TaxTMI 
TaxTMI 
2016 (9) TMI 1608
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....hat "Mark to Market" loss of Rs. 18,80,94,300/- arising on valuation of forward exchange contracts on the closing date of accounting year is not notional loss and, therefore allowable. 2. Whether on the facts and circumstances of the case and in law, the Id.CIT(A)was right in not taking cognizance of the decision of the ITAT,'E' Bench, Mumbai in ITA NO.506/Mum/2013 dt.03.05.2013 in the case of M/s. S. Vinodkumar Diamond Pvt. Ltd. 3. Briefly stated facts are that the assessee firm is engaged in the manufacturing and export of cut and polished diamonds. The AO during the course of assessment proceedings noticed that the assessee has debited a sum of Rs. 18,80,94,300/- as loss on account of outstanding foreign exchange forward contracts. He required the assessee to explain the same as to why the same should not be disallowed by treating the same as notional loss. The assessee explained that the loss on account of "Mark to Market‖ revaluation of forward contracts as per rupee value equivalent to US $ as on 31.3.2009 was claimed. The AO required the assessee to file the details of these losses. According to the AO these losses have not been crystallized and hen....
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....the above, Your Honor shall appreciate the fact that the total amount of foreign currency exposure as on 31 March, 2009 amounts to USD 194.71 million approx. 1.4 Considering the substantial foreign currency exposure and due to substantial fluctuation in foreign currency rates, the appellant entered into the forward contracts (FCs) with the Banks as integral part of the export import business with the aim to hedge and safeguard against the foreign exchange fluctuation of the US doller vis-à-vis the Indian currency, from time to time. 2.0 Details relating to the Forward Contract undertaken by the Appellant during the financial year ended 31 March 2009 2.1 The Appellant herewith submits the following details of foreign exchange gain (loss) made during the year ended 31 March 2009,* such as: Sr. No. Particulars Annexure 1 Statement of revaluation of outstanding forwardcontract as on 31 March 2009 for exchange loss of Rs. 18,80,94,300 A 2 Statement of Gain / (Loss) for Forward Contracts outstanding as on 31 March 2009 and its effect in the subsequent year ended 31 March 2010 B 2.2 The Appellant further submits that th....
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....nd of the year which is as under:- Sr. No. Nature of foreign currency exposure Amount (USD in million, 1 Exports receivables (i.e. overseas debtors) 19.22 2 Imports Payables (i.e. overseas creditors) 9.31 3 Bank loan 65.78 4 Advance from Overseas Customers 8.96 5 Closing Stock for export 91.44 Total 194.72 2.4.6 The appellant has also given the average and month wise exposure in foreign exchange during the F.Y.2008-09 as per which the monthly average of outstanding foreign debtors was US Dollar 40.86 million. Also, stock as on 31.3.2004 was worth US Dollar 91.44 million. The said chart is reproduced herein below:- Average and month wise exposure in foreign exchange during the financial year 2008-09 Month Outstanding forex debtors as on month end Outstanding forex creditors as on month end Outstanding bank loan as on monthend Advance from customers as month end Stock as on month end (expected forex receivables) Total foreign exchange exposure as on contract Apr-08 44,816,959 31,288,490 75,534,866 21,008,529 112,410,918 285,059,763 May-08 44....
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.... [Explanation 1]***** 2.4.8 Justifying that this loss on revaluation was real, Ld.AR for the appellant further contends that: (i)There is no dispute about the incurrence of this loss (ii)Similarly, there is no dispute that the method of accounting followed by the appellant is mercantile as the ld. AO has recorded this fact in the assessment order. (iii)It is not disputed that these losses have been recognized by the appellant in accordance with applicable accounting standards/policies in this regard. (iv)The Id. AO has raised only dispute that this loss is not allowable as a deduction in the year of incurrence computed under mercantile system by following the accounting standards in this respect. (v) `The appellant was obliged to convert outstanding balance of forward contract at the year end rate, which were executed at higher rates, resulting in considerable loss on account of year -end conversion of forward contract positions 2.4.9 It was also stated that The Institute of Chartered Accountants of India, the legal apex body, on accounting matters has issued an Accounting standard "Accounting for the effects o....
