Dr. B.P Saraf, J.:— By this reference under section 256(1) of the Income-tax Act, 1961, the Income-tax Appellate Tribunal, at the instance of the Revenue, has referred the following question of law to this court for 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?”

2. The facts giving rise to this reference, briefly stated, are as follows: The assessee is a limited company deriving income from business in the manufacture and sale of aluminium. The assessment year involved in this reference is 1974–75, the relevant previous year being the year ended December 31, 1973. The assessee had entered into an agreement with the Import-Export Bank of Washington on September 22, 1960, by virtue of which it obtained a loan which was used for the purchase of machinery and other equipment relating to its import-export business. There were two supplementary agreements with the same party on the same subject on September 16, 1963, and January 14, 1965. The assessee was to repay the loan to the said bank in instalments. The value of the loan was recorded in the books of the assessee in terms of rupees adopting the rate of exchange prevailing at that time. Subsequently, there was a devaluation of the rupee in the year 1966 and its revaluation in the year 1971. Apart from that, there were day to day fluctuations in the rate of exchange resulting from the market forces of demand and supply of dollars. During the year under consideration, the assessee found that it had to pay a sum of Rs. 13,59,794 over and above the amount recorded in its books in order to buy the necessary amount of dollars required for remitting the instalments. In other words, the assessee was required to pay the aforesaid amount over and above the amount originally envisaged because as a result of fluctuations in the exchange rate, the dollar became dearer in terms of the rupee on the date of the remittance of the instalments. The assessee claimed the said amount as revenue expense incidental to the carrying on of its business. The Income-tax Officer disallowed the same on the ground that it was incurred on capital account. The assessee appealed to the Appellate Assistant Commissioner, who agreed with the finding of the Income-tax Officer and dismissed the appeal of the assessee. The assessee went in second appeal to the Income-tax Appellate Tribunal and reiterated its contention that the expense under consideration was incurred on revenue account. It was contended that section 43A of the Act did not apply to the facts of the case, because the said section applied only to cases of devaluation. According to the assessee, the expense arose out of the day-to-day fluctuations in the rate of exchange and, as such, it was allowable as revenue expense. The stand of the Revenue before the Tribunal was that the expense under consideration was incurred on capital account because the loan had been obtained to purchase a capital asset and so any expense in connection therewith would also be on capital account. The Tribunal, on a consideration of the rival contentions, held the expenditure in question to be a revenue expenditure. Hence this reference under section 256(1) of the Act at the instance of the Revenue.

3. Learned counsel for the Revenue submits that section 43A of the Act (which was inserted in the Act by the Finance (No. 2) Act of 1967, with effect from April 1, 1967, i.e, for and from the assessment year 1967–68) makes it abundantly clear that any increase or reduction in the assessee's liability expressed in Indian currency for payment of the whole of the loan in foreign currency obtained by it for acquisition of a capital asset has to be treated as an expenditure on capital account and such increase or reduction will have the effect of increasing or reducing the original actual cost of the capital asset acquired by the assessee. According to learned counsel, the cause which occasioned such loss—whether day to day fluctuation in rates of exchange or devaluation brought about by the act of the State is not material in determining the true nature and character of the loss. Reliance is placed on the decision of the Supreme Court in Sutlej Cotton Mills Limited v. Commissioner Of Income Tax, Calcutta, [1979] 116 ITR 1. Counsel for the assessee, on the other hand, submits that any loss suffered by the assessee as a result of day-to-day fluctuations in the rate of exchange stands on a different footing from the loss occasioned as a result of devaluation and the decision of the Supreme Court in Sutlej Cotton Mills Ltd.'s case, [1979] 116 ITR 1 applies only to losses occasioned due to devaluation. Losses on account of fluctuations in exchange rate due to market factors cannot be treated as on capital account.

4. On a careful consideration of the rival submissions, we find ourselves in agreement with learned counsel for the Revenue. In our opinion, 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 an act of the State or fluctuations in the exchange rates by market forces. The factor or circumstance which causes such fluctuation and the resultant loss to the assessee is not material in determining the true nature and character of the loss. The determining factor would be whether the loss was in respect of a trading asset or a capital asset. In the former it would be a trading loss but not so in the latter. Putting it differently, as done by the Supreme Court in Sutlej Cotton Mills Ltd.'s case, [1979] 116 ITR 1, if the amount in foreign currency is utilised or intended to be utilised in the course of business or for a trading purpose or for effecting a transaction on revenue account, loss arising from depreciation in its value on account of alteration in the rate of exchange would be a trading loss, but if the amount is held as a capital asset, loss arising from depreciation would be a capital loss.

