Holding

The Court held that exchange losses on foreign‑currency loans are deductible under section 37(1) in the year of fluctuation and that, under the unamended section 43A, adjustments to the actual cost of foreign‑currency assets may be made at each balance‑sheet date, the amendment being merely amendatory.

Summary

The Commissioner of Income Tax appealed against the Delhi High Court’s order allowing M/s Woodward Governor India Ltd. to deduct unrealised foreign‑exchange losses on loans taken for revenue purposes. The Court examined whether such losses could be claimed under section 37(1) in the year the exchange rate fluctuated or only when the loan was repaid, and also whether the actual cost of imported assets could be adjusted for exchange‑rate changes at each balance‑sheet date under section 43A. Relying on the mercantile system of accounting, the mandatory Accounting Standard‑11 and the ordinary principles of commercial accounting, the Court held that the exchange loss recorded on the balance‑sheet date is a deductible expenditure under section 37(1). It further held that, under the unamended section 43A, adjustments to the actual cost of foreign‑currency assets may be made at each balance‑sheet date, and that the amendment made by the Finance Act 2002 is merely amendatory. Consequently, the Department’s appeals were dismissed.

Issues considered

Whether additional liability arising from foreign‑exchange fluctuation on loans taken for revenue purposes is deductible under section 37(1) in the year of fluctuation or only in the year of repayment.
Whether the assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency for exchange‑rate fluctuations at each balance‑sheet date pending actual payment, i.e., the scope of section 43A (pre‑ and post‑amendment).

Legislation cited

Companies Act, 1956s. 209
Income Tax Act, 1961s. 145, s. 28, s. 29, s. 37(1), s. 43, s. 43A

Subjects

section 37(1) deductionforeign exchange lossexchange rate fluctuationAccounting Standard 11section 43Aactual cost adjustmentmercantile accountingincome taxcapital assetrevenue account

Judgment

(2009] 5 S.C.R. 738
"'
A COMMISSIONER OF INCOME TAX, DELHI
v.
MIS WOODWARD GOVERNOR INDIA P. LTD.
(Civil Appeal No. 2206 of 2009)
APRIL 8, 2009
B
[S.H. KAPADIA AND AFTAB ALAM, JJ.]

Income Tax Act, 1961:

c s. 37(1) - Loan for revenue purpose - Fluctuation in rate
of exchange - Deduction of additional liability arising therein
uls 37(1) in year of fluctuation in rate of exchange or in year
of repayment of such loan - Held: Loss on account of
exchange difference as on date of balance sheet is item of
,,.
..
D expenditure u/s.37(1) and is deductible thereunder - Any
difference, Joss or gain, arising on conversion of said liability
at closing rate, should be recognized in profit and loss
account for the reporting period ·- Accounting method
followed by assessee continuously for a given period of time
is presumed to be correct till Assessing Officer points out
E
defects therein - No finding by AO on correctness of accounts
of assessee and also on correctness of accounting standards
followed by assessee - Thus, claim of assessee for deduction
of unrealized loss due to foreign exchange fluctuation as on
last date of previous year to be allowed. t
F
Accounting Standard-11 - Is giving of accounting
treatment on the balance sheet date for the effects of changes
in foreign exchange rates.
\'
s. 43A (unamended) - Liability on capital account -
G
Fluctuation in rate of exchange - Adjustment at each balance
sheet date pending actual payment of varied liability -
Entitlement of- Held: s. 43A provides for adjustment in actual
cost of assets pursuant to change in foreign currency

H 738
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 739
GOVERNOR INDIA P. LTD.
"
exchange rates, actual payment not being a condition A
precedent- s. 43A corresponds to para 10 of AS-11- Thus,
adjustment in actual cost of assets pursuant to foreign
exchange fluctuation are to be made at each balance sheet
date.

s. 43A (amended) - Nature of - Held: Is amendatory and
B
not clarificatory in nature - Under amended s. 43A adjustment
in the actual cost is made on cash basis - Actual payment
of decreased/enhanced liability is made a condition
precedent for making adjustment in carrying amount of fixed
asset. c
The question which arose for determination in these
appeals is (i) whether the additional liability arising on
'
. account of fluctuation in the rate of exchange in respect
7
of loans taken for revenue purposes could be allowed as · D
deduction under section 37(1) of the Income Tax Act,
1961 in the year of fluctuation in the rate of exchange or
whether the same could only be allowed in the year of
repayment of such loans; and (ii) Whether the assessee
is entitled to adjust the actual cost of imported assets E
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.

J Dismissing the appeals, the Court
F
HELD: 1.1. The profits and gains of the previous year
are required to be computed in accordance with the
relevant accounting standard. The basis on which stock-
in-trade is valued is part of the method of accounting. It
is well established, that, on general principles of G
commercial accounting, in the P&L account, the values
of the stock-in-trade at the beginning and at the end of
' the accounting year should be entered at cost or market
value, whichever is lower-the market value being
ascertained as on the last date of the accounting year and H
740 SUPREME COURT REPORTS [2009) 5 S.C.R.

A not as on any intermediate date between the
commencement and the closing of the year, failing which
it would not be possible to ascertain the true and correct
state of affairs. No gain or profit can arise until a balance
is struck between the cost of acquisition and the
8 proceeds of sale. The word "profit" implies a comparison
between the state of business at two specific dates,
usually separated by an interval of twelve months. Stock-
in-trade is an asset. It is a trading asset. Therefore, the
concept of profit and gains made by business during the
year can only materialize when a comparison of the
C assets of the business at two different dates is taken into
account. Section 145(1) enacts that for the purpose of
section 28 and section 56 alone, income, profits and
gains must be computed in accordance with the method
of accounting regularly employed by the assessee. In the
D instant case, the concern is with regard to section 28.
Therefore, section 145(1) is attracted to the facts of the
instant case. Under the mercantile system of accounting,
what is due is brought into credit before it is actually
received; it brings into debit an expenditure for which a
E legal liability has been incurred before it is actually
disbursed. Therefore, the accounti11g method followed by
an assessee continuously for a given period of time
needs to be presumed to be correct till the AO comes to
the conclusion for reasons to be given that the system
F does not reflect true and correct profits. In the instant
cases, there is no finding given by the Assessing Officer
on the correctness or completeness of the accounts of
the assessee. Equally there is no finding that the
assessee has not complied with the accounting
G standards. [Paras 14 and 16] [759--H; 760-A-F, G; 759-F]

United Commercial Bank v. CIT 240 ITR 355, relied on.

