TaxTMI 
TaxTMI 
2016 (7) TMI 1051
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.... sale of motor vehicle parts and accessories. The assessee filed its e-return on 29.09.2009 for assessment year 2009-10 admitting a loss of Rs. 28,78,28,997/-. Subsequently, the case was selected for scrutiny and the assessment u/s.143(3) was completed on 29.12.2011 after making certain disallowances. 3.1 The facts of first ground relates to disallowance u/s.14A of the Act to the tune of Rs. 15,23,543/-. During the course of assessment proceedings, the AO had found that the assessee had investment in tax free territory amounting to Rs. 2,09,41,000/- as on 31.3.2008. The investment in mutual fund had 'been redeemed and the value as at 31.3.2009 is Rs: Nil. The assessee had got dividend income of Rs. 1.25 crores during the year which is exempt u/s 10(35). The AR submitted before the AO that the disallowance' is uncalled for since the assessee has not incurred any expenditure towards operating and maintaining the same by relying on series of case laws delivered in assessee's favour and further contended that the interest payment is for loan' obtained for specific purposes and not for investments. The AR has also contended before the AO that the assessee has enormous Reserves & Surp....
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....ule 8D(ii), the total disallowance should be Rs. 13,02,894/- and disallowance under Rule 8D(iii) i.e. 0.5% of the average investments of Rs. 10,47,05,000/- worked out Rs. 5,23,525/-. Then total disallowance should be Rs. 18,26,419/-. He submitted that the findings of CIT(A) with reference ot applicability to component 'C' in formula A x B / C in Rule 8D(ii) is also in-appropriate. The, he submitted that the order of the AO may be confirmed. 3.5 We have heard both the parties and perused the material on record. In this case, the assessee having investments which yielded exempt income and which does not form total income of assessee, then this Rule-8D is applicable. The plea of the assessee is that Rule-8D(ii) & (iii) is not applicable to the assessee's case as the assessee is having own funds. However, the assessee is not able to demonstrate what is the own funds available to the assessee to make investments which yielded exempt income. The fund flow filed by the assessee does not show date on which the assessee made investments out of own funds. Being so, the argument of assessee cannot be the good explanation to hold that the assessee is not incurred interest expenditure on fun....
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....on that lower authorities have taken the correct view of the facts of the case and this ground of assessee is rejected. 5. The next ground in revenue's appeal is with regard to MTM losses on forward contracts are contingent in nature and a provision created on such notional loss cannot be allowed. 5.1 The facts of the issue are that the assessee has failed to add back provision for MTM losses of Rs. 18.51 crorés. During the assessment proceedings, the ld.A.R submitted that the removal of MTM losses from the profits of business is incorrect since it is irretrievably linked to the business of the assessee. AO observed that re-statement of export receivables as at the end of the Financial Year is acceptable, though notional because of the decision of Supreme Court in the case Woodward Governor Ltd. reported in (2009) 312 ITR 254. In case of MTM losses on forward contracts, the export receivables are already received by the assessee at the time of entering the forward contract and the transaction traverses from debtors to that of the Banker. Therefore, the transactions lose its identity as business transaction. Further, AO observed that losses on forward contracts when the....
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....ative is a financial instrument whose value depends on the values of the underlying exposure. The underlying exposure in the case of forex derivatives is the foreign exchange rates. The common foreign exchange derivatives are, forward contracts, option contracts and swap contracts, etc. These instruments are used to hedge the currency risk on account of adverse currency movements. 4.5.2 The term ' Marked to Market' losses (MTM) refers to losses computed as on a particular date with reference to prevailing exchange rate in respect of contracts that have not matured (i.e. open contracts). As per the prescribed Accounting Standards, companies are required to account for the MTM losses in their books of account despite the fact that the contract has not yet matured as on the Balance Sheet date. 4.5.3 Foreign exchange Forward Contract means an agreement to exchange different currencies at a forward rate. Forward rate is the specified rate for exchange of currency at a specified future date. The assessee, in the case on hand, entered into a forward contract with the Bank to buy or sell foreign exchange at an agreed price on a future date in order to hedge against possib....
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....d not give the assessee the right to claim the loss under the Income Tax Act. It is this contention of the Assessing Officer that requires to be examined, having regard to the fundamental commercial principles which have received judicial recognition. It is a settled principle, upheld in several decisions of the Courts, that deduction is allowable under the Act in respect of liabilities that have crystallised during the year. If an anticipated future liability is coupled with a present obligation, then that results in crystalhsed hability, even though the quantification may vary depending upon the terms of contract. A contingent liability depends purely on the happening or not happening of an event. Whereas, if an event has taken place, which in the case on hand was of entering into the contract and undertaking of the obligation to meet the liability, and only the consequential effect of the same is to be determined, then it cannot be said that it is in the nature of contingent liability. It is to be borne in mind that the issues relating to the accrual of income cannot be decided on the same footing and considerations on which issues relating to losses are to be decided. In the ca....
