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Assst. C.I.T., Vadodara vs. Elecon Engineering Co. Ltd. dated 2010-02-26

                                                                                REPORTABLE

 
 

                       IN THE SUPREME COURT OF INDIA

                       CIVIL APPELLATE JURISDICTION

                      CIVIL APPEAL NO. 2057 of 2010

                 (Arising out of S.L.P. (C) No.8363 of 2009)

 

Assst. C.I.T., Vadodara                                                    ... Appellant (s)

 

                                            Versus

 
Elecon Engineering Co. Ltd.                                               ... Respondent(s)

                                             WITH

 

Civil   Appeal   No.   2058   of   2010   arising   out   of   SLP(C)   No.8898 of 2009

Civil   Appeal   No.   2059   of   2010   arising   out   of   SLP(C)   No.8905 of 2009

Civil   Appeal   No.   2060   of   2010   arising   out   of   SLP(C)   No.9264 of 2009

Civil   Appeal   No.   2061   of   2010   arising   out   of   SLP(C)   No.9136 of 2009

Civil   Appeal   No.   2062   of   2010   arising   out   of   SLP(C)  No.13041of 2009

Civil   Appeal   No.   2063   of   2010   arising   out   of   SLP(C)   No.9135 of 2009

Civil   Appeal   No.   2064   of   2010   arising   out   of   SLP(C)   No.20622 of 2009

Civil   Appeal   No.   2065   of   2010   arising   out   of  SLP(C)   No.16721 of 2009

 
 

                                    JUDGMENT

 
 
S. H. KAPADIA, J.
 
 
        Leave granted.
 
 

2.      This batch of civil appeals concerns the nature of roll over premium

 

charge incurred by the assessee as also the scope and applicability of Section

 

43A of the Income Tax Act, 1961 ("the Act" for short), in the context of

 
such charges.

                                                                              2

 
 

3.    The lead matter in this batch of civil appeals is civil appeal arising out

 

of S.L.P.(C) No.8363 of 2009.        It concerns assessment year 1986-87.

 
Assessee is a manufacturing company.             It manufactures gears and
 
mechanical handling equipments. It procured a foreign currency loan for
 

expansion of existing business. Since the repayment of loan was stipulated

 

in instalments, assessee desired to ensure that foreign currency required for

 
repayment of the loan be obtained at a pre-determined rate and cost.
 
Accordingly, the assessee booked forward contracts with Citibank for
 
delivery of the required foreign currency on the stipulated dates.         The
 

contract was entered into for entire outstanding amount and the delivery of

 

foreign currency was obtained under the contract for instalment due from

 

time to time. The balance value of the contract, after deducting the amount

 

withdrawn towards repayment, was rolled over for a further period up to the

 

date of the next instalment.      Assessee filed its return of income for

 

assessment year 1986-87 on 30.6.1986. A revised return was filed by it on

 
27.3.1989 declaring a total income of Rs.2,10,08,640/-.             The A.O.
 

disallowed an amount of Rs.8,86,280/-, being the roll over premium charges

 

paid by the assessee in respect of foreign exchange forward contracts to

 
Citibank N.A. on the ground that the said charges were incurred in
 

connection with the purchase of a capital asset (plant and machinery), hence,

 

it was not admissible for deduction under Section 36(1)(iii) or under Section

                                                                          3
 
 
37 of the Act. On appeal, the CIT (A) held that the roll over premium
 

charge(s) incurred by the assessee was allowable as it was incurred by the

 

assessee to mitigate the risk involved in higher payment because of adverse

 

fluctuation of rate of exchange. According to CIT (A), roll over premium

 

charge(s) constituted an expenditure incurred for raising loans on revenue

 

account, hence, the said expenditure was allowable under the Act. It may be

 

noted that CIT (A) did not refer to a specific section under which assessee

 

was entitled to such deduction. The CIT(A) did not examine Section 43A of

 

the said Act. The CIT(A) relied upon the judgment of the Supreme Court in

 

support of its findings in the case of India Cements Ltd. v. Commissioner

 
of Income-Tax, Madras - (1966) 60 ITR 52.
 
 

4.    Vide order dated 21.3.2001, the Tribunal held that roll over premium

 

charges (carry forward charges) were required to be paid to the authorized

 

dealer as consideration for permitting the unutilized amount of the contract

 

(balance value of the contract) to be availed of at a latter date and in the

 
circumstances roll over premium charges had to be capitalized under
 

Explanation 3 to Section 43A of the said Act. Consequently, the Tribunal

 
upheld the order of the assessment.
 
