Bharat Forge Co. Ltd. v. Commissioner Of Income-Tax.

Sujata Manohar, J.:— This reference arises out of reference applications filed both by the assessee as well as by the Department arising out of the order of the Income-tax Appellate Tribunal dated February 20, 1976. The order pertains to the assessment year 1968–69. After the Order of the Tribunal, the assessee moved two miscellaneous applications while the Department moved one miscellaneous application. These were disposed of by the Tribunal by a consolidated order dated July 15, 1979. The questions which are referred to us arise from the order of the Tribunal disposing of the assessee's appeal as also the order of the Tribunal in the miscellaneous application.

2. The following questions are referred to us, one at the instance of the assessee and two at the instance of the Revenue:

(A) Assessee's Reference Application:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in directing to reduce the cost of plant and machinery by a sum of Rs. 24.92 lakhs on the ground that to that extent, the Bank of India had reimbursed the assessee's cost of plant and machinery?”

(B) Department's Reference Application:

“(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the receipt of Rs. 24.92 lakhs from the Bank of India was not in the nature of capital gains?

(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that in determining the cost of plant and machinery for the purpose of grant of development rebate, provision of section 33 read with section 43(1) alone would apply and not the provision of section 43a(1) and (2)?”

3. As far as question No. 2 at the instance of the Department is concerned, we are not setting out the facts because it is an accepted position that, in view of the decision of the Supreme Court in the case of Commissioner Of Income Tax, Gujarat v. Arvind Mills Ltd.., [1992] 193 ITR 255, the second question must be answered in the negative and in favour of the Revenue. The question is answered accordingly. We are, therefore, required to consider only two questions; one at the instance of the assessee and one at the instance of the Revenue. The relevant facts in this connection are as follows:

The assessee, Bharat Forge Company Ltd. is a company registered under the Companies Act, in June, 1961, with the object of manufacturing and selling finished crankshafts for which it was granted necessary import licence for importing plant and machinery by the Central Government. The import licence was issued with an endorsement “Issued under Exim Bank Loan Programme”. In other words, in terms of the import licence, the assessee could not remit any foreign exchange from India for the purpose of making payment for capital goods, namely, plant and machinery imported by it. The cost of such plant and machinery was to be met from the funds made available for this purpose by the Export and Import Bank of Washington, U.S.A

4. The assessee entered into an agreement for this purpose which is dated October 11, 1963, with the Exim Bank under which the assessee obtained a loan from the Exim Bank of U.S dollars 3,908,000 for the purpose of financing the purchase of its fixed capital assets, plant and machinery in the U.S.A for the purpose of establishing a forge plant at Pune in India. The loan which the assessee obtained from the Exim Bank was repayable with interest by half yearly instalments. The assessee, accordingly, purchased and imported its plant and machinery for its forging plant at Pune out of the funds so made available to the assessee by the Exim Bank, some time prior to June, 1966. The plant of the assessee was set up towards the end of the accounting year ending on June 30, 1966, and the manufacturing activity of the assessee commenced in the next year commencing from July 1, 1966.

5. In terms of the loan agreement, the assessee-company was required to repay in dollars to the Exim Bank the following amounts which are set out in dollars:

Date Principal Interest Total Rs. Rs. Rs. 1-6-1966 — 1,12,355 1,12,355 1-12-1966 _ 1,12,355 1,12,355 1-6-1967 _ 1,12,355 1,12,355 1-12-1967 2,17,110 1,12,355 3,29,465 1-6-1968 2,17,110 1,06,112 3,23,222 1-12-1968 2,17,110 99,871 3,16,981 6,51,330 6,55,403 13,06,733

