Capitalization of Exchange Fluctuation loss on fixed assets
There have been many controversies in the field of direct taxes revolving around loss on exchange fluctuation for liability incurred to purchase assets in India and outside India.
There have been many controversies in the field of direct taxes revolving around loss on exchange fluctuation for liability incurred to purchase assets in India and outside India. More specifically in a scenario where Rupee is continuously depreciating as against Dollar since last few years. Treatment for tax purposes is guided by section 43A of the Income tax Act, 1961 (Act) which permits capitalization of realized foreign exchange fluctuation loss on liability incurred for acquisition of assets outside India. However, from an Accounting perspective, Para 46A of Accounting Standard 11 'The Effects of Changes in Foreign Exchange Rates' permits capitalization of exchange difference on foreign borrowings to the cost of the depreciable assets irrespective of asset being acquired in India or outside India.
Therefore an important point marking distinction in accounting and direct taxes is exchange loss capitalized as per books towards liability for domestically acquired assets is not allowed to be capitalized from direct tax perspective in absence of any specific provision under the Act. Further, recently notified Income Computation and Disclosure Standards (ICDS) applicable from AY 2017-18 and onwards is also silent on said aspect. Also, judicially the position is not settled and majority of decision are against the assessee.
Therefore, in essence, such exchange loss is neither allowed to be added to block of asset nor allowed as revenue expenditure as the same is attributable for purchase of capital assets. As no deduction neither deprecation on such loss is allowed, it eventually results in dead loss for the companies entailing approx. 30% tax outlay on said amount making a profitable decision of purchase from domestic manufacturers, a financially incorrect decision from tax perspective.
In recent past wherein Rupee is deprecating, the provisions of section 43A has motivated business houses to purchase assets from outside India rather than domestically from indigenous manufacturers. However, it seems that not allowing exchange loss on liability incurred for purchase capital asset in India is not the intent. Also, Government at Centre has already clarified its stand to rationalize provisions of Income tax Act. Therefore, in current scenario where at one end Government is rationalizing norms for FDI to have manufacturing facilities in India and initiative such as "Make in India" to boost Indian economy & create more job opportunities, it is expected to have provisions of direct taxes in line with the intent of Government.
Moreover, during last few years Rupee has depreciated significantly against the US Dollar severely impacting the industry particularly those who have exposure to External Commercial Borrowings (ECBs) and Foreign Currency Convertible Bonds (FCCBs). Therefore it is expected that Section 43A would be amended to allow Capitalization of such foreign exchange loss even for domestically acquired asset. This will set direct tax laws in line with Government policies to boost Indian Economy and rationalize the provisions of Income tax as a way forward to build a better brand India.
The Author is Partner; and Mr. Kinjesh Thakkar is Deputy Manager with Deloitte Haskins & Sells LLP