OETIKER INDIA P.LTD,MUMBAI vs. DCIT 13(1)(1), MUMBAI

During the course of the appellate proceedings before us, the 26. Learned Authorised Representative for Appellant vehemently contended that the services were actually rendered to the Appellant. He submitted that although IT Service Agreement (filed before TPO, vide submission dated 03/01/2015,) pertained to the Financial Year 2012-13, the terms of the services stated therein as well as the method of charge had continued to be the same since the Financial Year 2010-11 relevant to the Assessment Year 2011-12. It was also contended by the Appellant that the DRP rejected the objections raised by the Appellant without returning independent findings and that the TPO had failed to use one of the prescribed methods for determining ALP as ‘Nil’. Per Contra, the Learned Departmental Representative submitted placed reliance on the order passed by the TPO/DRP and submitted that the Appellant had failed to establish that the services were actually rendered. No independent party would have paid the IT Service Charges without receiving any services and therefore, the TPO/DRP were correct in concluding that the ALP of IT Service Charges was ‘Nil’ by applying CUP Method.

We have heard the rival submissions. There is nothing on record to 27. show that the terms and conditions stated in the IT Service Agreement applicable for the Financial Year 2012-13 were identical to the terms and conditions as applicable during the Financial Year 2011-12. Therefore, the IT Service Agreement by itself does not advance the case of the Appellant as regards the fulfillment of the need-purpose-benefit test is concerned. During the course of the (Assessment Year: 2011-12) hearing the Learned Authorised Representative had vehemently contended that the Appellant was, at the relevant time, still in the start-up phase and hence needed assistance to set up the business. Thus, in order to reduce its expenditure, it was not feasible for the Appellant to own its own software/IT license due to which it used the license provided by the AE and additionally purchases IT equipments from third parties in India. Further, the electro mechanic machines of the Appellant were IT enabled and require a robust set of IT setup for operation, maintenance & trouble shooting. The Appellant had submitted documents such as email correspondence before TPO/DRP. However, the TPO/DRP failed to consider the same. On the other hand, the Learned Departmental Representative relied on the order passed by the TPO and DRP wherein it was stated that the Appellant had failed to establish that the services were actually rendered and failed to satisfy the need, purpose and benefit test. Therefore, the TPO was correct in applying CUP Method to benchmark the transaction at ‘Nil’ as no independent party would have made payment of IT Charges. However, we also note that the Learned Departmental Representative had, while advancing arguments in relation to Ground No. 2 to 2.8 pertaining to transfer pricing adjustment related to royalty payments, submitted that the Appellant made multiple payments to its AEs and that there was need to examine the overlapping of scope of services and related payments. We note that Appellant had claimed that the IT Service Charges paid to AE are in the nature of cost allocation charges on which mark-up of 10% has been charged by the AE to the Appellant. The Appellant has filed invoices related to the IT Charge payments. Keeping in view the submissions advanced by both the sides and overall facts and circumstances of the case, we

(Assessment Year: 2011-12) deem it appropriate to grant another opportunity to the Appellant and remand the issue back to the file of the Assessing Officer to establish and substantiate the need, purpose and benefit of the IT Service Charges. Accordingly, the addition of INR 41,75,987/- in respect of IT Charge is set aside and Ground No. 3 to 3.8 are allowed for statistical purposes.

Ground No. 4 Ground No. 4 raised by the Assessee is directed against the 28. disallowance of INR 4,04,64,260/- being the foreign exchange loss on account of External Commercial Borrowings.

The Assessee had entered into The External Commercial Borrowings 29. Agreements, dated 22/01/2007 (Amendment Agreement dated 20/11/2008) and 30/03/2009 with its holding company, Inter Clamp Holding AG. Based on these ECB Agreements, the Appellant had raised the ECBs from Inter Clamp Holding AG:

S.No. Date of Receipt of ECB Amount ECB Amount ECB Funds [ CHF]…. [INR]..... 1 26.10.2007 1,000,000 3,30,70,000 2 28.01.2008 5,00,000 1,77,24,714 3 23.06.2008 20,00,000 8,22,35,800 4 01.12.2008 5,00,000 2,32,99,160 5 22.03.2009 22,50,000 9,70,72,898 Total 62,50,000 25,34,02,572 Note: Out of the above 62,50,000 CHF was converted into equity share capital as per RBI approval.

On the last day of the relevant previous year (i.e. 31.03.2011), the 30. outstanding ECB amount was restated at the prevailing foreign exchange rate and the difference on account of foreign exchange

(Assessment Year: 2011-12) rate was debited to the Profit & Loss Account, being foreign exchange loss amounting to INR 4,04,64,260/- in terms of Accounting Standard - 11 [for Short ‘AS-11’] issued by the Institute of Chartered Accountants of India (ICAI). The AO disallowed the amount of INR 4,04,64,260/-. According to the Assessing Officer the ECB amount outstanding represents a capital expenditure. Further, the ECB proceeds were also utilised for discharging liability towards capital goods. Expenditure on account of capital nature was not allowable as a deduction under Section 37(1) of the Act. Further, the Appellant had only made a provision for contingent liability. Giving the aforesaid reasoning, the Assessing Officer disallowed the aforesaid deduction of INR 4,04,64,260/- being loss of account of foreign exchange fluctuation debited to the Profit & Loss Account on account of restatement of outstanding ECB liability as on the last day of the relevant previous year.

While disposing objections filed by the Assessee against above 31. disallowance in the Draft Assessment Order, the DRP upheld the action of the Assessing Officer holding as under:

"13.2.3: From the fact of the case it is evident that the assessee has revalued the ECB loan and claimed it as expenses for the current year. In the first place, a revaluation is of a loan is capital in nature and should not impact the P/L account. Secondly, it is only a book/notional loss and would not qualify as an allowable expense under the provisions of the Act. Under such circumstance, the contentions of the assessee are rejected." Being aggrieved, the Appellant is now in appeal before us. 32.

