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TMI Blog2018 (4) TMI 428X X X X Extracts X X X X X X X X Extracts X X X X ..... r defined in clause [iv] of Explanation 2 to Section 10A of the Income Tax Act 1961, which clearly states that they need to be excluded. 3. Any other ground that may be taken up at the time of hearing." 3. On verification of the details in Forms 56F, the AO noticed that the assessee did not exclude communication charges, payments made abroad to foreign subsidiaries and forex realization beyond 6 months in 1 case related to Unit - 3 from the export turnover. The AO, therefore, excluded from the export turnover while computing deduction u/s 10A. 3.1 When the assessee objected the same before the DRP, the DRP directed the AO to reduce telecommunication charges not only from export turnover but also from the total turnover for the purpose of computing deduction u/s 10A. 4. Aggrieved by the order of DRP, the revenue is in appeal before us. 5. Considered the rival submissions and perused the material facts on record. The Hon'ble Courts and the coordinate benches of ITAT have consistently held that the internet charges have to be excluded both from the export turnover as well as from the total turnover while computing deduction u/s 10A of the Act. The Hon'ble Bombay High Cou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rprise, Infotech Enterprises America Inc. The TPO considered this as an international transaction and proposed to determine its arms length price at Rs. 35,66,500/-worked out @ 2% on the outstanding balance of the loan as on 1.4.2009 of Rs. 17,83,25,009/- as commission for providing bank guarantee. The second guarantee was given on behalf of its AE, Infotech Enterprises Limited, UK in favour of Ordinance Survey, UK for an amount of GBP 1.6 million. The TPO considered this also as an international transaction and proposed to determine its arm's length price at Rs. 23,31,552/- worked out @ 2% as commission on the outstanding balance of the loan as on 1.4.2009 of Rs. 11,65,77,600/-. 9.1 Before the DRP, the assessee submitted the ITAT in case of Glenmark Pharmaceutical case upheld the guarantee commission rate @ 0.53%. He, therefore, submitted that since the rate adopted by the TPO @ 2% is too high, the rate may be reduced suitably. 9.2 The DRP, however, confirmed the action of the TPO. 9.3 Considered the rival submissions and perused the material facts on record. Assessee has provided corporate guarantee to its AE in the current AY without charging any fees for the same. The te ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , hold that the Explanation to Section 92B cannot be applied retrospectively and for the years under consideration the assessee having not incurred any costs in providing corporate guarantee it would not constitute "International Transaction" within the meaning of Section 92B of the Act and consequently, ALP adjustment is not warranted on this aspect." Respectfully following the above decision, we reject the treatment of corporate guarantee as international transaction and consequently, ALP adjustment is not warranted on this aspect. Accordingly, the ground raised by assessee is allowed. 10. As regards ground no. 3 regarding unrealized gain on foreign exchange forward contracts of Rs. 9,04,81,526/-, the assessee deducted this amount in the computation of income. However, the AO added back the said amount to the income of the assessee on the ground that there was no reason to deduct the same in computation. 10.1 Before the DRP, the assessee argued that this gain represents unrealized gain and that it was arrived at only by making the contract to market and it is being a notional gain, the same was reduced from the computation of income, though, it was taken into accounts in the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng mercantile system of accounting regularly, any gain or loss on forward contracts has to be considered in the computation of total income. As per Accounting Standards on this item both loss and gain are to be reckoned as an end of accounting period The AO has no option except to follow the prescribed procedure as per law. The panel do not interfere in his action as there is no infirmity. Accordingly, the assessee's objection is rejected" 20. It is submitted that there is a fallacy in the above decision of the Hon'ble DRP. The DRP having directed to allow loss on revaluation in A.Y.2010-11 which was not claimed in earlier year, by following the method of computing taxable income as per rule of consistency, the DRP ought to have directed to exclude profit/gain on foreign exchange transactions which were valued on 'mark to market' basis. Notional losses as well as gains should not be taken into account while computing taxable income 21. In the case of CIT v. Indian Overseas Bank [1985] 151 ITR 446 (Mad.), the Hon'ble Madras High Court held that the unrealized losses on outstanding foreign exchange contracts are not allowable. Similarly, it held that unreali ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... does not result at all, there cannot be a tax- even though for purposes of book keeping, an entry is made about an hypothetical income which doesn't materialize and a mere book keeping entry cannot be income unless income has actually resulted. The question whether there is a loss or profit on foreign exchange transactions can be ascertained after the settlement of the forward contracts and not before and so long as that stage has not been reached the loss can only be notional and not actual or real and notional loss cannot be claimed as a deduction. Whether a loss or profit, the principle applicable would be the same and the estimated profit, till the settlement of the forward foreign exchange contracts, could be regarded only as notional and not actual or real and such notional profits cannot be assessed" (Emphasis supplied) 23. It may kindly be observed that the Madras High Court has clearly held notional profit on outstanding contracts cannot be brought to