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Commissioner Of Income-Tax v. Century Enka Ltd.

Calcutta High Court

May 30, 1991

Judgment

Subsequent
References

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Structured Summary of the Opinion delivered by Ajit K. Sengupta, J.

Factual and Procedural Background

This reference arises under section 256(1) of the Income-tax Act, 1961 for the assessment year 1978-79. The core factual matrix, as stated in the opinion, is:

The assessee-company manufactures nylon yarn and claimed investment allowance on Rs. 4,04,741. This amount represented an additional liability attributable to variation in the rate of exchange relating to a foreign loan, which the assessee had added to the cost of plant and machinery.
The Income-tax Officer ("ITO") disallowed the assessee's claim for reasons set out in the assessment order (the assessment order's detailed reasons are not reproduced in the opinion).
On appeal, the Commissioner of Income-tax (Appeals) held that the ITO was justified: the assessee had not placed material to justify the investment allowance and had not created the statutory reserve required under the Act.
On further appeal, the Income-tax Appellate Tribunal ("Tribunal") held that the assessee was entitled to investment allowance and directed the ITO to give the assessee an opportunity of creating the required reserve before allowing the investment allowance.
The question referred to this Court was whether the Tribunal was justified in law in holding that the assessee was entitled to investment allowance and in directing the ITO to give the assessee an opportunity of creating a reserve before allowing the investment allowance.

Legal Issues Presented

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the assessee was entitled to investment allowance and in directing the Income-tax Officer to give the assessee opportunity of creating a reserve before allowing the investment allowance?”

Arguments of the Parties

Assessee's Arguments (as presented by Mr. Bajoria)

The additional liability was incurred due to variation in the rate of exchange relating to the foreign loan liability; such additional liability must be added to the cost of acquisition of the asset.
On the basis of several judgments of this Court, investment allowance is allowable on the additional amount of liability so added to the cost of the asset.
The Tribunal was correct in directing the ITO to give the assessee an opportunity to create the investment allowance reserve before allowing the investment allowance.

Revenue's Position (Income-tax Officer and Commissioner of Income-tax (Appeals))

The ITO rejected the claim for investment allowance for reasons set out in the assessment order (the opinion does not reproduce those reasons).
The Commissioner (Appeals) held that the ITO was justified because the assessee had not placed material before him to justify the investment allowance and had not created the statutory reserve required by the Act.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Union Carbide India Ltd. v. Commissioner Of Income-Tax, West Bengal-III, [1981] 130 ITR 351	Held that where, at repayment of a loan obtained to purchase a capital asset, an assessee has to provide an extra amount in rupees due to fluctuation in the rate of exchange, such additional expenditure is on capital account and must be added to the actual cost for purposes such as granting development rebate (section 43A(2) interpretation; Division Bench dissented from Madras HC view).	The Court stated it is bound by this decision and applied its principle to hold that additional liability on repayment (due to fluctuation) can be capitalised and included in actual cost for allowing development rebate and related allowances.
CIT v. Bharat General and Textile Industries Ltd., [1986] 157 ITR 158	Held that there is no qualitative difference between additional expenditure arising from devaluation and that arising from fluctuation in the rate of exchange; in both situations additional liability is imposed and treated similarly for capitalisation.	The Court relied on this authority to support the proposition that fluctuation-induced liabilities, like devaluation-induced liabilities, may be capitalised when they represent additional liability on repayment.
South India Shipping Corporation Ltd. v. Addl. CIT, [1979] 116 ITR 819 (Madras High Court)	Held that section 43A(2) indicates the Legislature did not intend to take variation in the cost of acquisition arising out of devaluation of the rupee for the purpose of granting development rebate under section 33.	The Court noted this contrary view but observed that the Division Bench of this Court in Union Carbide had dissented from the Madras High Court, and this Court considered itself bound by Union Carbide rather than by the Madras decision.
Shri Shubhlaxmi Mills Ltd. v. Addl. CIT, [1989] 177 ITR 193 (Supreme Court)	Held that to claim development rebate under section 33(1) it is obligatory that the debit entry in profit & loss account and the corresponding credit to a reserve account be made in the relevant previous year in which the machinery or plant is installed or first put to use; mere book entries suffice but must be made before profit & loss account is finally drawn up.	The Court recognized that the Supreme Court had imposed a strict requirement as to timing of reserve creation. However, the Court also noted that subsequent legislative amendments (Finance Act, 1990) retrospectively altered the statutory position, effectively superseding the effect of the Shri Shubhlaxmi Mills decision in relation to section 32A.
Bharatiya Vehicles & Engineering Co. Ltd. v. Union of India (S.L.P. Civil Nos. 11925 & 11926 of 1989) — order cited	Referenced in relation to litigation on the timing and permissibility of creating reserves for investment allowance where the assessee had incurred losses in earlier years.	The opinion records procedural steps in that matter (grant of notice for final disposal, special leave, listing before a larger bench) and uses it to illustrate contemporaneous judicial consideration of reserve-creation issues; no substantive legal holding from that SLP is applied beyond what the opinion reports.

