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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 ..... h 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 1-4-2003 is clarificatory and therefore retrospective. 4. The other context in which the question arises is 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 circu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oreign 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 to Section 43-A with effect from 1-4-2003 is only clarificatory and has a retrospective effect. Reliance is placed on the decisions in CWT -vs- Swaran Kumar Swarup, 210 ITR 886 (SC), Poddar Cement -vs-CIT, 226 ITR 625 (SC), Lohia Machines -vs- CIT, 152 ITR 308, Motilal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessees. 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 Nippon, 261 ITR 275(SC). It is further contended that Central Government also has issued Circulars from time to time recognising these accounting standards. (e) It is emphasized that merely because payment is deferred to a later date, the liability does not cease; it continu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on 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 explains the Revenue's contention that the amendments should be seen as being clarificatory and hence retrospective. 9. In view of the changed scenario brought about by the amendment to Section 43-A of the Act, it would appear that the question in the present form has not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o 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 State for India, [1925] 1 ITC 363 at 371 where it was explained thus: "Accrues,' 'arises,' and 'is received' are three distinct terms. So far as receiving of income is concerned there can be no difficulty; it conveys a clear and definite meaning, and I can think of no expression which make ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 periods to which they relate." What is required, therefore, is that all anticipated liabilities and foreseeable losses have to be provided for while caution is to be exercised against accounting for unearned gains. Ultimately, the emphasis is on presenting a true and correct state of affairs o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s- 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 whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets. 11. The carrying amount of fixed assets which are carried in terms of revalued am ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave 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): "The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal 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 future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in present though it will be discharged at a future date. It does ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld 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 contingent or notional and therefore not allowable as a deduction. 31. The Revenue relied upon the decision of the Calcutta High Court in Bestobell (India) Ltd. in support of the submission that the increased liability on repayment of a loan borrowed in foreign exchange for business purposes as a result of exchange rate fluctuation would be a capital loss and not a tradin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 in foreign exchange rates on the closing day of the year has been disallowed by the Assessing Officer, inter alia, on the ground that this liability was a contingent liability and the loss was a notional one. The main ingredient of a contingent liability is that it depends upon happening of a certain event. We are of the considered opinion that in the case of the assessee, the ?event? i.e. the change in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . 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 the asset. The proposed section also secures that where there is a decrease in the rupee liability of the assessee in respect of assets acquired by him from abroad due to a change in the exchange value of the rupee, the original actual cost of the asset will be correspondingly reduced. The additional rupee liability incurred on imported capital assets or, as the case may be, any decrease in such liability, the circ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lopment 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 in the rat of exchange". 41. In a large number of decisions of the High Courts, the adjustments of the actual cost of the asset was allowed under Section 43-A of the Act. These include CIT -vs- Motor Industries Company Ltd., (No. 2) [1998] 229 ITR 137 (Karnataka), CIT - vs- Madras Fertilisers Ltd., [2002] 124 Taxman 581 (Madras), Usha Beltron (Patna), [1999] 238 ITR 133 New India Industries Ltd. (Guj.) and Padamjee Pulp and Pape ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ior 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 [2006] 286 ITR 341 applied the same reasoning to uphold the contention of the assessee that (page 349) ; "there is not reason why Section 43 A (1) should be applied to vary depreciation but not investment allowance." 44. One more argument of the Revenue requires to be dealt with. It was argued that Section 43-A is limited to five specific instances and that it does not require the revaluation of the asset every time there is a fluctuation in the rate of foreign exchange. It was also s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... od 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 is no scope for entertaining the plea of the Revenue that the amendment is declaratory and, therefore, retrospective. Accepting such a plea would be negating the express terms of the amendment and that is clearly impermissible. This Court, therefore, does not find it necessary to discuss the cases cited by the Revenue in support of its plea. The decision in Lohia Machines [1985] 152 ITR 308 (SC) did not involve an amendment to a substantive provision but to a procedural provision in the fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 in the rate of foreign exchange prevailing on the last day of the financial year is notional or contingent and therefore cannot be allowed as a deduction in terms of Section 37 of the Act. (iii) In the capital account cases where the cost of asset has been either paid fully or in part prior to the fluctuation in the rate of foreign exchange, the cost of the asset would correspondingly be permitted to be reworked for purposes of repayment or depreciation or investment allowance as the case may be with reference ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 impugned orders of the ITAT. Therefore, on this additional ground as well, the appeals are dismissed. 59. ITA Nos.9/2005, 1076/2005, 941/2006, 645/2006, 748/2006, 878/2006, 1051/2006, 1508/2006, 1633/2006, 1222/2006, 1738/2006 60. These appeals by the Revenue are yet to be admitted. In light of the view that we have taken in our Judgment in ITA No.49/2005 delivered today, we find that no substantial question of law arises for consideration in the present appeals. The appeals are dismissed. 61. ITA No.52/2002, 278/2002, 6/2004, 304/2004, 325/2004, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... owards 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, question No.2 is answered in the negative, i.e in favour of the assessee and against the Revenue. 68. Accordingly, the appeal is dismissed. 69. ITA 1389-1390/2006 (CIT v. Maruti Udyog Ltd.) 70. ITA 1389/2006 is an appeal by the Revenue against the impugned Order dated 20.2.2006 of the Income Tax Appellate Tribunal (ITAT), Delhi in ITA No.5331/1998 for the Assessment Year 1993-1994. ITA 1390/2006 is an appeal by the Revenue against the Order dated 17.2.2006 of the ITAT in ITA No.7042/1994 for the Assessment Year 1991-1992. Both appeals are at the notice stage and are yet to be admitted ..... X X X X Extracts X X X X X X X X Extracts X X X X
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