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TMI Blog2016 (9) TMI 1608X X X X Extracts X X X X X X X X Extracts X X X X ..... arising on valuation of forward exchange contracts on the closing date of accounting year is not notional loss and, therefore allowable. 2. Whether on the facts and circumstances of the case and in law, the Id.CIT(A)was right in not taking cognizance of the decision of the ITAT,'E' Bench, Mumbai in ITA NO.506/Mum/2013 dt.03.05.2013 in the case of M/s. S. Vinodkumar Diamond Pvt. Ltd. 3. Briefly stated facts are that the assessee firm is engaged in the manufacturing and export of cut and polished diamonds. The AO during the course of assessment proceedings noticed that the assessee has debited a sum of Rs. 18,80,94,300/- as loss on account of outstanding foreign exchange forward contracts. He required the assessee to explain the same as to why the same should not be disallowed by treating the same as notional loss. The assessee explained that the loss on account of "Mark to Market‖ revaluation of forward contracts as per rupee value equivalent to US $ as on 31.3.2009 was claimed. The AO required the assessee to file the details of these losses. According to the AO these losses have not been crystallized and hence again asked the assessee as to why the same should not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... D 194.71 million approx. 1.4 Considering the substantial foreign currency exposure and due to substantial fluctuation in foreign currency rates, the appellant entered into the forward contracts (FCs) with the Banks as integral part of the export import business with the aim to hedge and safeguard against the foreign exchange fluctuation of the US doller vis-à-vis the Indian currency, from time to time. 2.0 Details relating to the Forward Contract undertaken by the Appellant during the financial year ended 31 March 2009 2.1 The Appellant herewith submits the following details of foreign exchange gain (loss) made during the year ended 31 March 2009,* such as: Sr. No. Particulars Annexure 1 Statement of revaluation of outstanding forwardcontract as on 31 March 2009 for exchange loss of Rs. 18,80,94,300 A 2 Statement of Gain / (Loss) for Forward Contracts outstanding as on 31 March 2009 and its effect in the subsequent year ended 31 March 2010 B 2.2 The Appellant further submits that there was huge volatility in exchange rate of US Dollar viz. Rupee from April 2008 to March 2009. USD had registered an appreciation from Rs. 39.7650 to Rs. 51.9700 during the year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... overseas creditors) 9.31 3 Bank loan 65.78 4 Advance from Overseas Customers 8.96 5 Closing Stock for export 91.44 Total 194.72 2.4.6 The appellant has also given the average and month wise exposure in foreign exchange during the F.Y.2008-09 as per which the monthly average of outstanding foreign debtors was US Dollar 40.86 million. Also, stock as on 31.3.2004 was worth US Dollar 91.44 million. The said chart is reproduced herein below:- Average and month wise exposure in foreign exchange during the financial year 2008-09 Month Outstanding forex debtors as on month end Outstanding forex creditors as on month end Outstanding bank loan as on monthend Advance from customers as month end Stock as on month end (expected forex receivables) Total foreign exchange exposure as on contract Apr-08 44,816,959 31,288,490 75,534,866 21,008,529 112,410,918 285,059,763 May-08 44,781,311 41,323,348 73,532,621 18,919,110 113,654,036 292,210,425 Jun-08 46,587,421 53,896,970 65,980,079 12,131,098 112,462,944 291,058,512 July-08 51,339,913 51,149,907 68,528,680 20,569,801 120,631,271 312,219,572 Aug-08 51,753,000 53,002,048 67,088,900 18, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es in this regard. (iv)The Id. AO has raised only dispute that this loss is not allowable as a deduction in the year of incurrence computed under mercantile system by following the accounting standards in this respect. (v) `The appellant was obliged to convert outstanding balance of forward contract at the year end rate, which were executed at higher rates, resulting in considerable loss on account of year -end conversion of forward contract positions 2.4.9 It was also stated that The Institute of Chartered Accountants of India, the legal apex body, on accounting matters has issued an Accounting standard "Accounting for the effects of changes in foreign exchange rates (AS-11)(revised)" which is required to be compulsorily followed from 1 st April 1995. In accordance with the stipulations of this standard, all the monetary items are required to be valued at the closing rate and the profit or loss arising there from is required to be debited or credited to the profit and loss account as can be seen from the following excerpts: At each balance sheet date: 1. Monetary items denominated in a foreign currency (e.g. foreign currency notes and loans denominated in a .foreign curr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nly rational way to evaluate profit / loss in a given period. Loss, although purported to be stated by the Id. AO to be notional, is actual and quantifiable. Loss had occurred and accrued, as a result of conversion. Only thing is that such a loss in the subsequent period would get either further aggravated or get placid, depending upon the foreign exchange fluctuation that may happen against the rupee. v) Foreign exchange loss as a result of conversion of outstanding position of Forward contracts is - * real * quantifiable with precision * based on commercial accounting principles * as a result of cut-off * in consonance with the Accounting standard -11 issued by the Institute of Chartered Accountants of India * allowable 