"Loan Transaction Between Assessee and Commonwealth Development Corporation Essential for Assessee's Financing Business Operations"

1.The appeal in question contests the judgement and order issued on 2.4.2008 by the High Court of Karnataka. The appellant company claimed a loss of income due to currency exchange fluctuation, which was not accepted during the assessment process.

2.In the appeal to the ITAT, the appellant sought a deduction for this loss and also introduced a new claim for revenue expenses erroneously capitalised in their returns. The ITAT accepted this new claim and decided that the loss suffered by the appellant due to currency exchange fluctuation should be considered revenue expenditure and therefore an allowable deduction.

3.The Department appealed against this decision at the High Court, which then reversed the decision of the ITAT, citing insufficient reasoning and a lack of basis for the conclusion.

4.The appellant borrowed money from the Commonwealth Development Corporation in the UK for the purpose of expanding its business of leasing and hire purchasing of capital equipment to existing Indian enterprises. The loan, which was in foreign currency, resulted in a higher repayment due to the fluctuation in the exchange rate, causing a loss to the appellant. This transaction was considered an independent business activity by the appellant.

The case presents a dispute regarding the nature of the loss due to exchange fluctuation as either a capital or revenue expenditure.

This legal document discusses a dispute involving an appellant (a party appealing a decision) and the Commonwealth Development Corporation. The dispute pertains to the nature of a loan transaction that occurred between them.

The appellant, in its business of financing, borrowed money from the Commonwealth Development Corporation, which wasn't for the creation or acquisition of an asset from outside India for the purpose of its business. The appellant argues that this expenditure is a deductible one, citing Section 37 (of Income Tax Act, 1961). This section seems to concern expenses that are wholly and exclusively for business purposes.

The Income Tax Appellate Tribunal (ITAT) had ruled in favor of the appellant, allowing the entire expenditure or loss connected with the transaction to be deductible. The ITAT had relied on previous decisions from the Indian Supreme Court, specifically India Cements Ltd. vs. Commissioner of Income Tax, Madras and Empire Jute Co. Ltd. vs. Commissioner of Income Tax. These cases touched upon the nature of an outgoing, the loan not being an asset, the act of borrowing, and the classification of the expenditure.

The High Court, however, had not considered these aspects in their decision. The document critiques this oversight, arguing that these considerations were essential to the context of the case.

The Assistant Solicitor General, representing the department, argued against allowing the appellant to claim the entire expenditure as revenue expenditure. He stated that the appellant had made a conscious plea in its return regarding the expenditure being part capital and part revenue, and should not be allowed to change its stance.

However, this argument was rejected by the court, which allowed the appellant to treat the amount declared as capital expenditure in the returns as revenue expenditure. The court clarified that such a fresh claim could be entertained by the ITAT, as per the court's ruling in National Thermal Power Co. Ltd., even if it is raised for the first time before the ITAT.

The court finally ruled in favor of the appellant, overturning the High Court's decision and restoring the ITAT's judgment. As a result, the entire claim of Rs.3,56,57,727 was to be considered revenue expenditure, and the final assessment order was to be adjusted accordingly. The court further ruled that any benefits, such as depreciation related to the stated amount towards exchange fluctuation related to leased assets capitalised (being Rs.2,46,04,418), were to be treated as unavailable and non-existent.

Please note that this is a simplification of the complex legal arguments presented in the document and should not be used as a source of legal advice.

1. This appeal takes exception to the judgment and order dated 2.4.2008 passed by the Division Bench of the High Court of Karnataka at Bengaluru in I.T.A. No. 633/2004.

2. Briefly stated, the appellant company submitted returns of income on 29.11.1997 for the assessment year 1997­1998, mentioning loss of income, amongst others, owing to exchange fluctuation of Rs.1,10,53,909/­. After processing the return under Section 143(1)(a) (of Income Tax Act, 1961)1, the assessment was completed on 16.3.2000. As against the loss declared by the appellant due to exchange fluctuation, the assessment was concluded by

positive taxable income. Against that decision, the matter was carried in appeal by the appellant before the Commissioner of Income Tax (Appeals)2 and eventually, by way of appeal before the Income Tax Appellate Tribunal being I.T.A. No. 795 (Bang)/2000.

