1. ' SALEEM AKHTAR, J.--The applicant is a private limited company and a subsdiary of General Tyre and Rubber Co. Inc., Arken Chio, USA hereinafter referred as the Parent Company. The applicant filed its return for the assessm ent year 1973-74 and claimed deduction of Rs,5,050,055 on account of of increase in its liability of technical assistance fee which could not be remitted to its parent company on accrual. The applicant has a Technical Service Agreement dated 265-1963 with the Parent Company according to which it has agreed to pay a fee equal to 5% of its annual not sale.
2. The payment was to be made on or before last day of each month without prejudice to the year and adjustment. All payments due to the arent company as technical fee were to be made in U.S. Dollar at the exchange rate prevalent on the due date. The fee which had accrued under the said agreement could not be remitted to the parent company in that year. In the meanwhile Pakistan Rupee was devalued with the result that the applicant's liability in respect of unpaid amount of technical fee increased to the extent of Rs,5,050,055 which was deducted in the computation of profit for the year under reference.
3. ' The Income-tax Officer did not accept the claim as according to him the applicant has not suffered any additional burden of liability chargeable as revenue expense. According to him the liability of the applicant was in terms of Pakistan rupee which remained unchanged. This order was confirmed in appeal by the Appellate Assistant Commissioner. The applicant agitated the matter before the Tribunal which after taking into consideration various clauses of the agreement concluded that the applicant failed to perform its obligation with regard to the payments of sums due to the parent company, and therefore, the final liability for payment of technical assistance fee was incurred and quantified in Pakistan rupee. Hence the devaluation of Pak. Rupee did not affect the liability of the applicant. The applicant then filed an application under section 66 (1) of the Income Tax Act and the following question has been referred for our opinion: "Whether on the facts and in the circumstances of the case, the sum of Rs,5,050,055 paid by the assessee company on account of Technical Assistance Fee is an admissible deduction in the ascertainment of its profit chargeable to Income tax for the assessment year 1973-74?
4. ' Before adverting to the question it is necessary to examine various relevant clauses of the agreement regarding payment of the technical fee to the parent company which are reproduced as follows:- ' Clause 5. "The Company agrees to pay to Supplier, for the use of the technical information furnished hereunder, a fee equal to five per cent (5%) of the Company's annual net sales. The term "net sales" shall mean all sales of all products and services less trade or cash discounts returned goods, commissions, transportation allowance, bonuses allowed to customers on the volume of sales and adjustments for defective merchandise. Inasmuch as the aforementioned fee is determined by sales, it is agreed that all prices, terms, discounts and major sales and manufacturing policies shall meet with Supplier's approval prior to adoption by the Company. It is also understood that Supplier shall have the right through its representative; to inspect the books of the Company in order to verify the amount of sales or for any other matters connected with this agreement. Promptly after the close of each month, the Company shall send to Supplier copies of its Balance Sheet, Profit and Loss Statement, and Sales Manufacturing and Production Report.
5. ' Clause 6: On or before the last day of each month, the Company shall pay to Supplier a sum equal to the percentage stipulated in Article 5 on the net sales of the preceding month. The Company shall be entitled to a discount equal to five per cent (5%) of each fee payment which is made to Supplier in United States Dollars on or before the due date of said payment. Such payments shall be without prejudice to year-end adjustments. Within sixty (60) days after the end of each year Company shall furnish Supplier with a detailed and final report verified by an executive of the Company of the yearly net sales and at that time an appropriate adjustment shall be made between the fee paid and the amount earned.
6. 7.Payment of all sums which may become due to Supplier by virtue of this contract shall be made to it promptly in United States Dollars at the exchange rate for dollars in effect on the due date.
7. 13.If by reason of exchange or other restrictions it becomes impossible for the Company to make payment in United States Dollars as called for herein then it shall promptly deposit in the name of supplier the respective United States Dollars equivalent at that date in a bank selected by Supplier in Country.
8. 14.
9. ' Neither of the parties hereto shall be deemed to be in default in the performance of this contract in case of force majeure or for other reasons beyond their respective control. However, in the case of failure to make payment as provided under the terms hereof, whatever may be the cause, supplier may terminate the services herein stipulated to be furnished by it."
