TMI Blog2015 (1) TMI 869X X X X Extracts X X X X X X X X Extracts X X X X ..... onsideration 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 contracts is allowable as expenditure u/s 37. - Decided in favour of assessee. Disallowance u/s.14A - Held that:- Where the assessee has not earned any income exempt u/s. 10(38) of the Act, disallowance of expenditure u/s. 14A of the Act is not tenable. Thus we also hold that the disallowance of expenditure u/s. 14A of the Act is not tenable and therefore delete the disallowance of ₹ 7,34,975 made by the Assessing Officer. - Decided in favour of assessee. Recomputation of MAT Credit u/s.115JAA considering the enhanced income on account of the disallowance made in the order of assessment for Assessment Year 2008-09 - Held that:- It is settled principle that the provisions of section 115 of the Act is a separate code in itself and that the ‘book profits’ have to be computed as provided under th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;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 2009-10 for the reason that the loss had been actually incurred and there is no logic in restricting the loss to the extent of provision created in the earlier year. On the issue of disallowance under section 14A of the Act, the learned CIT (Appeals) agreed with and upheld the finding of the Assessing Officer. 3. Aggrieved with the order of the learned CIT (Appeals) for Assessment Year 2009-10 dt.11.11.2013, both revenue and the assessee are in appeal before this Tribunal raising the following grounds. 3.1 Assessee's Grounds of appeal 1. The order passed by the learned Commissioner of Income Tax (Appeals) - III [ CIT(A) ] in relation to the disallowance of provision for losses on derivative contracts and disallowance under provisions of section 14A of the Act read with Rule 8D of the In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 75 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 equity shares by the Appellant is a considerable part of the total assets and concluding that the Appellant would have incurred expenditure for earning of the exempt income; 13. The learned CIT(A) has erred in law and on facts by not appreciating the principle laid out by the jurisdictional Karnataka High Court judgment of CCI Ltd Vs JCIT (ITA No 359 of 2011) wherein it was held that where there is no intention to earn exempt income, the notional expenditure cannot be disallowed under section 14A of the Act; 14. Without prejudice to the above, an amount of ₹ 4,947,000 representing share application money (classified as investments)should not have been considered as investment for the purpose of making disallowance under section 14A of the Act read with Rule 8D of the Inc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 speculation in future years. 4. For these and other grounds that may be urged at the time of hearing, it is prayed that the order of the CIT (Appeals) in so far as it relates to the above grounds may be reversed and that of the Assessing Officer may be restored. 5. The appellant craves leave to add, alter, amend and / or delete any of the grounds mentioned above. Assessee's Appeal in ITA No.257/Bang/2014 (A.Y. 2009-10) 4. Provision for loss on derivative contracts : ₹ 19,96,59,000. 4.1 The Grounds raised at S.Nos.1 to 9, by the assessee are in respect of the issue of disallowance of provision for losses on derivative contracts amounting to ₹ 19,96,59,000 by the learned CIT (Appeals). 4.2.1 The facts of the matter as emanate from the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 decision of Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra) is misplaced since that case concerns allowance of losses on restatement of existing currency assets and liabilities. In the case on hand, it relates only to future sales transactions without certainty of valuation of the same. The two situations are distinguishable. iv) Regarding the reliance placed on AS-11 and the decision in the case of DCIT V Bank of Bahrain Kuwait (ITA No.4404 1883/Mum/2004), in that case it was held that if the quantification of the liability can be determined with reasonable accuracy, the same could be adopted. However, in the case on hand, the sale itself has not taken place and the question of any existing liability is itself uncertain. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 deciding the expenditure claim, unless it is repugnant to the provisions of the Act. iii) The assessee follows the mercantile system of accounting and is required to follow the procedure advised in AS-11 and there is no provision in the Act prohibiting the assessee from following the same. iv) The decision of the Hon'ble Apex Court in the case of Woodward Governor India P. Ltd. (supra) squarely applies to the assessee's case. v) The forward contracts are entered into on a reasonable estimate. The learned Authorised Representative of the assessee also took us through the judicial pronouncements relied upon by him in support of the various principles put forth above. 