In a ruling which will afford mega relief to corporates, a special bench of the Income Tax Appellate Tribunal has held -- in the case of Apollo Tyres Ltd -- that the gains earned on the cancellation of foreign exchange forward contracts are capital receipts and the same should be deducted from the cost of plant and machinery for which foreign loans were raised by the assessee.
The ITAT observed that the principles underlying the distinction between a capital sale and an adventure in the nature of trade were examined by the Apex Court in G. Venkataswami Naidu & Co. v. Commissioner of Income-tax, 2002-Taxindiaonline-179-SC-IT, where it has been held that the character of a transaction cannot be determined solely on the application of any abstract rule, principle or test but must depend upon all the facts and circumstances of the case.
Ultimately, it is a matter of first impression with the court whether a particular transaction is in the nature of trade or not. It has been said that a single plunge may be enough provided it is shown to the satisfaction of the court that the plunge is made in the waters of the trade; but mere purchase/sale of shares -- if that is all that is involved in the plunge -- may fall short of anything in the nature of trade. Whether it is in the nature of trade will depend on the facts and circumstances.
Where the purchase of any article or of any capital investment is made without the intention to resell at a profit, a resale under changed circumstances would only be a realization of capital and would not stamp the transaction with a business character (Commissioner of Income-tax v. P.K.N. Co. Ltd, (2002-Taxindiaonline-180-SC-IT).
Special Bench held that gains from cancellation of forward exchange contractors were capital receipt and did not arise from any business of dealings in foreign exchange or any adventure in the nature of trade.
"The forward contracts in the instant case were entered into by the assessee with the sole purpose of acquisition of plant and machinery abroad and, therefore, gains arising from cancellation of the contract, to the extent these relate to principal amounts of outstanding loans would clearly fall in the capital filed.
"The essential characteristics which stamp the character of a revenue nature on any transaction, namely, multiplicity of transactions, a prior association of business and the existence of a scheme, system and business operations are totally conspicuous by their absence in the present case before us.
"The dominant intention, motive and purpose of entering into forward foreign exchange contracts and cancellation thereof were clearly to provide a hedging mechanism against enhancement of liabilities for repayment of foreign loans raised for the purpose of acquisition of capital asset by the assessee.
"The conduct of the assessee, as manifested in the facts and features of the case enumerated hereinabove, does not reflect profit motive in entering into forward contracts and canceling the same thereafter. The crucial date is March 27, 1992, when the Reserve Bank of India lifted the ban on cancellation of foreign exchange contracts since Liberalized Exchange Rate Management System had been introduced by the government.
"In the instant case, contracts have substantially been booked prior to 27.3.1992 and with regard to these contracts profits motive possibly cannot be attributed to the assessee. Even with regard to contracts entered into and cancelled after 27.3.1992, the transactions are a few in number and looking to the magnitude of the outstanding dollar loan, the contracts entered into are only six in number out of which two have been cancelled during the year. Gains arising from these two 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 out opinion stamp the transaction with a business character. Merely because the assessee company did not choose to all over the contracts beyond April 30, 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 30.4.92 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.
"In the changed scenario, the assessee felt that the rupee currency may not depreciate in the future. The dominant motive, purpose and intention of the assessee was clearly to hedge against enhancement of rupee liability for repayment of foreign currency loans."
It was held that the entire activity of entering into and cancellation of forward contract, which are directly connected with the repayment of foreign currency loans fall in the capital filed and gains arising therefrom would therefore, be capital receipts.
It was further held that where profits and loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be treated as profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset on as part of circulating capital embarked in the business.
But, on the other hand, if the foreign currency is held as a capital asset or as a fixed asset, such profit of loss would be of capital nature.
The decision of the Supreme Court on the issue in CIT Vs. Tata Locomotive and Engineering Company Ltd (2002-Taxindiaonline-181-SC-IT) the assessee, which was a limited company carrying on business of locomotive boilers and locomotives had for the purpose of its manufacturing activity to make purchases of plant and machinery in the United States.
The assessee remitted a sum of $33,850 to the United States with the sanction of the exchange control authorities for the aforesaid purpose of purchasing capital goods. The assessee also earned a commission of $ 36,123 as selling agent in the United States and the amount was retained in the United States for capital purposes after obtaining the sanction of the Reserve Bank of India.
The court held that even though the amount of $36,123 was a revenue receipt in the assessee's business of commission agency, retention of this amount in the United States with the sanction of the Reserve Bank of India for buying capital goods fall in the capital field and any profit accruing on subsequent repatriation of this amount on account of exchange variation was a capital profit.
See full text of Judgement in 2004-Taxindiaonline-32-ITAT-DEL-SB in Legal Corner.