2020 (5) TMI 402 - AT - Income Tax

Rejection of books of accounts - Addition on account of low gross profit - CIT-A deleted the addition - HELD THAT - Books of accounts were rejected by the AO merely on the basis of variation of signatures of karigars, workers as appearing in the salary register. However, no specific defects have been pointed out by the AO. Therefore, the difference in signature cannot be a ground to reject the books of accounts. CIT(A) has rightly observed that the AO is not hand writing expert to distinguish the signature of the karigar. CIT(A) has rightly allowed the ground of rejection of books of accounts u/s.145(3) of the Act in favour of the assessee. GP addition - Genuineness of the labour charges cannot be doubted. Further, the GP ratio has gone down because as against the rise in average purchase cost of imports and local purchases by 51% and 34% respectively in AY.2009-10, the rise in average price of export is only to the extent of 22.51%, therefore, the fall in GP is quite justified - there was overall recession in the diamond industry during the relevant period and most of the sales were export sales of the assessee, whereas the GP was disclosed at 3.71% - the export sales of the assessee constituted almost 99% of the total sales while local sales were only at 1.14%. Deletion of GP addition is justified, hence, we do not find any infirmity in the order of CIT(A) for deleting of GP addition. CIT(A) has upheld the addition of an amount of electricity expenses of to be added to the manufacturing cost to calculate the closing stock by taking the average cost of ₹ 11318.91 per carat which has been arrived after reducing the GP margin of 3.71% from the average export price of ₹ 11756.69 per carat. Therefore, this ground of assessee is dismissed. Forward contract cancellation loss disallowed - forward contract were not booked for any specific export and import and not utilized in business and terminated without affecting delivery of foreign exchange - HELD THAT - The assessee is in the business of export of diamonds wherein the assessee is exposed to the risk of fluctuation in the exchange rate of currency. In order to hedge against losses, the assessee had booked foreign exchange in the forward market with bank and on cancellation on the contracts, the appellant is either entitled to profit or loss depending on the rate of contracts prevailing at the time of cancellation. The assessee has entered to this forward exchange contract in order to protect against fluctuation in the rate of foreign exchange currency to minimize the risk. Therefore, the assessee has not entered into any speculation transaction as held by the CIT(A). The ld. counsel has placed reliance on the decision of Friends Friends Shiping Pvt. Ltd 2013 (5) TMI 458 - GUJARAT HIGH COURT wherein held that where assessee exporter entered into foreign exchange contract as incidental to its export business and incurred loss in said contracts, said loss was not speculative loss but business loss. Similar loss was also expressed in the case of Badridas Gauridu (P) Ltd 2003 (1) TMI 61 - BOMBAY HIGH COURT and CIT v. Panchmahal Steel Ltd. 2013 (5) TMI 686 - GUJARAT HIGH COURT . In view of these facts, we do not find any infirmity in the order of CIT(A). Valuation of closing stock - direction to the AO to recalculate the value of closing stock after considering electricity expenses in manufacturing expenses and thereby increasing the value of closing stock - HELD THAT - As we have uphold that finding of CIT(A) to consider, the electricity expenses in manufacturing expenses and thereby increase the value of closing stock. Since the value of closing stock has been increased during this year, it becomes opening stock for the next year. Therefore, the AO is directed to consider to increase the opening stock of the equal amount in AY.2010-11 in the opening stock. Therefore, this ground of appeal of the assessee is allowed. Rectification u/s 154 - Calculation of closing stock by adopting the cost of sale - whether AO has committed an error while giving effect to the appeal effected to the appeal order and he should have calculated the closing stock by adopting the cost of sale at ₹ 11,318.91/- per carat, after reducing the GP margin of 3.71% - HELD THAT - In the appeal order dated 18.04.2013 it was held that the working of the AO in the remand report of recalculation of the closing stock by including exports sales and local sales to work out the average price is not the correct method to calculate the closing stock. So the cost of the sales should have been reduced at ₹ 11,318/- per carat instead of ₹ 11211 per carat. The AO suggested to enhance the closing stock by ₹ 1,97/82,848/- in the remand report and this working was not accepted in the appeal order except in respect of the electricity expenses of ₹ 52,30,2447- which was to be included in the manufacturing cost. AO while giving effect to the appeal order should have calculated the closing stock by adopting the cost of sales at ₹ 11,318.91/- per carat after reducing the GP margin of 3.71%. Similar direction was also given while deciding the appeal order against the 154 application dated 17.01.2014. The AO is directed to give the appeal effect order as per the directions mentioned above. The ground of appeal is allowed.