3. In the appeal before the ITAT, the appellant not only claimed

deduction in respect of loss of Rs.1,10,53,909/­ arising on account of

exchange fluctuation, but also set up a fresh claim in respect of

revenue expenses to the tune of Rs.2,46,04,418/­, erroneously

capitalised in the returns. The ITAT entertained this fresh claim set

forth by the appellant and recorded in its judgment that the

department’s representative had no objection in that regard.

Additionally, the ITAT adverted to the decision of this Court in

National Thermal Power Co. Ltd. vs. Commissioner of Income

Tax in support, for entertaining fresh claim of the appellant in

exercise of powers under Section 254 of the Income Tax Act, 1961. The ITAT, in

the first place, reversed the finding given by CIT(A) regarding

application of Section 43A of the Income Tax Act, 1961. The ITAT opined that the

said provision had no application to the fact situation of the present

case. Having said that, it then proceeded to consider the question

whether the loss suffered by the appellant owing to exchange

fluctuation can be regarded as revenue expenditure or capital

expenditure incurred by the appellant, and answered the same in

favour of the appellant by holding that it would be a case of

expenditure on revenue account and an allowable deduction. The

ITAT answered the same in the following words: ­

“... So far as the argument whether the impugned

expenditure or loss is revenue or capital in nature we find

that the funds borrowed were utilised for the purposes of

regular finance business carried on by the assessee. Such an

income has also been offered for taxation and accepted by the

department. Quantification of exchange fluctuation loss has

been done as per rule 115 (of Income Tax Rules, 1962). Said rule must be

applied in computing the total income of the assessee had

held by the Supreme Court in CIT vs. Chowgule Co Ltd. – 218

ITR 384. Further the exchange fluctuation loss is an

expenditure incidental to carrying on of business and

comes within the purview of section 37 (of Income Tax Act, 1961) as the

same is incurred wholly and exclusively for the purposes

of business. It is nobody’s case that the funds borrowed

in foreign exchange have been diverted for non­business

purposes. In such a case the decision of the Supreme Court

in India Cement Case (supra) fully covers the issue in favour

of the assessee. We also find that in this case, assessee’s

claim satisfies all the tests laid down by Supreme Court in

124 ITR 1 extracted supra. In this case entire borrowal of

loan and the utilisation of the same, is in trading operations

of the company more profitably and the fixed capital in this

case is untouched. Hence the expenditure is on revenue

account and allowable.

We also find the loss incurred by the assessee cannot be

treated as contingent in nature as the loss on account of

foreign exchange fluctuation has been quantified in terms of

rule 115 (of Income Tax Rules, 1962) and further the liability is real as per

terms of the agreement with CDC. Just because the liability

is payable in future does not covert the actual liability into

contingent liability as held by the Supreme Court in Calcutta

Co Ltd. vs. CIT – 37 ITR 1 and Bharat Earth Movers Ltd. vs.

CIT – 245 ITR 428. Similar view has been expressed by ITAT

special bench in ONGC case 83 ITR 51 (SB). Looking from

any angle the claim on this issue is allowable. Accordingly,

we allow the entire claim of Rs.3,56,57,727/­. We direct the

AO to do so. This issue is held in favour of the assessee.”

(emphasis supplied)

4. The matter was carried before the High Court by the department.

Amongst others, following questions were formulated for consideration

as substantial questions of law concerning subject deduction claimed

by the appellant. The same read thus: ­

“(3) Whether on facts and in the circumstances of the case,

the Tribunal is justified in deleting the dis­allowance of claim

to the tune of Rs.1,10,53,509/­ for the assessment year

1997­98 in respect of exchange fluctuation that was made by

the Assessing Officer? (in ITA No. 633/2004 only).

(4) Whether on facts and in the circumstances of the case,

the Tribunal is justified in allowing the additional claim of

Rs.2,46,04,418.00 for the assessment year 1997­98 holding

that the capitalisation of the said sum is to be treated as

revenue expenses? (in ITA No. 633/04 only).”

The High Court vide impugned judgment has reversed the view taken

by the ITAT, mainly observing that the ITAT had not recorded

sufficient reasons in support of its conclusion and in any case, the

conclusion was without any basis.

