The increase in global trade and dependency on the foreign capital for the purposes of conduct of business in India has led to various transactions with the entities which are situated outside India. The business is conducted with such entities in the foreign currency unlike the Indian currency which is used for conduct of trade with entities located in India. As all are aware that since the rate of foreign currency is market driven, there may always be a difference in the value of foreign currency at which the transaction takes place and at which the transaction gets settled or closed for the purposes of accounting at the Indian entity. The difference arising from such value between the transaction date and settlement/closure date would give raises to gains or losses depending upon the rate of foreign currency on both such dates. The treatment of such foreign exchange (for brevity ‘forex’) gain/loss from the perspective of provisions of Income Tax Act, 1961 (for brevity ‘IT Act’) is the main object of this article. Let us proceed, to understand the treatment of forex gain/loss under the various provisions of IT Act.
Introduction:
The treatment of forex gain/loss under the provisions of IT Act is
guided by the residuary provisions and general provisions for majority of the
time. The gains were taxed under the charging section that dealt with PGBP[1] and losses were claimed under
Section 37 of IT Act. However, the gains that were arising from transactions
which are capital in nature, the tax payer was not ready to offer any tax
stating that such gains are capital profits and not to be taxed. On a similar
footing, the Revenue tried to disallow losses arising from transactions which
are capital in nature, stating that capital losses are not allowed.
However, the challenge was when a loss/gain is treated as arising from
capital or revenue transaction to determine its exclusion or allowability for
computation of income.
Let us say, commission income earned in foreign currency retained with
the agent of service provider outside India for the purposes of procurement of
capital goods, when repatriated to India, since the procurement did not happen
and on such repatriation, if the commission income yielded a gain, whether such
a gain is to be treated as gain arising on revenue transaction (earning
commission income) or on capital transaction (retained for procurement of
capital goods)?
Another example would be, where profits of a foreign branch of Indian
company when repatriated to India and on such repatriation, there was a loss,
whether such loss amounts to capital transaction (repatriation of reserves) or
revenue transaction (profits from trading activity)?
Whether the loans taken from foreign country for the purposes of
procurement of capital assets, and loss on fluctuation at the time of repayment
or at the time of reinstatement amounts to capital transaction (since loan used
for procurement of capital assets) or revenue transaction (loss arising due to
fluctuation in the ordinary course of business and not dependent upon the
asset)?
Questions like the above have occupied courts on various occasions and
the courts have dealt them in their own way. The introduction of Section 43A,
which dealt with treatment of forex loss/gains in specific instances namely in
cases of imported assets has settled issues to a certain extent, leaving the
scope of litigation for other forex items namely for treatment of forex loss
where foreign loans have been used for procurement of non-imported assets or
treatment of forex loss where foreign loans have been used for revenue
transactions and others.
Further, things would appear to ease down with introduction of Section
43AA with effective from 01st April 17, which states, when
read with ICDS[2] -06[3], that any forex loss/gain pertaining to
monetary items has to be treated as income or loss, however, unsettles certain
settled issues, which we will be dealing at appropriate place.
In this article, we try to formulate certain issues and then answer them
at the end of the write-up looking the impact under different regimes namely
prior and post Section 43A, prior and post to Section 43AA. In this exercise,
we would not be concluding any aspect unless, we take the help of jurisprudence
available.
Issues:
As stated above, the taxation of forex fluctuations always centred
around whether the said fluctuation is a capital or revenue in nature. However,
to decide, whether a fluctuation arises from a capital or revenue item is not
an easy thing for the courts. The said matter was visited by courts again and
again leading to formulation of certain principles. Till the introduction of
Section 43A with effect from 01st April 1967,
the courts were occupied with the following questions:
- Whether the forex fluctuation arising out of
loans taken which were used for procurement of capital assets were capital
or revenue in the nature?
- Whether the forex fluctuation arising out of
loans taken which were used for purposes of revenue items were to be
treated as capital or revenue in nature?
As stated earlier, let us examine certain important judgments which have
tried to answer the above said questions. Since the courts would have dealt all
or any of the questions in their respective judgments, we would not be
examining the judgments qua above listed questions, but attempt at the end
answering the above questions in light of the principles laid down by courts.
Before proceeding to examine the judgments, let us understand the board legal
position pre and post April 2017.
Position - Pre April 2017:
Treatment of Forex Gain/Loss – Instances covered under Section 43A:
Section 43A deals with a situation where any asset is acquired from a
country outside India for the purposes of business and if there is an increase
or reduction in liability as expressed in Indian Currency (as compared to the
liability existing at the time of acquisition of the asset) at the time of
making payment towards the whole or part of the cost of the asset or towards
repayment of whole or part of money borrowed by him from any person directly or
indirectly, in any foreign currency specifically for the purposes of acquiring
the asset along with interest, if any, the amount by which the liability as
aforesaid is so increased or reduced during such previous year and which is
taken into account at the time of making payment, irrespective of method of
accounting adopted by the assessee, shall be added to, or as the case may be
deducted from the actual cost of asset and the amount arrived at after such
addition or deduction shall be taken as actual cost of the asset.
Hence, the provisions of Section 43A shall be applicable only if an
asset is acquired from a country outside India and at the time of payment,
there is a difference in liability, instead of treating the same as income or
loss, the same shall be adjusted to the actual cost of the asset and the
balance shall be taken as actual cost. This is the stark contrast between
Section 43A and Section 43AA. Except for instances mentioned in Section 43A,
all other instances would require treatment under Section 43AA.
Treatment of Forex Gain/Loss – Other than Section 43A:
As stated in the introduction, all through this period, that is right
from the inception of 1922 Act till April 17, broadly, the courts held that if
forex gain/loss is on a revenue item, it would be taken for the purposes of
computation and in all other case, the said forex gain/loss will not be taken
into consideration for the purposes of computation, only exception being the
instances mentioned in Section 43A.
