Madras HC Allows Deduction u/s 37 of Compensation Paid for Exchange Rate Fluctuation as Business Expenditure [Read Order]

The Madras High Court has held that compensation paid by an assessee to its agent for losses arising due to foreign exchange rate fluctuation, caused by delayed payments, is allowable as a business expenditure under Section 37 of the Income Tax Act, 1961.

The ruling was delivered in a tax case appeal filed by M/s. Assab Sripad Steels Private Limited concerning the assessment year 2004-05. The dispute related to the disallowance of ₹45.67 lakh paid as compensation for exchange fluctuation losses and ₹35 lakh paid for premature termination of an agreement. The Court examined whether the payment towards exchange loss could be treated as an allowable expenditure in the absence of a specific clause in the agreement.

The assessee had entered into an agreement with a trading intermediary for importing materials. Under the agreement, the intermediary was required to make foreign remittances within six months of dispatch. The assessee failed to make payments within the stipulated time, which resulted in significant delays lasting more than one year. Due to fluctuating foreign exchange, the intermediary suffered losses. The losses were later quantified and compensated by the assessee.

The Assessing Officer disallowed the claim for deduction of the exchange fluctuation compensation on the ground that the agreement did not contain any such clause. While the Commissioner of Income Tax (Appeals) allowed the claim on grounds of commercial expediency, the Income Tax Appellate Tribunal reversed this finding and upheld the disallowance.

Before the High Court, the assessee contended that the liability to pay compensation had crystallised during the relevant financial year. It was further argued that the genuineness of the payment was never disputed by the Revenue.

The Division Bench comprising Justice Dr. Anita Sumanth and Justice Mummine­ni Sudheer Kumar observed that Clause (f) of the agreement permitted the raising of invoices that included mutually agreed compensation for services rendered.

The Court further held that merely because the agreement did not expressly mention compensation for exchange loss, the expenditure could not be disallowed when it was incurred out of commercial expediency.

Relying on the Supreme Court’s ruling in Bharat Earth Movers v. Commissioner of Income Tax, the Court also held that the liability had crystallised during the relevant accounting year and could not be treated as contingent merely because the actual payment was made in a subsequent year.

Accordingly, the High Court set aside the order of the Tribunal and allowed the assessee’s appeal. The Court directed that the assessment for AY 2006-07 be revised as the disallowance of ₹45.67 lakh was unsustainable.

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