Ita/272/2013 Of M/S.apollo Tyres Ltd v. The Deputy Commissioner Of Income Tax

IN THE HIGH COURT OF KERALA AT ERNAKULAM PRESENT THE HONOURABLE MR.JUSTICE S.V.BHATTI & THE HONOURABLE MR. JUSTICE BECHU KURIAN THOMAS WEDNESDAY, THE 4 DAY OF AUGUST 2021 / 13TH SRAVANA, 1943 ITA NO. 272 OF 2013 AGAINST THE ORDER IN ITA 31/COCH/2010 OF I.T.A.TRIBUNAL,COCHIN BENCH, ERNAKULAM APPELLANT/ APPELLANT : M/S.APOLLO TYRES LTD.,6TH FLOOR, CHERUPUSHPAM BUILDINGS, SHANMUGHAM ROAD, KOCHI-31. (PAN NO:AAACA69900) BY ADVS.SRI.JOSEPH MARKOSE (SR.)SRI.V.ABRAHAM MARKOSSRI.ABRAHAM JOSEPH MARKOSSRI.ABRAHAM VARGHESE THARAKANSRI.BINU MATHEWSRI.TOM THOMAS KAKKUZHIYIL RESPONDENT/ RESPONDENT : THE DEPUTY COMMISSIONER OF INCOME TAXCIRCLE 1(1), RANGE-1, KOCHI-682 018. BY ADVS.SRI.P.K.R.MENON,SR.COUNSEL, GOI(TAXES)SRI.JOSE JOSEPH, SC, FOR INCOME TAXSRI.CHRISTOPHER ABRAHAM, INCOME TAX DEPARTMENTSRI.K.M.V.PANDALAI, INCOME TAX DEPARTMENT THIS INCOME TAX APPEAL HAVING COME UP FOR ADMISSION ON04.08.2021, THE COURT ON THE SAME DAY DELIVERED THEFOLLOWING: JUDGMENT Dated this the 4[th] day of August, 2021 Bechu Kurian Thomas, J. The issue raised in this appeal relates to thedisallowance of foreign exchange loss of Rs.5,09,01,001/- forthe assessment year 2006-07. This appeal was admitted on the following three questions of law :- 1. Whether on the facts and in the circumstances of thecase, the learned Tribunal is justified in law in confirmingthe disallowance of foreign exchange loss ofRs.5,09,01,000/- holding that the amount is of the nature ofcapital loss; 2. Whether on the facts and in the circumstances of thecase, the impugned order of the learned Tribunal on theissue is vitiated by perversity in as much as the Tribunalhas confirmed the disallowance of foreign exchange loss bysetting up an entirely new case invoking the doctrine oflifting the corporate veil without any supporting facts andevidence on record and without any such finding recordedby the assessing officer. 3. Whether on the facts and in the circumstances of thecase the very basis adopted by the Tribunal for confirmingthe disallowance namely that the acquisition of the businessof Dunlop by the subsidiary of the appellant is in factacquisition of capital asset by the appellant itself runscontrary to the separate legal entity principle endorsed bythe Hon'ble Supreme Court in Azadi Bachao Andolan[263 ITR 706 (SC)] and Vodafone InternationalHoldings [344 ITR 1 (SC). 2. The assessee is a company engaged inmanufacture and sale of automobile tyres and tubes. For the assessment year 2006-07, the assessing officer computed thetotal income of the asessee at Rs.66,15,44,477/-. Whilecomputing the total income of the assessee, an amount ofRs.5,09,01,000/- claimed as a deduction on account of foreignexchange fluctuation loss was disallowed by the assessing officerby treating it as a capital loss. On appeal, the AppellateAuthority dismissed the appeal filed by the assessee against thedisallowance. In second appeal, the Tribunal confirmed the saiddisallowance. Thus, the assessee has preferred this appeal underSection 260A of the Income Tax Act, 1961 (for short, 'the Act'). 3. It may be necessary to refer briefly to thecircumstances of this case as pleaded by the assessee. With aview to expand its business, the assessee intended to take overthe Dunlop Tyre Manufacturing Company in South Africa. Forthat purpose, it formed a company in Mauritius as a wholly-owned subsidiary of the assessee known as Apollo (Mauritius)Holdings Pvt. Ltd (AMHPL). Assessee had formed yet anothersubsidiary known as Apollo (South Africa) Holding Pvt. Ltd.(ASAHPL). In the meantime, assessee entered into a foreignexchange forwards contract with the Citi Bank to reduce the riskof foreign exchange rate fluctuation. On that basis, a loan was 3. It may be necessary to refer briefly to thecircumstances of this case as pleaded by the assessee. With aview to expand its business, the assessee intended to take overthe Dunlop Tyre Manufacturing Company in South Africa. Forthat purpose, it formed a company in Mauritius as a wholly-owned subsidiary of the assessee known as Apollo (Mauritius)Holdings Pvt. Ltd (AMHPL). Assessee had formed yet anothersubsidiary known as Apollo (South Africa) Holding Pvt. Ltd.(ASAHPL). In the meantime, assessee entered into a foreignexchange forwards contract with the Citi Bank to reduce the riskof foreign exchange rate fluctuation. On that basis, a loan was issued by Citi Bank to the assessee. The loan of 314 MillionSouth African Rand issued to the assessee was given as a loanby the assessee to its subsidiary AMHPL who inturn gave it toASAHPL to acquire the business of Dunlop Tyre ManufacturingCompany in South Africa. It is the case of the assessee thatsince the purpose for which the foreign exchange forwardscontract was entered into, could not fructify till March 2006, theforward contract with the Bank had to be settled on the due datewhich was on 14.03.2006 and since the RBI did not permit rollover of payments beyond three months, the loan received had tobe settled with the bank. The settlement of foreign exchange inMarch 2006 resulted in a loss of Rs. 5,09,01,000/-. This loss isthe subject matter of this appeal. (It is worth mentioning thatASAHPL had acquired the entire shares of Dunlop Tyre Companyof South Africa on 21-04-2006.) 