$~
* IN THE HIGH COURT OF DELHI AT NEW DELHI
RESERVED ON: 19.03.2015
% PRONOUNCED ON: 15.05.2015
+ ITA 37/2000
IRCON INTERNATIONAL LTD. ..... Appellant
Through: Mr. V.Giri, Sr. Advocate with
Mr. Tanmay Mehta, Advocate.
versus
DEPUTY COMMISSIONER OF INCOME TAX
..... Respondent
Through: Mr. Kamal Sawhney, Sr. Standing
Counsel with Mr. Basabraj Chakraborty and
Mr. Shikhar Garg, Advocates.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE R.K. GAUBA
JUSTICE S.RAVINDRA BHAT
%
1. The question of law which arises in this appeal, under Section
260A of the Income Tax Act, 1961 (hereafter "the Act") is: -
"Whether the assessees claim that there was a loss and/or
it was a capital loss is legally tenable"
2. The order impugned in this case was made by the Income Tax
Appellate Tribunal ("ITAT") on 19.04.1999, dismissing ITA
ITA 37/2000 Page 1
4486/Del/1998. The impugned order upheld the concurrent findings
of the AO and the CIT (A) with respect to the amounts accruing,
during the assessment year, to the assessee from bonds issued to it, by
the Central Government, in lieu of the debt amounts payable to it for
services under contract to the Iraqi Government.
3. The brief facts are that in the year 1983-84, the Government of
Iraq expressed inability to pay the US Dollar Component to the
assessee and other project exporters who had provided services under
contract to it, under those contracts due to its involvement in war with
Iran. Protocol Agreements were signed between the Union (Indian)
Government and Government of Iraq. Banking arrangements were
also worked out between Exim Bank of India and Central Bank of
Iraq. In consideration of the appellant assigning debt receivables for
the work done in US$ entered in the books of Central Bank of Iraq by
executing Deed of Assignment dated 10.3.1995, the Central
Government of India, pursuant to its notification dated 24.3.1995
issued Compensation Bonds-2001 governed by the provisions of the
Public Debts Act, 1944 and the Public Debt Rules, 1945.
4. By computing the value of such bonds, on indexed cost of
acquisition the assessee claimed loss in its return for Assessment Year
1995-96. The loss under the head ,,Capital Gains" was stated at
`1,48,22,66,649/-. By Assessment Order dated 6.3.1998 under Section
143(3) of the Income Tax Act, the Assessing Officer (AO) was of the
view that the head of ,,Capital Gains was not attracted to the
deduction claimed by the assessee in its return for Assessment Year
(AY) 1995-96. The AO held the amount to be taxable under the head
ITA 37/2000 Page 2
"Income from business and profession". In the appeal against said
order, the learned CIT (A) by order dated 1.7.1998 was of the view
that since the Government of India issued compensation bonds to the
assessee in lieu of debts due from Government of Iraq, this receipt was
nothing but "Profit & Gain of business" taxable under Section 28 of
the Income Tax Act. The assessees appeal to ITAT was unsuccessful.
It consequently appeals to this Court.
5. For the assessee, learned senior counsel Mr. V. Giri urged that
the terms and stipulations contained in the Deed of Assignment
executed in favour of the Central Government entitled the assessee to
receive the value in the form of Compensation Bonds in 2001 and was
not considered properly. It was argued that the Iraqi Governments
debts, recoverable by the assessee, were in the nature of
blocked/sterilized debts or money. In terms of the Government to
Government protocol agreements, the banking arrangements between
the Exim Bank of India and the Central Bank of Iraq and the relative
developments vis-a-vis the debts detailed in the Deed of Assignment,
had to be determined under the Act. The assessee was not entitled to
and was in fact barred from using the receivables from the Iraqi
Government in any manner, much less in the course of, or in carrying
on its business activities. This was due to the supervening
impossibility caused by entirely extraneous circumstances. The effect,
however, was that the amounts could never be said to have been the
main part of its entitlement. The acceptance of compensation bonds
under these circumstances upon assigning of the Iraqi debts (to the
Central Government) was not a part of the appellants business or
ITA 37/2000 Page 3
trading activities. Counsel, therefore, faulted the ITATs findings on
this aspect.
