot be allowed

as a revenue loss?

While answering this question, the Andhra Pradesh High Court held that the statement of case stated that the payment was part of the instalments

payable to the French company for the supply of plant and machinery. The extra amount was not paid to the creditor (German firm) to discharge

the debt due by the assessee to the German firm. The assessee did not dispute this statement of fact before the Tribunal. Therefore, the amount

paid as exchange difference was capital expenditure.

A similar question arose for consideration before the Andhra Pradesh High Court in the case of Mopeds India Ltd. Vs. Commissioner of Income

Tax, . According to the facts arising in that case, the assessee, a public limited company, engaged in the manufacture and sale of mopeds

purchased some machinery from a French manufacturer. The assessee was granted a foreign exchange loan by a German financier. The assessee

was to repay the said loan in instalments, to be remitted through the ICICI. The assessee had to pay the sum in rupees, i.e., the rupee equivalent of

the instalment to the ICICI, which was to remit the instalment in foreign currency. On the question whether the extra payments made due to

variation in exchange rates was allowable as revenue expenditure, it was held that the amounts represented capital expenditure for acquisition of

plant and machinery and were not deductible.

Likewise, the Kerala High Court also had an occasion to consider a question of similar nature. It was raised in the following manner in the case of

Periyar Chemicals Ltd. Vs. Commissioner of Income Tax, :

Whether, on the facts and in the circumstances of the case, the assessee is entitled to deduction of Rs. 81,837 being the additional amount paid by

it in connection with the repayment of the instalment of loan on account of fluctuation in the rate of exchange as revenue expenditure in computing

its income for the asst. yr. 1976-77 ?

While answering the above question, the Kerala High Court held that the extra expenses incurred for repayment of the loan raised for the purpose

of payment of the price of the capital goods purchased from Germany was not of the nature of revenue expenditure and could only be treated as

capital expenditure.

Again, the Kerala High Court had an occasion to consider a similar question in the case of Ashok Textiles Ltd. Vs. Commissioner of Income Tax,

wherein the Kerala High Court while considering the question : Whether, on the facts and circumstances of the case, the Tribunal was right in law

in holding that the sum of Rs. 15,369.84 being the excess amount paid due to fluctuation in the rate of exchange was not allowable as revenue

expenditure in computing the income of the applicant for the asst. yr. 1975-76, it was held that the original expenditure for the machinery was

capital expenditure. Hence, the enhanced payment represented by the difference due to the fluctuation in exchange rate was also capital in nature.

In the case of Commissioner of Income Tax Vs. Hindustan Aluminium Corporation Ltd., , the following question was referred to the Bombay High

Court, for its opinion :

Whether, on the facts and in the circumstances of the case, the loss of Rs. 13,59,790 suffered due to the fluctuations in the rate of exchange at the

time of remitting the instalments of a loan acquired for purchasing capital assets is admissible as revenue expense while computing the business

income of the assessee ?

While answering the above question, the Bombay High Court held that whether the loss suffered by the assessee was a trading loss or not would

depend on the answer to the question whether the loss was in respect of a trading asset or a capital asset. It would be a trading loss in the former

case and a capital loss in the latter. It makes no difference whether it is occasioned by devaluation brought about by the act of the State or the

fluctuations in the exchange rates by market forces. The factor or circumstances which cause such fluctuation and the resultant loss to the assessee

is not material in determining the true nature and character of the loss. The utilisation or the intended utilisation of the foreign currency is the relevant

factor for determining whether the loss resulting from depreciation in value on account of alteration in the rate of exchange would be a trading loss

or a capital loss. In the instant case, the amount borrowed in foreign currency was utilised for acquiring a fixed asset. Therefore, the loss suffered

by the assessee was a capital loss. However, the increased liability due to fluctuations in the rate of exchange could be added to the actual cost of

the asset for the purpose of calculating depreciation as provided in s. 43A of the IT Act, 1961.

So also in the case of Padamjee Pulp and Paper Mills Ltd. Vs. Commissioner of Income Tax, , while answering a question of similar nature, the

Bombay High Court, held that the additional liability on account of fluctuations in the foreign exchange rates in respect of liability incurred for

import of machinery would not constitute revenue expenditure. It was further held that in view of s. 43A of the IT Act, 1961 the additional liability

amounting to Rs. 21,36,840 and Rs. 4,89,502 on account of exchange fluctuations with reference to the amount of loan outstanding on the last day

of the accounting period at the then prevailing exchange rate had to be added to the actual cost of the machinery for the purpose of computation of

depreciation for that year.