 

5.    Aggrieved by the decision of the Tribunal, the assessee filed an

 
appeal(s) before the Gujarat High Court inter alia challenging the
                                                                              4
 
 

capitalization of the roll over charges paid in respect of foreign currency.

 
The said appeal(s) was allowed by the High Court which came to the
 

conclusion that the roll over premium charge(s) paid by the asssessee was in

 

the nature of interest or committal charge(s), hence, the said charges were

 

allowable under Section 36(1)(iii) of the said Act, hence this civil appeal(s).

 
 
 

6.    According to the Department, the roll over charge was required to be

 
capitalized in view of Section 43A of the Act. In answer to this basic
 

argument, Mr. P.H. Parekh, learned senior counsel appearing on behalf of

 
the assessee submitted that the roll over contract mechanism came to be
 

devised because at the relevant time forward contracts could be entered into

 

for a period of six months ahead of the required delivery of foreign currency

 

for payment of instalments. However, the "term loan agreements" stipulated

 

repayment    schedule    extending    beyond     the   six   months'    period.

 
Consequently, there arose a need for a mechanism whereby foreign
 

currencies required to be remitted to meet the instalments falling due beyond

 
six months were made available at a pre-determined exchange rates.
 
Accordingly, the roll over contract mechanism came to be devised.
 
Assessee accordingly entered into a contract with the foreign exchange
 
authorized dealer (Citibank) for providing the entire amount of foreign
 

currency outstanding at an appropriate exchange rate. The authorized dealer

                                                                          5
 
 

in turn agreed to provide, out of such contracted sum, such amount as may

 

be necessary to meet the instalments on due dates and to carry forward the

 

unutilized portion of the foreign currency contracted to meet the subsequent

 
payments. Accordingly, out of the total foreign currency contracted and
 
outstanding, as and when any instalment became due, the borrower
 
deposited the rupee equivalent of the instalment due at the pre-determined
 

rate and carried forward or rolled over the balance unutilized amount of the

 

contracted foreign currency.     According to the assessee, this exercise

 

involved a cost for carrying forward the contracted foreign currency, which

 

was not immediately required for repayment. The said cost was called "the

 

roll over charges". According to the assessee, such cost is akin to the

 

interest payable on the rupee equivalent, which the authorized dealer had

 

invested in holding the foreign currency at the borrower's account. This

 

argument was accepted by the High Court. Thus, according to the assessee,

 
the said roll over charges incurred by the assessee during the relevant
 

assessment years was altogether different from increase in cost on account of

 

exchange rate fluctuation as envisaged under Section 43A and Explanation 3

 

and, consequently, according to the assessee, in this case Section 43A was

 

not applicable. According to the assessee, Section 43A, as it stood at the

 

relevant time, applied only when there was an increase or reduction in the

 

liability of the assessee consequent upon change in the rate of exchange of

                                                                            6

 
 

currency for payment of cost of asset or for payment of loan. According to

 

the assessee, the roll over premium was not paid because of any fluctuation

 

in the rate of exchange. It was paid as a premium to the dealer for the risk

 

taken by the dealer in holding the foreign exchange at pre-determined rate

 
on borrower's account. According to the assessee, roll over charge had
 

nothing to do with the fluctuation in the rate of exchange and was payable

 

even if there was no fluctuation in the liability of the assessee in Indian

 
currency for making payment towards repayment of the money borrowed.
 
Therefore, according to the assessee, Section 43A was not attracted.
 
According to the assessee, the second reason why Section 43A was not
 

applicable was because there was no increase or reduction in the liability for

 

payment of cost of asset as a result of the change in the rate of exchange.

 

On the contrary, according to the assessee, the said payment was made to

 

avoid the increase or reduction in liability as a consequence of the change in

 

the rate of exchange. According to the assessee, only certain charges were

 

required to be added to the actual cost under Explanation 3 to Section 43A.

