2015 (5) TMI 40 - AT - Income Tax

Disallowance of foreign exchange loss on account of marking to mark to market of forward contracts - Disallowance of foreign exchange loss on account of forex derivative contracts - Business loss or Speculation loss - Disallowance of Professional fees - Disallowance of sharing of common marketing expenses u/s 40A(2)(b) - Held that - Disallowance of loss on mark to market Forward Contracts - We find that the issue relating to mark to market loss in forward contracts in foreign exchange has come up for consideration before the coordinate bench of this Tribunal and has been decided vide order dated 12.2.2014 in the case of M/s S. Rajiv & CO. 2015 (5) TMI 38 - ITAT MUMBAI . It may be further observed that the Hon'ble Supreme Court in the case of Woodward Governor India (P.) Ltd. 2009 (4) TMI 4 - SUPREME COURT , while dealing with the question as to whether the additional liability arising on account of fluctuation in the rate of exchange can be allowed to be adjusted pending actual payment of the varied, has observed that expenditure as used in section 37 in Income Tax Act may in the circumstances of a particular case cover an amount which is a loss even though said amount has not been given from the pocket of the assessee. While dealing with the issue of the nature of forward contracts in commodity derivatives, the co-ordinate bench of the Tribunal in the case of Kotak Mahindra Investment Ltd. 2013 (7) TMI 355 - ITAT MUMBAI relating to A.Y. 2008-09, has observed that such type of forward contracts are not purely contingent in nature rather loss or profit is somewhat ascertainable in such type of contracts because of constant watch on daily market rates. The quantum of profit or loss though not actually ascertainable can be anticipated in view of the trends of the market. The difference between the predetermined price and market price is settled daily on mark-to-market basis. In such type of contracts, it is not the stock value which is subject matter of the contract rather the contract itself is the stock in trade. Contracts in such type of cases can be squared off before the arrival of actual performance of date of contract, as the profit and loss are calculated on daily basis and the margins are settled accordingly. We may further observe from the guidelines issued by the Reserve Bank of India relating to general principles to be observed for forward foreign exchange contracts that the banks have been permitted to enter into such contracts after thorough verification of documentary evidences etc. about the genuineness of the underlying foreign currency exposure and the need of hedging of the loss. Further the maturity of the hedge should not exceed the maturity of the underlying transaction. In view of the above discussions, it can be safely held that in case of import/export business, where the transactions are demonetarized in the foreign currencies and for the purpose of hedging of the anticipated loss resulting from such import-export business and not otherwise, if the assessee enters into a forward contract in foreign exchange, then such forward contracts are to be treated as integral part or incidental to the business of export/import and cannot be said to be the speculative contracts attracting the provisions of section 43(5) of the Act. The loss from such hedging transactions would be treated as business loss eligible to be set off against the profits and gains of business and profession. It is held accordingly that the foreign exchange loss incurred by the assessee on account of entering into forward contracts with the banks for the purpose of hedging the loss in connection with his import/export business cannot be held to be a speculative loss rather a business loss which can be set off against profit and gains of business subject to the condition that the assessee will have to satisfactorily prove that the maturity of the hedge did not exceed the maturity of the underlying transaction. The findings of the CIT(A) given vide impugned order are therefore set aside and the issue is restored back to the file of the AO to decide the same accordingly after giving proper opportunity to the assessee to represent its case. Disallowance of Professional fees - The AO in the case in hand has disallowed the expenditure incurred/paid to AASL being excessive or not relating to the business activity of the assessee, the department on the other hand had made the additions in the hand of AASL on the ground that the income/ consideration for services provided by AASL to the assessee in this case was less and therefore adhoc addition had been made in the case of AASL. Thus the department has taken a contradictory stand. Under such circumstances it is difficult to believe that the payment made by the assessee to AASL for the services obtained was excessive or that it was not relating to the business of the assessee. This ground is accordingly allowed in favour of the assessee. Disallowance of sharing of common marketing expenses - As per the agreement, the assessee has been made liable to pay 60% of the expenses incurred by the VGIL in market/promotion of the products. It is not a case of reimbursement of actual expenses incurred by the VGIL on behalf of the assessee. Whereas it is a case of composite agreement as per which the assessee has been made liable to pay 60% of the total and expenses incurred by the VGIL for marketing of its own products and that of assessee, which means that the assessee has been paying service charges to the VGIL who has been providing marketing services to the assessee. Further, it has been specifically provided in clause 8 of the agreement that the VGIL shall at all times be an independent contractor and nothing contained in the agreement shall in any way imply employer-employee relationship, principal agent relationship or a commercial-agent relationship. These clauses in the agreement prove beyond doubt that the VGIL has been providing the services to the assessee as an independent contractor. Hence, the assessee was liable to deduct tax at source as per the provisions of chapter XVII-B of the Act and therefore disallowance was attracted in this case under section 40(a)(ia) of the Act. Adhoc disallowance - So far the issue relating to the adhoc disallowance @20% of the expenses is concerned, we do not find any justification for the same on the part of the lower authorities. We hold that if the claim of the assessee, otherwise will be found to be eligible for deduction in view of our findings given above relating to the alternate contention of the assessee, then no disallowance will be called for on adhoc basis. - Decided partly in favour of assessee.

