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TMI Blog2009 (4) TMI 4X X X X Extracts X X X X X X X X Extracts X X X X ..... two categories. In the first category, we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of Sections 28, 29, 37(1) and 145 of the Income-tax Act, 1961 ("1961 Act"). In the second category of cases, we are concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of Section 43(1), 43A (both, before and after Amendment vide Finance Act, 2002). Facts in M/s Woodward Governor India P. Ltd. [Civil Appeal arising out of SLP(C) No. 593/08] REVENUE ACCOUNT CASE: 5. The assessee filed its Return of Income on 28.1.1998 for the assessment year 1998-99 on a total income of Rs. 1,10,28,190.00. That return was processed under Section 143(1)(a) on 23.3.1999. On 16.8.1999 a notice under Section 143(2) was issued to the assessee stating that in the cours ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ility at any point of time prior to payment cannot fall within the meaning of the word "expenditure" in Section 37(1). Therefore, according to the learned counsel, the requirement of expenditure is not met in this case. According to the learned counsel, similarly the requirement of money being "expended or laid out" is also not satisfied and thus additional liability arising on account of fluctuation in foreign exchange rate is not deductible under Section 37(1). 7. Shri C.S. Aggarwal, learned senior counsel appearing for M/s Woodward Governor India P. Ltd. (Civil Appeal arising out of S.L.P.(c) No. 593/08), submitted that the assessee had debited a sum of Rs. 41,06,748.00 to its P&L account of which a sum of Rs. 29,49,088.00 stood for the unrealized loss due to foreign exchange fluctuation. According to the learned counsel, the assessee has been following mercantile system of accounting. According to the learned counsel, under mercantile system of accounting, which is also known as accrual system of accounting, whenever the amount is credited to the account of the payee (creditor) liability stands incurred by the assessee even though the amount is actually not paid. I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore, as a corollary, the Department has to allow deduction in the year in which the assessee incurs business loss on account of the increase in the dollar rate. Therefore, according to the learned counsel, there is no warrant for interfering in the impugned judgment of the High Court. 9. Shri S. Ganesh, learned senior counsel appearing for M/s Maruti Udyog Ltd. (Civil Appeal arising out of SLP (c) No. 18967/08), adopted the argument advanced by Shri C.S. Aggarwal. In addition, he pointed out that the assessee had maintained its accounts right from 1985 on accrual system of accounting. He submitted that during the assessment years 1985-86 to 1989-90 loss claimed was allowed. It was pointed out on facts that the assessee borrowed loans in dollar and yen. It was pointed out that in the assessment year 1990-91, the dollar rate stood increased but the yen rate stood reduced resulting in gain, which was offered as income and which was accordingly taxed. But when it came to the year in question, namely, assessment year 1991-92, in which year there was a loss on account of fluctuation in the foreign exchange rate, the Department has taken a contradictory stand that accrual of liability i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vious years whenever the dollar rate stood reduced, the Department had taxed the gains which accrued to the assessee on the basis of accrual and it is only in the year in question when the dollar rate stood increased, resulting in loss that the Department has disallowed the deduction/debit. This fact is important. It indicates the double standards adopted by the Department. 11. The dispute in this batch of civil appeals centers around the year(s) in which deduction would be admissible for the increased liability under Section 37(1). 12. We quote hereinbelow Section 28(i), Section 29 Section 37(1) and Section 145 of the 1961 Act, which read as follows: Profits and gains of business or profession: Section 28 : "The following income shall be chargeable to income-tax under the head "Profits and gains of business or profession", - (i) the profits and gains of any business or profession which was carried on by the assessee at any time during the previous year." Income from profits and gains of business or profession, how computed: Section 29: "The income referred to in section 28 shall be computed in accordance with the provisions contained in sections 30 to 43D." General: Sectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in presenti and a liability de futuro. The word "expenditure" is not defined in the 1961 Act. The word "expenditure" is, therefore, required to be understood in the context in which it is used. Section 37 enjoins that any expenditure not being expenditure of the nature described in Sections 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head "profits and gains of business". In Sections 30 to 36, the expressions "expenses incurred" as well as "allowances and depreciation" has also been used. For example, depreciation and allowances are dealt with in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L account the value of the stock-intrade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading Section 37(1) with Section 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the Rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ertained as on the last date