Summary

Issues Involved:
1. Deletion of addition on account of low gross profit by rejecting the books of accounts under section 145(3) of the Income Tax Act.
2. Allowance of forward contract cancellation loss.
3. Direction to recalculate the value of closing stock after considering electricity expenses.
4. Conflicting directions regarding the calculation of closing stock value.

Detailed Analysis:

1. Deletion of Addition on Account of Low Gross Profit:
The Revenue challenged the deletion of an addition of ?5,58,41,797/- made due to low gross profit (GP) by rejecting the books of accounts under section 145(3) of the Income Tax Act. The assessee showed a GP of ?8,12,24,118/- at 3.7% on a turnover of ?2,18,98,74,418/-, compared to a GP of ?9,50,28,006/- at 6.14% on a turnover of ?1,54,61,22,671/- in the previous year, indicating a fall in GP by 2.44%. The Assessing Officer (AO) noted that the assessee did not furnish the required details or produce the books of accounts for verification. The AO rejected the books of accounts due to the lack of quality-wise and piece-wise details of polished diamonds and the variation in the signatures in the labor charges register. However, the Commissioner of Income-Tax (Appeals) [CIT(A)] found that the AO is not a handwriting expert and that the rejection of books based on signature variation is not justified. The CIT(A) also noted that the method of valuation of closing stock was consistently followed by the assessee and upheld by the ITAT in a similar case. The Tribunal agreed with the CIT(A), stating that no specific defects were pointed out by the AO, and thus, the deletion of the GP addition was justified.

2. Allowance of Forward Contract Cancellation Loss:
The AO disallowed a forward contract cancellation loss of ?7,55,57,457/- on the grounds that it was speculative in nature under section 43(5) of the Act. The CIT(A) observed that the assessee, being an exporter of diamonds, entered into forward contracts to hedge against foreign exchange fluctuations, which is a common practice to minimize risk. The CIT(A) relied on judicial precedents, including decisions from the ITAT Mumbai Bench and the Bombay High Court, to conclude that such transactions are hedging transactions and not speculative. The Tribunal upheld the CIT(A)'s decision, noting that the forward contracts were entered into to protect against currency fluctuation risks and thus, the loss was not speculative but a business loss.

3. Direction to Recalculate the Value of Closing Stock:
The CIT(A) directed the AO to recalculate the closing stock by including electricity expenses of ?52,30,244/- in the manufacturing cost. The Tribunal upheld this direction, stating that the method of valuation should include all relevant manufacturing costs. The CIT(A) had specified that the average cost per carat should be calculated after reducing the GP margin of 3.71% from the average export price.

4. Conflicting Directions Regarding Calculation of Closing Stock Value:
The Revenue contended that the CIT(A) issued conflicting directions regarding the calculation of the closing stock value. Initially, the CIT(A) directed the AO to adopt an average cost of ?11,318.91 per carat, but later mentioned reducing the GP margin of 3.71%. The Tribunal found that the CIT(A) had clarified the directions and that the AO should calculate the closing stock by adopting the cost of sales at ?11,318.91 per carat after reducing the GP margin of 3.71%. The Tribunal upheld the CIT(A)'s order, finding no infirmity in the directions provided.

Conclusion:
The Tribunal dismissed the Revenue's appeals and partly allowed the assessee's appeal, upholding the CIT(A)'s decisions on all issues. The Tribunal found that the rejection of books of accounts was not justified, the forward contract cancellation loss was a business loss, and the recalculation of closing stock should include electricity expenses as directed by the CIT(A). The Tribunal also upheld the CIT(A)'s clarification on the calculation method for closing stock value.