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PETITIONER: SUTLEJ COTTON MILLS LTD.

       Vs.

RESPONDENT: COMMR. OF INCOME TAX, WEST BENGAL, CALCUTTA

DATE OF JUDGMENT27/09/1978

BENCH: BHAGWATI, P.N. BENCH: BHAGWATI, P.N. TULZAPURKAR, V.D.

CITATION:  1979 AIR    5            1979 SCR  (1) 976  1978 SCC  (4) 358  CITATOR INFO :  RF         1980 SC 680  (11)

ACT:      Income Tax Act, 1922-Secs. 10(1), 10(2)-Loss occasioned on account  of  devaluation-Whether  deductible  as  revenue expenditure-Circulating capital and fixed capital.      The assessee  is a  Limited  Company  having  its  Head Office in Calcutta.

HEADNOTE:      It has  inter alia  a  Cotton  Mill  situated  in  West Pakistan where  it carries  on business of manufacturing and selling cotton  fabrics. For the accounting year relevant to the assessment  year 1954-55,  the  assessee  made  a  large profit in  the unit  in West  Pakistan. The Pakistan profit, according to  the official  rate of exchange, which was then prevalent, namely,  100 Pakistani  rupees being equal to 144 Indian rupees  amounted to  Rs. 1,68,97,232  in  terms    of Indian rupees.  Since the  assessee  was  taxed  on  accrual basis, the sum of Rs. 1,68,97,232 representing the Pakistani profit was  included in the total income of the assessee for the assessment  year 1954-55  and  the  assessee  was  taxed accordingly  after   giving  double   taxation   relief   in accordance with  the bilateral  agreement between  India and Pakistan. On  8th August,  1955,  the  Pakistani  rupee  was devalued and  parity between  Indian and Pakistani rupee was restored. The assessee thereafter succeeded in obtaining the permission of  the Reserve  Bank of Pakistani to remit a sum of Rs.  25 lakhs  in Pakistani  rupees out  of the Pakistani profit for the assessment year 1954-55. The profit of Rs. 25 lakhs in  terms of Pakistani rupees had been included in the total income of the assessee for the assessment year 1954-55 as Rs.  36 lakhs  in terms of Indian rupees according to the then prevailing  rate of  exchange and,  therefore, when the assessee received  the sum  of Rs. 25 lakhs on remittance of the profit  of Rs.  25 lakhs  in Pakistani rupees during the assessment years  1957-58, the  assessee suffered  a loss of Rs. 11  lakhs, in  the process  of conversion  on account of appreciation  of  the  Indian  rupee  qua  Pakistani  rupee. Likewise, in  the assessment  year 1959-60, a further sum of Rs. 12,50,000  was remitted  by the assesses to India out of the Pakistani  profit for  the assessment  year 1954-55  and

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suffered a loss of Rs. 5,50,000. The assessee claimed in its assessment for  the year  1957-58  and  1959-60  that  these losses of Rs. 11 lakhs and Rs. 5,50,000 should be allowed in computing the  profit from  business. The Income Tax Officer and the Tribunal disallowed the claim. On a reference to the High Court,  the High  Court took  the view that no loss was sustained by  the assessee on remittance of the amounts from West Pakistan  and that  in any event, the loss could not be said to be a business loss because it was not a loss arising in the  course of business of the assessee but it was caused by devaluation  which was  an act  of State.  The High Court accordingly answered  the question  in favour of the Revenue and against the assessee.      Disposing of the appeals by special leave the Court, 977 ^      HELD: The  first question  that arises  is whether  the assessee suffered any loss on the remittance of Rs. 25 lakhs and Rs.  12,50,000. These two amounts admittedly came out of the Pakistani profit for the assessment year 1954-55 and the equivalent of  these two amounts in Indian currency, namely, Rs. 36  lakhs and  Rs. 18 lakhs respectively was included in the assessment  of the  assessee as part of Pakistani profit but by  the time  these amounts  came to  be repatriated  to India, the  rate of exchange had undergone change on account of  devaluation   of  Pakistani  rupee  and,  therefore,  on repatriation, the  assessee received  only Rs.  25 lakhs and Rs. 12.50  lakhs in  Indian currency instead of Rs. 36 lakhs and Rs.  18 lakhs.  The assessee thus suffered a loss of Rs. 11 lakhs  in one  case and Rs. 5.50 lakhs in the other case. The fact  that no loss was reflected in the books of the two accounts of the assessee was not a conclusive factor and the High Court  ought not  to have relied on it. It is now well- settled that  the way  in  which  entries  are  made  by  an assessee in his books of account is not determinative of the question whether  the assessee  has  earned  any  profit  or suffered any loss. [981 A-D, 982 A-B C]      Commissioner  of   Income  Tax   v.   Tata   Locomotive Engineering Co., 60 I.T.R. 405 relied on.      The question  arising in  the case  is whether the loss sustained by the assessee was a trading loss and if it was a trading loss  whether it  would be  liable to be deducted in computing the  taxable profit  of the  assessee  under  Sec. 10(1) of  the Income Tax Act, 1922. The argument which found favour with  the High Court was that because the devaluation was an  act of the sovereign power, it could not be regarded as a  loss arising  in the  course of  the business  of  the assessee  or   incidental,  to  such  business,  is  plainly erroneous. It  is true  that a loss in order to be a trading loss must  spring directly  from the carrying on of business or be  incidental to  it, but it would not be correct to say that where  a loss  arises in  the process  of conversion of foreign currency  which is  part of  trading  asset  of  the assessee, such  loss cannot  be regarded  as a  trading loss because the  change in  the rate of exchange which occasions such loss is due to an act of the sovereign power. [982 D-G]      Badri Das Dada v. C.I.T., 34 I.T.R., 10 relied on.      It is  not the  factor or circumstance which caused the loss that  is material  in determining  the true  nature and character of  the loss, but whether the loss has occurred in the course  of carrying  on the business or is incidental to it. If  there is  a loss  in trading  asset, it  would be  a trading loss,  whatever be  its cause, because it would be a loss in the course of carrying on the business. If the stock in trade  of a  business is stolen or burnt the loss, though