4. According to the assessee, the acquisition of Dunlop Tyre of South Africa enabled the parent company i.e; theassessee, to run its business more efficiently and effectively. Theestablished distribution network of Dunlop, the advantages ofacquiring the know-how of ultra-high-performance radial cartyres and easier access to raw materials at reduced costs were the advantages of the acquisition as claimed by the assessee. 5. Assessee claimed that the loan advanced by it to the subsidiary was on consideration of business expediency andthat was the reason forthe loss of Rs.5.09 crores for the AY2006-07. Therefore, it claimed deduction under section 37(1) ofthe Act. However, the assessing officer disallowed the loss. Itwas held that the expenditure incurred by the subsidiarycompany for its business was not allowable in the hands of theholding company as the subsidiary company was a separate legalentity and also that the expenditure incurred for acquisition of acapital asset was a capital expenditure. The first appeal andeven the second appeal to the Tribunal were both rejected. TheTribunal sustained the disallowance after holding that if thecorporate veil of the two subsidiary companies, i.e; those atMauritius and the other at South Africa are lifted, loss in questioncould be understood to be suffered during the process ofacquisition of a capital asset and hence the loss ought to treatedonly as a capital loss. The assessee has thus preferred thisappeal under section 260A of the Act. 6. We heard Senior Advocate Joseph Markoseinstructed by Adv. Sharad Joseph Kodianthara, on behalf of the assessee and the Adv. Jose Joseph, learned Standing Counsel forthe Department. 7. Appellant had entered into the foreign exchange forward contract with Citi Bank in January 2006. The purposefor which the loan was availed could not materialise even byMarch 2006. As the RBI did not permit roll over of a foreignexchange forward contract beyond three months, assesseerepaid the loan on 14-03-2006. In the course of repayment, dueto fluctuation in the rate of foreign exchange, assessee incurreda loss of Rs.5,0,901,000/-. 6. We heard Senior Advocate Joseph Markoseinstructed by Adv. Sharad Joseph Kodianthara, on behalf of the assessee and the Adv. Jose Joseph, learned Standing Counsel forthe Department. 7. Appellant had entered into the foreign exchange forward contract with Citi Bank in January 2006. The purposefor which the loan was availed could not materialise even byMarch 2006. As the RBI did not permit roll over of a foreignexchange forward contract beyond three months, assesseerepaid the loan on 14-03-2006. In the course of repayment, dueto fluctuation in the rate of foreign exchange, assessee incurreda loss of Rs.5,0,901,000/-. 8. The foreign exchange forward contracts aregenerally entered into by Assessees as a measure of protectionagainst an increase in liabilities while advancing foreignexchange currency loans due to the exchange rate fluctuations.Accordingly, when profit and loss arise to an assessee on accountof appreciation or depreciation in the value of foreign currencyheld by it, on conversion into another currency, such profit orloss are generally treated as profit and loss on revenue account.If, on the other hand, the foreign currency is held as a capitalasset or as a fixed asset, such profit or loss would be of a capitalnature. I.T.A. No.272/13 9. It was contended that the loss of Rs. 5.09 croreswas incurred due to cancellation of forward contracts in foreignexchange which was inextricably linked to the advancement offoreign currency loans to the Mauritius subsidiary and the loanwas an advance for the purpose of the business of the assesseecompany. The advantage intended to be gained by the assesseewas an enhancement of efficiency of tyre manufacturing businessby leveraging the sophisticated technology of Dunlop tyres forthe manufacture of radial tyres as well as obtaining a widedistribution network and improved availability of raw materials atreduced costs. 