Dy. Commissioner of Income Tax (Asstt.) vs The Garden Silk Mills Ltd.

D.A. Mehta, J.—At the time of admission on 19.07.2000, the following substantial question of law was framed by the High Court:

Is profit on cancellation of forward exchange contract a capital receipt or a revenue receipt ?

After hearing the learned Advocates for the parties, the Court feels that the controversy between the parties is best reflected by the following reformulated substantial question of law:

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was justified in holding that the sum of Rs. 68,66,673/- received by the assessee upon cancellation of forward foreign exchange contract was a capital receipt?

The Assessment Year in question is 1993-94, relevant accounting period being Financial Year ended on 31.03.1993. During course of assessment proceedings u/s 143(3) of the Income Tax Act, 1961 (the Act), the Assessing Officer having noted the fact of assessee having received sum of Rs. 68,66,673/- on cancellation of forward foreign exchange contract (hereinafter referred to as ''the contract'') called upon the assessee to explain as to why the said amount should not be brought to tax. The explanation tendered by the assessee has been summarized in the assessment order in paragraph Nos. 4.4(a) to 4.4(c). The Assessing Officer has thereafter treated the surplus realised on cancellation of the contract as not liable to tax by observing as under:

I have carefully considered the submissions made by the Assessee co. and have gone through the decisions relied upon by the Assessee co. It is undisputed that the Assessee co. is not a banking company, not is it engaged in the business of purchasing foreign exchange or dealing in the same by entering into forward contracts for the same. The surplus realised on cancellation of the forwarded contract would, therefore, ordinarily have formed part of the surplus on transfer of a capital asset and liable to tax as capital gain. However, I see merit in the arguments of the Assessee co. in relying upon the decision of the Hon''ble Supreme Court in the case of Vania Silk Mills Ltd.(supra) wherein the Court has held that in order to constitute existence of the asset before and after the transfer is absolutely essential. It is undisputed that in the instant case the contract for the forward cover of the foreign exchange has been cancelled, and as such, it cannot be said that the capital asset in the form of right to foreign exchange was in existence before the cancellation and thereafter. Under the circumstances, I am respectfully following the decision of the Hon''ble Supreme Court, I held that there is no transfer of a capital asset on cancellation of the forward exchange contract.

5.1. Respectfully following the aforesaid decisions, I held that the sum of Rs. 68,66,673/- is not liable to tax.

The assessment order so framed was taken in revision by Commissioner of Income Tax, Surat (CIT) by invoking powers u/s 263 of the Act. After considering the reply filed by the assessee to the Show Cause Notice issued by CIT, order dated 27.03.1997 came to be made by CIT by holding that the profit derived on cancellation of the contract is definitely taxable and the order of Assessing Officer is erroneous and prejudicial to the interests of revenue. After holding so, in paragraph No. 16 finally, the following direction was issued by CIT:

In view of the above discussion, the proceeding u/s 263 of the Act is disposed of with a direction to the Assessing Officer to examine and bring to tax the profit derived on cancellation of foreign exchange forward contract either as revenue profit or as capital gain...

The assessee carried the matter in Appeal against the aforestated order made by CIT and succeeded. The Tribunal has found that in the computation of income filed by the assessee along with return of income, the aforesaid amount was deducted from the net profit on the ground that the same was a capital receipt not liable to tax. The Tribunal has thereafter recorded that the assessee company is a manufacturer of textile fabrics and for this purpose imports various machineries and equipments by raising loans in foreign currency. The assessee entered into forward foreign exchange contract towards the liability incurred by the assessee to make payment to the seller of machineries and equipments so as to guard against the fluctuations in the rate of foreign currency. It has further been recorded by the Tribunal that Reserve Bank of India has formulated a policy which permits companies to enter into forward contracts for foreign exchange to be drawn by the companies with a view to limit or regulate exposure of the Indian Companies. The Tribunal has further found that the assessee company is not engaged in the business of financing or dealing in foreign exchange and as such, the exchange acquired by the assessee, does not partake the character of a trading asset. It is further found that the foreign exchange acquired under the contract is for the purpose of discharging an obligation on capital account i.e. towards borrowing made for the purpose of importing capital assets by entering into the contract. By such an act, the assessee was merely freezing its capital liability which arose on debts/borrowings in foreign exchange. After recording the aforesaid findings, the Tribunal has placed reliance on the ratio of decisions of the Apex Court in the case of Commissioner of Income Tax, Bombay City Vs. Tata Locomotive and Engineering Co., Ltd., as well as in the case of Universal Radiators, Coimbatore Vs. Commissioner of Income Tax, Tamil Nadu, to hold that the net surplus enuring to the assessee company upon cancellation of such contract will partake the character of a capital receipt.

