Deduction allowable on loss suffered by assessee on Foreign Exchange Fluctuation Loss

PCIT Vs United Spirits Ltd. (Karnataka High Court)

Conclusion: Loss suffered by an assessee on account of foreign exchange difference as on the date of balance sheet was an item of expenditure under Section 37(1) as the view of AO and CIT (A) that the investments were made on, from the FNCR loans was not based on any supporting material and was only a presumption.

Held: Assessee claimed towards the foreign exchange fluctuation loss. AO disallowed the same holding that assessee had not established the nexus for utilization of the funds raised in FNCR were used for the business purposes. AO held that the loan had been used for certain investments into share capital of various companies. The same had been confirmed by CIT (A).  Tribunal however allowed a deduction. It was held that assessee had demonstrated before Tribunal that increase in investments from Rs.102.92 crores to Rs.380.32 crores was on account of investment of Rs.287 crores in 8% redeemable preference shares which was made on 31.03.2005 i.e., on the last day of the year and therefore the working capital obtained on various dates between 02.04.2004 and 31.03.2005 could not have been utilized from the same. Moreover, interest paid on the loans were allowed by AO himself as a deduction, however no loss in connection thereto was allowed. The action of AO accepting the Foreign Exchange but disallowing the loss appeared to be erroneous. Therefore, the loss suffered by an assessee on account of foreign exchange difference as on the date of balance sheet was an item of expenditure under Section 37(1). The view of AO and CIT (A) that the investments were made on, from the FNCR loans was not based on any supporting material and was only a presumption. Hence, the question was decided in favour of assessee.

FULL TEXT OF THE JUDGMENT/ORDER OF KARNATAKA HIGH COURT

Since common and akin issues are involved in these appeals, they are heard together and disposed of by this common judgment.

2. ITA No.548/2015 is filed by the revenue under Section 260A of the Income Tax Act, 1961 (‘Act’ for short) challenging the order dated 31.03.2015 of the Income Tax Appellate Tribunal, “A” Bench, Bangalore (‘Tribunal’ for short) in ITA No.652/Bang/2013 relating to the assessment year 2008-09.

3. ITA No.37/2010 is filed by the revenue under Section 260A of the Income Tax Act, 1961 challenging the order dated 21.08.2009 of the Income Tax Appellate Tribunal, “B” Bench, Bangalore (‘Tribunal’ for short) in ITA No.217/Bang/2009 relating to the assessment year 2005-06.

4. These appeals were admitted to consider the following substantial questions of law:

In ITA No.548/2015:

“Whether on the facts and in the circumstances of the case, the Tribunal is right in holding that the funds raised in FCNR were utilized for business purpose and exchange loss was to be allowed in spite of the fact that the same was not established to be linked to the working capital of the business of the assessee and even when the case relied upon by the Tribunal is not applicable to present case?”

In ITA No.37/2010:

“1. Whether the finding of the Tribunal that the assessee is entitled to write off bad debts and the same is eligible for deduction, is based on conjectures and surmises and not on material on record and therefore unsustainable?

2. Whether the finding of the Tribunal that the loss incurred due to foreign exchange loan is eligible for deduction without any material on record, is perverse and arbitrary?

3. Whether the finding of the Tribunal that the assessee is entitled to deduction for research and development expense in the absence of any material produced in that behalf, is perverse and arbitrary?”

5. The assessee is a company engaged in the manufacture and trading in Beer, relating to the assessment year 2005-06 the assessee filed return declaring the income of Rs.37,52,98,972/-. After scrutiny, Assessing Officer [AO] inter alia made certain additions and disallowances by passing the Assessment Order under Section 143 [3] of the Act which are as under:

1. Disallowance towards R&D Rs.1,18,78,000/-

2. Disallowance of Foreign Exchange loss[FCNR] Rs.1,80,22,000/-

3. Disallowance of Bad debts/advances Rs.1,09,93,814/-

6. On appeal before the CIT[A], the order passed by the Assessing Officer was confirmed. On further appeal before the Tribunal by the assessee herein, the Tribunal allowed the appeal allowing the deductions under these heads. Being aggrieved, the Revenue has filed ITA No.37/2010 relating to the Assessment year 2005-06.

