ICDS VI : Effects of Changes in Foreign Exchange Rates - Income Tax - Ready Reckoner - Income Tax

ICDS VI : EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES This ICDS corresponds to Accounting Standard (AS) 11 The Effects of Changes in Foreign Exchange Rates of the Companies (Accounting Standards) Rules, 2006 and Indian Accounting Standard (Ind AS) 21 The Effects of changes in foreign exchange rates, prescribed under section 133 of the Companies Act, 2013 as notified under the Companies (Indian Accounting Standards) Rules, 2015 . 1. Scope:- This Income Computation and Disclosure Standard deals with:- treatment of transactions in foreign currencies translating the financial statements of foreign operations treatment of foreign currency transactions in the nature of forward exchange contracts. Note:- Foreign currency under this ICDS means currency other than the reporting currency. Reporting currency has been defined to be the Indian currency, except for foreign operations, where it would mean currency of the country where the operations are carried out. Considering this, generally, reporting currency would be the Indian currency and accordingly, foreign currency would generally mean currency other than the Indian currency. Forward exchange contract as defined under this ICDS means an agreement to exchange different currencies at a forward rate, which is also the definition of this term under AS 11. However, the definition under this ICDS also specifically includes a foreign currency option contract or another financial instrument of a similar nature. 2. Foreign Currency Transactions:- Initial Recognition: Foreign currency transactions are to be recorded initially in the reporting currency i.e. Indian currency and at exchange rate of the foreign currency on the date of the transaction. However, there is an option to use an average rate during a period for recording the foreign currency transactions in the reporting currency, if the average rate approximates the actual rate at the date of the transaction. However, the ICDS requires usage of actual rate, if the exchange rate fluctuates significantly. 3. Conversion at Last Date of Previous Year:- At last day of each previous year:- ( a ) ICDS prescribes recording of monetary items at the end of the year by applying closing rate. Since the treatment is the same under ICDS as well as the Accounting Standards, difference would not arise and consequently, no adjustment would be required in computing the income. (b) Clause (b) provides an exception to Clause (a) to the effect that if closing rate is unrealistic then the rate to be applied is the rate at which such monetary item is likely to be realised or disbursed. AS 11 has a similar clause.However, Ind AS 21 provides adoption of only closing rate for the conversion of such items. Considering that the rate used for the year-end conversion as per ICDS and Ind AS may be different, the variance if any, needs to be considered while computing the income. (c) ICDS covers all non-monetary items whether carried at historical cost or fair value, except inventory carried at net realisable value (NRV). It prescribes conversion of these nonmonetary items at the exchange rate at the date of transaction. (d) non-monetary item being inventory which is carried at net realisable value denominated in a foreign currency shall be reported using the exchange rate that existed when such value was determined. 4. Recognition of Exchange Differences:- ( i ) In respect of monetary items, exchange differences arising on the settlement thereof or on conversion thereof at last day of the previous year shall be recognised as income or as expense in that previous year. Note: In respect of long term foreign currency monetary item for acquisition of depreciable asset and other assets / items, AS 11 prescribes specific accounting treatment. As per this Standard, the entity can exercise an option which is irrevocable for such class of assets i.e. to capitalise or de-capitalise the exchange difference to the cost of the asset and to be depreciated over the balance life of the asset. In case of long term foreign currency monetary items for acquisition of other assets, the entity can exercise an irrevocable option, i.e. to accumulate the exchange difference in foreign currency monetary item translation reserve account to be amortized over the balance period of such long-term asset or liability. ( ii ) In respect of non-monetary items, exchange differences arising on conversion thereof at the last day of the previous year shall not be recognised as income or as expense in that previous year. Therefore, exchange difference recognised through closing value of inventory in accounts will have to be adjusted to compute taxable income. 5. Exceptions to Paragraphs 3, 4 and 5 of ICDS:- Notwithstanding anything contained in paragraphs 3, 4 and 5; initial recognition, conversion and recognition of exchange difference shall be subject to provisions of section 43A of the Act or Rule 115 of Income-tax Rules, 1962 , as the case may be. As per the said section, if there exists an unpaid foreign currency liability towards the cost of an asset or for repayment of moneys borrowed for the purpose of acquiring such asset, then the exchange difference i.e. increase or decrease in the liability as expressed in Indian currency would entail a corresponding increase or decrease in the actual cost of the asset as defined in section 43(1) of the Act in the year of payment. 6. Financial Statements of Foreign Operations:- The financial statements of a foreign operation shall be translated using the principles and procedures in paragraphs 3 to 6 of this ICDS as if the transactions of the foreign operation had been those of the person himself. Accordingly, the assets and liabilities of the foreign operations would need to be classified into monetary and non-monetary items and the foreign exchange gain/loss would be recognized to profit and loss or not will be as per para 5 (subject to para 6). 7. Forward Exchange Contracts:- Here ICDS deals with treatment of premium or discount that arise at the inception of a forward exchange contract and exchange difference on such a contract. The premium or discount that arises on the contract is measured by the difference between the exchange rate at the date of the inception of the contract and the forward rate specified in the contract. For example, if a forward exchange contract is entered in respect of an obligation to pay a vendor in foreign currency after 2 months and the prevailing foreign exchange rate at the inception is ₹ 65.00 and the forward contract is booked at ₹ 65.60. In this case, the premium paid is ₹ 0.60. Further, if at the end of the period of 2 months, if the prevailing exchange rate is ₹ 66.50, then the exchange difference would be an expense of ₹ 0.90. However, there would be a corresponding exchange gain of ₹ 0.90 also during the intervening period on account of the forward contract. In the above example, the premium of ₹ 0.60 is to be claimed as an expense, pro-rated over 2 months, being the period of forward exchange contract and the exchange difference of ₹ 0.90 with a corresponding exchange gain on forward contract of ₹ 0.90 is to be recognised as income and expense at the end of the said period. Notes:- This treatment of income or expense arising on account of premium, discount or exchange difference does not apply to contracts that are intended for trading or speculation purposes. These provisions also do not apply to a contract that is entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction. Firm commitment does not refer to assets and liabilities existing at the end of the previous year. Premium, discount or exchange difference on contracts that are intended for trading or speculation purposes, or that are entered into to hedge the foreign currency risk of a firm commitment or a highly probable forecast transaction shall be recognised at the time of settlement. As per this ICDS, marked-to-market gain/loss on forward exchange contract intended for trading or speculation cannot be recognised as income/expense till such time they are eventually settled. 8. Transitional Provisions:- This ICDS provides for transitional provisions which are summarized as follows: Particulars Provisions under this ICDS Foreign Currency Transactions entered on or after April 1, 2016 As per this ICDS Exchange differences on monetary/ non-monetary items on settlement during previous year commencing April 1, 2016 or conversion on last day of previous year commencing April 1, 2016 In cases where the monetary or non-monetary items are settled during the year ending on March 31, 2017, the resultant exchange difference is to be routed to Profit and Loss account on the date of settlement. In the rest of the cases, where such settlement has not occurred during the year, the exchange difference arising on account of conversion as on March 31, 2017 is to be routed to the Profit and Loss account. Financial Statements of foreign operations for previous year commencing on April 1, 2016 To be translated in accordance with this ICDS after taking into account, the amount recognised on March 31, 2016 for any carry forward item All forward exchange contracts existing on April 1, 2016 or entered on or after April 1,2016 To be dealt with in accordance with this ICDS after taking into account the income/expense if any recognised in respect of said contract for previous year ending on or before March 31, 2016 Note: There are no specific disclosures required under this ICDS.