5. We have heard Mr. S. Ganesh, learned senior counsel for the

appellant and Mr. Vikramjit Banerjee, learned Additional Solicitor

General appearing for the respondent.

6. The broad undisputed relevant facts, as can be culled out from

the record are that the appellant entered into a loan agreement with

one Commonwealth Development Corporation having its registered

office at England in the United Kingdom, for borrowing amount to

carry on its project described in Schedule 1 to the agreement ­ for

expanding its primary business of leasing and hire purchase of capital

equipment to existing Indian enterprises. Schedule 1 of the agreement

reads thus: ­

“SCHEDULE 1 (referred to in Recital A) Description of the Project

The Project consists of the financing by the Company of the

acquisition of plant, machinery and equipment to be used in

its leasing business in accordance with the applicable laws

and regulations of India and the Company’s Memorandum

and Articles of Association.”

The loan was obtained in foreign currency (5 million pounds sterling).

However, while repaying the loan, due to the difference of rate of

foreign exchange, the appellant had to pay higher amount, resulting in

loss to the appellant. Indeed, the loan amount was utilised by the

appellant for financing the existing Indian enterprises for procurement

of capital equipment on hire purchase or lease basis. The fact

remains that the activity of financing by the appellant to the existing

Indian enterprises for procurement or acquisition of plant, machinery

and equipment on leasing and hire purchase basis, is an independent

transaction or activity being the business of the appellant.

7. As regards, the transaction of loan between the appellant and

Commonwealth Development Corporation, the same was in the nature

of borrowing money by the appellant, which was necessary for

carrying on its business of financing. It was certainly not for creation

of asset of the appellant as such or acquisition of asset from a country

outside India for the purpose of its business. In such a scenario, the

appellant would be justified in availing deduction of entire expenditure

or loss suffered by it in connection with such a transaction in terms of

Section 37 (of Income Tax Act, 1961). For, the loan is wholly and exclusively used for

the purpose of business of financing the existing Indian enterprises,

who in turn, had to acquire plant, machinery and equipment to be

used by them. It is a different matter that they may do so because of

the leasing and hire purchase agreement with the appellant. That

would be, nevertheless, an activity concerning the business of the

appellant. In that view of the matter, the ITAT was right in answering

the claim of the appellant in the affirmative, relaying on the dictum of

this Court in India Cements Ltd. vs. Commissioner of Income Tax,

Madras. The exposition in this decision has been elaborated in the

subsequent decision of this Court in Empire Jute Co. Ltd. vs.

Commissioner of Income Tax.

8. The ITAT has extracted the relevant portion of the decision in

India Cements Ltd., which reads thus: ­

“7. where there is no express prohibition, an outgoing, by

means of which an assessee procures the use of a thing by

which it makes a profit, is deductible from the receipts of the

business to ascertain taxable income.

16. the loan obtained is not an asset or advantage of an

enduring nature the expenditure was made for securing

the use of money for a certain period and it is irrelevant to

consider the object with which the loan was obtained.

17. the act of borrowing money was not incidental to

the carrying on of a business.”

Similarly, the exposition in the case of Empire Jute Co. Ltd.8

is also extracted by the ITAT, which reads thus: ­

“5. it is not a universally true proposition that what may

be capital receipt in the hands of the payee must necessarily

be capital expenditure in relation to the payer. The fact that a

certain payment constitutes income or capital receipt in the

hands of the recipient is not material in determining whether

the payment is revenue or capital disbursement qua the

payer.

8. There may be cases where expenditure, even if

incurred for obtaining advantage of enduring benefit, may,

nonetheless, be on revenue account and the test of enduring

benefit may break down. It is not every advantage of enduring

nature, acquired by an assessee that brings the case within

the principle laid down in this test. What is material to

consider is the nature of the advantage in a commercial

sense and it is only where the advantage is in the capital

field that the expenditure would be disallowable on an

application of this test. If the advantage consists merely

in facilitating the assessee's trading operations or

enabling the management and conduct of the assessee's

business to be carried on more efficiently or more

profitably while leaving the fixed capital untouched, the

expenditure would be on revenue account, even though

the advantage may endure for an indefinite future. The

test of enduring benefit is therefore not a certain or

conclusive test and it cannot be applied blindly and

mechanically without regard to the particular facts and

circumstances of a given case.

