2010 (2) TMI 23 - SC - Income Tax

Applicability of Section 43A foreign exchange fluctuation - Assessee filed its return of income for assessment year 1986-87 on 30.6.1986. A revised return was filed by it on 27.3.1989 declaring a total income of 2, 10, 08, 640/-. The A.O. disallowed an amount of 8, 86, 280/- being the roll over premium charges paid by the assessee in respect of foreign exchange forward contracts to Citibank N.A. on the ground that the said charges were incurred in connection with the purchase of a capital asset (plant and machinery) hence it was not admissible for deduction under Section 36(1)(iii) or under Section 37 of the Act. CIT(A) allowed the deduction - It may be noted that CIT (A) did not refer to a specific section under which assessee was entitled to such deduction. The CIT(A) did not examine Section 43A of the said Act ITAT reversed the order of CIT(A) and confirmed the order in assessment HC reversed the order of ITAT and allowed the deduction held that - the year-end liability of the assessee had to be looked into - it cannot be said that roll over charge has nothing to do with the fluctuation in the rate of exchange - the contention of the assessee that roll over charges have nothing to do with the fluctuation in the rate of exchange is not acceptable - in this case we are concerned with capitalization of exchange difference in respect of acquisition of fixed assets acquired from abroad. According to Indian Accounting Standards by Dolphy D Souza roll over charges are indicative of the increase or decrease in the liability of the company in the next specified period generally of six months. Roll over charges represent the difference arising on account of change in foreign exchange rates. Roll over charges paid/ received in respect of liabilities relating to the acquisition of fixed assets should be debited/ credited to the asset in respect of which liability was incurred. However roll over charges not relating to fixed assets should be charged to the Profit & Loss Account. Decided in favor of revenue

Summary

Issues Involved:
1. Nature of roll over premium charge incurred by the assessee.
2. Scope and applicability of Section 43A of the Income Tax Act, 1961 in the context of roll over premium charges.

Detailed Analysis:

1. Nature of Roll Over Premium Charge Incurred by the Assessee:
The assessee, a manufacturing company, procured a foreign currency loan for business expansion and entered into forward contracts with Citibank to secure foreign currency at pre-determined rates for loan repayment. The roll over premium charges were incurred when the balance value of the forward contracts was rolled over to future dates. The Assessing Officer disallowed these charges, considering them capital in nature, but the CIT (A) allowed them as revenue expenditure, without specifying the applicable section. The Tribunal later held that these charges should be capitalized under Explanation 3 to Section 43A, a decision which was challenged by the assessee in the Gujarat High Court. The High Court concluded that the roll over premium charges were akin to interest or commitment charges and allowed them under Section 36(1)(iii) of the Act.

2. Scope and Applicability of Section 43A of the Income Tax Act, 1961:
The Department argued that the roll over charges should be capitalized under Section 43A. The assessee contended that Section 43A, as it stood, applied only to changes in liability due to exchange rate fluctuations and not to roll over charges, which were paid to avoid such fluctuations. The Supreme Court analyzed Section 43A, noting that it applied to the entire liability at the year-end, not just to instalments paid during the year. The Court found that roll over charges were related to exchange rate fluctuations and thus fell within the scope of Section 43A. The Court also referenced Indian Accounting Standards, which indicate that roll over charges related to fixed assets should be debited or credited to the asset's cost.

Conclusion:
The Supreme Court held that roll over charges should be capitalized under Explanation 3 to Section 43A as it stood prior to the assessment year 2003-04. The Court dismissed the alternative submissions by the assessee regarding depreciation and the waiver of interest or penalty, noting that the Tribunal had already allowed depreciation on the adjusted cost of the fixed asset. Consequently, the Court set aside the High Court's judgment and allowed the Department's appeals, with no order as to costs.

Judgment Summary:
The Supreme Court concluded that roll over premium charges incurred by the assessee should be capitalized under Explanation 3 to Section 43A of the Income Tax Act, 1961, as it stood at the relevant time. The Court dismissed the alternative arguments presented by the assessee and upheld the Tribunal's decision to allow depreciation on the adjusted cost of the fixed asset. The Department's appeals were allowed, and the High Court's judgment was set aside.