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TMI Blog2007 (4) TMI 118X X X X Extracts X X X X X X X X Extracts X X X X ..... asset has been shown in the accounts of the assessee on the basis of the exchange rate prevailing on the date of the filing of the Bill of Entry. The question that arises is whether this cost of the asset would correspondingly increase or decrease with the fluctuation in the rate of foreign exchange. The contention of the assessees is that, consistent with Section 43-A of the Income Tax Act, 1961 ("the Act") as it stood prior to its amendment with effect from 1-4-2003, the increase or decrease in the liability as a result of fluctuation would go to alter the cost of the asset, such increase or decrease being liable to be reflected in the year in which the fluctuation occurs. It is submitted that merely because the payment is postponed to a later date, the liability does not cease. On the other hand, it is contended by the Revenue that since payment has been agreed to be made on a deferred basis, no actual liability accrues until and unless the liability to make the payment arises; and the increase or decrease in liability will be available to be reflected in the cost of the asset only on the date of payment. It is also contended that the amendment to Section 43-A with effect from 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ncurred by the assessee during the previous year. It will not go to revise the cost of the asset till the increased cost is actually payable. (b) The wording of Section 43-A of the Act indicates that the facility of revising the cost of the asset as a result of foreign exchange fluctuation is available only in five specific instances. It does not require the revaluation of the asset every time there is a fluctuation in foreign exchange. (c) If the liability has to be revised every time there is a fluctuation in foreign exchange, then day-to-day fluctuations would also have to be accounted for and this would make the system unworkable. (d) The decisions of this Court in CIT -vs- IFFCO, 142 Taxman 466 (Delhi) and CIT -vs- Paper Products Ltd., 271 ITR 472 do not decide the of the applicability of the amendment to Section 43-A retrospectively. The decision in Arvind Mills - vs- Commissioner of Income-Tax, 193 ITR 255 (SC) does not apply on all fours since that decision was essentially about the impact of foreign exchange fluctuation on development rebate and not in the context of depreciation or investment allowance in the context of Section 43-A of the Act. (e) The amendment t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nion of India vs- Satish Panna Lal Shah, 249 ITR 221(SC), Berger Paints India Ltd. "vs- CIT, 266 ITR 99 (SC). (c) It is further submitted that the question in the instant case has arisen for consideration before several High Courts and have been held in favour of the assessees. Placing reliance on the dictum of the Hon'ble Supreme Court in CIT -vs- P.J.Chemicals, 210 ITR 310 (SC), it is submitted that a view which has found favour with the majority of the High Courts should normally be adopted by this Court as well. (d) The assessees here follow the mercantile system of accounting and have, in terms of Section 145 of the Act, to abide by the accounting standards laid down by the Institute of Chartered Accountants of India (ICAI). These accounting standards require the liability to be revised in the very year in which the fluctuation of exchange takes place in order to reflect the true state of affairs of the business of the assessee. The accounts have to be prepared by adopting the principle of prudence. The Courts have also generally deferred to accounting standards. Reliance is placed on the decisions in Challapalli Sugars Ltd. "vs- CIT, 98 ITR 167 (SC) and CIT -vs- Indo Nipp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of the Hon'ble Supreme Court in Sutlej Cotton Mills Ltd. holds that the loss on account of adverse foreign exchange fluctuation in respect of foreign currency utilised for current account purposes is to be allowed as a revenue deduction whereas loss incurred in relation to acquisition of capital assets is to be regarded as a capital loss. Likewise the decision of the Hon'ble Supreme Court in Arvind Mills also holds that adjustment in the actual cost of assets in terms of Section 43-A of the Act would be allowed consequent upon the fluctuation in the foreign exchange rates. The only question that perhaps did not arise for consideration in the capital account cases was the effect of the amendment to Section 43-A with effect from 1-4-2003. Therefore, in the post-amendment scenario, the Revenue may be justified in contending that the question would require a fresh look since the present amendment makes a dramatic change not only in the system of accounting but also the year in which the increase or decrease in liability has to be accounted for. What in fact the amendment does is to take away the impact of the earlier judicial decisions which were beneficial to the assessee. This exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nies to keep accounts on accrual basis only. 12. The concept of "accrual" has been explained by the Hon'ble Supreme Court in E.D.Sassoon [1954] 26 ITR 27 as under: "If income has accrued to the assessee it is certainly earned by him in the sense that he has contributed to its production or the parenthood of the income can be traced to him. But in order that the income can be said to have accrued to or earned by the assessee it is not only necessary that the assessee must have contributed to its accruing or arising by rendering services or otherwise but he must have created a debt in his favour. A debt must have come into existence and he must have acquired a right to receive the payment. Unless and until this contribution or parenthood is effective in bringing into existence a debt or a right to receive the payment or in other words a debitum in praesenti,solvendum in futuro it cannot be said that any income has accrued to him. The mere expression 'earned' in the sense of rendering the services etc. by itself is of no avail." 