Appreciation in the value of the Foreign Exchange and its Taxation

Appreciation in the value of the Foreign Exchange and its Taxation

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Appreciation in the value of the Foreign Exchange and its Taxation

 
The international tour & travels are on the rise. This may be for the purpose of leisure trip, for medical reasons, for the purpose of education or for meeting the near and dear ones abroad or any other reason.
One may note that FEMA permits a person to carry FC equal to USD 2,50,000 on account of present account transaction.
For such travel, the person traveling needs foreign currency which is purchased by it from the bank or authorized dealer on a particular date. The foreign exchange rate is often subject to fluctuation at the international market.
Let us consider the example of Mr. X who wants to visit the USA to meet his son who is doing a job there. He has purchased the $ 10,000 at the rate of Rs. 70 (i.e., Rs. 7 Lakh in INR) at the time of visits to the USA. He came back to India and his loving son didn’t let him spend a single paisa and so he is back with $ 10,000/- as it is.
As per the RBI Guidelines, citizens are duty bound to surrender the unused foreign currency to the bank/authorized dealer.
He returned it to the bank or Authorized dealer at a prevailing rate of say Rs. 75 (i.e., Rs. 7.50 Lakh in INR). Now emerges the question whether Rs. 50,000/- appreciation in the value of the currency would be taxable in the hands of Mr. X or not? If taxable, whether it will be Capital gain income or not?
It may be noted that the taxation would broadly depend upon whether it is done for personal purposes or for the purpose of the business?
If visit was for Personal Purpose:
Appreciation is taxable as Capital Gain Income?:
  1. For taxation of any income, there are two important ingredients. First, there must be capital assets and second it must be transferred.
  1. Section 45 of Income Tax Act, 1961 provides that any profits or gains arising from the transfer of a capital asset affected in the previous year will be chargeable to income-tax under the head ‘Capital Gains’.
Section 45 provides as under:
“Any profits or gains arising from the transfer of a capital asset affected in the previous year shall, save as otherwise provided in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F, 54G and 54H, be chargeable to income-tax under the head “Capital gains”, and shall be deemed to be the income of the previous year in which the transfer took place.”
  1. To trigger capital gains, a “capital asset” needs to be “transferred”.
  2. “Transfer” is defined Section 2(47) as sale, exchange, relinquishment of asset, extinguishment of any rights.
  3. In the case of Jayakumari and Dilharkumari [1986] 29 Taxman 177 Karnataka High Court has held that mere conversion of one currency into another currency cannot be considered as ‘exchange’. The exchange in the context must mean transfer of one capital asset from another capital asset.
Further, like a sale, exchange also requires two persons.
There cannot be a sale to oneself. Such a conversion could never be considered as exchange within the meaning of section 2(47).
  1. The said decision was also upheld by Madras High Court in case of E.I.D. Parry Ltd (38 Taxman 84).
So, with this perspective, any appreciation in the value of the foreign exchange gain on account of personal foreign visit will not be subject to capital gains as such.
One may note the remarkable observation by the Karnataka High Court in the case of Jayakumari and Dilharkumari [1986] 29 Taxman 177 as under:
The ‘switch’ contemplated beneath part 2(47) envisages little question, sale alternate or relinquishment of the asset, and so on. However mere conversion of 1 foreign money into one other foreign money can’t be thought-about as ‘alternate’. The alternate within the context should imply switch of 1 capital asset from one other capital asset. Like a sale it requires two individuals. There can’t be a sale to oneself. So too within the case of alternate. Within the current case, the possession of the cash remained with the assessee even after the alternate within the first place. Secondly, it was only a conversion of 1 sort of foreign money into one other variety within the regular course and never linked with any enterprise. Such a conversion might by no means be thought-about as alternate throughout the which means of part 2(47)
Appreciation is taxable as Income from other source?:
What is sought to be taxed under the Income Tax Act- 1961 is “Income? Though the definition of income given in the Act is an inclusive defitnition, it is a well established principle of taxation that capital receipt cannot be taxed under the Income Tax Act-1961.
Appreciation in the value of the foreign exchange cannot be categorized as “Income” within the broader parameters of income as provided in the Act or as laid down by the judiciary by its various judgments. As such, the appreciation in the value of the foreign currency cannot be taxed as “Income from other source” as well.
Supreme Court in Sutlej Cotton Mills Ltd. v. CIT 1979 AIR(SC) 5, 1979 (116) ITR 1 , 1978 (4) SCC 358 , 1979 (1) SCR 976 , 1978 CTR(SC) 155 , in which the principle of law has been stated reads as under:
“The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as trading asset or as part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature.”
If the foreign currency acquired for Business Purpose:
The tax treatment would certainly be different if the appreciation in the value of the foreign currency has arisen during the course of business. If taxpayers purchase the foreign currency for a business tour then the appreciation or depreciation in the value of foreign currency can very well be categorized as business income or loss. In normal course also, businessmen doing import or export during the course business also have the impact of foreign currency fluctuation as well.
Since it is a business activity, any income arising due to such business would be covered by Section 28 of the Act and so it will be taxable as “Business Income” only.
Further, section 43A provides that if foreign currency is related to acquisition of the capital assets then the fluctuation which may be appreciation or depreciation need to be adjusted against the value of the capital assets.
However, if the if foreign currency is not related to acquisition of the capital assets then the fluctuation which may be appreciation or depreciation need to be recognized in the P & L A/c U/s 43AA read with ICDS.

