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    Effects of Changes in Foreign Exchange Rates

    Section 43A of Income Tax Act, 1961 (ITA/Act) provides that in case, where assessee has acquired any asset in the previous year from country outside India for the purposes of business or profession, the cost of such asset shall be adjusted because of increase or decrease in liability with change in exchange rate after the acquisition of asset at the time of payment of whole or part of cost of the asset. 

    The increase or decrease in liability and adjustment to the actual cost of the asset shall be made only if the payment is made by the assessee. 

    This adjustment is made only in relation to the actual cost mentioned in Sec 43(1)/Capex mentioned in Sec 35(1)(iv)/ Capex referred to in Sec 35A/ Capex referred to in Sec 36(1)(ix) and cost of acquisition referred to in Sec 50. 

    New Section – 43AA: 

    Finance Bill 2018 proposed a new section in relation to treatment of gain or loss on account of change in foreign exchange rates as income or loss. Such computation has to be made with reference to Income Computation Disclosure Standards (ICDS) notified under Sec 145(2) of ITA, 1961. 

    The gain or loss on account of change in foreign exchange rates shall be in respect of all foreign currency transactions. These include: 

    • Monetary and Non-monetary items; 
    • Translation of financial statements of foreign operations;
    • Forward exchange contracts;
    • Foreign currency translation reserves. 

    The new section is subject to provisions of Sec 43A. In other words, new section has broadened the areas of application beyond capital items. 

    As per the proposed section the gains or loss on account of change in foreign exchange rates has to be computed with reference to notified ICDS( New) VI on ‘The Effects of Changes in Foreign Exchange Rates’. It is effective from 01-04-2016 and applicable to AY 2017-18 and subsequent assessment years. 

    The ICDS (New) VI deals with treatment of transaction in foreign currencies/translating financial statement of foreign operations/ treatment of foreign currency transactions in the nature of forward exchange contracts. 

    ICDS are to be applied for computation of income under the head Profits and Gains of Business or Profession and Income from Other Sources. 

    The ICDS (New) VI is subject to the provisions of Sec 43A and Rule 115 of Income Tax Rules, 1962. 

    Initial Recognition: 

    As per ICDS (New) VI a foreign currency transaction1 shall be initially recorded using the exchange rate on the date of transaction2

    Recognition on the last date of previous year: 

    Foreign Currency monetary items3 in foreign currency shall be converted into reporting currency by applying closing rate except in case of restriction on remittances or closing rate being unrealistic. 

    In case of non-monetary items4 , except inventory, in foreign currency shall be converted in to reporting currency by using exchange rate on the date of transaction. 

    In case on inventory which is carried on Net Realisable Value (NRV) denominated in foreign currency shall be reported using the exchange rate existed when such value was determined. 

    Financial statement of Foreign Operations (disregarding distinction of Integral Operations or Non-Integral Operations) are to be translated as if the transactions as operation had been those of himself. The term Foreign Operations covers only branch, by whatever name called, the activities of which are based or conducted in a country other than India. 

    Key Note: 

    As per Rule 115 of ITA Rules, 1962 income accruing or arising or received or deemed to accrue or arise or deemed to be received in foreign currency and chargeable under the head Profits and Gains of Business or Profession and Income from Other Sources be converted in to rupees using TT buying rate on the last day of previous year of the assessee. 

    As per ICDS (New) VIExchange Rate is the ratio for exchange of two currencies. There is no specific reference as TT buying rate in the ICDS (New) VI. This could result in exchange differences. Since differentiation of foreign operations into integral or non-integral is removed accumulation of foreign currency translation reserve do not arise(may be relevant in the context of transitional provisions). 

    Exchange Differences: 

    Exchange Differences in respect of monetary items on settlement or conversion on the last day of the previous year shall be recognized as income or expenses in that previous year. In case of non-monetary items exchange differences shall not be recognized as income or expense. 

    Exchange rate differences on assets acquired using from outside India for business or profession shall be dealt in accordance with Sec 43A of ITA, 1961.

    1Buying or Sale of goods/ services or borrowing or lending denominated in foreign currency/ party to un performed forward exchange contract/ acquisition or disposal of assets/ liabilities incurred in denominated in foreign currency.

    2

    Avg rate for week or month that approximates the actual rates may be used for all transactions occurred during the period.

    3

    Money, Assets to be received or Liabilities to be paid in fixed or determinable amount of money.

    4Assets or Liabilities other than monetary items. 

    Forward Exchange Contracts: 

    Any premium or discount arising at the inception of a forward exchange contract, other than entered for trading or speculative purposes, shall be amortised as expense or income over the life of the contract. 

    The premium or discount is measured by the difference between the exchange rate at the date of the inception of the contract and the forward rate specified in the contract. 

    Exchange differences on such a contract shall be recognised as income or as expense in the previous year in which the exchange rates change. Any profit or loss arising on cancellation or renewal shall be recognised as income or as expense for the previous year. 

    Premium or discount and exchange differences on contracts intended for trading or speculation purposes or held for hedge purposes shall be recognized at the time of settlement.

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