Position – Post April 2017:
Treatment of Forex Gain/Loss – Instances covered under Section 43A:
No major changes post April 2017 qua this section. The position as
stated under ‘Position – Pre April 2017’ will hold good here too.
Treatment of Forex Gain/Loss – Other than Section 43A:
Section 43AA of IT Act deals with taxation of Forex fluctuation. The
said section states that subject to the provisions of Section 43A, any gain or
loss arising on account of any change in foreign exchange rates shall be
treated as income or loss, as the case may be, and such gain or loss shall be
computed in accordance with ICDS notified under Section 145(2)[4].
Section 43AA is applicable for all forex transactions including those
relating to monetary, non-monetary, translation of Financial Statements of
Foreign Operations, Forward Exchange Contracts and Foreign Currency Translation
Reserves. In other words, except for situations stated in Section 43A, for all
other situations, the gain/loss arising from forex transactions is to be dealt
in accordance with Section 43AA read with relevant ICDS.
Section 145(2) of IT Act has notified 10 ICDS with effective from
Assessment Year (AY) 2017-18. ICDS - 06 deals with Effects of Foreign Exchange
Rates. Para 1 of ICDS – 06 states that said standard deals with inter alia,
treatment of transactions in foreign currencies. The treatment of foreign
exchange fluctuations for monetary items and non-monetary items is different.
Para 2(k) of ICDS-06 defines ‘monetary items’ are money held and assets
to be received or liabilities to be paid in fixed or determinable amounts of
money. Cash, receivables and payables are examples of monetary items. Para 2(l)
defines ‘non-monetary items’ assets and liabilities other than monetary items.
Fixed Assets, inventories and investment in equity shares are examples of
non-monetary items. Further, Para 2(g) defines ‘Foreign Currency Transaction’
is a transaction which is denominated in or requires settlement of foreign
currency, including transactions arising when a person:
- buys or sells goods or services whose price is
determined in a foreign currency or
- borrows or lends funds when amounts payable or
receivable are denominated in foreign currency or
- becomes a party to an unperformed forward
exchange contract or
- otherwise acquires or disposes of assets,
incurs or settles liabilities, denominated in a foreign currency
Initial Recognition:
Para 3(1) states that a foreign currency transaction shall be recorded
on initial recognition in the reporting currency, by applying the foreign
currency amount the exchange rate between the reporting currency and the
foreign currency at the date of transaction.
Conversion at Last Date:
Para 4(a) states that at last day of previous year foreign currency
monetary items shall be converted into reporting currency by applying the
closing rate. Para 4(c) states that, for non-monetary items in a foreign
currency, they shall be converted into reporting currency by using the exchange
rate at the date of transaction.
Recognition of Exchange Differences:
Para 5(i) states that in respect of monetary items, exchange differences
arising on the settlement thereof or on conversion thereof at last day of
previous year shall be recognised as income or expense in that previous year.
Para 5(ii) states that in respect of non-monetary items, exchange differences
arising on conversion thereof at the last day of previous year shall not be
recognised as income or expense in that previous year.
Exception to Initial Recognition, Conversion and Recognition of Exchange
Differences:
Para 6 states that notwithstanding anything contained in Para 3, 4 and
5, initial recognition, conversion and recognition of exchange difference shall
be subject to the provisions of Section 43A.
Hence, from the above, it is evident that except for the circumstances
as described in Section 43A, the gain or loss arising from forex fluctuations
on monetary items has to be treated as income or loss in terms of ICDS-06 read
with Section 43AA. With this understanding, let us proceed to examine, the instances
which would attract the provisions of Section 43A.
Now, with the position prior and post April 2017 in the background, we
shall examine various judgments which would help out to answer the issues
framed.
In the matter of Tata Locomotive and Engineering Co Limited – Supreme
Court:
In the facts of this matter, the assessee is in the business of
manufacture of locomotives boilers and locomotives, for the purpose of
manufacturing activity had to make purchases of plant and machinery in USA.
With the sanction of Exchange Control Regulator, it had remitted to its agent
in USA an amount of $33,850. As selling agent for Baldwin Locomotives
Works of USA for the sale of their products in India, the assessee incurred
certain expenses and also earned commission of $36,123. With the permission of
Exchange Control Regulator, the Assessee has requested the Baldwin to deposit
the commission and reimbursement of expenses with its agent M/s Tata Inc, New
York.
The letter written to Exchange Control Regulator, the assessee has
stated that the said amounts will be used for purchase of capital goods and not
for any other purposes. The commission income earned is however offered to tax
in India in respective assessment years. The pound sterling and with it the
Indian Rupee were devalued on September 1949. Thereafter, the assessee found it
would be more expansive to buy American goods and also noted that the
Government of India has put some sanctions on purchase of goods from USA.
The assessee then permission with Exchange Control Regulator has brought
back the amounts retained with its agent into India. The said amounts when
brought back have led to realisation of profits due to exchange fluctuations.
The Revenue contends that the said profits were pertaining to commission
income, which was earned by assessee from Baldwin, which would be revenue in
nature and accordingly the profit arising from such revenue item would be
subjected to tax, since it is a profit incidental to business. The assessee
however contends that since the amounts were retained outside India for the
purposes of procurement of capital goods, any gain arising on forex account
pertains to fixed capital and accordingly not subjected to tax.
The tribunal has not agreed with the view of the assessee and
accordingly upheld the order of AO[5]. The matter travelled to SC[6], wherein the court stated that the act of
retaining the monies in USA for capital purposes after obtaining the sanction
of Reserve Bank was not a trading transaction in the business of manufacture of
locomotive boilers and locomotives, it was clearly a transaction of
accumulating dollars to pay for capital goods, the first step to the
acquisition of capital goods. Hence, the surplus attributable to $36,123 was
capital accretion and not profit taxable in the hands of assessee.
