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Taxation of Forex profit and loss under section 43A

Manish Kumar Agarwal 
on 30 April 2015

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From the ACT.

Notwithstanding anything contained in any other provision of this Act, where an assessee has acquired any asset in any previous year from a country outside India for the purposes of his business or profession and, in consequence of a change in the rate of exchange during any previous year after the acquisition of such asset, there is an increase or reduction in the liability of the assessee 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—

(a) towards the whole or a part of the cost of the asset; or

(b) towards repayment of the whole or a part of the moneys borrowed by him from any person, directly or indirectly, in any foreign currency specifically for the purpose 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 the payment, irrespective of the method of accounting adopted by the assessee, shall be added to, or, as the case may be, deducted from—

(i) the actual cost of the asset as defined in clause (1) of section 43; or

(ii) the amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1) of section 35; or

(iii) the amount of expenditure of a capital nature referred to in section 35A; or

(iv) the amount of expenditure of a capital nature referred to in clause (ix) of sub-section (1) of section 36; or

(v) the cost of acquisition of a capital asset (not being a capital asset referred to in section 50) for the purposes of section 48,

and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid:

Provided that where an addition to or deduction from the actual cost or expenditure or cost of acquisition has been made under this section, as it stood immediately before its substitution by the Finance Act, 2002, on account of an increase or reduction in the liability as aforesaid, the amount to be added to, or, as the case may be, deducted under this section from, the actual cost or expenditure or cost of acquisition at the time of making the payment shall be so adjusted that the total amount added to, or, as the case may be, deducted from, the actual cost or expenditure or cost of acquisition, is equal to the increase or reduction in the aforesaid liability taken into account at the time of making payment.

Explanation 1.—In this section, unless the context otherwise requires,—

(a) "rate of exchange" means the rate of exchange determined or recognised by the Central Government for the conversion of Indian currency into foreign currency or foreign currency into Indian currency;

(b) "foreign currency" and "Indian currency" have the meanings respectively assigned to them in [[Section 2 of section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999).

Explanation 2.—Where the whole or any part of the liability aforesaid is met, not by the assessee, but, directly or indirectly, by any other person or authority, the liability so met shall not be taken into account for the purposes of this section.

Explanation 3.—Where the assessee has entered into a contract with an authorised dealer as defined in section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999), for providing him with a specified sum in a foreign currency on or after a stipulated future date at the rate of exchange specified in the contract to enable him to meet the whole or any part of the liability aforesaid, the amount, if any, to be added to, or deducted from, the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset under this section shall, in respect of so much of the sum specified in the contract as is available for discharging the liability aforesaid, be computed with reference to the rate of exchange specified therein.

Depreciation Impact.

Section 43A of Income-tax Act contains speacial provision to provide for additional depreciation allowance to the assessee in respect of capital assets whose actual cost is affected by the changes in the rate of exchange of currency.

Depreciation impact on account of foreign exchange fluctuations

The amount by which the liability of the assessee in terms of Indian Rupees is increased or decreased as a result of change in the rate of exchange of the currency, would be added to or as the case may be deducted from the actual cost of the asset as defined in Section 43(1) ***

Consequently, the amounts of depreciation allowable to assessee in respect of the asset would correspondingly be increased or reduced, as the case may be.

*** Section 43 (1) which deals with actual cost of depreciable asset says if on account of devaluation, the liability in respect of repayment of the moneys borrowed for the purchase of machinery increases, it can be legitimately taken into account in determining the actual cost of the assets and calculated depreciation under section 32 on increased cost accordingly]

As a consequence of the insertion of the Section 43A, it has became possible to adjust the increase/decrease in liability relating to acquisition of capital assets on account of exchange rate fluctuation, in the actual cost of the assets acquired in foreign currency and accordingly  depreciation to be allowed with reference to such increased/decreased cost

Situation for depreciation being restricted to 50 per cent of the normal depreciation:-

The above situation is applicable if following conditions are satisfied.

1. Payment for import of asset is made during the previous year

2. It is paid after 180 days during relevant previous year.

[If payment is made before 180 days calculated from relevant previous year then FULL RATE of normal depreciation is allowable]

Condition for adjustment in actual cost of fixed assets:-

ACTUAL PAYMENT of decreased or increased liability is mandatory condition precedent for making adjustment in the carrying amount of the fixed asset.

