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  • Mr. Justice Sabyasachi Mukherji
  • Mr. Justice Suhas Chandra Sen
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  • Mr. Justice Sabyasachi Mukherji
  • Mr. Justice Suhas Chandra Sen
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Smart Summary

Summary of Opinion

Factual and Procedural Background

The assessee is a company. The relevant assessment years in dispute are 1968-69 and 1969-70, the corresponding accounting periods being the calendar years ended 31 December 1967 and 31 December 1968 respectively. The Tribunal referred four questions of law to this High Court. The first question (relating to additional expenses incurred because of the devaluation of the Indian rupee) was referred at the instance of the Revenue. Questions two, three and four were referred at the instance of the assessee.

The context includes an earlier reference concerning the assessment year 1967-68 (I.T. Reference No. 71 of 1977, Oil India Co. Ltd. v. CIT), in which this High Court addressed the treatment of amounts arising from devaluation and the year in which any loss or liability was to be recognised. The Tribunal had allowed certain deductions for the years now under appeal; the Revenue challenged at least the first question on reference. The High Court was asked to answer the four specific questions of law referred by the Tribunal.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 8,35,359 and Rs. 3,30,965, being the additional expenses incurred by the assessee in the payment of its loan to the Bank of Scotland due to the devaluation of the Indian rupee, was an expenditure wholly and exclusively laid out by the assessee for the purpose of its business and as such was an allowable revenue expenditure under Section 37(1) of the Income-tax Act, 1961, for the assessment years 1968-69 and 1969-70, respectively?
  2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 8,71,399, being the amount of guarantee commission paid to the bank represented a part of the capital expenditure and, therefore, was not allowable under Section 37(1) of the Income-tax Act, 1961, for the assessment year 1969-70?
  3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expression "such profits and gains" appearing in section 80-I of the Income-tax Act, 1961, referred only to profits and gains attributable to priority industry as included in the gross total income and such profits and gains signified profits and gains of the priority industry determined and finally included in the gross total income in accordance with the provisions of the said Act including its sections 32, 33, 71 and 72?
  4. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that no depreciation was admissible on drains, culverts and roads for the assessment year 1969-70?

Arguments of the Parties

Assessee's Arguments

  • The assessee submitted that the Tribunal acted logically and correctly in allowing the deductions in the years under appeal because the Tribunal had allowed similar relief on the basis of actual payment (cash basis) in an earlier year; thus, allowing the deduction on actual payment in the present years was consistent and not erroneous.
  • The assessee (or parties supporting that contention) also relied on a Supreme Court judgment in Sutlej Cotton Mills Ltd. v. CIT to argue that the principle applied in certain earlier mercantile-accounting cases was not correctly stated or should not apply to the facts at hand (the opinion records this reliance and addresses it by distinguishing that case).

Revenue's Arguments

  • The Revenue objected to the Tribunal's allowance of the amounts claimed on account of devaluation and asserted that under the mercantile system of accounting the liability or loss arose in the earlier accounting year (the year in which devaluation occurred) and therefore could not be allowed as a deduction in the later assessment year. The Revenue's objections were the basis for the first question being referred to this Court.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Oil India Co. Ltd. v. CIT (I.T. Ref. No. 71 of 1977) [1982] 137 ITR 156 Held inquiry whether devaluation caused expenditure or business loss was of little relevance; liability for the additional amount accrued during the period in which devaluation took place; Tribunal erred in its treatment for assessment year 1967-68. The Court treated that earlier decision as controlling on the question of accrual under mercantile accounting and applied its logic to conclude the amounts could not be allowed again in the later assessment years; this formed a key basis for answering the first question in favour of the Revenue.
Bestobell (India) Ltd. v. CIT Stated that where accounts are on mercantile basis, on devaluation the liability to a foreign creditor immediately increases and a liability arises in that assessment year (not contingent). Used to support the proposition that loss or liability on devaluation accrues when devaluation occurs; relied upon in the reasoning that the loss should have been accounted for in the earlier year.
Kedarnath Jute Manufacturing Co. Ltd. v. CIT Referenced (with Bestobell) in the earlier decision concerning devaluation and accrual. Referred to as supporting authority in the earlier High Court decision (Oil India) which the Court applied in the present matter.
Calcutta Jute Agency (P.) Ltd. v. CIT Decision concerned character of funds held in foreign country and whether devaluation produced capital or revenue receipt. The Court distinguished this case, noting it did not involve a finding that the assessee followed the mercantile system of accounting or that income arose in the accounting year in which devaluation took place; reliance on it was held to be misplaced for present purposes.
Khandelwal Brothers Pvt. Ltd. v. CIT [1979] 117 ITR 452 Held that currency surplus (or change arising from exchange) accrued at the time of devaluation; application of mercantile accounting principles. Identified as a supporting authority for the proposition that accrual occurs on devaluation and therefore the effect must be recognised in that year.
Sutlej Cotton Mills Ltd. v. CIT (Supreme Court) Stated that profit or loss on appreciation/depreciation of foreign currency when converted would ordinarily be trading profit/loss if the currency is held on revenue account or as a trading asset. The Court explained that the facts and issues in Sutlej were materially different and that Sutlej did not assist the assessee's contention in the present case; the Court therefore distinguished this authority.
Imperial Tobacco Co. v. Kelly [1943] 25 TC 292 (CA) Expressed the principle that foreign currency held as part of business operations should be treated like any other commodity and that value fluctuates similarly; used to analyse foreign-exchange transactions on mercantile principles. The Court cited and quoted this decision to support the view that foreign currency transactions are to be treated on the same footing as purchases and sales of other business commodities when applying accounting and tax principles.
CIT v. Orient Paper Mills Ltd. [1983] 139 ITR 763 (I.T. Ref. No. 424 of 1977) Considered the scope and effect of Section 80-I of the Income-tax Act. The Court followed the principles laid down in this Division Bench decision and answered the third question in the reference in the negative and in favour of the assessee.
CIT v. Kalyani Spinning Mills Ltd. [1981] 128 ITR 279 Addressed principles relating to depreciation on roads, drains and culverts. The Court followed the principles from this decision in answering the fourth question in the reference in the negative and in favour of the assessee.