Court's Reasoning and Analysis

The Court's reasoning proceeded in a sequence rooted in statutory interpretation and precedent application. The principal steps of the Court's analysis, as reflected in the opinion, are:

Distinction between "devaluation" and "fluctuation": the Court explained that devaluation is a reduction in the value of a currency or monetary unit, whereas fluctuation denotes day-to-day changes in the exchange rate. The Court emphasized that day-to-day fluctuation does not by itself determine liability; the "crucial day" is the date of repayment of the foreign currency loan.
Date of ascertainment of additional liability: the Court held it is necessary in each case to ascertain whether additional liability was in fact incurred on the date of repayment (or payment of instalment). Only if additional liability is incurred on that date because of the rate of conversion will that liability be capitalised and added to the cost of the capital asset, thereby attracting depreciation and investment allowance.
Application of section 43A (Income-tax Act, 1951): the Court referred to the provisions of section 43A as applicable where an assessee acquires a capital asset from abroad on credit or loan and the rate of exchange changes causing increase or reduction in the liability in Indian currency; in such events the original actual cost must be increased or reduced accordingly for tax purposes.
Reliance on Union Carbide and related authorities: the Court observed that Union Carbide (Division Bench of this Court) and Bharat General had held that additional liability on repayment due to exchange variation is capital in nature and forms part of actual cost. The Court felt itself bound by Union Carbide and consequently accepted the capitalisation principle for fluctuation-linked additional liabilities.
Consequence of treating fluctuation-linked additional liability as business deduction: the Court noted a converse risk—if such an additional liability arising at conversion were treated as a revenue expenditure (allowed as a deduction in the course of carrying on business), then adding it to cost for depreciation/investment allowance would not arise. That supported the need to determine the character of the liability (capital v. revenue) by reference to the date and nature of the liability.
On creation of investment allowance reserve (section 32A(4)(ii)): the Court analysed the statutory requirement that an "investment allowance reserve" equal to 75% of the amount of investment allowance actually allowed must be created by debiting the profit and loss account of a relevant previous year and crediting a reserve account. The Court considered the effect of the Supreme Court decision in Shri Shubhlaxmi Mills and the subsequent legislative amendment (Finance Act, 1990) which amended section 32A(4)(ii) retrospectively from 1 April 1976.
Effect of the Explanation to section 32A(4): the Court explained that where an assessee has transferred to the reserve account an amount not less than required on the basis of the investment allowance claimed, and the Assessing Officer proposes to make additions entitling the assessee to a larger allowance, the Explanation requires the Assessing Officer to give notice permitting the assessee to make good the deficiency in the reserve (either in the accounting year of the notice or the immediately preceding year if accounts are not finalised). This permitted the Tribunal's direction that the ITO give the assessee an opportunity to create the reserve.
Application to the present facts: since the additional liability in the present case arose subsequently (i.e., at the time of actual payment/repayment), the assessee could not have created the reserve earlier. Given the amended statutory framework and the Explanation, the Tribunal's direction for the ITO to give an opportunity to create the reserve before allowing the investment allowance was consistent with the statute and correctly directed.

Holding and Implications

Holding:

The Court answered the referred question in the following terms:

— The assessee would be entitled to investment allowance on such sum as may be found to represent any additional liability on the date of actual payment of the loan arising due to fluctuation in the rate of conversion; and

— The Income-tax Officer shall allow the assessee an opportunity of creating a reserve in respect of such additional sums eligible for investment allowance.

There was no order as to costs.

Practical implications and scope:

The direct effect for the parties in this matter is that the assessee's claim for investment allowance on exchange-fluctuation-related additional liability is recognised, subject to the factual determination of whether such additional liability existed on the date of payment; and the ITO must afford the assessee an opportunity to make good any shortfall in the investment allowance reserve as permitted by the statutory Explanation.
The Court stated it was bound by the earlier Division Bench decision in Union Carbide and applied that principle; the opinion also records that the Finance Act, 1990 amended section 32A(4)(ii) retrospectively and omitted section 32A(9), thereby modifying the statutory landscape and superseding the effect of the Supreme Court decision in Shri Shubhlaxmi Mills to the extent discussed in the opinion.
The opinion does not announce a novel legal principle beyond applying and reconciling existing decisions and the statutory amendments to the facts of the reference; it resolves the specific reference in favour of the assessee on the basis of the authorities and statutory provisions discussed.

