Holding

Rule 115 is a valid provision that fixes the exchange rate for foreign‑currency income at the end of the accounting period but does not require conversion of amounts already received in rupees; therefore the Commissioner’s s.263 order was invalid.

Summary

The appellant, the Commissioner of Income Tax, challenged the Bombay High Court’s order quashing a notice issued under s.263 of the Income Tax Act against Chowgule & Co. Ltd., an exporter of iron ore whose export proceeds were credited in rupees by an Indian bank. The issue was whether Rule 115 of the Income Tax Rules, 1962 – which fixes the exchange rate for converting foreign‑currency income at the end of the accounting year – was ultra vires the Act and whether it required conversion of amounts already received in rupees during the year. The Supreme Court held that Rule 115 is a valid rule under the Act and merely fixes the rate of conversion for foreign‑currency income that remains unconverted at the end of the year; it does not compel conversion of amounts already received in rupees. Consequently, the Commissioner’s order under s.263 was erroneous and the High Court’s quashing of that order was correct, although the High Court was wrong to strike down Rule 115 as ultra vires. The appeal was dismissed.

Issues considered

The validity of Rule 115 of the Income Tax Rules, 1962 in view of the Income Tax Act, 1961.
Whether Rule 115 applies to export proceeds that have already been credited in rupees during the accounting period.
Whether the Commissioner’s order under s.263(1) of the Income Tax Act was justified.

Legislation cited

Subjects

Income TaxRule 115foreign exchange conversionexport incomeassessment revisionultra viress.263taxability of export proceeds

Judgment

COMMISSIONER OF INCOME TAX, KARNATAKA (CENTRAL), A
BANGALORE AND ORS.
v.
CHOWGULE AND CO. LTD.

JANUARY II, 1996
B
[DR. A.S. ANAND AND SUHAS C. SEN, JJ.]

..
Income Tax Act, 1961/lncome fax Rules, 1962 :

S.143,263/Rule 115-lncome arising out of export of goods-Foreign
currenq-Conversion of into rupees-Assessment of to tax-Held, Rule JI 5 C
fixes rate of exchange for conversion into rupees of income in foreign currency
at the end o.f accounting period--Rule applies to any income in .foreign ex-
change to be converted for purpose of computing total income for any account-
ing period and not to income already converted into rupees during the account-
ing period-Rule is not ultra vires the Act. D
The respondent-company exported iron ore to foreign buyers. The
price was paid by the foreign buyers through an Indian bank, which on
behalf of the foreign buyers opened letters of Credit, and the amounts
receivable by the assessee were credited in its account by its Bank in
rupees. The assessee offered for assessment the amount received during E
the relevant accounting period i.e. July, 1982 to June 30, 1983, as price
of the goods sold to the foreign buyers as and when the amounts were
received; and as regards the amounts which were not actually received
from the foreign buyers during the accounting period the same were
converted into rupees on the basis of the exchange rate on the last day of F
the accounting year i.e. June 30, 1983 and were brought to tax accordingly.
The Commissioner of Income Tax held that the income was wrongly
assessed without applying Rule 115 of the Income Tax Rules 1962; he
issued a notice under s.263 of the Income Tax Act, 1961 proposing to revise
the order of assessment- The assessee challenged the order as also the vires
G
of Rule 115 of the Rules in a writ petition before the High Court, which
quashed the order passed by the Commissioner and also declared clause
(C) of Rule 115 as ultra vires the Acl Aggrieved, the Revenue filed the
present appeal.

It was contended for the Revenue that since the contract specified H
367
368 SUPREME COURT REPORTS [1996] 1 S.C.R.
A that the payments would be made in foreign exchange and the assessee was
entitled to receive the payment in foreign exchange, and though the Bauk
at the time of payment might !lave converted the foreign exchang~ irtto
rupees and paid the assessee in Indian currency, Rule 115 was clearly
attracted, and the amount of foreign exchange received by the Assessee
B would be. valued on the last day of accounting period on the basis of
exchange rate prevalent on that day.

