2017 (8) TMI 378 - HC - Income Tax

Royalty - exchange gain - Income attributable to royalty and interest remitted from Malaysia after retaining in Malaysia for sometime - Taxability in India - Indo-Malaysian DTAA - system of accounting followed - Conversion of Malaysian currency into Indian currency - Held that - Revenue has correctly placed reliance upon the Accounting Standard AS11 issued by the Institute of Chartered Accountants of India which indicates that any benefit derived on account of currency fluctuation after the year of accrual is to be considered as income/expense in the period in which they arise. The Apex Court in Woodward Governor India (P) Ltd. (2009 (4) TMI 4 - SUPREME COURT) placed reliance upon AS11 to hold that gain or loss made on account of rate difference in foreign exchange post the date of balance sheet has to be taken in the year in which the gain or loss has arisen on account of exchange rate fluctuation subsequent to close of the Accounting Year which records the accrual of income at the rate prevailing on the last date of the accounting year. The income has been earned in Malaysia on account of royalty and interest but the same is retained there and not brought repatriated to India immediately on the same accruing to the Appellant/assessee. This leads to a gain/loss in foreign exchange valuation. This gain/loss on account of foreign exchange variation would not bear the character of income on account of royalty and interest earned in Malaysia. This is so as the gain/loss on account of foreign exchange variation is not a part of royalty and interest nor is it any accretion to it. In this case, it is the generation of further income which is taxable in the subject assessment year when the variation in foreign exchange has resulted in further income in India to the Appellant/assessee. Although the Revenue would in cash system of accounting record the income only on receipt of the same, yet for the purposes of taxation it would split the amount received from Malaysia on account of royalty and interest in the year in which it arose/accrued at the rate prevailing then as one head of income and the income gained on account of exchange rate variation due to passage of time at the time of conversion as the other head of income. The Revenue would bring to tax the later gain arising on account of exchange rate variation to tax as income arising from a different source. The amount attributable to royalty and interest received from Malaysia on the basis of foreign exchange rate existing on the last date of the Accounting year in which this income would be receivable by the Applicant/Assessee as a different head of receipt excluded from tax by ADTT. Thus, we do not accept the above submission made on behalf of the appellant as the source of receipt is different and two fold. Decided in favour of revenue

Summary

Issues Involved:
1. Characterization of exchange rate difference as royalty under Article 13 of the AADT with Malaysia.
2. Characterization of exchange rate difference as interest under Article 12 of the AADT with Malaysia.
3. Applicability of the AADT to income at the accrual stage versus the receipt stage concerning exchange fluctuation.

Detailed Analysis:

Issue 1: Characterization of Exchange Rate Difference as Royalty
The primary issue was whether the difference in exchange rate amounting to ?24,81,922/- should be treated as royalty derived from Malaysia under Article 13 of the AADT. The assessee, a public limited company, received royalty income from a Malaysian joint venture, which was initially accounted for on an accrual basis. The Assessing Officer, Commissioner of Income Tax (Appeals), and the Tribunal all concluded that the extra income arising from exchange rate fluctuations did not retain the character of royalty. The Tribunal noted that the royalty income was exempt under the AADT but held that the exchange rate difference accrued in India and was thus taxable.

Issue 2: Characterization of Exchange Rate Difference as Interest
Similarly, the second issue involved whether the exchange rate difference amounting to ?1,29,220/- should be treated as interest under Article 12 of the AADT. The facts and conclusions were parallel to the royalty issue. The authorities and the Tribunal determined that the additional income from exchange rate fluctuations did not retain the character of interest and was taxable as it arose in India.

Issue 3: Applicability of AADT at Accrual vs. Receipt Stage
The third issue examined whether the AADT should apply to royalty and interest income only at the accrual stage and not at the receipt stage concerning exchange fluctuations. The Tribunal and lower authorities held that the income arising from exchange rate fluctuations was independent of the original royalty and interest income. The Tribunal emphasized that the gain from exchange rate fluctuations was a separate transaction occurring in India and thus taxable.

Judgment Analysis:
The High Court upheld the Tribunal's findings on all issues. It was noted that the income from royalty and interest earned in Malaysia was recorded at the exchange rate prevailing at the time of accrual and was exempt from tax under the AADT. However, the subsequent gain due to exchange rate fluctuations when the income was repatriated to India was considered a separate income source. The court relied on Accounting Standard AS-11, which mandates recognizing exchange differences as income or expense in the period they arise. The Supreme Court's decision in CIT vs. Woodward Governor India (P) Ltd. was cited, affirming that gains or losses from exchange rate fluctuations should be accounted for in the year they occur.

The court dismissed the appellant's argument that the exchange rate difference should be treated as part of the original royalty and interest income. It clarified that under both cash and mercantile systems of accounting, the exchange rate difference would be treated as a separate income source. The court also distinguished the present case from those involving Section 80HHC of the Act, which specifically includes exchange rate differences in export turnover for deduction purposes.

Conclusion:
The High Court answered all three questions of law in favor of the Revenue, affirming that the exchange rate differences were taxable as separate income arising in India and not as part of the original royalty and interest income exempt under the AADT. The reference was answered accordingly, with no order as to costs.