1. This is a Reference made by the Income-lax Appellate Tribunal (hereinafter referred to as the Tribunal) under Section 66 (1) of the Indian Income-tax Act (hereinafter referred to as the Act). Assessee is a limited company registered under the Indian Companies Act, VII of 1913, and has its registered office at Bombay. The main business of the assesses company is the manufacture of locomotive boilers and locomotives. For the purpose of its manufacturing activities, the assesses company had to make purchases of plant and machinery, etc. In various countries including the Unites States of America. Assessee company had appointed M/s. Tata Inc, New York as its purchasing agents in the Unites States. In the year 1946 the assessee-company with the sanction of the Exchange Control Authorities sent a remittance of Rs. 33,850 to its purchasing agents, Messrs. Tata Inc. of New York for purposes of purchasing capital goods in the United States of America and meeting other expenses connected therewith. In connection with the survey and setting up of the factory of the assessee-company, representatives of Baldwin Locomotive Works, Philadelphia, U.S.A. used to visit India. The assessee made available funds to such representatives for the purpose of meeting their expenses in India. The assessee-company was appointed as the sole selling agents of the Baldwin. Locomotive Works for the sale of their products in India and in connection with the sale of the products of Baldwin Locomotive Works in India, the assessee had to incur expenses on their behalf in India. The funds so made available to the representatives of the Baldwin Locomotive Works and the expenses incurred by the assessee on behalf of the Baldwin Locomotive Works in India were re-imbursed to the assessee by the Baldwin Locomotive Works of U.S.A. by paying the amounts due to the assessee's selling agents Tata Inc. in New York. The amounts so paid by the Baldwin Company to the Tata Inc. with the previous permission of the Reserve Bank of India were retained in the assessee's account with the Tata Inc. for the purchase of capital goods. Now, as already stated, the Baldwin Company had appointed the assessee-Company as its sole selling agents in India. Commission in that respect was agreed to be paid in dollars to the assessee-company in America. With the prior permission of the Reserve Bank the amounts received by way of commission by the assessee-company from Baldwin Company were also credited in the account of the assessee company with the Tata Inc., which, was opened in 1946 for purposes of purchasing capital goods in America. The question that has been referred to us relates, to the amounts of commission received by the assessee during the year 1948-49 and from 1st April 1949 to 16th of September 1949. It would, therefore, be convenient to reproduce at this stage the letter writtenby the assessee-company to the Reserve Bank for obtaining the necessary permission to keep those amounts in their aforesaid account with the Tata Inc. The letter is of date 26th October 1948 and the material part is in the following terms:
'It would be more convenient if the amount of commission payable to us periodically be deposited into our account with our representatives, Messrs. Tata Inc., NEW York, opened with reference to your letter EC. BY. 7031/74 dated 2nd October 1946 as the same would go to reduce the amount of remittances to be made from here in recoupment of that amount from time to time. These amounts will be utilised solely for the purposes detailed in our letter to you TG-679 dated 15th August, 1946'. It is an admitted position that the purposes referred to in the said letter of 15th August 1946 were purchase of capital goods. The Reserve Bank granted the permission to the assessee company to credit the amounts received by them by way of commission from Baldwin company to their account with the Tata Inc. opened in 1946 for purchase of capital goods in America. The amounts accordingly received in the year 194849 and from 1st April 1949 to 16th September 1949 amounted to $. 36,123.02. On the amount of commission received, the assessee-company paid Income-tax in India on the accrual basis in the relevant years. Thus the sources from and the extent to which the assesses came to hold dollars on 16-9-1949 In its account with its purchasing agents Tata Inc. were:
1.Remittances from Bombay Less Dollars spent In the U.S.A. for capital purposes.
$ 33,850.00 $ 30,282.96
$ 3,562.042.Amount reimbursed by Baldwin Locomotive Works against funds made available to its representatives in India.
