Capital gains on Sale of business undertaking as a going concern: Section 50B & Slump Sale
Short Overview Since industrial unit was sold as a whole and as a continuing business concern with land, building, plant, machinery and all equipments as a going business with assets and liabilities for a consolidated sum, the same squarely attracted definition of ‘undertaking’ covered by Explanation 1 to section 2(42C) and computation of capital gains under section 50B by AO was correct.
Assessee engaged in process of frozen foods sold two of its units. According to AO, sale of these two units was in the nature of slump sales and income arising out of these had to be computed as profit under section 50B. Assessee submitted that what was sold were depreciable assets and provisions of section 50B were not applicable and the value was clearly bifurcated as attributable to immovable and movable property.
It is held that Since industrial unit was sold as a whole and as a continuing business concern with land, building, plant, machinery and all equipments as a going business with assets and liabilities for a consolidated sum, the same squarely attracted definition of ‘undertaking’ covered by Explanation 1 to section 2(42C) and computation of capital gains under section 50B by AO was correct.
Decision: Against the assessee.
Income Tax Act, 1961, Section 43B
Business disallowance under section 43B—Deduction on actual payment—Interest accrued on loan not paid to bank before due date of filing return—Assessee pleading subsequent waiver of interest by bank
Conclusion: As per section 43B, interest to financial institutions/banks could be allowed as deduction only on payment basis, that too before the specified date. As assessee had not paid interest amount till specified date subsequent waiver of interest could not be a valid ground to not to apply provisions of section 43B and allow non-payment of interest as deduction when it was not paid in accordance with section 43B.
Assessee claimed interest accrued on loans from banks/financial institutions which were not paid before the due date of filing of the return of income for the relevant assessment year. Assessee’s contention was that interest was waived of by financial institutions and amount involved was offered as income for the assessment year 2004-05. AO considered this argument as irrelevant since only interest paid to financial institutions before specified date of filing of the return could be allowed as deduction under section 43B. Held: As per section 43B, interest to financial institutions/banks could be allowed as deduction only on payment basis, that too before the specified date. As assessee had not paid interest amount till specified date subsequent waiver of interest could not be a valid ground to not to apply provisions of section 43B and allow non-payment of interest as deduction when it was not paid in accordance with section 43B.
Decision: Against the assessee.
IN THE ITAT, COCHIN BENCH
CHANDRA POOJARI, AM & GEORGE GEORGE K., JM
Dy. CIT v. Accelerated Freeze Drying Co. Ltd.
ITA Nos. 714/Coch/2008 & 1286/Coch/2005
28 June, 2019
Assessee by: R. Srinivasan, FCA
Revenue by: A.S. Bindhu, Sr. DR
ORDER
Chandra Poojari, AM
These appeals filed by the assessee and the Revenue are directed against the different orders of the Commissioner (Appeals)-IV, Kochi for the assessment year 2002-03. These appeals were originally disposed of by the Tribunal vide Order, dated 13-11-2009. Against this, the Revenue went in appeal before the High Court in ITA No. 201 & 281/2010 wherein the High Court vide judgment dated 02-08-2018 remitted the issue to the file of the Tribunal with the following observation:
“Especially noticing the long pendency, we request the Tribunal to dispose of the appeals within a period of six months from the date of receipt of a certified copy of this judgment.”
Hence, these appeals came up for hearing today for fresh consideration.
2. The Revenue has raised the following grounds of appeal:
(1) The Commissioner (Appeals) has wrongly held that the effective date of transfer of the Taloja property took place when the assessee took possession of the assets and made entries in the books of account on 31-3-1997 and hence, the holding period was more than 36 months when the assets finally sold on 10-5-2001 and therefore, the assessee is liable only to long term capital gains.
(2) The Commissioner (Appeals) ought to have seen that the deed of assignment by which the assessee took over the Taloja property was registered only on 5-8-1999 and the assessee sold the property on 10-5-2001 and therefore, the holding period was less than 36 months for which the assessee is liable to short term capital gains.
