' SAJJAD ALI SHAH, J.-This Income-Tax Reference relates to assessment year 1968-69. Questions of law for consideration arising from the order of the Appellate Tribunal are stated below :- 'Whether in the facts and circumstances of the case the Tribunal is right in holding that the sum of Rs, 1,21,90,740 representing reduction of liability towards the foreign loans due to devaluation of Pound Sterling was a revenue receipt and liable to Income-tax ?
' Whether in the facts and circumstances of the case there was any material or evidence on record to support the Tribunal's observation that the ingredients of the loan is not only the acquisition of the aircraft but also other necessities which may be of a revenue nature ?"
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2. Briefly stated the relevant facts are that applicant/assessee is a statutory .Corporation carrying on the business of operating airlines from Pakistan and makes up its accounts on 20th of June, every year. During the account year ending 30th June, 1968 the applicant owed huge sums of money to foreign lenders. These loans were obtained for purchasing capital assets. During the year in question Pound Sterling was devalued as a result of which the liability of the applicant towards the loans was reduced by Rs, 1,21,90,740.
3. The Income-tax Officer who made the assessment for assessment year 1968-69 held that the reduction of liability on account of the devaluation of Pound Sterling was revenue receipt.
4. Applicant filed an appeal to the Income-tax Appellate Tribunal and contended that the loans were obtained specifically for the purpose of purchasing capital assets and any reduction in liability due to devaluation of Pound Sterling was of a capital nature and was not liable to Income- tax. Appellate Tribunal, however, up held the order of the Income-tax Officer and further observed that in their view the gain was obtained by the assessee during the course of carrying on its business activity and, therefore, was rightly taxed. It was further observed by the Tribunal that after all the loans were obtained for the business activity and the necessary ingredients of which were not only the acquisition of aircraft in the shape of capital assets but also other necessities which may be of a revenue nature. Orders passed by the Income-tax Officer and the Income-tax Appellate Tribunal are on the record.
5. Before us Mr. Ali Athar, Advocate, for applicant submitted that there was no material available in the shape of documents or otherwise before the Tribunal to justify the observation in the order passed by it that loans were obtained for the business activities, necessary ingredients of which were not only the acquisition of aircrafts in the shape of capital assets but also other necessities which may be of a revenue nature. It was submitted that there were no such documents before the Tribunal to warrant such conclusion. Even the finding that the other necessities connected with acquisition of aircraft may be of revenue nature is conjectural in nature. It is further stated that even Income-tax Officer did not hold that loan was obtained for any purpose other than purchasing the aircraft. On our enquiry as to whether loan agreement was available to peruse terms and conditions in order to find out the intention of the contracting parties, we were told that not much was known about the availability of such document now. In any case order of the Income-tax Officer sheds some light on this matter and it is stated therein that as the loan was taken in the course of and in connection with business operations and exigencies, it has to be held as a pure and simple revenue gain on the same ground as interest on capital borrowed for the business is allowable whether the loan is utilised for capital or revenue items. Normally before the Income-tax Officer registers and necessary documents are produced to prove or disprove an assertion. In any case this finding of the Income-tax Officer was challenged in appeal. On this point the stand taken by the assessee before the Tribunal was that foreign loans were taken to obtain capital assets and therefore by change in exchange rates only the foreign loans liability had decreased whereby the assessee had gained nothing and consequently the gain could neither be treated as a capital gain nor a revenue gain. It appears from the order of the Tribunal that the Tribunal took the view that the gain had been obtained by the appellant during the course of carrying on his business activities and, therefore, was rightly taxed. Further, it was observed by the Tribunal that after all the loans were obtained for business activities and the necessary ingredients of which were not only the acquisition of aircrafts in the shape of capital assets but also other necessities which may be of a revenue nature. If the assessee saved, therefore, any amount in the course of payment for these acquisitions, in the course of carrying on the present business, it would,, therefore, be a revenue gain and has rightly been taxed as such.
6. Mr. Ali Athar, Advocate, stated before us that all the relevant facts are stated in the application which are not disputed and no document has been filed by the respondent in the rebuttal.
According to the learned counsel the case of the assessee is that loans were obtained for capital assets. In the text book on Income-tax, Seventh Edition, Volume-I by N. A. Palkhivala and B.A.
