CIT vs. Woodward Governor (Supreme Court)

Foreign Exchange fluctuation losses are allowable on accrual basis

Where the assessee carrying on the mercantile system of accounting claimed that:

(i) The additional liability arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes was allowable as deduction u/s 37(1) in the year of fluctuation in the rate of exchange and not in the year of repayment of such loans; and

(ii) The actual cost of imported assets acquired in foreign currency is entitled to be adjusted u/s 43A (prior to the amendment by the FA 2002) on account of fluctuation in the rate of exchange at each balance sheet date, pending actual payment of the varied liability HELD approving the claim that:

(a) The term “expenditure” in s. 37 covers an amount which is a “loss” even though the said amount has not gone out from the pocket of the assessee. The “loss” suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure u/s 37(1) ;

(b) Profits and gains are required to be computed in accordance with commercial principles and accounting standards (AS-11);

(c) Accounts and the accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till the AO comes to the conclusion for reasons to be given that the system does not reflect true and correct profits;

(d) The fact that the department taxed the gains on fluctuation on the basis of accrual while disallowing the loss is important and indicates the double standards adopted by the Department;

(e) U/s 43A (pre-amendment), the change in the rate of exchange subsequent to the acquisition of asset triggers the adjustment in the actual cost of the assets. Actual payment of the liability as a consequence of the exchange variation is not required. The amendment of s. 43A by the FA 2002 w.e.f. 1.4.2003 is not clarificatory.

Note: The judgement of the ITAT Special Bench in ONGC vs. ITO 83 ITD 151 has the unique distinction of being affirmed by the Delhi High Court in Woodward Governor 294 ITR 451 and being reversed (after being termed “perverse”) by the Uttaranchal High Court in CIT vs. ONGC 301 ITR 415. With the present verdict of the apex court, the judgement of the Special Bench stands approved and that of the Uttaranchal High stands impliedly overruled.