Take-Aways:
The SC stated that once the amounts are retained with the agent for the
purposes of procurement of capital goods, the said amount would lose its
character of revenue even though the amounts retained were from originally from
a revenue item like commission income. The SC stated that Revenue would not had
any issue, if the amounts were remitted to India and then sent back to New York
for the purposes of procurement of capital goods. Since, in the case, with
permission of RBI since the assesse has retained such amounts for the purposes
of capital goods, the same would obtain the nature of capital even though the
said capital goods were not ultimately purchased. The SC has culled out the
intention of retention from the letter written by assessee to RBI and
accordingly held that the gain arising due to forex fluctuation is capital in
nature and no tax is to be paid. The SC further referred to the decision of European
Court in the matter of Davies (H.M Inspector of Taxes) v. The Shell Company of
China Limited[7] and arrived
at the above conclusion.
In the matter of Bestobell (India) – Supreme Court:
In the facts of this matter, the assessee has taken loan from parent
company for the purposes of execution of works in India. The terms of the
contract state that the loan has to be repaid within one year or availability
of funds whichever is earlier. On the balance sheet date, the loan was
outstanding and the fall in rupee made assesse to account for additional loss
for the repayment of loan.
The assessee claimed that such loss is revenue in nature and should be
allowed. However, the Revenue claims that such loss is arising out of capital
transaction and hence capital loss. The court held that the loss arising from
devaluation of rupee on outstanding loan cannot be considered as extra expenditure
to be incurred for meeting the debt like postal expenses or bank charges or as
extra expenditure resulting in a business loss of revenue nature. If there had
been a devaluation in favour of the assessee as a result of which the assessee
had to pay less to its creditors, the surplus would arising would have been of
capital nature and could not have been assessed in the hands of assessee as a
business profit. Conversely, as a result of the exchange rate going against the
assessee, the loss which the assessee incurred cannot be held to be revenue
loss.
Take-Aways:
Even though, this judgment is post Tata Locomotive and Engineering Co.
Limited’s verdict, the SC has not referred the later for arriving at the said
conclusion. The SC went to state that since the loss arising was not similar to
the expenditure a company would incur on postal expenses or bank charges, the
said loss cannot be allowed as revenue in nature. Further, the SC went on to
state that the same is also not allowed as revenue in nature since, if there
was a gain, the assessee would not have offered it to tax. From the above
judgment, it is clear that the SC has not undertaken the analysis as to whether
the forex loss was arising out of a capital or revenue nature but simply
concluded that the forex loss cannot be allowed as revenue nature despite the
said loan is used for the purposes of working capital/business. Hence, to this
extent, this judgment needs a re-look.
In the matter of Sutlej Cotton Mills Limited – Supreme Court:
In the facts of this matter, the assessee was engaged in the business of
manufacture and sale of cotton fabrics. The assessee had a cotton mill in West
Pakistan and such cotton mill has earned good amount of profit for the period
ended 31st March 1954. Since the assesse was taxed on accrual basis, the
profits of West Pakistan branch has been included in the profits of Indian
Company and tax was paid accordingly after taking the benefit of double
taxation relief in accordance with treaty existed therein.
When the profits were offered to tax in India, the exchange rate between
Pakistan and India stood at 100 Pakistani Rupees being equal to 144 Indian
Rupees. Later when Indian company has applied for repatriation of certain
amounts of profits lying at West Pakistan branch, the exchange rate existed was
100 Pakistani Rupee being equal to 100 Indian Rupees and accordingly the Indian
company, realised the same amount that has been applied for repatriation.
The Indian company hence claimed a loss of amount due to foreign
exchange fluctuation under Section 10(1)[8] of Income Tax Act, 1922. The tax was
paid at 144 Pakistan Rupees but realisation happened at 100 Pakistan Rupees.
The Income Tax Officer has not allowed such deduction which has arisen due to
foreign exchange fluctuation stating that such loss is due to state action and
not relating to the business of assessee. The assessee has approached the High
Court against such an order but could not succeed. Then the assessee has
approached the SC.
The SC after placing reliance on various English Judgements has held
that any devaluation of foreign exchange on account of trading asset would be
trading loss and on account of capital asset would be capital loss. The SC also
formulated a test in a way by asking the question whether the loss was in
respect of circulating capital[9] or in respect of fixed capital. If
it was pertaining to circulating capital, then it would be revenue loss which
should be allowed and if it was pertaining to fixed capital, then it would be
capital loss which should not be allowed as deduction.
Accordingly the SC remanded the matter to the lower authority to
examine, whether the amounts which the assessee Indian company repatriated
constitutes ‘circulating capital’ or ‘fixed capital’ to determine the
deductibility of the loss. This judgement forms base for all the future
judgments till date.
Take-Aways:
The SC has rightly held that in order to decide whether a forex gain or
loss is taxable or allowable, the important question that needs to be addressed
is whether the said gain or loss is arising from the fixed capital or
circulating capital. The SC has referred and followed the principle laid down
by European Court in The Shell Co of China Limited (supra) [which was also
relied by SC in the matter of Tata Locomotive and Engineering Co Limited
(supra)]. This judgment lays down an important observation to decide the fate
of forex gain/loss. If the forex gain/loss is arising from a fixed capital, the
same would be capital in nature and not allowed as loss or taxed. In other
cases, the same is to be treated as arising from circulating capital and
accordingly to be allowed as deduction or taxed.
In the matter of Union Carbide Limited – Supreme Court:
In the facts of this matter, the assesse took a loan from Export Import
Bank of Washington for making payment in United States of America (USA), the
price of capital, plant and machinery purchased for new project. The loan was
taken and repayable in dollars. Out of this loan, payment was made to various
supplier in USA for purchase of such assets. On the balance sheet date, the
value of rupee devalued and accordingly liability to pay loan has increased.