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occasioned by external agency or act of God would clearly be a trading loss. Whether the loss suffered by the assessee is a trading  loss or  not, would  depend on  the answer to the query whether the loss is in respect of a trading asset or a capital asset.  In the  former case,  it would  be a trading loss but not so in the latter. The test may be formulated in another way  by asking  the question  whether the loss is in respect of  circulating  capital  or  in  respect  of  fixed capital. It is, of course, not easy to define precisely what is  the  line  of  demarcation  between  fixed  capital  and circulating  capital   but  there   is  a   well  recognised distinction between  the two  concepts. Adam  Smith  in  his ’Wealth of  Nations’ describes  fixed capital  as  what  the owner turns to profit by keeping it in his 978 own possession  and circulating  capital as  what  he  makes profit of  by parting with it and letting in change masters. Circulating capital  means capital  employed in  the trading operations of the business and the dealings with it comprise trading receipts  and trading  disbursements,  while  ’fixed capital’ means  capital not  so employed  in  the  business, though it  may be  used for  the purposes of a manufacturing business but  does not  constitute capital  employed in  the trading operations of the business. [982 H, 983 A-F]      Golden Horse  Shoe (new) Ltd. v. Thurgood, 18 T.C. 280; approved.      Landes Bros.  v. Simpson  19 T.C.  65; Davis v. Shell & Co. of  Chine Ltd.  32 T.C.  133; Imperial  Tobacco  Co.  v. Kelly; 25 T.C. 292; referred to with approval.      Commr. of  Income-tax. Bombay City v. Tata Locomotive & Engineering Co. Ltd. 34 I.T.R. 10 approved.      Commr. of  Income-tax, Mysore  v. Canara  Bank Ltd.  63 I.T.R. 308 approved.      It is  clear from  the authorities that where profit or loss arises  to an  assessee on  account of  appreciation or depreciation in  the value  of foreign  currency held by it, on conversion  into another  currency, such  profit or  loss would ordinarily  be trading  profit or  loss if the foreign currency is  held by  the assesses  on Revenue account or as trading asset  or as part of circulating capital embarked in the business.  But  if,  on  the  other  hand,  the  foreign currency is  held as  a capital  asset or  as fixed capital, such profit or loss would be of capital nature. [991 B-C]      In the  present case,  no finding has been given by the Tribunal as to whether the sum of Rs. 25 lakhs and Rs. 12.50 lakhs were  held by the assessee in West Pakistan on capital account or  Revenue account  and whether they were a part of fixed  capital   or  of  circulating  capital  embarked  and adventured in  the business  in West  Pakistan. If these two amounts were  employed in  the business in West Pakistan and formed part of the circulating capital of that business, the loss of  Rs. 11  lakhs and  Rs. 5.50  lakhs resulting to the assessee on  remission of  these two  amounts on  account of alterations in  the rate  of exchange,  would be  a  trading loss, but  if instead these two amounts were held on capital account and  mere part  of  fixed  capital  the  loss  would plainly be a capital loss. [991 C-E]      The Court was, therefore, unable to answer the question whether the loss suffered by the assessee was a trading loss or a  capital loss.  Ordinarily, the Court would have called for a supplementary statement of the case, from the Tribunal but since  both the  parties agreed  that it would be proper that the  matter should  go back  to  the  Tribunal  with  a direction to the Tribunal either to take additional evidence itself  or   to  direct  the  Income  Tax  Officer  to  take

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additional evidence  and make  a report,  the Court  made an order accordingly  and directed  the tribunal  to dispose of the case  on the basis of the additional evidence and in the light of the law laid down in the Judgment. [991 E-H]

