Per D.K. AGARWAL (JM).
These two appeals preferred by the revenue are directed against the separate orders dated 31.1.2005 and 11.7.2006 passed by ld. CIT(A) for the Assessment Years 2001-02 and 2003-04 respectively. Since facts are identical and issues involved are common, both these appeals are disposed of by this common order for the sake of convenience.
2. Briefly stated the facts extracted from ITA No.3703/M/2005 for Assessment Year 2001-02 are that the assessee is a Branch Office in India of Staubli A.G., Switzerland. It acts as a commission and meketing agent in respect of textile machineries manufactured by the Staubli Group entities, to customers in India. The Staubli Group entities directly sell/invoice and ship the machineries to the Indian customers. The assessee does not enter into a sales contract with the customers. The assessee also assists the customers in installation of the machineries at the client’s site. The machineries supplied by the Staubli Group entities are sold by them under a warranty –twelve months from the date of manufacture. The assessee renders after sales and maintenance services under the warranty period to the customers in India for which it receives service fees at agreed rates over and above its commission on sales of machineries. Besides this, the assessee also renders services to local customers after the warranty period and bills them locally for the services rendered. For the Assessment Year in question the assessee filed its return of income declaring total income at Rs.17,32,730/-. However, after making certain additions/disallowances the A.O. passed the assessment order u/s.143(3) of the I.T. Act, 1961(the Act) dated 19th March, 2004, determining the taxable income at Rs.42,78,830/-. On appeal, the ld. CIT(A) deleted the addition and disallowance of depreciation made by the AO in toto and accordingly allowed the appeal.
3. Being aggrieved by the order of the ld. CIT(A) the revenue is in appeal before us.
4. Ground No.1 reads as under :
“1. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in directing to delete the addition of Rs.25,08,701/- made by the Assessing Officer by estimating the commission income @ 10%, without appreciating the fact that:
i. The assessee is assuming risks in respect of the sales of products made by the Head Office/Staubli Group Entities.
ii. The profits arising on account of such risks assumed by the Indian Branch is the income of the branch and not of the Head Office/ Staubli Group Entities.
iii. The Arm’s length payment of commission to the Indian branch by the Head Office/Staubli Group Entities(Principals) does not extinguish the assessment of the principals in India.”
5. The brief facts of the above issue are that during the course of assessment it was interalia observed by the AO that the assessee has only shown income by way of commission from Staubli AG (HO) and service revenues from manufacturing group of companies. It also earns commission on sale of spare parts to the customers in India. In response to various queries raised by the AO with regard to the justification of commission shown by the assessee, the assessee submitted detailed replies which were summarised by the AO in para-3 of the assessment order as under :
– As per Article 5(2), the assessee being an Indian branch of Staubli A.G., it constitutes a permanent extablishment (PE) of Staubli A.G. in India.
– The PE would be liable to be taxed n India in respect of income directly or indirectly attributable to it. This right to tax does not extend to profits that Staubli A.G. may derive otherwise than through the PE.
– All activities other than marketing activity such as manufacturing, sales, managerial control, etc. carried outside India. Considering the activities carried in India and the risk borne by the branch office in India, the branch has made adequate/reasonable/arm’s length profits.
– Without prejudice to the above, Staubli A.G. would be liable to pay tax only on the income which accrues, arises or received or deemed to accrue,arise or receive in India.
– Reliance has been placed on CBDT’s Circular No.23 dated 23.07.1969 which lays down that “…If the agent’s commission fully represents the value of the profit attributable to his services, it should prima facie extinguish the assessment.”
Since Staubli A.G., has made sales in India on principal-to-principal basis and has compensated the Indian Branch on an arm’s length basis, it is fully covered by the said circular and, therefore, no further income of Staubli A.G. is taxable in India.
– Reliance was further placed on the following judgments in respect of its submission that no further profits can be attributable to the India Branch
a. Addl. CIT vs. Skoda Export, Praha 172 ITR 358(AP).
b. CIT(A) vs. Tata Chemicals Ltd. 94 ITR 85 (Bom.)
c. CIT(A) vs. Ahmedbhai Umarbhai & Co. 18 ITR 72 (SC)
– Attention has been invited to the CBDT’s circular No.1 dated 02.01.2004 which is in respect of the taxation of Business Process Outsourcing Units in India.
