Tuesday, December 29, 2009

Applicability of year end rate for conversion of business income earned in foreign currency

This article summarizes ruling of the Delhi Income Tax Appellate Tribunal (ITAT) in the case of DCIT v Dolphin Drilling Pte. Ltd. (Taxpayer) [2009-TIOL-754- 1TAT-DEL]. The ITAT held that the conversion of business income earned in foreign currency into INR, in accordance with Rule 115 (Rule) of the Indian Tax Law (ITL), is to be made by adopting the conversion rate prevailing at the end of the tax year. It also held that the Taxpayer, a company incorporated in Singapore and engaged in the business of hiring out drill-ship in India, is entitled to claim depreciation on the value of the drill-ship.

Background and facts of the case

  • As per the Rule, taxpayers earning income in foreign currency are required to convert such income into INR using the telegraphic transfer (TT) buying rate as on the specified date. The specified date is different for different sources of income. In respect of income chargeable under the head 'house property', 'business and profession' and 'income from other sources', the specified date is the last day of the relevant tax year.
  • The Taxpayer, a company incorporated in Singapore, hired out its drill-ship to its sister concern in connection with the execution of the latter's contract with an Indian entity. The income from hiring out was earned in USD by the Taxpayer.
  • The Taxpayer declared the hiring income as business income. In its computation, the Taxpayer claimed deduction for depreciation on the cost of drill-ship which was incurred in USD. For earning the hiring income, the Taxpayer also incurred certain expenses in foreign currencies other than USD.
  • Relying on the Rule, the Taxpayer converted revenue and expenses by adopting the conversion rate prevailing at the end of the tax year.
  • In support of its claim for depreciation, the Taxpayer furnished the invoices, the auditor's certificate certifying the actual cost, the certificate of registration and the valuation report from renowned valuers.
  • The Tax Authority held that the method for conversion adopted by the Taxpayer was incorrect. The Tax Authority contended that the Taxpayer's business income should be computed by first converting the business transactions in other currencies into USD by applying the rate on the date of such transaction. Thereafter, the net result in terms of USD should be converted to INR by adopting the rate prevailing at the end of the tax year.
  • The Tax Authority also denied the claim of depreciation by contending that the Taxpayer had failed to substantiate the ownership of the drill-ship, as also the actual cost incurred for acquiring the drill-ship.
  • The Tax Authority rejected the Taxpayer's books of account for the above reasons and computed the income on a presumptive basis, with reference to its gross receipts.
  • The first appellate authority accepted the Taxpayer's contentions and approved the method adopted for conversion of income in terms of the Rule. It also held that the Taxpayer was entitled to depreciation on the drill-ship as it had adequately substantiated the proof of ownership and the actual cost.
  • Aggrieved by the decision of the first appellate authority, the Tax Authority further appealed to the ITAT.

Contentions of the Tax Authority

  • The Taxpayer maintains its books of account in USD and also receives revenue in USD. It should, therefore, first convert all its business transactions in other currencies into USD by adopting the rate prevailing on the date of the transaction and then convert the net result in USD into INR by adopting the rate prevailing at the end of the tax year. The method adopted by the Taxpayer of directly converting all business transactions into INR at the year-end rate is not in accordance with the accounting principles.
  • The Taxpayer had failed to substantiate the ownership of the drill-ship, as also the actual cost incurred for acquiring the drill-ship.
  • For the above reasons, the Tax Authority was justified in rejecting the Taxpayer's books of accounts and computing the income on a presumptive basis, with reference to its gross receipts.

Contentions of the Taxpayer

  • The Taxpayer had correctly computed its income earned in foreign currency, by applying the Rule. The conversion of revenue and expenses directly into INR by adopting year­end rate is consistent with the method prescribed by the Rule.
  • As regards the claim for depreciation on the cost of the drill-ship, the documents submitted in support of proof of ownership by way of the invoice, the auditor's certificate, the certificate of registration and the valuation reports, adequately substantiate the Taxpayer's ownership over the drill-ship and the actual cost incurred by the Taxpayer.
  • The Taxpayer had allotted shares of the value of USD 270 m (of face value USD 1 each) to its sister concern as the consideration for the purchase of the drill-ship which was made at an arms' length price. The same had been evidenced by way of a Chartered Accountant's report (in Form 3CEB) submitted to the Tax Authority, under the transfer pricing provisions of the ITL.

Ruling of the ITAT

The ITAT held that the Taxpayer had correctly converted income earned in foreign currency by applying the Rule. It also allowed the claim for depreciation on drill-ship for the following reasons:

  • Since the Taxpayer is in the business of hiring out drill-ship, the hiring income has to be assessed either under the head 'profits and gains of business or profession' or 'income from other sources'.
  • It is a settled position that the Rule provides for conversion of income earned in foreign currency by adopting the rate prevailing on the specified date. The Rule does not require the taxpayer to convert the income first into USD or any other currency and subsequently into INR.
  • Income under the head 'profits and gains from business or profession' is the culmination of the day-to-day business transactions. The requirement under the Rule, to convert the income at the end of the year, effectively implies that the day-to-day transactions are to be converted at the year­end rate.
  • As regards the admissibility of the depreciation on the drill-ship, the ITAT took into account the diverse evidence of ownership of the drill-ship furnished by the Taxpayer, including the purchase agreement, the registration certificate, the customs clearance record etc. Considering this evidence, the ITAT confirmed that the Taxpayer had adequately substantiated both its ownership over the drill-ship as well as the actual cost incurred and held that the Taxpayer was entitled to depreciation on the drill-ship.

Comments :-This ruling provides guidance on the application of Rule 115 that the conversion of income earned in various foreign currencies into USD, prior to its conversion into INR, is not required. The requirement under the Rule is only to convert 'income from profits and gains from business' i.e. the net result at the year-end rate. The ruling also emphasizes the need for adequate documentation for establishing ownership and the actual cost of an asset in order to claim depreciation thereon.



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