Foreign Exchange Fluctuation Loss Allowable; AS-11 & ICDS VI Compliance is Key

Issue

Whether foreign exchange fluctuation loss recorded on outstanding monetary items at the year-end (unrealised) is an allowable business expenditure under Section 37(1), or if it is merely a “notional” loss as claimed by the Assessing Officer.

Facts

Assessment Year: 2018-19.
The Claim: The assessee (an engineering consultancy) claimed a deduction of Rs. 2.89 crores for foreign exchange fluctuation loss.
AO’s Disallowance: The AO disallowed the claim, arguing that the loss was “unrealised/notional” as it was merely recorded on the reporting date without actual payment (crystallisation).
Accounting Treatment: The assessee followed the mercantile system and accounted for the loss as per Accounting Standard 11 (AS-11). Crucially, this treatment is also in line with ICDS VI (Income Computation and Disclosure Standards) notified by the CBDT.

Decision

Supreme Court Precedent: This ruling aligns with the landmark Woodward Governor judgment. Under the mercantile system, the restatement of monetary assets/liabilities at closing rates is mandatory.
Real Loss: The Tribunal held that such restatement results in a recognized business loss or gain, not a notional one. Since the treatment complied with AS-11 and ICDS VI, the disallowance was unjustified.
Ruling: The addition was deleted, and the loss was allowed as business expenditure.

II. Section 79 Loss Carry Forward Allowed; “Ultimate Beneficial Ownership” Prevails

Issue

Whether the carry forward of losses can be denied under Section 79 due to a change in shareholding post-amalgamation, if the ultimate beneficial ownership of the company remains consistent.

Facts

The Action: The AO invoked Section 79 to deny the set-off of earlier years’ losses, citing a substantial change in shareholding (more than 51%) due to an amalgamation.
The Defense: The CIT(A) analyzed the structure and found that while the immediate registered shareholding changed, the ultimate beneficial ownership (the holding company/group) remained the same.

Decision

Substance over Form: Section 79 restricts carry forward only if the beneficial voting power changes hands. Courts (e.g., Karnataka High Court in Amco Power Systems) have held that if the ultimate holding company remains the same, internal group restructuring does not trigger Section 79 restrictions.
Ruling: Since the beneficial ownership remained consistent, the Tribunal upheld the order allowing the carry forward of losses.

Key Takeaways

Forex Loss Deductibility: The Department often calls MTM (Mark-to-Market) forex losses “notional.” However, for monetary items (receivables/payables), ICDS VI explicitly mandates recognizing these exchange differences. This is a strong defense against such additions.

Section 79 Planning: When planning intra-group mergers, always trace the shareholding up to the ultimate parent. If the parent holds >51% before and after the restructuring (even indirectly), your accumulated losses are safe.

IN THE ITAT DELHI BENCH ‘G’

Assistant Commissioner of Income-tax

Lurgi Indianlnternational Services (P.) Ltd.^*

Challa Nagendra Prasad, Judicial Member
and Avdhesh Kumar Mishra, Accountant Member

IT Appeal No.5826 (Del) of 2024
[Assessment year 2018-19]

NOVEMBER 26, 2025

Manish Gupta and Ajay Kumar Arora, Sr. DRs for the Appellant. Shubham Jain and Tapan Misra, Advs. for the Respondent.

ORDER

Avdhesh Kumar Mishra, Accountant Member.- This appeal preferred by the Revenue for Assessment Year (‘AY’) 2018-19 is directed against the order dated 17.12.2024 of the Commissioner of Income Tax (Appeals), New Delhi [‘CIT(A)’].

2. The revenue has raised following grounds of appeal:

“1. Whether on the facts and in the circumstances of the case, the Id. CIT(A) has erred in deleting the disallowance of Rs. 2,89, 12,346/- on account of foreign exchange loss u/s 37 of the Act ignoring the the fact that the loss of Rs. 2,89,12,346/- is unrealized loss which has been recorded on periodic basis based on the market rate on the reporting date. Such Periodic unrealized loss is typically notional and cannot be allowed under income tax provisions.

2. Whether on the facts and circumstances of the case, the Ld. CIT(A) erred in deleting the disallowance of Rs. 2,89, 12,346/- in view of the order of Hon’ble Supreme Court in the case of M/s Sanjeeve Woolen mills v. CIT (Sanjeev Woollen Mills v. Commissioner of Income-tax (SC)) and the decision of Hon’ble ITAT in the case of M/s Bechtel India (P.) Ltd. v. ACIT, ITAT Delhi, [2017] Bechtel India (P.) Ltd. v. Assistant Commissioner of Income-tax, Circle-4(2) ITD 282 (Delhi – Trib.) (Delhi – Trib.)/[2017] 165 ITD 282.

