High Court Of Bombay
Ballarpur Industries Ltd. Vs. CIT, Vidarbha Nagpur
Section : 9, 145
Assessment Year : 1991-1992
M.S. Sanklecha And Manish Pitale, Jj.
It Reference No. 11 Of 2002
August 1, 2017
JUDGMENT
M.S. Sanklecha, J. – By this reference under Section 256(1) of the Income Tax Act, 1961 (the Act), the Income Tax Appellate Tribunal (the Tribunal) seeks our opinion on the following questions of law :
1. Whether in the facts and circumstances of the case and in law the difference in exchange rate amounting to Rs.24,81,922/- does not partake the same character of royalty derived from Malaysia as provided in Article 13 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion with Malaysia (AADT) ?
2. Whether in the facts and circumstances of the case and in law the difference in exchange rate amount to Rs.1,29,220/- does not partake the same character of interest derived from Malaysia as provided in Article 12 of the AADT between Malaysia and India ?
3. Whether in the facts and circumstances of the case and in law and in the light of the findings of the Tribunal that Royalty and interest income from Malaysia fall under exemption method, the provisions of AADT should be construed to apply to such income only at accrual stage and should not apply at the receipt stage in respect of exchange fluctuation ?
2. This Reference relates to Assessment Year 1991-1992.
3. The facts set out in the statement of case for our consideration are as under :
‘2. The Assessee is a Public Limited Company. In respect of accounting year ended 31.3.1991, relevant to Assessment Year 1991-92, the Deputy Commissioner of Income-Tax (Assessment) Special Range-1, Nagpur, completed the assessment u/s.143(3) of the Income-Tax Act assessing the loss at Rs.15,99,11,740/-. During the relevant Assessment year, the Assessee/Company derived its income from manufacturing and sale of paper, stationery, glass, caustic soda, salt etc. besides income by way of royalty and interest from a joint venture Company viz. M/s. JG Containers (Malaysia) Sdn. Bhd., Malaysia.
The Assessee/ Company had in the earlier years credited in its books, the income by way of royalty and interest from the Malaysian company on accrual basis.
3. In the relevant Assessment Year, the Assessee/Company had received the royalty and interest which were accounted in the earlier years on accrual basis. Though the Malaysian Company remitted the same foreign currency, as a difference in exchange rate, the assessee-company received more than what was earlier accounted in terms of Indian Rupees. There was no change in the income in terms of Malaysian Currency.
4. The Assessing Officer in his Assessment Order dated 30.3.1994 has allowed the royalty and interest credited in the accounts on accrual basis as income exempt from tax in view of Double Taxation Avoidance Agreement with Malaysia.
5. However, the Assessing Officer declined to accept the claim of the Assessee-Company that the differential amount arising on account of exchange fluctuation on remittance of royalty and interest pertaining to the earlier years had retained its original nature as royalty and interest and accordingly should be exempt from tax. The Assessing Officer in his order dated 30.3.1994 has held as under :
“The royalty and interest which were not repatriated from Malaysia of the earlier years were held on a revenue account and not on any capital account. It is said in law that income arising on account of exchange fluctuation in respect of foreign currency held abroad on revenue account is a trading receipt and is liable to tax. But it cannot be said that this trading receipt retains the character of royalty and interest. Apart from that what the assessee received in India was in terms of Malaysian Dollars which on conversion in India received the extra income. Therefore, this extra income arose in India and not in Malaysia as the conversion took place in India. This amount, therefore, cannot be excluded from the computation. “
6. The Commissioner of Income-Tax (Appeals) vide his order dated 18-4-1995 also disallowed the claim of the Assessee-Company and he had held that :
“admittedly the amount which was received by the assessee this year from Malaysia had been earned by it as income in the earlier years. The amount was obviously held on revenue account and not as a capital asset. Therefore, as per the decision of the Supreme Court in the case of CIT vs. Sutlej Cotton Mills Ltd. (116 ITR 1), the profit arising to the appellant on account of appreciation in the value of foreign currency held by it has to be treated as trading profit. Such profit would necessarily be different from the appellant’s regular source of income in Malaysia i.e. royalty and interest. The Double Taxation Avoidance Agreement did not extend to cover such income.”
