TaxTMI 
TaxTMI 
2010 (8) TMI 578
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.... the accounting period. In such cases, the assessee evaluates the unmatured forward contracts on the last day of the accounting period on the basis of rate of foreign exchange prevailing on that date and books the loss or profit, accordingly. This methodology was adopted keeping in view the guidelines laid down by the Reserve Bank of India as per rates notified by Foreign Exchange Dealers Association of India (FEDAI). The revenue's stand is that in view of the decision of the Hon'ble Madras High court in the case of Indian Overseas Bank, 183 ITR 200(Mad), this method of accounting is not correct because the loss is incurred on the date of maturity of the contract and there cannot be any loss prior to such date. The assessee's stand is based on the decision of the Mumbai Tribunal in the case of Deutsche Bank A.G., 86 ITD 431(Mum) and FEDAI guidelines. In the reference order, it is pointed out that the decision in the case of Deutsche Bank A.G. (supra) proceeded on the basis that forward contract constitutes stock-in-trade, and, therefore, same could be valued at the end of the year, which may result into loss. It is further pointed out that in Deutsche Bank (supra) the decision of t....
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....p;Broken period interest on securities lying in stock-in-trade. : Rs. 8,95,011/- iii) Loss on forward exchange transaction : Rs. 12,42,648/- iv) Deferred guarantee commission : Rs. 1,45,27,210/- (Rs.1,70,46,547 -Rs.25,19,337/-) v) Interest attributable to investments in Shares : Rs. 1,01,34,587/- 4. For the assessment year 1998-99 also, the Assessing Officer determined the total income a....
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....; He further pointed out that the Hon'ble Supreme Court admitted the SLP filed by the department against the decision of the Hon'ble Karnataka High Court in the case of Canara Bank. He, accordingly, held that since the assessee was following mercantile system of accounting, the profit or loss at the end of the accounting year will be based not on the difference between what was actually received or paid but on the difference between the right to receive and the liability to pay. 8. Before ld CIT(A), it was, inter alia, contended that with the abolition of sections 18, 19 and 20 of the I.T. Act w.e.f. 1.4.1989, no provision is made in the Act to define separately the scope of interest on securities which could be taxable. Consequently, the interest on securities assessable would be the amount which could be charged under the charging provisions of section 5, which, apart from charging income on receipt basis, also provides for charging of income when it accrues or is deemed to accrue to the assessee. Section 145 of the Act provides that the income from business should be computed in accordance with the method of accounting regularly employed by....
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....see's own case for the assessment years 1992-93, 1993-94, 1995-96 and 1996-97. In A.Y. 1996-97, the Tribunal has allowed the assessee's appeal, inter alia, observing as under:- "We have carefully perused the order of the Tribunal cited above. In that case also, the issue was identical, namely, whether in the case of Government securities, interest accrues on day to day basis or only on the coupon dates. The Tribunal held that interest accrues only on the coupon dates and not on day to day basis. In coming to this conclusion, the Tribunal placed reliance on the judgment of the Lahore High court in Haveli Shah Sardarilal v CIT,Punjab, 4 ITR 297, the Full Bench of the Patna High Court in Ranjit Prasad Singh v CIT, Bihar & Orissa (4 ITC 264) and the Karnataka High Court judgment in Addl CIT, Mysore v. The Vijay Bank Ltd., Mangalore (1976) Tax LR 524. It was also noticed by the Tribunal that the contention advanced on behalf of the revenue before Tribunal in that case was totally contradictory to the contention advanced by the revenue before the Karnataka High court in the case of Vijay Bank(supra) before the Tribunal. The department had placed reliance on the judgement of the ....
