The nature of any particular receipt as capital or revenue is one of the fundamental steps in deciding the taxability of any income. Unfortunately, Income Tax Act, 1961 (as ‘IT Act’) does not provide any unambiguous explanation for the terms ‘capital receipt’ or ‘revenue receipt.’ With the advent of capital market transactions and international financial assets, the nature of monetary transactions has become increasingly controversial because tax authorities are finding themselves at loggerheads with taxpayers regarding the nature of such receipts. Tax authorities seek to expand the scope of categories such as ‘income from other sources’ or gains specified under section 45 of the IT Act.

In a similar attempt by the tax authorities, in the case of Aditya Balkrishna Shroff v. Income Tax Officer, the assessing officer (as ‘AO’) sought to tax a gain accrued to the assessee from fluctuations in the exchange value of a foreign currency which the assessee received on account of a personal loan extended by him.

The author here analyses the process by which this gain should have been dealt with by the AO and how ITAT Mumbai has clarified its position on the nature of gains accrued from foreign exchange fluctuations.


The case revolves around a personal interest-free loan extended by Mr. Aditya Balkrishna Shroff (as ‘assessee’) to his cousin (as ‘borrower’) in Singapore amounting to USD 2,00,000 on March 29, 2010. The said transaction was executed under the Liberalized Remittance Scheme (as ‘LRS’) of the Reserve Bank of India (as ‘RBI’).

As on the lending date, the exchange rate for Indian currency vis-à-vis USD was Rs. 45.14. Accordingly, the assessee made a payment of Rs. 90,30,758 towards the loan amount of USD 2,00,000. The borrower repaid the loan on May 24, 2012, and the exchange rate for USD increased to Rs. 56.18. As a result, the assessee received a total of Rs. 1,12,35,326 against his interest-free loan of Rs. 90,30,758.

During the auditing process under section 143(3) of the IT Act for the financial year 2012-13, corresponding to the accounting year of 2013-14, the AO considered this difference of Rs. 22,04,568 as in the nature of ‘income’ and sought to tax the same under ‘income from other sources’ category provided under the IT Act. AO also initiated penalty proceedings against the assessee for not specifying the true nature of the income in his filings.

The assessee filed an appeal before the CIT(A).

Observations of CIT(A)

CIT(A) agreed with the assessment done by the AO and insisted on the argument that the present transaction’s gain should either be treated as an interest payment or under the ‘income from other sources’ category.

The assessee argued that the present loan is executed under the LRS forwarded by RBI and should not be taxed. CIT(A) found this argument by the assessee as untenable because LSR only allows for rupee-denominated loans made to non-residents of India or Persons of Indian origin. However, in the present case, the loan was predominantly in US Dollars, against which the assessee made a profit. Therefore, the assessee will have to pay taxes on any surplus from such loan transaction. The profit accrued will form part of the income of the assessee.


The central contentions of this case are:

1. Whether gains arising out of foreign exchange fluctuation from the repayment of a personal loan extended by the assessee fall under the category of capital receipts or not?

2. If they fall under the category of capital receipts, can such gains be chargeable to tax?


Section 45 of the IT Act specifies a list of taxable capital gains. Section 45, read with section 2(24)(vi), clearly establishes that any capital gain not mentioned under section 45 or not explicitly included in the definition of ‘income’ by a specific deeming fiction is not taxable. ITAT relied on the authority of CIT v. DP Sandu Bros. Chembur (P) Ltd, where the Supreme Court observed that it is against the letter and intent of section 56 of the IT Act to include everything exempted from capital gains in the statute as a taxable nonrecurring receipt under section 10(3) of the IT Act.

The Calcutta HC, in Shaw Wallace & Co Ltd v. DCIT, held that, in principle, capital receipts are outside the purview of taxable income and could not be taxed unless they are expressly included in the definition of income under IT Act. No degree of liberal interpretation of the statute could convert a capital receipt into a revenue receipt or blur the fundamental distinction between the two for the purposes of calculating tax.

Negating the observations made by CIT(A), ITAT Mumbai observed that only the principal amount of the loan is being repaid. As such, the definition of interest under section 2(28A) of the IT Act does not even come into play. Any benefit the assessee accrued is because of the foreign exchange fluctuations and not from any interest payment. Since the fluctuation was in relation to a capital transaction, the gain would be a capital receipt. Therefore, the observation by CIT(A) that the gain was in nature of interest income is erroneous.

Concludingly, ITAT held that gains accrued from foreign exchange fluctuations would amount to capital receipt, not taxable under the IT Act. Regarding the applicability of LRS, ITAT believed that since the same is not relevant to ascertain taxability, Tribunal will not take it up. As a passing observation, ITAT clarified that it is not the prerogative of AO to assess if the loan is permitted under Foreign Exchange Management Act regulations or not. 

