Section 42 Income Tax Act 2025: How Is Foreign Exchange Fluctuation Capitalised?

Section 42 governs how changes in foreign exchange rates affect the capital cost of an asset acquired from outside India for business or professional purposes when a related liability is paid.

Legal position: The Income-tax Act, 2025 came into force on 1 April 2026, subject to its provisions. This guide discusses Section 42 in the Act as amended by the Finance Act, 2026. The provision broadly corresponds to Section 43A of the Income-tax Act, 1961.
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When does Section 42 apply?

Under Section 42(1), the provision applies where an assessee acquires an asset from a country outside India for the purposes of business or profession and, when making payment during the tax year, experiences a variation in the liability expressed in Indian currency because of a change in the exchange rate. The section overrides inconsistent provisions of the Act for this specific adjustment.

The relevant payment may relate to the asset's price or repayment of borrowing specifically used to acquire the asset, including the interest component referred to in the provision. An unpaid year-end exchange fluctuation, without the payment contemplated by Section 42, should not automatically be treated as an adjustment under this section.

How is the foreign exchange variation calculated?

Section 42(2) prescribes the formula:

A = B - C

A = variation in liability;
B = the payment expressed in Indian rupees when made, towards the whole or part of the asset cost or towards repayment of relevant foreign-currency borrowing (including interest) specifically for acquiring the asset;
C = the corresponding liability in Indian rupees at the time the asset was acquired.

Any portion of the liability met directly or indirectly by another person or authority is excluded. A positive result indicates an increase in the rupee liability; a negative result indicates a decrease.

Where is the variation added or deducted?

Section 42(3) directs that the computed variation be added to, or deducted from, the appropriate capital amount:

  • The actual cost of the asset under Section 39;
  • Capital expenditure referred to in Section 32(i) or Section 45(1)(a)(i); or
  • The cost of acquisition of a capital asset for Section 72, excluding a capital asset referred to in Section 74.

The resulting adjusted amount becomes the relevant actual cost, capital expenditure or cost of acquisition for the purposes specified in the Act. The treatment is therefore not simply an automatic deduction of every exchange loss as a revenue expense.

What happens when a forward exchange contract is used?

Section 42(4) addresses a contract with an authorised dealer as defined in Section 2 of the Foreign Exchange Management Act, 1999, to provide a specified amount of foreign currency on or after a future date at an agreed exchange rate. To the extent that the contracted foreign currency is available to discharge the relevant liability, the adjustment is calculated using the contractual exchange rate.

Practical illustration of Section 42

Suppose a business imports equipment for USD 100,000 when the exchange rate is Rs. 80 per USD. The corresponding liability on acquisition is Rs. 80,00,000. If the entire liability is later paid when the exchange rate is Rs. 84 per USD, the payment is Rs. 84,00,000.

Illustrative variation: Rs. 84,00,000 - Rs. 80,00,000 = Rs. 4,00,000. Subject to the statutory conditions, the relevant capital cost increases by Rs. 4,00,000.

If the payment instead occurred at Rs. 78 per USD, the corresponding variation would be negative Rs. 2,00,000, reducing the relevant capital cost. These simplified examples assume the entire eligible liability is paid and no other person bears any part of it.

Relevant terms and statutory references

Assessee: A person whose tax liability or proceedings fall within the statutory definition in Section 2 of the Income-tax Act, 2025.
Tax year: The period defined under Section 3 of the Income-tax Act, 2025.
Actual cost: The cost determined under Section 39, including applicable statutory adjustments.
Variation in liability: The difference computed as A = B - C under Section 42(2), subject to the statutory exclusions.
Authorised dealer: An authorised dealer within the meaning of Section 2 of the Foreign Exchange Management Act, 1999, as referred to in Section 42(4).

Frequently asked questions

Is every foreign exchange loss deductible immediately?

No. Section 42 provides for an adjustment to the specified capital cost where its conditions are met. Other foreign currency transactions may fall under different provisions, including Section 43.

Does Section 42 cover imported business assets?

Yes, where an asset is acquired from outside India for business or profession and the payment-related exchange variation meets the statutory conditions.

Does Section 42 correspond to an earlier provision?

It broadly carries forward the subject matter of Section 43A of the Income-tax Act, 1961. The applicable law and tax year should be checked before relying on older authorities.

Statutory text and official references

Income-tax Act 2025 (official amended text)Income Tax Department: Act 2025India Code

Last reviewed: 10 November 2026. This article is general legal information; application depends on the facts and current statutory text.