The assessee has claimed the said loss as expenditure, whereas AO has
not accepted stating that the loss was on loan which was used for purchase of
capital assets and hence capital in nature. The Appellate Commissioner and
Tribunal followed the AO’s order. The SC following the earlier decision in
Sutlej Cotton Mills Limited (supra), has held that since loss was arising on
account of fixed capital, the same cannot be allowed as revenue expenditure.
Take-Aways:
The SC held that, where profit or loss arises on account of appreciation
or depreciation in the value of foreign currency held by it, on conversion into
another currency, such profit or loss would ordinarily be trading profit or
loss if the foreign currency is held on revenue account or as a trading asset
or part of circulating capital embarked in the business. But, if on the other
hand, the foreign currency is held as capital asset or as fixed capital, such
profit or loss would be of capital nature. The SC has followed the ratio laid
down in its earlier decision of Sutlej Cotton Mills Limited and stated that
since the loan is taken for purchase of assets, the same is not to be allowed
as revenue expenditure. The issue in the current case pertains to Assessment
Year 1967-68 and the Section 43A being inserted with effect from 01.04.1967, it
appears the SC has used only Section 43A for the purposes of interpretation of
another issue involved in the same matter dealing with development rebate.
In the matter of Bharath General Textile Industries Limited – Calcutta
High Court:
In the facts of the matter, the assessee has borrowed a certain amount
of Japanese Yen for setting up a capital asset. The said loan was repayable in
instalments in Japanese Yen. In order to repay the instalments of price of
machinery purchased on deferred payment basis, the assessee has to pay and
additional amount due to day to day fluctuation in the exchange rate. The
assessee has claimed the said loss, which was negatived by AO but allowed by
Tribunal. The assessee conceded that the loss on account of devaluation is
covered by Section 43A and since in the instant case, the loss was due to
fluctuation and not devaluation and accordingly such loss has to be allowed as
revenue expenditure.
Further, the assessee has purchased a capital asset and the purchase
price was converted into loan which was repayable in instalments. Thus the
expenditure was on capital account and cannot be deductible. Followed the SC
decision in Sutlej Cotton Mills Limited (supra).
Take-Aways:
The Calcutta HC stated that there is no qualitative difference in
additional expenditure incurred due to the fluctuation or devaluation in the
exchange. But whether the expenditure involving this additional liability will
be allowable or not in computing the profit will depend on whether the
expenditure is on capital or revenue account. It is the nature and character
that would determine the question. The HC following the decision of SC in the
matter of Sutlej Cotton Mills Limited (supra) has rejected the allowability of
expenditure. A Special Leave Petition was filed before SC was dismissed.
In the matter of Periyar Chemicals Limited – Kerala High Court:
In the facts of the matter, the assessee was a public limited company
carrying on the business of manufacture and sale of chemicals. The company
imported machinery from Germany and for that purpose, it had availed of a
foreign currency loan of Deutsche Marks 7,36,855 from a German company through
the ICICI Bank.
The loan was to be repaid in German currency in instalments spread over
a number of years. At the time when the loan was taken, the exchange rate was
Rs. 2,258 for one Deutsche Mark. During the accounting year ending on June 30,
1975, the assessee had paid an instalment of 1,13,700 Deutsche Marks. On the
date of payment due to forex fluctuation, the assessee has to incur additional
amount to repay the instalment. Such additional amount was claimed as revenue
deduction for which the AO has not accepted and Tribunal has upheld the AO’s
order. The matter when reached the HC, the court held that such an expenditure
pertains to the capital asset and accordingly disallowed the expenditure.
Take-Aways:
The Kerala HC following the decisions of Supreme Court in Tata
Locomotive and Engineering Co Limited, Sutlej Cotton Mills Limited and Union
Carbide India has not allowed the said expenditure as revenue.
In the matter of Calcutta Electric Supply Corporation Limited – Calcutta
High Court:
The assessee, a foreign company, claimed the following deductions - the
extra amount remitted for purpose of distribution of dividend on account of
devaluation of the Indian rupee, additional expenses incurred due to
devaluation in redeeming its sterling debentures.
The AO has disallowed the expenditure stating that such an expenditure
was not stated in Section 36 and since this was not an expenditure incurred
wholly for the purposes of business, the assesse cannot claim the forex loss on
dividends under Section 37. The Court held that once dividend was declared, the
assessee as a company was bound to pay the same to the shareholders and a
liability arose which had to be met by the assessee. The extra amount which had
to be paid on account of devaluation of the Indian rupee was laid out for
purposes of business and was deductible as such.
The Court held that it had been found that the money borrowed on
debentures had been utilised for financing a capital expenditure programme. The
extra amount paid on account of devaluation of the Indian rupee in redeeming
its debentures was capital expenditure. It was not deductible. Followed the
Bestobell (India) Limited judgment.
Take-Aways:
This is one of the matters where the court has an occasion to examine
the allowability of forex loss as deduction arising on a revenue item. The
Court stated that once the dividends are declared, the company is under
statutory obligation to pay the same and accordingly forex loss on such
dividends is allowable expenditure. Whereas, the forex loss arising on money
borrowed on debentures which has been utilised for purpose of capital
expenditure programme was disallowed stating that the same was capital in
nature by following the Bestobell (India) judgment (supra).
In the matter of Tata Iron & Steel Co Limited – Supreme Court:
In the facts of the matter, the assessee-company has reduced the forex
gain while repaying the instalments of the foreign loan, from the actual cost
of the asset and claimed deprecation on the balance. Further, in the same year,
the assessee-company has increased the actual cost by adding the forex loss on
capital account and claimed depreciation on the same.
