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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 ..... 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. The functional dissimilarity as well as distinction in the geographical market in the light of foreign exchange fluctuation risk of the assessee company coupled with below 25% RPT undertaken by the CIEL, we, therefore, decline to agree with the conclusion of the AO/DRP/TPO that the CIEL is a suitable comparable for the purpose of proposed TP adjustment made by the authorities below. Functional dissimilarity and other aspects cannot be ignored and these factors clearly demonstrate that CIEL should not have been included in the final set of comparables for making transfer pricing adjustment pertaining to the impugned international transactions of the assessee company and we order to exclude the same from the final set of comparables. Mark to market losses on foreign exchange forward contracts disallowed - Held ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e file of AO/DRP for a fresh adjudication after factual analysis and examination of the impugned transactions after affording due opportunity of hearing for the assessee and without being prejudiced by the earlier orders. - I.T.A.No.882/Del/2014 - - - Dated:- 14-10-2015 - SHRI S.V. MEHROTRA, ACCOUNTANT MEMBER AND SHRI CHANDRA MOHAN GARG, JUDICIAL MEMBER For The Appellant : Shri S.D. Kalipa, R.R.Maurya, Praveen Sharma, Sanjay Kumar, Advocates For The Respondent : Shri Ravi Jain, CIT DR, Subhakant Sahoo, Sr. DR PER CHANDRAMOHAN GARG, J.M. This appeal by the assessee has been preferred against the order of DCIT, Circle 2(1), New Delhi dated 6.1.2014 passed u/s 143(3) r/w section 144C of the Income Tax Act, 1961 (for short the Act) in pursuance to the directions of the Dispute Resolution Panel-I (DRP), New Delhi dated 26.11.2013 u/s 144C(5) of the Act for AY 2009-10. 2. In the beginning of the argument, ld. Counsel appearing for the assessee submitted that the assessee does not want to press ground no. 1, 2, 3.6, 3.7, 3.8 and 4, therefore, we dismiss the same as not pressed. Remaining grounds for adjudication read as under:- 3. That on facts and circumsta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in forex-derivatives. Also, the instruction is issued after the year under consideration. Thus, accordingly the same is not applicable to the assessee. Further, the said this Instruction is ultra vires to the scope of section 119 of the Income-tax Act, 1961 being prejudicial to the interest of the assessee. 5.3 That the Ld. AO 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. 5.4 That the Ld. AO erred in disregarding the order passed by the Hon'ble Delhi Bench of the Income Tax Appellate Tribunal in the Appellant's own case for the assessment year 2008-09 reported as Bechtel India (P.) Ltd. vs. ACIT [2013] 33 taxmann.com 213 wherein the mark to market losses in respect of foreign exchange forward contracts as on the balance sheet date was allowed to the Appellant. 6. That the Ld. AO has erred in charging interest under section 234B, 2340 and 244A of the Act amounting to INR 13,40,39,006. 7. That on the facts and in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le in TP study i.e. - 4.49%, the final adjustment was captured as ₹ 6,22,45,957/-, whereby the TPO proposed margin of 32.47% without providing adjustment towards working capital, risk and ideal capacity. Ld. Counsel further pointed out that after ld. DRP ruling, the margin after providing working capital adjustment was 15.34% wherein risk and ideal capacity adjustment was not provided by DRP/TPO for making impugned addition. 6. Ld. Counsel of the assessee reiterating its written submissions dated 17.6.2015 spread over 7 pages submitted that in the Transfer Pricing study, the assessee selected 7 comparables while the TPO accepted that the assessee is in the business of providing engineering support services and accepted TNMM as MAM and OP/TC as PLI the assessee as a tested party. Ld counsel submitted that the assessee mainly disputes selection of Certification Engineers International Ltd. (CEIL) and NTPC Electrical Supply CO. Ltd. (NTPCES) without any basis and the DRP has considered the issue of Related Party Transaction (RPT) even though specific objections were raised by the assessee. Ld. counsel further pointed out that the TPO applied this filter mechanically by taking ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Private company- incorporated in 1994 as 100% subsidiary of Bechtel Corporation, USA. Government company 100% subsidiary of National Thermal Power Corporation (NTPC), which is a Government company. Government Company. Till 1994, it was a division of Engineers India Ltd. (EIL), ( a government company) from which it was demerged as a 100% subsidiary company. 