6. Mr. V. Giri, learned senior counsel relied upon the judgment of
the Supreme Court in Sutlej Cotton Mills v. CIT, West Bengal, 116
ITR 1 (SC) and highlighted the distinction between fixed capital and
circulating capital. The former is what the owner turns into profit by
keeping it in his possession and the latter is what makes profit by
parting with and letting it change masters. Circulating capital
consequently means amounts employed in trading operations of the
business and dealings with it comprise "trading receipts" and "trading
disbursements". It was also submitted that Sutlej is an authority for
the further propositions that it can never be stated with certainty that a
traders assets be placed in two compartments only, and that the
character of the deposits is to be determined to see if it is employed in
trading operations.
7. Learned senior counsel also relied upon the judgment of the
Supreme Court in Commissioner of Income Tax, Mysore v. Canara
Bank Ltd., AIR 1967 SC 417. In that case, the question that the
Supreme Court had to deal with related to the foreign exchange
fluctuation difference which had accrued to the assessee on account of
an embargo placed due to difficulties in remittances from the foreign
branch of an Indian Bank. The devaluation of the foreign currency led
to an increase in the value of the Indian Rupee and enhanced the
amounts lying in the assessees account at its overseas branch. The
Court upheld the High Courts decision that the increment which
arises in such eventuality was not due to trading operations in the
ITA 37/2000 Page 4
carrying on of banking business and that the assessees amount was a
blocked or sterilized balance for the period or duration it could not be
utilized until it was finally remitted to India. The Court then went on
to state: -
"in our opinion, the money changed its character "of stock-
in-trade" when it was "blocked" and "sterilized" and the
increment in its value owing to the exchange fluctuation
must be treated as a capital receipt".
Learned senior counsel also relied upon the subsequent judgment in
Universal Radiators v. Commissioner of Income Tax 1993 (2) SCC
629 to say that the casual and non-recurring income arising to the
account of or derived by the assessee cannot be treated as income. In
that case too, the change in valuation of surplus due to settlement of a
claim by the insurance company was not treated as income and the
Court had then noticed and followed its previous rulings in Canara
Bank (supra).
8. Learned senior counsel argued that the amount received upon
debt assignment could not be treated as income under Section 2(24)
but was receipt in value, in consideration of assignment, in the form of
compensation bond. The receipt was the consideration in transfer of a
capital asset under Section 2(47) of the Income Tax Act. Learned
counsel relied upon the decision of the Supreme Court in Karanpura
Development Co. v. Commissioner of Income Tax (1962) 44 ITR 362
to say that income is derived through a periodical monetary receipt not
in the nature of a windfall but coming in with some sort of regularity
or expected regularity. Such amount, however, would not include
ITA 37/2000 Page 5
fixed capital or realization of fixed capital but earning into other form
of capital or money. So stating learned counsel submitted that the
assessees contentions were well founded and could not have been
rejected by the ITAT.
9. Learned counsel for the Revenue argued that ITATs impugned
order should not be disturbed. He submitted that the assessee claimed
capital loss of `1,48,22,66,649/- in its revised return on account of
assignment of right to receive its debt (amounting to US$ 59,967,085)
from the Iraqi government. The assignment was to the Central
Government. The assessee received equivalent value bonds and has
urged that the transfer of right to realize its debt from the Iraqi
Government to the Central Government amounted to transfer of
capital asset. The computation of capital loss was furnished in the
revised return; Note 6 of the said return stated that `12,61,252 lakhs
was not credited to the profit and loss account as it pertained to debts
realized till 31.3.1995 and that the correct amount finally worked-out
on this account was `1,23,42,79,007. The assessee had contended that
income, if any, due on account of FEFR on discharge of Iraqi debts
would accrue in the year in which the bonds were to be paid by the
Central Government. The bonds were received by the company during
AY 1996-97.
