Deduction on hedging cost paid on swap
This query is : Resolved
26 April 2018
Hello Friends,
Our company has taken foreign currency loans against which they have taken swap agreements (cross currency swaps/plain vanilla swaps) from banks. Now on those swap agreements we have to pay hedging cost (swap cost) as per contract on half yearly basis to banks.
Question is that can we take deduction of this cost as revenue expenditure under income tax. If yes then kindly help me with the relevant section or relevant portion of income tax act.
Thanks in advance
Regards
Prateek
Our company has taken foreign currency loans against which they have taken swap agreements (cross currency swaps/plain vanilla swaps) from banks. Now on those swap agreements we have to pay hedging cost (swap cost) as per contract on half yearly basis to banks.
Question is that can we take deduction of this cost as revenue expenditure under income tax. If yes then kindly help me with the relevant section or relevant portion of income tax act.
Thanks in advance
Regards
Prateek
27 April 2018
Yes you can take deduction of this cost as revenue expenditure under income tax. Hedging and swap expenses incurred to protect foreign exchange fluctuations allowed as business expenditure under income tax.
04 May 2018
Thank you sir. Can you please assist me with the relevant section so that I can present it to my management and be affirmed about it.
05 May 2018
In this context, the worth noting part of RBI guideline which is usually referred to in a Swap contract with an Authorized Dealer (usually "Bank") is reproduced herein under:
"that as on date and as on the date of the maturity of the transaction, the counterparty has and shall have the underlying exposure for which the transaction has been entered into as a hedge and as on date there is no other hedge already in place for the said exposure---"
The above clause in swap contracts amply clarifies the fact that the swap contract in foreign currency can be entered into only in case the enterprise is having underlying as foreign currency denominated loans both at the time of entering into transaction as well as at the time of maturity of transaction. (Emphasis provided) To summarise, the company has entered into swap contracts for the underlying being foreign currency denominated loans taken for the purpose of global trading business of the assessee company as is evident on perusal of sample copies of contracts with banks and notes forming part of Schedule - Secured loans being part of the Balance sheet. Since, the assessee company has entered into currency swap contracts for working capital loans which is pre-requisite for the dynamic business of export and import of commodities, the loss of Rs 6.04 Crores being incurred in respect of circulating/working capital is an allowable expense u/s 37 of the IT Act as is held in I.T.A. No. 1545/Ahd/2014 A.Y. 2008-09 (Adani E nte rprise s Ltd. vs. ACIT) Page 18 various judicial pronouncements. The assessee company places reliance on the landmark decision in this context of the Hon'ble Supreme Court in the case of Sutlej Cotton Mills Ltd Vs C1T reported in 116 ITR 1 (SC).The relevant part of head note of the said decision reads as under:
"Whether where profit or loss arises to an assessee on account of appreciation or depreciation in value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if foreign currency is held by assessee on revenue account or as a trading asset or as part of circulating capital embarked in business - Held, yes - Whether, however, if foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature - Held, yes "
(15) Your good self has sought an explanation regarding allowability of Loss of Rs 1.96 Crores on derivatives contracts. We are submitting herewith the break up of the said loss of Rs 1.96 Crores and copies of the relevant ledger accounts. (Annexure-2) On perusal of the same, your good self would find that the said loss consists of Rs 0.73 Crores in respect forex derivative contracts and Rs 1.23 Crores in respect of commodity derivative contracts. In so far as loss on forex derivatives contracts is concerned, we submit that the said loss is in the nature of mark to market loss in respect of forward contracts entered into by the assessee company in respect of trade obligations and accordingly, the said loss being in the nature of trading expenditure is allowable u/s 37 of the IT Act as it is incurred during the course of carrying on of the business and particularly in view of the decision of the Hon'ble Supreme Court in the case of CIT Vs Woodward Governor India (P) Ltd reported in 312 ITR 254 (SC).TK head note of the said decision is reproduced herein under for ready reference:
"Section 37(1), read with section 145, of the Income- tax Act, 1961 - Business expenditure - Allowability of - I.T.A. No. 1545/Ahd/2014 A.Y. 2008-09 (Adani E nte rprise s Ltd. vs. ACIT) Page 19 Assessment year 1998-99 - Whether expression 'expenditure' as used in section 37 may, in circumstances of a particular case, cover an amount which is really a 'loss', even though said amount has not gone out from pocket of assessee - Held, yes - Whether loss suffered by assessee on account of foreign exchange difference as on date of balance sheet is an item of expenditure under section 37(1) - Held, yes - Whether accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till Assessing Officer comes to conclusion for reasons to be given that said system does not reflect true and correct profits - Held, yes - Whether an enterprise has to report outstanding liability relating to import of raw material using closing rate of foreign exchange and any difference, loss or gain, arising on conversion of said liability at closing rate should be recognized in profit and loss account for reporting period -Held, yes"
Further, the loss of Rs 1.23 Crores is incurred in, respect of hedging transactions in commodity derivatives entered into on commodity exchanges. On perusal of details submitted to your good self and Annexure XVII of the Tax Audit Report, it is evident that the assessee company deals in various agro products viz pulses, rice, sugar, soyabean oil etc and to hedge against the fluctuation in the price of agro products, the assessee company entered into commodity derivatives transactions in the year under consideration. Since, the loss of Rs 1.23 Crores is incurred on derivative contracts to hedge against the fluctuation in the price of agro products which is traded by the assessee company, the said hedging loss being realized trading expenditure is allowable u/s 37 of the IT Act in view of various judicial pronouncements.
