Facts of the Case

The assessee, PTC India Financial Services Ltd., is a resident corporate entity registered as a Non-Banking Financial Company (NBFC) engaged in providing financial assistance to companies in the energy sector. For the Assessment Year (AY) 2015-16, the assessee filed its return declaring income of approximately ₹304.46 crores.

During assessment proceedings, the Assessing Officer (AO) observed that the assessee had claimed foreign exchange fluctuation loss of ₹5,15,28,999 arising due to exchange rate differences relating to External Commercial Borrowings (ECB) and hedging contracts. The AO treated the loss as notional in nature and disallowed the deduction.

Further, the AO also examined the deduction claimed under Section 36(1)(viii) amounting to ₹48.62 crores transferred to a special reserve, and made proportionate disallowance.

In addition, issues relating to depreciation on windmill turbine generators and disallowance under Section 14A read with Rule 8D were also raised in the Revenue’s appeal. The Commissioner of Income Tax (Appeals) partly allowed the assessee’s claims, leading to cross-appeals before the Income Tax Appellate Tribunal (ITAT), Delhi for AY 2015-16 and AY 2016-17. 

Issues Involved

  1. Whether foreign exchange fluctuation loss on reinstatement of ECB liability is allowable as deduction under Section 37(1) of the Income Tax Act.
  2. Whether deduction claimed under Section 36(1)(viii) on transfer to special reserve was allowable.
  3. Whether the assessee was eligible for depreciation on windmill turbine generators used in its business.
  4. Whether disallowance under Section 14A read with Rule 8D should be computed considering all investments or only those generating exempt income. 

Petitioner’s Arguments (Assessee)

  • The assessee contended that the foreign exchange fluctuation loss arose on reinstatement of ECB liability at the balance sheet date, which is a revenue item and allowable as business expenditure.
  • Reliance was placed on judicial precedents including the Supreme Court decision in Woodward Governor India Pvt. Ltd., which recognizes such forex loss on accrual basis as allowable expenditure.
  • It was argued that the Revenue had accepted forex gains in later years as taxable income; therefore, the same treatment should be applied to forex losses.
  • With respect to Section 36(1)(viii), the assessee argued that deduction is allowable when profits are transferred to a special reserve, and the AO wrongly relied on conditions under Section 80-IA which are not applicable to Section 36(1)(viii).
  • Regarding depreciation on windmill turbines, the assessee maintained that it owned and used the assets for business purposes, making it eligible for depreciation.
  • For Section 14A, the assessee submitted that disallowance should be restricted only to investments that actually generated exempt income during the relevant year.

Respondent’s Arguments (Revenue)

  • The Revenue contended that foreign exchange fluctuation loss was merely notional and therefore not deductible.
  • It argued that the deduction claimed under Section 36(1)(viii) was not justified as the relevant entities had commenced operations prior to the prescribed time frame.
  • The Revenue also argued that the assessee’s investment in windmill turbine generators was in the nature of investment activity rather than business activity, thereby questioning the allowability of depreciation.
  • In relation to Section 14A, the Revenue supported the AO’s computation under Rule 8D, which considered the overall investment portfolio for determining disallowable expenditure. 

Court’s Findings / Order

The ITAT Delhi decided largely in favour of the assessee and held as follows:

  1. Foreign Exchange Fluctuation Loss
    • The Tribunal noted that the issue had already been decided in favour of the assessee in earlier assessment years.
    • Following its earlier orders and the principle laid down by the Supreme Court in Woodward Governor India Pvt. Ltd., the Tribunal held that foreign exchange loss arising on reinstatement of ECB liability is allowable expenditure.
    • Accordingly, the disallowance made by the AO was deleted.
  2. Deduction under Section 36(1)(viii)
    • The Tribunal held that the AO had wrongly applied the timeline applicable under Section 80-IA, which has no relevance to Section 36(1)(viii).
    • Since the Revenue had allowed similar claims in subsequent assessment years, the disallowance was deleted and deduction allowed.
  3. Depreciation on Windmill Turbine Generators
    • The Tribunal observed that similar issues in earlier years had been decided in favour of the assessee and even upheld by the jurisdictional High Court.
    • As the assessee owned the assets and used them for business purposes, depreciation was allowed.
  4. Disallowance under Section 14A
    • The Tribunal upheld the decision of the Commissioner (Appeals) directing the AO to compute disallowance by considering only those investments which yielded exempt income during the year.

Important Clarification

  • Foreign exchange fluctuation loss on ECB liability, when recorded on accrual basis in accordance with accounting principles, is allowable as business expenditure under the Income Tax Act.
  • Section 36(1)(viii) deduction relating to transfer to special reserve cannot be restricted by applying conditions from unrelated provisions like Section 80-IA.
  • Depreciation is allowable where the asset is owned and used for business, even if the activity involves investment-based income generation.
  • For Section 14A, only those investments that actually generate exempt income during the relevant year should be considered while computing disallowance. 

Sections Involved

  • Section 37(1) – Business Expenditure
  • Section 36(1)(viii) – Deduction in respect of special reserve
  • Section 14A – Disallowance of expenditure relating to exempt income
  • Rule 8D of Income Tax Rules
  • Section 32 – Depreciation 

Link to download the order -  https://itat.gov.in/public/files/upload/1703238017-ita%20nos.%206081,%207515,%206913,%205654%20PTC%20INDIA%20FINANCIAL%20SERVICES%20LTD..pdf

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