11. “What is an outgoing of capital and what is an

outgoing on account of revenue depends on what the

expenditure is calculated to effect from a practical and

business point of view rather than upon the juristic

classification of the legal rights, if any, secured, employed or

exhausted is the process.”

The question must be viewed in the larger context of

business necessity or expediency. .....”

(emphasis supplied)

9. A priori, we are of the considered opinion that the analysis done

by the ITAT and the conclusion arrived at in respect of the subject

claim of the appellant being the correct approach consistent with the

exposition of this Court, needs to be upheld. In our opinion, the High

Court missed the relevant aspects of the analysis of the ITAT

concerning the fact situation of the present case. As a matter of fact,

the High Court has not even adverted to the aforementioned reported

decisions, much less its usefulness in the present case.

10. The learned ASG appearing for the department had faintly argued

that since the appellant in its return had taken a conscious explicit

plea with regard to the part of the claim being ascribable to capital

expenditure and partly to revenue expenditure, it was not open for the

appellant to plead for the first time before the ITAT that the entire

claim must be treated as revenue expenditure. Further, it was not

open to the ITAT to entertain such fresh claim for the first time. This

submission needs to be stated to be rejected. In the first place, the

ITAT was conscious about the fact that this claim was set up by the

appellant for the first time before it, and was clearly inconsistent and

contrary to the stand taken in the return filed by the appellant for the

concerned assessment year including the notings made by the officials

of the appellant. Yet, the ITAT entertained the claim as permissible,

even though for the first time before the ITAT, in appeal under Section

254 of the 1961 Act, by relying on the dictum of this Court in

National Thermal Power Co. Ltd.. Further, the ITAT has also

expressly recorded the no objection given by the representative of the

department, allowing the appellant to set up the fresh claim to treat

the amount declared as capital expenditure in the returns (as

originally filed), as revenue expenditure. As a result, the objection

now taken by the department cannot be countenanced.

11. Learned ASG had placed reliance on the decision of this Court in

Goetze (India) Ltd. vs. Commissioner of Income Tax10 in support of

the objection pressed before us that it is not open to entertain fresh

claim before the ITAT. According to him, the decision in National

Thermal Power Co. Ltd.11 merely permits raising of a new ground

concerning the claim already mentioned in the returns and not an

inconsistent or contrary plea or a new claim. We are not impressed by

this argument. For, the observations in the decision in Goetze (India)

Ltd.12 itself make it amply clear that such limitation would apply to

the “assessing authority”, but not impinge upon the plenary powers of

the ITAT bestowed under Section 254 (of Income Tax Act, 1961). In other words, this

decision is of no avail to the department.

12. Learned counsel for the department had also relied on the

decision of this Court in Assistant Commissioner of Income Tax,

Vadodara vs. Elecon Engineering Company Limited13. This

decision is on the question of application of Section 43A (of Income Tax Act, 1961)

Act. Accordingly, the exposition in this decision will be of no avail to

the fact situation of the present case. For, we have already noticed

that the appellant had not acquired any asset from any country

outside India for the purpose of his business.

13. In view of the above, this appeal ought to succeed. The

impugned judgment and order of the High Court needs to be set aside

and instead, the decision of the ITAT dated 3.6.2004 in favour of the

appellant on the two questions examined by the High Court in the

impugned judgment, needs to be affirmed and restored. We order

accordingly.

14. As a result of allowing the entire claim of the appellant to the

tune of Rs.3,56,57,727/­ being revenue expenditure, suitable amends

will have to be effected in the final assessment order passed by the

assessing officer for the concerned assessment year, thereby treating

the consequential benefits such as depreciation availed by the

appellant­assessee in relation to the stated amount towards exchange

fluctuation related to leased assets capitalised (being

Rs.2,46,04,418/­), as unavailable and non­est.

15. The appeal is allowed in the above terms with no order as to

costs.

Pending interlocutory applications, if any, stand disposed of.

(A.M. Khanwilkar)

(Abhay S. Oka)

(C.T. Ravikumar)

New Delhi;

April 12, 2022.