 

According to the assessee, the roll over charge was not required to be added

 

to the actual cost nor was it required to be capitalized as such roll over

 

charge had nothing to do with the actual cost of the asset. According to the

 

assessee, when a forward contract is entered into with an authorized dealer,

 

then, only at the forward rate, assets can be capitalized. This is what the

                                                                              7

 
 

assessee has in fact done.     The assessee has capitalized the actual rate

 
difference and it claimed depreciation thereof.        The only controversy,
 

according to the assessee, is in respect of the roll over charges. According to

 

the assessee, Explanation 3 does not talk of any roll over charges to be

 
capitalized under Section 43A. Hence, according to the assessee, in the
 

present case, the assessee had rightly debited the roll over charges in its

 

Profit & Loss Account under the Head Administrative Expenses - Insurance

 

/ Bank Charges.       According to the assessee, roll over charges are

 

commitment charges. They are in the nature of interest. They are paid in

 

relation to the amounts borrowed. They are akin to the interest payable on

 

the rupee equivalent, which the authorized dealer had invested in holding the

 

foreign currency on the borrower's account. For the afore-stated reasons, it

 
was submitted that roll over charges were allowable as deduction under
 

Section 36(1)(iii) of the Act. According to the assessee, roll over charges

 

were also meant for covering a risk on account of fluctuations between the

 

rupee and the contracted foreign currency. Such risk is built into the roll

 
over charges, hence, such charges were allowable as deduction under
 

Section 36(1)(iii) of the Act. In the alternative, on behalf of the assessee, it

 

was submitted that in the event of this Court coming to the conclusion that

 

roll over charges were not deductible under Section 36(1)(iii) then in that

 

event such charges were deductible under Section 37 of the Act. In support

                                                                            8

 
 

of this contention, learned counsel for the assessee placed reliance on the

 
judgment of this Court in CIT v. Gujarat Alkalis and Chemicals Limited,
 
(2008) 2 SCC 475 which held that commitment and insurance charges
 

payable by the assessee were admissible deductions under Section 37 of the

 
Act.
 

7.     At the outset, we quote hereinbelow Section 43A, as it stood at the

 
relevant assessment years, as under:
 

             "43A. Special provisions consequential to changes in

             rate of exchange of currency--(1) Notwithstanding

             anything contained in any other provision of this Act,

             where an assessee has acquired any asset from a country

             outside India for the purposes of his business or

             profession and, in consequence of a change in the rate of

             exchange at any time after the acquisition of such asset,

             there is an increase or reduction in the liability of the

             assessee as expressed in Indian currency for making

             payment towards the whole or a part of the cost of the

             asset or for repayment of the whole or a part of the

             moneys borrowed by him from any person, directly or

             indirectly, in any foreign currency specifically for the

             purpose of acquiring the asset (being in either case the

             liability existing immediately before the date on which

             the change in the rate of exchange takes effect), the

             amount by which the liability aforesaid is so increased or

             reduced during the previous year shall be added to, or, as

             the case may be, deducted from, the actual cost of the

             asset as defined in clause (1) of section 43 or the amount

             of expenditure of a capital nature referred to in clause

             (iv) of sub-section (1) of section 35 or in section 35A or

             in clause (ix) of sub-section (1) of section 36, or, in the

             case of a capital asset (not being a capital asset referred

             to in section 50), the cost of acquisition thereof for the

             purposes of section 48, and the amount arrived at after

             such addition or deduction shall be taken to be the actual

                                                                               9

 
 

             cost of the asset or the amount of expenditure of a capital

             nature or, as the case may be, the cost of acquisition of

             the capital asset as aforesaid.

 
             ***                        ***                        ***

             Explanation 3: Where the assessee has entered into a

             contract with an authorised dealer as defined in section 2

             of the Foreign Exchange Regulation Act, 1947 (7 of

             1947), for providing him with a specified sum in a

             foreign currency on or after a stipulated future date at the

             rate of exchange specified in the contract to enable him

             to meet the whole or any part of the liability aforesaid,

             the amount, if any, to be added to, or deducted from, the

             actual cost of the asset or the amount of expenditure of a

             capital nature or, as the case may be, the cost of

             acquisition of the capital asset under this sub-section

             shall, in respect of so much of the sum specified in the

             contract as is available for discharging the liability

             aforesaid, be computed with reference to the rate of

             exchange specified therein."

 
 

8.    Before analysing the Section quoted above, by way of preface, we

 

need to state that exchange differences are required to be capitalized if the

 

liabilities are incurred for acquiring the fixed asset, like plant and machinery.

 

It is the purpose for which the loan is raised that is of prime significance.

