2019 (11) TMI 857 - AT - Income Tax

Claim for deduction on account of foreign exchange fluctuation loss as a result of restatement of the Assessee s liability as on the last date of the previous year, without there being an actual payment or settlement - HELD THAT - It is no doubt true that there has been no actual payment and at the time of ultimate settlement, there may not be a loss also. Nevertheless, AS 11 of ICAI requires such liability also to be reflected in the financial statements. The Hon ble Supreme Court considered all these aspects in the case of CIT(A) Vs. Woodward Governor 2009 (4) TMI 4 - SUPREME COURT . The first aspect examined by the Hon ble Supreme Court was as to whether the additional liability due to exchange rate fluctuation was a liability. The Hon ble Supreme Court held that the expression expenditure as used in s. 37 may, in the circumstances of a particular case, cover an amount which is really a loss even though the said amount has not gone out from the pocket of the assessee. The Court explained that the word paid in s. 43(2) means actually paid or incurred according to the method of accounting on the basis of which profits or gains are computed under s. 28/29 and that Sec. 37(1) has to be read with ss. 28, 29 and 145(1). Therefore, loss suffered by the assessee in respect of a revenue liability on account of exchange difference as on the date of the balance sheet is an item of expenditure allowable under s. 37(1). The Court explained that under para 9 of AS-11, exchange differences arising on foreign currency transactions have to be recognized as income or expense in the period in which they arise, except as stated in para 10 and para 11. An enterprise has to report the outstanding liability relating to import of raw materials using closing rate or exchange. Any loss arising on conversion of said liability at the closing rate has to be recognized in the P L a/c for the reporting period. In the present case, there is no dispute that the outstanding liability was in respect of trade receivables and payables and therefore loss would be on revenue account. In such circumstances, we are of the view that the CIT(A) was justified in allowing the claim made by the assessee. We find no grounds to interfere in the order of the CIT(A). Accordingly, appeal by the Revenue is dismissed.

Summary

Issues:
1. Whether CIT(A) was justified in directing AO to allow deduction for foreign exchange fluctuation loss without actual payment or settlement.
2. Allowability of foreign exchange loss under section 37(1) for Assessment Years 2012-13 and 2013-14.

Analysis:
1. Issue 1 - CIT(A) Decision Justification:
- The appeals questioned whether CIT(A) rightly directed the AO to allow deduction for foreign exchange fluctuation loss without actual payment or settlement. In the case of Assessment Year 2012-13, the department sought to withdraw the appeal due to the tax effect being less than the threshold set by CBDT Circular No.17/2018. Consequently, the appeal was dismissed.

2. Issue 2 - Allowability of Foreign Exchange Loss under Section 37(1):
- The core issue was whether the foreign exchange loss claimed by the assessee for Assessment Year 2013-14 was allowable under section 37(1). The AO contended that the loss was notional and hence not deductible, citing the decision of the Hon'ble Supreme Court in the case of M/s Sanjeev Woolen Mills vs. CIT 279 ITR 434.
- The CIT(A) allowed the deduction, emphasizing that the appellant followed the mercantile system of accounting and the loss was a result of restatement of outstanding trade payables and receivables, meeting the criteria of an ascertained liability under section 37(1).
- The Tribunal upheld the CIT(A)'s decision, citing precedents such as CIT vs. Woodward Governor and Karnataka High Court in the case of CIT vs. Motorola India. It highlighted that the loss due to exchange rate fluctuation on the balance sheet date is an allowable expenditure under section 37(1) as per the Accounting Standards.
- The Tribunal clarified that although there was no actual payment, the liability was required to be reflected in the financial statements as per AS-11 of ICAI. It referenced the Supreme Court's interpretation that an amount constituting a loss, even if not physically paid, could be considered an allowable expenditure under section 37(1).

3. Conclusion:
- The Tribunal dismissed the Revenue's appeal, affirming the CIT(A)'s decision to allow the deduction for foreign exchange loss. It concluded that the loss, arising from the restatement of trade receivables and payables, qualified as an allowable expenditure under section 37(1) based on relevant legal interpretations and accounting standards.