Commissioner of Income Tax vs Enron Oil and Gas India Ltd.

Prafulla C. Pant, J.—All these three appeals are directed against the same judgment and order dt. 29th Sept., 2006, passed by the Tribunal, Delhi Bench ''H'', New Delhi, in ITA No. 1821/2005; ITA No. 1823/2005 and ITA No. 1824/2005, relating to asst. yrs. 1999-2000, 2000-01 and 1998-99, respectively, whereby the depreciation on account of foreign exchange loss allowed to the assessee by the CIT(A), Dehradun, vide his order dt. 11th Feb., 2005, is affirmed.

Heard learned Counsel for the parties and perused the record.

Following are the substantial questions of law involved in these appeals:

In IT Appeal No. 74 of 2007.-Whether, Tribunal erred in law in upholding the decision of CIT(A) on facts and circumstances of the case, in allowing foreign exchange loss of Rs. 11,58,44,887 u/s 42 of the IT Act, 1961, without appreciating the fact that the loss is only a book entry and no loss was incurred by the company/assessee ?

In IT Appeal No. 76 of 2007-Whether, Tribunal erred in law in upholding the decision of CIT(A) on facts and circumstances of the case, in allowing foreign exchange loss of Rs. 46,54,30,105 u/s 42 of the IT Act, 1961, without appreciating the fact that the loss is only a book entry and no loss was incurred by the company/assessee ?

In IT Appeal No. 77 of 2007.-Whether, Tribunal erred in law in upholding the decision of CIT(A) on facts and circumstances of the case, in allowing foreign exchange loss of Rs. 38,63,38,980 u/s 42 of the IT Act, 1961, without appreciating the fact that the loss is only a book entry and no loss was incurred by the company/assessee?

In substance, in all the three appeals the same question is to be decided, whether the foreign exchange loss claimed by the assessee-company was admissible u/s 42(1) of the IT Act, 1961, in terms of agreement entered into between the parties on account of foreign exchange loss?

Brief facts of the case

Enron Oil and Gas India Ltd. (EOGIL) is a non-resident company, engaged during the relevant assessment years viz. 1998-99, 1999-2000 and 2000-01 in production of crude oil from Panna and Mukta oil fields along with its joint venture partners M/s Oil and Natural Gas Corporation Ltd. and M/s Reliance Industries Ltd. under the production sharing contracts entered with the Government of India. During the asst. yr. 1998-99, the assessee nonresident company has debited foreign exchange loss of Rs. 46,54,30,105 to its P&L a/c. During the asst. yr. 1999-2000, the assessee non-resident company has debited foreign exchange loss of Rs. 38,63,38,980 to its P&L a/c. And, during the asst. yr. 2000-01, the assessee non-resident company has claimed debit of foreign exchange loss to the tune of Rs. 11,58,44,887 to its P&L a/c. In all the three appeals, for translation purposes the previous month''s average daily means of the buying and selling rate of exchange as per SBI are used for the month in which the transaction has occurred as provided under production sharing contract. The assessee non-resident company draws monthly balances. And monthly balances are translated in the balance sheet at the prevailing exchange rates as on the date of balance sheet. Foreign currency loans are repaid out of the sale proceeds received, in US Dollars from Indian Oil Corporation Ltd., and Gas Authority of India Ltd. The assessee non-resident company admittedly borrows in US Dollars and repays it in the same currency. On these facts, the AOs in the aforesaid assessment years took the view that foreign exchange loss claimed by the assessee non-resident company was notional and the same was not admissible to it as depreciation. The respondent assessee non-resident company preferred appeals against the orders of the AOs before the Commissioner of Income Tax (Appeals), Dehradun [for brevity ''CIT(A)''], who registered the same as Appeal No. 21/DDN/CIT(A)-II/2004-05 against the order passed by AO in respect of asst. yr. 1990-2000; Appeal No. 22/DDN/CIT(A)-II/2004-05 against the order passed by AO in respect of asst. yr. 1998-99 and Appeal No. 51/DDN/CIT(A)-II/2004-05 against the order passed by AO in respect of asst. yr. 2000-01. After hearing the parties, the CIT(A), Dehradun, allowed all the three appeals, accepting the assessee-non-resident company''s claim of foreign exchange loss vide his order dt. 11th Feb., 2005 in the three appeals mentioned above.