JUDGMENT:      CIVIL APPELLATE  JURISDICTION: Civil  Appeal Nos. 1847- 1848/72. 979      From the  Judgment and  Order dated  30-4-1970  of  the Calcutta High Court in Income Tax Reference No. 128 of 1966.      V. S. Desai, P. V. Kapur, S. R. Agarwal, R. N. Bajoria, A. T. Patra and Praveen Kumar for the Appellant.      J.  Ramamurthy   and  Miss   A.  Suhbashini   for   the Respondent.      The Judgment of the Court was delivered by      BHAGWATI,  J.-These   appeals  by   special  leave  are directed against  a judgment  of  the  Calcutta  High  Court answering the  first question referred to it by the Tribunal in favour  of the  Revenue and  against the  assessee. There were in  all five  questions referred  by the  Tribunal  but questions Nos.  2 to  5 no  longer survive and these appeals are limited  only to question No. 1. That question is in the following terms:-           "Whether on  the facts and in the circumstances of      the case, the assessee’s claim for the exchange loss of      Rs. 11  lakhs for  the assessment  year 1957-58 and Rs.      5,50,000/- for  the assessment  year 1959-60 in respect      of  remittances   of  profit   from  Pakistan  was  not      allowable as a deduction? Since there  are two assessment years in regard to which the question arises,  there are  two appeals  one in  respect of each assessment  year, but  the question is the same. W will briefly state the facts as that is necessary for the purpose of answering the question.      The assessee  is a  limited  company  having  its  head office in  Calcutta. It has inter alia a cotton mill situate in  West   Pakistan  where   it  carries   on  business   of manufacturing and  selling cotton fabrics. This textile mill was quite a prosperous unit and in the financial year ending 31st March,  1954, being the accounting year relevant to the assessment year 1954-55, the assessee made a large profit in this unit.  This profit obviously accrued to the assessee in West Pakistan and according to the official rate of exchange which was then prevalent, namely, 100 Pakistani rupees being equal to  144 Indian  rupees, this profit, which may for the sake of  convenience be  referred  to  as  Pakistan  profit, amounted to  Rs. 1,68,97,232/-  in terms  of Indian  rupees. Since the assessee was taxed on actual basis, the sum of Rs. 1,68,97,232/- representing the Pakistani profit was included in the  total income of the assessee for the assessment year 1954-55 and  the assessee was taxed accordingly after giving double taxation  relief in  accordance  with  the  bilateral agreement between  India and Pakistan. It may be pointed out that for  some time,  after the  partition of  India.  there continued to be parity in the rate of exchange between India and 980 Pakistan but  on 18th  September 1949, on the devaluation of the Indian  rupee, the  rate of  exchange was changed to 100 Pakistani rupees  being equal  to 144 Indian rupees and that was the  rate of  exchange at which the Pakistani profit was converted into Indian rupees for the purpose of inclusion in

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the total  income of  the assessee  for the  assessment year 1954-55. The  rate of  exchange  was,  however,  once  again altered when  Pakistani rupee  was devalued  on 8th  August, 1955 and  parity between  Indian  and  Pakistani  rupee  was restored. The assessee thereafter succeeded in obtaining the permission of the Reserve Bank of Pakistan to remit a sum of Rs. 25 lakhs in Pakistani rupees out of the Pakistani profit for  the  assessment  year  1954-55  and  pursuant  to  this permission, a  sum of  Rs. 25  lakhs in Pakistani rupees was remitted by the assessee to India during the accounting year relevant to  the assessment  year 1957-58. The assessee also remitted to India during the accounting year relevant to the assessment year  1959-60 a further sum of Rs. 12,50,000/- in Pakistani  rupee   out  of  the  Pakistani  Profit  for  the assessment  year   1954-55  after  obtaining  the  necessary permission of  the Reserve Bank of Pakistan. But by the time these remittances came to be made, the rate of exchange had, as pointed  out above,  once again  changed to 100 Pakistani rupees being  equal to  100 Indian  rupees and  the  amounts received by  the assessee  in terms  of Indian  rupees were, therefore, the same, namely, Rs. 25 lakhs and Rs. 12,50,000. Now, the profit of Rs. 25 lakhs in terms of Pakistani rupees had been  included in  the total  income of the assessee for the assessment  year 1954-55  as Rs.  36 lakhs  in terms  of Indian rupees  according to the  prevailing rate of exchange of 100  Pakistani rupees  being equal  to 144  Indian rupees and, therefore, when the assessee received the sum of Rs. 25 lakhs in Indian rupees on remittance of the profit of Rs. 25 lakhs in  Pakistani rupees  on the  basis of  100  Pakistani rupees being  equal  to  100  Indian  rupees,  the  assessee suffered a loss of Rs. 11 lakhs in the process of conversion on account of appreciation of the Indian rupee qua Pakistani rupee.  Similarly,  on  remittance  of  the  profit  of  Rs. 12,50,000 in Pakistani currency the assessee suffered a loss of Rs.  5,50,000/-. The  assessee claimed in its assessments for the  assessment years  1957-58 and  1959-60  that  these losses of  Rs. 11 lakhs and Rs. 5,50,000/- should be allowed in computing  the profits  from  business.  This  claim  was however rejected  by the  Income Tax  Officer. The  assessee carried the matter in further appeal to the Tribunal but the Tribunal also sustained the disallowance of these losses and rejected the  appeals. The  decision  of  the  Tribunal  was assailed in a reference made at the instance of the assessee and Question  No. 1 which we have set out above was referred by the  Tribunal for  the opinion  of the High Court. On the reference the High Court took substantially the same view as 981 the Tribunal  and held  that no  loss was  sustained by  the assessees on  remittance of  the amounts  from West Pakistan and that  in any  event the  loss could  not be said to be a business loss,  because it  was not  a loss  arising in  the course of  business of  the assessee  but it  was caused  by devaluation which  was an  act  of  State.  The  High  Court accordingly answered  the question  in favour of the Revenue and against  the assessee.  The assessee thereupon preferred the present  appeal after  obtaining certificate  of fitness from the High Court.      The first  question that  arises for  consideration  is whether the  assessee suffered any loss on the remittance of Rs. 25  lakhs and Rs. 12,50,000/- in Pakistani currency from West Pakistan.  These two  amounts admittedly  came  out  of Pakistan profit  for the  assessment year  1954-55  and  the equivalent of  these two amounts in Indian currency, namely, Rs. 36  lakhs and Rs. 18 lakhs respectively. was included in the assessment  of the  assessee as part of Pakistan profit.