Palkhivala at page 106, it is stated that a receipt is not taxable when it is referable to fixed capital, it is taxable as a revenve, item when it is referable to circulating capital or stock-in. Trade. In other words, circulating capital is capital which is turned over, and in the process of being turned over yields profit or loss. Fixed capital is not involved directly in that process, and remains unaffected by it.
7. In support of his argument Mr. Ali Athar Advocate cited the case of John Smith and Son v. Moore (1). In that case the sole proprietor of a coal merchant's business died in the year 1915, and his son took over the business at a valuation, in which nothing was charged for good-will. This was according to the terms of his trust disposition and settlement. The price paid included a sum of 30,000, representing the value of certain unexpired contracts with colliery owners for the supply of coal at fixed prices, all of which contracts expired on or before the 31st December, 1915. The son paid one-third of the profits of the business as remuneration to a relative who, it was admitted, was a person concerned in the management of the business. This relative was not employed in the business prior to the war, nor were any expenses incurred in respect of manager's remuneration in the last pre-war trade year. The Commissioners of Indian Revenue refused to allow the deduction of the whole of the remuneration in question and the General Commissioner, on appeal, held that they (the General Commissioners) had no jurisdiction in the matter. It was held by the House of Lords that the sum of 30,000 paid in respect of the unexpired coal contracts was not an admissible deduction in computing the profits of the business for the purposes of Excess Profits of Duty for the accounting period from the 7th March, 1915, to the 31st December, 1915 on the ground that it was capital expenditure.
8. In the case of Devies (H. M. Inspector of Taxes) v. The Shell Company of China Limited (2) the question of depreciation of foreign currency came up for consideration and it was decided that deposits so received from the agents of the Company had been used as fixed capital and not as circulating capital as such the profit on exchange was a capital profit not subject to Income-tax, Briefly stated the facts of the case were that Company was British Company which sold and distributed petroleum products in China. The Company made a practice of requiring its agents to deposit with the Company a sum of money usually in Chinese Dollars, which was repayable when the agency came to an end. Previously the Company had left on deposit with banks in Shanghai amounts approximately equal to the agency deposits, but because of the hostilities between China and Japan the Company transferred these sums to the United Kingdom and deposited the sterling equivalents with its parent company, which acted as its banker. Owing to the subsequent depreciation of the Chinese dollar with respect to sterling, the amounts eventually required to repay agency deposits in Chinese currency were much less than the sums held by the Company to meet the claims, and a substantial profit accrued to the Company. Contention raised that the deposits to which Company could have recourse in the event of default by the agent, were circulating capital and that the exchange profit was made in the course of the Company's business and must be included in the computation of its profits for Income-tax purposes was rejected. It was held that exchange profit was a capital profit not subject to Income-tax. In support of the argument relevant paragraph at page 154 of the report is reproduced as under :- "The Company might conceivably have used these deposits in such a way as to mingle them with the capital employed in its trading {{FOOT NOTE}}
(I) 12 Tax Cas. 266 (2) 32 Tax Cas. 133 {{FOOT NOTE}} in petrol and petroleum products. It might have invested the deposits in the purchase of petroleum, treating the depositors as trade creditors, the deposits as trade receipts, and repayments of deposits as trade outgoing. If that had been so then it might well have been said, it seems to me, that whatever the nature of the transaction was at "the outset the company had so dealt with the deposits in question as to make them part of its circulating or trading capital, with the result that any profit which accrued through reduction in the Company's liabilities in respect of the deposits owing to the alteration in the rate of exchange could be nothing else but a trading profit. But nothing of that sort happened here and as appears from what I have already said, in fact and in practice the Company at all times kept, at first in China and afterwards with its parent Company in England, deposit accounts covering the amounts of the agents' deposits. That is consistent with a view on the part of the Company that the amounts of these deposits should be treated as something apart from the circulating capital of the Company. It is a course consistent with that view, and at all events I think one can say this, that if, contrary to Sir Andrew Clark's contention, the deposits did not in origin bear the character of trading receipts but were merely in the nature of capital receipts by way of loan, there was nothing in the subsequent dealing by the Company with the deposits, so far as the evidence goes, to impart to them a character of trading receipts which they did not in origin possess."