13 In the same decision, the Court referred to the decision of the Privy Council in Roggers Pyatt Shellac and Company -vs- Secretary of Stat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also acknowledges the need to follow accounting standards. These may be prescribed by the Central Government. The accounting standards prescribed by the ICAI are also required to be followed by the assessees. This has received recognition in several decisions of the High Courts and the Hon'ble Supreme Court. Accounting Standards of the ICAI 15. The earliest acknowledgment by the Courts of accounting practices as explaining the concept of accrual can be found in the decision of the Privy Council in The Commissioner of Income-Tax Bombay -vs- The Ahmedabad New Cotton Mills Co. Ltd., 4 ITC 245. 16. The accounting standards issued by the ICAI require that accounting policies must be governed by the principle of 'prudence'. In other words, "Provisions should be made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only the basic estimate in the light of available information." Para 6 of Accounting Standard 1 defines accrual as "the assumption that revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at existed when the values were determined (e.g. if the fair value is determined as on the balance sheet date, the exchange rate on the balance sheet date may be used); and d. the carrying amount of fixed assets should be adjusted as stated in paragraphs 10 and 11 below. 8. Recognition of Exchange Differences- Paragraphs 9 to 11 set out the accounting treatment required by this Statement in respect of exchange differences on foreign currency transactions. 9. Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise, except as stated in paragraphs 10 and 11 below. 10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . In fact, it is noted in the judgment itself that? in the instant case, there is no scope for application of Section 43A." 20. Therefore, the judicially accepted position appears to be that in determining whether there has in fact been accrual of liability or income, the accountancy standards prescribed by the ICAI would have to be followed and applied. Capital Account or Revenue Account: The Tests 21. Fluctuation in the rates of foreign exchange can result in either a gain or a loss depending on whether the value of the currency appreciates or depreciates. If the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital used in the business, the appreciation or depreciation in the value of the foreign currency would result in either trading profit or trading loss. Thus, the gain or loss would be on the revenue account. On the other hand, if the foreign exchange liability arises in relation to acquisition of capital assets, the corresponding gain or loss would be of a capital nature. This was explained by the Hon'ble Supreme Court in Sutlej Cotton Mills Ltd. [1979] 116 ITR 1 in the following terms (ITR, p.13): ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n had been obtained. Even if the foreign currency was intended or had originally been utilised for acquisition of fixed asset, if at the time of devaluation it had changed its character and had assumed the new character of stock-in-trade or circulating capital, the loss that occurred on account of devaluation shall be a revenue loss an not a capital loss. (vii) The way in which the entries are made by an assessee in the books of account is not determinative of the question whether the assessee has earned any profit or suffered any loss. What is necessary to be considered is the true nature of the transaction and whether in fact it has resulted in profit or loss to the assessee." 24. This Court in BHEL explained that if the loss was in respect of a trading asset it would be a trading loss and if it was in respect of capital asset, a capital loss. 25. The underlying principle that appears to have been firmly settled as noted by the Hon'ble Supreme Court in Bharat Earth Movers as follows (ITR, p.431): " .If a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the revenue account cases. Revenue Account Cases 29. In some of the appeals the question arises on account of the increase or decrease in the value of the foreign currency held on revenue account or as a trading asset or as a part of circulating capital of the business. The claim of the assessees is that the resultant increase or decrease in the liability would be in the nature of business expenditure allowable under Section 37 of the Act notwithstanding that the liability has not been discharged in the year in which the fluctuation in the rate of foreign exchange occurred. On the other hand, the argument that the Appellant repeatedly advanced was that the liability was a contingent or a notional one and would get postponed to the date of actual payment. 