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Income Tax Appellate Tribunal, “C” BENCH, AHMEDABAD
Before: SHRI PRADIP KUMAR KEDIA & SHRI MAHAVIR PRASAD
आदेश/O R D E R
PER PRADIP KUMAR KEDIA - AM: The captioned appeal has been filed at the instance of the Revenue against the order of the Commissioner of Income Tax (Appeals)-2, Ahmedabad (‘CIT(A)’ in short), dated 25.05.2015 arising in the assessment order dated 07.03.2013 passed by the Assessing Officer (AO) under S. 143(3) of the Income Tax Act, 1961 (the Act) concerning AY 2010-11.
ITA No.2379/Ahd/15 [ACIT vs. M/s. Mark Bioscience Ltd.] A.Y. 2010-11 - 2 -
As per its ground of appeal, the Revenue has challenged the action of the CIT(A) in reversing the disallowance of Rs.1,46,62,979/- being loss on derivatives foreign exchange transactions.
Briefly stated, the assessee in the instant case, filed its return of income for ay 2010-11 and inter alia declared loss of Rs.1,46,62,979/- being ‘loss on derivatives’. The assessee in justification of the aforesaid loss to be revenue in nature submitted before the AO that the assessee entered into ‘derivatives foreign exchange transaction’ with ICICI Bank Ltd. On 16th July, 2007 for a period of two years wherein as permitted by Reserve Bank of India, the Indian Rupee Loan of Rs.600 Lakhs was converted into CHF (Swiss currency) loan. The objective of taking the aforesaid derivative foreign exchange transaction was to reduce the interest cost. The interest rate on Rupee Term Loan was stated to be 11.5%. As against this, the interest rate of CHF loan was 1.67% only. Thus, the assessee intended saving in interest costs of nearly 10% by such protection structure by way of foreign exchange transaction. It was further explained that despite all precautions, the assessee suffered loss on account of severe exchange fluctuation owing to unprecedented global melt down in forex market. It was submitted that in the year 2009, there was a major turmoil in international forex market due to sub-prime scan in USA due to which, the protection structure was broken and huge forex liability befallen to the assessee due to wide fluctuation in exchange. It was contended that the cardinal objective of the transaction was to save on interest costs. For probable loss in forex, the protection structure was also taken but however due to uncontrollable outside circumstances, the assessee suffered loss in the aforesaid transaction. The transaction was explained before the AO as under:
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Objective Converting INR loan into CHF loan to reduce interest cost
Amount Rs.6,00,00,000/-
Date of Contract July 16, 2007
Interest Rate 1.67%
CHF/INR rate Rs.33.6941/I CHF
Converted CHF Loan 17,80,726 CHF (USD 14,80,997)
Contract Period July 10, 2009
Currency Strike Rate Settlement Rate
USD/CHF 1.2011 1.05
USD/INR 40.4700 45.20
CHF/INR 33.6941 43.0476
Loan Amount -17,80,726 CHF Difference of Exchange Rate 9.3535 (Difference of Settlement Rate – Strike Rate i.e. Rs.43.0476-Rs. 33.6941) Amount Payable - Rs.166.56 Lacs Less: Interest @ 1.67% - Rs.20.02 Lacs Net Amount - Rs.146.54 Lacs Had CHF remained below 1.07, there was a protection for Rate Fluctuation.”
The AO however disregarded the claim of the assessee as not being satisfactory for the reason that relevant documentary evidences were not produced to corroborate the claim. The AO accordingly disallowed the loss on forex derivatives claimed as above. It was further observed by the AO that assessee has suffered losses on account of forex fluctuation which is incidental and ancillary to capital borrowings and are therefore be construed to be capital in nature and could not be allowed under s.37 of the Act.
Aggrieved by the denial of claim of loss, the assessee preferred appeal before the CIT(A).
