M/S.APOLLO TYRES LTD. vs. 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 4TH 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 MARKOS SRI.ABRAHAM JOSEPH MARKOS SRI.ABRAHAM VARGHESE THARAKAN SRI.BINU MATHEW SRI.TOM THOMAS KAKKUZHIYIL RESPONDENT/ RESPONDENT : THE DEPUTY COMMISSIONER OF INCOME TAX CIRCLE 1(1), RANGE-1, KOCHI-682 018. BY ADVS. SRI.P.K.R.MENON,SR.COUNSEL, GOI(TAXES) SRI.JOSE JOSEPH, SC, FOR INCOME TAX SRI.CHRISTOPHER ABRAHAM, INCOME TAX DEPARTMENT SRI.K.M.V.PANDALAI, INCOME TAX DEPARTMENT THIS INCOME TAX APPEAL HAVING COME UP FOR ADMISSION ON 04.08.2021, THE COURT ON THE SAME DAY DELIVERED THE FOLLOWING:

I.T.A. No.272/13 -:2:- JUDGMENT Dated this the 4th day of August, 2021 Bechu Kurian Thomas, J. The issue raised in this appeal relates to the disallowance of foreign exchange loss of Rs.5,09,01,001/- for the 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 the case, the learned Tribunal is justified in law in confirming the disallowance of foreign exchange loss of Rs.5,09,01,000/- holding that the amount is of the nature of capital loss; 2. Whether on the facts and in the circumstances of the case, the impugned order of the learned Tribunal on the issue is vitiated by perversity in as much as the Tribunal has confirmed the disallowance of foreign exchange loss by setting up an entirely new case invoking the doctrine of lifting the corporate veil without any supporting facts and evidence on record and without any such finding recorded by the assessing officer. 3. Whether on the facts and in the circumstances of the case the very basis adopted by the Tribunal for confirming the disallowance namely that the acquisition of the business of Dunlop by the subsidiary of the appellant is in fact acquisition of capital asset by the appellant itself runs contrary to the separate legal entity principle endorsed by the Hon'ble Supreme Court in Azadi Bachao Andolan [263 ITR 706 (SC)] and Vodafone International Holdings [344 ITR 1 (SC).

I.T.A. No.272/13 -:3:- assessment year 2006-07, the assessing officer computed the total income of the asessee at Rs.66,15,44,477/-. While computing the total income of the assessee, an amount of Rs.5,09,01,000/- claimed as a deduction on account of foreign exchange fluctuation loss was disallowed by the assessing officer by treating it as a capital loss. On appeal, the Appellate Authority dismissed the appeal filed by the assessee against the disallowance. In second appeal, the Tribunal confirmed the said disallowance. Thus, the assessee has preferred this appeal under Section 260A of the Income Tax Act, 1961 (for short, 'the Act').

I.T.A. No.272/13 -:4:- issued by Citi Bank to the assessee. The loan of 314 Million South African Rand issued to the assessee was given as a loan by the assessee to its subsidiary AMHPL who inturn gave it to ASAHPL to acquire the business of Dunlop Tyre Manufacturing Company in South Africa. It is the case of the assessee that since the purpose for which the foreign exchange forwards contract was entered into, could not fructify till March 2006, the forward contract with the Bank had to be settled on the due date which was on 14.03.2006 and since the RBI did not permit roll over of payments beyond three months, the loan received had to be settled with the bank. The settlement of foreign exchange in March 2006 resulted in a loss of Rs. 5,09,01,000/-. This loss is the subject matter of this appeal. (It is worth mentioning that ASAHPL had acquired the entire shares of Dunlop Tyre Company of South Africa on 21-04-2006.)