10. ' From the statement of the case and the order passed by various authorities of the Income Tax it is clear that they have proceeded on the ground that the agreement between the applicant and its parent company for payment of technical fee was in terms of Pak. Rupee. Therefore, the devaluation of Pak. Currency did not affect the liability. The basic approach to the problem seems to have been completely mis-understood. To correctly appreciate the problem the nature of contract and principles of Private International Law governing such international contracts involving two different currencies has to be clearly understood. First we will deal with the contract itself. As is obvious from the aforestated clauses of the agreeement the parent company had agreed to supply technical as well as information and data for successful manufacture and sale of tyres, tubes accessories and repair materials and also to keep the applicant hilly informed as to modern manufacturing methods used by the parent company. The applicant was to utilise the technical information, data and methods of manufacturing in its business. For the use of technical information furnished by the parent company, the applicant agreed to pay a fee aqual to 5% of its annual net sale. The applicant was to submit immediately after the close of each month, its blance sheet, profit and loss statement and as well as manufacturing and production report. The technical fee was to be paid on or before the last day of each month on the net sale of the preceding month.
11. The applicant was entitled to discount equal to 5% of each fee if payment was made to the parent company in U.S. Dollar on or before the due date of the said payment which would be without prejudice to the year and adjustment. Within 60 days after the end of each year the applicant was to furnish a detailed report and appropriate adjustment was to be made. According to clause 3 of the agreement the payment was to be made to the Parent company in U.S Dollar at the rate of exchange prevalent on the due date. Clause 13 provides that if due to exchange or other restriction remittance is not possible in U.S. Dollars then it shall be deposited in the name of the Parent company, the respective US Dollar equivalent at that date in a bank selected by the parent company. These clauses clearly stipulate that the amount equivalent to 5% of the net sale shall be quantified in terms of Pak. Rupee because the sales are made in Pakistan and the earning of the applicant is in this country. But so far as the liability for payment of this amount is concerned it is not in terms of rupee. It is in terms of U.S. Dollar, at the rate of exchange prevalent on the due date.
12. It further emphasises and contemplates for contingency when due to certain restriction imposed on foreign exchange remittance, the technical fee cannot be remitted to the parent company. In that event the amount equivalent to dollar has to be deposited in a bank in Pakistan by the parent company. Therefore, the agreement consistently provides that the liability to pay the parent company is in terms of U.S. Dollar whether it is paid monthly, yearly or in a contingency as contemplated by clause 13. If the intention of the agreement would have been to pay the technical fee in rupee then in cases of contingencies as provided in clause 13 it would have not provided to deposit the money in Pakistan equivalent to U.S. Dollar. Therefore, the agreement contemplates and fixes the liability of the applicant for payment of technical fee in terms of U.S. Dollars.
13. ' We will now examine the principles which govern the interpretation of agreement involving payment in foreign currency. These principles have been stated in Dicey's "Conflict of Laws" and have been accepted and followed by our courts as well as by the English Courts. These principles have been fully expllained, quoted and ilustrated in the Commissioner of Income Tax North Zone, West Pakistan, Lahore v. Khanewal Oil Mills Ltd., Khanewal (1962) 6 Taxation 66. The relevant portion of the judgment is reproduced as follows:- "The answer to the above question is to be found not in any statute book, but in the rules of the Private International Law and the decided cases on the subject. In Dicey's Conflict of Laws this subject is discussed under rules 154 and 178 under the Chapter "Law of Obligations". The first mentioned rule lays down that the interpretation of a contract and the effect, i.e,, the rights and obligations under it of the parties thereto, are to be determined in accordance with the proper law of the contract. The comment under the rule is to the effect that the laws of different countries differ as to the incident which they attach to a given contract. The true meaning and the effect, i.e,, the rights or obligations of the parties, cannot be determined until we have ascertained the law by which the contract is to be governed. The one general principle which, the law of England supplies for the answer to this inquiry is, "that the rights of the parties to a contract are to be judged by that law by which they intended (to bind), or rather by which they may justly be presumed to have bound themselves". "You must have regard to the law of the contract, by which I mean the law which the contract itself imports is to be the law governing the contract." In other words, the meaning and effect of every contract depends upon the law by which the parties intended it to be governed, i.e,, upon its proper law. This general principle applies both to the interpretation or explanation of a contract and to the effects of a contract, i.e,, the rights and obligations of the parties under it. Thus, the term "proper law" in rule 154 means the law by which the parties intended it to be governed whether by specific mention of the law or by necessary presumption in this behalf. The illustrations under this rule are quite instructive. For example, an English contract provides for the payment of "Pounds" in Australia, English law will be applied by the Court in deciding how the term "Pound" is to be construed i.e, whether the amount owing by the debtor to the creditor must be measured in English or in Australian currency. If Australia is the only place of payment i.e,, if the creditor has no option to demand payment in several alternative countries with different 'pound' currencies e.g., in Australia or in Newzealand and if the debtor is now a Government outside Australia the meaning to be attached to the term connoting the currency unit may according to English domestic law be that which it bears at the place of payment, if the circumstances show that this interpretation was in the minds of the parties. Again when an action was brought in London on a contract which was a Chilean contract, to be interpreted by Chilean law, the Chilean law in relation to matters which may be taken into account in interpreting the contract was held to apply just as much as it would apply if it were to be determined in Chile. To exclude from application those parts of the foreign law of contract which in England domestic law are classified as belonging to the Law of Evidence would be taentamount to distorting the foreign law and to refusing to give effect to the intentions of the parties. How these matters are to be proved is a question to be answered by the lexfori, but what facts should be allowed to throw light on the intention of the parties is to be determined by the lex causae, i.e,, the proper law of the contract. In this case the characterisation used by the English system of the Conflit of Laws does not coincide with that used in English Domestic law."
