Gain From Foreign Exchange Fluctuations Can't Be Claimed As Deduction Under S.80 HHC Income Tax Act : Supreme Court

Recently, the Supreme Court (on November 21), while interpreting Section 80 HHC of the Income Tax Act, held that the profit from exchange fluctuation is independent of export earnings. Pertinently, Section 80 HHC provides for the deduction of profits which the assessee derives from exporting goods/merchandise.

The Court, while stressing upon the wordings of Section 80 HHC, held that the same enables deduction to the extent of profits derived by the assessee from the export of such goods and merchandise and none else.

“The policy behind the deductions of profits from the business of exports is to encourage and incentivise export trade. Through Section 80HHC, the Parliament restricted the deduction of profit from the assessee's export of goods/merchandise.,” the Court added.

While doing so the Court refused to accept the interpretation offered by the assessee that the profits earned due to price fluctuation, can be treated as derived from the business of export income of the assessee.

The issue for adjudication before the Bench of Justices B.V. Nagarathna and Justice SVN Bhatti was “whether the gain on foreign exchange fluctuation in the EEFC (Exchange Earners Foreign Currency) account of the assessee partakes the character of profits of the business of the assessee from exports and can the gain be included in the computation of deduction under profits of the business of the assessee under Section 80 HHC of the Act?”

The Court, while relying upon catena of judgments, held that the gain from foreign exchange fluctuations from the EEFC account does not fall within the meaning of “derived from” the export of garments by the assessee.

Factual Background

The brief background of the facts that have led to this appeal are such that the assessee is a 100% EOU of garments. In the concerned financial year, the assessee recorded the turnover of exports and the profits from the export of goods and merchandise outside India. Further, Assessee, without delay, received the consideration against the goods exported. With respect to the foreign exchange earned from the exports of goods, instead of converting the exchange immediately to Indian currency, the assessee credited a percentage of the foreign exchange to the EEFC account. The assessee received a gain of Rs. 26,62,927/- from the amount credited to the EEFC account due to an upward revision in the exchange rate at the end of the financial year. The assessee claimed deduction of gains from fluctuation in foreign currency under Section 80 HHC of the Act.

However, the Assessing Officer (AO) disallowed the deduction claim and instead added it to the assessee’s taxable income. The case of the Revenue was that the gain/profit on account of foreign currency fluctuations in the Exchange Earners Foreign Currency (EEFC) account cannot be attributed as an earning from the export of goods/merchandise outside India by the assessee. Further, a notification of the Reserve Bank of India (FERA.159/94-RB) dated 01.03.1994 was brought into attention. The same permitted foreign exchange earners to open and operate an EEFC account by crediting a percentage of foreign exchange into the account. Ultimately, when the matter was carried to the High Court in an appeal by the Revenue, the same was allowed. Aggrieved by the same, the assessee approached the Supreme Court.

Contentions Of The Parties

It was contended by the assessee that EEFC is an enabling account for an exporter of the categories covered by the virtue of above-mentioned notification. Besides that, the account holders are authorised to meet their overseas financial commitments from the foreign exchange credited in their EEFC account. Therefore, the EEFC account is used for the assessee’s business; hence, the gain in foreign exchange fluctuation is treated as profits of business while computing the permissible deduction under Section 80 HHC of the Act.

Per contra, the argument taken by the Revenue was that crediting foreign exchange earned in an EEFC Account is only an enabling facility provided by the RBI to the export earners. However, the account does not have much to do with the business of the assessee, viz., export of garments. In other words, it is neither necessary nor incidental for doing export business of garments but is purely optional.

Analysis and Observations of the Supreme Court

Referring to the relevant documents, the Court held that opening and maintaining an EEFC account is not a mandatory requirement for export business or earning profits in the business of export outside India.

After perusing the arguments of both the sides, the Court examined the relevant section. For convenience, the relevant portions read as follows:

“S.80HHC. Deduction in respect of profits retained for export business.- Where an assessee, being an Indian company or a person (other than a company) resident in India, is engaged in the business of export out of India of any goods or merchandise to which this section applies, there shall, in accordance with and subject to the provisions of this section, be allowed, in computing the total income of the assessee, a deduction to the extent of profits, referred to in sub-section (1B), derived by the assessee from the export of such goods or merchandise.

….(3) For the purposes of sub-section (1),- (a) where the export out of India is of goods or merchandise manufactured or processed by the assessee, the profits derived from such export shall be the amount which bears to the profits of the business, the same proportion as the export turnover in respect of such goods bears to the total turnover of the business carried on by the assessee;”

For the purposes of interpretation, the Court referred to the decision in St. Aubyn (LM) v. A.G, (1951) 2 All ER 473, and cited the observations marked by Lord Simonds:

“the question is not at what transaction the section is according to some alleged general purpose aimed, but what transaction its language according to its natural meaning fairly and squarely hits.”

Moving forward, the Court underscored that a taxing provision, including a deduction/exemption, is interpreted strictly.

“With wisdom and experience, the Parliament used the words “derived from” in Section 80 HHC to indicate the extent to which the deduction is permitted.,” added the Court.

Following this, the Court bolstered these observations by citing a thread of precedents pertaining to the interpretation of expression “derived from”. These decisions also included Commissioner of Income Tax, Karnataka v. Sterling Foods, Mangalore, (1999) 4 SCC 98, wherein it was clearly held that there must be, for the application of the words “derived from”, a direct nexus between the profits and gains and the industrial undertaking.

Drawing from these observations, the court held that the contours of deduction as intended in the section is restricted to the profits gained from the export of goods. Thus, interpreting the Section otherwise by including any other income would be ‘counter-productive’ to scope of Section 80 HHC of the Act.

“From the requirements of sub-sections (2) and (3) of Section 80 HHC, it can be held that the deduction is intended and restricted only to profits of the business of export of goods and merchandise outside India by the assessee. Therefore, including other income as an eligible deduction would be counter-productive to the scope, purpose, and object of Section 80 HHC of the Act.”

In view of the same, the Court, while affirming the view taken in the impugned judgment held that the gain from foreign exchange fluctuations from the EEFC account does not fall within the meaning of “derived from” the export of garments by the assessee.

Case Title: Shah Originals v. Commissioner of Income Tax-24, Mumbai, CIVIL APPEAL NO. 2664 OF 2011 with CIVIL APPEAL NO. 2665 OF 2011.

Citation : 2023 LiveLaw (SC) 1004

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