Year-end foreign-exchange loss measured at closing rate deductible under Section 37; Section 43A amendment prospective from 1-4-2003

HC held that increase in liability from foreign-exchange fluctuation measured at the exchange rate prevailing on the last day of the financial year is allowable as a deduction under Section 37 and is not merely notional or contingent. ICAI accountancy standards require reworking cost with reference to the year-end rate; capital-account items paid before fluctuation may be revalued for cost, depreciation or investment allowance accordingly. The amendment to Section 43A was held to be prospective from 1-4-2003 (per CBDT), so prior judicially accepted practice remains operative. Appeals decided for the assessee against Revenue.

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Issues Involved:
1. Whether the alleged increase in liability due to foreign exchange fluctuation as per the exchange rate prevailing on the last day of the financial year is merely notional and cannot be allowed as a deduction.
2. The applicability of Section 43-A of the Income Tax Act, 1961, before and after its amendment effective from 1-4-2003.
3. The impact of foreign exchange fluctuation on revenue and capital accounts.
4. The concept of accrual under the mercantile system of accounting.
5. The principle of consistency in tax assessments.

Issue-wise Detailed Analysis:

1. Increase in Liability Due to Foreign Exchange Fluctuation:
The court examined whether the increase in liability due to foreign exchange fluctuation is merely notional and thus not allowable as a deduction. The assessee contended that, consistent with Section 43-A of the Income Tax Act, 1961, prior to its amendment effective from 1-4-2003, such fluctuations should alter the cost of the asset and be reflected in the year they occur. The Revenue argued that no actual liability accrues until payment is due and that such liabilities are contingent or notional.

2. Applicability of Section 43-A:
The court analyzed the applicability of Section 43-A before and after its amendment. Before the amendment, the section allowed the reworking of the cost of the asset due to foreign exchange fluctuations. The amendment effective from 1-4-2003 changed the timing and method of accounting for such fluctuations, making it prospective. The court held that the amendment is not retrospective and should be applied from the specified date.

3. Impact on Revenue and Capital Accounts:
The court differentiated between the impact of foreign exchange fluctuations on revenue and capital accounts. For revenue accounts, the court affirmed that such fluctuations should be treated as business expenditure and allowable under Section 37, even if the liability is not discharged within the year. For capital accounts, the cost of the asset should be reworked for purposes of depreciation or investment allowance based on the rate prevailing on the last day of the financial year in which the fluctuation occurs.

4. Concept of Accrual under Mercantile System of Accounting:
The court reiterated the importance of the mercantile system of accounting, which recognizes liabilities and income when they accrue rather than when they are paid or received. The court emphasized the need to follow accounting standards prescribed by the Institute of Chartered Accountants of India (ICAI), which require provisions for all known liabilities and losses.

5. Principle of Consistency:
The court highlighted the principle of consistency, noting that the Revenue should not contradict its stand in successive assessment years for the same assessee. The court cited several cases where the Revenue had accepted the assessee's claims in previous years and held that the same treatment should be applied consistently.

Judgment Summary:
The court concluded that the increase in liability due to foreign exchange fluctuation as per the exchange rate prevailing on the last day of the financial year is allowable as a deduction and is not merely notional or contingent. The court affirmed the decisions of the ITAT and other High Courts that have consistently held in favor of the assessee on this issue. The amendment to Section 43-A is prospective and does not apply retrospectively. The principle of consistency was upheld, ensuring that the Revenue cannot change its stance arbitrarily in successive assessment years. The appeals by the Revenue were dismissed, and the substantial question of law was answered in favor of the assessee.

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