2024 (9) TMI 1458 - HC - Income Tax

Interpretation of Section 43A - losses arising out of fluctuation of exchange rates in servicing a foreign currency loan that is utilized partly for acquiring assets from outside India and partly for acquisition of assets within India - ITAT allowed the foreign exchange losses to be broken up in proportion to the value of import of assets and value of assets acquired locally, and allowed the latter component to be treated as revenue expenditure - whether losses should be entirely capitalised with the value of the assets acquired? - Accounting Standard (AS) 11 and its amendment - HELD THAT - In the case at hand, the Respondent-Assessee opted for capitalizing and adding the expense arising out of exchange rate fluctuation on its foreign currency loan to the cost of the capital asset. Such election was under AS-11 and therefore, obviously, regardless of whether the assets financed thereby had been imported from outside India or acquired locally in India. It is trite law that accounting treatment in the commercial books is no conclusive indication of treatment in the tax returns, and one must have regard to the legislative stipulation in the tax legislation to ascertain if the expense is allowable as revenue expenditure or is to be capitalised as a capital expenditure. It is in this context that we are of the view that Section 37 (1) must necessarily be dealt with. Positive Mandate of 43A vs. Negative Caveat in 37 (1) - It is apparent that to attract the mandatory obligation to capitalise the expense relating to exchange rate fluctuation under Section 43A, the ingredients of Section 43A have to be attracted. The essential jurisdictional fact for the mandatory capitalisation of such an expense under Section 43A is that the capital asset financed by the foreign currency loan in question, must have been brought into India from a country outside India. To the extent the loan was utilised for such an import, even the Respondent-Assessee has without demur, capitalised the loss on exchange rate fluctuation in servicing the loan, to add to the cost of the asset. Looking at the ingredients of Section 37 (1) of the Act, we believe it would be necessary to look at the substance of the expenditure and come to a view that it is not in the nature of capital expenditure, for it to qualify as revenue expenditure for purposes of Section 37 (1). The gap in the Impugned Order is that the analysis on whether the expenditure in question cannot be regarded as capital expenditure, is missing. Effect of judgement in Wipro Finance Ltd. 2022 (4) TMI 694 - SUPREME COURT - Section 43A contains a positive enjoinment that losses due to exchange rate changes on a foreign currency loan taken for import of a capital asset must not be treated as revenue expenditure. This is why Section 43A is a non-obstante provision, that positively imposes such obligation notwithstanding anything contained in the Act. However, that positive obligation would not necessarily mean the converse that any loss on exchange rate fluctuation on a foreign currency loan taken for acquiring capital assets would necessarily not be a capital expenditure, only because the assets were not imported into India from abroad. It is made clear that the relevance of whether the fluctuation results in erosion of an asset s value or in enhancement of a liability s size, can also be fully articulated by the parties before the ITAT this was a facet hotly contested before us. To be clear, the question to be answered by the ITAT on remand is as follows - Whether the expenditure in the sum of Rs. Rs.4,78,38,245/- that has been disallowed by the AO and the CIT-A, and allowed by the ITAT, would on its own showing (de hors Section 43A that contains a positive enjoinment of treating such exchange rate losses relating to foreign currency loan deployed to import assets as capital expenditure), qualify as not being capital expenditure, so that it can be considered towards allowance as revenue expenditure under Section 37 (1). We are deeply conscious that this Appeal pertains to the Assessment Year 2009-10. By the time this litigation came to be filed in the High Court, after traveling through two rounds of appeal, it was October 2017. Final hearing of this appeal took place in 2024. The scope of remand being limited, as articulated above, we trust the ITAT would deal with the remanded proceedings at its earliest possible convenience, bearing in mind the vintage of the proceedings. Both the Revenue and the Assessee are also requested to extend full cooperation to the ITAT by participating in the hearings expeditiously, without seeking unnecessary adjournments, so as to enable the ITAT to deal with the issue at the earliest. We also make it clear that nothing contained in this judgement and order is to be regarded as an expression of our opinion on the merits of the issue being remanded to the ITAT.