The Tribunal has thereafter also taken note of the fact that such a capital receipt is not liable to capital gains tax as cancellation of such a contract does not involve any transfer or assignment of any asset within the meaning of Section 2(47) of the Act. The Tribunal has therefore held that upon cancellation of the contract with the bank, the surplus arising to the assessee company is not liable to tax in view of decision of the Apex Court in the case of Vania Silk Mills (P) Ltd. Vs. Commissioner of Income Tax, Ahmedabad [OVERRULED],

Thereafter, the Tribunal has dealt with the observation of the CIT: that the receipt is taxable as profit u/s 28(iv) of the Act: by recording that the assessee was not dealing in the machineries in relation to which the contract was entered into, but such machineries and equipments were imported to be used by the assessee as capital assets for the purpose of its manufacturing activities. Alternatively, the Tribunal has stated that since the surplus realised on cancellation of contract was received in cash, provisions of Section 28(iv) of the Act could not be invoked in view of the decision of this High Court in the case of Commissioner of Income Tax, Gujarat-I Vs. Alchemic Pvt. Ltd., which was followed and applied in case of Commissioner of Income Tax Vs. New India Industries Ltd., and the said judgment has since been approved by the Apex Court in the case of Commissioner of Income Tax, Bombay, etc. Vs. M/s. Mafatlal Gangabhai and Co. (P) Ltd.,

The Tribunal has further recorded that the order u/s 263 of the Act made by CIT has not given any valid reasons to show how the surplus earned on cancellation of the contract was assessable as revenue receipt. The Tribunal finds that the view taken by the Assessing Officer in holding that the surplus was on capital account was a much more reasonable view than the view adopted by CIT and that as noted in paragraph No. 16 of the order u/s 263 of the Act, the CIT himself was not sure whether the profit earned on cancellation of the contract was a revenue receipt or a capital gain liable to tax, considering the directions issued to the Assessing Officer to tax the surplus either as profits on revenue account or as capital gains. The Tribunal has therefore stated that powers u/s 263 of the Act are not to be exercised lightly and orders of subordinate authorities should not be cancelled or set aside on mere whims and fancies. That for exercising such jurisdiction, there must be compelling reasons permitting CIT to interfere by exercising powers u/s 263 of the Act. It is this order of the Tribunal which is under challenge in the present Tax Appeal.

Mr. B.B. Naik, learned Standing Counsel appearing for Appellant-Revenue submitted that the Tribunal had committed an error in interfering with the order made by CIT because the surplus in question was liable to be taxed on revenue account, the same having been received on cancellation of contract, which had nothing to do with the original transactions of import of capital goods. Referring to the observations made by CIT in paragraph No. 5 of the order u/s 263 of the Act, Mr. Naik submitted that such surplus could be utilised by the assessee the way assessee wanted to, including payment towards capital asset, raw material, or even just for making a profit by cancelling the contract. It was further submitted that instead of making payment towards acquisition of capital asset, the contract had been cancelled and the surplus credited to various accounts including the profit and loss account, thus contradicting the claim of the assessee that the sum was a capital receipt. Thereafter, it was contended that, in the alternative, provisions of Section 2(47) of the Act would take within its sweep the relinquishment of right to acquire foreign exchange under the contract and thus upon cancellation because of deemed transfer, the amount was liable to capital gains tax. It was submitted that the decisions relied upon by the assessee and referred to by the Tribunal were not applicable as the said cases related to devaluation of currency and not a conscious act of cancellation of contract. The learned Counsel therefore, submitted that the Appeal of Revenue should be allowed and order of Tribunal be reversed.

