TaxTMI 
TaxTMI 
2015 (1) TMI 869
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....,000 under Chapter VI-A of the Income Tax Act, 1961 (hereinafter referred to as 'the Act'). The return was processed u/s.143(1) of the Act and the case was subsequently taken up for scrutiny. The assessment was completed under section 143(3) of the Act by order dt.22.2.2013, wherein the income of the assessee was determined at Rs. 44,91,86,187 as against the returned income ofRs.28,48,96,860 due to the following additions thereto / disallowances made : i) Disallowance of provision on loss on derivative contracts : Rs. 16,35,54,352. ii) Disallowance u/s.14A : Rs. 7,34,975. 2.2 Aggrieved by the order of assessment for Assessment Year 2009-10 dt.22.2.2013, the assessee preferred an appeal before the CIT(Appeals) - III, Bangalore. The learned CIT (Appeals) disposed off the assessee's appeal by order dt.11.11.2013 allowing the assessee partial relief. In this order, the learned CIT (Appeals) upheld the decision of the Assessing Officer in disallowing the provision for loss in derivative contracts. The learned CIT (Appeals), however, allowed the entire actual loss incurred in respect of derivative contracts in the period under consideration i.e. Assessment Year 2009-....
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....ture sales that were determined with reasonable certainty; 8. The learned CIT(A) has erred in law and on facts in holding that the decision of the Honourable Supreme Court in the case of Woodward Governor India Private Limited (312 ITR 254) is not applicable in the case of the Appellant on the basis that the facts are completely distinguishable; 9. The learned CIT(A) has erred in law and on facts in not following the decision of the Mumbai Income Tax Appellate Tribunal (Special Bench) in the case of DCIT v. Bank of Bahrain & Kuwait (ITA No 4404 & 1883/MUM/2004), the facts of which squarely apply to the Appellant's case in hand; 10. The learned CIT(A) has erred in law and on facts in making disallowance under section 14A of the Act read with Rule 8D of the Rules of Rs. 734,975 in the computation of business income; 11. The learned CIT(A) has erred in not appreciating the fact that the Appellant has not earned any exempt income by way of investment in equity shares of the companies either during the subject AY or in the prior years from the time that such investments were made; 12. The learned CIT(A) has erred in law and on facts by stating that the investments in the ....
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....8-09. 20. Without prejudice to the existing grounds of appeal and the additional ground of appeal, that the AO be directed to allow carry forward of the losses arising on marking to market the derivative contracts, incurred during the subject AY 2009-10, for set-off against profits/ gains arising from derivative contracts in the future Assessment Years." 3.2 Revenue's Grounds of appeal. "1. The order of the learned CIT (Appeals) is opposed to law and facts of the case. 2. On the facts and in the circumstances of the case the learned CIT (Appeals) erred in law in directing the Assessing Officer to allow the assessee a loss on speculation actually incurred by the assessee amounting to Rs. 4,17,44,239. 3. On the facts and in the circumstances of the case the learned CIT (Appeals) erred in not appreciating the CBDT Instruction NO.3/2012 as per which the contracts in derivatives were clearly speculative ones and the provisions of section 73 of the Act do not provide for allowing the setting off the speculation loss against the income of the current assessment year and the speculative loss can only be allowed to be carried forward and set off against the income from specul....
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....speculative transaction; iv) Loss not arising out of regular business transactions and also not on account of restatement of assets and liabilities is only speculative loss and cannot be allowed as expenditure. v) CBDT Instruction No.3/2010 has laid down the guidelines that whenever there is no sale or settlement, the losses on financial instruments on MTM basis are notional losses and contingent in nature and cannot be allowed to be set off against taxable income. 4.2.3 On appeal, the learned CIT (Appeals) upheld the decision of the Assessing Officer in adding back the provision by relying on the decision of her predecessor for Assessment Year 2008-09. The relevant points made in the order of the earlier year, quoted by the learned CIT (Appeals) is enumerated below, to get the perspective of the reasoning adopted by the learned CIT (Appeals) :- i) The law does not provide for the deduction of liabilities which are unascertained because the actual transactions had not taken place. ii) Notional losses and notional income do not come within the purview of the IT Act, except when specifically provided for such as sections 115, 44AC, etc. iii) The reliance on the deci....
