Foreign Exchange Fluctuation: A Discussion Based On Sec43A of The Income Tax Act 1961

FOREIGN
EXCHANGE
FLUCTUATION
A DISCUSSION BASED ON SEC43A OF THE INCOME TAX ACT 1961
Notwithstanding anything contained in any other provision of this Act,

1. Section 43A provides generally for modification
of the actual cost of the asset consequent on the
variation in exchange rate in the year in which the
increase or reduction in liability arises,
2. Section 43A applies only in respect of assets
acquired from a country outside India
through a loan in foreign currency or a foreign
suppliers credit
where an assessee has acquired any asset from a country

1
outside India
for the purposes of his business or profession and,

in consequence of a change in the rate of exchange at any time
2
after the acquisition of such asset ,

Section 43A shall
not apply where an asset is
purchased in India through a foreign
there is an increase or reduction in the liability of the assessee as
currency loan
expressed in Indian currency for making payment
3. This refer to a loss or gain due to changes in

forex rates , For eg , at the time of purchase of
machine the forex rate was 1 rupee = 40 $
(a) towards the whole or a part of the cost of the asset or
(b) for repayment of the whole or a part of the moneys borrowed by
And on the date of making payment the rupee

weakens, and the rate changes to 1 rupee = 45$.
him from any person, directly or indirectly, in any foreign currency
Then there will be a loss while making payment,

this loss or a gain is referred here in this section
specifically for the purpose of acquiring the asset along with

interest , if any
4. The adjustment referred

to in section 43A shall
be made only in the previous year in which actual

payment is made
5. If the liability is reinstated at the year end i.e on
st
31 march with the exchange rate prevailing on
st
31 march , the adjustment in the cost
/expenditure/CoA will not be made for the
Income Tax Purposes , adjustment can only be
made at the time of actual payment (see example
at the bottom)
Foreign
supplier
creditor
Repay the foreign currency loan
(being in either case, the liability existing immediately before the date
on which the change in the rate of exchange takes effect),
the amount by which the liability aforesaid is so increased or reduced

during the previous year shall be {added to, or, as the case may be,
deducted from},
i. the actual cost of the asset as defined in 43(1) or
Extra/less amount paid bcoz of changes in

forex rates will be adjusted from
WDV (as decided in Arvind Mills)

35(1)(iv) i.e capex on scientific research
will adjusted in the year in which
payment is made and as per the
provision of sec 35(1)(iv) , deduction in
respect of this capex is also allowed.
CoA of Non Depreciable Capital asset
ii. the amount of expenditure of a capital nature referred to 35(i)(iv)

iii. in the case of a capital asset (not being a capital asset referred to
in section 50),the cost of acquisition thereof 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.
Just for clarification purpose,
Explanation 1 : In this sub-section, unless the context otherwise requires, - (a) "Rate of
exchange" means the rate of exchange determined or recognised by the Central Government for
the conversion of Indian currency into foreign currency or foreign currency into Indian currency;
(b) "Foreign currency" and "Indian currency" have the meanings respectively assigned to them in
section 2 of the Foreign Exchange Regulation Act, 1947 (7 of 1947) 685 .
If the cost of the asset is met by any

other person , example Govt , then
such subsidy will be deducted from
the actual cost of the asset .
Explanation 2 : Where the whole or any part of the liability

aforesaid is
met, not by the assessee, but directly or indirectly, by
any other person or authority, the liability so met shall not be

taken into account for the purposes of this sub-section.
Explanation 3 : Where the assessee has entered into a contract
If hedging is done by entering into a

contract such as forward contract
then the difference between the
forex rate at which the asset was
purchased and the rate at which the
forward contract is done will be
adjusted at the time of making the
payment in the cost to the assessee
with an {686 authorised dealer as defined in section 2 of the Foreign Exchange

Regulation Act, 1947 (7 of 1947) 686a}
authorized dealer for providing
him with a specified sum in a foreign currency on or after a stipulated

future date at the
rate of exchange specified in the contract
to enable him to meet the whole or any part of the liability aforesaid,
the amount, if any, to be added to, or deducted from, 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 under this sub-section shall, in respect of so much of

the sum specified in the contract as is available for discharging the
liability aforesaid, be computed with reference to the rate of
exchange specified therein.
Example
Hypothetical facts
15.07.2011
-foreign Currency loan is taken for 100000$
15.07.2011
-Asset of 10000$ is purchases from a country outside India
15.07.2011
-Rate of Exchange 1$ = 50Rs.
31.03.2012
01.06.2012
-$50000 of loan repaid
01.06.2012
Depreciation for the previous year ending 31.03.2012 was Rs.500000