– The rates of commission by the India Branch is much more than its counterparts in other countries.
– The financial statements for the F.Y. 2001/2000 show that Staubli A.G. has earned less than 2% net profits.”
The AO considered the assessee’s submission in the light of the Board Circular 23 of 1969, Article of 7(2) of the Singapore Treaty, Commentary of Ld. Author Klaus Vogel (Article 5 para-71), Rule-10 of Income tax Rules, Circular No.1 of 2004 dated 2.1.2004, theory of Dependent Agent and Independent Agent, OECD Discussion Draft, meaning of Business of Agent and Business of Principal, Rule of Force of Attraction, applicability of Arm’s Length Price and observed that the TP Regulation is applicable for Assessment Year 2002-03 onwards, and further observed that the claim of the assessee that if payment to the agent is made at arm’s length, then the non-resident is not liable to tax (hypothesis) is not acceptable for the following reasons:-
a) The payment to the agent and profit of the assessee from business operations in India are two separate things which cannot be compared.
b) The hypothesis is applicable only in the case of independent agents where no assets/capital of NR are used in India, no risk is assumed by the NR in India and no other activity is carried out by the NR in India. It is so in DTAA with USA and Singapore.
c) The draft discussion paper of OECD also suggest apportionment basis for determination of profits attributable to PE which is similar to the provisions of Rule 10 of the I.T. Rules.
d) No such categorical statement/hypothesis has been suggested by the OECD or any other commentary.
e) It would also not be in accordance with the statutory provisions like section 44B of the Act which is a self contained code.
f) The circular No.01 of 2004 also provides that when core activities of the business of the assessee is outsourced, then there would be substantial profit of the principal would be the income of the non-resident taxable in India.
g) There has been undue reliance on one line of the circular No.23 of 1969 without looking into the entire context.
h) It would make principles of force of attraction inapplicable in India.
i) Without prejudice to the above, the assessee has not substantiated its claim that the agent has been paid at arm’s length price.
The AO after referring the assessee’s nature of business activities further observed that there may be sales made directly by Staubli Group entities to the customers in India without the involvement of Staubli India and hence, the nature of business of assessee is something more than that of a `Commission Agent’. He further observed that the assessee is rendering “after sales and maintenance services” under the warranty period. Obviously, for such services, the assessee is not getting anything from the customers. He further observed that in case of supply of faulty `products’ in India the cost is to be borne by the Indian Branch and not the HO, hence, the profit arising out of such risks taken by the Indian Branch, is the income of the Branch and not of the agent. In the light of the above, the AO concluded that he has no option but to estimate the income of the Indian Branch. Further no explanation has been offered by the assessee as to why there are varying rates for similar products and accordingly he estimated 10% of the total sales made by Staubli Group in India as the profits attributable to the PE in India i.e. the assessee and worked out the extra income at Rs.25,08,701/- and added the same to the income of the assessee.
