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TMI Blog2015 (12) TMI 1275X X X X Extracts X X X X X X X X Extracts X X X X ..... in making an addition of Rs. 57,46,70,024/- to the returned income of the Appellant by re-computing the arm's length price of the international transactions under section 92 of the Act. Thus, in passing the order, the Ld. AO/Ld. TPO/Ld. DRP erred in: 3.1 Rejecting the comparable companies set adopted by the Appellant in its transfer pricing documentation on the basis of additional/modified quantitative filters which lacked valid and sufficient reasoning. 3.2 Ignoring the comparable set proposed by Appellant as a result of fresh benchmarking study without assigning any reasoning. 3.3 Accepting companies which were functionally not comparable to the Appellant in terms of Functions, Assets and Risk profile. 3.4 Including companies with high/supernormal margins in the comparable set adopted. 3.5. Including government held enterprises in the final comparable set adopted. 3.6 Not providing the benefit of economic adjustment on account of difference in working capital profile and thus not following the binding directions of Hon'ble DRP. 3.7 Denied the benefit of economic adjustments on account of difference in risk profile in arriving at the arm's length m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o. 3 to 3.5 of the assessee 3. Apropos these grounds, we have heard arguments of both the sides and carefully perused the relevant material placed on record. 4. Ld. Counsel of the assessee submitted that the ld. DRP and the AO erred in making an addition of Rs. 57,46,70,024 to the returned income of the assessee by recomputing ALP of the international transaction u/s 92 of the Act. Ld. Counsel further contended that the TPO was not justified in rejecting the comparable companies set adopted by the Appellant in its transfer pricing documentation on the basis of additional/modified quantitative filters which lacked valid and sufficient reasoning. Ld. Counsel further contended that the TPO was not correct in ignoring the comparable set proposed by Appellant as a result of fresh benchmarking study without assigning any reasoning and accepting companies which were functionally not comparable to the Appellant in terms of Functions, Assets and Risk profile. Ld. counsel vehemently contended that TPO/DRP and the AO were incorrect on facts and in law in including companies with high/supernormal margins in the comparable set adopted for benchmarking impugned transaction of the assessee and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ondments of employees by the holding company. Ld. Counsel contended that in the case of NTPCES, ld. DRP failed to note that this company does not even discuss RPT in its relevant annual report and it is pertinent to note that Schedule 9 of annual report clearly states that the amount payable to NTPC under the head current liability as on 31.3.2009 was Rs. 12.87 crores which alone is 18% of its operating revenue. 7. Ld. Counsel further pointed out that while evaluating comparables of these two impugned companies, the DRP has ignored the material difference in functional, geographical location of party and related party transaction (RPT) and the sole criteria adopted by the ld. DRP for treating NTPCES and CEIL as suitable comparables is only with Bechtel India Private Ltd. These two companies employ high-end technological and engineering resources and personnel. Ld. Counsel vehemently contended that the DRP erred in analyzing the function of these entities in terms of resources employed and failed to consider the wide variation in skills and qualification of employees. In the light of broad functional profile of these companies which cannot be held as comparable for benchmarking int ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inspection services. JV for retail distribution of power & Project Management Consultancy to Discoms and Power generating companies. Its functional profile is similar to Bechtel USA, holding company (Pg.1/DRP order). The contracts/projects 'entrusted' (Pg. 811/Vol.-IV). (Ref. Pg. 810-812, 835-838, 843/Vol.-IV.) Third Party Inspection (TPI), & Certification of equipment supplied by vendors and fabrication or installation work of Contractors of ONGC under a MOU between EIL & ONGC dt. 11/4/1985 on nomination basis. (Ref. Pg. 765-773, 803-805/Vol.-IV). Terms of MOU are not known. Also carries on similar TPI & Certification work independently for other PSUs. 4. Geographical Market International- 100% exporter of service. Domestic customers-Nil export Domestic customers-Insignificant export of service. 5. Forex Fluctuation Risk Yes Nil Insignificant Forex earning 3.75% of operating revenue. (Schd. 3(3) at pg. 803/Vol.-IV 6. RPT (DRP has failed to consider objection) 100% (1) RPT not reported in A.R Transactions mainly with related parties (other Government Company/Govt. Departments) Schd. 9 of A.R current Liability (i)"Amount payable to NTPC Ltd. Rs. 12.87 crore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fall within 5% + - limit and there would be no requirement of making any transfer pricing adjustment to the returned income of the assessee. 