TaxTMI 
TaxTMI 
2008 (9) TMI 3
X X X X Extracts X X X X
X X X X Extracts X X X X
....hare of income. They were not to be treated as an AOP. 4. EOGIL filed his return of income for Assessment Year 1999-00 declaring its taxable income of Rs. 71,19,50,013 under Section 115JA. 5. During the year, EOGIL debited its P&L account by exchange loss of Rs. 38,63,38,980. The A.O. disallowed this loss on the ground that it was a mere book entry and actually no loss stood incurred by the assessee. 6. The decision of the A.O. was challenged in appeal by EOGIL before CIT(A), who after analyzing the PSC held that each co-venturer in this case had made contribution at a certain rate whereas the expenditure incurred out of the said contribution stood converted on the basis of the previous month's average daily means of the buying and selling rates of exchange which exercise resulted into loss/profit on conversion. Under the circumstances, according to CIT(A), it cannot be said that the assessee had incurred notional loss. In fact, during the course of proceedings, CIT(A) found that during Assessment Years 1995-96 and 1996-97 assessee had earned profits which stood taxed by the Department. He further found that one co-venturer (ONGC) had gained Rs. 293.73 crores during Assessmen....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 8. The above concurrent finding stood confirmed by the impugned judgment delivered by the Uttrakhand High Court in ITA No. 74/07 along with ITA No. 76/07 and ITA No. 77/07 decided on 17.1.2008. Hence, this civil appeal. 9. The only question which needs to be considered in this civil appeal is whether the assessee was entitled to claim deduction for foreign exchange losses on account of foreign currency translation? In other words, whether loss arising on account of foreign currency translation is allowable as deduction or not and conversely whether the gains on account of foreign currency translation is to be treated as a receipt liable to tax. 10. At the outset, we quote hereinbelow Section 42(1) of the Income Tax Act, 1961, which reads as follows: "Special provision for deductions in the case of business for prospecting, etc., for mineral oil. 42. (1) For the purpose of computing the profits or gains of any business consisting of the prospecting for or extraction or production of mineral oils in relation to which the Central Government has entered into an agreement with any person for the association or participation of the Central Government or any person authorised by....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ither single company or a consortium are the other parties to the contract. The consortium consists of an Indian partner and a foreign company. The private parties are generally called as Contractors. These contractors have a defined share which is called as "Participating Interest". One of the Contractors would be designated as an "Operator", who would have a control over day to day operations. Upfront investments are made generally by the Contractors. For this purpose, the Operator "in this case being M/s EOGIL" would make "cash calls". The operating expenses are also similarly funded. In these Contracts, generally there are three types of costs, namely, exploration costs, which is a capital expenditure, development cost which is also capital expenditure and production cost which is operational expenditure. Under the PSC, costs are recovered from the oil produced until such time as they are fully absorbed. Oil so recovered is called "Cost Oil". Oil in excess of "Cost Oil" is called "Profit Oil". In Profit Oil there is the sharing percentage. The share of each constituent is equal to their participating interest. Similarly, between the Contractors and the Government, the oil produ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... of the cash calls. Similarly, as stated above, the accounts were required to be drawn up in USD. For that purpose also one had to reconvert the costs from barrels to monetary terms. For the said reasons, clauses 1.6.1 and 1.6.2 of appendix `C' to the PSC envisaged booking of all currency gains and losses irrespective of whether such gains/losses stood realized or remained unrealized. In case of gains, a part of the credit would go to the Government, and taxes would be payable on the income to the extent of such gains credited. Therefore, in our view, currency gains and losses constituted an inextricable part of the accounting mechanism for expenses incurred on the development and production of oil. 16. Section 42 of the 1961 Act was enacted to ensure that where the structure of the PSC was at variance with the accounting principles generally used for ascertaining taxable income, the provisions of the PSC would prevail. Section 42 provides for deduction on expenditure incurred on prospecting for or extraction or production of mineral oil whereas Section 44 BB contains special provision for computing profits and gains in connection with the business of exploration or extraction or....
