Court Upholds Business Loss Claim on Forex Fluctuation, Dismisses Revenue’s Appeal

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Case Name

Principal Commissioner of Income Tax vs. HCL Comnet Systems & Services Ltd. (High Court of Delhi)

ITA 81/2021

Date: 24th March 2021

Key Takeaways

• Foreign exchange losses arising from currency fluctuations can be claimed as business losses if specific conditions are satisfied.
• The Supreme Court’s decision in Commissioner of Income-tax, Delhi vs. Woodward Governor India (P.) Ltd., [2009] 312 ITR 254 (SC) is the key precedent, setting out six conditions for such claims.
• The Revenue cannot raise new arguments on appeal if they were not raised before lower authorities.
• The court emphasized consistency in accounting treatment: if gains from forex fluctuations are taxed, losses should also be allowed.
• The appeal was dismissed, reinforcing the principle that notional losses, if accounted for properly, are deductible.

Issue

Can a taxpayer claim a deduction for notional losses arising from foreign currency fluctuations as a business loss under the Income Tax Act, 1961, when the accounting treatment is consistent and in line with established legal principles?

Facts

• The assessee (HCL Comnet Systems & Services Ltd.) claimed a deduction for losses due to foreign currency fluctuations, treating them as business losses.
• The Assessing Officer (AO) disallowed this claim, arguing that such losses are notional and not allowable.
• The ITAT ruled in favor of the assessee, allowing the deduction.
• The Revenue appealed to the High Court under Section 260A of the Income Tax Act, 1961, raising several questions of law, including the treatment of foreign exchange losses.
• The Revenue relied on CBDT Instruction No. 3 of 2010 and argued that not all conditions from the Supreme Court’s Woodward Governor India (P.) Ltd. judgment were met.
• The assessee countered that all conditions were satisfied and pointed out that gains from forex fluctuations had been taxed in earlier years.

Arguments

Revenue (Tax Department)

• The loss from foreign currency fluctuation is not a real loss but a notional one, and thus not allowable as a business deduction.
• The conditions set by the Supreme Court in Woodward Governor India (P.) Ltd. were not fully met, specifically regarding consistency in accounting treatment.
• Cited CBDT Instruction No. 3 of 2010 to support their position.
• Relied on the Karnataka High Court’s decision in Commissioner of Income-tax, Central Circle vs. Wipro Finance Ltd., [2013] 351 ITR 153 (Karnataka).

Assessee (HCL Comnet Systems & Services Ltd.)

• All six conditions from the Supreme Court’s Woodward Governor India (P.) Ltd. judgment were satisfied.
• The company consistently followed the same accounting method, and both gains and losses from forex fluctuations were treated similarly.
• The Revenue had taxed gains from forex fluctuations in earlier years, so it would be unfair to disallow losses now.
• The ITAT and CIT(A) had already examined and accepted the assessee’s position.

Key Legal Precedents

1. Commissioner of Income-tax, Delhi vs. Woodward Governor India (P.) Ltd., [2009] 312 ITR 254 (SC)

• Established that notional losses from foreign exchange fluctuations can be claimed as business losses if certain conditions are met.
• Laid down six conditions for such claims, including consistency in accounting and treatment of gains and losses.

2. Commissioner of Income-tax, Central Circle vs. Wipro Finance Ltd., [2013] 351 ITR 153 (Karnataka)

• Reiterated the importance of consistent accounting treatment and the need to offer gains to tax if losses are claimed.

3. Section 260A of the Income Tax Act, 1961

• Governs appeals to the High Court on substantial questions of law.

4. CBDT Instruction No. 3 of 2010

• Provided administrative guidance on the treatment of notional losses.

Judgement

• The High Court found that the Assessing Officer had not raised any concerns about the fulfillment of the Supreme Court’s conditions in the lower proceedings.
• The court noted that the assessee had consistently followed the same accounting method and that gains from forex fluctuations had been taxed in earlier years.
• The court held that the Revenue could not raise new arguments at the High Court stage that were not raised before the CIT(A) or ITAT.
• The court dismissed the Revenue’s appeal, confirming that the loss from foreign currency fluctuation is allowable as a business loss, provided the established conditions are met.
• The appeal was dismissed, and the ITAT’s decision in favor of the assessee was upheld.

FAQs

Q1: What are the six conditions from the Woodward Governor India (P.) Ltd. case?

A1:

1. The assessee follows the mercantile system of accounting.
2. The same system is followed from the beginning, or any change is bona fide.
3. Gains and losses from forex fluctuations are treated the same way.
4. Consistent and definite entries are made in the books for both gains and losses.
5. The method aligns with nationally accepted accounting standards.
6. The system is fair and reasonable, not just for tax reduction.

Q2: Why did the court dismiss the Revenue’s appeal?