This was pertaining to Assessment Year 1960-61, at time where the
provisions of Section 43A were not on the statute book. The HC has allowed the
claim of the assessee-company by following its own decision in the matter of
Tata Hydro-Electric Power Supply Co Limited[10]. The revenue went on appeal before SC
stating that the HC has relied on the judgment which deals with Section 43A and
in the instant case, for the assessment years in question, the provisions of
Section 43A does not apply and accordingly reliance by HC was unwarranted. The
SC interestingly accepted the contention of the Revenue but continued to hold
that the conclusion of HC was not erroneous.
Take-Aways:
The SC has stated that what is actual cost must depend upon the amount
paid by the assessee to acquire the asset. The amount may have been borrowed by
the assessee, but even if the assessee did not repay the loan it will not alter
the cost of the asset. What has to be borne in mind is that the cost of asset
and the cost of raising money for purchase of the asset are two different and
independent transactions. The SC held that mode of repayment of loan has
nothing to do with the actual cost of asset. It further stated that raising of
loan for the purposes of purchase of asset is different from the purchase of
asset and both of them are two different transactions. By stating so, the SC
has stated that for all the matters which are not coming after the introduction
of Section 43A, the actual cost cannot be altered based on a subsequent event,
that is forex fluctuation. This was an interesting view which did not surface
till that point of time.
In the matter of Woodward Governor India Private Limited – Supreme
Court:
The SC had another occasion to deal with the issue whether the loss
arising out of foreign exchange fluctuations in terms of revenue items can be
allowed under Section 37(1) for the purposes of income tax at each balance
sheet date despite of the fact that the payment for such item has not arisen.
Further, the loss arising out of foreign exchange fluctuations on balance sheet
date in terms of capital items can be adjusted to the actual cost in terms of
Section 43A despite of the fact that the same was not paid during the year.
The SC has stated that for the purposes of Section 37, the word
‘expenditure’ includes ‘loss’ and the assessee can be allowed deduction of loss
which was arising out of adoption of AS-11 for the revenue items and there is
no necessity that the loss has to be allowed on actual incurred basis. As far
as the capital assets are concerned, the SC has allowed the loss to be adjusted
to the actual cost despite there being no payment during the year. The SC has
held that the amendment to Section 43A which allows changes to actual cost
based on payment is prospective and does not apply to the period under
consideration.
Take-Aways:
The SC has held that forex loss on revenue items can be claimed as
expenditure under Section 37 in the year which such loss was accrued and need
not wait till the date of actual payment. The forex loss on revenue items can
be claimed on accrual basis. Further, the SC has also cleared that the
amendment to Section 43A which allows changes to actual cost based on the actual
payment is prospective.
In the matter of Cooper Corporation (P) Limited – Pune ITAT[11]
The facts in the matter of this case, is that a foreign currency loan
was availed by the assessee and utilised the same for acquisition of assets and
expansion of project. On the year end, the outstanding foreign currency loan is
required to be translated into Indian Rupees by applying the foreign exchange
rate as on closing day of reporting period and the net exchange difference
resulting in translation is required to be recognized as income or
expense for the respective financial period as per the Accounting Standard -11
issued by ICAI.
The assessee has initially availed loans from Indian Banks and the said
loans are converted to foreign currency loans in order to take benefit of lower
rate of interest on such foreign currency loans vis-Ã -vis loans in Indian
currency, leaving an exposure to changes in foreign exchange. Because of
stronger US Dollar, the assessee at year end has incurred a loss on such
foreign currency loan. The said loss was claimed as deduction under Section
37(1) of the Act. The AO has rejected the plea of the assessee on various
grounds, one of them being that such loss is on account of loans used for
purposes of acquisition of capital assets and accordingly the loss is capital
in nature and the same cannot be allowed under the provisions of Section 37(1)
of the Act.
The ITAT has held that in absence of applicability of Section 43A and in
absence of any provisions of the Income Tax Act dealing with issue, claim of
exchange fluctuation loss in revenue account in accordance with generally
accepted accounting standards notified by ICAI, conversion of foreign currency
loans which led to loans, were dictated by revenue considerations towards
saving interest costs etc., the loss can be allowed under Section 37(1) of the
Act.
Take-Aways:
The ITAT has held that such loans were initially taken in Indian
currency and later converted them to the foreign currency in order to save
interest and on assumption that there will be no loss arising on foreign
exchange fluctuation. The ITAT has also stated that there was no dispute the
fact that the acquisition of capital assets/expansion of projects etc from the
term loans taken are completed and the assets so acquired have been put to use.
As a consequence, the loss occasioned from foreign currency loans so converted
is post facto subsequent to capital assets having been put to use. The ITAT
also has examined the provisions of Section 43A and stated that the same would
not be applicable to the facts of the instant case for the reason that the
assets are procured within India, whereas Section 43A shall be applicable in
case of asset purchase outside India. Then the ITAT has proceeded to examine
the issue, whether the loss is on revenue or capital account has to be tested
in light of generally accepted accounting principles, pronouncements and
guidelines etc.
The ITAT has proceeded thereafter to examine the provisions of Section
43(1) of IT Act which deals with ‘actual cost’. The ITAT has stated that
despite there are number of explanations dealing with ‘actual cost’ in various
circumstances, there is no explanation which deals with any gain or loss on
foreign currency loan acquired for purchase of indigenous assets will have to
be added or reduced to the cost of assets. Accordingly, ITAT has stated
that nothing can be added or reduced to actual cost of assets except a
situation which is envisaged in Section 43A because of its non-obstinate
clause. Thereafter, the ITAT has referred to the decision of Honourable Supreme
Court in the matter of Tata Iron & Steel Company Limited (supra) and stated
that the activity of loan repayment and actual cost of asset are two different
things and cannot be read one into another. Then, the ITAT proceeded to
examine the provisions of Section 36(1)(iii) and stated that the utilisation of
loan for capital account or revenue account purpose has nothing to do with
allowability of interest expenditure. The only restriction to Section
36(1)(iii) is that interest till the date of asset being put to use is not
allowed as revenue deduction. In other words, the ITAT has held that interest
is allowed as revenue expenditure after the asset is being put to use even
though the interest expenditure is pertaining to capital account. The ITAT then
stated that impugned fluctuation loss therefore has a direct nexus to the
saving in interest costs without bringing new capital asset into existence.