5. In Sutlej Cotton Mills Ltd.'s case, [1979] 116 ITR 1 (SC) a somewhat similar argument was advanced by the Revenue and a distinction was sought to be made between loss caused by fluctuations in exchange rates due to market forces and loss caused on account of devaluation which was an act of the State. This argument also found favour with the High Court. The Supreme Court, however, did not approve the same and observed (at page 6):

“This argument is plainly erroneous and cannot stand scrutiny even for a moment. It is true that a loss in order to be a trading loss must spring directly from the carrying on of business or be incidental to it as pointed out by Venkatarama Aiyar J., speaking on behalf of this court in Badridas Daga v. Commissioner Of Income Tax, [1958] 34 ITR 10 (SC), but it would not be correct to say that where a loss arises in the process of conversion of foreign currency which is part of the trading asset of the assessee, such loss cannot be regarded as a trading loss because the change in the rate of exchange which occasions such loss is due to an act of the sovereign power. The loss is as much a trading loss as any other and it makes no difference that it is occasioned by devaluation brought about by an act of State. It is not the factor or circumstance which causes the loss that is material in determining the true nature and character of the loss, but whether the loss has occurred in the course of carrying on the business or is incidental to it. If there is loss in a trading asset, it would be a trading loss, whatever be its cause, because it would be a loss in the course of carrying on the business. Take for example the stock-in-trade of a business which is sold at a loss. There can be little doubt that the loss in such a case would clearly be a trading loss. But the loss may also arise by reason of the stock-in-trade being stolen or burnt and such a loss, though occasioned by external agency or act of God, would equally be a trading loss. The cause which occasions the loss would be immaterial: the loss, being in respect of a trading asset, would be a trading loss. Consequently, we find it impossible to agree with the High Court that since the loss in the present case arose on account of devaluation of the Pakistani rupee and the act of devaluation was an act of sovereign power extrinsic to the business, the loss could not be said to spring from the business of the assessee. 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. In the former case, it would be a trading loss but not so in the latter.”

(emphasis* supplied)

6. The Supreme Court also examined the controversy from another angle. It said (at page 7):

“The test may also be formulated in another way by asking the question whether the loss was in respect of circulating capital or in respect of fixed capital. This is the formulation of the test which is to be found in some of the English decisions. It is, of course, not easy to define precisely what is the line of demarcation between fixed capital and circulating capital, but there is a well-recognised distinction between the two concepts. Adam Smith in his Wealth of Nations describes ‘fixed capital’ as what the owner turns to profit by keeping it in his own possession and ‘circulating capital’ as what he makes profit of by parting with it and letting it change masters. ‘Circulating capital’ means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursements, while ‘fixed capital’ means capital not so employed in the business, though it may be used for the purposes of a manufacturing business, but does not constitute capital employed in the trading operations of the business. Vide Golden Horse Shoe (New) Ltd. v. Thurgood, [1933] 18 TC 280 (CA). If there is any loss resulting from depreciation of the foreign currency which is embarked or adventured in the business and is part of the circulating capital, it would be a trading loss, but depreciation of fixed capital on account of alteration in exchange rates would be a capital loss. Putting it differently, if the amount in foreign currency is utilised or intended to be utilised in the course of business or for a trading purpose or for effecting a transaction on revenue account, loss arising from depreciation in its value on account of alteration in the rate of exchange would be a trading loss, but if the amount is held as a capital asset, loss arising from depreciation would be a capital loss.”

(emphasis supplied).

7. It is clear from the above decision of the Supreme Court that the utilisation or the intended utilisation of the foreign currency is the relevant factor for determining whether the loss resulting from the depreciation in its value on account of alteration in the rate of exchange would be a trading loss or a capital loss. If the amount is held as capital asset, loss arising from alteration in the rate of exchange would be a capital loss. In the instant case, there is no dispute about the fact that the amount borrowed in foreign currency was utilised for acquiring a fixed asset. In that view of the matter, there can hardly be any controversy in regard to the fact that the loss caused to the assessee on account of alteration in the rate of exchange is a capital loss.

