Facts

The assessee-company had debited to its profit and loss account certain unrealized loss due to foreign exchange fluctuation in foreign currency transaction on revenue items, on the last date of the accounting year. The Assessing Officer held that the liability as on the last date of the previous year under consideration was not an ascertained liability, but a contingent liability and, consequently, it had     to be added back to the total income of the assessee. The Commissioner upheld   the assessment order. The Tribunal allowed the claim, which was affirmed by the High Court [2007] 294 ITR 451 (Delhi) (HC).

Issue

Whether the fluctuation loss suffered by assessee on account of foreign exchange difference as on date of balance sheet is an item of expenditure under section 37(1)?

View

The term ‘expenditure’ in section 37 not defined in the Act and therefore, has to understood contextually. It 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 under section 37(1). Further, profits and gains are required to be computed in accordance with commercial principles and accounting standards (AS-11). 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;

Held

The Supreme Court on affirming the judgment of the High Court held:

• The word ‘expenditure’, which is not defined in the Act, has to be understood in the context in which it is used. The said expression may,  in the circumstances of a particular case, cover an amount which is really   a ‘loss’, even though said amount has not gone out from the pocket of the

• Accounting Standards, which are continuously adopted by an assessee, can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under section 145(3), the method   of accounting undertaken by the assessee continuously is supreme. In the instant case, there was no finding given by the Assessing Officer on the correctness or completeness of the accounts of the assessee. Equally, there was no finding given by the Assessing Officer stating that the assessee  had not complied with the Accounting Standards. As per AS 11, any difference, loss or gain arising on conversion of the said liability at the closing rate, should be recognized in the profit and loss account for the reporting
• The following factors have to be taken into account in order to find out if an expenditure is deductible:

“(i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment  to losses claimed to have accrued and to the gains  that  may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains;

(v) whether the method adopted by the assessee  for making entries in the books both in respect of losses and gains as per accepted Accounting Standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reduce the incidence of taxation.”

Thus, loss suffered by the assessee on account of fluctuation in the rate of foreign exchange as on the date of the balance sheet is an item of expenditure under section 37(1) of the Act. (AY. 1998-99) (CA Nos. 2206 & 2214 of 2009

1. 8-4-2009)

   Editorial: This judgment has been followed by various High Courts some of which are as under:

   Ramamurthy v. DCIT (2011) 15 taxmannn.com 57 (Mad) (HC) CIT v. Bharat Hotels (2016) 380 ITR 552 (Delhi) (HC)

   Ballarpur Industries Ltd. v. CIT (2017) 84 taxmann.com 61 (Bom) (HC)

    

   “The real love is to love them that  hate you, to love your neighbor even though youdistrust him.”

   – Mahatma Gandhi