Court's Reasoning and Analysis

The court's analysis proceeds on the following lines (stated using the language and reasoning of the opinion):

  1. The first question centers on additional expenses suffered due to the devaluation of the Indian rupee (devaluation date: 6 June 1966). The Tribunal had allowed specified losses for the assessment years 1968-69 and 1969-70 on the basis of actual payment.
  2. The Court considered an earlier High Court reference concerning the assessment year 1967-68 (Oil India Co. Ltd. v. CIT). That earlier decision held that the liability for the additional amount accrued during the period in which devaluation took place and that the Tribunal's treatment in that year was erroneous in failing to apply the accrual (mercantile) principle correctly.
  3. The Court emphasised the mercantile system of accounting: where an assessee follows mercantile accounting, a profit or loss arising from devaluation must be recognised in the accounting year in which the devaluation occurs. The court cited and relied on authorities applying this principle (including Bestobell and Khandelwal Brothers).
  4. The Court rejected the assessee's contention that the Tribunal was merely being consistent by allowing the deduction on actual payment grounds in the later years. The Court held that the Tribunal in the earlier year had erred by not applying the mercantile principle, and having so held, the Court was bound to conclude that the sums could not be allowed again as deductions on a cash basis in the later year.
  5. The Court addressed a contrary reliance on Sutlej Cotton Mills Ltd. v. CIT by distinguishing the facts of that Supreme Court decision: Sutlej involved different factual circumstances (profits arising in and taxed on accrual in Pakistan, later remitted) and therefore did not alter the application of the mercantile accrual principle to the present facts.
  6. The Court also cited the English authority Imperial Tobacco Co. v. Kelly to illustrate the general principle that foreign currency held as part of business operations behaves like any other commodity and that gains or losses on it are governed by ordinary commercial accounting principles.
  7. For the second question, the Court noted the assessee-company did not wish to press the question and accordingly the Court declined to answer it.
  8. For the third question (scope and effect of section 80-I), the Court followed a Division Bench decision in CIT v. Orient Paper Mills Ltd. and answered that question in the negative and in favour of the assessee.
  9. For the fourth question (depreciation on drains, culverts and roads), the Court followed the principles in CIT v. Kalyani Spinning Mills Ltd. and answered the question in the negative and in favour of the assessee.

Holding and Implications

Holding:

  • First question: Answered in the negative and in favour of the Revenue. The Court held that, applying the mercantile system of accounting and the authority of the earlier High Court decision, the amounts in question could not be allowed as deductions in the assessment year under consideration because the liability arose on devaluation and should have been recognised in the earlier accounting year.
  • Second question: The Court declined to answer the question because the assessee-company chose not to press it.
  • Third question: Answered in the negative and in favour of the assessee, following the Division Bench decision in CIT v. Orient Paper Mills Ltd.
  • Fourth question: Answered in the negative and in favour of the assessee, following the decision in CIT v. Kalyani Spinning Mills Ltd.

