IN THE HIGH COURT OF GUJARAT AT AHMEDABAD INCOME TAX REFERENCE No 227 of 1985 For Approval and Signature: Hon'ble MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE KUNDAN SINGH ============================================================ 1. Whether Reporters of Local Papers may be allowed to see the judgements? 2. To be referred to the Reporter or not? 3. Whether Their Lordships wish to see the fair copy of the judgement? 4. Whether this case involves a substantial question of law as to the interpretation of the Constitution of India, 1950 of any Order made thereunder? 5. Whether it is to be circulated to the Civil Judge? -------------------------------------------------------------- COMMISSIONER OF INCOME-TAX Versus WINDSOR FOODS LTD. -------------------------------------------------------------- Appearance: MR MIHIR JOSHI, Advocate for the Revenue - Appellant MR RK PATEL with MR B.D. KARIA, Advocates for the assessee - Respondent -------------------------------------------------------------- CORAM : MR.JUSTICE R.K.ABICHANDANI and MR.JUSTICE KUNDAN SINGH Date of decision: 05/03/98 ORAL JUDGEMENT (Per R.K.Abichandani,J.) The Income Tax Appellate Tribunal has referred the following three questions for the opinion of this Court under Section 256(1) of the Income Tax Act, 1961:- At the instance of the Revenue: 1. "Whether on the facts and in the circumstances of the case and in law the Tribunal was right in coming to the conclusion that the assessee was entitled to investment allowance on the amount of Rs. 80,414/- being the additional liability arising due to fluctuation in foreign exchange rate in respect of the payment of outstanding instalments of machinery?" 2. "Whether on the facts and in the circumstances of the case and in law the Tribunal was right in coming to the conclusion that the assessee was entitled to deduction under Section 35B of Rs. 14,105/- for packing credit?" At the instance of the Assessee: 3. "Whether on the facts and in the circumstances of the case and in law the Tribunal was right in holding that the additional liability on account of exchange fluctuations in repayment of foreign exchange loans from financial institution for purchase of machinery was not revenue expenditure?" The assessee company filed return of income on 30th August, 1980, in respect of the Assessment Year 1980-81, in response to the notice under Section 143(2) of the said Act. The company had claimed a loss of Rs. 80,414/- on account of exchange fluctuation of repayment of foreign exchange loans obtained from the financial institutions for the purchase of machinery. According to the assessee, the said expenditure was incurred not on acquisition of the asset, but on repayment of loan and was therefore, allowable as a revenue expenditure. According to the assessee, the provisions of Section 43A were therefore, not applicable. The Assessing Officer negatived this contention and relying upon the decision of the Hon'ble Supreme Court in Satlej Cotton Mills Ltd. Vs. CIT, reported in 116 ITR 137, held that the loss on account of exchange rate fluctuation in the instant case, was referable to capital asset and hence, cannot be allowed as a revenue loss. The assessee had put up an alternative contention that if the said amount of Rs. 80,414/- was to be treated as capital expenditure, then investment allowance should be granted on it under Section 32A of the Act. The ITO held that no such investment allowance could be granted on the said amount because an investment allowance can be granted if the machinery is installed or put to use during the year under consideration. As the machineries were installed much earlier than the previous year of 1979-80, the claim of the assessee could not be accepted, according to the ITO. Therefore, the said amount was added to the total income of the assessee. The assessee had claimed a weighted deduction under Section 35B of the Act on interest amount of Rs. 14,105/- on packing credit. The ITO however, rejected that claim for weighted deduction. In the appeal the CIT (Appeals) also held that the additional liability of Rs. 80,414/- that had arisen due to fluctuations in the foreign exchange rate, was relatable to the acquisition of the capital asset and hence, it was not allowable as a revenue item. As regard the alternative claim for investment allowance on the said additional liability, it was held that the basic condition laid down for availability of investment allowance was not satisfied in the said previous year because the relevant plant and machinery were installed and put to use long ago and it is only in that earlier previous year that the investment allowance was available to the assessee. The alternative plea was therefore, rejected. As regards weighted deduction under Section 35B on the amount of interest on packing credit (which was shown as Rs. 18,807/- in the order of the ITO and the appellate order), the appellate Authority held that the weighted deduction under Section 35B should be allowed on 25% claimed on interest on packing credit. In the further appeal before the Tribunal, the Tribunal up-held the view of the lower authorities that the additional liability of Rs. 80,414/- on account of exchange fluctuations in repayment of foreign exchange loans taken for purchase of machinery, was not a revenue expenditure and that it was capital expenditure. It however, held that the final cost of the plant and machinery could be determined only after the last instalment of the repayment of loan was paid because only by that time the actual payment in Indian currency in respect of the cost of machinery purchased on the basis of foreign currency can be ascertained. It was held that the investment allowance if granted in the first year of use on the basis of the conversion