9. Replying to the above, ld. DR contended that for AY 2009-10, the TPO/AO rightly held that impugned two companies are suitable comparable for benchmarking international transaction of the assessee company as functional profile of these companies are similar to the assessee company and mere pointing out some micro differences do not lose the title of comparability with the assessee company. Ld. AR also contended that the assessee company rendering engineering design, project support including design as per specification of foreign AE and impugned two companies NTPCES and CEIL are also rendering services in the similar field, therefore their suitability and comparability cannot be challenged on the frivolous and petty grounds. Adjudication of comparability of NTPCES with the assessee company 10. On careful consideration of above submissions of both the sides, we find it appropriate to consider the issue of comparability of NTPCES and CEIL one by one with the assessee company Bechtel India Pvt. Ltd. Ld. Counsel reiterating its written subm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xport services and the same cannot be held as comparable with the assessee company having 100% export of services outside India to its AE only. 13. Ld. Counsel also pointed out that the assessee company is having 100% RPT with its AE whereas RPT of NTPCES has not been reported in the annual report and this company has undertaken transaction mainly with the related parties such as government companies and government departments. Ld. Counsel also pointed out that as per annual report of the NTPCES during the financial period under consideration the amount of Rs. 12.87 crore was payable to the NTPC Ltd. and as per notes on account, all the employees of NTPCES are on settlement from the holding company and the NTPCES was utilising common services for its office at Noida provided without any charges by the holding company. Ld. Counsel vehemently contended that all the employees of NTPCES are on secondment from the holding company at cost and benefits received from holding NTPCES are not monetised in the annual report. Placing reliance on the judgment of ITAT in the case of Thyseen Krupps India (Pvt.) Ltd. vs ACIT (2013) 33 Taxman.com 107 (Mumbai Tribunal). Ld. Counsel submitted that wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... BIPL in April 1994 to render engineering support service in respect of engineering designs and drawings, BIPL executes engineering designs and drawings for various overseas group entities to support the overseas offices' turnkey project execution. Presently, BIPL undertakes engineering design and related services for its overseas group companies. ' * The development of the Arm's length Price ('ALP') by the taxpayer recognizes that BIPL performs contract engineering design services for its group companies. BIPL leverages on all the valuable intellectual Property ('IP') Right ('IPRs') [know-how, copyrights, etc] and other commercial processes, methodologies, etc. belonging to its AEs. Further, the Group is involved in complex operations of marketing, bidding for projects, providing turnkey solutions, project management and adhering to delivery timelines. BIPL provides engineering design services exclusively to its overseas AEs. Based on above, BIPL has less complex operations, bears lesser share of risks and was accordingly selected as the tested party for the analysis ." In view of rival submissions of both the sides, at the very outset, we note t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lectrification of 4107 villages, execution of turnkey projects and also provided third party inspection services. While the NTPCES is also rendering services for retail distribution of power and management consultancy to DISCOMs and other power generating companies, then its functionality with the asessee company cannot be held as comparable. We are also not in agreement with the conclusion of the DRP/TPO that the functional profile of NTPCES is similar to Bechtell Corporation USA i.e. holding company because we have to compare comparability of assesee company and not its holding company. Turning to the issue of geographical markets of both the companies, undisputedly assessee company having international transactions only with AE exporting 100% services to Bechtell Corporation USA whereas the NTPCES has nil exports having 100% domestic customers who are government companies and departments. We cannot also ignore this fact that the assessee Bechtell has 100% related party transaction with its AE and RPT have not been reported in the annual report of the NTPCES. It cannot be ignored that the contracts purchased for rural electrification schemes essential to NTPCES under Rajiv Gand ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fully completing the project of IOCL and other public sector undertaking and the related party transaction were much more than the filter of 25%, therefore, the order for exclusion of Engineers India Ltd. was passed by the Tribunal. In the present case, the NTPCES was sheltered by its holding company NTPCES and