Implications:

  • Direct effect on the parties: The Court disallowed the claimed deductions (as claimed by the Tribunal for the later years) arising from devaluation for the assessment years under consideration, applying the principle that such losses accrue when devaluation occurs under mercantile accounting. The assessee cannot again claim those amounts as deductions in these later years.
  • On the other issues (section 80-I interpretation and depreciation on roads/drains/culverts), the Court resolved the questions in the assessee's favour by following prior Division Bench decisions; those holdings apply to the references before the Court.
  • The Court applied and followed existing precedents and principles (it distinguished contrary authorities where facts differed). The opinion does not purport to establish a novel general principle beyond applying and following the mercantile accounting accrual rule and relevant prior decisions.

Other Procedural Outcome

The Court directed that each party will pay and bear its own costs.

Show full summary ...

    Commissioner Of Income Tax, Central-Ii v. Oil India Ltd.

    1. The assessee is a company and the relevant assessment years are 1968-69 and 1969-70, corresponding accounting period being the calendar years ended on 31st December, 1967, and 31st December, 1968, respectively. The following questions of law have been referred by the Tribunal for opinion of this court :

    " 1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the sum of Rs. 8,35,359 and Rs. 3,30,965, being the additional expenses incurred by the assessee in the payment of its loan to the Bank of Scotland due to the devaluation of the Indian rupee, was an expenditure wholly and exclusively laid out by the assessee for the purpose of its business and as such was an allowable revenue expenditure under Section 37(1) of the Income-tax Act, 1961, for the assessment years 1968-69 and 1969-70, respectively ?

    2. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the sum of Rs. 8,71,399, being the amount of guarantee commission paid to the bank represented a part of the capital expenditure and, therefore, was not allowable under Section 37(1) of the Income-tax Act, 1961, for the assessment year 1969-70?

    3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the expression 'such profits and gains' appearing in section 80-I of the Income-tax Act, 1961, referred only to profits and gains attributable to priority industry as included in the gross total income and such profits and gains signified profits and gains of the priority industry determined and finally included in the gross total income in accordance with the provisions of the said Act including its sections 32, 33, 71 and 72?

    4. Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that no depreciation was admissible on drains, culverts and roads for the assessment year 1969-70 ? "

    2. The first question has been referred at the instance of the Revenue. The questions Nos. 2, 3 and 4 have been referred at the instance of the assessee.

    3. The first question arises out of devaluation of the Indian rupee which took place on 6th June, 1966. On this question the Tribunal held as follows :

    We have given a careful consideration to the rival submissions and do not find any merit to the objections raised on behalf of the Revenue before us. In view of the order of the Appellate Tribunal dated 31st December, 1975, relating to the assessment year 1967-68, which was passed after the orders of the Appellate Assistant Commissioner and the Income-tax Officer relating to the assessment years now under appeal before us, the assessee was perfectly justified in raising the issues in the grounds of appeal taken for the instant years. The statement appearing at page 24 of the assessee's paper book was relied upon by the Appellate Tribunal while disposing of the appeal relating to the assessment year 1967-68 and the sum of Rs. 9,85,664 forming part of Rs. 40,60,560 represented a sum total of two amounts of Rs. 4,86,147 and Rs. 4,99,517, being losses claimed by the assessee on account of remittances on 30th June, 1966, and 31st December, 1966, respectively. Therefore, we have no hesitation to accept the veracity of the statement of the assessee and to direct the Income-tax Officer to allow losses of Rs. 8,35,359 and Rs. 3,30,965 in the respective assessments for the assessment years 1968-69 and 1969-70. In this connection, we must mention here also that the assessee had in computing the losses taken into consideration the devaluation of pound sterling on 18th November, 1967. This has relevance for the departmental appeal relating to the assessment year 1968-69 (I.T.A. No. 537(C)/73-74).

    4. So far as the assessment year 1967-68 is concerned, there was a reference to this High Court on this question and the point was decided by a judgment delivered on 17th/18th December, 1980, in I.T, Reference No. 71 of 1977 (Oil India Co. Ltd. v. CIT [1982] 137 ITR 156). In that case it was held that the inquiry as to whether by reason of the devaluation the assessee had incurred an expenditure or had suffered business loss was of little relevance. In that case reliance was placed on the decisions in the cases of Bestobell (India) Ltd. v. CIT and Kedarnath Jute Manufacturing Co. Ltd. v. CIT . It was held that the liability for the additional amount accrued during the relevant period in which devaluation took place. It was held in that case (p. 170):

    "We have already observed that the Division Bench held, in the facts of the case before that Bench, that the loss was a capital loss. But that is not the controversy here and it is undisputed that the expenditure in respect of the additional expenditure incurred was of a revenue nature. Following the ratio of the said decision on the two aspects, we are of the opinion that the Tribunal was in error in not holding that the amount was not deductible in computing the assessee's income for the assessment year 1967-68."

