Foreign exchange fluctuation loss deemed trading loss, not capital loss, in export business

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Case Name:

Commissioner of Income Tax Vs Taiko Chander Nagar Chemicals (P) Ltd. (High Court of Delhi)

ITA 897/2007

Date: 23rd October 2007

Key Takeaways

1. Foreign exchange fluctuations affecting advance payments for future exports can be treated as trading losses.

2. The nature of the foreign currency holding (revenue account vs. capital asset) determines whether the resulting profit or loss is trading or capital in nature.

3. Accounting standards and practices play a crucial role in determining the treatment of such losses.

Issue

The central legal question in this case was: Should the loss incurred by the assessee (Taiko Chander Nagar Chemicals) due to foreign exchange rate fluctuations be considered a trading loss on revenue account or a capital loss?

Facts

1. Taiko Chander Nagar Chemicals manufactures and exports Fuller's earth (bleaching earth) to Singapore and Malaysia.

2. The company received advance payments in foreign currency (US dollars) from buyers for future exports.

3. These advances were shown in the company's balance sheet under "Current liabilities."

4. The company received remittances in May and July 2000 but adjusted them against supplies made from April 1, 2001, to December 31, 2001, and the balance on March 25, 2002.

5. Due to exchange rate fluctuations, the company's liability increased as of March 31, 2001, requiring them to supply more goods than initially agreed upon.

6. The company treated this increased liability as a trading loss. 

Arguments

Assessee's argument:

- The loss due to exchange rate fluctuations should be treated as a trading loss on revenue account.

Revenue's argument:

- The loss should not be considered a trading loss (implying it should be treated as a capital loss).

Key Legal Precedents

The main legal precedent cited in this case was:

Sutlej Cotton Mills Ltd. vs. CIT 1978 CTR (SC) 155 : (1979) 116 ITR 1 (SC)

This Supreme Court decision established that:

"Where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature....." 

Judgement

The High Court dismissed the appeal, agreeing with the Income Tax Appellate Tribunal's decision. Key points of the judgment:

1. The Tribunal correctly concluded that the assessee was required to make adjustments due to foreign exchange fluctuations.

2. This treatment was permissible under prevalent accounting standards.

3. The increased liability resulting from the upward revision in the US dollar rate could be treated as a trading loss on revenue account, consistent with accounting practices.

4. The court found no fault in the Tribunal's view and stated that no substantial question of law arose from this case. 

FAQs

1. Q: Why was this case significant?

  A: It clarified the treatment of foreign exchange fluctuation losses in export businesses, confirming that such losses can be considered trading losses under certain circumstances.

2. Q: What determines whether a foreign exchange loss is a trading loss or a capital loss?

  A: The nature of the foreign currency holding is crucial. If it's held on revenue account or as part of circulating capital, the resulting profit or loss is typically considered a trading profit or loss. If held as a capital asset, it would be considered capital in nature.

3. Q: How did accounting standards influence this decision?

  A: The court recognized that the treatment of the loss was permissible under prevalent accounting standards, which played a role in accepting it as a trading loss.

4. Q: What impact might this decision have on other exporters?

  A: This decision could potentially benefit other exporters who face similar situations, allowing them to treat foreign exchange fluctuation losses as trading losses under similar circumstances.

5. Q: Does this mean all foreign exchange losses in business can be treated as trading losses?

  A: Not necessarily. The treatment depends on how the foreign currency is held and used in the business. Each case would need to be evaluated based on its specific facts and circumstances.

1. The Revenue is aggrieved by an order dt. 15th Dec., 2006 passed by the Income-tax Appellate Tribunal (‘Tribunal’), Delhi Bench ‘A’, New Delhi in ITA No. 3100/Del/2004 relevant for the asst. yr. 2001-02.

2. The assessee is a manufacturer of bleaching earth (also known as Fuller’s earth) which is used for purification of coconut oil. The assessee also exports Fuller’s earth to Singapore and Malaysia. It appears that the assessee used to receive advances from the foreign buyers in foreign exchange to be adjusted against the supplies to be made and that the assessee was maintaining some sort of a running account. It showed this amount in its balance sheet under the head "Current liabilities". The admitted position is that although it received the remittance by way of advances in foreign exchange in May and July, 2000, it adjusted the advances partly against the supplies made for the period 1st April, 2001 to 31st Dec., 2001 and the balance against the sales made on 25th March, 2002.

3. As a result of the fluctuation in the rate of foreign exchange (US dollars), as on 31st March, 2001, there was an increase in the liability of the assessee as it would have been required to supply somewhat larger quantities of Fuller’s earth than what had been agreed to on the basis of prevalent rate of the US dollars at the time of placing of the order. The assessee treated this as a trading loss. This was, however, not accepted by the AO or by the Commissioner of Income-tax (Appeals) [‘CIT(A)’].

4. The Tribunal, on examination of the facts of the case came to the conclusion that the assessee was required to make the adjustments due to the fluctuations in the rate of foreign exchange and that this was permissible in terms of the prevalent accounting standards. It was held that consistent with the accounting practices the assessee could treat the increased liability resulting from the upward revision in the rate of US dollars as a trading loss on revenue account. The Tribunal followed the decision of the Supreme Court in Sutlej Cotton Mills Ltd. vs. CIT 1978 CTR (SC) 155 : (1979) 116 ITR 1 (SC) where it was held as follows :

"The law may, therefore, now be taken to be well-settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature....." (p. 13)

5. On the facts of the present case, we are unable to find any fault in the view taken by the Tribunal.

No substantial question of law arises.

6. Dismissed.

MADAN B. LOKUR, J

S. MURALIDHAR, J

OCTOBER 23, 2007