Exchange gains on foreign-currency deposits were treated as capital accretion, not trading income, where the deposits were security funds.

An exchange gain on converting Chinese dollar balances into sterling, and on later repurchasing Chinese dollars to repay agents' deposits, was treated as a capital accretion rather than trading income. The deposits were held to be in substance loans or capital receipts, repayable in Chinese dollars on termination of the agency and intended as security for the agents' obligations. As the company's business was marketing petroleum products and not dealing in foreign currency, and the deposits were not shown to have been used as circulating capital, the gain did not arise as a revenue receipt assessable under Case I of Schedule D. The company's position was upheld.

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Issues: Whether the profit arising from the conversion of Chinese dollar balances into sterling and the later repurchase of Chinese dollars to repay agents' deposits was a trading profit assessable under Case I of Schedule D of the Income Tax Act, 1918, or a capital profit not subject to income tax.

Analysis: The agents' deposits were received under agreements by which the company could use the money, but the deposits were repayable in Chinese dollars on termination of the agency and were intended as security for the agents' obligations. The company's ordinary business was the marketing of petroleum products, not dealing in foreign currency, and the exchange gain did not arise as a necessary incident of a revenue transaction of the kind considered in the cases where foreign currency was acquired for an intended trading operation. The deposits were not shown to have been used as circulating capital in the trading business; rather, they were treated as funds available to meet a capital liability. On the facts found by the Special Commissioners, the character of the deposits remained that of loans or capital receipts, and the subsequent exchange gain was an appreciation in a capital asset, not a trading receipt.

Conclusion: The profit was held to be a capital profit and not taxable as trading income; the finding in favour of the company was upheld.

Final Conclusion: The appeal failed because the exchange difference was treated as a capital accretion arising from repayment of a capital liability, rather than as a profit of the trade.

Ratio Decidendi: An exchange gain arising on the repayment of foreign-currency deposits will not be taxable as trading income where the deposits are in substance loans or capital receipts and are not shown to have been employed as circulating capital in the course of the trade.

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