government companies and departments awarded/entrusted various projects/contracts for rural electrification, distribution of power and project management consultancy, therefore, NTPCES loses the tag of comparability with the assessee Bechtell India. We also find it appropriate to mention that it cannot be ignored that the NTPCES is also enjoying settlement of all employees from the holding company NTPCS at cost and the benefits received from the holding company and related party transactions (RPT) are not monetised in the annual report and in absence of specific data in this regard, NTPCES cannot be held as comparable with the assessee company. Therefore, AO/TPO was not justified in including NTPCES in the final set of comparables for benchmarking impugned international transaction of the assessee company and they are directed to delete the same. We order accordingly. Adjud ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... receives its remuneration/revenues from its AE in foreign exchange having forex fluctuation risk whereas the CIEL having insignificant forex earning of 3.75% of operating revenue as per Schedule III at page 803 of Volume IV of paper book of the assessee. Ld. Counsel vehemently contended that the related party transaction (RTP) are 100% in the case of asessee Bechtell India whereas the RTP of CIEL are only monetary transaction with the holding company having 19.60% transaction with ONGC, IOCL etc. which are not quantified. Ld. Counsel also pointed out that the jobs awarded by ONGC on nomination basis are being governed by the MOU or by holding company dated 11.4.1985. 20. Ld. Counsel also pointed out that contracts being awarded to CIEL for rural electrification schemes sanctioned to NTPCES are not awarded under open tender as per CVC Circular dated 3.3.2007 and hence, this company having privilege of awarding contracts and job on nomination basis without any open tender cannot be held as functionally comparable with the assessee company. 21. Replying to the above, ld. CIT DR submitted that apart from engineering design, project support and procurement services also has objects l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied by the AO for the purpose of selecting comparables viz. (i) companies having revenue of less than Rs. 5 crore from rendering support services and; (ii) revenue from engineering support services is less than 75% of total operating revenue. Ld. Counsel also canvassed another submission that the ld. TPO/DRP have applied aforesaid two filters for selecting comparables because they accept that the primary business of the assessee company is of procuring design and drawings for AE enabling them to execute engineering products for clients outside India. Ld. Counsel contended that the ld. TPO/DRP have wrongly rejected the assessee's objection regarding inclusion of CIEL on altogether different basis i.e. the issue regarding functional non-comparables; is also not acceptable that in the cases of TNMM analysis one examines the comparables at a very broad level unlike CUP analysis where exact similarity is required. Ld. Counsel has also drawn our attention towards relevant part of the DRP order available at page 48 of the assesse's paper book wherein sole criterion adopted by the DRP for treating NTPCES and CIEL s comparable to the assessee is that like Bechtel India, these two companies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of ITAT in the case of Motorola Solutions India (P) Ltd. in ITA No.5637/D/11 submitted that the RPT filter must not exceed 15%. Ld. Counsel vehemently contended that prerequisite of arriving at ALP with the transaction of tested party should be benchmarked with the uncontrolled transaction under Rule 10B(1)(e)(ii) of the Rules. Finally, ld. counsel submitted that the filter should be restricted to 15% of the total revenue. On careful consideration of above submissions, we are of the view that the ITAT Delhi in the case of Nokia India (P) Ltd. (supra) held that in principle if any company though functionally comparable but is more than specific percentage of RTP, then the same should be ignored by treating as a controlled transaction. The Tribunal in this order further held that the percentage of RPT to make the company as ineligible for comparison should be taken as more than 25% and it was held that a company can be considered as incomparable if its RPT exceeds 25%. The relevant operative part of this order in para 15 and 16 read as under:- "15. The assessee has relied on the decision of BMW India Pvt. Ltd. vs. Addl. CIT (ITA No. 5354/D/2012) dated 16th August, 2013. The assess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion has been provided hereunder: (Para 6.20, page 50 of BMW India order): Quote On examination of contemporary Guidelines/jurisprudence on the subject, we are of the view that a distributor is rewarded by the entity for whom the distributor works and the rewards are guaranteed upto an extent and the risk component vis-a-vis a manufacturer is necessarily very less. The rewards can be and generally are based on pricing adjustments and can also be compensated over and above that if greater