7. Relating to the Assessment year 2008-09, the Assessing Authority made disallowance of Bad debts, set off of brought forward losses and charged interest under Section 234C and 234D of the Act further disallowing foreign exchange loss. The assessee preferred appeal before the CIT[A] which came to be partly allowed. Hence, the assessee as well as the Revenue both preferred appeals before the Tribunal. The Tribunal has restored the first four issues to the file of the Assessing Authority and dismissed the appeal of the Revenue with regard to issue pertaining to the disallowance of foreign exchange loss by relying on its own decision which is the subject matter of ITA No.37/2010.

Re. Substantial Question of Law No.1. (in ITA No.37/2010).

8. The Assessing Officer has rejected the claim in respect of the bad debts and advances primarily for the reason that no information was furnished by the assessee with regard to the bad debts for the purpose of claiming as expenditure in computation of profits. The same being confirmed by the First Appellate Authority, the Tribunal has observed that the Assessing Officer ought to have verified the claims of amounts taken in the very nature of their expenses have been allowed as day to day business expenses considering the assessee’s own case relating to assessment years 1996-97, 1997­98, where the amount was claimed as revenue expenditure on renovation and repairs of an asset not owned by the assessee but categorized as the advances paid to Martin Burns Limited, which has been paid subject to deduction at source. Thus, considering trade of the credit as claimed by the assessee being revenue in nature allowed the claim.

9. Learned counsel for the revenue has placed reliance on the judgment of the Hon’ble Apex Court in the case of Vijaya Bank vs. Commissioner of Income-tax reported in (2010) 323 ITR 166 (SC), wherein it has been explained that after the explanation vide Finance Act, 2001, in Section 36(1)(vii) with effect from 01.04.1989, the assesee (s) is now required not only to debit the profit and loss account but simultaneously also reduce loans and advances or the debtors from the asset side of the balance sheet to the extent of the corresponding amount so that, at the end of the year, the amount of loans and advances/debtors is shown as not of provisions for impugned bad debt.

10. There is some force in the said arguments advanced by the Revenue. None of the authorities have examined the issue in this angle in deciding the matter relating to substantial questions of law No.1. Hence, we remand the matter to the Tribunal to reconsider the matter in the light of the judgment of the Hon’ble Apex Court in the case of Vijaya Bank, supra.

Re. Substantial Question of Law No.2 (in ITA No.37/2010):

11. The assessee claimed an amount of Rs.1,80,22,000/- towards the foreign exchange fluctuation loss. The Assessing Officer disallowed the same holding that the assessee had not established the nexus for utilization of the funds raised in FNCR are used for the business purposes. It was assumed by the Assessing Officer that the loan had been used for certain investments into share capital of various companies. The same has been confirmed by the CIT

(A). The Tribunal having noticed that the assessee had offered the foreign exchange to tax which had been accepted by the Assessing Officer held that the assessee had established that the loss was in relation to working capital loans and the said loans were not utilized to making the interest as observed by the Assessing Officer. Thus, the said loss was allowed as a deduction.

12. At this juncture, it is beneficial to refer to the judgment of the Hon’ble Apex Court in the case of Taparia Tools Ltd., vs. Joint Commissioner of Income Tax, reported in (2015) 372 ITR 605 (SC), wherein the Hon’ble Apex Court has held thus:-

“18. In the instant case, as noticed above, the assessee did not want spread over of this expenditure over a period of five years as in the return filed by it, it had claimed the entire interest paid upfront as deductible expenditure in the same year. In such a situation, when this course of action was permissible in law to the assessee as it was in consonance with the provisions of the Act which permit the assessee to claim the expenditure in the year in which it was incurred, merely because a different treatment was given in the books of accounts cannot be a factor which would deprive the assessee from claiming the entire expenditure as a deduction. It has been held repeatedly by this Court that entries in the books of accounts are not determinative or conclusive and the matter is to be examined on the touchstone of provisions contained in the Act [See – Kedarnath Jute Manufacturing Co. Ltd. v. CIT; Tuticorin Alkali Chemicals & Fertilizers Ltd., Madras v. CIT; Sutlej Cotton Mills Ltd. v. CIT and United Commercial Bank, v.CIT.”