Following Adjustment and Entries will be made
15.07.2011
Entry of Purchase will be made
31.03.2011
Asset A/c
Dr.
50,00,000
To Forex Loan
50,00,000
No adjustment will be made , only depreciation will be adjusted , i.e WDV will be
5000000-500000 = 4500000 , (Closing WDV)
01.06.2012
Adjustment in WDV will be made to the extent of $50-$45 , i.e Rs.5/$ 50000$ = 250000.
i.e. now WDV stands to be 45,00,000 250000 = 42,50,000
31.03.2013
Depreciation will now be allowed on WDV of Rs.4250000
CASE LAWS
ARVIND MILLS LTD. Supreme Court Decision dt.10-121991
Relevant points for Sec 43A
ADJUSTMENT BECAUSE OF
FOREX FLUCTUATIONS WILL
BE ADJUSTED FROM WDV
Additional cost of repayment in terms of rupees because of Foreign

Exchange Rate Fluctuations should be considered as enhancing the
cost of the corresponding asset purchased.
The assessee will be able to get a higher amount of depreciation in
subsequent years on the basis of the revised cost Depreciation
must be provided on the additional cost according to the method
of depreciation normally employed by the company. The Supreme
Court held that as per Sec43A, the increase/decrease in liability at
the time of payment has to be adjusted from actual cost of the
asset. As per Supreme Court Actual Cost referred to in section
43A should be read as actual cost minus depreciation allowed till
date
ASSST. C.I.T., VADODARA Vs ELECON ENGINEERING CO.

LTD. Date of Judgment: Friday, February 26, 2010
ROLL OVER PREMIUM WILL BE

ADDED TO WDV
Roll Over Premium charges, (commonly understood as charges for

taking forward contract ) paid by the assessee in respect of foreign
exchange forward contract relating foreign currency loan taken by
assessee shall be added to the WDV of Block of assets as per sec
43A
Relevant Extract from the judgment (source: internet)

An alternative argument was advanced on behalf of the assessee that in
the event this Court holds that roll over charges are to be capitalized in
terms of Explanation 3 to Section 43A as it stood prior to assessment year
2003-04, then, in that event the Tribunal may be directed to grant
depreciation allowance on the written down value of the asset not only
for the concerned years but also for the subsequent years till the entire
value of the asset is written off. According to the assessee, such a
direction is required to be given because the depreciation, according to
the assessee, is available even for the assessment years after AY 1994-95.
On behalf of the assessee it was further submitted, as and by way of
alternative submission, that the Department may not be allowed to
charge interest or penalty as the issue involved is debatable
M/s Woodward Governor India Private Limited
Exchange Difference arising on

Foreign Currency Transactions have
to be recognized as income or as
expense in the period in which they
arise.
As per AS -11 , an enterprise has to

report the outstanding liability
relating to import of raw material
using closing rate of exchange . Any
Difference , loss or gain arising on
conversion of the said liability at the
closing rate should be recognized in
the profit & loss account for the
reporting period.
If an assessee converts the

outstanding liability relating to the
import of raw material using the
closing rate of exchange as on 31st
march i.e last day of the previous
year and such conversion results in a
loss , then such loss is allowable
under section 37(1) of the Income
Tax Act , 1961
The taxpayer filed its return of income for the Assessment Year
1998-99 after claiming a deduction of unrealized loss due to foreign
exchange fluctuation on the last date of the accounting year. The
Assessing Officer (AO) disallowed the aforesaid claim of the
taxpayer on the pretext that the liability as on the last date of the
previous year under consideration being a contingent liability was
not an ascertained liability and consequently it had to be added
back to the total income of the taxpayer. The order of the AO was
upheld by the Commissioner of Income-tax (Appeals) [CIT(A)]. The
Income-tax Appellate Tribunal ( the Tribunal) relying on its earlier
decision in the case of the taxpayer held that the claim of the
taxpayer for deduction of unrealised loss due to foreign exchange
fluctuation as on the last date of the previous year had to be
allowed. This decision of the Tribunal was upheld by the Delhi High
Court.
In view of the above, the appeals were filed by the tax department
before the SC.
Tax Departments Contentions