(3) The Commissioner (Appeals) ought to have seen that as per the decision of the Supreme Court in Alappattu Venkitaraman v. CIT 57 ITR 185 (SC), entries in the books are not relevant for the purpose of determining the date of transfer. The effective date of transfer is the date on which the transfer deed is registered.
(4) Having held that the capital gains on the transfer of he said property should be assessed under section 50B, the Commissioner (Appeals) ought to have see that according to proviso to section 50B(1), capital assets “owned and held” by an assessee for less than 36 months shall be deemed as short term capital assets. The Commissioner (Appeals) went wrong in applying the definition of capital assets in section 2(14) and ignoring the mere specific provisions contained in the proviso to section 50B(1).
3. The facts of the case are that by Order dated 28-12-2006, the assessing officer completed the assessment under section 143(3) read with section 147 determining a total income of Rs. Rs. 4,85,37,340 against Nil income. During the relevant assessment year the assessee had sold two of its units at Taloja in the State of Maharashtra and Veraval in the State of Gujarat. The assessee was engaged in the processing of frozen foods either as Block or as IQF. According to the assessing officer, the sale of these two units would partake the nature of slump sales and income arising out of these should be computed as profit under section 50B of the Income Tax Act. A Report in Form 3CEA indicating the computation of the net profit of these units was also asked to be filed The assessee submitted that what was sold were the depreciable assets and provisions of section 50B were not applicable and the value was clearly bifurcated as attributable to immovable and movable property.
3.1 It was found that the unit at Taloja Industrial Area was transferred in favour of Allana Investments and Trading Co., Mumbai for a consideration of Rs. 1.25 Crores which was bifurcated towards land and building at Rs. 5 Crores and towards value of movable plant and machinery and other installation at Rs. 7.5 crores. As regards the Veraval Unit, this was sold to Allana Frozen Foods Ltd., Mumbai, being lease hold rights for a consideration of Rs. 1.75 crores, being Rs. 1.00 crore for land and Rs. 0.75 lakhs towards movable plant and machinery installation which was treated as slump sales.
3.2 The assessing officer referred to various decisions to bring the transactions within the definition of section 2 of section 42(C) read with section 50B to treat the same as slump sales.
3.3 It was contended that the Taloja unit initially leased out from innovative Marine Foods Ltd., an associate concern of the assessee was taken possession by the assesseeon 31-3-1997, being the leasehold right for factory building and office building and plant and machinery and on these dates the assessee had passed an entry for consideration of purchase to the tune of Rs. 23.65 cores. The Department had granted depreciation from the subsequent year. Therefore, it was submitted that all these assets had been included as early as 31-3-1997 so much so it cannot be held to be a short-term capital gain. Therefore, the assessee had rightly deducted the sale proceeds from the block of assets..
4. On appeal, the Commissioner (Appeals) decided the issue in favour of the assessee.
5. Against this, the Revenue is in appeal before us.
6. We have heard the rival submissions and perused the record. Admittedly, a similar issue was considered by the Jurisdictional High Court in assessee’s own case in ITA Nos. 640 & 1470 of 2009, dated 6-10-2010 wherein it was held as under:
“3. The admitted facts that lead to the controversy are the following. The assessee which was engaged in seafood processing and export with their own factories transferred one of their industrial units as a going concern during the previous year relevant for the assessment year 2003-04 to Hindustan Lever Limited for a total consideration of 22.20 crores. The consideration agreed is the aggregate value for land, building, machinery and all equipments with liabilities specifically mentioned in the agreement entered into between parties. The sale is in two parts, one sale deed executed and registered covers, land, and building and for the purpose of payment of Stamp duty and registration fee a valuation was separately made based on which stamp duty and registration fee were are paid. Besides the valuation of land and building which is specifically stated in the conveyance deed as fair market value adopted only for the purpose of payment of stamp duty and registration charges, sale consideration was not separable between value for land and building and for other items sold.
