Commissioner Of Income Tax, Dehradhun & Anr v. Enron Oil & Gas India Ltd

A COMMISSIONER OF INCOME TAX, DEHRADUN & ANR. \/. ENRON OIL & GAS INDIA LTD. (Civil Appeal No. 5433 of 2008) SEPTEMBER 2, 2008 B [S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.] Income Tax Act, 1961 - s. 42 (1) - Deduction under --Product Sharing Contract (PSC) For depletion of mineral c [oil in ][th~ ][mining area ][-][ Between Government ][of ][India and ][a ]consortium of companies, Operator whereof was a foreign -Company Return of income filed by foreign Company, deducting foreign exchange losses on account of foreign -currency translation Deduction not allowed by Assessing D [Officer ][-][ Allowed by authorities/Courts below ][-][ On ][appeal, ]held such deduction is admissible - In view of Appendix C to the·PSC which provides for translation of currency, such loss is actual and not merely notional. -Words and Phrases - 'Production Sharing Contract' E Meaning of Government of 'India, through Petroleum Ministry awarded contract for development of concessional " blocks to a consortium of Companies i.e. respondent-a foreign company and two other Indian Companies. F Respondent was designated as the Operator. The > respondent along with two other companies executed Production Sharing Contract (PSC) with Government of India. Under the PSC each co-venturer remitted money, known as Cash Call to the Operator in USA. The· G expenditure for the joint venture was made, out of the said account. The Trial Balance was required to be made ....-.. at the end of the month in USO which was then required to be translated on the basis of accounting procedure mentioned in Appendix 'C' to PCS. As per Notification H 1168 dated 8.3.1996 u/s 293A of Income tax Act, 1961, each co- venturer was liable to be assessed for his own share of income. Respondent filed its return of income for the Assessment year 1990-2000. It debited its Profit and Loss B Account by the loss due to exchange of currency. Assessing Officer disallowed the same on the ground that it was only a book entry and not actual loss. In appeal CIT (A) allowed the deduction. The order was further confirmed by appellate Tribunal as well as High Court. Hence the present appeal. c Dismissing the appeal, the Court HELD: 1.1 The respondent-assessee was entitled to claim deduction for foreign exchange losses on account of foreign currency translation. Due to the kind of D structure of the Product Sharing Contract (PSC), inherently _there has to be frequent conversion from one currency to the other. Cash calls were made in USO; some of the cash calls were required to be converted to INR for local expenses; some of the expenses stood incurred in E USO whereas some to be incurred in INR; the sale price of oil was in USO whereas the accounts were drawn up in USO. At the time of sale, the INR - USO rate would change from that on the date of the cash calls. Similarly, the accounts were required to be drawn up in USO. For F 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 G 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 ga.ins credited. Therefore, currency gains and losses constituted an inextricable part of the accounting mechanism for expenses incurred H A on the development and production of oil. [Paras 9 and 15] [1174,H; 1178,B-F] 1.2 Section 42(1) of Income tax Act, 1962 provides 5433) 1170 1172 2008 का for- admissibility in respect of three types of allowances provided they are specified in the PSC. They relate to 8 expenditure incurred on account of abortive exploration, expenditure incurred, before or after the commencement of commercial production, in respect of drilling or exploration activities and expenses incurred in relation to depletion of mineral oil in the mining area. The above C three allowances are admissible only if they cire so specified in the PSC. [Para 19] [1179,D-F] 1.3 Article 20.2 of PSC 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 0 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 E appendix 'C' provides for classification of costs and expenditures. Clause 1.6.1 of Appendix-·c· provides for translation. [Para 23] [1182,A-C] 1.4 PSC not only deals with ascertainment of profits F of individual stakeholders including Government of India but it also refers to taxes on individual shares, calculation of costs against revenues from sale of petroleum, allowances admissible for deduction, taxability, valuation, recovery, conversion