 

Whether the purpose of the loan is to finance the fixed asset or working

 

capital is the question which one needs to answer and in order to ascertain

 

that purpose, the facts and circumstances of the case, including the relevant

 
loan agreement and the correspondence between the parties concerned are
 

required to be looked into. In the present case, it appears that the relevant

 

contract and correspondence has not been produced by the assessee. We are

                                                                            1

 
 

proceeding on the basis that the purpose of the loan taken by the assessee

 
from ICICI was to finance the purchase of plant and machinery.
 
 

9.    Section 43A, before its substitution by a new Section 43A vide

 
Finance Act, 2002, was inserted by Finance Act, 1967 with effect from
 

1.4.1967, after the devaluation of the rupee on 6 June, 1966. It applied

 

where as a result of change in the rate of exchange there was an increase or

 

reduction in the liability of the assessee in terms of the Indian rupee to pay

 
the price of any asset payable in foreign exchange or to repay moneys
 

borrowed in foreign currency specifically for the purpose of acquiring an

 

asset. The Section has no application unless an asset was acquired and the

 
liability existed, before the change in the rate of exchange.      When the
 
assessee buys an asset at a price, its liability to pay the same arises
 

simultaneously. This liability can increase on account of fluctuation in the

 

rate of exchange.     An assessee who becomes the owner of an asset

 

(machinery) and starts using the same, it becomes entitled to depreciation

 

allowance. To work out the amount of depreciation, one has to look to the

 

cost of the asset in respect of which depreciation is claimed. Section 43A

 

was introduced to mitigate hardships which were likely to be caused as a

 

result of fluctuation in the rate of exchange. Section 43A lays down, firstly,

 

that the increase or decrease in liability should be taken into account to

                                                                            1

 
 

modify the figure of actual cost and, secondly, such adjustment should be

 

made in the year in which the increase or decrease in liability arises on

 

account of fluctuation in the rate of exchange. It is for this reason that

 
though Section 43A begins with a non-obstante clause, it makes Section
 

43(1) its integral part. This is because Section 43A requires the cost to be

 
recomputed in terms of Section 43A for the purposes of depreciation
 
(Sections 32 and 43(1)). A perusal of Section 43A makes it clear that
 

insofar as the depreciation is concerned, it has to be allowed on the actual

 

cost of the asset, less depreciation that was actually allowed in respect of

 

earlier years. However, where the cost of the asset subsequently increased

 

on account of devaluation, the written down value of the asset has to be

 
taken on the basis of the increased cost minus the depreciation earlier
 
allowed on the basis of the old cost.       One more aspect needs to be
 

highlighted. Under Section 43A, as it stood at the relevant time, it was inter

 

alia provided that where an assessee had acquired an asset from a country

 
outside India for the purposes of his business, and in consequence of a
 

change in the rate of exchange at any time after such acquisition, there is an

 

increase or reduction in the liability of the assessee as expressed in Indian

 

currency for making payment towards the whole or part of the cost of the

 

asset or for repayment of the whole or part of the moneys borrowed by him

 

for the purpose of acquiring the asset, the amount by which the liability

                                                                            1

 
 

stood increased or reduced during the previous year shall be added to or

 

deducted from the actual cost of the asset as defined in Section 43(1). This

 

analysis indicates that during the relevant assessment year adjustment to the

 

actual cost was required to be done each year on the closing date, i.e., year-

 

end. Subsequently, Section 43A underwent a drastic change by virtue of a

 
new Section 43A inserted vide Finance Act, 2002. Under the new Section
 
43A such adjustment to the cost had to be done only in the year in which
 

actual payment is made. In this case, we are not concerned with the position

 

emerging after Finance Act, 2002. Under Explanation 3 to Section 43A, if

 

the assessee had covered his liability in foreign exchange by entering into

 
forward contract with an authorized dealer for the purchase of foreign
 

exchange, the gain or loss arising from such forward contract was required

 
to be taken into account.
 
 

10.   In the present case, one of the main arguments advanced on behalf of

 

the assessee before us was that Section 43A was not applicable because roll

 
over charge stood paid to avoid increase or reduction in liability as a
 
consequence of the change in the rate of exchange.         According to the
 

assessee, Section 43A, as it stood at the material time, applied only to cases

 

where there existed a fluctuation in the rate of exchange and since the roll

 
over charge was paid to the authorized dealer by the assessee to avoid

                                                                             1

 
 

increase or reduction in liability on account of such fluctuation, Section 43A

 

read with Explanation 3 thereto would not apply to such roll over charges.

