2016 (9) TMI 1608 - AT - Income Tax

Disallowance of Mark to Market loss on revaluation of forward exchange contracts which was outstanding as on the date of balance sheet, treating the same as notional loss - business to hedge against the forex loss - CIT(A) held it not notional loss and therefore allowable - assessee argued that more than 90% of the assessee s business is deriving income from exports of diamonds and most of the purchases and sales were made in foreign currency - HELD THAT - Considering the substantial foreign currency exposure and due to substantial fluctuation in foreign currency rates, the assessee entered into the forward contracts (FCs) with the Banks as integral part of the export import business with the aim to hedge and safeguard against the foreign exchange fluctuation of the US vis- -vis the Indian currency, from time to time. From the details filed by the assessee it is clear that there was huge volatility in exchange rate of US Dollar viz. Rupee from April 2008 to March 2009. US Dollar had registered an appreciation from ₹ 39.7650 to ₹ 51.9700 during the year as is evident from the yearly graph plotting the volatility filed before us. We find that the assessee has hedge the underlying exposure in foreign currency and as such, the forward contracts entered were for the purpose of the business to hedge against the forex loss. Assessee has forex exposure on all limbs its business activities. The firm has not entered into the forward contracts with an intention to earn any gain due to fluctuation in foreign currency rate but it is necessary for it to enter into such forward contracts to hedge against foreign exchange rate fluctuation. This is an integral part of the business undertaken by the assessee and incidental to the export and import business. In the absence of such forward contracts, the firm may sustain huge losses. It becomes essential for the firm to book such forward contracts as a prudent business practices. Further, we find that the assessee is engaged in the business of diamonds export and not in the business of foreign exchange. This is evident from the financial results of the firm. In view of the same, we are of the view that these contracts are nothing but an integral part of its export and import activities and the resultant hedging difference on their revaluation cannot be isolated artificially as notional loss. Hence, we confirm the order of CIT (A) and this issue of revenue s appeal is dismissed. Disallowance of additional claim of depreciation - AO disallowed the claim by observing that the assessee is not engaged in manufacturing or production of any article or thing - claim of the assessee is that the business of cutting and polishing of diamonds is manufacturing and production of an article or thing as required for claiming additional depreciation - HELD THAT - Respectfully following the Coordinate Bench decision in the case of Flawless Diamond India Ltd. 2014 (9) TMI 261 - ITAT MUMBAI we hold that cutting and polishing of diamonds amounts to manufacturing or production of article or thing as envisaged for the purpose of claiming additional depreciation u/s 32(1) (iia) of the Act. Hence, we confirm the order of the CIT (A) on this issue and dismiss the Revenue s appeal.

Summary

Issues Involved:
1. Disallowance of "Mark to Market" loss on revaluation of forward exchange contracts.
2. Disallowance of additional depreciation claim.

Issue-wise Detailed Analysis:

1. Disallowance of "Mark to Market" Loss on Revaluation of Forward Exchange Contracts:

The Revenue appealed against the CIT (A)'s decision to delete the disallowance made by the AO of "Mark to Market" loss on revaluation of forward exchange contracts, which was treated as notional loss. The AO had disallowed the loss, arguing it was not crystallized and hence notional. The assessee, engaged in the export of cut and polished diamonds, argued that the loss was claimed as per Accounting Standard-11 (AS-11) guidelines issued by ICAI, which requires revaluation of forward contracts at the balance sheet date. The CIT (A) accepted the assessee's argument, noting that the loss was real and quantifiable, and in line with AS-11 and various judicial precedents, including the Supreme Court's decision in CIT v. Woodward Governor India (P.) Ltd. The Tribunal upheld the CIT (A)'s decision, emphasizing that the forward contracts were integral to the assessee's business of hedging against foreign exchange fluctuations, and the resultant losses were real and allowable as per AS-11 and consistent judicial decisions.

2. Disallowance of Additional Depreciation Claim:

The Revenue also contested the CIT (A)'s decision to allow the assessee's claim for additional depreciation on the ground that diamond cutting and polishing does not constitute manufacturing or production of an article or thing. The CIT (A) relied on the Supreme Court's decision in Arihant Tiles & Marble Pvt. Ltd., which held that such activities do qualify as manufacturing. The Tribunal, referencing the case of Flawless Diamond India Ltd. and other judicial precedents, confirmed that the process of cutting and polishing diamonds results in a distinct product and thus qualifies as manufacturing or production. Consequently, the Tribunal upheld the CIT (A)'s decision to allow the additional depreciation claim.

Conclusion:

The Tribunal dismissed the Revenue's appeal on both issues, affirming the CIT (A)'s decisions to allow the "Mark to Market" loss on forward exchange contracts and the additional depreciation claim, based on consistent application of accounting standards and judicial precedents.