Our Income Tax law leaves the method of accounting to be desired by the assessee. The insistence is only on the consistency of the method of accounting employed over substantial number of years. Any claim of deduction towards Business expenditure is allowed based on the cash basis or accrual or hybrid system of accounting as adopted by assessee. But the treatment of exchange loss in computation of Taxable profits was once a grey area which then got decided in favour of the assessee by Supreme Court in the popular CIT vs. Woodward Governor case. The ruling was that the assessee can claim the forex loss depending on the regular method of accounting employed by him. The halcyon days ended partly with the introduction of Finance act 2002.
In an attempt to align with the then Schedule VI of the Companies Act 1956, Sec.43A was inserted in Income tax act 1961 which came as the overriding rule to the above SC decision. This section mandated capitalization of exchange loss to an asset where there is an increase in a foreign currency liability due to exchange rate fluctuation when such loss arises at the time of actual payment towards the cost of asset or repayment of the liability. The impact is only on the exchange loss relating to capital assets, but the above SC ruling will still hold well as far as the forex loss on account of revenue expenditure is concerned. Thankfully, history repeats itself under Sec.45 (7) of the proposed Direct tax code Bill as well.
Despite the respite, danger still lurks from the viewpoint of assessees. If there is an amendment similar as above the massive benefit of claiming huge exchange losses on revenue expenses will be eroded. This is especially true when it is a period of recession where the interest rates go up and in parallel there is depreciation in home currency as well. To recollect the current accounting standard AS-11 (or for that matter the forthcoming ‘Desi’ version of IAS-21) requires translation of foreign currency monetary items at the closing rate i.e. Balance sheet date. It may be noted that the MCA notification amending AS-11 to provide for accumulation and amortization of exchange differences on other than long term liability in a separate reserve is permissible only until 31.3.2011. There could also be another whammy here. Currently assessees have not been required to add back the exchange loss while computing Book profits under Sec.115JB of the Income tax act 1961 under the caption ‘‘Provision for meeting unascertained liabilities’. In Chapter V of the Direct Tax code Bill too, the computation of Book profit (same as earlier Sec.115JB) requires such adding back. Exchange fluctuation being an uncertain component of a foreign exchange transaction clearly is an endangered species. All these days the department was not able to raise the issue respecting the above opinion of Supreme Court on estimated exchange losses. It would be terrific if such amendments open the Pandora Box by allowing the same interpretation to be carried over in calculation of Book profits under MAT provisions.
It is also imperative to note that Government’s stand in this issue seems very clear that exchange losses are to be recognized only in the year of actual payments. This can be well substantiated. Some time back, ICAI pioneered the marking of all derivatives to market and routing these gains or losses through P&L. But then CBDT quite cleverly got the better off through its own circular which binds the department to disallow the claim of Mark to Market losses on account of derivatives calling them as ‘Notional’ be it for hedging or speculation. Also Sec.43 (5) specifically discarded Derivative transactions as speculator in nature. This got also reflected the same way in computation of Book profits for MAT. The form may be different but the underlying stand is well established.
There could be one positive if tax law happens to thrust the same rule of forex loss deduction on revenue expenditure. Importers may tend to refrain from withholding or delaying their import payments beyond the taxation year end to avoid the disallowance. Companies in India which have related party transactions outside India cannot afford to sit idle under the pretext of ‘No Interest on delayed payments’. Already our FEMA 1999 (Foreign Exchange Management act) requires payment of all import Bills within a period of 6 months or else the importer is answerable for any interest obligations. RBI will feel relaxed in monitoring if importers get disciplined this way.
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