Expression rate of exchange:-

RATE OF EXCHANGE must be taken to mean rate of exchange recognized by central government for conversion of Indian Rupee into foreign currency.

Proof at the time of scrutiny: – It is important for assessee to keep the records of payment of foreign liability, calculation of realized loss or gain which is added or reduced from actual cost of fixed asset for depreciation purpose to prove income tax department at the time scrutiny.

Accounting standard 11 (The effects of changes in foreign exchange rates)  vis a vis section 43A

The liability expressed in foreign currency at the reporting date will be increased or decreased based on rates prevailing at the close of reporting period for which corresponding increase or decrease will be routed through profit and  loss statement and not effected in value of related assets where as section 43A provides for increase or decrease only for currency fluctuation at the time of payment. This will have a major implication for increase or decrease in unpaid foreign liability as though creditors for fixed assets for the same has to be increased or decreased in the books of account, the same would not be eligible for depreciation under income tax computation.

Tax treatment of exchange fluctuation loss on ECB

Backdrop


One of the most apprehensive subjects for India for last couple of years has been the dwindling rupee value which besides triggering inflation and broadening the current account deficit has also augmented certain tax related issues. One such issue stems from the concerns relating to the treatment of foreign exchange loss arising on revaluation of External Commercial Borrowing (ECB) for assets acquired within India. Whether such loss can be capitalised with the cost of assets or can be claimed as revenue loss is a question many taxpayers are grappling with today.

 

Law on the subject

If the proceeds of ECBs are utilized to acquire capital assets from any place outside India, the provisions of Section 43A of the Income-tax Act, 1961 (“the Act”) would govern the situation.  Section 43A provides for capitalisation of the loss with the cost of asset at the time of repayment of the ECB resulting in crystallisation of loss. However, the said section is inapplicable in the context of indigenous assets as its language confines its applicability only to a case “where an assessee has acquired any asset from a country outside India”.

In the absence of any specific provision in law on this facet, coupled with some distinct judicial pronouncements in the past, there is an element of uncertainty surrounding this aspect.
 

There are no precise rules formulated to distinguish a loss on revenue count vis-à-vis a loss on capital count and there lies a thin line of demarcation between the two, but certain judicial pronouncements are worth noting in the present issue under consideration to understand the nature of such a loss. While revenue loss is allowable, the capital loss on the other hand cannot be allowed as a deduction while computing business income [see end note 1].

Section 43A of the Act, was introduced by the legislature vide Finance (No. 2) Act, 1967 with effect from 1st April, 1967. Supreme Court in Tata Iron & Steel [TISCO - (1998) 231 ITR 285 (SC)] had an occasion to deal with this issue for a period prior to its introduction. The assessee in that case acquired certain depreciable assets using foreign currency loans, and adjusted the foreign exchange fluctuation with the cost of the asset. The apex court, on these set of facts, besides observing that section 43A is inapplicable (as was being introduced later), held that, “the manner of repayment of loan can’t affect the cost of the assets so acquired. What is the actual cost must depend on the amount paid to acquire the asset. The company might have raised the funds to purchase the asset by borrowing but what the company had paid for it was the price of the asset. That price could not change by any event subsequent to the acquisition of the asset. What has to be borne in mind is that the cost of an asset and the cost of raising money for purchase of the asset are two different and independent transactions.”

Given that the provisions of Section 43A requiring foreign exchange gain/loss to be adjusted with the cost of the assets, apply only with respect to imported assets, the case of indigenous assets will continue to be governed by the ratio of the Tata Iron & Steel’s decision (supra). However, the matter becomes complex as there are certain judicial pronouncements analogous to the issue under consideration, which have denied deduction by holding such loss to be on capital count.  But before we proceed to discuss those cases, following decisions are relevant for setting the things in perspective.
 

In the Shell Company of China Ltd. [22 ITR 1 (CA)] the Court of Appeals held that, “gains arising on deposits (in foreign currency) are capital receipt as the deposits were in essence loan/capital and not a trading receipt.”

