2015 (4) TMI 1368 - HC - Income Tax

Assessing officer's addition rejected; books, stock and forex derivative loss claim upheld due to consistent treatment and recoveries

CIT CENTRE CIRCLE -22 Versus KOHINOOR FOODS LTD (FORMERLY KNOWN AS) M/s SATNAM OVERSEAS LTD

HC upheld ITAT, rejecting the assessing officer's addition and finding no irregularity in books or stock treatment; consistent high recovery and higher GP ... Treatment of losses on account of derivatives transactions - correctness of the ITAT’s findings with respect to the addition of 1% of sale - HELD THAT:- Treatment of the stock in previous years, which had attained finality, showed that there was nothing irregular in the books maintained by the assessee and that since the assessee had been consistently reporting high yield recovery, i.e., second highest in the industry which was 67% - as against the normal rate of 63-65%, the conclusions drawn by the AO were unsupportable. Besides, the assessee had already shown higher G.P. return rates in the concerned assessment year including the current assessment year, as against that in immediately three preceding years which had attained finality. For the same reasons, the first question sought to be urged by the Revenue does not arise. Loss on account of forex derivatives - ITAT allowed deduction - The assessee - an exporter hedges itself through forex derivatives instrument which ensure that it is not subjected to foreign exchange fluctuation risks. For the relevant year, its realisation led to losses. Its claim for losses was disallowed. The assessee had, inter alia, pointed out that for the previous years, i.e., 2005-06, 2006-07 and 2007-08 in respect of similar transactions, i.e., assumption of derivative trading or sale, the claim for profits and tax realized therefrom had been accepted. Assessee had shown that for some of the years, the net gain/losses had been accepted. That for FY 2006-07, the net profit or gain of Rs.3.72 crores; for FY 2007-08, the net profit of Rs.1.34 crores had been taxed as business profit. On this ground, the ITAT, applying the rule of consistency [accepted by this Court in CIT v. New Poly Pack (P) Ltd. [2000 (4) TMI 26 - DELHI HIGH COURT] accepted the assessee’s contentions. There is nothing to show that the assessee was in any manner disentitled to claim the loss, the correctness of which was never doubted, we are of the opinion that ITAT’s findings cannot be faulted. No question of law arises. ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer's addition of 1% of sales (as a disallowance or adjustment) was justified in view of the assessee's consistent books and historically accepted stock treatment. 2. Whether losses claimed by the assessee on foreign-exchange derivative transactions (held to hedge export/import and foreign-currency exposures) are allowable as business losses or are to be treated as speculative and therefore disallowable. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Validity of 1% of sale addition Legal framework: The assessment must be grounded on demonstrable irregularity in books, inconsistencies with prior finalised assessments, or legally supported basis for estimating income; additions by AO require justification when books have attained finality in prior years. Precedent Treatment: The Court applied its prior common order in related matters rejecting Revenue contentions where prior treatment of stock had attained finality and assessee consistently reported yields higher than industry norms. Interpretation and reasoning: The Tribunal's and this Court's review focused on the consistency of bookkeeping and the assessee's historically higher gross profit/recovery rates (second highest in industry, 67% v. 63-65% norm); prior years' finalised treatment of stock and comparable or higher GP rates in immediately preceding years undercut AO's basis for a blanket 1% addition. Absent fresh material showing irregular bookkeeping or a lawful basis for estimating income, the AO's conclusion was unsupportable. Ratio vs. Obiter: Ratio - where books and prior assessments have attained finality and consistent profit/stock treatment is established, an AO cannot make a mechanical percentage addition without specific enquiry or contrary material. Obiter - none beyond application to facts. Conclusion: The first question does not arise; the addition of 1% of sales was unsupportable and revenue's challenge fails. Issue 2 - Allowability of losses on forex derivative hedging contracts Legal framework: Losses or gains from derivative contracts entered into bona fide for hedging business exposures are to be taxed/allowed as business income/loss, subject to existence of underlying exposure and compliance with RBI/authorized dealer requirements. The rule of consistency governs treatment across years where facts and characterisation are substantially similar. Precedent Treatment: The Tribunal applied the rule of consistency as accepted by this Court (referenced precedent on consistency). No precedent was overruled; the Tribunal's approach was to follow established treatment of similar transactions in prior assessment years. Interpretation and reasoning: The assessee demonstrated export/import invoices, CA certificates of export/import turnover, bank realisation certificates, consultancy confirmations, and evidence that hedging contracts were booked with authorized dealers pursuant to RBI guidelines. The Tribunal found that the AO failed to make specific enquiries and 'simply brushed aside' the evidence, neglecting to identify any particular derivative as not linked to an underlying asset/liability/income/expense. The Tribunal also relied on the fact that in prior years (FY 2006-07 and 2007-08) net gains from similar hedging transactions were offered and taxed as business profit, supporting consistent treatment. Given these facts, the loss was held to be on bona fide hedging transactions and not speculative. Ratio vs. Obiter: Ratio - where detailed evidence establishes that derivatives were entered into as hedges for underlying business exposures and prior assessments have consistently treated similar gains/losses as business income/loss, an AO must examine the specifics before treating losses as speculative; failure to do so warrants allowing the loss. Obiter - observations on the types of exposures hedged (export proceeds, import obligations, FC convertible bonds, PCFC loans) illustrate factual context but are ancillary. Conclusion: The Tribunal's allowance of the claimed loss on hedging transactions is correct; the AO was unjustified in treating those losses as speculative without specific enquiry. The findings of fact and law by the Tribunal cannot be faulted; no substantial question of law arises. Cross-references and Consolidated Outcome The Court affirmed the Tribunal's factual and legal conclusions on both issues: (a) the mechanical 1% addition lacked foundation given finalised prior treatments and consistent profit metrics, and (b) losses from duly documented forex hedging transactions entered with authorised dealers and supported by underlying exposures are allowable as business losses, particularly where prior years' consistent treatment exists. Consequently, the appeal is dismissed.