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Background
The Supreme Court in its recent judgment1 has held that ’Roll over premium charges’ incurred in respect of liabilities relating to the acquisition of fixed assets should be added / reduced from the actual cost of the asset in respect of which liability was incurred, in accordance with the provisions of section 43A of Income-tax Act, 1961 (“the Act”).
Facts
• Elecon Engineering Co. Ltd. (‘assessee’ or the
‘Company’) is in the business of manufacturing of gears and mechanical handling equipments.
• The Company, during the Assessment Year (“AY”) 1986-87, procured a foreign currency loan for expansion of existing business.
• Since the repayment of loan was stipulated to be in installments, the Company desired to ensure that foreign currency required for repayment of the loan
1 ACIT v. Elecon Engineering Co. Ltd. [2010-TIOL-19-SC-IT]
be obtained at a pre-determined rate and cost.
Accordingly, the Company booked forward contracts with Citibank, N.A for delivery of the required foreign currency on the stipulated dates.
• The contract was entered into for the entire outstanding amount and the delivery of foreign currency was obtained under the contract for instalment due from time to time. The balance value of the contract, after deducting the amount withdrawn towards repayment, was rolled over for a further period up to the date of the next instalment.
• The Company filed its return of income for AY 1986- 87 and subsequently, filed a revised return.
• Pursuant to the assessment proceedings, the assessing officer (“AO”) disallowed an amount of Rs.886,280, being the roll over premium charges, paid by the Company in respect of foreign exchange forward contracts to Citibank, N.A.
Roll-over charges for foreign currency loans are not allowable as revenue expenditure Tax & Regulatory Services
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• The AO contended that the said charges were incurred in connection with the purchase of a capital asset (plant and machinery), and accordingly, it was not admissible for deduction under section 36(1)(iii) or under section 37 of the Act.
According to the Department, the roll over charges were required to be capitalised in light of the provisions of section 43A of the Act.
• On appeal before the Commissioner of Income-tax (Appeals) (“CIT(A)”), it was held that the roll over premium charge(s) incurred by the assessee was allowable as it was incurred by the assessee to mitigate the risk involved in higher payment due to adverse exchange rate fluctuation. Further, the CIT(A), relying on the principles laid down in the Supreme Court (“SC”) judgment2, held that roll over premium charge(s) constituted an expenditure incurred for raising loans on revenue account, hence, the said expenditure was allowable under the Act.
• Aggrieved by the order of CIT(A), the Department filed an appeal before the Income-tax Appellate Tribunal (“the Tribunal”). The Tribunal held that roll over premium charges (carry forward charges) were required to be paid to the authorised dealer (“AD”) by the Company as consideration for permitting the unutilised amount of the contract (i.e. balance value of the contract) to be availed of at a later date. Accordingly, roll over premium charges had to be capitalised in terms of Explanation 3 to Section 43A of the Act. Consequently, the Tribunal upheld the order of the AO.
• Aggrieved by the order of the Tribunal, the Company filed an appeal before the Gujarat High Court (“HC”), inter alia challenging the capitalisation of the roll over charges paid in respect of foreign currency. The Gujarat HC held that the roll over premium charges paid by the Company was in the nature of interest or committal charge(s), and hence, the said charges were allowable under section 36(1)(iii) of the said Act.
• Aggrieved by the order of the HC, the Department preferred an appeal before SC.
Assessee’s contentions
• The ‘roll over charges’ are akin to the interest payable on the rupees equivalent, which the AD had invested in holding the foreign currency at the borrower’s account. Hence, the roll over charges incurred by the Company during the relevant assessment years were altogether different from increase in cost on account of
2 India Cements Ltd v. CIT, [1966] 60 ITR 52 (Mad)
exchange rate fluctuation as envisaged under section 43A and in terms of Explanation 3 to section 43A of the Act.
• The roll over premium was not paid on account of any fluctuations in the rate of exchange, but was paid as a premium to the AD for the risk taken by the AD in holding the foreign exchange at pre-determined rate on borrower’s account. As such, the payment was made to avoid such increase or reduction in liability on account of exchange fluctuation.
• As per Explanation 3 to section 43A of the Act, the roll over charges were not required to be added to the actual cost, nor required to be capitalised, as the roll over charge had nothing to do with the actual cost of the asset.
• The roll over charges are deductible under section 36(1)(iii) of the Act, since
- the same were in the nature of commitment charges or interest paid in relation to the amount borrowed.
- Roll over charges were also meant for covering a risk on account of fluctuations between the rupee and the contracted foreign currency and such risk is built into the roll over charges.
• The Company, relying on the SC judgment3, also contended that if the said roll over charges were not deductible under section 36(1)(iii) of the Act, the same should be allowed to be deducted under section 37 of the Act.
Supreme Court Ruling
• It is the purpose for which the loan is raised that is of prime significance i.e. to finance the fixed asset or working capital and to ascertain the purpose as well as the facts and circumstances of the case, including the relevant loan agreement and the documentation between the parties concerned.
• Section 43A of the Act lays down, firstly, that the increase or decrease in liability should be taken into account to modify the figure of actual cost and, secondly, such adjustment should be made in the year in which the increase or decrease in liability arises on account of fluctuation in the rate of exchange (the provisions as it stood during the relevant assessment year).
3 CIT v. Gujrat Alkalis and Chemicals Ltd. [2008] 2 SCC 475 (SC)
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• The SC rejected contention of the assessee that section 43A of the Act was not applicable in case of roll over charges paid to avoid increase or reduction in liability consequent upon change in the rate of exchange.
• The SC held that the Notes to Accounts of the Company clearly establishes existence of adverse fluctuations in the exchange rate which made the assessee opt for forward cover and which in turn, made the Company pay roll over charges.
The word “adverse” in the Notes to accounts itself presupposes increase in the liability incurred by assessee during the year ending 31 December, 1986.
• Further, the SC held that according to Indian Accounting Standards by Dolphy D’souza, roll over charges are indicative of the increase or decrease in the liability of the Company in the next specified period, generally of six months. Roll over charges respresent the difference arising on account of change in foreign exchange rates. Roll over charges paid / received in respect of liabilities relating to the acquisition of fixed asset should be debited / credited to the asset in respect of
which liability was incurred. However, roll over charges not relating to fixed assets should be charged to the Profit & Loss Account.
• The SC also held that the ‘roll over charges’ are not in the nature of interest, warranty charges and commitment expenses and are not deductible.
Conclusion
The SC has held that section 43A of the Act applies only to cases where there is fluctuation in the rate of exchange. Further, it has established that roll over charges has a close nexus with the fluctuation in the rate of exchange. Roll over charges paid / received in respect of liabilities relating to the acquisition of fixed assets, should be debited / credited to the asset in respect of which the liability was incurred.
The judgment would have far reaching implication on Companies which hedge their risk of exchange fluctuation on the forward contracts for the acquisition of the capital assets.
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