Forex loss reimbursement held not taxable u/s28(iv); s.40(a)(iii) remanded; s.37 disallowance finally deleted as reversed (iii)

ITAT Bangalore allowed the assessee's appeal in part. It held that reimbursement received from an associated enterprise towards foreign exchange fluctuation loss on repayment of external commercial borrowing, being a monetary receipt, is not taxable as business income under s. 28(iv), and directed deletion of the addition. On the disallowance under s. 40(a)(iii) relating to payments made to a foreign entity under a secondment arrangement, ITAT set aside the issue to the AO for fresh adjudication after examining the agreement, invoices and employee relationships. On the disallowance under s. 37 concerning a reversed provision earlier disallowed, ITAT accepted the assessee's claim and deleted the addition.

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1. ISSUES PRESENTED AND CONSIDERED

1.1 Whether reimbursement in cash of foreign exchange fluctuation loss on repayment of External Commercial Borrowing is taxable as "benefit or perquisite" under section 28(iv) of the Act.

1.2 Whether payments routed through a foreign entity in connection with seconded employees to Indonesia attract disallowance under section 40(a)(iii) for failure to deduct tax at source, and the need for further factual examination.

1.3 Whether reversal of a provision for expenses, which had been fully disallowed in the year of creation under section 40(a)(ia), can again be brought to tax under section 37 on the ground that tax was not deducted at source.

1.4 Effect of non-pressing of grounds relating to a general challenge to the assessment order and disallowance under section 37, and the consequential/premature nature of grounds on interest under section 234B and initiation of penalty.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Taxability under section 28(iv) of reimbursement of foreign exchange fluctuation loss on ECB

(a) Legal framework (as discussed)

2.1 The Court examined section 28(iv) of the Act in light of the judicial interpretation that for a "benefit or perquisite" to be taxable thereunder, it must be "other than in the shape of money". Reliance was placed on the decisions of the Supreme Court in Mahindra and Mahindra Ltd. and of the High Court in IG Petrochemicals Ltd., including the discussion on the Finance Act, 2023 amendment to section 28.

(b) Interpretation and reasoning

2.2 The assessee had availed ECB for capital purposes; unrealised forex losses on restatement in earlier years were suo motu disallowed as capital in nature and not claimed as deduction. On repayment in the relevant year, a net realised forex loss was incurred and, as per agreement, reimbursed in full by the associated enterprise.

2.3 The assessee reduced the reimbursement from taxable income on the basis that: (i) the underlying losses had never been claimed as deduction, and taxing the reimbursement would cause double taxation; (ii) the ECB related to a capital asset and the reimbursement was capital in nature; and (iii) the receipt was a pure reimbursement in cash, without income element or benefit/perquisite.

2.4 The Assessing Officer treated the reimbursement as a benefit taxable under section 28(iv), relying on a High Court decision concerning waiver of liability.

2.5 The Court found that the receipt in question was in the "shape of money" and therefore fell outside the ambit of section 28(iv) as interpreted by the Supreme Court. The Court further noted that the forex loss had never been allowed as a deduction and the reimbursement did not contain any profit or income element.

(c) Conclusion

2.6 The reimbursement of foreign exchange fluctuation loss on repayment of ECB, being a monetary receipt without embedded income and relating to an expense never allowed as deduction, is not taxable under section 28(iv) of the Act. The addition was directed to be deleted.

Issue 2: Disallowance under section 40(a)(iii) on payments routed through Indonesian entity for seconded employees

(a) Legal framework (as discussed)

2.7 The Court considered section 40(a)(iii), which disallows deduction of salaries payable outside India or to a non-resident unless tax is deducted at source, read with section 9(1)(ii) regarding income under the head "Salaries" deemed to accrue or arise in India. The India-Indonesia DTAA Article 15 (Dependent Personal Services) was also reproduced and examined by the Assessing Officer for context.

(b) Interpretation and reasoning

2.8 The assessee seconded its employees to Indonesia and entered into an agreement with an Indonesian entity to sponsor work permits/visas and to pay local salaries and social security charges. The assessee reimbursed these costs and also paid a 15% service fee to the Indonesian entity, without withholding tax.

2.9 The Assessing Officer, based on the secondment agreement and factual control, held that: (i) the assessee remained the real employer; (ii) the Indonesian entity merely acted as a paying conduit; and (iii) salaries paid abroad to seconded employees, being chargeable under "Salaries", attracted TDS; failure to deduct tax warranted disallowance under section 40(a)(iii).

2.10 The DRP agreed that the assessee had management and supervisory control over seconded employees and upheld application of section 40(a)(iii).

2.11 Before the Court, the assessee contended that: (i) payments were made to a third-party foreign entity and not to employees; (ii) no employer-employee relationship existed between the assessee and the Indonesian entity; (iii) services were rendered outside India; and (iv) therefore section 9(1)(ii) and section 40(a)(iii) could not apply. Authorities were cited to support these propositions.

2.12 The Court observed that although the Assessing Officer had referred to the secondment agreement and invoices, the DRP did not examine the agreement or the detailed written submissions. The precise nature of the relationship (who is the real employer, to whom the payments are effectively made, whether the sums are chargeable to tax in India) required proper factual verification.

(c) Conclusion

2.13 The disallowance under section 40(a)(iii) was set aside and the matter remanded to the Assessing Officer for fresh examination. The assessee was directed to produce the secondment agreement, invoices, and all relevant evidence to establish: (i) the true employer-employee relationship; and (ii) whether the amounts paid to the Indonesian entity are chargeable to tax in India. The Assessing Officer is to re-decide the issue in accordance with law after such examination.

Issue 3: Taxability of reversal of provision for expenses earlier disallowed under section 40(a)(ia)

(a) Legal framework (as discussed)

2.14 The Court considered the interaction of section 37 (allowability of business expenditure) with section 40(a)(ia) (disallowance for failure to deduct tax at source) in the context of a provision that had already been fully disallowed in a prior year.

(b) Interpretation and reasoning

2.15 The assessee had created a provision for professional and contractor charges in an earlier year and, since tax was not deducted at source, had voluntarily disallowed the entire provision under section 40(a)(ia) in that year.

2.16 In the year under appeal, part of the provision was utilised for actual expenditure on which TDS was duly deducted and remitted; the balance, no longer required, was reversed. As the provision had never been allowed as a deduction (having already been disallowed in the earlier year), the assessee excluded the reversal from income.

2.17 The Assessing Officer nevertheless added the reversed amount to income, and the DRP upheld the addition, on the ground that tax had not been deducted at source on the original provision.

2.18 The Court noted that the provision had already suffered disallowance in the year of creation; consequently, its subsequent reversal did not represent income, as there had been no prior allowance of the expenditure and no tax benefit earlier claimed or granted.

(c) Conclusion

2.19 The reversal of the provision, which had been fully disallowed in the earlier year under section 40(a)(ia), is not chargeable to tax in the present year. The addition was directed to be deleted.

Issue 4: Non-pressed, consequential and premature grounds

2.20 The general ground challenging the assessment order and the ground relating to disallowance of provision for expenses under section 37 were expressly not pressed; both were dismissed without adjudication on merits.

2.21 The ground relating to interest under section 234B was treated as consequential and the ground concerning initiation of penalty proceedings as premature; both were dismissed on that basis.

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