2007 (8) TMI 477 - AT - Income Tax

Deduction from business income - loss on unmatured contracts - fluctuation in the exchange rate of currencies - Forward Foreign Exchange Contracts - HELD THAT - In the case of Chainrup Sampatram v. CIT 1953 (10) TMI 2 - SUPREME COURT , Hon'ble Supreme Court took note of this position and observed that while anticipated loss is taken into account, anticipated profit...is not brought into account as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is lower, and it is now generally accepted as an established rule of commercial practice and accountancy . No doubt these observations were made in the context of valuation of stock but what is material is the theory underlying the principle of valuing closing stock at cost or market price whichever is lower and the fact that such a theory has the acceptance of the Hon'ble Supreme Court. Just because anticipated profits are not assessed to tax, it would not follow, as a corollary thereto, that anticipated losses cannot be allowed as deduction in computation of business income. Thus, we are of the considered view that the very basis of the action of the Assessing Officer was vitiated in law and on facts. We, therefore, deem it fit and proper to direct the Assessing Officer to delete the impugned disallowance. The assessee gets the relief accordingly. Disallowance by way of capital expenditure out of the pre-operative expenses - HELD THAT - In the case of CIT v. Bush Boake Allen (India) Ltd. 1981 (10) TMI 32 - MADRAS HIGH COURT , held that expenses incurred cannot always be viewed as derivative expenses taking colour from the particular transaction to which they relate. Their Lordships were dealing with legal expenses. Their Lordships held that as the expenses are of revenue nature in their own right, the same have to be allowed as revenue deduction irrespective of its linkage with a capital expense. In our considered view, the same holds good true for travelling expenses as well. The travelling expenses are revenue expenses in nature and merely because the travel was in connection with doing the interior decoration work, it cannot be held to be capital expenditure in nature. We, therefore, deem it fit and proper to delete the impugned disallowance. The assessee gets the relief accordingly. Ground No. 6 is thus allowed. In the result, the appeal is partly allowed in the terms indicated above.

Issues Involved:
1. Dismissal of Ground No. 1 for want of prosecution.
2. Applicability of artificial disallowances under Article 7(3) of the India-UAE tax treaty.
3. Tax rate applicable to the assessee's business income.
4. Disallowance of loss on Forward Foreign Exchange Contracts.
5. Disallowance of capital expenditure out of pre-operative expenses.

Detailed Analysis:

1. Dismissal of Ground No. 1:
The appeal's Ground No. 1 was dismissed for want of prosecution as it was not pressed by the assessee.

2. Applicability of Artificial Disallowances:
The assessee contended that artificial disallowances such as entertainment expenses and payments violating rule 6D should not be made under Article 7(3) of the India-UAE tax treaty. This issue was previously addressed in the assessee's case for the assessment year 1996-97. The Tribunal had observed that the provisions of domestic tax laws continue to apply except where specific contrary provisions are made in the tax treaty. In the context of the India-UAE tax treaty, Article 25(1) specifies that domestic tax laws will govern unless expressly overridden by the treaty. Thus, the Tribunal held that artificial disallowances under sections 40A(3), 40A(12), 37(2A), and 43B of the Income-tax Act continue to apply. The plea of the assessee was dismissed, and the disallowances sustained by the CIT(A) were confirmed.

3. Tax Rate Applicable to Business Income:
The assessee argued that the tax rate applicable to its business income should be 43% (40% tax and 7.5% surcharge) instead of 55%, citing the non-discrimination clause in Article 26 of the tax treaty. The Tribunal referred to its decision for the assessment year 1996-97, which stated that the differential tax rate between domestic and foreign companies is not considered discrimination under the enabling provision of section 90 of the Income-tax Act. The Tribunal emphasized that the comparison for non-discrimination purposes should be with a domestic enterprise of the same form of ownership. Since the assessee is a company incorporated in the UAE, its PE should be compared with a domestic company carrying on similar activities. The Tribunal dismissed the assessee's grievance and confirmed the CIT(A)'s order.

4. Disallowance of Loss on Forward Foreign Exchange Contracts:
The assessee claimed a deduction for a loss on forward exchange contracts that were unmatured as of the balance sheet date. The Assessing Officer disallowed this, considering it a contingent loss. The Tribunal, however, noted that anticipated losses should be provided for in the computation of income, as per the principle of conservatism in accountancy, which is recognized by the courts. The Tribunal directed the Assessing Officer to delete the disallowance, allowing the assessee's claim.

5. Disallowance of Capital Expenditure Out of Pre-Operative Expenses:
The assessee contested the disallowance of Rs. 1,43,200, which was spent on traveling expenses related to interior decoration work and treated as capital expenditure. The Tribunal upheld the assessee's plea, stating that traveling expenses are revenue expenses by nature and should not be treated as capital expenditure merely because they are related to a capital transaction. The Tribunal directed the deletion of the disallowance, allowing the assessee's claim.

Conclusion:
The appeal was partly allowed. Ground No. 1 was dismissed for want of prosecution. The Tribunal upheld the CIT(A)'s decisions on artificial disallowances and the applicable tax rate. However, it allowed the assessee's claims regarding the loss on forward foreign exchange contracts and the traveling expenses treated as capital expenditure.

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