3. Whether on the facts and in the circumstances of the case, the Id. CIT(A) has erred in allowing the carried forward losses of the assessee for A.Y. 2014-15 & 2015-16 ignoring the fact that shareholding of 97% shares has been changed in F.Y. 2015-16 and as per section 79 of the Act, losses of previous year cannot be carried forward, if there is a change in shareholding of a company.

4. Whether on the facts and circumstances of the case, the Ld. CIT(A) has erred in not considering the decision of Hon’ble Delhi High Court in the case of M/s Yum Restaurants (India) Private Limited v. ITO in ITA no. 349 of 2015 before allowing carry forward of losses.”

2.1. Vide above grounds, the Revenue has raised two issues:

Disallowance of Foreign Exchange fluctuation loss of Rs.2,89,12,346/-

ii.

Disallowance of carry forward of losses under section 79 of the Income Tax Act, 1961 (‘the Act’)

3. The relevant facts giving rise to this appeal are that the assessee, engaged in the business of engineering consultant, Research Engineers Press Engineers Planning and Consultant Engineers etc., filed its Income Tax Return (‘ITR’) for the relevant year on 11.10.2018 declaring loss of Rs. (-) 3,16,95,696/-. The case was picked up for scrutiny and consequential assessment was completed at loss of Rs. (-) 36,71,430/- after making disallowance of the foreign exchange loss of Rs.2,89,12,346/- and addition of provisions of Rs.64,54,780/-. Aggrieved, the assessee filed appeal before the Ld. CIT(A) who allowed the appeal. Hence, the Revenue is before us on the above-mentioned two issues.

4. The Ld. Assessing Officer (‘AO’) disallowed the foreign exchange loss of Rs.2,89,12,346/- on the reasoning that the said loss is notional loss and thus in the nature of notional expenditure which could not be allowed as a business expenditure. The relevant finding of the Ld. AO reads as under: –

“5.1. It is seen that the assessee has debited an amount of Rs. 2,89,12,346/- as fluctuation loss during the current year. The details were called for vide Notice U/s 142(1) dated 05.02.2021. As per submissions dated 08.02.2021 the assessee has stated that The Fluctuation Loss is not on account of M to M loss. It is rather due to reinstatement of creditors and debtors outstanding as on 31st March, 2018.

5.2. The submissions made by the assessee have been verified and they are not acceptable for the following reasons. The loss of Rs. 2,89,12,346/- is unrealized loss, which has been recorded on a periodic basis based on the market rate on the reporting date. Such periodic unrealized loss is typically notional and such losses are not actually incurred but there has been variation in the fair value of the advance as on the reporting date, therefore, it has been reported in the annual result. The actual loss or gain can only be ascertained /determined after the expiry of period of contract or its termination. All these losses can be categorized as the notional losses. Under Indian Income Tax act there is no special provision or treatment for this method of accounting. Under this method of accounting, loss or gain arises due to revaluation of financial instrument. There is no actual loss on account of dealings in Forex until their final values are known. Though on the given date the liability does not crystallize, it is a prudent accounting practice that all these losses are reported as mandated by ICAI. However, if the contracts run to their full course, no losses may arise. The reporting of such notional losses to adhere to the accounting guidelines does not by itself make it deductible for income tax purposes. The provisions of Income Tax Act, 1961 do not allow deduction of any such notional loss for which the liability has not crystallized. Therefore, losses on account of revaluation of Forex transaction are only notional and cannot be deductible as business losses under income Tax provisions.

5.3. Reliance is placed on the decision of the Hon’ble Supreme Court in the case of M/s. Sanjeev Woollen mills v. CIT (Sanjeev Woollen Mills v. Commissioner of Income-tax (SC)) wherein the Hon’ble court has upheld the principle “that notional income cannot be charged through tax and the assessee cannot also get benefit of notional loss which he has not incurred”. While applying the same principle the mark-to-market losses in case of derivative/forward contract it would have to be considered that these losses are not accrued but are being reported merely on the ground that the same is required due to the accounting code to be followed. Apparently, these losses are notional in nature.