10. Learned counsel for the Revenue submitted that the amount
shown as receivable from the Iraqi Government was under the head of
"sundry debtors" and could by no stretch of imagination be termed as
a "capital asset". It was highlighted that the assessee was like any
ITA 37/2000 Page 6
other project exporter to Iraq who had suffered a blockage of its debt
receipts, (due to extraneous factors such as US sanctions), and was the
recipient of the hardship mitigation measures by the Central
Government, which took over such debts and issued equivalent rupee
bonds. It was argued that there was no profit element due to the
taking-over of the debts by the Central Government and issuing bonds
in return. In fact, no profit accrued to the assessee from the Central
Government. On the other hand, profit was an intrinsic element of the
debts which would have accrued in the event the Iraqi Government
was capable and permitted to discharge its debt obligations. That the
assessee was able to realize its debts through a third agency, i.e. the
Central Government did not mean that the character of the amount
transformed and the transaction became one of transfer of capital
asset.
11. Learned counsel for the Revenue relied upon the AOs order
who had drawn an analogy with Section 36(1)(vii), where assessees
are allowed deduction in respect of bad debts or part thereof written
off as irrecoverable. The AO observed that bad debts are treated as
revenue expenditure, and the business income to the extent of those
debts is reduced. Conversely, if debts are recovered above the book
value, such amount would have to be taxed as income. Analogically,
exchange gain in respect of debts would fall in the same category, and
would be liable to be taxed as business income. It was argued by
learned counsel for the Revenue that the intervening development of
the Central Government taking over the debt and issuing bonds for a
ITA 37/2000 Page 7
particular value did not in any way disturb the character of the
amounts received or receivable from the Iraqi Government which
would have also shown exchange gain. Learned counsel further
submitted that debts were not the assessees investment as understood
in common parlance in the sense that a profit was intended to be
earned on their sale or transfer.
12. Learned counsel lastly highlighted that the debt in the present
case due from the Iraqi Government was an incident of the assessees
business and its settlement by the Central Government, (which allotted
compensation bonds) could not on the date of such transfer, result in
transfer of capital asset. Consequently, the assessees cla im for
entitlement to the benefit of indexation on the compensation bonds
received (for which the value of the bonds at US$ 59,967,085/- was
shown to be after indexing at US$ 107,173,029/-) and a
corresponding rupee equivalent loss upon conversion claimed at
`1,48,22,66,649/- was unacceptable either in the commercial sense of
the term or based upon application of any legal principle. Learned
counsel highlighted that the accounting treatment given by the
assessee established that the gain on account of exchange fluctuation
was a business receipt.
Analysis and conclusions
13. The appellant in its return for AY 1995-96 claimed a capital
loss of `1,48,22,66,649/-. It was a project exporter entitled to receive
amounts as part of its consideration from the Iraqi Government for a
ITA 37/2000 Page 8
number of years. The unpaid dues were on account of the Iraqi
Governments inability to repatriate any amounts due to economic
blockage and the consequent sanctions imposed upon it. When the
assessee had entered into the contracts, for a short duration, the Iraqi
Government paid part-consideration in Iraqi Dinars and the rest in
US$. The payments receivable in respect of executed work up to
accounting year 1991-92, but not paid aggregated to US$ 59,967,085/.
