TMI Blog2018 (10) TMI 847X X X X Extracts X X X X X X X X Extracts X X X X ..... p Gosain, JM For the Assessee : Shri Chaitanya Anjaria For the Revenue : Ms. Aarti Vissanji ORDER PER R.C.SHARMA (A.M): This is an appeal filed by the Revenue against the order of CIT(A)- 30, Mumbai dated 11/08/2016 for A.Y.2012-13 in the matter of order passed u/s.143(3) of the Income Tax Act, 1961. 2. In this appeal Revenue is aggrieved by CIT(A) s action for allowing mark to market loss on account of outstanding forward contract liability. 3. Rival contentions have been heard and record perused. 4. Facts in brief are that aassessee is a partnership firm engaged in the business of Manufacture and Export Trade of Diamonds'. During the course of assessment proceedings, it was noticed by the LD. AO that the assessee has debited a sum of ₹ 1,99,35,578/- towards losses on account of the outstanding/open foreign exchanges forward contracts. The assessee was asked to explain as to why M to M losses of ₹ 1,99,35,578/- should not be disallowed. Vide letter dated 27/01/2015, the assessee explained that all the forward contracts were booked against the underlying export receivables on a bill to bill basis to hedge against the risk associ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ract agreement which is entered with reputed commercial banks supervised by the RBI and also governed by various international laws of commerce and also national and international forums. Banks are specifying in its loan sanction letters the upper limit that can be entered into by the importer / exporter for booking the forward contracts which clearly shows that forward contracts is a firm asset / liability legally binding on both the parties and though outcome is not crystalised on the date of balance sheet, definitely it will result in to some gain / loss on maturity. Thus, it is an asset / liability which is in existence on the balance sheet date but its final quantification is determined only on maturity date. Even if the importer / exporter cancel the contract, it is required to pay the difference between booking date and cancellation date. It is argued that, if loss on open forward contracts is not allowable as deduction then corresponding translation gain booked on open receivables also should not be considered as income since forward contracts are entered only based on the strength of the underlying receivables / payables. 6.2.1 From the legal front, the appellant subm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed March 23, 2010 states that loss accounted on marked to market basis (i.e. comparing open position with the market rate) notional loss would be contingent in nature and cannot be allowed to be set off against the taxable income and the same should therefore be added back for the purpose of computing the taxable income of an assessee. It is also submitted that CBDT Instruction is not binding on the Assessee. Further, the Instruction was issued with the background that corporates have suffered substantial losses on account of trading in forex derivatives . It may be noted that Assessee has not at all traded in the derivative contracts. In fact RBI guidelines on booking and cancellation of Forward Contracts do not allow assessee to trade in the risk mitigating products. Thus, CBDT Instructions is not at all applicable to the Assessee, it is stated. 6.2.3 The appellant drawn the attention to the Supreme Court decision in the case of Woodward Governor India Pvt Ltd (294 ITR 451). In this case, Assessee had debited to its Profit Loss Account a sum of ₹. 41,06,746 out of which a sum of ₹.29,49,088 was the unrealized loss due to foreign exchange fluctuation on the las ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erved that Before concluding, we would like to point out that the assessee's claim for loss arising as a result of fluctuation in foreign exchange rates on the closing day of the year has been disallowed by the AO, inter alia, on the ground that this liability was a contingent liability and the loss was a notional one. The main ingredient of a contingent liability is that it depends upon happening of a certain event. We are of the considered opinion that in the case of the assessee, the event i.e. the change in the value of foreign currency in relation to Indian currency has already taken place in the current year. Therefore, the loss incurred by the assessee is a fait accompli and not a notional one. The decision in the case of ONGC was affirmed by the Supreme Court vide its judgement dated 15 March 2010. 6.2.4 The appellant argued that those anticipated liabilities are not allowable which are contingent in nature but, if an anticipated liability is coupled with present obligation and only quantification can vary depending upon the terms of contract, then a liability is said to have crystalised on the balance sheet date. It is in conformity with the principles of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be reported using the dosing rate. 2. Exchange difference arising on foreign currency transactions should be recognized as income or as expense in the period in which they arise. 