foreign exchange management

1. TAX TREATMENT OF FOREIGN
EXCHANGE GAINS AND LOSSES

2. INTRODUCTION
• When any entity enters into any transaction in foreign currency, it is exposed to exchange
fluctuation risk on such transaction unless the same is hedged by the entity through
hedging techniques like Forward Contracts, Currency Invoicing etc.
• The risk associated with such transactions may result into either Exchange Gain or
Exchange Loss.
• Both Accounting Standard – 11 and Indian Accounting Standard (Ind AS) 21 (both
together can be termed as “Generally Accepted Accounting Principles” or “GAAP”) on
Accounting of foreign currency transactions provides for the accounting of realized as
well as unrealized gain/losses.

3. STEPS TO ASCERTAIN TAX TREATMENT
Step 1: Ascertain the amount of total foreign exchange fluctuation gain/loss arises:
First of all, we need to ascertain the sum total of Exchange Fluctuation Gain/Loss from
the financial statements of the entity for the relevant previous year prepared as per GAAP.
The same needs to be collected not only from the sources of Statement of Profit and Loss
but also the amount which has been capitalized in any account including amount
capitalized in any item of Property, plant and equipment or Intangible assets.

4.  Step 2: Ascertain whether the Exchange Fluctuation is on Revenue/ Capital Account:
• Exchange Fluctuations arises on Revenue Account: The exchange fluctuations which are not related to
acquisition, installation, disposition of any capital asset, such fluctuations are treated to arise on Revenue
Account. For Example, the realized/ unrealized exchange fluctuation gain/loss which have been arisen on
transaction with Trade Receivables, Trade Payables, Working Capital ECBs (External Commercial Borrowings)
etc. are fluctuation impacts on Revenue Account.
• Exchange Fluctuations arises on Capital Account: The exchange fluctuations which are related to acquisition,
installation, disposition of any capital asset, such fluctuations are treated to arise on Capital Account. For
Example, the realized/ unrealized exchange fluctuation gain/loss which have been arisen on capital creditors,
outstanding ECBs taken for acquisition/ installation of any capital assets etc. are fluctuation impacts on Capital
Account.
 Step 3: Tax treatment
• Exchange Fluctuation Impacts on Revenue Account Transactions:
As per the provisions of Income tax laws, the exchange fluctuations arises on transactions relating to Revenue
Account shall be allowed as deduction (in case of loss) or taxed (in case of gain) in the year in which such gain/loss
arise. Further to clarify that the unrealized exchange fluctuation gain/loss are also allowed as deduction in the year
in which the same has been accounted for.

5. • Exchange Fluctuation Impacts on Capital Account Transactions:
The exchange fluctuation impacts on Capital Account Transactions can be further classified into two parts:
 Capital Account transactions which are covered under Section 43A of the Income tax Act, 1961;
 Other Capital Account transactions.
 Transactions covered under Section 43A of the Income tax Act, 1961
Section 43A of the Income tax Act, 1961 applies on Capital Account Transactions when the following
conditions are fulfilled:
 The asset MUST BE ACQUIRED FROM OUTSIDE INDIA;
 The asset must be acquired for the purpose of business and profession; then,
the amount of exchange gain/loss arisen on such asset shall be added to the actual cost of the asset on
realization basis. In case of gain, the same shall be deducted from the same.
Such Exchange gain/loss can arise on the following:
 On payment of vendor from whom such capital asset has been procured; On repayment of any loan which
has been borrowed for the purpose of such capital asset. (Foreign Currency Loan can be taken from India
as well as Outside India but asset must be imported for the purpose of application of Section 43A).
 On payment of Interest on such loan.

6. Transactions of capital nature not covered under Section 43A of the Income tax Act, 1961:
Guidance given in Income Computation and Disclosure Standards (“ICDS”): ICDS do not segregate the
Exchange Gain/loss between revenue nature and capital nature. The same simply provides that except the
Exchange Gain/loss dealt in by Section 43A of the Act, all other Exchange gain/loss arises on monetary
items (e.g. cash, receivables, payables etc.) shall be allowed under the Act
The assessee can opt for the situation which is more beneficial to him which can be understood as follows:
 In case of Exchange gain: Do not tax the Exchange gain arisen on Capital Account Transaction (not
related to Section 43A) by applying the Hon’ble Supreme Court in the case of Sutlej Cotton Mills Ltd v
CIT [1979] 116 ITR 1 (SC) read with Hon’ble Delhi High Court Judgment in case of The Chamber of tax
Consultants.
In case of Exchange loss: Since the department is bound by the circulars issued by CBDT, hence the
assessee can take a plea of allowing the same.
It is to note that once the assessee has taken any of the above option in a particular previous year, the same
is not advisable to be changed in the subsequent years based on the beneficial status. Hence, the option
should be chosen by due deliberation to be given to the future outcomes of foreign currency transactions.