services are rendered and pricing adjustments have not covered the cost of routine services rendered. Generally speaking the remuneration model for a distributor is reward-based and rewards are based on the quantity of sales. Unquote The second point pronounced by the Hon'ble Tribunal was that during the year under consideration in the order, BMW India's operating profit margin was higher than that of the comparables. The comparable companies set and their margins were not disputed by the Ld. TPO and the Hon'ble DRP. Hence, the Hon'ble Tribunal held that the compensation for AMP services was embedded in the pricing arrangement of the contract goods itself and that no further co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he BMW India order held as under (Para 6.28, page 58 of BMW India order): Quote We hold that in the facts of the present case there was no occasion for the AE to further compensate the assessee for the services rendered towards building the brand of the AE as the same already stood factored in the pricing adjustment of the contract goods. As such the occasion to consider the applicability of mark-up does not arise. Unquote The Hon'ble Tribunal, in para no. 6.27 of the BMW India order has also mentioned that the Special Bench has accepted that there are diverse nature of facts, business models and peculiar terms and conditions of different assesses and there cannot be any straight jacket formula. Applicability to MSIPL As provided in the detailed hearings and submissions provided, MSIPL for the relevant year under consideration also acted as a distributor of mobile handsets, walkie-talkies and telecom equipment. During the year under consideration, under the TNMM analysis the operating profit margin on sales (OP/Sales) of MSIPL was higher than that of the comparable companies. This has been mentioned in para 1 of page 1 of the written submission filed with Your Honours on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itten submission filed with Your Honours on May 20, 2013." 15.1 Thus, the main contention of assessee is that remuneration model in case of Distributor towards AMP Expenses is different from the compensation model in case of License Manufacturer. Therefore, before considering the application of BMW's case to assessee's case, it is necessary that the business profile of assessee's case viz-a-viz BMW's case with reference to LG's Spl. Bench case is to be considered. Admittedly, the decision in the LG's case has been rendered in regard to AMP Expenses and for quantification of AMP Expenses also detailed guidelines have been laid down in the case of LG. 15.2 In case of LG Electronics brief facts were as under: "The factual matrix of the case is that L.G. Electronics Inc. (hereinafter called as - LGK), is a Korean based company, engaged in the business of manufacture, sale and distribution of electronic products and electrical appliances such as television, audio/video equipments, washing machines, refrigerators and air- conditioners etc. Pursuant to the approval of the Govt. of India, conveyed vide letter dated 29-1-1997, LGK was permitted to establish a whol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the assessee described its activities as that of a distributor. The TPO referred to the Importation Agreement between the parent company BMW AG and the assessee and observed that the same had been entered into w.e.f. 01.01.2006 and it stated that the assessee had the following duties in regard to marketing and promotion of the products of the parent company: "2.2. Responsibility in the Contract Territory BMW India represents the interest of BMW AG in the Contract Territory. It is responsible for the sale promotion and the full utilization of the market potential for the Contract Goods in the Contract Territory. It is further responsible for ensuring the provision of the best possible customer service and adequate stocks of original BMW parts in the Contract Territory. Furthermore, BMW India undertakes the following functions in the Contract Territory in accordance with the laws of the contracting territory: * Establishment and supervision of an efficient BMW distribution network; * Performance of an adequate advertisement and sales promotion as well as public and media relations. * Collection, evaluation and communication of market information to BMW AG. 3. Scope ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng sectors, encompassing; ~ Review of Detailed Engineering ~ Independent Analysis and Review of Designs/Drawings ~Conformance of Materials & Equipments to National/International Codes - ~ Review and Approval of Inspection Test Plans ~Review of Installation, Pre-commissioning and Commissioning Procedures ~ Third Party Inspection Services / Pre-shipment Inspection ~ Supervision of Site Construction for cross country water / gas pipelines ~ PMC Services for Infra structure projects of Municipalities ~ HAZOP Studies / Quantitative Risk Analysis ~ Mitigation Measures Report with recommendations to reduce the risk factor is issued after studying the above. 