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TMI Blog2015 (2) TMI 401X X X X Extracts X X X X X X X X Extracts X X X X ..... 4,27,69,660 in view of the following additions/disallowances to the returned income ;- (i) Disallowance towards provision for FCNR loss ; Rs. 1,79,99,380. (ii) Disallowance u/s.l4A : Rs. 13,087. 2.2 In the course of assessment proceedings, the Assessing Officer observed that the assessee had shown an amount of Rs. 1,79,99,380 as provision for FCNR fluctuation loss in the Balance Sheet and treated this amount as a notional loss from speculation business in the original return of income filed. However, this amount was treated as a revenue loss and was claimed as a deduction in the revised return of income filed by the assessee. After examining the details of the transaction, the Assessing Officer held the loss to be notional in nature and disallowed the assessee's claim of this loss being revenue expenditure. 2.3 Aggrieved by the order of assessment for Assessment Year 2008-09 dt.28.12.2010, the assessee preferred an appeal before the CIT(Appeals) - III, Bangalore. The learned CIT (Appeals) called for a remand report from the Assessing Officer on the submissions of the assessee. After examining the views and contentions of both parties, the learned CIT (Appeals) vide order dt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eciate that the swap transaction was a hedging arrangement and not a speculative transaction. 7. For that the CIT (Appeals) failed to appreciate that the exchange loss resulting on account of translation of foreign currency obligation outstanding on the balance sheet date and which is accounted as per AS 11 is a deductible expenditure. 8. For that assuming without conceding that the transaction is a speculative transaction, the CIT (Appeals) failed to appreciate that one single transaction does not constitute a business. 9. For that the CIT (Appeals) ought to have appreciated that section 73 of I. T. Act, 1961 speaks about speculative business and not speculative transaction. 10. For that without prejudice to the above, if the loss is to be treated as a speculative loss then the same should be set off against the speculative income earned during the year. 11. For these grounds and such other grounds that may be urged before or during the hearing of the appeal it is most humbly prayed that the Hon 'ble Tribunal may be pleased to - a. Delete the disallowance of claim of Rs.l,79,99,380 as expenditure. b. Pass such other orders as the Hon 'ble Tribunal may deem fit." 4. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... company; (v) The settlement date of the option B rollover fell in the next financial year. As on the date of closing of the year under consideration, the option B rollover subsisted. 4.3.3 It was the assessee's contention that as per the requirement of the Accounting Standards ('AS') - 11 dealing with "Accounting with effect of changes in Foreign Exchange Rates", the assessee is required to provide for losses in respect of all outstanding option contracts at the Balance Sheet date by marking them to market. This marking to market losses has been provided as per the accounting requirements. The assessee contends that, in the above mentioned factual matrix, such a provision for losses is deductible under the provisions of the Act. 4.3.4 Opposing the view of Revenue, the assessee made submissions that :- (i) Section 43(5) of the Act does not cover foreign currency swap option transactions; (ii) Since the learned CIT (Appeals) has observed that entering into such transactions is not the business of the assessee, the provisions of section 43(5) and Explanation 2 to section 28 of the Act do not apply to the assessee; (iii) The foreign currency swap option transactions h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rs to losses computed as on a particular date with reference to prevailing exchange rate in respect of contracts that have not matured (viz. open contracts). As per the prescribed Accounting Standards, companies are required to account for MTM losses in their books of account despite the fact that the contract has not yet matured as on the Balance Sheet date. 4.3.6 In the light of these basic principles, we proceed to examine the facts of the case on hand. The assessee has submitted copies of quotations of the option contracts as additional evidences in terms of Rule 29 of the ITAT Rules. The documents submitted gives the indicative terms and conditions for the FCNR hedge taken by the assessee. The trade date is not specified, indicating that the date can be decided by the assessee at a later date. There is no certainty of the trade date, which can be chosen by the assessee at its option, From the details given for pay off, it is seen that the payoff is not firmed up or certain but would depend on the currency trading position. Therefore, neither the pay off date nor the pay off amount is firmed up or certain. It follows that the provision created as on the Balance Sheet date ther ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he provisions of s. 43(1), 43A (both, before and after amendment vide Finance Act, 2002)." 4.3.9 The Hon'ble Apex Court had analysed the issue and decided as under :- '13. As stated above, one of the main arguments advanced by the learned Additional Solicitor General on behalf of the Department before us was that the word "expenditure" in Section 37(1) connotes "what is paid out" and that which has gone irretrievably. In this connection, heavy reliance was placed on the judgment of this Court in the case of Indian Molasses Company (supra). Relying on the said judgment, it was sought to be argued that the increase in liability at any point of time prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-a-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ounting. The quantum of allowances permitted to be deducted under diverse heads under Sections 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining the word "paid" in Section 43(2), which is used in several Sections 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under Section 28/29. That is why in deciding the question as to whether the word "expenditure" in Section 37(1) includes the word "loss" one has to read Section 37(1) with Section 28, Section 29 and Section 145(1). One more principle needs to he kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under Section 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essee. Equally, there is no finding given by the AO stating that the assessee has not complied with the accounting standards. 