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....est component as a revenue item. The AO was of the opinion that since the interest element was a part of lumpsum consideration, therefore, to the extent, the securities were lying in the stock, the interest paid on the same could not be disallowed as deduction, inter alia, observing that since they were current investments, the amount of interest paid on assets, which were purchased and sold during the year, was ignored. The AO had relied on the decision of the Hon'ble Supreme Court in the case of Vijay bank, 187 ITR 541, wherein, it was held that the broken period interest paid is a part of capital cost of the asset. 15. Before ld CIT (A), the assessee submitted that the interest pertained to the period during which, the securities were held by the assessee did not accrue to the assessee but to the vendors. Accordingly, although the assessee received such interest from the issuer, it did not belong to the assessee and, hence, the same could not be subjected to tax in its hands. Ld CIT (A) pointed out that the facts in the case of Vijay Bank were different and the assessee's case was identical to the case of American Express International Banking Corporation. He, accordingl....
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.... would not be entitled to any further deduction and the disallowance of broken period interest with reference to securities not sold during the year was to be upheld. He submitted that in the present case, the decision in the case of Vijay bank (supra) is applicable. He further submitted that in case of any doubt in this regard, the matter may be restored back to the file of the AO to verify the same in view of RBI guidelines and Board's circular No.665. Alongwith written submissions, he has filed an Article giving details of RBI guidelines regarding securities by M.S.Prasad. 17. Ld counsel for the assessee submitted that in assessee's own case for the assessment year 1992-93, the issue has been decided in favour of the assessee. He pointed out that the CIT (DR) in his submissions conceded that if the securities are held as trading asset, then the broken period interest would be allowable. He clarified that the profit made by the bank on sale of the securities has been taxed as business profit and not as capital gain. In this regard, he referred to the AO's computation at the end of the assessment order. He further pointed out that this fact has been mentioned by the ITAT in its....
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....n account of deferred guarantee commission. 21. Facts are that the AO required the assessee to submit the details of guarantee commission received during the year and whether the same had been accounted for as income or not. The assessee submitted that it was following mercantile system of accounting and, therefore, accounting the guarantee commission related to the year only. The AO was of the opinion that the transaction involving bank guarantee is only in the year the guarantee is given. The assessee got the right to receive the said commission in the said year. He observed that guarantee commission was not advance commission received and, therefore, there was no question of deferring the same to future year. He, accordingly, considered the entire income relating to guarantee commission in the year in which the guarantee was given. 22. Before ld CIT (A), it was contended that since the assessee was following mercantile system of accounting and had been offering to tax the guarantee commission during the currency of the period of guarantee, there was no justification to assess the same on receipt basis. Ld CIT (A) after considering the concept of accrual observed that ....
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.... Thus, the decision in the case of Bank of Tokyo Ltd (supra) is not applicable. He submitted that the spread over of the guarantee commission can be allowed only if the commission was refundable on premature revocation of guarantee. He submitted that fact whether the commission was refundable or not has not been examined and, therefore, the matter may be restored to the file of the AO. 24. Ld counsel for the assessee relied on the order of ld CIT (A), the decision of the Hon'ble Calcutta High Court in the case of Bank of Tokyo Ltd (supra) and also the decision of the Hon'ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd (supra). He submitted that in view of the decision of the Hon'ble Supreme Court in the case of Madras Industrial Investment Corporation Ltd (supra), the guarantee commission is required to be spread over the period of guarantee on the principle of matching . 25. We have considered the rival submissions and perused the record of the case. The fundamental principle of taxing the income under the mercantile system of accounting is time of its accrual. It is not material whether the amount has been received at the time o....
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...., then the guarantee commission is to be spread over the period for which the guarantee is given else it is to be taxed in the year the guarantee had actually been given irrespective of the period for which it spread. This ground is allowed for statistical purposes. 26. Ground No.5 similar to both the assessment years is that ld CIT (A) erred in deleting the addition being interest attributable to investment, dividends from which is exempt from tax. 27. The Assessing officer noticed that the assessee had earned dividend of Rs.1,13,63,468/- out of shares of various companies. He was of the opinion that since income from dividend was exempt from tax, therefore, proportionate disallowance was called for out of interest paid on borrowed fund. The assessee in its submissions pointed out that the investment was made out of its own funds and no expenditure had specifically been incurred wholly and exclusively for the purpose of earning such income. The AO did not accept the assessee's contention that since no specific borrowings were made for investment in shares, therefore, proportionate interest on borrowing should not be disallowed. He observed that the borrowed funds m....
