THE COMMISSIONER OF INCOME-TAX, BOMBAY CITY-II Versus MESSRS VITRO ENGINEERING CO.

DESAI, J.‑‑ The assessee before us is Messrs Vitro Engineering Co., Bombay. It carries on work in India as consulting engineers. However, it is not a separate entity in the sense known to Company Law, being a division or a branch of Messrs Vitro Corporation, a corporation incorporated in the United States of America. However, the Indian Division viz. the assessee will be required to be considered a company under the Indian Income‑tax Act.

2. Some of the employees of. the Assessee are American nationals who were paid salaries partly in Dollars and partly in Rupees. The Dollar part of the salary was paid by the head office in New York. The head office also charged the Assessee for certain overhead expenses. A third head of amounts which was claimed by the' head office pertains to work like design, supply of drawings, etc. All this work was done in the United States of America and payment for the same was made in dollars in the United States of America. A running account used to be kept between the head office and the Assessee. The Assessee‑Company had obtained the permission of the Reserve Bank of India for maintenance of such account. The said account was allowed to be operated and remittances effected to the head office on the conditions imposed by the Reserve Bank of India and with the approval of the Reserve Bank of India.

3. Credit and debit entries in respect of the current account were made on the basis of the credit and debit notes sent to the Assessee by the head office. Prior to 5th June, 1966, the exchange rate adopted for these entries was Rupees 4.76 for one U.S. Dollar, which was the official exchange rate. On 5th June, 1966, amount standing to the credit of the head office under this account came to Rs.13,63,682. Apart from a small amount of Rs.15, 805‑68 which represented the cost of capital assets transferred by the head office, the rest of it was on account of the revenue expenditure in respect of the Indian business.

4. On 6th June, 1966, the rupee was devalued to the extent of 57.5%. The new exchange rate for one U.S. Dollar after devaluation came to Rs.7.50. To give effect to this changed exchange rate, the Assessee credited the head office with the sum of Rs.7,64,330.27 which would seem to represent the devaluation loss. A corresponding amount was debited earlier to gain or loss on foreign exchange. Between 5th June, 1966 and 31st. December, 1966, the Assessee remitted to its head office $1,60,124.84 which in terms of the devalued rupee amounted to Rs.12,00,936.30. This would be against the rupee equivalent of Rs.7,62,499 24 which was required prior to devaluation. In other words the Assessee had to pay Rs.4,38,437.06 more to discharge its dollar liability to the head office to the extent it was discharged during this period.

5. In this reference we are concerned with the previous year ending 31‑12‑1966. For this previous year, the Assessee claimed a net loss of Rs.6,82,355.30. The principal amount of this loss was sum of Rs.7,64,830.2. To this a small amount of Rs.16,492.31 being the difference in the exchange value at the time of actual remittance was added and 'the aggregate sum was reduced by Rs.98,967.28 which excess amount have been received from the Atomic department from whom $ 36,144.57 was payable prior to the devaluation. The higher rupee equivalent was received for this amount after the devaluation end Rs.98,967.28 had thus been credited to the account designated as gain or loss on foreign exchange. Thus, the total net loss claimed came to Rs.6,82,355.30.

6. Before the Income‑tax Officer, the said amount was claimed as business loss in respect of the Assessee's income for the previous year ending 31‑12‑1966 that is in the assessment year 1967‑68. Before the Income‑tax Officer it was contended that the Indian business was a self‑contained unit of assessment so far as the Indian Income‑tax Act was concerned and that the‑ separateness of the head office and the branch would have to be recognised and accepted in computing the profits in respect of the Indian business. It was pointed out that the Indian branch had in fact purchased dollars at increased rate from the authorised dealer to make the actual payment to the head office and would be required to make the necessary extra provision in rupees for this purpose in respect of the balance amount payable to the head office. It was urged that the head office was required to be reimbursed in respect of the expenses incurred by it in dollars and that for purchasing these dollars a higher amount in terms of rupees was required to be paid by the Indian branch, that is the Assessee. It was pointed out that no profit accrued to the head office in respect of this payment but there was a loss to the Assessee which had directly arisen on account of the devaluation. It was contended that this additional liability of the Assessee represented a business loss properly deductible in computing the Assessee s total income

7. These submissions were not accepted by the Income‑tax Officer. The Income‑tax Officer was of the view that the Assessee as such had no liability as on the date of the devaluation. He held further that the loss which arose at the time of remittance was not in the course of earning the income. A copy of the order of the Income‑tax Officer is found annexed as Annexure 'A' to the Statement of Case.

8. The Assessee appealed to the Appellate Assistant Commissioner and elaborate arguments were addressed to him in support of the claim. It was urged that either the entire amount of Rupees 7,81,322 or at least Rs.3,38,437 which represented the actual extra rupee payment incurred to obtain dollars. sent to United States between 6th June, 1966 and 31st December, 1966 should be allowed. The substance of the various arguments advanced before the Appellate Assistant Commissioner was that the expenses incurred by the head office were on revenue account, that they were in respect of the business carried on in India and,, that following the devaluation an increased burden by virtue of the same being payable in dollars had fallen on the Assessee. It was urged that such increased burden was a loss incidental to the Assessee's business and that the same was allowable in computing the Assessee's income. It was pointed out that under the Indian Income‑tax Act, the Indian Branch was a separate assessable entity and this dichotomy between the Branch and the head office had to be borne in mind in considering the claim.