tax. Till contracts are settled, there is no taxable gain nor allowable loss. 24. A similar view was taken by the CSOT in instruction No. 03/2010 dated 23/03/2010. In this instruction, the CSOT considered the issue o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e rates. In case of the revenue items falling under section 37(1) para 9 of AS-11, which deals with recognition of exchange differences, needs to be considered. Under this para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise. The important point to be noted is that AS-11 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 profit and loss account for the reporting period [Para 18]. " Gains on Mark to market transactions are required to be ignored under well recognized "concept of prudence II / "convention of conservatism" of followed in mercantile system of accounting 28. Even if unrealized losses on outstanding foreign exchange contracts are allowable as deduction in view of the Apex court decision i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Woodward Governor India (P.) Ltd. [312 ITR 254] in para 10 to 17 (Pages 260-265 of ITR), the Department having accepted the method consistently adopted by the appellant in earlier years, it cannot be permitted to adopt different view for the year under consideration to add only gains on revaluation but ignore losses on revaluation. In this case, the apex court has held that a method of accounting followed by the assessee continuously for a given period of time has to be presumed to be correct till AO comes to a conclusion for reasons to be given that the said system doesn't reflect true and correct profits. It has observed in para 10 of its order as under: '10. As stated above, on facts in the case of M/s Woodward Governor India (P.) Ltd the Department has disallowed the deduction/debit to the P&L account made by the assessee in the sum of Rs. 29,49,088/- being unrealized loss due to foreign exchange fluctuation. At the very outset it may be stated that there is no dispute that in the previous years whenever the dollar rate stood reduced the Department had taxed the gains which accrued to the assessee on the basis of accrual and it is only in the year in question when t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... picture. In the absence of any reason whatsoever, there was no warrant or justification to depart from the previous accounting system which was accepted by the Department in respect of the previous years. [Para 16] Therefore, there was no merit in the instant appeal and the same was to be dismissed" (Emphasis supplied) 34. In the case of CIT v. Margadarsi Chit Fund Private Limited (155 ITR 442), it has been held that before rejecting the system of accounting consistently followed by the assessee by several years and accepted by Department in the past, it must refer to inherent defects in the system and record a clear finding that the system of accounting followed by the assessee is such that correct profits cannot be deduced from books of account maintained by the assessee. 35. In the case of CIT v. Bilahari Investment (P.) Ltd (299 ITR 0001), it was held as per the head note, as under: "Every assessee is entitled to arrange its affairs and follow the method of account which the Department has earlier accepted It is only in those cases where the Department records a finding that the method adopted by the assessee results in distortion of profits that the Department can ins ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nception is he must have acquired a right to receive the income. There must be a debt owed to him by somebody There must be otherwise expressed debitum in presenti solvendum in future unless and until there is created in favour of the assessee a debt due by somebody, it cannot be said that he acquired a right to receive the income or that income has accrued to him." 41. As per the above decision of Supreme Court, only the accrued gains can be bought to tax. In this case, the assessee was awarded compensation for the land acquired from him by the government by the arbitrator but the government went in appeal against the award. As the matter was pending before the court, the Supreme Court held that the party could not be taxed on the amount awarded to it. In other words, even after the award of the arbitrator, it was held that the gains did not accrue as the matter was in dispute before the court. 42. Similarly, in the present case the maturity period of the contract is not over and the loss/gain is not actually ascertained. Whether a contract in question would yield profit or loss and quantum thereof are matters in the womb of future. So, there is no basis for the making additio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alized gain on forex. As far as the treatment of gain/loss on forex difference, assessee followed consistent method of accounting policies. It is a fact that the gain/loss determined by the assessee based on the closing rates based on mark to market are notional and not real loss or gain as the forward contracts were not concluded. Real gain/loss is only when the contracts are concluded. Therefore, recognition of this notional gain or loss depends upon accounting policies or method of accounting regularly followed by the assessee, since the assessee is following mercantile system of accounting, recognition of gain/loss are traceable over the years. Since, all the notional gain/loss are regularly declared by the assessee in its financial accounts. Therefore, in our opinion, assessee is consistently following a method of accounting and also discloses foreign currency transactions in its books of account and consistently following the same method of accounting over a period of time. Further, the Instruction No. 03/2010 dated 23/03/2010 issued by CBDT wherein it is clearly observed as under: "A 'Marked to Market' loss may be given different accounting treatment by different a ..... X X X X Extracts X X X X X X X X Extracts X X X X
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