The present article deals with treatment of foreign exchange (“forex”) fluctuations on computation of total income in case of capital assets acquired by using funds borrowed from outside India in the form of ECB, Loans and payment to suppliers (“borrowed funds”). 1. Foreign currency loan for acquisition of :
- Imported fixed assets
- Indigenous fixed assets.
2. The above transaction may result into following types of foreign exchange gain or loss either on repayment of loan installment/payment to supplier or on restatement of outstanding foreign currency loan borrowed or on accrued interest or payment of interest on such borrowed funds.
3. Imported Fixed Asset:
The above four type of gain or loss on foreign exchange fluctuation for Foreign Currency loans used for Imported Fixed asset is dealt by section 43A of The Income Tax Act, 1961 which provides:
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.
♠ The above provisions of section 43A of the Income Tax Act are summarized hereunder:
- Where the assessee has acquired any assets from a country outside India
- The assets are acquired for the purpose of business or profession.
- 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.
- Such increase or reduction in the liability shall be added or deducted from the actual cost of assets as and when paid or received.
♠ Hence in view of the same, when foreign currency loans are utilized for acquisition of imported assets being assets purchased from outside India, The gain or loss arising on given situation is dealt as under:
|Type of Gain or Loss||Realized or not?||Effect under Income Tax Act, 1961|
|Gain or loss on foreign exchange fluctuation on Loan principal repayment||Realized||Gain to be deducted from cost of fixed asset / Loss to be added to cost of fixed asset in view of section 43A|
|Gain or loss on foreign exchange fluctuation on Loan restatement||Unrealized||Gain or loss being capital in nature: Gain is not taxable/loss is disallowed|
|Gain or loss on foreign exchange fluctuation on accrued interest booked||Unrealized||Gain or loss being revenue in nature: Gain is taxable/loss is allowed for deduction|
|Gain or loss on foreign exchange fluctuation on interest payment||Realized||Gain or loss being revenue in nature: Gain to be deducted from cost of fixed asset / Loss to be added to cost of fixed asset in view of section 43A|
4. Indigenous Fixed Asset:
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.
The issue is whether foreign exchange fluctuation gain on foreign currency loan borrowed to acquire indigenous fixed assets and/or imported fixed asset is chargeable to income tax. The possible issues could be as under:
- Whether gain or loss is of capital nature or revenue nature.
- If gain or loss is of capital nature, then whether the same can be taxed as such.
- If it cannot be taxed, whether the same can be reduced from the cost of assets.
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:
- Sutlej Cotton Mills Ltd. vs. CIT – 116 ITR 1 (SC) (1979)
- CIT vs. Tata Locomotive and Engineering Company Ltd. – 60 ITR 405 (1966)(SC)
- CIT vs. V.S.Dempo & Co Pvt. Ltd (206 ITR 291) (1994) (HC-Bombay)
- CIT vs Woodward Governor India P. Ltd (312 ITR 254) (2009) (SC).
- DCIT vs. Maruti Udhyog Ltd. 101 TTJ 760 (ITAT)
- Oil and Natural Gas Corpn. Ltd vs. DCIT 77 TTJ 387 (ITAT)
- Silicon Graphics India Pvt Ltd vs. DCIT 106 TTJ 1153 (ITAT)
- CIT vs. Tata Iron & Steel Co Ltd 99 Taxmann 459 (SC)
♠ In case of Sutlej Cotton Mills Ltd. vs. CIT – 116 ITR 1, it was observed by the Apex court that:
“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”
Further observation made in above case 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.
♠ In case of CIT vs. V.S. Dempo & Co Pvt. Ltd (206 ITR 291) which has specifically laid down principles in order to decide whether loss/gain arising out of foreign exchange fluctuations is in nature of revenue or capital, of which at para 5 of said principles which says as follow:
“Loss resulting from depreciation of the foreign currency which is utilised or intended to be utilised in business and is part of the circulating capital, would be a trading loss, but depreciation of fixed capital on account of alteration in exchange rate would be capital loss”
The above principles have been followed by various courts in deciding whether particular exchange loss or gain is of capital nature or revenue nature.
Therefore it is concluded that it is necessary to see the nature of utilization of foreign currency loan amount, if it is capital purpose, Loss is not deductible being capital in nature. But however, interest cost on said loan being an item of revenue in nature, Loss pertaining to interest paid and interest accrued is deductible.
