Taxation of Gain due to appreciation in the value of the foreign currency

 

Bombay High court in the case of CIT  v. Popular Metal Works & Rolling Mills has held as under:

21. Having regard to the view which we have taken, it is clear to us that the excess amount of Rs. 1,14,710 constituted business profit and was assessable to tax as such. The question referred to us is, therefore answered by holding that the sum of Rs. 1,14,710 is assessable to tax as a business profit. The assessee to pay the costs of the reference.

The copy of the order is as under:

 

Commissioner Of Income Tax

v.

Popular Metal Works & Rolling Mills

(High Court Of Judicature At Bombay)

Income Tax Reference No. 57 Of 1973 | 02-03-1982

1. In the accounting year 1966-67 for which the corresponding assessment year was 1967-68, the assessee-firm, which is a manufacturing concern, had indented for import of 2,592 ingots of fire refined copper from the British Metal corporation Ltd, England. The goods were dispatched to the assessee by S.S. City of Pretoria and the invoice dated 3rd August, 1965, showed the value of the goods at pound 14,732-10-5. The documents including the bill of exchange were presented to the assessee through the Canara Bank Ltd., Bombay, for payment. They were honoured for Rs. 1,98,696.63 and were placed with the bank

2. When in the course of transit the goods reached Karachi Port they were discharged between 6th September and 3rd October, 1965, by the order of the Govt. of Pakistan, who, on 21st September, 1965, served a writ on the carrying vessel in an action in prize instituted on 20th September, 1965, in the High Court of West Pakistan, Karachi (prize jurisdiction).

3. The assessee had assigned the goods to National Transport Company, Bombay, who made a claim with the Custodian of Enemy Property, Ballard Estate, Bombay. The claim was for Rs. 2,05,539.62 which was the insured value of the goods. The claim was ultimately settled by Lloyds, who by their letter, through their agents, James Finlay & Company Ltd., informed the National Transport Company that the consignment was requisitioned and/or sold by the Pakistan Govt. and Lloyds were authorized to effect the settlement of the claim. The claim was adjusted and passed for Rs. 3,21,467.16, at the rate of pound 4.8120 equal to Rs. 100, the insured value of the complete consignment lost being taken at pound 15,469. The assessee-company thus received Rs. 1,14,710 in excess of the value of the stock-in-trade, the excess being due to the devaluation of the rupee during the period between the making of the claim and its settlement.

4. The ITO negatived the claim of the assessee that the excess amount was a casual receipt or alternatively a capital gain and could not be taxed as profit. This order of the ITO was also confirmed by the AAC. In appeal by the assessee company before the Tribunal, the Tribunal found that the excess amount resulted from the devaluation of the Indian currency in terms of sterling and that in view of the Supreme Court decision in CIT v. Canara Bank Ltd : [1967]63ITR328(SC) , the excess could not be taxed as profit. The Tribunal took the view that the amount received in excess of the sum for which the goods were insured was due to the fact that the Indian currency was devalued and the excess was, therefore, not a trading receipt because the assessee was not dealing in foreign exchange. Thus, holding that the accretion was not due to any trading activity, the excess amount of Rs. 1,14,710 was directed to be treated as capital gains.

5. Arising out of the order of the Tribunal, the following question has been referred to this court at the instance of the Revenue under s. 256(1) of the I.T. Act, 1961 :

“Whether, on the facts and circumstances of the case, the sum of Rs. 1,14,710 is assessable to tax as a capital gain or as a business profit ?”

6. The learned counsel appearing on behalf of the Revenue has contended that the whole transaction as a result of which the assessee has received the excess amount is a part and parcel of the business carried on by the assessee and that the excess amount must be treated as the profit of the assessee, notwithstanding the fact that the excess was received as a result of the devaluation of the Indian rupee. The learned counsel has contended that the facts of the present case are more or less similar to the facts in the decision of the Madras High Court in CIT v. Universal Radiators : [1979]120ITR906(Mad) . According to the learned counsel for the assessee, the excess receipt must be treated as having been received on capital account because the excess has not arisen as a result of any trading activity and, according to the learned counsel, when the stock-in-trade was insured by the assessee, the assessee was in fact insuring capital which was invested in the stock-in trade. It was also contended that when the goods were seized by the Govt. of Pakistan, the goods had lost their character of stock-in trade and, therefore, the payment of the money by the insurance company could not be directly related to the stock-in-trade. It appeared to be the contention of Mr. Pandit that where such excess arises as a result of a change in the exchange rate, then it does not arise out of any business dealings and, therefore, the excess must be treated as a capital receipt.