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....s accrue on daily basis depending on the fluctuation of US$ and Indian Rupee. Any prudent person would constantly monitor the position of forward contract value on daily basis to assess the impact of profit or loss. It may be appreciated that values of outstanding position of Forward contract is clearly measurable based on daily position of spot rate of US $ against the Rupee, so is it also measurable with complete accuracy, as on the last date of the Balance sheet. iv) Cut-off of 31st March splits profits /losses of outstanding position of forward contracts into two different accounting periods, and that is the only rational way to evaluate profit / loss in a given period. Loss, although purported to be stated by the Id. AO to be notional, is actual and quantifiable. Loss had occurred and accrued, as a result of conversion. Only thing is that such a loss in the subsequent period would get either further aggravated or get placid, depending upon the foreign exchange fluctuation that may happen against the rupee. v) Foreign exchange loss as a result of conversion of outstanding position of Forward contracts is - * real * quantifiable with precision....
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....fied by the legislative enactment. It also held that the method of accounting continuously undertaken by the assessee is supreme as there is no finding given by the AO on the correctness and completeness of accounts or any finding to the contrary that the assessee had not complied with the accounting standards. It was, inter alia, concluded as under: " in order 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 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 l....
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....naturally expose them to fluctuation risk. To hedge such risk, they had entered into forward contracts, and had made year-end conversion on outstanding position of the forward contracts, although such forward contracts were never reflected in their Balance sheet, and losses so incurred as a result of transfer had remained unrealized at the point of conversion. On the same analogy, the appellant's stock, eventually although gets realized mostly in terms of foreign currency, they needed to translate the same into Indian currency for Indian reporting and Indian taxation. This exposed them to the exchange fluctuation risk, if the Rupee would appreciate against the US$. In both the cases, that is of Bank of Bahrain & Kuwait and the present appellant, foreign currency positions were hedged by entering into Forward contracts, and they had incurred year-end forward contract conversion losses. 2.4.17 In the case of BHARAT EARTH MOVERS LTD (supra), the court has differentiated between what is accrued liability and contingent liability. The relevant portion of the principles laid down by the Hon'ble court are reproduced as under: * For an assessee maintaining his acc....
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....monds of the assessee. 8.2 The ORP concurred with the view of the TPO on the ground that the foreign exchange earning are against cancellation of forward contracts and not integral part of the assessee's business. 9 . Before us, the Id Sr. counsel for the assessee has submitted that the assessee earned foreign exchange on cancellation of forward contracts which are connection of its purchase/sales of diamonds. Foreign exchange gain is directly dependent on the activity of export or import undertaken by the assessee. The assessee has entered into forward contracts for the purpose of reducing the foreign exchange risk faced by it in respect of its transactions with AEs. He has further submitted that foreign exchange fluctuation gain has been earned by the assessee under the hedging contract which is duly backed by the sales and purchase contract/orders in respect of diamonds. The Id Sr counsel has further contended that dealing in foreign exchange being treasury transaction is not permitted by the RBI and therefore, the gain arising from the forward contracts is part and parcel of operating profit of the -assessee, In support of his contention he has relied upon....
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....d whether or not the tested party is responsible for them. Second, any hedging of foreign currency exposure on the underlying trade receivable or payable also needs to be considered and treated in the same way in determining the net profit. In effect, if a transactional net margin applied to a transaction in which the foreign exchanger risk is borne by the tested party, foreign exchange gains or losses should be consistently accounted for (either in the calculation of the net profit indicator or separately). " 10.1 It is clear that in case of hedging of foreign currency exposure on the underlining trade receivable or payable the profit of loss will be treated in the same way in determining the net profit. 10.2 In view of the facts that the assessee has entered into forward contracts for the purpose of hedging of foreign currency exposure on the export and import of diamond, the gain or loss arising of the said, will be treated as part and parcel of the operating profit." (Emphasis supplied) 2.4.19 In a recent decision in the case of Societe Generate (2013ITS-737-ITAT), the Hon'ble Mumbai Tribunal has allowed a similar claim of the assessee fo....
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....s was held allowable in similar circumstances, where the business of ONGC was not that of a foreign exchange dealer. Therefore, it is not the nature of business or the stock dealt with i.e., currency or commodities or goods like diamonds in the present case that matters. 2.4.24 Recently, Hon'ble Mumbai ITAT "H" bench in the case of H. Dipak & Co.,Mumbai I.T.A. No. 7629/Mum/2011 on 30 April, 2013 has held that- "We have heard the arguments of both the sides and also perused the relevant material available on record. It is observed that a similar claim for marked to market loss claimed by the assessee in respect of forward foreign exchange contract debited to the P&L account has been allowed by the Special Bench of this Tribunal in the case of Bank of Behrein & Kuwait (supra) after discussing and considering all the relevant aspects of the matter,and the relevant observations of the tribunal recorded in this context are summarized as under:- (i) A binding obligation accrued against the Appellant the minutes (sic) it entered into forward foreign exchange contracts. (ii) A consistent method of accounting followed by the Appellant cannot be disreg....
