2016 (6) TMI 1465 - AT - Income Tax

Tribunal upholds CIT(A)'s decision on 'Mark to Market' loss & foreign exchange fluctuation. Revenue's appeal dismissed.

The Tribunal upheld the CIT(A)'s decision regarding the allowability of 'Mark to Market' loss on revaluation of creditors and addition made on revaluation ... ‘Mark to market’ loss arising on re-valuation of creditors outstanding on the closing date of accounting year - allowable notional loss - CIT-A deleted the addition - HELD THAT:- CIT(A) has rightly relied upon the decision of Woodward Governor India (P.) Ltd. [2009 (4) TMI 4 - SUPREME COURT] wherein, while dealing with the question as to whether the additional liability arising on account of fluctuation in the rate of exchange can be allowed to be adjusted pending actual payment of the varied, the Hon'ble Supreme Court has observed that 'expenditure' as used in section 37 in Income Tax Act may in the circumstances of a particular case cover an amount which is a 'loss' even though said amount has not been given from the pocket of the assessee. CIT(A) has also rightly held that section 43A is not applicable to the trading assets. The issue is thus, squarely covered in favour of the assessee. Revaluation of closing stock - Whether payment on account of foreign exchange ought to be added to the actual cost of purchase of diamonds and closing stock revalued accordingly? - CIT-A deleted the addition - HELD THAT:- As decided in “IBM Global Services India P. Ltd [2007 (5) TMI 554 - ITAT BANGALORE] held at the time of purchase of the inventory, if the item has been purchased from a foreign country and the amount is payable in foreign exchange and if, the payment is deferred and the liability increases in Indian Rupees, then such liability cannot be termed to have increased the cost of the material. The cost price would be the original cost price and it cannot be increased due to subsequent foreign exchange fluctuation and increased liability on that account. Also confirmed by HC [2014 (5) TMI 852 - KARNATAKA HIGH COURT] Addition on account of sale of wastage and scrap value - Whether such scrap is valuable and used in various industries? - CIT-A deleted the addition - HELD THAT:- AO has made addition on certain assumptions that the scrap/wastage of the rough diamond must have fetched to the assessee an income. However, there is no evidence brought by him in this respect. He has just estimated the income at the rate of 5% of the purchase value of the rough diamonds. The Ld. CIT(A), however, has deleted the addition observing that there was no evidence of sale of scrap by the assessee. However, the Ld. CIT(A) has not given any finding as to what is done with the scrap and whether it has a nil value or it fetches some value to the assessee. Contention of the Ld. A.R., before us, is that the value of the scrap is taken into consideration while settling the rates with the labour contractor. We find that these facts have not been thoroughly examined by the lower authorities. We accordingly restore this issue to the file of the AO to decide it afresh after considering the evidences and explanations that may be furnished by the assessee in this respect. Issues Involved:1. Allowability of 'Mark to Market' loss on revaluation of creditors.2. Addition made on revaluation of closing stock due to foreign exchange fluctuation.3. Addition on account of sale of wastage and scrap value.Detailed Analysis:Ground No.1: Allowability of 'Mark to Market' Loss on Revaluation of CreditorsThe issue revolves around whether the 'Mark to Market' loss of Rs. 4,03,05,856/- arising from the revaluation of creditors due to foreign exchange fluctuation is allowable as a deduction. The AO disallowed the loss, considering it notional and contingent, and not allowable under section 43A of the Act, which pertains to actual payments for asset acquisition.The CIT(A) deleted the addition, noting that the assessee incurred foreign exchange loss on imports and gains on exports, both revalued at year-end. The CIT(A) referenced AS-11, which mandates reporting foreign currency monetary items using the closing rate on the balance sheet date. The CIT(A) also cited the Supreme Court's decision in CIT Vs. Woodward Governor, which held that such losses are deductible under section 37(1) of the Act. The CIT(A) found the AO's stance contradictory and irrelevant under section 43A, which applies to capital assets, not trading assets.The Tribunal upheld the CIT(A)'s decision, affirming that the loss is allowable under section 37(1) and that section 43A is inapplicable to trading assets. The issue was thus resolved in favor of the assessee, and Ground No.1 of the Revenue's appeal was dismissed.Ground No.2: Addition Made on Revaluation of Closing Stock Due to Foreign Exchange FluctuationThe AO added Rs. 1,72,95,930/- to the closing stock value, arguing that foreign exchange fluctuation payments should be included in the cost of diamonds. The AO noted that the assessee valued inventory per AS-2 but did not add exchange rate fluctuation costs at the time of payment to the purchase cost.The CIT(A) deleted the addition, explaining that AS-11 requires foreign currency transactions to be recorded at the exchange rate on the transaction date and not revaluation for non-monetary items like closing stock. The CIT(A) emphasized that foreign exchange loss is a revenue outflow, not a cost, and should not be added to inventory cost. The CIT(A) also noted the principle of valuing stock at the lower of cost or realizable value, which does not support adding foreign exchange fluctuation to inventory cost.The Tribunal supported the CIT(A)'s decision, referencing the Bangalore Tribunal's decision in IBM Global Services India P. Ltd. and its affirmation by the Karnataka High Court. The Tribunal concluded that foreign exchange fluctuation after purchase does not affect inventory valuation, and this issue was decided in favor of the assessee.Ground No.3: Addition on Account of Sale of Wastage and Scrap ValueThe AO estimated an income of Rs. 1,01,11,946/- from the sale of scrap/wastage generated during diamond cutting and polishing, based on a 5% estimate of the purchase value of rough diamonds. The AO observed that the assessee did not report any income from such scrap/wastage.The CIT(A) deleted the addition, noting the lack of evidence of scrap/wastage sales and no findings during a survey under section 133A. The CIT(A) emphasized that the onus to prove income lies with the Revenue, which was not discharged. The CIT(A) also noted that the yield was consistent with industry standards and past assessments without any scrap income findings.The Tribunal found that the AO's addition was based on assumptions without evidence. However, the CIT(A) did not address the actual handling of scrap or its value. The Tribunal restored the issue to the AO for fresh examination, considering the assessee's explanations and evidence.Conclusion:The appeal of the Revenue was partly allowed for statistical purposes, with the Tribunal upholding the CIT(A)'s decisions on Grounds No.1 and No.2, and remanding Ground No.3 for further examination. The order was pronounced in the open court on 29.06.2016.