3. Function Rendering Engineering a support service including related design and drawings as per specifications of foreign AEs. As per website NTPC. Com: The company was formed on August 21, 2002. It is a wholly owned subsidiary company of NTPC with the objective of making a foray into the business of distribution and supply of electrical power, as a sequel to reforms initiated in the power sector. The company was also mandated to take up consultancy and other assignments in the area of Electrical Distribution Management System. (Copy of screenshot at Annexure 1A) As per Schedule 17 of AR (pg. 843 of Vol.-IV/AR) The company is operating in a single segment, that is, providing consultancy, project management and supervision se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies/Departments, which must be considered as related parties. Reliance placed on ITAT order in Thyseen Krupp Pg. 678 at 694/Vol-III. Note: Contracts/projects for rural electrification schemes ' entrustesd'/sanctioned to NTPCES under Rajiv Gandhi Vidyutidaran Yojana are not awarded under open tender as per CVC Circular dt. 3/3/2007. (1) RPT declared are only monetary transactions with Holding Co. only (19.60%) Transactions with other AEs like ONGC, IOCL etc. not quantified, (Pg. 215/Vol-II/DRP submission) SCHEDULE J (Notes on accounts) (5) The jobs awarded by ONGC on nomination basis are being governed by the MOU signed between EIL ONGC dated 11/4/1985. (6) The company has a Memorandum of Understanding with Engineers India Ltd. (The Holding Company) for providing manpower services, office space and facilities etc. The MOU provides level basesd fixed man hour/man-day rates for EIL employees, inclusive of overheads and fixed annual cost towards space, infrastructure and facilities etc. provided by EIL. The company also has a Memorandum of Understanding with Engineers India Limited for providing manpower services to EIL at ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g designs and drawings as per the specifications of the foreign AEs i.e. Bechtel Corporation USA. Ld. Counsel further pointed out that the assessee company is securing operating revenue of ₹ 178.36 crore from its 100% export of services to its AE having forex fluctuation risk and 100% related party transactions (RPT) and DRP has failed to consider these important factual aspects while rejecting the objections of the assessee company to the comparability of NTPCES. 11. Ld. Counsel further pointed out that NTPCES is a 100% government owned company subsidiary to the National Thermal Power Corporation (NTPC). Ld. Counsel further pointed out that NTPCES was formed on 21.8.2002 is wholly owned subsidiary of NTPC with the objective of making a foray into the business of distribution and supply of electric power as a sequel to reforms initiated in the power sector. Ld. Counsel also submitted that NTPCES was also mandated to take up consultancy and other assignments in the area of electric distribution management system and the company is also operating in a single segment of providing consultancy, project management and supervision services. 12. Ld. Counsel further pointed out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and submitted that if related party transactions are much more, then the filter of 25%, is not a suitable comparable and therefore, the order for the exclusion of the same would be appropriate. 14. Ld. counsel of the assessee pointed out that TPO was not correct in applying the filters by taking companies whose income is less than ₹ 5 crore as the analysis would not lead to a proper comparability and moreover their low cost/sales base makes their result unreliable. Ld. counsel also pointed out that companies whose revenue from engineering support services is less than 75% of the total operative revenue should be excluded. The ld. Counsel also pointed out that the ld. DRP in its order dated 16.12.2014 for AY 2005-06 has concluded that NTPCES is not functionally comparable with the assessee Bechtel India. He took us through operative para at pages 5-6 of the DRP order (supra). 15. Replying to the above, ld. DR pointed out that business profile of the assessee company as taxpayer recorded by the DRP in para 3 page 2 of the DRP order and submitted that the assessee company has less complex o NTPCES and CEIL operations and was accordingly selected as a tested party for the T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... designs and drawing for various overseas group entities to support the overseas offices in turnkey project execution. The assessee company also undertakes engineering design and relates services for its overseas group companies. From the aforesaid business and functional profile it is amply clear that the assessee company performs contract engineering design services for its group companies. BIPL leverages on all the valuable intellectual Property ( IP') Right ('IPRs') and other commercial processes, methodologies, etc. belonging to its AE i.e. Bechtell Corporation USA. The DRP has also recorded that the