End of summary based exclusively on the text of the provided opinion.

Show all summary ...

The Judgment of the Court was delivered by

Ajit K. Sengupta, J.:— In this reference under section 256(1) of the Income-tax Act, 1961, for the assessment year 1978-79, the following Question of law has been referred to this court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that the assessee was entitled to investment allowance and in directing the Income-tax Officer to give the assessee opportunity of creating a reserve before allowing the investment allowance?”

2. Shortly stated, the facts are that the assessee-company which is engaged in the manufacture of nylon yarn claimed investment allowance on a sum of Rs. 4,04,741 representing additional liability referable to acquisition of assets resulting from variation in the rate of exchange relating to the foreign loan liability which has been added to the cost of plant and machinery. The Income-tax Officer, for the reasons given in his assessment order, did not accept the assessee's claim. On appeal, the Commissioner of Income-tax (Appeals) held that the Income-tax Officer was justified in rejecting the assessee's claim as no material had been placed by the assessee before him to justify the granting of investment allowance of Rs. 4,04,741, and the assessee had not created any reserve as prescribed in the Act.

3. In the appeal filed by the assessee, the Tribunal held that the assessee was entitled to investment allowance. It directed the Income-tax Officer to give the assessee an opportunity of creating a reserve before allowing the investment allowance.

4. At the hearing before us, Mr. Bajoria, learned counsel appearing for the assessee, has contended that, in this case, additional liability was incurred due to variation in the rate of exchange relating to foreign loan liability and, in view of the several judgments of this court, such liability has to be added to the cost of acquisition of the asset and investment allowance is allowable on the additional amount of liability. He has also submitted that the Tribunal was right in directing the Income-tax Officer to give the assessee an opportunity of creating a reserve before allowing the investment allowance.

5. It cannot be disputed that this court in Union Carbide India Ltd. v. Commissioner Of Income-Tax, West Bengal-Iii, [1981] 130 ITR 351 and in CIT v. Bharat General and Textile Industries Ltd., [1986] 157 ITR 158, held that if, at the point of repayment of the loan, the assessee had to provide an extra amount in rupees by reason of the fluctuation in the rate of exchange and if such loan was obtained to purchase a capital asset, such expenditure by way of additional liability on account of fluctuation will be on capital account. It has been held in Bharat General and Textile Industries Ltd., [1986] 157 ITR 158 (Cal), that there is no qualitative difference in the additional expenditure incurred due to the devaluation or fluctuation in the rate of exchange. In both the cases, an additional liability is imposed.

6. In devaluation, there is a reduction in the value of a currency or of a standard monetary unit whereas in the case of fluctuation, there is no such reduction in the value of a currency or of a standard monetary unit; there is only fluctuation in the rate of exchange in day-to-day transactions. The day-to-day fluctuation in the rate of foreign exchange will not have any bearing on the liability as such. The crucial day is the date of repayment of the loan obtained for the purpose of acquisition of any capital asset. If a capital asset has been acquired by obtaining a loan or [by deferred payment of the purchase price, and if, on the date of repayment of the loan or payment of any instalment of purchase price, any additional liability is imposed because of fluctuation in the rate of exchange, the assessee will be entitled to capitalise such liability.