7. The Tribunal has also affirmed the decision of the Assessing Officer and observed under para No.33, page 10 of the order dated 19-3-1997 as under :
” There is no doubt that interest and royalty income was a trading receipt in the hands of the assessee. But for the Double Taxation Avoidance Agreement this would have been charged to tax in the assessee’s hands. The said income was treated as exempt only because it was covered by the Double Taxation Avoidance Agreement. That the agreement, however, does not cover the amounts accrued to the assessee as a result of exchange rate fluctuations. Moveover, the amount of Rs.26,11,142/- had arisen in India as the conversion took place in India. The said amount is, therefore, held to be taxable in the hands of the assessee”.’
4. It is on the above facts, that the Tribunal has at the instance of the applicant/assessee referred the above questions to us for our opinion.
5. Mr. K.P. Dewani, learned Counsel appearing for the applicant/assessee in support of this reference submits as follows :
(a) In terms of Articles 12 and 13 of the Indo-Malaysian AADT Income attributable to royalty and interest remitted from Malaysia is not exigible to tax in India. The aforesaid amount has already discharged the tax payable thereon in Malaysia. Undisputedly, the amounts attributable to royalty and interest is not taxable in India. The conversion of the above Malaysian currency into Indian currency cannot be subjected to tax, as it is not even the case of the Revenue that the appellant is engaged in activity of trading in foreign exchange.
(b) The Revenue does not dispute that the exchange gain upto the close of the Accounting Year emanating from foreign exchange realisation on the amount received from Malaysia is on account of royalty and Interest. Therefore, mere date of realisation/remittance being subsequent to the end of the Accounting year will not change the character of income being on account of royalty and interest;
(c) Section 145 of the Act recognizes cash or mercantile system of accounting. In case the cash system of accounting was followed, then the receipt of royalty and interest from Malaysia would be recorded as income only on receipt. Therefore, merely because the applicant-assessee follows a mercantile system of accounting amounts received on account of royalty and interest cannot be partly subjected to tax. The exigibility to tax under cash or mercantile system of accounting cannot be different; and
(iv) The amount received on foreign exchange fluctuation in respect of export turnover is eligible for benefit of deduction under Section 80HHC of the Act as export receipts. In support, reliance is placed upon the decision of this Court in CIT v. Amber Exports (India) Ltd. [2010] 326 ITR 455 (Bom.) , of Gujarat High Court in CIT v. Amba Impex [2006] 282 ITR 144/[2007] 164 Taxman 344 (Guj.) and decision of Calcutta High Court in Raghunath Exports (P.) Ltd. v. CIT [2011] 330 ITR 144/200 Taxman 85 (Mag.)/11 taxmann.com 273 (Cal.). The same principle is applicable to the present facts.
6. As against the above, Mr.Bhattad, learned Counsel for the Revenue, in support of the impugned order, submits as under :
(a) Admittedly, the amount sought to be taxed on account of gain on foreign exchange fluctuation is not from the tax free income for the subject Assessment Years, but for earlier years. The amount attributable to royalty and interest under the AADT was duly accepted for the year in which it had accrued at the foreign exchange rate then prevailing. The receipt of the royalty and interest and conversion of Malaysian currency into Indian rupees later will be a benefit/income arising from a subsequent transaction in a different year and not related to the origin/source of the receipts. There is no continuation in the manner of the earning in Malaysia and gain on foreign exchange fluctuation arising out of the same transactions.
(b) The Accounting Standard particularly AS 11 issued by the Institute of Chartered Accountants of India clearly indicates that any benefit derived on account of currency fluctuation beyond the year of receipt cannot be correlated to the original amount received. This benefit is on independent source of income; and
(c) The entire issue is no longer res-integra as it stands concluded by the decision of the Apex Court in CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254/179 Taxman 326 in favour of the Revenue.
