2009 (4) TMI 4 - SC - Income Tax

Fluctuation in rate of exchange - Increased liability in respect of loans taken - in which year, loss incurred on revenue account should be deducted u/s 37(1) - held that loss suffered as on the date of balance sheet is an item of expenditure u/s 37(1) - increase in liability on capital account - scope of S. 43A (unamended) prior to 1.4.03 assessee entitled to adjust the actual cost of imported assets at each balance sheet date - held that amended section is amendatory, not clarificatory

Issues Involved:
1. Deductibility of additional liability due to exchange rate fluctuations under Section 37(1).
2. Adjustment of actual cost of imported assets due to exchange rate fluctuations under Section 43A.

Issue-Wise Detailed Analysis:

1. Deductibility of Additional Liability Due to Exchange Rate Fluctuations Under Section 37(1):

Facts and Background:
The assessee filed its return for the assessment year 1998-99, which included an unrealized loss due to foreign exchange fluctuation. The Assessing Officer (AO) disallowed this deduction, treating it as a contingent liability. The Tribunal and the Delhi High Court, however, allowed the deduction, leading to the Department's appeal to the Supreme Court.

Arguments by the Department:
The Department argued that the term "expenditure" in Section 37(1) means "what is paid out" and "something which is gone irretrievably," relying on the judgment in Indian Molasses Co. (Private) Ltd. v. CIT. They contended that the increase in liability due to exchange rate fluctuation does not meet the criteria of "expenditure" as it is not paid out and can revert.

Arguments by the Assessee:
The assessee argued that under the mercantile system of accounting, liabilities are recorded when incurred, not when paid. They highlighted that the Department taxed gains from exchange rate fluctuations in previous years, thus should allow deductions for losses under the same principle. They cited the definition of "paid" in Section 43(2) and emphasized consistency in accounting treatment.

Supreme Court's Analysis:
The Court noted that the term "expenditure" in Section 37(1) includes losses, even if not actually paid out, aligning with commercial accounting principles. The Court emphasized that accounts maintained regularly are presumed correct unless proven otherwise. The Court also referred to Accounting Standard-11 (AS-11), which mandates recognizing exchange differences in the profit and loss account at the balance sheet date.

Conclusion:
The Supreme Court held that the loss due to exchange rate fluctuation is deductible under Section 37(1) as it is an expenditure incurred in the course of business, consistent with the mercantile system of accounting and AS-11. The appeal by the Department was dismissed.

2. Adjustment of Actual Cost of Imported Assets Due to Exchange Rate Fluctuations Under Section 43A:

Facts and Background:
The issue was whether the assessee could adjust the actual cost of imported assets acquired in foreign currency due to exchange rate fluctuations at each balance sheet date, pending actual payment.

Arguments by the Department:
The Department argued that under the pre-amended Section 43A, adjustments should be made at the point of payment, not at each balance sheet date. They contended that the amendment by the Finance Act, 2002, was clarificatory, emphasizing that the accrual of liability should coincide with payment.

Arguments by the Assessee:
The assessee argued that Section 43A (unamended) allowed for adjustments in the actual cost of assets due to exchange rate fluctuations at each balance sheet date. They cited the judgment in CIT v. Arvind Mills Ltd., which supported adjustments irrespective of actual payment.

Supreme Court's Analysis:
The Court analyzed Section 43A (unamended) and noted that it allowed adjustments for exchange rate fluctuations without requiring actual payment. The Court emphasized that the amendment by the Finance Act, 2002, introduced a structural change, making actual payment a condition for adjustment. This amendment was deemed amendatory, not clarificatory.

Conclusion:
The Supreme Court held that under the unamended Section 43A, adjustments for exchange rate fluctuations could be made at each balance sheet date without actual payment. The amendment by the Finance Act, 2002, changed this to require actual payment for adjustments. The appeal by the Department was dismissed.

Overall Conclusion:
The Supreme Court upheld the decisions of the Delhi High Court, allowing the deduction of losses due to exchange rate fluctuations under Section 37(1) and permitting adjustments in the actual cost of imported assets under Section 43A (unamended) without requiring actual payment. The appeals by the Department were dismissed with no order as to costs.

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