M/S.OIL TOOLS INTERNATIONAL SERVICES PRIVATE LIMITED,MUMBAI vs. ASSISTANT COMMISSIONER OF INCOME TAX 15(2)(2), MUMBAI

O R D E R PER S. RIFAUR RAHMAN (AM)

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., u/s. 143(1) of Income-tax Act, 1961 (in short “Act”). Subsequently the case was selected for scrutiny under CASS and statutory notices u/s.143(2) and 142(1) of the Act were issued and served on the assessee. In response AR of the assessee attended and submitted the relevant information as called for.

“6.2. Assessee vide his letter dated 19/12/2016 submitted the following "The ECB loan outstanding during year were borrowed money from outside India in foreign currency either to acquire capital asset or to repay earlier ECB loan is 5.25% pa. which is quite low compare to similar domestic loans. The assets bought from these funds were indigenous assets. A similar facts case [TS-265-ITAT-2016(Pune)] was decided by Pune Bench of Income-tax Appellate Tribunal. The Pune bench of the Income-tax Appellate Tribunal (Tribunal) upheld the taxpayer's claim that foreign exchange fluctuation loss has a direct nexus with savings in interest costs and no new capital asset was brought into existence.

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., The Tribunal observed that foreign exchange fluctuation loss utilized for acquiring indigenous assets was not covered by section 43A of the Income-tax Act, 1961 (the Act) It further noted that the taxpayer was mandatorily required to draw its accounts as per Accounting Standard (AS) -11 in terms of the Companies Act, 1956 as well as the Act. The Tribunal rejected Revenue's contentions that such loss was capital in nature and also notional and contingent Thus forex loss on borrowings is revenue expenditure as it has direct nexus with interest cost savings and hence should not be disallowed as capital expenditure.”

2. The appellant craves leave to add, amend, alter or delete any of the above grounds of appeal.”

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., 8. On the other hand, Ld. DR relied on the orders of the lower authorities.

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., into an agreement with the lenders to convert the loans in foreign currency equivalents to take advantage of the lower rate of interest rate applicable to later. The assessee has factually demonstrated that the conversion into foreign currency loans have actually benefited the Assessee in terms of saving of interest costs. We also notice that there is no dispute on the fact that the acquisition of capital assets / expansion of projects etc. from the term loans taken are already complete and the assets so acquired have been put to use. As a consequence, the loss occasioned from foreign currency loans so converted is a post facto event subsequent to capital assets having been put to use. We simultaneously notice that there is no adverse finding from the Revenue about the correctness or completeness of accounts of assessee on the touchstone of section 145 of the Act. In other words, the profits/gains from the business have been admittedly computed in accordance with generally accepted accounting practices and guidelines notified. 10.2 The assessee has inter alia applied AS-11 dealing with effects of the changes in the exchange rate to record the losses incurred owing to fluctuation in the foreign exchange. AS-11 enjoins reporting of monetary items denominated foreign currency using the closing rate at the end of the accounting year. It also requires that any difference, loss or gain, arising from such conversion of the liability at the closing rate should be recognized in the profit & loss account for the reporting period. In the same vain, CBDT notification S.O. 892(E) dated 31-03-2015 referred to also inter alia deals with recognition of exchange differences. The notification also sets out that the exchange differences arising on foreign currency transactions have to be recognized as income or business expense in the period in which they arise subject to exception as set out in Section 43A or Rule 115 of the Income Tax Rules, 1962 as the case may be. 10.3 The contention of the revenue that the loss is only contingent and notional and subsisting has been examined. As per section 209 of the Companies Act, 1956, the Assessee being a company is required to compulsorily follow mercantile system of accounting. S. 211 of the Companies Act, 1956 also, in terms, mandates that accounting standards as applicable is required to be followed while drawing statement of affairs. S. 145 of the Income Tax Act,1961 similarly casts obligation to compute business income either by cash or mercantile system of accounting. Thus, in view of the various provisions of the Companies Act and Income Tax Act, it was mandatory to draw accounts as per AS 11. Thus, in our considered view, the loss recognized on account of foreign exchange fluctuation as per notified accounting standard AS 11 is an accrued and subsisting liability and not merely a contingent or a hypothetical