13. In the case of Commissioner of Income Tax vs. Reliance Industries Ltd., reported in (2019) 102 taxmann.com 52 (SC), while considering the question “whether the High Court is correct in holding that interest amount being interest referable to funds given to subsidiaries is allowable as deduction under Section 36(1)(iii) of the Income Tax Act, 1961 (for short ‘the Act’) when the interest would not have been payable to banks, if funds were not provided to subsidiaries?,” the Hon’ble Apex Court held that, the issue raises a pure question of fact. The High Court has noted the finding of the Tribunal that the interest free funds available to the assessee were sufficient to meet its investment. Hence, it could be presumed that the investments were made from the interest free funds available with the assessee.

14. In the case of Commissioner of Income-tax vs. Reliance Utilities and Power Ltd., reported in (2009) 178 Taxman 135 (Bombay), the Hon’ble High Court of Bombay has held thus:-

“10. If there be interest-free funds available to an assessee sufficient to meet its investments and at the same time the assessee had raised a loan it can be presumed that the investments were from the interest-free funds available. In our opinion, the Supreme Court in East India Pharmaceutical Works Ltd. Case (supra) had the occasion to consider the decision of the Calcutta High Court in Woolcombers of India Ltd., case (supra) where a similar issue had arisen. Before the Supreme Court it was argued that it should have been presumed that in essence and true character the taxes were paid out of the profits of the relevant year and not out of the overdraft account for the running of the business and in these circumstances the appellant was entitled to claim the deductions. The Supreme Court noted that the argument had considerable force, but considering the fact that the contention had not been advanced earlier it did not require to be answered. It then noted that in Woolcombers of India Ltd.’s case, (supra) the Calcutta High Court had come to the conclusion that the profits were sufficient to meet the advance tax liability and the profits were deposited in the over draft account of the assessee and in such a case it should be presumed that the taxes were paid out of the profits of the year and not out of the overdraft account for the running of the business. It noted that to raise the presumption, there was sufficient material and the assessee had urged the contention before the High Court. The principle, therefore, would be that if there are funds available both interest-free and over draft and/or loans taken, then a presumption would arise that investments would be out of the interest-free fund generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption is established considering the finding of fact both by the CIT (Appeals) and ITAT.”

15. In the light of the aforesaid legal position, we may advert to the findings recorded by the Tribunal on this point and the same is quoted hereunder:

“6. On the issue of foreign exchange loss on conversion claim, as noted by the authorities below, details as in the paper book have been furnished to establish nexus of incurring this loss as a business loss in the hands of the assessee. The annexure furnished indicates the forward rate and the spot rate during the accounting year therefore resulted in loss amounting to Rs.1.8 crores is brought out clearly to be allowed as a business loss when primarily the assessee indicates that the loans were obtained in foreign exchange for working capital from its banks therefore indicated that a foreign exchange loss as noted by the bank was not to be borne by the banks but by the assessee. Therefore it is clear that the assessee has been able to establish its working capital requirements as was not related as otherwise noted by the Assessing Officer claimed as interest on forward contracts for investment in shares of companies which investment increased from Rs.102 crores to Rs.380 crores. Justifiably the learned counsel pointed out the issue in accordance with the provisions of section 43A distinguishing the capital/revenue nature imbibed therein to result in consideration thereof as were claimed by the assessee before the authorities below. The assessee himself rendered income on gain from exchange fluctuation on identical nature of revenue from loans remaining unpaid. The same is to be allowed on the facts and circumstances of the assessee.

16. The assessee has demonstrated before the Tribunal that increase in investments from Rs.102.92 crores to Rs.380.32 crores was on account of investment of Rs.287 crores in 8% redeemable preference shares of Phipso Distillery Ltd., which was made on 31.03.2005 i.e., on the last day of the year and therefore the working capital obtained on various dates between 02.04.2004 and 31.03.2005 could not have been utilized from the same. It was also pointed out that the interest paid on the loans were allowed by the Assessing Officer himself as a deduction, however no loss in connection thereto was allowed. The action of the Assessing Officer accepting the Foreign Exchange but disallowing the loss appears to be erroneous.

