TMI Blog2015 (2) TMI 401X X X X Extracts X X X X X X X X Extracts X X X X ..... the transaction entered into by the assessee is speculative in nature; the losses shown are notional in character and therefore the provision for loss claimed as a deduction is liable to be disallowed. As regards the alternate contention of the assessee that if the transaction in question is held to be speculative in nature, then the provision for loss should be allowed as a deduction from the gains reported from such transactions, we are unable to agree with the contention of the assessee in this regard. It is nobody's case that the assessee is engaged in the business of speculation. It has also been held that the loss shown is a notional loss only and such notional loss is not liable to be adjusted against the profit actually earned by the assessee. The stage for adjustment arises only when the loss/liability actually crystallises. - Decided against assessee. - IT APPEAL NO. 85 (BANG.) OF 2013 - - - Dated:- 17-10-2014 - N.V. VASUDEVAN, AND JASON P. BOAZ, JJ. For The Appellant : Banushekar, C.A. For The Respondent : L.V. Bhaskar Reddy, J. CIT DR. ORDER Jason P. Boaz, Accountant Member - This appeal by the assessee is directed against the order of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ness of the assessee and arises out of a speculative strategy and therefore cannot be treated as business transactions; (iii) The facts of the assessee's case are clearly distinguishable from the facts of the case of CIT v. Woodward Governor India (P.) Ltd. [2009] 312 ITR 254 relied on by the assessee; (iv) The Assessing Officer is correct in holding that the loss claimed is an entirely notional one and such a notional loss is not eligible for deduction as expenditure. The learned CIT (Appeals) also rejected the alternate contention of the assessee that, in case the losses claimed are to be treated as speculative losses, it should be allowed to be set off against the speculation income earned during the same year. 3. Aggrieved by the order of the CIT(Appeals) - III, Bangalore for Assessment Year 2008-09 dt.31.10.2012, the assessee is in appeal before this Tribunal raising the following grounds ;- 1. that the order of the Commissioner of Income Tax (Appeals) is contrary to law, facts and circumstances of the case and at any rate is opposed to the principles of equity, natural justice and fair play. 2. For that the Commissioner of Income Tax (Appeals) failed to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... before the learned CIT (Appeals). The learned Authorised Representative of the assessee also submitted written submissions and relied on various case law, which are taken on record. The assessee also submitted additional evidence under Rule 29 of the ITAT Rules, which were the copies of quotations related to the options entered into by the assessee. 4.3 Per contra, the learned Departmental Representative strongly supported the order of the learned CIT (Appeals) and placed reliance on the decision inthe case of S. Vinod Kumar Diamonds (P) Ltd. v Addl. CIT . 4.3.1 We have heard both parties at length and perused and carefully considered the material on record, including the judicial decisions cited and placed reliance upon by both parties. 4.3.2 The undisputed facts in the case on hand are that the assessee is in the business of dealing/trading in steel tubes, pipes, PVC, etc. and is not in the business of entering into such option transactions. The assessee had raised a bank loan and had entered into a foreign currency swap option , reportedly as a measure to reduce the interest cost on the loan. According to the assessee, by entering into such a foreign currency swap opti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wo limbs to the options arrangement and the loss has arisen only on the hedging limb, which is not a speculative transaction; (vi) On the issue of notional loss, the assessee is following the mercantile method of accounting regularly employed as required by the Accounting Standards. As per AS-11, monetary items have to be restated; which proposition has been upheld by the Hon'ble Apex Court in the case ofWoodward Governor India (P.) Ltd.(supra). (vii) In the case of ABN Amro Securities India (P.) Ltd. v ITO [2011] 133 ITD 343 the Tribunal has held that loss on restatement of interest swap rate at the year end is to be allowed as a deduction; (viii) The CBDT Instruction No.03/2010 dt.23.3.2010, directing the Assessing Officer to add back the marked to market loss is contrary to the decision of the Hon'ble Apex Court in Woodward Governor India (P.) Ltd. (supra) and therefore the decision of the Hon'ble Apex Court supersedes the CBDT's Instruction, (ix) If the loss arising out of foreign exchange swap option transactions is held to be speculation loss, then without prejudice to the assessee's contentions to the contrary, the loss should be allowed to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra). Per contra, it is the contention of Revenue that the facts of the case on hand are distinguishable from that of the Hon'ble Apex Court in Woodward Governor India (P.) Ltd. (supra). 4.3.8 In this context, we proceed to examine the decision of the Hon'ble Apex Court in the case of Woodward Governor Ltd. (supra). The substantial questions of law decided by the Hon'ble Apex Court in that case, as extracted from para 3 of the order, are as under :- (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 section 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 cast 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd 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. Section 37 enjoins that any expenditure not being expenditure of the nature described in Sections 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 Sections 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 Section 32. Therefore, Parliament has used the expression any expenditure in Section 37 to cover both. Therefore, the expression expenditure as used in Section 37 may, in the circumstances of a particular case, cover an amount which is realty 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 v. CIT reported in 165 ITR 765 the Madhya Pradesh High Court has held that the expression expenditure as used in Section 37 may, in the circumstances of a particular