Since the business exigencies are implicit as well as explicit in the action of
the assessee and the argument that the act of conversion has served a hedging
mechanism against revenue receipts from exports also portrays commercial
expediency, the interest can be held to be related to revenue account and
accordingly eligible for deduction under Section 37(1).
In the matter of TVS Motor Company Limited – Chennai ITAT
In the facts of this matter, the assessee has taken external commercial
borrowing (ECB). The actual loss on exchange difference in repayment of ECB
which was used toward non-imported assets was claimed as revenue expenditure.
The Revenue has disallowed such expenditure and allowed depreciation on the
extent of loss instead of completely allowing the loss.
The assessee claimed before the Tribunal that the actual loss on
exchange difference in repayment of ECB should be allowed as revenue expenditure
on the ground that provisions of Section 43A shall not be applicable and placed
reliance on judgement of Cooper Corporation (supra). However, AO invoked the
provisions of the Section 43A and accordingly allowed depreciation. The ITAT
placing reliance on Cooper Corporation (supra) has allowed the actual loss as
revenue expenditure.
Take-Aways:
The ITAT has relied upon the judgment of ITAT Pune in Cooper Corporation
(supra)[12] and passed order in favour of
assessee. The ITAT has not made any specific observations as to the actions of
AO invoking provisions of Section 43A.
In the matter of Country Club Hospitality & Holidays Limited –
Hyderabad ITAT:
In the facts of the matter, the assessee company has raised term funds
from international market by issuing Foreign Currency Convertible Bonds (FCCB),
which is having the convertible option to equity shares or repayment of bonds
after 5 years. The assessee has incurred forex loss of Rs 21.92 Crores on FCCB
and the assessee has re-instated the bonds at currency rates prevailing at year
end and the difference is transferred to ‘Foreign Currency Monitory Translation
Difference Account’ to be written off over a period of 3 years accordingly for
the relevant assessment year under consideration, the assessee has written off
1/3rd of such loss to profit & loss account.
The AO in light of CBDT Circular stated that where the financial
instruments are valued at market price so as to report the actual value on the
reporting date which is required from the point of view of transparent
accounting practices for the benefits to the shareholders of the company, but
is notional loss as the asset continues to be owned by the company and
accordingly held that was a notional loss and cannot be allowed. The ITAT by
placing reliance on judgement of Supreme Court in the matter of Woodward
Governor India Private Limited (supra) has held that such loss is not a
notional loss and accordingly can be allowed.
The AO has disallowed the loss on the other ground stating that loss on
FCCBs is capital loss and not a revenue loss. The ITAT following the decision
of M/s Crane Software India Limited has held that the expenses relating to
FCCBs till they get converted into equity are to be considered as revenue and
accordingly allowed the loss.
Take-Aways:
The ITAT has followed the decision of Woodward Governor India Private
Limited (supra) and held that loss on balance sheet is not a notional loss and
can be claimed.
Responses to Issues:
Geared up with above rationale from various judgements, now let us
proceed to examine each issue and try to address them under different regimes
namely, pre and post Section 43A and pre and post Section 43AA.
Whether the forex fluctuation arising out of loans taken which were used
for procurement of capital assets were capital or revenue in the nature?
|
Regime |
Treatment |
|
Pre-Section
43A |
·
The Supreme Court in the matter of Tata Locomotives & Engineering Co
Limited (supra) has held that once it is identified that the purpose of
retention of forex was for the procurement of capital goods, any forex fluctuation
thereof shall be on capital account. ·
The Supreme Court in the matter of Sutlej Cotton Mills Limited (supra) has
held that the taxability of forex fluctuations is completely dependent upon,
whether such fluctuations arise on account of fixed capital or circulating
capital. If the same is on account of fixed capital, the loss cannot be
allowed and gain cannot be charged. However, if the same is on account of
circulating capital, then the loss can be allowed and gain shall be charged. ·
The Supreme Court in Union Carbide Limited (supra) has held that loan which
was taken for the procurement of assets would be capital in nature by
following the decision of Sutlej Cotton Mills Limited (supra). ·
Hence, from the above, it is evident that the position pre-Section 43A would
be, that if the forex loss (because of re-instatement or actual loss) is
arising on loans used for procurement of capital assets, then such loss would
be treated as capital loss and accordingly not allowed. If the loans would
have resulted in forex gain (because of re-instatement or actual gain), the
same would be not subjected to tax. |
|
Post –
Section 43A |
·
If the loan falls under the ambit of Section 43A, then the loss or gain shall
be adjusted to the actual cost of the asset and on the revised value, the
assessee can claim depreciation. This is better when compared to previous
position, since in the previous case that is prior to Section 43A, the loss
is not even considered for depreciation. |
|
Pre – Section
43AA |
·
If the loan does not falls under the ambit of Section 43A, then the loan has
to be dealt in accordance with the general provisions of the Income Tax Act. ·
If one adopts the rationale of Honourable Supreme Court in Sutlej Cotton
Mills Limited (supra) and other decisions which followed it, since the forex
fluctuation is as a result of loan which has been used for procurement of
capital asset, then such forex fluctuation would assume the character of
capital. ·
Once the same is to be treated as capital, the loss cannot be claimed as
expenditure under Section 37 since the said section does not allow claiming
of expenditure which is capital in nature. ·
A question may arise that, whether loss if at all can be claimed under
Section 37, since the said section deals with expenditure but not loss.
