2017 (3) TMI 966 - AT - Income Tax

Disallowance of foreign exchange loss due to fluctuation - Held that - The facts in the instant case are undisputed that that the instant loss is arising in respect to the forward contracts which had not expired on the last day of the accounting year. It is also not disputed that the assessee is following mercantile system of accounting which requires to account for all the expenses in the profit and loss account on accrual basis. Accordingly, the assessee has claimed the losses on the basis of mercantile system of accounting. Thus, in our considered view the assessee is very much eligible for the deduction of the impugned loss. See CIT Vs. Woodward Governor India (P) Ltd 2009 (4) TMI 4 - SUPREME COURT Thus the losses which are arising due to the foreign exchange fluctuation should be accounted for in the books of accounts and accordingly the assessee is eligible to claim the deduction of such losses. - Decided in favour of assessee

Issues:
1. Disallowance of foreign exchange loss amounting to ?8,46,64,000.
2. Interpretation of Accounting Standard-11 regarding foreign exchange transactions.
3. Applicability of CBDT instruction No. 3 of 2010.
4. Mercantile system of accounting versus accrual basis for recognizing foreign exchange losses.
5. Judicial interpretation of foreign exchange fluctuations and their treatment in financial statements.

Issue 1: Disallowance of foreign exchange loss amounting to ?8,46,64,000

The appellant challenged the disallowance of foreign exchange loss by the Assessing Officer (AO) and the Commissioner of Income Tax (Appeals) upheld the decision. The AO treated the loss as notional since it was on account of foreign currency hedging contracts. The appellant argued that the loss was recognized on accrual basis as per Accounting Standard-11 and should be allowable under section 37(1) of the Income Tax Act. The CIT(A) confirmed the disallowance, stating that the liability was contingent and not yet ascertained. However, the appellant's alternative plea for allowing the loss in the year of maturity was accepted. The ITAT reversed the decision of the authorities below, holding that the loss should be accounted for in the books of accounts as per the principles laid down by the Supreme Court in similar cases.

Issue 2: Interpretation of Accounting Standard-11 regarding foreign exchange transactions

The appellant contended that the foreign exchange loss was recognized in accordance with Accounting Standard-11 issued by the Institute of Chartered Accountants of India. The AS-11 requires foreign currency transactions to be accounted for as per the exchange rates on the balance-sheet date. The appellant argued that since they followed the mercantile system of accounting, the loss should be deductible. The ITAT agreed with this interpretation and allowed the appellant's claim for deduction based on the principles outlined in the AS-11 and relevant judicial precedents.

Issue 3: Applicability of CBDT instruction No. 3 of 2010

The CBDT instruction No. 3 of 2010 was cited by the authorities to disallow the appellant's claim for foreign exchange loss. The appellant argued that this instruction should not override the accounting principles and judicial interpretations applicable to foreign exchange transactions. The ITAT held that the CBDT instructions are not binding on the courts and do not supersede established legal principles, thereby allowing the appellant's appeal.

Issue 4: Mercantile system of accounting versus accrual basis for recognizing foreign exchange losses

The dispute revolved around whether the foreign exchange loss should be recognized on an accrual basis or based on the mercantile system of accounting. The appellant maintained that the loss was recognized in accordance with the mercantile system and should be deductible. The ITAT agreed with the appellant's argument, emphasizing the importance of following accounting standards and principles in determining the treatment of foreign exchange losses.

Issue 5: Judicial interpretation of foreign exchange fluctuations and their treatment in financial statements

The ITAT relied on the judgment of the Supreme Court in the case of CIT Vs. Woodward Governor India (P) Ltd to support its decision in allowing the appellant's claim for deduction of foreign exchange losses. The court emphasized the need to account for foreign exchange fluctuations in financial statements as per accounting standards and recognized legal principles. The ITAT concluded that the appellant was eligible to claim the deduction for the losses arising from foreign exchange fluctuations, overturning the decisions of the authorities below.

In conclusion, the ITAT allowed the appellant's appeal, holding that the foreign exchange losses should be recognized and accounted for in the books of accounts based on the principles laid down by the Supreme Court and Accounting Standard-11, irrespective of the CBDT instruction. The judgment emphasized the importance of following established legal principles and accounting standards in determining the treatment of foreign exchange fluctuations in financial statements.

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