5.4. In fact there is always a possibility that there may be a loss on balance sheet date but subsequently when the derivative/forward contract expires, it may yield a gain. Thus, the liability/loss may ultimately cease to exist. To underline the same point further, a reference can be made to the case of CIT v. Oriental Motors Car Co. P. Ltd 124 ITR 74 (1980), in which the Hon’ble Allahabad High Court has held that a liability which has not been accepted by the assessee in a financial year cannot be claimed in that financial year:

“….it is settled that the mere fact that an assessee keeps his account on the mercantile system does not give him a handle to debit liability of every kind whatsoever. The liability that can be debited is only that which is certain, and which arises in present….”

5.5. C.B.D.T. has issued an instruction relating to non-allowability of contingent and unascertained losses in case of the banks. INSTRUCTION No. 17/2008 dated 26-11-2008 of CBDT clearly lays out the following principles:

“. Section 37 of the Income Tax envisages that an amount debited in the P&L account in respect of an accrued or ascertained liability only is an admissible deduction, while any provision in respect of any unascertained liability or a liability which has not accrued, do not qualify for deduction. A contingent liability cannot constitute a deductible expenditure for the purpose of Income Tax Act. Thus, putting aside of money which may become an expenditure on happening of an event would normally not constitute an allowable expenditure under the Income Tax Act.”

[Emphasis supplied]

5. Besides the above disallowance of foreign exchange loss, the AO had also disallowed not only the provision of Rs.64,54,780/- claimed as business expenses but also had invoking the provisions of section 79 of the Act denied the carry forward of losses of AYs 2014-15 to 2015-16 on the reasoning that there was substantial change in the shareholding. Aggrieved the assessee filed appeal before the Ld. CIT(A), who allowed the appeal of the assessee. The finding of the Ld. CIT(A) with respect to disallowance of foreign exchange loss is as under:

” 8.1. The appellant has also referred to the decision of Hon’ble Supreme Court in the case of CIT v/s Woodward Governor India P Ltd . In the said case, the Apex Court identified specific sectors which are critical in determining whether an expenditure relating to foreign exchange is deductible. The same are reproduced as under:

• Whether the Assessee follows a mercantile system of accounting, which allows for the accrual of expenditure and revenue;

• Whether the Assessee has consistently followed this system from the beginning and, if there was a change, whether the change was bona fide;

• Whether the Assessee has given the same treatment to losses claimed to have accrued as to the gains that may accrue;

• Whether the Assessee has been consistent and definite in recording entries in the account books for both losses and gains;

• Whether the method adopted by the Assessee for making entries in the books is in accordance with nationally accepted Accounting Standards;

• Whether the system adopted by the Assessee is fair and reasonable or is used solely to reduce the incidence of taxation.

……

8.2. It is submitted by the appellant that all the factors laid down by the Apex Court in the above referred decision have been satisfied by the appellant i.e., the appellant is following mercantile system of accounting, the foreign exchange loss has been accounted as per Accounting Standards 11 complied with ICDS VI and offered the foreign exchange gains for taxation whenever earned.”

6. Further, the Ld. CIT(A) also reversed the order of the Ld. AO on the issue of losses to be carried forward in subsequent year as under:

“10. Ground No 5 is relating to carry forward of loss at Rs.6,01,40,630/-as against the total carried forward loss of Rs.41,79,03,557/- claimed by the appellant. The contention of the AO in doing so is that as per the provisions of section 79 of the Act, losses of earlier years are not allowable to be carried forward to subsequent year since there is a change in the shareholding of the company and considering that the shareholding of 97% shares were changed in FY 2015-16, the losses of AY 2014-15 and 201516 are not allowed to be carried forward.

10.1. According to the appellant, 99.98% of the share capital prior to amalgamation were held by Air Liquide Global E & C Solutions India P Ltd in the appellant company. Post amalgamation, the share holding pattern changed and Air Liquide International France acquired 97.79% of the shares. Despite this change, the contention of the appellant is that the ultimate holding company remained the same i.e. L’Air Liquide SA. Consequently, it is submitted that ultimate beneficial ownership of the appellant company remained consistent with L’Air Liquide SA throughout the period of restructuring. The appellant places reliance on the decision of CIT V/s Amco Power Systems Ltd (Karnataka)/[2015] 379 ITR 375 (Karnataka). In the said case, it was held that section 79 of the Act specifies that “not less than 51% of the voting power were beneficially held by the person”. This stresses on beneficial ownership rather than voting power and no new owner should purchase the shares of the company only to get benefit of set off of business losses of the previous years. Hence, it is provided that 51% of the voting power which was beneficially held by a person or persons should continue to be held then only such benefit could be given to the company.