    5. The question in this year really follows the decision of the earlier year. In this case the Tribunal has allowed the deduction on the basis that in this year the actual payment was made and the Revenue has come up on reference against it. The logical corollary of the judgment given in the earlier year is that the amount cannot be allowed as deduction in this year because the liability was incurred and allowed as a deduction in the earlier year.

    6. It has been argued on behalf of the assessee that the Tribunal has only been logical and, therefore, the Tribunal has not committed any mistake in this particular year. The Tribunal in the earlier year had held that the amount could be allowed on the basis of actual payment and this year it has been allowed on the basis of actual payment. Therefore, the Tribunal had done only what could be done under the circumstances. Therefore, the decision of the Tribunal cannot be held to be erroneous on principle in the facts found by the Tribunal.

    7. We are, however, unable to accept this contention. The decision of the Tribunal in the earlier year was held to be erroneous by this High Court on the ground that it failed to appreciate that under the mercantile system of accounting which the assessee was following the loss arose or accrued in the earlier accounting year and should have been allowed in that year.

    8. In this case we are not interfering with any finding of fact made by the Tribunal, The Tribunal had failed to apply the principles of mercantile system of accounting in the assessment year 1967-68 and also in the assessment year 1968-69, which is under consideration in the present case. Therefore, having held in the earlier reference for the assessment year 1967-68, that the Tribunal should have allowed the amount in question on accrual basis, we are bound to hold that the amount in question cannot once again be allowed as a deduction on cash basis in this year.

    9. Reliance placed on a Division Bench judgment of this High Court in Calcutta Jute Agency (P.) Ltd. v. CIT , is also misplaced. In that case there was no finding that the assessee was following the mercantile system of accounting and there was no argument that the income in question arose in the accounting year in which devaluation took place. The only point that came up for consideration in that case was whether the money that was lying in foreign country before devaluation had changed its character and whether as a result of devaluation there was a capital receipt or a revenue receipt. The year in which the receipt should be assessed was not an issue in that case at all.

    10. The principle that in a case where the assessee follows the mercantile system of accounting, a profit or loss on account of devaluation takes place in the year in which the devaluation takes place has been consistently followed in a number of cases.

    11. A Division Bench of this High Court in the case of Khandelwal Brothers Pvt. Ltd. v. CIT [1979] 117 ITR 452, held that the currency surplus accrued to the assessee at the time of devaluation and not at the time of subsequent adjustment of the accounts of the assessee or at the time when the assessee obtained the sanction of the Reserve Bank of India to adjust its two accounts. This was done on the basis of the principles underlying the mercantile system of accounting.

    12. The point was also gone into at length in the case of Bestobell (India) Ltd. v. CIT , where it was held that since the assessee maintained its accounts on mercantile basis, on the devaluation of the Indian currency the liability of the assessee to its foreign creditor immediately increased to the extent of rupees devalued and the assessee became liable to pay and/or spend an extra amount in rupees in order to pay its dues. The liability of the assessee arose during the assessment year and could not be said to be a contingent liability or an anticipated future loss.

    13. It has been argued that the principle enunciated in the aforesaid cases is not correct and reliance was placed for this purpose on a judgment of the Supreme Court in the case of Sutlej Cotton Mills Ltd. v. CIT and in particular on the following passage at p. 13 :

    "The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, 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."

