PHARMABASE INDIA P.LTD,MUMBAI vs. DCIT 13(1)(2), MUMBAI

The first issue to be decided in this appeal is as to whether the ld. CIT(A) was justified in confirming the disallowance of foreign exchange fluctuation loss of Rs.2,92,79,250/- arising out of re-statement of External Commercial Borrowings (ECB) at the year end rates in accordance with Accounting Standard – 11 (AS-11) prescribed by the Institute of Chartered Accountants of India (ICAI). The interconnected issue involved therein is as to whether the ld. CIT(A) was justified in confirming the disallowance of foreign exchange loss above by holding that it is capital expenditure and cannot be allowed as deduction u/s.37(1) of the Act.

We have heard rival submissions. At the outset, we find that the assessee had borrowed ECB in earlier years and had restated the same at the exchange rate prevailing at the end of the year and had incurred exchange fluctuation loss thereon during the year in the sum of Rs.2,92,79,250/-. This was debited to the profit and loss account by the assessee under the head “Finance Charges” as is evident in Note No.23 of the Balance Sheet as on 31/03/2012. In other words, since assessee is not paying any interest on the said ECB, in view of the huge exchange fluctuation risk undertaken by the assessee, the assessee pursuant to its renegotiation with its foreign lender had resorted to treat the exchange fluctuation loss as finance charges (i.e. interest). It is not in dispute that the foreign lender had also agreed to the fact of not charging any interest on the ECB advanced by them to the assessee. Hence, it could be safely concluded that the difference in exchange rate resulting in exchange fluctuation loss would partake the character of interest liability for the assessee. It is not in dispute that the ECB loan availed by the assessee was utilised for capital expenditure by the assessee. It is not in dispute that the loan has been utilised for the purpose of business of the assessee in the earlier years. During the year the only movement in the M/s. Pharmabase India Pvt. Ltd., ECB is with regard to exchange fluctuation loss arising due to re- statement at the year end exchange rates in accordance with AS-11 issued by ICAI which is mandatorily to be complied with by the assessee as per Section 211(3C) of the companies Act, 1956. The assessee had debited this exchange loss in its P & L account in the sum of Rs.2,92,79,250/- and claimed the same as deduction in the return of income. The ld. AO held that the ECB was used for capital purposes by the assessee, the exchange loss arising there from would also take the character of capital expenditure and accordingly disallowed the same u/s.37(1) of the Act. The ld. AO had not granted depreciation of foreign exchange loss even though the same was treated as capital in nature. The ld. AO also applied the provisions of Section 43A of the Act in support of his contentions. We find that the ld. CIT(A) had observed that the provisions of Section 43A of the Act are not applicable to the facts of the instant case as admittedly the assets were purchased by the assessee only in India and not from abroad. We find that both the ld. AO as well as the ld. CIT(A) had observed that the exchange fluctuation loss arising due to re-statement of ECB loan at the year end exchange rates is only a notional loss and not actual loss. In this regard, we hold that it is mandatory on the part of the assessee company to comply with the requirements of AS-11 issued by ICAI which mandates re-statement of foreign currency assets and liabilities at the exchange rate prevailing at the end of the year and correspondingly debit / credit the exchange fluctuation loss / gain thereon, as the case may be, in the profit and loss account of the assessee company. We find that the assessee company had duly complied with AS-11 issued by ICAI in this regard. We also find from the tabulation furnished in page 72 of the paper book that assessee had been earning exchange gain and had been incurring exchange loss due to re-statement of ECB loan at the year end rates from A.Y.2007-08