of the foreign currency into Indian currency at the then prevailing exchange rate, would require modification on the basis of the correct cost determined finally and looking at the matter from this angle, the additional liability incurred by the assessee was nothing, but a part of the cost of the plant and machinery, which was required to be varied because of the method of adopting cost of machinery arrived at on the basis of the then prevailing exchange rate. It was therefore held that the additional liability should be treated as a part of the cost of machinery entitled to investment allowance in the year in which the additional liability was incurred because of the fluctuation in the exchange rate, irrespective of the fact that the machineries were installed in the past previous year. The ITO was therefore, directed to modify the assessment accordingly on this count. As regards the claim of deduction under Section 35B for interest on packing credit, the Tribunal following the earlier decision of the Tribunal in the case of Adydee Corporation, accepted the assessee's claim. 2. Question No.2 The assessee's claim under Section 35B for weighted deduction in respect of the interest amount on packing credit cannot be sustained in view of the decision of this Court in CIT Vs. Jay Industries, reported in 196 ITR 313 and the decision in CIT Vs. Girdharlal Vithaldas, reported in 196 ITR 316. In the latter case, an amount was claimed as weighted deduction on payment of interest on packing credit to the Bank and following the decision in Jay Industries' case (supra), the question was answered against the assessee. In Jay Industries' case, the amount was claimed in respect of certain items of expenditure including expenditure incurred by the assessee by way of payment of interest to the Bank on packing credit. The controversy involved was confined to the interest paid to the Bank on packing credit. It was held that such expenditure by way of payment of interest to the Bank on its packing credit account did not fall under sub-clause (iii) of clause (b) of Section 35B(1) of the Act, because the expenditure was incurred by the assessee in India. It was held that the expenditure incurred in India for supply of goods outside India would not qualify for weighted deduction, as such expenditure was specifically excluded under sub-clause (iii) of Section 35B(1)(b) of the Act. It was further held that such expenditure did not fall under any one of the sub-clauses of clause (b) of Section 35B(1) and therefore, the assessee was not entitled to claim weighted deduction in respect of such expenditure. In this view of the matter, we hold that the Tribunal committed an error in coming to the conclusion that the assessee was entitled to weighted deduction under Section 35B of the Act, on the amount in question being payment of interest to the Bank on the packing credit account. The question No.2 is therefore, answered in the negative in favour of the Revenue and against the assessee. 3. Question No.3 This question has been referred at the instance of the assessee, who wants the additional liability of Rs. 80,414/- that had arisen due to fluctuation in foreign exchange rate in respect of payments of outstanding instalments of machinery, to be treated as Revenue expenditure. In Satlej Cotton Mills Ltd. (supra), the Hon'ble Supreme Court held that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss, if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature. It was held that what is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee. The said decision was rendered in context of the provisions of the Indian Income Tax Act, 1922, since the matter related to the Assessment Years 1957-58 and 1959-60. In our view, if a tax payer incurs obligations and before such obligations have been satisfied by payment there is a variation in the rate of exchange which involves him in a loss on exchange, that loss would be an allowable deduction in the year of payment if, and to the extent to which it is referable to liabilities on revenue account, but not if, and to the extent to which it is referable to liabilities of a capital nature. In the present case, the additional liability arising due to the fluctuation in the exchange rate in the previous year 1979-80 was clearly referable to liabilities of a capital nature and not to liabilities on revenue account. In the previous year in which the liability arose due to fluctuation in the exchange rate, that amount, by which the liability had increased in that previous year, was to be added in the actual cost in the asset in view of the provisions of Section 43A(1) of the Act and obviously therefore, this additional liability was of a capital nature and should never be treated on revenue account. The Tribunal was therefore right in holding that the said additional liability was not revenue expenditure. The question No.3 is therefore answered in the affirmative against the assessee and in favour of the Revenue. 