ITAT upholds forex loss as deductible business expense and allows carry forward of losses under section 79
ITAT Delhi dismissed Revenue's appeal, upholding CIT(A)'s allowance of the assessee's foreign exchange fluctuation loss as a deductible business expenditure. The Tribunal held that the loss was not merely notional and distinguished the precedents in Sanjeev Woollen Mills (SC) and Bechtel India (ITAT Delhi) as factually different. Relying on Woodward Governor (SC) and Sutlej Cotton Mills (SC), it confirmed the treatment of forex loss. ITAT further upheld CIT(A)'s decision permitting carry forward of losses under section 79, noting no change in shareholding post-amalgamation, following AMCO Power Systems (Karnataka HC).
1. ISSUES PRESENTED AND CONSIDERED
1.1 Whether foreign exchange fluctuation loss arising on reinstatement of outstanding creditors and debtors at year-end is a deductible business expenditure under section 37 when the loss is "unrealized" on the balance sheet date.
1.2 Whether carry forward of business losses of earlier assessment years is barred by section 79 on account of substantial change in shareholding pursuant to amalgamation, when ultimate beneficial ownership remains the same and there is no change in shareholding between the year of loss and the year under appeal.
2. ISSUE-WISE DETAILED ANALYSIS
Issue 1: Deductibility of foreign exchange fluctuation loss on reinstatement of creditors and debtors
Legal framework (as discussed)
2.1 The Assessing Officer treated the foreign exchange loss as "unrealized", "notional" and contingent, relying on:
(a) Section 37, permitting deduction only of accrued or ascertained liabilities and not contingent or unascertained losses.
(b) Instruction No. 17/2008 dated 26-11-2008 of CBDT, clarifying that contingent liabilities and unascertained losses are not allowable as deduction.
(c) Judicial precedents: the principle in Sanjeev Woollen Mills that notional loss which has not been incurred cannot be allowed; and Oriental Motor Car Co. P. Ltd., holding that only a "certain" liability arising in the present can be debited even under mercantile accounting.
2.2 The appellate authority and the assessee relied on the Supreme Court decision in Woodward Governor India (P.) Ltd., which identified key factors for allowability of foreign exchange loss under mercantile system and in accordance with Accounting Standards.
Interpretation and reasoning
2.3 The Assessing Officer reasoned that:
(a) The loss of Rs. 2,89,12,346/- arose due to revaluation of foreign currency items (reinstatement of creditors and debtors) as on the reporting date and hence represented "periodic unrealized loss", not actually incurred.
(b) Such loss is merely due to variation in fair value of financial instruments; actual loss or gain can only be determined on expiry or termination of the underlying contracts.
(c) Reporting such mark-to-market loss in compliance with ICAI guidelines does not make it deductible under the Income-tax Act because the liability has not crystallized.
(d) Applying Sanjeev Woollen Mills, notional income cannot be taxed and correspondingly notional loss cannot be allowed; therefore, the foreign exchange loss is not deductible.
2.4 The Commissioner (Appeals), relying on Woodward Governor India (P.) Ltd., examined whether the conditions prescribed therein were met, namely:
(a) The assessee follows mercantile system of accounting consistently.
(b) The treatment of foreign exchange losses is consistent with the treatment of foreign exchange gains (both recognized on the same basis).
(c) Entries are passed in accordance with nationally accepted Accounting Standards, particularly AS-11 and ICDS VI.
(d) The system adopted is fair and reasonable and not tailored solely to reduce tax incidence.
2.5 The Commissioner (Appeals) accepted the assessee's submission that:
(a) The loss was not on account of mark-to-market valuation of speculative or derivative contracts, but due to reinstatement of trade creditors and debtors outstanding as on 31 March.
(b) The assessee recognized foreign exchange loss in accordance with AS-11 and ICDS VI and consistently offered foreign exchange gains to tax whenever earned.
(c) All factors laid down by the Supreme Court in Woodward Governor were satisfied, making such loss a real business loss under mercantile accounting, notwithstanding that it was "unrealized" in cash terms on the balance sheet date.
2.6 Before the Tribunal, the assessee distinguished:
(a) Sanjeev Woollen Mills as dealing with a change in method of valuation of closing stock to enhance profit eligible for deduction under section 80HHC, factually different from year-end foreign currency reinstatement of trade items.
(b) Bechtel India (P.) Ltd. as relating to forward contracts settled by actual delivery through export receivables with no additional outgo beyond the contracted rate, again factually different from the present case of reinstatement of creditors and debtors.
2.7 The Tribunal noted that:
(a) The Commissioner (Appeals) had applied the test laid down in Woodward Governor India (P.) Ltd.
(b) The Revenue did not bring any contrary material on record to dislodge the factual findings that the assessee followed mercantile system, complied with AS-11/ICDS VI, and consistently offered foreign exchange gains to tax.
Conclusions
2.8 The Court held that the foreign exchange fluctuation loss on reinstatement of outstanding creditors and debtors at year-end, accounted for under mercantile system in accordance with AS-11 and ICDS VI and consistently with the treatment of gains, is an allowable business expenditure under section 37 even if "unrealized" on the balance sheet date.