7. Now, in order to decide whether the excess amount received by the assessee-company from the insurance company partakes of the nature of revenue receipt, it has to be decided whether the receipt is in respect of a trading asset or whether it is in respect of a capital asset. In other words, What has first to be determined is whether the excess amount which has accrued to the assessee-company arises out of transaction in respect of a trading asset or in respect of a capital asset.

8. Now, there is no dispute that the excess amount was received as a result of the devaluation of the Indian currency. In other words, if there was no devaluation of the Indian currency and if the rate of exchange between sterling and Indian rupee would have remained constant, the assessee would have received the exact amount for which the goods were insured, viz., Rs. 2,05,539.62. The question to be asked is what would be the nature of the receipt which the assessee would have received if the rate of exchange remained the same. Now, what the assessee has, in fact, received is in the nature of compensation for goods lost and, normally, the compensation would have represented the price of the stock-in-trade for which the assessee had taken out the insurance. Therefore, moneys received from the insurance company, in fact, represented the equivalent in money value of the goods which were insured. There can hardly be any dispute that such receipt would clearly be of a revenue nature. The character of such receipt would be the same as the amount which the assessee-company would have received by the sale of the stock-in-trade to its customers. The only difference is that if the assessee had received the stock-in-trade, he would have received the price of the stock-in-trade from the customers but the stock-in-trade having been seized by the Govt. of Pakistan, the money value thereof is paid to the assessee-company by the insurance company. On principle, therefore, the nature of the receipt of the amount paid by the insurance company is in no way different or what it would have been if the price for the stock-in-trade would have been received when the stock-in-trade is sold to the buyers. If any authority for this proposition is needed, we may refer to the decision of the House of Lords in IRC v. J. Gliksten & Son Ltd. [1929] 14 TC 364 . That was a case in which a large quantity of timber belonging to the company – timber merchants – was destroyed in a fire which broke out. The goods had, in due course of business, been insured and the company received pound 477,838 from the insurance company. In the books of the company the timber which was destroyed was valued at pound 160,824 and, according to the company, only this amount was liable to be brought in for the purposes of assessment to Income Tax, while the Inland Revenue authorities asserted that they were bound to bring in the larger sum. The question which fell for consideration before the House of Lords was, “ought the total amount of these insurance moneys to be regards as part of the profits and gains of the trade ?” Answering this question in the affirmative, Lord Buckmaster observed as follows (p. 384) :

“What has happened has been this, that the timber which the Appellants held has been converted into cash. It is quite true it has been converted into cash through the operation of the fire, which is no part of their trade, but loss due to it is protected through the usual trade insurances, and the timber has thus been realised, It is now represented by money, whereas formerly it was represented by wood. If this results in a gain, as it has done, it appears to me to be an ordinary gain – a gain which has taken place in the course of their trade – none the less because, as Mr. Macmillan put it, and as I think Sir John Simon before him appears to have put it, It is no part of a timber merchants business to trade in fires. I think that a few words in the judgment of Lord Justice Sargant express the whole matter in a sentence, and to them it is unnecessary to add anything more. He says : To my mind the book value of the timber in the companys books has nothing at all to do with the amount of the loss or with the amount which has been recovered in respect of the loss. That amount is a gain of the company in the course of its business no less than the sale price of the timber would have been if the timber had been sold in the course of ordinary sales during the continuance of the companys business; and in estimating the balance of the profits or gains which the company has to bring into account for the purposes of Income Tax, the amount of the excess of the sum recovers over the book value of the timber in the companys books has to be brought into account just as fully and completely as if there had been a sale in the ordinary course of business at that price.”

9. In the same judgment, Viscount Dunedin pointed out that the result of the fire appears that the company got rid of so much timber and got the insurance money at that figure, and “that seems to me precisely in the same position as if they got rid of it by giving it to a customer.”