A. Basis of determination of capital or revenue nature being Utilization concept is vague:
It should be noted that very basis of determination that any loss or gain arising out of foreign exchange fluctuation for in connection with borrowed funds shall be of capital nature or revenue nature is based on utilization of said loan amount. It should be noted that by raising loan itself no capital asset comes into existence and hence expenses for raising loan should 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 as in comparison with acquisition of assets out of said loan amount borrowed. The claim of exchange fluctuation loss as revenue on count is founded on strong legal arguments. It should be noted that utilization of loan amount has nothing to do with allowability of any expenditure in connection with loan repayment. Both are independent and distinct transaction in nature. It should be noted that section 43A specifically and categorically provide for adjustment in cost of asset for loss or gain arising out of foreign currency fluctuations in respect of borrowed funds in foreign currency. However, the same rational cannot be applied to loss or gain arising from foreign currency loss utilized for purchase of indigenous assets.
If we apply basis as determined by various case laws cited above, then every loan/liability require to be analyzed from the angle of usage of such loan or liability. And the application of criteria used for determination of expenditure/loss/gain connected with loan/liability is of capital nature or revenue nature wholly depends on utilization of loan/borrowed funds. If it is the case then, interest cost allowed under section 36(1)(iii) of the Act shall also requires to analyse whether such loan in respect of which such interest cost pertains is used for capital account transactions or revenue account transactions which will result in allowbality of interest cost attributable to revenue account transactions. The section 36(1)(iii) does not contemplates such type of division of interest cost and thereby allow deduction of the same. Section 36(1)(iii) allows deduction of interest expenditure for in connection with loan which ultimately utilized for both revenue and capital account transactions. The same is also consistently followed by other sections of Income Tax Act for allowability of any expenditure in connection with liability incurred. Therefore very basis of decision in above mentioned various cases is invalid and requires re-examination. Hence, in our view, utlisation of loan for capital account or revenue account purpose has nothing to do with allowabilty of any expenditure in connection with liability or loan raised in foreign currency. This is subject matter of litigation require further strong legal argument in this area.
B. Section 45 bring specific charge for taxability of capital receipts or allowbility of capital loss:
Further analysis as regard to taxability of loss or gain considering the same as capital loss requires following to understand:
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. 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/ allows same as capital loss.
C. Meaning of Actual cost as provide under section 43(1):
The next question arises is, whether the gain or loss can be reduced or added from/ to 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.
D. Contraveining decision of CIT V. Tata Iron and Steel Co. Ltd and Sutlej Cotton Mills Ltd. vs. CIT – 116 ITR 1 (SC) (1979)
Further in case of CIT V. Tata Iron and Steel Co. Ltd. (1998) 231 ITR 285 where it has been held that cost of an asset and cost of raising money for purchase of asset are two different and independent transactions and events subsequent to acquisition of assets cannot change price paid for it. Therefore, fluctuations in foreign exchange rate while repaying instalments of foreign loan raised to acquire asset cannot alter actual cost of assets for computing depreciation. Hence, it restricts assessee’s right to add such loss incurred on account of currency fluctuations to the cost of asset. Thereby, the decision given by Sutlej and Tata Iron and Steel are contrary in views. In former mentioned case it restricts the assessee’s right to claim such loss on currency fluctuations considering the same as attributable to capital account transactions and and at the same time does not allow to add the same to cost of the asset by following principle laid down in Tata Iron and Steel case.
E. AS-11 mandatory to be followed when I T Act is silent for treatment for taxability
Schedule VI of Companies Act, suggests treatment of the ‘gain/loss’ as capital in nature and should be adjusted to the cost of relevant asset, whereas Accounting Standards 11 suggests that treatment of ‘gain/loss’ attributable to foreign borrowings should be reflected in profit and loss account. (Refer para 13 of AS-11 issued by ICAI). However, said conflict was resolved by MCA Circular it was clarified by MCA that accounting treatment of exchange differences will be made as per AS 11 and further categorically mentioned that provisions of AS-11 is required to be followed irrespective of the relevant provision of Schedule-VI to the Companies Act, 1956. Therefore in view of the same, the exchange difference is required to be recognized in profit and loss account. Hence, any loss arising out of foreign currency fluctuation is allowed to be deducted from computation of total income.
The Companies Act 2013 mandates the financial statements of companies to be compliant with applicable Accounting Standards (including AS – 11). Thus, exchange gain/loss is recognized in the financial statements in accordance with AS – 11 and reference may be had to generally accepted principles of accounting as provided by various Accounting Standards issued by ICAI in absence of specific provisions in the Income Tax Act in relation to treatment of exchange fluctuation gain or loss. The above principle is followed in case of Prakash Leasing Ltd.  23 taxmann.com 3 (Kar.), it was held that:
“In the absence of any specific provision in the Act dealing on the subject, when the Accounting Standard is now made the basis of maintaining the accounts for the purpose of income-tax, even if the Central Government has not notified in the Official Gazette the Accounting Standards, certainly the Accounting Standards prescribed by the Institute of Chartered Accountants have to be followed. Therefore, the reasoning of the authorities, though the claim of the assessee is based on such Accounting Standards of the ICAI while deciding whether receipt of money is taxable or not, that it has to be decided in accordance with the provisions of law and not in accordance with the accounting practice, has no substance as there is no inconsistency between the said accounting practice and any provisions of the Act.”
