Section 37(1) – When the assessee converts Indian rupee loan borrowed for purchasing assets from India into foreign currency loan for taking benefit of lower interest rates and thereafter as per AS – 11 translates foreign currency loan into Indian Rupees by applying the foreign exchange rate as on the closing day of reporting period and such translation results in business loss, then the resultant loss is allowed as deduction u/s 37(1) as such loss is dictated by revenue considerations of saving interest costs.
FACTS
The assessee had initially availed various term loans in Indian rupees from banks for acquisition of assets and for expansion of project, etc. Subsequently, said loans were converted into foreign currency loans to take benefit of lower rate of interest on such foreign currency loans visa- vis loans in Indian rupee.
The assessee, following Accounting Standard – 11 (AS- 11) issued by Institute of Chartered Accountants of India (ICAI), translated foreign currency loan into Indian Rupees by applying the foreign exchange rate as on the closing day of reporting period and the same resulted in exchange loss. The said translation loss resulted in business loss which was disallowed by the AO.
The assessee argued before the AO that there is no provision in the Income-tax Act to reject the loss incurred on fluctuation in exchange as revenue expense except section 43A which provides for capitalization of such loss where the loan was taken on acquisition of any capital asset outside India. Since the assessee had not acquired assets from a country outside India section 43A was not applicable.
However, the AO held that the so-called loss was merely a notional loss and not an actual loss incurred by the company. The Assessing Officer further observed that even presuming that increased liability for repayment of foreign currency loans had been saddled on the assessee, still the same would be a payment of capital nature since impugned loans were obtained for acquiring the capital asset. The AO, thus, held that the loss claimed on account of fluctuation in the foreign exchange rate could not be allowed as revenue expenditure.
On appeal, the CIT-(A) granted partial relief to assessee on account of foreign currency fluctuation loss arising on loans found by him to be connected to revenue items such as bill discounting, debtors, etc. However, in respect of other loans, the CIT-(A) observed that such loans were taken for capital purposes such as acquisition of assets and expansion of the projects and, therefore, the assessee was not entitled to losses from fluctuation in currency as revenue expenditure.
On second appeal:
HELD
It may be pertinent to examine whether the increased liability due to fluctuation loss can be added to the carrying costs of corresponding capital assets with reference to section 43(1). Section 43(1) defines the expression ‘actual cost’. As per section 43(1), actual cost means actual cost of the assets of the assessee, reduced by that portion of the costs as has been met directly or indirectly by any other person or authority. Several Explanations have been appended to section 43(1). 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 costs of the assets.
The issue is also tested in the light of provision of section 36(1)(iii) governing deduction of interest costs on borrowings. Section 36(1)(iii) states that utilization of loan for capital account or revenue account purpose has nothing to do with allowing deduction of corresponding interest expenditure. A proviso inserted thereto by Finance Act, 2003, also prohibits claim of interest expenditure in revenue account only upto the date on which capital asset is put to use. Once the capital asset is put to use, the interest expenditure on money borrowed for acquisition of capital asset is also treated as revenue expenditure.
Thus, viewed from the perspective of section 43(1) and section 36(1)(iii), such increased liability cannot be bracketed with cost of acquisition of capital assets save and except in terms of overriding provisions of section 43A.
CBDT notification S.O. 892(E) dated 31-3-2015 also inter alia deals with recognition of exchange differences. The notification also sets out that the exchange differences arising on foreign currency transactions have to be recognized as income or business expense in the period in which they arise subject to exception as set out in section 43A or rule 115 of the Income Tax Rules, 1962 as the case may be.
A bare reading of section 43A, which opens with a non obstante and overriding clause, would show that it comes into play only when the assets are acquired from a country outside India and does not apply to acquisition of indigenous assets. Another notable feature is that section 43A provides for making corresponding adjustments to the costs of assets only in relation to exchange gains/ losses arising at the time of making payment. It, therefore, deals with realised exchange gain/loss. The treatment of unrealised exchange gain/loss is not covered under the scope of section 43A. It is, thus, apparent that special provision of section 43A has no application to the facts of the case. Therefore, the issue whether the loss is on revenue account or a capital one is required to be tested in the light of generally accepted accounting principles, pronouncements and guidelines, etc.
The Supreme Court in the case of CIT vs. Tata Iron and Steel Co. Ltd. [1998] 231 ITR 285 held that cost of an asset and cost of raising money for purchase of asset are two different and independent transactions. Therefore, fluctuations in foreign exchange rate while repaying instalments of foreign loan raised to acquire asset cannot alter actual cost of assets. The assessee may have raised funds to purchase the asset by borrowing but what the assessee has paid to acquire asset is the price of the asset. That price cannot change by any event subsequent to the acquisition of the asset.
The assessee has inter alia applied AS-11 dealing with effects of the changes in the exchange rate to record the losses incurred owing to fluctuation in the foreign exchange. AS-11 enjoins reporting of monetary items denominated foreign currency using the closing rate at the end of the accounting year. It also requires that any difference, loss or gain, arising from such conversion of the liability at the closing rate should be recognized in the profit & loss account for the reporting period.
As per section 209 of the Companies Act, 1956, the assessee being a company is required to compulsorily follow mercantile system of accounting. Section 211 of the Companies Act, 1956 also mandates that accounting standards as applicable are required to be followed while drawing statement of affairs. Section 145 of the Income Tax Act, 1961 similarly casts obligation to compute business income either by cash or mercantile system of accounting. The Supreme Court in the case of CIT vs. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 has observed that AS-11 is mandatory in nature. Thus, in view of the various provisions of the Companies Act and the Income-tax Act, it was mandatory for the assessee to draw accounts as per AS-11. Thus, the loss recognized on account of foreign exchange fluctuation as per notified accounting standard AS 11 is an accrued and subsisting liability and not merely a contingent or a hypothetical liability. A legal liability also exists against the assessee due to fluctuation and loss arising there from. Actual payment of expense is an irrelevant consideration to ascertain the point of accrual of liability. As a corollary, the revenue has committed error in holding the liability as notional or contingent.
Besides AS-11, the claim of exchange fluctuation loss as revenue account is also founded on the argument that the aforesaid action was taken to save interest costs and, consequently, to augment the profitability or reduce revenue losses of the assessee. The impugned fluctuation loss therefore, has a direct nexus to the saving in interest costs without bringing any new capital assets into existence. Thus, the business exigencies are implicit as well explicit in the action of the assessee. The argument that the act of conversion has served a hedging mechanism against revenue receipts from export also portrays commercial expediency. Thus, the plea of the assessee that claim of expenditure is attributable to revenue account has considerable merits.
For the aforesaid reasons and in the light of the fact that the conversion in foreign currency loans which led to impugned loss were dictated by revenue considerations towards saving interest costs, etc., the said loss is considered as being on revenue account and is an allowable expenditure u/s. 37(1). The order of the CIT-(A) sustaining the disallowance is thus reversed.
