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Direct Tax Laws and International Taxation · Income Computation and Disclosure Standards (ICDS)

ICDS VI: Effects of Changes in Foreign Exchange Rates

Updated 11 October 2026 · Fact-checked

ICDS VI deals with how exchange rate changes affect foreign currency transactions. Under the Income-tax Act, 2025, section 43 taxes the gain or loss as income or loss, computed per ICDS. Section 42 is the exception: for imported business assets, the variation in liability on payment adjusts the asset's cost instead.

Understand Foreign Exchange Effects and Taxation of Fluctuation

A business that buys, sells or borrows in foreign currency records each deal in rupees. The rupee value changes when the exchange rate moves. That change is an exchange difference. The question is whether it is income, loss, or an adjustment to the cost of an asset.

The Income-tax Act, 2025 gives two rules. Section 43 says any gain or loss from a change in exchange rates on foreign currency transactions is income or loss, computed as per the ICDS notified under section 276(2). It applies to monetary and non-monetary items, translation of financial statements of foreign operations, forward exchange contracts and foreign currency translation reserves. It is subject to section 42.

Section 42 applies first, when you acquire an asset for business or profession from a country outside India. If at the time of payment the rupee liability varies because the rate changed, that variation is not income or loss. It is added to or reduced from the actual cost of the asset. This changes depreciation later.

So your first job is to classify. Is the difference on payment for an imported business asset (or on repaying money borrowed specifically for it, with interest)? Then section 42 applies. Otherwise section 43 and ICDS VI apply, and the difference goes to the profit and loss computation.

In ICDS VI, the usual treatment is: record the transaction at the rate on the date of the transaction; restate monetary items (cash, receivables, payables, loans) at the year-end rate; treat the resulting difference as income or expense. Check the ICDS text you have for the rules on non-monetary items, forward contracts and foreign operations, as those are examined less often than monetary items.

Key rules to remember

Section 43 charge
Exchange gain or loss on foreign currency transactions = income or loss, computed as per ICDS
Subject to section 42. Covers monetary and non-monetary items, translation of foreign operations, forward contracts and translation reserves.
Variation in liability (section 42)
A = B – C
A = variation in liability. B = payment in rupees at the time it is made. C = corresponding liability in rupees at the time of acquiring the asset.
B for section 42
B = payment made (a) towards cost of the asset, or (b) towards repayment of money borrowed, with interest in foreign currency, specifically for acquiring the asset
Any part of the liability met directly or indirectly by another person or authority is excluded.
Effect on cost
Revised actual cost = Original cost ± A
A positive A (rupee payment is higher) increases cost; a negative A reduces it. Applies to actual cost under section 39, capital expenditure under section 32(i) or 45(1)(a)(i), or cost of acquisition for section 72.
Forward contract with authorised dealer (section 42(4))
Use the rate specified in the contract for the part of the sum available to discharge the liability
The contract must be with an authorised dealer under FEMA, 1999, for a specified sum on or after a stipulated future date at a stated rate.

How to solve Foreign Exchange Effects and Taxation of Fluctuation questions

Use this order for any question on exchange differences. Classify first, then compute.

  1. 1Identify each foreign currency item: asset purchase, loan, receivable, payable, forward contract or foreign operation.
  2. 2Check whether the item relates to an asset acquired from outside India for business or profession. If yes, section 42 applies at the time of payment.
  3. 3For section 42, compute A = B – C. Convert the payment at the rate on the payment date (B) and the same foreign amount at the rate on the acquisition date (C).
  4. 4Exclude any part of the liability met by another person or authority. If a forward contract with an authorised dealer covers the payment, use the contract rate for the covered amount.
  5. 5Add A to the asset's cost if positive, or reduce cost if negative. Then work out depreciation on the revised cost.
  6. 6For all other items, apply section 43 and ICDS VI: record at the transaction-date rate and restate monetary items at the year-end rate.
  7. 7Treat the net difference as income or loss in the business computation.
  8. 8State your conclusion in one line, naming the section applied.

Quickest way: Two-question filter

When to use it: Use this in the exam hall for MCQs and for the first minute of a written question.

  1. Ask: is this payment for an imported business asset or its specific foreign loan? If yes, adjust cost (section 42). Difference = payment-date rate minus acquisition-date rate, times the foreign amount.
  2. If no, ask: is it a monetary item at year end? If yes, restate at the closing rate and take the difference to profit or loss (section 43).
  3. Sign check: a higher rupee outflow raises cost under section 42, and creates a loss under section 43.