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But by  the time these two amounts came to be repatriated to India, the  rate of exchange had undergone change on account of  devaluation   of  Pakistani  rupee  and,  therefore,  on repartition, the assessee received only Rs. 25 lakhs and Rs. 12,50,000/- in  Indian currency  instead of Rs. 36 lakhs and Rs. 18 lakhs. The assessee thus suffered a loss Rs. 11 lakhs in one  case and  Rs. 5,50,000/-  in other in the process of conversion of Pakistani currency into Indian currency. It is no doubt  true-and this was strongly relied upon by the High Court for  taking the  view that no loss was suffered by the assessee-that the  books of  account of the assessee did not disclose any loss nor was any loss reflected in the balance- sheet or profit and loss account of the assessee. The reason was that  though, according  to the  then prevailing rate of exchange, the  equivalent of  Pakistani profit  in terms  of Indian rupee  was Rs.  1,68,97,232/- and that was the amount included  in   the  assessment   of  the  assessee  for  the assessment year  1954-55,  the  assessee  in  its  books  of account maintained  at the  Head Office  did not  credit the Pakistani profit  at the  figure of  Rs. 1,68,97,232/-,  but credited it at the same figure as in Pakistani currency. The result  was   that  the  loss  arising  on  account  of  the depreciation of  Pakistani rupee  vis-a-vis Indian rupee was not reflected  in the  books of  account of the assessee and hence it  could not  figure in  the balance-sheet and Profit and Loss Account. But it is now well settled that the way in which entries  are made  by an  assessee  in  his  books  of account is  not determinative  of the  question whether  the assessees has  earned any  profit or  suffered any loss. The assessee may,  by making entries which are not in conformity with the  proper accountancy  principles, conceal  profit or show loss and the entries 10-699SCI/7 982 made by him cannot, therefore, be regarded as conclusive one way or  the other. What is necessary to be considered is the true nature  of the  transaction and  whether in fact it has resulted in  profit or  loss to  the assessee.  Here, it  is clear that the assessee earned Rs. 36 lakhs and Rs. 18 lakhs in terms of Indian rupees in the assessment year 1954-55 and retained them  in West  Pakistan in  Pakistani currency  and when they  were subsequently remitted to India, the assessee received only  Rs. 25  lakhs and  Rs. 12,50,000/-  and  thus suffered loss  of Rs.  11 lakhs  and Rs.  5,50,000/- in  the process of  conversion on  account of alteration in the rate of exchange.  It is,  therefore, not  possible to accept the view of  the High  Court that  no loss  was suffered  by the assessee on  the remittance  of the  two sums of Rs.25 lakhs and Rs.  12,50,000/- from  West Pakistan. This view which we are taking  is clearly  supported by  the decision  of  this Court in  Commissioner of  Income  Tax  v.  Tata  Locomotive Engineering Company  (1) which  we shall  discuss  a  little later.      That takes  us to  the next and more important question whether the  loss sustained  by the  assessee was  a trading loss. Now this loss was obviously not an allowable deduction under any  express provision of section 10(2), but if it was a trading  loss, it  would  be  liable  to  be  deducted  in computing the  taxable profit  of the assessee under section 10(1). This indeed was not disputed on behalf of the Revenue but the  serious  controversy  raised  by  the  Revenue  was whether the loss could at all be regarded as a trading loss. The argument which found favour with the High Court was that the loss  was  caused  on  account  of  devaluation  of  the Pakistani rupee  which was an act of the sovereign power and it could  not, therefore,  be regarded  as a loss arising in