7. It is common knowledge that the rate of exchange fluctuates every day depending on the conditions prevailing in the International Monetary Market but such fluctuation in conversion cannot be taken into account unless, at the time of actual payment of the liability in foreign currency, there has been, in fact, an additional liability. It is, therefore, necessary to ascertain in every case whether the assessee incurred any additional liability on the date of repayment or not. Only if any additional liability is incurred on the date of repayment due to change in the rate of conversion, such liability will be added to the cost of the capital asset and benefit of depreciation and investment allowance will be allowed on such added cost. The provisions of section 43A of the Income-tax Act, 1951, would apply in a case where an assessee has acquired any capital asset from abroad for the purpose of his business or profession, on credit or on deferred payment terms, or against a loan in foreign currency, and the whole or a part of the cost of such asset or of the loan in foreign currency is outstanding as on the date on which there is a change in the rate of exchange of currency. In such a case, where, in consequence of the change in the rate of exchange of currency, there is an increase or reduction in the assessee's liability as expressed in Indian currency for payment of the whole or a part of the cost of the asset or of the loan in foreign currency, the original actual cost, to the assessee of the machinery or plant or other capital asset, is required to be increased or reduced, as the case may be. A contention was raised as to whether, for the purpose of determining the actual cost of an asset on which depreciation allowance is admissible and also its written down value, depreciation allowance alone or depreciation as well as development rebate would be calculated with reference to the actual cost of the asset so increased or reduced. In Union Carbide India Ltd., [1981] 130 ITR 351, a Division Bench of this court has dissented from the view taken by the Madras High Court in South India Shipping Corporation Ltd. v. Addl. CIT, [1979] 116 ITR 819. There, the Division Bench of this court held that section 43A(2) only excludes the provisions of section 43A(1). Thus, where the contract itself stipulates repayment in foreign currency, the actual cost of the asset must be computed on the value of the foreign currency. Therefore, anything which goes into that repayment, that is to say, any cost (due to change in the value of foreign currency) which actually goes in repaying the debt, must form part of “actual cost”, as contemplated by section 43(1), for the purpose of granting development rebate.

8. The Madras High Court in South India Shipping Corporation Ltd., [1979] 116 ITR 819, however, held that, from the specific provisions of section 43A(2) (at page 825), “it is clear that the Legislature has clearly intended not to take the variation in the cost of acquisition of an asset arising out of the devaluation of the Indian rupee for the purpose of granting development rebate under section 33 of the Act. In these circumstances, the general principles, according to which the increase in the cost of the asset arising out of the devaluation of the rupee must be treated as part of the cost of the asset cannot be applied for the purpose of granting development rebate under section 33 in view of the definite provisions against it in section 43A(2)”.

9. We are bound by the aforesaid decision of this court in Union Carbide India Ltd., [1981] 130 ITR 351. It cannot be disputed that, where machinery is purchased from a foreign country on deferred payment basis or by obtaining a loan repayable in foreign currency, any additional amount payable due to periodical fluctuation in the currency rate in respect of foreign currency forms part of the actual cost for allowing development rebate. Section 43A(2) does not seem to be a bar in allowing such development rebate.

10. We may, however, add that as soon as the Indian rupee is devalued, the additional liability in terms of outstanding liability to the foreign supplier or creditor in terms of Indian currency becomes ascertained. But, in a case of fluctuation, it is only at the time of conversion of the Indian currency into foreign currency that additional liability may arise depending on the rate of conversion. If such an additional liability, in the course of conversion of the Indian currency into foreign currency, is treated as a liability arising in the course of carrying on of the business and is allowed as a deduction, the question of such liability being added to the cost of the asset and allowing depreciation or investment allowance on suchadditional liability may not arise at all.

11. The next question is with regard to the creation of the reserve for allowing the investment allowance. One of the conditions for allowance of the investment allowance as contained in section 32A(4)(ii) is that the assessee has created an “investment allowance reserve” equal to 75 per cent, of the amount of investment allowance to be actually allowed. Such a reserve is created by debiting such amount in the profit and loss account of any previous year in respect of which the deduction is to be allowed under section 32A(3) or any earlier previous year not being a previous year earlier than the year in which the ship or aircraft was acquired or the machinery or plant was installed or the ship, aircraft, machinery or plant was first put to use and crediting the same to the reserve account.

12. Our attention has also been drawn to a decision of the Supreme Court in Shri Shubhlaxmi Mills Ltd. v. Addl. CIT, [1989] 177 ITR 193, where the Supreme Court held that (headnote):

“In order to claim the deduction on account of development rebate under section 33(1) of the Income-tax Act, 1961, it is obligatory that the debit, entries in the profit and loss account and the credit entry in a reserve account should be made in the relevant previous year in which the machinery or plant is installed or first put to use. In view of the Explanation added with retrospective effect from the commencement of the Act to clause (a) of section 34(3), it is clear-that what is contemplated is the creation of a reserve fund in the relevant previous year irrespective of the result of the profit and loss account disclosed by the books of the assessee. Mere book entries will suffice for creating such a reserve fund. The debit entries and the entries relating to the reserve fund have to be made before the profit and loss account is finally drawn up. This is a condition for securing the benefit of development rebate and if the condition is not satisfied, the deduction on account of development rebate cannot be claimed at all.”

