Time and again, the income tax authorities are faced with the issue of determining whether a particular receipt is capital in nature and hence exempt from taxation or is a revenue receipt and hence, taxable. This quagmire is attributable to the fact that the Income Tax Act does not stipulate any definition of the term “capital receipt” or “revenue receipt”. Therefore, in circumstances when the transaction does not fit squarely into any provision under the Income Tax Act, there is always a situation of conflict where on the one hand, the department tries to broadens the horizons of Section 45 of the Income Tax Act and include various transactions under its garb, while on the other hand, the taxpayers claim the transaction to be pertaining to capital account and hence, not taxable.
Recently, the Mumbai bench of Income Tax Appellate Tribunal (“ITAT”) in the case of Aditya Balkrishna Shroff v ITO[1] elaborated on tax implications of gains arising on foreign exchange currency fluctuations on repayment of a personal loan. The important details from the order are highlighted below.
Facts
On March 29, 2010, Aditya Shroff (the “Assessee”) had furnished an interest free loan of USD 2,00,000 (INR 90,30,758) to his cousin in Singapore when the exchange rate was 1USD = INR 45.14. When the cousin returned the same amount (USD 2,00,000) on May 24, 2012, the exchange rate was 1 USD = INR 56.18 and hence, on conversion, the amount credited to Assessee’s account was INR 1,12,35,326. While the Assessee had reflected receipt of this amount in his capital account, the Assessing Officer made a noting that the gain on realization of loan (INR 22,04,568) was subject to taxation under the head of Income from Other Sources. Notwithstanding his contention that the receipt is non-taxable, the Assessee complied with the tax due on such receipt. However, to his surprise, the Assessing Officer initiated penalty proceedings against him for disclosure of incorrect income. The Assessee filed an appeal against this order.
The appeal filed before the Commissioner of Income Tax was dismissed and the order of Assessing Officer was upheld on the grounds that only a rupee loan is permissible under the Foreign Exchange Management Act (“FEMA”) and related rules/guidelines and hence, as there is gain in Indian rupees, such surplus should be treated as interest or income from other sources.
Dissatisfied with such order, the Assessee filed an appeal with the ITAT.
Issue
ITAT had to determine only one issue which is whether gains on foreign exchange fluctuations at the time of repayment of a personal loan is a capital receipt or partakes the nature of income?
Decision
The ITAT allowed the appeal and held that such receipt is a capital receipt on the following grounds:
1. The nature of the receipt hinges on its character in hands of person receiving it and not on the source of such person. The nature of the receipt does not stand altered on giving a wide or narrow interpretation to the term “income” which is taxable as mentioned in Section 2(24) of the Income Tax Act.
2. Section 2(24)(vi) clearly stipulates that only such capital gains are taxable as stipulated under Section 45 and other capital receipts falling outside the ambit of the Section are exempted.
4. It is undisputed by the Assessing Officer and CIT that the transaction is capital in nature. This approach is identical to putting the cart before the house as without determining the nature of the transaction, the lower authorities have decided the head of the income under which it should be taxed.
4. The loan was a personal loan and was denominated in United States Dollars. Moreover, the loan amount and the amount repaid was exactly the same that is USD 2,00,000. The accretion of money was not on account of payment of interest on the loan amount but was solely attributable to increase in value of the US dollars.
5. Even if FEMA permits loan only in Indian rupees, it is not for an income tax authority to determine whether loan was granted in compliance with the provisions of FEMA and nevertheless, non-compliance under FEMA is inconsequential to analysis under Income Tax Act.
Analysis
This decision clarifies that any gains on repayment of interest free personal loan arising due to fluctuation in foreign exchange would not be taxable income in hands of the recipient.
Even though the ITAT does not make a reference to the test laid down by the Supreme Court in case of Sutlej Cotton Mills Ltd v. Commissioner of Income Tax, West Bengal[2] with respect to taxability of gain/ loss arising out of foreign exchange fluctuations, it is in consistence with the ratio of the same. The Supreme Court in the Sutlej case had held that “any gain/loss attributable to appreciation/ depreciation in value of foreign currency would be trading profit or loss if the foreign currency is held by the on revenue account or as a trading asset or as part of circulating capital embarked in the business. But if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature”.
The principle has also been followed in the recent order passed by the Delhi bench of ITAT in case of Havells India Limited[3] where one of the issues was with respect to foreign exchange gain on remittance of amount received on redemption of shares in a foreign subsidiary. The ITAT observed that the investment as well as redemption of shares was in Euro and hence, the actual profit or loss has to be first calculated in Euro and then converted into Indian rupees. As the shares were redeemed at the face value which is the investment amount, there was no profit or loss in Euro and hence, no capital gain would be chargeable under Section 45 of the Income Tax Act. The ITAT also emphasized on the fact that the gain due to depreciation of Indian currency is independent of the underlying transaction of transfer of the shares and hence not taxable.
Conclusion
This decision of ITAT, Mumbai comes at a very crucial time when a lot of wealthy individuals had lent support to their non-resident relatives who were in dire need of financial assistance to sail through the hard times presented by the pandemic. The ITAT has reinforced that only those capital receipts which fall within the contours of Section 45 of the Income Tax Act are taxable. It is worthwhile to note that while ITAT declared the accretion of money as a capital receipt and hence, exempt from taxation, proceedings might be instituted against the same loan transaction if it is found falling foul of provisions of FEMA by the concerned authorities. Hence, it is important to check any and every transaction against all the rules applicable to the same to avoid pitfalls.
[1] Aditya Balkrishna Shroff v ITO, ITA No. 4472/Mum/2019, ITAT Mumbai, decided on May 17, 2021.
[2] AIR 1979 SC 5.
[3] Havells India Limited v ACIT, ITA No. 4695/Del/2012, ITAT Delhi, decided on November 10, 2020.
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