On behalf of the respondent-assessee, the learned Advocate submitted that the observation made by the Tribunal as regards the instalment of loan payable and interest payable on such loans were divorced from facts and had no basis and hence, the Tribunal had ultimately rightly come to the conclusion that the entire surplus was a capital receipt. It was further submitted that the findings recorded by the Tribunal on facts were not disputed and hence, no case was made out for interfering with the impugned order of Tribunal. That in the case of Sutlej Cotton Mills Limited Vs. Commissioner of Income Tax, Calcutta, the Apex Court has laid down the principles which should be applied while determining the controversy of the nature which has been brought before the Court today. Attention was also invited to the earlier decision of the Apex Court in the case of Commissioner of Income Tax, Mysore Vs. The Canara Bank Ltd., to submit that the position in law was well settled. The learned Advocate also submitted that the Tribunal''s order was in two parts, and the Tribunal had in the second part, also come to the conclusion that the CIT had not made out a case for exercising jurisdiction u/s 263 of the Act, the Assessing Officer having made necessary inquiries and applied his mind while coming to the conclusion that the receipt in question was on capital account. That the Tribunal had found the said view to be more reasonable. In this context, the learned Advocate placed reliance on the Apex Court decision in the case of Malabar Industrial Co. Ltd. v. (2000) 243 ITR 83 and decision of this Court in the case of Commissioner of Income Tax Vs. Nirma Chemicals Works P. Ltd., to submit that where the view taken by the Assessing Officer was one of the two views possible, CIT may not exercise jurisdiction u/s 263 of the Act. That the Tribunal''s order was required to be sustained even on this count also.

The facts reveal that, as noted by the CIT, for this very purpose the Assessing Officer, after framing original assessment, had issued notice u/s 148 of the Act on 3.2.1995, for Assessment Years 1992-93 and 1993-94 for this very issue. The said notices were challenged by way of Writ Petition before this Hon''ble High Court and in the judgment rendered in assessee''s own case Garden Silk Mills Ltd. Vs. Deputy Commissioner of Income Tax (No. 2), this Court took note of the fact that out of amount received on the cancellation of the forward foreign exchange contract a sum came to be credited to plant and machinery account, to roll over premium expense account, and to the profit and loss account. The Court while recording facts has taken note of the policy framed by Reserve Bank of India permitting the companies to enter into forward contracts for the foreign exchange to be drawn by the companies with a view to limit or regulate exposure of the Indian Companies. The Court has also noted that the assessee is not engaged in financing business or dealing in foreign exchange. Thereafter, the High Court has referred to the Apex Court decision in case of CIT v. Canara Bank Ltd. (supra), State Bank of India v. CIT : [1986]157ITR67(SC) , CIT v. Tata Locomotive and Engineering Co. Ltd. (supra), Universal Radiators v. CIT (supra) and Vania Silk Mills Pvt. Ltd. (supra). Finally, the Court has found that the reasons recorded do not point out any new information, but it is only a change of opinion. That while framing original assessment, the Assessing Officer had considered the entire material and was satisfied about factual and legal aspects and thereafter applied the judgments of the Apex Court in favour of the assessee. Thus, it can be stated that though the reassessment proceedings were quashed and set aside the Court had taken note of the basic facts, which remain the same even today, the Assessment Year being 1993-94, which had come up before this Court, and hence, it is not possible to state that the Assessing Officer had committed any error in law so as to vest the CIT with jurisdiction u/s 263 of the Act.

