2009 (2) TMI 95 - HC - Income Tax

High Court affirms surplus from contract cancellation as capital receipt, not subject to tax

The High Court upheld the Tribunal's decision that the surplus from the cancellation of a forward exchange contract was a capital receipt not subject to ... Surplus received on cancellation of forward foreign exchange contract - AO has treated the surplus as not liable to tax – CIT plea is that order of AO is erroneous – held that mere cancellation of the contract does not result in any transfer of any asset - held that the surplus received was a capital receipt not liable to tax - since AO made necessary inquiries and applied his mind while concluding that the receipt was on capital account, CIT could not exercise jurisdiction u/s 263 Issues Involved:1. Whether the profit on cancellation of a forward exchange contract is a capital receipt or a revenue receipt.2. The applicability of Section 28(iv) of the Income Tax Act, 1961.3. The applicability of capital gains tax under Section 2(47) of the Income Tax Act, 1961.4. The validity of the Commissioner of Income Tax's (CIT) invocation of powers under Section 263 of the Income Tax Act, 1961.Detailed Analysis:1. Profit on Cancellation of Forward Exchange Contract:The primary issue was whether the sum of Rs. 68,66,673/- received by the assessee upon cancellation of a forward foreign exchange contract was a capital receipt. The Tribunal found that the assessee, a manufacturer of textile fabrics, entered into the forward contract to guard against foreign currency rate fluctuations for importing machinery and equipment. The Tribunal held that the surplus was a capital receipt because it was related to discharging an obligation on capital account, i.e., borrowing for importing capital assets. This finding was supported by precedents, including CIT Vs. Tata Locomotive And Engineering Co. Ltd. and Universal Radiators Vs. CIT, which established that such surplus partakes the character of a capital receipt.2. Applicability of Section 28(iv):The Tribunal also addressed the CIT's observation that the receipt could be taxable under Section 28(iv) of the Act. It concluded that since the surplus was received in cash, Section 28(iv) could not be invoked. This conclusion was based on the High Court's decision in CIT Vs. Alchemic Pvt. Ltd. and CIT Vs. New India Industries Ltd., which were upheld by the Supreme Court in CIT Vs. Mafatlal Gangabhai And Co.(P.) Ltd. Section 28(iv) applies to benefits or perquisites that are not in cash, thus not applicable to the cash surplus received by the assessee.3. Applicability of Capital Gains Tax:The Tribunal held that the surplus from the cancellation of the contract did not involve any transfer or assignment of any asset under Section 2(47) of the Act. The cancellation did not constitute a transfer of a capital asset, aligning with the Supreme Court's decision in Vania Silk Mills P. Ltd. Vs. CIT. Therefore, the surplus was not liable to capital gains tax.4. Validity of CIT's Invocation of Section 263:The Tribunal found that the CIT's invocation of Section 263 was not justified. The Assessing Officer had made necessary inquiries and concluded that the surplus was on capital account, a view the Tribunal found more reasonable than the CIT's. The Tribunal noted that the CIT was uncertain whether the profit was a revenue receipt or a capital gain, as indicated by the direction to the Assessing Officer to tax the surplus either way. The Tribunal emphasized that Section 263 powers should not be exercised lightly and require compelling reasons. This view was supported by the Supreme Court's decision in Malabar Industrial Co. Ltd. Vs. CIT, which stated that if the Assessing Officer's view is one of the possible views, the CIT cannot treat it as erroneous unless it is unsustainable in law.Conclusion:The High Court upheld the Tribunal's decision, affirming that the surplus received on cancellation of the forward foreign exchange contract was a capital receipt not liable to tax. The Tribunal's findings on the non-applicability of Section 28(iv) and capital gains tax were also upheld. The CIT's invocation of Section 263 was deemed unjustified as the Assessing Officer's view was reasonable and sustainable in law. The appeal was dismissed with no order as to costs.