However, the Supreme Court in the matter of Woodward Governor India Private
Limited (supra) has held that the phrase ‘expenditure’ which was used in
Section 37 covers ‘loss’ also. Hence, the forex loss cannot be claimed under
Section 37. ·
Since the same cannot be claimed as loss under Section 37, a question may
arise, whether the said loss can be adjusted to actual cost, in order to
arrive at revised actual cost and accordingly claim depreciation on the same,
in similar terms as done for Section 43A. ·
This cannot be done because, there is no section which permits the same. In
certain cases, AO has resorted to such an action, but the same is doubtful in
absence of any specific provision to support such an action. ·
However, if one adopts the decision of Supreme Court in the matter of Tata
Iron and Steel Co Limited, the loss/gain can be adjusted against actual cost
and depreciation can be claimed on the revised actual cost. The Supreme Court
in the subject matter held that repayment of loan has nothing to do with
actual cost of asset. It stated that raising of loan for the purpose of
purchase of asset is different from the purchase of asset and both of them
are two different transactions and one cannot influence the other. But it
appears that while coming to the above conclusion, the Supreme Court has not
referred to any of the previous judgments of its own and proceeded to lay
down a new law. Hence, this judgment has to be taken with such caution. ·
Further, by adopting and following the above judgment, the Pune ITAT in the
matter of Cooper Corporation (P) Limited (supra) has held that in absence of
any provisions of IT Act to deal with treatment of loss arising from loans
which are used for procurement of assets and Section 43A being not
applicable, the forex loss should be taken under revenue account by adopting
the accounting standards issued by ICAI. ·
However, in Cooper Corporation (P) Limited (supra), the ITAT has also
observed that the loss was arising on loans which were used for procurement
of capital assets/expansion of project and such assets were put to use. In other
words, the forex loans on loss was arising on re-instatement of loans which
were used for procurement of assets and such forex loss was pertaining to the
period where post such assets were put to use. ·
Whether this particular fact made the ITAT to lean in favour of allowing the
forex loss as revenue loss is not clear from the text of the judgement.
However, the judgment makes reference to Section 36(1)(iii) and states that
the utilisation of loan for capital or revenue account purpose has nothing to
do with the allowability under Section 36(1)(iii) and only restriction vide
proviso to said section is that, the interest cannot be claimed as deduction
till the period such asset was put to use and once the asset is put to use,
the interest is allowed as deduction despite the fact that such interest
pertains to the funds used for purpose of acquisition of capital assets. ·
The fact is that following Cooper Corporation (P) Limited, there are many
judgments which has held that such forex loss can be claimed as revenue loss
under Section 37. |
|
Post –
Section 43AA |
·
After introduction of Section 43AA, if the loss is pertaining to a monetary
item, the same shall be allowed as deduction in computation of profits and
gains. ·
Since the foreign currency loan is a monetary item in terms of definition
laid out in ICDS-06, the loss arising from such foreign currency loan shall
be allowed as deduction irrespective of the fact that the same is used for
procurement of capital assets. In a way, the treatment under Section 43AA
nullifies the decision of Supreme Court in the matter of Sutlej Cotton Mills
Limited (supra) and upholds the decision of Supreme Court in the matter of
Tata Iron & Steel Co Limited and Pune ITAT’s decision in the matter of
Cooper Corporation (P) Limited. ·
However, the story goes good as long as the forex fluctuation is loss. If the
forex fluctuation ends up in gain and if the assesse is asked to pay tax in
terms of ICDS-06 read with Section 43AA, then the assessee may turn on to
place reliance right from Supreme Court judgments from Tata Locomotive and
Engineering Co Limited, Sutlej Cotton Mills Limited and various others and
claim that such profits are not taxable. ·
The assessee can take aid of the preamble of ICDS-06 which states that in
case of conflict between provisions of IT Act and ICDS, the provisions of the
IT Act shall prevail. Accordingly, since capital items are not subject matter
of tax, the assessee can very well claim that to such an extent the
provisions of ICDS will not be applicable and accordingly such forex gains
may not be brought to tax. However, this has to be tested in the days yet to
come. |
Whether the forex fluctuation arising out of loans taken which were used
for purposes of revenue items were to be treated as capital or revenue in
nature?
