JUDGMENT (S.H. KAPADIA, J.)

1. Leave granted.

2. Respondent-Enron Oil & Gas India Ltd. ("EOGIL") is a company incorporated in Cayman Islands engaged in the business of oil exploration. In 1993, Government of India through Petroleum Ministry invited bids for development of Concessional Blocks. EOGIL offered its bid for the development of concessional blocks. A consortium of EOGIL with RIL was given the contract. Later on, ONGC joined. EOGIL with RIL and ONGC executed Production Sharing Contract (PSC) with Government of India. EOGIL was entitled to a participating interest of 30% in the rights and obligations arising under the PSC. RIL was also entitled to participating interest of 30%. ONGC was entitled to a participating interest of 40%. EOGIL was designated as the Operator under the said PSC.

3. Vide Notification No. 9997 dated 8.3.1996 under Section 293A of the Income Tax Act, 1961 ("1961 Act"), each co-venturer was liable to be assessed for his own share of income. They were not to be treated as an AOP.

4. EOGIL filed his return of income for Assessment Year 1999-00 declaring its taxable income of Rs. 71,19,50,013 under Section 115JA.

5. During the year, EOGIL debited its P&L account by exchange loss of Rs. 38,63,38,980. The A.O. disallowed this loss on the ground that it was a mere book entry and actually no loss stood incurred by the assessee.

6. The decision of the A.O. was challenged in appeal by EOGIL before CIT(A), who after analyzing the PSC held that each co-venturer in this case had made contribution at a certain rate whereas the expenditure incurred out of the said contribution stood converted on the basis of the previous months average daily means of the buying and selling rates of exchange which exercise resulted into loss/profit on conversion. Under the circumstances, according to CIT(A), it cannot be said that the assessee had incurred notional loss. In fact, during the course of proceedings, CIT(A) found that during Assessment Years 1995-96 and 1996-97 assessee had earned profits which stood taxed by the Department. He further found that one co-venturer (ONGC) had gained Rs. 293.73 crores during Assessment year 1997-98 because the Indian rupee had appreciated as compared to foreign currency and the Department had taxed the same but when during the assessment year in question there is a loss on account of such conversion, the Department has refused to allow the deduction for such conversion losses. According to CIT(A), the Department cannot blow hot and cold. Consequently, it was held that just as foreign exchange gain was taxable, loss was allowable under Section 42(1) of Income Tax Act in terms of the PSC. Therefore, CIT(A) allowed as deduction the loss of Rs. 38,63,38,980.

7. Aggrieved by the order passed by CIT(A) the Department carried the matter in appeal to ITAT objecting to the deletion made by CIT(A) on the ground that the loss was only a book entry. It may be noted that before the Tribunal the matter pertained to Assessment Years 1999-00, 1998-99, 2000- 01 and 1996-97. However, for the sake of convenience, the Tribunal focused its attention on the facts and figures given for Assessment Year 1999-00. Before the Tribunal, the Department contended that the assessee borrows in USD and repays in the same currency for the preparation of the Balance Sheet. The loans, according to the Department, were stated at prevalent exchange rates and the loss so arrived at was charged to the P&L account. Therefore, according to the Department, the said loss was a book entry and it was not an actual loss in the foreign exchange caused to the assessee. This argument of the Department was rejected by the Tribunal. It was held that the assessee was a foreign company. It carried out business activity in India. It had to maintain its accounts in rupees for the purpose of income tax, that the PSC had to be read with Section 42(1) of the Income Tax Act, which entitled the assessee to claim conversion loss as deduction, particu