X X X X Extracts X X X X
X X X X Extracts X X X X
....with definitions. Under Article 1.21 "Contract Costs" means exploration costs, development costs, production costs and all other costs related to petroleum operations. Similarly, "Cost Petroleum" is defined to mean the portion of the total volume of petroleum produced which the contractor is entitled to take for the recovery of Contract Costs as specified in Article 13. Under Article 13 the Contractor is entitled to recover Contract Costs out of the total volume of petroleum produced. That costs include development and exploration costs. Similarly, Article 1.69 defines "Profit Petroleum" to mean all petroleum produced and saved from the Contract Area in a particular period as reduced by Cost Petroleum and calculated in terms of Article 14. Continuing the analysis of PSC, Article 7 inter alia provides that the contractor shall provide for all funds necessary for the conduct of petroleum operations. Article 13 deals with recovery of costs, as stated above. Article 15 deals with taxes, royalties, rentals etc. It indicates that Government of India is entitled to get taxes apart from profit petroleum. Article 15.2.1 inter alia provides that in order to compute profits of the business co....
X X X X Extracts X X X X
X X X X Extracts X X X X
....to whether the expenses were of revenue or capital nature. In view of the special accounting procedure prescribed by the PSC, Accounting Standard 11 had to be ruled out. 23. The question before us still remains as to whether the PSC talks of translation, and if so, whether translation losses could be claimed by EOGIL. In this connection, we need to consider Article 20.2 which inter alia states that the rates of exchange for the purchase and sale of currency by the Contractor shall be the prevailing rates as determined by the State Bank of India and for accounting purposes under the PSC such rates shall apply as provided for in clause 1.6 of Appendix `C' to the PSC. Appendix is a part of PSC. The purpose of Appendix `C' inter alia is to prescribe the Accounting Procedure. Clause 1.1 of appendix `C' provides for classification of costs and expenditures. That classification is warranted as PSC contemplates costs recovery by the contractor(s), who has made initial contribution/investment of funds in foreign currency. The said classification of costs and expenditures is also indicated in appendix `C' for profit sharing purposes and for participation purposes. Appendix `C' prescribes t....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... of the daily means of buying and selling rates of exchange (see clause 1.6.1 of Appendix `C' to PSC). 27. The above analysis shows that the capital contribution had to be converted under the PSC at one rate whereas the expenditure had to be converted at a different rate. This exercise resulted into loss/profit on conversion. Under the PSC, the respondent had to convert revenues, costs, receipts and incomes. If EOGIL had a choice to prepare its accounts only in USD, there would have been no loss/profit on account of currency translation. It is because of the specific provision in the PSC for currency translation that loss/profit accrued to EOGIL. Moreover, under clause 1.6.2 of Appendix `C' to PSC it was inter alia provided that any realized or unrealized gains or losses from the exchange of currency in respect of Petroleum Operations shall be credited or charged to the Accounts. Therefore, it would be wrong to say, as stated by the A.O., that the currency translation losses incurred by EOGIL, during the years in question, was only a notional loss/ book entry. 28. To sum up, the simple question which arises for determination in this civil appeal is whether translation losses ar....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ove, in PSC, the foreign company provides the capital investment and cost and the first proportion of oil extracted is generally allocated to the company which uses oil sales to recoup its costs and capital investment. The oil used for that purpose is termed as "cost oil". Often a company obtains profit not just from the "profit oil", but also from "cost oil". Such profits cannot be ascertained without taking into account translation losses. Moreover, as stated above, taxes are embedded in the profit oil. If these concepts are kept in mind then it cannot be said that "translation losses" under the PSC are illusory losses. 32. Before concluding, we may point out that on behalf of the Department, great emphasis was placed on clause 3.2 of Appendix `C' annexed to the PSC which inter alia referred to costs not recoverable and not allowable under the Contract (PSC). In the said clause it was stated that exchange losses on loans or other financing would not be admissible for deduction. We find no merit in this argument advanced on behalf of the Department. As stated above, "Cash Call" is not a loan. It is a contribution made into the Account of the Operator by each co-venturer in USD. ....