Further in Sutlej Cotton Mills Ltd., [(1979) 116 ITR 1 (SC)] it was held by Supreme Court that, “the law may, therefore, now be taken to be well settled that where the profit or loss arises to an assessee 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 a trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as a part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.”
 

Also in Tata Locomotive & Engineering Co. Ltd. [TELCO - (1966) 60 ITR 405 (SC)] a similar view was again reiterated.

The aforesaid decisions were later consistently followed by some High Courts in Bestobell (India) Ltd. [see end note 2], Union Carbide India [see end note 3], Oil India Limited [see end note 4], Bharat General and Textile Industries Limited [see end note 5], Groz-Beckert Saboo Ltd. [see end note 6], Sandoz (India) [see end note 7], Electric Lamp Manufacturers (India) Limited [see end note 8] and V. S. Dempo & Co. (P) Ltd. [see end note 9] in the context of ECB holding that if the foreign exchange fluctuation loss arises on restatement of ECBs utilized for acquiring capital asset indigenously in India, then such loss will be capital in nature.

As is evident from above analysis, the controversy really finds its foundation when the decision of Court of Appeal in the case of the Shell Company of China was first followed by Calcutta High Court. Later decisions also drew support from the decisions of Sutlej Cotton Mills and TELCO though rendered in the context of foreign currency held as an asset as against a foreign currency loan.
 

Many corporate taxpayers find it a safe proposition to capitalise the exchange loss and claim depreciation thereon rather than claiming it as revenue loss.  One should however bear in mind that if in a subsequent year the tax authorities deny depreciation on the capitalised loss relying on the decision of Supreme Court in TISCO (supra) then in such an eventuality taxpayers may find it difficult to revisit the earlier years’ return and claim it as revenue loss therein. It is therefore important that the decision in this regard shall be taken after a thorough research and analysis of the legal position both from the perspective of technical merits as well as from the perspective of strategy.

Case Study.

Back Ground

1. ‘A´ Limited is a well-respected engineering company in India. It enjoys a formidable presence in textile engineering sector with complete solutions for spinning, knitting, weaving, non-woven, processing and printing plants. Over the years, it has also successfully diversified into other sectors such as web handling equipment, graphic printing equipment and consumables, industrial pumps, and contract manufacturing of engineering components and assemblies.

Facts

2. The company ‘A´ Limited has availed foreign currency loan for acquisition of imported and indigenous fixed assets including machinery. It has also converted its existing Indian rupee loan, with the financial institution/bank utilised to purchase indigenous as well as imported machinery, into the foreign currency loan. During the previous year ended 31st March, 2004 on account of fall in value of USD, a substantial amount of foreign exchange fluctuation gain has accrued to ‘A´ Limited in respect of outstanding principal amount of foreign currency loans. The company also has realized foreign exchange fluctuation gain on part of the installments of loan paid during the year. A part of the foreign exchange fluctuation gain is attributable to the loan utilised for purchase of imported machinery which would be governed by the special provisions consequential to changes in rate of exchange of currency as per section 43A, However a major portion of the balance foreign exchange fluctuation gain is in relation to foreign currency loan attributable to acquisition of indigenous machinery.

Issue

3. The substance of issue is whether foreign exchange fluctuation gain on foreign currency loan borrowed to acquire indigenous fixed assets is chargeable to income tax. The possible issues could be as under:

a) Whether receipt is of capital nature or revenue nature
b) If receipt is of capital nature, then whether the same can be taxed as such
c) If it cannot be taxed, whether the same can be reduced from the cost of assets

Observations

1. The provisions of section 43A of the Income Tax Act are summarised hereunder:

a) Where the assessee has acquired any assets from a country outside India 

b) The assets are acquired for the purpose of business or profession.

c) Consequent to change in rate of exchange, there is increase / decrease in the liability of the assessee expressed in Indian currency towards cost of the assets or repayment of money borrowed for acquiring capital asset along with interest in foreign currency.

d) Such increase or reduction in the liability shall be added or deducted from the actual cost of assets as and when paid or received.

The provisions of section as can be seen from the above are not applicable where indigenous assets are acquired out of foreign currency loans.