2.4.12 To summarize, it was stated that (a) It is only coincidental that rupee was almost at the peak at the beginning of the. year, while it was at its bottom at the end of the year against the US$ resulting in loss on the outstanding value of Forward contracts at the year-end. (b) The Assessee incurred loss on account of outstanding value of forward contracts at the year-end (31st March, 2009); while in past and subsequent years, assessee had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es due and before it is actually received; (ii) whether the same system is followed by assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the account books both in respect of losses and gains is as per nationally accepted accounting standards; whether the system adopted by assessee* is fair and reasonable or is adopted only with a view to reducing the incidence of taxation" 2.4.14 In fact, even if the losses are allowed in the year of realisation of export proceeds that would tantamount to following cash system of accounting which will be contrary to section 145(1) of the Act-- CIT v. UP State Industrial Development Corpn. [1997] 225 ITR 703/92 Taxman 4-5 (SC). 2.4.15 Similarly, as pleaded earlier, in the case of Dy. CIT (International Taxation) v. Bank of Bahrain & Kuwait [2010] 41 SOT 290 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ns were hedged by entering into Forward contracts, and they had incurred year-end forward contract conversion losses. 2.4.17 In the case of BHARAT EARTH MOVERS LTD (supra), the court has differentiated between what is accrued liability and contingent liability. The relevant portion of the principles laid down by the Hon'ble court are reproduced as under: * For an assessee maintaining his account on the mercantile system, a liability already accrued, through to be discharged at future date would be a proper deduction while working out the profits and gains of his business, regard be had to the accepted principles of commercial and accountancy. It is not as if such deduction is permissible only in the case of amount actually expended or paid. * Just as receipts though not actual receipts but accrued and due are brought in for income tax assessment so also liabilities accrued due would be taken in to account while working out the profits and gains of the business. * A condition subsequent,' the fulfillment of which may result in reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability * Di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... contract/orders in respect of diamonds. The Id Sr counsel has further contended that dealing in foreign exchange being treasury transaction is not permitted by the RBI and therefore, the gain arising from the forward contracts is part and parcel of operating profit of the -assessee, In support of his contention he has relied upon the decision of the Bangalore Benches of the Tribunal in the case of SAP Labs India (P.) v ACIT in ITA No.398iBangI02;in the case of Bombay Diamond Co Ltd. v. DCIT in ITA No.7488/Mum/07; in the case of c/r v. Badridas Gauridu (P.) Ltd. [2003]261 ITR 256 1[2004] 134 Taxman 376 (Bom). He has further submitted that the premium or discount arising at the 1nception of forward exchange contracts is amortized as expense or income over the life of contract. The exchange difference on such contract are recognized in the profit & loss account for the year in which the exchange rate changes resulting in the profit or loss arising on cancellation or renewal of forward exchange contract is recognized as income or as expenses. 9.1 The Id OR on the other hand has submitted that as per DECD guidelines on the Transfer Pricing, the foreign exchange gain or loss should be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iamond, the gain or loss arising of the said, will be treated as part and parcel of the operating profit." (Emphasis supplied) 2.4.19 In a recent decision in the case of Societe Generate (2013ITS-737-ITAT), the Hon'ble Mumbai Tribunal has allowed a similar claim of the assessee for the loss of Rs. 9.16 crores on foreign exchange contracts outstanding as on 31-3-1998 holding that this issue was squarely covered in favour of the assessee by the decision of the Special Bench of IT AT in the case of Bank of Bahrain & Kuwait (supra). 2.4.20 In the case of ONGC Vs CIT 322 ITR 180, Hon'ble Supreme Court has reiterated the principles laid down above while answering the question that when the assessee maintained their accounts on mercantile system of accounting and there was no finding by the AO on the correctness or completeness of the account and when the assessee had complied with the accounting standards, laid down by the central Government, the "loss" suffered by it on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet was to be allowed as an expenditure under section 37(1) of the Act notwithstanding the fact that the liability had not b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... summarized as under:- (i) A binding obligation accrued against the Appellant the minutes (sic) it entered into forward foreign exchange contracts. (ii) A consistent method of accounting followed by the Appellant cannot be disregarded. The Appellant has consistently followed the same method of accounting in regard to recognition of profit or loss both, in respect of forward foreign exchange contract as per the rate prevailing on March, 31, (iii) A liability is said to have ~crystallized when a pending obligation on the balance sheet date is determinable with reasonable certainty. (iv) As per AS-11 when, the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period. (v) In view of the decision, of the. Supreme Court in the case of Woodward Governor India (I) P Ltd, the Appellant's claim is allowable. (vi) In the ultimate analysis, there is no revenue effect and it is only the timing of taxation of loss/profit. 