On the other hand, learned counsel appearing for the assessee relied upon a decision in the case of India Cements Ltd. Vs. Commissioner of

Income Tax, Madras, . According to the facts arising in this case, the appellant obtained a loan of Rs. 40 lakhs from the Industrial Finance

Corporation secured by a charge on its fixed assets. In connection therewith it spent a sum of Rs. 84,633 towards stamp duty, registration fees,

lawyer''s fees, etc., and claimed this amount as business expenditure.

The question that arose for consideration is whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that

the sum of Rs. 84,633 expended by the assessee in obtaining the loan or any part thereof is an allowable expenditure. While answering this

question, the Court held that the amount spent was not in the nature of capital expenditure and was laid out or expended wholly and exclusively for

the purpose of the assessee''s business and was therefore allowable as a deduction under s. 10(2)(xv) of the Indian IT Act, 1922. The act of

borrowing money was incidental to the carrying on of the business, the loan obtained was not an asset or an advantage of enduring nature, the

expenditure was made for securing the use of money for a certain period, and it was irrelevant to consider the object with which the loan was

obtained. The facts arising in the abovesaid case, are entirely different from the facts arising in this case. Therefore, it would not render any

assistance for establishing his case.

Learned counsel for the assessee also relied upon a decision in the case of BOMBAY STEAM NAVIGATION CO. (1953) PRIVATE LTD.

Vs. COMMISSIONER OF Income Tax, BOMBAY., . In that decision, the Supreme Court held that in considering whether expenditure is

revenue expenditure, the Court has to consider the nature and the ordinary course of business and the objects for which the expenditure is

incurred. The question whether a particular expenditure is revenue expenditure incurred for the purpose of the business must be viewed in the

larger context of business necessity or expediency. If the outgoing of expenditure is so related to the carrying on or conduct of the business that it

may be regarded as an integral part of the profit-earning process and not for acquisition of an asset or a right of a permanent character, the

possession of which is a condition to the carrying on of the business, the expenditure may be regarded as revenue expenditure. In this decision, the

question that came up for consideration is whether the interest paid by the assessee is allowable as a deduction under the IT Act under any of the

s. 10(2)(iii), 10(2)(xv) or 10(1). While answering the question, the Supreme Court enunciated the abovesaid test in order to find out whether a

particular expenditure is revenue expenditure or not. According to the facts arising in that case, there is no question of payment of interest.

Therefore, the principle contemplated by the Supreme Court in the above cited decision would not be helpful to support the assessee''s case.

Another decision relied upon by the assessee is the decision of Sivakami Mills Ltd. Vs. Commissioner of Income Tax, , wherein this Court held

that the payment of guarantee commission was unrelated to the working out of the case of acquisition of any depreciable machinery, plant or other

asset but was an expenditure which was incurred in the course of carrying on the business and not prior to the commencement of the business. The

payment was so closely related to the business that it could be viewed as an integral part of the conduct of the business and would be a revenue

expenditure. It did not bring into existence any asset of an enduring nature nor did it bring in any other advantage of an enduring benefit. The

acquisition of the machinery on instalment terms was only a business exigency. The very nature of the expenditure and the time at which it had been

incurred would justify the claim of the expenditure as revenue expenditure. This decision would also be of no use in deciding the issue arising in this

case.

Devaluation of currency has a far-reaching effect on the price of machinery, etc., purchased from foreign countries. It often increases the

originally agreed price. If such increase is between dates of the agreement and the acquisition of any such asset, the case is covered under s. 43(1)

and the escalation in price would go to increase the actual cost under those provisions. On the other hand, if the variation in the value of currency is

after the date of acquisition, there might have arisen some question as to, after fulfilment of an agreement of sale by delivery, how the actual cost

could be affected by such variation. It seems that in order to avoid such a question the legislature enacted s. 43A, w.e.f. 1st April, 1967, providing

that the escalation in such a case would go to swell the actual cost in a similar manner. What is true for escalation holds good also in the case of

de-escalation.

Therefore, the submission made by learned counsel for the assessee, that the sale transaction was already over and de hors the sale transaction, the

additional amount arising because of fluctuation in the exchange rate was paid only to the ICICI and, therefore, such payment should be

considered as an expenditure incurred after business was commenced cannot be accepted especially when there are direct decisions on this aspect

applicable on all fours rendered by the various High Courts cited supra. Accordingly, we hold that the Tribunal was not correct in coming to the

conclusions that the additional amount paid to the ICICI due to fluctuation in the exchange rate is only revenue expenditure and s. 43A is not

applicable to the facts of this case. In that view of the matter, we answer the questions referred to us in the negative and in favour of the

Department. Counsel''s fee fixed at Rs. 1,000.