10. Learned Senior Counsel for the assessee furthersubmitted that the Tribunal went on a completely wrong tangentin treating the loss suffered by the assessee due to the foreignexchange rate fluctuation as a capital loss. It was alsosubmitted that the Tribunal ought not to have indulged in liftingthe corporate veil to disallow the claim of deduction. Learnedcounsel relied upon the decisions in SA Builders Ltd. V.Commissioner of Income Tax(Appeals), Chandigarh andOthers [(2007) 288 ITR 1], Patnaik and Co. v. Commissionerof Income Tax [(1986) 27 Taxman 287) and Union of India and Others v. Azadi Bachao Andolanand Others [(2003)263 ITR 706:[(2004) 10 SCC 1] in support of his contentions. 11. The learned Standing Counsel for the Department, on the other hand, submitted that the loss incurred by theassessee was on account of the loan availed for purchasing acapital asset in South Africa through the subsidiary companiesand as it was intended for procuring a capital asset, the loss wasnot allowable as a deduction since it could be termed only as acapital expenditure. It was further submitted that the floating oftwo subsidiary companies one in Mauritius and the other inSouth Africa were clear attempts to avoid payment of tax.According to the learned counsel, the two companies that werefloated, as mentioned above, were sham companies. The entireloan for acquisition of assets can only be treated as a capitalasset. On the aforesaid basis, it was argued that the appeal onlymerits dismissal. 12. We have considered the rival contentions. It isadmitted that the assessee had availed the foreign exchangeloan for expanding its business by taking over Dunlop in SouthAfrica through the subsidiaries. It is worthwhile to refer tosection 37 of the Income Tax Act 1963; as it stood then : S. 37 General; 12. We have considered the rival contentions. It isadmitted that the assessee had availed the foreign exchangeloan for expanding its business by taking over Dunlop in SouthAfrica through the subsidiaries. It is worthwhile to refer tosection 37 of the Income Tax Act 1963; as it stood then : S. 37 General; (1)Any expenditure (not being expenditure of the naturedescribed in sections 30 to 36 and not being in the nature of capitalexpenditure or personal expenses of the assessee), laid out orexpended wholly and exclusively for the purposes of the business orprofession shall be allowed in computing the income chargeableunder the head “Profits and gains of business or profession”. [Explanation 1.- For the removal of doubts, it is hereby declared thatany expenditure incurred by an assessee for any purpose which isan offence or which is prohibited by law shall not be deemed to havebeen incurred for the purpose of business or profession and nodeduction or allowance shall be made in respect of suchexpenditure.] 13. The words ‘for the purpose of business’ in S.37(1)have been time and again observed by the Supreme Court to begiven a wider scope than the words for the purpose of earningincome, profits or gains (reference can be made to MadhavPrasad Gatiya v. Commissioner of Income Tax, UP.Lucknow [(AIR 1979 SC 1291). Similarly, in section 37 of theAct, it has also been stated that any expenditure which isexpended wholly and exclusively for the purposes of thebusiness or profession shall be allowed as an expense whilecomputing the income chargeable under the head “income orgains” under the business or profession. The expenditure referred to in section 37 of the Act will undoubtedly includeexpenses incurred as a measure of commercial expediency. 14. The words commercial expediency is a word of wide import. It has been held that the said word can includesuch expenditure that a prudent businessman would incur toimprove his business. In this context, the decision relied uponby the learned Senior Counsel for the assessee is relevant. InSA Builders Ltd. v. Commissioner of Income Tax(Appeals), Chandigarh and Others [(2007) 288 ITR 1],theSupreme Court considered a case where the assessee haddiverted funds borrowed by it to a sister concern withoutcharging any interest. The funds so borrowed incurredproportionate interest payable to the bank. The total interestpaid to the bank for the amount so borrowed, was claimed as adeduction under section 37 of the Act. The claim was disallowedby the Tribunal and confirmed by the High Court. However, theSupreme Court interfered with the finding. It was observed inthe said decision that “the correct view in our opinion waswhether the amount advanced to the subsidiary or associatedcompany or any other party was advanced as a measure ofcommercial expediency”. The Supreme Court further observed that “We agree with the view taken by the Delhi High Court inCommissioner of Income Tax v. Dalmia Cement (B.) Ltd. [2002 254ITR 377] that once it is established that there was nexus between theexpenditure and the purpose of the business (which need notnecessarily be the business of the assessee itself), the Revenuecannot justifiably claim to put itself in the arm-chair of thebusinessman or in the position of the board of directors and assumethe role to decide how much is reasonable expenditure having regardto the circumstances of the case. No businessman can be compelledto maximize his profit. The income-tax authorities must putthemselves in the shoes of the assessee and see how a prudentbusinessman would act. The authorities must not look at the matterfrom their own view point but that of a prudent businessman. Asalready stated above, we have to see the transfer of the borrowedfunds to a sister concern from the point of view of commercialexpediency and not from the point of view whether the amount wasadvanced for earning profits”. 