1.2. The "loss" suffered by the assessee on account

H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 741
)
GOVERNOR INDIA P. LTD.

of the exchange difference as on the date of the balance A
sheet is an item of expenditure under section 37(1) of the
1961 Act. [Para 15) [759-G]

1.3. Valuation is a part of the accounting system; that
business losses are deductible under Section 37(1) on 8
the basis of ordinary principles of commercial
accounting; and that the Central Government has made
Accounting Standard-11 mandatory. [Para 17] [761-A]

1.4. Accounting Standard-11 deals with giving of
accounting treatment for the effects of changes in foreign C
exchange rates. AS-11 deals with effects of Exchange
Differences. Under para 2, reporting currency is defined
to mean the currency used in presenting the financial
statements. Similarly, the words "monetary items" are
defined to mean money held and assets and liabilities to D
be received or paid in fixed amounts, e.g., cash,
receivables and payables. The word "paid" is defined
under section 43(2). Similarly, it is important to note that
foreign currency notes, balance in bank accounts
denominated in a foreign currency, and receivables/" E
payables and loans denominated in a foreign currency
as well as sundry creditors are all monetary items which
have to be valued at the closing rate under AS-11. Under
para 5, a transaction in a foreign currency has to be
recorded in the reporting currency by applying to the F
foreign currency amount the exchange rate between the
reporting currency and the foreign currency at the date
of the transaction. This is known as recording of
transaction on Initial Recognition. Para 7 of AS-11 deals
with reporting of the effects of changes in exchange rates G
subsequent to initial recognition. Para 7(a) inter a/ia states
that on each balance sheet date monetary items
denominated in a foreign currency should be reported
using the closing rate. In case of revenue items falling
H
742 SUPREME COURT REPORTS [2009] 5 S.C.R.

A under section 37(1), para 9 of AS-11 which deals with
recognition of exchange differences, needs to be
considered. Under that para, exchange differences
arising on foreign currency transactions have to be
recognized as income or as expense in the period in
B which they arise, except as stated in para 10 and para 11
which deals with exchange differences arising on
repayment of liabilities incurred for the purpose of
acquiring fixed assets, which topic falls under section
43A of the 1961 Act. The concern is with regard to para
C 9 which deals with revenue items. Para 9 of AS-11
recognises exchange differences as income or expense.
In cases where, e.g., the rate of dollar rises vis-a-vis the
Indian rupee, there is an expense during that period. AS-
11 stipulates effect of changes in exchange rate vis-a-vis
monetary items denominated in a foreign currency to be
0
taken into account for giving accounting treatment on the
balance sheet date. Therefore, an enterprise has to report
the outstanding liability relating to import of raw materials
using closing rate of exchange. Any difference, loss or
gain, arising on conversion of th1e said liability at the
E closing rate, should be recognized in the P&L account
for the reporting period. (Para 18] [761-C-H; 762-A-C]

1.5. In order to find out if an expenditure is deductible
the following have to be taken into account (i) whether
F the system of accounting followed by the assessee is
mercantile system, which brings into debit the
expenditure amount for which a legal liability has been
incurred before it is actually disbursed and brings into
credit what is due, immediately it becomes due and
G before it is actually received; (ii) whether the same system
i'> 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
H to the gains that may accrue to it; (iv) whether the
1
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 743
;)
GOVERNOR INDIA P. LTD.
assessee has been consistent and definite in making A
entries in the account books in respect of loss~s 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 notionally accepted accounting
4 standards; (vi) whether the system adopted by the B
assessee is fair and reasonable or is adopted only with
a view to reducing the incidence of taxation. [Para 21)
[763-C-F]
·-·
Indian Molasses Co. (P) Ltd. v. CIT 37 ITR 66; M.P.
Financial Corporation v. CIT 165 ITR 765 and Madras c
Industrial Investment Corporation Ltd. v. CIT 225 ITR 802,
referred to.
1
Law and practice of Income Tax by Kanga and
-I Palkhivala, referred to. D
2.1. Section 43A starts with a non obstante clause.
Section 43A(1) overrides the other provisions only as
regards cases falling. under that sub-section. Section
43A(1) applies only where as a result of change in the rate
of exchange there is an increase or reduction in the E
liability of the assessee in terms of the Indian rupee to
pay the price of any asset payable in foreign exchange
or to repay moneys borrowed in foreign curr.ency
specifically for the purpose of acquiring the asset.
•• Section 43A(1 ), therefore, has no application unless the F
asset is acquired and the liability existed, before the
change in the rate of exchange takes effect. [Para 30)
[767-G, H; 768-A]
""
2.2. Increase or decrease in liability in the repayment G
of foreign loan should be taken into account to modify
, the figure of actual cost in the year in which the increase
or decrease in liability arises on account of the
fluctuation in the rate of exchange. Thus, the adjustments
in the actual cost are to be made irrespective of the date of H
~
~~
r
744 SUPREME COURT REPORTS [2009] 5 S.C.R.
..
A actual Rayment in foreign currency made by the assessee.
[Para 31] [768-C]

CIT v. Arvind Mills Ltd. 193 ITR 255, relied on.

2.3. Section 43(1) defines actual cost for the purpose
B of grant of depreciation etc. to mean "the actual cost of
the assets to the assessee". Till the insertion of the
unamended s. 43A there was no provision in the Income
Tax Act for adjustment of the actual cost which was fixed
once and for all, at the time of acquisition of the asset.
c Accordingly, no adjustment could be made in the actual
cost of the assets for purposes of grant of depreciation
for any increase/decrease of liability subsequently arising
due to exchange fluctuation. Consequently, s. 43A was
introduced in the Act by Finance Act, 1967 w.e.f. 1.4.1967
D in the above terms to provide fo1r adjustment in the actual '
cost of assets pursuant to channe in the foreign currency
exchange rates. As a consequence of the insertion of the
said section, it became possible to adjust the increase/
decrease in liability relating to acquisition of capital assets
E on account of exchange rate fluctuation, in the actual
cost of the assets acquired in foreign currency and for,
inter alia, depreciation to be allowed with reference to
such increased/decreased cost. This position is also
made clear by Circular No. 5-P dated 9.10.1967 issued by
CBDT. Section 43A (unamended) corresponds to para 10
F
of AS-11 similarly providing for adjustment in the carrying
cost of fixed assets acquired in foreign currency, due to
foreign exchange fluctuation at each balance sheet date. "I~

[Para 32] [768-G, H; 769-A-C]