Disposing of the appeal, tliiis Court

HELD : 1.1. The High Court has wrongly construed Rule 115 of the
, C Income Tax Rules, 1962 and has erred in holding that the rule was. ultra
vires the substantive provisions of the Income Tax Act, 1961. (373-G]

1.2. Rule 115 fixes the rate of exchange for conversion into rupees
of income held in foreign currency at the end of the accounting period; it
does not lay down that entire foreign currency received by an assessee will
D be converted into rupees only on the last day of the accounting period. This
rule can only apply If any income in foreign currency has to be converted
for the purpose of computing total income for any accounting period. But,
if in course of the accounting period the conversion has already taken place
and on the last day of the previsous year the assessee does not have nay
E foreign currency in his hand or the assessee is not entitled to receive any
foreign currency, then there is no question of applying Rule 115 and
converting into rupees any income held in foreign currency. Clause (2),
which was introduced on April 1, 1990 is really clarilicatory and does not
bring about any change in Rule 115. [373-A-F]
F 2. The Commissioner of Income Tax also erred in holding that the
assessment was erroneous and prejudicial to the interest of the Revenue.
In the facts of the case, there cannot be any question of invoking Rule 115
since the sale proceeds of the goods exported by the assessee were credited
to its bank account in Indian rupees. The entire sum received by the
G assessee was offered for assessment and was duly assessed. There is no
dispute that the amounts which were outstanding and receivable by the
assessee on the last day of the accounting year from the foreign buyers had
to be converted into Indian rupees at the rate of exchange prevalent on
the last day of the accounting year. In the circumstances, the order under
H s.263 passed by the Commissioner of Income Tax was rightly quashed by
-~.
COMMR. OF IT KARNATAKA v. CHOWGULE & CO., LTD. [SEN, J.] 369
the High Court. [369-G-H; 374-C-D] A
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1650 of 1996.

From the Judgment and Order dated 3K3.92 of the Bombay High
Court in W.P. No. 310 of 1989.
B
S.C. Manchanda, S.N. Terdol, R. Chandra and B. Krishna Prasad for
the Appellants.

S. Ganesh, Mrs. A.K. Verma and P.D. Tyagi for Mis. J.B.D. & Co. for
, the Respondents.
c
The Judgment of the Court was delivered by

SEN, J. Special leave granted.

The Commissioner of Income Tax has come up in appeal against the
Judgment of the Division Bench of the Bombay High Court, quashing an D
Order passed by the Commissioner of Income Tax under Section 263 on
March 30, 1989. The High Court was also of the view that clause (c) of Rule
115 of the Income Tax Rules, 1962 was in conflict of the subslantive
provisions of the Income Tax Act and was ultra vires the Act.

The controversy in this case is about the taxability of the amounts E
received by the assessee from foreign buyers during the period July 1, 1982
to June 30, 1983 (assessment year 1984-85). The assessee offered for
assessment the amounts received as price of the goods sold to foreign buyers
. as and when the amounts were received in course of the accounting period and
was taxed accordingly. The amounts which were not actually received from F
the foreign buyers in course of the accounting period were converted into
rupees on the basis of the exchange rate on the last day of the accounting year
i.e. June 30, 1983 and was brought to tax accordingly for the assessment year
1984-85.

The Commissioner of Income tax was of the view that the Income Tax G
Officer had wrongly assessed the quantum of income arising out of the export
sales without applying Rule 115. Accordingly, he issued a notice under Section
263 upon the assessee proposing to revise the order of assessment. After
giving an hearing to the assessee, the Commissioner of Income Tax passed
the following order : H
370 SUPREME COURT REPORTS [1996] l S.C.R.

A "The last point is regarding application of Rule 115 in respect of
earnings on export of iron ore to Japan. The assessee has taken the
income at the rate at which the amount has actually been credited
by the bank. It did not apply the notional rate as required under Rule
115. Jn his reply the assessee has contended that Rule 115(c) can be
applied only to income which is expressed in foreign currency or not
B
otherwise. I am afraid this interpretation is unacceptable. I, there-
fore, direct the assessing officer to find out the actual rate of
conversion in respect of different remittances and also the Tel-
egraphic Transfer buying rate at the end of the year and convert the
foreign exchange at the Telegraphic Transfer buying rate on the last
c day of the previous year as required by Rule 115, if that is more
favourable to the revenue, and bring the difference to tax."