2.9 The disallowance of Rs. 2,89,12,346/- on account of foreign exchange fluctuation loss was rightly deleted by the Commissioner (Appeals), and no infirmity was found in that decision.
Issue 2: Applicability of section 79 to deny carry forward of losses after change in shareholding due to amalgamation
Legal framework (as discussed)
2.10 Section 79 restricts carry forward of losses in the case of closely held companies where there is a change in shareholding, unless on the last day of the previous year in which the loss is to be set off, shares carrying not less than 51% of the voting power are beneficially held by the same persons who held them in the year in which the loss was incurred.
2.11 The Assessing Officer invoked section 79 on the ground that 97% of shares changed in the financial year 2015-16 and therefore losses of assessment years 2014-15 and 2015-16 could not be carried forward.
2.12 The Commissioner (Appeals) and the assessee relied on:
(a) The principle that section 79 focuses on beneficial ownership of voting power, as recognized in the decision in Amco Power Systems Ltd., which emphasized that the stress is on beneficial ownership and on preventing acquisition of a loss-making company merely to utilize past losses.
(b) The concept of "appointed date" and effective date of amalgamation as explained by the Supreme Court in Marshall Sons & Co. (India) Ltd. and Intas Pharmaceuticals Ltd., whereby, once the scheme is sanctioned, the transfer and other consequences relate back to the appointed date.
(c) The Delhi High Court decision in Yum Restaurants (India) Private Limited, cited by the Revenue, which rejected "piercing the veil" to treat the holding company as beneficial owner in absence of any agreement or arrangement establishing such beneficial ownership.
Interpretation and reasoning
2.13 The Assessing Officer's reasoning was:
(a) There was a substantial change (97%) in shareholding in financial year 2015-16.
(b) Consequently, in terms of section 79, business losses of assessment years 2014-15 and 2015-16 were not eligible for carry forward.
2.14 The Commissioner (Appeals) recorded the assessee's shareholding structure as follows:
(a) Prior to amalgamation, 99.98% of the share capital of the assessee company was held by Air Liquide Global E & C Solutions India (P.) Ltd.
(b) Post amalgamation, 97.79% of the shares were held by Air Liquide International France.
(c) In both situations, the ultimate holding company and ultimate beneficial owner remained the same, namely L'Air Liquide SA.
2.15 Relying on Amco Power Systems Ltd., the Commissioner (Appeals) held that:
(a) Section 79 stresses on "beneficially held" voting power, not merely on the immediate registered shareholder.
(b) The mischief sought to be prevented is acquisition of shares by a new owner solely to obtain the benefit of set off of past business losses.
(c) Where the ultimate beneficial ownership remains with the same group/company, and there is only an internal restructuring or amalgamation within the same group, the restrictive condition of section 79 is not attracted in substance.
2.16 Before the Tribunal, the assessee further argued that:
(a) The amalgamation was effective from the "appointed date" 01.04.2013, as per the order of the High Court, although the order itself was passed later.
(b) In light of Marshall Sons & Co. (India) Ltd. and Intas Pharmaceuticals Ltd., once the amalgamation is sanctioned, it is deemed to be effective from the appointed date and the legal consequences, including shareholding, are reckoned from that date.
(c) The losses in question related to assessment years 2014-15 to 2016-17, and there was no change in shareholding after 31.03.2014 relevant to assessment year 2014-15; thus, between the year of loss and the year of set off, the shareholding pattern, viewed in terms of ultimate beneficial ownership, remained the same.
(d) The Delhi High Court decision in Yum Restaurants (India) Private Limited was distinguishable because in that case there was nothing to show any agreement or arrangement under which the holding company was the beneficial owner of the shares; hence, "piercing the veil" was declined. In the present case, the restructuring within the same ultimate parent (L'Air Liquide SA) ensured continuity of beneficial ownership.
2.17 The Tribunal noted that:
(a) The Commissioner (Appeals) had accepted that ultimate beneficial ownership of more than the requisite voting power continued with the same ultimate parent before and after amalgamation.
(b) The Revenue did not produce any contrary material to show that beneficial ownership had changed or that the restructuring was undertaken to exploit past losses.
(c) The categorical findings in the order of the Commissioner (Appeals), supported by the cited case law, remained uncontroverted.
Conclusions
2.18 The Court held that, in the facts of intra-group amalgamation where the ultimate holding company and ultimate beneficial ownership of the assessee company's shares remained unchanged, and where there was no change in shareholding between the year in which the losses were incurred and the year under appeal (reckoned with reference to the appointed date of amalgamation), section 79 did not operate to bar the carry forward of losses.
2.19 The direction of the Commissioner (Appeals) to allow carry forward of losses for assessment years 2014-15 and 2015-16 was upheld, and the denial of carry forward under section 79 by the Assessing Officer was found unsustainable.
2.20 Consequently, the entire appeal of the Revenue, encompassing both the foreign exchange loss disallowance and the denial of carry forward of losses under section 79, was dismissed.
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