The Judgment of the Court was delivered by

Thanikkachalam, J.:— At the instance of the Department in the assessment years 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 section 256(1) of the Income-tax 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 section 43A of the Act, the Appellate 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 Limited, is a revenue expenditure and should accordingly be allowed?

(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the excess payment made by the assessee to the Industrial Credit and Investment Corporation of India Limited, 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 section 43A of the Act, the Appellate 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 Limited, is a revenue expenditure and should accordingly be allowed?

(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the excess payment made by the assessee to the Industrial Credit and Investment Corporation of India Limited 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 Appellate Tribunal was right in law in holding that the provisions of section 43A of the Income-tax Act, 1961, would not apply to the assessee's case?”

2. 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 Limited (I.C.I.C.I). Several suppliers of the machinery have paid the price of the machinery supplied between November 15, 1971, and September 7, 1972, and spare parts supplied on February 26, 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 October 1, 1972. The Industrial Credit and Investment Corporation of India Limited had arranged for the payment to the suppliers in DM by KREDITANSTALT FURWIEDERAUFBAU (K.F.W) and, therefore, the agreement of the Industrial and Credit and Investment Corporation of India Limited 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 K.F.W The loan was to be repaid only by instalments. In view of the fluctuation in the rate of exchange for the previous year ended March 31, 1974, corresponding to the assessment year 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 assessment year 1975–76, corresponding to the previous year ended March 31, 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.

3. The assessee's claim was that this extra expenditure was revenue expenditure and was deductible in computing the total income. The Income-tax Officer rejected this claim. On appeal, the Appellate Assistant Commissioner also held that the expenditure was capital in nature and had to be disallowed. The Appellate Assistant Commissioner relied on a decision of this court in CIT v. South India Viscose Ltd., [1979] 120 ITR 451. Aggrieved, the assessee filed an appeal before the Income-tax Appellate 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. v. Commissioner Of Income-Tax, Madras., [1979] 120 ITR 211 (Mad) should be applied and not the decision in the case of South India Viscose Ltd., [1979] 120 ITR 451 (Mad) which was distinguishable on facts,

(iii) that section 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 section 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. v. Commissioner Of Income-Tax., [1981] 130 ITR 351.”

4. The Appellate 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 section 43A of the Act would not be applicable to the facts of the case.

5. 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 I.C.I.C.I for the purpose of purchasing the machinery. The I.C.I.C.I 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 I.C.I.C.I 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 I.C.I.C.I 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 I.C.I.C.I 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., I.C.I.C.I, 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 section 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 section 43A would not be applicable to the facts of this case.

6. 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 I.C.I.C.I 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 I.C.I.C.I for the repayment of the loan. The provision of section 43A will not be applicable to the facts of this case. The provision of section 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 section 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 section 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 I.C.I.C.I due to fluctuation in the exchange rate is only revenue expenditure and, therefore, allowable as deduction under section 37 of the Act.

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

8. A similar question came up for consideration before a Division Bench of this court in the case of CIT v. South India Viscose Ltd., [1979] 120 ITR 451. In the abovesaid case, the following question was referred for its opinion (page 452):“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 December 31, 1962, and December 31, 1964, are allowable as revenue expenditure for the assessment years 1963–64 and 1965–66, respectively?”

9. 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.

10. 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 section 43A in the Income-tax Act, 1961, by section 17 of the Finance (No. 2) Act, 1967, with effect from April 1, 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.

11. The special leave petition filed against this judgment was rejected by the Supreme Court as can be seen from [1983] 143 ITR (St.) 60. 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 I.C.I.C.I would also go towards the cost of the purchase of the machinery since the I.C.I.C.I 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 South India Viscose Ltd., [1979] 120 ITR 451 (Mad), cannot be made applicable to the facts of this case.

12. In the case of Union Carbide India Ltd. v. Commissioner Of Income-Tax., [1981] 130 ITR 351 (Cal), the following question was referred to the Calcutta High Court for its opinion viz., (page 354):

“Whether, on the facts and in the circumstances of the case, the Appellate 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?”

13. 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.

14. In the case of Union Carbide India Ltd. v. Commissioner Of Income-Tax., [1993] 203 ITR 584, before the Division Bench of the Calcutta High Court, the following question was referred for its opinion (page 587):

“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 I.C.I.C.I for purchasing machinery from abroad was a capital expenditure and not an allowable revenue expenditure?”

15. 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.

16. So also the Calcutta High Court in the case of Kesoram Industries and Cotton Mills Ltd. v. CIT, [1992] 196 ITR 845, 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.

17. 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. v. CIT, [1989] 177 ITR 532, wherein the Andhra Pradesh High Court held that section 43A(1) of the Income-tax 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. Section 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.

18. In Mopeds India Ltd. v. CIT, [1988] 172 ITR 552 (AP), the following question of law has been referred to the honble judges (page 553)’:

“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 beallowed as a revenue loss?”

19. 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.

20. A similar question arose for consideration before the Andhra Pradesh High Court in the case of Mopeds India Ltd. v. CIT, [1988] 172 ITR 555. 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 I.C.I.C.I The assessee had to pay the sum in rupees, i.e, the rupee equivalent of the instalment to the I.C.I.C.I, 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.

21. 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. v. CIT, [1986] 162 ITR 163 (page 165):

“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 assessment year 1976–77 ?”

22. 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.

23. Again, the Kerala High Court had an occasion to consider a similar question in the case of Ashok Textiles Ltd. v. Commissioner Of Income-Tax., [1989] 178 ITR 94, 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 assessment year 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.

24. In the case of Commissioner Of Income-Tax v. Hindustan Aluminium Corporation Ltd., [1994] 207 ITR 670, the following question was referred to the Bombay High Court, for its opinion (page 671):

“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?”

25. 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 section 43A of the Income-tax Act, 1961.

26. So also in the case of Padamjee Pulp and Paper Mills Ltd. v. CIT, [1994] 210 ITR 97 (Bom), 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 section 43A of the Income-tax 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.

27. On the other hand, learned counsel appearing for the assessee relied upon a decision in the case of India Cements Ltd. v. Commissioner Of Income Tax, Madras., [1966] 60 ITR 52 (SC). 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 section 10(2)(xv) of the Indian Income-tax 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.

28. Learned counsel for the assessee also relied upon a decision in the case of Bombay Steam Navigation Co. (1953) Pvt. Ltd. v. CIT, [1965] 56 ITR 52 (SC). 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 Income-tax Act under any of the sections 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.

29. Another decision relied upon by the assessee is the decision of Sivakami Mills Ltd. v. Commissioner Of Income-Tax, Madras., [1979] 120 ITR 211 (Mad), 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 section 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 section 43A, with effect from April 1, 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.

30. 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 I.C.I.C.I 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 I.C.I.C.I due to fluctuation in the exchange rate is only revenue expenditure and section 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.