6. The repayment, therefore, required to be made from June, 1966, onwards. In early 1966, the assessee-company thought that there was a possibility of devaluation of the rupee and it should hedge against such devaluation. The company instructed its bankers—Bank of India, Bombay, to make a forward purchase of U.S dollars 13,06,733 under its letter dated February 18, 1966. The Bank of India agreed to sell U.S dollars 13,06,733 at a forward rate of Rs. 484.25 per hundred dollars. Accordingly, the Bank of India sent a contract dated February 25, 1966, setting out the sale of U.S dollars 13,06,733 for delivery on January 25.February 24, 1967, at the exchange rate of Rs. 484.25 amounting in all to Rs. 63,27,854.55. This was confirmed by the assessee by its letter of March 4, 1966. It seems that some time in May, 1966, the bank received an intimation from the Reserve Bank of India that the contract which was entered into by the Bank of India with the assessee-company was in breach of section V(1) of the Exchange Control Manual of the Reserve Bank of India. This section sets out that all the sales of foreign currency are subject to regulation and control of the Reserve Bank of India and authorised dealers must use foreign currency only in accordance with the regulations laid down in this Manual. The contract which was entered into by the Bank of India with the assessee required prior approval of the Reserve Bank of India and as no approval to sustain the contract of such type was obtained from the Reserve Bank of India by the Bank of India prior to entering into the above contract, the Reserve Bank of India informed the Bank of India that this contract was not in conformity with the provisions of the Manual. Hence Form No. 8-A which was sent by the Bank of India to the Reserve Bank could not be approved. The bank accordingly wrote a letter dated June 3, 1966, cancelling the agreement entered into between it and the assessee-company. Although the letter is dated March 3, 1966, it was posted from Bombay only on June 9, 1966, and was received by the assessee-company on June 11, 1966. In the meanwhile, on June 6, 1966, the rupee was devalued.

7. As a result of the cancellation of the contract, the assessee-company sustained a loss of Rs. 37.38 lakhs as it had to buy dollars later at a higher rate for remitting the same to the Exim Bank. The assessee claimed damages from the Bank of India oh the ground that the bank had been negligent in the discharge of its duties towards the assessee. There were protracted negotiations between the assessee and the Bank of India. Ultimately, a settlement was arrived at between the Bank of India and the assessee which is recorded in the letter dated February 14, 1967, addressed by the Bank of India to the assessee. Under the terms of this agreement, the contract between the bank and the assessee-company was rescinded by mutual consent and it was agreed that the loss caused to the assessee should be shared. The assessee would bear one-third of the gross amount of the total loss of about Rs. 31,38,000. This amounted to Rs. 12,46,000, the bank would bear the remaining amount of the gross loss of Rs. 24,92,000. This amount of Rs. 24,92,000 was paid by the bank to the assessee. Paragraph 4 of the letter is as follows:

“The said payment of Rs. 24,92,000 to be made by us to you will be in full, final and complete discharge and satisfaction of all your claims against us for loss or damage or compensation whatsoever and howsoever arising (directly or indirectly) under or in respect of the said contract No. 127 dated February 25, 1966, for sale by us to you of U.S $1,306,733 and you will have no further claims on us whatsoever in relation to the said contract and/or the rescission thereof.”

8. This letter has been confirmed by the assessee. The amount of Rs. 24,92,000 so received by the assessee was shown as a capital reserve in its balance-sheet.

9. The Income-tax Officer, however, held that the sum of Rs. 24.92 lakhs was by way of short-term capital gains and he taxed the assessee accordingly. This finding was, in substance, upheld by the Appellate Assistant Commissioner. The Tribunal, however, has come to a conclusion that the receipt of Rs. 24.92 lakhs by the assessee was not in the nature of capital gains. From this finding of the Tribunal, the first question referred to above has been raised and referred to us at the instance of the Department. We will deal with this question first.

