2009 (9) TMI 877 - HC - Income Tax

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 ... Entitlement to claim deduction of expenditure incurred by way of forward contracts in connection with swapping of foreign currency funds for augmenting the rupee funds required by it for its business - Held that:- ITAT rightly held that the assessee was entitled to claim deduction incurred in connection with swapping of foreign currency funds in the year under consideration, i.e., the assessment year 1995-96. It is clear from the nature of the transaction, that the assessee had raised foreign currency borrowings and swapped such foreign currency into Indian rupees in order to augment its rupee resources for meeting its lending requirements. The foreign currencies borrowed were repayable to the foreign lenders on later dates falling within the current previous year ending on 31-3-1995 and in some cases falling in the next previous year relevant to subsequent assessment year. In order to ensure that it is able to repay the foreign lenders in the foreign currency on their respective due dates of repayments, the assessee had entered into forward contracts as a safeguard against foreign currency fluctuations. It is the difference between the forward contract rate and the exchange rate on the date of transaction which was claimed as deduction in that very year. The test laid down in Bharat Earth Movers’ [2000 (8) TMI 4 - SUPREME COURT] case to treat it as business expenditure in the same year, though part of the liability occurs on a future date, is allowable as expenditure in this very year. It was a debt owed by the assessee, which accrued on the date of entering into the forward contract itself, though as per the contract, part payment was to be made in succeeding years. The expenditure under the accrual system of accounting had, thus, crystallized on the date of the contract. The first thing which is to be noticed is that though the entire expenditure was incurred in that year, it was the assessee who wanted the spread over. The Court was conscious of the principle that normally revenue expenditure is to be allowed in the same year in which it is incurred, but at the instance of the assessee, who wanted spreading over, the Court agreed to allow the assessee that benefit when it was found that there was a continuing benefit to the business of the company over the entire period. Normally the ordinary rule is to be applied, namely, revenue expenditure incurred in a particular year is to be allowed in that year. Thus, if the assessee claims that expenditure in that year, the Income-tax department cannot deny the same. However, in those cases where the assessee himself wants to spread the expenditure over a period of ensuing years, it can be allowed only if the principle of matching concept is satisfied, which up to now has been restricted to the cases of debentures. The upshot of the aforesaid discussion is to answer the question in favour of the assessee and against the revenue 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.