REPORTABLE IN THE SUPREME COURT OF INDIA

CIVIL APPELLATE JURISDICTION

CIVIL APPEAL NO.7223 0F 2008

OIL & NATURAL GAS CORPORATION LTD.,  DEHRADUN THROUGH MANAGING DIRECTOR  

— APPELLANT

VERSUS

THE COMMISSIONER OF INCOME TAX,  DEHRADUN

— RESPONDENT

WITH  

[CIVIL APPEAL NOS.7224, 7225,   7228, 7229 AND 7231 OF 2008]

J U D G M E N T

D.K. JAIN, J.:

1.In these appeals, essentially the following two questions arise  

for our consideration:-

(i) Whether on the facts and circumstances of the case,  

the  additional  liability  arising  on  account  of  

fluctuations in the rate of exchange in respect of  

loans taken for revenue purposes could be allowed as  

deduction under Section 37(1) of the Income Tax, Act,  

1961 (for short “the Act”) in the year of fluctuation  

in  the  rate  of  exchange  or  whether  the  same  is  

allowable  only  in  the  year  of  repayment  of  such  

loans?

(ii) Whether the Assessee is entitled to adjust the actual  

cost of imported capital assets acquired in foreign  

currency  on  account  of  fluctuation  in  the  rate  of

exchange at each balance-sheet date, pending actual  

payment  of  the  varied  liability?  (only  in  C.A.  

No.7228/2008 – Assessment Year 1991-92)

2.As, in our opinion, both the afore-noted issues are no more  res  

integra,  we deem it unnecessary to state the facts in detail and  

with a view to appreciate the controversy, a brief reference to the  

foundational  facts  in  respect  of  assessment  year  1991-92  would  

suffice.  These are:

The appellant, hereinbefore referred to as “the Assessee”, is a  

public sector undertaking, substantially owned by the Government of  

India. It is engaged in capital intensive exploration and production  

of petroleum products for which it has to heavily depend on foreign  

loans to cover its expenses, both capital and revenue, on import of  

machinery  on  capital  account  and  for  payment  to  non-resident  

contractors in foreign currency for various services rendered.  The  

Assessee had made three types of foreign exchange borrowings — (i)  

in revenue account; (ii) in capital account and (iii) for general  

purposes, partly utilised in revenue account and partly in capital  

account.   As  per  terms  and  conditions  of  foreign  exchange  

borrowings, some of the loans became re-payable in the year under  

consideration but date of repayment of some loans fell after the end  

of the relevant accounting year.  The Assessee revalued in Indian  

currency all its foreign exchange loans in revenue account, capital  

account as also in its general purposes account, outstanding as on  

31st March, 1991 and claimed the difference between their respective

amounts in Indian currency as on 31st March, 1990 and on 31st March,  

1991 as revenue loss under Section 37(1) of the Act in respect of  

loans used in revenue account, and also took into consideration the  

similar difference in foreign exchange on capital account loans as  

an increased liability under Section 43A of the Act for the purposes  

of depreciation.  The foreign exchange loss incurred by the Assessee  

in the revenue account on account of repayment of these loans made  

in the year under consideration was allowed by the Assessing Officer  

as a deduction under Section 37(1) of the Act, and he also took into  

consideration an increased liability of foreign exchange loans taken  

in  capital  account  and  repaid  in  the  accounting  year,  for  the  

purposes  of  depreciation,  under  Section  43A  of  the  Act.   He,  

however,  did  not  allow  to  the  Assessee  its  claim  for  foreign  

exchange loss claimed on such foreign currency loans both in revenue  

account and in capital account which were outstanding on the last  

day of the accounting year under consideration and were as per terms  

of borrowings repayable after the end of the relevant accounting  

year.  Similar treatment was given to the foreign exchange loans  

taken  for  general  purposes,  used  partly  in  revenue  account  and  

partly in capital account.  Thus, the Assessee’s claim for foreign  

exchange loss/increased liability on revaluation of these foreign  

exchange loans at the end of the accounting year under consideration  

both in the revenue account and capital account as also on loans  

used partly in revenue account and partly in capital account, made  

on the ground that it had followed mercantile system of accounting  

in this regard, was disallowed by the Assessing Officer.  According

to  the  Assessing  Officer,  such  a  loss  could  be  allowed  to  the  

Assessee on discharge of liability at the time of actual repayment  

of these loans.   

3.Aggrieved, the Assessee preferred appeals before the Commissioner  

of Income Tax (Appeals).  Insofar as Assessee’s claim for foreign  

exchange loss in revenue account was concerned, the Commissioner  

(Appeals) affirmed the view taken by the Assessing Officer on the  

ground  that  it  was  a  notional  liability  and  the  same  had  not  

crystallised or accrued in the relevant assessment year.  However,  

as  regards  the  adjustment  for  increased  liability  made  by  the  

Assessee for the purposes of Section 43A of the Act in respect of  

foreign exchange loans in capital account, which were outstanding as  

on  31st March,  1991,  the  Commissioner  accepted  the  stand  of  the  

Assessee and directed the Assessing Officer to allow the benefit of  

such increased liability for computation of depreciation allowance  

on plant and machinery purchased out of such foreign exchange loans  

for the assessment year under consideration.