$ 8,882.243.Commission actually received from Baldwin locomotive Works & retained In the U.S.A.$ 36,123.02
Total.... $ 48,572,30
On 16th of September 1949 the pound sterling was devalued. Prior to that dale the rate of exchange between rupee end dollar was Rs. 3,330 per dollar. On devaluation the rate became Rs. 4.775 per doller. The result thus was the American goods became expensive than before. The Government of India also imposed restrictions on the import of goods from the U.S.A. It appears that this rendered, as the statement of case would show, the further purchase of capital goods from the U.S.A. practically impossible. The assessee considering that in these circumstances it was not necessary to retain large amount of $ 48,572.30 in America applied to the Reserve Bank on 17th of December 1949 for permission to repatriate a sum of 40,000/- dollars out of 48,572.30 dollars held by it In its account with the Tata Inc.. On the permission being granted a sum of 40,000/- dollars was repatriated to India. Similarly, a further sum of $ 9,500/- was also repatriated to India. Though these two remittances from the U.S.A. to India of $ 40,000/-and $ 9,500/- fell in different accounting years, the assessee agreed before the Income-tax Officer that both these remittances should be considered to have been received in the accounting year ending 31st March, 1950 and on that looting the case has proceeded throughout. As already stated the amount, which was to the credit of the assesseein its account with the Tata Inc. on 16th September 1949 amounted to $48,572.30. This sum in its entirety had been repatriated to India. The surplus amount gained by the assesses as a result of devaluation on the repatriation of the sum of $48,572-30 amounted to Rs. 70,147/- in the process of converting the amount of 48,572.30 dollars into rupee currency. It was the case of the Department that the assessee is liable to pay tax on the aforesaid amount of Rs. 70,147/- on the ground that it represented profits that arose to the assessee incidental in its carrying, on the business. On the other hand, it was the contention of the assessee that it was not liable to pay any tax because any benefit that might have accrued to the assesses was a benefit of its capital asset. The income-tax officer negatived the contention of the assessee and brought to, tax the entire amount of Rs. 70,147/-. The assessee's appeal to the Appellate Assistant Commissioner failed. Assesses, took further appeal to the Tribunal, Before the Tribunal it was contended on behalf of the assesses that the surplus, of Rs. 70,147/- attributable to the conversion of 48,572-30 dollars into rupee currency was of a nature of capital profit inasmuch as the said sum of 48,572.30 dollars was held by the assessee in America for capital purposes such as purchasing plant, machinery, etc. and meeting expenses connected with the technical know-how. The Tribunal did accept the contention of the assessee in respect of two amounts, namely, the sum of 3567/04 dollars balance remaining out of the first remittance of 33,850/- dollars, and the sum of 8882/24 dollars that is, the amount reimbursed by Baldwin Locomotive Works against the funds made available in India to its representatives by the assessee, holding that these two sums were held by the assessee for capital purposes, that is, for the purchase of capital goods and hence any profit that arose as a result of its conversion into rupee currency on account of the appreciation of the dollar in relation to the rupee, must be held on capital account. The Tribunal, therefore, directed that portion of the sum of Rs. 70,147/- attributable to the said two sums must be excluded for the purpose of computing the assessee's income.
2. As regards the third sum of 36,123.02 dollars received by the assessee by way of commission from the Baldwin company upto 16th September 1949, the Tribunal held that the benefit secured by the assessee in the process of converting those dollars Into rupee currency should be brought to tax as revenue receipt. On an application made by the assessee under Section 65 (1) of the Indian Income? tax Act, to make a reference to this Court, the Tribunal held that questions of law did arise and, has, therefore, submitted a statement of case raising the following two questions.
1. Whether on the facts and in the circumstances of the case, the surplus or difference arising as a result of devaluation in the process of converting dollar currency into rupee currency in regard to the sum of $ 36,123.02 repatriated to India was profit which was taxable in the hands of the assessee? and
2. Whether the said sum of $36,123.02 having seen taxed in the relevant earlier years, the surplus or difference in dollar exchange account arising by reason of the repatriation thereof as a result of devaluation was rightly laden as profit taxable?
