Redefining the Receipt of Gain through Personal Loan to Foreign Relative: A Critical Analysis of Aditya Balkrishna Shroff v. ITO (ITAT Mumbai)

Author: Riya Jain

College and Year: Damodaram Sanjivayya National Law University, Visakhapatnam; 6th Semester

Background
The assessee filed an appeal about the tax implications of foreign exchange fluctuation gains resulting from the repayment of a personal loan. It was argued by the Revenue that it is indeed part of “income from other sources” and hence taxable.
Facts
Mr. Shravan Shyam Shroff (hereinafter Shravan), the assessee’s cousin, received a personal interest-free loan of US $ 2,00,000 on March 29, 2010. The Reserve Bank of India’s Liberalized Remittance Scheme (hereinafter LRS) was used to make this remittance. The exchange rate for buying 1 US $ was Rs. 45.14 on the day of the transaction, resulting in the assessee paying a total of Rs 90,30,758. On 24th May 2012, Shravan paid back US $ 2,00,000 to the assessee at a rate of Rs 56.18 per US Dollar. Henceforth an excess of Rs 22,04,574 was deposited in assessee’s account. The Assessing Officer (hereinafter AO) while conducting the scrutiny proceedings u/s 143(3) of The Income Tax Act, 1961(hereinafter IT Act) concluded that the difference, in terms of Indian Rupees, on account of this transaction was of income nature and therefore falls under the category of “income from other sources”, hence taxable.
The assessee, who was dissatisfied with the AO’s decision, filed an appeal with the CIT(A). After reviewing the submissions made by the parties to the suit, the CIT(A) came to the conclusion that, “According to RBI’s FAQ, only rupee loans were permitted to Non Resident Indians/PIOs, and any surplus resulting from such loans would be treated as income from other sources, as the act of giving and taking loans does not fall within the assessee’s business operations”. As a result, there appears to be no cause to interfere with Ld. AO’s order. Dissatisfied with the decision, the assessee files the current appeal.
Issue
Whether the income gained due to foreign currency fluctuation is required to be taxed at the end of assessee or not?
Analysis
The bench in the matter of  Shaw Wallace & Co Ltd v. DCIT, went into great detail about the tax ramifications of a receipt in the capital field, as well as what qualifies as a capital receipt in the first place.
When a receipt is in the capital field, even if that be a gain, it is in the nature of a capital gain, but then, as the definition of income, under section 2(24)(vi), stands, only such capital gains can be brought to tax as are permissible to be taxed under section 45. In other words, a capital gain, which is not taxable under the specific provisions of Section 45 or which is not specifically included in the definition of income, by way of a specific deeming fiction, is outside the ambit of taxable income.
The contention of learned CIT(A) falls back when he asserted the accretion of money due to fluctuation of currency as “income from other sources” whereas such transaction were in the field of capital transaction and not of revenue nature. Hence, the tribunal now here focuses on the question of law being whether an accretion of value in respect of an asset held in capital account, i.e. foreign exchange denominated loan advanced, can be subjected to tax in the hands of the assessee.
The Supreme Court held in Padmaraje R. Kadambande v. CIT, that the amount received by the assessee in the form of a capital receipt does not fall within the meaning of “income” under Section 2(24) of the IT Act, and hence a capital receipt is beyond the scope of “income” chargeable to tax. Hence, to tax a receipt under income, it has to be of revenue nature or there must be some specific provisions in the IT Act to tax it. Furthermore, such receipts cannot be taxed until and unless a particular provision is made to classify them as income.
However, in CIT v. Kamal Behari Lal Singha, the Supreme Court focused on determining the form of a receipt based solely on its character in the hands of the receiver, and the source of payment has no influence on that subject.
The Supreme Court stated in Dr. K. George Thomas v. CIT that the Revenue Department bears the burden of proving that a particular receipt is of a revenue nature, and that once the nature of the receipt is established, the burden transfers to the assessee to prove whether it falls under the exemption or not. The Tribunal believes that in this matter, revenue has failed to adequately show the receipt to be of revenue character; at best, it has emphasised the fact that because it is not taxed as a capital gain, it can only be of revenue character. As a result, there is a clear fallacy in this argument: a transaction that is not taxable as a capital gain does not infer, or even suggest, that it is a revenue receipt. There are numerous cases where receipts of capital nature were not chargeable to tax.