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the course  of the business of the assessee or incidental to such business  This argument is plainly erroneous and cannot stand scrutiny  even for a moment. It is true that a loss in order to  be a  trading loss  must spring  directly from the carrying on  of business  or be  incidental to it as pointed out by  Venkatarama Iyer,  j., speaking  on behalf  of  this Court in  Badri Das  Dage v.  C.I.T. (2) but it would not be correct to  say that  where a  loss arises in the process of conversion of  foreign currency  which is  part  of  trading asset of  the assessee,  such loss  cannot be  regarded as a trading loss  because the  change in  the rate  of  exchange which occasions  such loss is due to an act of the sovereign power. The  loss is  as much a trading loss as any other and it makes  no difference that it is occasioned by devaluation brought about  by an  act of  State. It is not the factor or circumstance which  causes the  loss  that  is  material  in determining the true 983 nature and  character of  the loss, but whether the loss has occurred in  the course  of carrying  on the  business or is incidental to  it. If  there is  loss in a trading asset, it would be  a trading  loss, whatever be its cause, because it would be  a loss  in the course of carrying on the business. Take for  example the  stock-in-trade of a business which is sold at  a loss.  There can be little doubt that the loss in such a  case would  clearly be  a trading loss. But the loss may also  arise by reason of the stock-in-trade being stolen or burnt  and such  a loss,  though occasioned  by  external agency or  act of  God, would equally be a trading loss. The cause which  occasions the  loss would  be immaterial  : the loss, being  in respect  of a  trading  asset,  would  be  a trading loss.  Consequently, we  find it impossible to agree with the  High Court that since the loss in the present case arose on  account of  devaluation of the Pakistani rupee and the act  of  devaluation  was  an  act  of  sovereign  power extrinsic to  the business,  the loss  could not  be said to spring from  the business  of the assessee. Whether the loss suffered by  the assessee  was a  trading loss  or not would depend on  the answer  to the  query whether the loss was in respect of a trading asset or a capital asset. In the former case, it  would be a trading loss, but not so in the latter. The test may also be formulated in another way by asking the question whether  the loss  was in  respect  of  circulating capital  or  in  respect  of  fixed  capital.  This  is  the formulation of  the test which is to be found in some of the English decisions.  It is  of  course  not  easy  to  define precisely what  is the  line of  demarcation  between  fixed capital and  circulating  capital,  but  there  is  a  well- recognised distinction  between the two concepts. Adam Smith in his ‘Wealth of Nations’ describes ‘fixed capital’ as what the  owner  turns  to  profit  by  keeping  it  in  his  own possession and ‘circulating capital’ as what he makes profit of by  parting  with  it  and  letting  it  change  masters. ‘Circulating capital’  means capital employed in the trading operations of the business and the dealings with it comprise trading receipts  and trading  disbursements,  while  ‘fixed capital means  capital not  so  employed  in  the  business, though it  may be  used for  the purposes of a manufacturing business, but  does not  constitute capital  employed in the trading operations  of the  business. Vide Golden Horse Shoe (new) Ltd.  v. Thurgood.,(1)  If there is any loss resulting from depreciation  of the foreign currency which is embarked or adventured in the business and is part of the circulating capital, it  would be  a trading  loss, but  depreciation of fixed capital  on account  of alteration  in  exchange  rate

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would be  a capital  loss. Putting  it differently,  if  the amount in  foreign currency  is utilised  or intended  to be utilised in  the course of business or for a trading purpose or for effecting a 984 transaction  on   revenue   account,   loss   arising   from depreciation in  its value  on account  of alteration in the rate of  exchange would be a trading loss, but if the amount is held  as a  capital asset, loss arising from depreciation would be  a capital  loss. This  is clearly borne out by the decided cases which we shall presently discuss.      We will  first refer  to the  English decisions  on the subject for  they are quite illuminating. The first decision to which we should call attention is that in Landes Brothers v. Simpson(1).  There the appellants who carried on business as fur  and skin merchants and as agents were appointed sole commission agents  of a company for the sale, in Britain and elsewhere, of furs exported from Russia, on the terms, inter alia, that  they should advance to the company a part of the value of  each consignment. All the transactions between the appellants and the company were conducted on a dollar basis, and owing  to fluctuations  in the  rate of exchange between the  dates  when  advances  in  dollars  were  made  by  the appellants to  the company  against goods  consigned and the dates  when  the  appellants  recouped  themselves  for  the advances on  the sale  of the goods, a profit accrued to the appellants  on  the  conversion  of  prepaid  advances  into sterling. The question arose whether this profit formed part of the  trading receipts  of the  appellants  so  as  to  be assessable to  tax. Singleton,  J., held  that the  exchange profit arose  directly in  the  course  of  the  appellants’ business with the company and formed part of the appellants’ trading receipts  for the purpose of computing their profits assessable to  income tax  under Case  I of  Schedule D. The learned Judge  pointed out  that "the profit which arises in the present  case is  a profit  arising  directly  from  the business which  had to  be done,  because-the  business  was conducted  on   a  dollar  basis  and  the  appellants  had, therefore, to  buy dollars  in order  to make  the  advances against the  goods as  prescribed  by  the  agreements.  The profit accrued  in this  case because  they had  to do that, thereafter  as   a  trading  concern  in  this  country  re- transferring or  re-exchanging  into  sterling."  Since  the dollars were  purchased for  the purpose  of carrying on the business as  sole commission  agents and as an integral part of the  activity of  such business,  it was  held  that  the profit arising  on retransfer or re-exchange of dollars into sterling was  a trading  profit falling  within  Case  I  of Schedule D. This decision was accepted as a correct decision by the  Court of  Appeal in  Davis v.  Shell &  Co. of Chine Ltd.(2) 985      We may  then refer  to the  decision of  the  Court  of Appeal in  Imperial Tobacco Co. v. Kelly(1). That was a case of a  company which,  in accordance with the usual practice, bought American dollars for the purpose of purchasing in the United States,  tobacco leaf.  But before tobacco leaf could be  purchased,   the  transaction  was  interrupted  by  the outbreak of  war and  the company had, at the request of the Treasury, to  stop all  further purchases of tobacco leaf in the United  States. The  result was  that  the  company  was required to sell to the Treasury and owing to the rise which had in  the mean  time occurred  in the dollar exchange, the sale resulted  in a profit for the company. The question was whether  the  exchange  profit  thus  made  on  the  dollars

