B.P. Saraf, J.
1. By this reference under Section 256(1) of the Income-tax Act, 1961 ('the Act'), the Income-tax Appellate Tribunal has referred the following question of law to this court for opinion at the instance of the Revenue :
'Whether, on the facts and circumstances of the case, the Appellate Tribunal was justified in holding that the sum of Rs. 19,07,217 is an allowable expenditure ?'
2. The assessee is a private limited company.
3. The relevant assessment year is 1967-68. During the years 1957-58 and 1958-59, the assessee-company borrowed a sum of $7,00,000 equivalent to Rs. 33,42,783 from Messrs. Eisenberg Incorporated, Tokyo, Japan, who were selling agents of the assessee-company for iron ore. There is another limited company, viz., Messrs. Dempo and Souza Ltd., in which the assessee-company holds 50 per cent. of the shares. This company used to extract iron ore from the mines and supply the same exclusively to the assessee. As the method of extracting iron ore from its mines by the said company had become outdated, it was felt by the company as well as the assessee-company that the mines of the former company should be mechanised in order to reduce the cost of production as well as to increase the production. The necessary machinery for mechanisation was to be imported from Germany and other countries. The assessee-company agreed to provide the necessary foreign exchange required for the import of machinery. Accordingly, the assessee-company advanced the sum of $7,00,000 which it had obtained as loan from Messrs. Eisenberg Incorporated, Tokyo, Japan, to the said company for the import of mining machinery. The loan given by the assessee was thus utilised by the other company for the import of mining machinery. The amount so advanced was agreed to be adjusted against the price of iron ore supplied by the said company to the assessee.
4. On June 6, 1966, there was a devaluation of the Indian rupee. On account of devaluation, the assessee's liability in respect of the above loan from Messrs. Eisenberg, Japan, was increased by a sum of Rs. 19,07,217 which the assessee claimed as a deduction in computing its income for the relevant previous year. The Income-tax Officer disallowed the claim on the ground that the whole of the amount of loan was utilised for purchase of machinery for the use of another company, namely, Messrs. Dempo and Souza Ltd., which was the capital equipment of that company. The nature of the loan, according to the Income-tax Officer was, therefore, capital and the increased liability consequent to the devaluation also remained the same in nature. He, therefore, disallowed the claim of the assessee. On appeal by the assessee, the disallowance was upheld by the Appellate Assistant Commissioner. The reasoning of the Appellate Assistant Commissioner was that the transaction of providing finance to the othercompany was of an investment nature and the asset, viz., the debt due to the assessee by Messrs. Dempo and Souza Ltd., was an asset of capital nature and hence the loss on account of devaluation was a loss due to depreciation of the value of a capital asset.
5. Aggrieved by the order of the Appellate Assistant Commissioner, the assessee preferred an appeal before the Appellate Tribunal It was urged by the assessee that the money borrowed had been utilised by it for the purpose of its business and, as such, any loss incurred by it on account of enhancement of the liability due to devaluation was a business loss which was allowable as a deduction in arriving at the real business income under Section 28 of the Act. The Tribunal found force in the assessee's submission. On a perusal of the facts, the Tribunal observed that though the loan of $7,00,000 taken by the assessee company from Messrs. Eisenberg Incorporated, Tokyo, Japan, was initially utilised for the purchase of machinery imported for the mechanisation of mines of Messrs. Dempo and Souza Ltd., it was ultimately realised from them in accordance with the terms and conditions of the loan by adjustment against the price of supplies of iron ore. It was further observed that as Messrs. Dempo and Souza Ltd. were supplying the iron ore extracted by them from their mines exclusively to the assessee-company, the assessee-company was benefited by advancing loan to them. It also found that the entire loan had been repaid by the said company to the assessee-company before the date of devaluation by adjustment against the price of iron ore supplied to the assessee. The Tribunal, therefore, held that the loss incurred by the assessee on account of devaluation was a revenue loss and hence an allowable deduction in computing its income under Section 28 of the Act. Accordingly, the Tribunal set aside the orders of the Appellate Assistant Commissioner and the Income-tax Officer and allowed the claim of the assessee.