2.4.25 On the basis of facts obtaining in the impugned appeal and the one in the case of H. Dipak (supra), following chart summarizes the similarities in the two cases ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of evaluation of the contracts on the last day of the accounting year, ie. Before the date of maturity of the Forward contract, is allowable deduction, which exactly matches with this case. Applicable to the appellant on the basis of same facts. 14 Only the timing of taxation of profit / loss The unmatured contracts at the year end, forwards contracts value date the year end rate and booked exchange difference at the end of the year which resulted in loss The unmatured contracts at the year end, forward contracts valued at the year end rate and booked exchange difference at the end of the year which resulted in loss of Rs. 7.14 cr. 2.4.26 At this stage, it may also be prudent to refer to the observations of Authority for Advance Ruling in the case of SOPROPHA S A., IN RE (2004) 268 ITR 37 (AAR) where the scope of Central Board of Revenue (The Board) circular No.23D (F No.412/4/60/TPL dt 12th Sept, 1960) has been analyzed. It was, inter alia, held therein as under: Now the scope of the provisions of the Act and Circular of the Board have to be examined in the light of material placed before us. Before the issue of circular of the Board, the IT authorities gave a restricti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ister. It does not, therefore, surprise us that the AOs have also taken an unduly narrow view in the matter and the genuine businessmen have been put to considerable hardship. We certainly appreciate, as we have done earlier, the principle underlying the proviso, but we equally disapprove of its wrong application for denying genuine hedging losses. We feel that the solution to the various problems which have been brought to our notice in relation to this subject can be found by expanding Expln. 2 to s. 24(1) so as to classify and exclude such transactions which should not come under the i mischief of this section. The AO should first examine whether a hedging transaction is genuine or not. If it is a genuine one, and it is by way of future sale of a commodity against stock of the same commodity, the loss arising out of this transaction should be excluded from the purview of speculation.... . 3.58 The hardship caused by a too literal interpretation of Expln. 2 to s. 24(1) of the IT Act was illustrated to us by a case where a dealer having ready cloth business entered into a contract for the purchase of 1000 bales of cloth from a mill on a forward delivery basis. Ultimately, it was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... essarily be in the same variety of the commodity. They could be in connected commodities e.g. one type of cotton against another type of cotton We accordingly rule as under: Q.No. 1-ln view of the meaning assigned to it in the Board's Circular No. 23D of 12th Sept., 1960,on facts and in circumstances of the case, forward transactions in which the applicant deals will be in the nature of hedging contracts. Q. No. 2- Though the existence of contract of sale is a condition precedent to attract cl. (a) of proviso to s. 43(5) of the Act, it stands relaxed to the extent allowed byCircular No. 230 of 12th Sept., 1960. Q. No. 3-Forward sale transactions, though not covered within the meaning of hedging contracts as per proviso (a) to s. 43(5), they are covered within the extended meaning given in Board's Circular No. 230 of 12th Sept., 1960. Q. No. 4-ln view of extended meaning assigned. to hedging transactions in the Board in Circular No. 230 of 12th Sept., 1960, the hedging contracts need not be of the identical quality/quantity of the goods held in stock." . (Emphasis supplied) 2.4.27 In light of the above, while construing as to what constitutes a ' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... actment is not a mechanical task. It is more than a mere reading of mathematical formulae because few words possess the precision of mathematical symbols. 1.1 is an attempt to discover the intent of the Legislature from the language used by it and it must always be remembered that language is at best an imperfect instrument for the expression of human thought and, as pointed out by Lord Denning, it would be idle to expect every statutory provision to be "drafted with divine prescience and perfect clarity". We can do no better than repeat the famous words of judge Learned Hand when he said: ' ... it is true that the words used, even in their literal sense, are the primary and ordinarily the most reliable source of interpreting the meaning of any writing: be it a statute, a contract or anything else. But it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary; but to remember that statutes always have some purpose or object to eccompllsh, whose sympathetic and imaginative discovery is the surest guide to their meaning. ' We must not adopt a strictly literal interpretation of ... but we must construe its langua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f a transaction based merely on its presentation, without going into its substance. When a legally tenable contract is in existence, duly supported by an underlying asset/stock and the contract having been entered during the course of business and further that the exchange rate as on date of entering the contract and as at the year- end being ascertainable, due effect of the contract at the year-end has to be given while assessing the appellant's income. Here, it is not out of place to mention that the upper