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.... genuine and valid hedging contracts of sale the total of such transactions should not exceed the value of total stock of raw material or the merchandise on hand Same situation 9 Method of accounting Consistently followed the method of accounting with regard to recognition of profit of loss both for forward foreign exchange contract at the rate prevailing on 31st March Same practice followed 10 Liability crystallized Has crystallized its liability as the amount can be determined with reasonable certainty Same treatment given 11 AS-11 When the FC transactions not settled in the same accounting period, book the profit/loss on the outstanding forward contracts as on 31st March by converting the same at closing rate Same practice followed 12 Decision of SC in case of Woodward Governor India (I) P Ltd. SC decision squarely applicable in appellate case On the basis of SC decision, appellant'sclaim is allowed 13 Dy.CIT (International taxation) V/s Bank of Baharain and Kuwait (2010) 41 SOT 290 (Mum) Held that, the loss incurred by the assessee on account of evaluation of the contracts on the last day of the accounting year, ie. Be....
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....iticism made by a large number of witnesses who appeared before us, had been that the assurance given by Shri C D Deshmukh, with regard to the treatment of bona fide hedging transactions as ordinary business, was not being duly implemented. It was stated that the spirit of the amendments had been lost sight of by the Department in the course of administration of the proviso and that sometimes even genuine hedging losses were being treated as speculative losses. In this connection, the distinction in the phraseology of cls.(a) and (b) of Expln. 2 to s. 24(1) of the IT Act, 1922, was brought to our notice. It was pointed out that while one clause made a reference to stocks held, the other did not and that some officers were taking a restrictive view and disallowing the deduction of hedging losses in commodities other than stocks and shares, if they were not against stocks held but against purchases. 3.56 We have examined the same at some length. We find that even the Central Board of Revenue had put too rigid and restrictive an interpretation on this provision, which is not in accord with the spirit of the assurances given by the Finance Minister. It does not, therefore, sur....
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....elivery on a future date and he then enters into a forward contract of purchase to minimize his loss due to price fluctuations, such a contract of purchase shall not be regarded as 'speculative transaction'. It was brought to the notice of the Board that a trader who has merchandise-in-stock may enter into a transaction of 'hedging sales' with a view to guard against the risk to merchendise-instocks falling in value and thereafter the Board issued the said Circular and expanded the scope of hedging transactions. 24. Keeping in view the Circular No. 230, and the decision of the Gujarat High Court in the case of Pankaj Oil Mills (supra), in the case of a trader, the following position emerges in regard to scope of hedging contracts: (1) Hedging contracts can be both for purchase and sale; (2) In order to be genuine and valid hedging contract of sales, the total of such' transactions should not exceed the total stock of the raw material or merchandise on hand; (3) In order to be genuine and valid hedging contract of purchase, there should be an existing forward contract of sale by actual delivery. (4) The hedging contrac....
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....hat construction which will defeat the plain intention of the Legislature even though there may be some inexactitude in the language used - Salmon v. Duncombe [1886]11 AC 627 p. 634 (PC), Curtis v. Stovin [1889]22 CBD 513 referred to in S. Teja Singh' s case (supra). If the choice is between two interpretations, the narrower of which would fail to achieve the manifest purpose of the legislation we should avoid. Whenever it is possible to do so, it must be done to construe the provisions which appear to conflict so that they harmonise. It should not be lightly assumed that Parliament had given with one hand what it took away with the other." 2.4.28 Hon'ble Supreme Court, in the case of K.P. Varghese v. ITO [1981] 131 ITR 597/7 Taxman 13, has further held that the task of interpretation is not a mechanical task and, quoted with approval, Justice Hand's observation that "it is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of the dictionary but to remember that statutes always have some purpose or object to accomplish, whose sympathetic and imaginative discovery is the surest guide to their meaning". ....
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.... that the aforesaid risk is not bought by the appellant independent to the business carried by him. It is only with an intention to mitigate the risk associated with business that the appellant has entered into foreign exchange contracts. Therefore, as per the pleadings made by the Ld. AR what needs to be seen is whether the risk that the appellant has hedged by way of a forward contract has an underlying asset/stocks or liability, as the case may be. It is in this sense of the matter that the various courts have held that the profits or loss arising out of forward contracts forms part of the business income. This proposition has been dealt with at great length in the preceding paragraphs after considering in detail the submissions made by the Ld. AR as also the various case laws on the subject. It is, therefore, appropriate to understand at this stage that the appellant's pleadings veer around the proposition that the forward contracts entered into by it during the course of business, create a legal liability irrespective of the fact that whether these contracts mature during the accounting year or beyond . 2.4.30 The impugned transactions are two sides of the same co....
