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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 ..... 700 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. 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. It becomes essential for the firm to book such forward contracts as a prudent business practices. Further, we find that the assessee is engaged in the business of diamonds export and not in the business of foreign exchange. This is evident from the financial results of the firm. In view of the same, we are of the view that these contracts are nothing but an integral part of its export and impor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 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 be disallowed as notional loss on valuation of a liability. The ld. AR explained that as per accountancy prudence and in view of Accounting Standard -11 (AS-11) guidelines issued by ICAI the assessee claimed these losses, since there was a contractual liability on the part of the assessee with the banks to buy/sell US $ a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ency exposure as on 31 March, 2009 amounts to USD 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- -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 ₹ 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exchange exposure as at the end of the year which is as under:- Sr. No. Nature of foreign currency exposure Amount (USD in million, 1 Exports receivables (i.e. overseas debtors) 19.22 2 Imports Payables (i.e. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 195,837,227 Mar-08 19,224,253 9,311,415 65,785,464 8,961,480 91,442,232 194,724,845 Average 40,867,041 37,483,751 67,517,375 13,571,982 107,551,764 266,991,912 2.4.7 To understand the concept of a speculative transaction, at this stage, I may also be profitable to read section 43(5) which is as under: speculative transaction means a transaction in which a contract for the purchase or sale of 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 of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or (b) a contr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also stipulates the same methodology as can be seen from the following excerpts: 3. At each Balance sheet date, the foreign currency monetary items that result from transactions of the entity should be reported at the closing rate 4. Exchange difference arising on reporting an entity's long term foreign currency monetary items at rates different from those at which they were recorded during the period or presented in previous financial statements should normally be recognized in income for the period. 2.4.11 In a nutshell, the summary of the appellant's submissions are as under: i) In the first place, the ld. AO has failed to appreciate the characteristics of a Forward contract. Each Forward contract is always assigned with a value that is contracted with creation of a fettered obligation on the assessee to execute and meet at a future contracted date. All the contracts are always enforceable, in as much as realizable. ii) The point that the Id. AO was making was that anticipated liabilities are not allowable, which are notional in nature. But, the distinction in case of Forward contracts is that if an anticipated liability is coupled with present Obligati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ept loss incurred on conversion of the outstanding value of forward contracts, particularly if it has happened on account of controls beyond the assessee. (c) Accounting Standard 11 dealing with effects of foreign currency requires assessee to adjust its monetary assets at the year end with the year-end conversion rate and reflect profit or loss in the revenue statement. Therefore what we have done is what we are technically obliged to do. (d) Even mercantile system of accounting as recognized under section 145 requires that at the year end, an assessee should make provision for all known liabilities. 2.4.13 As evident from the above, it was pleaded' that similar question arose in the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 I 179 Taxman 326 (SC) that whether the loss arising on fluctuation of exchange in respect of loan taken for revenue purposed is allowable as deduction in the year of fluctuation of exchange rate or whether the same could be allowed only in the year of repayment of such loan. The Supreme Court held that the loss suffered by the assessee on account of exchange difference on the balance sheet date is an item of expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is allowable as deduction. It held that such loss is neither notional nor contingent liability in which the moment binding contract is enacted, it becomes allowable. Further reference could be made to Bharat Earth Movers v, CIT [2000] 245 ITR 4281 112 Taxman 61 (SC), Metal Box Co. of India . Ltd. v. Their Workmen [1969] 73 ITR 53 (SC) .and Calcutta Co. Ltd. v. CIT [1959] 37 ITR 1(SC) 2.4.16 In the case of DCIT vIs Bank of Bahrain Kuwait(supra), forward contracts were entered of an amount to protect the fluctuations in the foreign currency held as stock-in-trade. Forward contracts value entered by. Bank of Bahrain Kuwait had nothing to do with the foreign currency held as stock-in-trade except protecting fluctuations, while of course dealing with reporting in Indian currency. On the same footing, in the instant case of the appellant stock. as well as receivable mainly are dollar denominated and are realizable in foreign currency. To hedge possible fluctuations in US$ denominated stock, as well as resultant debtors out of such stock, the appellant had entered into forward contracts. The proposition in that case, as well as in this case is starkly similar. They being bank had ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... charged at a future date. What should be certain is the incurring of the liability. It should be also be capable of being estimated with reasons certainty though the actual quantification may not be possible. 2.4.18 Further, in the case of Rusabh Diamonds v. Assistant Commissioner Income-tax - 15(1), Mumbai [2013] 34 taxmann.com 160 (Mumbai - Trib.) in Appeal No. 7217 (MUM.)/2012 dated April 26, 2013, it has been, inter alia, held, under: 8.1 The assessee considered ₹ 5,20, 70, 149 as operating income on account of foreign exchange gain arising on forward contracts. The assessee contended that the exchange gain arising on cancellation forward contracts are to be considered as part of operating profit since it an integral part of the business of buying and selling of the diamonds al hence is an operating income. The TPO did not accept the claim of the assessee for the reason that the exchange gain earned are against cancellation of forward contracts and the assessee has separately disclosed as profits and gains from foreign exchange fluctuations, which are not included in purchases and sales. Further, the TPO was of the view that this constitutes speculative and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e risk of foreign exchange fluctuation; then exchange gain cannot be included in the profit of the assessee for the purpose of determination of net margin. The Id OR has referred the TP study at page 1.0 of the paper book and submitted that risk of foreign exchange fluctuation upto 3% in USD is to be earned by the AE. Therefore, the same cannot be included to the profit of the assessee for the purpose of computation of operating profit of the assessee. 