G 2.4. What triggers the adjustment in the actual cost
of the assets, in terms of 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
H
;;
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 745
) GOVERNOR INDIA P. LTD.
change in the rate of exchange, the same may be given A
effect to by way of adjustment of the carrying cost of the
fixed assets acquired in foreign currency. But for s. 43A
which corresponds to para 10 of AS-11 such adjustment
in the carrying amount of the fixed assets was not
,.. possible, particularly in the light of s. 43(1 ). The B
unamended s. 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 c
in the unamended s. 43A were "for making payment" and
not "on payment" which is now brought in by
amendment to s. 43A vide Finance Act, 2002. [Para 33]
[769-G, H; 770-A, BJ
2.5. The amendment of s. 43A by the Finance Act, D
2002 w.e.f. 1.4.2003 is amendatory and not clarificatory in
nature. The amendment is in complete substitution of the
section as it existed prior thereto. Under the unamended
s. 43A adjustment to the actual cost took place on the
happening of change in the rate of exchange whereas E
under the amended s. 43A the adjustment in the actual
cost is made on cash basis. This is indicated by the
words "at the time of making payment". Under the
unamended s. 43A, "actual payment" was not a condition
! precedent for making necessary adjustment in the F
carrying cost of the fixed asset acquired in foreign
currency, however, under amended s.43A w.e.f. 1.4.2003
such actual payment of the decreased/enhanced liability
is made a condition precedent for making adjustment in
the carrying amount of the fixed asset. [Para 34] [770-D, G
E]
3. There is no infirmity in the judgment of High Court
that claim of assessee for deduction of unrealized loss
due to foreign exchange fluctuation as on last date of
previous year is to be allowed. [Para 35] [770-G, H] H
746 SUPREME COURT REPORTS [2009] 5 S.C.R.
"
A Case Law Reference:
37 ITR 66 Referred to. Para 6
165 ITR 765 Referred to. Para 14
225 ITR 802 l~eferred to. Para 14
B
240 ITR 355 Relied on. Para 16
116 ITR 1 'Referred to. Para 20
193 ITR 255 Relied on. Para 31
c
CIVIL APPELLATE JURISDICTION : Civil Appeal No.
2206 of 2009.

From the Judgment & Order dated 30.4.2007 of the High
Court of Delhi at New Delhi in ITA No. 159 of 2006.
D
VVITH

Civil Appeal No. 2214/09

Civil Appeal No. 2212/09
E
Civil Appeal No. 2207/09

Civil Appeal No. 2213 /09

Civil Appeal No. 2226/09
F
Civil Appeal No. 2215/09

Civil Appeal No. 2210 /09

Civil Appeal No. 2235 /09
G
Civil Appeal No. 2208/09

Civil Appeal No. 2209/09

Civil Appeal No. 2211/09
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 747
GOVERNOR INDIA P. LTD.
Civil Appeal No. 2216/09 A

Civil Appeal No. 2217/09

Civil Appeal No. 2218/09

Civil Appeal No. 2219/09 B

Civil Appeal No. 2220/09

Civil Appeal No. 2221 /09

Civil Appeal No. 2222/09 c
Civil Appeal No. 2223/09

Civil Appeal No. 2224/09

Civil Appeal No. 2225/09 D

Civil Appeal No. 2227/09

Civil Appeal No. 2228/09

Civil Appeal No. 2229/09 E

Civil Appeal No. 2230/09

Civil Appeal No. 2231/09

) Civil Appeal No. 2232/09 F

Civil Appeal No. 2233/09

Civil Appeal No. 2234/09

Civil Appeal No. /09 @ SLP (C) No. /09 (CC No. 2868/09) G
Civil Appeal No. /09 @ SLP (C) No. /09 (CC No. 3007/09)
Civil Appeal No. /09 @ SLP (C) No. 109 (CC No. 1999/09)

Parag Tripathi, ASG, K. Radhakrishnan, S. Ganesh, Arti H
748 SUPREME COURT REPORTS (2009] 5 S.C.R.

A Gupta, Anubha Agrawal, Ranbir Chandra, Kunal Bahri, Arijit
Prasad, H, Raghavendra Rao, C.V. Subba Rao, D.K. Singh
Amey Nargolkar, Varun Sarin, B.L. Chhibber, N.K. Karhail,
Vismai Rao, T.V. Ratnam, M. Chandra Shekhar, Shweta Garg,
Ashish Gopal Garg, B.V. Balaram Das, Ajay Vohra, Kavita Jha,
B Sandeep S. Karhail, Bhargava V. Desai, Rahul Gupta, Reema
Sharma, Ravi Pratap Mall, S. Sukumaran, Anand Sukumar,
Meera Mathur, Pradeep K. Bakshi, Rajat Navet, Sridhar
Potaraju, Satyen Sethi, Johnson Bara, R.P. Goyal, Mahua
Kalra, Jagjit Singh Chhabra, K.K. Patra, Bindu Saxena,
c Shivendra Swarup, Vyom Bansalm and Shailendra Swarup for
the appearing parties.

The Judgment of the Court was delivered by

S.H. KAPADIA, J.1. Delay condoned.
D
2. Leave granted.

3. In this batch of civil appeals, the following question
arises for determination:

E (i) Whether, on the facts and circumstances of the
case and in law, the additional liability arising on
account of fluctuation in the rate of exchange in
respect of loans taken for revenue purposes could
be allowed as deduction under Section 37(1) in the
F year of fluctuation in the rate of exchange or whether
the same could only be allowed in the year of
repayment of such loans?
(ii) Whether the assessee is entitled to adjust the
actual cost of imported assets acquired in foreign
G currency on account of fluctuation in the rate of
exchange at each balance sheet date, pending
actual payment of the varied liability?

4. At the outset, for the sake of convenience, we may state
H that in this batch of civil appeals broadly we have before us two
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 749
GOVERNOR INDIA P. LTD [S.H. KAPADIA, J.]
-,I

categories. In the first category, we are concerned with A
exchange differences arising in foreign currency transaction on
revenue items. In such category, we are concerned with the
assessee(s) incurring loss on revenue account. In that category,
we are concerned with the provisions of Sections 28, 29, 37(1)
and 145 of the Income-tax Act. 1961 ("1961 Act"). In the second B
... category of cases, we are concerned with exchange differences
arising on repayment of liabilities incurred for the purpose of
acquiring fixed assets. In other words, in the second category
of cases, we are concerned with the assessee(s) incurring
liabilities on capital account. In such cases, we are required to c
consider the provisions of Section 43(1), 43A (both, before and
after Amendment vide Finance Act, 2002).

Facts in M/s Woodward Governor India P. Ltd.

[Civil Appeal arising out of SLP(C} No. 593/08) D

- REVENUE ACCOUNT CASE:

5. The assessee filed its Return of Income on 28.1.1998
for the assessment year 1998-99 on a total income of Rs.
1, 10,28, 190.00. That return was processed under Section E
143(1 )(a} on 23.3.1999. On 16.8.1999 a notice under Section
143(2) was issued to the assessee stating that in the course
of assessment proceedings under Section 143 it was noticed
by the Department that the assessee had debited to its Profit
; & Loss Account a sum of Rs. 41,06, 746.00 out of which a sum F
of Rs. 29,49,088.00 was the unrealized loss due to foreign
exchange fluctuation on the last date of the accounting year. The
AO held that the liability as on the last date of the previous year
under consideration was a contingent liability, it was not an
ascertained liability and consequently it had to be added back G
to the total income of the assessee. Accordingly, he added
back Rs. 29,49,088.00 being the unrealized loss due to foreign
exchange fluctuation. In other words, the debit to the P&L
account was disallowed. This order of the AO was upheld by
the CIT(A) vide decision dated 29.11.2001. Being aggrieved, H
750 SUPREME COURT REPORTS [2009) 5 S.C.R.

