Compensation Paid Towards Exchange Rate Fluctuation Loss Is Allowable Deduction: Madras High Court

The Madras High Court has held that compensation paid towards exchange rate fluctuation loss pursuant to commercial expediency is an allowable deduction, even if such compensation is not expressly provided for in the written contract. The Bench of Dr. Justice Anita Sumanth and Justice Mummineeni Sudheer Kumar allowed the Tax Case Appeal setting aside the Income Tax Appellate Tribunal’s (ITAT) order to the extent it disallowed Rs. 45.67 lakh paid as exchange fluctuation compensation. The appeal arose from Assessment Year (AY) 2004–05. The assessee had declared an income of ₹92.91 lakh. During assessment, the Assessing Officer (AO) disallowed expenditure amounting to ₹81.63 lakh under three heads. The present dispute concerned two components. Firstly, Rs. 45,67,071 paid towards exchange rate fluctuation loss suffered by Sterling Metchem Trade (P) Ltd. (SMTPL). Secondly, Rs. 35,00,000 paid as compensation for premature termination of an agreement dated June 15, 2000. The Commissioner of Income Tax (Appeals) allowed both claims. However, on further appeal by the Revenue, the ITAT upheld the deletion of ₹35 lakh but reversed the relief granted in respect of ₹45.67 lakh, holding that the agreement did not contain any clause providing for compensation on account of exchange fluctuation loss. Aggrieved, the assessee approached the High Court under Section 260A of the Act. The central question before the High Court was whether compensation paid for exchange rate loss, though not expressly stipulated in the agreement, could be allowed as business expenditure under Section 37 of the Income Tax Act? The assessee had entered into an agreement with SMTPL under which SMTPL imported materials on its behalf and allowed a six-month credit period for payment. However, due to delays beyond the stipulated period—sometimes exceeding one year—SMTPL suffered losses because of volatile exchange rate fluctuations. SMTPL raised a claim for compensation. After adjusting gains and losses, the net loss was quantified. Considering commercial expediency and in the context of premature termination of the agreement, the parties mutually agreed upon a consolidated compensation of ₹80.67 lakh, of which ₹45.67 lakh represented exchange fluctuation loss. The assessee contended that the liability crystallised on March 18, 2004, through a Board Resolution. The payment was genuine and not disputed. Even if the agreement did not explicitly provide for exchange loss compensation, there was no prohibition against such payment. The expenditure was incurred wholly and exclusively for business purposes and was therefore allowable under Section 37. The department argued that the agreement did not contain any specific clause requiring the assessee to compensate SMTPL for exchange rate losses. Clauses relating to compensation covered only six-month credit compensation and premature termination. In the absence of an express covenant, such payment could not qualify as allowable business expenditure. The ITAT accepted this reasoning and disallowed the ₹45.67 lakh claim. The High Court disagreed with the Tribunal’s narrow interpretation of the agreement. The Court observed that although Clauses (g) and (j) did not expressly mention exchange loss compensation, Clause (f)permitted inclusion of “charges incurred” and mutually agreed compensation for services rendered. The Court held that the exchange fluctuation loss, caused due to delayed payment beyond the six-month credit period, would fall within the ambit of compensation contemplated under Clause (f). The Bench emphasized that allowability under Section 37 must be examined from the perspective of a prudent businessman. If an expenditure is incurred out of commercial expediency and is not prohibited by law, it cannot be disallowed merely because it is not expressly mentioned in a contract. The Court noted that the genuineness of the payment was never doubted. The department did not dispute the business necessity of the expenditure. There was no finding that the expenditure fell under Sections 30 to 36 or was excluded from Section 37. Relying on the Supreme Court’s decision in Bharat Earth Movers v. CIT (245 ITR 428), the Court held that once liability has crystallised during the relevant financial year, deduction cannot be denied merely because actual payment occurred later. The liability was crystallised on March 18, 2004, and therefore could not be treated as contingent. The Court directed that since the claim related to a subsequent assessment year based on accounting treatment, the assessment for AY 2006–07 should be revised to give effect to the allowance. The High Court allowed the appeal and set aside the Tribunal’s order insofar as it disallowed Rs. 45.67 lakh. The court held that compensation paid for exchange fluctuation loss is allowable under Section 37 when incurred out of commercial expediency and directed revision of the relevant assessment year to grant relief. Case Details Case Title: M/s.Assab Sripad Steels Private Limited Versus The Commissioner of Income Tax – 1 Case No.: T.C.A.No.465 of 2012 Date: 02.02.2026 Counsel For Petitioner: R.Meenakshi Sundaram Counsel For Respondent: D.Prabhu Mukunth Arunkumar Click Here To Read Order

Compensation Paid Towards Exchange Rate Fluctuation Loss Is Allowable Deduction: Madras High Court

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