9. In the case of Van Den Berghs, Limited v. Clark (H. M. Inspector of Taxes) (1) the question came up for consideration whether payment received by one company from the other as damages for cancellation of its future right under the agreement was to be treated as capital or income. Brief facts of the case are that two competing companies dealing in margarine and similar products, entered into an agreement by which the two companies bound themselves for the future to work in friendly alliance and agreed to share the profits, to bring within the operation of agreement any interest in other margarine concerns acquired by companies under their control not to enter any pooling or price arrangements with third parties inimical to the interests of the two companies, to set up a joint committee to make arrangements with outside firms, to promote generally the interests of the two Companies in the margarine business. Supplemental agreements made in 1913 and 1920 provided that, with certain modifications, the provisions of the 1908 agreement were to continue in force until 1940. From 1914 to 1919 the two Companies were unable to compute their profits owing to the difficulties caused by the war. Subsequently there were differences and the matter was referred to the arbitration and a settlement was arrived at in 1927, whereby, inter alia, all claims and counter-claims under the agreements for the period 1914 to 1927 were withdrawn in consideration of the payment by the Dutch Company of 450,000 to the Appellant Company as damages and the agreements were determined and each party released the other party from all claims thereunder. That sum was paid in 1927 and credited in the Appellant Company's accounts for that years. The Company was assessed to Income-tax for the year 1928-29, in an amount which included the sum of 450,000. On {{FOOT NOTE}}
(1) 19 Tax Cas. 390 {{FOOT NOTE}} appeal, the General Commissioners decided that the amount was paid in respect of the pooling agreements and must be brought in for the purpose of arriving at the balance of profits and gains of the appellants for the year to 31st December, 1927. It was held that the payment of 44,50,000 was a payment for the cancellation of the appellant Company's future right under the agreements, which constituted a capital asset of the Company, and that it was, accordingly, a capital receipt.
Relevant paragraph on the argument in support of the contention at page 431 of the report is reproduced as under :- "Now what were the Appellants giving up ? They gave up their whole rights under the agreements for thirteen years ahead. These agreements are called in the Stated Case 'pooling agreements', but that is a very inadequate description of them, for they did much more than merely embody a system of pooling and sharing profits. If the appellants were merely receiving in one sum down the aggregate of profits which they would otherwise have received over a series of years, the lump sum might be regarded as of the same nature as the ingredients of which it was composed. But even if a payment is measured by annual receipts, it is not necessarily in itself an item of income.
As Lord Buckmaster pointed out in the case of the Glenboig Union Fireclay Co., Ltd. v.
Commissioners of Inland Revenue : "There is no relation between the measure that is used for the purpose of calculating a particular result and the quality of the figure that is arrived at by means of the application of that test."
10. The above decision has been relied upon by the Division Bench of this Court in Indus Valley Construction Company v. Commissioner of Income-tax (East) Karachi (1), which has been decided on 29th February, 1984.
11. In Commissioner of Income-tax, Bombay City v. Tata Locomotive and Engineering Co. Ltd. (2) the assessee company carried on business in the manufacture of locomotive boilers and locomotives for the purpose of its manufacturing activity had to make purchases of plant and machinery in the U. S. A. With the sanction of the Exchange Control. Authorities, it had remitted to its agent in U. S. A $ 33,850 for purpose of purchasing capital goods and other expenses. As selling agent of Baldwin Locomotive Works of U.S.A. For the sale of their products in India the assessee incurred expenses on their behalf in India and also earned commission of $ 36,123. With the sanction of the Exchange Control Authorities the amounts paid by Baldwin Locomotive Works in reimbursement of the expenses and towards commission were retained with its agent in the U S.A for the purchase of capital goods there. The pound sterling and with it the Indian rupee were devalued on 16th September, 1949. Thereafter, the assessee found it more expensive to buy American goods and, as the Government of India also imposed restrictions on imports from the U. S. A., the assessee, with the permission of the Reserve Bank, repatriated $49,500. This resulted in a surplus and the Income- tax Officer assessed it as profit arising to the assessee incidentally to its carrying on business. The Appellate Tribunal, however, held that only that part of the surplus which was {{FOOT NOTE}}
(1) 1984 p T p426 (2) 1960-1966 1. T. R. 405 {{FOOT NOTE}} attributable to $36,123 received from Baldwin Locomotive Work was a trading profit. On a reference, the High Court held that the surplus attributable to $36,123 was an accretion to the assessee's fixed capital and was not liable to tax. On appeal, the Supreme Court held, that the act of retaining the monies in the U. S. A. For capital purposes after obtaining the sanction of the Reserve Bank was not a trading transaction in the business of manufacture of locomotive boilers and locomotives ; it was clearly a transaction of accumulating dollars to pay for capital goods, the first step to the acquisition of capital goods. The surplus attributable to $36,123 was capital accretion and not profit taxable in the hands of the assessee. On this point relevant paragraph at page 409 of the report is reproduced as under :- "It held that although the character of the commission earned was at the inception that of income, but when the assessee appropriated that sum for the specific purpose of purchasing capital goods with the permission of the Reserve Bank of India, the initial character of this sum underwent a change and it assumed the character of fixed capital of the company. This character was retained right upto 16th September, 1949, when the pound sterling was devalued, and it did not undergo any change till the benefit accrued on this amount to the assessee-company as a result of change in exchange rate. The 'High Court further held that 'there is no evidence in this case nor a finding recorded by the Tribunal that the assessee-company had at any time decided not to utilise these amounts for the purpose of purchasing goods, and, therefore, repatriated these amounts to India.'