30. In this context the reliance placed by the Revenue on the decision of the Madras High Court in Indian Overseas Bank is inappropriate. The Court there was dealing with the question whether unsettled foreign exchange contracts, held as stock-in-trade, could constitute contingent liability. It was held that the unpredictability of the loss or profit arising out of foreign exchange fluctuation rendered the liability ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tevens Co. Ltd., 158 ITR 235(Cal.) and CIT vs- IBM Trade Corporation , 161 ITR 673(Bom.). These decisions, with which we respectfully concur, make it clear that the question whether the assessee can claim deduction of the increased liability in the revenue account as a result of fluctuation in the rate of foreign exchange has to be answered in the affirmative. 34. We may also refer to the decision of the Special Bench of the ITAT in the ONGC where the following question was considered (page 4) : "Whether on the facts and circumstances of the case and in law the additional liability arising on account of fluctuations in the rate of exchange in respect of loans taken for revenue purposes could be allowed as deduction in the year of fluctuations in the rate of exchange or the same could only be allowed in the year of repayment of such loans". 35 Answering the question in favour of the assessee, it was held that the assessee's claim of loss on account of fluctuation in foreign currency rates is allowable. The ITAT explained its conclusion in the following manner: "After careful consideration it held that the assesees's claim for loss arising as a result of fluctuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ional rupee liability incurred by him in meeting the instalments of the cost of the asset or of the foreign loan, as the case may be, falling due for payment after the date of devaluation, will be allowed to be added to the original actual cost of the asset for the purpose of calculating the allowance on account of depreciation in computing the profits for the assessment year 1967-68 and subsequent assessment years. Similarly increase in the original actual cost will be allowed to be made in respect of capital assets acquired by the assessee to be used in scientific research related to the class of business carried on by him or patent rights or copyrights acquired from abroad or any capital asset required by a company for the purpose of promoting family planning amongst its employees. Further, in computing the capital gains arising to the assessee on the sale or transfer of a capital asset acquired by him from abroad on deferred payment terms or against foreign loan, the additional rupee liability incurred by him in repaying the instalments of the cost or the foreign loan, as the case may be, after the date of devaluation of the rupee, will be added to the original actual cost of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e installments of the cost of the asset or for repayment of the foreign loan against which the asset has been acquired, will not be applicable in computing the actual cost of the asset for the purpose of the deduction on account of development rebate under section 33..." 40. The occasion to examine if the benefit of the deduction as a result of fluctuation in foreign exchange rate would go to affect the computation of development rebate under Section 33 came to be examined by the Hon'ble Supreme Court in Arvind Mills. [1992] 193 ITR 255. It was held that the Section itself expressly excluded the availability of the deduction for computing development rebate. The said decision nevertheless acknowledged that the actual cost of the asset would have to be reworked to reflect the increased liability arising as a result of the foreign exchange fluctuation. The Court there observed (ITR p.270): "It (Section 43-A) lays down, firstly, that the increase or decrease in liability should be taken into account to modify the figure of actual cost and secondly that such adjustment should be made in the year in which the increase or decrease in liability arises on account of the fluctuation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said section lays down two things, namely: (i) the increase or decrease in the liability is to be taken into account to modify the figure of actual cost, and (ii) that such adjustment should be made in the year in which the increase or decrease in liability arises on account of fluctuations in the rate of exchange. It has been clearly held by the apex court that even in a case where the assessee has completely paid for the plant and machinery in foreign currency prior to the date of devaluation but the variation in exchange rate affects the liability of the assessee (as expressed in Indian currency) for repayment of the whole or part of the monies borrowed by him from any person, directly or indirectly in any foreign currency specifically for the purposes of acquiring the asset, adjustments in terms of section 43A(1) can be made". 