3. It is contended on behalf of the assessee that the amounts held by the assessee company in America in its account with its purchasing agents Tata Inc. were earmarked for purchase, of capital goods. The character of those?amounts, therefore, was that of fixed capita! end that character newer changed till the time those amounts were repatriated to India. Mr. Palkhivala, learned counsel for the assesses argued that the Tribunal has held that thesums of 3567/04 dollars and 8882/24 dollars included in the sum of 48,572/30 dollars were held by the assesseecompany on 16/9/1949 for capital purposes, that is, as fixed capital, and therefore, any profit that arose on itas a result of its conversion into rupee currency on account of appreciation of dollar in relation to rupee must be held on capital account. There is no reason to distinguishbetween these two amounts and the sum of 36,123.02 dollars held by the assessee company in the same account. Initially the character of that amount may be that of Income but the assessee company had asked the permissionof the Reserve Bank to keep that sum in America for purposes of purchasing capital goods and the said permission was granted by the Reserve Bank. That amount, therefore, was held by the company on capital account, and that character never changed. On the other hand, it has beenargued by Mr. Joshi, learned counsel for the Revenue, that the character of the said sum of 36,123.02 dollars was that of income when it became payable to the assessee inAmerica. The permission granted by the Reserve Dank of India to retain that amount in America cannot have the effect of changing the character of that amount. The Reserve Bank had only granted permission to the assessee to retain that amount in America for a specific purpose, namely, purchase of capital goods. That purpose having failed, the assessee company was, by virtue of Sub-section (3) of Section 4 of the Foreign Exchange Regulation Act (Act VII of 1947), bound to bring back that amount to India. It has accordingly brought that amount to India, in the process of exchange the assessee has benefited. The character of the said amount not having undergone any change till the time the said amount was repatriated to India, the profits made by the assessee-company are liable to tax because it is art incidental income made by the company during the course of its business. The character of this amount is not the same as that of the sums of 3567/04dollars and 8882/24 dollars. According to Mr. Joshi, the company was incorporated in the year 1945, the remittance of 33,850 dollars made in 1946 was made out of the capital of the company and out of that sum the amount of 3567/04 dollars is left. The initial character of that amount being capital, that character remained throughout till that sum was repatriated to India. The other amountof 8882/24 dollars represented the amount made available by the assessee-company to the representatives of Baldwin Company in India and the aforesaid amount paid by theBaldwin company to the assessee-company was only byway of repayment of the principal loan. That being the position, the initial nature of that amount was that ofcapital. Such is not the case with the amount of 36,123.02 dollars. We find it difficult to accept the contentions raised on behalf of the Revenue. In our opinion the contentions raised on behalf of the assessee are well-founded,
4. There is no material on record and there is no 'finding recorded by the Tribunal that the initial remittance of 33,850 dollars made by the assessee-company was madeout of its capital funds. The Tribunal has not allowed assessee's appeal In respect of the balance remaining out of that amount on that ground. The ground on which the Tribunal allowed the appeal in respect of the first two amounts was that these amounts were held by the assessee in America for capital purposes i.e., for purchase of capital (goods and, therefore, the appreciation in value as a result of change in exchange rate was not liable to tax, it is true that the amount of 36,123.02 dollars when first received by the assessee-company in America was in the nature of its income. The assessee had earned that income in dollars in the U.S.A. Sub-section (3) of Section 4 of the Foreign Exchange Registration Act 1947 provides:--
'Where any foreign exchange is acquired by any person other than an authorised dealer for any particular purpose, or where any person has been permitted conditionally to acquire foreign exchange, the said person shall not use the foreign exchange so acquired otherwise than for trial purpose or, as the case may be, fail to comply with any condition to which the permission granted to him is subject, and where any foreign exchange so acquired cannot be so used or, as the case may be, the conditions cannot be complied with, the. said person shall without delay sell the foreign exchange to an authorised dealer.'
Clause (ai) of Section 2 of the said Act defines 'authorised dealer' in the following terms:
''authorised dealer' means a person for the lime being authorised under Section 3 to deal In foreign exchange.'