9. The Appellate Assistant Commissioner accepted the contention that the expenses incurred by the head office were wholly for the business of the Indian branch, that is the Assessee, and that on that account they were fully allowable. The Appellate Assistant Commissioner also accepted that if a third party had made those expenses then the Assessee was liable to reimburse these expenses in dollars. In such a case viz. reimbursement to a third party, if such reimbursement was made after devaluation, then the increase in cost would depend either on the basis of accrual or remittance depending upon the system of accounting. The Appellate Assistant Commissioner also accepted that such loss would have been on revenue account because the liability did not relate to any capital assets acquired by the Indian branch. The Appellate Assistant Commissioner, however, was of the opinion that there was no legal liability on the part of the Assessee since the branch, that it is the Assessee, and the head office were in law two parts of the same legal entity. According to the Appellate Assistant Commissioner therefore, devaluation could no; have increased the legal liability of the Indian branch and such liability would arise and could be considered only when there is a third party involved. The Appellate Assistant Collector also did not accept that there was any obligation on the part of the Assessee to reimburse the head office in Dollars. On both these counts, therefore, the claims and contentions of the Assessee for allowing the entire amount or part of it were rejected.

10. The Assessee carried the matter to the Income‑tax Appellate Tribunal and in Appeal No. I.T.A No.3951 (Bom.) of 1970‑71, the Income‑tax Appellate Tribunal accepted fully the contentions of the Assessee. According to the Tribunal there was no vital difference between the case of reimbursement to a third party and reimbursement to the hood office. According to the Tribunal further the Appellate Assistant Collector had misdirected himself and not noted that there was no extra payment or excess payment being required to be made to the head office. According to the Tribunal excess rupee payment was what the branch was required to pay to the Reserve Bank of India to purchase the same amount of dollars on account of devaluation of rupee. In other words, the increase in liability was in respect of the trading liability of the Indian business whose profits are charged to Income‑tax and considered as a separate entity. The payment thus notional or actual was to be made to a third party viz., Reserve Bank or authorised exchange dealer to obtain the same amount of dollars which were to be sent to the head office for its reimbursement. It also rejected the conclusion reached by the Appellate Assistant Collector that there was no obligation to reimburse the head office in terms of dollars. It considered the practice as also the permission granted by the Reserve Banff; of India and observed that this made it amply clear that the payment had to be made abroad in terms of dollars. Thus, negativing these two conclusions of the Appellate Assistant Collector it agreed with the other aspects of his approach and came to the conclusion that the entire loss claimed and not the smaller amount, had to be met in the previous year, on the basis of the system of accounting of the Assessee which is mercantile. It observed that on this basis the Assessee had got to provide for this known and certain loss in the period between 6th June, 1966 and 31st December, 1966. Thus, the Tribunal allowed the entire deduction of loss of Rs.7,81,323 claimed by the Assessee.

11. Aggrieved by the decision of the Tribunal the Commissioner of Income‑tax, has made a Reference to the Court and the question referred to us is as under:

"Whether on the facts and in the circumstances, the assessee was entitled to the deduction of the full amount of Rs.7,81,323 or any part thereof as a business loss?"

12. Before us the learned counsel for the Revenue urged the argument which had appealed to the Appellate Assistant Commissioner. In our opinion the approach of the Appellate Assistant Commissioner was improper in the facts and circumstances of the case and was rightly rejected by the Tribunal. We may, however, briefly advert to two authorities cited by counsel for the revenue.

13. In Sutlej Cotton Mills Ltd., v. Commissioner of Income‑tax, West Bengal, 116 I T R 1: (A I R 1979 S C 5), the Supreme Court was considering remittances out of profits earlier earned by the assessee Company and the claim of the assessee that on the remittances which were subsequent to the devaluation of the Pakistan rupee it had suffered certain loss. On facts we are of the opinion that this case is not comparable to the one before us and the discussion would seem to be of very little assistance to the point being considered by us.

14. We were also referred to the decision of the Calcutta High Court, in Commissioner of Income‑tax, West bengal v. Invest Import 137 ITR 310: (1981 Tax L R 1842). In the said case the Calcutta High Court was considering, particularly the question whether the loss on account of diminution in value of Indian rupee could be allowable in the year in which it was claimed or in the year in which the amount was actually repatriate in terms of Dinars to Yugoslavia. The High Court held that there was no revenue loss in the year of devaluation and left open for consideration of other question. In our case there is a clear finding by the Tribunal that the Assessee kept its accounts on the mercantile system. On that system, it is clear to us, that the Assessee was required to provide a higher amount in terms of rupees for its liability for reimbursement and on this system the provision would be required to be made and considered in the assessment year in question that is for the previous year ending 31st December, 1966.

15. We are, therefore, unable to get any assistance in favour of the Commissioner from either of the aforesaid two decisions cited. In our opinion the view taken by the Tribunal is the proper view and in accordance with this the question referred to us is answered as under:‑

The Assessee was entitled to the deduction of the full amount of Rupees 7,81,323 as a business loss during the a.y. in question.

The Commissioner to pay the costs of the Reference to the Assessee.

M. B. A. Reference answered in affirmative.