43. The same Bench answered a similar question likewise in IFFCO Ltd., [2005] 142 Taxman 466 (Delhi), in line with their view in Paper Products. The impugned order of the Tribunal was held to not involve any question of law, much less a substantial question of law. The Bombay High Court recently in Associated Bearing Co. Ltd. v. CIT [ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 is merely clarificatory and, therefore, retrospective. One reason for this contention is that the amendment brings about a fundamental change regarding the time of payment and the method of contract. The amended Section now provides that the amount by which the liability is increased or reduced as a result of change in the rate of exchange "during any previous year after the acquisition of such asset" would be taken into account "at the time of making the payment, irrespective of the method of an accounting adopted by the assessee." The effect of the amendment is plainly to negate the benefit that was extended to the assessee as a result of the interpretation placed on the provisions as it stood prior to the amendment in the numerous judgments of the High Court and the Hon'ble Supreme Court. However, the amendment itself makes it clear that it is with effect from 1-4-2003. This has further been clarified by the CBDT Circular No.8 of 2002 [2000] 258 ITR(St.) 13 which in no uncertain terms states in para 34.5 that "the amendment will take effect from 1-4-2003 and will, accordingly, apply in relation to the assessment year 2003-04 and subsequent years." 47. Accordingly, there i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... principles and reasoned in an intellectually coherent and politically neutral way to his result'." 50. The assessees are also justified in their contention that in some of the cases, the Revenue has been taking contradictory stands in the successive assessment years on the question involved in the present appeals in respect of the same assessee. We have adverted to this aspect in some of the cases below. In those cases this is a further ground on which we have dismissed the appeal of the Revenue. Summary of the Conclusions 51. We may briefly summarise our conclusions: (i) The judicially accepted position appears to be that in determining whether there has in fact been 'accrual' of liability or income, the accountancy standards prescribed by the ICAI would have to be followed and applied. (ii) In the context of the revenue account cases, we affirm the decision of the ITAT in ONGC which rightly follows the settled position as explained it the judgment of the Hon'ble Supreme Court which we have referred to. We, therefore, reject the submission of the Appellant in these appeals that in the revenue account cases, the increase in liability on account of the fluctuation i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he accrued income would also not be taxable. Therefore, both the assessee and the Revenue appealed to the ITAT, which passed the impugned orders as already noticed. 57. While admitting this appeal on 14.2.2005 this Court framed a substantial question of law similar to the one set out in para 1 of this judgment. In view of the judgment rendered by us today the question stands answered in favour of the assessee and against the Revenue. In that view of the matter the appeal ought to be dismissed on this ground itself. 58. The appeal is also liable to be dismissed on the ground of consistency. Mr.C.S.Aggarwal, learned Senior Advocate appearing for the Respondent is right in pointing out that in each of the previous Assessment Years the plea of the assessee was accepted. Thus in the years 1995-96 and 1996-97 in the case of the assessee itself the ITAT by its Orders dated 28-3-2003 in ITA 5676/1998 and 8-3-2004 in ITA 3439/2000 respectively upheld the contention of the assessee. Following BHEL [1999] 239 ITR 756 (Delhi) and Indag Rubber Ltd. [2001 119 Taxman 736 (Delhi) we held that on the principle of consistency, the Revenue should not be permitted to challenge the impu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5,725/-made by disallowing the claim of loss on account of foreign exchange fluctuations" However, in view of this judgment, question no.1 has to be answered in the affirmative, i.e. in favour of the assessee and against the Revenue. 66. As regards question No.2 the ITAT concurred with the CIT (Appeals) and held against the Revenue. The finding of the CIT (Appeals) on this point was that the Fund Flow Statement produced by the assessee showed that out of the total loans obtained by issue of Euro Bonds, a substantial portion was used for Capital Assets and the remaining towards Working Capital. The CIT (A) observed ?since the assessee had utilised part of the loan for acquiring capital assets and part of the loan was used towards working capital, the additional liability on account of fluctuation rate was to be capitalised partly and was to be debited to the Profit and Loss Account partly as an allowable expenditure". The CIT(A) followed the decision of the Calcutta High Court in Oil India Company Ltd. vs- CIT, [1982] 187 ITR 156. 67. The decision of the CIT (A) which has been affirmed by the ITAT is consistent with what we have held in this judgment. Accordingly, questi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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