2. The Relevant portion of provisions of section 28 (iv) read as under:

“The following shall be chargeable to income tax under the head ‘Profit and Gains of business or profession´

The value of any benefit or perquisite, whether convertible into money or not, arising from business or the exercise of a profession”.

3. The gain on account of foreign exchange fluctuation results into benefit to the borrower. The question arises as to whether the benefit is arising from the business or exercise of profession.

4. The provisions of section 28 (iv) are applicable in case the benefit arises on revenue account. In the case under consideration the gain has arisen on account of reduction in liability on repayment of foreign currency loan. The loan was borrowed for acquiring fixed asset. The entire transaction i.e. borrowing loan and acquiring fixed asset is on capital account and therefore the corresponding gain cannot be on revenue account.

5. For the purpose of applicability of section 28 (iv) benefit or perquisite must relate to revenue account of the assessee.

6. The provisions of section 28 (iv) apply only incase where benefit or perquisite is not in form of cash. In the instant case loans have been borrowed by the company in cash in past. Further the benefit/gain arising on valuation of loan is also available to company in cash and therefore benefit if any arising upon is not regarded as benefit or perquisite within the meaning of section 28 (iv).

7. The relevant extracts of the decision of Gujarat High Court in case of CIT vs. Alchemic Pvt. Ltd. 130 ITR 168 is reproduced hereunder wherein it was held as under:

If what is received either by way of benefit or perquisite is money, there is no question of considering the value of such monetary benefit or perquisite under clause (iv) of section 28 and including the value of such benefit or perquisite under the head “Profit and Gains of Business or Profession”. It is only if the benefit or perquisite is not in cash or money that section 28 (iv) would apply and the question of including the value of such benefit or perquisite as income from business would ever arise”.

The reference can also be had to the Delhi High Court judgment wherein it expressed the same view in case of Ravinder Singh V CIT (1994) 205 ITR 353.

8 Ratio to identify as to whether a particular receipt is capital receipt or revenue receipt is laid down by Hon´ble Supreme Court in the following cases.

i) Sutlej Cotton Mills Ltd. vs. CIT – 116 ITR 1
        
ii) CIT vs. Tata Locomotive and Engineering Company Ltd. – 60 ITR 405
        
iii) CIT vs. Canara Bank – 63 ITR 328

9. In the case of Sutlej Cotton Mills Ltd., the facts of the case were as under:

The assessee was a limited company having cotton mill situated in Pakistan where it made large profit from that unit. At the relevant time, the rate of exchange prevailing was 100 Pakistani rupee being equivalent to 144 Indian Rupees. The entire profit of Rs. 1,68,97,282/- was taxed and included in the total income of the assessee for A.Y. 1954-55. The assessee remitted Rs. 25 lacs in Pakistani rupee out of Pakistani profit for the A.Y. 1954-55 in the A.Y. 1957-58. At the time of remittance, the rate of exchange was changed to 100 Pakistani rupee being equivalent to 100 Indian Rupees and therefore the assessee received Rs. 25 lacs only. Now the profit of RS. 25 lacs in terms of Pakistani rupee had been included in the total income for A.Y. 1954-55 as Rs. 36 lacs in terms of Indian Rupee as per prevailing rate of exchange of 100 Pakistani rupees being equivalent to 144 Indian Rupees and therefore, the assessee suffered loss of Rs. 11 lacs in the process of conversion on account of appreciation of Indian Rupee qua Pakistani Rupee. The claim of loss of Rs. 11 lacs was rejected by the Income Tax Officer while computing profit from business. The matter went in appeal to the Tribunal, which sustained the disallowance. The High Court agreed to the view of tribunal holding that no loss is sustained by the assessee on remittance and even if there is any loss, it could not be termed as business loss because it was not a loss arising in the course of business of the assessee, but it was caused by devaluation which was an act of state. The assessee therefore, preferred an appeal before the Supreme Court.