of the accounting year and not as on any intermediate date between the commencement and the closing of the year, failing which it would not be possible to ascertain the true and correct state of affairs. No gain or profit can arise until a balance is struck between the cost of acquisition and the proceeds of sale. The word "profit" implies a comparison between the state of business at two specific dates, usually separated by an interval of twelve months. Stock-in-trade is an asset. It is a trading asset. Therefore, the concept of profit and gains made by business during the year can only materialize when a comparison of the assets of the business at two different dates is taken into account. Section 145(1) enacts that for the purpose of Section 28 and Section 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with Section 28. Therefore, Section 145(1) is attracted to the facts of the present case. Under the mercantile system of accounting, what is due is brought into credit before it is actually received; it brings into debit an expenditure f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sing rate. In case of revenue items falling under Section 37(1), para 9 of AS-11 which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under Section 43A of the 1961 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-11 recognises exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-à-vis the Indian rupee, there is an expense during that period. The important point to be noted is that AS-11 stipulates effect of changes in exchange rate vis-à-vis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Therefore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted accounting standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation. Facts in M/s Honda Siel Power Products Ltd. [Civil Appeal arising out of SLP(C) No. 7632/08] CAPITAL ACCOUNT CASE: 22. The main issue which arises for determination in this batch of civil appeals is: whether the assessee was entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance sheet date pending actual payment of the varied liability. In this batch of civil appeals, we are concerned with increase in the existing liability on account of foreign exchange fluctuations on "capital account". 23. Before coming to the arguments, we quote hereinbelow Section 43A, as it stood prior to 1.4.2003: "43A. Special provisions consequential to changes in rate of exchange of currency — (1) Not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... text otherwise requires - (1) "actual cost" means the actual cost of the assets to the assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority." 26. Shri Parag Tripathi, learned Additional Solicitor General appearing on behalf of the Department, submitted that in Section 43A (as it stood prior to Finance Act, 2002) the expression "for making payment" is in the context of increase or decrease of liability and the same hinges on "making the payment towards the whole or a part of …". According to the learned counsel, the expression "towards the whole or a part of" makes it clear that Section 43A as it stood referred to whole or a part of the payment and therefore to the point of payment. According to the learned counsel, under the pre-amended Section 43A, the effect of increase or decrease of liability arose only at the point of payment because the point of accrual shifted to the point of payment. In this connection, learned counsel urged that the difference between accrual and payment of a liability is that normally the point of accrual and the point of payment represent two different time milestones. Ho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Mills Ltd. reported in 193 ITR 255. 29. To answer the controversy, we need to analyse Section 43A (unamended). The period in question in the batch of Civil Appeals is prior to Finance Act, 2002, therefore, we are required to consider the scope of Section 43A (unamended). 30. Section 43A starts with a non obstante clause. Section 43A(1) overrides the other provisions only as regards cases falling under that sub-section. For instance, in a case where the asset is acquired, or the liability to pay in foreign exchange arises, after the change in the rate of exchange, the said sub-section has no application and the general principles of law must be applied in deciding whether the actual cost is increased or reduced as a result of such change. In other words, Section 43A(1) applies only where as a result of change in the rate of exchange there is an increase or reduction in the liability of the assessee in terms of the Indian rupee to pay the price of any asset payable in foreign exchange or to repay moneys borrowed in foreign currency specifically for the purpose of acquiring the asset. Section 43A(1), therefore, has no application unless the asset is acquired and the liability exist ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n foreign currency and for, inter alia, depreciation to be allowed with reference to such increased/decreased cost. This position is also made clear by Circular No. 5-P dated 9.10.1967 issued by CBDT. One more point needs to be mentioned. Section 43A (unamended) corresponds to para 10 of AS-11 similarly providing for adjustment in the carrying cost of fixed assets acquired in foreign currency, due to foreign exchange fluctuation at each balance sheet date. The relevant para reads as follows: "10. Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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