F. Purpose of Loan does not determine nature of expenditure:
Further, the nature of expenditure being capital or revenue does not depend on the purpose for which foreign currency loan is obtained or on nature of ultimate utilization of loan amount. The same is also affirmed by Apex court in case of India Cements Limited vs. CIT (1966) (SC) 60 ITR 52.
G. Rational applied in case of CIT vs. Tungabhadra Industries Ltd for allowability of premium paid on debenture redemption:
It is to be noted that liability to pay or to provide for loss on account of foreign currency fluctuation does not arises at the time of obtaining/raising foreign currency loan but the same was incurred subsequently on devaluation of currency which is an independent event having no control over it by the assessee. The same currency fluctuation may result into gain or loss which is not ascertainable at the time of raising funds. Hence it cannot be said as capital expenditure. The liability to pay or to provide for foreign currency fluctuation arises only on devaluation of currency. And there may not be any liability to pay for loss on currency fluctuation if currency value is inflated subsequently. Similar rational was also applied for allowability of debenture redemption premium payable at the time of redemption as upheld in case of CIT vs. Tungabhadra Industries Ltd 76 Taxmann 185 (HC) (1994).
H. Analysis of decision of apex court in case of CIT vs. Woodward Governor India (P.) Ltd. 312 ITR 254 (SC) (2009) :
The one of the issue involved in above mentioned case was “Whether the assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date, pending actual payment of the varied liability?”
The above mentioned decision had considered the implication of Para 10 of AS-11 along with section 43A of the Act. While deciding the issue, it was observed by Hon’ble apex court at para 17:
“Having come to the conclusion that valuation is a part of the accounting system and having come to the conclusion that business losses are deductible under section 37(1) on the basis of ordinary principles of commercial accounting and having come to the conclusion that the Central Government has made Accounting Standard-11 mandatory, we are now required to examine the said Accounting Standard (“AS”).”
Apex court has decided in above matter to treat foreign exchange gain or loss arising on acquisition of fixed assets in foreign currency as per the treatment laid down in AS-11 (Revised 1994). Para-10 of AS-11 (revised 1994) provides as under:
“10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.”
AS-11(Revised 1994) provides for adjustment in the carrying cost of fixed assets acquired in foreign currency, due to foreign exchange fluctuation at each balance sheet date which also correspond to treatment given in section 43A. The issue accordingly decided by apex court in view of manner laid down in AS-11 (Revised 1994) at Para-10.
However, It is now necessary to reconsider the above decision in view of AS-11 (Revised 2003) wherein at Para 13 which provides for revision in treatment of exchange gain or loss. The revised treatment provided at Para 13 of AS-11 (Revised 2003) is given below:
“13. Exchange differences arising on the settlement of monetary items or on reporting an enterprise’s monetary items at rates different from those at which they were initially recorded during the period, or reported in previous financial statements, should be recognized as income or as expenses in the period in which they arise, with the exception of exchange differences dealt with in accordance with paragraph 15.”
In view of revision made in AS-11 in 2003, it can be said that treatment of foreign exchange loss arising out of foreign currency fluctuations in respect of fixed asset acquired through loan in foreign currency shall required to be given in profit and loss account. Said exchange loss should be allowed as revenue expenditure in view of amended AS-11 (2003). It may be noted that apex court had followed treatment of exchange loss / gain as per AS-11 (1994). In view of revision made in AS-11, now treatement shall be as per revised AS-11 (2003). Accordingly, exchange gain or loss on foreign currency fluctuations in respect of foreign currency loan acquired for acquisition of fixed asset should be allowed as revenue expenditure.
5. Relying upon the above mentioned legal arguments from A to H, it can be said that the assessee company may be allowed for deduction of any loss arising out of foreign currency fluctuation in respect of foreign currency loan obtained and used for acquiring indigenous assets. This is subject matter of highly debatable litigation.
Disclaimer: The views expressed herein are based on the interpretation of material available and analysis of various judicial pronouncements. No assertion is given that the tax authorities will concur with the views expressed. Views are based on the existing provisions of Act and its interpretation, which are subject to change from time to time.