5.7 Energy Efficiency Audit In addition to Certification Services, CEIL also carries out Energy Audit, Base Line Verification of energy intensive facilities e.g. pumping stations, municipal lighting, and commercial buildings as per client's requirements. CEIL is also prepared to provide Energy Service Contracting services (ESCO) for rehabilitation / replacement of energy inefficient equipments / appliances and to be paid back from affected savings in energy consumption. 6. Areas of Certific ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... business of rendering engineering support services including related design and drawing as per specifications of foreign AE and by using intangibles/IPR of parent company. 31. Ld. DR could not demolish this factum that the certification/TPI involves testing/assessing and auditing of the work done by the high-end technocrats which conforms to specifications prescribed in the contract; meets quality standard of work and material; meets safety standards; meets environmental standards and satisfactory works, plant commissioning and installation of various works and projects for the employer like ONGC. The CIEL certifies the work of the contractor that the employer accepts the work undertaken as per specifications of the contract and then makes the payment. Per contra, the business functional profile of assessee company is to perform the work of preparing and supplying design and drawings given by its parent Bechtel Corporation USA. In this modus operandi this work is outsourced by the nonresident AE to the assessee Bechtel India which carry out the work as per specifications given by the outsourcing company AE. We may also point out that the revenue of CIEL form export of surplus is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O erred in holding that Mark to Market losses in respect of re-measuring the foreign exchange forward contract as on balance sheet date is not allowable as the forward contracts have not been taken for the purpose of business on raising of export invoice but taken without due exposure. Ld. counsel has further drawn our attention towards order of ITAT in assessee's own case for AY 2008-09 reported as Bechtel India Pvt. India Ltd vs ACIT(2013) 33 Taxman.com 213 (Delhi Tribunal) and submitted that the mark to market losses in respect of foreign exchange forward contracts as on the balance sheet date was allowed to the assessee. Ld. counsel of the assessee also took us through the written submissions dated 13.6.15 filed on 17.6.15 which read as under:- "Schedule XIII - A. Significant Accounting Policies:- " iv) Foreign exchange transactions Foreign exchange transactions are recorded at the exchange rate prevailing at the date of transaction. Realized gains and losses on foreign exchange transactions during the year are recognized in the Profit and Loss Account. Foreign currency monetary assets and liabilities are translated to India Rupees at year end rates and any result ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hi High Court in Virtual Soft Systems Ltd. (341 ITR 593) brought to its notice. It has been held therein that:- "10 .... the fact that the opinion of the Institute of Chartered Accountants of India was expressed in a Guidance Note which had not attained a mandatory status, would not provide a basis to the Assessing Officer to disregard the books of account of the assessee and in effect method of accounting for leases, followed by the assessee. " iii) The action of the Ld. DRP is illegal in not following the order of the Hon'ble Tribunal for A.Y. 2008-09 without distinguishing it on facts. As held by the Hon'b1e Supreme Court in C1T Vs. Ralson Industries Ltd. (288 ITR 322), "where an order is passed by a higher authority, the lower authority is bound thereby keeping in view the principles of natural justice". It is significant to note the DRP's order dt. 26.11.2013 is appealable u/s 253(1)(d) of the Act and was not binding on the Department. iv) Holds Supreme Court decision in Woodward Governor is not applicable. Pg. 382/P.B.Vol.-II v) Follows CBDT Instruction no. 3/2010. vi) DRP selectively quotes guidelines issued by RBI. It ignores the Foreign Exchange ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olds the FCs' to be speculative transactions as It found that the aggregate amount of 'invoices raised' did not cover the exposure as per the FCs booked by the assessee with Bank of America on 6th August 2008. According to DRP, the assessee should have booked the FCs only after it had raised an invoice and only to the extent of amount as per each and everyone of the hundreds of invoices raised by the assessee under continuous service contracts with the AEs, which normally run for several months overlapping more than one financial year. The sample FCs and corresponding invoices, which run into hundreds, are at Pgs. 737-743 of Vol.-IV. The Ld. DRP has failed to appreciate that it would be not only unpractical, but will also be extremely costly proposition to take out forward contract for everyone of the hundreds of invoices issued to the AE under each of the service contracts (Ref. TP Study at Pg. 582/Vol.