Relief for Dalmia Bharat: ITAT Rules Cancellation of Forward Contract for Machinery is capital receipt [Read Order]
Observing that the forward contract was entered into for hedging the cost of acquiring a capital asset, the Tribunal ruled that the gain on its cancellation must be treated as a capital receipt and not a taxable revenue gain.
The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) deleted an addition of Rs. 92,05,509 and held that the gain from the cancellation of a foreign exchange forward contract was a capital receipt.
Dalmia Bharat Ltd., (assessee) which is engaged in the manufacture and sale of cement, refractories, and sponge iron, had entered into an agreement with Loesche GmbH Germany to import a Cement Vertical Roller Mill for its new Kapilas Unit. The contract price for the overseas supply was €41,79,800.
To protect itself against exchange rate fluctuations on this capital acquisition, the assessee booked a forward contract with UTI Bank on July 4, 2005. This contract was subsequently cancelled on July 13, 2006, resulting in a net gain of Rs. 92,05,509.
The company treated this gain as a capital receipt and, in the later Assessment Year (AY 2009-10) when the machinery was acquired, duly reduced this amount from the cost of the asset in line with Explanation 3 to Section 43A of the Income Tax Act, 1961.
During scrutiny proceedings for AY 2007-08, the Assessing Officer (AO) rejected the assessee's treatment, classifying the gain as speculative business income under Section 43(5) of the Act and adding it back to the total income.
Aggrieved by the AO’s order, the assessee filed an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)]. The CIT(A) confirmed the addition on different grounds. The CIT(A) held that the gain was a Revenue receipt chargeable to tax because the asset had not been acquired nor had any payment been made in the year under consideration.
The two-member bench comprising Vikas Awasthy (Judicial Member) and Naveen Chandra (Accountant Member) observed the issue of whether the gain on foreign exchange fluctuation was a revenue receipt or capital in nature.
The Tribunal relied on the landmark SupremeCourt decision in the case of Sutlej Cotton Mills Ltd. vs. CIT. which held that the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.
The bench observed that the forward contract was linked to the acquisition of a capital asset (plant and machinery). The Tribunal noted that the assessee’s motive was to hedge the transaction related to a capital asset.
The tribunal ruled that any gain arising from cancellation of the forward contract would result in capital gain as it is on account of capital transaction. The Tribunal also accepted the assessee’s submission that the gain had already been adjusted against the machinery’s cost of acquisition in AY 2009-10, and taxing it again in AY 2007-08 would result in double taxation.
Therefore, The tribunal set aside the order of the CIT(A) on this ground. The appeal of the assessee was partly allowed.
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