In other words the assessee sold the industrial unit as a going concern and as an operating unit for a total agreed consideration whereby the assessee received the net sale price after retaining liabilities to be borne by the purchaser. In clause 3.2 of the sale deed executed between the assessee and the purchaser it is clearly stated that the undertaking is transferred as a going concern on “slump sale basis”. The assessee also initially treated the sale of industrial unit as “slump sale” and when income tax return was filed assessee submitted auditor’s report in form 3 (EA) prescribed under rule 6(H) of the Income Tax Rules which is the requirement for the purpose of assessment of capital gains on “slump sale” under section 50B(3) of the Act. In spite of the declaration in the sale deed and treatment of the transfer of the industrial undertaking as a going concern to another company as a “slump sale” by obtaining and producing chartered accounts certification in the prescribed form in. terms of section 50B(3) of the Act, in the return filed, the assessee returned the transaction for assessment for capital gains as sale of depreciable items under section 50 of the Act. Before the assessing officer assessee contended that Form 3EA is furnished as a precaution and assessee’s contention is that the sale of industrial undertaking should be assessed for capital gains as sale of depreciable assets under section 50.of the Income Tax Act. The assessing officer noticed that the sale is a “slump sale” falling within the definition of section 2(42C) of the Act and he made the assessment for capital gain as provided under section 50B of the Income Tax Act. The assessment was made by invoking powers under section 147 of the Act which was also challenged by the assessee in appeal. In this case, the first appellate authority allowed the appeal on both the grounds that is by cancelling the income escaping assessment as passed without jurisdiction and on merits by holding that the sale of the industrial undertaking is not slump sale but is to be assessed as sale of depreciable asset under section 50 of the Act. In the connected case, the Commissioner (Appeals) took an entirely different view by upholding the assessment of sale of Industry as a “slump sale”. In the second appeal filed by the revenue before the Tribunal in this case, the Tribunal upheld the Commissioner (Appeals) order on merits but did not consider the validity of reopening raised by the revenue as the said ground had become academic by virtue of the Tribunal’s decision on merit in favour of the assesses. It is against this order of the Tribunal revenue has filed the appeal.
4. Based on the facts stated above, the only question to be considered is under what provision of the Income Tax Act capital gain is to be assessed on the profit received by the assessee on the sale of the industrial undertaking.
5. Slump sale is defined under section 2(42C) as follows:–
“Slump sale” means the transfer of one or more undertakings as a result of the sale for a lump sum consideration without values being assigned to the individual assets and liabilities in such sales.
Explanation 1-For the purposes of this clause, “undertaking” shall have the meaning assigned to it in Explanation 1 to clause (19AA).
Explanation 2 -For the removal of doubts, it is hereby declared that determination of the value of an asset or liability for the sole purpose of payment of stamp duty, registration fees or other similar taxes or fees shall not be regarded as assignment of values to individual assets or liabilities.”
We have already noticed that the unit transferred by the assessee is an industrial undertaking which is a fish processing factory with land, building, machinery, plant and all equipments as a going concern with all the assets and liabilities. The consideration agreed between assessee and the buyer is admittedly a lump sum amount of 22.20 crores. Since the industrial unit sold is as a whole and as a continuing business concern with land, building, plant, machinery and all equipments as a going business with assets and liabilities for a consolidated sum, the same squarely attracts definition of the undertaking covered by explanation 1 of the definition clause. Further, it has to be noted that the assessee was well aware of explanation 2 of section 2(42C) because except the value adopted for land and building which is specifically stated as for the purpose of payment of stamp duty and registration fee the sale price agreed and paid was a lump sum amount of Rs. 22.20 crores. Further the assessee and the purchaser have specifically stated in clause 3.2 of the sale deed that the sale is on “slump sale basis” which is nothing but adoption of the said terms as contained in the above provision of the Income Tax Act. ft is also to be taken note that the assessee knowing well the chance of transaction being treated as a “slump sale” for the purpose of assessment of capital gain furnished along with the return filed the chartered accountant’s certificate in form 3EA prescribed under rule 6H in terms of section 50B(3) of the Income Tax Act.
