(2010] 3 S.C.R. 386

OIL AND NATURAL GAS CORPORATION LTD.,

DEHRADUN THROUGH MANAGING DIRECTOR

THE COMMISSIONER OF INCOME TAX, DEHRADUN

(Civil Appeal No. 7223 of 2008)

MARCH 15, 2010

[D.K. JAIN AND T.5. THAKUR, JJ.]

Income Tax Act, 1961:

s.37(1) - AY 1991-92 to 1994-95 and 1997-98 - Deduction on account of fluctuations in rate of exchange - Appel/ant-assessee availed foreign loans to cover its expenses, both capital and revenue, on import of machinery D on capital account and for payment to non-resident contractors in foreign currency- Additional liability on account of fluctuations in the rate of exchange, in respect of loans . taken for revenue purpose - Assessee followed mercantile system of accounting - "Loss" suffered by assessee on E account of fluctuation in the rate of foreign exchange as on the date of balance-sheet - Held: Could be allowed as expenditure under s.37(1) notwithstanding the fact that the liability had not been actually-discharged in the year in which the fluctuation in the rate of foreign exchange had occurred.

F s.43A (as unamended, prior to 1-4-2003) - AY 1991-92 to 1994-95 and 1997-98 - Adjustment in actual cost of asset on account of change in the rate of exchange subsequent to

acquis!ion of asset in foreign currency - Appellant-assessee availed foreign loans to cover its expenses, both capital and G revenue, on import of machinery on capital account and for payment to non-resident contractors in foreign currency - Held: Assessee entitled to adjust the actual cost of imported capital assets acquired in foreign currency on account of

H 386

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fluctuation in the rate of exchange at each balance-sheet date, A pending actual payment of the varied liability.

The appellant-assessee is a . public sector undertaking, engaged in capital intensive exploration and production of petroleum products for which it has to heavily depend on foreign loans to cover its expenses, both capital and revenue, on import of machinery on capital account and for payment to non-resident c.ontractors in foreign currency for various services rendered. The Assessee made three types of foreign exchange borrowings -

(i) in revenue account; (ii) in C capital account and (iii) for general purposes, partly utilised in revenue account and. partly in capital account..

As per the terms and conditions of foreign exchange borrowings, some of the loans became re-payable in the D year under consideration but date of repayment of some loans fell after the end of the relevant accounting year.

The Assessee revalued in Indian currency all its foreign exchange loans in revenue account, capital

.. account as also in its general purposes account, outstandi.ng as on 31st March, 1991 and claimed the difference between th_eir respective amounts in Indian currency as on 31st March, 1990 and on 31st March, 1991 as revenue loss under Section 37(1) of the Income Tax Act, 1961 in respect of loans used in revenue account, arid also took into consideration the similar difference in . foreign .exchange on capital account lo::tns as an increased liability under Section 43A of the Act for the purposes of depreciation.

The foreign exchange loss incurred by the Assessee in the revenue account on account of repayment of the loans made in the year under consideration was allowed . by the Assessing Officer as a deduction under Section

37(1) of the Act, and he also took into consideration an

A increased liability of foreign exchange loans taken in

capital account and repaid in the accounting year, for the purposes of depreciation, under Section 43A of the Act.

He, however, did not allow the assessee's claim for foreign exchange loss claimed on such foreign currency B loans both in revenue account and in capital account which were outstanding on the last day of the accounting year under consideration and were as per the terms of borrowings, repayable at the end of the relevant accounting year. Similar treatment was given to the c foreign exchange loans.taken for general purposes, used

partly in revenue account and partly in capital account.

Thus, the Assessee's claim for foreign exchange loss/ increased liability on revaluation of these foreign exchange loans at the end of the accounting year under

0 consideration both in the revenue account and capital

account as also on loans used partly in revenue account and partly in capital account, made on the ground that it had followed mercantile system of accounting in this regard, was disallowed by the Assessing Officer.

According to the Assessing Officer, such a loss could be E allowed to the Assessee on discharge of liability at the time of actual repayment of these loans.

The assessee preferred appeals before the Commissioner of Income Tax (Appeals). Insofar as F assessee's claim for foreign exchange loss in revenue acco.unt was concerned, the Commissioner (Appeals) affirmed the view taken by the Assessing Officer on the ground that it was a notional liability and the same had not crystallised or accrued in the relevant assessment G year. However, as regards the adjustment for increased

liability made by the Assessee for the pu!poses of Section 43A of the Act in respect of foreign exchange loans in capital account, which were outstanding as on 31st March, 1991, the Commissioner accepted the stand H of the assessee and directed the Assessing Officer to

OF INCOME TAX, DEHRADUN

allow the benefit of such increased liability for A computation of depreciation allowance on plant and machinery purchased out of such foreign exchange loans . for the assessment year under consideration.

