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Income Tax Appellate Tribunal, ‘A’ BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & SHRI B R BASKARAN
Per SHRI B R BASKARAN ACCOUNTANT MEMBER
This appeal by the assessee is directed against the order of the CIT(A) dated 20/9/2021 for the asst. year 2011-12.
The assessee raised the following grounds before us
Disallowance of Rs.12,54,31,371 claimed on account of write off of obsolete inventory 1. Erred in upholding the order of the learned Assessing officer (AO) by disallowing an amount of Rs.12,54,31,371 claimed on account of obsolete and slow moving inventory write off 1.1. Failed to appreciate that the appellant has consistently followed the method of valuation of stock at cost or net realizable value whichever is lower as prescribed under “Accounting Standard 2 – Valuation of inventories” prescribed by the institute of Chartered Accountants of India 1.2. Erred in not appreciating the fact that such inventory is actually written off in the books of account and is not a mere provision as contemplated by the learned AO 1.3. Without prejudice to the above, even if it is treated as a provision of obsolete inventory the same ought to have been allowed as deduction 1.4. Without prejudice to the above the write-off ought to be allowed as a deduction in the subsequent year (AY 2003-04) as accepted by the learned CIT (A)
Disallowance of foreign exchange loss 2. Erred in not appreciating the fact that foreign exchange loss (arising either on account of payment to trade creditors or year-end restatement of their balances) is revenue in nature and thereby not deciding the issue himself but giving directions to the leaned AO to examine the nature of loss whether revenue or capital in nature
Initiating Penalty proceedings u/s.271(1)(c)
Erred in upholding the action of the AO in initiating the penalty u/s.271(1)(c)
The assessee has also raised an additional ground (Ground no,.4)before us with respect to claim towards advance write off – Excise duty on exports of Rs.1,20,16,395
• The assessing officer (Learned AO) and the Commissioner of Income Tax (Appeals) (Learned CIT (A)) has erred in law and on facts in not granting deduction in respect of amount paid towards excise duty on exports of INR 1,20,16,395 in AY 2002-03 after having denied the appellant’s claim for the same in AY 2007-08 • The Learned AO and Learned CIT(A), has erred in law and on facts in not appreciating the fact that the appellant was eligible for deduction in respect of amount paid towards excise duty on exports in INR 1,20,16,395 in AY 2002-03, but was recorded as receivable in the books of accounts owing to its eligibility to claim duty draw-back rebate with the excise authorities which was subsequently rejected 3 Brief facts of the case.
The assessee, Herbalife International India Private Limited (HIPL) was set up in the year 1998 pursuant to an approval accorded to Herbalife International of America Inc. (HIl) by the Foreign Investment Promotion Board (FIPB). The assessee is in the business of manufacturing and trading in health care and nutritional products. The assessee is manufacturing through contract manufacturers who are known as “coverters” certain weight loss nutritional products under license from HII, which are sold under the name Herbal Life. The assessee sells these products through a system of multilevel marketing i.e. by selling products to distributors who are individuals. The distributors are registered with the assessee and are sponsored by the Supervisors who are already doing business with the assessee. The sale of products is linked to the network of distributors who can appoint any number of distributors under them.
For the year under consideration the assessee furnished its return of income on October 31, 2001 declaring a loss of Rs. 19,24,19,480/-. The return of income was processed under section 143(1) of the Act on January 28, 2003 and subsequently it was taken up for scrutiny assessment and a notice under section 143(2) of the Act dated October 27, 2003 was issued by the Dy. Commissioner of Income Tax Circle 12(1) New Delhi (AO) who completed the assessment under section 143(3) of the Act. During the course of the assessment proceedings, the AO made a reference to the Transfer Pricing Officer who submitted his report dated February 21, 2005 proposing to take the cost of administrative expenses debited by the assessee for an amount of Rs.4,77,19,005/- as NIL.
