Forex gain on capital account is not income and therefore not taxable: ITAT Mumbai
Fact and Issue of the case
The issue in appeal lies in a very narrow compass of material facts. The assessee before us is an individual. During the course of scrutiny assessment proceedings, the Assessing Officer noticed that “as per the AIR information, and as per capital account of the assessee, the assessee is in receipt of Rs 1,12,35,326”. When the Assessing Officer probed this entry further, it was explained by the assessee that on 29th March 2010 the assessee had extended a personal interest free loan of US $ 2,00,000 to his cousin one Shravan Shyam Shroff in Singapore (SSS-S, in short). The remittance so made was under LRS (Liberalized Remittance Scheme) issued by the Reserve Bank of India. As on that date, the prevailing exchange rate for purchase of one US $ was Rs 45.14, and, therefore, the assessee had to pay Rs 90,30,758 for this remittance of US $ 2,00,000. The borrower, namely SSS-S, paid back this amount of US $ 2,00,000 to the assessee on 24th May 2012. On that day, while converting the US $ into Indian Rupees, the exchange rate for purchase of one US $ was Rs 56.18. Accordingly, the amount credited to the assessee’s account was Rs. 1,12,35,326. The entry in question was thus explained by the assessee. The matter, however, did not end there. The Assessing Officer was apparently of the view that while entry was explained, the difference, in terms of Indian Rupees, on account of this transaction was of income nature. It was explained by the assessee that the loan account was purely personal, it was not in the nature of a business transaction, and that there was no motive of economic gains in this transaction. It was explained that the loan transaction was in terms of the Liberalized Remittance Scheme of the Reserve Bank of India in as much as it was a permitted transaction, and specifically on capital account. It was further explained that the transaction was in capital field and that, therefore, “the gain is in the nature of capital receipt and hence not offered for taxation”. None of these submissions, however, impressed the Assessing Officer so far as taxability of the surplus amount, in rupee terms, was concerned.
The Assessing Officer observed that “no infirmity is observed on the advancement of loan to Shri Shyam Sunder Shroff, (but).. the dispute is with respect to gains on foreign exchange fluctuation”. He was of the view that “the gain on realization of loan would partake character of an income under the head income from other sources”. When the Assessing Officer persisted with this analysis and, as he puts it, ‘confronted’ the assessee with the same, the assessee, without prejudice to his claim on merits, paid tax on this amount. The Assessing Officer records this development as follows:
On being confronted, with the above facts, the assessee has made a without prejudice submission vide letter dated 28-03-2016, relevant portion of which is reproduced as under:-
“The undersigned hereby VOLUNTARILY AND SUO-MOTO OFFERS the said impugned Amount of Rs.22,02,286/- to Tax, WITHOUT PREJUDICE AND AS A MATTER OF ABDUNDANT PRECAUTION AND WITHOUT CONCEDING TO THE TAXABILITY THERE-OF AND WITH A VIEW TO PURCHASE PEACE, RESERVING THE UNDERSIGNED’S RIGHT TO APPEAL. The impugned Tax on the said amount together with all applicable interest, which works out to Appx. Rs.9,00,000/- is paid and necessary challan is attached herewith”
In view of the above, the gain on loan arising out of foreign exchange fluctuation amounting to Rs.22,04,568/- is held as taxable under the Head ‘Income from Other sources’. Penalty proceedings u/s. 271(1)(c) of the 1.T. Act, 1961 is hereby initiated for furnishing inaccurate particulars of income to conceal income chargeable to tax.
It was in this backdrop that the impugned addition of Rs 22,04,568 was made by the Assessing Officer, aggrieved by which the assessee unsuccessfully carried the matter in appeal before the CIT(A). Once again the assessee made elaborate and erudite submissions on how the receipt in question is a capital receipt which is not taxable in nature. A large number of judicial precedents were cited in the submissions so made. Learned CIT(A) extensively reproduced these submissions but was not swayed by these submissions nevertheless.
It is evident that Reserve Bank of India permitted to make only rupee loan to the Non Resident Indian/ PIO. Therefore, the permission was only for rupee loan which was remitted to Foreign Residence according to their convenience in foreign currencies but from perusal of scheme it is evident that loan was in terms of rupees. In case of appellant, the loan was for an amount of Rs 90,30,758/- against which he received an amount of Rs. 1,12,35,326/- resulting into a net surplus of Rs. 22,02,286/-. Since the loan was permitted to make a rupee loan, therefore, any surplus resulting as a result of such loan transaction will be treated as an income resulting out of such loan. As per provision of the Income-tax Act if giving and taking loan is not the business of the assessee then income arising out of the loan is treated as interest of the income or income from other sources. In view of these facts, I have no reason to interfere with the findings given by the Ld. AO, therefore I confirm the addition of Rs 22,04,568/- rate by the AO under the head income from other sources. The assessee is not satisfied and is in further appeal before ITAT.
Observation of the Tribunal
In the present case, it is not even in dispute, and rightly so, that the receipt is in question is in the capital field but the Assessing Officer has taxed it on the basis that “the gain on realization of loan would partake character of an income under the head income from other sources”, and the CIT(A) has justified such a taxation on the basis, which was altogether different vis-à-vis the reasoning adopted by the Assessing Officer, that the accretion in rupee terms is to be considered as interest, and is to be taxed as such by observing that “as per provision of the Income-tax Act if giving and taking loan is not the business of the assessee then income arising out of the loan is treated as interest of the income or income from other sources”. None of these reasonings meet our approval. The Assessing Officer has proceeded to proceed on the basis that gains on realization of loan partakes the character of an income under the head income from other sources. He proceed to put cart before the horse by deciding the head under which the income is to be taxed, even before deciding whether it is of income nature, and mixes up the concept of ‘income’ with the concept of ‘gains’. What he misses out is the critical fact that, in terms of the provisions of the Income Tax Act, all ‘gains’ are not covered by the scope of ‘income’. Take, for example, capital gains. Section 2(24)(vi) provides that “income, includes……any capital gains chargeable under section 45”. Once the statutory provision itself lays down the principle that only such capital gains are included in the scope of ‘income’ as are chargeable under section 45, it is only elementary that a capital gain, which is not chargeable to tax under section 45, cannot be included in income.
