2025 (8) TMI 1678 - AT - Income Tax

Forex hedge losses allowed; 1% stock addback deleted; DRP exceeded jurisdiction; TP capped at LIBOR; 92B interest disallowed; guarantee 1%

M/s Kohinoor Foods Ltd. Versus DCIT, Central Circle-28, New Delhi

ITAT DELHI - AT held that forex derivative losses were genuine hedging losses, not speculative, and allowed their deduction; the 1% ad-hoc closing-stock ... Loss in Forex derivatives - Whether speculative losses? - HELD THAT:- Issue had arisen in Assessment Year 2008-09 and that year has reached to the Hon’ble High Court in ITA No.79/2015 [2015 (4) TMI 1368 - DELHI HIGH COURT] held that relevant details were filed by the assessee before the AO and AO was not justified in the absence of any particular derivative any transaction was for hedging for assets/ liabilities/expenditure/income/transaction. It is also a fact that assessee has made profit on similar hedging transactions in the Assessment Year 2006-07 and 2007-08 of Rs. 3.72 crores and Rs. 1.34 crores respectively and the same have been offered as business profit in the respective year. We find that the revenue was not justified in not allowing the loss incurred by the assessee on the hedging transactions and holding the same as speculative loss. Ad-hoc addition in question made on account of discrepancy in closing stock at the rate of 1% of sale of rice deleted. DRP has roped new source for the first time during proceedings - Disallowance on account of payments made by the assessee to Marketing Committee Sonipat(MKS) - DRP was of the view that this amount is in the nature of penalty and hence not allowable as per explanation 1 appended to 37(1) - HELD THAT:- Issue on which the DRP has made an addition was not the subject matter of assessment proceedings. Therefore, in our view the DRP has acted beyond jurisdiction. It is settled position of law that there has to be finality of proceedings and if the AO has not touched certain issues, the appellate authorities are not allowed to look into those issues the powers of appellate authorities/ DRP is limited to the extent of those matters which have been discussed during assessment. It is also settled law that if an AO commits an error by not examining the facts and issues which are involved in a given case, then there are other remedies such as 147 and 263 as the case may be The observations made by the Hon’ble Full Bench in the case of Sardari lal [2001 (9) TMI 1130 - DELHI HIGH COURT] would mutatis mutandis apply to the proceedings before the DRP also. Therefore, we are of the firm view that the DRP has no power to assess new source of income which has not been the subject matter of the assessment proceedings. TP Adjustments - transaction of loan advanced by assessee to the AEs - It is pertinent to observe that while deciding the appeal of the assessee for Assessment Year 2016-17, 2014-15 and 2012-13 [2025 (8) TMI 145 - ITAT DELHI], have observed that in one of the impugned years, the CIT(A) has also held that LIBOR rate is justifiable with respect to the loans advance by the assessee to its AEs. Against this finding, the Revenue has not filed further appeal before the ITAT. Therefore, respectfully following the view of the Co-ordinate Bench for Assessment Year, 2008-09, 2009-10 and 2012-13, we hereby allow this grounds of the appeal of the assessee and direct the authorities to restrict the adjustment only to the extent of LIBOR. Addition of notional interest qua delayed the receivables - assessee pointed out that the amendment made in section 92B is not applicable to the impugned years and, hence, there is no question of treating this transactions as international transactions - HELD THAT:- We allow this ground of the appeal of the assessee on two counts a) the amendment brought to section 92B is prospective and not applicable to the present year and hence there is no question of treating this transaction as international transaction b) the assessee has not charged any interest on the outstanding related to Non- AEs. We further observe that in the case of SIRO Clinpharm (P.) Ltd. [2016 (5) TMI 633 - ITAT MUMBAI] has held that prior to the enhancement of the Explanation to section 92B, this transactions of outstanding receivables out of the purview of international transactions and hence cannot be subjected to TP adjustments. Addition on account of notional commission on Corporate Guarantee given by the assessee - We hereby direct the AO to compute the interest @ 1% towards the corporate guarantee given by the assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether losses on forex derivative hedging transactions are business losses or speculative losses and therefore allowable against business income. 2. Whether an ad-hoc addition of 1% of sales on account of alleged discrepancy in closing stock is sustainable. 3. Whether the Dispute Resolution Panel (DRP) can direct an addition in respect of a new source/issue not raised or considered by the Assessing Officer (AO) in the draft assessment order. 