1. The assessee before us is Messrs Vitre Engineering Co., Bombay. It carries on work in India as consulting engineers. However, it is not a separate entity in the sense known to company law being a division or a branch of Messrs Vitre Corporation, a Corporation incorporated in the United States of America. However, the Indian Division, viz. the assessee will be required to be considered as a company under the Indian I.T. Act, 1922.
2. Some of the employees of the assessee are American nationals, who were paid salaries partly in dollars and partly in rupees. The dollar part of the salary was paid by the head office in New York. The head office also charge the assessee for certain overhead expenses. A third head of account which was claimed by the head office pertains to work like designs, supply of drawings, etc. All this work was done in the United States of America and payment for the same was made in dollars in the United States of America. A running account used to be kept between the head office and the assessee. The assessee-company had obtained the permission of the Reserve Bank of India for maintenance of such account. The said office on the conditions imposed by the Reserve Bank of India and with the approval of the Reserve Bank of India.
3. Credit and debit entries in respect of the current account were made on the basis of the credit and debit notes sent to the assessee by the head office. Prior to June 5, 1966, the exchange rate adopted for these entries was Rs. 4.76 for one U.S. dollar, which was the official exchange rate. On June 5, 1966, the amount standing to the credit of the head office under the account came to Rs. 13,63,682. Apart from a small account of Rs. 15,805.68, which represented the cost of capital assets transferred by the head office the rest of it was on account of revenue expenditure in respect of the Indian business.
4. On June 6, 1966, the rupee was devalued to the extent of 57.5%. The new exchange rate for one U.S. dollar after devaluation came to Rs. 7.50. To give effect to this changed exchange rate, the assessee credited the head office with a sum of Rs. 7,64,830.. 27 which would seem to represent the devaluation loss. A corresponding amount was debited earlier to 'gain or loss on foreign exchange'. Between June 5, 1966, and December 31, 1966, the assessee remitted to its head office $1,60,124.84 which in terms of the devalued rupee amounted to Rs. 12,00,936.30. This would be against the rupee equivalent to Rs. 7,62,499.24 which was required prior to devaluation. In other words, the assessee had to pay Rs. 4,38,437.06 to discharge its dollar liability to the head office to the extent it was discharged during this period.
5. In this reference, we are concerned with the previous year ending December 31, 1966. For this previous year, the assessee claimed a net loss of Rs. 6,82,355.30. The principal amount of this loss was a sum of Rs. 7,64,830.27. To this a small amount of Rs. 16,492.31 being the difference in the exchange value at the time of actual remittance, was added and the aggregate sum was reduced by Rs. 93,967.28 which excess amount has been received from the atomic department from whom $ 36,144.57 was payable prior to the devaluation. The higher rupee equivalent was received for this amount after the devaluation and Rs. 98,967.28 had then been credited to the account designated as 'gain or loss on foreign exchange'. Thus, the total net loss claimed came to Rs. 6,82,355.30.
6. Before, the ITO, the said amount was claimed as a business loss in respect of the assessee's income for the previous year ending December 31, 1966, that is, in the assessment year 1967-68. Before the ITO, it was contended that the Indian business was a self-contained unit of assessment so far as the Indian I.T. Act was concerned and that the separateness of the head office and the branch would have to be recognised and accepted in computing the profits in respect of the Indian business. It was pointed out that the Indian branch had in fact purchased dollars at increased rate from the authorised dealer to make the actual payment to the head office and would be required to make the necessary extra provision in rupees for this purpose in respect of the balance amount payable to the head office. It was urged that the head office was required to be reimbursed in respect of the expenses incurred by it in dollars and that for purchasing these dollars a higher amount in terms of rupees was required to be paid by the Indian branch, that is, the assessee. It was pointed out that no profit accrued to the head office in respect of this payment but there was a loss to the assessee which had directly arisen on account of the devaluation. It was contended that this additional liability of the assessee represented a business loss proper in computing the assessee's total income.
7. These submissions were not accepts by the ITO. The ITO was of the view that the assessee as such had no liability as on the date of the devaluation. He held further that the loss which arose at the time remittance was not in the course of earning the income. A copy of order of the ITO is found annexed as annexure 'A' to the statement of case.
8. The assessee appealed to the AAC and elaborate arguments were addressed to him in support of the claim. It was urged that either the entire amount of Rs. 7,81,322 or at least Rs. 4,38,637 which represented the actual extra rupee payment incurred to obtain dollars sent to the United States between June 6, 1966, and December 31, 1966, should be allowed. The substance of the various arguments advanced before the AAC was that the expenses incurred by the head office were on revenue account, that they were in respect of the business carried on in India and that following the devaluation, an increased burden by virtue of the same being payable dollars had fallen on the assessee. It was urged that such increased burden was a loss incidental to the assessee's business and that the same was allowable in computing the assessee's income. It was pointed out that under the Indian I.T. Act, the Indian branch was a separate assessable entity and this dichotomy between the branch and the head office had to be borne in mind in considering the claim.