10. It is the contention of the Department that the assessee had capital assets in the form of the rights embedded in the contract of February 25, 1966. These rights were transferred for consideration of Rs. 24.92 lakhs. Hence, Rs. 24.92 lakhs represents the capital gains of the assessee. It is also submitted on behalf of the Department that the assessee has transferred its right to receive U.S $1,3,06,733 for a consideration of Rs. 24.92 lakhs. Hence, this should be considered as short-term capital gains. In support, Dr. Balasubramanium has relied upon a decision of this High Court in the case of Commissioner Of Income-Tax, Bombay City I v. Tata Services Ltd., [1980] 122 ITR 594 (Bom). In that case, the assessee had entered into an agreement with one AH to purchase land. The vendor was to obtain at his own cost the necessary permission from the municipal authorities for a sub-division of this land. If permission was not obtained, the vendor was entitled to cancel the agreement. Later, the vendor wanted to cancel the agreement on the ground that permission for sub-division was not granted by the Municipal Corporation, but this was not accepted by the assessee. Ultimately, under a tripartite agreement between the assessee, vendor and one Messrs. A and B, the assessee transferred and assigned in favour, of Messrs. A and B its rights under the agreement and received a sum of Rs. 5,90,000 from Messrs. A and B as consideration for the transfer and assignment of the assessee's rights of which Rs. 90,000 represented the earnest money earlier deposited by the assessee with the vendor. The sum of Rs. 5,00,000 so received by the assessee was held to be capital gains made by the assessee on transfer of its rights under the said agreement. This case has clearly no application at all to the facts of the present case. This is not a case where the assessee has assigned its rights under the agreement with the Bank of India in favour of any third party for a consideration. The ratio of this judgment, therefore, can have no application.

11. Dr. Balasubramanium also cited before us a judgment of the Supreme Court in the case of State Bank Of India v. Commissioner Of Income Tax, Ernakulam, [1986] 157 ITR 67. In this case, the assessee, which was the State Bank of India, purchased as part of its banking business various negotiable instruments drawn in foreign currencies as also foreign currencies themselves. These foreign exchange assets were sold or encashed through the assessee's correspondent banks in the foreign countries concerned and the proceeds credited to its current account with those banks. Consequent on the devaluation of the rupee on June 6, 1966, the amounts credited to the assessee in the foreign banks registered an increase in value of Rs. 4,65,515. The court held that the excess realisation on devaluation represented revenue receipts in the hands of the assessee since foreign exchange was the stock-in-trade of the assessee and the increase in value of the foreign currency was incidental to the banking business carried on by the assessee. The ratio of this judgment also does not apply to the present case at all. The assessee is not carrying on any banking business nor has any foreign currency purchased by it increased in value in terms of rupees on account of devaluation which took place on June 6, 1966.

12. The entire argument of the Department proceeds on a misunderstanding of the nature of the transaction and the nature of the settlement arrived at. We will assume that the rights embedded in the contract constituted a capital asset of the assessee. What were these rights? These rights were to purchase U.S dollars 13,06,733 at a forward rate of Rs. 484.25 per hundred dollars for delivery on January 25.February 24, 1967. These rights have not been transferred by the assessee in favour of anybody. It is true that the definition of “transfer” under section 2(47) of the Income-tax Act, 1961, defines a transfer in relation to a capital asset extensively to include, inter alia, the sale, exchange or relinquishment of an asset or the extinguishment of any rights therein. However, by the settlement of February 14, 1967, the assessee has not sold, exchanged or relinquished these rights in favour of the Bank of India nor are the assessee's rights under the contract “extinguished”, as per the definition of that term under section 2(47). The definition of “transfer” under section 2(47) came up for interpretation before the Supreme Court in the case of Vania Silk Mills (P) Ltd. v. Commissioner Of Income-Tax, Ahmedabad, [1991] 191 ITR 647. In that case, the assessee had bailed its machinery to Messrs. Jasmine Mills. The bailee had insured the machinery against fire. The machinery was destroyed in a fire which broke out in the premises of the bailee. The machinery belonging to the assessee became useless on account of damage caused by fire. On settlement of the insurance claim. Jasmine Mills received a certain amount out of which it paid Rs. 6,32,533 to the assessee on account of destruction of the machinery. The Income-tax Officer brought to tax the difference between the insurance amount received by the assessee and the original cost of the machinery as capital gains. The Supreme Court held that section 45 of the Income-tax Act, 1961, was not attracted. The Supreme Court held that mere extinguishment of rights howsoever brought about would not attract section 45. Whatever be the mode by which the transfer was brought about, the existence of the asset during the process of transfer was a precondition. Unless the asset existed in fact, there could not be a transfer of it. The extinguishment of a right or rights should, in any case, be on account of its or their transfer in order to attract the provisions of section 45. If the transfer did not occasion such an extinguishment and the extinguishment was on account of loss or destruction of the asset, it was not a transfer and did not attract the provisions of section 45 which related to transfer and not to mere extinguishment of a right. The Supreme Court considered the definition of “transfer” under section 2(47) and held that the rule of noscitur a sociis would have to be applied while construing the phrase “extinguishment of any rights” therein. This phrase takes colour from the associated words and expressions and will have to be restricted to the sense analogous to them. Hence the expression “extinguishment of any rights therein” will have to be confined to the extinguishment of rights on account of transfer and cannot be extended to mean any extinguishment of right independent of or otherwise than on account of transfer.