The Assessee and the Revenue filed cross-appeals B before the Income Tax Appellate Tribunal. The Trib.unal held that the loss claimed by the assessee on revenue account was allowable under Section 37(1) of the Act.

The appeal preferred by the Revenue on the question whether the Assessee was entitled to adjust the actual c cost of imported assets acquired in foreign currency on account of fluctuatidn in the rate of exchange, in terms

"""

of Section 43A of the Act, was dismissed.

The Revenue filed appeal before the High Court. By a common judgment pertaining to the assessment years D 199'1-92 to 1994-95 and 1997-98, the High Court reversed tbe decision of the Tribunal on both the issues.

'>L In appeals to this Court, the questions which arose for determination were :- (i) Whether on the facts and E circumstances of the case, the additional Ua_bility arising on account of fluctuations in the rate of. exchange in respect of loans taken for revenue purposes could be allowed as deduction under Section 37(1) of the Income Tax, Act, 1961 in the year of fluctuatioh in the rate of F exchange or whether the same is allowable only in the year of repayment of such loans and (ii) Whether the assessee is entitled to adjust the actual cost of imported capital assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance- G . sheet date, pending actual payment of the varied liability.

Allowing the appeals, the Court

HELD: 1.1. The factors to be taken into account in order to find out if an expenditure on account of H

A fluctuation in the foreign curren.cy rates, when the Assessee is following mercantile system of accounting, is deductible, are: (i) whether the system of accounting followed by the assessee is the mercantile system, which brings in the debits of the amount of expenditure for B which a legal liability has been incurred even before it is

actually disbursed and credits, what is due, immediately it becomes due even before it is actually received; (ii)" whether the same system is followed by the. assessee from the very beginning and if there was a change in the c system, whether the change was bonafide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect.

0 of losses and gains; (v) whether the method adopted by

the assessee for making entries in the books both .. in respect of losses and gains is as per nationally accepted accounting standards and (vi) whether the system adopted by the assessee is fair and reasonable or is E adopted only with a view to reducing the incidence of

taxation. [Para 10] [397-G-H; 398-A-F]

1.2. In the present case, the assessee followed mercantile system of accounting. Applying the aforesaid factors on the facts of the case, it is clear that the loss F claimed by the assessee on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet is allowable as expenditure under Section 37(1) of the Act, notwithstanding that the liability had not been discharged in the year in which the fluctuation in the rate G of foreign exchange occurred. [Paras 10] [398-F-H]

Commissioner of Income- Tax v. Woodward Governor India P. Ltd. 2009 (312) l.T.R. 254 (SC), relied on. ·

Oil & Natural Gas Commission & Anr. v. Collector of

OF INCOME TAX, DEHRADUN

Central Excise (1992) Supp (2) SCC 432 and Mahanagar A Telephone Nigam Ltd. v. Chairman, central Board, Direct Taxes & Anr. 2004 (267) l.T.R. 647 (SC), referred to.

2.1. Section 43A of the Income Tax Act, 1961 was amended by the Finance Act, 2002 w.e.f. 1st April, 2003.

Under the unamended Section 43A, "actual payment" was not a condition precedent , for making necessary adjustment in the carrying cost of the fixed asset acquired

in foreign currency but under the amended Section 43A, with effect from 1st April, 2003, such payment of the decreased/enhanced liability on account of fluctuation in C foreign exchange rate has been made a condition precedent for making adjustment in the carrying amount of the fix.ed asset. [Para 12] [399-G-H; 400-A-C]

2.2. AH the assessment years in question being prior D to the amendment in Section 43A of the Act with effect from 1st April, 2003, the assessee would be entitled to adjust the actual cost of the imported capital assets, acquired in foreign currency, on account of fluctuation in the rate of exchange at each of the relevant balance- E sheet dates pending actual payment of the varied liability. [Para 13] [400-C-E]

Commissioner of Income-Tax v. Woodward Governor India P. Ltd. 2009 (312) l.T.R. 254 (SC), relied on.

Case Law Reference:

2009 (312) l.T.R. 254 (SC) relied on Para 6

(1992) Supp (2) SCC 432 referred to Para 6

2004 (267) l.T.R. 647 (SC) referred to Para 6

CIVIL APPELLATE JURISDICTION : Civil Appeal No. 7223 of 2008.