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.... above, one of the main arguments advanced by the learned AddI. Solicitor General on behalf of the Department before us was that the word "expenditure" in s. 37(1) connotes "what is paid out" and that which has gone irretrievably. In this connection, heavy reliance was placed on the judgment of this Court in the case of Indian Molasses Company. Relying on the said judgment, it was sought to be argued that the increase in liability at any point of time prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-a-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression "expenditure incurred" while dealing....
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....paid" in s. 43(2), which is used in several ss. 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under s. 28/29. That is why in deciding the question as to whether the word expenditure' in s. 37(1) includes the word "loss11 one has to read s. 37(1) with S. 28, s. 29 and s. 145(1). One more principle needs to be kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under s. 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L a/c the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to....
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....et is an item of expenditure under s. 37(1) of the 1961 Act. 16. In the light of what is stated hereinabove, it is clear that profits and gains of the previous year are required to be computed in accordance with the relevant Accounting Standard. It is important to 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 lowerthe market value being ascertained as 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 aset. It is a trading asset. Therefore, the c....
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....y items which have to be valued at the closing rate under AS-il. Under para 5, a transaction in a foreign currency has to be recorded in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. This is known as recording of transaction on initial recognition. Para 7 of AS-il deals with reporting of the effects of changes in exchange rates subsequent to initial recognition.Para 7(a) inter alia states that on each balance sheet date monetary items, enumerated above, denominated in a foreign currency should be reported using the closing rate. In case of revenue items falling under s. 37(1), para 9 of AS-il which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under s. 43A of the 1961 Act. At this stage, we are ....
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....to find out if an expenditure is deductible the following have to be taken into account (i) whether the system of accounting followed by the assessee is mercantile system, which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due, immediately it becomes due and before it is actually received; (ii) whether the same system is followed by the assessee from the very beginning and if there was a change in the system, whether the change was bona fide; (iii) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue to it; (iv) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (v) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted Accounting Standards; (vi) whether the system adopted by the assessee is fair and reasonable or is adopted only with a view to reducing the incidence of taxation." 4.5.7 As can be seen from the extractions reproduced above, the decisi....
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....an obligation is pending on the balance sheet date and such a liability cannot be said to be a contingent liability. iv) The accounting treatment is as per Accounting Standards and the ICAI Guidelines. v) The principles enunciated by the Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra) are applicable to the facts of the case on hand. 4.5.9 We had earlier observed that the Assessing Officer had relied on the CBDTs Instruction No.3/2010. Paras land 3 of this Instruction reads as under: "1. Foreign Exchange derivative transactions entered into by the corporate sector in India have witnessed a substantial growth in recent years. This combined with extreme volatility in the foreign exchange market in the last financial year is reported to have resulted in substantial losses to an assessee on account of trading in forex-derivatives. A large number of assesses are said to be reporting such losses on 'marked to market' basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whether such losses on account of forex-derivatives can be allowe....
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....ettled and no actual delivery of the goods was effected under the settlement then it is a speculative transaction. The requirement of section 30 of the Indian Contract Act of the existence of the intention of the parties even at the time of the original contract not to give or take delivery of the goods in order to make it a speculative/wagering transaction is dispensed with for the purpose of the Act and if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes im-material. Thus, the true test is delivery of commodities/goods as per the contract, including a forwarding contract. Profit/loss in respect of unperformed contracts is considered speculation profit/loss. In short, in order that a transaction may fall within the scope of the expression 'speculative transaction', it must be a transaction in which a contract for purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips. 5.2.2. Here, it would be useful to appreciate in proper perspective how hedge transactions are ....
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....ery irrespective of the date on which the contract was entered into. In respect of a hedging contract, profit/loss arising there from can be ascertained or crystallied at fixed intervals of the term when the clearance takes place. 5.2.2.a. By resorting to counterbalancing transactions in the market for the ready commodity on the one hand and in the hedge market on the other hand, the hedger seeks to safeguard his position. The movement of prices in the two markets may not always follow an identical course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. This well-known technique, of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forw....
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....nst such loss that he entered into the forward contracts of sale, he could not claim the benefit of clause (a) of the proviso to section 43(5). With regard to speculative I hedging transactions we had benefit of perusing the judgments of M.G. Bros. V CIT (1985) 1564 itr 695/20 Taxman 90 (AP), Nuddea Mills Co. Ltd. V. CIT (1988) 171 ITR 169 (1987) 35 Taxman 3 (Cal), Delhi Flour Mills Co. Ltd. V CIT (1974) 95 ITR 151 (Del) and Pankaj Oil Mills V CIT (1978) 115 ITR 824 (Guj) delivered by the Hon'ble High Courts of Andhra Pradesh, Calcutta, Delhi and Gujarat respectively." 4.5.11 As discussed earlier, in the case on hand there has been an existing contract with a binding obligation accrued against the assessee when it entered into for-ex forward contracts. The forward contracts are in respect of consideration for exports proceeds, which are revenue items. There is an actual contract for sale of merchandise. In this factual matrix, it is clear in our view that the transaction in question will not qualify to be called as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision for losses on derivative con....