Case: Assst. C.I.T., Vadodara Vs. Elecon Engineering Co. Ltd

Assessee is a manufacturing company. It manufactures gears and mechanical handling equipments. It procured a foreign currency loan for expansion of existing business. Since the repayment of loan was stipulated in instalments, assessee desired to ensure that foreign currency required for repayment of the loan be obtained at a pre-determined rate and cost. Accordingly, the assessee booked forward contracts with Citibank for delivery of the required foreign currency on the stipulated dates. The contract was entered into for entire outstanding amount and the delivery of foreign currency was obtained under the contract for instalment due from time to time. The balance value of the contract, after deducting the amount withdrawn towards repayment, was rolled over for a further period up to the date of the next instalment. Assessee filed its return of income for assessment year 1986-87 on 30.6.1986. A revised return was filed by it on 27.3.1989 declaring a total income of Rs.2,10,08,640/-. The A.O. disallowed an amount of Rs.8,86,280/-, being the roll over premium charges paid by the assessee in respect of foreign exchange forward contracts to Citibank N.A. on the ground that the said charges were incurred in connection with the purchase of a capital asset (plant and machinery), hence, it was not admissible for deduction under Section 36(1)(iii) or under Section 37 of the Act. On appeal, the CIT (A) held that the roll over premium charge(s) incurred by the assessee was allowable as it was incurred by the assessee to mitigate the risk involved in higher payment because of adverse fluctuation of rate of exchange. According to CIT (A), roll over premium charge(s) constituted an expenditure incurred for raising loans on revenue account, hence, the said expenditure was allowable under the Act. It may be noted that CIT (A) did not refer to a specific section under which assessee was entitled to such deduction. The CIT(A) did not examine Section 43A of the said Act. The CIT(A) relied upon the judgment of the Supreme Court in support of its findings in the case of India Cements Ltd. v. Commissioner of Income-Tax, Madras - (1966) 60 ITR 52 4. Vide order dated 21.3.2001, the Tribunal held that roll over premium charges (carry forward charges) were required to be paid to the authorized dealer as consideration for permitting the unutilized amount of the contract (balance value of the contract) to be availed of at a latter date and in the circumstances roll over premium charges had to be capitalized under Explanation 3 to Section 43A of the said Act. Consequently, the Tribunal upheld the order of the assessment5. Aggrieved by the decision of the Tribunal, the assessee filed an appeal(s) before the Gujarat High Court inter alia challenging the capitalization of the roll over charges paid in respect of foreign currency. The said appeal(s) was allowed by the High Court which came to the conclusion that the roll over premium charge(s) paid by the asssessee was in the nature of interest or committal charge(s), hence, the said charges were allowable under Section 36(1)(iii) of the said Act, hence this civil appeal(s)

Court's reasoning:
10. In the present case, one of the main arguments advanced on behalf of the assessee before us was that Section 43A was not applicable because roll over charge stood paid to avoid increase or reduction in liability as a consequence of the change in the rate of exchange. According to the assessee, Section 43A, as it stood at the material time, applied only to cases where there existed a fluctuation in the rate of exchange and since the roll over charge was paid to the authorized dealer by the assessee to avoid increase or reduction in liability on account of such fluctuation, Section 43A read with Explanation 3 thereto would not apply to such roll over charges. We find no merit in this argument advanced on behalf of the assessee. According to the assessee, the cost for carrying forward the contracted foreign currency, not immediately required for repayment, is called the roll over charge(s). As stated above, according to the assessee, Section 43A was not applicable in this case as there was no increase or reduction in liability because such roll over charges were paid to avoid increase or reduction in liability consequent upon change in the rate of exchange. To answer this submission, one needs to keep in mind that during the relevant assessment years Section 43A applied to the entire liability remaining outstanding at the year-end, and it was not restricted merely to the instalments actually paid during the year. Therefore, at the relevant time, the year-end liability of the assessee had to be looked into. Further, it cannot be said that roll over charge has nothing to do with the fluctuation in the rate of exchange. In the present case, the Notes to the Accounts for the year ending 31st December, 1986 (Schedule 17) indicates adverse fluctuations in the exchange rate in respect of liabilities pertaining to the assets acquired. This Note clearly establishes existence of adverse fluctuations in the exchange rate which made the assessee opts for forward cover and which made the assessee pays roll over charges. The word "adverse" in the Note itself presupposes increase in the liability incurred by the assessee during the year ending 31st December, 1986. In the circumstances, we find no merit in the contention of the assessee that roll over charges have nothing to do with the fluctuation in the rate of exchange. Lastly, in this case we are concerned with capitalization of exchange difference in respect of acquisition of fixed assets acquired from abroad. According to Indian Accounting Standards by Dolphy DSouza, roll over charges are indicative of the increase or decrease in the liability of the company in the next specified period, generally of six months. Roll over charges represent the difference arising on account of change in foreign exchange rates. Roll over charges paid/ received in respect of liabilities relating to the acquisition of fixed assets should be debited/ credited to the asset in respect of which liability was incurred. However, roll over charges not relating to fixed assets should be charged to the Profit & Loss Account. [See page 325]In the present case, it appears that the relevant contract and correspondence has not been produced by the assessee. We are proceeding on the basis that the purpose of the loan taken by the assessee from ICICI was to finance the purchase of plant and machinery.