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....sue to the file of the AO. This ground is treated as allowed for statistical purposes. 32. Ground No.2 for the assessment year 1998-99 and Ground No.3 for the assessment year 1999-2000 in regard to which reference has been made to the Special Bench reads as under: 'Whether on facts and circumstances of the case, can it be said that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period i.e. before the date of maturity of the forward contract." 33. Facts in brief are that the AO noticed that the assessee had booked a loss on revaluation of forward foreign exchange contracts, which were unmatured on the date of balance sheet, of an amount of Rs.12,42,648/-. He noted that the assessee enters into forward contracts with clients to buy or sell foreign exchange at an agreed price on a future date. This future price was estimated according to certain norms such as forward premium rates for certain currencies. He noted that....
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....n the case of CIT v. Motor Industries Company Limited (229 ITR 137), wherein, it has been held that the income tax law does not allow as expenses all the deductions a prudent trader would make in computing his profits. It is only the actual liability in present which is allowable and not liability in future which for the time being, is only contingent. It was also held that what a prudent trader sets apart to meet a liability, not actually present but only contingent, cannot bear the character of expenses till the liability becomes real. He also referred to the decision of the Hon'ble Supreme Court in the case of Indian Molasses' case (37 ITR 66), wherein also, it was held that where the liability is contingent, the same is not allowable. The Hon'ble Supreme Court observed as under:- "The expenditure which is deductible for income tax purposes is one which is towards a liability actually existing at the time, but the putting aside of money which may become expenditure on the happening of an event is not expenditure." As regards the assessee's contention that bank was recording its income and expenditure on accrual basis, which was as per the provisions of Section 145 and the ....
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.... computation of total income of the assessee. He also pointed out that in this case the decision of the Hon'ble Madras High Court in the case of Indian Overseas Bank (supra) has been distinguished. 35. Ld CIT D.R. Shri Ajit Kumar Sinha submitted that the assessee is carrying on banking business in India and it is not the assessee's business to deal in forward contracts. It entered into forward contracts with its clients to buy or sell foreign currency at an agreed price on a future date in order to protect the interest of the bank. He submitted that it is a tool to safeguard the assessee's interest. Ld CIT D.R. submitted that these contracts are entered into in order to avoid wide fluctuation in foreign currency. He submitted that there is no dispute in regard to contracts which matured during the year in which they were entered into and the loss/profit was claimed as deduction/income, had been allowed/taxed, accordingly. The dispute is only in regard to those forward contracts, date of maturity of which fall after the end of the accounting year. The assessee revalued its profit/loss on notional basis as per rate of exchange prevailing on the balance sheet date and claimed....
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....e then in view of the decision of the Hon'ble Supreme Court in the case of Woodward Governor of India(supra), the exchange rate difference on the balance sheet date has to be considered for tax purposes. Ld CIT D.R.referred to the decision of the Hon'ble Bombay High Court in the case of CIT v. Kamani Metals and Alloys Ltd, 208 ITR 1017(Bom), wherein, the facts were that the assessee had entered into a contract with MMTC on August 27, 1974 for purchase of 49,981 kgs copper cathodes at the rate of Rs.33,825/- per M.T. The assessee had opened an irrevocable letter of credit on 28^th September, 1974. However, till the end of the relevant accounting year, no material was received by the assessee. The MMTC announced price of copper cathodes at Rs.25,461/- per M.T. for the quarter January to March, 1975. The assessee received the material on 12.3.1975. In the backdrop of these facts, the assessee made a provision amounting to Rs.4,18,021/- for the anticipated loss in the purchase account representing the difference between the contract price and the market price on the date of receipt of the material as the market price of the copper cathodes was less than the contract price. The as....
