Overview

• Initial recognition: use transaction-date rate; average rate allowed unless volatility is significant.
• Year-end: monetary items at closing rate → exchange differences to P&L; non-monetary items stay at historical rate (inventory at NRV uses rate when NRV set).
• Overrides: Section 43A (imported depreciable assets on loan repayment) & Rule 115 prevail; Section 43AA aligns taxation with ICDS.
• Forward contracts: Method depends on purpose—see dedicated section below.

Scope & Key Definitions

Scope

• Foreign currency transactions
• Translation of foreign operations’ financials
• Foreign currency forward exchange contracts

Important Definitions

• Monetary items: cash, receivables, payables—fixed/determinable amounts.
• Non-monetary items: fixed assets, inventories, equity investments.
• Closing rate: exchange rate on the last day of the previous year.
• Forward exchange contract: agreement to exchange currencies at a forward rate (includes FX options / similar instruments).

Core Recognition Rules (with sub-headings)

1) Initial recognition

• Record at transaction-date rate. Weekly/monthly average permitted if it approximates actual; not permitted during significant volatility.

2) Year-end conversion

• Monetary items: convert at closing rate; recognise exchange difference in P&L of that year.
• Non-monetary items: keep historical rate (no exchange difference). Inventory at NRV → use rate on the date NRV was determined.

3) Overrides (Act prevails)

• Section 43A: forex changes on repayment of foreign currency loans for imported depreciable assets adjust the asset’s actual cost.
• Section 43AA: taxation of forex fluctuation per ICDS.

Table: Monetary vs Non-Monetary Items

Forward Exchange Contracts (Purpose-based treatment)

A) Not for trading/speculation (to fix settlement currency)

• Amortise premium/discount over the contract life.
• Recognise exchange differences in the year exchange rates change.
• Cancellation/renewal → immediate P&L.

B) Trading/speculation OR hedging firm commitments / highly probable forecast transactions

• Recognise premium/discount and exchange difference **only on settlement** (i.e., no year-end MTM under ICDS).

Interaction with Sections 43A & 43AA

• Section 43A: Forex increase/decrease on repayment of foreign currency loans for imported depreciable assets → adjust asset’s actual cost (affects depreciation base).
• Section 43AA: Specifies that forex gains/losses are taxable/deductible as per ICDS methodology.

Worked Examples (numbers kept simple)

Example 1 — Monetary Receivable (P&L impact)

• Sale on 10-Jan: USD 10,000 @ ₹80 ⇒ initial recognition ₹8,00,000.
• 31-Mar closing: ₹82 ⇒ retranslate = ₹8,20,000 ⇒ gain ₹20,000 to P&L.
• Settlement on 30-Apr @ ₹81.50 ⇒ reverse ₹5,000 (loss) at settlement; net P&L equals actual.

Example 2 — Non-Monetary Inventory at cost (no P&L impact at year-end)

• Purchase on 5-Feb: USD 5,000 @ ₹83 ⇒ cost ₹4,15,000 (carried at this historical rate).
• 31-Mar: ₹85 (ignore—no restatement because item is non-monetary at cost).

Example 3 — Inventory at NRV (use rate when NRV set)

• NRV determined on 15-Mar at USD rate ₹84 ⇒ value stock at that rate; no separate year-end forex difference booking.

Example 4 — Forward Contract (non-speculative hedge)

• Forward taken on 1-Feb to buy USD 50,000 @ ₹84 for 1-May (to settle a payable).
• Spot on 1-Feb: ₹83.20 ⇒ premium = ₹0.80 × 50,000 = ₹40,000.
• Amortise ₹40,000 over Feb–Apr; recognise exchange differences during the period; at settlement, book residual difference.

Example 5 — Section 43A impact (capitalisation)

• Foreign loan used to acquire imported machinery.
• Repayment causes liability to increase by ₹1,20,000 due to forex movement.
• Under 43A, add ₹1,20,000 to the asset’s actual cost; future depreciation applies on the increased cost.

Case Laws (for conceptual clarity)

1) CIT v. Woodward Governor India (P) Ltd. (SC, 2009)

• Principle: Year-end forex loss on monetary items is a deductible business expenditure u/s 37(1).
• Relevance: Aligns with ICDS-VI recognition of exchange differences on monetary items.

2) ONGC v. CIT (SC, 2010)

• Principle: Forex loss on the balance-sheet date can be allowed even if liability not discharged in that year.
• Relevance: Supports year-end recognition approach.

3) CIT v. Soorajmull Nagarmull (Cal HC, 1981) & CIT v. Badridas Gauridu (P) Ltd. (Bom HC)

• Principle: Hedging forward-contract losses incidental to exports are **business losses**, not speculative u/s 43(5).
• Relevance: Helps classify forward-contract outcomes correctly under ICDS-VI intent.

Flowchart: Decide Treatment under ICDS VI

Questions with Hidden Solutions