17. It is apt to refer to the decision of the Hon’ble Apex Court in Commissioner of Income-tax, Delhi vs. Woodward Governor India (P.) Ltd., reported in (2009) 179 Taxman 326 (SC), wherein it has been enunciated that the loss suffered by an assessee on account of foreign exchange difference as on the date of balance sheet is an item of expenditure under Section 37(1) of the Act. The view of the Assessing Officer and the CIT (A) that the investments were made on, from the FNCR loans is not based on any supporting material and is only a presumption. Hence, confirming the view of the Tribunal, we answer this question in favour of the assessee and against the revenue.

Re. Substantial Question of Law No.3 (in ITA No.37/2010):

18. Learned counsel for the Revenue argued that in the absence of material evidence to establish that the research and development expenses expended by the assessee relates to the business activity in terms of Section 37[1] of the Act, merely on surmises and conjectures, the Tribunal proceeded to allow the claim of the assessee holding that the contention of the Revenue that the said amounts were claimed as a double deduction, further observing that the assessee is not claiming any weighted deduction thereupon. Drawing the attention of the Court to the submissions of the Revenue recorded in the order of the Tribunal argued that no such arguments were advanced by the Revenue as regards the double deduction and weighted deduction.

19. Assessing Officer has disallowed the expenses of Research and Development expenses on the ground that the said expenditure was not connected to the business of the assessee as it was in the business of manufacture and trading of beer and the details of research and development had not been furnished. The assessee contends that the details of the said expenditure were furnished before the CIT[A] which were primarily in the nature of employee related expenses with a breakup as under:

20. It was submitted that the assessee being in the business of manufacture and trading of IMFL, the act of blending for each brand is under an exclusive formula which requires to be tested at the technical centers. The assessee also explained that the manufacturing units of the assessee having technical laboratories where the quality control and development of the products manufactured are monitored, the research and development expenses are necessary which indeed are expended wholly and particularly for the business as per section 37[1] of the Act. The very same arguments are now advanced by the learned counsel appearing for the assessee in the present appeal proceedings. The CIT[A] upheld the disallowance. The Tribunal concluded that the said expenses are related to the business of the assessee and ought to be allowed. Learned counsel for the Revenue has argued that in the absence of the material evidence placed on record, the Tribunal on surmises and conjectures has allowed the deductions claimed.

21. As could be seen from the material on record, the Assessing Officer as well as the CIT (A) has disallowed the R & D claim made by the assessee mainly for the reason that no documents were placed on record to establish the same. But the Tribunal has proceeded to allow the claims made by the assessee on the ground that the same is not double deduction or weighted deduction. We are not convinced with the reasoning of the Tribunal in allowing this deduction for want of material evidence and lack of proper reasoning. Hence, we remand the matter to the Tribunal to re­consider on this issue sans answering this substantial question of law.

22. In ITA No.548/2015 relating to the assessment year 2008-09, the Tribunal following the assessee’s own case relating to the assessment year 2006-07, wherein the order of the Tribunal relating to the assessee’s own case for assessment year 2005-06 was considered, has dismissed the revenue’s appeal. In view of the said substantial question of law now answered in ITA No. 37/2010 against the revenue and in favour of the assessee, this appeal filed by the revenue deserves to be disposed of in similar terms.

23. For the reasons aforesaid, we pass the following

ORDER

IN ITA No.37/2010

i) ITA No.37/2010 is allowed in part.

ii) Substantial question of law No.2 is answered in favour of the assessee and against the revenue.

iii) Insofar as substantial questions of law Nos.1 and 3, the matter stands remanded to the Tribunal for re-consideration.

iv) The Tribunal shall re-consider the matter and take appropriate decision in accordance with law in an expedite manner.

IN ITA No.548/2015

In view of the decision rendered by this Court in ITA No.37/2010 relating to the substantial question of law No.2 therein, the substantial question of law raised in this appeal is answered in favour of the assessee and against the revenue.

ITA No.548/2015 stands dismissed.