2019 (2) TMI 792 - AT - Income Tax

Disallowance of crystallized losses of foreign exchange contracts - loss was amortized in books but claimed as a deduction while filing Return of Income - Held that - It is a decision of business man to minimize the losses on account of fluctuation in the foreign exchange rate and therefore it is very much connected with the assessee s business. Since in assessment year 2010-11, the assesseecancelled some export orders and as a result, the forward contracts linked with the export ordersshould also be cancelled and therefore it is natural that the bank has charged the cancellation charges of the forward contract, which is nothing but a business loss. Therefore, since the forward contracts have been taken in connection with the business and for the purpose of business hence the loss arising on account of cancellation of forward contract would also be a business loss and therefore the assessee is entitled to claim the said loss in his books of accounts. In view of the facts and precedents narrated above, it is abundantly clear that the Assessee Company has correctly accounted for the loss on account of Cancelled Forward Contract for hedging of Foreign Currency Risk and is an allowable Business Loss under section 28 of the Act. The loss on account of forward contract and loss on cancellation of forward contract, is a business loss and assessee is entitled to set offthe said loss against the business income, hence we delete the disallowance - Decided against revenue Disallowance being prior period expenses the liability for which crystallized during the relevant previous year - Held that - We note that the transportation charges of ₹ 1,00,000/- paid to M/s Santosh Transport Services pertaining to assessment year 2007-08 and it was stated that there was a dispute regarding the bill amount therefore, it could not be paid in the year in which it was incurred. The dispute got resolved during the assessment year under consideration hence, it was finally paid. We not that assessee is following mercantile system of accounting and the assessee s expenditure has got crystallized during the assessment year under consideration, therefore the assessee is entitled to claim the expenses. We note that the assessee had incurred the said expenditure for the purpose of business and liability has crystallized during the assessment year under consideration. Hence the addition needs to be deleted - Decided against revenue Disallowance being replacement cost of seven ring frames - treated by the assessee as revenue expenditure u/s 37(1) however, AO treated the same as capital expenditure - Held that - This issue is squarely covered against the assessee by the Judgment for assessment year 2005-06 as held Expenditure for replacement of a new ring frames is an addition to existing plant and machinery of the assessee giving enduring benefit and as such is capital in nature. - Decided against assessee

Issues Involved:
1. Disallowance of crystallized losses of foreign exchange contracts.
2. Foreign Exchange loss on account of canceled Forex Purchase contracts.
3. Disallowance of prior period expenses.
4. Disallowance of replacement costs of ring frames treated as revenue expenditure.

Detailed Analysis:

1. Disallowance of Crystallized Losses of Foreign Exchange Contracts:
The assessee, a company engaged in manufacturing and trading of yarn and fabrics, entered into various derivative contracts to hedge foreign exchange fluctuation risks. The Assessing Officer (AO) disallowed the crystallized losses of ?78,51,250/- for AY 2009-10 and ?1,54,44,375/- for AY 2010-11 on the grounds that these were speculative transactions not traded on a recognized stock exchange. The CIT(A) upheld the AO's decision, noting that the forward contracts were speculative and not linked to specific export receivables.

On appeal, the Tribunal considered the nature of derivative transactions and found that the assessee's forward contracts were for hedging business risks, thus qualifying as business losses under Section 28 of the Act. The Tribunal relied on various judgments, including the Hon’ble Madras High Court in Rajshree Sugars & Chemicals Ltd. vs. Axis Bank Ltd., and the ITAT Mumbai in Jaimin Jewellery Exports (P) Ltd Vs ACIT, concluding that such losses are not speculative but business losses. Consequently, the Tribunal deleted the disallowance of the crystallized losses.

2. Foreign Exchange Loss on Account of Canceled Forex Purchase Contracts:
The assessee claimed a loss of ?4,74,84,669/- due to the cancellation of foreign exchange forward contracts. The Tribunal noted that the assessee's substantial export turnover necessitated hedging against foreign exchange risks. The Tribunal found that the losses were business losses, citing the ITAT Mumbai in Reliance Industries Ltd. vs. CIT and DCIT v. Intergold (I) Ltd., which held that such losses are deductible as business losses. The Tribunal thus allowed the claim for the foreign exchange loss.

3. Disallowance of Prior Period Expenses:
The assessee claimed ?1,00,000/- as transportation charges for AY 2009-10, which the AO disallowed as a prior period item. The Tribunal noted that the expense crystallized during the relevant year due to a dispute over the bill amount, which was resolved in the assessment year under consideration. Since the liability crystallized in the relevant year and the expense was incurred for business purposes, the Tribunal deleted the disallowance.

4. Disallowance of Replacement Costs of Ring Frames Treated as Revenue Expenditure:
The assessee treated the replacement cost of seven ring frames amounting to ?3,13,43,120/- as revenue expenditure under Section 37(1) of the Act. The AO treated it as capital expenditure. The Tribunal referred to its earlier decision in the assessee's own case for AY 2005-06, where it was held that such expenditure provided an enduring benefit and was capital in nature. The Tribunal upheld the disallowance, confirming that the replacement of ring frames constituted a capital expenditure.

Conclusion:
The appeal for AY 2010-11 was allowed, and the appeal for AY 2009-10 was partly allowed. The Tribunal deleted the disallowances related to crystallized losses and foreign exchange loss on canceled contracts but upheld the disallowance of replacement costs of ring frames and prior period expenses.

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