The issue which was not the subject-matter of appeal could not be said to be merged with that of appellate order so as not to be revised by Commissioner under section 263.
The assessee's claim for allowance of depreciation on the increased rupee cost of the foreign exchange loans which the assessee had taken for the purchase of the ships was admittedly not the subject matter of appeal efore the Commissioner(Appeals) and indeed could not be since the claim had been allowed by the Income Tax Officer. In such circumstances, it could not be said that the assessment order had merged in the order of the Commissioner (Appeals) as regards this question. The Commissioner(Appeals) in revision was, therefore, justified in exercising his jurisdiction under section 262.
1. The assessee is aggrieved in this appeal by the order of the Commissioner under Section 263 of the Income-tax Act, 1961 ('the Act') whereby he has revised the assessment order directing the ITO to withdraw the depreciation allowed on a sum of Rs. 68,88,221, claimed as cost of additions made during the year to the assets constituted of ships owned and run in its shipping business by the assessee. The said amount was claimed as representing the increase in the assessee's liability on outstanding loans obtained for purchase of certain ships.
The ships had been purchased from foreign suppliers by raising loans in foreign currency. The increase in the liability was claimed to have arisen due to the increased cost of the outstanding loans in terms of Indian rupees. The loans were repayable by instalments. The Commissioner held that the assessee was entitled to such increase only in respect of the instalments which were payable during the year of account and not in respect of the entire liability. He directed the ITO to allow the claim for depreciation only with reference to the loan instalments payable in the year of account.
2. Several contentions were raised by the assessee in the course of the revision proceedings which have been reproduced by the Commissioner in the impugned order at para 2 thereof as under: (i) By virtue of Section 43A of the Act, the sum of Rs. 68.88 lakhs represents increase in the cost of the asset on which depreciation has rightly been allowed.
(ii) Since the department has not allowed the increase due to fluctuation of foreign exchange rate as a revenue loss, the ITO was correct in adding it to the cost and allowing depreciation on it.
(iii) Since the assessment order was the subject-matter of appeal, no revision under Section 263 is possible.
(iv) The company has been debiting the cost of the vessel and crediting the loan account whenever the foreign exchange has gone adverse at the close of the financial year. It has similarly decreased the cost of the asset as and when the foreign exchange has gone favourable to the company.
(v) Method of accounting followed is supported by rules and procedures laid down by shipping development fund committee, a wing of the Ministry of Shipping.
3. The Commissioner rejected all these contentions. These contentions are reiterated on behalf of the assessee before us and it is contended by Shri S.P. Mehta, the learned counsel for the assessee, that in the first instance, the order is invalid and void in law and in any case it deserves to be set aside as erroneous. Shri K.A. Sathe, on behalf of the department, relies upon the Commissioner's order and has sought to sustain it by reference to case law with which we shall presently deal.
4. Shri Mehta's challenge to the validity of the order is founded on the plea that inasmuch as the assessee had preferred an appeal against the assessment order to the Commissioner (Appeals) and was, thus, made subject-matter of that appeal, the assessment order had merged with the order of the Commissioner (Appeals), so that what the Commissioner purported to do in revision proceedings was really to exercise jurisdiction over the appellate order of the Commissioner (Appeals). He had no power to do so and his order was, therefore, invalidated by lack of jurisdiction. In support of this contention, Shri S.P. Mehta has sought to rely on a ruling of the Madhya Pradesh High Court in the case of CIT v. Mandsaur Electric Supply Co. Ltd.  140 ITR 677 (FB) and on an order of a Special Bench of the Tribunal in the case of Dwarkadas & Co. (P.) Ltd. v. ITO [IT Appeal No. 1852 (Bom.) of 1977-78 dated 27-7-1979] reported in  1 ITD 303 (Bom.).