6.3.2 The International Accounting standard (IAS - 21) also stipulates the same methodology as can be seen from the following excerpts; 3. At each Balance sheet date, the foreign currency monetary items that result from transactions of the entity should be reported at the dosing rate 4. Exchange difference arising on reporting an entity's long term foreign currency monetary items at rates different from those at which they were recorded during the period or presented in previous financial statements should normally be recognized in income for the period. 6.3.3 In a nutshell, the summary of the appellant's submissions are as under: i) In the first place, the Id. AO has failed to appreciate the characteristics of a Forward contract. Each Forward contract is always assigned with a value that is contracted with creation of a fettered obligation on the assessee to execute and meet at a future contracted date. All the contracts are always enforceable, in as much as r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ., [2009] 312 ITR 254 (SC) that whether the loss arising on fluctuation of exchange in respect of loan taken for revenue purpose is allowable as deduction in the year of fluctuation of exchange rate or whether the same could be allowed only in the year of repayment of such loan. The Supreme Court held that the loss suffered by the assessee on account of exchange difference on the balance sheet date is an item of expenditure as on balance sheet date. It further held that profits or losses as per mercantile system of accounting and as per the applicable accounting standard is allowable as deduction unless the system of accounting is superseded or modified 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 has 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 mercanti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an taxation, which would 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 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 had incurred year-end forward contract conversion losses. Further reliance is placed on Bharat Earth Moversv. O7~[2000] 245 ITR 428/ 112 Taxman 61. 6.3.7 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s part of the main business activity of manufacturing of diamonds of the assessee. 8.2 The DRP concurred with the view of the TPO on the ground that the foreign exchange earnings 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 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 RB1 and therefore, the gain arising from the forward contracts is part and parcel of operating profit of the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s on a trace receivable or payable) and 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 exchange 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 pro fit. 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) 6.3.9 In the decision rendered on 9th January, 2013 in the case of Society General (2013-ITS-737-ITAT), the Hon'ble Mumbai Tribunal has all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... k of Bahrain. 6.3.12 In the case of DIT(IT)-I vs. Citi Bank N.A. in ITA No 330 of 2013 dated 11-03-2015, Hon'ble Bombay High Court has held as under: 11. The question as formulated by the Revenue has been allowed by the Tribunal in the impugned order by following the decision of its Special Bench in DOT v/s. Bank of Bahrain Kuwait 132 TTJ/(Mum.)/505. Mr. Tejveer Singh, Counsel appearing for Revenue states that Revenue has not filed any Appeal against decision of the Special Bench in the case of Bank of Bahrain and Kuwait (supra). However, there is no ground made out in the appeal memo or in any affidavit as to why the Revenue is preferring an Appeal against the impugned order on the above issue when an identical question decided by the Special Bench of Tribunal in Bank of Bahrain and Kuwait(supra) has been accepted by the Revenue. Therefore, for the reasons indicated while dealing with Question (b) above, the appeal need not be entertained. 12. In any case, the Counsel are agreed that an identical question of law as Question (c) above in the Income Tax Appeal No. 1914 of 2011 and 5089 of 2010 by the Revenue, this Court by the orders dated 2^d March, 2013 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ords, the entire gamut of the impugned transactions is integral to the appellant's business and it cannot be called a contingent transaction. Therefore, whatever may be the result of the events listed out by the Ld. AO, such result has to be treated as business result at the time of its happening and hence, the effect of the forward contact as at the year-end has to be considered for the purpose of arriving at the appellant's income. 6.3.16 The judicial decisions of the Hon. Supreme Court and various other judicial forums are clearly in favour of the appellant on this issue. The restatement of the forward contract obligations was done as per AS-11 in a consistent manner over the years. What matters is whether the forward contract transaction was entered during the course of appellant's regular business or whether it is tainted with a colour of speculative transaction. 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. 6.3.17 For the reasons set out above and keeping in view of all the decided judgments of Hon'ble Supreme Court, various High Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X
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