Loan in foreign currency for acquisition of capital asset — Forward contract for obtaining foreign currency at a pre-determined rate — Roll-over charges paid to carry forward the contract have to be capitalised in view of S. 43A.

The assessee was engaged in the manufacture of gears and
mechanical handling equipment. It procured a foreign currency loan for expansion
of existing business. Since the repayment of loan was stipulated in instalments,
the assessee wanted to ensure that foreign currency required for repayment of
the loan be obtained at a pre-determined rate and cost. Accordingly, the
assessee booked forward contracts with Citibank for delivery of the required
foreign currency on the stipulated dates. The contract was entered into for the
entire outstanding amount and the delivery of foreign currency was obtained
under the contract for instalment due from time to time. The balance value of
the contract, after deducting the amount withdrawn towards repayment, was rolled
for a further period up to the date of the next instalment. The assessee filed
its return of income for the A.Y. 1986-87 on June 30, 1986. A revised return was
filed by it on March 27, 1989, declaring a total income of Rs.2,10,08,640. The
Assessing Officer disallowed an amount of Rs.8,86,280, being the roll-over
premium charges paid by the assessee in respect of foreign exchange forward
contracts to Citibank N.A. on the ground that the said charges were incurred in
connection with the purchase of a capital asset (plant and machinery), hence, it
was not admissible for deduction u/s.36(1)(iii) or u/s.37 of the Act. On appeal,
the Commissioner of Income-tax (Appeals) held that the roll-over premium charges
incurred by the assessee were allowable as they were incurred by the assessee to
mitigate the risk involved in higher payment because of adverse fluctuation of
rate of exchange. According to the Commissioner of Income-tax (Appeals),
roll-over premium charges constituted an expenditure incurred for raising loans
on revenue account, hence, the said expenditure was allowable under the Act.

The Tribunal held that roll-over premium charges (carry
forward charges) were required to be paid to the authorised dealer as
consideration for permitting the unutilised amount of the contract (balance
value of the contract) to be availed of at a later date and in the circumstances
the roll-over premium charges had to be capitalised under Explanation 3 to S.
43A of the said Act. Consequently, the Tribunal upheld the order of the
assessment.

The High Court came to the conclusion that the roll-over
premium charges paid by the assessee were in the nature of interest or committal
charges, hence, the said charges were allowable u/s.36(l)(iii) of the said Act.

The Supreme Court observed that S. 43A, before its
substitution by a new S. 43A vide the Finance Act, 2002, was inserted by the
Finance Act, 1967, with effect from April 1, 1967, after the devaluation of the
rupee on June 6, 1966. It applied where as a result of change in the rate of
exchange there was an increase or reduction in the liability of the assessee in
terms of the Indian rupee to pay the price of any asset payable in foreign
exchange or to repay moneys borrowed in foreign currency specifically for the
purpose of acquiring an asset. The Section has no application unless an asset
was acquired and the liability existed, before the change in the rate of
exchange. When the assessee buys an asset at a price, its liability to pay the
same arises simultaneously. This liability can increase on account of
fluctuation in the rate of exchange. An assessee who becomes the owner of an
asset (machinery) and starts using the same, becomes entitled to depreciation
allowance. To work out the amount of depreciation, one has to look to the cost
of the asset in respect of which depreciation is claimed. S. 43A was introduced
to mitigate hardships which were likely to be caused as a result of fluctuation
in the rate of exchange. S. 43A lays down, firstly, that the increase or
decrease in liability should be taken into account to modify the figure of
actual cost and, secondly, such adjustment should be made in the year in which
the increase or decrease in liability arises on account of fluctuation in the
rate of exchange. It is for this reason that though S. 43A begins with a non
obstante clause, it makes S. 43(1) its integral part. This is because S. 43A
requires the cost to be recomputed in terms of S. 43A for the purpose of
depreciation [S. 32 and 43(1)]. A perusal of S. 43A makes it clear that insofar
as the depreciation is concerned, it has to be allowed on the actual cost of the
asset, less depreciation that was actually allowed in respect of earlier years.
However, where the cost of the asset subsequently increased on account of
devaluation, the written down value of the asset has to be taken on the basis of
the increased cost minus the depreciation earlier allowed on the basis of the
old cost. U/s.43A, as it stood at the relevant time, it was, inter alia,
provided that where an assessee had acquired an asset from a country outside
India for the purpose of his business, and in consequence of a change in the
rate of exchange at any time after such acquisition, there is an increase or
reduction in the liability of the assessee as expressed in Indian currency for
making payment towards the whole or part of the cost of the asset or for
repayment of the whole or part of the moneys borrowed by him for the purpose of
acquiring the asset, the amount by which the liability stood increased or
reduced during the previous year shall be added to or reduced from the actual
cost of the asset as defined in S. 43(1). This analysis indicated that during
the relevant assessment year adjustment to the actual cost was required to be
done each year on the closing date, i.e., year end. Subsequently, S. 43A
underwent a drastic change by virtue of a new S. 43A inserted vide the Finance
Act, 2002. Under the new S. 43A, such adjustment to the cost had to be done only
in the year in which actual payment is made. The Supreme Court noted that in
this case, it was not concerned with the position emerging after the Finance
Act, 2002. Under Explanation 3 to S. 43A, if the assesse had covered his
liability in foreign exchange by entering into forward contract with an
authorised dealer for the purchase of foreign exchange, the gain or loss arising
from such forward contract was required to be taken into account.

According to the assessee, S. 43A was not applicable in this
case as there was no increase or reduction in liability because such roll-over
charges were paid to avoid increase or reduction in liability consequent upon
change in the rate of exchange.