entire Group is involved in complex operations of marketing, bidding for projects, providing turnkey solutions, project management and adhering to delivery timelines. The assessee company only provides engineering design services exclusively to its overseas AEs and the assessee has less complex operations, bears lesser share of risk. Ld. DR has not disputed and could not demolish this fact that as per website of NTPC.com the NTPCES is a wholly owned subsidiary company of NTPC with the objective of making a foray into the business distribution and supply of electrica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... note that the ITAT Mumbai has categorically held that when the related party transactions are much more than the filter of 25%, then the same should be excluded. The relevant observations of the Tribunal at page 694 read as under:- 12.8.1 Next is the case of Engineers India Limited, which was included by the TPO at his own. The learned Counsel for the assessee contended that this case should be ignored because it is a Government Undertaking. It was further pointed out that most of its customers of the 'Turnkey project division' are related parties, being, other Public Sector Undertakings, which is much more than the filter of 25%. The learned Departmental Representative, however, accentuated that the TPO was right in including this case in the list of comparables. 12.8.2 We find it as undisputed that Engineers India Limited is a Government company. It has several segments which also include Turnkey project'. Page 700 of the paper book is a copy of annual report of Engineers India Limited on turnkey project. It can be seen that the revenue has arisen from completing Paraxylene Plant of IOCL and further that company is engaged in execution of other unit of IOCL ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... privileges granted by ONGC and other government companies. Ld. Counsel strongly contended that the CIEL is a government company and it was a division of Engineers India Ltd. till 1994 from which it was demerged as a 100% subsidiary company of Engineers India Ltd. (EIL). Ld. Counsel pointed out that CIEL undertakes third party inspection and certification of equipment supplied by the vendors and fabrication and installation work of contracts of ONGC under MOU between EIL and ONGC dated 11.4.1985 on nomination basis. Referring to page 365 to 773 and 803 to 805 Volume IV of assessee s paper book submitted that the terms of said MOU are not known and open to the public domain and hence it can be safely inferred that the CIEL is enjoying the benefits of awarding of contact work on nomination basis without any open tender from its holding company EIL and other government companies. Ld. Counsel also pointed out that the CIEL also carries on similar Third party inspection (TPI) and certification work independently for other public sector undertaking and it cannot be compared with assessee Bechtell India who is rendering only engineering support services including related drawing and desig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... paid by one PSU or government company to another for goods or services represents Arms s Length Price (ALP). Ld. CIT DR contended that in this situation of open market environment, MOU between EIL and ONGC referred to in the annual report of CIEL for FY 2008-09 pertaining to AY 2009-10 has no relevance. 22. Ld. CIT DR also submitted that the TPO rightly observed that since a person holding voting shares of 26% in a company is considered to be its AE u/s 92A(2)(b), therefore, RPT filter of 25% of total revenue is justified, therefore, RPT filter of 25% without recognizing non-monetized benefits flowing from holding company to CEIL/NTPCES has been correctly applied. Ld. CIT DR strongly contended that the transactions between two government companies or public sector undertakings should not be considered to be related party transactions because shares in government companies are held by the President of India merely in the name and no effective control is exercised by him. Ld. CIT DR lastly submitted that no adverse inference needs to be drawn from non-disclosure of transactions between two state-controlled enterprises as no such requirement is prescribed in AS-18. Ld. DR finally ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction with other AE/government companies and departments like ONGC, IOCL etc. are not quantified. To support this contention he has drawn our attention towards assessee s paper book Volume II page 215 the submission of the assessee before DRP. Ld. Counsel parted with the argument that the AO/DRP/TPO should be directed to delete CIEL from the final set of comparables which is clearly functionally different with the assessee company. 