4. Whether notional interest (transfer pricing adjustment) is exigible on loans advanced to related foreign enterprises and the appropriate benchmark rate for arm's-length interest. 5. Whether notional interest is exigible on delayed receivables as an international transaction for years prior to the statutory amendment to section 92B (i.e., applicability of the amended Explanation to section 92B). 6. Whether a notional commission/guarantee fee is exigible on corporate guarantees provided to associated enterprises and the appropriate rate. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Tax treatment of losses on forex derivative hedging transactions Legal framework: Taxation of business losses and principle of recognising hedging transactions as business operations when they relate to underlying commercial exposures; rule of consistency in treatment across years. Precedent treatment: Tribunal and High Court decisions in the taxpayer's earlier assessment years accepted similar derivative transactions as hedging and treated profits/losses as business income/loss; those findings attained finality at the High Court. Interpretation and reasoning: The Court examined evidence of underlying commercial exposure (export/import invoices, bank realization certificates, PCA/authorized dealer dealings, CA certifications) and prior years' consistent taxation of gains arising from similar hedging. The AO failed to point to specific underlying assets/liabilities hedged or to rebut the documentary evidence. Given hedging purpose, losses arise from bona fide business risk management and are not speculative. Ratio vs. Obiter: Ratio - where derivatives are documented hedges of underlying commercial exposure and prior consistent treatment exists, losses are allowable as business losses; AO must identify material to justify a contrary finding. Obiter - none significant. Conclusion: Disallowance as speculative loss was set aside; additions for forex derivative losses deleted for impugned years, following High Court's view that ITAT findings could not be faulted where hedging nexus and prior consistency established. Issue 2 - Ad-hoc addition of 1% of sales for discrepancy in closing stock Legal framework: Burden on Revenue to demonstrate unsatisfactory books/accounts or material discrepancy warranting ad-hoc additions; assessment must be based on cogent material. Consistency in accounting and industry norms relevant to stock/yield reconciliation. Precedent treatment: Tribunal and High Court in related assessment years held that where books were properly maintained, industry yield and GP rates were comparable or superior, ad-hoc 1% of sales addition was unsupportable and deleted. Interpretation and reasoning: The Tribunal reviewed evidence of consistent high yield/recovery percentages, comparability of GP rates across years (including years with finality), and absence of cogent material to support the AO's ad-hoc assumption. Mere stock tally differences without specific corroborative evidence do not justify percentage-of-sales additions. Ratio vs. Obiter: Ratio - ad-hoc percentage additions for stock discrepancy cannot be sustained absent material and cogent reasons showing books are unreliable; consistency and demonstrated industry norms rebut speculative additions. Obiter - reliance on particular industry percentages as illustrative of reasonableness. Conclusion: The 1% ad-hoc addition on sales for alleged closing stock discrepancy set aside; AO directed to delete such addition following prior binding appellate findings. Issue 3 - DRP's power to introduce or enhance additions not raised in draft assessment order Legal framework: Section 144C(8) (and Explanation thereto) governs DRP powers to confirm, reduce or enhance variations in draft order; jurisprudence distinguishes matters arising out of assessment proceedings versus introduction of a new source not considered by AO; availability of other remedies (reopening under s.147/148 or rectification under s.263) where AO omitted to consider an issue. Precedent treatment: Conflicting authorities considered - decisions holding DRP may consider matters arising out of assessment proceedings (including Explanation to s.144C(8)) and Full Bench/ Supreme Court precedents limiting appellate enhancement to matters considered by AO; Full Bench Delhi High Court and Full Bench pronouncements emphasize that first appellate/DRP cannot assess new source not considered by AO. Interpretation and reasoning: The Tribunal distinguished cases where DRP examined matters already part of assessment proceedings from cases where DRP introduced a new source not addressed in the draft assessment. The Explanation to s.144C(8) permits DRP to consider matters arising out of assessment proceedings; it does not confer power to create a new source of income where AO never considered the issue. Finality and prescribed remedies (reopening, revision) prevent appellate/DRP from usurping