From the Judgment & Order dated 29.3.2007 of the High H

A Court of Uttarakhand at Nainital in Income Tax Appeal No. 50

of 2005.

WITH

C.A. Nos. 7224, 7225, 7228, 7229 and 7231 of 2008.

S. Ganesh, Ruchi Gaur Narula, Shweta Mishra, S.R. Setia for the Appellant.

B. Bhattacharya ASG, D.K. Singh, H.R. Rao, Mohd. c Manan, B.V. Balaram Das for the Respondent.

The Judgment of the Court was delivered by

D.K. JAIN, J. 1. In these appeals, essentially the following two questions arise for our consideration:-

(i) Whether on the facts and circumstances of the case, the additional liability arising on account of fluctuations in the rate of exchange in respect of loans taken for revenue purposes could be allowed as deduction under Section 37(1) of the Income Tax, Act, 1961 (for short "the Act") in the year of fluctuation in the rate of exchange or whether the same is allowable only in the year of repayment of . such loans?

(ii) Whether the Assessee is entitled to adjust the actual cost of imported capital assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance-sheet date, pending actual payment of the varied liability? (only in C.A.

No.7228/2008 - Assessment Year 1991-92)

2. As, in our opinion, both the afore-noted issues are no more res integra, we deem it unnecessary to state the facts in detail and with a view to appreciate the controversy, a brief

OF INCOME TAX, DEHRADUN [D.K. JAIN .. J.]

reference to the foundational facts in respect of assessment A year 1991-92 would suffice. These are:

The appellant, hereinbefore referred to as "the Assessee", . . is a public sector undertak!ng, substantially owned by the .

Government of India. It is engaged io capital intensi_ve 8 exploration and production of petroleum products for which _it .has to heavily depend on foreign loans to cover its expenses, .both capital and revenue, on import of machinery on capital account andJor payment to non-resident contractors in foreign currency for various sel'Vices renc:lered. The Assessee had . 111ade three types of foreign exchange borrowings .:.....,. (i) in C

re\lent.:ie account; (ii) in capital. accouritand (iii) for general · . ·. purposes, partly utilised in. revenue account and partly in capital . . account. As per terms and conditions of foreign exchange

bbrrowings,:some of the loans became re-payable in the year undercons.idetatioh but date of repayment of some Joans fell D after the end offhe relevant accounting year, The Assessee revalued in Indian currency all its foreign exchange loans in reven.ue account, capital account as also in its general purposes account, outstanding as on 31st March, 1991 and . claimed the difference between their respective amounts in E

lndi.an currency as on 31st March, 1990 and on 31st March, 1991 as revenue loss under Section 37(1) of the Act in respect of loans used in revenue account,•· and also. tOok into cqnsideration the s_imilar difference in foreign exchange on ·-capital account loans as an increased liability urider Section F

.· 43A of the Act for the purposes of depreciation. The foreign

exchange loss incurred by the Assessee in the revenue acrour:it on account of repayment of these loans made in the year u.nder consideration was .allowed by the Assessing Officer as a

deuction under Section 37(1} of the 'Ad, and he also took into G. consideration an increased liability of foreign exchange lol!Pls taken. in capital account and repaid in the accounting year, for tile purposes of epreciation, under Section 43A of tti~_Acf; frife,.

however, did not allow.to the Assessee its claim for foreign exchange loss claimed on such foreign currency loans both in H

A revenue account and in capital account which were outstanding on the last day of the accounting year under consideration and were as per terms of borrowings repayable after the end of the

relevant accounting year. Similar treatment was given to the foreign exchange loans taken for general purposes, used partly B in revenue account and partly in capital account. Thus, the Assessee's claim for foreign exchange loss/increased liability on revaluation of these foreign exchange loans at the end of the accounting year under consideration both in the revenue account and capital account as also on loans used partly in C revenue account and partly in capital account, made on the ground that it had followed mercantile system of accounting in this regard, was disallowed by the Assessing Officer.

According to the Assessing Officer, such a loss could be allowed to the Assessee on discharge of liability at the time of

0 actual repayment of these loans.

3. Aggrieved, the Assessee preferred appeals before the Commissioner of Income Tax (Appeals). Insofar as Assessee's claim for foreign exchange loss in revenue account was concerned, the Commissioner (Appeals) affirmed the view E taken by the Assessing Officer on the ground that it was a notional liability and the same had not crystallised or accrued in the relevant assessment year. However, as regards the adjustment for increased liability made by the Assessee for the purposes of Section 43A of the Act in respect of foreign F exchange loans in capital account, which were outstanding as on 31st March, 1991, the Commissioner accepted the stand of the Assessee and directed the Assessing Officer to allow the benefit of such increased liability for computation of depreciation allowance on plant and machinery purchased out G of such foreign exchange loans for the assessment year under consideration.