6. On appeal, before the ld. CIT (A), the assessee submitted that the AO has grossly erred in concluding that the nature of its business is something more than that of a `commission agent’ due to assuming of risk relating to rendering of after sales and maintenance service in the warranty period of the machinery supplied by the Head Office/Group entities and this necessitates a higher compensation/attribution of additional profits. It was further submitted that though it renders after sales support and warranty services to customers in India, it receives service charges for the work performed which is over and above the commission on sales. Further any spare parts, etc. required for this purpose is forwarded by the Staubli Head Office/Group Entities and no part of it is on the assessee’s account. It does not bear any risk of `after sales and maintenance services’ as alleged by the AO in the assessment order. It was further submitted that the assessee submitted a brief note on nature of business and the statement on oath recorded of Mr. S.N. Ganguli clarifying the above factual position, and in support break-up of the service income as reflected in the audited financial statements of the previous year was also filed to show distinct receipts from Head Office/Group Entities for providing the said warranty services. It was further submitted that in concluding the assessment, the AO has placed reliance on the India-Singapore Tax Treaty instead of Indo-Swiss Tax Treaty. The assessee is a Branch of Staubli A.G., which is a Swiss Entity and Tax Resident in Switzerland and therefore the applicable Tax Treaty should be Indo-Swiss Tax Treaty (DTAA or the Treaty) and not the India-Singapore Tax Treaty applied by the AO. It was further submitted that an arm’s length commission to an agent extinguishes the assessment of the Non-resident Principle as laid down by CBDT in Circular No.23 dated 23 July, 1969. The assessee constitutes a Permanent Establishment (PE) of Staubli A.G. (Switzerland) in India under Article 5 of the Treaty and the PE’s profits needs to be taxed as a distinct and separate enterprise dealing wholly independently with the enterprise of which it is a PE as per Article 7(2) of the Treaty. The CBDT Circular No.23 is not restricted to cases of independent agents but also applies to dependent agents. It was further submitted that in its case other than the marketing activities, all activities relating to the sale are carried on from outside India and the sales are directly made between its Head Office/Group Entities and the Indian customers. As per Explanation (a) to section 9(1)(i) of the I.T. Act only such part of the income as is reasonably attributable to the operations carried out in India is deemed to accrue or arise in India. It was further submitted that a note on the over view of the textile industry in India was filed before the AO to show the commission derived by the Indian Commission Agents and the range of rates earned by these agents which were the same as those received by the assessee from its Head Office. It was further submitted that the transfer pricing study conducted for later years confirmed arm’s-length nature of all transactions between the assessee and its Head Office during which the commission rates were same as in the previous year under consideration. It was further submitted that the CBDT Circular No.1 dated 2 January 2004, which reiterated the principles laid down in the earlier Circular No.23 (supra), that if the price charged in respect of such services by the PE is an arm’s-length/fair market price then no income shall separately accrue or arise to the non-resident principal in India (the said Circular is now withdrawn by Circular No.5 of 2004 dated 28 September 2004 on account of other controversies). It was further submitted that the financial statements for the year 2000 of Staubli A.G. are showing net profit of less than 2%. Thus, even on this count attribution of higher profits to the assessee’s activities in India was not justified. It was further submitted that a letter dated 30 January, 2004 from Staubli A.G., was filed before the AO showing their practice of payment of commission to its agents in the textile machinery division worldwide confirming that the commission received by the assessee was much more than its counterpart in other countries. It was further submitted that the Circular No.742 dated 2 May 1996 referred by the AO deals with the taxation of foreign telecasting companies, cannot be applied to the assessee’s case. It was further submitted that the judgment of the Hon’ble Supreme Court in Anglo French Textile Company (1953) 23 ITR 101 (SC) relied on by the AO is misplaced as the said judgment merely lays down that in cases of business connection through agents, a portion of profits attributable to the Indian Operations can be taxed in India. Moreover, in the aforesaid case, there was a complete denial in respect of liability to tax in India, which is not the assessee’s case.
7. The ld. CIT(A) after considering the assessee’s submission and the material available on record while observing that the arm’s length nature of commission earned by the appellant is very much ascertainable and the arbitrary recourse to Rule-10 of the I.T. Rules by the AO is totally unwarranted and hence he deleted the estimated addition of Rs.25,08,701/- made by the AO.
8. At the time of hearing, the ld. DR submits that for the reasons as mentioned in the assessment order, the ld. CIT(A) was not justified in deleting the addition of Rs.25,08,701/- made by the AO. The reliance was also placed on the decision in CIT and Another vs. Hyundai Heavy Industries Co. Ltd. (2007) 291 ITR 482(SC) and Ishikawajima-Harima Heavy Industries Ltd. vs. Director of Income tax, Mumbai (2007) 288 ITR 408(SC). He therefore, submits that the addition made by the AO be restored.
