2004 (3) TMI 345 - AT - Income Tax

Foreign Currency - production and sale of tyres and tubes - Whether, the gains earned on cancellation of the Foreign Exchange Forward Contract are capital receipt or revenue receipt? If it is capital receipt, whether the same should be reduced from the cost of plant machinery in connection with which the forward contract was entered into? - HELD THAT - In the instant case before us, contracts have substantially been booked prior to 27-3-1992 and with regard to these contracts profit motive possibly cannot be attributed to the assessee. Even with regard to contracts entered into and cancelled after 27-3-1992, we noticed that the transactions are a few in number and looking to the magnitude of the outstanding Dollar loan, the contracts entered into are only 6 in number out of which 2 have been cancelled during the year. Gains arising from these 2 contracts have been shown by the assessee as revenue receipt since these contracts relate to payment of interest liabilities on Dollar loans. The entire factual matrix of the case concerning the execution and cancellation of forward contracts does not in our opinion stamp the transaction with a business character. Merely because the assessee-company did not choose to roll over the contracts beyond 30-4-1992 would not alter the intrinsic nature of the contracts being in the capital field. If the contracts brought forward from the preceding year are accepted and acknowledged by the revenue authorities as being in capital account, mere cancellation on 30-4-1992 would not have 'denaturing' effect and divest them of inherent capital nature particularly when cogent reasons have been cited by the assessee for cancellation, namely, the emerging trends of the international monetary market and revised Reserve Bank of India regulations permitting cancellation of forward foreign exchange covers. Thus, we are inclined to accept the contention of ld. Counsel for the assessee that the entire activity of entering into and cancellation of forward contracts, which are directly connected with the repayment of foreign currency loans fall in the capital field and gains arising therefrom would, therefore, be capital receipts . Admitted, facts are that these contracts have been entered into for providing the assessee with foreign currency on or after a stipulated future date at the fixed exchange rate. The contracts are thus fully in conformity with the letter and spirit of Explanation 3. If the assessee has not opted for roll over of the contracts, this would not ipso facto make Explanation 3 inapplicable. The language of Explanation 3 does not contain any such qualification. The interpretation suggested by ld. Counsel would require the addition of the words and the contract has been Tolled over to the date of actual payment of instalment for foreign liability after the words to enable him to meet the whole or any part of the liability aforesaid in the Explanation. There is nothing in the present language of the Explanation which makes it inapplicable to a case where the contracts have not been rolled over to the date of actual repayment of the liability. We are unable to accept the interpretation suggested by the Id. Counsel which in fact would cause grave violence. to the language of the provision. Any such interpretation would be contrary to well-accepted principles of interpretation, namely, rule of literal interpretation as well as rule of proposive interpretation. It is an elementary principle of interpretation of statutes, reiterated by Courts time and again that the Court cannot read any thing into a statutory provision which is plain and unambiguous. In our considered opinion, the gain arising from cancellation of forward contracts which are connected. with the foreign loans raised for purchase of machinery are capital in nature and are liable to be capitalized towards the cost of the machinery by virtue of section 43A(1), read with Explanation 3 thereto.

Summary

Issues Involved:
1. Whether the gains earned on cancellation of the Foreign Exchange Forward Contract are capital receipt or revenue receipt.
2. If it is capital receipt, whether the same should be reduced from the cost of plant & machinery in connection with which the forward contract was entered into.

Summary:

Issue 1: Nature of Gains from Cancellation of Forward Contracts
The primary question was whether the gains earned on the cancellation of foreign exchange forward contracts are capital receipts or revenue receipts. The assessee argued that the forward contracts were initially entered to guard against currency losses due to exchange rate fluctuations, and not for commercial gain. The contracts were related to the repayment of foreign loans taken for acquiring plant and machinery, thus falling in the capital field. The revenue contended that the subsequent cancellation of these contracts was motivated by profit, making the gains taxable as revenue receipts. The Tribunal held that the gains from the cancellation of forward contracts were capital receipts, as the contracts were entered into to hedge against the enhancement of liabilities for repayment of foreign loans, which were for acquiring capital assets.

Issue 2: Reduction from Cost of Plant & Machinery
The second issue was whether the capital receipt should reduce the actual cost of plant and machinery by virtue of Explanation 3 to section 43A. The Tribunal noted that section 43A was enacted to adjust the cost of acquisition in cases where the value of foreign exchange varied after the machinery was acquired. The Tribunal concluded that the gains from the cancellation of forward contracts, which were connected with the foreign loans raised for purchasing machinery, should be capitalized towards the cost of the machinery as per section 43A(1), read with Explanation 3. The Tribunal emphasized that the contracts were entered into for providing foreign currency at a fixed exchange rate to meet the liability, and thus, the gains should be adjusted in the cost of the plant and machinery.

Conclusion:
The gains earned on cancellation of the foreign exchange forward contracts by the assessee are capital receipts, which should be reduced from the cost of plant and machinery in connection with which foreign loans were raised by the assessee.