Tax Tribunal: Forex & Derivative Losses on ECB Loans Recognized as Legitimate Business Expenses.

The Tribunal allowed the assessee's appeal, directing the deletion of additions made by the A.O. concerning foreign exchange losses on the ECB loan and losses on derivative contracts. The Tribunal determined that the foreign exchange loss was a trading loss, allowable as revenue expenditure under Section 37, and that the 'Marked to Market loss' on derivative contracts was not notional and thus allowable. The Tribunal's decision was based on precedents set in CIT vs. Woodward Governor India (P.) Ltd. and Cooper Corporation (P.) Ltd. vs. Dy. CIT, concluding that both losses were legitimate business expenditures.

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Issues Involved:
1. Disallowance of foreign exchange losses on ECB loan.
2. Adjustment on account of loss on derivative contracts.

Issue-wise Detailed Analysis:

1. Disallowance of Foreign Exchange Losses on ECB Loan:

Facts:
The assessee, a company engaged in manufacturing and trading activities, filed its return of income for the Assessment Year (A.Y.) 2015-16. The Assessing Officer (A.O.) made an upward adjustment of Rs. 2,28,62,345/- on account of foreign exchange losses on ECB loan. The assessee had availed an ECB loan from Canara Bank to refinance existing rupee borrowings. The loan was not used for acquiring fixed assets but to reduce borrowing costs, and the foreign exchange loss incurred was amortized over the loan period.

A.O.'s Stand:
The A.O. treated the foreign exchange loss as a capital loss, arguing it should be capitalized to the cost of the asset and is not allowable under Section 37 of the Income Tax Act. The A.O. relied on the Supreme Court decision in Sutlej Cotton Mills Ltd. vs. CIT, which distinguishes between trading loss and capital loss based on the nature of the foreign currency usage.

Assessee's Contention:
The assessee argued that the interest paid, including exchange differences, is not directly linked to asset acquisition and should be considered revenue expenditure. They contended that the loss was incurred for business activities and should be allowed under Section 37. The assessee cited the Supreme Court decision in CIT vs. Woodward Governor India (P.) Ltd., which supports the treatment of foreign exchange fluctuation loss as revenue loss under the mercantile system of accounting.

Tribunal's Findings:
The Tribunal observed that the loan was not utilized for acquiring assets but for reducing interest costs. The A.O. did not provide evidence to counter this. The Tribunal concluded that the foreign exchange loss is a trading loss and allowable as revenue expenditure under Section 37, following the principles laid out in CIT vs. Woodward Governor India (P.) Ltd. and Cooper Corporation (P.) Ltd. vs. Dy. CIT. The Tribunal directed the deletion of the addition made by the A.O.

2. Adjustment on Account of Loss on Derivative Contracts:

Facts:
The assessee entered into derivative contracts for interest and principal currency swaps, converting Rs. 100 crores into dollar loans. The contracts were valued at year-end, and 'Marked to Market losses' were recorded in the profit and loss account. The A.O. disallowed the loss of Rs. 29,28,34,962/-, treating it as notional and contingent.

Assessee's Contention:
The assessee argued that the derivative contracts were valued as per accounting standards, and the losses were actual and allowable. They cited the Supreme Court decision in CIT vs. Woodward Governor India (P.) Ltd. and other cases, which support the allowance of 'Marked to Market losses' even if they are not actual losses.

A.O.'s Stand:
The A.O. relied on CBDT Board Instruction No. 3/2010 and the Supreme Court decision in Sutlej Cotton Mills Ltd., treating the losses as capital and not allowable.

Tribunal's Findings:
The Tribunal held that the 'Marked to Market loss' is not notional and is allowable expenditure. They noted that the transaction is a hedging transaction and falls under the exception to Section 43(5) of the Act, which deals with speculative transactions. The Tribunal directed the A.O. to allow the loss while computing the income of the assessee.

Conclusion:
The appeal filed by the assessee was allowed, with the Tribunal directing the deletion of additions made by the A.O. on both accounts of foreign exchange losses on ECB loan and losses on derivative contracts. The order was pronounced in the open court on 17.02.2023.

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