2005 (3) TMI 699 - AT - Income Tax

Diamond Exporters - Interest on fixed deposits is eligible for deduction u/s 80HHC? - HELD THAT - In the case, the value of foreign currency was not to go up, there would not have been gains on cancellation of contracts but then the actual costs, in terms of domestic currency, that the assessee pays when he has to pay for imports in foreign currency does not also go up. Since it is an undisputed position that the imports, in connection with which the assessee had entered into forward contracts, actually took place, this profit on cancellation of forward foreign exchange contracts effectively only reduces the costs of purchases in respect of those imports, and cannot be, by any logic, construed as transactions independent of assessee s business of importing rough diamonds and exporting cut and polished diamonds. The fact of premature cancellation, therefore, cannot alter the nature of transaction. Thus, we are of the considered view that the credit shown in the profit loss account as profit on cancellation of forward contracts is as integral part of the export business, as purchases or imports. As it effectively controls and reduces the cost of imports, and is integral part of the export business profits, and as, in our considered view, the exclusion clause under clause ( baa ) of Explanation to section 80HHC cannot apply to these profits, the authorities below were indeed not justified in holding that 90% of these profits is required to be excluded from profits of export business. This amount is not covered by any of the categories which are covered by the aforesaid clause in Explanation to section 80HHC. We, therefore, uphold the contention of the assessee, and direct the Assessing Officer to recompute the deduction u/s 80HHC by, inter alia , not excluding 90% of the profit realized on cancellation of forward foreign exchange contracts, from the profits of export business. The assessee succeeds on this issue. Ground is thus allowed. In the result, the appeal is allowed in the terms indicated above.

Summary

Issues:
1. Adjustment of premium received on cancellation of forward contracts for computing depreciation under section 80HHC.
2. Adjustment of interest on fixed deposits for computing section 80HHC deduction.

Analysis:

Issue 1: Adjustment of premium received on cancellation of forward contracts for computing depreciation under section 80HHC

The appellant contested the CIT(A)'s decision to confirm the adjustment made by the Assessing Officer regarding the reduction of 90% of the premium received on cancellation of forward contracts for computing depreciation under section 80HHC. The Tribunal referred to a Special Bench decision and directed the Assessing Officer to recompute the deduction under section 80HHC by excluding only the net amount, i.e., interest received reduced by interest paid on the invested funds. The Tribunal allowed this ground for statistical purposes.

Issue 2: Adjustment of interest on fixed deposits for computing section 80HHC deduction

Regarding the adjustment of 90% of the interest on fixed deposits for computing section 80HHC deduction, the Tribunal upheld the Special Bench decision and directed the Assessing Officer to recompute the deduction under section 80HHC accordingly. The Tribunal allowed this ground for statistical purposes.

Detailed Analysis of the First Grievance:

The appellant, a diamond exporter, entered into forward contracts for foreign exchange to minimize risks due to fluctuations in currency values. The appellant canceled these contracts to realize profits, which the Assessing Officer sought to exclude from business profits under section 80HHC. The Tribunal disagreed with the Assessing Officer's view, stating that the profits from cancellation of forward contracts were integral to the export business. The Tribunal highlighted that these transactions were genuine business activities to hedge against increased costs, emphasizing that the profits were revenue-neutral and reduced the costs of imports. The Tribunal concluded that the exclusion clause under section 80HHC did not apply to these profits, overturning the lower authorities' decision and allowing the appellant's claim.

Detailed Analysis of the Second Grievance:

The second grievance involved the exclusion of 90% of interest on fixed deposits for computing section 80HHC deduction. The Tribunal followed the Special Bench decision and directed the Assessing Officer to recompute the deduction by excluding only the net amount. The Tribunal upheld the appellant's contention on this issue, allowing the appeal.

In conclusion, the Tribunal allowed both grounds of appeal, directing the Assessing Officer to recompute the deductions under section 80HHC in line with the Tribunal's decisions on both issues.