A2: Because the Revenue did not raise the issue of non-fulfillment of the Supreme Court’s conditions before the lower authorities, and the assessee had met all the required conditions.

Q3: Does this mean all notional losses from forex fluctuations are deductible?

A3: Not automatically. The taxpayer must meet the six conditions set by the Supreme Court and show consistent accounting treatment.

Q4: What is the significance of this judgment?

A4: It reinforces that notional losses from forex fluctuations can be claimed as business losses if the taxpayer’s accounting is consistent and in line with legal precedents.

Q5: What happens next for the parties?

A5: The assessee can claim the deduction for the forex loss, and the Revenue cannot challenge this unless new, substantive grounds are raised in the future.

1. This appeal is directed against the order dated 16.10.2019 passed by the Income Tax Appellate Tribunal [hereafter referred to as the ‘Tribunal’] rendered in ITA 4808/Del/2016 concerning the assessment year [in short

‘AY’] 2010-2011.

2. The appeal is preferred under Section 260A of the Income Tax Act,

1961 [in short ‘the Act’]. In this appeal, which is, instituted by the revenue, the following substantial questions of law have been suggested for being framed and adjudicated upon by this Court:

“a) Whether in the facts and circumstances of the case and in

law, ITAT misinterpreted the scope of Section 14A(1) of

the Act and errored in holding that Section 14(A) can

only be invoked if the Respondent has earned exempted

income during the assessment year ignoring the fact that

Section 14A doesn’t lay down such requirement and the

only precondition for invoking Section 14A is that there

must be “expenditure incurred in relation to such income

which does not form part of the total income under this

Act”?

b) Whether in the facts and circumstances of the case and in

law, ITAT errored in interpreting the Circular No. 5 of

2014 of the CBDT which clarifies the true scope and

meaning of Section 14A of the Act?

c) Whether in the facts and circumstances of the case and in

law, ITAT failed to appreciate that the AO, having regard

to the accounts of the Respondent, was not justified with

the correctness of such claim of the Respondent in

respect of such expenditure in relation to income which

does not form part of the total income under this Act?

d) Whether in the facts and circumstances of the case and in

law, ITA'T errored in deciding upon the true nature of the

license fee paid to the Department of telecommunication

by the assessee, which clearly established that the

expenditure was a capital expenditure and wrongly relied

upon the decision in CIT V Bharti Hexacom Limited 221

Taxman 323(Delhi)?

e) Whether in the facts and circumstances of the case and in

law, ITAT errored in holding that the exemption under

section 10A of the Act should not be computed after

excluding telecommunication expenses and foreign

currency expenditure from the export turnover?

f) Whether in the facts and circumstances of the case and in

law, ITAT erred in deleting the disallowance of unrealized foreign exchange loss on account of reinstatement of assets and liabilities of

Rs.15,97,25,873/- ignoring the fact that this is a notional

loss and not allowable to be set off against the taxable

income in view of the CBDT’s instruction no. 3 of 2010

dated 23.03.2010?”

3. Insofar as the first three questions of law i.e. (a), (b) and (c), as

suggested by the revenue, are concerned, Mr. Raghvendra Kishore

Singh, who appears for the revenue, fairly submits that they are

covered by the judgement of the coordinate Bench of this Court

rendered in Joint Investments (P.) Ltd. vs. Commissioner of Income-

tax, [2015] 372 ITR 694 (Delhi).

4. As regards the fourth question of law, that is set out in clause

(d) above, as suggested by the revenue, is concerned, once again, Mr.

Singh submits that the same is covered by the judgement of the

coordinate Bench of this Court in Commissioner of Income-tax vs.

Bharti Hexacom Ltd., [2014] 221 Taxman 323 (Delhi).

5. We may also indicate that the Tribunal in its order has referred

to the view taken in the assessee’s case in respect of an earlier AY (i.e.

AY 2007-2008).

5.1. The Tribunal rendered its order in respect of the said assessment

year on 15.01.2015. This order was passed in ITA 4546/Del./

2013.The order passed was in favour of the assessee.

6. Likewise, insofar as the fifth question of law, that is set out in

clause (e) above, as suggested by the revenue, is concerned, the same,

according to Mr. Singh, is covered by the judgement of the Supreme

Court rendered in Commissioner of Income-tax, Central - III vs.

HCL Technologies Ltd., [2018] 404 ITR 719 (SC).

7. Insofar as the sixth question of law, that is set out in clause (f)

above is concerned, as would be evident upon a perusal of the

question of law suggested by the revenue, it appears to be the

revenue’s contention that the disallowance of loss on account foreign

fluctuation should not have been deleted by the Tribunal in view of

CBDT’s instruction no. 3 of 2010, dated 23.03.2010.