-III). It is for this reason that the RBI regulations clearly provide that where the amount is not ascertainable the forward contract may be taken on the basis reasonable estimate expected export receipts. 8. The Ld. ORP has erred in treating clauses of proviso to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... led by way of actual delivery (as opposed to constructive delivery) of the underlying commodity, it is not speculative. (Ref. Davenport & Co. P. Ltd. Vs. CIT 100 ITR 715, SC). Also see the Hon'ble Tribunal in London Star Diamond Co. Vs. DCIT [2013J 38 Taxmann.com 338 (Mum. Trib). 12. Considering the fact that all the FCs are ultimately settled through delivery of US dollars. it's clear that the decisions of the Tribunal/ High Court relied on to by the DRP are not relevant as all those decisions deal with a situation where contract is cancelled because of non-delivery of dollars and settlement is reached by paying the difference between the contracted price and the price of the commodity on the date of settlement. AO/DRP in A.V. 2010-11:- 13. In the succeeding A.Y. 2010-11, the actual loss incurred was Rs. 15.75 crores and the remaining amount of Rs. 6.05 crores was offered to tax by the assessee in its return for A. Y. 20 10-11, which is accepted by the AO. (Re .Pg. 753 & 754I Vol.-IV). The DRP has also not interfered with the decision of the AO. Thus we have a situation where AO/DRP have treated FCs to be nonspeculative transaction entered into by the assessee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he assessee. Ld. CIT DR also pointed out that the special bench order was passed in the case of assessee bank and assessee of the present case is an engineering service provider assessee so the business profile varies substantially. 37. Replying to the above ld. Counsel of the assessee also placed written rejoinder to the written reply and submissions of the DR on the issue of mark to market losses, ld. Counsel submitted that the contentions of the ld. CIT DR are misconceived, that the assessee fails to satisfy any of the clauses of the proviso to section 43(5) of the Act, therefore, mark to market loess of forward contracts are not allowable being speculation losses. Ld. Counsel strongly contended that merely the ld. CIT DR reiterating the view as expressed by the ld. DRP and the DRP has ignored the main provisions of section 43(5) of the Act as the revenue has to show as to how the present case is covered by the definition of speculative transaction as defined in section 43(5) of the Act. Ld. Counsel also pointed out that the assessee accounts for forward contract loss based upon a consistency followed by accounting policy as stated in its final audited statement and since all f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een the FCs and the export invoices. - Apparently few Forward Contracts cancelled before the maturity date. which was a characteristic of speculation activity or there were any alterations. In view of the above, the following submissions are made: A. Forward Contracts are to be treated as commodity as held in 38 taxmann.com 338 (Mumbai-Trib.). Reliance on the decision or the Bombay High Court in the case of CIT v. Badridas Gauridu Pvt Ltd 2004 134 Taxrnan 376 (Bombay) and UT v. Soorajmull Nagarmull [1981] 129 ITR 169 (Cal) in the case of London Star Diamond Company (I) P. Ltd v. DCIT [2013] 38 taxrnann.com 338 (Mumbai- Trib.). Relevant extract of para 19 of the judgment reads as under: "Para /9. The above------- .Although there is decision of the Tribunal where it is held that the FCs are not commodities, considering the judgment of Hon'ble High court of Calcutta in the case of Sooraj Mull Magarmull supra, which was followed by the judgment of jurisdictional High Court in the case of Badridas Gauridu Pvt Ltd (supra), needs to be followed by us. The principle of "judicial discipline" assumes importance and therefore, the "commodity" includes the forward contract'. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n exchange were closed without actual delivery. Assessee was also unable to establish that booking and cancellation of forward contracts of foreign exchange were in respect of specified export or import. Hence, the loss on forward contract on cancellation and marked-to- market on outstanding contracts as on year end on hedging foreign exchange risk was held to be a speculative contract. B. Explanation to S. 37(1) inserted by the Finance Act 1998 with retrospective effect from 1-4-1962 reads as under: "Explanation - For the removal of doubts, it is hereby declared that any expenditure incurred by an assessee for any purpose which is an offence or which is prohibited by law shall not be deemed to have been incurred for the purpose of business or profession and no deduction or allowance shall be made in respect of such expenditure." The forex derivative contracts entered into in excess of the underlying foreign exchange exposure of the assessee are apparently in violation of the guidelines of RBl and FEMA and therefore hit by Explanation to S. 37(1). This explanation impliedly leads us to the conclusion that such losses on FCs are not allowable to the assessee. CBDT has also ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the