2016 (2) TMI 266 - AT - Income Tax

Foreign exchange gain taxability - restatement of foreign currency loan - foreign currency loan which has been recognized in the profit and loss account in accordance with Accounting Standard 11 (AS 11) issued by the Institute of Chartered Accountants of India (ICAI) - Held that - The Loan agreement clearly mentions that the loan is meant for general corporate purposes only which means it is meant for revenue account. If it is meant for any capital investment, then the loan agreement would have been differently worded specifying the purpose of making the investments and in which case, the loan would be categorized as a specific purpose loan. But in the instant case, it is mentioned as general corporate purposes meaning that the loan is meant for general business purposes of the assessee. The amounts advanced to Usha Martin Telematics Ltd is meant for business purposes of the assessee and has to be construed as amounts lent in the ordinary course of business only . The business of the assessee itself is making investments in other companies. We hold that just because no interest income is derived in this transaction, the character of the transaction for business purposes (i.e the loan utilization on revenue account) would not change. Hence the argument of the Learned AR that the utilization of borrowings is made on capital account is not appreciated. Once this is lost, then the decision of Woodward Governor case (2009 (4) TMI 4 - SUPREME COURT ) would automatically come into play on which point, the counsels of both the sides are agreeable. The concept of prudence has been considered in the judgement of supreme court in Woodward Governor case. Once the utilization of borrowings are held to be on revenue account, then the resultant exchange gain or loss at the end of the year due to restatement of foreign currency loan would automatically take the revenue receipt / expenditure as the case may be. However, we find that the assessee had incurred exchange losses due to restatement of the subject mentioned foreign currency loan at the end of the year in subsequent assessment years and had not claimed as deduction as it is notional in nature in line with the consistent stand taken by the assessee. In this regard, we deem it fit and appropriate in the interest of justice and fair play, to give directions to the Learned AO to grant deduction of notional exchange loss in the subsequent assessment years to be in consonance with our findings hereinabove. Otherwise, it would only result in revenue trying to blow hot and cold simultaneously. Accordingly, the ground raised by the revenue is allowed subject to the direction contained hereinabove.

Summary

Issues Involved:
- Taxability of foreign exchange gain on foreign currency loan restatement.
- Nature of the loan utilization (revenue account vs. capital account).
- Compliance with Accounting Standards (AS 11 and AS 1) issued by ICAI.
- Treatment of notional gains and losses for tax purposes.

Detailed Analysis:

Issue 1: Taxability of Foreign Exchange Gain
The primary issue is whether the foreign exchange gain of Rs. 6,71,12,500/- from the restatement of a foreign currency loan should be taxed. The assessee, engaged in investment and finance activities, borrowed USD 2 Crores interest-free from its shareholder and advanced Rs. 94,58,50,000/- to its subsidiary. The foreign currency loan was restated at the year-end exchange rate as per AS 11, resulting in the gain, which was credited to the profit and loss account but later excluded from taxable income by the assessee, considering it notional.

Issue 2: Nature of Loan Utilization
The Assessing Officer (AO) argued that the loan was utilized on revenue account, as the assessee is in the business of investment and financing, and hence the gain should be taxed. The AO emphasized that the loan agreement specified the loan was for general corporate purposes, indicating revenue account utilization.

Issue 3: Compliance with Accounting Standards
The AO and the revenue contended that as per AS 11 and AS 1, all foreign exchange fluctuations, including unrealized gains, must be recognized in the profit and loss account. The AO added the gain to taxable income, arguing that the assessee's action of crediting the gain in the profit and loss account aligns with AS 11 requirements.

Issue 4: Treatment of Notional Gains and Losses
The CIT(A) deleted the addition, stating that only real income should be taxed, not notional income. The CIT(A) referenced judicial precedents and distinguished the facts from the AO's cited cases, concluding that the foreign exchange gain was contingent and notional, thus not taxable.

Appellate Tribunal's Findings:
- The tribunal noted that the assessee's business involves financing and investment activities, and the foreign currency loan was utilized in the ordinary course of business.
- The tribunal disagreed with the AO's interpretation of AS 1, confirming that unrealized gains should not be recognized for tax purposes unless realized.
- The tribunal acknowledged that the foreign exchange gain was credited to the profit and loss account due to compliance with AS 11 but emphasized that book entries do not determine tax liability.
- The tribunal held that the loan was utilized on revenue account, as per the loan agreement's general corporate purposes clause, aligning with the business's nature.
- The tribunal referenced the Supreme Court's decision in the Woodward Governor case, which supports recognizing foreign exchange gains or losses on revenue account loans for tax purposes.
- The tribunal directed the AO to allow deductions for notional exchange losses in subsequent years to maintain consistency with the assessee's accounting method.

Conclusion:
The tribunal allowed the revenue's appeal, directing that the foreign exchange gain be taxed, but also instructed the AO to permit deductions for notional exchange losses in subsequent years to ensure fair treatment. The judgment emphasizes the importance of the nature of loan utilization and compliance with accounting standards in determining tax liability.