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....tion was done as per the guidelines of FEDAI, Ld CIT D.R.submitted that the income or expense is to be determined as per the requirements of Income tax Act and as per the guidelines prescribed for preparation of accounts. 38. Ld CIT D.R.further referred to the decision of the ITAT Calcutta Bench Third Member in the case of Eveready Industries India Ltd v. DCIT, 78 ITD 175 (Cal)(tm), wherein, it was held that exchange fluctuation loss of un-matured forward covers (i.e. forward contract) could not be allowed on accrual basis. However, since the assessee claimed that such contract got settled during the year and only remittance was made, the issue was set aside to the AO to ascertain the fact and reconsider the claim of the assessee in accordance with law. Ld CIT D.R.referred to section 145 of the I.T.Act and pointed out that as per sub-section (3), if the AO is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting or accounting standard have not been regularly followed, then the AO can make assessment u/s.144. He submitted that the main object of section 145 is to compute the correct profits and if the correct p....
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....is accrued loss or notional loss. Ld Counsel for the assessee referred to page 8 para 5.3 of ld CIT (A)'s order for A.Y. 1998-99 and pointed out that he has taken note of the fact that as per the RBI guidelines, the assessee was required to revalue its outstanding foreign exchange forward contract as per the rates notified by the FEDAI on March 31^st every year. Ld Counsel submitted that the assessee had to re-assess the anticipated loss at the end of the year in accordance with the method of accounting consistently followed by it. Therefore, it was allowable. Ld counsel submitted that now the issue stands settled by the decision of the Hon'ble Supreme Court in the case of Woodward Governor of India Ltd., 312 ITR 254(SC). Ld Counsel pointed out that the Hon'ble Supreme Court has affirmed the decision of the Hon'ble Delhi High Court in the case of CIT v. Woodward Governor of India Ltd., 294 ITR 451 (Del). In this regard, ld Counsel referred to page 469 and pointed out that in regard to revenue account cases, the Hon'ble Delhi High Court has, inter alia, observed in para 32 that the liability stands accrued the minute the contract was entered into. In support of his contention, ld Co....
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....mputed in accordance with the relevant Accounting Standard. It is important bear in mind that the basis on which stock- in-trade is valued is part of the method of accounting. It is well established, that, on general principles of commercial accounting, in the P&L account, the values of the stock-in-trade at the beginning and at the end of the accounting year should be entered at cost or market value, whichever is lower- the market value being ascertained on the last date of the accounting year and not as on any intermediate date between the commencement and the closing of the year, failing which it would not be possible to ascertain the true and correct state of affairs. No gain or profit can arise until a balance is struck between the cost of acquisition and the proceeds of sale. The word "profit" implies a comparison between the state of business at two specific dates, usually separated by an interval of twelve months. Stock-in- trade is an asset. It is a trading asset. Therefore, the concept of profit and gains made by business during the year can only materialize when a comparison of the assets of the business at two different dates is taken into account. Sec. 145(1) enacts th....
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....orward rate). A forward contract is a foreign currency transaction. The gain or loss on the contract is typically included in determining net income. The amount of gain or loss, except on a speculative forward contract (designed as a risky investment rather than as a hedge), is computed by multiplying the foreign currency amount of the forward contract by the difference between the spot rate at the balance sheet date and the spot rate at the date of inception of the contract." "Agreement that obligates an investor to deliver a specified quantity of one currency in return for a specified amount of another currency. Forward exchange contracts. A forward exchange contract (or forward contract) is a binding obligation to buy or sell a certain amount of foreign currency at a pre-agreed rate of exchange, on a certain future date. Summary A forward contract is an obligation to buy or sell a certain amount of foreign currency at a pre-determined date. Even if your requirements change over the term of the forward contract, you are still obliged to deal. A forward contract obliges you to deal at a specific rate - you are ....
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....he case of Silcon Graphics v ACIT, 105 TTJ 591 (Delhi) and CIT v. Brockhoven BV, (Mumbai ITAT). Ld Counsel for the assessee submitted that from the above decisions, it is evident that the additional liability arisen on account of foreign exchange fluctuation as at the end of the year, is not a contingent or notional liability and hence, allowable. Further, it is not necessary for such additional liability to be allowable, that it must relate to stock-in-trade because all the above cases were cases of loans and not stock-in-trade. he only requirement is that it must be on revenue account, which is not disputed in assessee's own case. 3) The loss on the revaluation of the outstanding forward exchange contracts is allowable on the well recognized principle that an assessee's stock/circulating capital has to be valued at cost or market price, wherever is lower. 40.4 Ld Counsel for the assessee submitted that in any event, forward foreign exchange contracts are in the nature of stock-in-trade and on this count ....
