Decision upholds deletion of notional forex gain; USFDA approval costs allowed as business expenditure under s.37(1); reassessment upheld
ITAT SURAT - AT dismissed the revenue appeal. The Tribunal upheld the CIT(A)'s deletion of a notional foreign-exchange gain on a foreign-currency loan, holding that such valuation gains are not real income and cannot be taxed, consistent with HC precedent. It also sustained allowance of expenses incurred for USFDA approval as wholly and exclusively for business under s.37(1). The Tribunal found no infirmity in the reassessment proceedings on the facts (the appellant's reply under s.148A(b) was filed and not ignored) and declined to remit the matter to the AO.
ISSUES PRESENTED AND CONSIDERED
1. Whether notional foreign exchange gain arising on conversion of capital loan advanced in foreign currency to a foreign subsidiary, reflected on the balance sheet, is taxable as income despite being capital in nature and not realized.
2. Whether the Income Computation and Disclosure Standards (ICDS) can be applied to override binding judicial precedents or statutory provisions to treat such notional foreign exchange gains as taxable.
3. Whether expenditures incurred for USFDA clinical trials (supply of both bare stents and drug-eluting stents) for approval of existing products are deductible as business expenses wholly and exclusively laid out for the purpose of business under section 37(1).
4. Whether issuance of notice under section 148 (after inquiry under section 148A) is invalid where the time granted to the assessee to reply to a section 148A(b) notice was less than seven days and the assessing officer passed the section 148A(d) order without considering the assessee's reply.
5. Whether procedural non-compliance with the sequence and requirements of sections 148A(a)/(b)/(c)/(d) is a mere procedural lapse or vitiates the notice and reassessment proceedings where prejudice is caused by denial of the statutory minimum period or non-consideration of the reply.
ISSUE-WISE DETAILED ANALYSIS - Notional Foreign Exchange Gain on Capital Loan (Issues 1 & 2)
Legal framework: Assessment of income under the Act; distinction between capital and revenue receipts; treatment of foreign exchange gains arising on conversion of monetary assets/liabilities; applicability of ICDS as notified under section 145(2) and the saving provision that Act provisions prevail in case of conflict.
Precedent treatment: The Tribunal relied on higher court authorities establishing that appreciation/depreciation on foreign currency held as capital asset yields capital gain/loss (not taxable as revenue) unless the currency is held on revenue account; authorities further hold valuation gains on foreign monetary items at year-end may be notional and not taxable as real income. The ICDS have been held not to override binding judicial precedent or express statutory provisions.
Interpretation and reasoning: The Tribunal found the loan advanced in Euro to a foreign subsidiary to be quasi-capital in nature and the appellant was not in the business of money-lending; interest on the loan was offered as income from other sources while exchange difference on conversion at balance sheet date was not realized and was not a trading receipt. The Tribunal held that such exchange gain is notional and of capital nature, and therefore the Assessing Officer erred in adding it as taxable income relying on ICDS VI. The Tribunal emphasized that ICDS cannot override statutory provisions or binding decisions; where conflict arises Act and precedent govern.
Ratio vs. Obiter: Ratio - Notional exchange gain on conversion of capital foreign currency loan into Indian rupees, where the foreign currency is held as capital asset and not as trading asset, is capital in nature and not taxable as income; ICDS cannot be applied to convert such notional capital gains into taxable income in contradiction to binding judicial precedents and statutory law. Obiter - reliance on particular factual characterisation as "quasi capital" and reference to specific prior cases for illustrative guidance.
Conclusion: The addition of the notional foreign exchange gain was rightly deleted; revenue appeal on these grounds dismissed. Cross-reference: See issues 1-2 above and reliance on authorities holding valuation gains on foreign monetary items to be notional.
ISSUE-WISE DETAILED ANALYSIS - Deductibility of USFDA Trial Expenses (Issue 3)
Legal framework: Deduction under section 37(1) - expenditure wholly and exclusively for the purpose of business; requirement of genuineness and nexus to business activity; commercial expediency test.