10. The Supreme Court made following observations:

“Whether the loss suffered by the assessee was a trading loss or not would depend on the answer to the question, whether the loss was in respect of a trading asset or a capital asset. In the former case, it would be a trading loss but not so in the latter. The test may also be formulated in another way by asking the question whether the loss was in respect of circulating capital or in respect of fixed capital”

The court also observed that:

“if the amount in foreign currency is utilised or intended to be utilised in the course of business or for a trading purpose or for effecting a transaction on revenue account, loss arising from depreciation in its value on account of alteration in the rate of exchange would be a trading loss, but if the amount is held as a capital asset, loss arising from depreciation would be a capital loss. This is clearly borne out by the decided cases which we shall presently discuss”

11. The Supreme Court noted English decision in the case of Davies vs. Shell Co. of China Ltd. In that case the company accepted deposits from its agent in Chines dollar, which was then transferred to UK and deposited the said sum in Sterling equivalent with its banker.

Owing to the subsequent depreciation of the Chinese dollar with respect to sterling, the amounts eventually required to repay agency deposits in Chinese currency were much less than the sums held by the company to meet the claims and a substantial profit accrued to the company. The question arose whether this exchange profit was a trading profit or a capital profit. The Court of Appeal held that it was a capital profit not subject to income-tax and the argument, which found favor with it, may be stated in the words of Jenkins L.J., who delivered the main judgment: 

"I find nothing in the facts of this case to divest those deposits of the character which it seems to me they originally bore, that is to say, the character of loans by the agents to the company, given no doubt to provide the company with a security, but nevertheless loans. As loans it seems to me they must prima facie be loans on capital not revenue account; which perhaps is only another way of saying that they must prima facie be considered as part of the company's fixed and not of its circulating capital. As appears from what I have said above, the evidence does not show that there was anything in the company's mode of dealing with the deposits when received to displace this prima facie conclusion. 

In my view, therefore, the conversion of the company's balances of Chinese dollars into sterling and the subsequent re-purchase of Chinese dollars at a lower rate which enabled the company to pay off its agents' deposits at a smaller cost in sterling than the amount it had realised by converting the deposits into sterling, was not a trading profit, but it was simply the equivalent of an appreciation in a capital asset not forming part of the assets employed as circulating capital in the trade."

12. The court also referred its own decision in the case of CIT vs. Telco (Referred Supra) in that case, the assessee made purchase of plant and machinery in US for sum of USD 33850/-. The assessee company was also selling agent of a US based company for the sale of its products in India. The assessee earned commission of USD 36123/- as selling agent of US company, which it offered for tax after converting it into rupees at the prevailing rate of exchange. This amount paid by US company were not remitted by the assessee to India but were retained with Tata Inc New York for purchase of capital goods with section of exchange control authority. There was balance of USD 48572.30 in the assessee´s account with Tata Inc New York, when on devaluation of rupee, the rate of exchange was Rs. 3.33 per dollar shot up to Rs. 4.77 per dollar. The consequence to the alternation in rate of exchange, the assessee found American goods more expensive repatriated the dollar deposit to India, which resulted into surplus of Rs. 70147/- on account of depreciation of rupee. The question arises, whether surplus of RS. 70147/- which was attributable to dollar 36123/- received as commission from US company was trading profit or capital profit.

The Supreme Court held in that case as under:

"...depends on whether the act of keeping the money, i.e., $ 36,123.02, for capital purposes after obtaining the sanction of the Reserve Bank was part of or a trading transaction. If it was part of or a trading transaction then any profit that would accrue would be revenue receipt; if it was not part of or a trading transaction then the profit made would be a capital profit and not taxable. There is no doubt that the amount of $ 36,123.02 was a revenue receipt in the assessee's business of commission agency. Instead of repatriating it immediately, the assessee obtained the sanction of the Reserve Bank to utilise the commission in its business of manufacture of locomotive boilers and locomotives for buying capital goods. That was quite an independent transaction, and it is the nature of this transaction, which has to be determined. In our view it 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. If the assessee had repatriated $ 36,123.02 and then after obtaining the sanction of the Reserve Bank remitted $ 36,123.02 to the U.S.A., Mr. Sastri does not contest that any profit made on devaluation would have been a capital profit. But, in our opinion, the fact that the assessee kept the money there does not make any difference especially, as we have pointed out, that it was a new transaction which the assessee entered into, the transaction being the first step to acquisition of capital goods." 

