2023 (3) TMI 909 - AT - Income Tax

Upward adjustment on account of foreign exchange losses on ECB loan - upward adjustment on account of loss on derivative contracts - AO had rejected the claim on the ground that ECB loan was availed by the assessee from Canara bank to refinance the other capital expenditure loans which was obtained in rupees and the foreign exchange loss incurred on repayment was in the nature of capital loss which has to be capitalized to the cost of the same and hence was not allowable u/s. 37 - HELD THAT - Section 42A of the Act is not applicable for the present case where the assessee is not said to have accrued any asset in foreign currency and the only object of refinancing the loan was to pay the earlier debts for the purpose of reducing the cost of interest. As in the case of Cooper Corporation (P.) Ltd. vs. Dy. CIT, Satara 2016 (5) TMI 809 - ITAT PUNE where similar issue has been dealt with extensively in favour of the assessee and the relevant extract of the said decision is cited hereunder for ease of reference For the aforesaid reasons, in the absence of applicability of section 43A of the Act to the facts of the case and in the absence of any other provision of the Income Tax Act dealing with the issue, claim of exchange fluctuation loss in revenue account by the assessee in accordance with generally accepted accounting practices and mandatory accounting standards notified by the ICAI and also in conformity with CBDT notification cannot be faulted. No inconsistency with any provision of Act or with any accounting practices been brought to our notice. Otherwise also, in the light of fact that the conversion in foreign currency loans which led to impugned loss, were dictated by revenue considerations towards savings interest costs etc. we have no hesitation in coming to the conclusion that loss being on revenue account is an allowable expenditure under s. 37(1) of the Act. The order of the CIT(A) sustaining the disallowance is not called for and is thus reversed. In the result, the ground no. 1 is allowed. Loss incurred by the assessee in foreign currency exchange is allowable as revenue expenditure and is a revenue loss for which the assessee is entitled to deduction as revenue expenditure . In the absence of any finding that the loan obtained by the assessee is utilized for the purpose of accruing assets, we hold that the said loan was availed for the purpose of reducing the cost of interest, which is an allowable expenditure u/s. 37(1). Adjustment on account of loss on derivative contracts - HELD THAT - We would like to place our reliance on the decision of Reliance Industries Ltd. 2014 (2) TMI 836 - ITAT MUMBAI wherein it was held that the forex loss incurred during fluctuation in foreign currency exchange is not a notional loss and was allowable as deduction . 'Marked to market loss is not a notional loss and is, therefore, allowable expenditure. We also hold that the said transaction is not a speculative transaction as per section 43(5) of the act and is merely a hedging transaction and thereby the same would fall under the exception to section 43(5) of the Act. We hereby direct the A.O. to allow the said loss while computing the income of the assessee.

Summary

Issues Involved:
1. Disallowance of foreign exchange losses on ECB loan.
2. Adjustment on account of loss on derivative contracts.

Issue-wise Detailed Analysis:

1. Disallowance of Foreign Exchange Losses on ECB Loan:

Facts:
The assessee, a company engaged in manufacturing and trading activities, filed its return of income for the Assessment Year (A.Y.) 2015-16. The Assessing Officer (A.O.) made an upward adjustment of Rs. 2,28,62,345/- on account of foreign exchange losses on ECB loan. The assessee had availed an ECB loan from Canara Bank to refinance existing rupee borrowings. The loan was not used for acquiring fixed assets but to reduce borrowing costs, and the foreign exchange loss incurred was amortized over the loan period.

A.O.'s Stand:
The A.O. treated the foreign exchange loss as a capital loss, arguing it should be capitalized to the cost of the asset and is not allowable under Section 37 of the Income Tax Act. The A.O. relied on the Supreme Court decision in Sutlej Cotton Mills Ltd. vs. CIT, which distinguishes between trading loss and capital loss based on the nature of the foreign currency usage.

Assessee's Contention:
The assessee argued that the interest paid, including exchange differences, is not directly linked to asset acquisition and should be considered revenue expenditure. They contended that the loss was incurred for business activities and should be allowed under Section 37. The assessee cited the Supreme Court decision in CIT vs. Woodward Governor India (P.) Ltd., which supports the treatment of foreign exchange fluctuation loss as revenue loss under the mercantile system of accounting.

Tribunal's Findings:
The Tribunal observed that the loan was not utilized for acquiring assets but for reducing interest costs. The A.O. did not provide evidence to counter this. The Tribunal concluded that the foreign exchange loss is a trading loss and allowable as revenue expenditure under Section 37, following the principles laid out in CIT vs. Woodward Governor India (P.) Ltd. and Cooper Corporation (P.) Ltd. vs. Dy. CIT. The Tribunal directed the deletion of the addition made by the A.O.

2. Adjustment on Account of Loss on Derivative Contracts:

Facts:
The assessee entered into derivative contracts for interest and principal currency swaps, converting Rs. 100 crores into dollar loans. The contracts were valued at year-end, and 'Marked to Market losses' were recorded in the profit and loss account. The A.O. disallowed the loss of Rs. 29,28,34,962/-, treating it as notional and contingent.

Assessee's Contention:
The assessee argued that the derivative contracts were valued as per accounting standards, and the losses were actual and allowable. They cited the Supreme Court decision in CIT vs. Woodward Governor India (P.) Ltd. and other cases, which support the allowance of 'Marked to Market losses' even if they are not actual losses.

A.O.'s Stand:
The A.O. relied on CBDT Board Instruction No. 3/2010 and the Supreme Court decision in Sutlej Cotton Mills Ltd., treating the losses as capital and not allowable.

Tribunal's Findings:
The Tribunal held that the 'Marked to Market loss' is not notional and is allowable expenditure. They noted that the transaction is a hedging transaction and falls under the exception to Section 43(5) of the Act, which deals with speculative transactions. The Tribunal directed the A.O. to allow the loss while computing the income of the assessee.

Conclusion:
The appeal filed by the assessee was allowed, with the Tribunal directing the deletion of additions made by the A.O. on both accounts of foreign exchange losses on ECB loan and losses on derivative contracts. The order was pronounced in the open court on 17.02.2023.