2025 (8) TMI 1643 - AT - Income Tax

Hedge premium on forward contracts treated as revenue, disallowance deleted; only pre-use interest capitalisable under s.36(1)(iii)

Deep Energy Resources Ltd. [Formerly Deep Industries Ltd.] Versus Assistant Commissioner of Income-tax Circle – 1 (1) (2), Ahmedabad

Deep Energy Resources Ltd. [Formerly Deep Industries Ltd.] Versus Assistant Commissioner of Income-tax Circle – 1 (1) (2), Ahmedabad - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether premium paid for forward foreign-exchange contracts to hedge foreign-currency liability constitutes revenue expenditure deductible under section 37(1) (or otherwise allowable), or is capital in nature requiring capitalization under section 43A or by analogy to capital expenditure? 2. Whether the disallowance of forward contract premium in the assessment year under appeal can be sustained where an identical disallowance for an earlier assessment year was deleted by a Co-ordinate Bench of the Tribunal (principle of consistency and precedential effect within the same assessee's proceedings). ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of forward contract premium: revenue deductible expense v. capital expenditure Legal framework: The Court examined section 43A (adjustment of exchange fluctuation in respect of liabilities for acquisition of capital assets), section 37(1) (allowability of expenditure incurred wholly and exclusively for business), and section 36(1)(iii) (allowability of interest on borrowed capital and rules for capitalization up to acquisition/first put to use). Precedent Treatment: The Tribunal referenced its own earlier order in the assessee's case (coordinate bench) where the addition for the earlier year was deleted. The appellate authority below had relied on decisions and reasoning treating similar outlays as capital, but the Tribunal found those authorities distinguishable on facts. Interpretation and reasoning: The Tribunal reasoned that section 43A deals with adjustment of gain/loss on exchange in relation to the amount/ liability actually paid for imported capital assets and is concerned with adjusting the cost of the capital asset. Section 43A does not extend to costs incurred to secure against potential exchange fluctuation (i.e., premiums paid to obtain forward contracts). The Tribunal analogised the premium paid to an insurance premium taken to protect business operations or assets: such cost is incurred in the course of business and does not itself create a capital asset. Further, section 36(1)(iii) permits deduction of interest on borrowed capital used for business; only interest up to the acquisition/first put to use must be capitalized. Here, the AO had allowed interest on the foreign-currency loan as revenue expenditure, and the forward premium related to hedging exchange fluctuation on interest payments - not an amount that required capitalization as pre-acquisition interest. The CIT(A)'s conclusion that loans were for capital acquisition (plant and machinery) and hence the premium must be capitalized was rejected as a wrongful presumption unsupported by law or record. Ratio vs. Obiter: Ratio - Forward-contract premium paid to hedge foreign-currency liability is not governed by section 43A and, when incurred in the course of business to protect against exchange fluctuation, is akin to insurance and deductible under section 37(1) (or otherwise allowable), subject to facts. Obiter - Analogies to insurance and consistency considerations, while persuasive, are explanatory rather than separate binding propositions beyond the facts. Conclusion: The premium paid for forward cover in the facts of the case is revenue in nature and allowable as deduction; it is not to be capitalized under section 43A or as pre-use interest under section 36(1)(iii) where not attributable to the pre-use period. Issue 2 - Effect of earlier Tribunal decision deleting identical disallowance (precedential and consistency considerations) Legal framework: Principles of consistency in tax assessments and binding or persuasive effect of coordinate-bench decisions in the same assessee's series of assessments. Precedent Treatment: The Tribunal relied on its own coordinate-bench decision deleting the identical addition for A.Y. 2014-15, which had analyzed section 43A, section 37(1), and factual matrix and held the premium allowable. The appellate authorities' reliance on the earlier disallowance (by AO and CIT(A)) was the sole basis for repeating the addition in the year under appeal. Interpretation and reasoning: Because the present disallowance was made only because an identical disallowance had been made in the prior year (and sustained by lower authorities), and because the Tribunal in the earlier year-on the merits-deleted that addition, the Tribunal found no reason to sustain the current-year disallowance. The Tribunal treated the coordinate-bench decision in the same assessee's case as controlling on the same legal and factual issue, further reinforced by the separate merits analysis rejecting application of section 43A and supporting allowability under section 37(1). The Tribunal also noted consistency in prior revenue treatment in earlier years as a supporting factor. Ratio vs. Obiter: Ratio - Where a coordinate-bench of the Tribunal has decided an identical issue in the assessee's own case on the facts and law, a subsequent disallowance based solely on the existence of that earlier disallowance cannot be sustained; the earlier Tribunal decision is followed. Obiter - Observations distinguishing other case law cited below are explanatory. Conclusion: The earlier Tribunal order deleting the disallowance governs the present factually identical issue; therefore the present-year addition based on the prior-year disallowance is not maintainable and must be deleted. Overall Conclusion The forward-contract premium paid to hedge foreign-currency liability is revenue in nature and allowable (akin to insurance/ expenditure incurred wholly and exclusively for business). Section 43A does not apply to such hedging costs; capitalization under section 36(1)(iii) is not warranted on the facts because the premium did not relate to interest pre-acquisition. Additionally, a coordinate-bench decision of the Tribunal in the assessee's own case deleting an identical addition in an earlier year is followed; accordingly the addition of the forward premium is deleted and the appeal is allowed.