9. On the other hand, the ld. Counsel for the assessee while reiterating the same submissions as submitted before the AO and the ld. CIT(A) further submits that the AO without considering the assessee’s explanation appearing at page 1 to 31 and statement on oath recorded u/s.131 of Shri Somnath Ganguly, a Resident Director, appearing at page 54-61 of the assessee’s paper book has made an adhoc addition of Rs.25,08,701/- on presumption basis and the ld. CIT(A) was fully justified in deleting the same. He further submits that the AO for the Assessment Years 2005-06 and 2007-08, after considering the nature of addition made in the impugned Assessment Year has made no addition in this regard vide assessment orders for the Assessment Years 2005-06 and 2007-08 dated 20.11.2007 and 21.01.2010 respectively passed u/s.143(3) of the Act. In support he also placed on record the copy of the said assessment orders. He, therefore, submits that the order passed by the ld. CIT(A) in deleting the addition be upheld.
10. We have carefully considered the submissions of the rival parties and perused the material available on record. We find that the facts are not in dispute inasmuch as the assessee has shown revenue as a commission on sale of machinery and spares. Apart from this, the assessee has also shown receipts from service charges from (i) local customers (post warranty) Rs.1,29,000/- and (ii) Group Staubli Rs.19,75,600/- aggregating to Rs.21,04,600/-. We further find that it is not the case of the AO that the assessee has not maintained regular books of account or has not furnished audited financial statements along with tax audit report. It is also not the case of the revenue that the books of account maintained by the assessee are not in terms of the provisions of sec. 145(1) of the Act. In other words, the AO has not rejected the books of account maintained by the assessee. The ld. CIT(A) after considering the factual matrix of the case has deleted the addition vide finding recorded in para 4.14 of his order which is reproduced as under:
“4.14 I have carefully considered the above submissions of the appellant and inclined to subscribe to the view that the commission earned by the appellant is at arm’s length, commensurate to its operations in India and as laid down by the CBDT Circular No.23 as arm’s length commission to the agent extinguishes the assessment of the Principle’s in India. In concluding his assessment, the A.O. has placed reliance on Rule 10 of the income tax Rules, 1962. I tend to agree with the Appellant’s contentions that the provisions of Rule 10 apply only to cases where income chargeable to tax in India cannot be ascertained definitely. The Appellant maintains accounts in India on mercantile basis and the same are also audited under the Companies Act 1956. Thus, the arm’s length nature of commission earned by the appellant is very much ascertainable. Therefore, the arbitrary recourse to Rule 10 of the I.T. Rules by the A.O. is totally unwarranted. In view of above, I hold that the addition of Rs.25,08,701/- made by the Assessing Officer estimating the commission income at 10% on all sales on an adhoc basis is unwarranted and be deleted.”
11. In Hyundai Heavy Industries Co. Ltd. supra, it has been observed and held by Their Lordships at placitum 13 at page 494 of the ITR that:
“Now coming to the question of the quantum of taxable profits attributable to the Indian permanent establishment of the assessee relating to the work of installation and commissioning of the platforms in Bombay High, we are of the view that, for the reasons mentioned hereinafter, profits arising from the activities of installation and commissioning were taxable at 10 per cent. of the payments relating to the said services/facilities carried out in Bombay High. Firstly, in the present case it is important to note that the accounts submitted by the assessee were rejected and the Assessing Officer had to invoke the provisions of the Act by way of best judgment assessment. Secondly, in the present case, the assessee themselves contended in the assessment proceedings that the Assessing Officer should have computed the income relating to Indian operations under section 44BB or under Instruction No. 1767 issued by the Central Board of Direct Taxes dated July 1, 1987. Thirdly, it is important to note that Chapter IV of the Act contains provisions for presumptive taxation of business income in certain cases as prescribed in sections 44B, 44BB, 44BBA and 44BBB of the Act. In the scheme of presumptive taxation, the assessee is presumed to have earned income at the rate of a certain percentage of his total turnover or gross receipts. If the assessee agrees to be taxed on presumed income, he is not required to maintain books of account. If, however, he claims that his income is less than the presumed figure, he is required to support his claim by producing books of account. In the present case, as indicated above, the Assessing Officer has rejected the accounts submitted by the assessee. This has not been challenged. Moreover, the assessee appeared before the Department and submitted that its income from Indian operations be computed under section 44BB or under Instruction No. 1767 issued by the Central Board of Direct Taxes. Under the said instruction, in cases where the sales take place outside, as in this case, only 10 per cent. of the gross receipts in respect of the activities of installation, commissioning etc. performed in India will be taxable. In view of the stand taken by the assessee, we are of the view that the Commissioner of Income-tax (Appeals) was right in computing the taxable profits at 10 per cent. of the gross receipts in respect of the activities of installation, commissioning etc. performed in India….”