other hand CBDT Instruction mandates disallowance. Apparently, the instruction from CBDT was either not pointed out to the ITAT or was subsequent to this order. Also, the question in the said case was whether MTM loss was a real loss or notional loss and the issue of speculation under 43(5) was not an issue before the ITA T. On this background, the benefit of this Special Bench order for claiming allowability of MTM losses despite the instruction to the contrary by the CBDT is not available especially due to the facts that the assessee failed to discharge its onus on giving real time data. Besides, the assessee in our case is Engg. Service exporter whereas this AB order was rendered for a bank, so the business profile varies substantially. C. Recent: RBI in order to regulate the currency market volatility has allowed the trading in currency future and forward on April 20,2007. As there was difficulty in managing the currency future along depending on FOREX with other derivatives traded in Security exchange market depending on SENSEX, therefore, RBI and SEBI formed a standing committee to analyze the trade in currency forward and future market around the world and thu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the actual delivery or transfer of the commodity or scrips: Provided that for the purposes of this clause- (a) a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect 0/ his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations: or (c) a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; or (d) an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange: shall not be deemed to be a speculative transaction. "[Emphasis supplied] The facts of our case are:- i. The assessee is an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to section 43(5) of the Act. Reliance in this regard is placed on the following: * Hon'ble Supreme Court in the case of Davenport & Co. P. Ltd. v. CIT, reported in (100 ITR 715), wherein the Apex Court has held as under: "For income-tax purposes speculative transaction means what the definition of that expression in Expln. 2 says. Whether a transaction is speculative in the general sense or under the Contract Act is not relevant for the purpose of this Explanation. The definition of 'delivery' in S. 2(2) of the Sale of Goods Act which has been held to include both actual and constructive or symbolical delivery has no bearing on the definition of 'speculative transaction' in the Explanation. A transaction which is otherwise speculative would not be a speculative transaction within the meaning of Expln. 2 if actual delivery of the commodity or the scrips has taken place; on the other hand, a transaction which is not otherwise speculative in nature may yet be speculative according to Expln. 2 if there is no actual delivery of the commodity or the scrips. The Explanation does not invalidate speculative transactions which are otherwise legal but gives a spe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by delivery of contracted US dollars. This fact is verified by the Ld. DRP in their order at Para 3.7.1 of DRP order at Pg 65 of PB Vol.1. 3. The reference by the Ld. CIT(DR) to the Explanation to section 37(1) of the Act is misplaced and irrelevant. It is an undisputed fact that the FCs were legally entered into by the assessee with Authorized Dealer Bank in terms of the RBI regulations. It is also undisputed that no illegality is ever found out or alleged by either the Bank or the RBI against the assessee in respect of the FCs. Also, the RBI regulations permits taking FCs based on reasonable estimate export receipts as discussed above. It is undisputed that the value of FCs is more than the export sales and export receivables. Thus, it cannot be said that entering into FCs is in violation of the RBI guidelines and the allegation that it is hit by explanation to section 37(1) is misplaced. 4. Reliance on the CBDT Instruction No. 23/2010 dated 23-3-2010 is also misplaced. The Ld. CIT(DR) fairly observed that MTM loss was held to be allowable by the Special Bench of Hon'ble Mumbai ITA T in the case of DCIT vs. Bank of Bahrain and Kuwait ([2010] 41 SOT 290) dated 13-08-2010 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e last contract would mature on 4.12.2009. Undisputedly, the total value of forward contract was Rs. 19.50 crore and in accordance with its method of accounting, the assessee booked loss of Rs. 21.8 crore on the unexpired contracts as on 31.3.09 being the difference in the INR value of USD as on 31.3.09 with the value of which contracts were agreed to be settled. 