A the assessee went in appeal to the Tribunal. By judgment and
order dated 1.4.2005 the Tribunal relying on its earlier decision
in the case of Mis Woodward Governor India P. Ltd. for the
assessment years 1995-96, 1996-97 and 1997-98 held that the
claim of the assessee for deduction of unrealized loss -due to
B foreign exchange fluctuation as on the last date of the previous
year had to be allowed. This decision of the Tribunal has been
upheld by the Delhi High Court vide the impugned judgment
dated 30.4.2007, hence, this Civil Appeal is filed by the
Department.
c 6. Shri Parag Tripathi, learned Additional Solicitor General,
appearing on behalf of the Department submitted that, in this
case, the assessee(s) claims deduction under Section 37,
which is a residuary provision, as there is no specific provision
dealing with adjustment based on foreign exchange fluctuations
D on the Revenue account (akin to Section 43A, which deals with
such adjustments in the Capital account). According to the
learned counsel, the essence of deductibility under Section 37
is that the increase in liability due to foreign exchange
fluctuations must fulfill the twin requirements of "expenditure"
E and the factum of such expenditure having been "laid out or
expended". According to the learned counsel, the expression
"expenditure" is "what is paid out" and "something which is gone
irretrievably". In this connection, learned counsel placed reliance
on the judgment of this Court in the case of Indian Molasses
F Co. (Private) Ltd. v. CIT reported in 37 ITR 66. According to
the learned counsel, the increase in liability at any point of time
prior to payment cannot fall within the meaning of the word
"expenditure" in Section 37(1). Therefore, according to the
learned counsel, the requirement of expenditure is not met in
G this case. According to the learned counsel, similarly the
requirement of money being "expended or laid out" is also not
satisfied and thus additional liability arising on account of
fluctuation in foreign exchange rate is not deductible under
Section 37(1).
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 751
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.)
7. Shri C.S. Aggarwal, learned senior counsel appearing A
... for M/s Woodward Governor India P. Ltd. (Civil Appeal arising
out of S.L.P.(C) No. 593/08), submitted that the assessee had
debited a sum of Rs. 41,06,748.00 to its P&L account of which
a sum of Rs. 29,49,088.00 stood for the unrealized loss due
\
to foreign exchange fluctuation. According to the learned B
counsel, the assessee has been following mercantile system
of accounting. According to the learned counsel, under
mercantile system of accounting, which is also known as
accrual system of accounting, whenever the amount is credited
to the account of the payee (creditor) liability stands incurred c
by the assessee even though the amount is actually not paid.
In this connection, learned counsel placed reliance on the
definition of the word "paid" in Section 43(2). According to the
learned counsel, in the past in some years when the value of
the rupee becomes stronger vis-a-vis US$, the Department had
~j
D
taxed the gains as income. Therefore, according to the learned
counsel, when it comes to "income", the Department says that
accrual is enough for taxability and "payment" is irrelevant but
when it comes to "loss", the Department says that "payment"
alone is relevant for taxability. According to the learned counsel,

- such double standards cannot be countenanced. Learned E
counsel further gave the following example in support of his
contentions:

1. Where amount is borrowed and used in business:
F
4.4.1999 - "X" borrows $ 100/-
- debits the loan Ale by Rs. 3500/-
(at Rs. 35/- per dollar)
on the basis of prevailing market rate.
G
- Amount borrowed is utilized in business.

31.3.2000 - Rate of exchange fluctuated and it became
Rs. 40/- per Dollar.
- Liability increased by Rs. 500/-.
H
752 SUPREME COURT REPORTS [2009] 5 S.C.R.

A 2. The liability thus was, since by way of loan, the
increased liability of Rs. 500/- was towards business
increased by Rs. 500/- which resulted into business loss
as a result of modification of existing liability. Likewise if
on fluctuation, the dollar rate is reduced to Rs. 32/- per
B dollar, the liability will get reduced by Rs. 300/- and there
)
would be a business gain of Rs. 300/-.

8. In the light of the above illustration, learned counsel
urged that when the assessee(s) borrows 100 US$ on 1.4.1999
he incurs a crystallised liability, however, the value of that liability
C undergoes a change by 31.3.2000 on account of the fall in the
rupee value. In other words, the rate of exchange fluctuated from
Rs. 35 per dollar as on 1.4.1999 to Rs. 40 per dollar as on
31.3.2000, thus, increasing the liability of the assessee by
Rs.500. According to the learned counsel, the assessee was
D entitled therefore to deduction under Section 37(1) for such
enhanced liability. Similarly, if the dollar rate had reduced from
Rs. 35 to Rs. 32 per dollar, then the assessee's liability would
stand reduced by Rs. 300 and there would be a gain of Rs.
300 which would become taxable. From this hypothetical
E example, learned counsel urged that the liability stood incurred
on the date on which the assessee borrows 100 $ which in the
above example is 1.4.1999, however, on account of fluctuation ......
in the dollar rate, the liability may enhance or may reduce by
31.3.2000. This has to be taken into account by the
F Department. The learned counsel submitted that whenever the
dollar rate stood reduced, the Department has taxed in the past
the business gains, therefore, as ·a corollary, the Department
has to allow deduction in the year in which the assessee incurs
business loss on account of the increase in the dollar rate.
G Therefore, according to the learned counsel, there is no warrant
for interfering in the impugned judgment of the High Court.

9. Shri S. Ganesh, learned senior counsel appearing for
Mis Maruti Udyog Ltd. (Civil Appeal arising out of SLP (C) No.
18967/08), adopted the argument advanced by Shri C.S.
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 753
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.)
" Aggarwal. In addition, he pointed out that the assessee had A
maintained its accounts right from 1985 on accrual system of
accounting. He submitted that during the assessment years
1985-86 to 1989-90 loss claimed was allowed. It was pointed
out on facts that the assessee borrowed loans in dollar and yen.
\
It was pointed out that in the assessment year 1990-91, the B
dollar rate stood increased but the yen rate stood reduced
resulting in gain, which was offered as income and which was
accordingly taxed. But when it came to the year in question,
namely, assessment year 1991-92, in which year there was a
loss on account of fluctuation in the foreign exchange rate, the c
Department has taken a contradictory stand that accrual of
liability is irrelevant and that the year of paymenUrepayment is
relevant. The point which the learned counsel made was that
having accepted the system of accounting undertaken by the
assessee, it was not open to the Department to introduce a new D
~
system of accounting. According to the learned counsel, the
liability to repay the loan in US$ or in yen accrues the moment
the contract is entered into. It has nothing to do with the time of
paymenUrepayment. According to the learned counsel, the date
of payment has nothing to do with the accrual of liability.
E
According to the learned counsel, at the end of the accounting

- year, namely, 31.3.1991 the assessee had to value the liability
which it had incurred during the accounting year in question.
He urged that Section 145 of the Income-tax Act, 1961 ties down
the AO to the Accounting System followed by the assessee in
) the past which accounting system has been accepted by the F
Department over the years and if the AO seeks to introduce a
new system of accounting he has to give reasons in his order
pointing out defects in the existing accounting system. Learned
counsel pointed out that, in this case, there is no such finding.
According to the learned counsel, valuation of asset and liability G
is a matter of accounting system. The AO cannot depart from
the existing accounting system without giving reasons for such
departure. According to the learned counsel, the existence of
liability stands crystallized on the date of the contract. It has
nothing to do with payment and valuation of liability at a later H
754 SUPREME COURT REPORTS [2009) 5 S.C.R.
l;

A date. According to the learned counsel, the income of the
assessee is decided only in terms of the system of
accounting. Therefore, according to the learned counsel, in the
facts of the case in Mis Maruti Udyog Ltd., the overall loss
suffered by the assessee cannot be disallowed on the ground
B that such loss has occurred on account of fluctuation in the
foreign exchange rate. According to the learned counsel, for the
above reasons, there is no need to interfere in the impugned
judgment.