The AO, in addition to the disallowance proposed by the TPO,made several additions/disallowances to the returned income of the assessee and reduced the returned loss to Rs. 73,79,890/- as detailed below:-. Rs. Rs. Loss as per return -19,24,19,480 Add Administrative Expenses 4,77,19,005 disallowed by the TPO Add Leasehold improvement 50,48,684 Add Inventory written off 12,54,31,371 Add Loss on account of 68,40,528 18,50,39,588 foreign exchange variation Total income (-)73,79,892 Rounded off (-)73,79,890
Aggrieved by the order of the DCIT, the assessee filed appeal before the CIT(A).
The CIT(A) partially allowed the appeal of the assessee by confirming following additions made by the AO:- i) Disallowance of inventory written off - Rs.12,54,31,371/- ii) Foreign exchange fluctuation loss – Rs.68,40,528/-
Now the assessee is before us aggrieved by the order of the CIT (A) for confirming the AO’s above mentioned disallowances of inventory write off and foreign exchange fluctuation loss
We will take up first the issue of disallowance of inventory written off.
9.1. The assessee during the year relevant to the assessment year 2002-03, claimed deduction of a sum of Rs.12,54,31,371/-towards inventory write off. This claim was debited to the P&L account as a separate item. It was mentioned in the Note 5 of the notes to account of the assessee’s financials that the write off of inventory is on account of obsolescence and adjustment to the net realizable value. The assessee submitted breakup details of the above said write off before the CIT(A) as under:- (i) Inventory of finished goods - Rs.3,60,73,411/- (ii) Inventory of raw material – Rs. 8,93,57,960/-, out of which a. Raw Material with Dominion Chemicals and Dominion Pharma – Rs.4,85,58,121 b. Raw Material with Litaka – Rs.4,07,99,839 M/s Dominion Chemicals, M/s Dominion Pharma and M/s Litika are “converters” (who process materials of the assessee on job work basis) for the assessee.
9.2 The assessee submitted before AO that the converters named M/s Dominion chemical Industries Ltd and M/s Dominion Pharmaceuticals P Ltd have become bankrupt and non-operational in 2002. Hence materials lying with them could not be recovered. Further owing to short shelf life of the raw materials and due to poor/long storage, the quality of materials got deteriorated. Hence the assessee was not in a position to recover anything from the above said converters. With regard to the raw materials lying with M/s Litaka Pharmaceuticals Ltd, it was submitted that the stock available with them became dead stock. It was submitted that the raw material available with Litaka amounting to Rs.2,60,08,063 pertained to excisable goods and that the Litaka obtained the approval of the Central Excise Department for destroying the goods. Post destroying the goods Litaka reversed the central excise duty in the books of accounts. Hence the assessee has written off materials lying with the above said converters and also materials lying with the assessee, which became obsolete. The assessee submitted that it has obtained approval from its parent company for writing off the above said items and accordingly furnished before AO, the copies of authorization obtained from its parent company for write off of inventory.
9.3 The assessing officer after considering the submissions of the assessee held that (i) How the stock which was lying with the converters was written off by the officials of the parent company of the assessee if they have not been able to inspect the same (ii) Why a provision debited to the profit and loss account should be allowed under the Income Tax Act
(iii) The loss of stock lying with converter which is to be allowed as a bad debt has to be established to have become bad and also actually write it off from the books during the year (iv) The date of which the converter became bankrupt is not furnished by the assessee but mentioned the year as 2002 (v) The actual write off details of the dead stock of raw materials of Rs.2,60,08,063 with Litaka Pharmaceuticals which was destroyed was not furnished by the assessee (vi) All evidences which have been filed indicate that if at all this inventory was to be written off it should have been written off in the financial year 2002-03 (AY 2003-04) (vii) The amounts debited in the books as of 31.03.2002 is not more than a mere provision and hence the deduction cannot be allowed for inventory writeoff The AO also observed that the inventories were written off as per the authorization memo between 21.10.02 to 24.10.02, i.e., six days before filing return of income. Accordingly, the AO took the view that the inventory has been actually written off in the succeeding year and not during the year under consideration. Accordingly, the AO expressed the view that the assessee, if at all is required to write off the inventory, should have written off in the succeeding year, i.e., in the financial year 2002-03 relevant to the assessment year 2003-04. Accordingly, the AO held that the claim of the assessee is not allowable. Accordingly he disallowed the claim of write off of inventory amounting to Rs.12,54,31,371/-.