In Ashoka Mktg. Ltd., the assessee reached an agreement with the vendor, who was unable to finalize the transaction due to a pre-existing mortgage on the property. Because the vendor was unable to finish the deal, he paid the assessee Rs 1,00,000 in liquidated damages. The High Court ruled that such a payment is neither a revenue nor a capital payment because it was not received via the sale of land. Since there was no expense associated with obtaining such liquidated damages, it could not be classified as a capital gain. As a result, such a receipt will fall beyond the scope of taxable income. It is safe to conclude that just because a receipt is not a capital gain subject to taxation, does not indicate it is revenue receipt. In the case of Seshasayee Bros. (P.) Ltd., the Madras High Court held that “a receipt referable to fixed capital is not taxable, but it is taxable as a revenue item when it is referable to circulating capital or stock in trade.” The High Court also emphasised the term “referable” and clarified the nexus to which it can be limited. When a capital asset does not disappear or sterilisation occurs, and the receipt can be legitimately attributed to, or related to, a capital asset, such receipt is a capital receipt in nature and hence outside the tax net.
In the present case, the AO taxed the receipt on the basis that “the gain on realisation of loan would partake character of an income under the head income from other sources,” and the CIT(A) justified the taxation of the receipt on the basis that “if giving and taking loan is not the assessee’s business, then income arising out of the loan is taxed under the head income from other sources.” The fallacy of AO’s approach is that he went straight to putting income under the heading income from other sources, even before defining the nature of that income, thereby conflating the concepts of “income” and “gains.” Under section 2(24)(vi) of the IT Act, not all gains are covered within the scope of ‘income’, which is further taxed under section 45 of the IT Act. It should go without saying that a capital gain, which is not taxable under section 45 cannot be included in income.
The bench cited the Shaw Wallace case again, stating that neither liberal nor limited reading of the term “income” can transform it from a revenue to a capital receipt or vice versa. As a result, the bench dismisses the arguments of AO and CIT(A), citing serious shortcomings in their analysis.
Interest as defined under section 2(28A) is “interest payable in any manner in respect of any moneys borrowed or debt incurred (including a deposit, claim or other similar right or obligation) and includes any service fee or other charge in respect of the moneys borrowed or debt incurred or in respect of any credit facility which has not been utilized”. This clarifies the ambit of interest as being the amount payable in any manner in consideration of the “money borrowed or debts incurred”. The benefit or gain arising in present case was not in lieu of the debt, whatever amount was received by the assessee was in consideration of the principal amount of the debt. Because the gain or benefit was the outcome of foreign exchange fluctuation with respect to capital receipt, the entire transaction was of a capital nature and hence could not be taxed as revenue or classified as “income from other sources.”
The tribunal further clarified its position on whether or not a loan to a close relative of an NRI/PIO was acceptable. The Court stated that the main question before the bench in this case is whether or not gains on foreign exchange fluctuations were necessary to be taxed in the hands of the assessee. The broader question does not fall within the ambit of this court and must be answered to FEMA or LRS. Henceforth, the assessee is not liable to pay tax on the gain obtained from the foreign exchange fluctuation.
Conclusion
The author is of the view that the decision of bench is in consonance with law and the anomalies in the reasoning CIT(A) were rightly identified. Firstly, the AO abruptly tried to put income from foreign exchange fluctuations under the umbrella of revenue receipt. There was no basis to state that a receipt if not of capital nature falls within the ambit of revenue receipt. Secondly, the amount received by the assessee was in consideration of principal amount and not in lieu of interest on the loan. Income mentioned under section 2(24)(vi) can only be taxed under section 45 of the IT Act. The amount received by assessee is the principal amount and not the interest on principal amount and hence cannot be taxed under section 45 of the IT Act. Amount received due to foreign exchange fluctuation is of capital nature and hence cannot be termed as revenue receipt.

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