Even after annexing the Chartered Accountant’s Certificate issued in the prescribed form for assessment under section 50B of the Act, assessee claimed that capital gain is assessable on sale of the undertaking as sale of depreciable assets under section 50 of the Act, The question now to be considered is whether the claim of the assessee is tenable or not. In this regard we have to consider the scope of section 50 and section 50B of the Act. In our view assessee’s claim for assessment of capital gainn under section 50 of the Act is not tenable because the said section provides for assessment of capital gains in the case of sale of depreciable assets. This section provides for assessment for capital gain of assets forming part of block of assets in respect of which depreciation is allowed under the Act. What the assessee has sold is not any asset in a block, if at all the assets sold form part of a block of asset on which depreciation was being allowed. On the other hand sale is of an industrial undertaking as a whole which includes land, building, machinery, equipments etc. as a going concern with all the assets and liabilities. We have already found that the sale is of business undertaking as a going concern and the same squarely falls within the definition of “slump sale” as defined under section 2(42C) of the Act.
Section 50B which provides for computation of capital gain in the case of slump sale is as follows:–
“(1) Any profits or gains arising from the slump sale effected in the previous year shall be chargeable to income-tax as capital gains arising from the transfer of long-term capital assets and shall be deemed to be the income of the previous year in which the transfer took place:
Provided that any profits or gains arising from the transfer under the slump sale of any capital asset being one or more undertakings owned and held by an assessee for not more than thirty-six months immediately preceding the date of its transfer shall be deemed to be the capital gains arising from the transfer of short-term capital assets.
(2) In relation to capital assets being an undertaking or division transferred by way of such sale, the “net worth” of the undertaking or the division, as the case may be, shall be deemed to be the cost of acquisition and the cost of improvement for the purposes of sections 48 and 49 and no regard shall be given to the provisions contained in the second proviso to section 48.
(3) Every assesses in the case of slump sale, shall furnish in the prescribed form along with the return of income, a report of an accountant as defined in The Explanation below sub-section (2) of section 288, indicating the computation of the net worth of the undertaking or division, as the case may be and certifying that the net worth of the undertaking or division, as the case may be, has been correctly arrived at in accordance with the provisions of this Section.
Explanation 1:- For the purposes of this Section, “net worth” shall be the aggregate value of total assets of the undertaking or division as reduced by the value of liabilities of such undertaking or division as appearing in its books of account.”
What is clear from the above is that section 50B is the only provision which provides for computation of capital gains in the case of slump sale, even though sale of business undertaking as a going concern will involve sale of assets forming block of assets on which depreciation was being allowed. Assessee’s counsel contended that when depreciable assets are sold, provision to be applied for assessment of capital gain is section 50. However we are of the view that section 50 applies only when an independent asset or a block of asset are sold on which depreciation was allowed and not when the industrial undertaking with depreciable assets are sold as a whole. In fact, when section 50B provides for computation of capital gain on the sale of the undertaking it covers capital gain payable on depreciable assets forming part of the industrial undertaking also. In other words the distinction between section 50 and 50B is that while section 50 provides for computation of capital gain on the sale of only depreciable assets section 50B provides for computation of capital gain on the sale of an undertaking as a whole which includes depreciable assets as well.
In fact there is also difference in the mode of computation of capital gains under section 50 for depreciable assets and for “slump sale” under section 50B.
Section 50 is a full code for computation of capital gains on depreciable assets.
On the other hand under section 50B the asset has to be first classified between long term or short term capital asset and then for the purpose of sections 48 and 49 net worth has to be computed in terms of explanation 1 of the said Section. The capital gain under section 50B is the sale proceeds as reduced by the net worth.