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purchased by  the company  was a trading profit or not ? The Court of Appeal held that it was a trading profit includible in the  assessment of the company under Case I of Schedule D and Lord  Green, Master  of the  Rolls delivering  the  main judgment, said :           "The purchase  of the dollar was the first step in      carrying  out   an  intended   commercial  transaction,      namely, the  purchase of tobacco leaf. The dollars were      bought in  contemplation of  that and nothing else. The      purchase on the facts found was, as I say, a first step      in the carrying out of a commercial transaction,-"           "The Appellant  Company having provided themselves      with this  particular commodity "namely, dollars" which      they proposed  to  exchange  for  leaf  tobacco,  their      contemplated   transactions    became   impossible   of      performance, or  were not  in fact performed. They then      realised the  commodity which  had  become  surplus  to      their requirements".  When  I  say  "surplus  to  their      requirements" I  mean surplus to their requirements for      the purpose  and the only purpose for which the dollars      were acquired."           "In these  circumstances, they  sell this  surplus      stock of  dollars : and it seems to me quite impossible      to  say   that  the   dollars  have  lost  the  revenue      characteristic which  attached to  them when  they were      originally bought,  and in  some  mysterious  way  have      acquired a  capital character.  In my  opinion, it does      not  make   any  difference   that   the   contemplated      purchasers were stopped by the operation of Treasury or      Governmental orders,  if that were the case; nor is the      case affected by the fact that the purchase was under a      Treasury requisition  and was  not a  voluntary one. It      would 986      be a  fantastic result,  supposing the Company had been      able voluntarily,  at its  own free will, to sell these      surplus dollars,  if in  that case the resulting profit      should be  regarded as income, whereas if the sale were      a compulsory one the resulting profit would be capital.      That is  a distinction  which, in  my  opinion,  cannot      possibly be made."           "To reduce  the matter  to its  simplest elements,      the Appellant  Company has  sold  a  surplus  stock  of      dollars which  it  had  acquired  for  the  purpose  of      affecting a  transaction on  revenue  account.  If  the      transaction is  regarded in that light, any trader who,      having acquired commodities for the purpose of carrying      out a  contract, which  falls under the head of revenue      for the purpose of assessment under Schedule D, Case I,      then finds  that he  has bought more than he ultimately      needs and proceeds to sell the surplus. In that case it      could not  be suggested  that the  profit so  made  was      anything  but   income.  It  had  an  income  character      impressed upon it from the very first." This decision  clearly laid  down that  where an assessee in the course  of its  trade engages  in a trading transaction, such as  purchase of  goods  abroad,  which  involves  as  a necessary incident  of the  transaction itself, the purchase of currency  of the  foreign country  concerned, then profit resulting  from   appreciation  or   loss   resulting   from depreciation  of   the  foreign  currency  embarked  in  the transaction would  prima facie  be a  trading  profit  or  a trading loss.      The last English decision to which we may refer in this connection is  Davis v. The Shell Company of Chine, (supra).

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The Company  made a  practice of  requiring  its  agents  to deposit with  the company  a sum of money usually in Chinese dollars which  was repayable when the agency came to an end. Previously the  Company had  left  on  deposit  in  Shanghai amounts approximately  equal to  the  agency  deposits,  but because of  the hostilities  between China  and  Japan,  the Company transferred  these sums  to the  United Kingdom  and deposited the  sterling equivalents  with its parent company which  acted   as  its   banker.  Owing  to  the  subsequent depreciation of the Chinese dollar with respect to sterling, the amounts  eventually required to repay agency deposits in Chinese currency  were much  less than  the sums held by the Company to  meet the claims and a substantial profit accrued to the  Company. The  question arose  whether this  exchange profit was  a trading  profit or a capital profit. The Court of 987 Appeal held  that it  was a  capital profit  not subject  to income tax  and the  argument which found favour with it may be stated  in the words of Jenkins, L. J., who delivered the main judgment :           "I find  nothing in  the facts  of  this  case  to      divest those  deposits of  the character which it seems      to  me  they  originally  bore,  that  is  to  say  the      character of  loans by the agents to the company, given      no doubt  to provide  the company  with a security, but      nevertheless loans.  As loans  it seems to me they must      prima facie  be loans  on capital, not revenue account;      which perhaps  is only  another way of saying that they      must prima facie be considered as part of the company’s      fixed and  not of  its circulating  capital. As appears      from what I have said above, the evidence does not show      that there  was  anything  in  the  company’s  mode  of      dealing with  the deposits  when received  to  displace      this prima facie conclusion.           In my view, therefore, the conversion of company’s      balance  of  Chinese  dollars  into  sterling  and  the      subsequent re-purchase  of Chinese  dollars at  a lower      rate, which  enabled the company to pay off its agents’      deposits at  a smaller cost in sterling then the amount      it  had   realised  by  converting  the  deposits  into      sterling, was  not a  trading profit, but it was simply      the equivalent  of an  appreciation in  a capital asset      not forming  part of the assets employed as circulating      capital in the trade." Since the  Court took the view that the deposits were in the nature of  fixed capital, any appreciation in their value on account of  alteration in  the rate  of exchange would be on capital account  and that  is why  the Court  held that such appreciation represented  capital  profit  and  not  trading profit.      That takes  us to the two decisions of this Court which have discussed  the law  on the  subject and  reiterated the same principles for determining when exchange profit or loss can be said to be trading profit or loss. The first decision in chronological  order is  that reported in Commissioner of Income-Tax, Bombay  City v.  Tata Locomotive and Engineering Co. Ltd.  (supra). There  the assessee,  which was a limited company carrying  on  business  of  locomotive  boilers  and locomotives, had,  for  the  purpose  of  its  manufacturing activity, to  make purchases  of plant  and machinery in the United States. Tata Ink, New York, a company incorporated in the United  States, was  appointed by  the assessee  as  its purchasing agent in the United States 988

