Capital character of ECB-related foreign exchange gain and deposit interest affirmed where funds were tied to a project.

ECB funds raised for a new manufacturing project were treated as capital in nature where the loan proceeds were used for acquisition of capital assets, so the year-end foreign exchange restatement of the outstanding liability was not taxable as a revenue addition. Interest earned on fixed deposits from temporarily unutilised project funds was also treated as part of the project cost because it was inextricably linked to the borrowing and deployment of capital funds. The appellate forum further noted that a pure legal ground may be raised for the first time in appeal if the relevant facts are already on record, and the claim could be remitted for fresh adjudication. The Revenue's challenge failed on the substantive additions.

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Issues: (i) Whether the foreign exchange gain on year-end restatement of ECB loan liability and the interest earned on fixed deposits out of unutilised ECB funds were taxable additions, or were capital in nature and liable to be excluded from income. (ii) Whether a new legal claim that interest on fixed deposits was a capital receipt could be entertained at the appellate stage and sent back for adjudication.

Issue (i): Whether the foreign exchange gain on year-end restatement of ECB loan liability and the interest earned on fixed deposits out of unutilised ECB funds were taxable additions, or were capital in nature and liable to be excluded from income.

Analysis: The ECB borrowing was obtained for setting up a new manufacturing plant and the liability restated at year-end was linked to capital expansion. The findings recorded that the loan proceeds were used for acquisition of capital assets in India, making the foreign exchange fluctuation on the outstanding liability a capital item. The provisions concerning foreign currency adjustment on capital assets were held inapplicable on the facts. As to interest on fixed deposits, the earning of such interest and the borrowing cost were found to be inextricably linked, and the interest was treated as part of the project cost. The authority relied on settled principle that interest generated from temporary parking of borrowed funds for a capital project assumes the character of capital receipt.

Conclusion: The additions on account of foreign exchange gain and interest on fixed deposits were rightly deleted, and the Revenue's challenge failed.

Issue (ii): Whether a new legal claim that interest on fixed deposits was a capital receipt could be entertained at the appellate stage and sent back for adjudication.

Analysis: A legal contention can be raised before the appellate authority even if it was not made in the return or before the assessing authority, provided the relevant facts are already on record. The bar against a new claim without a revised return operates at the assessment stage and does not curtail appellate powers to admit a pure legal ground. Since the appellate authority had not examined the claim on merits, the matter required fresh consideration after giving both sides an opportunity.

Conclusion: The assessee's additional legal ground was entertainable and the matter was remitted for fresh adjudication.

Final Conclusion: The Revenue's appeals were rejected, while the assessee obtained partial relief through remand of the additional ground for reconsideration on merits.

Ratio Decidendi: Where ECB funds are raised for a capital project, year-end foreign exchange adjustment on the outstanding borrowing and interest earned from temporary deployment of such funds may be capital in character if they are integrally connected with the acquisition of capital assets; a pure legal ground can also be raised for the first time in appeal if the relevant facts are already on record.

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