Deduction allowed for forward contract losses on currency swap of foreign borrowings, crystallized on contract date under accrual accounting

HC upheld the ITAT, ruling the taxpayer was entitled to deduct losses on forward contracts used to swap foreign currency borrowings into rupees in AY 1995-96. The court found the liability and corresponding expenditure crystallized on the date of the forward contract under accrual accounting, so the difference between the forward and spot rates was allowable in that year. While revenue expenditure is normally allowed in the year incurred, the court noted spreading requested by the taxpayer is permissible only where matching principles and continuing business benefit are satisfied. Decision for the assessee against the revenue.

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Issues Involved:
1. Entitlement of the assessee to claim deduction of Rs. 67.06 crores incurred in connection with swapping of foreign currency funds in the assessment year 1995-96.

Issue-wise Detailed Analysis:

1. Entitlement to Claim Deduction of Rs. 67.06 Crores:
Background and Facts:
The assessee, a financial institution, engaged in making loans and advances, raised foreign currency borrowings and swapped these into Indian rupees to meet its lending requirements. The foreign currencies were repayable on future dates, and the assessee entered into forward contracts with banks to safeguard against foreign currency fluctuations. The difference between the forward contract rate and the exchange rate on the transaction date amounted to Rs. 67.06 crores, which the assessee claimed as a deductible expense in the assessment year 1995-96.

Assessing Officer's (AO) Decision:
The AO disallowed the claim of Rs. 67.06 crores, arguing that the expenditure pertained to future periods and not the assessment year in question. The AO considered the expenditure as capital in nature and allowed only Rs. 1,466.55 lakhs, which was charged to the profit and loss account during the year.

Commissioner of Income-tax (Appeals) [CIT(A)] Decision:
The CIT(A) upheld the AO's decision, agreeing that the expenditure did not relate to the current assessment year.

Income-tax Appellate Tribunal (ITAT) Decision:
The ITAT allowed the assessee's appeal, overturning the AO's decision and permitting the deduction of Rs. 67.06 crores in the assessment year 1995-96.

Revenue's Argument:
The revenue argued that under the mercantile system of accounting, only expenditures accrued during the year were allowable. They cited the Supreme Court's judgment in Madras Industrial Investment Corpn. Ltd. v. CIT, which discussed the matching concept, suggesting that expenditure should be spread over the period it benefits.

Assessee's Argument:
The assessee contended that the liability for the swapping cost was crystallized at the time of entering into the forward contract, making it an accrued liability, not a contingent one. They cited several judgments, including Calcutta Co. Ltd. v. CIT and Bharat Earth Movers v. CIT, to support that an accrued liability should be deductible in the year it arises, even if the payment is to be made in the future.

Court's Analysis:
The Court examined various precedents, including Calcutta Co. Ltd. v. CIT, Metal Box Co. of India Ltd. v. Their Workmen, and Bharat Earth Movers v. CIT, which established that an accrued liability, even if to be discharged in the future, is deductible in the year it arises under the mercantile system of accounting. The Court noted that the forward contract created a definite, ascertainable liability at the time of entering the contract, making it an allowable expense in the year of the contract.

Conclusion:
The Court concluded that the ITAT correctly allowed the deduction of Rs. 67.06 crores in the assessment year 1995-96. The swapping cost incurred by the assessee was determined at the time of the forward contract's execution, and the liability crystallized in that year. The revenue's argument for spreading the expenditure over subsequent years was rejected, affirming that the ordinary rule is to allow revenue expenditure in the year it is incurred unless the assessee opts for spreading it, which was not the case here.

Judgment:
The appeal was dismissed with costs, and the question was answered in favor of the assessee and against the revenue.

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