10. Now the next question is whether the fact that the excess arose because of a change in the exchange rate makes any difference to the nature of the receipt. As already pointed out, if the existing rate had remained constant, the assessee-company would have received an amount equivalent to Rs. 2,05,539.62, which was the value for which the goods were insured, being the equivalent of pound 15,469. It is argued by Mr. Pandit that the excess cannot be treated as having been received as incidental to the business. Now, normally, in international trade, when an account with regard to buying and selling of commodities is settled, that settlement will depend on the rate of exchange of the two currencies in the trading countries. In such transactions the right of the seller to receive from the buyer at the existing rate of exchange, unless otherwise agreed to, is very much a normal incident of business and, therefore, any excess received because of the fall in the value of the Indian rupee in relation to the sterling, cannot be of any different nature, than the equivalent of the price of stock-in-trade in respect of which the amount was received by the assessee. Therefore, whether the difference arose because of a change in the exchange rate or not, is not at all relevant for the purpose of determining the nature of the receipt. The nature of the receipt does not cease to be on revenue account merely because the amount is being remitted by the foreign insurer to the buyer at the prevailing rate of exchange which has, in the meantime, risen.

11. It is difficult to accept the argument of Mr. Pandit that the stock-in-trade, when it was seized by the Govt. of Pakistan, ceased to be stock-in-trade and it must be treated as capital of the assessee-company. As a matter of fact, once the stock-in-trade was seized by the Govt. of Pakistan and it could not be retrieved by the assessee, the right to claim compensation arises in favour of the assessee, and that compensation, as already pointed out, would partake of the same nature as the price of the stock-in-trade. There is no question of that stock-in-trade converting itself into a capital of the assessee. We shall presently deal with the decision of the Supreme Court on the basis of which this argument has been founded, but suffice it for the present to point out that there is no question of stock-in-trade converting itself into capital asset of the assessee on the day on which the stock-in-trade was seized by the Govt. of Pakistan.

12. We may, in this context, refer to decision in Landes Brothers v. Simpson [1934] 19 TC 62 , which has been cited with approval by the Supreme Court in Sutlej Cotton Mills Ltd. v. CIT : [1979]116ITR1(SC) . In Landes Brothers case, Landes Brothers, who carried on business as fur and skin merchants and as agents were appointed sole commission agents of a company for the sale in Britain and elsewhere, of furs exported from Russia, on the terms, inter alia, that they should advance to the company a part of the value of each consignment. All the transactions between the appellants and the company were conducted on a dollar basis, and, owing to fluctuations in the rate of exchange between the dates when advances in dollars were made by the appellants to the company against goods consigned and the dates when the appellants recouped themselves for the advances on the sale of goods, a profit accrued to the appellants on the conversion of repaid advances into sterling. The question which arose was whether this profit formed part of the trading receipts of the appellants so as to be assessable to tax. Singleton J., holding that exchange profit arose directly in the course of the appellants business with the company and formed part of the appellants trading receipts for the purpose of computing profits assessable to Income Tax under Case I of Sch. D, pointed out that (p. 69) “the profit which arises in the present case is a profit arising directly from the business which had to be done, because, ….. the business was conducted on a dollars in order to make the advances against the goods as prescribed by the agreements. The profits accrued in this case because they had to do that, thereafter as a trading concern in this country re-transferring or re-exchanging into sterling”. Thus, since the dollars were purchased for the purposes of carrying on a business as sole commission agents and as an integral part of the activity of such business, it was held that the profit arising on re-transfer or re-exchange of dollars into sterling was a trading profit falling within Case I of Sch. D. As the Supreme Court pointed out, this decision was accepted as correct decision by the Court of Appeal in Davies v. Shall Co. of China Ltd. [1951] 32 TC 133; [1952] 22 ITR (Supp) 1.

13. So far as the present case is concerned, receiving compensation for stock-in-trade lost in transit from the insurance company would very much be an integral part of the business of the assessee-company, and any excess amount received, therefore, must be attributed to the assessee-company.