6. Aggrieved by the order of the Tribunal, the Revenue applied for reference under Section 256(1) of the Act and the Tribunal, on being satisfied that a question of law did arise out of its order, has referred the question set out above to this court for opinion.
7. We have heard Mr. G. S. Jetly, learned counsel for the Revenue. The submission of Mr. Jetly is that the loan was taken by the assessee in the years, 1957-58 and 1958-59 and was for acquisition of the machinery and that too by another company which used to supply its products to the assessee. That being so, according to the Revenue, the loan was utilised for acquisition of a capital asset and, as such, any loss incurred byenhancement of the liability on account thereof by devaluation cannot be treated as a revenue loss.
8. On the other hand, the contention of Mr. S.J. Mehta, learned counsel for the assessee, is that the object for which the loan was taken is not at all relevant. What is relevant is the utilisation of the loan or the asset acquired by utilisation thereof at the time of devaluation. According to the assessee, the amount received by it as a loan was utilised by a company which was supplying the iron ore extracted by it exclusively to the assessee which formed the stock-in-trade of the assessee. It is also contended that at the time of devaluation, the entire amount advanced by the assessee to the other company for the purchase of mining machinery had been repaid by it by way of adjustment against the price of supplies of iron ore. In other words, according to counsel for the assessee, what the assessee acquired in lieu of the advance made by it to the other company was 'iron ore' which was its stock-in-trade. As such, even if the original purpose of obtaining the loan is held to be acquisition of a capital asset, the utilisation thereof had changed in course of time and at the time of devaluation, the uncontroverted position was that the entire amount had been received back by the assessee and was used by it as circulating capital. In this connection, learned counsel referred to the order of the Tribunal wherein the statement of the assessee contained in its letter dated December 8, 1969, written to the Income-tax Officer, had been set out. It appears that in the said letter the assessee had clearly stated as follows :
'(3) In pursuance of the aforesaid arrangement to extend financial assistance up to a sum of Rs. 4 million, their liability to us was reduced on account of adjustment made by them in 1960. Thereafter, the said company has repaid us from time to time, as in past years, by adjustment against price of the ore supplied by them to us. You will also note that it is we who owed them money, which is apparent from the statement of the balance of outstandings in their books against us :
Rs. Ps.31-12-1961Dr.9,63,169.8631-12-1962'17,69,956.1431-12-1963'32,49,774.0331-12-1964'41,64,148.1331-12-1965'33.41,480.1631-12-1966'23,47,613.0431-12-1967'18,77,157.36
(4) From the aforesaid, it is fairly clear that the money was returned to us by the said company and also remained in our business as working capital at all relevant time and specially at the time of devaluation.
(5) On devaluation on June 6, 1966, our liability in respect of the said loan was increased by a sum of Rs. 19,07,217 and it is this liability which we are claiming as a deduction in computation of our income for the assessment year 1967-68.'
9. The Tribunal has observed in its order that the above statement had not been doubted either by the Income-tax Officer or by the Appellate Assistant Commissioner. The Tribunal also recorded that it was clear from the above facts that the loan of $7,00,000 taken by the assessee-company from Messrs. Eisenberg Incorporated, Tokyo, Japan, which was initially utilised for the purchase of the machinery imported for the mechanisation of the mines of Messrs. Dempo and Souza Ltd., was ultimately realised from Messrs. Dempo and Souza Ltd. by 1966 by adjustment against the price of supplies of iron ore and, as such, on the date of devaluation, the entire amount of loan was utilised by the assessee for the purpose of its business. In that view of the matter, the Tribunal came to the conclusion that the loss incurred by the assessee as a result of devaluation was a revenue loss because the amount of loan at the time of devaluation was undisputedly being used as circulating capital of the assessee. Counsel for the assessee submits that in view of the above finding, no fault can be found with the decision of the Tribunal that the loss on account of devaluation is a revenue loss. Reliance is placed in support of this submission on the decisions of the Supreme Court in CIT v. Tata Locomotive and Engineering Co. Ltd. : [1966]60ITR405(SC) ; Sutlej Cotton Mills Ltd. v. CIT : [1979]116ITR1(SC) and some decisions of this court and other High Courts.