8. Besides this, Mr. Singh submits that although, the principle

enunciated by the Supreme Court in Commissioner of Income-tax,

Delhi vs. Woodward Governor India (P.) Ltd., [2009] 312 ITR 254

(SC) would apply, what ought to have been considered by the

authorities below was whether or not the six conditions adverted to in

the said judgement were, in fact, fulfilled.

8.1 In support of this view, Mr. Singh has relied upon the

judgement of the Division Bench of the Karnataka High Court in

Commissioner of Income-tax, Central Circle vs. Wipro Finance Ltd.,

[2013] 351 ITR 153 (Karnataka).

8.2. Mr. Singh says that two out of the six conditions have not been

fulfilled by the assessee. These being:

“(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;

(iv) Whether the assessee has been consistent and definite in

making entries in the account books in respect of losses and

gains.”

9. Mr. Ajay Vohra, learned senior counsel, who appears on advance

notice on behalf of the assessee, emphatically states that all the conditions stipulated in Woodward Governor India (P.) Ltd. (supra) by the Supreme Court stand fulfilled.

9.1 In support of his contention, Mr. Vohra has drawn our attention to the

relevant paragraphs of the order passed by the Commissioner of Income Tax

(Appeals). In particular, he has drawn our attention to the contentions raised by the assessee before the CIT(A) concerning this issue and the discussion qua the same by the CIT(A).

9.2 Mr. Vohra goes on to say that the Tribunal has noticed the findings of

fact returned by the CIT(A), and thereafter concluded that both on principle

and on facts, the judgment of the Supreme Court rendered in Woodward

Governor India (P.) Ltd. (supra) would apply.

10. Having heard the counsel for the parties and perused the record, we

find that the assessing officer has raised no concern as to the non-fulfilment of the conditions stipulated in the judgment of the Supreme Court rendered in Woodward Governor India (P.) Ltd. (supra).

10.1. As a matter of fact, the argument made before us by Mr. Singh does

not find mention in the proceedings preferred either before the CIT(A) or the Tribunal. The record shows that the CIT(A) after perusing the record and

hearing the contentions raised before him has made the following

observations:

“(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

(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 in appellant's own case for AY 2009-10,

while disallowing the loss is important shall amount to 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 been approved by the Hon. Supreme Court in the case of

CIT vs Woodward Governor India Pvt Ltd 312 ITR 254.

Respectfully, following the order of the Hon. Supreme Court in

312 ITR 254 the decided in favour of the appellant. The AO is

directed to allow the consequential relief”

10.2. We may also add that in the appeal filed before us, no such ground

has been taken as is articulated across the bar by Mr. Singh.

10.3. What is important is that in the AY 2009-2010, on account of

fluctuation in the currency, the gain, which accrued to the assessee, was,

concededly, offered to tax. As a matter of fact, the judgment of the

Karnataka High Court relied upon by Mr. Singh uses this indicia almost as a

litmus test to ascertain as to whether conditions stipulated in Woodward

Governor India P. Ltd. (supra) stand fulfilled. For the sake of convenience,

the relevant observations made by the Karnataka High Court in Wipro

Finance Ltd. (supra) are extracted hereafter:

“4. The view taken by the Supreme Court in this judgment is to

the effect that while even a notional loss can be claimed by way

of a business loss and as a deductible item in computing the

income of the assessee for the year, as it is a computation on

notional basis, it is made dependent on the manner of conduct

of the assessee in respect of the earlier assessment period

and particularly as to the assessee has been following this

uniformly over a period of years and the test being when there

was a notional gain as to whether it had been offered for tax

etc. The Supreme Court took the view that such claim can be

entertained subject to fulfillment of the following six conditions:

(i) whether the system of accounting followed by the

assessee is the 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 is as per nationally accepted accounting standards;

(vi) whether the system adopted by the assessee is fair

and reasonable or is adopted only with a view to

reducing the incidence of taxation.”

11. Given these circumstances, we have to remind ourselves that the

power invested in this Court under Section 260A of the Act is to adjudicate

upon the substantial question(s) of law. The revenue, having not laid an

edifice concerning the purported non-fulfilment of any of the conditions,

stipulated by the Supreme Court in Woodward Governor India P. Ltd.

(supra), cannot, for the first time, without even taking a ground in the

instant appeal, argue before us that the loss which accrued to the assessee on account of the foreign currency fluctuation cannot be claimed by it as a

business loss.

11.1. Therefore, for the reasons stated hereinabove, we are not inclined to

admit the question of law set out either in clause (f) or any of the other

clauses, i.e., (a) to (e). As noticed hereinabove questions of law, as

suggested in clause (a) to (e) are no longer res integra insofar as this Court is concerned.

12. Given the aforesaid position, we are not inclined to entertain the

appeal. The appeal is, accordingly, dismissed.