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and with  the sanction  of the  Exchange Control Authorities the assessee  remitted a  sum of $ 33,850/- to Tata Ink, New York for the purpose of purchasing capital goods and meeting other expenses.  The assessee  was also the selling agent of Baldwin Locomotive  Works of  the United States for the sale of their products in India and in connection with this work, the assessee  incurred expenses on their behalf in India and these expenses were reimbursed to the assessee in the United States by  paying the  amount to  Tata Ink,  New  York.  The assessee also  earned a  commission of $ 36,123/- as selling agent of  Baldwin Locomotive  Works and this amount received as commission  was taxed in the hands of the assessee in the relevant  assessment  year  on  accrual  basis  after  being converted into  rupees according to the then prevailing rate of exchange  and tax  was paid  on it  by the  assessee. Now these  amounts   paid  by   Baldwin  Locomotive   Works   in reimbursement of  the expenses and by way of commission were not remitted by the assessee to India but were retained with Tata Ink,  New York  for the  purchase of capital goods with the sanction of the Exchange Control Authorities. The result was that  there  was  a  balance  of  $.  48,572.30  in  the assessee’s  account   with  Tata   Ink,  New  York  on  16th September, 1949  when, on devaluation of the rupee, the rate of exchange  which was  Rs. 3.330  per dollar  shot upto Rs. 4.775 per  dollar. The consequence of this alteration in the rate of  exchange  was  that  the  assessee  found  it  more expensive to  buy American goods and the Government of India also imposed  some restrictions  on imports  from the United States and  the assessee,  therefore, with the permission of the Reserve  Bank of India, repatriated $ 49,500/- to India. The repatriation  of this  amount at  the  altered  rate  of exchange gave  rise to  a surplus  of Rs.  70,147/-  in  the process of  converting dollar  currency into rupee currency. The question  arose in  the assessment  of the  assessee  to income tax whether that part of the surplus of Rs. 70,147/-, which was  attributable to $ 36,123/- received as commission from Baldwin  Locomotive Works  was a  trading profit  or  a capital profit.  The matter was carried to this Court by the Revenue and  in the  course of  the  judgment  delivered  by Sikri, J.,  this Court  pointed out  that the  answer to the question :           "..... depends  on whether  the act of keeping the      money, i.e.,  $ 36,123/02,  for capital  purposes after      obtaining the  sanction of the Reserve Bank was part of      or a  trading transaction.  If it  was  part  of  or  a      trading transaction  then any  profit that would accrue      would be  revenue receipt;  if it  was not part of or a      trading transaction,  then the  profit made  would be a      capital profit  and not taxable. There is no doubt that      the amount of $ 36,123.02 was a revenue 989      receipt  in   the  assessee’s  business  of  commission      agency. Instead  of repatriating  it  immediately,  the      assessee obtained  the sanction  of the Reserve Bank to      utilise the  commission in  its business manufacture of      locomotive boilers  and locomotives  for buying capital      goods. That  was quite  an independent transaction, and      it is  the nature  of this  transaction which has to be      determined.  In   our  view   it  was   not  a  trading      transaction  in   the  business   of   manufacture   of      locomotive boilers  and locomotives;  it was  clearly a      transaction of  accumulating dollars to pay for capital      goods, the  first step  to the  acquisition of  capital      goods. If  the assessee had repatriated $ 36,123.02 and      then after  obtaining the  sanction of the Reserve Bank

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    remitted $ 36,123.02 to the U.S.A., Mr. Sastri does not      contest that  any profit made on devaluation would have      been a  capital profit.  But, in  our opinion, the fact      that the  assessee kept  the money  there does not make      any difference  specially, as we have pointed out, that      it was  a new  transaction which  the assessee  entered      into,  the   transaction  being   the  first   step  to      acquisition of capital goods." This Court  held that the act of retaining $ 36,123/- in the United States  for  capital  purposes  after  obtaining  the sanction of  the Reserve  Bank of  India was  not a  trading transaction in  the business  of manufacture  of  locomotive boilers and locomotives, but it was clearly a transaction of accumulating dollars  to pay  for capital  goods, the  first step in  the acquisition  of capital  goods and  the surplus attributable to $ 36,123/- was, therefore, capital accretion and not  profit taxable  in the  hands of  the assessee.  It would, thus, be seen that the test applied by this Court was whether the  appreciation in  value had  taken  place  in  a capital asset  or in  a trading  asset or in other words, in fixed capital or in circulating capital and since the amount of $  36,123/-, though  initially a trading receipt, was set apart for  purchase of  capital goods and was thus converted into a  capital asset  or fixed  capital, it  was held  that appreciation in its value on conversion from dollar currency to rupee  currency was  a capital  profit and  not a trading profit. The  position was  the same  as if  the assessee had repatriated $  36,123/- in  the relevant  assessment year in which  it  was  earned  and  then  immediately  remitted  an identical amount  to the  United States  for the purchase of capital  goods   and  profit   had  accrued   on  subsequent repatriating of  this amount on account of alteration in the rate of exchange. 990      The other decision to which we must refer is the one in Commissioner of  Income Tax,  Mysore v. Canara Bank Ltd.(1). The assessee  in this  case was  a  public  limited  company carrying on  the business  of banking  in India  and it  had opened a branch in Karachi on 15th November, 1946. After the partition in  1947, the  currencies of  India  and  Pakistan continued to  be at  par until the devaluation of the Indian rupee on  September 18, 1949. On that day the Karachi branch of the  assessee  had  with  it  a  sum  of  Rs.  3,97,221/- belonging to  its Head  Office. As  Pakistan did not devalue its currency,  the old  parity between  Indian and Pakistani rupee ceased  to exist.  The exchange  ratio between the two countries was,  however, not determined until 27th February, 1951 when  it was  agreed that 100 Pakistani rupees would be equivalent to  144 Indian rupees. The assessee did not carry on any  business in  foreign currency  in Pakistan  and even after it  was permitted  to carry  on business  in Pakistani currency on  3rd April,  1951,  it  carried  on  no  foreign exchange business.  The amount  of Rs.  3,97,221/, which was lying with  the Karachi  branch remained  idle there and was not utilised  in any banking operation even within Pakistan. On  July  1,  1953,  the  State  Bank  of  Pakistan  granted permission for  remittance and  two days later, the assessee remitted the amount of Rs. 3,97,221/- to India. This amount, in view  of the  difference in  the rate  of exchange became equivalent to Rs. 5,71,038/- in terms of Indian currency and in the process, the assessee made a profit of Rs, 1,73,817/- . The  question arose  in the  assessment  of  the  assessee whether this  profit of Rs. 1,73,817/- was a revenue receipt or a capital accretion. Ramaswami, J., speaking on behalf of this Court,  pointed out  that the  amount of Rs. 3,97,221/-