10. As stated above, on facts in the case of Mis Woodward
c Governor India P. Ltd., the Department has disallowed the
deduction/debit to the P&L account made by the assessee in
the sum of Rs. 29,49,088.00 being unrealized loss due to
foreign exchange fluctuation. At the very outset, it may be stated
that there is no dispute that in the previous years whenever the
D dollar rate stood reduced, the Department had taxed the gains \-

which accrued to the assessee on the basis of accrual and it
is only in the year in question when the dollar rate stood
increased, resulting in loss that the Department has disallowed
the deduction/debit. This fact is important. It indicates the
E double standards adopted by the Department.

11. The dispute in this batch of civil appeals centers around
the year(s) in which deduction would be admissible for the
increased liability under Section 37(1 ).
-
F 12. We quote hereinbelow Section 28(i), Section 29 \ ..
Section 37(1) and Section 145 of the 1961 Act, which read as
follows:
Profits and gains of business or profession:
G
Section 28:

"The following income shall be chargeable to income-tax
under the head "Profits and gains of business or
profession", -
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 755
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]
(i) the profits and gains of any business or profession A
which was carried on by the assessee at any time
during the previous year."

Income from profits and gains of business or profession,
how computed:
B
Section 29:

"The income referred to in section 28 shall be computed
in accordance with the provisions contained in sections 30
to 430." c
General:

Section 37:

"(1) Any expenditure (not being expenditure of the D
nature described in sections 30 to 36 and not being
in the nature of capital expenditure or personal
expenses of the assessee), laid out or expended
wholly and exclusively for the purposes of the
business or profession shall be allowed in E
computing the income chargeable under the head
,;Profits and gains of business or profession".

Explanation. - For the removal of doubts, it is hereby
.> declared that any expenditure incurred by an
assessee for any purpose which is an offence or F
which is prohibited by law shall not be deemed to
have been incurred for the purpose of business or
profession and no deduction or allowance shall be
made in respect of such expenditure."
G
(emphasis supplied)

Method of Accounting:
Section 145:
H
756 SUPREME COURT REPORTS (2009) 5 S.C.R.

A "(1) Income chargeable unider the head "Profits and
gains of business or profession" or "Income from
other sources" shall, subject to the provisions of
sub-section (2), be computed in accordance with
-
either cash or mercantile system of accounting
B regularly employed by the assessee. '
(2) The Central Government may notify in the Official
Gazette from time to time accounting standards to
be followed by any class of assessees or in respect
of any class of income.
c
(3) Where the Assessing Officer is not satisfied about
the correctness or completeness of the accounts of
the assessee, or where the method of accounting
provided in sub-section (1) or accounting standards
D as notified under sub-section (2), have not been
regularly followed by thE~ assessee, the Assessing
Officer may make an assessment in the manner
provided in section 144."

E 13. As stated above, one of the main arguments advanced
by the learned Additional Solicitor General on behalf of the
Department before us was that the word "expenditure" in
Section 37(1) connotes "what is paiid out" and that which has
gone irretrievably. In this connection, heavy reliance was placed
on the judgment of this Court in the case of Indian Molasses ~
F Company (supra). Relying on the said judgment, it was sought
to be argued that the increase in liability at any point of time
prior to the date of payment cannot be said to have gone
irretrievably as it can always come back. According to the
learned counsel, in the case of increase in-liability due to foreign
G exchange fluctuations, if there is a revaluation of the rupee vis-
a-vis foreign exchange at or prior to the point of payment, then
there would be no question of money having gone irretrievably
and consequently, the requirement of "expenditure" is not met.
Consequently, the additional liability arising on account of
H fluctuation in the rate of foreign exchange was merely a
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 757
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]
contingenUnotional liability which does not crystallize till A
payment. In that case, the Supreme Court was considering the
meaning of the expression "expenditure incurred" while dealing
with the question as to whether there was a distinction between
the actual liability in presenti and a liability de futuro. The word
"expenditure" is not defined in the 1961 Act. The word B
"expenditure" is, therefore, required to be understood in the
context in which it is used. Section 37 enjoins that any
expenditure not being expenditure of the nature described in
Sections 30 to 36 laid out or expended wholly and exclusively
for the purposes of the business should be allowed in c
computing the income chargeable under the head "profits and
gains of business". In Sections 30 to 36, the expressions
"expenses incurred" as well as "allowances and depreciation"
•-, has also been used. For example, depreciation and allowances
_,
are dealt with in Section 32. Therefore, Parliament has used D
the expression "any expenditure" in Section 37 to cnver both.
Therefore, the expression "expenditure" as used in Section 37
may, in the circumstances of a particular case, cover an amount
which is really a "loss" even though the said amount has not
gone out from the pocket of the assessee.
E
14. In the case of M.P. Financial Corporation v. CIT
reported in 165 ITR 765 the Madhya Pradesh High Court has
held that the expression "expenditure" as used in Section 37
may, in the circumstances of a particular case, cover an amount
>
~
which is a "loss" even though the said amount has not gone out F
from the pocket of the assessee. This view of the Madhya
Pradesh High Court has been approved by this Court in the
case of Madras Industrial Investment Corporation Ltd. v. CIT
reported in 225 ITR 802. According to the Law and Practice of
Income Tax by Kanga and Palkhivala, Section 37(1) is a G
residuary section extending the allowance to items of business
expenditure not covered by Sections 30 to 36. This Section,
according to the learned. Author, covers cases of business
expenditure only, and not of business losses which are,
however, deductible on ordinary principles of commercial H
758 SUPREME COURT REPORTS [2009] 5 S.C.R.

