Facts of the Case

The assessee had issued 15% Unsecured Redeemable Non-Convertible Debentures carrying interest at 15% per annum. For repayment of these debentures, the assessee obtained FCNR(B) loans from banks at lower interest rates compared to ordinary loans. To protect itself from foreign exchange fluctuations, the assessee entered into forward contracts with banks in India. During the relevant assessment year, the assessee incurred foreign exchange fluctuation loss amounting to Rs. 49,98,072/- on the FCNR(B) loan and claimed the same as revenue expenditure.

The original assessment under Section 143(3) was completed without examination of the said expenditure. Subsequently, the Commissioner exercised revisionary jurisdiction under Section 263 directing the Assessing Officer to examine applicability of Section 43A and the nature of the expenditure.

The Assessing Officer held that Section 43A applied and treated the expenditure as capital in nature. However, the Commissioner of Income Tax (Appeals) and later the Income Tax Appellate Tribunal reversed the findings and held the loss to be allowable revenue expenditure.


Issues Involved

  1. Whether foreign exchange fluctuation loss incurred on FCNR(B) loan repayment was covered under Section 43A of the Income Tax Act, 1961.
  2. Whether the expenditure incurred towards hedging foreign exchange fluctuation risk was capital expenditure or revenue expenditure.
  3. Whether foreign exchange fluctuation loss incurred for repayment of debentures through FCNR(B) loans was allowable as deduction under Section 37(1) of the Income Tax Act.

Petitioner’s Arguments (Revenue)

The Revenue argued that:

  • The foreign exchange fluctuation loss related to loans connected with acquisition of assets and therefore Section 43A was applicable.
  • The expenditure was capital in nature and could not be allowed as revenue deduction.
  • The judgments relied upon by the assessee regarding foreign exchange fluctuation losses were not applicable to loan-related losses.
  • Since the matter involved loans allegedly linked to acquisition of capital assets, the loss should be adjusted to the cost of assets instead of being claimed as revenue expenditure.

Respondent’s Arguments (Assessee)

The assessee contended that:

  • FCNR(B) loans were obtained solely for redemption of debentures and not for acquisition of capital assets.
  • The objective of the FCNR(B) loan was reduction of financing cost and efficient debt servicing.
  • The foreign exchange fluctuation loss was actual expenditure incurred towards forward contracts and not a notional or contingent liability.
  • No capital asset was acquired out of the FCNR(B) loan and therefore Section 43A had no application.
  • The expenditure was incurred wholly and exclusively for business purposes and allowable under Section 37(1).
  • The accounting treatment was consistent with Accounting Standard AS-11.

Court Findings / Court Order

The Delhi High Court dismissed the Revenue’s appeal and upheld the orders passed by the Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal. The Court held that:

  • Section 43A was not applicable because the FCNR(B) loan was not utilized for acquisition of any capital asset payable in foreign currency.
  • The loss of Rs. 49,98,072/- was actual expenditure incurred for protection against foreign exchange fluctuation risk and formed part of debt servicing cost.
  • The expenditure was revenue in nature and allowable as deduction under Section 37(1) of the Income Tax Act.
  • The Court relied upon the Supreme Court judgment in CIT vs Woodward Governor India Pvt. Ltd. reported in 312 ITR 254 regarding allowability of foreign exchange fluctuation losses under mercantile accounting principles and AS-11 standards.
  • The Court observed that the expenditure was effectively similar to interest expenditure incurred for availing cheaper financing facilities.

Important Clarification by the Court

The Court clarified that Section 43A applies only where foreign currency loans are directly connected with acquisition of capital assets from outside India. Since the FCNR(B) loan in the present case was used for repayment of debentures and not for acquisition of fixed assets, the foreign exchange fluctuation loss could not be treated as capital expenditure.

The Court further clarified that expenditure incurred for hedging foreign exchange risks in relation to business financing arrangements constitutes revenue expenditure where the dominant purpose is reduction of financing cost and debt servicing.

Sections Involved

  • Section 37(1) of the Income Tax Act, 1961
  • Section 43A of the Income Tax Act, 1961
  • Section 143(3) of the Income Tax Act, 1961
  • Section 263 of the Income Tax Act, 1961
  • Section 145 of the Income Tax Act, 1961
  • Accounting Standard (AS)-11 relating to Foreign Exchange Fluctuation


Link to download the order -https://delhihighcourt.nic.in/app/case_number_pdf/2014:DHC:4077-DB/VKR22082014ITA4712014.pdf

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