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....bankers to sell foreign curriencies at a pre-determined rate. These contracts are typically spread over a period of 2 - 3 years. Due to the financial turmoil and uncertainty in the year under consideration, the Indian Rupee depreciated against the dollar thereby resulting in significant losses. 4.3.3 Such foreign exchange losses are required to be provided for and debited to the profit and loss account, as per the requirements of AS-11 dealing with "Accounting with the effects of changes in the Foreign Exchange Rates" and also the announcement of accounting for derivatives issued by the ICAI dated 29.3.2008. In accordance with the same, the assessee has provided for losses on derivative contracts and charged it off to the profit and loss account. 4.3.4 Relying on various judicial pronouncements and the principles laid down therein, the assessee submitted that the losses are allowable as business expenditure due to the following reasons :- i) The MTM losses are claimed as per the requirements of AS-11 and the guidelines on accounting of derivatives issued by ICAI. ii) It is settled principle that the accounting practice regularly followed should be taken as the basis for....
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....uy or sell foreign exchange at an agreed price on a future date in order to hedge against possible future financial loss due to fluctuation in the rate of foreign currency. Therefore; (i) Firstly, the foreign exchange forward contract created a continuing, binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity; and (ii) Secondly, it is in the nature of a hedging contract because it is a contract entered into against possible future financial losses. It follows from the above that while it is true that the assessee would come to know of the actual profit / loss only on the date of maturity, unless there is any premature cancellation of the contract, it is equally true that the assessee could anticipate the loss on the valuation date, say 31st March, with reasonable accuracy. Prudent accounting and commercial principles require that all accrued losses have to be taken into account. 4.5.4 Having considered the nature of the contract, it needs to be examined whether on account of the existing obligation arising out of the contract, a liability accrued as per the provisions of the Income Tax Act. In this regard, it is nece....
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....ich issues relating to losses are to be decided. In the case of loss / expenditure, the concept of reasonable certainty to meet an existing obligation comes into play; which in legal terminology is referred to as "crystallisation of liability". This is in keeping and consonance with the principle of prudence as considered by the Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra). The substantial questions of law before the Hon'ble Apex Court for consideration as extracted from para 3 of its order is as under :- "3. In this batch of civil appeals, the following question arises for determination: "(i) Whether, on the facts and circumstances of the case and in law, the additional liability arising on account of fluctuation in the rate of exchange in respect of loans taken for revenue purposes could be allowed as deduction under s. 37(1) in the year of fluctuation in the rate of exchange or whether the same could only be allowed in the year of repayment of such loans? (ii) Whether the assessee is entitled to adjust the actual cost of imported assets acquired in foreign currency on account of fluctuation in the rate of exchange at each balance s....
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....f the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in praesenti and a liability de futuro. The word "expenditure" is not defined in the 1961 Act. The word "expenditure" is, therefore, required to be understood in the context in which it is used. Sec. 37 enjoins that any expenditure not being expenditure of the nature described in ss. 30 to 36 laid out or expended wholly and exclusively for the purposes of the business should be allowed in computing the income chargeable under the head "Profits and gains of business". In ss. 30 to 36, the expressions "expenses incurred" as well as "allowances and depreciation" has also been used. For example, depreciation and allowances are dealt with in s. 32. Therefore, Parliament has used the expression "any expenditure" in s. 37 to cover both. Therefore, the expression "expenditure" as used in s. 37 may, in the circumstances of a particular case, cover an amount which is really a "loss" even though the said amount has not gone out from the pocket of the assessee. 14. In the case of M.P. Financial Corporation vs. CIT (1986) 51 CTR (MP) 249 : (1987) 165 ITR ....