13. It appears that in Bharatiya Vehicles and Engineering Co. Ltd. v. Union of India (S.L.P Civil Nos. 11925 and 11926 of 1989: [1990] 181 ITR (St.) 7-8 (SC), the Supreme Court has, by an order dated November 6, 1989, directed the issue of a notice for final disposal at the notice stage itself, in a special leave petition by the assessee against the order dated June 27, 1989. as modified by the order dated August 27, 1989, of the Assistant Commissioner of Income-tax, Special Circle I(i), New Delhi. The assessee in that case had suffered loss and, therefore, could not create a reserve and, therefore, investment allowance under section 32A of the Income-tax Act, 1961, was not allowed for the assessment years 1986-87 and 1987-88, although the plant and machinery were installed and put to use during 1986-87. In 1988-89, the assessee had a profit and created a reserve of 75 per cent, of the investment allowance which was allowed in its entirety for that year. Subsequent to the decision of the Supreme Court in Shri Shubhlaxmi Mills Ltd., [1989] 177 ITR 193, the entire investment allowance was withdrawn by way of rectification. The assessee came up by way of a special leave petition against the order of rectification contending that (i) it would be futile to proceed by way of appeal and reference since the authorities and the High Court would feel bound by [1989] 177 ITR 193; (ii) that the words “75 per cent, of the investment allowance actually allowed” in section 32A(4)(ii) meant that the reserve had to be created in the year when the investment allowance was to be allowed and not in any other year where, due to loss, the investment allowance was not allowed; and (iii) that, to this extent, the decision in Shri Shubhlaxmi Mills Ltd., [1989] 177 ITR 193, needed reconsideration. Thereafter, the Supreme Court, by an order dated March 19, 1990, has granted special leave and directed the resultant appeal to be listed before a larger Bench of three judges (see [1990] 182 ITR (St.) 411).

14. The Finance Act, 1990, has amended section 32A(ii) retrospectively from April 1, 1976, i.e, from the assessment year 1976-77. It provides that the investment allowance reserve account for an amount equal to 75 per cent, of the investment allowance to be actually allowed is to be created by debiting such amount to the profit and loss account of any previous year in respect of which the deduction is to be allowed under section 32A(3) or any earlier previous year not being a previous year earlier than the year in which the ship or aircraft was acquired or the machinery or plant was installed or the ship, aircraft, machinery or plant was first put to use.

15. As a result of the amendment made in section 32A(4)(ii) by the Act, 1990, with retrospective effect from April 1, 1976, and the omission of section 32A(9) by that Act, also with effect from that date, the effect of the Supreme Court decision in Shri Shubhlaxmi Mills Ltd., [1989] 177 ITR 193, has statutorily been superseded. The net effect of such amendments is that the condition of creation of investment allowance reserve even in a year of loss on the analogy of the principle laid down by the Supreme Court in Shri Shubhlaxmi Mills Ltd., [1989] 177 ITR 193, will not be mandatory retrospectively for and from the assessment year 1976-77. As a result of such amendments, such reserve can be created in any previous year in respect of which the deduction is to be allowed under section 32A(3) or any earlier previous year not being a previous year earlier than the year in which the ship or aircraft was acquired or the machinery or plant was installed or the ship, aircraft, machinery or plant was first put to use.

16. In this case, the assessee could not make the reserve as required in view of the fact that additional liability arose subsequently. But, in view of the provisions contained in section 32A(4)(ii), where the amount transferred by the assessee to the investment allowance reserve account is not less than the amount required to be so transferred on the basis of the amount of investment allowance claimed in the return of income, and the Assessing Officer proposes to make some additions (other than as a result of the invoking of the first proviso to section 145(1), or section 145(2), or any concealment of income) entitling the assessee to a larger amount of investment allowance than claimed, the Explanation to section 32A(4) enjoins upon the Assessing Officer to afford an opportunity to the assessee by a notice in writing to make good the deficiency in the Reserve. In such a case, the assessee may make good the deficiency by transferring the deficit amount, in the accounting year the assessee gets the notice (or in the immediately preceding year if the accounts for that, year have not been finalised), to the reserve account. On so doing, the assessee shall be entitled to get allowance for the larger than claimed allowance.

17. In this case, as we have already indicated, the Tribunal has directed the Income-tax Officer to give an opportunity to the assessee for creating the reserve before allowing the investment allowance. We do not find any infirmity in such a direction in view of the provisions of the Act as discussed hereinbefore.

18. For the reasons aforesaid, we answer the question in this reference by saying that the assessee would be entitled to investment allowance on such sum as may be found to represent any additional liability on the date of actual payment of the loan arising due to fluctuation in the rate of conversion and the Income-tax Officer shall allow the assessee an opportunity of creating a reserve in respect of such additional sums eligible for investment allowance. There will be no order as to costs.

Shyamal Kumar Sen, J.:— I agree.