7. We have considered the rival submissions. It is clear from the Statement of the case sent by the Tribunal that the amounts which were received by the Assessee this year from Malaysia on account of royalty and interest income had been earned and shown as it’s income in the earlier years. At that time no tax on the same was paid in view of AADT entered into between Malaysia and India. Further the income on account of royalty and interest which arose in Malaysia and had accrued to the appellant was accounted in the very year of accrual at the foreign exchange rate prevailing on the last day of that financial year. On the aforesaid income, on account of royalty and interest from Malaysia as valued on the last date of the earlier years was not subjected to any tax. This was so as it was exempt/excluded from tax in India by virtue of AADT agreement entered into between Malaysia and India. These amounts/income for the earlier years which have now been repatriated from Malaysia has been brought to tax only to the extent of gain made on account of difference in foreign exchange rate prevailing on the last date of the financial year in which the aforesaid income had been recorded in the Appellant’s Books of Account (taxable in that year but for AADT) and gain made on account of foreign exchange variation at the time when the amounts were received from Malaysia in Malaysian dollars and converted into Indian Rupees in India. Therefore earned in India. This gain on account of foreign exchange variation cannot be attributable to royalty and interest earned in Malaysia, but is benefit/income arising from subsequent transaction not related to interest and royalty which has accrued earlier and was taxable (but for AADT) in an earlier Assessment year.
8. The learned Counsel for the Appellant was at pains to point out that the royalty and interest which is received from Malaysia is not exigible to tax in India. This is so as it has already been subjected to tax in Malaysia. It is submitted that the mere fact that subsequent to the end of the previous year relevant to the Assessment year the amount have been received and gain has been made on foreign exchange variation, will not change the character of income being on account of royalty and interest earned in Malaysia. This income, according to the Appellant, is not taxable in India as it would stand excluded by ADTT.
9. In fact, the Revenue has correctly placed reliance upon the Accounting Standard AS11 issued by the Institute of Chartered Accountants of India which indicates that any benefit derived on account of currency fluctuation after the year of accrual is to be considered as income/expense in the period in which they arise. We would fruitfully reproduce extracts from the AS 11 which clarifies the issue as under :—
“9. Exchange differences arising on foreign currency transactions should be recognized as income or as expense in the period in which they arise, except as stated in paragraphs 10 and 11 below.
10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.
11. The carrying amount of fixed assets which are carried in terms of revalued amounts should also be adjusted in the manner described in paragraph 10 above. However, such adjustment should not result in the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that class, the remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve.
12. An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period. However, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. “
(emphasis supplied)
This is because the same is independent source of income.
10. We further find that the Apex Court in Woodward Governor India (P) Ltd. (supra) approved the applicability of AS 11 to determine the taxability in similar situation by observing as under :
’17. Having come to the conclusion that valuation is a part of the accounting system and having come to the conclusion that business losses are deductible under s. 37(1) on the basis of ordinary principles of commercial accounting and having come to the conclusion that the Central Government has made Accounting Standard-11 mandatory, we are now required to examine the said Accounting Standard (“AS”).
18. AS-11 deals with giving of accounting treatment for the effects of changes in foreign exchange rates. AS-11 deals with effects of exchange differences. Under para 2, reporting currency is defined to mean the currency used in presenting the financial statements. Similarly, the words “monetary items” are defined to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g., cash, receivables and payables. The word “paid” is defined under s. 43(2). This has been discussed earlier. Similarly, it is important to note that foreign currency notes, balance in bank accounts denominated in a foreign currency, and receivables/payables and loans denominated in a foreign currency as well as sundry creditors are all monetary items which have to be valued at the closing rate under AS-11. Under para 5, a transaction in a foreign currency has to be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. This is known as recording of transaction on initial recognition. Para 7 of AS-11 deals with reporting of the effects of changes in exchange rates subsequent to initial recognition. Para 7(a) inter alia states that on each balance sheet date monetary items, enumerated above, denominated in a foreign currency should be reported using the closing rate. In case of revenue items falling under s. 37(1), para 9 of AS-II which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under s. 43A of the 1961 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-11 recognises exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-a-vis the Indian rupee, there is an expense during that period. The important point to be noted is that AS-11 stipulates effect of changes in exchange rate vis-a-vis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Therefore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P&L account for the reporting period.’