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.... business profits arising during the year needs to be computed. This is one more reason for reading s. 37(1) with s. 145. For valuing the closing stock at the end of a particular year, the value prevailing on the last date is relevant. This is because profits/loss is embedded in the closing stock. While anticipated loss is taken into account, anticipated profit in the shape of appreciated value of the closing stock is not brought into account, as no prudent trader would care to show increase profits before actual realization. This is the theory underlying the rule that closing stock is to be valued at cost or market price, whichever is the lower. As profits for income-tax purposes are to be computed in accordance with ordinary principles of commercial accounting, unless, such principles stand superseded or modified by legislative enactments, unrealized profits in the shape of appreciated value of goods remaining unsold at the end of the accounting year and carried over to the following years 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 no....
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.... 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 that for the purpose of s. 28 and s. 56 alone, income, profits and gains must be computed in accordance with the method of accounting regularly employed by the assessee. In this case, we are concerned with s. 28. Therefore, s. 145(1) is attracted to the facts of the present case. Under the mercantile system of accounting, what is due is brought into credit before it is actually received; it brings into debit an expenditure for which a legal liability has been incurred before it is actually disbursed. (judgment of this Court in the case of United Commercial Bank vs. CIT (1999) 156 CTR (SC) 380 : (1999) 240 ITR 355 (SC)). Therefore, the accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till the AO comes to the conclusion for reasons to be given that the system does not reflect true and correct profits. As stated, there is no finding given by the AO on the correctness of the Accounting Sta....
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....1 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-11 recognises exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-a-vis the Indian rupee, there is an expense during that period. The important point to be noted is that AS-11 stipulates effect of changes in exchange rate vis-a-vis monetary items denominated in a foreign currency to be taken into account for giving accounting treatment on the balance sheet date. Therefore, an enterprise has to report the outstanding liability relating to import of raw materials using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P&L account for the reporting period. 19. A company imports raw material worth US $ 250000 on 15th Jan., 2002 when the exchange rate was Rs. 46 per US $. The company records the transaction at that rate. The payment for the imports is made on 15th April, 2002 when the exchange rate is Rs. 49 per US $. However, on the balance sheet date, 31st March, 2002, the rate of exchange is Rs. 50 per US $. In such a case, in terms of AS-11, ....
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....e case of Woodward Governor India Pvt. Ltd. (supra) has been rendered in respect of "monetary items", denominated in foreign currency which include to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency notes, balance in bank accounts denominated in a foreign currency, receivables / payables and loans denominated in a foreign currency, sundry creditors, etc. are all monetary items. The decision is also related to transactions in which a legal liability has been incurred before it is actually disbursed. We are therefore unable to concur or agree with the view of the learned CIT (Appeals), that liability could arise only when the contract would have matured, as such a stand is totally divorced from the accounting principles and is in variance with the principle upheld by the Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra). It can also be seen that the decision in the case of Woodward Governor India Pvt. Ltd. (as extracted above) has been rendered with regard to items in the revenue account and capital account. Therefore, the view of the learned CIT (Appeals) that this decision of the Hon'b....
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....sidered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below: 2...... 3. Treatment of loss from actual transactions in forex-derivatives. In a case where a loss on a forex-derivative transaction arises on actual settlement / conclusion of contract and is not a notional or marked to market book entry, a further question will arise as to whether such a loss is on account of a speculative transaction as contemplated in Section 43(5) of the Income tax Act. For determining whether loss from a transaction in respect of a forex-derivative is a speculation loss or not, the Assessing Officers may refer to Proviso (d) below sub-section (5) of Section 43 inserted by the Finance Act, 2005, with effect from 1.4.2006. It lays down that any 'eligible transaction' in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956, that has been carried out in a recognized stock exchange shall not be treated as a speculative transaction. Further, an 'eligible transaction' for this purpose would be one that fulfils the conditions laid down in Explanation to Section 4....