25. On careful consideration of above rival submissions of both the sides, t the very outset, let us deal with the issue of related party transactions (RPT). Ld. DR relying on the TPO s observations submitted that since the person holding voting shares of 26% in a company is considered to be its AE u/s 92A(2)(b) of the Act, thereafter RPT filter of 25% of total revenue is justified. Ld. DR further pointed out that RPT filter of 25% without recognising nonmonetized benefits flowing from the holding company CIEL/NTPCES has been correctly applied. Ld. DR has also contended and reiterated that the transaction between two government companies should not be considered to be RPT because shares in government companies are hold by the President of Indi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... T.A .No.-5354/DeIl2012) while deciding the issue relating to advertising, marketing and promotion ( AMP ) on behalf of the Appellant. This is with respect to Motorola Solutions India Private Limited ( MSILP ) appeal no. ITA 56371 Dell 2011 for Assessment Year ( AY ) 2007-08. The hearings for the same were concluded on July 18, 2013 and the order was reserved on that date. The matter is now awaiting pronouncement of the decision by Your Honours. In the meantime the'!' Bench of the Hon'ble Income Tax Appellate Tribunal ( Tribunal ), New Delhi has pronounced its decision in the case of BMW India Pvt. Ltd. vs. Addl.. CIT (I.T.A .No.- 5354/DeI/2012 for AY 2008-09) ( BMW India order ). The said order was passed on August 16, 2013. Your Honours attention may kindly be drawn to the following: As mentioned in the BMW India order, BMW India acted as a distributor of motor vehicles and parts. During the year under consideration in the order, under the Transactional Net Margin method ( TNMM ) applied by BMW India its operating profit margin was higher than the operating profit margin of the comparable companies. During the transfer pricing assessment proceedings, the Ld. Transfer p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in case of BMW India is provided here below(Para 6.25, 6.26 page 53, 55 of BMW India order): Quote We hold that in the facts of the present case the assessee has demonstrated that the compensation for the higher services was embedded in the pricing arrangement of the contract goods itself It is seen that the comparables identified by the assessee and accepted by the TPO as having similar intensity functions have earned profit at the gross and net levels far below the profits both at gross and net levels as achieved by the assessee. In the circumstances as evidenced from record, we are inclined to agree with the submissions advanced on behalf of the assessee that no further compensation was required to be made by the AE as the same has already been received. Thirdly, the Hon'ble Tribunal in BMW India order provided that BMW India was rewarded by price adjustments to earn profits which included the cost of AMP with mark up. It held that the tax department cannot insist that the mode of compensation received by BMW India from its AE necessarily had to be direct compensation and that pricing adjustment was not acceptable. The relevant text of the Hon'ble Tribunal ruling ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. TPO based on the bright line analysis held that MSIPL should have been reimbursed by the AE for the excess AMP expenses incurred by it along with a mark-up. The Appellant filed an appeal before the Hon'ble Tribunal. The grounds related to AMP issue are covered in grounds nos. 2.1 to 2.10 and 3. (The details have been mentioned in para 4-43 of page 2-23 of the written submission filed with Your Honours on May 20, 2013 and again in para 8 of page 133-138 of the written submission filed with Your Honours on May 20, 2013.) In this regard we humbly submit that the decision in case of BMW India order also applies to MSIPL, as the facts of MSIPL are similar to that in the BMW India order. Hence, we humbly submit that the decision rendered in the BMW case has a direct bearing on the AMP issue. This has been summarized as under: 1.BMW India is a distributor of motor vehicles and related parts. MSIPL is also a distributor. Hence, what is relevant for consideration is the remuneration model of a distributor in both the cases. 2.BMW India's operating margin was higher than that of the comparables. Similarly, MSIPL also operated at a higher net operating margin than that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7, as per which both entered into a mutual foreign collaboration agreement. Thereafter a Technical assistance and royalty agreement was entered into between these two entities on 1-7- 2001 by which LGI, in the capacity of a licensee, obtained a right to use the technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of the agreed products from the LGK i.e. the licensor. 