Precedent treatment: No specific precedents were overruled; Tribunal applied principles regarding business expenditure, nexus and commercial expediency, and the weight of regulatory guidelines (USFDA) in establishing requirement for both bare and drug-eluting stents in clinical trials.
Interpretation and reasoning: The Tribunal accepted the assessee's explanation that USFDA guidelines require submission of both bare and drug-eluting stents for animal clinical trials to evaluate drug effect; the expenditure aimed at entering/extending the existing product into the US market (not establishing a new business). The AO's bifurcation and proportional disallowance were rejected because the supplies of both types were integral and necessary for the trials and thus wholly and exclusively for business. The Tribunal held that the AO is not competent to dictate business conduct when the expenditure is genuine and guided by regulatory requirements.
Ratio vs. Obiter: Ratio - Expenditure incurred to comply with regulatory clinical-trial requirements for testing existing products, where both items (bare and drug-eluting stents) are objectively required by regulator and the purpose is extension of existing business, is deductible under section 37(1). Obiter - commentary that AO cannot direct business operations when genuine regulatory/commercial requirements exist.
Conclusion: Deletion of the AO's disallowance of Rs. 2,08,99,216 was upheld; revenue appeal on these grounds dismissed.
ISSUE-WISE DETAILED ANALYSIS - Validity of Section 148 Notice Where Section 148A Procedure Not Followed (Issues 4 & 5)
Legal framework: Statutory scheme introduced by section 148A - inquiry before issuing section 148 notice, requirement of issuing a section 148A(b) notice with not less than seven days to reply, consideration of the reply under section 148A(c), and passing of section 148A(d) order on validity of reopening. Principles of natural justice and effect of procedural non-compliance where prejudice is caused.
Precedent treatment: The Tribunal applied recent High Court decisions (including Karnataka and Meghalaya High Courts) holding that failure to afford the statutory minimum period under section 148A(b) or failure to consider the assessee's reply before passing the section 148A(d) order vitiates the notice/ reassessment where prejudice is caused; distinguished a case where remand (for adjournment) was appropriate because facts differed (Manish Kumar). The Tribunal also relied on NTPC for admissibility of additional ground.
Interpretation and reasoning: The Tribunal found that the AO issued a 148A(b) notice dated 23.03.2022 giving time up to 29.03.2022 (6 days), thereby violating the statutory minimum of not less than seven days. The assessee filed a reply on 29.03.2022, but the AO passed the 148A(d) order on 31.03.2022 without considering that reply, contravening clauses (c) and (d). The Tribunal held that these procedural failures are not mere technicalities but substantive breaches causing prejudice; the factual matrix (reply filed but not considered) distinguished this case from authorities relied on by revenue where other procedural facts applied. Consequently, the notice and reassessment were set aside.
Ratio vs. Obiter: Ratio - Non-compliance with the express time requirement in section 148A(b) and non-consideration of the assessee's reply under section 148A(c)/(d) vitiates the notice under section 148 and consequential reassessment where the assessee is prejudiced; such procedural lapses are not necessarily curable under section 292BB where objections were not raised earlier if non-compliance affects validity. Obiter - distinctions drawn from cases with different factual sequences (e.g., where remand to afford opportunity was directed) and observations about applicability of section 292BB not required to be adjudicated once appeal dismissed.
Conclusion: The Tribunal upheld the CIT(A)'s finding that the section 148 notice and reassessment were invalid due to violation of section 148A procedure; revenue appeal dismissed. Cross-reference: Additional cross-objections and admitted legal grounds were not adjudicated after dismissal of revenue appeal.
ADMINISTRATIVE/CORRECTIVE DIRECTIONS
The Tribunal directed the Assessing Officer to verify and correct clerical/quantitative discrepancies in the tax effect stated in Form 36 where indicated by the assessee.
TaxTMI 
AI Drafter ✕
TaxTMI 
TaxTMI 