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....ing the assessee has to be adopted. In this regard, he referred to the decision of the 5 Members Special Bench in the case of Narang Overseas v ACIT, 114 ITJ (Mum) 433. 41. In the rejoinder, Ld CIT D.R. submitted that the decision in the case of Woodward Governor of India Ltd, 312 ITR 254 (SC) and 294 ITR 541 (Del) and ONGC (supra) has to be considered in the context in which the same is delivered. He pointed out that the Hon'ble Supreme Court in the case of Woodward Governor (supra) held that the foreign currency notes, balance in bank accounts denominated in foreign currency and receivables/payables and loans denominated in foreign currency as well as sundry creditors are all 'monetary items', which have to be valued at closing rate at the end of the accounting year as per AS-11. He pointed out that this judgment is mainly with reference to stock-in-trade and applies to foreign exchange liabilities in respect of raw materials or stock-in-trade and at the most it can be extended to monetary items noted above. But in the present case, forward foreign exchange contracts are not similar to this specified item. He submitted that in forw....
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.... of currency at a specified date. The assessee enters into forward contract with clients to buy or sell foreign exchange at an agreed price at a future date in order to hedge against the possible future financial loss on account of wide fluctuation in the rate of foreign currency. Thus, firstly, forward foreign exchange contract creates a continuing binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity and secondly, it is in the nature of hedging contract because it is a contract entered into against possible financial losses . Let us take a hypothetical example. Suppose 'X & Co.' is assessee's client. It entered into a contract with 'Y & Co.' on 15.2.2010 for supply of goods at 1,00,000 $, for which payment was to be made after three months on 15.5.2010. Suppose, on the date of contract, the value of Dollar vis-à-vis Rupee was Rs.45. After three months, 'X & Co.', keeping in view the prevailing economic conditions etc., anticipated wide fluctuation in exchange rate. Therefore, it entered into with its bank (assessee) to purchase 1,00,000 $ on 15.5.2010 at say Rs.47/-. Thus 'X & Co.' had hedged the loss ....
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....account per se does not give right to the assessee to claim the loss under Income tax Act. However, ld CIT D.R.'s contention needs to be examined having regard to fundamental commercial principles which have received judicial recognition. It is settled principle that deduction is allowable under the Income-tax Act in respect of those liabilities which crystalise during the previous year. Therefore, the concept of crystalisation of liability under Income-tax Act assumes significance vis-à-vis commercial principles in vogue. As per the commercial principles of policy of prudence, all anticipated liabilities have to be accounted for but as per I.T.Act, only that liability will be allowed which has actually accrued. As a matter of fact, Courts have time and again given due weightage to commercial principles in deciding such issues. However, those anticipated liabilities are not allowable which are contingent in nature but, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystalised on the balance sheet date. It is in conformity with the principles of prudence al....
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..... It does not make any difference if the future date on which the liability shall have to be discharged is not certain. 5. In Metal Box Co. of India Ltd. vs. Their Workmen (1969) 73 ITR 53 (SC) the appellant company estimated its liability under two gratuity schemes framed by the company and the amount of liability was deducted from the gross receipts in the P&L a/c. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability not all at once but spread over a number of years. The practice followed by the company was that every year the company worked out the additional liability incurred by it on the employees putting in every additional year of service. The gratuity was payable on the termination of an employee ' s service either due to retirement, death or termination of service-the exact time of occurrence of the latter two events being not determinable with exactitude beforehand. A few principles were laid down by this Court, the relevant of which for our purpose are extracted and reproduced as under : (i) For an assessee maintaining his accounts on mercantile system, a liability already accrued, though to be discharged at ....