4. Question No.1 There is no dispute about the fact that the machinery and plant in question were installed and put to use by the assessee many years ago and that the investment allowance which is now sought to be claimed in view of the additional liability due to fluctuation in the foreign exchange rate is not on the basis of any carried forward investment allowance. In other words, whatever investment allowance was due to be made to the assessee in that past relevant previous year when the machinery or plant were installed and put to use, were all claimed and deductions were allowed at the relevant time. The claim is therefore, confined to the additional liability of Rs. 80,414/- which had arisen in the previous year of 1979-80 due to the change in the rate of exchange in repayment of the loans which were taken by the assessee for acquiring the asset in the past. It was in this context contended on behalf of the Revenue that having regard to the scheme of allowing deductions in respect of the investment allowance under Section 32A of the Act, the investment allowance gets quantified during the relevant previous year in which the machinery or plant is installed and put to use and if not put to use in the previous year, in which it was installed, then in the year immediately succeeding that previous year in which it is put to use. It was therefore argued that there was no scope for changing the quantum of the investment allowance once it is worked out in the relevant previous year. The provisions which allow the deduction if not availed due to insufficiency of total income to be carried forward upto 8 years, contained in sub-section (3) of Section 32A, cannot be so construed as to entitle revision of investment allowance in such subsequent years. It was also contended that Section 43A(1) did not warrant any such revision of investment allowance which was already quantified in the past relevant year. The learned Counsel appearing for the assessee strongly contended that the investment allowance was to be worked out on the basis of the actual cost of the machinery or plant as provided under Section 32A. In cases where there is additional liability due to fluctuation in the exchange rate, the actual cost is to be revised and if as a result of that revision the assessee becomes entitled to a higher investment allowance, there would be no justification for denying the same in the previous year in which the additional liability had arisen. It was contended that any such additional liability arising due to fluctuation in the exchange rate which has the effect of increasing the actual cost as per Section 43A(1) must relate back to the actual cost on the basis of which the investment allowance was worked out in the past relevant previous year and the investment allowance should stand revised accordingly on the basis of the revised actual cost. The deduction in respect of such additional investment allowance should be allowed in the previous year in which additional liability arose, subject to the provisions of sub-sections (3) and (4) of Section 32A of the Act. It was further contended that in the years prior to the previous year in which the additional liability arose, the assessee could not have claimed the additional investment allowance since he could not have created a reserve in respect of such additional allowance. It was submitted that the assessee could at that time create reserve only qua the investment allowance calculated on the basis of the actual cost in the year of user. However, because of Section 43A(1), since the actual cost increases in the previous year of fluctuation, the assessee could now create a reserve having become entitled to the additional investment allowance on the increased portion of the actual cost. It was submitted that the provisions of Section 32A read with Section 43A should be liberally construed. Reliance was placed by the learned Counsel on the decision of the Karnataka High Court in CIT Vs. Widia (India) Ltd., reported in 193 ITR 475, in which it was held that the assessee was entitled to investment allowance on the cost of assets as enhanced due to fluctuations in foreign currency rates, relying upon its earlier decision in CIT Vs. Motor Industries Co.Ltd., reported in 173 ITR 374, the ratio of which, according to the Court, concluded the said question. It will be noted that the question had arisen in that earlier case with regard to the proposal to withdraw the depreciation allowance on the extra liability incurred by the assessee as a result of fluctuation in the market rate of exchange. The ratio of the decision in Motor Industries Co.Ltd.. (supra) in context of the depreciation allowance was followed by the Karnataka High Court without any discussion on the matter in Widia (India) Ltd. by holding that "the first question is covered by the decision of this Court in CIT Vs. Motor Industries Ltd.". That first question related to investment allowance and was not in respect of depreciation allowance. 5. Section 32A(1) which falls for our consideration, to the extent it is relevant in the context of the contentions raised, reads as under:- "32A. Investment allowance. (1) In respect of a ship or an aircraft or machinery or plant specified in sub-section (2) which is owned by the assessee and is wholly used for the purposes of the business carried on by him there shall, in accordance with and subject to the provisions of this section be allowed a deduction, in respect of the previous year in which the ship or aircraft was required or the machinery or plant was installed or, if the ship, aircraft, machinery or plant is first put to use in the immediately succeeding previous year, then, in respect of that previous year, of a sum by way of investment allowance equal to twenty-five per cent of the actual cost of the ship, aircraft, machinery or plant to the assessee: xxx xxx" If we analyse this provision, the following four separate aspects are reflected. Firstly, this provision identifies the ship, aircraft machinery or plant to which it applies and these are specified in sub-section (2). Therefore, the provision will apply to these specified assets only. Secondly, the provision lays down as to when it will operate in respect of such ship, aircraft, machinery or plant and provides that it would be attracted when these are owned by the assessee and wholly used for the purposes of the business carried on by the assessee. Thirdly, it provides as to how the deduction is to be worked out and lays down that the deduction will be allowed of a sum by way of