15. For the reasons given hereinabove, we hold that, in the present case, the "loss " suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure under Section 37(1) of the 1961 Act. 16. In the light of what is stated hereinabove, it is clear that profits and gains of the previous year are required to be computed in accordance with the relevant accounting standard. It is important to bear in mind that the basis on which stock- in-trade is valued is part of the method of accounting. It is well established, that, on general principles of commercial accounting, in the P&L account, the values of the stock-in-trade at the beginning and at the end of the accounting year should be entered at cost or market value, whichever is lower - the market value being ascertained as on the last dale of the accounting year and not as on any intermediate date between the commencement and the closing of the year, failing which it would not be possible to ascertain the true and correct state of affairs. No gain or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... id" is defined under Section 43(2). This has been discussed earlier. Similarly, it is important to note that foreign currency notes, balance in bank accounts denominated in a foreign currency, and receivables/payables and loans denominated in a foreign currency as well as sundry creditor's are all monetary items which have to be valued at the closing rate under AS-11. Under para 5, a transaction in a foreign currency has to be recorded 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. This is known as recording of transaction on Initial Recognition. Para 7 of AS-11 deals with reporting of the effects of changes in exchange rates subsequent to initial recognition. Para 7(a) inter alia states that on each balance sheet date monetary items, enumerated above, denominated in a foreign currency should be reported using the closing rate. In case of revenue items falling under Section 37(1), para 9 of AS-11 which deals with recognition of exchange differences, needs to he considered. Under that para, exchange differences arising on foreign currency transactions h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a part of circulating capital embarked in the business. But, if on the other hand, the foreign currency is held as a capital asset or as fixed capital, such profit or loss would be of capital nature. "(emphasis supplied) 21. In conclusion, we may state that in order to find out if an expenditure is deductible the following have to be taken into account (i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the hooks both in respect of losses and gains is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t goods in order to make it a speculative/wagering transaction is dispensed with for the purpose of the Act and if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes im-materlal. Thus, the true test is delivery of commodities/goods as per the contract, including a forwarding contract. Profit loss in respect of unperformed contracts is considered speculation profit/loss. In short, in order that a transaction may fall within the scope of the expression 'speculative transaction', it must be a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. 5.2.2. Here, it would be useful to appreciate in proper perspective how hedge transactions are commercially understood before determining the true scope, width and nature of proviso (a) to section 43(5). Hedge contracts are those contracts which hedge against prejudicial price fluctuations. In speculative transactions the modus operandi of persons indulging in them is that when one enters ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ket for the ready commodity on the one hand and in the hedge market on the other hand, the hedger seeks to safeguard his position. The movement of prices in the two markets may not always follow an identical course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. This well-known technique, of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forward contracts by way of hedge transactions usually afford a cover to a trader inasmuch as his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... delivered by the Hon'ble High Courts of Andhra Pradesh, Calcutta, Delhi and Gujarat respectively. 5.4. From the principles laid down by these judgments one thing becomes clear that for hedging transaction commodity dealt should be the same. If the subject matter of the transactions is different it cannot be termed a hedging transaction. In the case of M. G. Brothers (supra) assessee-firm was carrying on business of the manufacturing and sale of groundnut oil and its by-products. For the AY.1973-74, the assessee filed its return declaring an income of Rs. 2,90,807/- and claimed a loss of Rs. 1,60,946/- in respect of certain transactions which it had entered into in cotton seed oil and neem oil. The assessee claimed that said transactions were hedging transactions. Matter finally travelled up to the Hon'ble High Court of AP. Deciding the issue against the assessee Hon'ble Court held as under; "....the forward contracts entered into by the assessee in cotton seed oil and neem oil were not covered by cl (a) of the proviso to s. 43(5) and were not hedging transactions. The forward transactions were speculative in character and the loss arising there from could not be set ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... price fluctuation in respect of the contract for actual delivery of the goods manufactured." In order that forward transactions in commodities may fall within proviso (a) to section 43(5) of the Act, it is necessary that the raw materials or merchandise in respect of which the forward transactions have been made by the assessee must have a direct connection with the goods manufactured or the merchandise sold by him. In other words raw material in respect of which the assessee has entered into forward transactions must be the same raw material which is used by him in his manufacturing business. We find that in the case under consideration assessee was not dealing in Foreign Exchange, therefore transactions entered into by it in foreign Exchange cannot be held to be hedging transactions.' 4.3.11A The facts of the above cited case of S. Vinodkumar Diamonds (P.) Ltd. (supra) are very similar to the facts of the case on hand. The assessee in the case on hand, has entered into a derivative contract of option, whereas the business of the assessee is trading in steel tubes, pipes, PVC, etc. It is not in dispute that the option transactions were not in respect of specified imports or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 43(5), the same would fall outside the purview of section 43(5). We see no merit in the above connections. The expression "commodity" would cover all articles of trade including stocks and shares. Even under section 43(5), the expression "commodity" is not expanded to include "stocks and shares". In fact, the use of "comma" in between, the word "commodity" and the words "including stocks and shares" in section 43(5) make it clear that transactions for purchase of any commodity would include transaction for purchase or sale of stocks and shares. In other words, section 43(5) does not seek to expand the scope of the expression "commodity" but merely emphasizes that the transaction in commodity includes transactions in stocks and shares. Therefore, transactions in futures contracts like transactions in stocks and shares when settled otherwise than by actual delivery would be speculative transactions under section 43(5) of the Act.' The finding rendered in the afore cited decision in the case of Bharat R Ruia (HUF) (supra) for future contracts would, in our considered view, apply equally to the option contract entered into by the assessee, as both these are derivative transa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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