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....me of entering into the contract, the assessee has recorded the income/loss on the basis of difference between the contracted rate and the spot rate. Thus, to say that the contract was incapable of being recognized in the books of account, is not correct. The assessee recorded only the net effect of the transaction and not the entire transaction. Whether the deduction is allowable or not, therefore, cannot be guided by this factor. 46. With regard to observations of the AO regarding method of accounting, we may observe that it is well settled law that a method of accounting regularly employed by the assessee cannot be disregarded unless AO is of the opinion that profits are not correctly deductible from such method of accounting as per the provisions of section 145(3) of the Act. The AO cannot reject the method of accounting followed by the assessee merely on the ground that a better method of accounting could be the alternate one. However, in the present case, though observations have been made by the AO to this effect but actual disallowance has been made by treating the impugned amount as contingent liability. 47. Now, we will consider the issue with reference to....
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....ying amount of fixed assets which are carried in terms of revalued amounts should also be adjusted in the manner described in para 10 above. However, such adjustment should not result in the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that class, the remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve. 12. An exchange difference results when there is a change in the exchange rate between the transaction date and the date of settlement of any monetary items arising from a foreign currency transaction. When the transaction is settled within the same accounting period as that in which it occurred, the entire exchange difference arises in that period/ however, 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" 50. Therefore, this Accounting Standard mandates that in a situation like in the present case, since the transaction is not settled in the same accounting perio....
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....ing year's account in a continuing business are not brought to the charge as a matter of practice, though, as stated above, loss due to fall in the price below cost is allowed even though such loss has not been realized actually." Ld CIT D.R.'s submission is that this decision is with reference to monetary items as referred to in AS-11 and since forward foreign exchange contracts do not come within the monetary items, therefore, the said decision cannot be applied. However, we have already discussed in the concept of recognition of various events in financial statements and have noted that the assessee , in fact, has recorded net effect in its profit and loss account. Therefore, on this count, the department's plea cannot be accepted. Thus, in view of the decision of the Supreme Court in the case of Chellapali Sugar Mills (supra), and also in view of decision of the the Hon'ble Supreme Court in the case of Woodward Governor India (P)Ltd., (supra), assessee's plea deserves to be accepted. 51. Now, coming to the objection of ld CIT D.R. with reference to various decisions relied upon by ld counsel for the assessee on the ground that in the sai....
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....r. Under these facts, the Hon'ble High court held that notional loss claimed by the assessee on the balance sheet date was not allowable because there was merely the contract to purchase the material at a future date. Neither any payment was made by the assessee nor any material was received. This case, in our opinion, cannot be applied to the facts of the present case as in the present case, we are concerned about the anticipated loss booked by the assessee on account of foreign exchange rate fluctuation as on balance sheet date, which was in accordance with RBI guidelines as well as in accordance with AS-11. Moreover, a binding obligation arose the minute the contract was entered into. However, now the decision of the Hon'ble Supreme Court in the case of Woodward Governor India P. Ltd (supra) covers the issue on account of variation in foreign exchange rate with reference to current assets. The facts in the case of CIT v. Kamani Metals and Alloys Ltd (supra) are more akin to such a situation where the assessee has simply ordered for purchase of material at a particular rate but the material has not been supplied by the seller by the end of the accounting period. No liability is a....
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....support of the submission that the increased liability on repayment of a loan borrowed in foreign exchange for business purposes as a result of exchange rate fluctuation would be a capital loss and not a trading loss. What weighed with the Calcutta High Court there appears to be that there was no outflow of funds during the year, as has been urged by the revenue before us. However, a closer scrutiny of the said decision indicates that the Calcutta High Court in this case relied upon its earlier judgement in Sutlej Cottons Mills Ltd v CIT (1971) 81 ITR 641. It will be recalled that the Hon'ble Supreme Court in Sutlej Cotton Mills Ltd v CIT(1979) 116 ITR 1 reversed the aforesaid decision of the Calcutta High Court on this point and held that such liability would be treated as a trading loss. In that view of the matter, the reliance placed by the revenue on the judgement of the Calcutta High Court in Bestobell (India Ltd., (1979) 117 ITR 789 appears misplaced." 56. The controversy stands now resolved in view of the decision of the Supreme Court in the case of Sutlej Cotton Mills Ltd., 116 ITR 1 (SC), wherein, it has been held that fluctuation on account of foreign exchange rate is ....