# SUTLEJ COTTON MILLS v. C.I.T. (Bhagwati, !.) - **Citation:** [1979] 1 S.C.R. 976 - **Court:** Supreme Court of India - **Decided:** 1978-09-27 - **Bench:** P. N. Bhagwati, V. D. Tulzapurkar - **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/sutlej-cotton-mills-v-c-i-t-bhagwati-7553 - **Pages:** 17 ## Headnote 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~ It has inter alia a Cotton !\fill situated in West Pakistan where it carries on business of manufacturing and selling cotton fabrics. For theaccounting year relevant to the assessment year 1954-55, the assessee made a large profit in the unit in \\-'est Pakistan. The Pakistan profit, according to the D 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 19"54-55\. 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 E 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. 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 F 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. t 1 lakhessee 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 tbe 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 snbstantially the same view as ' 1 .. SUTLEJ COTTON MILLS v. C.I.T. (Bhagwati, J.) 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 lciss 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 :iccordc ingly answered the question in favour of the Revenue and agamst the assessee. The assessee thereupon preferred \he 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. 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 repatriation, the assessee received only Rs. 25 lakhs and Rs. 12,50,Q..00/- 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 prolit 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 ligure 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 ent~es. which are not in conformity with the proper accountancy pnnc1ples, conceal profit or show loss. and the entries I ()-699SC[/7 A B c D E F G H A B c D E F G H 982 SUPREME COURT It.EPORT& [1979] 1 s.c.R. made by him cannot, therefore, be regarded as conclusive one way oc 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 195455 and retained them in West Pakistan in Pakisani 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(') which we shall discnss 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 Joos 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 taxa hie 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 argumen.t 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 soversigni power and it could not, therefore, be regarded as a loss arising in 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 behalr, of this Court in Badri Das Dage v. C.l. T. (') but it would not be correct to say that where a loss arises in the proces~ 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 (I) 60 I. T. R. 405. (2) 34 I. T. R. 10. ~ • .. • SUTLEJ COTTON MILLS v. C.I.T. (Bhagwati, J.) 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 ~hl!re is loss in a trading asset, it would be a trading Joss, whatever be its cause, because it would be a Joss 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 Joss in such a case would clearly be a trading Joss. But the loss may also arise by reason of the stock-in-trade being stolen or burnt and such a IO§S, though occasioned by external agency or act of God, would equally be a trading Joss. The cause which occasions tl1e loss would be immate- 'y rial : 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 Joss 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 Joss suffered by t11e "°ssessee was a trading loss or not would depend on the answer to the query whether the loss was in respect of a t'ra_f_lmsiness or for a trading purpose or for effecting a (I) 18 T. C. 280. A B c D E F G H 984 SUPREME COURT REPORTS [1979] l s.c.R. A transaction on revenue account, loss arising from depreciation in its value on account of alteration in the rate of exchange would be :t 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. B c D E F 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('). 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 recou_ped 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 t]Je 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 • .• •nces against the goods as prescribed by the agreements. The profit /' accrued in this case because they had to do that, thereafter, as a G H trading concern in this country re-transferring or re-exchanging into gerling." 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 restransfer 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) (!) 19.T. C. 65. (2) 32 T. C. 133. • ··~ j ... "" • - " SUTLEJ COTTON MILLS v. C.I.T. (Bhagwati, J.) 985 We may then refer to the decision of the Court of Appeal in Imperial Tobacco Co. v. Kelly('). 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 traJ)saction 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 lo sell to the Treasury and owing to the rise which had in the mean time occurred in the dolla~ exchange, the 9le resulted in a profit for the company. The question was whether the exchange profit thus made on the dollars 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 cornpany 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 fir~t step in the carrying out of a comn1crciaJ transaction,-" "The Appellant Company having provided themselves with this particufar 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 inwossible to say that the dollars have 106t the revenue characteristic which attached to them when they were originally bought, and in some m~sf:erio~s way have acquired a qipital character. In my opm1on, it does not make any difference that the contempla!ed 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 (I) 25 T. C. 292. A B c D E F G H A B c D 986 SUPREME COURT REPORTS 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 reve1me 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 transE action 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 decisio11 to }Vhich we may refer in this connec- ). 'Ji F tion is Davis v. The Shell Company of Chine, (supra). The Company / made a practice of requiring its agents to deposit with the company · ... - G B a sum of money usually in Chinese dollars which wa~ 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 iu Chinese currency were much less than the sums held by the Company to meet the claims and a substanllal profit accrued to the Company. The question arose whether this exchange profit was a trading profit or a capital profit. The Court of ,,, __ _.,..- ' SUTLEJ COTTON MILLS v. C.I.T. (Bhagwati, J.) 987 Appeal held that it was a c~pital profi~ not subject to income tax and thei 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 t.Qe company, given no doubt to provide the company with a security, but nevertheless loans. As loans it seems to !Ile they must prima facie be loans on capital, not revenue account; which perhaps is only another way of saying that they must prima fade 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 conclnsion. A B c In my view, therefore, the conver§ion of company's D balance of Chinese dollars into sterling· and the subsequent re-purchase of Chinese dollars at a lower rate, which enabled the company to pay of! its agents' deposits at a smaller cost in sterling then the amount it had realised by converting the deposits into sterling, was not a tradjng profit, but it was simply the equivalent of an appreciation in a E 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 F ···'°" 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 11rofit or loss can be said to be trading G profit or loss. The first decision in chron_ological order is that reJlorted 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 H Ink, New York, a company incorporated in the United States, was appoi.ttted by the assessee as its purchasing agent in the United States A B c D E G H 988 SUPREME COURT REPORTS [1979) 1 s.c.R. 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 o!!Jer 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 exp«nses 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 taJ