"that as on date and as on the date of the maturity of the transaction, the counterparty has and shall have the underlying exposure for which the transaction has been entered into as a hedge and as on date there is no other hedge already in place for the said exposure---"
The above clause in swap contracts amply clarifies the fact that the swap contract in foreign currency can be entered into only in case the enterprise is having underlying as foreign currency denominated loans both at the time of entering into transaction as well as at the time of maturity of transaction. (Emphasis provided) To summarise, the company has entered into swap contracts for the underlying being foreign currency denominated loans taken for the purpose of global trading business of the assessee company as is evident on perusal of sample copies of contracts with banks and notes forming part of Schedule - Secured loans being part of the Balance sheet. Since, the assessee company has entered into currency swap contracts for working capital loans which is pre-requisite for the dynamic business of export and import of commodities, the loss of Rs 6.04 Crores being incurred in respect of circulating/working capital is an allowable expense u/s 37 of the IT Act as is held in I.T.A. No. 1545/Ahd/2014 A.Y. 2008-09 (Adani E nte rprise s Ltd. vs. ACIT) Page 18 various judicial pronouncements. The assessee company places reliance on the landmark decision in this context of the Hon'ble Supreme Court in the case of Sutlej Cotton Mills Ltd Vs C1T reported in 116 ITR 1 (SC).The relevant part of head note of the said decision reads as under:
"Whether where profit or loss arises to an assessee on account of appreciation or depreciation in value of foreign currency held by him, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if foreign currency is held by assessee on revenue account or as a trading asset or as part of circulating capital embarked in business - Held, yes - Whether, however, if foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature - Held, yes "
(15) Your good self has sought an explanation regarding allowability of Loss of Rs 1.96 Crores on derivatives contracts. We are submitting herewith the break up of the said loss of Rs 1.96 Crores and copies of the relevant ledger accounts. (Annexure-2) On perusal of the same, your good self would find that the said loss consists of Rs 0.73 Crores in respect forex derivative contracts and Rs 1.23 Crores in respect of commodity derivative contracts. In so far as loss on forex derivatives contracts is concerned, we submit that the said loss is in the nature of mark to market loss in respect of forward contracts entered into by the assessee company in respect of trade obligations and accordingly, the said loss being in the nature of trading expenditure is allowable u/s 37 of the IT Act as it is incurred during the course of carrying on of the business and particularly in view of the decision of the Hon'ble Supreme Court in the case of CIT Vs Woodward Governor India (P) Ltd reported in 312 ITR 254 (SC).TK head note of the said decision is reproduced herein under for ready reference:
"Section 37(1), read with section 145, of the Income- tax Act, 1961 - Business expenditure - Allowability of - I.T.A. No. 1545/Ahd/2014 A.Y. 2008-09 (Adani E nte rprise s Ltd. vs. ACIT) Page 19 Assessment year 1998-99 - Whether expression 'expenditure' as used in section 37 may, in circumstances of a particular case, cover an amount which is really a 'loss', even though said amount has not gone out from pocket of assessee - Held, yes - Whether loss suffered by assessee on account of foreign exchange difference as on date of balance sheet is an item of expenditure under section 37(1) - Held, yes - Whether accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till Assessing Officer comes to conclusion for reasons to be given that said system does not reflect true and correct profits - Held, yes - Whether an enterprise has to report outstanding liability relating to import of raw material using closing rate of foreign exchange and any difference, loss or gain, arising on conversion of said liability at closing rate should be recognized in profit and loss account for reporting period -Held, yes"
Further, the loss of Rs 1.23 Crores is incurred in, respect of hedging transactions in commodity derivatives entered into on commodity exchanges. On perusal of details submitted to your good self and Annexure XVII of the Tax Audit Report, it is evident that the assessee company deals in various agro products viz pulses, rice, sugar, soyabean oil etc and to hedge against the fluctuation in the price of agro products, the assessee company entered into commodity derivatives transactions in the year under consideration. Since, the loss of Rs 1.23 Crores is incurred on derivative contracts to hedge against the fluctuation in the price of agro products which is traded by the assessee company, the said hedging loss being realized trading expenditure is allowable u/s 37 of the IT Act in view of various judicial pronouncements.
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