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The CIT(A) took note of submissions made by the assessee as well as admitted an additional evidence in the form of a copy of swap confirmation letter issued by ICICI Bank Ltd. indicating the transaction in corroboration of the claim. A remand report was called by the CIT(A) and after taking note of rejoinder to the remand report, the CIT(A) decided the issue in favour of the assessee. The relevant operative para of the order of the CIT(A) reads as under:
“3.3. Decision: I have carefully considered the facts of the case, the assessment order and the written submission of the appellant. The AO has disallowed loss of Rs. 1.46 crores claimed by the appellant towards loss on derivatives in the profit and loss account. The AO held that the appellant did not furnish any relevant documentary evidence such as agreement entering into derivative foreign exchange transaction with 1CICI bank Ltd, permission granted by RB1, agreement regarding conversion of loan for two years etc. He accordingly disallowed the claim of the appellant. During the course of appellate proceedings, the appellant submitted relevant documentary evidence during information about the derivative transaction in foreign exchange with 1C1CI bank Ltd. Since, the information was new and was not given before the AO during the course of assessment proceedings and the same was forwarded to him for perusal and comments. The comments of the AO have been mentioned in the preceding discussion. It has been pointed out by the AO that the transaction is capital in nature and should not be allowed u/s 37 of the Act. The appellant in response to the remand report given by the AO has submitted that the transaction was not incidental and ancillary to capital borrowing and was therefore not a capital expenditure. It has also been pointed out by the appellant that in earlier assessment years i.e. A.Y. 2007-08 and 2008-09 the gain due to foreign exchange fluctuation from the very same derivative transactions have been shown as revenue income forming part of the taxable income. On a careful consideration of entire facts of the case, it is noted that the appellant had taken a term loan from Central Bank of India loan. The appellant entered into a derivative foreign exchange transaction with ICICI bank taking notional principal amount of Rs. 600 lakh INR. The transaction was a notional transaction and the loan as such was not converted into a foreign exchange loan. The appellant has entered into a protection structure for lowering the effective interest rate paid by the appellant on the term loan of Rs. 600 Lacs. It is noted that the protection structure is the normal business product offered by various banks in which a notional loan amount is given considering the rates of interest applicable in that country and the position of the rate of currency of that country viz-a-viz the Indian rupee. On that product a notional the rate is charged. The period of protection structure is 2 to 3 years and at the end of each year the variation in foreign exchange rate and the gain earned by
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the customer and the notional interest are taken into account and the net payment is either made to the customer or if there is a loss due to wide fluctuation in foreign currency the customer has to pay or compensate the bank. In the case of the appellant the appellant has taken this structure with reference to the Swiss Frank (CHF). The product 1 was for three years. In first two years the appellant earned profit which was shown by it in the income tax return as income. However, in that third year i.e. the year under consideration, there was a loss in the deal as there was wide fluctuation in the foreign currency market in India due to severe depreciation of the Indian rupee. The issue which is now to be decided is that whether the loss claimed by the appellant is revenue or capital in nature and whether it is allowable as business loss. The facts which have emerged from various documents and the details available on record are that the contract entered by the appellant with the bank is in accordance with the RB1 approval and it is linked to the term loan taken by the appellant from Central bank of India. It is also noted that this is the standard product which is offered by various banks to the customers to take advantage of the variation in foreign exchange market. The appellant has not done any transaction on the stock exchange or purchase and sale of foreign exchange so that it can be termed as speculative transaction. The transaction is in the nature of hedging transaction and was done as derivative foreign exchange transaction with ICICI bank Ltd on 16/07/2007. The appellant has claimed that the objective of taking this transaction was to reduce interest cost. It has been claimed that the interest rate of rupee term loan was 11.50% against this the interest rate of CHF loan was 1 .67%. Therefore, by converting Indian rupee loan into CHF loan, the appellant claims, that there would have been saving of approximately 10% provided exchange rate remained the same. The claim of the appellant that the interest rate of CHF loan was 1 .67% is supported by the documents of the ICICI bank given during the course of proceedings.
It is clear from the evidences given by the appellant and various written submission given by him that the loan amount of Rs. 600 Lacs has not been converted into foreign currency and the appellant has only taken a foreign exchange derivative transactions of the same amount hoping that the foreign exchange fluctuation would be in its favour and it can earn some gain on that account. In first two years of the transaction the appellant earned something however in the present year the fluctuation was not in its favour and the appellant has incurred huge losses. In view of the above discussion it is seen that the transaction is linked to the term loan taken by the appellant and the same has been entered in order to reduce the interest burden. The nature of this transaction is, therefore, should be of revenue nature as it is linked to the interest cost being incurred by the appellant and the difference is settled on a yearly basis by taking into account the notional interest and the foreign exchange fluctuation difference. Therefore the objection of the AO that it is in the nature of capital is not acceptable. There is no doubt that this is not a traditional instrument which can be straightaway classified as capital or revenue or speculative. In the present business scenario where the banks and the taxpayers are exposed to global trading practices, these kind of products appear to be very attractive and offers a
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good business solution to the taxpayer for reducing the cost of financing. The cost of financing i.e the interest is clearly revenue expenditure and the interest is allowable as deduction from income as production has commenced. It is further noted that the transaction has been entered by the appellant in order to save interest on the loan taken by it in Indian currency. However, due to exchange rate variation in that period, the appellant incurred a loss on the transaction and there was effectively no saving of interest in this assessment year. There is no doubt that the entire agreement was for the purpose of business and any profit and loss arising in this transaction has to be treated as revenue item. The protection structure taken by the appellant is directly linked with the term loan taken by the appellant company. The expenditure is therefore for the purpose of business. The instrument and contract signed by the appellant with ICICI bonk is not in the nature of speculation and is an authorised derivative transaction which is approved by the RBI. The underlying transaction was the transaction of term loan which has been taken by the appellant company from bank and it is for this transaction the derivative transactions has been undertaken by the appellant with the ICICI bank. Since, the appellant has itself not done any trading in the market the transaction is not in the nature of the speculative transaction specified in section 43(5). The loss which has occurred in this year should accordingly be allowed as deduction from the income and the same has rightly been claimed by the appellant in the return. It is further noted that the gain on similar arrangement has been offered to tax by the appellant in the year 2007-08 and 2008-09. The same has also been accepted and taxed by the assessing officer in those years. In view of the above discussion, 1 am of the considered opinion that the appellant's claim on loss on derivatives is an allowable deduction. The disallowance made by the AO is, therefore, directed to be deleted. The ground of appeal is accordingly, allowed.”
