THE COMMISSIONER INCOME TAX, vs. M/S. BHAGEERATHA ENGINEERING LTD.,

The Assessing Officer for the Assessment Year 1996- 97 completed assessment under Section 143(3) on 11.03.1999, -3- disallowing the claim of loss on revaluation and sale of RBI bonds, amounting to Rs.6,04,75,315/- and Rs.43,30,000/- respectively. The circumstances relevant for appreciating the controversy, admittedly, are that the assessee had undertaken a few projects in Iraq as subcontractor of M/s. Indian Railway Construction Company Ltd. (Ircon). The assessee in the Assessment Year 1986-87, 1987-88 claims to have completed a portion of the construction work. The works were also certified and the assessee has not received the full consideration for the certified work in the corresponding previous years. The assessee for the Assessment Year 1986-97 adopted completed contract method and the receipts of the work executed in Iraq have not been reflected for consideration in the books of accounts. The Revenue insisted that mercantile system was the procedure followed by the assessee in the previous assessment years and change of accounting system for one project to -4- completed contract accounting system is not acceptable and made the assessment order.

1 The assessee challenged the decision of the Revenue in this behalf and contended that the assessee has discretion to adopt an accounting standard commensurate to its business exigencies as is available in standard accountancy practices. However, such option ought not to be with a view to avoid or evade tax payable in the year of accounting. It is contextual to refer to the view we have taken in the accompanying order on the same issue before us in I.T.R .No.264/1997, wherein we have upheld on the discretion available to the assessee, particularly in the facts and circumstances of this case, to adopt completed contract method of accounting. It is stated by the assessee that the assessee entered into supplemental agreement with Ircon which facilitated deferred payment of receivable towards work executed by the assessee in Iraq. Towards the receivables in -5- the works executed in Iraq in the previous year ending 31.03.1996, the assessee has received RBI and ECGC bonds amounting to Rs.27,67,95,395/-, including interest. The said recovery represents Rs.22,10,00,000/- as RBI bond and ECGC bond of Rs.5,57,95,595/-. The assessee for the Assessment Year claimed Rs.6,04,75,315/- as loss on revaluation and sale of RBI bonds of Rs.43,30,000/-.

2 The assessee treated the RBI/ECGC bonds as deferred realization and treated them as current asset, claimed loss on actual sale of bonds and loss on revaluation of bonds. The two items form subject matter of appeal before the Income Tax Officer, as noted above, made the order under Section 143(3) of the Act. The assessee filed I.T.A. No. 21/JC/Ekm/CIT-II/99-2000 before CIT (Appeals) Kochi. The Commissioner upheld the addition made by the Assessing Officer. On appeal to the ITAT in I.T.A. No.47/Coch/2000, the Tribunal accepted the claim of -6- assessee that, in the facts and circumstances of this case, the assessee has shown receivables from the work executed in Iraq, and the assessee has not received cash but received bonds under an arrangement made by the Government of India, Ircon etc, again payable at a future date. Therefore, the assessee is correct in treating bonds as current asset and by taking note of valuation adopted in respect of current assets, actual revaluation is recognized and the assessee is entitled to claim loss on revaluation of bonds and sale of RBI bonds. Hence the instant appeal.

Following questions are framed for consideration:

Learned Senior Standing Counsel Mr.Christopher Abraham argues that the assessee, in lieu of receivables for the work executed in Iraq, has realized the bonds from RBI/ECGC. Upon the receipt of bonds, the bonds have to be treated as capital asset and not current asset. The Tribunal recorded a finding that the entry of government bonds cannot come within the purview of stock-in-trade and however committed serious error by including RBI bonds under the head ‘current asset’. The notional loss, at any rate, should not have been computed and allowance granted to assessee. Therefore, he argued that the order of the Tribunal to the said extent is illegal and substantial questions framed fall within the jurisdiction of this Court under Section 260A of the Act and prays to allow the appeal.

Per contra, learned Senior Advocate Mr. Sreedharan contends that the assessee has been showing notional profit or -8- loss in all the previous Assessment Years. The assessee was entitled to receive from Ircon consideration for the work executed by the assessee in Iraq. The circumstances of the case are very unusual and the revenue of assessee was stuck up in a war ravaged country. Under an arrangement made by the Government of India and in terms of deferred payment mechanism entered into by the assessee, the assessee has received the RBI bonds. The bonds are realizable or payable at a future date. Had the assessee received straight transfer of consideration to its bank account, then receivable in assessee's account is transferred into cash balance in account. But the assessee has received bonds payable in future i.e., after five years. Therefore, in the books of accounts one form of receivable is substituted by another form of receivable. The sale of a few bonds at the current rate, firstly suffered actual loss, and secondly, the other receivables at hand as on the last -9- date of accounting year are to be revalued according to the present market rate. The assessee has revalued the bonds retained by it and notional loss has been booked.