4.Being  dissatisfied,  both  the  Assessee  as  well  as  the  Revenue  

carried the matter in further appeals to the Income Tax Appellate  

Tribunal (for short “the Tribunal”). The Tribunal observed that the  

method  of  accounting  adopted  by  the  Assessee  right  from  the  

assessment  year  1982-83  is  mercantile  system;  it  has  been  

consistently claiming loss suffered by it on account of fluctuation  

in foreign exchange rates on accrual basis; in respect of assessment  

years 1982-83 to 1986-87, the Assessee’s claim on this account had

been  allowed  by  the  Assessing  Officer  himself;  in  respect  of  

assessment year 1997-98, the Assessee had shown a gain of Rs.293.37  

crores on account of fluctuation in foreign exchange because the  

Indian Rupee had appreciated as compared to the foreign currency and  

that the said amount was taxed as Assessee’s income.  Taking all  

these factors into consideration, the Tribunal held that the loss  

claimed  by  the  Assessee  on  revenue  account  was  allowable  under  

Section 37(1) of the Act.   The appeal preferred by the Revenue on  

the question whether the Assessee was entitled to adjust the actual  

cost of imported assets acquired in foreign currency on account of  

fluctuation in the rate of exchange, in terms of Section 43A of the  

Act, was also dismissed.  

5.The Revenue took the matter in further appeal to the High Court.  

By a common judgment pertaining to the assessment years 1991-92 to  

1994-95 and 1997-98, the High Court has reversed the decision of the  

Tribunal on both the issues.  Terming the order of the Tribunal as  

perverse,  having  been  passed  without  any  material  on  record  and  

against the statutory provisions, the High Court has held that the  

foreign  exchange  loss  claimed  by  the  Assessee  being  only  a  

contingent and notional liability, it was not allowable as deduction  

under Section 37(1) of the Act.  Insofar as the applicability of  

Section 43A of the Act was concerned, the High Court observed that  

the said provision is confined only to those liabilities which have  

become due as per the terms and conditions of written agreement  

between the Assessee and the foreign creditors but since in the

present case, no such agreement was made available by the Assessee  

at any stage of the proceedings, the claim of the Assessee was not  

justified.  According to the High Court, the variation in foreign  

exchange was neither quantified, nor it had become due or repaid  

and, therefore, deductions on that account had been allowed by the  

Tribunal without application of mind and were, therefore, illegal.  

Being aggrieved by the said decision, the Assessee is before us in  

these appeals.

6.Mr. S. Ganesh, learned senior counsel appearing on behalf of the  Assessee, submitted that in view of the decision of this Court in  Commissioner of Income-Tax Vs. Woodward Governor India P. Ltd.1, the  decision of the High Court cannot be sustained.  Learned counsel  also argued that in view of the fact that the Committee on disputes  had expressly refused permission to the Revenue to pursue appeals  before the High Court, in the light of the decisions of this Court  in Oil & Natural Gas Commission & Anr. Vs. Collector of Central  Excise2 and Mahanagar Telephone Nigam Ltd. Vs. Chairman, Central  Board, Direct Taxes & Anr.3, the High Court should not have  entertained the appeals preferred by the Revenue.

7.Mr.  B.  Bhattacharya,  learned  Additional  Solicitor  General,  

appearing  on  behalf  of  the  Revenue,  on  the  other  hand,  while  

candidly  admitting  that  both  the  issues  raised  in  the  present  

appeals, have been decided by this Court in Woodward’s case (supra),  

submitted that in view of the finding by the High Court that no  

agreement between the Assessee and the foreign creditors had been  

placed on record, the High Court was correct in law in allowing  

Revenue’s appeals.

1 2009 (312) I.T.R. 254 (SC) 2 (1992) Supp (2) SCC 432 3 2004 (267) I.T.R. 647 (SC)

8.At the outset, we may note that although in view of the orders  

passed by the Committee on disputes, advising the Revenue not to  

file appeals against Tribunal’s orders, we find some substance in  

the  objection  of  learned  counsel  for  the  Assessee  about  the  

maintainability of Revenue’s appeals before the High Court but as we  

have heard learned counsel for the parties on merits of the appeals,  

at this stage, we do not propose to go into this question. We also  

reject at the threshold the submission of learned counsel for the  

Revenue that the claim of the Assessee qua capital account deserved  

to be disallowed because no agreement between the Assessee and the  

foreign  creditors,  as  observed  by  the  High  Court  was  placed  on  

record, because no such objection was raised by the Revenue at any  

stage of the assessment proceedings nor had the Assessing Officer  

rejected the claim of the Assessee on that ground.   