Whilst entering into the contracts with the Iraqi Government, the
assessee had procured a policy from Export Credit Guarantee
Corporation (hereinafter "ECGC"), which covered risk to the extent of
80% of the contracted amount. The inability of the Iraqi Government
to pay the consideration agreed for the execution of the work resulted
in the Central Government stepping in, and after negotiations,
executing those protocols spread over a period of time with the Iraqi
Government. The latter was granted deferred payment in respect of the
US$ portion of the contractors dues. In terms of the arrangements
under the protocols, the Iraqi Government through its Central Bank
granted credit in respect of the settled bills to the project exporters,
including the assessee and corresponding debt was raised by the
commercial bank against the Central Bank of Iraq. Since the Iraqi
Government failed to pay the amounts due within the stipulated
period, and the amount payable by ECGC was beyond its means, the
Central Government constituted a Task Force comprising of various
experts. This resulted in an execution of MoU between ECGC and
exporters and countersigned by the other banks. In terms of this MoU,
ECGC started settlement of claims due to the assessee and other
ITA 37/2000 Page 9
contractors. As a result, the assessee received some cash payment
which was adjusted by the Exim Bank against rupee loan availed to
the Exim Bank. The amounts ultimately paid were in the form of
bonds issued and guaranteed by the Central Government, maturing in
2001 and carrying 12.08% interest per annum (they were entitled "the
12.08 Government of India Compensation (Project Exports to Iraq)
Bonds, 2001"). The value of the bonds so issued to the assessee
included a foreign exchange fluctuation gain of ` 1,234,279,007/-.
The assessee treated the currency fluctuation gain in its books of
account for AY 1996-97. The assessee accepted the year of accrual of
income or loss as AY 1995-96 based on a board circular and claimed
capital loss by refusing its return of income and sought to carry
forward loss which according to it was unabsorbed. The income or
gain on assignment of the debt to the Central Government in view
of the bonds, was computed under the head "capital gain". The
assessee contended that the Iraqi debt was a capital asset which was
transferred and that the full value of such consideration on account of
transfer fell short of indexed cost of acquisition. The computation of
indexed cost of acquisition and the computation of loss claimed by the
assessee was as follows:
Financial Year Amount Cost Inflation Indexed Cost of
receivable from Index acquisition in
Iraq in US$ US$
1984-85 24,384,541 259/125 50,524,769
1985-86 2,520,294 259/133 4,907,941
1986-87 2,463,774 259/140 4,557,982
1987-88 1,820,390 259/150 3,143,207
1988-89 10,209,575 259/161 16,424,099
ITA 37/2000 Page 10
1989-90 15,319,151 259/172 23,067,791
1990-91 2,617,221 259/182 3,724,507
1991-92 632,139 259/199 822,733
59,967,085 107,173,029
(ii) Computation of capital loss:
Full value of consideration of Iraqi
Debts being the amount of debt
converted into bonds. US $ 5,99,67,085
Less : Indexed cost of acquisition US $ 10,71,73,029
of Iraqi Debts as per (i) above
Loss under the head Capital Gains US $ 4,72,05,944
Loss in Rs. (converted @ 1 US $ = Rs.148,22,66,649
Rs.31.40
14. As is evident, all the revenue authorities and the ITAT
negatived the assessees contentions. Its submission is that whatever
be the initial character of the amounts of dues owed by the Iraqi
Government, on account of the intervening developments of their
impossibility of repatriation or payment, they were "blocked" or
rendered "sterile." Strong reliance is placed upon the decision of the
Supreme Court in Canara Bank (supra) and Universal Radiators
(supra). The ITAT in its impugned order relied on Sutlej Cotton
(supra) to hold that appreciation or depreciation in foreign currency
value upon its conversion would ordinarily be trading profit or loss if
currency is held in revenue account or in a trading account or part of
circulating account. However, the exception is that if such currency is
held as capital account, such profit or loss would be of capital nature.
The ITAT then held as follows:
ITA 37/2000 Page 11
".....................The amounts receivable were as a result of
project so executed. The amount has arisen directly from
carrying on the aforesaid business. But for the UN sanction
as imposed, the amount would have been repatriated to
India as was the case before UN sanction and employed in
the trading operation of the business. In such a situation it
would constitute a circulating capital as it is intended to be
utilized in the course of business or for trading purpose or
for effecting a transaction on revenue account. The amount
retained abroad was on account of factor beyond the
assessees power. The latter is however, not material for
determining the character of the receipt. The amount as
retained was not for utilising it for purchase of any capital
asset.
