Facts of the Case

The assessee, PTC India Financial Services Ltd., is a Non-Banking Financial Company (NBFC) engaged in providing financing to companies operating in the energy sector.

For the Assessment Years 2015-16 and 2016-17, the assessee filed its return of income declaring taxable income and during assessment proceedings the Assessing Officer noticed that the assessee had claimed foreign exchange fluctuation loss amounting to ₹5,15,28,999 arising due to exchange rate differences relating to External Commercial Borrowings (ECB) and hedging contracts.

The Assessing Officer held that the loss was merely notional in nature and therefore disallowed the deduction and added the amount to the income of the assessee. The addition was also confirmed by the Commissioner of Income Tax (Appeals).

Aggrieved by the decision, the assessee filed an appeal before the Income Tax Appellate Tribunal (ITAT), Delhi Bench.

Issues Involved

  1. Whether foreign exchange fluctuation loss arising on restatement of External Commercial Borrowings (ECB) at the balance sheet date can be allowed as deduction.
  2. Whether such loss constitutes allowable business expenditure under Section 37(1) of the Income Tax Act, 1961 or is merely a notional loss not allowable for tax purposes. 

Petitioner’s Arguments (Assessee)

The assessee submitted the following contentions:

  • The foreign exchange loss arose on account of reinstatement of ECB liabilities as per accounting standards, which require restatement of foreign currency liabilities at the closing exchange rate.
  • The company consistently followed the mercantile system of accounting and recognized both gains and losses arising from exchange rate fluctuations.
  • The ECB funds were used for business purposes, namely onward lending in the normal course of financing activities, therefore the loss was incurred wholly and exclusively for business.
  • The issue had already been decided in favour of the assessee in earlier assessment years by the Tribunal.
  • Reliance was placed on the judgment of the Supreme Court in
    CIT v. Woodward Governor India Pvt. Ltd., which held that foreign exchange fluctuation loss as on the balance sheet date is an allowable expenditure under the Income Tax Act.     

Respondent’s Arguments (Revenue / Department)

The Revenue argued that:

  • The loss claimed by the assessee was notional and contingent, since the liability had not actually been discharged.
  • Such fluctuation losses should only be recognized at the time of settlement of the liability, not merely due to year-end restatement.
  • Therefore, the deduction claimed by the assessee under the head of foreign exchange fluctuation loss should be disallowed while computing taxable income. 

Court Order / Findings

The Income Tax Appellate Tribunal (ITAT), Delhi held in favour of the assessee and observed that:

  • The issue was already decided in the assessee’s own case for earlier assessment years, where similar disallowances were deleted.
  • The Tribunal followed the ratio laid down by the Supreme Court in CIT v. Woodward Governor India Pvt. Ltd., which recognizes foreign exchange fluctuation loss arising on the balance sheet date as an allowable deduction.
  • If exchange fluctuation gains are taxable when recognized, losses arising from the same treatment cannot be ignored.
  • The foreign exchange fluctuation loss was incurred during the course of business and therefore qualifies as allowable business expenditure.

Accordingly, the Tribunal set aside the orders of the lower authorities and deleted the addition made by the Assessing Officer.

Important Clarification

The Tribunal clarified that:

  • Foreign exchange fluctuation loss on ECB liabilities recognized under the mercantile system and accounting standards is not a notional loss.
  • Such loss is a legitimate business expenditure allowable under Section 37(1) if it arises in the normal course of business and is consistently accounted for.
  • If the Revenue accepts foreign exchange gains for taxation purposes, the same principle must apply to losses as well.

Link to download the order -  https://itat.gov.in/public/files/upload/1703237945-ita%20nos.%206081,%207515,%206913,%205654%20PTC%20INDIA%20FINANCIAL%20SERVICES%20LTD..pdf

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