9. The AAC accepted the contention that the expenses incurred by the head office were wholly for the business of the Indian branch, that is, the assessee, and that on that account they were fully allowable. The AAC also accepted that if a third party had incurred these expenses, then the assessee was liable to reimburse these expenses in dollars. In such a case, viz. reimbursement to a third party, if such reimbursement was made after devaluation, then the increase in cost would depend either on the basis of accrual or remittance depending upon the system of accounting. The AAC also accepted that such loss would have been on revenue account because the liability did not relate to any capital assets acquired by the Indian branch. The AAC, however, was of the opinion that there was no legal liability on the part of the assessee since the branch, that is, the assessee, and the head office were in law two parts of the same legal entity. According to the AAC, therefore, devaluation could not have increased the legal liability of the Indian branch and such liability would arise and could be considered only when there is a third party involved. The AAC also did not accept that there was any obligation on the part of the assessee claims and contentions of the assessee for allowing the entire amount or part of it were rejected.
10. The assessee carried the matter to the Income-tax Appellate Tribunal and in I.T.A. No. 3951 (Bom) of 1970-71, the Income-tax Appellate Tribunal accepted fully the contentions of the assessee. According to the Tribunal, there was no vital difference between the case of reimbursement to a third party and reimbursement to the head office. According to the Tribunal, further, the AAC had misdirected himself and had not noted that there was no extra payment or excess payment required to be made to the head office. According to the Tribunal, the excess rupee payment was what the branch was required to pay to the Reserve Bank of India to purchase the same amount of dollars on account of devaluation of the rupees. In other words, the increase in liability was in respect of the trading liability of the Indian business whose profits are charged to income-tax and considered as a separate entity. The payment, thus, notional or actual, was to be made to a third party, viz., the Reserve Bank or authorised foreign exchange dealer, to obtain the same amount of dollars which were to be sent to the head office for reimbursement. It also rejected the conclusion reached by the AAC that there was no obligation to reimburse the head office in terms of dollars. It considered the practice as also the permission granted by the Reserve Bank of India and observed that this made it amply clear that the payment had to be made abroad in terms of dollars. Thus, negativing these two conclusions of the AAC, it agreed with the other aspects of his approach and came to the conclusion that the entire loss claimed, and not the smaller amount, had to be met in the previous year on the basis of the system of accounting, had to be met in the previous year on the basis of the system of accounting of the assessee which is mercantile. It observed that, on this basis, the assessee had got to provide for this known and certain loss in the period between June 6, 1966 and December 31, 1966. Thus, the Tribunal allowed the entire deduction of loss of Rs. 7,81,323 claimed by the assessee.
11. Aggrieved by the decision of the Tribunal, the Commissioner of Income-tax has made a reference to this court and the question referred to us is as under :
'Whether, on the facts and in the circumstances of the case, the assessee was entitled to the deduction of the full amount of Rs. 7,81,323 or any part thereof as a business loss ?'
12. Before us the learned counsel for the Revenue urged the argument which had appealed to the AAC. In our opinion, the approach of the AAC was improper in the facts and circumstances of the case and was rightly rejected by the Tribunal. We may, however, briefly advert to two authorities cited by counsel for the Revenue.
13. In Sutlej Cotton Mills Ltd. v. CIT : 116ITR1(SC) , the Supreme Court was considering remittances out of profits earlier earned by the assessee-company and the claim of the assessee that on the remittances which were subsequent to the devaluation of the Pakistan rupee, it had suffered certain loss. On facts, we are of the opinion that this case is not comparable to the one before us and discussion would seem to be or very little assistance to the point being considered by us.
14. We were also referred to the decision of the Calcutta High Court in CIT v. Invest Import : 137ITR310(Cal) . In the said case, the Calcutta High Court was considering particularly the question whether the loss on account of diminution in value of Indian rupee could be allowable in the year in which it was claimed or in the year in which the amount was actually repatriated in terms of dinars to Yugoslavia. The High Court held that there was no revenue loss in the year of devaluation and left open for consideration the other question. In our case, there is a clear finding by the Tribunal that the assessee kept its accounts on the mercantile system. On that system, it is clear to us that the assessee was required to provide a higher amount in terms of rupees for its liability for reimbursement and on this system 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.
15. We are, therefore, unable to get any assistance in favour of the Commissioner from either of the aforesaid two decisions cited. In our opinion, the view taken by the Tribunal is the proper view and in accordance with this, the question referred to us is answered as under :
16. The assessee is entitled to the deduction of the full amount of Rs. 7,81,323 as a business loss during the assessment year in question.
17. The Commissioner to pay the costs of the reference to the assessee.