This order was challenged by the assessee by a writ petition in Bombay
High Court in which the vires of Rule 115(c) of the Income Tax Rules, 1962
D was also questioned. The facts of the case, as recorded in the order of the
High Court, are as under :

"The petitioners in this case are a company incorporated under the
Companies Act, 1956. The petitioners are exporting iron ore to
foreign countries, more particularly to Japan, the petitioners entered
E into agreements for sale of iron ore with foreign buyers at certain
prices. As per the arrangements between the foreign buyers and the
petitioners, the foreign buyers opened a letter of credit with a bank
in India. As soon as the iron ore is loaded into the ship, the bill of
lading is signed by the master of the ship and the petitioners raise
invoice~ against the foreign buyers for the price of the ore shipped.
..
F
Thereafter, these documents are presented by the petitioners to their
banker in India and the petitioners receive payment through the
Indian bankers in rupees at the rate of exchange prevailing then. If
on the date of closing of the financial year any amount of sale
proceeds remains outstanding, it is converted into Indian rupees at
G
the rate of exchange prevailing on the last day of the financial year
and is entered in the books of the petitioners and accounted for as
their income."

The High Court further examined the manner in which payment was
H made to the assessee by the foreign buyers and observed :
COMMR. OF 1.T. KARNATAKA '" CHOWGULE & CO., LTD. [SEN, J.] 371
"To come to a right conclusion about this question, we will have to A

- see in what manner the petitioners receive income and at what point
of time income tax is leviable. In the present case, the petitioners
entered into agreements for the sale of iron ore to the foreign buyers
at a certain price. This price is agreed in advance. The mode of
payment is in foreign currency through the Indian banker who is B
authorised to give foreign exchange. Under the contract, the payment
is made to the petitioners when the documents of bill of lading are
presented by the petitioners through their bankers in India. According
to the petitioners, it is at this point of time when the petitioners receive
money under the contract that they are liable to be taxed. The
petitioners have further stated thati during the previous accounting c
year from July 1, 1982 to June 30, 1983, the petitioners have paid tax
on the actual income they received from the bank in Indian currency.
It is also contended on behalf of the petitioners that, in fact, the
petitioners received the money on various dates at the rate of foreign
exchange prevailing on the date of the receipt of the money. The D
petitioners have also supplied a chart showing therein as to how,
during the said relevant period, they have received the payment in
Indian currency on each date as per the value of the rate of foreign
exchange prevailing on the date of the receipt. The petitioners,
therefore, contended that it is the actual money which they have E
received during the said period which is liable to be taxed under the
Act and not any notional income or income which they have never
received and there is no possibility of realising the same."

It has been contended on behalf of the appellants that the High Court
failed to realise that the payments were made in foreign exchange. The F
contract specified that the payments will be made in foreign exchange. The
price payable in the invoice was also expressed in foreign exchange. There-
fore, the payments were all received by the assessee in foreign exchange. The
Bank, at the time of payment, might have converted the foreign exchange into
rupees and paid the assessee in Indian currency, but, the fact remains that the G
assessee was entitled to receive the price of the goods sold in foreign exchange
and, therefore, Rule ll5 was clearly attracted and the amount of foreign

-"· exchange received by the assessee will have to be valued on the last day of
the accounting period on the basis of the exchange rate prevalent on that day.

Rule ll5, as it stood on the material date, was as under : H
372 SUPREME COURT REPORTS [1996] l S.C.R.
A "115. The rate of exchange for the calculation of the value in rupees
of any income accruing or arising or deemed to accrue or arise to the
assessee in foreign currency or received or deemed to be received by loo••
him or on his behalf in foreign currency shall be the telegraphic
transfer buying rate of such currency as on the specified date.
B Explanation : For the purpose of this rule, -

( 1) "telegraphic transfer buy mg rate" shall have the same meaning as
in the Explanation to rule 26;

(2) "specified dated" means -
c
(a) in respect of income chargeable under the head "Salaries", the
last day of the month immediately preceding the month in which
the salary is due, or is paid in advance or in arrears;

D (b) in respect of income chargeable under the head "Interest on
securities", the last day of the month immediately preceding the
month in which the income is due :

(c) in respect of income chargeable under the heads "Income from
house property" "Profits and gains of business or profession" not
E being income referred to in clause (d) and "Income from other
sources" (not being income by way of dividends), the last day of
the previous year of the assessee;

(d) ··································································································
F
(e) ··································································································

(t) ··································································································

