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TMI Blog2016 (7) TMI 1051X X X X Extracts X X X X X X X X Extracts X X X X ..... Rule -8D(ii). -Decided partly in favour of revenue Treatment of unabsorbed depreciation - priority for deduction u/s.10B of the Act over set off of brought forward unabsorbed depreciation allowance - Held that:- It is held by the Hon’ble Karnataka High Court in the case of CIT Vs. Himatsingka Seide reported in [2006 (8) TMI 125 - KARNATAKA High Court] held that unabsorbed depreciation has to be adjusted against the income for the purpose of exemption u/s.10B of the Act; exemption u/s.10B cannot be allowed by adjusting only a portion of unabsorbed depreciation of an earlier year against the income of the export unit and adjusted the balance of unabsorbed depreciation against other business income once again to show ‘Nil’ tax liability. Against this judgement, the assessee carried the matter to Supreme Court by way of SLP, which was dismissed by the Supreme Court. Hence, we are of the opinion that lower authorities have taken the correct view of the facts of the case - Decided against assessee MTM losses on forward contracts - whether are contingent in nature and a provision created on such notional loss cannot be allowed? - Held that:- The MTM loss on forward contracts is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e same by relying on series of case laws delivered in assessee s favour and further contended that the interest payment is for loan obtained for specific purposes and not for investments. The AR has also contended before the AO that the assessee has enormous Reserves Surplus and the investments were out of own funds. Hence, according to him, applying Rule 8D is untenable. The AO was not satisfied with the arguments of the AR and invoked the provisions of s.14A r.w. Rule 8D and disallowed ₹ 15,23,543/-. Aggrieved, the assessee carried the appeal before the Ld.CIT(A). Before CIT(A), the assessee took a plea that assessee has not incurred any expenditure in earning exempt income. The CIT(A) observed that the assessee has not discharged that the assessee has not incurred expenditure towards exempt income. Since the assessee has not not furnished details of expenditure, direct or indirect, interest expenditure, investments, use of own funds, utility of secured loans, trade profits of the assessee relatable to exempt income and taxable income in the form of separate accounts. According to CIT(A), the AO is justified in invoking the provisions of Rule-8D(ii) of Income Tax Rules, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee to make investments which yielded exempt income. The fund flow filed by the assessee does not show date on which the assessee made investments out of own funds. Being so, the argument of assessee cannot be the good explanation to hold that the assessee is not incurred interest expenditure on funds used for investments, which yield exempt income. 3.6 Regarding computation of total asset, the CIT(A) wrongly observed that total assets to be taken before the current liabilities are reduced as per the balance sheet. There is o reason for not reducing the current liabilities. However, we make it clear that total fixed assets after depreciation plus net current assets to be considered as the total asset, when the balance sheet is prepared in Straight Line method while applying the formula in Rule -8D(ii). 3.7 Accordingly, the ground raised by the assessee is dismissed and the ground raised by the Revenue is partly allowed. 4. The next ground in assessee s appeal is with regard to treatment of unabsorbed depreciation. 4.1 The facts of the issue are related to priority for deduction u/s.10B of the Act over set off of brought forward unabsorbed depreciation allowance o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts, the export receivables are already received by the assessee at the time of entering the forward contract and the transaction traverses from debtors to that of the Banker. Therefore, the transactions lose its identity as business transaction. Further, AO observed that losses on forward contracts when the same is squared up by delivery of export proceeds received (actual receipt) is also allowable. But, MTM losses as at restatement at the end of the Financial Year are not a business transaction but only a speculative transaction. It is because as on 31st March of the Financial Year actual delivery of foreign currency does not happen. It is based on this rationale that the Central Board of Direct Taxes vide Instruction No.3/2010 dated. 23.03.2010, had categorized the MTM losses on account of restatement of forward contracts as at 31st March of the Financial Year is speculative in nature. It does not fall under the classification of eligible transactions detailed in Sec. 43(5)(a). Such MTM losses on forward contracts are contingent in nature and a provision created on such notional loss, cannot be allowed and hence the profits of business should not include the speculation loss due ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t currencies at a forward rate. Forward rate is the specified rate for exchange of currency at a specified future date. The assessee, in the case on hand, entered into a forward contract with the Bank to buy or sell foreign exchange at an agreed price on a future date in order to hedge against possible future financial loss due to fluctuation in the rate of foreign currency. Therefore; (i) Firstly, the foreign exchange forward contract created a continuing, binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity; and (ii) Secondly, it is in the nature of a hedging contract because it is a contract entered into against possible future financial losses. It follows from the above that while it is true that the assessee would come to know of the actual profit I loss only on the date of maturity, unless there is any premature cancellation of the contract, it is equally true that the assessee could anticipate the loss on the valuation date, say 3l March, with reasonable accuracy. Prudent accounting and commercial principles require that all accrued losses have to be taken into account. 4.5.4 Having considered the natur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rmined, then it cannot be said that it is in the nature of contingent liability. It is to be borne in mind that the issues relating to the accrual of income cannot be decided on the same footing and considerations on which issues relating to losses are to be decided. In the case of loss! expenditure, the concept of reasonable certainty to meet an existing obligation comes into play; which in legal terminology is referred to as crystallisation of liability . This is in keeping and consonance with the principle of prudence as considered by the Hon1ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra). The substantial questions of law before the Hon ble Apex Court for consideration as extracted from para 3 of its order is as under: 3. In this batch of civil appeals, the following question arises for determination: (i) Whether, on the facts and circumstances of the case and in law, the additional liability arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes could be allowed as deduction under s. 37(1) in the year of fluctuation in the rate of exchange or whether the same could only be allowed in the year of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression expenditure incurred while dealing with the question as to whether there was a distinction between the actual liability in praesenti and a liability de ftituro. The word expenditure is not defined in the 1961 Act. The word expenditure is, therefore, required to be understood in the context in which it is used. Sec. 37 enjoins that any expenditure not being expenditure of the nature described in ss. 