BY CA SUREKHA
Foreign currency borrowings often appear attractive for Indian businesses due to lower interest rates abroad. However, when the rupee weakens, exchange differences arise—creating the critical question: what portion of such exchange loss can legitimately be capitalised as part of the cost of a qualifying asset, and what portion must be expensed?
This article integrates the principles under Accounting Standards (AS 16, AS 11, Ind AS 23) and the Income-tax Act (Section 43A and ICDS IX) with practical illustrations.
The Legal–Accounting Interface: The Core Issue
When a company imports machinery financed through a foreign currency loan, two distinct frameworks apply:
| Framework | Objective | Governing Provision |
|---|---|---|
| Accounting Standards (AS 16 / Ind AS 23) | Determine how much of exchange difference forms part of borrowing cost | ICAI Notification under Companies (Accounting Standards) Rules / Ind AS 23 |
| Income-tax Act | Determine actual cost for depreciation | Section 43A of the Income-tax Act, 1961 |
| Tax Computation Standards | Define borrowing cost recognition for tax | ICDS IX |
These provisions operate independently yet intersect in determining capitalisation limits.
Illustration: The Exchange Loss Scenario
Facts
| Particular | Details |
|---|---|
| Machinery imported | from Japan |
| Loan amount | USD 1 million (₹ 8.20 crore @ ₹ 82/USD) |
| Exchange rate at repayment | ₹ 87/USD |
| Exchange loss | ₹ 50 lakh |
| Interest on foreign loan | 3 % p.a. |
| Equivalent domestic borrowing rate | 9 % p.a. |
Issue: Whether the entire ₹ 50 lakh should be added to machinery cost or only a portion.
Accounting Perspective under AS 16 and AS 11
Legal Provision
AS 16, para 4(e) — “Exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs shall be considered part of borrowing costs.”
This phrase — “to the extent that they are regarded as an adjustment to interest costs” — forms the core test.
Interpretation
-
If the foreign borrowing yields an interest saving vis-à-vis domestic borrowing, the portion of exchange loss up to that interest differential is treated as additional interest cost → capitalisable.
-
Any exchange loss beyond such differential is not in the nature of borrowing cost → charge to Profit & Loss account under AS 11 (para 11).
Computation Example (AS 16 Approach)
| Step | Particular | Calculation | Result |
|---|---|---|---|
| 1 | Interest differential | (9 % – 3 %) × ₹ 8.20 cr | ₹ 49.20 lakh |
| 2 | Actual exchange loss | — | ₹ 50 lakh |
| 3 | Capitalisable (max. to differential) | — | ₹ 49.20 lakh |
| 4 | Expensed in P&L | — | ₹ 0.80 lakh |
Therefore:
-
₹ 49.20 lakh → included in asset cost
-
₹ 0.80 lakh → charged to P&L
Book value of machinery: ₹ 8.69 crore.
Ind AS 23 Interpretation
Ind AS 23, para 6A — “Exchange differences arising from foreign currency borrowings shall be regarded as an adjustment to interest costs to the extent that they are equal to the difference between the cost of borrowing in functional currency and the cost of borrowing in a foreign currency.”
Thus, Ind AS 23 codifies the same differential principle with explicit quantitative limitation.
Illustrative Comparison
| Scenario | Exchange Loss | Domestic Interest Diff. | Capitalisable Portion | Remark |
|---|---|---|---|---|
| Favourable (loss < diff.) | ₹ 40 lakh | ₹ 49 lakh | ₹ 40 lakh | Entire loss capitalised |
| Neutral (loss ≈ diff.) | ₹ 50 lakh | ₹ 49 lakh | ₹ 49 lakh | Restricted to differential |
| Adverse (loss ≫ diff.) | ₹ 80 lakh | ₹ 49 lakh | ₹ 49 lakh | Balance ₹ 31 lakh expensed |
Hence, Ind AS 23 provides a cap, ensuring exchange losses do not artificially inflate asset values.