16. In assessee's case the factual matrix has been reproduced earlier. Assessee is primarily engaged in the distribution of telecom equipment, mobile phones and provision of telecommunication service in India. The company also provides software development services to the group companies. Additionally the company also provides marketing and administrative support services to its group company. In the case of BMW the factual matrix was as under: 2.4 A perusal of the same shows that the TPO took note of the facts that the BMW Group has global operations in 3 segments namely Automobiles, Motorcycles and Financial Services. The parent company of the group is BMW AG i.e. the associated enterprise (hereinafter referred to as the AE ) which is h ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inal 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 of the Activity of BMW India 3.1 BMW India will meet its responsibility for the promotion of sales and the full utilization of the market potential for the Contract Goods by applying its best efforts and adequate resources toward effective sales promotion and advertising for the Contract Goods including available optional equipment and accessories. 27. In view of above, we are inclined to accept the contention of the ld. CIT DR because there is no straitjacket formula given in either section 92A(2)(b) or in Rule 92A(2)(b) or in Rule 10B of the Rules for applying filter to the related party transactions, however, it is a well-settled proposition that if any company is functionally comparable with the taxpayer but at the sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 Certification Expertise: CEIL avails a total synergetic support of its parent company EIL which has skilled and experienced professionals located at Head Office and spread across India and abroad who are fully conversant with national and international codes backed by over 4 million man hours of experience. It has on its roll Engineers qualified by various recognized NDT bodies like ASNT, ISNT and QMS. CEIL's expertise covers Design Verification, Quality Services and Commissioning Assistance on: ~ High pressure Reactors, Pressure Vessels, Columns, Heat Exchangers, Reformers of carbon steel, stainless steel, alloy steels non ferrous materials ~ Clad Columns ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 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 3% which is insignificant and the income from export of services by the asessee Bechtel India is 100% of operating income as there is no domestic client, thus, as per Rule 10B(2)(d) of the Rules, the comparability test also fails on this count. 32. On the basis of foregoing discussion, we have no hesitation to hold that the functions of assessee Bechtel India are quite dissimilar with CIEL which was wrongly taken by the TPO as a suitable comparable for benchmarking of impugned international transaction undertaken by the assessee during the relevant financial period. The functional dissimilarity as well as distinction in the geographical market ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unsel 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 resulting gain/loss on such translation is also recognized in the Profit and Loss Account. v) Forward foreign exchange contracts The company enters into forward foreign exchange contracts with the bankers to mitigate the risks associated with foreign exchange fluctuations associated with the accounts receivable and forecasted sales transactions. Any premium or discount arising at the inception of the forward exchange contract, which have been taken on underlying transaction, is recognized as expenses/income over the life of the contract and exchange differences arising on such forward exchange contract is recognized in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tems 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 Management (Foreig ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee on AEs, holds 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 treati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... law that- if a contract is ultimately settled 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 ₹ 15.75 crores and the remaining amount of ₹ 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 trea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it of the Special Bench order for claiming allowability cannot be extended to the 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 follo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r value than the export receivables. As such, the assessee did not demonstrate rupee-to-rupee and date-specific correlation between 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 fol ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e was a dealer in diamonds, hence only forward contracts in diamonds could be treated as hedging contracts. Further, the forward contracts for foreign 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... te analysis, there is no revenue effect and it is only the timing of taxation of loss/profit. This creates a situation where on one hand a Special Bench decision allows