2021 (5) TMI 1050 - AT - Income Tax

Tax implications of foreign exchange fluctuation gains arising upon receiving the repayment of a personal loan, extended by the assessee, denominated in US Dollars - As explained that the loan transaction was in terms of the Liberalized Remittance Scheme of the Reserve Bank of India inasmuch as it was a permitted transaction, and specifically on capital account and that the transaction was in capital field and that, therefore, the gain is in the nature of capital receipt and hence not offered for taxation - HELD THAT - It is not even in dispute, and rightly so, that the receipt is in question is in the capital field but the AO has taxed it on the basis that the gain on realization of loan would partake character of an income under the head income from other sources , and the CIT(A) has justified such a taxation on the basis, which was altogether different vis- -vis the reasoning adopted by the AO, that the accretion in rupee terms is to be considered as interest, and is to be taxed as such by observing that as per provision of the Income-tax Act if giving and taking loan is not the business of the assessee then income arising out of the loan is treated as interest of the income or income from other sources . None of these reasonings meet our approval. Interest is the amount payable in any manner in respect of moneys borrowed or debts incurred but in the present case nothing more than principal debt has been paid by the borrower, and unless borrower pays an amount in respect of moneys borrowed or debts incurred, the definition of interest does not come into play. Yes, there was a benefit or a gain to the assessee; that is not even in dispute. The benefit or the gain was not on account of interest payment; that benefit or gain was on account of foreign exchange fluctuation but since the foreign exchange fluctuation with respect to a transaction in capital field, on the facts of this case foreign exchange fluctuation receipt itself turned out to be a capital receipt. CIT(A) was, therefore, in error in holding the foreign exchange fluctuation income to be in the nature of interest . As for his holding that the income was taxable as income from other sources, that is exactly what the Assessing Officer had also done, and, for the detailed reasons set out above, that approach does not meet my judicial approval either. In any case, merely because the rupee loans are specifically permitted to the NRI/PIO close relatives, this fact per se cannot lead to the conclusion that foreign exchange denominated loans being extended to the NRI/PIO close relatives was prohibited. Be that as it may, we are not inclined to, nor do I see any reasons to, deal with the broader question as to whether or not such a transaction of foreign exchange denominated loan, as the assessee has indeed entered into, was permissible or not. That is neither my domain nor my concern. If this transaction was impermissible under the Foreign Exchange Management Act, 1999, the consequences must flow under that legislation itself. The Income Tax Act, 1961 has nothing to do with the consequences, even if that be so, of impermissibility of such transactions under the FEMA or Liberalized Remittance Scheme framed thereunder- at least in the context of dealing with an income. The impugned addition is not sustainable in law. AO is, accordingly, directed to delete the same. Decided in favour of assessee.

Issues Involved:
1. Tax implications of foreign exchange fluctuation gains on the repayment of a personal loan.
2. Nature of the receipt (capital or revenue).
3. Permissibility of foreign exchange denominated loans under the Liberalized Remittance Scheme (LRS).

Issue-wise Detailed Analysis:

1. Tax Implications of Foreign Exchange Fluctuation Gains:
The primary issue in this case revolves around the tax implications of foreign exchange fluctuation gains arising from the repayment of a personal loan extended by the assessee in US Dollars. The Assessing Officer (AO) observed that the difference in the amount received due to the fluctuation in the exchange rate should be considered as income. The AO held that the gain on realization of the loan would partake in the character of income under the head "Income from Other Sources." The assessee, however, argued that the transaction was purely personal, not a business transaction, and the gain was a capital receipt, hence not taxable.

2. Nature of the Receipt (Capital or Revenue):
The core of the dispute is whether the receipt from the foreign exchange fluctuation is capital or revenue in nature. The assessee maintained that the loan was extended under the LRS, and the gain from the exchange rate fluctuation was a capital receipt. The AO and the Commissioner of Income Tax (Appeals) [CIT(A)] disagreed, treating the gain as income. The Tribunal, however, clarified that when a receipt is in the capital field, even if it is a gain, it is in the nature of a capital gain. Only capital gains taxable under section 45 of the Income Tax Act can be brought to tax. Since the loan was in US Dollars and the repayment was also in US Dollars, the gain in rupee terms was due to the increase in the value of the US Dollar, which is a capital receipt and not taxable unless specifically included in the definition of income.

3. Permissibility of Foreign Exchange Denominated Loans Under LRS:
The CIT(A) argued that the LRS only permitted rupee loans to Non-Resident Indians (NRIs) or Persons of Indian Origin (PIOs) who are close relatives. The Tribunal noted that the AO had not found any infirmity in the loan transaction itself, focusing instead on the gains from foreign exchange fluctuation. The Tribunal further stated that whether such a transaction was permissible under the Foreign Exchange Management Act (FEMA) or LRS is not within the purview of the Income Tax authorities. The transaction did take place, and the primary question was whether the gains from foreign exchange fluctuation were taxable. The Tribunal concluded that the permissibility of the loan under FEMA or LRS does not affect the taxability of the gains under the Income Tax Act.

Conclusion:
The Tribunal held that the foreign exchange fluctuation gain was a capital receipt and not taxable under the Income Tax Act. The addition of Rs 22,04,568 made by the AO was not sustainable in law, and the AO was directed to delete the same. The appeal was allowed in favor of the assessee.

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