Aggrieved by the same, the Revenue filed IT Appeal No. 1821 of 2005 against the order dt. 11th Feb., 2005, passed by CIT(A) in Appeal No. 21/DDN/CIT(A)-II/2004-05 in respect of asst. yr. 1999-2000; IT Appeal No. 1823 of 2005 against the order dt. 11th Feb., 2005, passed by CIT(A) in Appeal No. 51/DDN/CIT(A)-II/2004-05 in respect of asst. yr. 1999-2000; and IT Appeal No. 1824 of 2005 against the order dt. 11th Feb., 2005, passed by CIT(A) in Appeal No. 22/DDN/CIT(A)-II/2004-05 in respect of asst. yr. 1998-99. All the three appeals were heard and decided by the Tribunal, Delhi Bench ''H'', New Delhi, which allowed the three appeals vide its orders dt. 29th Sept., 2006. Hence, these appeals are preferred by the Revenue u/s 260A of the IT Act, 1961, on the substantial questions of law mentioned above.

Relevant provision of law and relevant clauses of the agreement entered into between the parties:

Before further discussion, it is pertinent to mention here the relevant provision of law applicable to the case. Section 42 of the IT Act, 1961, reads as under:

Special provision for deductions in the case of business for prospecting etc., for mineral oil.-(1) For the purpose of computing the profits or gains of any business consisting of the prospecting for or extraction or production of mineral oils in relation to which the Central Government has entered into an agreement with any person for the association or participation of the Central Government or any person authorized by it in such business (which agreement has been laid on the Table of each House of Parliament), there shall be made in lieu of, or in addition to, the allowance admissible under this Act, such allowances as are specified in the agreement in relation:

(a) to expenditure by way of infructuous or abortive exploration expenses in respect of any area surrendered prior to the beginning of commercial production by the assessee;

(b) after the beginning of commercial production, to expenditure incurred by the assessee, whether before or after such commercial production, in respect of drilling or exploration activities or services or in respect of physical assets used in that connection, except assets on which allowance for depreciation is admissible u/s 32:

Provided that in relation to any agreement entered into after 31st March, 1981, this clause shall have effect subject to the modification that the words and figures "except assets on which allowance for depreciation is admissible u/s 32" had been omitted; and

(c) to the depletion of mineral oil in the mining area in respect of the assessment year relevant to the previous year in which commercial production is begun and for such succeeding year or years as may be specified in the agreement,

and such allowances shall be computed and made in the manner specified in the agreement, the other previsions of this Act being deemed for this purpose to have been modified to the extent necessary to give effect to the terms of the agreement.

Explanation.-For the purposes of this section, ''mineral oil'' includes petroleum and natural gas.

Now, we deem it proper to quote the Articles 1.6-1 and 1.6-2 of the production sharing contract (''PSC'') entered into between the parties, which provides accounting procedure. The same are being reproduced below:

1.6 Currency Exchange Rates:

1.6-1 For translation purposes between US Dollars and Indian Rupees or any other currency, the previous month''s average of the daily means of the buying and selling rates of exchange as quoted by the SBI (or any other financial body as may be mutually agreed between the parties) shall be used for the month in which the revenues, cost, expenditure, receipts or income are recorded. However, in the case of any single non-US Dollar transaction in excess of the equivalent of one hundred thousand US Dollars (US Dollar 1,00,000), the conversion into US Dollars shall be performed on the basis of the average of the applicable exchange rate for the day on which the transaction occurred.

1.6-2 Any realized or unrealized gains or losses from the exchange of currency in respect of petroleum operations shall be credited or charged to the accounts. A record of the exchange rates used in converting Indian Rupees or any other currencies into US Dollars as specified in Clause 1.6-1 shall be maintained by the contractor and shall be identified in the relevant statements required to be submitted by the contractor in accordance with Clause 1.4-2.