We have heard the rival submission, perused the material on record 33. and considered the position in law.

(Assessment Year: 2011-12) We find that the Appellant had borrowed funds by way of External 34. Commercial Borrowings (ECBs) from its AE. As per the RBI Guidelines, ECBs can be raised either under automatic route or after obtaining necessary approval. However, the ECBs raised, whether under automatic route or approval route, are subject to end-use restrictions. At the relevant time, the ECBs could be raised for investment such as import of capital goods and the use of ECBs for the purpose of working capital purposes, general corporate purposes and for repayment of existing rupee loan was not permitted [Refer to as per the Master Circular on External Commercial Borrowings and Trade Credits, dated July 1, 2011]. We note that the Appellant had, in the written submission (@ page 14 of 18), stated that INR 12,03,72,058/- was used for purchase of imported goods. However, it is not clear whether the goods were purchased within India or from outside India which is to be considered for determining the applicability or otherwise of Section 43A of the Act. Accordingly, this issue is remanded back to the file of the Assessing Officer for fresh adjudication after verifying the correct fact and keeping in view the applicable ECB Regulations, Section 43A or 37 of the Act, the provisions of AS-11 and the accounting policy actually followed by the Appellant. Ground No. 4 raised by the Assessee is allowed for statistical purposes.

Ground No.5 Ground No. 5 raised by the Appellant are directed against the 35. disallowance of loss on account of foreign exchange currency fluctuation related to interest payable on ECB.

We have considered the rival submissions and perused the material 36. on record. Admittedly, the Appellant has claimed deduction of loss 16

(Assessment Year: 2011-12) on restatement of interest payable on ECB. In our view the aforesaid loss is not in the nature of contingent liability and is allowable as deduction under Section 37 of the Act in terms of the judgment of the Hon’ble Supreme Court in the case of Commissioner of Income Tax, Delhi Vs. Woodward Governor India Pvt. Ltd. : [2009] 312 ITR 254 (SC), wherein it has been held as under: “15. For the reasons given hereinabove, we hold that, in the present case, the "loss" suffered by the assessee on account of the exchange difference as on the date of the balance sheet is an item of expenditure under section 37(1) of the 1961 Act. 16. xx xx 17. xx xx 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 "monetary items" are defined to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g., cash, receivables and payables. The word "paid" is defined under section 43(2). This has been discussed earlier. Similarly, it is important to note that foreign currency notes, balance in bank accounts denominated in a foreign currency, and receivables/payables and loans denominated in a foreign currency as well as sundry creditors are all monetary items which have to be valued at the closing rate under AS-11. 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-11 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 section 37(1), para 9 of AS-11 which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to (Assessment Year: 2011-12) 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 section 43A of the 1961 Act. At this stage, we are concerned 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. xx xx 20. xx xx 21. In conclusion, we may state that 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 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.” As per the judgment of the Hon’ble Supreme Court the loss/gain 37. arising on account of foreign exchange fluctuation is to be recognized in the Profit & Loss Account for the relevant previous

(Assessment Year: 2011-12) year. Accordingly, the loss arising on account of restatement of interest payable thereon on the last day of the previous year as on account of foreign currency fluctuation per the provisions of Accounting Standard 11 would have to be recognized as loss of the relevant previous year.

In view of the above, we delete the disallowance of INR 39,18,016/- 38. made by the Assessing Officer. Ground No. 5 raised by the Assessee, therefore, allowed.

Ground No.6 Ground No. 6 raised by the Appellant are directed against the 39. disallowance of loss on account of foreign exchange currency fluctuation related to Other Expenses.

On perusal of record we find that the Assessing Officer disallowed 40. INR 26,65,991/- holding the same to be foreign exchange loss debited to the Profit & Loss Account under the sub-head ‘Others’.

Before DRP, it was contended on behalf of the Appellant that the 41. foreign exchange loss under consideration arose on restatement of the amounts payable in foreign currency to the vendors for supply of raw materials, production consumables and services due to foreign exchange fluctuations. It was claimed on behalf of the Assessee that the expenses and the corresponding foreign exchange loss were a revenue nature and therefore, the Assessing Officer ought to have allowed deduction for the foreign exchange loss. It was further submitted that while disallowance of INR 26,65,991/- was made by the Assessing Officer, the correct amount was INR 8,24,190/- only. In view of the aforesaid submissions, the DRP

(Assessment Year: 2011-12) directed the Assessing Officer to verify the claim of the Assessee and provide appropriate relief.

In the Final Assessment Order, dated 29/01/2016, the Assessing 42. Officer denied deduction claiming that the Assessee had failed to provide necessary documents and supporting evidences.

The Ld. Authorised Representative for the Assessee reiterated the 43. submissions made before DRP and submitted that the Assessing Officer had failed to take into consideration the break-up of foreign exchange loss submitted by the Assessee and therefore, failed to implement the directions issued by DRP. Per contra, the Ld. Departmental Representative relied upon the Final Assessment Order and submitted that even after the directions given by the DRP the Assessee had failed to substantiate it’s claim for deduction. In rejoinder, the Ld. Authorised Representative for the Assessee submitted that, even if for the sake of arguments the contention of the Ld. Departmental Representative was to be accepted, the amount of disallowance could not have being more than INR 8,24,190/-.

(Assessment Year: 2011-12) allowed for statistical purposes.

In terms of the above, the present appeal by the Assessee is partly 45. allowed.

Order pronounced on 25.08.2023.