The issue before the Supreme Court

Whether the assessee was entitled to claim deduction for foreign exchange losses on account of foreign currency translation? In other words, whether loss arising on account of foreign currency translation is allowable as deduction or not and conversely whether the gains on account of foreign currency translation is to be treated as a receipt liable to tax.

Contention of the Department:

Department contended that the assessee borrows in USD and repays in the same currency for the preparation of the Balance Sheet. The loans, according to the Department, were stated at prevalent exchange rates and the loss so arrived at was charged to the P&L account. Therefore, according to the Department, the said loss was a book entry and it was not an actual loss in the foreign exchange caused to the assessee.

Decision of the Apex Court

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Section 42 of the 1961 Act was enacted to ensure that where the structure of the PSC was at variance with the accounting principles generally used for ascertaining taxable income, the provisions of the PSC would prevail. Section 42 provides for deduction on expenditure incurred on prospecting for or extraction or production of mineral oil whereas Section 44 BB contains special provision for computing profits and gains in connection with the business of exploration or extraction or production of mineral oils. The Head Note itself indicates that Section 42 is a special provision for deduction on expenditure incurred on prospecting, extraction or production of mineral oils.

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Before concluding, we may point out that on behalf of the Department, great emphasis was placed on clause 3.2 of Appendix `C' annexed to the PSC which inter alia referred to costs not recoverable and not allowable under the Contract (PSC). In the said clause it was stated that exchange losses on loans or other financing would not be admissible for deduction. We find no merit in this argument advanced on behalf of the Department. As stated above, "Cash Call" is not a loan. It is a contribution made into the Account of the Operator by each co-venturer in USD. Clause 3.2 of Appendix `C' refers to loans borrowed by an assessee or loans which are financed on which the assessee has to pay interest. Interest costs incurred by the assessee on such loans is not allowable under clause 3.2 of Appendix `C' to the PSC. That clause is not applicable for cash call/contribution. It may be noted that PSC is a special regime. It does not come under Accounting Standard 11. Note 12 annexed to the Accounts for the year ending 31.3.1999 refers to carrying costs of fixed assets financed through loans. This Note refers to the P&L account of EOGIL. It is a comment regarding the 2nd tier whereas clause 1.6.1 of Appendix `C' to the PSC refers to tier 1. If one keeps in mind the concept of PSC being a separate regime and if one keeps in mind the concept of cash call being an investment and not a loan then the entire controversy stands resolved. In this case, we are concerned with foreign currency transaction under which all monetary balances were required to be translated at the exchange rates prevailing as on the last date of the accounting year (balance sheet date) and accordingly the resultant translation gains/losses were required to be recognized which is referred to in Note 1(d) to Schedule R, annexed to the Accounts for the year ending 31.3.1999. 

Assessee is entitled to claim deduction for foreign exchange losses on account of foreign currency translation?

 

(For full text of judgment - visit: - 2008 -TMI - 30581 - SUPREME COURT)

Foreign currency translation losses treated as deductible when arising from cash call contributions under production-sharing contracts. Where co-venturer contributions under a production-sharing contract are treated as Cash Call investments rather than loans, foreign currency translation differences arising from translating monetary balances at balance-sheet exchange rates are recognised in profit and loss; clause 3.2 of Appendix C disallowing exchange losses on loans does not apply to cash call contributions, so such translation losses are deductible and translation gains are treated as receipts.