A accounting. (see page 617 of the eighth edition). It is this
principle which attracts the provisions of Section 145. That
section recognizes the rights of a trader to adopt either the
cash system or the mercantile system of accounting. The
quantum of allowances permitted to be deducted under diverse
B heads under Sections 30 to 43C from the income, profits and
gains of a business would differ according to the system
adopted. This is made clear by defining the word "paid" in
Section 43(2), which is used in several Sections 30 to 43C,
as meaning actually paid or incumed according to the method
c of accounting upon the basis on which profits or gains are
computed under Section 28/29. That is why in deciding the
question as to whether the word "expenditure" in Section 37(1)
includes the word "loss" one has to read Section 37(1) with
Section 28, Section 29 and Section 145(1). One more principle
needs to be kept in mind. Accounts regularly maintained in the
0
course of business are to be taken as correct unless there are
strong and sufficient reasons to indicate that they are unreliable.
One more aspect needs to be highlighted. Under Section 28(i),
one needs to decide the profits and gains of any business which
is carried on by the assessee during the previous year.
E Therefore, one has to take into account stock-in-trade for
determination of profits. The 1961 Act makes no provision with
regard to valuation of stock. BUit the ordinary principle of
commercial accounting requires that in the P&L account the
value of the stock-in-trade at the beginning and at the end of
F the year should be entered at cost or market price, whichever
is the lower. This is how business profits arising during the year
needs to be computed. This is one more reason for reading
Section 37(1) with Section 145. For valuing the closing stock
at the end of a particular year, the value prevailing on the last
G date is relevant. This is because profits/loss is embedded in
ihe closing stock. While anticipated loss is taken into account,
anticipated profit in the shape of appreciated value of the
closing stock is not brought into account, as no prudent trader
would care to show increase profits before actual realization.
H This is the theory underlying the Rule that closing stock is to
_,' COMMNR. OF INCOME TAX, DELHI v. WOODWARD 759
GOVERNOR INDiA P. LTD. [S.H. KAPADIA, J.]
J
be valued at cost or market price, whichever is the lower. As A
profits for income-tax purposes are to be computed in
accordance with ordinary principles of commercial accounting,
unless, such principles stand superseded or modified by
· legislative enactments, unrealized profits in the shape of
appreciated value of goods remaining unsold at the end of the B
" accounting year and carried over to the following years account
~

., in a continuing business are not brought to the charge as a
matter of practice, though, as stated above, loss due to fall in
1 the price below cost is allowed even though such loss has not
•
""< been realized actually. At this stage, we need to emphasise c
once again that the above system of commercial accounting
can be superseded or modified by legislative enactment. This
is where Section 145(2) comes into play. Under that section,
the Central Government is empowered to notify from time to
" . time the Accounting Standards to be followed by any class of D
assessees or in respect of any class of income. Accordingly,
under Section 209 of the Companies Act, mercantile system
of accounting is made mandatory for companies. In other
words, accounting standard which is continuously adopted by
an assessee can be superseded or modified by Legislative
E
intervention. However, but for such intervention or in cases
falling under Section 145(3), the method of accounting
-I •' undertaken by the assessee continuously is supreme. In the
present batch of cases, there is no finding given by the AO on
the correctness or completeness of the accounts of the
}
assessee. Equally, there is no finding given by the AO stating F
that the assessee has not complied with the accounting
~
..{
standards .

15. For the reasons given hereinabove, we hold that, in the
present case, the "loss" suffered by the assessee on account G
of the exchange difference as on the date of the balance sheet
is an item of expenditure under Section 37(1) of the 1961 Act.
16. In the light of what is stated hereinabove, it is clear that
profits and gains of the previous year are required to be
H

'
;~
760 SUPREME COURT REPORTS (2009) 5 S.C.R. .
~

A computed in accordance with the re1levant accounting standard.
It is important to bear in mind that the basis on which stock-in-
trade is valued is part of the method of accounting. It is well
established, that, on general principles of commercial
accounting, in the P&L account, the values of the stock-in-trade
B at the beginning and at the end of the accounting year should ,.
be entered at cost or market valu1e, whichever is lower - the
market value being ascertained as on the last date of the
accounting year and not as on any intermediate date between
the commencement and the closing of the year, failing which it
c would not be possible to ascertain the true and correct state
of affairs. No gain or profit can arise until a balance is struck
between the cost of acquisition and the proceeds of sale. The
-
word "profit" implies a comparison between the state of
business at two specific dates, usually separated by an interval
of twelve months. Stock-in-trade is an asset. It is a trading ...
D
asset. Therefore, the concept of profit and gains made by
business during the year can only materialize when a
comparison of the assets of the business at two different dates
is taken into account. Section 145(1) enacts that for the
purpose of Section 28 and Section 56 alone, income, profits
E
and gains must be computed in accordance with the method
of accounting regularly employed by the assessee. In this case,
we are concerned with Section 28. Therefore, Section 145(1) ......
is attracted to the facts of the present case. Under the
mercantile system of accounting, what is due is brought into
F credit before it is actually receiv1ed; it brings into debit an ~

expenditure for which a legal liabili1y has been incurred before
it is actually disbursed. (see judgmi:mt of this Court in the case
of United Commercial Bank v. CIT reported in 240 ITR 355).
Therefore, the accounting method followed by an assessee
G continuously for a given period of time needs to be presumed
to be correct till the AO comes to the conclusion for reasons to
be given that the system does not reflect true and correct profits.
As stated, there is no finding given by the AO on the
correctness of the accounting standard followed by the
H assessee(s) in this batch of Civil Appeals.

'l
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 761
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]

17. Having come to the conclusion that valuation is a part A
of the accounting system and having come to the conclusion
that business losses are deductible under Section 37(1) on the
basis of ordinary principles of commercial accounting and
having come to the conclusion that the Central Government has
made Accounting Standard-11 mandatory, we are now required B
to examine the said Accounting Standard ("AS").

18. AS-11 deals with giving of accounting treatment for the
effects of changes in foreign exchange rates. AS-11 deals with
effects of Exchange Differences. Under para 2, reporting
currency is defined to mean the currency used in presenting the
c
financial statements. Similarly,_ the words "monetary items" are
defined to mean money held and assets and liabilities to be
received or paid in fixed amounts, e.g., cash, receivables and
payables. The word "paid" is defined under Section 43(2). This
has been discussed earlier. Similarly, it is important to note that D
f

foreign currency notes, balance in bank accounts denominated
in a foreign currency, and receivables/payables and loans
denominated in a foreign currency as well as sundry creditors
are all monetary items which have to be valued at the closing
rate under AS-11. Under para 5, a transaction in a foreign E
currency has to be recorded in the reporting currency by
/
applying to the foreign currency amount the exchange rate
between the reporting currency and the foreign currency at the
date of the transaction. This is known as recording of
.... ; transaction on Initial Recognition. Para 7 of AS-11 deals with F
reporting of the effects of changes in exchange rates
subsequent to initial recognition. Para 7(a) inter alia states that
on each balance sheet date monetary items, enumerated
above, denominated in a foreign currency should be reported
using the closing rate. In case of revenue items falling under G
Section 37(1), para 9 of AS-11 which deals with recognition
of exchange differences, needs to be considered. Under that
~ para, exchange differences arising on foreign currency
transactions have to be recognized as income or as expense
in the period in which they arise, except as stated in para 10 H
762 SUPREME COURT REPORTS (2009] 5 S.C.R.