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was lying idle in the Karachi branch and it was not utilised in any  banking operation  and the Karachi branch was merely keeping that  money with it for the purpose of remittance to India and  as soon  as the  permission of  the State Bank of Pakistan was obtained, it remitted that money to India. This money was  "at no  material time  employed, expended or used for any  banking  operation  or  for  any  foreign  exchange business". It  was, to  use  the  words  of  Ramaswami,  J., "blocked and  sterilised from  the period of the devaluation of the  Indian rupee  upto the  time of  its  remittance  to India". Therefore,  even if  the money was originally stock- in-trade, it  "changed its  character of stock-in-trade when it was blocked and sterilised and the increment in its value owing to  the exchange  fluctuation must  be  treated  as  a capital receipt".  Since the  sum of  Rs. 3,97,221/- was, on the finding of fact reached by the Revenue authorities, held on capital  account and  not  as  part  of  the  circulating capital em- 991 barked in the business of banking, it was held by this Court that the  profit arising  to the  assessee on  remittance of this amount on account of alteration in the rate of exchange was not a trading profit but a capital accretion.      The law may, therefore, now be taken to be well settled that where  profit or  loss arises to an assessee on account of appreciation  or depreciation  in the  value  of  foreign currency held  by it,  on conversion  into another currency, such profit  or loss  would ordinarily  be trading profit or loss if  the foreign  currency is  held by  the assessee  on revenue account  or  as  a  trading  asset  or  as  part  of circulating capital  embarked in the business. But if on the other hand,  the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature. Now, in the present case, no finding appears to have been given  by the Tribunal as to whether the sums of Rs. 25 lakhs and  Rs. 12,50,000/- were held by the assessee in West Pakistan on  capital account  or Revenue account and whether they were  part of  fixed capital  or of circulating capital embarked and adventured in the business in West Pakistan. If these two  amounts were  employed in  the business  in  West Pakistan and  formed part of the circulating capital of that business, the  loss of  Rs.  11  lakhs  and  Rs.  5,50,000/- resulting to  the assessee on remission of these two amounts to India.  On account of alteration in the rate of exchange, would be  a trading loss, but if, instead, these two amounts were held on capital account and were part of fixed capital, the loss  would plainly  be a  capital  loss.  The  question whether the loss suffered by the assessee was a trading loss or a  capital loss  cannot, therefore, be answered unless it is first  determined whether  these two amounts were held by the assessee  on capital account or on revenue account or on revenue account  or to  put it differently, as part of fixed capital or of circulating capital. We would have ordinarily, in these circumstances, called for a supplementary statement of case  from  the  Tribunal  giving  its  finding  on  this question, but  both the  parties agreed before us that their attention was not directed to this aspect of the matter when the case  was heard  before the  Revenue Authorities and the Tribunal and  hence it  would be  desirable that  the matter should go  back to  the Tribunal  with a  direction  to  the Tribunal either  to take  additional evidence  itself or  to direct the  Income Tax  Officer to  take additional evidence and make a report to it, on the question whether the sums of Rs. 25  lakhs and Rs. 12,50,000/- were held in West Pakistan as capital  asset or as trading asset or, in other words, as

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part of  fixed capital or part of circulating capital in the business. The Tribunal will, on the basis of this additional evidence and in the light of the law laid down by us in this judgment, determine whether the loss 992 suffered by  the assessee  on remittance  of the two sums of Rs. 25  lakhs and  Rs. 12,50,000/-  was a  trading loss or a capital loss.      We accordingly  set aside  the order  of the High Court and send  the case  back to the Tribunal with a direction to dispose it  of in accordance with the directions given by us and in  the light  of the  law laid  down in  this judgment. There will be no order as to costs of the appeal. P.H.P.    Appeals allowed and case remanded. 993