6. From the above findings, we hold that the sale of the undertaking is a stump sale within the meaning of section 2(42C) assessable under section 50B of the Act and assessee also rightly styled the transaction as such as “slump sale” in the sale documents and even got the Auditor’s report prepared and filed along with return in terms of section 50B(3) of the Act. We therefore allow the appeal by reversing the order of the Tribunal and that of the first appellate authority and hold that assessment was rightly made by the Officer under section 50B treating the transaction as “slump sale”. Since the Tribunal has not considered the question raised on the validity of re-opening and completion of assessment under section 147, we remand the matter to the Tribunal for decision on this issue after hearing both sides.
7. As already stated the issue raised in I.T. Appeal 640/2009 filed by the revenue is the same as in the case decided above and both the companies are stated to be related companies of the same group. Tribunal allowed assessee’s appeal by reversing the order of the Commissioner (Appeal) following their decision in ITA 1470/2009 which we have reversed vide above judgment. Since the facts are the same following our above judgment we allow this appeal also by reversing the order of the Tribunal and by restoring the order of the Commissioner (Appeal) confirming the assessment.
8. Counsel appearing for the assessee in I.T.A./470/2009 contended that the computation of capital gains under section 50B by the assessing officer itself is not correct and there was no occasion to consider the correctness of computation by any of the appellate authorities because issue happened to be decided in their favour by the first appellate authority and the Tribunal. We give one more opportunity to the assessee to raise this issue before the assessing officer. If the Tribunal upholds the income escaping assessments and remands the matter for revision of assessment in terms of our judgment.”
6.1 Since the similar issue has already been decided against the assessee in assessee’s own case by the above judgment of the Jurisdictional High Court, we allow the appeal of the Revenue. Thus, the appeal of the Revenue in ITA No. 714/Coch/2008 is allowed.
ITA No. 1286/Coch/2005 : 2002-03
7. The assessee has raised the following grounds of appeal:
(1) The Officers below are not justified in confirming the addition of Rs. 2,07,99,000 under section 43B being interest accrued on loans from Banks/Financial Institutions for the reason that this has not been paid before the due date of filing the return.
(2) The Officers failed to appreciate the fact that such interest has been waived by the Bank/Financial Institutions shown as income in the assessment year 2004-05 so much so this would amount to double taxation.
(3) The Officers below are not justified in confirming the disallowance of interest claimed for the reason that funds have been diverted to sister concern.
(4) The Officers failed to appreciate the fact that interest claimed as paid to banks and financial institutions have been for specific advances like term loans, export packing credit which are not otherwise available for diversion.
(5) The Officers below were not justified in disallowing the loss which has occurred on the re-instatement of foreign exchange loans procured for working capital requirements more so when the appellant has been consistently following the system of accounting year after year and booking into account the loss or gain arising on re-instatement of foreign exchange loans.
(6) The Commissioner (Appeals) did not consider the opinion given by the Institute of Chartered Accountants of India in regard to the treatment of similar losses.
8. The facts of the case are that the assessee is an exporter of marine products. For the assessment year 2002-03, the assessee filed return of income showing net loss of Rs. 1,88,41,046. The assessment was completed on a total income of Rs. 10.17,840.
8.1 The first ground relates to disallowance under section 43B of Rs. 2,07,99,000. The assessing officer found that the assessee had claimed interest accrued on loans from banks/financial institutions of Rs. 2,07,99,000 which were not paid before the due date of filing of the return of income for the assessment year 2002-03. The assessee ‘s contention was that this interest was waived by the financial institutions and the above sum was offered as income for the assessment year 2004-05. The assessing officer considered this argument as irrelevant since only the interest paid to financial institutions before the specified date of filing of the return could be allowed as deduction under section 43B.
8.2 On appeal, the Commissioner (Appeals) observed that the provisions of section 43B are very clear.
As per section 43B, the interest to financial institutions/banks could be allowed as deduction only on payment basis, that too before the specified date. In this case, the Commissioner (Appeals) observed that the assessee had not paid the amount till date and held that waiver of interest cannot be a valid ground not to apply provisions of section 43B.