8. This conclusion of ours gets full support from section 43A of the Act (as inserted with effect from April 1, 1967) which has given statutory recognition to this legal position. Section 43A, so far as relevant reads:

“43A. (1) Notwithstanding anything contained in any other provision of this Act, where an assessee has acquired any asset from a country outside India for the purposes of his business or profession and, in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there is an increase or reduction in the liability of the assessee as expressed in Indian currency for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of the moneys borrowed by him from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability aforesaid is so increased or reduced during the previous year shall be added to, or, as the case may be, deducted from, the actual cost of the asset as defined in clause (1) of section 43 or the amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1) of section 35 or in section 35A or in clause (ix) of subsection (1) of section 36, or, in the case of a capital asset (not being a capital asset referred to in section 50), the cost of acquisition thereof for the purposes of section 48, and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid…

(2) The provisions of sub-section (1) shall not be taken into account in computing the actual cost of an asset for the purpose of the deduction on account of development rebate under section 33.”

9. Amendment in identical terms was made in Schedule VI to the Companies Act, 1956, in the form of balance-sheet prescribed for companies. In the third column setting out “the instructions in accordance with which assets should be made out”, the following instructions had appeared against “fixed assets” at the very top of the form:

“Under each head the original cost, and the additions thereto and deductions therefrom during the year, and the total depreciation written off or provided up to the end of the year to be stated.”

10. To this, a new paragraph, in language identical with that employed in section 43A above, was added by a notification dated January 3, 1968. It read:

“Where the original cost aforesaid and additions and deductions thereto, relate to any fixed asset which has been acquired from a country outside India, and in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of moneys borrowed by the company from any person, directly or indirectly in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect), the amount by which the liability is so increased or reduced during the year, shall be added to, or, as the case may be, deducted from the cost, and the amount arrived at after such addition or deduction shall be taken to be the cost of the fixed asset.

Explanation 1.— ….”

11. These provisions and the effect thereof came up for consideration before the Supreme Court in CIT v. Arvind Mills Ltd., [1992] 193 ITR 255.

12. The Supreme Court summed up the existing position of treatment of additional liability arising from exchange fluctuations as follows (at page 261):

“… the position appears to be that, on strict accountancy principles, the increase or decrease in liability towards the actual cost of an asset arising from exchange fluctuation can be adjusted in the accounts of the earlier year in which the asset was acquired (if necessary, by reopening the said accounts). In that event, the accounts of that earlier year as well as of subsequent years will have to be modified to give effect to variations in depreciation allowances consequent on the redetermination of the actual cost. In other words, in the illustration given earlier, the actual cost of Rs. 1,00,000 and the allowances based thereon shown in the accounts for the financial year 1965–66 would have to be revised to show an actual cost of Rs. 1,20,000 and allowances based on that figure. The figures of written down value and depreciation allowances for subsequent years would also need consequential revision. However, though this is a course which is theoretically advisable or precise, its adoption may create a lot of practical difficulties. That is why the Institute of Chartered Accountants gave an option to business people to make a mention of the effect of devaluation by way of a note on the accounts for the earlier year in case the balance-sheet in respect thereof has not yet been finalised but actually to give effect to the necessary adjustments in the subsequent years instead of reopening the closed accounts of the earlier year. This also appears to be in accord with the principle laid down by this court in Commissioner Of Income Tax, Madras. v. A. Gajapathy Naidu, Madras, [1964] 53 ITR 114 and CIT v. Swadeshi Cotton and Flour Mills Pvt. Ltd., [1964] 53 ITR 134.

This is also the principle subsequently recognised by the amendment to the Companies Act, 1956 …”

13. It was held (at page 270):

“Section 43A provides for a case in which, as in the present case, the assessee has completely paid for the plant or machinery in foreign currency prior to the date of devaluation but the variation in exchange rate affects the liability of the assessee (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… 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.”

14. The Supreme Court also held that on the face of the clear language of sub-section (2) of section 43a, which provides that for the purpose of development rebate any increase or decrease in the actual cost consequent on fluctuations in exchange rates should not be taken into account, no development rebate can be claimed by the assessee on the increased cost.

15. Applying the principles set out above to the facts of the present case it is clear that the loss of Rs. 13,59,790 suffered by the assessee due to fluctuations in the rate of exchange at the time of remitting the instalments of the loan acquired for purchasing a capital asset would be capital loss and the assessee is not entitled to any deduction in computation of its income on account thereof. This amount, however, will have the effect of modifying the actual cost of the asset for the purpose of calculating depreciation as provided in section 43A of the Act. In the result, the question referred to us is answered in the negative, i.e, in favour of the Revenue and against the assessee.

16. Under the facts and circumstances of the case, there shall be no order as to costs.