XXXXXX XXXXXX XXXXXX
6. This finding of ours is also supported by the
accounting entries made by the assessee in its books of
accounts. It is true that the way in which entries are made
by the assessee in its books of accounts is not determinative
of the character of the income which has to be determined
on the facts and circumstances of each case. Nevertheless
the conduct of the assessee cannot be completely ignored.
The accounting entries as made have relevance while
deciding the issue. At this juncture it would be relevant to
mention that even before the Board of Direct Taxes this has
never been the stand of the assessee. We would also like to
mention that under Section 36 of the Act deduction in
respect of any bad debt has been specifically allowed under
clause (vii) of sub-sec. (1) of Sec. 36 of the Act. Under the
aforesaid section the deductions have been provided for
items which are of revenue nature. Deductions in respect of
the items of capital nature have been specified as such as is
the case in sec. 35(A). 35 AAB in distinction to sec. 35AB of
the Act. In the circumstances, the arguments of the learned
AR in this regard are relevant only in case the project
receivables are held to be on capital account. This would
ITA 37/2000 Page 12
also include the arguments relating to the computation of
capital gain.
7. Having come to the conclusion that the gain as
received constitutes a revenue receipt, now we would like to
revert to the arguments of the learned counsel. Shri Desai
has started with the proposition that as the debt assigned
falls under the expression ,,capital asset as defined in
sec.2(14) of the Act, any gain or loss arising on account of
fluctuation in foreign exchange would constitute a capital
asset. It is something like first assuming the nature of
receipt and then trying to prove as to how it is so. Starting
with the definition of capital asset under sec.2(14) of the Act
and assignment of debt under the provisions of Transfer of
Property Act with the help of the judicial pronouncement he
has gone to show that the project receivables were on
capital account. In this process he has lost sight of the fact
that the first step is to determine the nature of the amount
receivable. The real question is not whether the later stage
of the operation, i.e. assignment of debt is in the course of
trading transaction but whether the first step towards the
transaction is in the course of business. This cannot be
delinked with the first stage. It is the nature of debt assigned
which is relevant. Since the debt as assigned is on account
of trading transaction, the same is of revenue nature. This is
also evident from the treatment given to it under the Act."
15. In the present case, the assessees submissions hinge almost
entirely on the two decisions of the Supreme Court in Canara Bank
(supra) and Universal Radiators (supra). In the first case, the issue
was the inability of a foreign branch of an Indian bank to repatriate
amounts to India due to difficulties faced on account of delayed
valuation of currency. The subsequent currency valuation and the
banks ultimate successes in repatriating the amount to its
headquarters, was with an exchange gain. This exchange gain was
ITA 37/2000 Page 13
held to not be income. Unlike in the present case, the amount always
belonged to the bank its foreign branch was not a separate
incorporated entity but was in fact integral to its operation. Also, the
amount was not profit, but part of its general stock in trade. The event
which intervened and injected temporary blockage of the funds was
the partition of India. It was in these circumstances that the amounts
lying in the foreign branch which were part of its stock in trade,
were treated as such; they never lost their character. Likewise, in the
case of Universal Radiators (supra), the amount sought to be taxed by
the Revenue was an insurance claim settled by the American insurer
due to loss of goods at high seas, when hostilities broke out between
India and Pakistan. The Rupee devaluation resulted in an increment in
the ultimate payment made by the insurer as against equivalent foreign
exchange value originally claimed. The Revenue had contended that
this amount was "income". It was in this context that the Supreme
Court held that since the assessee did not carry on business of selling
of ingots but manufacturing of iron and steel products, the
compensation received by it was not for any trading or business
activity but just equivalent in money of the goods lost by it which
otherwise it would have used. The excess which accrued to the
assessee was not due to any business but entirely due to fortuitous
circumstance, i.e. the valuation of currency.