AO's jurisdiction to initiate assessment of a new source. Ratio vs. Obiter: Ratio - DRP lacks power to assess a new source of income not considered by AO in draft assessment; issues not raised in AO's proceedings cannot be validly introduced by DRP and additions made on that basis are beyond jurisdiction. Obiter - clarification on interplay between Explanation to s.144C(8) and established precedents. Conclusion: DRP's addition in respect of late fee/penalty claimed as new source (not considered by AO) held beyond jurisdiction and therefore not sustainable; where DRP relied on matters not traversed by AO, the addition must be deleted. Issue 4 - Transfer pricing: notional interest on loans to associated enterprises and appropriate benchmark Legal framework: Arms-length pricing under transfer pricing provisions; selection of most appropriate comparable for interest rates on cross-border loans; use of internationally recognized benchmarks (e.g., LIBOR) for foreign-currency loans. Precedent treatment: Co-ordinate Bench decisions in earlier assessment years of the same taxpayer held LIBOR (with appropriate spread) to be the correct benchmark for loan transactions in foreign currency; those findings were followed by subsequent Tribunal benches and not challenged further by Revenue. Interpretation and reasoning: The Tribunal found CRISIL corporate bond yields and domestic market data inappropriate comparables for loans denominated in foreign currency. LIBOR is an internationally recognized benchmark for such foreign-currency lending and thus the appropriate yardstick; TPO/DRP's higher rate (based on CRISIL) was unsuitable. Ratio vs. Obiter: Ratio - for foreign-currency loans between related parties, LIBOR (applicable to the year) is the appropriate bench-mark for determining arm's-length interest; comparables should match currency and market characteristics. Obiter - directions to compute adjustment year-wise using the applicable LIBOR. Conclusion: Adjustment restricted to interest computed using LIBOR (with directions to compute annually); higher notional interest based on CRISIL corporate bond rates rejected. Issue 5 - Notional interest on delayed receivables prior to amendment to section 92B Legal framework: Original Explanation to section 92B as in force for relevant years; statutory amendment clarifying international transaction definition made effective prospectively; requirement that an item be an international transaction within the statutory scheme before transfer pricing adjustment can be made. Precedent treatment: Co-ordinate Bench and other authorities held that prior to the Explanation/enhancement to s.92B (effective from 2013-14), notional interest on receivables did not constitute an international transaction and thus was not chargeable to TP adjustments. Interpretation and reasoning: The Tribunal observed that the statutory amendment was prospective and not applicable to the impugned years; additionally, the assessee's commercial practice of not charging interest to unrelated parties demonstrated that charging notional interest only to AEs would be inconsistent and unreasonable. Absent charging interest to non-AEs, symmetrical treatment required rejection of notional interest adjustment. Ratio vs. Obiter: Ratio - prior to the statutory enhancement of Explanation to s.92B, notional interest on delayed receivables did not fall within the definition of international transaction and cannot be subjected to TP adjustment; if no interest is charged to non-AEs, similar notional interest cannot be imposed on AE transactions. Obiter - reference to comparative sales data to support parity of treatment. Conclusion: Notional interest on delayed receivables disallowed for the impugned years on both grounds (prospective inapplicability of amendment and absence of interest charging to non-AEs). Issue 6 - Notional commission/guarantee fee on corporate guarantees Legal framework: Transfer pricing adjustment for guarantees provided to AEs where an arm's-length guarantee fee/commission may be attributable; selection of an appropriate notional rate where comparables justify a standard percentage. Precedent treatment: Co-ordinate Bench in earlier years of the same taxpayer upheld imputation of a 1% notional commission on corporate guarantees as an appropriate arm's-length rate. Interpretation and reasoning: Applying consistency with co-ordinate decisions and accepted practice in the taxpayer's prior assessments, a notional commission of 1% on guaranteed amounts was held to be appropriate for computing TP adjustment; matter remitted to AO for computation at that rate. Ratio vs. Obiter: Ratio - where co-ordinate findings establish an appropriate benchmark, a 1% notional guarantee commission is permissible to compute arm's-length adjustment for corporate guarantees. Obiter - none material. Conclusion: Authorities directed to compute guarantee-related adjustment at 1% commission; implementation remitted to AO for calculation.