Accordingly, the Commissioner (Appeals) sustained the disallowance made by the assessing officer
8.3 Against this, the assessee is in appeal before us.
8.4 We have heard the rival submissions and perused the record. As per the provisions of section 43B(d) and (e) of the Act, the assessee has to pay the interest on any loan or borrowings in accordance with the terms and conditions of agreement governing such loan or borrowings when it was borrowed from the public financial institution or a State financial corporation or a State industrial investment corporation or a scheduled bank. However, in the present case, the learned AR has fairly conceded that the assessee has not paid interest on loan or borrowings made from such institutions and shown as income in the subsequent year on its waiver. According to the learned AR, it cannot be added in the assessment year under consideration. In our opinion, offering of income on waiver in the subsequent assessment year cannot be a reason to allow non-payment of interest as deduction when it was not paid in accordance with the provisions of section 43B of the Act. Hence, we are in full agreement with the finding of the Commissioner (Appeals) and the same is confirmed. Thus, this ground of appeal of the assessee is dismissed.
9. The next ground is relating to disallowance of part of interest claimed. The assessing officer in para 4 of the assessment order has stated that the assessee had given interest free loans to sister concerns amounting to Rs. 804.71 lakhs. The assessee had paid interest of Rs. 826,26 lakhs on secured loans 6f Rs. 6,424.10 lakhs. The assessing officer held that proportionate interest on money advanced without charging interest should be disallowed. He worked out the proportionate disallowance at Rs. 1,03,50,000. He also relied on the decision of the Kerala High Court in the case of VI Baby & Co. (2002) 254 ITR 248 (Ker) : 2002 TaxPub(DT) 0847 (Ker-HC) contention of the assessee is that the interest was paid for specific advance like term loan, export packing credit and export bill discounting charges. It is the contention of the assessee that interest bearing funds were not diverted to the sister concerns as the assessee had sufficient resources.
9.1 On appeal, the Commissioner (Appeals) observed that the assessing officer had made similar disallowance for the assessment year 1997-98 and he had sustained the disallowance by relying on the decision of the Kerala High Court in the case of V I Baby & Co. The Court wherein it was held as under:
“We are inclined to accept the argument raised by counsel for the Revenue, because the advances to the partners, their relatives and the sister concerns are not for business purposes and the assessee has not derived any benefit out of the same. Admittedly, no interest was charged on these advances. The Tribunal appears to have placed reliance on the fact that the partners and their relatives have utilised the amounts for business purposes, such as construction of a shop building, etc. So long as the assessee-firm is not the beneficiary of such investments, the nature of investment or the utilisation of such advances has no relevance. So far as the assessee is concerned, it is only an interest free advance. The claim of the assessee’s counsel that cash balances were available with the firm for advances to the partners, their relatives and the sister concerns does not advance the assessee’s case. If cash balances are available, the borrowing itself is not for the purpose of the business. An assessee with liquidity cannot claim that it can give interest free advances to the partners and others and then borrow funds from the bank on interest for business purposes.
Such borrowings will not be for business purposes, but for supplementing the cash diverted by the assessee without any benefit to it, ‘Therefore, so long as the assessee is not the beneficiary of the investments made by the partners, their relatives and the sister concerns, and so long as the advances are interest free, the assessing officer is perfectly justified in disallowing the interest in proportion to the advances made. There is no dispute with regard to working out of the proportionate disallowance of interest. The decision relied on by the Tribunal and referred to above does not appear to be applicable to the facts of this case, because-that was an individual-assessee advancing interest free loan to a firm engaged in a related business as the assessee and in which he is also a partner along with his wife and minor children. Whatever benefit accrued to that firm will also be treated as income of the assessee assessable in his individual capacity. Therefore such an advance also should be taken as for business purposes of the assessee, and we do not see how that decision will apply to the facts of this case. We are of the view that the Tribunal went wrong in relying on the said decision and allowing the appeals.”
9.2 The High Court had held that an assessee with liquidity cannot claim that it can give interest free advances and then borrow funds on interest for business purposes. In the light of the decision of the Kerala High Court cited supra, the Commissioner (Appeals) confirmed the disallowance of interest.