14. ' In the referred case the respondent a Pakistani company had supplied cotton seeds to two parties residents in India for a total sum of Rs33,693-12-0. The respondents maintained mercantile system of accounting. On 19th September, 1949 the Indian Government devalued its currency in consequence of which the assessee showed a trading loss of Rs,10,295. The Income Tax Officer refused to accept it as a trading loss, deductible from the total income. In appeal the Appellate Assistant Commissioner maintained the treatment but for different reason. He held that the assessee did not deal in exchange business, therefore, any appreciation and depreciation in the valuation of outstanding due to exchange fluctuation was outside the scope of tax. On further appeal the Income Tax Appellate Tribunal came to a contrary conclusion. In the reference made to the High Court, after explaining the principle as stated above, it was observed that:- "the Indian parties who purchased cotton-seeds from the assessee are bound to tender the sum of Rs33,693-12-0 in such currency notes as are the legal tender in Pakistan viz., the form in which such payment was intended to be made or shall be presumed to have been made by the parties when the buyer incurred the obligation to pay to the assessee the aforementioned sum in Pakistan currency regulated by the municipal law of Pakistan whose unit of account is in question. Similarly, as held by Lord Russell of Killowen in In re Chesterman's Trusts, the buyer's obligation in this case is to pay in whatever at the date of repayment is the legal tender and legal currency in the foreign country. In the present case it would be Pakistan wherefrom they purchased cotton-seeds and in that sense lent its money."
15. ' For this reason the deduction was not allowed because the money was payable in Pakistan in Pak.
16. Currency and the devaluation of the Indian currency did not in any manner affect the assessee's right to receive the money, in its own currency.
17. In the present case the applicant was liable to pay technical fee to its parent company in U.S. Dollar. The place of payment has not been mentioned in the agreement, but according to well- recognised principle that the debtor must seek the creditor, the payment should be made at the place of business of the parent company. Therefore, the payment in U.S. Dollar was to be made in U.SA. This factor itself determines the liability of the applicant to make payment in U.S. Dollars.
18. Therefore, the applicant was to pay a determined and ascertained amount of dollar to the parent company at the relevant date in U.SA. If this payment has not been made then on any future date when the payment is made it should be the same amount of dollar which the parent company was entitled to receive on the due date. The applicant will have therefore, to spend Pakistan rupee for obtaining the determined and ascertained amount of dollar for payment to the parent company.
19. In view of the devaluation of Pak. Currency the ascertained amount of dollar could be remitted only on payment of extra rupee which the applicant will have to spend for the purpose of remittance of technical fee.
20. ' Mr. Iqbal Naim Pasha the learned counsel for the applicant has referred to Radio Picture Ltd. v. The Commissioner of Inland Revenue 22 Tax Case 106. In this case the applicant an English company was a subsidiary of American company known as R.KO. Production Incorporated was granted a licence to distribute films of the American company within a specified territory. Under this agreement the applicant was to pay 70% of the gross receipt after deducting authorised amount.
21. The agreement was silent about the exchange basis on which account was to be maintained. By a separate letter the applicant was directed to maintain its account with the American Company on the basis of a fixed rate of exchange. The difference in the rate of exchange was to be kept in suspense account. Due to delay in payment and fall in the value of pounds, the adverse differences were shown in the suspense account. The applicant maintained the account on Sterling basis without regard to the suspense account and it was assessed to Income Tax for three years. The applicant filed application for relief on the plea that the agreement and letter together required payment in dollars and therefore the adverse differences in exchange were deductable in computing its profits. This claim was rejected by the Commissioner of the Inland Revenue which was upheld by the Special Commissioner. The applicant filed appeal before the High Court of Justice (King Bench Division) which was allowed. In further appeal by the Revenue it was held that the obligation of the applicant is a dollar obligation. It was further observed that:- "If that be the true position, that, to my mind, is an end to this case, because it would establish that the liability of the English Company was a dollar liability of the amount appearing in the books kept in the way I have indicated, and that when the Company came to discharge the liability it would have to provide the necessary sum of sterling to purchase those dollars at the current rate of exchange."