9.Thus, the questions surviving for determination are :- (i) that  

when the Assessee maintained their accounts on mercantile system of  

accounting and there was no finding by the Assessing Officer on the  

correctness or completeness of the account and that the Assessee had  

complied with the accounting standards, laid down by the Central  

Government, can the “loss” suffered by it on account of fluctuation  

in the rate of foreign exchange as on the date of balance-sheet be  

allowed  as  expenditure  under  Section  37(1)  of  the  Act  

notwithstanding the fact that the liability had not been actually  

discharged  in the  year in  which the  fluctuation in  the rate  of  

foreign  exchange  had  occurred  and  (ii)  whether  on  account  of

fluctuation in the rate of exchange at the end of the previous year,  

the  Assessee  is  entitled  to  adjust  the  actual  cost  of  imported  

assets acquired in foreign currency?

10.Having carefully perused the decision of this Court in Woodward’s  

case  (supra), we  are of  the opinion  that both  the issues  stand  

concluded  by  the  said  decision.   Dealing  with  the  said  issues  

extensively, speaking for the Bench, S.H. Kapadia, J. summarised the  

following factors which should be taken into account in order to  

find out if an expenditure on account of fluctuation in the foreign  

currency rates, when the Assessee is following mercantile system of  

accounting, is deductible:  

(i) whether  the  system  of  accounting  followed  by  the  

assessee is the mercantile system, which brings in  

the debits of the amount of expenditure for which a  

legal liability has been incurred even before it is  

actually  disbursed  and  credits,  what  is  due,  

immediately it becomes due even 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.   

Applying these factors on the facts of that case, it was held that  

the “loss” suffered by the Assessee, maintaining accounts regularly  

on mercantile system and following accounting standards prescribed  

by  the  Institute  of  Chartered  Accountants  of  India  (ICAI),  on  

account of fluctuation in the rate of foreign exchange as on the  

date of balance-sheet was an item of expenditure under Section 37(1)  

of  the  Act,  notwithstanding  that  the  liability  had  not  been  

discharged  in the  year in  which the  fluctuation in  the rate  of  

foreign exchange occurred.   

11.We are of the opinion that the ratio of the said decision, with  

which we are in respectful agreement, squarely applies to the facts  

at hand and, therefore, the loss claimed by the Assessee on account  

of fluctuation in the rate of foreign exchange as on the date of  

balance-sheet is allowable as expenditure under Section 37(1) of the  

Act.   

12.On the question whether an Assessee is entitled to adjust the  

actual  cost  of  imported  assets  acquired  in  foreign  currency  on  

account of fluctuation in the rate of exchange at each balance-sheet  

date, pending actual payment of the varied liability with reference

to unamended Section 43A of the Act, in Woodward’s case (supra), the  

Court observed thus:  

“…what triggers the adjustment in the actual cost of the  assets, in terms of the unamended section 43A of the 1961  Act is the change in the rate of exchange subsequent to the  acquisition  of  asset  in  foreign  currency.   The  section  mandates that at any time there is change in the rate of  exchange,  the  same  may  be  given  effect  to  by  way  of  adjustment of the carrying cost of the fixed assets acquired  in foreign currency.  But for section 43A which corresponds  to paragraph 10 of AS-II such adjustment in the carrying  amount of the fixed assets was not possible, particularly in  the  light  of  section  43(1).   The  unamended  section  43A  nowhere required as condition precedent for making necessary  adjustment in the carrying amount of the fixed asset that  there should be actual payment of the increased/decreased  liability as a consequence of the exchange variation. The  words used in the unamended section 43A were “for making  payment” and not “on payment” which is now brought in by  amendment to section 43A, vide the Finance Act, 2002.”

Opining that the amendment of Section 43A of the Act by the  

Finance Act, 2002 with effect from 1st April, 2003 is amendatory and  

not clarificatory and would thus, apply prospectively, the Court  

explained that under the unamended Section 43A, adjustment to the  

actual cost takes place on the happening of change in the rate of  

exchange, whereas under the amended Section 43A, the adjustment in  

the actual cost is made on cash basis.  In other words, under the  

unamended  Section  43A,  “actual  payment”  was  not  a  condition  

precedent for making necessary adjustment in the carrying cost of  

the fixed asset acquired in foreign currency but under the amended  

Section 43A, with effect from 1st April, 2003, such payment of the  

decreased/enhanced liability on account of fluctuation in foreign

exchange  rate  has  been  made  a  condition  precedent  for  making  

adjustment in the carrying amount of the fixed asset.

13.We  are  of  the  opinion  that  the  decision  of  this  Court  in  

Woodward’s  case  (supra)  settles  the  second  issue  as  well.   We  

respectfully concur with the same and hold that all the assessment  

years in question being prior to the amendment in Section 43A of the  

Act with effect from 1st April, 2003 the Assessee would be entitled  

to adjust the actual cost of the imported capital assets, acquired  

in  foreign  currency,  on  account  of  fluctuation  in  the  rate  of  

exchange at each of the relevant balance-sheet dates pending actual  

payment of the varied liability.

14.Resultantly, all the appeals are allowed; the impugned orders are  

set aside and both the questions formulated in para 1 (supra) are  

answered in favour of the Assessee, leaving the parties to bear  

their own costs.  

…………………………….J. (D.K. JAIN)

                              …………………………….J.  (T.S. THAKUR)

NEW DELHI; MARCH  15, 2010.