2025 (3) TMI 617 - AT - Income Tax

Determination of nature of forex fluctuation loss as to capital or revenue - HELD THAT - The appellant strictly complied with mandatory operational norms of EEFC a/c and operated solitarily for the purpose of receipt of sales proceeds from its export s sale and their utilization either for current account transaction or withdrawal therefore in INR. This in our considered view is sufficient to establishes that the very character of closing balance held as trading receipts. The said closing balance remained unutilized thus represents noting other than a circulating capital more precisely the working capital. On the other hand the Revenue could hardly bring any deprecative evidence on records to dismantle the appellant s claim and these findings emerged in the course of physical hearing. Having determined the character of balance held in EEFC a/c now turning to deductibility of losses arising therefore - The issue of deductibility of fluctuation of forex loss arising out of trading transactions came for consideration before in CIT Vs Vinergy International Pvt. Ltd. 2016 (8) TMI 1041 - BOMBAY HIGH COURT wherein their lordship following the decision in Woodward Governor 2009 (4) TMI 4 - SUPREME COURT upheld the adjudication of Ld. Co-ordinate bench in allowing deduction for forex fluctuation losses in relation to monetary items u/s 37(1) of the Act. The appellant recognised the losses on forex fluctuation in relation to closing balance held in EEFC a/c on a regular basis in accordance with the AS-11 and method of accounting regularly employed u/s 145 of the Act. The same was consistently followed by the appellant in all immediate proceeding later years which the Revenue accepted in regular scrutiny assessments. Thus there was no scope for the Revenue to take a swap to treat the same as notional now and outdo the aforestated binding judicial precedents. Accordingly guided precedentially by aforestated decisions whereby the Revenue has already accepted the claim of fluctuation loss as the real revenue in nature hence deductible u/s 37(1) so must be here. Per contra in the absence of compelling reasons it much less necessitates a diversion from the settled position of law. Assessee appeal allowed.

ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this judgment are:

Whether the forex fluctuation loss on closing balances held in the Exchange Earners Foreign Currency Account (EEFC) is notional or real.
Whether such forex fluctuation loss is capital or revenue in nature.
Whether the disallowance of the forex fluctuation loss by the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) [CIT(A)] was justified under the Income-tax Act, 1961.

ISSUE-WISE DETAILED ANALYSIS

1. Nature of Forex Fluctuation Loss: Notional or Real

Relevant Legal Framework and Precedents: The court considered the principles laid down in the case of 'CIT Vs M/s Woodward Governor India Pvt Ltd.' which dealt with the treatment of forex fluctuation losses. The court also referenced the absence of explicit provisions in the Income-tax Act, 1961, for the deductibility of exchange losses until the introduction of Section 43AA by the Finance Act 2018.
Court's Interpretation and Reasoning: The court emphasized the principle that only real income and real expenditure are taxable and deductible unless explicitly provided otherwise by law. Notional income or expenditure must be proven to have accrued to be considered real.
Key Evidence and Findings: The court noted that the forex fluctuation loss was recognized in the books in accordance with Accounting Standard 11 (AS-11) and the method of accounting regularly employed by the assessee.
Application of Law to Facts: The court found that the forex fluctuation loss was not merely notional but was recognized consistently and in compliance with applicable accounting standards.
Treatment of Competing Arguments: The court rejected the Revenue's argument that the loss was notional and contingent, emphasizing the consistent recognition of the loss as per accounting standards.
Conclusions: The court concluded that the forex fluctuation loss was real and not merely notional.

2. Nature of Forex Fluctuation Loss: Capital or Revenue

Relevant Legal Framework and Precedents: The court referred to the decision in 'Sutlej Cotton Mills Ltd. Vs CIT' which established that the nature of a loss as trading or capital depends on whether it relates to a trading asset or a capital asset.
Court's Interpretation and Reasoning: The court determined that the balance in the EEFC account was a trading receipt and part of the circulating capital, thus making the forex fluctuation loss revenue in nature.
Key Evidence and Findings: The court found that the EEFC account was used for receiving export sales proceeds and for current account transactions, indicating its nature as circulating capital.
Application of Law to Facts: The court applied the principles from 'Sutlej Cotton Mills Ltd. Vs CIT' and 'CIT Vs M/s Woodward Governor India Pvt Ltd.' to determine the nature of the loss as revenue.
Treatment of Competing Arguments: The court dismissed the Revenue's assertion that the forex fluctuation loss was capital in nature, emphasizing the trading nature of the EEFC account balance.
Conclusions: The court concluded that the forex fluctuation loss was revenue in nature and deductible under Section 37(1) of the Act.

SIGNIFICANT HOLDINGS

Verbatim Quotes of Crucial Legal Reasoning: The court reiterated the principle from 'Sutlej Cotton Mills Ltd. Vs CIT': "The law is well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business."
Core Principles Established: The court established that forex fluctuation losses related to trading assets and circulating capital are revenue in nature and deductible under Section 37(1) of the Income-tax Act, 1961.
Final Determinations on Each Issue: The court allowed the appeal of the assessee, concluding that the forex fluctuation loss was real, revenue in nature, and deductible under the applicable provisions of the Income-tax Act, 1961.