Summary

Issues Involved:
1. Disallowance of foreign exchange loss on mark-to-market forward contracts.
2. Disallowance of foreign exchange loss on cancellation of forward contracts.
3. Disallowance of professional fees paid to a sister concern.
4. Disallowance of share of common marketing expenses under Section 40(a)(ia).

Issue-wise Detailed Analysis:

1. Disallowance of foreign exchange loss on mark-to-market forward contracts:
The assessee, engaged in manufacturing automobile parts, entered into forward contracts to hedge against currency fluctuation risks. The assessee incurred a loss of INR 18,22,633 on mark-to-market forward contracts. The Assessing Officer (AO) disallowed this loss, deeming it notional and non-deductible as business loss. The CIT(A) upheld this disallowance. The assessee argued that the loss was ascertained and consistently accounted for in previous and future years, and thus should be deductible under Section 37. The Tribunal, referencing the case of "ACIT Vs. M/s S. Rajiv & CO." and the Supreme Court decision in "CIT v. Woodward Governor India (P.) Ltd.", held that such losses are allowable as business losses if they are integral to the business and not speculative. The case was remanded to the AO for verification.

2. Disallowance of foreign exchange loss on cancellation of forward contracts:
The assessee did not press this ground, and it was dismissed accordingly.

3. Disallowance of professional fees paid to a sister concern:
The assessee paid INR 1,23,90,218 as professional fees to Anand Automotive Systems Limited (AASL) for various services. The AO disallowed 20% of this expenditure, citing a lack of quantification of services. The CIT(A) upheld this disallowance. The assessee contended that the fees were for legitimate services consistently paid over years without prior disallowance. The Tribunal found the department's contradictory stance (disallowing expenses in the assessee's case while adding income in AASL's case) unjustified and allowed the expenditure as deductible.

4. Disallowance of share of common marketing expenses under Section 40(a)(ia):
The assessee paid INR 1,44,78,000 to Victor Gaskets India Limited (VGIL) for shared marketing expenses without deducting TDS. The AO disallowed this amount under Section 40(a)(ia) and alternatively disallowed 20% as excessive. The CIT(A) upheld the disallowance. The assessee argued that the payments were reimbursements, not income, and thus not subject to TDS. Alternatively, it was contended that VGIL had declared this income and paid taxes, invoking the second proviso to Section 40(a)(ia). The Tribunal, referencing the Bangalore bench decision in "Shri S.M. Anand Vs. ACIT", held that the proviso is retrospective and remanded the issue to the AO for verification of VGIL's tax payments. The Tribunal also found no justification for the 20% ad-hoc disallowance if the claim was otherwise eligible.

Conclusion:
The appeal was partly allowed, with specific issues remanded for further verification and adjudication based on the Tribunal's guidelines. The Tribunal emphasized the importance of consistent accounting practices and the need for a fair assessment of legitimate business expenses.