A and para 11 which deals with exchange differences arising on
repayment of liabilities incurred for the purpose of acquiring
fixed assets, which topic falls under Section 43A of the 1961
Act. At this stage, we are concerned only with para 9 which
deals with revenue items. Para 9 of AS-11 recognises
B exchange differences as income or expense. In cases where,
e.g., the rate of dollar rises vis-a-vis the Indian rupee, there is
an expense during that period. The important point to be noted
is that AS-11 stipulates effect of changes in exchange rate vis-
a-vis monetary items denominated in a foreign currency to be
c taken into account for giving accounting treatment on the
balance sheet date. Therefore, an enterprise has to report the
outstanding liability relating to import of raw materials using
closing rate of exchange. Any difference, loss or gain, arising
on conversion of the said liability at the closing rate, should be
recognized in the P&L account for the reporting period.
D
19. A company imports raw material worth US$ 250000
on 15.1.2002 when the exchange rate was Rs. 46 per US $.
The company records the transaction at that rate. The payment
for the imports is made on 15.4.2002 when the exchange rate
E is Rs. 49 per US $. However, on the balance sheet date,
31.3.2002, the rate of exchange is Rs. 50 per US$. In such a
case, in terms of AS-11, the effect of the exchange difference
has to be taken into P&L account. Sundry creditors is a
monetary item and hence such item has to be valued at the
F closing rate, i.e. Rs. 50 at 31.3.2002, irrespective of the • "'
payment for the sale subsequently at a lower rate. The
difference of Rs. 4 (50-46) per US $ is to be shown as an
exchange loss in the P&L account and is not to be adjusted
against the cost of raw materials.
G
20. In the case of Sutlej Cotton Mills Ltd. v. CIT reported
in 116 ITR 1 this Court has observ,ed as under:

"The law may, therefore, now be taken to be well settled · •
that where profit or loss arises to an assessee on account
H of appreciation or depreciation in the value of foreign
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 763
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]
f
currency held by it, on conversion into another currency, A
such profit or loss would ordinarily be a trading profit or
loss if the foreign currency is held by the assessee on
revenue account or as a trading asset or as a part of
circulating capital embarked in the business. But, if on
the other hand, the foreign currency is held as a capital B
asset or as fixed capital, such profit or loss would be of
capital nature."

(emphasis supplied)

21. In conclusion, we may state that in order to find out if c
an expenditure is deductible the following have to be taken into
account (i) whether the system of accounting followed by the
assessee is mercantile system, which brings into debit the
expenditure amount for which a legal liability has been incurred
before it is actually disbursed and brings into credit what is D
due, immediately it becomes due and before it is actually
received; (ii) whether the same system is followed by the
assessee from t~e 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 E
to have accrued and tci 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 F
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.

Facts in Mis Honda Siel Power Products Ltd. G

[Civil Appeal arising out of SLP(C) No. 7632/081
- CAPITAL ACCOUNT CASE:
22. The main issue which arises for determination in this H
764 SUPREME COURT REPORTS (2009] 5 S.C.R.

A batch of civil appeals is: 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 at
each balance sheet date pending actual payment of the varied
liability. In this batch of civil appeals, we are concerned with
B increase in the existing liability on account of foreign exchange
fluctuations on "capital account".

23. Before coming to the arguments, we quote hereinbelow
Section 43A, as it stood prior to 1.4.2003:

c "43A. Special provisions consequential to changes in
rate of exchange of currency-(1) Notwithstanding
anything contained in any other provision of this Act, where
an assessee has acquired any asset from a country
outside India for the purposes of his business or
D profession and, in conseque11ce of a change in the rate of
exchange at any time after the acquisition of such asset,
there is an increase or reduction in the liability of the
assessee as expressed in Indian currency for making
payment towards the whole or a part of the cost of the
E asset or for repayment of the whole or a part of the moneys
borrowed by him from any person, directly or indirectly, in
any foreign currency specifically for the purpose of
acquiring the asset (being in either case the liability
existing immediately before the date on which the change
F in the rate of exchange takes effect), the amount by which
the liability aforesaid is so increased or reduced during the
previous year shall be added to, or, as the case may be,
deducted from, the actual cost of the asset as defined in
clause (1) of section 43 or the amount of expenditure of
a capital nature referred to in clause (iv) of sub-section (1)
G
of section 35 or in section 35A or in clause (ix) of sub-
section (1) of section 36, or, in the case of a capital asset
(not being a capital asset referred to in section 50), the
cost of acquisition thereof for the purposes of section 48,
and the amount arrived at after such addition or deduction
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 765
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]
;
shall be taken to be the actual cost of the asset or the A
amount of expenditure of a capital nature or, as the case
may be, the cost of acquisition of the capital asset as
aforesaid."

24. We also quote hereinbelow Section 43A, as it stands 8
in the Statute book after substitution by the Finance Act 2002
w.e.f. 1.4.2003:

"43A. Notwithstanding anything contained in any other
provision of the Act, where an assessee has acquired any
.. asset in any previous year from a country outside India for c
the purposes of his business or profession and, in
consequence of a change in the rate of exchange during
any previous year after the acquisition of such asset, there
is an increase or reduction in the liability of the assessee
as expressed in Indian currency (as compared to the D
liability existing at the time of acquisition of the asset) at
the time of making payment."

(emphasis supplied)
25. We also quote hereinbelow provisions of Section E
43(1 ):

"43. In sections 28 to 41 and in this section, unless the
context otherwise requires -
F
(1) "actual cost" means the actual cost of the
assets to the assessee, reduced by that
portion of the cost thereof, if any, as has been
met directly or indirectly by any other person
or authority."
G
26. Shri Parag Tripathi, learned Additional Solicit.or
General appearing on behalf of the Department, submitted that
• in Section 43A (as it stood prior to Finance Act, 2002) the
expression "for making payment" is in the context of increase
or decrease of liability and the same hinges on "making the H
766 SUPREME COURT REPORTS [2009] 5 S.C.R.

A payment towards the whole or a part of ... ". According to the
learned counsel, the expression "towards the whole or a part
of' makes it clear that Section 43A as it stood referred to whole
or a part of the payment and therefore to the point of payment.
According to the learned counsel, under the pre-amended
B Section 43A, the effect of increase or decrease of liability arose
only at the point of payment because the point of accrual shifted
to the point of payment. In this connection, learned counsel
urged that the difference between accrual and payment of a
liability is that normally the point of accrual and the point of
c payment represent two different time milestones. However,
according to the learned counsel, in the case of a contingent
liability, like that of foreign exchange fluctuations, the point of
accrual and the point of payment become the same. According
to the learned counsel, under the pre-amended dispensation
0 of Section 43A, the effect of increase or decrease of liability
could only arise at the point of payment, as the point of accrual
shifts to the point of payment.

