2019 (7) TMI 74 - AT - Income Tax

Revision u/s 263 - under valuation of closing stock - non consideration of foreign exchange fluctuation cost in the valuation of the cost of closing stock - HELD THAT - Accounting standard 11 clearly states that a foreign currency transaction should be recorded on initial recognition in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. Each Balance Sheet date, foreign currency monetary items should be reported using the closing rate and non-monetary items which are carried in terms of historical cost denominated in a foreign currency should be reported using the exchange rate at the date of transaction. The revaluation of creditors or debtors or the loss incurred on the actual of payment is not to be considered for the purpose of reporting the non-monetary items, like closing stock. Secondly, the foreign exchange loss incurred is not an item of cost, and rather it is a revenue outflow or an expenditure provided by prudence depending on the date of payment or the Balance Sheet Date and therefore, it cannot be added to the cost of the inventory even under the AS-2. Even for a moment it is accepted that the increase in foreign exchange rate would yield a higher value of the unsold stocks, still it would amount that it would go to add the realizable value and not the cost of the said stocks. Thus, considering the principle that as a matter of prudence stocks are valued at lower of the cost or the realizable value, such increase in realizable value has no bearing on the profits computed. Normally, the expenditure/ loss incurred due to foreign exchange fluctuation on account of actual payments would be a parameter kept in mind for deciding the sale piece of the stock that a prudent businessman would like to recover the said expenditure/ loss when the stocks are sold and would not increase the value of the closing stock and thereby increase the profits before actual realization of the same. Therefore, the foreign exchange fluctuation loss cannot be added to the cost of inventories. In view of the above, we are of the view that the Revision order carried out by PCIT is without any basis and on merits also the assessee has a case, hence, we set aside the revision order passed by PCIT and allow the appeal of the assessee.

Summary

Issues Involved:
1. Legality of the revision order passed by PCIT under section 263 of the Income Tax Act.
2. Erroneous and prejudicial nature of the assessment order to the interests of the revenue.
3. Under-valuation of closing stock due to non-inclusion of foreign exchange fluctuation cost.

Issue-wise Detailed Analysis:

1. Legality of the Revision Order Passed by PCIT:
The assessee challenged the legality of the revision order passed by the Principal Commissioner of Income Tax (PCIT) under section 263 of the Income Tax Act, 1961. The PCIT revised the assessment order on the grounds that the Assessing Officer (AO) did not consider the foreign exchange fluctuation cost while valuing the closing stock of rough and polished diamonds. The Tribunal examined whether the PCIT had the authority to revise the assessment order and concluded that the revision was conducted without a proper basis. The Tribunal found that the assessee consistently followed an accepted method of accounting for valuing the opening and closing stock, which did not include foreign exchange differences as part of the cost of goods.

2. Erroneous and Prejudicial Nature of the Assessment Order:
The PCIT deemed the assessment order erroneous and prejudicial to the interests of the revenue because the AO failed to include the foreign exchange fluctuation cost in the valuation of the closing stock. The PCIT referred to the decision of the Delhi Tribunal in West Falia Separator India Pvt. Ltd. vs. ACIT, which held that forex gain or loss on trading transactions is part of the price import or value of export transactions. The Tribunal, however, noted that the assessee's method of valuing stock at cost or realizable value, whichever is lower, was consistently followed and accepted. The Tribunal cited the Supreme Court's decision in Woodward Governor India P. Ltd., which stated that foreign exchange differences should be recognized as income or expense in the period they arise, and not necessarily included in the cost of stock.

3. Under-valuation of Closing Stock:
The PCIT's revision order was based on the observation that the assessee undervalued its closing stock by not including the foreign exchange fluctuation cost. The Tribunal analyzed the method employed by the assessee, which valued rough diamonds at cost and polished diamonds at estimated cost or realizable value, whichever was lower. The Tribunal found that the foreign exchange fluctuation loss is a revenue outflow and not an item of cost, and thus, should not be added to the cost of inventory. The Tribunal referred to Accounting Standard AS-11 and AS-2, which support the treatment of foreign exchange differences as income or expense rather than part of inventory cost. Consequently, the Tribunal concluded that the foreign exchange fluctuation loss should not be included in the valuation of closing stock.

Conclusion:
The Tribunal allowed the appeal of the assessee, setting aside the revision order passed by the PCIT. The Tribunal held that the assessee's method of accounting for foreign exchange differences was consistent and accepted, and that such differences should be treated as revenue items rather than part of the cost of closing stock. The Tribunal found no basis for the PCIT's revision order and ruled in favor of the assessee. The appeal was pronounced in the open court on 03.06.2019.