Whereas in the case before us it is not the case of the revenue that the AO has rejected the books of account and invoked the provisions of sec.145(3) of the Act, further it is not the case that presumptive taxation of business as prescribed under the relevant provisions of the Act are applicable to the assessee or the assessee has agreed to be taxed on presumed income, without maintaining books of account. For these reasons, the decision relied on by the ld. DR is distinguishable and not applicable to the present case.
12. In Ishikawajima-Harima Heavy Industries Ltd. (supra), it has been held (page 411 – 414 of head notes of 288 ITR):
“(i) that section 9 of the Income-tax Act, 1961, raises a legal fiction ; but, having regard to the contextual interpretation and in view of the fact that the court is dealing with a taxation statute, the legal fiction must be construed having regard to the object it seeks to achieve. The legal fiction created under section 9 must also be read having regard to the other provisions thereof.
Maruti Udyog Ltd. v. Ram Lal  2 SCC 638 followed.
(ii) That since the appellant carried on business in India through a permanent establishment it would clearly fall out of the applicability of article 12(5) of the Convention and fall within the ambit of article 7. In the Protocol to the Convention it was stated that the term “directly or indirectly attributable” indicated the income that should be regarded on the basis of the extent appropriate to the part played by the permanent establishment in those transactions. The permanent establishment in this case had no role to play in the transaction of offshore supply, sought to be taxed, since the transaction took place abroad.
(iii) That the second sentence of article 7(1) which allowed the State of the permanent establishment to tax business profits, but only so much of them as was attributable to the permanent establishment excluded the applicability of the principle that where there was a permanent establishment, the State of the permanent establishment should be allowed to tax all income derived by the enterprise from sources in the State irrespective of whether or not such income was economically connected with the permanent establishment. The State of the permanent establishment was allowed to tax only those profits which were economically attributable to the permanent establishment, i.e., those which resulted from the permanent establishment’s activities, which were economically from the business carried on by the permanent establishment. In this case, the permanent establishment’s non-involvement in the transaction of offshore supply, excluded it from being a part of the cause of the income itself and thus there was no business connection.
(iv) That for attracting the tax there had to be some activities through the permanent establishment. If income arose without any activity of the permanent establishment, even under the Convention the taxation liability in respect of overseas services would not arise in India. Section 9 spelled out the extent to which the income of a non-resident would be liable to tax in India. Section 9 had a direct territorial nexus. Relief under a Double Taxation Avoidance Treaty, having regard to the provisions contained in section 90(2), would arise only in the event taxable income of the assessee arose in one Contracting State on the basis of accrual of income in another Contracting State on the basis of residence. So far as accrual of income in India was concerned taxability must be read in terms of section 4(2) read with section 9, whereupon the question of seeking assessment of such income in India on the basis of the Double Taxation Treaty would arise. Paragraph 6 of the Protocol to the Convention was not applicable, because, for the profits to be “attributable directly or indirectly”, the permanent establishment must be involved in the activity giving rise to the profits.
(v) That the fact that the contract was signed in India was of no material consequence, since all activities in connection with the offshore supply were outside India, and therefore income could not be deemed to accrue or arise in the country.
(vi) That where different severable parts of a composite contract were performed in different places, as in this case, the principle of apportionment could be applied to determine which fiscal jurisdiction could tax that particular part of the transaction. This principle helped determine where the territorial jurisdiction of a particular State lay and to determine its capacity to tax an event. Applying it to composite transactions which had some operations in one territory and some in the other, was essential to determine the taxability of various operations. Therefore, the concepts of profits of business connection and permanent establishment should not be mixed up. Whereas business connection was relevant for the purpose of application of section 9, the concept of permanent establishment was relevant for assessing the income of a non-resident under the Convention.