10. We have carefully considered the rival submissions of learned counsel for the parties in the light of the various decisions referred to above. The law in regard to the treatment of profit or loss arising on account of appreciation or depreciation in the value of foreign currency held by an assessee on conversion into another currency is well-settled now by a catena of decisions of the Supreme Court and various High Courts. The Supreme Court in Sutlej Cotton Mills Ltd. v. CIT : [1979]116ITR1(SC) has made it clear beyond all doubt that a loss arising in the process of conversion of foreign currency which is part of the trading assets of the assessee is as much trading loss as any other and it makesno difference because it is occasioned by devaluation brought about by the State. It was observed (at page 6) :
'It is not the factor or circumstance which causes the loss that is material in determining the true nature and character of the loss, but whether the loss has occurred in the course of carrying on the business or is incidental to it. If there is loss in a trading asset, it would be a trading loss, whatever be its cause, because it would be a loss in the course of carrying on the business. Take for example, the stock-in-trade of a business which is sold at a loss. There can be little doubt that the loss in such a case would clearly be a trading loss. But the loss may also arise by reason of the stock-in-trade being stolen or burnt and such a loss, though occasioned by external agency or act of God, would equally be a trading loss. The cause which occasions the loss would be immaterial : the loss, being in respect of a trading asset, would be a trading loss. .... Whether the loss suffered by the assessee was a trading loss or not would depend on the answer to the question, whether the loss was in respect of a trading asset or a capital asset. In the former case, it would be a trading loss but not so in the latter. The test may also be formulated in another way by asking the question whether the loss was in respect of circulating capital or in respect of fixed capital. This is the formulation of the test which is to be found in some of the English decisions. It is, of course, not easy to define precisely what is the line of demarcation between fixed capital and circulating capital, but there is a well-recognised distinction between the two concepts. Adam Smith in his Wealth of Nations describes 'fixed capital' as what the owner turns to profit by keeping it in his own possession and 'circulating capital' as what he makes profit of by parting with it and letting it change masters. 'Circulating capital' means capital employed in the trading operations of the business and the dealings with it comprise trading receipts and trading disbursements, while 'fixed capital' means capital not so employed in the business, though it may be used for the purposes of a manufacturing business, but does not constitute capital employed in the trading operations of the business. Vide Golden Horse Shoe (New) Ltd. v. Thurgood [1933] 18 TC 280. If there is any loss resulting from depreciation of the foreign currency which is embarked or adventured in the business and is part of the circulating capital, it would be a trading loss, but depreciation of fixed capital on account of alteration in exchange rate would be a capital loss. Putting it differently, if the amount in foreign currency is utilised or intended to be utilised in the course of business or for a trading purpose or for effecting a transaction on revenue account, the loss arising from depreciation in itsvalue on account of alteration in the rate of exchange would be a trading loss, but if the amount is held as a capital asset, the loss arising from depreciation would be a capital loss.'
11. The law was summed up by the Supreme Court in Sutlej Cotton Mills Ltd.'s case : [1979]116ITR1(SC) as follows (at page 13) :
'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.'