The Apex Court decision in case of Malbar Industrial Co. Ltd. v. CIT (supra) specifically says that where two views are possible and the Assessing Officer has taken one view with which the CIT does not agree, the assessment order cannot be treated to be an erroneous order prejudicial to the interests of the revenue, unless the view taken by the Assessing Officer is unsustainable in law. In the facts of the present case, it is not possible to take that view viz., hold that the view adopted by the Assessing Officer is not sustainable in law. Therefore, the Tribunal was justified in holding that CIT could not have invoked provisions of Section 263 of the Act.

On merits also, it is not possible to state that the impugned order of Tribunal suffers from any legal infirmity. The observation of the Tribunal: ''Against the instalment of loan payable and interest payable on such loans, the assessee-company has entered into contract covering the foreign exchange components to guard against the fluctuation in the rate of the foreign currency as appearing in paragraph No. 9 of the order has to be read in context of the following finding which appears in the same paragraph: The foreign exchange acquired under the contract is for the purpose of discharging an obligation on capital account, i.e. for borrowing for the purpose of importing capital asset by entering into the foreign exchange forward contract, the assessee-company was merely wishing to freeze its capital liability to discharge debts/borrowing in foreign exchange''. Hence, undue emphasis on behalf of the Revenue by picking up one sentence out of the entire order and trying to build a case thereon to submit that at least some portion of the surplus was relatable to interest and thus on revenue account does not merit acceptance. It is necessary to note that the very same sentence appears in judgment rendered by this Court in assessee''s own case in the judgment reported in Garden Silk Mills Ltd. Vs. Deputy Commissioner of Income Tax (No. 2), of the reports.

Thus, the finding by the Tribunal is that the foreign exchange was acquired under the contract for the purpose of discharging an obligation on capital account viz. towards borrowing for the purpose of import of capital assets, which would indicate that the surplus realised on cancellation of such contract would bear the same characteristic. As held by the Apex Court, the principle that is to be applied for determining the character of a receipt, whether results in any profit or loss on account of appreciation or depreciation in the value of foreign currency held by the assessee, upon conversion into another currency, would depend on whether the transaction is relatable to a trading transaction or is in relation to a capital asset or in relation to fixed capital. On reading of the entire case law on the subject matter, it becomes clear that this principle has been reiterated by the Apex Court time and again. Applying the settled principles to the facts found by the Tribunal, it cannot be stated that the Assessing Officer and the Tribunal have committed any error in law in holding: that the surplus received by the assessee company upon cancellation of forward foreign exchange contract will partake character of a capital receipt.

The findings in relation to non applicability of provisions of Section 28(iv) of the Act also do not deserve intervention. The Tribunal has applied the principles enunciated by this High Court and the Apex Court in relation to the said provisions and held that the amount received in cash cannot be termed to be a benefit or perquisite within the meaning of Section 28(iv) of the Act, considering that, the said provision further stipulates by use of the phrase ''whether convertible into money or not'' to indicate that it is only a benefit or a requisite which is received otherwise than in cash for being amenable to provisions of Section 28(iv) of the Act.

Similarly in so far as liability to be taxed under the head ''capital gains'' is concerned, the view taken by the Assessing Officer and the Tribunal cannot be faulted. For bringing any receipt to tax under the head ''capital gains'' the first requirement is transfer of a capital asset. In the present case, mere cancellation of the contract does not result in any transfer of any asset, even if the extended definition u/s 2(47) of the Act is made applicable. The said finding recorded by the Tribunal is in consonance with the law laid down by the Apex Court.

Therefore, on none of the grounds pleaded can it be stated that the impugned order of Tribunal suffers from a legal error so as to warrant intervention. The reformulated question is therefore required to be answered accordingly, the Tribunal was justified in law in holding that the surplus received on cancellation of forward foreign exchange contract was a capital receipt not liable to tax.

The Appeal is dismissed accordingly with no order as to costs.