14. The view similar to the one which was taken, has been taken by the Madras, Calcutta and the Mysore High Courts. In CIT v. Universal Radiators : [1979]120ITR906(Mad) , the assessee had entered into a contract with an American company for the purchase of copper bars for re-rolling them into strips and sheets. The assessee opened a letter of credit in a bank in favour of the foreign seller but the ship in which the goods were sent was, however, seized by the Pakistan Govt., due to hostilities between India and Pakistan. The assessee and its clearing agents took up the matter with the insurance company in America which ultimately accepted the liability and paid the amount in American dollars. On account of devaluation of the Indian rupee, the assessee got a higher amount in Indian rupee than what it had paid, and the question was whether the surplus was liable to tax as a trading profit. The surplus was treated as a trading profit by the ITO and the AAC but the Tribunal took the view that when the vessel was impounded by the Pakistan authorities, the character of the goods changed and they became sterilised and ceased to be the stock-in-trade of the assessee and hence the amount was a capital receipt. The Tribunal also held that the profit on account of devaluation did not arise directly from the assessees normal receipts and the profit was not a business profit. Reversing the view of the Tribunal, the Madras High Court held that so long as the profit accruing to the assessee had its origin on revenue account, the assessee would be liable to be taxed and the transaction was of revenue account because the profit arose to the assessee on account of the transaction with respect to raw materials. It was held that there was no capital element in the transaction and the seizure of the goods by Pakistan was of the same nature as loss goods in transit. The High Court pointed out that the whole transaction was part and parcel of the business carried on by the assessee and not extraneous to it and the fact that the profit has been occasioned by an external factor like devaluation would make no difference. A similar view was taken by that court in S. G. R. Subramania Iyer v. CIT : [1979]116ITR746(Mad) , in which the assessee had placed an order with an American firm for the supply of pesticides of particular purity but the goods were found to be substandard and the consignment was returned to the supplier. The bank with whom the letter of credit had been opened, had paid an amount of Rs. 24,300, being the actual value of the goods. The consignor refunded the amount in dollars but due to devaluation which had taken place in the meanwhile, the assessee received an extra amount of Rs. 16,534. The Madras High Court held that the surplus amount was received by the assessee while receiving the refund of the value of the pesticides and hence the receipt of the amount was an integral part of the business and was eligible to tax.

15. In Calcutta Jute Agency (p.) Ltd. v. CIT : [1979]117ITR741(Cal) , the facts were that the assessee had carried on business for purchase and sale of jute. On behalf of the assessee an agent had entered into a contract for purchase jute in London from Pakistan in 1965 and opened a letter of credit there covering the price of the said jute in favour of the intending seller. Because of hostilities between India and Pakistan, which had broken out in the meantime, the contract could not be performed and the letter of credit remained unoperated. Consequent upon the devaluation of the Indian rupee in June, 1966, the agent received a sum of Rs. 1,52,710 in excess over the amount originally deposited by them in rupees. The question was whether the surplus was to be treated as a trading receipt or not. The Tribunal treated the surplus as business profits and in the reference, the Calcutta High Court held that the accretion to the fund which was lying in the foreign country for the purchase of jute goods and which was part of the circulating capital of the assessee, resulted in a profit to the assessee in its business though the accretion might have been caused by an external factor like devaluation. The High Court also held that though the fund became frozen or immobilized, it was the nature and character of the fund and not its mobility that should be considered, and the excess was income of the assessee and was liable to tax.

16. The Kerala High Court has taken a similar view in M. Shamsuddin & Co. v. CIT : [1973]90ITR323(Ker) . That was a case in which for cashew kernels exported by the assessee-firm and in respect of forward contracts. price used to be fixed in dollars and at the time of payment the assessee would receive the rupee equivalent of the price. After the devaluation of the Indian currency on 6th June, 1966, the assessee earned a profit of Rs. 2,54,862 which the ITO held to be a taxable profit. This view was confirmed in appeal. On a reference, the Kerala High Court held that the result of the devaluation was that the assessee became entitled to receive a larger price in terms of rupees for the goods and that was directly in the course of the trade and constituted a trading profit. The Kerala High followed the decision of the Mysore High Court in Hindustan Aircraft Ltd. v. CIT : [1963]49ITR471(KAR) .

17. The decision in Shamsuddins case : [1973]90ITR323(Ker) . was also followed by the same High Court in Sree Hanuman Trading Co. v. Cit : [1980]125ITR1(Ker)

18. Now, the decision of the Kerala High Court in CIT v. Union Engineering Works : [1976]105ITR311(Ker) , on which heavy reliance is placed by the learned counsel for the assessee, has taken the view that the excess profit arising entirely due to devaluation was in the nature of a windfall and could not be regarded as a receipt from business within the meaning of s. 10(3)(ii) of the I.T. Act, 1961. In that case the assessee firm carried on the business of manufacturing and selling tin sheets, fittings and battery covers. In the relevant assessment year the assessee imported tin sheets from London but upon arrival, it was found that more than half of the quantity was rusty. The goods were insured with an insurance company in London. The assessee entered into an agreement with the insurer whereby it agreed to accept the rusty sheets at a discount. The insurer issued a cheque drawn in favour of the assessee on a bank in London. Within a fortnight of the receipt of the cheque, the rupee was devalued and the assessee realized and excess amount of Rs. 13,455.75. On the question whether its amount was a casual and non-recurring receipt, the Kerala High Court took the view that the claim for damage caused to the goods had been settled with the insurer and the sum so settled did not include any excess profit. The excess profit arose entirely due to devaluation and was in the nature of a windfall. It appears that the Division Bench distinguished Shamsuddins case : [1973]90ITR323(Ker) , and the decision of the Division Bench shows that the Division Bench accepted the finding of the Tribunal that the excess amount was not a receipt arising from business and both sides had admitted that it was not capital gains.