4. Being dissatisfied, both the Assessee as well as the Revenue carried the matter in further appeals to the Income Tax Appellate Tribunal (for short "the Tribunal"). The Tribunal H

OF INCOME TAX, DEl-;4RADUN [D.K. JAIN, J.]

observed that the method of accounting adopted by the A

Assesse right from the assessment year 1982-83 is mercantile system; it has been consistently claiming loss suffered by it on account of fluctuation in foreign exchange rates on accrual basis; in respect of assessment years 1982-83 to 1986-87, the Assessee's claim on this account had been B allowed by the Assessing Officer himself; in respect of assessment year 1997-98, the Assessee had shown a gain of Rs.293.37 crores on account of fluctuation in foreign exchange because the Indian Rupee had appreciated as compared to the foreign currency and that the said amount.was taxed as C Assessee's income. Taking all these factors into consideration, the Tribunal held that the loss claimed by the Assessee on revenue account was allowable under Section 37(1) of the Act.

The appeal preferred by the Revenue on the question whether the Assessee was entitled to adjust the actual cost of imported D assets acquired iR foreign currency on account of fluctuation in the rate of exchange, in terms of Section 43A of the Act, was also dismissed.

5. The Revenue tsok the matter in further appeal to the High E Court. By a common judgment pertaining to the assessment years 1991-92 to 1994-95 and 1997-98, the High Court has reversed the decision of the Tribunal on both the issues.

Terming the order of the Tribunal as perverse, having been passed without any material on record and against the statutory provisions, the High Court has held that the foreign' exchange loss claimed by the Assessee being only a contingent and notional liability, it was not allowable as deduction under Section 37(1) of the Act. Insofar as the applicability of Section 43A of

the Act was concerned, the High Court observed that the said provision is confined only to those liabilities which have become G due as per the terms and conditions of written agreement between the Assessee and the foreign creditors bJ.Jt since in the present case, no such agreement was made available by

the Assessee at any stage of fhe proceedings, the claim of the Assessee was not justified. According , o the High Court, the H-

...

A . variation in foreign exchange was neither quantified, nor it had become due or repaid and, therefore, deductions on that account had been allowed by the Tribunal without application . of mind and were, therefore, illegal. Being aggrieved by the said decision, the Assessee is before us in these appeals.

6. Mr. S. Ganesh, learned senior counsel appearing on behalf of the Assessee, submitted that in view of the decision of this Court in Commissioner of Income-Tax vs. Woodward Govemor India P. Ltd., 1 the decision of the High Court cannot be sustained. Learned counsel also argued that in view of the C fact that the Committee on disputes had expressly refused permission to the Revenue to pursue appeals before the High .Court, in the light of the decisions of this Court in Oil & Natural . Gas Commission & Anr. vs. Collector of Central Excise2 and Mahanagar Telephone Nigam Ltd. vs. Chairman, Central D Board, Direct Taxes & Anr., 3 the High Court should not have entertained the appeals preferred by the Revenue.

7. Mr. B. Bhattacharya, learned Additional Solicitor General, appearing on behalf of the Revenue, on the other hand, E while candidly admitting that both the issues raised in the present appeals, have been decided by this Court in Woodward's case (supra), submitted that in view of the finding by the High Court that no agreement between the Assessee and the foreign creditors had been placed on record, the High F Court was correct in law in allowing Revenue's appeals.

8. At the outset, we may note that although in. view of the orders passed by the Committee on disputes, advising the Revenue not to file appeals against Tribunal's orders, we find some substance in the objection of learned counsel for the G Assessee about the maintainability of Revenue's appeals before the High Court but as we have heard learned counsel

1. 2009 (312) l.T.R 254 (SC).

(1992) Supp (2) sec 432.

H 3. 2004 (267) l.T.R. 647 (SC).

OF INCOME TAX, DEHRADUN [D.K. JAIN, J.]

for the parties on merits of the appeals, at this stage, we do A not propose to go into this question. We also reject at the threshold the submission of learned counsel for the Revenue that the claim of the Assessee qua capital account deserved to be disallowed because no agreement between the Assessee and the foreign creditors, as observed by the High B Court was placed on record, because no such objection was raised by the Revenue at any stage of the assessment proceedings nor had the Assessing Officer rejected the claim of the Assessee on that ground.

