Gains from Foreign Exchange Fluctuations Are Not Taxable: ITAT Mumbai

Fact and issue of the case

The case revolves around a personal interest-free loan extended by Mr. Aditya Balkrishna Shroff (as ‘assessee’) to his cousin (as ‘borrower’) in Singapore amounting to USD 2,00,000 on March 29, 2010. The said transaction was executed under the Liberalized Remittance Scheme (as ‘LRS’) of the Reserve Bank of India (as ‘RBI’).

As on the lending date, the exchange rate for Indian currency vis-à-vis USD was Rs. 45.14. Accordingly, the assessee made a payment of Rs. 90,30,758 towards the loan amount of USD 2,00,000. The borrower repaid the loan on May 24, 2012, and the exchange rate for USD increased to Rs. 56.18. As a result, the assessee received a total of Rs. 1,12,35,326 against his interest-free loan of Rs. 90,30,758.

During the auditing process under section 143(3) of the IT Act for the financial year 2012-13, corresponding to the accounting year of 2013-14, the AO considered this difference of Rs. 22,04,568 as in the nature of ‘income’ and sought to tax the same under ‘income from other sources’ category provided under the IT Act. AO also initiated penalty proceedings against the assessee for not specifying the true nature of the income in his filings.

The assessee filed an appeal before the CIT(A).

Observation of the court

CIT(A) agreed with the assessment done by the AO and insisted on the argument that the present transaction’s gain should either be treated as an interest payment or under the ‘income from other sources’ category.

The assessee argued that the present loan is executed under the LRS forwarded by RBI and should not be taxed. CIT(A) found this argument by the assessee as untenable because LSR only allows for rupee-denominated loans made to non-residents of India or Persons of Indian origin. However, in the present case, the loan was predominantly in US Dollars, against which the assessee made a profit. Therefore, the assessee will have to pay taxes on any surplus from such loan transaction. The profit accrued will form part of the income of the assessee.

The central contentions of this case are:

Whether gains arising out of foreign exchange fluctuation from the repayment of a personal loan extended by the assessee fall under the category of capital receipts or not?

If they fall under the category of capital receipts, can such gains be chargeable to tax?

Judgment

Section 45 of the IT Act specifies a list of taxable capital gains. Section 45, read with section 2(24)(vi), clearly establishes that any capital gain not mentioned under section 45 or not explicitly included in the definition of ‘income’ by a specific deeming fiction is not taxable. ITAT relied on the authority of CIT v. DP Sandu Bros. Chembur (P) Ltd, where the Supreme Court observed that it is against the letter and intent of section 56 of the IT Act to include everything exempted from capital gains in the statute as a taxable nonrecurring receipt under section 10(3) of the IT Act.

The Calcutta HC, in Shaw Wallace & Co Ltd v. DCIT, held that, in principle, capital receipts are outside the purview of taxable income and could not be taxed unless they are expressly included in the definition of income under IT Act. No degree of liberal interpretation of the statute could convert a capital receipt into a revenue receipt or blur the fundamental distinction between the two for the purposes of calculating tax.

Negating the observations made by CIT(A), ITAT Mumbai observed that only the principal amount of the loan is being repaid. As such, the definition of interest under section 2(28A) of the IT Act does not even come into play. Any benefit the assessee accrued is because of the foreign exchange fluctuations and not from any interest payment. Since the fluctuation was in relation to a capital transaction, the gain would be a capital receipt. Therefore, the observation by CIT(A) that the gain was in nature of interest income is erroneous.

Concludingly, ITAT held that gains accrued from foreign exchange fluctuations would amount to capital receipt, not taxable under the IT Act. Regarding the applicability of LRS, ITAT believed that since the same is not relevant to ascertain taxability, Tribunal will not take it up. As a passing observation, ITAT clarified that it is not the prerogative of AO to assess if the loan is permitted under Foreign Exchange Management Act regulations or not.