27. Learned counsel next contiended that on a proper and
true interpretation of the amendment to Section 43A,
E introduced by Finance Act, 2002, Section 43A is clarificatory.
According to the learned counsel, the occasion for the
clarificatory amendment arose in view of the judgments of the
various High Courts, which interpreted the unamended
provision as laying down the proposition that in case of increase
F or decrease of liability due to foreign exchange fluctuations, the
same is to be recognized at the end of each financial year,
irrespective of whether such "incremental liability" had accrued
and had been paid or not. According to the learned counsel,
Section 43A, as amended, recognizes the fact that in case of
G foreign exchange fluctuations, the accrual of liability is co-
terminus with the payment of liability and therefore the
amendment to Section 43A is clarificatory and not amendatory,
notwithstanding the fact that the amendment operates w.e.f. ..
1.4.2003.
H
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 767
GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]
;
28. In reply, Shri Ajay Vohra, learned counsel appearing A
on behalf of the assessee, submitted that Section 43A (even
prior to the amendment) was inserted to provide for adjustment
in the actual cost of assets pursuant to change in foreign
currency exchange rates. As a consequence of Section 43A
-•, (unamended), it became possible to adjust to increase/ B
decrease in liability relating to acquisition of capital assets on
account of exchange rate fluctuation, in the actual cost of the
assets acquired in foreign currency and for depreciation to be
allowed with reference to such increased/decreased cost.
According to the learned counsel, the provisions of Section 43A c
(unamended) are pari materia with para 10 of AS-11 which
inter alia provides for adjustment in the carrying cost of fixed
assets acquired in foreign currency, due to foreign exchange
fluctuation at each balance sheet date. In this connection,
" learned counsel has placed reliance on the judgment of this
D
Court in the case of CIT v. Arvind Mills Ltd. reported in 193
ITR255.
29. To answer the controversy, we need to analyse Section
43A (unamended). The period in question in the batch of Civil
Appeals is prior to Finance Act, 2002, therefore, we are E
required to consider the scope of Section 43A (unamended).
30. Section 43A starts with a non obstante clause. Section
43A(1) overrides the other provisions only as regards cases

- falling under that sub-section. For instance, in a case where the
asset is acquired, or the liability to pay in foreign exchange
arises, after the change in the rate of exchange, the said sub-
F

section has no application and the general principles of law
must be applied in deciding whether the actual cost is
increased or reduced as a result of such change. In other
words, Section 43A(1) applies only where as a result of change G
in the rate of exchange there is an increase or reduction in the
liability of the assessee in terms of the Indian rupee to pay the
price of any asset payable in foreign exchange or to repay
moneys borrowed in foreign currency specifically for the
purpose of acquiring the asset. Section 43A(1), therefore, has H
768 SUPREME COURT REPORTS (2009] 5 S.C.R.

A no application unless the asset is acquired and the liability
existed, before the change in the rate of exchange takes effect.
In such a case, Section 43A contemplates recomputation of the
cost of the assets for the purposes of depreciation [Sections
32 and 43(1)]. and also as regards capital assets for scientific
B research [Section 35(1)(iv)] and also regarding patent rights or
copyrights [Section 35A].

31. As held in Arvind Mills case (supra) increase or
decrease in liability in the repayment of foreign loan should be
taken into account to modify the figure of actual cost in the year
C in which the increase or decrease in liability arises on account
of the fluctuation in the rate of exchange. Thus, the adjustments
in the actual cost are to be made imraspective of the date of
actual payment in foreign currency made by the assessee. This
position also finds place in the clarification issued by the Ministry
D of Finance dated 4.1.1967 which inter alia reads as under:

"2. The Government agrees that for the purposes of the
calculation of depreciation allowance, the cost of capital
assets imported before the date of devaluation should be
E written off to the extent of the full amount of the additional··
rupee liability incurred on account of devaluation and not
what is actually paid from year to year. The proposed legal
provision in the matter is intended to be framed on this
basis."
F (emphasis supplied)
32. One more aspect needs to be mentioned. Section
43(1) defines actual cost for the purpose of grant of depreciation
etc. to mean "the actual cost of the assets to the assessee".
G 'Till the insertion of the unamended Section 43A there was no
provision in the Income-tax Act for adjustment of the actual cost
which was fixed once and for all, at the time of acquisition of
the asset. Accordingly, no adjustment could be made in the
actual cost of the assets for purposes of grant of depreciation
H for any increase/decrease of liability subsequently arising due
COMMNR. OF INCOME TAX, DELHI v. WOODWARD 769
, GOVERNOR INDIA P. LTD. [S.H. KAPADIA, J.]

- to exchange fluctuation. Consequently, Section 43A was A
introduced in the Act by Finance Act, 1967 w.e.f. 1.4.1967 in
the above terms to provide for adjustment in the actual cost of
assets pursuant to change in the foreign currency exchange
rates. As a consequence of the if"lsertion of the said section, it
became possible to adjust the increase/decrease in liability B
relating to acquisition of capital assets on account of exchange
rate fluctuation, in the actual .cost of the assets acquired in
foreign currency and for, inter a/ia, depreciation to be allowed
with reference to such increased/decreased cost. This position
is also made clear by Circular No. 5-P dated 9.10.1967 issued c
by CBDT. One more point needs to be mentioned: Section 43A
(unamended) corresponds to para 1O of AS-11 similarly
providing for adjustment in the carrying cost of fixed assets
..., acquired in foreign currency, due to foreign exchange fluctuation
, at each balance sheet date. The relevant para reads as follows: D
"10. Exchange differences arising on repayment of
liabilities incurred for the purpose of acquiring fixed assets,
which carried in terms of historical cost, should be adjusted
in the carrying amount of the respective fixed assets. The
carrying amount of such fixed assets should, to the extent E
•, not already so adjusted or otherwise accounted for, also
be adjusted to account for any increase or decrease in the
liability of the enterprise, as expressed in the reporting
currency by applying the closing rate, for making payment
... towards the whole or a part of the cost of the assets or for F
repayment of the whole or a part of the monies borrowed
by the enterprise from any person, directly or indirectly, in
foreign currency specifically for the purpose of acquiring
those assets."
33. As stated above, what triggers the adjustment in the G
actual cost of the assets, in terms of 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 H
770 SUPREME COURT REPORTS (2009] 5 S.C.R.

A adjustment of the carrying cost of the fixed assets acquired in
foreign currency. But for Section 43A which corresponds to para
10 of AS-11 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 nowhen3 required as condition
B precedent for making necessary adjL1stment 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
c now brought in by amendment to Sec:tion 43A vide Finance
Act, 2002.
34. Lastly, we are of the view that amendment of Section
43A by the Finance Act, 2002 w.e.f. 1.4.2003 is amendatory
and not clarificatory. The amendment is in complete substitution
o of the section as it existed prior thereto. Under the unamended
Section 43A adjustment to the actual cost took 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. This is indicated by the words "at the time
E of making payment". 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, however, under amended
Section 43A w.e.f. 1.4.2003 such actual payment of the
F decreased/enhanced liability is made a condition precedent for
making adjustment in the carrying am<>unt of the fixed asset.
This indicates a complete structural change brought about in
Section 43A vide Finance Act, 2002. Therefore, the amended
section is amendatory and not clarificatory in nature.
G Conclusion:
35. For reasons given hereinabovei, we find no infirmity in
the impugned judgments of the Delhi High Court and
accordingly the Civil Appeals filed by the Department stand
dismissed with no order as to costs.
H N.J. Appeals dismissed.