(emphasis supplied)
Thus, the Apex Court placed reliance upon AS11 to hold that gain or loss made on account of rate difference in foreign exchange post the date of balance sheet has to be taken in the year in which the gain or loss has arisen on account of exchange rate fluctuation subsequent to close of the Accounting Year which records the accrual of income at the rate prevailing on the last date of the accounting year.
11. Therefore, in the present facts, we find that the income has been earned in Malaysia on account of royalty and interest but the same is retained there and not brought repatriated to India immediately on the same accruing to the Appellant/assessee. This leads to a gain/loss in foreign exchange valuation. This gain/loss on account of foreign exchange variation would not bear the character of income on account of royalty and interest earned in Malaysia. This is so as the gain/loss on account of foreign exchange variation is not a part of royalty and interest nor is it any accretion to it. In this case, it is the generation of further income which is taxable in the subject assessment year when the variation in foreign exchange has resulted in further income in India to the Appellant/assessee.
12. It was contended on behalf of the Appellant/Assessee that, in terms of Section 145 of the Act, the Assessee is entitled to follow either the Cash or Mercantile System of Accounting. It is submitted that, in case the Cash System of Accounting was followed, the receipt of royalty and interest from Malaysia including exchange rate differences would be recorded as income on the date of receipt/repatriation. However, merely because the Assessee followed the Mercantile System of Accounting, an amount received on exchange conversion on account of royalty and interest is being partly subjected to tax. This exigibility to tax under the Cash or Mercantile system of Accounting cannot be different.
13. This submission on the part of the Appellant/assessee overlooks the fact that although the Revenue would in cash system of accounting record the income only on receipt of the same, yet for the purposes of taxation it would split the amount received from Malaysia on account of royalty and interest in the year in which it arose/accrued at the rate prevailing then as one head of income and the income gained on account of exchange rate variation due to passage of time at the time of conversion as the other head of income. The Revenue would bring to tax the later gain arising on account of exchange rate variation to tax as income arising from a different source. The amount attributable to royalty and interest received from Malaysia on the basis of foreign exchange rate existing on the last date of the Accounting year in which this income would be receivable by the Applicant/Assessee as a different head of receipt excluded from tax by ADTT. Thus, we do not accept the above submission made on behalf of the appellant as the source of receipt is different and two fold.
14. Lastly, the Applicant/Assessee placed reliance upon the decision of this Court in Amber Exports (India) Ltd. (supra), the Gujarat High Court in the case of Amba Impex (supra) and the Calcutta High Court in Raghunath Exports (P) Ltd. (supra) to contend that any amount gained on account of foreign exchange fluctuation in respect of export turnover continues to be part of export turnover eligible for benefit of deduction under Section 80 HHC of the Act. The same principle, it is submitted, should be extended to present facts. The aforesaid submission on behalf of the Appellant/Assessee completely ignores the fact that Section 80 HHC of the Act is a self-contained provision and it specifically defines “Export turn over” to mean the sale proceeds received or brought into India in convertible foreign exchange within a period of six months from the end of the previous year or within such further period as the Competent Authority may allow. It is in view of the specific provision of Section 80 HHC of the Act that any gain or loss made on account of amounts received in convertible foreign exchange is to be included as export turn over for the purposes of computing deduction. In the absence of any such specific definition, receipt of foreign exchange on sale proceeds of exports beyond the end of the previous year relevant to the Assessment year resulting in gain or loss would not be considered to be a part of export turn over, but an income arising on separate transaction i.e. arising due to variation in foreign exchange rates and would not be included as part of export turnover. Therefore, reliance upon the decision of the Bombay, Calcutta and Gujarat High Courts which were rendered in the context of the specific provision found in Section 80 HHC of the Act cannot apply to the present facts.
15. In the above view, all the three substantial questions of law raised for our consideration are answered in the affirmative i.e. in favour of the Respondent/Revenue and against the Appellant/Assessee.
Accordingly, the Reference is answered in the above terms. No order as to costs.
[Citation : 398 ITR 134]
