Capitalising the impact of foreign exchange fluctuation
[As per the Income Tax Act, 2025 (this Act) w.e.f. 1st April, 2026.]
Section 42(1) of Income Tax Act 2025
42(1) Irrespective of anything contained in any other provision of this Act, where at the time of making payment during the tax year, there is a variation in liability of an assessee as expressed in Indian currency due to change in rate of exchange in relation to an asset acquired for the purpose of business or profession in foreign currency from a country outside India, it shall be dealt with in the manner specified in sub-sections (2) and (3).
Section 42(2) of Income Tax Act 2025
42(2) For this section, “variation in liability” shall be computed as—
- A = B-C
- where,—
- A = variation in the liability;
- B = amount paid in Indian currency (excluding any part met, directly or indirectly, by any other person or authority) during the tax year for acquisition of the asset for—
- (a) the whole or part of the cost of asset; or
- (b) repayment of money borrowed along with interest in foreign currency, specifically for acquiring such asset;
- C = liability, corresponding to the amount referred in B, in Indian currency at the time of acquisition of such asset.
Section 42(3) of Income Tax Act 2025
42(3) The variation in liability shall be added or reduced from the—
- (a) actual cost of the asset as referred in section 39; or
- (b) expenditure of capital nature referred to in section 45(1)(a) or (c) or 32(i); or
- (c) cost of acquisition of a capital asset (not being capital asset referred to in section 74) for the purpose of section 72,
and the amount arrived at after such addition or deduction shall be taken to be the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset.
Section 42(4) of Income Tax Act 2025
42(4) Where the assessee has entered into a contract with an authorised dealer as defined in section 2 of the Foreign Exchange Management Act, 1999, for providing him with a specified sum in a foreign currency on or after a stipulated future date at the rate of exchange specified in the contract to enable him to meet the whole or any part of the said liability, the amount, if any, to be added to, or deducted from, the actual cost of the asset or the amount of expenditure of a capital nature or, as the case may be, the cost of acquisition of the capital asset under this section shall, in respect of so much of the sum specified in the contract as is available for discharging the said liability, be computed with reference to the rate of exchange specified therein.
FAQs on Section 42 of Income Tax Act 2025
1. What is the purpose of Section 42?
Section 42 deals with adjusting the cost of an asset or capital expenditure due to foreign exchange rate fluctuations when an asset is acquired from outside India.
2. When does Section 42 apply?
It applies at the time of actual payment during the tax year when there is a change in exchange rate affecting the Indian currency liability of an asset acquired in foreign currency.
3. How is the variation in liability calculated?
The variation is computed as:
A = B – C, where:
- A = variation in liability
- B = actual amount paid (in INR) during the tax year
- C = corresponding liability in INR at time of acquisition
4. What types of payments are covered under Section 42(2)(b)?
It includes repayments of borrowed money plus interest in foreign currency, if specifically borrowed for acquiring the asset.
5. How is this variation treated in books or tax computation?
The variation is added to or deducted from:
- the actual cost of the asset under Section 39,
- the capital expenditure under Section 45(1)(a)/(c) or Section 32(i), or
- the cost of acquisition under Section 72.
6. Can foreign exchange losses also be capitalised?
Yes. Both gains and losses due to exchange rate variations are adjusted in the actual cost, capital expenditure, or cost of acquisition.
7. What if the assessee uses a forward contract for currency?
If a forward contract is entered into with an authorised dealer, the variation is computed based on the rate specified in the contract, not the spot market rate.
8. Does this apply to all types of assets?
It applies only to assets acquired for business/profession and capital assets, excluding capital assets under Section 74 (such as specified shares or securities).
9. Is this applicable if the liability is met by someone else?
No. Any amount met directly or indirectly by another person or authority is excluded from this computation.
10. Is the adjustment allowed for partial payments?
Yes. Even if only a part of the cost or loan is paid in a particular tax year, the variation for that payment is adjusted accordingly.
11. Is the fluctuation adjusted even if the asset is not fully paid for?
Yes. Section 42 applies each time a payment is made, so fluctuation is considered on each payment basis, not just at acquisition.
12. How is the impact shown in depreciation computation?
The adjusted actual cost (after forex variation) becomes the revised base for depreciation under Section 33, impacting WDV accordingly.
Section 42 ensures that any gain or loss due to foreign exchange fluctuations while acquiring business assets or capital assets is systematically adjusted in the cost of such assets. It aligns tax treatment with the real financial outlay borne by the assessee in Indian currency.
The provision offers clarity and consistency, especially when forward contracts are used, ensuring that actual financial impact is capitalised—thereby affecting depreciation, capital gains, or capital expenditure in a rational and transparent manner.
