Business expenditure — Foreign exchange borrowings — Loss on account of fluctuation in rate of foreign exchange on the last date of balance sheet — If the borrowings are on revenue account, the loss is allowable as deduction u/s.37(1) and if the same is o

The assessee, a public sector undertaking, substantially
owned by the Government of India, was engaged in capital intensive exploration
and production of petroleum products for which it had to heavily depend on
foreign loan to cover its expenses, both capital and revenue, on import of
machinery on capital account and for payment to non-resident contractors in
foreign currency for various services rendered. The assessee had made three
types of foreign exchange borrowings : (i) in revenue account; (ii) in capital
account, and (iii) for general purposes, partly utilised in revenue account and
partly in capital account. As per terms and conditions of foreign exchange
borrowings, some of the loans became repayable in the year under consideration
but the date of repayment of some loans fell after the end of the relevant
accounting year. The assessee revalued in Indian currency all its foreign
exchange loans in revenue account, capital account as also in its general
purposes account, outstanding as on March 31, 1991 and claimed the difference
between their respective amounts in Indian currency as on 31st March, 1990 and
on March 31, 1991 as revenue loss u/s.37(1) of the Act in respect of loans used
in revenue account, and also took into consideration the similar difference in
foreign exchange on capital account loans as an increased liability u/s. 43A of
the Act for the purposes of depreciation. The foreign exchange loss incurred by
the assessee in the revenue account, on account of repayment of these loans made
in the year under consideration was allowed by the Assessing Officer as a
deduction u/s.37(1) of the Act, and he also took into consideration an increased
liability of foreign exchange loans taken in capital account and repaid in the
accounting year, for the purposes of depreciation, u/s.43A of the Act. He,
however, did not allow to the assessee its claim for foreign exchange loss
claimed on such foreign currency loans both in revenue account and in capital
account which were outstanding on the last day of the accounting year under
consideration and were as per the terms of borrowings repayable after the end of
the relevant accounting year. Similar treatment was given to the foreign
exchange loans for general purposes, used partly in revenue account and partly
in capital account. Thus, the assessee’s claim for foreign exchange
loss/increased liability on revaluation of these foreign exchange loans at the
end of the accounting year under consideration both in the revenue account and
capital account as also on loans used partly in revenue account and partly in
capital account, made on the ground that it had followed mercantile system of
accounting in this regards, was disallowed by the Assessing Officer. According
to the Assessing Officer, such a loss could be allowed to the assessee on
discharge of liability at the time of actual repayment of these loans.

Aggrieved, the assessee preferred appeal before the
Commissioner of Income-tax (Appeals). Inso-far as the assessee’s claim for
foreign exchange loss in revenue account was concerned, the Commissioner of
Income-tax (Appeals) affirmed the view taken by the Assessing Officer on the
ground that it was a notional liability and the same had not crystallised or
accrued in the relevant assessment year. However, as regards the adjustment for
increased liability made by the assessee for the purposes of S. 43A of the Act
in respect of foreign exchange loans in capital account, which were outstanding
as on March 31, 1991, the Commissioner accepted the stand of the assessee and
directed the Assessing Officer to allow the benefit of such increased liability
for computation of depreciation allowance on plant and machinery purchased out
of such foreign exchange loans for the assessment year under consideration.

Being dissatisfied, both the assessee as well as the Revenue
carried the matter in further appeal to the Income Tax Appellate Tribunal (for
short ‘the Tribunal’). The Tribunal observed that the method of accounting
adopted by the assessee right from the A.Y. 1982-83 is mercantile system; it has
been consistently claiming loss suffered by it on account of fluctuation in
foreign exchange rates on accrual basis; in respect of the A.Y. 1982-83 to
1986-87, the assessee’s claim on this account had been allowed by the Assessing
Officer himself; in respect of the A.Y. 1997-98, the assessee had shown a gain
of Rs.293.37 crores on account of fluctuation in foreign exchange because of the
Indian rupee had appreciated as compared to the foreign currency and that the
said amount was taxed as the assessee’s income. Taking all these factors into
consideration, the Tribunal held that the loss claimed by the assessee on
revenue account was allowable u/s.37(1) of the Act. The appeal preferred by the
Revenue on the question whether the assessee was entitled to adjust the actual
cost of imported assets acquired in foreign currency on account of fluctuation
in the rate of exchange, in terms of S. 43A of the Act, was also dismissed.

For the A.Ys. 1992-93, 1993-94, 1994-95 and 1997-98 similar
findings were given by the Tribunal. The Revenue took the matter in further
appeal to the High Court. By a common judgment pertaining to the A.Ys. 1991-92
to 1994-95 and 1997-98, the High Court reversed the decision of the Tribunal on
both the issues. Terming the order of the Tribunal as perverse, having been
passed without any material on record and against the statutory provisions, the
High Court held that the foreign exchange loss by the assessee being only a
contingent and notional liability, it was not allowable as deduction u/s.37(1)
of the Act. Insofar as the applicability of S. 43A of the Act was concerned, the
High Court observed that the said provision is confined only to those
liabilities which have become due as per the terms and conditions of written
agreement between the assessee and the foreign creditors but since in the
present case, no such agreement was made available by the assessee at any stage
of the proceedings, the claim of the assessee was not justified. According to
the High Court, the variation in foreign exchange was neither quantified, nor
had it become due or repaid and, therefore, deductions on that account had been
allowed by the Tribunal without application of mind and were, therefore,
illegal.

On an appeal by the assessee, the Supreme Court was of the
opinion that the ratio of the decision in CIT v. Woodward Governor of India P.
Ltd., (2009) ITR 254 (SC) squarely applied to the facts at hand and, therefore,
the loss claimed by the assessee on account of fluctuation in the rate of
foreign exchange as on the date of balance sheet was allowable as expenditure
u/s.37(1) of the Act.