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., liability. A legal liability also exists against the assessee due to fluctuation and loss arising therefrom. Actual payment of loss is an irrelevant consideration to ascertain the point of accrual of liability. As a corollary, the revenue has committed error in holding the liability as notional or contingent. 10.4Copious reference has been made to S. 43A by Assessee as well as revenue. Thus, it would be pertinent to examine the issue on the touchstone of S. 43A of the Act. Section 43A, to the extent relevant in the context, reads as under: Notwithstanding anything contained in any other provision of this Act, where an assessee has acquiredany asset in any previous year from a country outside India for the purposes of his business or profession and, in consequence of a change in the rate of exchange during any previous year after the acquisition of such asset, there is an increase or reduction in the liability of the assessee as expressed in Indian currency (as compared to the liability existing at the time of acquisition of the asset) at the time of making payment— (a) towards the whole or a part of the cost of the asset; or (b) towards repayment of the whole or a part of the moneys borrowed by him from any person, directly or indirectly, in any foreign currency specifically for the purpose of acquiring the asset along with interest, if any, the amount by which the liability as aforesaid is so increased or reduced during such previous year andwhich is taken into account at the time of making the payment, irrespective of the method of accounting adopted by the assessee, shall be added to, or, as the case may be, deducted from— (i) the actual cost of the asset as defined in clause (1) of section 43; or (ii) the amount of expenditure of a capital nature referred to in clause (iv) of subsection (1) of section 35; or (iii) the amount of expenditure of a capital nature referred to in section 35A; or (iv) the amount of expenditure of a capital nature referred to in clause (ix) of subsection (1) of section 36; or (A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., (v) the cost of acquisition of a capital asset (not being a capital asset referred to in section 50) for the purposes of section 48, and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid: Provided that where an addition to or deduction from the actual cost or expenditure or cost of acquisition has been made under this section, as it stood immediately before its substitution by the Finance Act, 2002, on account of an increase or reduction in the liability as aforesaid, the amount to be added to, or, as the case may be, deducted under this section from, the actual cost or expenditure or cost of acquisition at the time of making the payment shall be so adjusted that the total amount added to, or, as the case may be, deducted from, the actual cost or expenditure or cost of acquisition, is equal to the increase or reduction in the aforesaid liability taken into account at the time of making payment A bare reading of the aforesaid provision of Section 43A, which opens with a non-obstante and overriding clause, would show that it comes into play only when the assets are acquired from a country outside India and does not apply to acquisition of indigenous assets. Another notable feature is that S. 43A provides for making corresponding adjustments to the costs of assets only in relation to exchange gains/ losses arising at the time of making payment. It therefore deals with realised exchange gain/ loss. The treatment of unrealised exchange gain/ loss is not covered under the scope of S. 43A of the Act. It is thus apparent that special provision of S. 43A has no application to the facts of the case. Therefore, the issue whether, the loss is on revenue account or a capital one is required to be tested in the light of generally accepted accounting principles, pronouncements and guidelines etc. 10.5 Before We delineate on the allowablity of loss based on generally accepted accountancy principles, it may be pertinent to examine whether the increased liability due to fluctuation loss can be added to the carrying costs of corresponding capital assets with reference to S. 43(1) of the Act. Section 43(1) defines the expression ‘actual cost’. As per S. 43(1), actual cost means actual cost of the assets to the assessee, reduced by that portion of the costs as has been met directly or indirectly by any other person or authority.

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., Several Explanations have been appended to S. 43(1). However, the section nowhere specifies that any gain or loss on foreign currency loan acquired for purchase of indigenous assets will have to be reduced or added to the costs of the assets. Thus, viewed from this perspective also, such increased liability cannot be bracketed with cost of acquisition of capital assets save and except in terms of overriding provisions of S. 43A of the Act. 10.6 We also simultaneously note here that the Hon’ble Supreme Court in the case of CIT vs. Tata Iron and Steel Co. Ltd. (1998) 22 ITR 285 held that cost of an asset and cost of raising money for purchase of asset are two different and independent transactions. Thus, events subsequent to acquisition of assets cannot change price paid for it. Therefore, fluctuations in foreign exchange rate while repaying installments of foreign loan raised to acquire asset cannot alter actual cost of assets. The relevant operative para is reproduced hereunder. “Coming to the question raised, we find it difficult to follow how the manner of repayment of loan can affect the cost of the assets acquired by the assessee. What is the actual cost must depend on the amount paid by the assessee to acquire the asset. The amount may have been borrowed by the assessee, but even if the assessee did not repay the loan it will not alter the cost of the asset. If the borrower defaults in repayment of a part of the loan, the cost of the asset will not change. What has to be borne in mind is that the cost of an asset and the cost of raising money for purchase of the asset are two different and independent transactions. Even if an asset is purchased with non-repayable subsidy received from the Government, the cost of the asset will be the price paid by the assessee for acquiring the asset. In the instant case, the allegation is that at the time of repayment of loan, there was a fluctuation in the rate of foreign exchange as a result of which, the assessee had to repay a much lesser amount than he would have otherwise paid. In our judgment, this is not a factor which can alter the cost incurred by the assessee for purchase of the asset. The assessee may have raised the funds to purchase the asset by borrowing but what the assessee has paid for it, is the price of the asset. That price cannot change by any event subsequent to the acquisition of the asset. In our judgment, the manner or mode of repayment of the loan has nothing to do with the cost of an asset acquired by the assessee for the purpose of his business. We hold that the questions were rightly