Income-tax Treatment under Section 43A
5.1 Statutory Text (Extract)
“Where an assessee has acquired any asset from a country outside India for which payment is made in foreign currency and, in consequence of a change in the rate of exchange at any time after acquisition, there is an increase or decrease in the liability of the assessee… such increase or decrease shall be added to, or deducted from, the actual cost of the asset.” — Section 43A(1)
5.2 Interpretation and Judicial Position
-
Mandatory Capitalisation:
Section 43A is a non-obstante clause; hence, exchange differences on repayment must be capitalised or reduced from cost, irrespective of accounting treatment. -
Not Dependent on Accounting Entry:
CIT v. Woodward Governor India (P) Ltd. (2009) 312 ITR 254 (SC) clarified that liability restatement as on balance-sheet date is allowable; and ONGC v. CIT (2010) 322 ITR 180 (SC) reaffirmed that adjustment to asset cost is obligatory. -
Timing: Adjustment arises when liability is discharged or restated in balance-sheet at closing rate if not settled.
Thus, for tax computation, the entire ₹ 50 lakh exchange loss is capitalised to asset cost.
ICDS IX (Borrowing Costs) and Book–Tax Difference
ICDS IX defines borrowing cost as “interest and other costs incurred in connection with borrowing of funds.” It excludes exchange differences from its ambit.
Hence, under tax computation:
| Framework | Exchange Difference Eligible for Capitalisation | Result |
|---|---|---|
| AS 16 / Ind AS 23 | Limited to interest differential | ₹ 49.20 lakh |
| Section 43A | Full fluctuation adjustment | ₹ 50 lakh |
| ICDS IX | Not part of borrowing cost | Adjustment through asset cost under Section 43A |
This leads to temporary timing differences → create Deferred Tax Asset/Liability under Ind AS 12 / AS 22.
Depreciation Impact Illustration
| Particular | Books (AS 16) | Tax (Sec 43A) |
|---|---|---|
| Machinery Cost | ₹ 8.20 cr | ₹ 8.20 cr |
| Add: Capitalised Exchange Loss | ₹ 0.492 cr | ₹ 0.50 cr |
| Depreciable Value | ₹ 8.692 cr | ₹ 8.70 cr |
| Depreciation @ 15 % | ₹ 1.3038 cr | ₹ 1.305 cr |
Result: Slight book–tax difference → deferred tax of approximately ₹ 0.012 lakh (rounded).
Practical Compliance Matrix
| Area | Governing Rule | Treatment | Documentation |
|---|---|---|---|
| Accounting Books | AS 16 + AS 11 / Ind AS 23 | Capitalise up to interest differential | Working papers for rate comparison, board approval for capitalisation |
| Income Tax | Section 43A | Capitalise full exchange fluctuation | Loan agreement, import invoice, exchange rate certificate |
| Tax Audit Report | Clause 18 of Form 3CD | Report adjustment to actual cost | Reconcile with FA register |
| Disclosure | Schedule III / Ind AS 107 | Disclose forex risk exposure and exchange difference treatment | Notes to accounts |
Analytical Insights
-
Dual Regime Compliance:
Accounting focuses on substance and prudence, while taxation follows statutory prescription. Both must be reconciled in fixed-asset registers. -
Interest Differential Benchmarking:
The interest differential should be evidenced by market-linked domestic borrowing rates (e.g., MCLR/benchmark yields) on the borrowing date. -
Exchange Risk Management:
Companies should evaluate forward cover or natural hedge strategies to stabilise asset cost volatility. -
Deferred Tax Reconciliation:
Where Section 43A capitalisation exceeds book treatment, deferred tax should be recognised on the temporary difference. -
Disclosure Ethics:
Transparent disclosure of exchange-difference policy avoids qualification in audit reports under SA 705 / CARO 2020.
Visual Summary: Exchange Difference Decision Path
Conclusion and Strategic Recommendations
-
Under AS 16 / Ind AS 23:
Capitalise only the portion of exchange difference that mirrors the interest differential, ensuring faithful representation of borrowing cost. -
Under Income-tax Act, 1961:
Capitalise the entire exchange difference under Section 43A, regardless of accounting treatment. -
Implementation Checklist:
-
Maintain detailed computation of differential.
-
Disclose policy consistently in financial statements.
-
Reconcile book and tax fixed-asset registers annually.
-
Adjust deferred tax accordingly.
-
This dual-layer approach safeguards statutory compliance, strengthens audit credibility, and optimises tax depreciation, while ensuring the asset value reflects the true economic cost of foreign financing.
