Gains from Cancelled Forex Contracts Deemed Capital Receipts, Adjusted Against Plant & Machinery Costs u/s 43A(1.

The Tribunal determined that the gains from the cancellation of foreign exchange forward contracts are capital receipts, as they were entered into to hedge against liabilities from foreign loans used for acquiring capital assets. Consequently, these gains should be deducted from the cost of plant and machinery as per section 43A(1), aligning with Explanation 3.

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Issues Involved:
1. Whether the gains earned on cancellation of the Foreign Exchange Forward Contract are capital receipt or revenue receipt.
2. If it is capital receipt, whether the same should be reduced from the cost of plant & machinery in connection with which the forward contract was entered into.

Summary:

Issue 1: Nature of Gains from Cancellation of Forward Contracts
The primary question was whether the gains earned on the cancellation of foreign exchange forward contracts are capital receipts or revenue receipts. The assessee argued that the forward contracts were initially entered to guard against currency losses due to exchange rate fluctuations, and not for commercial gain. The contracts were related to the repayment of foreign loans taken for acquiring plant and machinery, thus falling in the capital field. The revenue contended that the subsequent cancellation of these contracts was motivated by profit, making the gains taxable as revenue receipts. The Tribunal held that the gains from the cancellation of forward contracts were capital receipts, as the contracts were entered into to hedge against the enhancement of liabilities for repayment of foreign loans, which were for acquiring capital assets.

Issue 2: Reduction from Cost of Plant & Machinery
The second issue was whether the capital receipt should reduce the actual cost of plant and machinery by virtue of Explanation 3 to section 43A. The Tribunal noted that section 43A was enacted to adjust the cost of acquisition in cases where the value of foreign exchange varied after the machinery was acquired. The Tribunal concluded that the gains from the cancellation of forward contracts, which were connected with the foreign loans raised for purchasing machinery, should be capitalized towards the cost of the machinery as per section 43A(1), read with Explanation 3. The Tribunal emphasized that the contracts were entered into for providing foreign currency at a fixed exchange rate to meet the liability, and thus, the gains should be adjusted in the cost of the plant and machinery.

Conclusion:
The gains earned on cancellation of the foreign exchange forward contracts by the assessee are capital receipts, which should be reduced from the cost of plant and machinery in connection with which foreign loans were raised by the assessee.

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