I.T.A. No.272/13 -:5:- 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 and that was the reason for the loss of Rs.5.09 crores for the AY 2006-07. Therefore, it claimed deduction under section 37(1) of the Act. However, the assessing officer disallowed the loss. It was held that the expenditure incurred by the subsidiary company for its business was not allowable in the hands of the holding company as the subsidiary company was a separate legal entity and also that the expenditure incurred for acquisition of a capital asset was a capital expenditure. The first appeal and even the second appeal to the Tribunal were both rejected. The Tribunal sustained the disallowance after holding that if the corporate veil of the two subsidiary companies, i.e; those at Mauritius and the other at South Africa are lifted, loss in question could be understood to be suffered during the process of acquisition of a capital asset and hence the loss ought to treated only as a capital loss. The assessee has thus preferred this appeal under section 260A of the Act. 6. We heard Senior Advocate Joseph Markose instructed by Adv. Sharad Joseph Kodianthara, on behalf of the

I.T.A. No.272/13 -:6:- assessee and the Adv. Jose Joseph, learned Standing Counsel for the Department. 7. Appellant had entered into the foreign exchange forward contract with Citi Bank in January 2006. The purpose for which the loan was availed could not materialise even by March 2006. As the RBI did not permit roll over of a foreign exchange forward contract beyond three months, assessee repaid the loan on 14-03-2006. In the course of repayment, due to fluctuation in the rate of foreign exchange, assessee incurred a loss of Rs.5,0,901,000/-. 8. The foreign exchange forward contracts are generally entered into by Assessees as a measure of protection against an increase in liabilities while advancing foreign exchange currency loans due to the exchange rate fluctuations. Accordingly, when profit and loss arise 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 are generally treated as profit and loss on revenue account. If, on the other hand, the foreign currency is held as a capital asset or as a fixed asset, such profit or loss would be of a capital nature.

I.T.A. No.272/13 -:7:- 9. It was contended that the loss of Rs. 5.09 crores was incurred due to cancellation of forward contracts in foreign exchange which was inextricably linked to the advancement of foreign currency loans to the Mauritius subsidiary and the loan was an advance for the purpose of the business of the assessee company. The advantage intended to be gained by the assessee was an enhancement of efficiency of tyre manufacturing business by leveraging the sophisticated technology of Dunlop tyres for the manufacture of radial tyres as well as obtaining a wide distribution network and improved availability of raw materials at reduced costs.

I.T.A. No.272/13 -:8:- and Others v. Azadi Bachao Andolan and 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 the assessee was on account of the loan availed for purchasing a capital asset in South Africa through the subsidiary companies and as it was intended for procuring a capital asset, the loss was not allowable as a deduction since it could be termed only as a capital expenditure. It was further submitted that the floating of two subsidiary companies one in Mauritius and the other in South Africa were clear attempts to avoid payment of tax. According to the learned counsel, the two companies that were floated, as mentioned above, were sham companies. The entire loan for acquisition of assets can only be treated as a capital asset. On the aforesaid basis, it was argued that the appeal only merits dismissal. 12. We have considered the rival contentions. It is admitted that the assessee had availed the foreign exchange loan for expanding its business by taking over Dunlop in South Africa through the subsidiaries. It is worthwhile to refer to section 37 of the Income Tax Act 1963; as it stood then :

I.T.A. No.272/13 -:9:- S. 37 General; (1) Any expenditure (not being expenditure of the nature described in sections 30 to 36 and not being in the nature of capital expenditure or personal expenses of the assessee), laid out or expended wholly and exclusively for the purposes of the business or profession shall be allowed in computing the income chargeable under the head “Profits and gains of business or profession”. [Explanation 1.- For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure.] 13. The words ‘for the purpose of business’ in S.37(1) have been time and again observed by the Supreme Court to be given a wider scope than the words for the purpose of earning income, profits or gains (reference can be made to Madhav Prasad Gatiya v. Commissioner of Income Tax, UP. Lucknow [(AIR 1979 SC 1291). Similarly, in section 37 of the Act, it has also been stated that any expenditure which is expended wholly and exclusively for the purposes of the business or profession shall be allowed as an expense while computing the income chargeable under the head “income or gains” under the business or profession. The expenditure

I.T.A. No.272/13 -:10:- referred to in section 37 of the Act will undoubtedly include expenses 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 include such expenditure that a prudent businessman would incur to improve his business. In this context, the decision relied upon by the learned Senior Counsel for the assessee is relevant. In SA Builders Ltd. v. Commissioner of Income Tax (Appeals), Chandigarh and Others [(2007) 288 ITR 1], the Supreme Court considered a case where the assessee had diverted funds borrowed by it to a sister concern without charging any interest. The funds so borrowed incurred proportionate interest payable to the bank. The total interest paid to the bank for the amount so borrowed, was claimed as a deduction under section 37 of the Act. The claim was disallowed by the Tribunal and confirmed by the High Court. However, the Supreme Court interfered with the finding. It was observed in the said decision that “the correct view in our opinion was whether the amount advanced to the subsidiary or associated company or any other party was advanced as a measure of commercial expediency”. The Supreme Court further observed