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....iso (a) to section43(5). Hedge contracts are those contracts which hedge against prejudicial price fluctuations. In speculative transactions the modus operandi of persons indulging in them is that when one enters into a contract of purchase, he also simultaneously enters into one or more contracts of sale against the same quantity deliverable at the same time either to the original vendor or to someone else, so as either to secure profit or to minimize loss, before the Vaida day ; and similarly when he enters into a contract of sale, he simultaneously enters into one or more contracts to purchase the same quantity before the Vaida day. The result of such dealings, when the sale and purchase are to and from the same person, has the effect of cancelling the contracts leaving only differences to be paid. The technique of hedge trading can be understood in simple terms. It is said that the hedge contract is so called because it enables the persons dealing with the actual commodity to hedge themselves, i.e., to insure themselves against adverse price fluctuations. A dealer or a merchant enters into a hedge contract when he sells or purchases a commodity in the forward market for deliver....
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.... his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the commodity, manufactured or the merchandise sold. 5.3. Hedging contracts are dealt in Clause (a) of the proviso to section 43(5) of the Act. From the above discussion it can safely stated that the said clause applies, if following conditions are fulfilled: (1) There is a contract for actual delivery of goods manufactured by the assessee /a merchandise sold by it, (2) Assessee must be a subsequent transaction intend to guard against losses through future price fluctuations in respect of such contract, (3) Transaction in question must be a contract entered into in respect of raw materials or merchandise in the course of the assessee's manufacturing business and it should....
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....llowance u/s.14A of the Act. 5.1 In the course of assessment proceedings, the Assessing Officer noticed that the assessee had total investments amounting to Rs. 2018.07 lakhs as on 31.3.2009, out of which Rs. 1900.45 lakhs was investment in equity shares. The assessee submitted that it had not earned any exempt income in the form of dividends from these investments during the year under consideration and therefore the provisions of section 14A of the Act are not applicable. The Assessing Officer, however, did not accept the above submissions of the assessee and held that the provisions of section 14A r.w. Rule 8D of the I.T. Rules, 1962 mandates that the Assessing Officer determines the expenditure incurred in relation to income which does not form part of the total income. In coming to this view, the Assessing Officer placed reliance on the decision of the Special Bench of the Mumbai ITAT in the case of Cheminvest Ltd. V ITO reported in 121 ITD 318. Invoking the provisions of section 14A r.w. Rule 8D(2)(iii), the Assessing Officer determined the expenditure incurred at Rs. 7,34,975 and disallowed the same. 5.2 On appeal, the learned CIT (Appeals) upheld the decision of the A....
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....(Appeals) in deleting the disallowance of Rs. 2,03,752 u/s. 14A ignoring the fact that there is difference of opinion of various courts on the view taken by the ITAT that in the absence of tax free income, no disallowance u/s. 14A is permissible." The Hon'ble High Court has answered the above question of law as under :- " As regards the second question, section 14A of the Act provides that for the purposes of computing the total income under the Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under the Act. Hence, what section 14A provides is that if there is any income which does not form part of the income under the Act, the expenditure which is incurred for earning the income is not an allowable deduction. For the year in question, the finding of fact is that the assessee had not earned any tax free income. Hence, in the absence of any tax free income, the corresponding expenditure could not be worked out for disallowance. The view of the CIT (Appeals), which has been affirmed by the Tribunal, hence does not give rise to any substantial question of law. Hence, t....
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....s raised by the assessee at S.Nos.15 and 16 are disposed off as indicated above. 7. Additional Grounds raised by the assessee. 7.1 In view of our decision rendered in the substantive grounds of appeal at S.Nos. 1 to 9, the additional grounds raised by the assessee at S.Nos.19 & 20 (supra) require no adjudication. 8. In the grounds at S.No.17, the assessee denies itself liable to be charged interest under section 234B of the Act. The charging of interest is consequential and mandatory and the Assessing Officer has no discretion in the matter and we therefore uphold his action of charging the said interest. The charging of interest has been upheld by the Hon'ble Apex Court in the case of Anjum M.H. Ghaswala reported in 252 ITR 1. The Assessing Officer is, however, directed to recompute the interest chargeable under section 234B of the Act, if any, while giving effect to this order. 9. In the ground raised at S.No.18, the assessee has challenged the order of the learned CIT (Appeals) in dismissing its appeal on the issue of the Assessing Officer initiating penalty proceedings by issue of notice under section 274 r.w.s. 271 of the Act. As observed by the learned CIT (Ap....