13. In the light of this judgment of the Supreme Court, if we consider the facts of the present case, the settlement dated February 14, 1967, does not transfer the rights of the assessee to receive these dollars at contractual exchange rate in favour of the Bank of India, thereby extinguishing the assessee's rights. On the contrary, there is a serious dispute between the assessee and the Bank of India as to whether the contract is a valid contract or not. It was the contention of the Bank of India that, in the absence of a specific prior permission of the Reserve Bank of India for this contract, the contract was void ab initio. The assessee, on the other hand, contended that the contract was valid. In the alternative, the assessee contended that if what the bank said was correct, then the bank was grossly negligent in not obtaining such prior permission before entering into the contract in question. As there was a relationship of banker and customer between the assessee and the bank and, by its negligence, the bank caused a loss to the assessee, the bank was liable to make good the loss to the assessee. These disputes were settled by the settlement dated February 14, 1967, as a result of which the parties agreed to share the loss which was occasioned to the assessee on account of non-fulfilment of the contract by the bank. Such an arrangement cannot be considered as the transfer of the assessee's fights under the contract in favour of the Bank of India or extinguishment of rights of the assessee in the contract by such a transfer of rights as contemplated under section 2(47) read with section 45 of the Income-tax Act, 1961.

14. It is also submitted by Mr. Inamdar, learned advocate for the assessee, that, assuming that there was a valid contract between the parties, the Bank of India, in any event, refused to perform this contract and the payment in the alternative be viewed as damages for this breach of contract on the part of the Bank of India. The only right which the assessee had in these circumstances was the right to sue the Bank of India for damages for breach of contract. This right was extinguished by the settlement. This right, however, to sue for damages cannot be considered as a transfer of a capital asset at all since a mere right to sue is not a property which can be transferred. In this connection, he has relied upon a decision of our High Court in the case of CIT v. Abbasbhoy A. Dehgamwalla, [1992] 195 ITR 28, where the court has held that a right to sue is not a capital asset.

15. Hence, in the present case, by virtue of this settlement, there is no extinguishment of any right in a capital asset by transfer for which the assessee has received Rs. 24.92 lakhs. Far from being a gain, this is compensation which the assessee has received in respect of a loss of Rs. 37.38 lakhs which the assessee had suffered on account of the failure of the Bank of India to honour the contract which it had entered into. We fail to understand how this can be considered under any circumstances as capital gains.

16. The Tribunal has set out its reasons for holding that the receipt of Rs. 24.92 lakhs by the assessee from the Bank of India under the settlement recorded on February 14, 1966, cannot be considered as capital gains. In our view, the Tribunal was right in so holding. Question No. 1, on behalf of the Department is, therefore, answered in the affirmative and in favour of the assessee.

17. That brings us to the question which is raised at the instance of the assessee. In this connection, the Tribunal has held that the assessee was required to pay an additional sum of Rs. 37,38,000 for purchase of dollars at the prevailing rate after devaluation. So the cost of assets was increased by the additional amount which the assessee was required to pay after devaluation. Under the settlement, the reimbursement was borne by the Bank of India to the extent of Rs. 24,22,000 towards the increased liability of the assessee. Hence, the amount of Rs. 24.92 lakhs was required to be deducted from the total cost of the asset as it stood in the immediately succeeding year ending on June 30, 1967. The cost of the assets worked out after the deduction of Rs. 24.92 lakhs will be the actual cost as contemplated under sub-section (1) of section 43 of the Income-tax Act. This finding of the Tribunal appears to have been arrived at suo motu without any such contention before it being raised by either party.