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., answered by the High Court. The appeals are dismissed. There will be no order as to costs. “ Thus, it is evident the variation in the loan amount has no bearing on the cost of the asset as the loan is a distinct and independent transaction as in comparison with acquisition of assets out of said loan amount borrowed. Actual cost of the corresponding fixed asset acquired earlier by utilizing the aforesaid loan will not undergo any change owing to such fluctuation. 10.7 The issue is also tested in the light of provision of S. 36(1)(iii) governing deduction of interest costs on borrowals. As stated earlier, manner of utilization of loan amount has nothing to do with allowability of any expenditure in connection with loan repayment. Both are independent and distinct transactions in nature. Similar analogy can be drawn from S. 36(1)(iii) of the Act which also reinforces that utilization of loan for capital account or revenue account purpose has nothing to do with allowablity of corresponding interest expenditure. A proviso inserted thereto by Finance Act, 2003, also prohibits claim of interest expenditure in revenue account only upto the date on which capital asset is put to use. Once the capital asset is put to use, the interest expenditure on money borrowed for acquisition of capital asset is also treated as revenue expenditure. As also noted, S. 43A specifically and categorically calls for adjustments in cost of assets for loss or gain arising out of foreign currency fluctuations in respect of funds borrowed in foreign currency for acquisition of foreign assets. However, the same rationale of a deeming provision of S. 43A cannot be applied to loss or gain arising from foreign currency loss utilized for purchase of indigenous assets. Needless to say, impugned currency fluctuation loss has emanated from foreign currency loans. Besides AS-11, the claim of exchange fluctuation loss as revenue account is also founded on the argument that the aforesaid action was taken to save interest costs and consequently to augment the profitability or reduce revenue losses of the assessee. The impugned fluctuation loss therefore has a direct nexus to the saving in interest costs without bringing any new capital asset into existence. Thus, the business exigencies are implicit as well explicit in the action of the Assessee. The argument that the act of conversion has served a hedging mechanism against revenue receipts from export also portrays commercial expediency. Thus, We are of the opinion that the plea of the assessee for claim of expenditure is attributable to revenue account has considerable merits. 10.8 Section 145 of the Income Tax Act deals with method of accounting and states that business income inter-alia has to be computed in accordance with cash or mercantile system of (A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., accounting. Sub-section (2) thereof authorizes the Central Government to notify accounting standards to be followed for determination of business income. Section 211 of the Companies Act also similarly casts a duty on a company to give a true and fair view of the profit and loss of the company for the financial year. It also requires the company to adhere the accounting standards for preparation of profit in the Profit & Loss Account and the Balance Sheet. A conjoint reading of section 145 of the Act and section 211 of the Companies Act leaves no room for doubt that the Assessee is obliged to follow the accounting standards prescribed to determine business income under the head “business or profession”. We notice that the Hon’ble Supreme Court in the case of Woodward Governor India (P) Ltd. (supra) has observed that AS-11 is mandatory in nature. In the light of observations made in Woodward Governor India (P) Ltd. (supra), we are of the view that loss arising on foreign exchange fluctuation loss has been rightly accounted for as a revenue expense in the Profit & Loss account in accordance with accounting fiat of AS-11. 10.9 We find that the decision in the case of Sutlej Cotton Mills Ltd. (supra) relied upon by the Ld. Departmental Representative is of no assistance to the Revenue. The Hon’ble Supreme Court therein stated the principle of law that where any profit or loss arises to an assessee on account of depreciation in foreign currency held by him on conversion from another currency, such profit and loss would ordinary be trading loss if the foreign currency held by the assessee on revenue account as trading asset or as a part of circulating capital embargo in business. However, if the foreign currency is held as a capital asset, the loss should be capital in nature. The aforesaid principle of law is required to be applied to the facts of case to determine whether the foreign currency is held by the assessee on revenue account or as a part of circulating capital. In the present case, fluctuation loss inflicted upon the assessee bears no nexus or relation to the acquisition to the assets. The action of the assessee is tied up to its underlying objective i.e. saving in interest costs, hedging its revenue receipts etc. which are undoubtedly on revenue account. Thus, the loss generated in impugned action bears the character of revenue expenditure. Similarly, decision of the Apex Court in the case of Tata Iron and Steel co. (supra) also weighs in favour of the assessee. We also note that reliance placed by the CIT(A) on Elecon Engineering Co. Ltd. (supra) is misplaced. The decision concerns applicability of S. 43A in the facts of that case and thus clearly distinguishable.

11. For the aforesaid reasons, in the absence of applicability of section 43A of the Act to the facts of the case and in the absence of any other provision of the Income Tax Act dealing with the issue,

(A.Y. 2013-14) M/s. Oil Tools International Services Pvt. Ltd., claim of exchange fluctuation loss in revenue account by the Assessee in accordance with generally accepted accounting practices and mandatory accounting standards notified by the ICAI and also in conformity with CBDT notification can not be faulted. No inconsistency with any provision of Act or with any accounting practices has been brought to our notice. Otherwise also, in the light of fact that the conversion in foreign currency loans which led to impugned loss, were dictated by revenue considerations towards saving interest costs etc. we have no hesitation in coming to the conclusion that loss being on revenue account is an allowable expenditure under S. 37(1) of the Act. The order of the CIT(A) sustaining the disallowance is not called for and is thus reversed. In the result, the Ground No.1 is allowed.”

Order pronounced in the open court on 30th January, 2023