19. On principle we fail to see why the amount received by the assessee-company in that case could not be of revenue nature, when instead of selling the rusty sheets in the market they were purchased by the insurer and the insurer paid the price for the rusty sheets. In the hands of the assessee-company the entire amount would normally be the price received and the fact that more amount was received on account of devaluation made no difference to the nature of the receipt, in our view. We may point out that in Sree Hanuman Trading Companys case [1980] 125 ITR 323 was followed, the decision in Union Engineering Works case : [1976]105ITR311(Ker) , has been cited but has been distinguished on the ground that the facts and the nature of the payment were totally different and the principle laid down therein had no application to the case in the decision of Sree Hanuman Trading Company. The decision in Union Engineering Works case obviously runs counter to the decision in Shamsuddins case on principle. If that decision lays down that the excess, which accrues in the hands of the assessee as a result of devaluation, amounts to a windfall, assuming that such amount is a windfall, in our view, the real nature of that receipt, though it was a business windfall, would be of revenue nature and not a casual receipt.

20. The other decision on which reliance is placed by Mr. Pandit is in CIT v. Canara Bank Ltd. : [1967]63ITR328(SC) . It the facts of the case are appreciated properly, it would be seen that the decision therein turned on the finding recorded by the Tribunal that the amount in question had ceased to be part of the circulating capital in the business of banking. The facts in that case were that the Canara Bank had opened a branch in Karachi on November 15, 1946. After partition in 1947, the currencies of the two Dominions of India and Pakistan continued to be at par until there was a devaluation of the Indian rupee on September 18, 1949. The Canara Bank had a sum of Rs. 3,97,221 at the Karachi branch belonging to its head office. As Pakistan did not devalue its currency the parity between the Indian rupee and the Pakistan rupee ceased to exist. The exchange ratio between the two countries was not determined until February 27, 1951. The Canara Bank did not carry on any business in foreign currency and, even after it was permitted to carry on business in Pakistan currency on April 3, 1951, it carried on no foreign exchange business. The State Bank of Pakistan granted permission on 1st July, 1953, and two days later, the bank remitted the amount to India and, in view of the difference in the values of the currencies, made a profit of Rs. 1,73,817. The Tribunal had found that the money was lying idle in the Karachi branch and was not utilized for any internal banking operations even in Pakistan. The question was whether the profit of Rs. 1,73,817 was a revenue receipt, and it was held that the appreciation of the money did not arise in the course of any trading operation and assuming that the amount of Rs. 3,97,221 was originally stock-in-trade. when it was blocked and sterilized and the bank was unable to deal with that amount, it ceased to be its stock-in trade and the increase in its value owing to exchange fluctuation was a capital receipt. Therefore, the reason why the excess was held to be a capital receipt was the finding that the amounts at the time when they were remitted to India were held as capital and it ceased to be stock-in-trade. It is difficult to see how any assistance can be sought by the learned counsel for the assessee from this decision. We may, however, point out that in the same case the Supreme Court pointed out that if by virtue of exchange operations, profits are made during the course of business and in connection with business transactions, the excess receipts on account of conversion of one currency into another would be revenue receipts. But if the profit by exchange operation comes in, not by way of business of the assessee, the profit would be capital. These observations will also show that on the views which we have taken that the recovery of compensation for the stock-in-trade lost on account of being seized by the Govt. of Pakistan was in connection with the business transaction of the assessee, viz., as a dealer in stock-in-trade, in view of the decision of the Supreme Court in Canara Banks case : [1967]63ITR328(SC) , also the excess receipt would be of a revenue nature.

21. Having regard to the view which we have taken, it is clear to us that the excess amount of Rs. 1,14,710 constituted business profit and was assessable to tax as such. The question referred to us is, therefore answered by holding that the sum of Rs. 1,14,710 is assessable to tax as a business profit. The assessee to pay the costs of the reference.