MTM losses, while on 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he term speculative transaction reads as under: .. (5) speculative transaction meansa transaction in which a contract for the purchase or sale 0/ any commodity. including stocks and shares, is periodically or ultimately settled otherwise than 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 i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... P order at Pg 65 of PB Vol.1). Since, all FCs are settled by actual delivery of the contracted amount of US dollars, it is not a speculative transaction under section 43(5). Since it is not a speculative transaction under section 43(5), there is no question of applicability of proviso 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 p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f contract through payment of difference between the value of foreign exchange on the contracted rate in INR and the prevailing rate on the date of settlement. The Ld. CIT(DR) lost sight of the undisputed facts of the case that none of the FCs of the assessee were cancelled and all FCs were fully honored 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eign exchange forward contracts on 6.8.2008 with au authorised dealer of the bank in order to protect the value of anticipated sale proceeds receivables from its AE in the form of foreign exchange i.e. USD. The first of 9 contracts would mature on 3.4.2009, therefore contract would start maturing every succceding month and the last contract would mature on 4.12.2009. Undisputedly, the total value of forward contract was ₹ 19.50 crore and in accordance with its method of accounting, the assessee booked loss of ₹ 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 whic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he other hand CBDT instructions mandates disallowance. It was also contended on behalf of the revenue that the instructions from CBDT (supra) was either not pointed out to the special bench or was subsequent to this order and the question in the said case was whether MTM loss was a real loss or a notional loss and the issue of speculation 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e value of foreign exchange in contract rate in INR and prevailing rate on the date of settlement. Ld. Counsel further contended that reliance placed by the ld. CIT DR on these judgements is wholly misplaced perhaps he lost sight of the undisputed fact that none of the forward contracts of the assessee were cancelled and all forward contracts 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 tak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f this loss as in the subsequent year the AO after due verification has allowed these losses; (ii) Similarly, there is no dispute on the method of accounting followed by the assessee is mercantile as the AO has recorded this fact in the assessment order. (iii) It is not disputed that these losses have been recognised by the assessee in accordance with applicable 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 ₹ 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... v-08 Dec-08 Jan-09 Mar-09 (5,001) 33, 512,400 2,392,577 (9) (250,495) 1,627 24,538,846 116,877,386 (452) YES YES YES YES YES 157124 4-May-09 146167 6-Aug-08 3,000,000 Jan-09 Feb-09 Mar-09 830,550 2,169,380 70 40,572,363 108,230,382 3,567 YES YES YES 157869 4-Jun-09 146169 6-Aug-08 3,100,000 3,100,000 Jan-09 Feb-09 Mar-09 637 1,041,624 2,057,739 YES YES YES 158594 3-Jul-09 146171 6-Aug-08 828,047 Mar-09 828,047 42,296,660 YES 159290 4-Aug-09 Sub-Total 12,728,047 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere duly honoured by delivery of contracts under USD. In this situation, in principle, we agree that in view of the ratio laid down by Hon ble Supreme Court in the case of Woodward Governer (312 ITR 254), while the assessee is following mercantile system of accounting, the loss suffered by the assessee by fluctuation in the foreign exchange as on the date of balance sheet is an item of expenditure u/s 37(1) of the Act. Under this proposition and dicta of Hon ble apex court, and facts emerging from the DRP order, we find it appropriate that the issue requires detailed examination and verification and calculation on scientific basis at the end of the AO/DRP in the light of relevant proposition and provisions of the Act. Therefore, relying on the said propositions and following the judgement of Hon ble apex court in the case of Woodward Governor (312 ITR 254), we restore this issue to the file of AO/DRP for a fresh adjudication after factual analysis and examination of the impugned transactions after affording due opportunity of hearing for the assessee and without being prejudiced by the earlier orders. 51. Accordingly, ground no. 5 to 5.4 of the assessee are allowed for statistic ..... X X X X Extracts X X X X X X X X Extracts X X X X
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