investment allowance equal to 25% of the actual cost of such machinery or plant to the assessee. This quantification lays down the limit upto which the deduction of investment allowance can be allowed. Finally, the provision clearly lays down the previous year in respect of which such deduction can be allowed in accordance with and subject to the provisions of this Section, and such previous year can be the year in which the machinery or plant which is owned by the assessee and is wholly used for the purposes of the business carried on by him, was installed or if the machinery or plant is first put to use in the immediate succeeding previous year, then that previous year. It is thus, clear that the amount of investment allowance equal to twentyfive per cent of the actual cost of the machinery or plant gets quantified in the relevant previous year in which such machinery or plant was installed and put to use. The investment allowance so fixed would be allowed as a deduction in the previous year in which the machinery or plant is installed, provided the same is used for the purpose of business in the year of installation. However, if the machinery or plant is first put to use in the immediate succeeding previous year, the investment allowance would be allowed in such previous year. If the machinery or plant is first put to use later than the previous year immediately succeeding the previous year of its installation, the right to claim the investment allowance would be completely lost. In that sense the investment allowance to which the assessee can be entitled under Section 32A is one time allowance and it is not an allowance which is recurring - that is to say, an allowance which is required to be calculated year after year. Therefore, the actual cost of machinery or plant in the previous year in which it is installed and first put to use, would be the basis of working out the investment allowance at an amount equal to 25% of that actual cost. The amount of investment allowance so worked would get crystalised in that year and thereafter the only question that remains is whether the investment allowance which is so worked out and to which the assessee is entitled for claiming deduction, should be actually allowed by way of deduction. As noted above, Section 32A(1) provides that the deduction should be allowed in accordance with and subject to the provisions of Section 32A. That would happen only after the investment allowance admissible to the assessee is worked out on the basis of the actual cost at 25% thereof. The conditions laid down in sub-section (4) have also to be satisfied before such deduction is allowed and one of the important conditions is that of creation of a reserve account by the assessee. The assessee who has sufficient total income, can be allowed deduction of the full amount of investment allowance in the very first year of his entitlement, namely in the first previous year in which the machinery or plant was put to use. However, if there is no sufficient total income and the deduction cannot therefore be actually allowed in that previous year, sub-section (3) of Section 32A enables the assessee to carry forward the investment allowance and claim deduction in the next assessment year, if there is sufficient total income from which such deduction can be allowed. It will be seen from the provisions of sub-section (3) of Section 32A that the basis of allowing the deduction is the full amount of investment allowance which is already quantified during the relevant previous year on the basis of the actual cost to the assessee of the machinery or plant in that year, when it was installed and put to use. If the total income is sufficient to absorb the deduction of the allowance and the condition regarding creation of the reserve is satisfied by the assessee, then the deduction would be allowed in that assessment year. Every time the question arises under sub-section (3) of Section 32A of allowing the deduction out of full amount of the investment allowance or the remaining part thereof depending upon the total income available, the question of creation of reserve would go hand in hand with it as a condition of allowing the deduction of the investment allowance in that assessment year. Under sub-section (4) of Section 32A, an assessee can be allowed deduction only if an amount equal to 75% of the investment allowance to be actually allowed is debited to the profit and loss account of any previous year in respect of which the deduction is to be allowed under sub-section (3) or any earlier previous year being a previous year not earlier than the year in which the machinery or plant was installed or was first put to use, and credited to a reserve account to be utilised as indicated therein. From the wordings of this provision, it is sought to be contended that the full investment allowance already quantified in the relevant previous year was to be worked out afresh for the purpose of creating a reserve in subsequent years. Such a construction of sub-clause (ii) of sub-section (4) of Section 32A is not at all warranted. If in the relevant previous year there is no total income or no sufficient total income to cover up the full investment allowance and consequently no reserve can be created, there would arise no question of allowing any deduction in that initial previous year of the full amount of investment allowance. In the next succeeding year if there is a total income then, to the extent it can cover up the investment allowance out of the full amount of investment allowance or its remaining part, and a reserve can be created, the investment allowance would be actually allowed in that assessment year and the balance of the investment allowance if any still outstanding after that exercise, will