Aggrieved by the relief granted by the CIT(A), the Revenue has preferred appeal before the Tribunal.
The learned DR relied upon the order of the AO.
The learned AR for the assessee, on the other hand, relied upon the order of the CIT(A). In furtherance, the learned AR pointed out that the solitary objective of the derivative foreign exchange transaction with ICICI Bank Ltd. was to save on interest costs of borrowed funds by way of term loan from Central Bank of India in Indian rupee. The learned AR also observed that the protection
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structure in foreign exchange was taken from ICICI Bank Ltd. for a notional amount of Rs.6Crore INR with a view to hedge the borrowed funds in Indian rupee. The learned AR pointed out that by adoption of such structure, assessee has in fact earned profits in the first two years, which was shown by it in the income tax return as income. However, in the third year i.e. year under consideration, there was a loss in the deal having regard to the massive global turmoil resulting in sever fall in the value of the Indian currency. The learned AR also referred to judicial precedents both for entitlement of the CIT(A) to take note of additional evidences as well as for eligibility of foreign currency loss owing to exposure taken by the assessee. The learned AR accordingly submitted that no interference with the order of the CIT(A) is called for.
We have carefully considered the rival submissions. The eligibility of loss arising to the assessee on account of exposure taken by the assessee in derivative foreign exchange transaction is subject matter of dispute. The reasons recorded by the CIT(A) for reversing the action of the AO and allowing the claim of loss of the assessee is self-explanatory. The CIT(A) has discussed in length the relevant facts and observed that the transaction undertaken by the assessee were hedging transaction to avail lower rate of interest and to improve the profitability of the company. The assessee has actually earned profits in two assessment years which was subjected to taxation. The CIT(A) has recognized that the loss was caused to the assessee in this year due to unforeseen and unpredictable global melt down in forex market owing to which the derivative transaction undertaken was settled at a very high price owing to fall and weaking of rupee. The benefit of lower interest was thus not only eroded, the assessee ended up paying for the additional loss due to unprecedented fall in strength of rupee. The loss of such nature has been rightly recorded to be
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revenue in nature by the CIT(A). The expenditure, in our view, is clearly for the purposes of business when the test of commercial expediency and principles of ordinary commercial trading are applied. The expenditure has been incurred to facilitate the carrying on of the business and is supported by commercial expediency. We thus see no infirmity in the conclusion drawn by the CIT(A). We accordingly decline to interfere there with.
In the result, appeal of the Revenue is dismissed in toto.
This Order pronounced in Open Court on 29/03/2019
Sd/- Sd/- (MAHAVIR PRASAD) (PRADIP KUMAR KEDIA) ACCOUNTANT MEMBER JUDICIAL MEMBER Ahmedabad: Dated 29/03/2019 True Copy S. K. SINHA आदेश क� ��त�ल�प अ�े�षत / Copy of Order Forwarded to:- 1. राज�व / Revenue 2. आवेदक / Assessee 3. संबं�धत आयकर आयु�त / Concerned CIT 4. आयकर आयु�त- अपील / CIT (A) 5. �वभागीय ��त�न�ध, आयकर अपील�य अ�धकरण, अहमदाबाद / DR, ITAT, Ahmedabad 6. गाड� फाइल / Guard file. By order/आदेश से,
उप/सहायक पंजीकार आयकर अपील�य अ�धकरण, अहमदाबाद ।