'Foreign Exchange' is defined in Clause (d) of Section 2 of the Foreign Exchange Regulation Act. It is not in dispute that but for the permission granted by the Reserve Bank, the assessee not being an authorised dealer within the meaning of the Act would have been required to sell those dollars to an authorised dealer without any delay. The assessee, however, had obtained the permission of the Reserve Bank to retain that amount in America and it has to be seen what is the effect of the permission granted and subsequent dealings of the assessee with those dollars. It is indeed true that the permission granted by the Reserve Bank for retention of any foreign exchange In a foreign country by itself cannot have the effect of turning the amount, which is a revenue receipt, into a capital receipt, But the permission granted by the Reserve Bank has to be taken in the context of the facts and circumstances leading to the grant of permission by the Reserve Bank. We have already reproduced the letter of the assessee-company of 26th October 1948 by which the assessee asked the permission of the Reserve Bank to retain the amounts of commission received by it from Baldwin Company in America in the account opened by it with its purchasing agents M/s. Tata Incorporated for the purposes detailed by it in Its letter of 15th August 1946. When the permission granted by the Reserve Bank is taken in the context of this letter, it becomes abundantly clear that the assessee had, at the time it asked permission of the Reserve Bank to retain the amount in America, taken a decision to use, utilise and earmark this amount for the purpose of purchasing capital goods. The main business of the assessed-company is manufacture of locomotive boilers and locomotives. For the purpose of its manufacturing activities, the assessee had to make purchases of plant and machinery in foreign countries including America and for that purpose it had appointed Messrs. Tata Incorporated as its purchasing agents. It was necessary for the assessee-company to open an account and build up funds in America to pay for the machinery that would be purchased in America by its purchasing agents and for that specific purpose in the year 1946 the assessee-company had asked permission to remit amounts to America in its account with its purchasing agents M/s. Tata Inc. That permission was granted in the year 1946. The account thereafter opened by the assessee-company with the Tata Incorporated for the specific purpose of purchasing plant and machinery in Americawas in existence at the time the assesses asked permission on 26th October 1948, the permission asked for was to allow it to credit this amount in that account and retain it in America for this specific purpose. The permission asked for by the assessee-company has been granted by me Reserve Bank for this specific purpose. That being the position, in our opinion, it is fully established that the assessee-company had taken a Decision to utilise this amount of 36,123.02 dollars for a specific purpose of its manufacturing activities. It is true that the character of this amount at the inception was that of income. But when the assessee had taken a decision to utilise this sum for capital purposes and when the assessee-company obtained the requisite permission of the Reserve Bank to use it for this purpose and also when the assessee-company had, by crediting it in the account of the Tata Incorporated, appropriated that sum for the specific purpose, in our opinion, the initial character of this sum underwent a change and it assumed the character of fixed capital of the company. The amount of 33,123.02 dollars had remained throughout in deposit in this account right upto 16th September 1949, that is, the date the pound sterling was devalued as well as till its its repatriation along with other amounts in that account. That being the position on facts, in our opinion, the character assumed by this amount of fixed capital did not undergo any change till the time benefit accrued on this amount to the assessee-company as a result of change in the exchange rate.
5. An alternative argument was advanced before us by Mr. Joshi that the assessee-company had, after the devaluation of the pound sterling, of its on accord decided to bring back the money to India and when the assessee-company had taken the decision and brought back the amount to India, it had given up its idea of utilising this amount for capital purposes and, therefore, the character of this deposit as a fixed capital never remained. He referred us to the extract of the letter of the assessee-company reproduced by the Tribunal in para 6 of its appellate order. The extract reads as follows:--
'As we anticipate that our disbursements in the United States in the next few months may not exceed $ 8,000.00 we desire to bring to India $40,000.00 out of the above balance (i.e. $ 48,572-GLP). We shall be glad if you will please accord your sanction for the same.'
This extract read by itself might suggest that even though it was possible for the assessee to purchase capital goods in America the assessee-company decided not to utilise the amount standing to its credit in the Tata Incorporated account for the purpose of purchase of capital goods. But that does rot appear to be the position in view of the facts stated in the statement of case submitted by the Tribunal. In para 10 of the statement it has been observed:
'On 16th September 1949 the pound sterling was devalued. Prior to the devaluation the rate of exchange between rupee and dollar was Rs. 3,330 per dollar and on devaluation the rate became Rs. 4,775 per dollar. The result was that American goods became very expensive and further the Government of India also imposed restrictions on imports from the U.S.A. This rendered further purchases of capital Bonds from the U.S.A. practically impossible. There was, therefore, no need for the assessee to retain in the U.S.A. the large amount of 48,572/30 dollars which the assessee held on 16th September 1949. The assesee, therefore, applied to the Reserve Bank of India on 17th December 1949 for permission to repatriation a sum of 40,000/- dollars out of the said sum of 48,572/30 dollars,which permission was given and the sum of 40,000/- dollarswas repatriated to India. Under similar circumstances inOctober 1950 a sum of $ 9,500/- was repatriated to India.'
These observations in the statement of case show that itwas not the decision of the assessee-company not to utilisethis amount for the purchase of capital goods that led tothe repatriation of that amount to India, but it was the(sic) of bringing goods from America toIndia that led the assessee-company to repatriate theseamounts to India. There is no evidence in this case, nora finding recorded by the tribunal that the assesee-companyhad at any time decided not to utilise these amounts forthe purpose of purchasing capital goods and, therefore, repatriated these amounts to India. That being the positionon record, it is difficult to accept this contention of Mr.Joshi also.