(vii) That in this case the entire transaction was completed on the high seas and, therefore, the profits on sale did not arise in India. Once excluded from the scope of taxation under the Income-tax Act application of the Double Taxation Avoidance Treaty would not arise.
(viii) That, in relation to offshore services, section 9(1)(vii)(c) required two conditions to be met : to be taxable in India the services which were the source of the income sought to be taxed had to be rendered in India as well as utilized in India. In this case, both these conditions were not satisfied simultaneously, thereby excluding the income from the ambit of taxation in India. Thus for a non-resident to be taxed on income for services, such a service had to be rendered within India, and had to be part of a business or profession carried on by such person in India. The appellants had provided services to persons resident in India, and though they had been used here, they had not been rendered in India.
(ix) That whatever was payable by a resident to a non-resident by way of technical fees would not always come within the purview of section 9(1)(vii). It must have sufficient territorial nexus with India so as to furnish a basis for imposition of tax.
(x) That even in relation to such income, viz., income from offshore services, the provisions of article 7 of the Convention would be applicable, as services rendered outside India would have nothing to do with the permanent establishment in India. Thus, if any services had been rendered by the head office of the appellant outside India, only because they were connected with the permanent establishment, even in relation thereto the principle of apportionment would apply.
(xi) There exists a distinction between a business connection and a permanent establishment. The permanent establishment cannot be equated to a business connection, since the former is for the purpose of assessment of income of a non-resident under a Double Taxation Avoidance Agreement, and the latter is for the application of section 9 of the Income-tax Act.
Clause (a) of Explanation 1 to section 9(1)(i) states that only such part of the income as is attributable to the operations carried out in India, are taxable in India. The existence of a permanent establishment would not constitute sufficient “business connection”, and the permanent establishment would be the taxable entity. The fiscal jurisdiction of a country would not extend to taxing the entire income attributable to the permanent establishment.
There exists a difference between the existence of a business connection and the income accruing or arising out of such business connection.
In construing a contract, the terms and conditions thereof are to be read as a whole. A contract must be construed keeping in view the intention of the parties. No doubt, the applicability of the tax laws would depend upon the nature of the contract, but the same should not be construed keeping in view the taxing provisions.
The concepts of profits of business connection and permanent establishment should not be mixed up. Whereas business connection is relevant for the purpose of application of section 9, the concept of permanent establishment is relevant for assessing the income of a non-resident under the Double Taxation Avoidance Agreement.”
Whereas in the case before us the facts and issue are entirely different, inasmuch as the ld. DR has failed to show as to how the ratio of the above judgment is applicable to the facts of the present case, therefore, the decision relied on by the ld. DR is distinguishable and not applicable to the present case.
13. In this view of the matter and in the absence of any contrary material brought on record by the revenue against the finding of the ld. CIT(A) and keeping in view that the assessee has also shown, in its Profit and Loss Account, income from services and other income amounting to Rs.21,04,600/- and Rs.2,78,026/- respectively and also keeping in view that the AO has given no basis for making ad hoc addition we are of the view that the AO was not justified in making addition of Rs.25,08,701/- and hence we are inclined to uphold the order of the ld. CIT(A) in deleting the said addition made by the AO. The ground taken by the revenue is therefore rejected.
14. Ground No.2 reads as under :
“2. On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in holding that the Assessing Officer was not justified in disallowing depreciation of Rs.37,399/- on capitalization of exchange control fluctuation arising on foreign currency borrowing from its Head Offices relatable to fixed assets acquired in India without appreciating that section 43A is not applicable in the present case.”
15. The brief facts of the above issue are that it was observed by the AO that in the notes to the computation of income, the assessee has stated that “additions to the fixed assets include loss of foreign exchange rates at the year-end which is added to the written down value of the block of assets. This adjustment pertaining to fixed assets i.e. (premises) acquired in India out of foreign currency loans. The assessee was asked as to why such claim should not be disallowed. The assessee has given a similar reply to what has been stated above. However, the AO did not accept the assessee’s explanation. The AO was of the view that from the definition of WDV, it is quite clear that it only includes actual cost to the assessee or actual cost less depreciation. Therefore, the definition of WDV itself excludes “the charge in the rate of exchange of currency” to be part of it. Further, section 43A of the Act talks about acquisition of assets outside India and is, therefore, not applicable in this case. Accordingly he disallowed the excess claim of depreciation of Rs.37,399/-. On appeal, the ld. CIT(A) while observing that perhaps there would be a case to claim full amount of exchange fluctuation as revenue loss, allowed the claim of the assessee of depreciation on account of foreign exchange revaluation.