13. The Hon´ble Supreme Court also referred in the above case the decision of same court in CIT vs. Canara Bank (Referred Supra). In that case, the assessee had a branch in Karachi in Pakistan. Karachi branch of the assessee had sum of Rs. 3,96,220/- belonging to HO. On account of devaluation of Indian Rupee, the amount when remitted to HO became equivalent to Rs. 571098/- and in the process, the assessee made profit of Rs. 173870/-. The question arises in the assessment of the assessee, whether this profit of Rs. 173870/-, is revenue receipt or capital acquisition. The court noted the observation in the case of Canara bank in the following words:
   

“Ramaswami J., speaking on behalf of this court, pointed out that the amount of Rs. 3,97,221 was lying idle in the Karachi branch and it was not utilised in any banking operation and the Karachi branch was merely keeping that money with it for the purpose of remittance to India and as soon as the permission of the State Bank of Pakistan was obtained, it remitted that money to India. This money was "at no material time employed, expended or used for any banking operation or for any foreign exchange business". It was, to use the words of Ramaswami J., "blocked and sterilised from the period of the devaluation of the Indian rupee up to the time of its remittance to India". Therefore, even if this money was originally stock-in-trade, it "changed its character of stock-in-trade when it was blocked and sterilised and the increment in its value owing to the exchange fluctuation must be treated as a capital receipt". Since the sum of Rs. 3,97,221 was, on the finding of fact reached by the revenue authorities, held on capital account and not as part of the circulating capital embarked in the business of banking, it was held by this court that the profit arising to the assessee on remittance of this amount on account of alteration in the rate of exchange was not a trading profit but a capital accretion”.

14. The Supreme Court in the case of Sutlej Cotton Mills Ltd. finally concluded as under:

“The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee 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 by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature”.

The Supreme Court sent back the above matter to decide the case in accordance with the above direction and in the light of law laid down in the judgement since it was not noted by the lower court that whether sum held in Pakistan by the assessee company was capital asset or trading asset.

15. In the present case, ‘A´ LIMITED has borrowed Foreign Currency Loan / converted the existing Rupee Term Loan into Foreign Currency Loan. The loan was used for acquisition of capital assets. The said transaction was clearly on capital account as per law laid down by Hon´ble Supreme Court in the case of Sutlej Cotton Mills Ltd. (Referred Supra). The gain arising to ‘A´ LIMITED on fluctuation in foreign currency was entirely forming part of its fixed capital assets and hence, is capital receipt.

16.A revenue receipt is taxable as income unless it is expressly exempt under the Act. On the other hand, a capital receipt is generally exempt from tax unless it is expressly taxable under section 45 – Cadell Wvg. Mill Co. (P) Ltd. V CIT (2001) 116 Taxman 77 (Bom). In the case under consideration, the provisions of section 45 or any other section of the chapter under the heading capital gain nowhere creates charge on the above income.

17.The next question arises is, whether the gain as above can be reduced from the cost of assets as per provisions of section 43(1) of the Income Tax Act. As per section 43 (1) actual cost means actual cost of the assets to the assessee, reduced by that portion of the cost as has been met directly or indirectly by any other person or authority. The section also has twelve explanations, however, the section nowhere specifies that any gain or loss on foreign currency loan acquired for purchase of indigenous assets will have to be reduced or added to the cost of the assets.

18. Reference can be had to the provisions of section 43 (6) of the Income Tax Act, which defines the term written down value. As per the section WDV means:

a) Aggregate of WDV of the assets falling within the block of assets at the beginning of the previous year as increased by actual cost of the assets falling within the block, acquired during the previous year and reduced by the money payable in respect of any assets falling within that block which is sold or discarded or demolished or destroyed during the previous year together with the amount of scrap value, if any, however, the amount of such deduction does not exceed WDV as so increased.

The section clearly specifies the amount which can be deducted from the WDV which includes the money payable in respect of assets under different circumstances but it nowhere specifies that gain accrued on valuation of Foreign Currency Loan at the balance sheet date should be reduced from the WDV of the asset.