case, cover an amount which is a los ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g Section 37(1) with Section 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 not been realized actually. At this stage, we need to emphasise once again that the above ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ins 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. Section 145(1) enacts that for the purpose of Section 28 and Section 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 Section 28. Therefore, section 145(l) 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, (see judgment of this Court in the case of United Commercial Bank v. CIT reported in 240 ITR 355). Therefore, the accounting method followed by an assessee continuously for a given period of time needs to be presumed to be correct till the AG 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 Appeal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d 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 15.1.2002 when the exchange rate was ₹ 46 per US $. The company records the transaction at that rate. The payment for the imports is made on 15.4.2002 when the exchange rate is ₹ 49 per US $. However, on the balance sheet date 31.3.2002, the rate of exchange is ₹ 50 per US $, In such a case, in terms of AS-11, the effect of the exchange differenc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ra) has been rendered in respect of monetary items denominated in foreign currency, which include in its meaning, money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency, balances in bank accounts denominated in a foreign currency, sundry creditors, etc., all monetary items. Further, the citied decision (supra) is rendered in relation to transactions in which a legal liability has been incurred before it is actually disbursed. In the case on hand, however, as discussed earlier, the liability has neither been ascertained nor crystallised as on the Balance Sheet date. Further, the transaction in 'question is not related to monetary items, as the underlying exposure behind the transaction is only foreign exchange. In this view of the matter, we are in agreement with the decision of the learned CIT (Appeals) that the decision of the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra) does not apply to the facts of the case on hand. 4.3.11 Having decided and held that the decision of the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. (supra) is not applicable to the facts of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 val ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 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 succeed 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ute goods. In view of overseas offer, it decided to manufacture special quality jute goods. Assessee entered in to forward purchases of standard jute goods and purchase back of forward contracts of sale. Assessee incurred loss in covering its forward contracts of sale. In the appeal filed by the assessee Hon'ble Calcutta High Court, confirming the order of the ITAT, held that losses suffered by the assessee were result of the speculative transactions. In the case of Delhi Flour Mills Co. Ltd.(supra) Hon'ble Delhi High Court held that forward transactions made by the assessee in respect of matra (a substitute of gram) could not be treated as hedging transactions and the loss sustained by the assessee in such transactions could not be set off against its profits in the business of manufacturing atta (wheat flour) and other wheat products. Hon'ble Allahabad High Court, while deciding the appeal of M.P. Sugar Mills (P.) Ltd.(148 ITR 203) has held as under: Section 43(5)(a) of the Income-tax Act, 1961, which excludes hedging contracts from the definition of speculative transactions, contemplates contracts entered into by two classes of persons, namely, (1) persons who ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons in question. We are of the considered view that the transactions entered into by the assessee were not hedging transactions, but the same were speculative and therefore the assessee's case is not covered by proviso (a) to section 43(5) of the Act. 4.3.12 In the written submissions filed, the assessee has referred to the decision of the Hon'ble Bombay High Court in the case of CIT v. Bharat R Ruia, (HUF) [2011] 337 ITR 452 In that case, the Hon'ble Bombay High Court has held that the future contracts for purchase/sale of an underlying security settled otherwise than by actual delivery would be speculative transactions under section 43(5) of the Act. The relevant paragraphs of the said order at paras 26, 28, 33 and 34 thereof are extracted as under :- '26. Section 43(5) of the Act defines the expression speculative transaction to mean a transaction in which a contract for the 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. 27. ** ** ** 28. The expression commodity is not defined under the Act, Therefore, the expression ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ifferent from that of the assessee's in the case on hand. In that case, the tax payer was in the business of dealing in derivatives, whereas, admittedly, the undisputed factual position in the case on hand is that the assessee is not in the business of dealing in derivatives. Therefore, the aforesaid decision in the case of ABN Amro Securities India (P.) Ltd. (supra) would not be of any help to the assessee. 4.3.14 In view of the above discussion of the facts and circumstances of the case from paras 4.3.1 to 4.3.13 of this order, we conclude that the transactions in question in the case on hand are speculative transactions and therefore, the learned CIT (Appeals) was right in upholding the decision of the Assessing Officer that the transaction entered into by the assessee is speculative in nature; the losses shown are notional in character and therefore the provision for loss claimed as a deduction is liable to be disallowed. 5. As regards the alternate contention of the assessee that if the transaction in question is held to be speculative in nature, then the provision for loss should be allowed as a deduction from the gains reported from such transactions, we are unable ..... X X X X Extracts X X X X X X X X Extracts X X X X
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