limits of exposure to forward contracts are regulated by the RBI guidelines and that they are allowed only to certain extent of receivables or payables and not to the full extent. Further, banks also insist on collecting margins in case the movement of forward contracts before maturity is against the exporter/importer. In other words, the entire gamut of the impugned transactions is integral to the appellant's business and it cannot be called a contingent transaction. There is no merit in the Ld. AO's argument in treating the impugned transaction as independent to that of appellant's business and to state that the flow of benefit is not known or it depends on an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... acknowledgement" 2.4.33 Similarly, as discussed, this decision has been approved by the Hon. Supreme Court in CIT v Woodward Governor India P Ltd (312 ITR 254). 2.4.34 Further, as seen earlier, in the case of DCIT v/s. Bank of Bahrain and Kuwait (ITA Nos. 4404 & 1883/Mum./2004), the Special Bench of Jurisdictional Mumbai ITAT held that MTM losses in respect of forward foreign exchange contracts debited to profit and loss account is allowable. 2.4.35 Similarly, in the case of ONGC Vs CIT 322 ITR 180, Hon'ble Supreme Court has reiterated the principles laid down above while answering the question that when the assessee maintained its accounts on mercantile system of accounting and there was no finding by the Assessing Officer on the correctness or completeness of the account and that the assessee had complied with the accounting standards, laid down by the Central Government, the "loss" suffered by it on account of fluctuation in the rate of foreign exchange as on the date of balance-sheet is an allowable expenditure under section 37(1) of the Act notwithstanding the fact that the liability had not been actually discharged in the year in which the fluctuation in the rate of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . On the other hand, the ld.AR for the assessee argued that more than 90% of the assessee's business is deriving income from exports of diamonds and most of the purchases and sales were made in foreign currency. According to him, the assessee had availed substantial banking channels in foreign currency and had used export on account of fluctuation in foreign currency rates. He argued that in order to mitigate this export in foreign currency rates the assessee entered into forward contract to hedge the fluctuation of foreign currency rates in respect of export and import transactions, which is integral part of institutional to the exports business undertaken by the assessee. He stated that as on 31.3.2009, the assessee revalued all the monitory assets and liability outstanding by following AS-11 and recognized profit and loss account during the year. Similarly, it also recognized "Mark to Market Loss" in respect of outstanding forward exchange contracts. In our opinion, these contracts are as per AS-11 of the ICAI. He stated that the CIT (A) has considered all these facts, which are reproduced in the above order. The ld. Counsel also stated that transactions in foreign exchange were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gainst the foreign exchange fluctuation of the US $ vis-à-vis the Indian currency, from time to time. 8. From the details filed by the assessee it is clear that there was huge volatility in exchange rate of US Dollar viz. Rupee from April 2008 to March 2009. US Dollar had registered an appreciation from Rs. 39.7650 to Rs. 51.9700 during the year as is evident from the yearly graph plotting the volatility filed before us. We find that the assessee has hedge the underlying exposure in foreign currency and as such, the forward contracts entered were for the purpose of the business to hedge against the forex loss. The assessee has forex exposure on all limbs its business activities. The firm has not entered into the forward contracts with an intention to earn any gain due to fluctuation in foreign currency rate but it is necessary for it to enter into such forward contracts to hedge against foreign exchange rate fluctuation. This is an integral part of the business undertaken by the assessee and incidental to the export and import business. In the absence of such forward contracts, the firm may sustain huge losses. Therefore, it becomes essential for the firm to book such forwa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nch. In the aforesaid decision, reference was also made to the decision of Hon'ble Supreme Court in the case of Gen India Mfg. Co. 249 ITR 307 and the subsequent decisions of the apex Court in the case of Arihant Tiles and Marble (P) Ltd. 320 ITR 79 (SC), Vijay Ship Breaking Corpn. 314 ITR 309 (SC) and Empee Poly Yarn Pvt. Ltd. 320 ITR 665 to hold that t he assessee was engaged in the business of manufacturing of cutting and polishing rough diamonds and hence, it was eligible for deduction u/s 80 IA of the Act. Following the above said decisions, the appellant's claim for additional depreciation u/s. 32(1) (ii) of the Act was allowed. As the facts obtaining in the current year are in pari material with the facts obtaining in earlier year in respect of the appellant's claim of additional depreciation, this ground is allowed." 11. We also find that the Tribunal in the case of Flawless Diamond India Ltd. Vs Addl. CIT (2014) 45 Taxmann.com 67 (Mum.) after considering the recent of the Hon'ble Supreme Court held that cutting and polishing of diamonds amounts to manufacturing or production of article or thing by observing in Para 16 as under:- "16. Thus, from the aforesaid decision, i ..... X X X X Extracts X X X X X X X X Extracts X X X X
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