5. Now there is no dispute that the assessee's claim for allowance of depreciation on the increased rupee cost of the foreign exchange loans which the assessee had taken for the purchase of the ships was not the subject-matter of appeal before the Commissioner (Appeals) and indeed could not be, since the claim had been allowed by the ITO. In such circumstances, can it be said that the assessment order had merged in the order of the Commissioner (Appeals) as regards this question, i.e., as regards the assessee's claim of depreciation on the increased cost of the ships We have the direct authority of the Madhya Pradesh High Court in the case of CIT v. R.S. Banwarilal  140 ITR 3 (FB), on the question whether in such circumstances the doctrine of merger would operate to preclude the revisional jurisdiction of the Commissioner under Section 263. Shri Mehta's reliance on the case of Mandsaur Electric Supply Co. Ltd. (supra) is of no avail, since in that case what the Commissioner had sought to do under Section 263 was to set aside the assessment order in its entirety which included matters which had been the subject-matter of appeal before the Commissioner (Appeals). It was in those circumstances that their Lordships were pleased to hold that the Commissioner had no jurisdiction to set aside the assessment order. Respectfully following the ruling of the Madhya Pradesh High Court in the case of R.S. Banwarilal (supra), which has followed the law as laid down by the Supreme Court in the case of CIT v. Amritlal Bhogilal & Co.  34 ITR 13 and State of Madras v.Madurai Mills Co. Ltd. AIR 1967 SC 681 and the ruling of the Bombay High Court in the case of CIT v. Sakseria Cotton Mills Ltd.  124 ITR 570, we hold that there is no force in the contention raised on behalf of the assessee and that the jurisdiction exercised by the Commissioner under Section 263 was valid and proper.
6. Turning now to the merits of the assessee's claim as to whether it was entitled to depreciation on the amount of Rs. 68,88,221 for the assessment year under consideration, the relevant facts which are not in dispute may be clearly kept in view. The assessee had purchased ships for the purposes of its business from foreign suppliers who were to be paid in foreign currency. The ships were purchased in years prior to the relevant year of account. The purchase of the ships was effected by raising loans in foreign currencies. The loans were to be repaid by instalments over a period of years. The assessee had admittedly to find the necessary rupee resources for purchasing the foreign currencies to enable it to make the loan repayments. In other words, its liability for repayment of the foreign currency loans had to be met out of rupee funds. Thus, at any given point of time, the amount of its liabilities towards these loans in terms of Indian rupees would depend upon the rate of exchange as between the rupee and the foreign currency in question. It follows that the liability would, thus, vary according to the fluctuating rate of exchange. The assessee admittedly maintains its books of account for its business according to the mercantile system of accountancy. It bears to keep in view the principles of this method. As observed by the Supreme Court in the case of Keshav Mills Ltd. v. CIT  23 ITR 230: The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of book-keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed....
Following this method, the assessee had necessarily to take into account all accrued liabilities although their disbursement was to be effected in the future.
7. Now it was in accordance with the mercantile method of accounting regularly employed by the assessee that the liability for the loans to purchase the ships which it had incurred had been debited in the books as an accrued liability. It had necessarily to provide for its outstanding liability on this account as at the end of each accounting year for the purposes of drawing up a true and correct position of its state of affairs in the final accounts. Only then would the balance sheet and profit and loss account reflect the correct position of the business. In order to achieve this end, what the assessee did was to measure its outstanding liability on the loan account in terras of rupees at the rate of exchange prevalent as on the last day of the accounting year. The result naturally was a variation in the liability according to the fluctuation in the value of the rupee in terms of the rate of exchange of the rupee with the foreign currencies. If the value of the rupee fell, so would the outstanding liability increase; equally, if the value of the rupee had risen, so would its liability be reduced The assessee would write up or write down its liability accordingly. Thus, for the year under consideration as against its liability brought forward as on the first day of the accounting year, i.e., on 1-7-1973, there was an increase in the liability as on the closing day of the accounting year, i.e., 30-6-1974, to the tune of Rs. 68,88,221. In the next year, on the same basis, there was a reduction of the liability to the tune of Rs. 86,43,465 and, accordingly, the liability was written down by that amount and the depreciation was claimed on the written down value so adjusted.