Ratio Decidendi

Gains from foreign exchange fluctuation accrued to the assessee from repayment of a personal loan in US Dollar denomination is a capital receipt and, as such, not chargeable to tax. 


Defining Nature of Income – In the present case, the AO decided to categorize the income received from a “gain on the realization of loan” under the head of ‘income from other sources’ without defining the nature of the income accrued. The CIT(A) agreed with the assessment of AO. However, this approach fundamentally goes against the intent of section 2(24)(vi) of the IT Act, which clearly states that not all gains can be covered under the ambit of taxability. The question of converting a revenue receipt to a capital receipt or vice-versa would never even arise if AO moves on to tax a particular income without determining its true nature.

Burden of ProofDr. K. George Thomas v. CIT established that the burden of proving the nature of any receipt as ‘revenue receipt’ would fall on the Revenue Department, and only after that, it is shifted to the assessee to prove that the receipt falls under any of the exemptions under the statute. However, CIT(A) failed to appreciate the safeguards established by past jurisprudence and arbitrarily held the foreign exchange fluctuation gain as a taxable receipt. CIT(A) even entertained the argument that a capital receipt that cannot be taxed must be a revenue receipt. However, such logic does not fall under any legal provision relating to taxation or otherwise.

Nature of Foreign Exchange Fluctuations – The loan extended by the assessee is not in the nature of ‘business activity,’ and therefore, fluctuation cannot fall under the ‘Profits and Gains from Business or Profession’ category. The gain cannot be considered an interest payment either, as the borrower only repaid the principal amount. It is only because of exchange market fluctuations that the assessee accrued a gain. Therefore, the gain must be categorized under capital receipts, not interest income or income from other sources.

Taxability of Capital Receipts – In the case of Shaw Wallace & Co Ltd v. DCIT, the Calcutta High Court went into great detail about the criteria for a receipt to be termed as a ‘capital receipt’ and the tax liability of such receipts. The Court explained that not all capital receipts can be taxed. Additionally, the Supreme Court has already made it clear in the case of Padmaraje R. Kadambande v. CIT that any income received by an assessee against a capital receipt will not fall under the definition of “income” under section 2(24) of the IT Act. Such receipts cannot be taxed unless a specific provision under IT Act is not made for them to be taxable.

The moot question before the Tribunal was whether an accretion of value in relation to an asset in the capital field, like an advancement of a foreign currency-denominated loan, is subject to tax liability. Even though repayment of such a loan, on the face of it, may seem like a capital receipt, in cases such as CIT v. Kamal Behari Lal Singha, the Supreme Court decided to focus on evaluating the form of a receipt based only on its nature in receiver’s hands with the source of such a receipt having no effect whatsoever.

Tax Liability of Foreign Exchange Fluctuation – The Supreme Court in Sutlej Cotton Mills Ltd v. Commissioner of Income Tax, West Bengal, laid down the test to assess the tax liability of gain/loss accruing solely from exchange market fluctuations. The Court observed:

“any gain/loss attributable to appreciation/ depreciation in value of the foreign currency would be trading profit or loss if the foreign currency is held by the on revenue account or as a trading asset or as part of circulating capital embarked in the business. But if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.” (Para 10)

ITAT applied this test laid down in Havells India Limited v ACIT to hold that a gain received on foreign exchange gain in connection to currency received on the redemption of shares of a foreign subsidiary. It was also observed that the fluctuation increase could not be considered as part of the consideration for redemption of such shares. 


The judgment came after the fallout of the COVID-19 pandemic, during which many financially sound residents extended loans to their overseas friends and relatives. Since the economy is opening up, those personal loans are being repaid. With the controversial nature of ‘capital’ and ‘revenue’ receipts, this decision has fortified tax authorities’ understanding of the nature of exchange market fluctuation gains.

ITAT Mumbai decided that gains arising out of foreign exchange fluctuation from the repayment of a personal loan extended by the assessee fall under the category of capital receipts and, as such, are not chargeable to tax.

This decision will help Indian taxpayers to extend personal loans to acquaintances outside India and get repaid in foreign currencies. With the constant devaluation of the Indian Rupee in light of the Russia-Ukraine conflict, it might become a way for individuals to trick the exchequer and earn tax-free income, all through the official procedures of LRS.

Author Bio

Name: Manav
Qualification: Student- Others
Company: NALSAR University of Law
Location: Hyderabad, Telangana, India
Member Since: 24 Jan 2023 | Total Posts: 1

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One Comment

  1. D Venkatramana says:

    Honorable Courts and Tribunals should have viewed the subject of foreign exchange transactions from the point of risk of losing the capital if the movements had been adverse.

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