9.3 Against this, the assessee is in appeal before us.
9.4 We have heard the rival submissions and perused the record. In view of the judgment of the Jurisdictional High Court in the case of V.I. Baby & Co., cited supra, the Commissioner (Appeals) had confirmed the disallowance of the interest made by the assessing officer. However, we make it clear that assessing officer has to compute interest on diversion of funds to sister concerns on outstanding balances on day to day basis. With this observation, we remit this issue to the file of the assessing officer for re-computation of interest. This ground of appeal of the assessee is partly allowed for statistical purposes.
10. The last ground is with regard to disallowance of loss which had occurred on the re-instatement of foreign exchange loans procured for working capital requirements.
10.1 The brief fact of the case are that the assessee had taken foreign exchange loans for purchase of assets as well as for working capital requirements. The practice adopted by the assessee was to revalue the loan amount payable on the basis of exchange rate as on 31st March every year. The loan amount payable was restated on the basis of the exchange rate prevailing on that date. The difference between the amount in the books and the restated amount was debited or credited to the P&L account. If the exchange rate was at a lesser rate than that adopted in the books of account, the ”profit” arising on “restatement” was credited to the P&L account. On the other hand, if the restatement results in a loss, then that loss is debited to P&L account. For the assessment year 2002-03, the assessee had debited to the P&L account a sum of Rs. 84,06,770 as foreign exchange loss on restatement of foreign exchange loans. The assessing officer issued a notice requiring the assessee to explain why this amount should not be disallowed. The assessee has stated as under: —
“The foreign exchange loss of Rs. 84,06,770 debited to the Profit and Loss account is on account of the reinstatement of the External commercial Borrowing availed by the company from Sumitomo Mitsui Banking Corporation for working capital purposes. Accordingly, loss on reinstatement of the loan as per the exchange rate prevailing as on 31-3-2002 has been debited to the Profit and Loss account. In fact for the assessment years 2003-04 & 2004-05 the Company has earned profit on reinstatement of the External Commercial Borrowing which has been taken as revenue income. That apart, there is a difference in the fluctuation of the External Commercial Borrowing as between one borrowed for working capital and one borrowed for acquisition of fixed assets. The working capital loan is mainly availed to acquire stock in trade and for meeting other expenditure whereas term loan was availed for acquisition of fixed assets. Therefore, any fluctuation in the reinstatement of External commercial Borrowings as far as working capital is concerned could only be taken as revenue expenditure whereas in other case it is capitalized to the assets. “
10.1 The assessing officer held that the entire claim was in the capital field as the loan received is a capital receipt. The fluctuation loss was mostly on account of periodical reinstatement of the External Commercial Borrowings. The assessing officer relied on the decisions of the Delhi High Court in (2005) 272 ITR 355 (Del) : 2005 TaxPub(DT) 0211 (Del-HC) and (2002) 254 1TR 570 (Del) : 2002 TaxPub(DT) 0498 (Del-HC).
10.2 Before the Commissioner (Appeals), the assessee had given a break-up of the total amount of Rs. 84,06,770 as follows:–
“Rs. 26,04,139 : This amount represents the loss on restatement of the loan utilized to purchase the assets situated at the Taloja factory. We have been consistently following the accounting policy of charging the loss or gain on account of the restatement of the foreign currency loans, to the fixed .assets that have been purchased with the loan.
However, during the relevant financial year i.e. 2001-02, the Taloja factory was disposed off and the proceeds therefrom was used to repay the loans which was used to finance the acquisition of the Taloja factory. A portion of these loans continued to remain outstanding as on 31-3-2002 since the sales proceeds were inadequate to repay the loans in full. Hence the loss/gain arising on restatement of these loans were debited/credited to the Profit & Loss account.
The above explanation would hold good for the following amounts debited/credited to the Profit & Loss account.
(a) Rs. 69,158.83
(b) Rs. 1.70
(c) Rs. 22,934.99
(d) Rs. 4,243,12 (Cr)
Rs. 57,14,725.60 : This amount represents the loss on restatement of the ECB availed by the company from Sumitomo Bank for its working capital requirements.”