I.T.A. No.272/13 -:11:- that “We agree with the view taken by the Delhi High Court in Commissioner of Income Tax v. Dalmia Cement (B.) Ltd. [2002 254 ITR 377] that once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize his profit. The income-tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman. As already stated above, we have to see the transfer of the borrowed funds to a sister concern from the point of view of commercial expediency and not from the point of view whether the amount was advanced for earning profits”. 15. It is the admitted case of the assessee that the loan was taken for providing funding to its subsidiary company at Mauritius to acquire a company in South Africa for the purpose of enhancing its business and for procuring raw materials at reduced costs. Generally, any prudent businessman

I.T.A. No.272/13 -:12:- would attempt to indulge in such acts for increasing their profits by improving the business. However, the Tribunal has proceeded to treat these acts of the assessee as an attempt to acquire property and increase their capital base. For this purpose, the Tribunal has lifted the corporate veil. 16. In the case of Union of India (UOI) and Others v. Azadi Bachao Andolan and Others [(2003) 263 ITR 706 (SC)] the Supreme Court held that the Indo-Mauritius Double Taxation Avoidance Convention, 1983 has great legal significance and that, notwithstanding the legal steps taken by an assessee under the convention, if the intended legal result has not been achieved, the court will be entitled to overlook intermediate steps but it would not be permissible for the court to treat the intervening legal step as non est based upon some hypothetical assessment of the “real motive.” 17. On an appreciation of the findings recorded by the Tribunal, we notice that the Tribunal has proceeded on a singular angle with an assumption that the ultimate aim of acquiring an asset was a measure of tax avoidance without even bearing in mind the principles of the Indo-Mauritius Double Taxation Avoidance Convention, 1983. The Tribunal has also not

I.T.A. No.272/13 -:13:- considered the concept of commercial expediency while determining the question whether the expenditure claimed is allowable as a deduction under section 37 of the Act. It cannot be stated as a general principle that in every case where a loan is taken, even if the ultimate purpose is for acquiring a capital asset, and a resulting loss ensues thereon, the same ought to be treated as a business loss. According to us, the answer depends upon the facts and circumstances of each case. The issue should have been approached from the point of view of a prudent businessman and not from the eyes of the taxing authorities. Whether the loan was taken as a measure of commercial expediency or not ought to have governed the consideration of the issue in this case rather than the motive behind establishing the two subsidiaries. The concept of lifting the corporate veil had no application in the instant case. The corporate veil is lifted only in certain specific instances, especially when fraud is committed, or when tax is sought to be evaded, or when the Company resorts to illegal activities. Formation of subsidiary company in Mauritius cannot be regarded as such an illegal act as explained by the Supreme Court in Union of India (UOI) and Others v. Azadi Bachao Andolan and Others [(2003) 263 ITR 706 (SC)]. We feel that

I.T.A. No.272/13 -:14:- as a final fact finding authority, the Tribunal ought to have considered the matter from a practical point of view, bearing in mind the principles laid down by the Supreme Court in the above referred cases. 18. Having regard to the view taken by the Supreme Court in the decisions referred to above and the contradictory findings recorded by the Tribunal, which according to us clearly amounts to making a new case in favour of the revenue, We are of the view that the order of the Tribunal is liable to be set aside and a fresh consideration is to be carried out by the Tribunal. In the aforesaid circumstances, we set aside the order of the Tribunal dated 29.5.2013 in I.T.A. No.31/Coch/2010 and remand the same to the Tribunal itself, for fresh consideration. Sd/-

S.V.BHATTI, JUDGE Sd/- BECHU KURIAN THOMAS, JUDGE RKM

I.T.A. No.272/13 -:15:- APPENDIX PETITIONER'S ANNEXURES : A1 : COPY OF THE ASSESSMENT ORDER DATED 19.12.2008 OF THE 1ST RESPONDENT. A2 : COPY OF THE APPELLATE ORDER DATED 30.11.2009 OF THE 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.