42. From the assessment order it is apparent that the AO had disallowed the said claim of the assessee on the ground that the loss booked and claimed by the assessee is a notional loss which is not allowable. Ld. Counsel has drawn our attention towards Schedule XIII of the significant accounting policies of the assessee and submitted that where the company enters into forward foreign exchange contract with the bankers to mitigate the risk associated with the foreign exchange fluctuation which is further associated with the accounts receivables and amount forecasted sales transactions. It was also pointed out that the fair value of forward foreign exchange contract which have been taken to cover foreign exchange risk in respect of probable forecasted transaction have a difference between the contracted rate and forward rat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... u/s 43(5) was not an issue before the Special Bench, therefore, the same was not considered. Ld. CIT DR further contended that in this background of aforesaid facts and issues before the Special Bench, the Bench of ratio of the Special Bench order for claiming allowability of MTM losses despite the instructions to the contrary by the CBDT is not available due to the fact that the assessee failed to discharge its onus on giving real time data regarding its claim, specially to demonstrate that the contracts were finalised and performed by way of actual physical delivery of foreign exchange resulting into booked/claimed losses therefrom. Ld. CIT DR finally prayed that the issue is not covered in favour of the assessee and this issue calls for detailed adjudication in the light of CBDT Circular No. 03/2010 (supra) and other relevant provisions of the Act. 45. Ld. Counsel of the assessee also placed written rejoinder to the written synopsis of the ld. CIT DR on 29.6.15 as reproduced hereinabove. Ld. Counsel submitted that the contention of the ld. CIT DR emphasising that the assessee fails to satisfy any of the clauses of the proviso to section 43(5) of the Act, therefore, mark to mark ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s were fully honoured by delivery of contracted USD. This fact was also verified by the ld. DRP in their order at page 3.7.1 at page 65 of paper book volume I of the assessee. Ld. Counsel also contended that CBDT instruction dated 23.3.2010 (supra) are not binding on the appellate authorities and the decision of Special Bench Mumbai in the case of DCIT vs Bank of Bahrain and Kuwait (supra) dated 13.8.2010 was passed in later time against the issuance of CBDT instruction. Lastly, ld. Counsel vehemently contended that the revenue is harping on the baseless and incorrect propositions which have been settled by the ITAT Delhi in assessee's own case for AY 2008-09 on the similar set of facts and circumstances and hence the issue is squarely covered in favour of the assessee by this order of the Tribunal. 47. At the very outset, we respectfully take cognizance of decision of ITAT 'I' Bench in assessee's own case for AY 2008-09 (supra) wherein the issue of mark to market losses has been decided in favour of the assessee with following observations:- "8. Coming to the corporate additions i.e. disallowance of loos, it clearly emerges from the record that the assessee in respect of foreig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... able accounting standards/policies in this regard. (iv) The AO has raised only dispute that this loss is not allowable as deduction in the year of incurrence computed under mercantile system by following the accounting standards in this respect or at the time of realization of export proceeds on maturity of forward contracts." 49. Undisputedly, the facts and circumstances of the present case are more or less similar to the present AY 2009-10 and the assessee booked mart to market loss of Rs. 21.80 crore as on 31.3.09 being difference in the INR value of the USD as on 31.3.09 and the value of which the hedging contract was agreed to be settled. We further note that the assessee is following mercantile system of account for recognition of this loss in its financial statements. When we see the order of the DRP para 3.7.1, then it is amply clear that the ld. DRP has alleged that the forward contracts are not fully supported by the underlying support invoice both in terms of the amount as well as the tenure. DRP has drawn the table in this appeal and thereafter noted that out of 9 forward contracts, the assessee has only used 4 forward contract fully and the assessee has not used t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 174 6-Aug-08 3,300,000 Beyond 31.3.09 NO 160558 1-Oct-09 146175 7-Aug-08 3,000,000 Beyond 31.3.09 NO 161236 4-Nov-09 146176 7-Aug-08 3,100,000 Beyond 31.3.09 NO 162068 4-Dec-09 Sub-Total 14,871,953 GRAND TOTAL 27,600,000 It can be seen that out of the 9 FCs, the assessee has used only 4 FCs fully. The assessee has not used these FCs immediately but started using them against the sales invoices after a lapse of time of few months. To elaborate it further, it is noticed that the contract no. 146164 was used for the first time in 31st October 2008 for nominal sum of US$ 27,55,121. Thus, it is evident that there was no underlying asset for this contract from 6.8.2008 till 31st October 2008. The entire FC could be utilized only by 31st December 2008. Likewise the contract no. 146167 and 146169 taken on 6.8.2008 have been started to be used by the assessee from January 2009 onwards. Thus, there was no underlying asset for these contracts from 6.8.2008 till 31.12.2008. Out of th ..... X X X X Extracts X X X X X X X X Extracts X X X X
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