10.3 Before the Commissioner (Appeals), it was argued that the claim was to be allowed as the assessee had consistently followed the above method of accounting. It was claimed that for the assessment years 2003-04 and 2004-05, the company had earned profit on restatement and these were offered for assessment.
10.4 According to the Commissioner (Appeals), depending on the foreign exchange rate as on the last date of the accounting year, the assessee quantified the amount payable to the borrower as on 31st March of every year. The Commissioner (Appeals) was of the view that the amount of loan repayable undergoes a change on the basis of foreign exchange rate at the end of each year. Thus, the Commissioner (Appeals) observed that restatement resulted in the assessee requiring a higher or lower amount to clear the loan liability.
According to the Commissioner (Appeals), the amount debited for Rs. 84.06 lakhs actually represented the excess amount of liability to clear the loan account as on 31-3-2002. The Commissioner (Appeals) noted that the assessee had not made any payment on 31-3-2002 and the actual amount to be paid depended upon the exchange rate at the time of repayment. The Commissioner (Appeals) observed that the source was the loan obtained from foreign banks/financial institutions and undoubtedly, the loan received was a capital receipt. Therefore, according to the Commissioner (Appeals), the increase or decrease in the liability should also fall in the capital field. Therefore, the amount debited represented capital expenditure only. According to the Commissioner (Appeals), even if it is to be held that the amount can be claimed under section 37, still it is to be disallowed because the claim is purely contingent in nature. The additional liability, if any, would crystallize only on the date(s) of repayment of loan. Accordingly, the Commissioner (Appeals) upheld the disallowance of interest made by the assessing officer.
10.5 Against this, the assessee is in appeal before us.
10.6 We have heard the rival submissions and perused the record. The issue involved in the appeal is whether the difference amount arising out of restatement of foreign currency transactions taking into account the prevailing exchange rate as on the end of accounting year is liable to tax or not. The Supreme Court in the case of Sutlej Cotton Mills Ltd. v. CIT (1979) 116 ITR 1 (SC) : 1979 TaxPub(DT) 0782 (SC) has held as under:–
“The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be a trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as a 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.”
10.7 The ratio of the above decision is whether the gain or loss should be brought to tax or allowed as deduction depends upon whether the foreign currency transactions were carried on account of capital or revenue items. If the foreign currency transactions are undertaken on capital account, the gain made out of such transaction is outside ambit of taxation, of course subject to the application of provisions of section 43A of the Act. If the transactions undertaken are on account of revenue items, the gain is clearly taxable and so the loss also is clearly allowable. The assessee except making bald assertion that the transactions were undertaken on account of capital items no evidence was brought on record to establish that the foreign currency transactions were undertaken on capital items. The assessing officer also had failed to undertake this exercise. The Hon’ble Supreme Court in the case of CIT v. Woodward Governor India Pvt. Ltd. (2009) 312 ITR 254 (SC) : 2009 TaxPub(DT) 1628 (SC) had clearly held that the actual payment was not a condition precedent for making adjustment in respect of foreign currency transactions as the end of the closing year. We are therefore, unable to concur or agree with the view of the Commissioner (Appeals), that liability could arise only when the contract would have matured, as such a stand is totally divorced from the accounting principles and is in variance with the principle upheld by the Apex Court in the case Woodward Governor India (P.) Ltd. (supra).
It can also be seen that the decision in the case of Woodward Governor India (P.) Ltd. (supra) has been rendered with regard to items in the revenue account and capital account.
10.8 In the light of our above findings, we restore the matter to the file of assessing officer with the direction that to re-do the assessment keeping in view the principles enunciated above after affording a reasonable opportunity of being heard to the assessee. Accordingly, the appeal of the assessee is partly allowed for statistical purposes. Thus, the appeal of the assessee is partly allowed for statistical purposes.
11. In the result, the appeal of the Revenue is allowed and the appeal of the assessee is partly allowed for statistical purposes.
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