6. In our opinion, therefore, the sum of 36,123.02 dollars belonging to the assessee-company and lying with the Tata Incorporated to the credit of the assessee-company was a 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.
7. The view taken by us finds support in the ratio of the decision reported in 1952 22 ITR Supp 1, Davies v. Shell Co. of China Ltd. The facts of this case are: The assessee-company was a British company carrying on business of sale and distribution of petroleum products in China. It had employed number of Chinese agents to whom petroleum products were supplied by the assessee-company without receiving payment for the goods in advance. These agents, however, were required by terms of the contract to deposit with the company certain sums in Chinese dollars. The company was at liberty to use the Chinese dollars in any manner it liked. The company also was authorised to take out of this deposit any amount which might become due from the agents in the event of their default. The amount remaining due to the credit of the agents was repayable to them with interest at the determination of the agency. The company kept these Chinese dollars received by its Chinese agents in the Shanghai Bank. When War broke out between China and Japan, the company sold the Chinese dollars for sterling at the then current rate of exchange, transferred the resultant sterling amount to the United Kingdom and subsequently the company closed down its operations in China. At that time there was depreciation of the Chinese dollars with respect to sterling, and the amounts required to repay the deposits of the agents In Chinese dollars, were much less than the amounts which the company had formerly held in the Shanghai Bank for meeting that purpose. The question raised was whether the profit resulting to the assessee company as a result of change in exchange rates was taxable. The Special Commissioner held that the profits resulting to the assessee-company was a capital profit and, therefore, not subject to income-lax. This view of the Commissioner has been upheld right upto the appellate Court. In dealing with the question, the Court of appeal at page 21 of the report, reproduced the following observations from Lord Haldane's speech in John Smith and Son v. Moore, (1921) 12 Tax Cas 266 (at p. 282):
'My Lords, it is not necessary to draw an exact line of demarcation between fixed and circulating capital Since Adam Smith drew the distinction in the Second Book of his 'Wealth of Nations', which appears in the chapter onthe Division Stock, a distinction which has since become classical, economists have never been able to define much more precisely what the line of demarcation is. Adam Smith described fixed capital as what the owner turns to profits by keeping it in his own possession, circulating capital as what he makes profit of by parting with it and letting It change masters.'
At the same page, thereafter, it is staled:
''Circulating capital' simply means capital employed In the trading operations of the business and the dealings with it comprise trade receipts and trade disbursements, while 'fixed capital' simply means capital not so employed in the business, though it may be used for the purposes of the business, as a factory is used for the purpose of a manufacturing business, but does not constitute capital employed in the trading operations of the business.' In the light of the principles of law stated above, in conclusion it was observed; 'I find nothing in the facts of this ease to divestthose deposits of the character which it seems to methey originally bore, that is to say, the character of loansby the agents to the company, given no doubt to providethe company with a security, but nevertheless loans. Asloans it seems to me they must prima facie be loans oncapital not revenue account; which perhaps is only anotherway of saying that they must prima facie be consideredas part of the Company's fixed and not of its circulatingcapital. As appears from what I have said above, the evidence does not show that there was anything in the company's made of dealing with the deposits when received todisplace this prima facie conclusion.'
The aforesaid observations indicate that in deciding whether a particular sum is part of a fixed capital of anassessee or his circulating capital, the crucial test to beapplied is to ascertain the purpose to which the assesseehas appropriated that amount. No doubt the initial character of the amount at the time of its receipt would berelevant in determining the issue. In the absence of anyevidence to the contrary, the amount shall continue to bearthe same character, but the subsequent course of dealingwith that amount by an assessee is capable of changingthe initial character of the amount. If an assessee has sochanged the character of the amount then it is the use,to which that amount had been put, that would determinethe issue. If the assessee has appropriated or employed theamount to uses other than trading operations of his business, then the amount would bear the character of fixedcapital of the assessee.
8. As already stated, the assessee had decided to use these amounts for the specific purpose of purchasing capital goods and had for that purpose put it in its account with its purchasing agents specifically earmarked for that purpose. The amount thus stood appropriated to the specific purpose of purchasing capital goods. As already stated, there is no evidence or any material on record to show that the assessee had thereafter taken any different orother decision.
9. In the result, in our opinion, the answer to boththe questions should be in the negative. We answer accordingly. Costs of the assessee shall be paid by the Department.
10. Reference answered in negative.