18. In this connection, it is necessary to deal with the provisions of section 43(1) on which reliance has been placed by the Tribunal. Under section 43 which defines certain terms which are relevant to income from profits and gains of business or profession, sub-section (1) defines “actual cost” to mean “actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority”. We have, therefore, to see whether any part of the cost of assets of the assessee has been met directly or indirectly by any other authority. In the present case, the cost of assets which have been acquired by the assessee and installed prior to June, 1966, was met by the assessee by obtaining a loan from the Exim Bank, U.S.A The assets were paid for and imported by the assessee prior to June, 1966. The dollars which were required to be remitted to the Exim Bank, U.S.A, were in repayment of the loan so obtained by the assessee for purchasing the assets and interest on this loan. The first instalment of interest which was payable on June 1, 1966, was required to be paid prior to the plant going into commercial production and this instalment has been, we are informed, capitalised. The other instalments of interest were required to be paid after the plant so purchased and imported had gone into commercial production. All these instalments of interest would not normally form a part of the cost of assets of the assessee. Out of 13,06,733 dollars which were sought to be purchased under the assessee's agreement with the Bank of India, a substantial portion of such dollars was for payment of interest after the plant went into commercial production which, in any event, cannot be considered as a part of the cost of the assets.

19. The contract, therefore, with the Bank of India was in connection with the dollars required by the assessee to fulfil its obligations towards the Exim Bank, U.S.A, for repayment of the loan with interest. For breach of this contract, the assessee has received as damages/compensation the sum of Rs. 24.92 lakhs. It is difficult to see how this receipt can be considered as payment towards meeting the cost of the assets of the assessee. The payment is basically to meet the liability of the bank to the assessee under the contract dated February 25, 1966.

20. In this connection, Mr. Inamdar, has drawn our attention to the judgment of the Kerala High Court in the case of CIT v. Cochin Co. (P.) Ltd., [1990] 184 ITR 230. In that case also, the assessee had purchased certain items of machinery by taking a loan. The assessee was not able to repay this loan in full. Hence the lender wrote off a portion of the debt due from the assessee including the balance payable on the purchase of machinery. The Income-tax Officer reduced the cost of machinery for purpose of computing depreciation by the amount of the loan so written off. The High Court has held that it was a far cry to state that, though at the time of purchase of the machinery, no person met the cost either directly or indirectly, if, long thereafter a debt incurred in that connection was written off, it could be equated to a position that the financier met part of the cost of the asset to the assessee. Such relinquishment of right does not fall under the provisions of section 43(1). In the present case also, the cost of the machinery purchased by the assessee was met by the assessee from a loan which it had obtained from the Exim Bank, U.S.A To repay this loan, the assessee was required to remit dollars. To reduce the cost of these dollars to the assessee, the assessee entered into a forward contract for purchase of dollars with the Bank of India in anticipation of devaluation. This contract was not honoured by the Bank, of India. To meet its liabilities, which were likely to arise under this contract which was so breached, the Bank of India avoided litigation by arriving at a settlement, paying to the assessee a sum of Rs. 24.92 lakhs. This payment, in our view, is far removed from the payment made by the assessee towards the cost of the assets acquired by it. In fact, this payment is far more remote than the writing off of a debt in the case before the Kerala High Court. Mr. Inamdar has also drawn our attention to the decision of our High Court to which one of us (Mrs. Sujata Manohar J.), was a party, in the case of Commissioner Of Income-Tax v. Elys Plastics Pvt. Ltd., [1991] 188 ITR 11, where the court held that a subsidy which was granted by the Central/State Government as an incentive for setting up or shifting industrial units to a backward area could not be considered as payment to meet the cost of land, building, plant and machinery although the quantum of subsidy was calculated on the basis of the fixed capital investment of the company in these assets.

21. The Tribunal, therefore, was not right in directing that the cost of plant and machinery should be reduced by a sum of Rs. 24.92 lakhs. The question, therefore, which is referred to us at the instance of the assessee is answered in the negative and in favour of the assessee. No order as to costs.