Loss on forex from capital-account loans can be revenue expense under s.37(1); s.43A amendment is prospective

SC held that, for assessment years prior to 1 April 2003, an assessee maintaining mercantile accounts and following ICAI standards may treat loss from foreign-exchange fluctuation on capital-account loans as revenue expenditure under s.37(1) and adjust the cost of imported capital assets at each balance-sheet date pending actual payment. The Court ruled the Finance Act 2002 amendment to s.43A is prospective, and under the unamended s.43A actual payment was not a condition precedent for adjustment. All appeals were allowed and the impugned orders set aside.

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Issues Involved:
1. Deduction of additional liability due to exchange rate fluctuations under Section 37(1) of the Income Tax Act, 1961.
2. Adjustment of the actual cost of imported capital assets due to exchange rate fluctuations under Section 43A of the Income Tax Act, 1961.

Detailed Analysis:

Issue 1: Deduction of Additional Liability Due to Exchange Rate Fluctuations under Section 37(1)
The primary question was whether additional liability arising from exchange rate fluctuations on loans taken for revenue purposes could be deducted under Section 37(1) in the year of fluctuation or only upon repayment.

The Assessee, a public sector undertaking engaged in petroleum exploration, revalued its foreign exchange loans and claimed the fluctuation difference as a revenue loss under Section 37(1). The Assessing Officer allowed the deduction only for loans repaid within the year, disallowing claims for loans repayable after the accounting year.

The Commissioner of Income Tax (Appeals) upheld the Assessing Officer's decision, treating the liability as notional. However, the Income Tax Appellate Tribunal (ITAT) allowed the Assessee's claim, noting the consistent mercantile accounting system and prior acceptance of similar claims.

The High Court reversed ITAT's decision, deeming the foreign exchange loss as contingent and not allowable under Section 37(1). The Supreme Court, referencing CIT v. Woodward Governor India P. Ltd., concluded that the loss due to exchange rate fluctuations, when accounts are maintained on a mercantile basis, is deductible under Section 37(1) even if the liability is not discharged within the year.

Issue 2: Adjustment of Actual Cost of Imported Capital Assets under Section 43A
The second question was whether the Assessee could adjust the actual cost of imported capital assets for exchange rate fluctuations at each balance-sheet date, pending actual payment.

The Assessing Officer disallowed such adjustments for loans repayable after the accounting year. The Commissioner of Income Tax (Appeals) allowed the adjustment for increased liability under Section 43A, which the ITAT upheld.

The High Court disagreed, stating Section 43A applies only to liabilities due per written agreements, which were not provided by the Assessee.

The Supreme Court, again referencing Woodward Governor, clarified that under the unamended Section 43A, adjustments are triggered by exchange rate changes, not actual payment. The amendment effective from April 1, 2003, requiring actual payment, was deemed prospective. Thus, for the relevant assessment years, the Assessee could adjust the cost of imported assets for exchange rate fluctuations at each balance-sheet date.

Conclusion
The Supreme Court allowed the appeals, setting aside the High Court's orders. It held that:
1. The loss due to exchange rate fluctuations is deductible under Section 37(1) when accounts are maintained on a mercantile basis.
2. The Assessee is entitled to adjust the actual cost of imported capital assets for exchange rate fluctuations at each balance-sheet date under the unamended Section 43A.

Both questions were answered in favor of the Assessee, with each party bearing its own costs.

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