9. Thus, the questions surviving for determinatio_n are:- (i) that when the Assessee maintained their accounts on mereantile system of accounting and there was no finding by the Assessing Officer on the correctness or completeness of

the account and that the Assessee had complied with the 0 . accounting standards, laid down by the Central Government, can the "loss" suffered by it on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet be allowed as expenditure under Section 37(1) of the Act notwithstanding the fact that the liability had not been actually discharged in the year in which the fluctuation in the rate of E foreign exchange had occurred and (ii) whether on account of fluctuation in the rate of exchange at te end of the previous year, the Assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency?

10. Having carefully perused the decision of this Court in Woodward's case (supra), we are of the opinion that both the issues stand concluded by the said decision. Dealing with the said issues extensively, speaking for the Bench, S.H. Kapadia,

J. summarised the following factors which should be taken into G account in order to find out if an expenditure on account of fluctuation in the foreign currency rates, when the Assessee is following mercantile system of accounting, is deductible:

I (iii) whether the system of accounting followed by the H

assessee is the mercantile system, which brings in the debits of the amount of expenditure for which a legal liability has been incurred even before it is actually disbursed and credits, what is due, immediately it becomes due even before it is actually received; ·

(iv) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide;

(v) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it;

(vi) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains;

(vii) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted accounting standards;

(viii) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation.

Applying these factors on the facts of that case, it was held that the "loss" suffered by the Assessee, maintaining accounts regularly on mercantile system and following accounting G standards prescribed by the Institute of Chartered Accountants of India (ICAI), on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet was an item of expenditure under Section 37(1) of the Act, notwithstanding that the liability had not been discharged in the year in which the H fluctuation in the rate of foreign exchange occurred.

OF INCOME TAX, DEHRADUN [D.K. JAIN, J.]

11 .. We are of the opinion that the ratio of the said decision, A with which we are in respectful agreement, squarely applies to the facts at hand and, therefore, the loss claimed by the Assessee on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet is allowable as expenditure under Section 37(1) of the Act. 8

12. On the question whether an Assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance-sheet date, pending actual payment of the varied C liability with reference to unamended Section 43A of the Act, in Woodward's case (supra), the Court observed thus:

" ... what triggers the adjustment in the actual cost of the assets, in terms of the unamended section 43A of the 1961 Act is the change in the rate of exchange subsequent to D the acquisition of asset in foreign currency. The section mandates that at any time there is change in the rate of exchange, the same may be given effect to by way of adjustment of the carrying cost of the fixed assets acquired in foreign currency. But for section 43A which corresponds E to paragraph 10 of AS-II such adjustment in the carrying amount of the fixed assets was not possible, particularly in the light of section 43(1). The unamended section 43A nowhere required as condition precedent for making necessary adjustment in the carrying amount of the fixed F asset that there should be actual payment of the increased/ decreased liability as a consequence of the exchange variation. The words used in the unamended section 43A were "for making payment" and not "on payment" which is now brought in by amendment to section 43A, vide the G Finance Act, 2002."

Opining that the amendment of Section 43A of the Act by the Finance Act, 2002 with effect from 1st April, 2003 is amendatory and not clarificatory and would thus, apply

A prospectively, the Court explained that under the unamended

Section 43A, adjustment to the actual cost takes place on the happening of change in the rate of exchange, whereas under t:-; e amendeq Section43A, the adjustment in the actual cost is made oh cash basis. In other words, under the unamended B Section 43A, "actual payment" was not a condition precedent for mc; iking necessary adjustment in the carrying cost of the fixed asset acquired in foreign currency but under the amended S.ection 43A, with effect from 1st April, 2003, such payment of the decreased/enhanced liability on account of fluctuation in foreign exchange rate has been made a condition precedent C for making adj1,1stment in the carrying amount of the fixed asset.

13. We are of the opinion that the decision of this Court in Woodward's case (supra) settles the second issue as well. We respectfully concur with the same and hold that all the D assessment years in question being prior to the amendment

 in Section 43A of the Act with effect from 1st April, 2003 the Assessee would be entitled to adjust the actual cost of the imported capital assets, acquired in foreign currency, on account of fluctuation in the rate of exchange ateach of the E relevant balance-sheet dates pending actual payment of the

, varied liability.

14. Resultantly, all the appeals are allowed; the impugned orders are set aside and both the questions formulated in para 1 (supra) are answered in favour of the Assessee, leaving the parties to bear their own costs.

B.B.B.

Appeals allowed.

' I