8. It is on the facts discussed in the foregoing paragraphs that we have to examine the correctness of the order of the Commissioner under Section 263. His material objection to the assessee's claim is that it is not covered by the provisions of Section 43A of the Act on the footing that any increased liability due to day to day foreign exchange fluctuation would not enhance the value of the asset for the purpose of depreciation allowance. The Commissioner, however, appears to contradict himself by holding that only the increased liability arising on the payment of the instalments falling due for the year of account could be so allowed. Now Section 43A provides that where an assessee has acquired an asset from a country outside India for the purpose of his business or profession and in consequence of a change in the rate of exchange at any time after the acquisition of such assets, there is an increase or reduction in the liability of the assessee as expressed in. Indian currency for making payment towards the whole or a part of the cost of the asset or for repayment of the monies borrowed by him in any foreign currency specifically for the purpose of acquiring the asset, being in either case the liability existing immediately before the date on which the change in the rate of exchange takes effect, the amount by which the liability aforesaid is so increased or reduced during the previous year shall be added to, or as the case may be, deducted from, the actual cost of the asset, and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset, for the purpose, inter alia, of grant of depreciation allowance. On a plain reading of the statutory provision it appears to us that the assessee's claim squarely falls for allowance within its terms. There was an increase in the assessee's liability expressed in terms of Indian rupees as a result of the fluctuation in the rate of exchange and the increase took place after the date of acquisition of the asset and the assessee would, therefore, be entitled to claim depreciation with reference to this increase in terms of Section 43A.9. Indeed, the Commissioner appears to have accepted in principle that the assessee was entitled to its claim within the meaning of Section 43A, but he has whittled down the claim to the liability arising in respect of the instalements payable for the year of account for which we find no justification. It would appear that the Commissioner equated the liability of the assessee with the amount of the instalments payable during the year of account. But in doing so, he appears to have ignored the fact that what had already accrued as a liability to the assessee was the full amount payable on the foreign loans. Payment by instalments was only a mode of repayment, but that had no bearing on the accrual of the liability. As already brought out in this order, according to the mercantile system adopted by the assessee, it was the full amount of the accrued liability which had to be accounted for and which represented the cost of the assets, i.e., the ships. Shri K.A.Sathe, the learned departmental representative, has sought to overcome this flaw in the reasoning of the Commissioner by raising the contention that in determining the actual cost of the asset with reference to which alone depreciation allowance had to be computed, the particular method of accounting followed by the assessee is of no relevance. He has sought to rely on two rulings of the Supreme Court, cited as Challapalli Sugars Ltd. v. CIT  98 ITR 167 and Madeva Upendra Sinai v. Union of India  90 ITR 209 in support of his contention.' 10. In our view, there is no substance whatsoever in the contention raised by the departmental representative. We fail to see why the method of accounting regularly followed by the assessee in accordance with which it takes account of the receipts and disbursements or outlay of its business has to be given short shift when it comes to determining the actual cost of its assets. That cost to the assessee, where it follows the mercantile system of accounting, would necessarily be the liability which it has incurred on the acquisition of the asset.
In other words, it is the accrued liability on that account which would be the actual cost of the asset. It is nobody's case that the cost of the assets which had been debited by the assessee in its accounts did not represent its accrued liability for acquiring them. As for the rulings on which the departmental representative relies, we find that they are of no avail to sustain his contention. In the case of Challapalli Sugars Ltd. (supra) the Supreme Court was pleased to lay down the correct meaning of the expression 'actual cost' and to hold that for determining tbe cost of fixed assets, all expenditure has to be included as is necessary to bring such assets into existence and to put them in working condition and that interest on monies borrowed for acquisition and installation of plant and machinery forms part of the actual cost. In the case Madeva Upendra Sinai (supra) the Supreme Court was pleased to consider and determine the meaning of the terms 'actually' and 'actually allowed', in the context of the writ petitions filed in that case challenging the validity of the second proviso to Clause 3 of the Taxation Laws (Extension to Union Territories) (Removal of Difficulties) Order No. 2 of 1970. No question arose in these cases as to whether the assessee is entitled to claim depreciation with reference to its increased liability as regards the actual cost of assets, the increase being due to fall in the rate of exchange of the rupee as provided for under Section 43A.11. We, therefore, find that the assessee was clearly entitled to claim depreciation with reference to the amount of Rs. 68,88,221 and we would note here that in making the adjustments in regard to its liability, the assessee had also complied with the rules and procedures laid down by the Ministry of Shipping and Transport, Government of India, which are in the following terms: Item No. 6: Shipping companies will generally have to draw foreign exchange loans. These will have to be revalued as at the date of the balance sheet to take into account currency fluctuations and corresponding liability will be offset by additions to the value of the assets in the debit side of the balance sheet." It is true, as the Commissioner has observed, that those rules would not be conclusive in determining the depreciation allowance due to the assessee under the Act. However, in the instant case, we find that compliance with those rules was in consonance with the relevant provisions of the Act governing grant of depreciation allowance.
12. In the result, we set aside the order of the Commissioner on the point and restore that of the ITO. The assessee's appeal is allowed.