# COMMISSIONER OF INCOME TAX, DELHI v. MIS WOODWARD GOVERNOR INDIA P. LTD

- **Citation:** [2009] 5 S.C.R. 738
- **Court:** Supreme Court of India
- **Decided:** 2009-04-08
- **Case number:** Civil Appeal No. 2206 of 2009
- **Bench:** S.H. Kapadia, Aftab Alam
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/commissioner-of-income-tax-delhi-v-mis-woodward-governor-india-p-ltd-25750
- **Pages:** 33

## Headnote

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
,,.
expenditure u/s.37(1) and is deductible thereunder - Any
..
D 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
E is presumed to be correct till Assessing Officer points out
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.
\'
G
s. 43A (unamended) - Liability on capital account -
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 c
asset.
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 stockin-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. Stockin-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. Secti

## Text

_Characters 0–39,892 of 63,569. This is a partial read: ask again with offset=39892 for what follows._

(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)
B
APRIL 8, 2009
[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
,,.
expenditure u/s.37(1) and is deductible thereunder - Any
..
D 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
E is presumed to be correct till Assessing Officer points out
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.
\'
G
s. 43A (unamended) - Liability on capital account -
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 c
asset.
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 stockin-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. Stockin-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. AS11 stipulates effect of changes in exchange rate vis-a-vis
0
monetary items denominated in a foreign currency to be
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. c
Financial Corporation v. CIT 165 ITR 765 and Madras
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
E
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 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
F CBDT. Section 43A (unamended) corresponds to para 10
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
H
previous year is to be allowed. [Para 35] [770-G, H]
A
B
c
D
E
F
G
H
746
SUPREME COURT REPORTS
[2009] 5 S.C.R.
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
240 ITR 355
Relied on.
Para 16
116 ITR 1
'Referred to.
Para 20
193 ITR 255
Relied on.
Para 31
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 IT A No. 159 of 2006.
VVITH
Civil Appeal No. 2214/09
Civil Appeal No. 2212/09
Civil Appeal No. 2207/09
Civil Appeal No. 2213 /09
Civil Appeal No. 2226/09
Civil Appeal No. 2215/09
Civil Appeal No. 2210 /09
Civil Appeal No. 2235 /09
Civil Appeal No. 2208/09
Civil Appeal No. 2209/09
Civil Appeal No. 2211/09
"
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
D
E
F
G
the appearing parties.
The Judgment of the Court was delivered by
S.H. KAPADIA, J.1. Delay condoned.
2. Leave granted.
3. In this batch of civil appeals, the following question
arises for determination:
(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
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
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.
E
1, 10,28, 190.00. That return was processed under Section
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, 7 46.00 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
~j
the rupee becomes stronger vis-a-vis US$, the Department had
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,
E
such double standards cannot be countenanced. Learned
-
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.
- Amount borrowed is utilized in business.
G
31.3.2000 - Rate of exchange fluctuated and it became
Rs. 40/- per Dollar.
- Liability increased by Rs. 500/-.
H
A
B
752
SUPREME COURT REPORTS
[2009] 5 S.C.R.
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
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.
H
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.
)
......
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
F
the past which accounting system has been accepted by the
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.
c
10. As stated above, on facts in the case of Mis Woodward
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
D
that there is no dispute that in the previous years whenever the
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
H
profession", -
.>
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:
Section 29:
"The income referred to in section 28 shall be computed
in accordance with the provisions contained in sections 30
B
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
A
B
c
D
756
SUPREME COURT REPORTS
(2009) 5 S.C.R.
"(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
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.
(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
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 visa-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
0 needs to be kept in mind. Accounts regularly maintained in the
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
_,
J
GOVERNOR INDiA P. LTD. [S.H. KAPADIA, 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.