19. The provisions of section 41 (1) of the Income Tax Act are applicable in case were an allowance or deduction has been made in the assessment for any year in respect of loss / expenditure or trading liability incurred by the assessee and subsequently during any previous year benefit in respect of such trading liability is obtained either for cash or any other manner by way of remission or secession thereof. In the present case, ‘A´ LIMITED has not claimed any loss or expenditure or deduction in respect of fluctuation in foreign currency loan in any of the previous assessment year. Further depreciation claimed by ‘A´ LIMITED on fixed assets acquired out of foreign currency loan is a separate and distinct transaction and not related with the raising or conversion of foreign currency loan. Acquisition of assets is subsequent event and not related with former.

As discussed above, the entire transaction is on capital account and therefore, ‘A´ LIMITED has not incurred any trading liability in any previous year. Further, ‘A´ LIMITED has not obtained any advantage either on account of remission or cessation and therefore, provisions of section 41 (1) are not applicable at all in the present case.

20.It has been held by Hon´ble Supreme Court in the case of CIT vs Tisco Ltd. 230 ITR 285 that availing of loan and acquiring capital assets out of the loan are two separate and distinct transactions and any gain on valuation of foreign currency loan on account of change in the rate of exchange has nothing do with the cost of those capital assets.

21. In this regard, the decision of Hon´ble Gujarat High Court in the case of Synbiotics Limited vs CIT 259 ITR 122 is worth noting. In that case, the assessee claimed loss on foreign currency loan on account of exchange fluctuation as revenue expenditure. The Hon´ble Gujarat High Court in that case disallowed the claim of assessee as revenue expenditure by making following observations:

“This issue is squarely covered by the decision of the Supreme Court in case of CIT V. Tata Iron and Steel Co. Ltd. (1998) 231 ITR 285, wherein it is held that at the time of repayment of loan, there was a fluctuation in the rate of foreign exchange as a result of which, the assessee had to repay a much lesser amount than he would have otherwise paid. It was further held that this was not a factor, which could alter the cost incurred by the assessee for purchase of the asset. The assessee might have raised the funds to purchase the asset by borrowing but what the assessee had paid for it was the price of the asset. The manner or mode of repayment of the loan had nothing to do with the cost of an asset acquired by the assessee for the purpose of his business. Following this decision, we hold that the assessee is not entitled to claim the exchange loss of Rs. 26924/- as revenue expenditure. Accordingly, question No. 2 is answered in the affirmative, in favor of the Revenue and against the assessee.”

Since loss on exchange is treated as capital expenditure, converse is true and therefore gain on exchange would be regarded as capital receipt.

22. ‘A´ Limited has in its books of account account reduce the gain from the WDV of the assets in accordance with Accounting Standard 11 “Accounting for the Effects of Changes in Foreign Exchange Rates”. However, the treatment in books of account is not determinative of the tax treatment thereof for the purpose of income tax. As held by Supreme Court in Sutlej Cotton Mills Limited (Referred Supra) and also in case of Tuticorin Alkali Chemicals and Fertilizers Limited 227 ITR 172, it is now well settled that the manner in which the entries are made in the books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss.


23. To sum up and conclude, the gain arising to ‘A´ limited on account of fluctuation in the currency on foreign currency loan is clearly capital receipt not exigible to Income tax. 

Summing up

Many multinationals, small and medium enterprises and corporate houses in India prefer availing foreign currency borrowings with a view to save on interest cost. Very often those funds are utilized to acquire capital assets indigenously in India and hence the issue of dealing with foreign exchange fluctuation calls importance.

This short write-up attempts to highlight that the determination of correct treatment of exchange fluctuation loss is extremely complex since the ratio of the decision in Tata Iron and Steel is apparently in contrast with the ratio of the decision in Sutlej Cotton Mills and various other High Courts. Fundamentally, by raising loan itself no capital asset comes into existence and hence expenses for raising loan should in authors’ view be treated as revenue in nature.  Further the variation in the loan amount has no bearing on the cost of the asset as the loan is a distinct and independent transaction. The author believes that the claim of exchange fluctuation loss as revenue on count is founded on strong legal arguments. Nevertheless, given the contrary judicial precedents the matter is undoubtedly prone to litigation.

Please feel free to write to me at taxbymanish@yahoo.com in case you need any further clarification. 


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