Arguments:

Mr. Arvind Vashisth, learned Counsel for the appellants (Revenue) argued that the foreign exchange loss claimed by the assessee non-resident company in respect of assessment years in question, is nothing but only a loss shown in the book entry as the assessee non-resident company had invested the amount under the contract in US Dollar and it has been repaid in the same currency. However, as against this, on behalf of the respondent/assessee non-resident company it is submitted that the loss claimed by the assessee non-resident company is the actual loss on account of change in the foreign exchange rates. It is contended on behalf of the respondent/assessee non-resident company that for the profits shown by the assessee non-resident company due to the change in foreign exchange rates in other assessment years, the AOs have charged and accepted the tax on such profits shown, therefore, for the assessment years in which loss has occurred, for the same reason the depreciation cannot be denied. Lastly, it is submitted on behalf of the respondent/assessee non-resident company that when the other co-venturers, namely Oil and Natural Gas Corporation Ltd. and Reliance Industries Ltd. were allowed depreciation on account of change of exchange rates, the assessee being foreign company cannot be deprived of the same. Discussion:

On behalf of the appellants/Revenue it is submitted that the decision of Tribunal, Delhi, in (2002) 83 ITD 151 in the impugned order dt. 11th Feb., 2005. has been set aside by this High Court vide its judgment and order in CIT v. Oil & Natural Gas Corporation Ltd. IT Appeal No. 91 of 2003, dt. 9th March, 2007 (along with eight connected appeals). On that ground it is argued that the depreciation cannot be allowed unless there is actual loss to the assessee non-resident company. We have gone through the aforesaid judgment and order passed by this Court which interprets Section 37 of the IT Act, 1961, and in that case, no repayment of loan claimed was found to have been made by the borrowing company in the relevant assessment year, and only in the account books it was shown as expenditure. In the case in hand, the facts are different and it is nobody''s case that no expenditure had taken place in relevant assessment years. The point of dispute is whether, on the expenditure made by the assessee non-resident company, is it entitled to the further loss incurred by it on account of change in the foreign exchange rates, or not ?

Section 42 of the IT Act, 1961, quoted above, contains a special provision whereby the expenditure incurred by the assessee non-resident company in commercial production of mineral oil is to be depreciated in terms of the agreement mentioned therein. It is not the case of the parties that the agreement between the parties is not covered or it does not fulfil the requirements u/s 42 of the aforesaid Act. It is clear from Article 1.6-1 of the accounting procedure, quoted above, set out in the Appendix-C to the production sharing contract (PSC) that expenditure incurred in foreign exchange by the co-venturer during any particular calendar month has to be converted into Indian Rupee at the rate which has to be determined at the end of the calendar month. The example quoted by CIT(A) in his judgment, passed in Appeal No. 21/DDN/CIT(A)-II/2004-05, is relevant to be reproduced here:

To understand the conversion loss, let us take an example in the case of borrowing : assessee borrows dollar one lakh USD at Rs. 38 a dollar in the year 1999. Entry for the borrowing will be made at Rs. 38 lakhs. Now the proceeds of sale which assessee receives is at Rs. 41 a dollar as per the PSC. It repays the loan so borrowed out of sale proceeds converted at the rate of Rs. 41 a dollar. Though he borrows in dollars and repays in dollar but actually he had incurred a loss of Rs. 3 per dollar because the dollar which he borrowed was at Rs. 38, he repaid loan in dollar which was converted at Rs. 41. Therefore, it is clear that he has incurred loss of Rs. 3 lakhs. This kind of transaction may also result in gain or profit in the case of currency appreciation. Under these circumstances, to say that assessee incurring notional loss, is incorrect.

For the reasons as discussed above, we agree with the reasoning given by the CIT(A) and the Tribunal in holding that the depreciation claimed by the assessee non-resident company on account of foreign exchange loss was admissible to it u/s 42 of the IT Act, 1961, read with the clauses of the agreement, quoted above.

We are also of the view that when the Revenue is accepting the tax on the profits/gains arisen out of the change in foreign exchange rates in other assessment years accrued to the respondent/assessee non-resident company, it cannot deny depreciation on account of loss incurred for that reason.

Accordingly, all the three substantial questions of law are answered against the Revenue. The appeals are liable to be dismissed. The same are dismissed.