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2010 (3) TMI 81 - SC - Income TaxBusiness expenditure under section 37(1) Revenue Expenses The Appellant a public sector undertaking was engaged in capital intensive exploration and production of petroleum products for which it had to heavily depend on foreign loans to cover its expenses both capital and revenue and for payment to non resident contractor in foreign currency for various service rendered. The Appellant revalued its foreign exchange loan in foreign exchange on revenue account on capital account and for general purposes outstanding as on March 31 1991 and claimed the difference between their respective amount in Indian currency as revenue loss under section 37(1) in respect of loans used in revenue account. It also treated the similar difference in foreign exchange as an increased liability under section 43A. Held that- (i) the losses claimed by the appellant on account of fluctuation in the rate of foreign exchange as on the date for balance sheet was allowable as expenditure under section 37(1). (ii) That the appellant was entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each of the relevant balance sheet dates pending actual payment of the liability under section 43A prior to its amendment by finance act 2002.
Issues Involved:
1. Deduction of additional liability due to exchange rate fluctuations under Section 37(1) of the Income Tax Act, 1961. 2. Adjustment of the actual cost of imported capital assets due to exchange rate fluctuations under Section 43A of the Income Tax Act, 1961. Detailed Analysis: Issue 1: Deduction of Additional Liability Due to Exchange Rate Fluctuations under Section 37(1) The primary question was whether additional liability arising from exchange rate fluctuations on loans taken for revenue purposes could be deducted under Section 37(1) in the year of fluctuation or only upon repayment. The Assessee, a public sector undertaking engaged in petroleum exploration, revalued its foreign exchange loans and claimed the fluctuation difference as a revenue loss under Section 37(1). The Assessing Officer allowed the deduction only for loans repaid within the year, disallowing claims for loans repayable after the accounting year. The Commissioner of Income Tax (Appeals) upheld the Assessing Officer's decision, treating the liability as notional. However, the Income Tax Appellate Tribunal (ITAT) allowed the Assessee's claim, noting the consistent mercantile accounting system and prior acceptance of similar claims. The High Court reversed ITAT's decision, deeming the foreign exchange loss as contingent and not allowable under Section 37(1). The Supreme Court, referencing CIT v. Woodward Governor India P. Ltd., concluded that the loss due to exchange rate fluctuations, when accounts are maintained on a mercantile basis, is deductible under Section 37(1) even if the liability is not discharged within the year. Issue 2: Adjustment of Actual Cost of Imported Capital Assets under Section 43A The second question was whether the Assessee could adjust the actual cost of imported capital assets for exchange rate fluctuations at each balance-sheet date, pending actual payment. The Assessing Officer disallowed such adjustments for loans repayable after the accounting year. The Commissioner of Income Tax (Appeals) allowed the adjustment for increased liability under Section 43A, which the ITAT upheld. The High Court disagreed, stating Section 43A applies only to liabilities due per written agreements, which were not provided by the Assessee. The Supreme Court, again referencing Woodward Governor, clarified that under the unamended Section 43A, adjustments are triggered by exchange rate changes, not actual payment. The amendment effective from April 1, 2003, requiring actual payment, was deemed prospective. Thus, for the relevant assessment years, the Assessee could adjust the cost of imported assets for exchange rate fluctuations at each balance-sheet date. Conclusion The Supreme Court allowed the appeals, setting aside the High Court's orders. It held that: 1. The loss due to exchange rate fluctuations is deductible under Section 37(1) when accounts are maintained on a mercantile basis. 2. The Assessee is entitled to adjust the actual cost of imported capital assets for exchange rate fluctuations at each balance-sheet date under the unamended Section 43A. Both questions were answered in favor of the Assessee, with each party bearing its own costs.
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