16. This Court is of the opinion that both the cases are of no
assistance to the assessee. The Iraqi debts were appropriately part of
the profits which arose or accrued to the assessee. Concededly, the
ITA 37/2000 Page 14
assessee follows a mercantile method. The fact that it could not realise
those amounts for a considerable period which resulted in the Indian
Government intervening and negotiating protocols and eventually
taking over the debts and issuing bonds instead, did not in any manner
transform or alter the nature or character of the amount receivable.
The analogy drawn on the basis of the two decisions is neither sound
nor appropriate. In neither case did the Supreme Court hold that the
increase in value of the Indian Rupee, amounts to a gain as is being
urged here. All that was said was that the isolated transactions in both
cases, i.e Canara Bank (supra), the exchange fluctuation resulting in
gain on account of devaluation of Pakistani Rupee was an intrinsic
part of the banks operation; and in Universal Radiators (supra), the
settlement of the insurance claim as compensation, the receipts were
in the true sense not "real income" but capital and unintended
accruals. Here, however, the debts payable were not on account of any
advances given to the Iraqi Government by the assessee but rather as
consideration for the services provided. In fact, for some of the years,
part consideration was paid through Iraqi Dinars. It was the balance
payable in hard currency which could not be repatriated due to
external factors and economic sanctions.
17. A fact which did not go unnoticed by the Revenue is that the
assessees statutory auditors in note 6 of their debt report dated
28.06.1995 commented adversely that the credit balance appearing in
the Foreign Exchange Fluctuation Reserve Account (FEFR A/c)
relating to the debts released till 31.03.1995 - a sum of ` 1,261,252/-
ITA 37/2000 Page 15
was not credited to the P&L account thereby understating the profit to
the said extent. This was sought to be explained by the assessee that
income, if any, due on account of FEFR on discharge of the Iraqi
debts would accrue only in the year in which the bonds would be paid
by the Central Government. The assessee further sought to elaborate
by stating that the deed of assignment dated 10.03.1995 resulted in the
Central Government purchasing its right to realize the amount in hard
currency from the Iraqi Government. The bond amount was to mature
in 2001. Consequently, the assessee contended that the income would
be shown when the bonds mature. However, the lower authorities
rejected that explanation. During the pendency of the assessment
proceedings, on 7.5.1996, the CBDT had issued a circular that income,
if any, arising out of the receipts of the bonds would be taxable in AY
1995-96.
18. In this Courts opinion, the holding of amounts in foreign
currency for diverse reasons by itself cannot be determinative of its
character. As held in Sutlej Cotton (supra), appreciation or
depreciation in foreign currency value upon conversion would be
either trading profit or trading loss. However, the exception to this is
that if foreign exchange currency is kept as capital asset or fixed
capital in such event, the gain or loss would be of capital nature. In
the present instance, the amounts as indicated earlier were payable for
services provided by way of projects executed by the assessee in Iraq.
The Iraqi Governments inability to pay due to sanctions imposed by it
and the subsequent Central Governments negotiating an arrangement
ITA 37/2000 Page 16
for its payment through bonds that were to mature in future with
interest did not in any way alter their character or convert them into
capital assets as the assessee argues. Rather, this Court is also of the
opinion that the analogy of bad debts and their reduction from the
revenue receipts in a given year and its converse treatment by virtue
of Section 36(1)(vii) is apt to the circumstance of the case. The
assessees claim of capital loss, based on indexed treatment of capital
gain is therefore insubstantial and unfounded on any principle.
19. For the above reasons, the Court is of the opinion that the
impugned order does not suffer from any infirmity. The question of
law is answered against the assessee and in favour of the Revenue. For
these reasons, the appeal has to fail and is, therefore, dismissed.
S. RAVINDRA BHAT
(JUDGE)
R.K.GAUBA
(JUDGE)
MAY 15, 2015
ITA 37/2000 Page 17
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