1 He argues that receivables can be treated under the head ‘current asset’. The bond substituted the receivable and the bonds are realizable at a future point of time. Therefore, the bonds substitute the existing entry and the assessee has not included it in stock-in-trade and did not treat it as a capital asset. The case of the Department is not that the assessee is not entitled to claim revaluation and book notional loss thereon. But, the objection is that bonds are to be treated as capital assets. For the said purpose, he reiterates the very argument which was considered by the Tribunal while dealing with Section 2(14)- what ‘capital asset’ means, and submits that once the definition by itself does not attract bonds, the assessee is having discretion to treat the bonds as current asset.

2 He further argues that the Act does not, in itself, deal with and/or define current asset. There is no prohibition in any of the standard formats of accountancy system for including a receivable/bond, under current assets. The notional loss recorded in one year will be the valuation for the next year; as and when the transactions take place in that year, the actual profit or loss of the assessee is determined depending upon the rate at which the transaction takes place. He submits that the Revenue once is unable to establish that bonds can be included within the hold of capital asset, the substantial questions of law now framed are without merit and do not come within the scope of this Court’s jurisdiction and prays to dismiss the appeal.

3 He further argues that the bonds are not investment made by the assessee and assessee is not in the business of sale and purchase of securities, bonds etc. the assessee is in -11- possession of bonds as a consequence of inevitable option offered by the Government of India. The assessee treated it as current asset depending upon the business exigencies for selling and realizing the amount from the sale of bond.

The Tribunal in detail considered the case of Revenue, referred to the definition of 'capital asset' and that the government bonds attract the nature of capital asset and briefly noted as follows: “A reading of the Section 2(14) of the IT Act would show that unless specifically excluded, property of any kind held by the assessee would be capital asset. The authorised representative has admitted that it is a part of circulating capital and a current asset. The Goverment had also agreed to redeem it at par. These have been continued to be held and interest income accrued thereon. His other contention that it constitutes stock-in-trade is also not borne out by the facts of the case. The appellant is engaged in the business of civil construction, such as that of dams, bridges, canal, earth work etc. The business of the appellant is not that of purchase and sale of securities or bonds. Admittedly, the bonds were sold to -12- augment the working capital requirements and not to purchase further securities. These bonds are in lieu of realisation of debts and would constitute capital asset within the meaning of section 2(14) of the IT Act. Its subsequent conversion into money another current asset would give rise to capital gains/loss only. Under the circumstances, the action of the Assessing Officer in disallowing Rs.6,04,75,315/- being the notional loss on revaluation of bonds is upheld. In this connection, it may be pointed out that even the so-called revaluation loss has not been currently worked out by the appellant, as the bonds have been sold at the rate of Rs.89/- to Rs.90/-, as per letter dated 9.2.96 of LIC of India filed by the appellant. In this connection, reliance is placed on the decision of the Hon'ble Supreme Court in the case of Vijaya Bank Limited, reported in 187 ITR 541. Similarly, the action of the Assessing Officer in treating a sum of Rs.43,30,000/- as short term capital loss is upheld. Accordingly, ground Nos.2 and 3 of the appellant are rejected. Aggrieved, the assessee is in appeal before the Tribunal.

