NEW DELHI, JUNE 16, 2011: THE Income Tax – Sections 10A, 143(3), 263 – Whether assessee is entitled to deduction u/s 10A even if the foreign exchange fluctuation gain is derived from external commercial borrowings and not from the export activity. NO is the Tribunal's answer.
Facts of the case
Assessee company had raised external commercial borrowings from its parent company for meeting its working capital requirements which were reinstated on year end which resulted in a notional foreign exchange gain of Rs. 382,15,000/- to the company. After adjusting the loss on export remittance, net income of Rs. 3,52,90,374/- was shown as "other income" in the profit and loss account and deduction was claimed u/s 10A – AO accepted the claim of the assessee in the order made u/s 143(3).
CIT initiated proceedings u/s 263 of the IT Act stating that the assessee had shown income from foreign exchange fluctuation gain of Rs. 352,90,374/- under the head "other income" and this income was different from "income from operation". Provisions of section 10A envisage deduction of such profits and gains as are derived by an undertaking from the export of articles or things or computer software so such deduction on foreign exchange gain u/s 10A was clearly deviation from law and directed the AO to not allow deduction u/s 10A on the said amount - accordingly deduction claimed by the assessee u/s 10A on foreign exchange gain of Rs. 352,90,374/- was disallowed by AO.
CIT (Appeal) dismissed the appeal of the assessee observing that the deduction u/s 10A on the `other income' which was derived on account of fluctuation of foreign exchange did not satisfy the mandatory conditions of section 10A and was rightly disallowed.
In appeal before the ITAT, an additional plea was raised by assessee that no income had accrued to it, as it was a case of merely reflecting the income by a book entry made in accordance with the AS 11 issued by the ICAI - the said sum did not represent an income, since it was an amount, which represented the difference between the amount credited to the account of the loan creditor by adopting the rate of exchange in Indian Rupees to the Foreign Currency on the date of raising the loan and the rate of exchange at the close of the year, which sum alone was the liability to be discharged by the assessee - thus there was no gain other than artificial gain.
After hearing both the parties, the ITAT held that,
++ followed the decision of Supreme Court in the case of Woodword Governor India Pvt. Ltd. (2009-TIOL-50-SC-IT) in which it was held that "in case of revenue item falling under section 37(1), paragraph 9 of AS-11, which deals with recognition of exchange differences, needs to be considered. Under that paragraph, exchange differences arising on foreign exchange transactions have to be recognized as income or as expenses in the period in which they arise". The assessee was following mercantile system of accounting. The same is followed in respect of fluctuation in rate of foreign exchange. The assessee has made entries in the books on this basis for profits and losses. Rule 115 requires that reduction in liability on revenue account on account of rate of foreign exchange shall be reckoned on the last date of the previous year as per telegraphic transfer buying rate. This means that any reduction in liability, leading to revenue gain will have to be accounted as profits in case of business income. Thus, this rule independently reinforces the contents of AS-11 for recognition of income as well as loss arising on revenue account. Thus the additional ground was dismissed;
++ section 10A(1) provides for connotation of such profit or gain as are derived from the export of articles or things or computer software. By using the expression "derived from" in S. 10A(1), the Parliament intended to cover sources not beyond the first degree. Gain is not on account of fluctuation in foreign exchange relating to assessee's export activities. The same is with respect to the external commercial borrowings. This cannot be termed as derived from the export activity of the assessee. Section 10A(4) only provides the formula for computing profits derived from the export activity. First, the income or gain has to be derived from export activity, only then the computation formula can be applied. Thus, the assessee is not entitled to deduction u/s 10A.
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