4.4 Per contra, the learned Departmental Representative strongly suppo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pate 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 necessary to consider and take into account some of the settled principles regarding accounting propositions, which are as under :- (i) Income is to be accounted for only when the right to receive the same has accrued in favour of the assessee, thereby creating a realisable debt in its favour; i.e. a legally enforceable right; (ii) All anticipated losses, which accrued on the date of balance sheet have to be accounted for as per prudent accounting policies; (iii) Stock-in-trade is valued at the end of the previous year in accordance with the matching principle in order to find out the true profit / loss. (iv) The method of accounting consistently followed by the assessee should not be discarded casually without having good and sound reasons for the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 sheet date, pending actual payment of the varied liability? The above questions of law were elaborated by their Lordships at para 4 of the order which is extracted as under :- 4. At the outset, for the sake of convenience, we may state that in this batch of civil appeals broadly we have before us two categories. In the first category, we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of ss. 28, 29, 37(1) and 145 of the IT Act, 1961 ( 1961 Act ). In the second category of cases, we arc concerned with exchange differences arising on repayment of liabilities in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 765 (MP) the Madhya Pradesh High Court has held that the expression expenditure as used in s. 37 may, in the circumstances of a particular case, cover an amount which is a loss even though the said amount has not gone out from the pocket of the assessee. This view of the Madhya Pradesh High Court has been approved by this Court in the case of Madras Industrial Investment Corporation Ltd. vs. CIT (1997) 139 CTR (SC) 555 : (1997) 225 ITR 802 (SC). According to the Law and Practice of Income-tax by Kanga and Palkhivala, s. 37(1) is a residuary section extending the allowance to items of business expenditure not covered by ss. 30 to 36. This section, according to the learned author, covers cases of business expenditure only, and not of business losses which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting, 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 not been realized actually. At this stage, we need to emphasise once again that the above system of commercial accounting can be superseded or modified by legislative enactment. This is where s. 145(2) comes into play. Under that section, the Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, under s. 209 of the Companies Act, mercantile system of accounting is made mandatory for companies. In other words, Accounting Standard which is continuously adopted by an assessee can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under s. 145(3), the method of accounting undertaken by ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he 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 Standard followed by the assessee(s) in this batch of civil appeals. 17. Having come to the conclusion that valuation is a part of the accounting system and having come to the conclusion that business losses are deductible under s. 37(1) on the basis of ordinary principles of commercial accounting and having come to the conclusion that the Central Government has made Accounting Standard-II mandatory, we are now required to examine the said Accounting Standard ( AS ). 18. AS-11 deals with giving of accounting treatment for the effects of changes in foreign exchange rates. AS-11 deals with effects of exchange differences. Under para 2, reporting currency is defined to mean the currency used in presenting the financial statements. Similarly, the words monet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... account for the reporting period. 19. A company imports raw material worth US $ 250000 on 15th Jan., 2002 when the exchange rate was ₹ 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 ₹ 49 per US $. However, on the balance sheet date, 31st March, 2002, the rate of exchange is ₹ 50 per US $. In such a case, in terms of AS-11, the effect of the exchange difference has to be taken into P L account. Sundry creditors is a monetary item and hence such item has to be valued at the closing rate, i.e. ₹ 50 at 31st March, 2002, irrespective of the payment for the sale subsequently at a lower rate. The difference of ₹ 4 (50-46) per US $ is to be shown as an exchange loss in the P L account and is not to be adjusted against the cost of raw materials. 20. In the case of Sutlej Cotton Mills Ltd. vs. CIT 1978 CTR (SC) 155 (1979) 116 ITR 1 (SC) this Court has observed as under: The law may, therefore, now be taken to be well settled that where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly 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'ble Apex Court relates to only restatement of existing currency liabilities and assets is not correct. 