 
We find no merit in this argument advanced on behalf of the assessee.
 
According to the assessee, the cost for carrying forward the contracted
 

foreign currency, not immediately required for repayment, is called the roll

 

over charge(s). As stated above, according to the assessee, Section 43A was

 

not applicable in this case as there was no increase or reduction in liability

 

because such roll over charges were paid to avoid increase or reduction in

 

liability consequent upon change in the rate of exchange. To answer this

 

submission, one needs to keep in mind that during the relevant assessment

 

years Section 43A applied to the entire liability remaining outstanding at the

 

year-end, and it was not restricted merely to the instalments actually paid

 

during the year. Therefore, at the relevant time, the year-end liability of the

 

assessee had to be looked into. Further, it cannot be said that roll over

 

charge has nothing to do with the fluctuation in the rate of exchange. In the

 

present case, the Notes to the Accounts for the year ending 31st December,

 

1986 (Schedule 17) indicates adverse fluctuations in the exchange rate in

 

respect of liabilities pertaining to the assets acquired. This Note clearly

 

establishes existence of adverse fluctuations in the exchange rate which

 

made the assessee opts for forward cover and which made the assessee pays

 

roll over charges.    The word "adverse" in the Note itself presupposes

                                                                             1

 
 

increase in the liability incurred by the assessee during the year ending 31st

 

December, 1986. In the circumstances, we find no merit in the contention of

 

the assessee that roll over charges have nothing to do with the fluctuation in

 

the rate of exchange.       Lastly, in this case we are concerned with

 

capitalization of exchange difference in respect of acquisition of fixed assets

 

acquired from abroad.      According to Indian Accounting Standards by

 

Dolphy D'Souza, roll over charges are indicative of the increase or decrease

 

in the liability of the company in the next specified period, generally of six

 

months. Roll over charges represent the difference arising on account of

 

change in foreign exchange rates.      Roll over charges paid/ received in

 

respect of liabilities relating to the acquisition of fixed assets should be

 

debited/ credited to the asset in respect of which liability was incurred.

 

However, roll over charges not relating to fixed assets should be charged to

 
the Profit & Loss Account. [See page 325]
 
 

11.   Before concluding, we may state that this judgment is confined to the

 

facts of the present case. We may also clarify that the judgments cited on

 
behalf of the assessee concerning commitment charges, warranty charges,
 

etc., do not apply to the present case. None of these judgments deal with roll

 
over charges. Hence, it is not necessary to discuss those judgments.

                                                                            1

 
 

12.   An alternative argument was advanced on behalf of the assessee that

 

in the event this Court holds that roll over charges are to be capitalized in

 

terms of Explanation 3 to Section 43A as it stood prior to assessment year

 
2003-04, then, in that event the Tribunal may be directed to grant
 

depreciation allowance on the written down value of the asset not only for

 

the concerned years but also for the subsequent years till the entire value of

 

the asset is written off. According to the assessee, such a direction is

 

required to be given because the depreciation, according to the assessee, is

 

available even for the assessment years after AY 1994-95. On behalf of the

 

assessee it was further submitted, as and by way of alternative submission,

 

that the Department may not be allowed to charge interest or penalty as the

 
issue involved is debatable.
 
 

13.   We find no merit in the alternative submissions advanced on behalf of

 

the assessee. The Tribunal while holding that roll over charges are required

 

to be adjusted in the carrying amount of fixed asset, has allowed the assessee

 

the benefit of depreciation on the adjusted cost of fixed asset. Hence, it is

 

not necessary for this Court to give direction to the Tribunal, as sought by

 

the assessee. On the facts and circumstances there is no question of this

 
Court directing dispensation from payment of interest and penalty.
                                                                              1
 
 

14.   For the afore-stated reasons, we find merit in this batch of civil

 

appeals filed by the Department and set aside the impugned judgment of the

 
High Court. Accordingly, the civil appeals filed by the Department are
 
allowed with no order as to costs.
 
 
 
 

                                             .................................J.

                                             (S.H. KAPADIA)

 
 
 

                                              ................................J.

                                             (H.L. DATTU)

 
New Delhi;
February 26, 2010.
 


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