The learned counsel for the assessee, Shri Sarangan made the following written submissions: "The appellant was executing contracts in Iraq as sub contractor of IRCON and was receiving periodical payments from Govt. of Iraq through IRCON and these -13- receivables were accounted for as business receipts in the trading account in the respective years. The contracts provided for deferred payments, and these deferred payments also, as and when receivable/received were accounted for as business receipts. There was default by the Iraqi Government in making payments to Indian Contractors who executed work in Iraq including M/s IRCON and M/s IRCON in turn defaulted in making the payment to the appellant. Government of India offered the bonds to all Indian contractors including M/s IRCON in lieu of the money receivable from Iraq on the execution of the contracts. Having regard to the fact that the bonds were issued in lieu of amounts due i.e. Business receipts, and having regard to unavailability of any other option for realisation of such amounts due; the bonds were liable to be considered as business receipts. It is thus clear that the bonds were liable to be considered as business receipts and any shortfall either by revaluation or on actual realisation was liable to be considered as a business loss. The bonds are normal current asset in the hands of the appellant in the same way, as the receivables in respect of the contracts executed would be current assets. Money receivable could not be treated as capital assets such as Plant & Machinery or investments. The -14- appellant being in need of money for the purpose of carrying on the business continued to treat the bonds as current assets and sell them as and when necessary even at a loss of replenishing the cash bill. Thus both from the point of Income Tax Law and the ordinary commercial accounting procedure the loss sustained on valuing the bonds as at 31.03.96 at cost or market price whichever is lower is on sound accounting principles approved by the Supreme Court in the case of British Paints v CIT (188 ITR 44 SC). These RBI/ECGC bonds cannot be treated as investment. In the first place, the appellant should have surplus money in its hands and take conscious decision as to how the money should be deployed. If the Board of Directors of the Company takes a conscious decision that the money should be used for purchase of any specified asset, such asset would be classified as investment. It may be appreciated that in the appellant's case, money was due by way of business receivables from Iraqi Goverment through IRCON and that money was not paid by the said Government. On the basis of an Indo-Iraqi Government Agreement, the dues to Indian contractors were deferred and acknowledging their responsibility the Government of India issued the said bonds to M/s IRCON who in turn -15- transferred the bonds at a face value of Rs.27.68 crores to the appellant. Thus it is clear that the bonds came to the appellant in substitution to the receivables. The appellant had no choice, option or freedom to take money and thereafter invest, in Government of India Bonds. The bonds were accepted in lieu of the receipts. It therefore, cannot be comprehended as to how the said Bonds can be treated as investment. Accepting the RBI/ECGC bond by the appellant, as in the present case became obligatory on the part of the appellant since there were no options to realise the receivables in any other form or manner. This is not a case where the assessee opted for settlement of his reeivables in the form of bonds. The appellant was forced to accept the bonds purely on business consideration as at that point of time the appellant knew or fully aware that non acceptance of the bonds means non realisation of the receivables for an uncertain period. At the time of acceptance the bonds, the appellant was aware that these bonds having maturity period of over five years can be traded only at a much less price than the face value and decided to accept the said loss purely on commercial consideration. The CIT(A) has build up his case for confirming the -16- disallowance of the loss on revaluation amount of Rs.6,04,75,316/- and for treating Rs.43,30,000/- as capital loss, by wrong interpretation of Sec.2(14) of the Act. If the interpretation of Sec.2(14) as given by the CIT(A) is applied, bills,receivables, cash in hand, cash with banks, sundry debtors and such other assets, will have to be classified as capital assets. By any stretch of imagination, these assets forming part of circulating capital of any business cannot be termed as capital assets within the meaning of Section 2(14). It is also relevant to observe that where a particular word is defined with the clause "unless the context otherwise requires". (As is the case in Sec.2 of the Act), it is not mandatory that one should mechanically attribute to the said word the meaning assigned to it in the definition clause. Ordinarily that is so. But where the context does not permit or where the context requires otherwise the meaning assigned to it in the definition clause need not apply. (Printers (Mysore) Ltd. v Asst.CTO (1994) 2 Sec. 434, 444(SC). Therefore CIT(A) was wrong in holding the bonds received by the company in lieu of receivables and held by it as current assets, as capital assets."

The Tribunal, on consideration of the decisions and -17- the circumstances, examined the bonds, whether as capital asset or current asset. The Tribunal noted that this depends upon the facts and circumstances of the case. Adverting to circumstances of the case, the Tribunal observed that the assessee had not made a conscious decision in investing in bonds, but the assessee was forced to accept the bonds in place of receivables and rightly held that the option could not be refused by the assessee. Otherwise the assessee would have to forego entire receivable amount. The assessee, in our view, gets cash only upon sale of the bonds. Till such time the bonds cannot be treated as capital asset, and as rightly held by the Tribunal, not even stock-in-trade. The assessee is recording notional loss or profit on revaluation of the earlier years as well. The same procedure is followed in the subject assessment year as well. There is consistency in the pattern followed by the assessee and considering the nature of business the assessee has -18- been doing, the bonds are rightly treated as current assets in the facts and circumstances of the case. The finding of fact recorded by the Tribunal is proper and correct. In the totality of circumstances the assessee enjoyed consensus ad idem when entering into contract with Ircon. Thereafter, the assessee has no option except to accept circumstances unfurling before it and accept the offer of Government Of India/Ircon. The option exercised is to treat the receivable as a current asset. The option of treating the receivables converted as bonds realisable at a future point of time is tenable. In the facts of the case running out of cash reserves, the decision to treat bonds also as receivable has been taken. As correctly observed by the Tribunal, the treatment of an entry in a particular method needs to be appreciated in the peculiar facts of the case. In view of the above consideration, the questions of law cannot be decided in isolation to the circumstances of the case and we -19- express our agreement with the findings recorded by the Tribunal and answer the question in favour of assessee and against the Revenue. I.T.A. No.301/2009 is dismissed. S.V.BHATTI JUDGE BECHU KURIAN THOMAS JUDGE jjj -20-