 

For ease of reference, Section 43A & 43AA are reproduced hereunder:

 

SECTION 43A:
Special provisions consequential to changes in rate of exchange of currency.
43A. Notwithstanding anything contained in any other provision of this Act, where an assessee has acquired any asset in any previous year from a country outside India for 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 liability existing at the time of acquisition of the asset) at the time of making payment—
(a) towards the whole or a part of the cost of the asset; or
(b) towards 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 along with interest, if any,
the amount by which the liability as aforesaid is so increased or reduced during such previous year and which is taken into account at the time of making the payment, irrespective of the method of accounting adopted by the assessee, shall be added to, or, as the case may be, deducted from—
  (i) the actual cost of the asset as defined in clause (1) of section 43; or
 (ii) the amount of expenditure of a capital nature referred to in clause (iv) of sub-section (1) of section 35; or
(iii) the amount of expenditure of a capital nature referred to in section 35A; or
(iv) the amount of expenditure of a capital nature referred to in clause (ix) of sub-section (1) of section 36; or
(v) the cost of acquisition of a capital asset (not being a capital asset referred to in section 50) for the purposes of section 48,
and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset as aforesaid:
Provided that where an addition to or deduction from the actual cost or expenditure or cost of acquisition has been made under this section, as it stood immediately before its substitution by the Finance Act, 2002, on account of an increase or reduction in the liability as aforesaid, the amount to be added to, or, as the case may be, deducted under this section from, the actual cost or expenditure or cost of acquisition at the time of making the payment shall be so adjusted that the total amount added to, or, as the case may be, deducted from, the actual cost or expenditure or cost of acquisition, is equal to the increase or reduction in the aforesaid liability taken into account at the time of making payment.
Explanation 1.—In this section, unless the context otherwise requires,—
(a) “rate of exchange” means the rate of exchange determined or recognised by the Central Government for the conversion of Indian currency into foreign currency or foreign currency into Indian currency;
(b) “foreign currency” and “Indian currency” have the meanings respectively assigned to them in section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999).
Explanation 2.—Where the whole or any part of the liability aforesaid is met, not by the assessee, but, directly or indirectly, by any other person or authority, the liability so met shall not be taken into account for the purposes of this section.
Explanation 3.—Where the assessee has entered into a contract with an authorised dealer as defined in section 2 of the Foreign Exchange Management Act, 1999 (42 of 1999), for providing him with a specified sum in a foreign currency on or after a stipulated future date at the rate of exchange specified in the contract to enable him to meet the whole or any part of the liability aforesaid, the amount, if any, to be added to, or deducted from, the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset under this section shall, in respect of so much of the sum specified in the contract as is available for discharging the liability aforesaid, be computed with reference to the rate of exchange specified therein.
SECTION 43AA:
Taxation of foreign exchange fluctuation.
43AA. (1) Subject to the provisions of section 43A, any gain or loss arising on account of any change in foreign exchange rates shall be treated as income or loss, as the case may be, and such gain or loss shall be computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145.
(2) For the purposes of sub-section (1), gain or loss arising on account of the effects of change in foreign exchange rates shall be in respect of all foreign currency transactions, including those relating to—
  (i) monetary items and non-monetary items;
 (ii) translation of financial statements of foreign operations;
(iii) forward exchange contracts;
(iv) foreign currency translation reserves.

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