|
Regime |
Treatment |
|
Pre-Section
43A |
·
The Supreme Court in the matter Bestobell (India) (supra) has examined the
subject issue. In the said matter, a loan was taken for the purposes of
execution of certain works in India by a subsidiary company from the parent
company. The loss arising on forex fluctuations was not allowed as deduction
stating that the forex loss cannot be considered as extra expenditure for
meeting the debt like postal expenses or bank charges or as extra expenditure
resulting in business loss of revenue nature. ·
Basis above rationale, the Supreme Court held that forex loss on loans which
were used for purposes of execution of works (which leads to revenue profits)
as capital loss. Well, this judgement is prior to the judgment of Supreme
Court in the matter of Sutlej Cotton Mills Limited, where the principle of
fixed capital and circulating capital was discussed. Hence, the judgment in
Bestobell (India) has to be taken with such caution. |
|
Post –
Section 43A |
·
Since the loan is used for the purposes of revenue items, the provisions of
Section 43A would not have any role to play and accordingly there would not
be any impact on such forex fluctuation arising of such loans even after
introduction of Section 43A. |
|
Pre –
Section 43AA |
·
In continuation to the position under ‘Pre-Section 43A’, the assessee can
very well now make arguments that based on the judgement of Supreme Court in
the matter of Sutlej Cotton Mills Limited (supra) and argue that since the
forex loss is arising out of loan which is used for working capital or
revenue items, the same would be on account of circulating capital and
accordingly should be allowed as loss. Further, reliance can be placed on the
judgement of Calcutta Hight Court in the matter of Calcutta Electric Supply
Corporation Limited (supra), where in the forex loss arising on payment of
dividends is held to be on revenue account and thereby allowed the same as
deduction. The assesse can also place reliance ·
The assessee can also take a plea that when the forex loss arising on loans
used for procurement of capital assets was itself allowed as revenue
expenditure under Section 37 in the matter of Cooper Corporation (P) Limited
(supra), TVS Motor Company Limited (supra) and various other judgements that
followed Cooper Corporation (P) Limited, the forex loss arising on revenue
items has to be definitely allowed. ·
One another challenge that the assessee would face is that the forex loss if
it is on account of re-instatement at the year end, then the AO may deny the
loss stating that the same is notional loss and not on actual account. Since,
Section 37 allows actual loss and not notional loss, the deduction may be
disallowed under Section 37 despite of the fact, that AO has accepted such
loss to be revenue loss in the first place. ·
However, the assesse can rely on the judgment of Honourable Supreme Court in
the matter of Woodward Governor India Private Limited, wherein it was stated
that loss which was recognised as a consequence of Accounting Standard -11 is
not a notional or contingent loss and should be allowed as deduction under
Section 37. |
|
Post –
Section 43AA |
·
There would not be any issue post introduction under Section 43AA because the
said section states that forex fluctuations arising from monetary items has
to be taken for the purposes of computation of income. The above treatment
would put rest to certain judicial precedents like Bestobell (India) Limited
and others which followed them. |
[1] Profits and Gains
from Business or Profession
[2] Income
Computation and Disclosure Standards
[3] Effects of
Foreign Exchange Rates
[4] ICDS were
initially notified vide NN 32/15 to be effective from 1st April 15.
Later, NN 32/15 was rescinded vide NN 86/16. Later, the same ICDS were notified
vide NN 87/16 notifying 10 ICDS w.e.f AY 17-18. The said notifications were
challenged as ultra vires the provisions of the Act, principally on ground that
such ICDS were aimed at nullifying various judicial precedents of Supreme Court
and High Courts and CBDT does not have such powers. The challenge was made
before Delhi High Court in the matter of Chamber of Tax Consultants [2017 (11)
TMI 465], where the High Court struck down the notifications stating that they
are ultra vires the Act. To overcome this decision, the IT Act was amended by
introducing certain sections such as 43AA, 43CB and 145A vide Finance Act, 2018
retrospectively to make them effective from 01st April 17.
However, CBDT has not notified the ICDS again and the ICDS are still in force
vide the NN 87/16 which was struck down. Hence, ICDS will not come into effect
unless same are notified again. To such an extent ICDS lacks full force as on
date.
[5] All through
the article, we refer the first authority as ‘AO’ – Assessing Officer, for the
convenience of reader.
[6] Honourable
Supreme Court
[7] The assessee
involved therein was a British Company which carried on the business of sale
and distribution of petroleum products in China and it employed a number of
Chinese Agents to whom such petroleum products were consigned. Each agent is
required to deposit certain sums in Chinese Dollars and the company was
empowered to use the deposit it liked. The deposit carried an interest at fixed
rate. The Company has deposited the Chinese Dollars in Shanghai Banks. When war
broke out between China and Japan, the Company has sold the Chinese Dollars for
Sterling and deposited such amount with its parent company. Subsequently, when
the Company closed its business through Chinese Agents, had to repay the
deposit amounts and then due to depreciation of the Chinese Dollars qua
Sterling, the Company gained profits due to incurring of lower amounts in
Chinese Dollars for settlement of their claims. The said profit was not offered
to tax and the Revenue wanted to charge tax on said amount and the Company
claimed that the same was Capital Profit and not subjected to tax. The Court
held that the same was not trading profit, but simply equivalent to
appreciation of capital asset not forming part of the assets employed as
circulating capital in trade and therefore not assessable to tax.
[8] Akin to
Section 37(1) of IT Act, 1961
[9] The court
further proceeded to refer to Adam Smith’s ‘Wealth of Nations’ to describe
‘fixed capital’ and ‘circulating capital’. A ‘fixed capital’ as what the owner
turns to profit by keeping it in his own possession and ‘circulating capital’
means capital employed in the trading operations of the business and the
dealings with it comprise trading receipts and trading disbursements, while
‘fixed capital’ means capital not so employed in the business, though it may be
used for manufacturing purposes of business, but does not constitute capital
employed in the trading operations of the business.
[10] In this
matter, the Bombay HC was dealing with depreciation allowance qua forex loss
arising on loans which were used for purchase of capital assets. The forex
fluctuations were added to the actual cost and depreciation was claimed in
accordance with Section 43A. The Revenue argued that the provisions of Section
43A are applicable prospectively and in the instant case, since the capital
assets were purchased prior to introduction of Section 43A, the provisions of
said section cannot be applied to assets which were purchased prior to
introduction of such section. The Bombay HC stated that there is no doubt to
state that the provisions of Section 43A are applicable prospectively, however,
there is nothing in the text of Section 43A, which stated that the said
provisions will be applicable only for assets which are acquired post
introduction of Section 43A. Hence, the forex loss which arose after
introduction of Section 43A qua assets which are purchased prior to Section 43A
are allowed to be added to actual cost and accordingly depreciation on such
increased actual cost should be allowed.
[11] Income Tax
Appellate Tribunal
[12] The same
judgment was followed by Pune ITAT in the matter of Neuman & Esser
Compressor Application Centre Private Limited [2019 (6) TMI 1434 – ITAT Pune],
Sri Ramadas Paper Boards (P) Limited [2019 (8) TMI 613- ITAT Hyderabad] and
Hueco Electronics (I) Pvt Limited [2020 (2) TMI 419 – ITAT Pune]
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