Foreign Exchange Loss on Outstanding Import Liabilities Allowed Considering Mercantile Accounting Method Followed: ITAT Deletes Addition [Read Order]

The Income Tax Appellate Tribunal ( ITAT ), Delhi Bench has deleted an addition of ₹1.19 crore made on account of disallowance of foreign exchange fluctuation loss, holding that the assessee was consistently following the mercantile system of accounting and recognition of outstanding foreign currency liabilities at year-end rates was in line with accepted accounting standards.

The assessee, Donyi Polo Timbers Pvt. Ltd, engaged in timber imports, had carried forward outstanding liabilities towards two Hong Kong-based suppliers from earlier years.

While no new business operations were carried out in AY 2014-15, the assessee debited a foreign exchange loss of ₹1,19,56,753/- to its profit and loss account, reflecting the increased liability due to fluctuation in the rupee-dollar rate.

The PCIT revised the assessment under section 263 of the Income-tax Act, treating the loss as notional, doubtful, and inadmissible, citing the absence of actual remittance and ongoing inquiries by the DRI. The NFAC upheld this disallowance.

On appeal, the ITAT observed that under the mercantile system of accounting, liabilities denominated in foreign currency must be restated at the year-end exchange rate, and any difference whether gain or loss is to be recognized in the profit and loss account.

The bench of Satbeer Singh Godara (Judicial member) and S. Rifaur Rahman (Accountant member) illustrated that if a liability of US$1,000 remained unsettled across years, it must be restated annually at prevailing rates, leading to a real incremental liability irrespective of actual settlement. Since the assessee had consistently followed this method, the foreign exchange loss could not be treated as merely notional.

The bench noted that “We observe that the method adopted by the assessee is consistent over the years and rupee liability will keep increasing depending upon the period of outstanding, considering the state of Indian currency, the liability will keep on increasing every year. Considering the consistent method of accounting adopted by the assessee, in our considered view, the loss claimed by the assessee is justified, it may look not actual but since assessee is following mercantile system, the loss has to be recorded immediately. Accordingly, the same is directed to be deleted and the grounds raised by the assessee are allowed.”

The Tribunal held that the disallowance was unjustified and directed deletion of the entire addition, thereby allowing the assessee’s appeal.

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