10.2. In view of the above, the AO is directed to allow the carried forward losses of the appellant for AY 2014-15 & 2015-16. Ground No 5 of the appeal is treated to have been allowed.”

[Emphasis supplied]

7. Dissatisfied with the order of the Ld. CIT(A), the Revenue is in appeal before us challenging the above-mentioned two issues.

8. Before us, the Ld. Sr. DR placed reliance on the finding of the Ld. AO and case laws cited in various grounds of appeal. He prayed for setting aside the impugned appellate order with direction to restore the assessment order.

9. On the other hand, the Ld. Counsel submitted that the Revenue had challenged the relief allowed by the Ld. CIT(A) on the issue of foreign exchange losses on the reasoning that the Ld. CIT(A) had not considered the decision of the Sanjeev Woollen Mills v. CIT (SC) and the Tribunal decision in the case of Bechtel India (P.) Ltd. v. Asstt. CIT ITD 282 (Delhi – Trib.). The Ld. Counsel, drawing our attention to these case laws, submitted that the issue in Sanjeev Woolen Mills (supra) was in respect of valuation of closing stock in which the assessee had changed its method of valuation of closing stock which enhanced its profit eligible for deduction under section 80HHC of the Act. The finding of the Hon’ble Supreme Court was in respect of that facts which were quite different than the case in hand. With respect to the case law of the Tribunal in case Bechtel India (P.) Ltd. (supra), the Ld. Counsel submitted that the assessee had entered into forward contract which were settled on actual delivery through dollars received on export receivable and there was no extra outgo for settlement of forward contract other than what was already determined in the forward contract, whereas the facts of the present case were quite different. He further submitted that the case of the assessee was squarely covered by the decision of the Hon’ble Supreme Court in the case of CIT v. Woodward Governor of India (SC)/[2009] 312 ITR 254 (SC), which was followed by the Ld. CIT(A) in the impugned order. Further, he also placed reliance on the case of Sutlej Cotton Mills Ltd. v. CIT [1979] 116 ITR 1 (SC).

10. With respect to the issue of denial of carry forward of loss under section 79 of the Act, the Ld. Counsel submitted that the case of the assessee was squarely covered by the decision of the Hon’ble Karnataka High Court in the case of CIT v. AMCO Power Systems Ltd. ITR 375 (Karnataka). Further, he submitted that the decision of Hon’ble Delhi High Court in the case of Yum Restaurants (India) Private Limited v. ITO ITR 637 (Delhi) mentioned in the above grounds of appeal was not applicable in the case of the assessee as the Hon’ble Delhi High Court had held that

“There is nothing to show that there was any agreement or arrangement that the beneficial owner of such shares would be the holding company, Yum USA. The question of ‘piercing the veil’ at the instance of Yum Indian does not arise.”

11. The Ld. Counsel further contended that there was no change in shareholding in the year of the loss and the year under appeal. There was no change in shareholding since 01.04.2013; i.e. the day on which the amalgamation by the Hon’ble Delhi High Court was granted to the assessee. He submitted that the effective date of amalgamation, in view of the Hon’ble High Court order, would be 01.04.2013 though the order of amalgamation came later. The appointed date of amalgamation was 01.04.2013 and thereafter there was no change in the shareholding. To buttress his contention, the Ld. Counsel placed reliance on the decisions of the Hon’ble Supreme Court in the cases of Marshall Sons & Co. (India) Ltd. v. ITO (SC)/[1997] 223 ITR 809 (SC) and Pr. CIT v. Intas Pharmaceuticals Ltd. ITR 421 (SC). In view of the above cited decisions, the Ld. Counsel submitted that the actual date of issue of share happened subsequently after the Hon’ble High Court’s order of amalgamation though it was effective from 01.04.2013. The losses considered for disallowance by the Ld. AO pertained to AY 2014-15 to 2016-17. There was no change in shareholding after 31.03.2014 relevant to AY 2014-15. Thus, the provision of Section 79 of the Act did not get attracted, submitted the Ld. Counsel.

12. We have heard both parties and have perused the material available on record. After thoughtful consideration of facts and material available on the record, we find merit in submissions/contentions/arguments of the Ld. Counsel. The Revenue has not brought any material on the record to contradict the finding of the Ld. CIT(A). Therefore, in view of the above case laws relied upon by the Ld. Counsel and categorical finding in the impugned order, we do not find any infirmity in the order of the Ld. CIT(A). Hence, the appeal preferred by the Revenue is dismissed.

13. In the result, the appeal of Revenue is dismissed as above.