    14. The points that came up for decision before the Supreme Court and the facts of that case were entirely different. There the assessee, a limited company, had its head office in Calcutta and a cotton mill in West Pakistan where it carried on business of manufacturing and selling cotton fabrics. In the accounting year ending on 31st March, 1954, relevant to the assessment year 1954-55 the assessee made a large profit in West Pakistan unit. At the prevalent rate of exchange of 100 Pakistani rupees being equal to 144 Indian rupees the profit amounted to Rs. 1,68,97,232 in terms of Indian rupees. Since the assessee was taxed on accrual basis, the sum of Rs. 1,68,97,232 representing the Pakistan profit was included in the total income of the assessee for the assessment year 1954-55. The assessee was taxed accordingly after giving double taxation relief in accordance with the bilateral agreement between India and Pakistan. Thereafter, the profit made by the assessee was lying unused in Pakistan. The assessee succeeded in obtaining the permission of the Reserve Bank of Pakistan to remit a sum of Rs. 25,00,000 in Pakistani rupees and remitted the said amount to India during the accounting year relevant to the assessment year 1957-58. The assessee also remitted during the accounting year relevant to the assessment year 1959-60 a further sum of Rs. 12,50,000 in Pakistani rupees out of the Pakistani profit for the assessment year 1954-55. By the time these remittances came to be made, the rate of exchange had once again changed to 100 Pakistani rupees being equal to 100 Indian rupees and the amount received by the assessee in terms of Indian rupees was, therefore, the same, namely, Rs. 25,00,000 and Rs. 12,50,000. The profit of Rs. 25,00,000 in terms of Pakistani rupees had been included in the total income of the assessee for the assessment year 1954-55 as Rs. 36,00,000 in terms of Indian rupees according to the then prevailing rate of exchange. Therefore, when the assessee ultimately converted the amount into Indian currency at par on the basis of the new rate of exchange, the assessee suffered a loss on account of appreciation of Indian rupee qua Pakistani rupee. The question before the Supreme Court was whether this loss which the assessee suffered on actual remittance of the amount of money lying in Pakistan to India was capital loss or revenue loss.

    15. It is to be noted that in the case before the Supreme Court when the profits arose in Pakistan it Was taxed in India on accrual basis without any actual physical conversion but on a notional conversion of Pakistani rupees into Indian rupees at the prevailing rate of exchange. After the income accrued and was taxed, the money was retained in Pakistan for some time and ultimately repatriated to India, upon repatriation the question arose whether the loss suffered due to further fluctuation in the rate of exchange was capital loss or revenue loss. In our opinion, this judgment does not help the assessee in the case before us in any way at all.

    16. The profit or loss arising out of transactions made in foreign exchange has to be treated on the same footing as the purchase and sale of any other business commodity. The Supreme Court has not in the case of Sutlej Cotton Mills Ltd. v. CIT , laid down any special rule for taxation in case of profit or loss arising out of appreciation or depreciation in value of foreign currency. If the assessee follows the mercantile system of accounting, the profit or loss will have to be assessed on the accrual basis and if the assessee follows the cash system of accounting, the profit or loss will have to be assessed on the basis of actual receipt.

    17. The principle to be applied in the transactions involving foreign exchange has been stated in the case of Imperial Tobacco Co. v. Kelly [1943] 25 TC 292 (CA), by Lord Greene M.R., at p. 300 in the following words :

    " We must decide this case having regard to the facts as found. In the light of those facts, the acquisition of these dollars cannot be regarded as colourless. They were an essential part of a contemplated commercial operation.

    That being so, what is the true analysis of the position ? A manufacturer has provided himself with a commodity, namely, dollars. I call dollars a ' commodity ' not for the reason that they are not currency in this country, but because they have a characteristic which is common to other commodities, and is not shared by sterling, namely, that their value from day to day varies in terms of sterling, just in the same way as coal, or bricks, or anything else may do."

    18. And then again at p. 301 :

    " In the present case it is truly said that it was no part of the company's business to buy and sell dollars. But in each case the commodity (in the one case the coal and in the other case the dollars) was acquired for the purpose of transactions on revenue account and nothing else."

    19. A point was also made that as a result of devaluation of the English pound, the assessee also suffered some loss and that has also to be taken into account in this year. The question before us is, however, limited to the loss because of devaluation of Indian rupee and, therefore, that question is not before this court and we need not go into that question.

    20. On the facts and in the circumstances of this case, the first question is answered in the negative and in favour of the Revenue,

    21. So far as the second question is concerned, the assessee-company has stated that it does not wish to press the question and, therefore, we decline to answer this question.

    22. So far as the third question is concerned, the scope and effect of Section 80-I has been gone into by a Division Bench of this High Court in the case of CIT v. Orient Paper Mills Ltd. The judgment was delivered on 18th/19th March, 1981, in I.T. Ref. No. 424 of 1977--since reported in [1983] 139 ITR 763. Following the principles laid down in that judgment, this question is answered in the negative and in favour of the assessee.

    23. So far as the fourth question is concerned, the principles relating to depreciation on roads, drains and culverts will be governed by the decision given by this High Court in the case of CIT v. Kalyani Spinning Mills Ltd. [1981] 128 ITR 279. In view of the principles laid down in the said decision, this question is answered in the negative and in favour of the assessee.

    24. In the facts and circumstances of this case, each party will pay and bear its own costs.

    Sabyasachi Mukharji, J.

    25. I agree.

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    Comments

    Commissioner Of Income Tax, Central-Ii v. Oil India Ltd.
    (Mar 30, 1982)