10. We have considered the rival submissions as well as the relevant material on record. The assessee has entered into forward contracts for the purpose of hedging of foreign currency exposure on export and import of diamonds with AEs. Therefore, the hedging of foreign currency has nexus with the export and import activity of the assessee and the exposure of the assessee in relation to the export and import. The OECD guidelines in para 2.82 are as under; 2.82 Whether foreign exchange gains and losses should be included or excluded from the determination of the net profit indicator raises a number of difficult comparability issues. First, it needs to be considered whether the foreign exchange gains and losses are of a trading n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nswered the question in favour of the assessee. 2.4.21 Thus, the judicial decision of the Hon. Supreme Court and various other authorities are clearly in favour of the appellant on this issue. That apart, as discussed earlier, the liabilities in foreign exchange. were incurred during the normal course of the appellant's business and the restatement of the forward contract obligations was done as per AS-11 in a consistent manner over the years. 2.4.22 In fact, the gain earned on such revaluation was accepted and brought to tax in the respective years and there was no reason for the Ld. AO. to arrive at a different conclusion in present case merely because there was loss during the year Apparently, the Id. AO was of the view that the appellant was not a dealer in foreign exchange unlike the Bank of Bahrain, and therefore the said decision was held as not applicable to the facts of the case. However, as seen earlier, this issue is no more res integra and is settled by a plethora of judicial decisions. 2.4.23 It is not out of place to mention that the Hon. Supreme Court, in the case of ONGC (supra), upheld the same principles that were laid down in the case of Woodword Gov ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ership Firm 1 Business Activity Engaged in the business of Import, Manufacturing and Export of Cut Polished diamonds Similar activity i.e engaged in the business of Manufacturing, trading as well as import and export of cut and polished diamond 2 Import (USD) ₹ 517.10 Cr ₹ 476.68 Cr 3 Export (USD) ₹ 714.98 Cr. 4 % of Export Salesto Total Sales Export 95% of total sales 5 Credit Facility fromBank Enjoying Foreign Currency Loan from say PCFC Loan from Bank Enjoying Foreign Currency Loan say PCFC Loan from Bank 6 Accounting Policy for Currency Transactions Policy followed by the firm clearly stated in the Significant Accounting Policies on Foreign Currency Transactions Policy followed by the firm clearly stated in Para 6 of Schedule-F of Balance Sheet unde ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 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 restrictive meaning to the hedging transactions. The said view was also confirmed by various High Courts including Madras High Court and Allahabad High Court in the cases relied on before us. It was, however, brought to our notice that in the case of Raghunath Das Prahlad Oas (supra); Allahabad High Court followed Gujarat High Court's decision in the case of Chimenlel Chhotalal (supra). How ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arious 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 found that the mill could supply only 980 bales, the remaining twenty bales being rejected on account of some defect and the settlement was made between the dealer and the mill regarding these twenty bales by payment of difference in price. It was stated even such a transaction was taken by the AO to fall within the mischief of the Expln. 2 to s. 24(1) of the IT Act on the ground th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 'hedging contract , we may derive guidance from the observations made by Hon'ble Supreme Court, in the case CIT v. Hindustan Bulk Carriers [2003] 259 ITR 449/126 Taxman 321(SC) , as follows: A construction which reduces the statute to a futility has to be avoided. A statute or any enacting provision therein must be so construed as to make it effective and operative on the p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 language having regard to the object and purpose which the Legislature had in view in enacting that provision and in the context of the setting in which it occurs. We cannot ignore the context and the collection of the provisions in which .appears, because, as pointed out by judge Learned Hand in the most felicitous language: interpret ' ... the meaning of sentence may be m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 any one of the various events listed by him. In fact the Ld. AO has failed to see that such events are part and parcel of the appellant's business and not external to it. Therefore, whatever may be the result of the events listed out by the Ld. AO, such result has to be treated as business result at the time of its happening and hence, the effect of the forward contact ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rward 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 foreign exchange had occurred. 2.4.36 To reiterate, thus the judicial decisions of the Hon. Supreme Court and various other Authorities are clearly in favour of the appellant on this issue. That apart, as discussed earlier, the transactions in foreign exchange were carried out during the normal course of the appellant's business and the restatement of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gn 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 carried out during the normal course of business of the assessee and restatement of the forward contracts application was done as per AS-11 in consistent manner over the years. He explained that whenever accounts are revalued and excess, what so ever, was offered to tax and accepted by the revenue in the respective years. He stated that there is no reason ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to hedge and safeguard against the foreign exchange fluctuation of the US $ vis- -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 ₹ 39.7650 to ₹ 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n detail by the Hon ble ITAT, Mumbai Bench. 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:- ..... X X X X Extracts X X X X X X X X Extracts X X X X
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