Section 42

Section 42: capitalising the impact of foreign exchange fluctuation

Section 42 addresses what happens when an assessee borrows in foreign currency (or otherwise incurs a foreign-currency liability) to acquire a business asset from outside India, and the rupee value of that liability changes because of exchange-rate movement at the time of payment. Rather than treating the resulting gain or loss as a revenue item, the section requires it to be capitalised - added to or subtracted from the cost of the related asset.

This explanation is AI-assisted and pending review by our CA/CS team. It is general information, not professional advice - always cross-check against the bare law text above or talk to our tax team for guidance specific to your situation.

When this section applies

Section 42(1) applies where, at the time an assessee makes a payment during the tax year, there is a variation in liability (expressed in Indian currency) due to a change in the exchange rate, in relation to an asset acquired for business or profession from a country outside India.

How the variation is computed

Section 42(2) excludes any part of the liability met directly or indirectly by another person, and computes the "variation in liability" as A = B minus C, where B is the payment in Indian currency at the time it is made (towards the asset's cost, or towards repayment of foreign-currency borrowings taken specifically to acquire the asset, including interest), and C is the corresponding liability in Indian currency at the time the asset was acquired.

Where the variation gets added or reduced

Section 42(3) requires the variation in liability to be added to, or reduced from: the actual cost of the asset (as computed under Section 39); the capital expenditure referred to in Section 32(i) or 45(1)(a)(i); or the cost of acquisition of a capital asset (other than one covered by Section 74) for the purposes of Section 72. The resulting figure becomes the revised actual cost, capital expenditure, or cost of acquisition.

Forward contracts

Section 42(4) covers the case where the assessee has a forward contract with an authorised dealer (as defined under FEMA, 1999) to receive a specified sum in foreign currency at a stipulated future date at a contracted exchange rate, to meet the liability. To the extent the contracted sum is available for discharging the liability, the amount to be added or deducted is computed with reference to the rate specified in that forward contract.

Frequently asked questions

Is a foreign-exchange gain or loss on a business asset loan treated as revenue income or expense?

No - under Section 42, where the liability relates to an asset acquired from outside India for business/profession, the exchange-rate variation is capitalised: it is added to or reduced from the asset's actual cost (or related capital expenditure/cost of acquisition), not treated as a separate revenue gain or loss.

What if I have a forward contract to hedge the foreign-currency liability?

Under Section 42(4), to the extent the forward contract covers the liability, the amount to be added to or deducted from the asset's cost is computed using the exchange rate specified in that forward contract rather than the rate at actual payment.