22. ' The learned counsel for the applicant also referred to Commissioner of Income Tax Bombay City 2 v. Vitre Engineering Co. 1984 150 I T R 183. In this case the assessee which was a branch of a company in America carried on its work in India as consulting engineer. Some of the employees of the assessee were American nationals who were paid salaries partly in dollar and partly in rupee.
23. The dollar part of the salary was paid by the head office. The head office also required the assessee for certain overhead expenses and also for supply of drawing etc. A running account was maintained between the head office and the assessee. In June 1966 rupee was devalued and in view of the changed exchange rate the assessee credited the head office with a sum of Rs,71/2 lakhs. The assessing officer rejected the claim. The Tribunal, however, held that increase in liability was in respect of trading liability of the assessee and was deductible. On reference being made whether the assessee was entitled to deduction of Rs,781, 323 or any part as a business loss, the High Court observed as follows:- "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 rupee for its liability for reimbursement and on this system provision would be required to be made and considered in the assessment year in question, that is, for the previous year ending on December 31, 1966."
24. ' From the above authorities it is clear that where an assessee under any arrangement, business dealing or contract is obliged to pay any party in foreign currency then it incurs a liability in foreign currency. If the devaluation of a currency adversely affects the liability of the assessee it has to procure some amount of foreign currency by spending more local currency and then it suffers a loss. The question arises whether such loss is an admissible allowance and can it be deducted in computing the profits. The reply to this querry can be found after ascertaining whether the loss is a trading loss or a capital loss. In this regard Mr. Pasha has referred to Sutlej Cotton Mills v.
25. Commissioner of Income Tax West Bengal (1979) 116 I T R 1 where while dealing similar question it was observed as follows: "The law may, therefore, now be taken to be well settled that where profit or 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 trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature."
26. In the present case the applicant is contractually bound to pay the technical fee in U.S. Dollars.
27. Such payment was made for business purposes and therefore the loss suffered due to devaluation of Pak currency was a trading loss. The applicant was thus entitled to its deduction.
28. ' Mr. Shaikh Haider the learned counsel for the respondent has contended that the liability claimed by the applicant is not liable to deduction under section 10 (2) (xvi). According to him it was not due to business expediency nor was it directly connected with the business. The learned counsel has referred to Travancore Titanium Product Ltd. v. Commissioner of Income Tax, Kerala (1966) 60 I T R.
277. While dealing with section 10 (2) (xv) which is equivalent to section 10 (2) (xvi) of the Pakistan Income Tax Act 1922 it was observed as follows:- "An allowance permissible under clause (xv) in the computation of taxable income is, therefore, expenditure incurred in the year of account in respect of a business carried on by the assessee the expenditure must not be in the nature of capital expenditure or personal expenses of the assessee and it must have been laid out or expended wholly and exclusively for the purpose of the business ' The nature of the expenditure or outgoing must be adjudged in the light of accepted commercial practice and trading principles. The expenditure must be incidental to the business and must be necessitated or justified by commercial expediency. It must be directly and intimately connected with the business and be laid out by the taxpayer in his character as a trader. To be a permissible deduction, there must be a direct and intimate connection between the expenditure and business i.e, between the expenditure and the character of the assessee as a trader, and not as owner of assets, even if they are assets of the business."
29. There can be no cavil with the aforestated proposition of law. In the present case the assessee is a subsidiary company of its parent company which is in U.SA. As stated above the agreement between the two parties spells out the area and sphere of technical assistance which is rendered by the parent company. The assistance, designs, and data which are supplied from time to time are necessary for the applicant not only for proper standardising its products but to make improvement from time to time and also to be acquainted with and benefited by the research, experience, expertise and technical knowledge which the parent company acquires in U.SA.
30. Therefore, the technical fee paid by the applicant is directly and intimately connected and wholly related to the business of the applicant. If the agreement is revoked or terminated then the applicant will be deprived of the assistance necessary for a better and proper manufacture of its products. From the various clauses reproduced above it is clear that in case of non-payment the parent company can terminate the agreement. The termination of the agreement is bound to affect the applicant adversely. Therefore, any loss caused or extra expenses incurred in payment of technical fee would be wholly and exclusively for the purpose of the business.
31. ' Mr. Iqbal Naim Pasha has referred to British Sugar Manufacturer Ltd. v. Harris (Inspector of Taxes)
32. (1939) 7 I T R 101. In this case a company engaged in manufacturing business contracted with two other companies to pay them stated percentage of its net profits in lieu of their supplying to the company technical and financial knowledge experience and advice. The company claimed deduction of the money so paid in computation of profit. It was held that it was entitled to deduction as being "money wholly and exclusively laid out or expended for the purposes of the trade".
33. ' In view of the above discussion our answer to the question is in the affirmative.