4.5.8 In the case on hand, it is not in dispute that the forward contracts have been entered into by the assessee in order to protect its interest against fluctuations in foreign currency, in respect of consideration for export proceeds, which is a revenue item. Therefore, in sum and substance, it has the trappings of stock-in-trade and the assessee has to restate or revalue the same as on the Balance Sheet date. The consequent effect of this accounting treatment was to recognize the exchange fluctuation gain or loss in the profit and loss account as on the valuation date. In view of the facts and circumstances of the case as discussed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t, 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 43(5)(d). Any loss in a speculative transaction can be set off only against profit from speculative transactions. In the case on hand, as discussed earlier, a contract has been concluded and a liability has crystallized. In this factual matrix, from the wordings of the Instruction, it follows that the loss arising out of the forward contract is not notional. In such a case, the CBDT Instruction requires the Assessing Officer to examine whether such a loss is on account of a speculative transaction as contemplated in section 43(5) of the Act. 4.5.10 The issue of speculative transactions and hedging transactions has been examined and analysed in detail in the decision of the ITAT, Mumbai in the case of S. Vinod Kumar Diamonds (P) Ltd. rep ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ancelling 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 delivery at a future date. His transaction in the forward market may correspond to a previous purchase or sale in the ready market or he may propose to cover it later by a corresponding transaction in the ready market, or he may offset it by a reverse transaction on the forward market itself. Hedging contracts need not succeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within reasonable time. In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 have been settled otherwise than by actual delivery of goods, (4) Hedging contracts may be both with regard to sales and purchases, (5) Hedging contracts need not succeeed the contracts for sale and actual delivery of goods manufactured, but the latter may be subsequently entered into, provided they are within the reasonable time not exceeding generally the assessment year, (6) In order to be genuine and valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchases, (7) The hedging contract need not necessarily be in the same variety of the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 7,34,975 and disallowed the same. 5.2 On appeal, the learned CIT (Appeals) upheld the decision of the Assessing Officer in making the disallowance of ₹ 7,34,975 u/s.14A r.w. Rule 8D, citing the decision in the case of Cheminvest Ltd. (supra) relied on by the Assessing Officer, quoting therefrom and also noting that the view taken therein has been supported by the decision of the ITAT, Delhi in the case of Techno Pack Advisers Pvt. Ltd. V Addl. CIT reported in 50 SOT 31. 5.3 In appellate proceedings before us, the learned A.R. of the assessee reiterated the submissions of the assessee made before the authorities below, that these investments have been made in the Group Companies and have not been made with the intention to earn income and that no income has been earned by the assessee on these investments during the year ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... come 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, the deletion of the disallowance ofRs.2,03,752 made by the Assessing Officer was in order. 5.5.3 The Hon'ble Gujarat High Court in the case of Corrtech Energy Pvt. Ltd. (supra) has adjudicated on this issue at para 3.2 thereof as under :- 3.2 .. We have given our thoughtful consideration to the facts and the decision relied upon by the ld.AR. The Hon'ble Punjab Haryana High Court in the case of CIT Vs. Winsome Textile Industries Ltd. reported at (2009) 319 ITR 204 (P H) has held that in the present case, admittedly, the assessee did not make any claim for exemption. In such a situation, section 14A could have no application. In this case also, the assessee has not claimed any exempt income in this year. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a 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 (Appeals), at the stage of initiation of penalty proceedings by the Assessing Officer, no cause of grievance arises to the assessee, since there is no penalty levied. We are of the view that this ground is premature and not maintainable and is therefore dismissed. 10. In the result, the assessee's appeal for Assessment Year 2009-10 is partly allowed as indicated above. ITA No.275/Bang/2014 - Revenue s appeal for Assessment Year 2009-10. 11. The grounds at S.Nos.1, 4 5 raised by revenue being general in nature, no adjudication is called for thereon. 12.1 In the grounds raised at S.Nos.2 and 3, revenue has assailed the decision of the learned CIT (Appeals) to allow the loss on speculation actually incu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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