It is not even the case of the authorities below that the capital gains in question are taxable under section 45. As noted by Hon’ble Supreme Court in the case of CIT Vs D P Sandu & Bros Chembur Pvt Ltd [(2005) 273 ITR 1 (SC)], “it would be illogical and against the language of section 56 to hold that everything that is exempted from capital gains by statute could be taxed as a casual or non-recurring receipt under section 10(3) read with section 56. ITAT is fortified in view by a similar argument being rejected in Nalinikant Ambalal Mody v. S.A.L. Narayan Row, CIT [(1966) 61 ITR 428 (SC)]”. Interestingly, this judicial precedent was repeatedly cited before the authorities below, but there was not even an effort to deal with this judicial precedent. It is also important to note that, as elaborated in Shaw Wallace case (supra), “a capital receipt, in principle, is outside the scope of ‘income’ chargeable to tax and a receipt cannot be taxed as income unless it is in the nature of a revenue receipt or is specifically brought within ambit of ‘income’ by way of specific provisions of the Income-tax Act”, and that “Howsoever liberal or narrow be the interpretation of expression ‘income’, it cannot alter character of a receipt i.e. convert a capital receipt into a revenue receipt or vice versa. There is no warrant for inference that even the most liberal interpretation of ‘income’ can nullify or blur the all-important distinction between capital receipt or revenue receipt”. Viewed thus, the reasoning adopted by the Assessing Officer was incorrect and it does not meet our approval. Learned CIT(A)’s line of reasoning was no better. While he accepts that the transaction in question was in the capital field, he proceeds to hold that ‘income’ arising out of the loan transaction is required to be treated as ‘interest’ or ‘income from other sources’, but all this was a little premature because he proceeded to decide as to what is the nature of income or under which head is to be taxed, without dealing with the foundational plea that the scope of income does not include the gains in capital field. If the transaction was in capital field, as he accepts, where is the question of a capital receipt being taxed as income unless there is a specific provision of bringing such a capital receipt to tax.
In any case, where the loan is foreign currency denominated and the amount advanced as loan, as also received back as repayment, is exactly the same, there is no question of interest component at all. The expression ‘interest’ is neatly defined under the provisions of the Income Tax Act. Under section 2(28A), interest is defined as “interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized”. Essentially, therefore, interest is the amount “payable” in any manner in respect of “moneys borrowed or debts incurred” but in the present case nothing more than principal debt has been paid by the borrower, and unless borrower pays an amount in respect of moneys borrowed or debts incurred, the definition of interest does not come into play. Yes, there was a benefit or a gain to the assessee; that is not even in dispute. The benefit or the gain was not on account of interest payment; that benefit or gain was on account of foreign exchange fluctuation but since the foreign exchange fluctuation with respect to a transaction in capital field, on the facts of this case foreign exchange fluctuation receipt itself turned out to be a capital receipt. The CIT(A) was, therefore, in error in holding the foreign exchange fluctuation income to be in the nature of ‘interest’. As for his holding that the income was taxable as income from other sources, that is exactly what the Assessing Officer had also done, and, for the detailed reasons set out above, that approach does not meet my judicial approval either.
Let now deal with the other limb of reasoning adopted by the CIT(A) with respect to his stand that, under the TERMS issued by the Reserve Bank of India, only rupee loans were permissible to the non-resident close relatives. That cannot be a subject matter of adjudication by an income tax authority, or even for this Tribunal. Whether the transaction of loan to NRI/PIO close relative was permissible or not, the fact remains that, beyond any controversy or dispute, such a transaction did take place, and the Assessing Officer has specifically observed that “no infirmity is observed on the advancement of loan to Shri Shyam Sunder Shroff, (but) the dispute is with respect to gains on foreign exchange fluctuation”. The limited question that was required to be adjudicated by the CIT(A), therefore, was whether given this factual matrix, the gains on foreign exchange fluctuations were required to be taxed in the hands of the assessee or not. Nothing, therefore, turns on the fact, even if that be so, that only rupee denominated loans were permitted to be extended by the assessee to his close relative NRI/PIO cousin. In any case, merely because the rupee loans are specifically permitted to the NRI/PIO close relatives, this fact per se cannot lead to the conclusion that foreign exchange denominated loans being extended to the NRI/PIO close relatives was prohibited. Be that as it may, I am not inclined to, nor do I see any reasons to, deal with the broader question as to whether or not such a transaction of foreign exchange denominated loan, as the assessee has indeed entered into, was permissible or not. That is neither my domain nor my concern. If this transaction was impermissible under the Foreign Exchange Management Act, 1999, the consequences must flow under that legislation itself. The Income Tax Act, 1961 has nothing to do with the consequences, even if that be so, of impermissibility of such transactions under the FEMA or Liberalized Remittance Scheme framed thereunder- at least in the context of dealing with an income. For the detailed reason set out above, I am of the considered view that the impugned addition of Rs. 22,04,568 is not sustainable in law.
In the result, the appeal is allowed in the terms that the impugned addition of Rs. 22,04,568 is not sustainable in law. The Assessing Officer is, accordingly, directed to delete the same. The assessee gets the relief accordingly.
Read the full order from belowForex-gain-on-capital-account-is-not-income-and-therefore-not-taxable-ITAT-Mumbai