This rule was later amended by insertion of clause (2) which, it is
argued, is only clarificatory in nature. Clause (2) which came into effect from
G April 1, 1990 is as under :

"Nothing contained in sub-rule (I) shall apply in respect of income
referred to in clause (c) of the Explanation to sub-rule (1) where such
income is received in, or lirought into, India by the assessee or on
H his behalf before the specified date in accordance with the provi-
COMMR. OF I.T. KARNATAKA v. CHOWGULE & CO., LTD. [SEN, J.] 373
sions of the Foreign Exchange Regulation Act, 1973 (46 of 1973)." A
Rule 115 merely lays down that "for the calculation of the value of rupees
of any income accruing or arising or deemed to accrue or arise to the assessee
in foreign currency or received or deemed to be received by him or on his behalf

-
in foreign currency", the rate of exchange shall be the telegraphic transfer
buying rate of such currency as on the specified date. Explanation (2) has B
clarified that the 'specified date' will mean in respect of income chargeable
under the heading of "Profits and gains of business or profession", the last day
of the previous year of the assessee. This only means that if an assessee is
assessable in respect of any income accruing or arising or deemed to have
' accrued or arisen in foreign currency or has received or deemed to have re- C
ceived income in foreign currency, then such foreign currency shall be con-
verted into rupees notionally at the telegraphic transfer buying rate of such
currency as on the last day of the previous year of the assessee. If on the last
day of the previous year, the assessee does not have any foreign currency in
his hand or the assessee is not entitled to receive any foreign currency, then D
there is no question of conversion of such foreign currency into rupees. It is only
the foreign currency which will have to be converted into rupees. But, if the
foreign currency received by an assessee has been converted into rupees before
the specified date, question of application of Rule 115 does not arise. Rule 115
does not lay down that all foreign currencies received by an assessee will be
converted into rupees only on the last day of the accounting period. Rule 115 E
only fixes the rate of conversion of foreign currency. If there is no foreign
currency to convert on the last day of accounting period, then no question of
invoking Rule 115 will arise. The assessee in this case is agreeable to have the
outstanding amount of foreign currency payable to him at the rate of exchange
prevalent on the last day of the previous year of the assessee. But, this rule F
cannot apply to the amounts received by the assessee in course of the account-
ing period in rupees. Clause (2), which was introduced on April 1, 1990, is
really clarificatory and does not bring about any change in Rule 115.

We are of the view that the High Court was clearly in error in holding
that Rule 115 was ultra vires the substantive provisions of the Income Tax Act, G
1961. We are also of the view that the High Court has wrongly construed this
rule. The rule fixes the rate of exchange for conversion into rupees of income
held in foreign currency at the end of the accounting period. This rule can only
apply if any income in foreign currency has to be converted for the purpose
of computing total income for any accounting period. But, if in course of the H
374 SUPREME COURT REPORTS [1996] l S.C.R.

A accounting period the conversion has already taken place, then there is no
question of converting into rupees any income held in foreign currency.

The facts of the case, as stated by the High Court, also makes it clear
...'"'JI
that the assessee from time to time had exported goods. Price was paid by the

-
foreign buyers through an Indian Bank. The Indian bank, on behalf of foreign
B buyers, opened letters of credit. The bills of lading, invoices and other
documents were presented by the assessee through their Bank to the Bank of
the foreign buyers. The amounts receivable by the assessee were credited in
their account by their Bank in rupees. The entire sum received by the assessee
was offered for assessment and was duly assessed. We fail to see how the
c Commissioner of Income Tax came to the conclusion that the assessment was
erroneous and prejudicial to the interest of the revenue. In the facts of this
case, there cannot be any question of invoking Rule 115. The sale proceeds
of the goods exported by the assessee were credited to their bank account in
Indian rupees. There is no dispute that the amounts which were outstanding
D and receivable by the assessee on the last day of the accounting year from the
foreign buyers had to be converted into Indian rupees at the rate of exchange
prevalent on the last day of the accounting year.

In the circumstances, we hold that the order under Section 263 passed
"
by the Commissioner of Income Tax was rightly quashed by the High Court.
E But, we also hold that the High Court was in error in striking down Rule 115 .,._
of the Income Tax Rules.

The appeal is disposed of accordingly. There will be no order as to costs.

R.P. Appeal disposed of.