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.... vis-a-vis, forward contracts entered in dollar terms, to demonstrate the above position (refer the chart at para 2.4.6, supra). Further, to reiterate, the appellant has been consistently following mercantile system of accounting and has been valuing the year-end outstanding foreign exchange transactions in terms of the Accounting Standard AS-11. 2.4.32 As seen earlier, in the case of Woodward Governor 294 ITR 451, Hon. Delhi High Court has observed as under:- "In the instant cases, on the other hand, the liability arises out of already concluded contracts; the liability already stands accrued the minute the contract was entered into. The mere postponement of the payment to different date cannot extinguish the liability and render it notional or contingent. The decision of Hon. Supreme Court in Bharat Earth Movers settles the position. That decision explains that what should be certain is the incurring of the liability and it being estimate with reasonable certainty even if the exact quantification is not feasible. Even if the liability is discharged at a future date, it will nevertheless be a liability which is certain and not contingent. This approach is consist....
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....owing the loss on account revaluation of pending forward contracts was considered by the Honble. ITAT Mumbai bench in the case of M/s Bhavani Gems Vs ACIT CC-35 in ITA No.2855/Mum/2010 dated 30/3/2011 for A.Y 2006-07 and the said loss was allowed as business loss and the issue was held to be covered by Special Bench decision in the case of DCIT Vs. Bank of Bahrain (supra). Therefore, in my considered opinion the facts of the appellant's case are fully covered by the above cited decisions of the Hon. Supreme Court and the ITAT Mumbai bench. 2.4.37 For the reasons set out above and keeping in view all the decided judgments of Hon'ble Supreme Court, various High Courts/AAR and Income Tax Appellant Tribunals, I am of the considered view that the appellant was indeed. eligible for incurring of losses of business by way of the 'marked to market' losses on forward contract for assessment year 2009-10. Accordingly, Ground No.2 is allowed." 5. In this view of the facts, the CIT (A) deleted the disallowance and allowed the claim of the assessee. Aggrieved by the order of CIT (A), revenue is in second appeal before the Tribunal. Before us, the Ld. CIT(DR) only made....
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....s a partnership firm, mainly engaged in the business of import of diamonds, cutting and polishing and export of cut and polished diamonds. The total export turnover during the Previous Year 2008-2009 relevant to AY 2009-2010 under consideration, was Rs. 714.98 crores and total import of diamonds was Rs. 517.10. crores. Apart from the said import of diamonds, the assessee has also purchase diamonds of Rs. 20.66 crores locally through Diamond Dollar Account, which were settled in foreign currency. Accordingly, both the limbs of transactions i.e. purchase and sales are in foreign currency. As on 31 March 2009, the outstanding foreign exposure of the assessee is as under: Sr. No. Nature of foreign currency exposure Amount (USD in million, 1 Exports receivables (i.e. overseas debtors) 19.22 2 Imports Payables (i.e. overseas creditors) 9.31 3 Bank loan 65.78 4 Advance from Overseas Customers 8.96 5 Closing Stock for export 91.44 Total 194.72 From the above facts, it is clear that the total amount of foreign currency exposure as on 31 March, 2009 amounts to USD 194.71 million approx. Considering the su....
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....stances .of the case, the Ld.CIT(A) erred in not appreciating the fact that Hon'ble Supreme Court in the case of CIT Vs. Gem India Manufacturing Co.(2001) 249 ITR 307 (SC) & Hon'ble High Court of Bombay in the case of London Star Diamond Co(I)Ltd.213 ITR 517 (Bom) had held that the diamond cutting & polishing amounts to processing of goods and not manufacturing of goods and decision relied upon in the case of M/s Sheetal Manufactures has not been accepted on merits" 10. We have heard the rival contentions of the parties and perused the material placed before us. We find that the claim of the assessee is that the business of cutting and polishing of diamonds is manufacturing and production of an article or thing as required for claiming additional depreciation u/s 32(1) (iia) of the Act. The AO disallowed the claim by observing that the assessee is not engaged in manufacturing or production of any article or thing. The CIT (A) relying on the decision of the Hon'ble Supreme Court in the case of Arihant Tiles & Marble Pvt. Ltd. 320 ITR 79 (SC) allowed the claim of the assessee vide Para 2.4.40 as under:- "2.4.40 It is seen that in the earlier year, this claim has b....