The High Court further held that the sum of $36,123.02 was 'part of its fixed capital and remained so till the date it was repatriated to India. The surplus or difference arising as a result of devaluation in the process of converting these dollars into rupee currency in repatriating them to India was an accretion to its fixed capital and was not, therefore, liable to tax'. The High Court felt that the ratio of the decision in Davies v. Shell Company of China supported the view it had taken."
12. In Commissioner of Income-tax, Bombay City v. Mehboob Production P.V.T. Ltd. (1), the assessee- company was based in Bombay and had a distribution Office at Karachi. Accounts were kept on the mercantile system and showed in the accounts for some years the profits received in Pakistan and such profits assessed to tax. It allowed some portion of the assessed profits to remain in Pakistan. On the devaluation of the currency in Pakistan, the company claimed deduction of the loss incurred by devaluation on the ground that it was a business loss, or at least a bad debt. It was held by the Bombay High Court that an amount initially earned as profits by the assessee, which had once been assessed and borne tax, which is left with the assessee's distributing agent in a foreign country as an asset of the assessee, cannot ordinarily partake of the nature of a business asset ; it could only be held to be an asset of a capital nature. It is only if it is shown that the fund was utilised or was intended to be utilised in the course of trade or for a {{FOOT NOTE}}
(1) 1969-74 I T R 676 {{FOOT NOTE}} trading purpose, that it can be said that there would be realisation of profit or loss on exchange, and the profit or loss would be taken into account on taxation. Otherwise, the loss would merely be a loss due to depreciation in value of capital asset. The mere fact that the asset was held on behalf of a company doing business would not be decisive of the fact that it was a business asset, for a company doing business can as well hold a capital asset in a foreign country. Such loss cannot be allowed as a bad debt as there was no "debt" due to the assessee and if there is a debt it had not become bad. If due to supervening causes such as devaluation, the amount receivable by the assessee had become less in value than the amount he would have been previously intitled to, that will still be the same "debt". The only result of devaluation is that one and the same "debt" is now worth less to the assessee than it was before devaluation.
13. In the case of Commissioner of Income-tax (Central) v. Beach Luxury Hotel Ltd. (1) the Division Bench of our own High Court has held that surplus arising from the difference in the face and the purchase prices of compensation books and credited to capital reserve account in balance-sheet, was not taxable. The facts of that case are that the assessee purchased evacuee hotel in open auction from Settlement Department by surrendering compensation books for adjustment of the price at face value. Compensation books were purchased in open market at discount. Object of assessee was not trading in the compensation books but the whole activity was aimed at acquiring the capital asset in a cheaper manner and not to make a profit out of it. High Court held that Appellate Tribunal was right in holding that the net surplus of Rs, 16,74,788 arising from the difference in the face and purchase prices of compensation books and credited to the capital reserved account in balance-sheet, was not chargeable to tax.
14. In view of the case law discussed above, we hold that in the instant case sum of Rs, 1,21,90,740 representing deduction of liability A towards the foreign loans due to devaluation of Pound Sterling was an accretion to assessee's fixed capital and was not liable to tax. Secondly the finding of the Tribunal that loans were obtained for business activities and the necessary ingredients of which was not only the acquisition B of aircraft but also other necessities which may be of revenue nature, is not supportable by documents and is conjectural in nature as is self-evident from the order.
' For the facts and reasons stated above, both questions in the reference under consideration are answered in the negative. The reference stands disposed of in terms stated above and there will be no order as to costs.
(1) 1983 PTD 178