Summary

Issues Involved:
1. Interpretation of Section 43A of the Income-tax Act, 1961.
2. Treatment of foreign exchange losses as revenue expenditure under Section 37(1) of the Income-tax Act, 1961.

Issue-wise Detailed Analysis:

1. Interpretation of Section 43A of the Income-tax Act, 1961:

The central issue is whether losses from exchange rate fluctuations on a foreign currency loan used partly for acquiring assets from outside India and partly for assets within India should be entirely capitalized. The Appellant-Revenue contends that such losses must be fully capitalized under Section 43A, regardless of the origin of the assets. The Respondent-Assessee argues that losses should be proportionally allocated: capitalized for assets imported and treated as revenue expenditure for assets acquired domestically.

The ITAT ruled that Section 43A applies only to assets imported into India, allowing the foreign exchange losses to be split proportionally. Consequently, the ITAT permitted the portion of losses related to domestic assets to be treated as revenue expenditure. This decision was challenged by the Revenue, leading to the present appeal.

2. Treatment of Foreign Exchange Losses as Revenue Expenditure under Section 37(1) of the Income-tax Act, 1961:

The question is whether the balance component of foreign exchange losses, not covered by Section 43A, should be treated as revenue expenditure under Section 37(1). Section 37(1) allows any expenditure, not covered by Sections 30 to 36 and not being capital expenditure, incurred wholly for business purposes, to be deductible.

The ITAT did not provide a detailed analysis of whether the expenditure could be regarded as non-capital in nature. The High Court emphasized that the classification of expenditure between capital and revenue is a mixed question of fact and law, requiring a detailed factual and qualitative analysis, which was missing in the ITAT's proceedings.

Factual Background and Context:

- The assessment year in question is 2009-10.
- The Respondent-Assessee availed a foreign currency loan from DBS Bank, Singapore, for capital expenditure.
- The loan was restated as of March 31, 2009, resulting in a loss due to exchange rate changes.
- The loss was broken down proportionally: Rs. 51,86,755/- for imported assets (capitalized) and Rs. 4,78,38,245/- for domestic assets (claimed as revenue expenditure).
- The AO and CIT-A held that the entire loss should be capitalized, while the ITAT allowed the proportional treatment.

Section 43A and Section 37(1):

Section 43A mandates capitalization of losses from exchange rate fluctuations on foreign currency loans used for importing assets. The jurisdictional fact is that the asset must be imported into India. The ITAT's decision to allow proportional treatment was based on this interpretation.

Section 37(1) allows revenue expenditure deductions, provided the expenditure is not capital in nature. The High Court noted that the ITAT did not analyze whether the expenditure could be regarded as non-capital.

Accounting Standard (AS) 11 and its Amendment:

AS-11, amended on March 31, 2009, provided an option to capitalize exchange rate differences related to depreciable capital assets. The Respondent-Assessee opted for this treatment in its commercial books but treated the losses differently in its tax returns. The High Court emphasized that accounting treatment in commercial books is not conclusive for tax treatment.

Positive Mandate of Section 43A vs. Negative Caveat in Section 37(1):

Section 43A imposes a mandatory obligation to capitalize exchange rate losses on foreign currency loans for importing assets. The High Court highlighted that the ITAT's analysis on whether the expenditure is non-capital was missing.

Wipro and Implications:

The High Court referred to the Supreme Court's decision in Wipro Finance Ltd. v. Commissioner of Income-Tax, which emphasized the need for a detailed analysis to determine whether expenditure is capital or revenue. The ITAT's decision in Wipro was based on practical and business considerations, which the High Court found lacking in the present case.

Conclusion and Remand:

The High Court remanded the matter to the ITAT for a detailed analysis of whether the expenditure in question qualifies as non-capital expenditure under Section 37(1), independent of Section 43A. The ITAT is directed to consider the principles laid out in Wipro and other relevant case law. The High Court emphasized the need for an expedited hearing due to the vintage of the proceedings.

Final Judgment:

The appeal is disposed of with no order as to costs. The ITAT is instructed to address the remanded issue comprehensively, considering all relevant facets and case law.