Supreme Court Upholds Disallowance of Deduction on Foreign Exchange Gains Under Section 80HHC

In a significant judgment, the Supreme Court of India today dismissed the appeals filed by Shah Originals against the decision of the High Court concerning the disallowance of deduction under Section 80HHC of the Income Tax Act for gains arising from foreign exchange fluctuations in Export Earners’ Foreign Currency (EEFC) accounts. This decision reaffirms the strict interpretation of income tax provisions relating to deductions.

The Bench, comprising Justices B.V. Nagarathna and S.V.N. Bhatti, emphasized the essence of the legal principle involved. The Court stated, “In interpreting a section in a taxing statute, the question is not at what transaction the section is aimed, but what transaction its language fairly and squarely hits.” This observation underpins the Court’s approach in interpreting the provisions of the Income Tax Act.

The appeals by Shah Originals contested the High Court’s decision, which disallowed the deduction claimed under Section 80HHC for gains earned due to fluctuations in foreign exchange rates in the company’s EEFC account. The Supreme Court, in its detailed judgment, held that these gains do not partake in the character of profits of the business of the assessee from exports and, therefore, cannot be included in the computation of deduction under Section 80HHC of the Act.

Highlighting the nature of EEFC accounts, the Court observed that maintaining such an account is neither mandatory nor incidental to the export activity but is purely optional. Thus, the gains earned from foreign exchange fluctuations in these accounts cannot be treated as profits derived from the export business for deduction under Section 80HHC.

The Court’s decision sets a precedent in the interpretation of the term ‘derived from’ within the context of the Income Tax Act, underscoring that income considered under this section must have a direct nexus with the export of goods and not merely be attributable to it.

This ruling is expected to have widespread implications for businesses engaged in exports and their approach to claiming deductions under the Income Tax Act, particularly concerning foreign exchange earnings and fluctuations.

Date of Decision: 21st November 2023

Shah Originals VS Commissioner of Income