16. At the time of hearing the ld. DR supports the order of the AO.
17. On the other hand the ld. Counsel for the assessee relied on the order of the ld. CIT(A).
18. Having carefully considered the submissions of the rival parties and perusing the material available on record we find that the issue raised is no longer res integra. In CIT vs. Woodward Governor India P. Ltd. (2009) 312 ITR 254(SC), Their Lordships have held vide placitum 31 to 33 (at page 270 to 272 of the ITR) as under :
“As held in Arvind Mills` case  193 ITR 255 (SC) (supra) increase or decrease in liability in the repayment of foreign loan should be taken into account to modify the figure of actual cost in the year in which the increase or decrease in liability arises on account of the fluctuation in the rate of exchange. Thus, the adjustments in the actual cost are to be made irrespective of the date of actual payment in foreign currency made by the assessee.This position also finds place in the clarification issued by the Ministry of Finance dated January 4, 1967, which, inter alia, reads as under :
” 2. The Government agrees that for the purposes of the calculation of depreciation allowance, the cost of capital assets imported before the date of devaluation should be written off to the extent of the full amount of the additional rupee liability incurred on account of devaluation and not what is actually paid from year to year. The proposed legal provision in the matter is intended to be framed on this basis.” (emphasis supplied)
One more aspect needs to be mentioned. Section 43(1) defines actual cost for the purpose of grant of depreciation, etc., to mean ” the actual cost of the assets to the assessee” . Till the insertion of the unamended section 43A there was no provision in the Income-tax Act for adjustment of the actual cost which was fixed once and for all, at the time of acquisition of the asset. Accordingly, no adjustment could be made in the actual cost of the assets for purposes of grant of depreciation for any increase/decrease of liability subsequently arising due to exchange fluctuation. Consequently, section 43A was introduced in the Act by the Finance Act, 1967, with effect from April 1, 1967, in the above terms to provide for adjustment in the actual cost of assets pursuant to change in the foreign currency exchange rates. As a consequence of the insertion of the said section, it became possible to adjust the increase/decrease in liability relating to acquisition of capital assets on account of exchange rate fluctuation, in the actual cost of the assets acquired in foreign currency and for, inter alia, depreciation to be allowed with reference to such increased/decreased cost. This position is also made clear by Circular No. 5-P dated October 9, 1967, issued by the
Central Board of Direct Taxes. One more point needs to be mentioned. Section 43A (unamended) corresponds to paragraph 10 of AS-11 similarly providing for adjustment in the carrying cost of fixed assets acquired in foreign currency, due to foreign exchange fluctuation at each balance-sheet date. The relevant paragraph reads as follows:
” 10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which 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.”
As stated above, what triggers the adjustment in the actual cost of the assets, in terms of the unamended section 43A of the 1961 Act is the change in the rate of exchange subsequent to the acquisition of asset in foreign currency. The section mandates that at any time there is change in the rate of exchange, the same may be given effect to by way of adjustment of the carrying cost of the fixed assets acquired in foreign currency. But for section 43A which corresponds to paragraph 10 of AS-11 such adjustment in the carrying amount of the fixed assets was not possible, particularly in the light of section 43(1). The unamended section 43A nowhere required as condition precedent for making necessary adjustment in the carrying amount of the fixed asset that there should be actual payment of the increased/decreased liability as a consequence of the exchange variation. The words used in the unamended section 43A were ” for making payment” and not ” on payment” which is now brought in by amendment to section 43A, vide the Finance Act, 2002.”
19. Recently the Hon’ble Supreme Court in CIT vs. Maruti Udyog Ltd.(2010) 320 ITR 729(SC) following the above judgment held that the Tribunal was right in holding that the claim for depreciation on account of enhanced cost of depreciation due to fluctuation in foreign exchange rate was admissible for deduction u/s.37 of the Income tax Act, 1961.