The claim of deduction by the taxpayer is under the provisions of
Section 37 of the Act, which is a residuary provision, since there is
no specific provision dealing with the adjustment based on foreign
exchange fluctuations on the revenue account.
Section 37 of the Act allows the deduction in respect of any
revenue expenditure which is laid out or expended, wholly for
business purpose. The expenditure is therefore, allowable only if it
is paid or gone out irretrievably from the taxpayers pocket.
The expression expenditure is what is paid out and something
which is gone irretrievably. The increase in liability at any point of
time prior to the payment cannot fall within the meaning of the
word expenditure in Section 37(1) of the Act. Further, the
requirement of money being expended or laid out is also not
satisfied and thus the additional liability arising on account of
fluctuation in foreign exchange rate is not deductible under Section
37(1) of the Act.
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Taxpayers Contentions
Under the mercantile system of accounting so followed by the
taxpayer, whenever an amount is credited to the account of a
payee, the liability stands incurred by the taxpayer even though the
amount is actually not paid reference in this regard, was drawn to
the definition of the word paid in Section 43(2) of the Act. The fact
that the tax department had taxed the gains on fluctuation as
income on the basis of accrual whilst disallowing the loss on a
similar basis, indicates the double standards adopted by the tax
department.
Section 145 of the Act ties down the AO to the accounting system
followed by the taxpayer. The AO, having accepted the accounting
system of the taxpayer in the past, cannot depart from the same,
without giving reasons for such departure.
The existence of a liability stands crystallised on the date of the
contract. It has nothing to do with the payment and valuation of
liability at a later date.
The SC Ruling
The expression any expenditure as occurring in Section 37 of the
Act, may in particular circumstances, cover an amount which is
really a loss, even though the said amount has not gone out from
the pocket of the taxpayer
Section 145 of the Act recognizes the right of a trader to adopt
either the cash system or the mercantile system of accounting. The
accounting method followed by an taxpayer continuously for a
given period of time needs to be presumed to be correct till the AO
comes to the conclusion for reasons to be given that the system
does not reflect true and correct profits.
Accounting Standard 11 stipulates effect of changes in exchange
rate vis--vis monetary items denominated in a foreign currency to
be taken into account for giving accounting treatment on the
balance sheet date.
The profit or loss arising to an taxpayer on account of
appreciation or depreciation in the value of foreign currency held
by it, on conversion into another currency, would ordinarily be a
trading profit or loss, if the foreign currency is held by the taxpayer
on revenue account
The SC, while accepting taxpayers contentions laid down the
following tests for any expenditure to be deductible

under the provisions of the Act:
Whether the system of accounting followed by the taxpayer is
mercantile system, which brings into debit the expenditure amount
for which a legal liability has been incurred before it is actually
disbursed and brings into credit what is due, immediately before it
becomes due and before it is actually received.
Whether the same system is followed by the taxpayer from the very
beginning and if there was a change in the system, whether the
change was bona fide.
Whether the taxpayer has given the same treatment to losses
claimed to have accrued and to the gains that may accrue to it.
Whether the taxpayer has been consistent and definite in making
entries in the account books in respect of losses and gains.
Whether the method adopted by the taxpayer for making entries in
the books both in respect of losses and gains is as per nationally
accepted accounting standards.
Whether the system adopted by the taxpayer is fair and reasonable
or is adopted only with a view to reducing the incidence of taxation.
RELEVANT DIAGR
DIAGRAMS
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FOREIGN

Notwithstanding anything contained in any other provision of this Act,

where an assessee has acquired any asset from a country

for the purposes of his business or profession and,

after the acquisition of such asset ,

not apply where an asset is

purchased in India through a foreign

there is an increase or reduction in the liability of the assessee as

expressed in Indian currency for making payment

3. This refer to a loss or gain due to changes in

(a) towards the whole or a part of the cost of the asset or

(b) for repayment of the whole or a part of the moneys borrowed by

And on the date of making payment the rupee

him from any person, directly or indirectly, in any foreign currency

Then there will be a loss while making payment,

specifically for the purpose of acquiring the asset along with

4. The adjustment referred

be made only in the previous year in which actual

Repay the foreign currency loan

the amount by which the liability aforesaid is so increased or reduced

Extra/less amount paid bcoz of changes in

WDV (as decided in Arvind Mills)

ii. the amount of expenditure of a capital nature referred to 35(i)(iv)

Just for clarification purpose,

If the cost of the asset is met by any

Explanation 2 : Where the whole or any part of the liability

met, not by the assessee, but directly or indirectly, by

any other person or authority, the liability so met shall not be

Explanation 3 : Where the assessee has entered into a contract

If hedging is done by entering into a

with an {686 authorised dealer as defined in section 2 of the Foreign Exchange

authorized dealer for providing

him with a specified sum in a foreign currency on or after a stipulated

rate of exchange specified in the contract

cost of the asset or the amount of expenditure of a capital

capital asset under this sub-section shall, in respect of so much of

-foreign Currency loan is taken for 100000$

-Asset of 10000$ is purchases from a country outside India

-Rate of Exchange 1$ = 50Rs.

-Rate of Exchange 1$ = 55Rs.

-$50000 of loan repaid

-Rate of Exchange 1$ = 45Rs.

Depreciation for the previous year ending 31.03.2012 was Rs.500000

Entry of Purchase will be made

Depreciation will now be allowed on WDV of Rs.4250000

Additional cost of repayment in terms of rupees because of Foreign

ASSST. C.I.T., VADODARA Vs ELECON ENGINEERING CO.

ROLL OVER PREMIUM WILL BE

Roll Over Premium charges, (commonly understood as charges for

Relevant Extract from the judgment (source: internet)

M/s Woodward Governor India Private Limited

Exchange Difference arising on

As per AS -11 , an enterprise has to

If an assessee converts the

Tax Departments Contentions

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The SC, while accepting taxpayers contentions laid down the

following tests for any expenditure to be deductible