Common mistakes in Foreign Exchange Effects and Taxation of Fluctuation

  • Taking an exchange loss on an imported machine straight to the profit and loss account.

    Students remember that section 43 treats exchange differences as income or loss and stop there.

    Fix: Remember section 42 applies first. For imported business assets the variation on payment is added to or deducted from the cost of the asset.

  • Using the year-end rate in the section 42 calculation.

    Students mix up section 42 with year-end restatement of monetary items.

    Fix: Section 42 compares the rate at the time of payment with the rate at the time of acquisition. The year-end rate is not used.

  • Ignoring the part of liability met by another person or authority.

    The exclusion is in a sub-clause that is easy to miss.

    Fix: Remove any portion met directly or indirectly by another person or authority before computing A.

  • Applying the spot rate when a forward contract with an authorised dealer covers the payment.

    Students forget the contract rate rule in section 42(4).

    Fix: For the covered sum, compute the adjustment with the rate specified in the contract.

  • Quoting old section numbers from the Income-tax Act, 1961.

    Older material and notes use the earlier numbering.

    Fix: For June 2027 use the Income-tax Act, 2025: section 42 for capitalising, section 43 for taxation of exchange fluctuation.

Worked examples

Example 1

Meridian Engineering Ltd, an Indian company, imported a machine from Germany on 1 July for €50,000 on credit, when €1 = ₹90. It paid the full amount on 1 December when €1 = ₹95. No part of the liability was met by anyone else and there was no forward contract. Find the variation in liability and the revised cost, given the machine was recorded at the acquisition-date rate.

Show the solution
  1. The machine is an asset acquired from outside India for business, so section 42 applies at the time of payment.
  2. B = €50,000 × ₹95 = ₹47,50,000.
  3. C = €50,000 × ₹90 = ₹45,00,000.
  4. A = B – C = ₹47,50,000 – ₹45,00,000 = ₹2,50,000.
  5. A is positive, so it is added to the actual cost.
  6. Original cost = ₹45,00,000. Revised actual cost = ₹45,00,000 + ₹2,50,000 = ₹47,50,000.

Answer: Variation in liability is ₹2,50,000, added to cost. The revised actual cost of the machine is ₹47,50,000. It is not claimed as a loss.

Example 2

Kaveri Textiles Ltd has a trade payable of US$20,000 for goods purchased and recorded on 1 February at US$1 = ₹83. At 31 March the closing rate is ₹85. Show the treatment under section 43 and ICDS VI, assuming no section 42 asset is involved.

Show the solution
  1. The payable is for goods, not an asset covered by section 42, so section 43 applies.
  2. A payable is a monetary item, so restate it at the closing rate.
  3. Opening rupee value = US$20,000 × ₹83 = ₹16,60,000.
  4. Closing rupee value = US$20,000 × ₹85 = ₹17,00,000.
  5. Liability has increased by ₹17,00,000 – ₹16,60,000 = ₹40,000.
  6. An increase in a liability is a loss.

Answer: Exchange loss of ₹40,000 is recognised in computing business income for the year.

Exam tips

  • MCQs often test which section applies. Remember: section 42 for asset cost, section 43 for income or loss.
  • In written answers, name the classification step first. It earns marks even if arithmetic slips.
  • Show B and C separately in section 42 answers so partial marks are safe.
  • Write the sign clearly: higher rupee payment means higher cost, and lower payment means reduced cost.
  • Use Income-tax Act, 2025 numbering only, and mention tax year 2026-27 where relevant.

Practice questions from Income Computation and Disclosure Standards (ICDS)

Foreign Exchange Effects and Taxation of Fluctuation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Foreign Exchange Effects and Taxation of Fluctuation: frequently asked questions

What does section 43 of the Income-tax Act, 2025 say?

It treats any gain or loss from a change in foreign exchange rates on foreign currency transactions as income or loss. The amount is computed as per the income computation and disclosure standards notified under section 276(2). It covers monetary and non-monetary items, foreign operations, forward contracts and translation reserves.

How is section 42 different from section 43?

Section 42 applies to variation in liability at the time of payment for an asset acquired from outside India for business or profession. The variation adjusts the asset's cost. Section 43 covers other foreign exchange gains and losses, which are income or loss.

How do I compute variation in liability under section 42?

Use A = B – C. B is the payment in rupees at the time it is made. C is the corresponding liability in rupees at the time the asset was acquired. Add A to cost if positive and reduce cost if negative.

How is a forward contract treated for an imported asset?

If you have a contract with an authorised dealer under FEMA, 1999 for a specified sum at a stated rate on or after a future date, the adjustment for the covered sum is computed using the contract rate.