Deductibility of premium on forward contracts in the year of entering into such contracts

The Delhi High Court (HC) [2010-TIOL­42-HC-DEL-IT] in the case of CIT Vs Industrial Finance Corporation of India (Taxpayer) which held that the difference between forward rate and exchange rate prevailing on the date of entering into forward contracts is fully allowable as deduction even if the difference is amortised in the books of account over the life of the forward contracts.

Background and facts of the case

• The Taxpayer, a financial corporation, is engaged in the business of making loans and advances to various industrial concerns. The Taxpayer raises foreign currency borrowings for the purpose of meeting lending requirements. In order to safeguard loss on account of foreign exchange fluctuation, the Taxpayer enters into forward contracts with banks for the purchase of foreign currency.

• During the tax year 1994-95, the loss of INR 817 million was reckoned based on the difference between the forward rate and the exchange rate prevailing on the date of entering into the forward contracts. In terms of the relevant Accounting Standard issued by The Institute of Chartered Accountants of India, the Taxpayer amortised the loss over the life of the forward contracts and recognised INR 146 million as exchange loss in its books of account in tax year 1994-95 and carried forward the balance INR 671 million to be recognised over the balance life of the forward contracts. However, for tax purposes, the Taxpayer claimed deduction for the full amount of INR 817 million.

• The Tax Authority restricted the deduction to INR 146 million and disallowed the balance INR 671 million on the ground that the same pertained to future years.

• Aggrieved by the action of the Tax Authority, the Taxpayer appealed to the first appellate authority who upheld the Tax Authority’s order. The Taxpayer appealed further to the Tribunal which ruled in favor of the Taxpayer and allowed deduction for the full amount of INR 671 million. The Tax Authority appealed to the Delhi HC against the Tribunal’s ruling.

Contentions of the Tax Authority