Facts of the Case

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

For the Assessment Year 2015-16, the assessee filed its return declaring income of ₹3,04,46,18,830. During the assessment proceedings, the Assessing Officer noticed that the assessee had claimed foreign exchange fluctuation loss of ₹5,15,28,999 arising from exchange rate differences relating to External Commercial Borrowings (ECB) and hedging contracts.

The Assessing Officer held that the loss claimed was notional in nature and therefore disallowed the same. The disallowance was subsequently confirmed by the Commissioner of Income Tax (Appeals).

Further, the Assessing Officer also disallowed a part of the deduction claimed under Section 36(1)(viii) in respect of the amount transferred to special reserve. According to the Assessing Officer, deduction under the said provision was not available in respect of certain loans as the underlying entities had commenced operations before the relevant statutory timelines.

Aggrieved by the additions and disallowances, the assessee preferred an appeal before the Income Tax Appellate Tribunal (ITAT). 

Issues Involved

  1. Whether foreign exchange fluctuation loss on reinstatement of ECB liability is allowable as deduction under the Income-tax Act.
  2. Whether deduction claimed under Section 36(1)(viii) for transfer to special reserve can be restricted by applying the timeline prescribed under Section 80IA.
  3. Whether the assessee is entitled to depreciation on Windmill Turbine Generators used in its business.
  4. Whether disallowance under Section 14A read with Rule 8D should be computed considering only those investments that yielded exempt income during the year. 

Petitioner’s Arguments

The assessee submitted that the foreign exchange fluctuation loss on reinstatement of ECB liability is a legitimate business expenditure and allowable under Section 37(1) of the Income-tax Act. The loss had arisen due to exchange rate variation on outstanding borrowings and was recorded in accordance with the mercantile system of accounting and applicable accounting standards.

It was argued that such losses are not contingent or notional but arise due to revaluation of existing liabilities as per accounting principles. Reliance was placed on the decision of the Supreme Court in CIT vs Woodward Governor India (P) Ltd. (2009) which held that exchange fluctuation losses arising on revenue account are allowable deductions.

With regard to deduction under Section 36(1)(viii), the assessee contended that the provision is a complete code in itself and cannot be restricted by importing conditions from Section 80IA, as both provisions operate in different contexts and deal with different categories of taxpayers.

Regarding depreciation on Windmill Turbine Generators, the assessee submitted that the assets were owned by the company and were used for business purposes; therefore depreciation was allowable under the Act.

In respect of Section 14A disallowance, it was argued that disallowance should be computed only with respect to investments which yielded exempt income during the relevant assessment year. 

Respondent’s Arguments

The Revenue contended that the foreign exchange fluctuation loss claimed by the assessee was merely notional and had not actually crystallized during the year. Therefore, it should not be allowed as deduction.

The Revenue further argued that deduction under Section 36(1)(viii) should be restricted because the loans in question were granted to entities which had commenced operations long before the statutory timeline contemplated for infrastructure undertakings.

With respect to depreciation and disallowance under Section 14A, the Revenue challenged the findings of the Commissioner (Appeals) allowing the claims in favour of the assessee. 

Court Order / Findings

The Income Tax Appellate Tribunal (ITAT), Delhi Bench allowed the appeals filed by the assessee and dismissed the appeals filed by the Revenue.

The Tribunal held that the issue of foreign exchange fluctuation loss on ECB liability was already decided in favour of the assessee in its own cases for earlier assessment years. Following those decisions and relying on the principle laid down by the Supreme Court in CIT vs Woodward Governor India (P) Ltd., the Tribunal held that such loss is allowable as business expenditure. Accordingly, the disallowance made by the Assessing Officer was deleted.

On the issue of deduction under Section 36(1)(viii), the Tribunal observed that the provision operates independently and cannot be restricted by applying conditions from Section 80IA. The Assessing Officer erred in importing the timeline of Section 80IA while examining the deduction under Section 36(1)(viii). Therefore, the disallowance was deleted and the deduction was allowed.

Regarding depreciation on Windmill Turbine Generators, the Tribunal noted that the issue had already been decided in favour of the assessee in earlier years and even upheld by the jurisdictional High Court. Accordingly, the claim of depreciation was sustained.

In relation to Section 14A, the Tribunal held that the disallowance should be computed only with reference to those investments which actually yielded exempt income during the relevant assessment year, and therefore upheld the order of the Commissioner (Appeals). 

Important Clarification

The Tribunal reiterated several important legal principles:

  • Foreign exchange fluctuation loss on reinstatement of liability is allowable where the assessee follows the mercantile system of accounting and the loss arises from revenue transactions.
  • Section 36(1)(viii) is an independent provision and the eligibility conditions cannot be curtailed by importing timelines from Section 80IA.
  • Depreciation is allowable on assets owned and used for business purposes, even where the assets generate income indirectly.
  • Section 14A disallowance must be restricted to investments yielding exempt income during the relevant year.

Sections Involved

  • Section 37(1) – Allowability of business expenditure
  • Section 36(1)(viii) – Deduction in respect of special reserve created by specified financial entities
  • Section 80IA – Deduction relating to infrastructure undertakings
  • 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/1703238186-ita%20nos.%206081,%207515,%206913,%205654%20PTC%20INDIA%20FINANCIAL%20SERVICES%20LTD..pdf

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