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head Profits and gains of business . In ss. 30 to 36, the expressions expenses incurred as well as allowances and depreciation has also been used. For example, depreciation and allowances are dealt with in s. 32. Therefore, Parliament has used the expression any expenditure in s. 37 to cover both. Therefore, the expression expenditure as used in s. 37 may, in the circumstances of a particular case, cover ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of commercial accounting requires that in the P L a/c the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading s. 37(1) with s.145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st of acquisition and the proceeds of sale. The word profit implies a comparison between the state of business at two specific dates, usually separated by an interval of twelve months. Stock-in-trade is an aset. It is a trading asset. Therefore, the concept of profit and gains made by business during the year can only materialize when a comparison of the assets of the business at two different dates is taken into account. Sec. 145(1) enacts that for the purpose of s. 28 and s. 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with s. 28. Therefore, s. 145(1) is attracted to the facts of the present case. Under the mercantile system of accounting, what is due is brought into credit before it is actually received; it brings into debit an expenditure for which a legal liability has been incurred before it is actually disbursed. (judgment of this Court in the case of United Commercial Bank vs. CIT (1999) 156 CTR (SC) 380 : (1999) 240 ITR 355 (SC)). Therefore, the accounting method followed by an assessee continuously for a given period of time needs to be presumed to be c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hey arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under s. 43A of the 1961 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-li recognises exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-a-vis the Indian rupee, there is an expense during that period. The important point to be noted is that AS-il stipulates effect of changes in exchange rate vis-a-vis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Therefore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P L account for the reporting period. 19. A company imports raw material worth US $ 250000 on 15th Jan., 2002 when the exchange rate was ₹ 46 per US $. The company records the transaction at that rate. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pted Accounting Standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation. 4.5.7 As can be seen from the extractions reproduced above, the decision in the case of Woodward Governor India Pvt. Ltd. (supra) has been rendered in respect of monetary items , denominated in foreign currency which include to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency notes, balance in bank accounts denominated in a foreign currency, receivables / payables and loans denominated in a foreign currency, sundry creditors, etc. are all monetary items. The decision is also related to transactions in which a legal liability has been incurred before it is actually disbursed. We are therefore unable to concur or agree with the view of the learned CIT (Appeals), that liability could arise only when the contract would have matured, as such a stand is totally divorced from the accounting principles and is in variance with the principle upheld by the Hon ble Apex Court in the case of Woodwprd Governor India Pvt. Ltd. (supra). It can also be seen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whether such losses on account of forex-derivatives can be allowed against the taxable income of an assessee has been considered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below: 2 3. Treatment of loss from actual transactions in forex-derivatives. In a case where a loss on a forex-derivative transaction arises on actual settlement / conclusion of contract and is not a notional or marked to market book entry, a further question will arise as to whether such a loss is on account of a speculative transaction as contemplated in Section 43(5) of the Income tax Act. For determining whether loss from a transaction in respect of a forexderivative is a speculation loss or not, the Assessing Officers may refer to Proviso (d) below sub-section (5) of Section 43 inserted by the Finance Act, 2005, with effect from 1.4.2006. It lays down that any eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ltimately 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 sectiori43(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 into a contract of purchase, he also simultaneously enters into one or more contracts of sale against the same quantity deliverable at the same time either to the original vendor or to someone else, so as either to secure profit or to minimize loss, before the Vaida day ; and similarly when he enters into a contract of sale, he simultaneously enters into one or more contracts to purchase the same quantity before the Vaida day. The result of such dealings, when the sale and purchase are to and from the same person, has the effect of cancelling the contracts leaving only differences to be paid. The technique of hedge trading can be understood in simple terms. It is said that the hedge contract is so ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oss. 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 merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold. 5.3. Hedging contracts are dealt in Clause (a) of the proviso to section 43(5) of the Act. From the above discussion it can safely stated that the said clause applies, if following conditions are fulfilled: (1) There is a contract for actual delivery of goods manufactured by the assessee /a merchandise sold by it, (2) Assessee must be a sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision for losses on derivative contracts is allowable as expenditure. We, accordingly allow the Grounds at S.Nos.1 to 9 raised by the assessee. 5.3 Further, the Co-ordinate Bench of this Tribunal in the case of M/s.Cotton Blossom (I) Pvt. Ltd.,in ITA No.583/Mds./2014 1531/Mds./2015 vide order dated 31.1.22015 after considering the various judgements of the Co-ordinate Bench, in the case of M/s. Aishwarya Co P. Ltd in ITA No.860/Mds/2014, dated 29.05.2015, wherein they followed the judgment of the Calcutta High Court in the case of M/s. Baljit Securities Pvt. Ltd. (88 CCH 313) held that the Assessing Officer has to consider the foreign exchange derivative in proportion to export turnover as regular business transaction of the assessee. If the derivative transaction undertaken by the assessee is in excess of export turnover then that loss suffered in respect of that portion of excess transaction has to be considered as speculative loss only and that excess derivative transaction has no proximity with export turnover and the Assessing Officer is di ..... X X X X Extracts X X X X X X X X Extracts X X X X
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