Dr. B.P Saraf, J.:— By this reference made under section 256(1) of the Income-tax Act, 1961, at the instance of the Revenue, the Income-tax Appellate Tribunal, Bombay Bench ‘B’, Bombay, has referred the following two questions of law to this court for opinion:

“1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the ‘exchange loss’ as a result of fluctuations in the rates of exchange of currency was not a notional loss and that it represented real loss?

2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the aforesaid ‘exchange loss’ is allowable as a deduction in computing the income?”

2. The assessee is a banking company. This reference pertains to the assessment years 1973-74, 1974-75 and 1975-76. During these three assessment years, the assessee claimed deduction for the following amounts as exchange loss:

Year Amount (Rs.) 1973-74 3,70,180 1974-75 4,05,728 1975-76 84,251

3. The assessee claimed that these losses were on account of fluctuations in the rates of exchange and, hence, allowable as a deduction in the computation of its income. The Income-tax Officer did not accept the assessee's contention and disallowed its claim for deduction. The assessee appealed to the Commissioner of Income-tax (Appeals). The Commissioner (Appeals) examined the facts of the case and summed up the factual position thus: “At the close of each accounting year, the foreign branch statement of current assets and liabilities is converted at exchange rate ruling on that date. In the process, the foreign branch liability in respect of the head office is also valued at the same rate and the head office surrenders the profit resulting therefrom to tax. As currency is their stock-in-trade and the balance in the foreign branch represents holding of foreign currencies, the same requires valuation in consonance with the method of accounting and the profit thereon is rightly taxed.

4. As far as the current liabilities and assets of the foreign branches is concerned, due to fluctuation in exchange rate, there may be excess of current liabilities over current assets in respect of the foreign branch on the close of the accounting year.” On these facts, the Commissioner (Appeals) observed that the amount due to the head office was on par with current liabilities because it had been valued at current exchange rates on the valuation date. It was further observed that as the assessee-bank was holding many currency balances in foreign branches, all of which had been uniformly dealt with by it, the claim of the assessee for allowance of Loss in excess of current liabilities over current assets had to be allowed. The Commissioner (Appeals) accordingly allowed the claim of the assessee for deduction of loss on account of fluctuations in the rate of exchange. Aggrieved by the order of the Commissioner (Appeals), the Revenue appealed to the Income-tax Appellate Tribunal (“the Tribunal”). On consideration of the facts and circumstances of the case, the Tribunal dismissed the above appeal of the Revenue and confirmed the order of the Commissioner (Appeals). While doing so, the Tribunal followed its earlier order in the assessee's own case in respect of the earlier assessment years and observed that the only difference in the facts of that case and the case under reference was that the loss in the years under reference was on account of fluctuations in the rates of exchange and not from devaluation. Hence, this reference at the instance of the Revenue.

5. We have heard learned counsel for the parties. There is no controversy in this case about the fact that the loss had been occasioned on account of fluctuations in the rates of exchange and not on account of devaluation of the currency. There is also no dispute about the fact that this loss pertains to the current liabilities of the assessee-bank. In such a situation, the controversy in the case, in our view, would be covered by the ratio of the decision of the Supreme Court in Sutlej Cotton Mills Ltd. v. CIT, [1979] 116 ITR 1 and the decision of this court in CIT v. V.S Dempo and Co. Pvt. Ltd., [1994] 206 ITR 291 and following the same, the questions referred to us would have to be answered in favour of the assessee and against the Revenue. In Sutlej Cotton Mills Ltd. v. CIT, [1979] 116 ITR 1, the Supreme Court has held that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. It would, however, be profit or loss of capital nature, if the foreign currency is held as a capital asset or as fixed capital. To the same effect is the earlier decision of the Supreme Court in Cit, Bombay City v. Tata Locomotive & Engineering Co., Ltd., [1966] 60 ITR 405, where it was held that the real test to be applied in such cases is whether the depreciation in value had taken place in a capital asset or in a trading asset, or in other words, in fixed capital or in circulating capital. Therefore, what is relevant is the nature of the asset at the time of devaluation.

6. These decisions of the Supreme Court came to be considered by this court in CIT v. V.S Dempo and Co. Pvt. Ltd., [1994] 206 ITR 291. After elaborate discussion, the propositions emerging from the above decisions were summed up by this court (at pages 300 and 301) thus:

“(i) A loss arising in the process of conversion of foreign currency which is part of the trading asset of the assessee is a trading loss as any other loss.

(ii) In determining the true nature and character of the loss, the cause which occasions the loss is immaterial; what is material is whether the loss has occurred in the course of carrying on the business or is incidental to it.

(iii) 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.

(iv) Loss in respect of circulating capital is revenue loss whereas loss in respect of fixed capital is not.

(v) Loss resulting from depreciation of the foreign currency which is utilised or intended to be utilised in business and is part of the circulating capital, would be a trading loss, but depreciation of fixed capital on account of alteration in exchange rate would be a capital loss.

(vi) For determining whether devaluation loss is revenue loss or capital loss what is relevant is the utilisation of the amount at the time of devaluation and not the object for which the loan had been obtained. Even if the foreign currency was intended or had originally been utilised for acquisition of fixed asset, if at the time of devaluation it had changed its character and had assumed the new character of stock-in-trade or circulating capital, the loss that occurred on account of devaluation shall be a revenue loss and not a capital loss.

(vii) The way in which the entries are made by an assessee in the books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. What is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee.”

7. Applying the above principles to the facts of the present case, we are of the clear opinion that the Tribunal was right in holding that the exchange loss claimed by the assessee as a result of fluctuations in the rates of exchange of foreign currencies held by it as balance in its foreign branches was an allowable deduction because the foreign currencies were its stock-in-trade. Accordingly, both the questions referred to us are answered in the affirmative and in favour of the assessee and against the Revenue.

8. In the facts and circumstances of the case, we make no order as to costs.