15. It is the admitted case of the assessee that theloan was taken for providing funding to its subsidiary companyat Mauritius to acquire a company in South Africa for thepurpose of enhancing its business and for procuring rawmaterials at reduced costs. Generally, any prudent businessman would attempt to indulge in such acts for increasing their profitsby improving the business. However, the Tribunal has proceededto treat these acts of the assessee as an attempt to acquireproperty and increase their capital base. For this purpose, theTribunal has lifted the corporate veil. 16. In the case of Union of India (UOI) and Others v. Azadi Bachao Andolan and Others [(2003) 263ITR 706 (SC)] the Supreme Court held that the Indo-MauritiusDouble Taxation Avoidance Convention, 1983 has great legalsignificance and that, notwithstanding the legal steps taken byan assessee under the convention, if the intended legal resulthas not been achieved, the court will be entitled to overlookintermediate steps but it would not be permissible for the courtto treat the intervening legal step as non est based upon somehypothetical assessment of the “real motive.” 17. On an appreciation of the findings recorded bythe Tribunal, we notice that the Tribunal has proceeded on asingular angle with an assumption that the ultimate aim ofacquiring an asset was a measure of tax avoidance without evenbearing in mind the principles of the Indo-Mauritius DoubleTaxation Avoidance Convention, 1983. The Tribunal has also not I.T.A. No.272/13 considered the concept of commercial expediency whiledetermining the question whether the expenditure claimed isallowable as a deduction under section 37 of the Act. It cannotbe stated as a general principle that in every case where a loanis taken, even if the ultimate purpose is for acquiring a capitalasset, and a resulting loss ensues thereon, the same ought to betreated as a business loss. According to us, the answer dependsupon the facts and circumstances of each case. The issue shouldhave been approached from the point of view of a prudentbusinessman and not from the eyes of the taxing authorities.Whether the loan was taken as a measure of commercialexpediency or not ought to have governed the consideration ofthe issue in this case rather than the motive behind establishingthe two subsidiaries. The concept of lifting the corporate veil had noapplication in the instant case. The corporate veil is lifted only incertain specific instances, especially when fraud is committed, orwhen tax is sought to be evaded, or when the Company resorts toillegal activities. Formation of subsidiary company in Mauritius cannotbe regarded as such an illegal act as explained by the Supreme Court in Union of India (UOI) and Others v. Azadi BachaoAndolan and Others [(2003) 263 ITR 706 (SC)]. We feel that I.T.A. No.272/13 in Union of India (UOI) and Others v. Azadi BachaoAndolan and Others [(2003) 263 ITR 706 (SC)]. We feel that I.T.A. No.272/13 as a final fact finding authority, the Tribunal ought to haveconsidered the matter from a practical point of view, bearing inmind the principles laid down by the Supreme Court in the abovereferred cases. 18. Having regard to the view taken by the Supreme Court in the decisions referred to above and the contradictoryfindings recorded by the Tribunal, which according to us clearlyamounts to making a new case in favour of the revenue, We areof the view that the order of the Tribunal is liable to be set asideand a fresh consideration is to be carried out by the Tribunal. In the aforesaid circumstances, we set aside the orderof the Tribunal dated 29.5.2013 in I.T.A. No.31/Coch/2010 andremand the same to the Tribunal itself, for fresh consideration. Sd/- S.V.BHATTI, JUDGE RKM Sd/- BECHU KURIAN THOMAS, JUDGE APPENDIX PETITIONER'S ANNEXURES : A1 : COPY OF THE ASSESSMENT ORDER DATED 19.12.2008 OF THE 1ST RESPONDENT.1ST RESPONDENT. A2 : COPY OF THE APPELLATE ORDER DATED 30.11.2009 OF THE COMMISSIONER OF INCOME TAX (APPEALS)-II, KOCHI.COMMISSIONER OF INCOME TAX (APPEALS)-II, KOCHI. A3 : CERTIFIED COPY OF THE IMPUGNED ORDER DATED 29.05.2013 OF THE INCOME TAX APPELLATE TRIBUNAL, KOCHI BENCH.OF THE INCOME TAX APPELLATE TRIBUNAL, KOCHI BENCH.