12. The decision of the Calcutta High Court in Oil India Co. Ltd. v. CIT : [1982]137ITR156(Cal) is also relevant in this connection. In this case, the assessee had taken loans in sterling in England. The Tribunal found that the borrowings had been made for meeting the assessee's revenue expenditure and directly related to its business. It maintained its accounts on the mercantile system. On the question whether the repayment of Rs. 40,60,500 and the liability to pay an extra amount of Rs. 52,17,340 in the accounting year relevant to assessment year 1967-68 due to devaluation of the Indian rupee in June, 1966, was deductible as business expenditure, it being undisputed that the additional liability was in the nature of revenue, it was held that for the purpose of carrying on the business, the assessee borrowed the money and thereby became temporarily the owner of the fund and if the assessee had to incur an additional liability because of it, that would be a loss in connection with or arising out of the business. The loss was, therefore, held to be deductible. In CIT v. International Combustion (I.) P. Ltd. : [1982]137ITR184(Cal) also, though the assessee had purchased plant and machinery with the borrowed money, it was found by the Tribunal that such plant and machinery formed part of the stock-in-trade of the assessee. There was a loss on account of devaluation of the Indian rupee. The Tribunal held the additional liability to be allowable deduction by way of loss incurred in the course of the purchase of the goods and in the usual course of business of the assessee. This finding of the Tribunal was approved by the High Court. In Davidson of India P. Ltd. v. CIT : [1983]140ITR344(Cal) , the assessee-company had raised sterling loans carrying interest and the rupee equivalent of the loan hadbeen brought to India for use in the assessee's business as the company's circulating capital. The assessee repaid part of the loan but on June 5, 1966, i.e., the date of devaluation of the Indian rupee, a balance was outstanding. The liability increased in terms of the Indian rupee due to devaluation. This increase amounting to Rs. 4,17,833 was claimed by the assessee as a trading loss. The claim was disallowed by the Income-tax Officer. The Appellate Assistant Commissioner and the Tribunal found that the loan had been taken to augment the working funds of the assessee and was held as circulating capital. The Tribunal, however, held that the loss was not allowable as it had not sprung up directly from the carrying on of the business. On a reference, the High Court reversed the finding of the Tribunal and held that even if a loan is taken originally as loan but is utilised as circulating capital or as a trading asset, then any accretion or depreciation must be treated on the revenue account either as profit or loss as a result of devaluation.
13. It may be useful at this stage to refer to a decision of the High Court of Punjab and Haryana in Groz-Beckert Saboo Ltd. v. CIT , wherein it was held that neither the person from whom the loan was received by the assessee nor the time when it is received is of any significance in determining as to whether the loan was towards the trading account or capital account. The crucial thing is the utilisation of the loan.
14. As observed by the Supreme Court in CIT v. Tata Locomotive and Engineering Co. Ltd. : [1966]60ITR405(SC) , the real test that should be applied in such cases is whether the depreciation in value had taken place in a capital asset or in a trading asset, or in other words in fixed capital or in circulating capital. What is relevant is, therefore, the nature of the loan or the nature of the asset acquired out of it at the time of devaluation and not at the time of obtaining the loan.
15. The propositions that emerge from the above discussions may be summed up as follows :
(i) A loss arising in the process of conversion of foreign currency which is part of the trading asset of the assessee is a trading loss as any other loss.
(ii) In determining the true nature and character of the loss, the cause which occasions the loss is immaterial; what is material is whether the loss has occurred in the course of carrying on the business or is incidental to it.
(iii) If there is loss in a trading asset, it would be a trading loss, whatever be its cause because it would be a loss in the course of carrying on the business,
(iv) Loss in respect of circulating capital is revenue loss whereas loss in respect of fixed capital is not.
(v) Loss resulting from depreciation of the foreign currency which is utilised or intended to be utilised in business and is part of the circulating capital, would be a trading loss, but depreciation of fixed capital on account of alteration in exchange rate would be a capital loss.
(vi) For determining whether devaluation loss is revenue loss or capital loss what is relevant is the utilisation of the amount at the time of devaluation and not the object for which the loan had been obtained. Even if the foreign currency was intended or had originally been utilised for acquisition of fixed asset, if at the time of devaluation it had changed its character and had assumed the new character of stock-in-trade or circulating capital, the loss that occurred on account of devaluation shall be a revenue loss and not a capital loss.
(vii) The way in which the entries are made by an assessee in the books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. What is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee.
16. In the instant case, the admitted position is that the entire amount of loan which had been advanced to the other company for the purchase of machinery had been repaid by that company to the assessee by way of adjustment against the price of iron ore supplied to it which was its stock-in-trade. That being so, it cannot be disputed that whatever might have been the original object of the loan, at the time of devaluation, the amount of loan was utilised by the assessee as circulating capital. That being so, the loss which occurred due to devaluation of the Indian rupee was clearly a revenue loss and was allowable as a deduction in computation of the income of the assessee for the assessment year concerned.
17. Accordingly, the question referred to us is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.
18. Under the facts and circumstances of the case, we make no order as to costs.