etc. PSC is a complete Code by G itself. [Para 24] [1182,F-G] 1.5 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 H respondent had to convert revenues, costs, receipts and COMM. OF INCOME TAX, DEHRADUN & ANR. v. ENRON OIL & GAS INDIA LTD . incomes. If the respondent had a choice to prepare its A accounts only in USO, 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 the respondent. Moreover, under clause 1.6.2 of Appendix ·c· to PSC it was inter a/ia B 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, that the currency translation losses incurred by the respondent during the c years in question, was only a notional loss/ book entry. [Para 27] [1183,F-H; 1184,A] 1.6 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 D 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 E losses. Moreover, 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. [Para 31] [1185,C-E] 1.7 It is not correct to say that clause 3.2 of Appendix 'C' annexed to the PSC which stated .that exchange losses on loans or other financing would not be admissible for deduction. Clause 3.2 of Appendix 'C' refers to loans borrowed by an assessee or loans which are financed on which the assessee has to pay interest. That clause is G not applicable for cash call/contribution. "Cash Call" is not a loan. It is a contribution made into the Account of the Operator by each co-venturer in USO. PSC is a special regime. It does not come under Accounting Standard 11. In this case, the Court is concerned with foreign currency H SUPREME COURT REPORTS [2008] 12 S.C.R. 1172 1172 A transaction under which all monetary balances were required to be translated at the exchange rates prevailing as on the last date of the accounting year (balance sheet date) and accordingly the resultant translation gains/losses were required to be recognized which is referred to in Note B [1 (d) ][to ][Schedule ][R, ][annexed ][to ][the Accounts ][for ][the ][year ]ending 31.3.1999. [Para 31] [1185,F-H; 1185,A-D] CiVILAPPELLATE JURISDICTION: Civil Appeal No. 5433 of 2008 From the final Juagment and Order dated 17.1.2008 of the High Court of Uttarakhand at Nainital in Income Tax Appeal No. 77 of 2007 Parag P. Tripathi, ASG., Arti Gupta, Naresh Kaushik, Manish Kaushik and B.V. Balaram Das for the Appellants. Harish N. Salve, Rohan Shah,. Tarun Gulati, Praveen Kumar, Tushar Jarwal, Jaiveer Shergill, Ankur Chawla, Meenakshi Grover, Pallavi Langer and Prithvi Sidhu for the Respondent. The Judgment of the Court was delivered by S.H; KAPADIA, J. 1. Leave granted. 2. Respondent-Enron Oil & Gas India Ltd. ("EOGIL") is a company incorporated in Cayman Islands engaged in the F [business of oil exploration. ][In ][1993, Government of India through ]Petroleum Ministry invited bids for development of Concessional Blocks. EOGIL offered its bid for the development of concessional blocks. A consortium of EOGIL with RIL was given the contract. Later on, ONGC joined. EOGIL with RIL and ONGC G [executed Production Sharing Contract (PSC) with Government ]of India. EOGIL was entitled to a participating interest of 30% in the rights and obligations arising under the PSC. RIL was also entitled to participating interest of 30%. ONGC was entitled to a participating interest of 40%. EOGIL was designated as H [the Operator under the said PSC. ] COMM. OF INCOME TAX, DEHRADUN & ANR. v. ENRON OIL & GAS INDIA LTD. [S.H. KAPADIA, J.] 3. Vide Notification No. 9997 dated 8.3.1996 under A Section 293A of the Income Tax Act, 1961 ("1961 Act"), each co-venturer was liable to be assessed for his own share 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 c 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 D 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 E 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 Assessment year 1997-98 because the Indian rupee had appreciated as F compared to foreign currency and the Department had taxed the same but when during the assessment year in question there is a loss on account of such conversion, the-Department has refused to allow the deduction for such conversion losses. According to CIT(A), the Department cannot blow hot and cold. G Consequently, it was held that just as foreign exchange gain was taxable, loss was allowable under Section 42(1) of Income Tax Act in terms of the PSC. Therefore, CIT(A) allowed as deduction the loss of Rs. 38,63,38,980. 7. Aggrieved by the order passed by CIT(A) the H 1174