20. In the light of the said authoritative pronouncement of the Hon’ble Supreme Court and keeping in view that the assessee is claiming depreciation only on account of enhanced cost due to fluctuation in foreign exchange rate, we are of the view that the ld. CIT(A) was fully justified in allowing the assessee’s claim of depreciation on account of foreign exchange re-valuation. The ground taken by the revenue is therefore, rejected.
ITA No.5459/Mum/2006 (A. Y.2003-04) (Revenue’s Appeal):
21. Ground No.1 reads as under :
“1. On the facts and the circumstances of the case and in law, the ld. CIT(A) erred in directing to delete the addition of Rs.41,74,155/- made by the Assessing Officer by estimating the commission income @ 10% without appreciating the fact that :
(i) The assessee is assuming risks in respect of the sales of products made by the Head office/Staubli Group Entities.
(ii) The profits arising on account of such risks assumed by the India branch is the income of the branch and not of the head office/Staubli Group Entities.
(iii) The Arm’s length payment of commission to the India branch by the head office/Staubli Group Entities (Principals) does not extinguishes the assessment of the principals in India.”
22. At the time of hearing both parties have agreed that the facts of the above issue are the same as the facts in Ground No.1 for the Assessment Year 2001-02, therefore the plea taken by them for the said Assessment Year may be considered while deciding the above ground for the Assessment Year 2003-04.
23. That being so and in the absence of any distinguishing feature brought on record by the parties we direct the AO to follow our finding recorded in paras -10 to 13 of this order. We hold and order accordingly. The ground taken by the revenue is, therefore, rejected.
24. Ground No.2 reads as under :
“2. On the facts and the circumstances of the case and in law, the ld. CIT(A) erred in holding that the Assessing Officer was not justified in disallowing depreciation of Rs.18,636/- on capitalization of exchange control fluctuation arising on foreign currency borrowing from its head office relatable to fixed assets acquired in India without appreciating that section 43A is not applicable in the present case.”
25. At the time of hearing both parties have agreed that the facts of the above issue are the same as the facts in Ground No.2 for the Assessment Year 2001-02, therefore the plea taken by them for the said Assessment Year may be considered while deciding the above ground for the Assessment Year 2003-04.
26. After hearing the rival parties and perusing the material available on record we are of the view that the Hon’ble Supreme Court in Woodward Governor India P. Ltd. supra, has held vide placitum 34 (Page 272 of the ITR) as under :
“Lastly, we are of the view that the amendment of section 43A by the Finance Act, 2002, with effect from April 1, 2003, is amendatory and not clarificatory. The amendment is in complete substitution of the section as it existed prior thereto. Under the un-amended section 43A adjustment to the actual cost took place on the happening of change in the rate of exchange whereas under the amended section 43A the adjustment in the actual cost is made on cash basis. This is indicated by the words ” at the time of making payment” . In other words, under the unamended section 43A, ” actual payment” was not a condition precedent for making necessary adjustment in the carrying cost of the fixed asset acquired in foreign currency, however, under the amended section 43A with effect from April 1, 2003, such actual payment of the decreased/ enhanced liability is made a condition precedent for making adjustment in the carrying amount of the fixed asset. This indicates a complete structural change brought about in section 43A, vide the Finance Act, 2002. Therefore, the amended section is amendatory and not clarificatory in nature.”
In the absence of complete facts as to whether the assessee has also claimed only depreciation on the WDV or has also made actual payment on account of decreased/enhanced liability of foreign exchange fluctuation, we are of the view that the matter should go back to the file of the AO and accordingly we set aside the order passed by the revenue authorities on this account and direct the AO to apply the ratio of the decision of the Hon’ble Supreme Court (supra), and allow the due relief to the assessee after providing reasonable opportunity of being heard. The ground taken by the revenue is therefore, partly allowed for statistical purposes.
27. In the result, the revenue’s appeal for Assessment Year 2001-02 is dismissed and the appeal for the Assessment Year 2003-04 is partly allowed for statistical purposes.