9.4 Before Ld CIT(A), the assessee submitted the following with respect to the write off of finished goods lying with it. The assessee accumulated stocks in anticipation of growing demand by forming a policy of stocking 16 week’s sales. However, the actual sales suddenly slumped significantly from the anticipated sales and hence there was huge stock pile-up
(i) There were serious logistics issues relating to proper storage and warehousing of such a huge inventory due to which the quality of these products deteriorated.
(ii) During the normal quality control testing procedures, foul smell was detected as emanating from these products and, accordingly the products were rendered useless and unmarketable.
(iii) Accordingly the market value of such inventory of finished goods was assessed at nil as per the requirement of AS-2.
(iv) The write off in the books of account was an actual write off and not mere provision.
The assessee also submitted that the above said finished goods were physically removed from company’s warehouses and sent to the manufacturing facilities of various converters, where they underwent a complete re-working process. It was submitted that it exported these goods to Herbalife America for an amount of Rs.2,46,43,632/- in the succeeding year and has been duly disclosed in that year. The assessee also relied upon Accounting Standard 2 relating to Valuation of inventories in support of write off of finished goods and said that the closing stock is required to be valued at lower of cost or net realizable value.
9.5 With regard to the write off of the goods lying with Converters, the assessee reiterated the submissions made before the AO.
9.6 The CIT(A), however, was not convinced with the contentions of the assessee and accordingly confirmed the disallowance made by the AO. The CIT(A), in his order, has made the following observations on the submissions made by the assessee:-
“On examination of these Inventory Disposal Authorization sheets, it appears that the stock has not been disposed of till 24.10.2002. Moreover the sheets do not indicate in any manner that the inventory written off was to be disposed off as on 31.03.2002. Inventory Disposal Authorization indicates an authorization to dispose. A power to authorize necessarily includes the power not to authorize. Therefore, even if it were considered that there was due authorization to dispose of inventory as on 24.10.2002, there could not have been an authorization to dispose of the inventory items by a prior date of 31.03,2002. Another aspect of the matter is that the appellant has stated that the goods had become useless and gave foul smell. Such determination could only be with a prospective date. It is not conceivable as to how on 24.10.2002 it could be determined that the goods had become worthless or soul smelling as on 31.03,2002.
The letter containing information about M/s. Dominion Pharmaceuticals Pvt Ltd and M/s Dominion Chemical Industries given by the ACIT Central Excise Bengaluru II division date 08.08.2008 does not help the case of the appellant as it could not be true that the information regarding non traceability as per the letter dated 08.08.2008 would be available with the appellant as on 31.03.2002……….The appellant has not submitted any contemporaneous evidence which led to the conclusion that the so called converter companies had become bankrupt as on 31.03.2002
Therefore I agree with the conclusion of the assessing officer that the deduction for inventory write off was not allowable in the present assessment year. The allowability of inventory write off could only have been considered in the following assessment year relating to financial year 2002-03.”
Before us, the Ld.AR reiterated the contentions as submitted before the Ld.CIT(A). The Ld.AR brought to our attention to the Balance sheet, P&L account and specifically notes No.5, where the reason for write off of inventory of finished goods and raw materials are stated. The Ld.AR submitted that the assessee has followed the Accounting Standards 2 relating to valuation of inventories and Accounting standard 4 relating to Contingencies and Events occurring after the Balance sheet date in writing off of the inventory as on 31.03.2002. He submitted that the closing stock has to be valued at lower of cost or net realizable value. Hence the value of finished goods lying with the assessee was taken as NIL. With regard to the stocks lying with the converters, the assessee came to know of the loss before the finalization of the Balance Sheet and hence had to account for the loss, even though it was an event occurring after the balance sheet date, yet its impact was related to the stock available with the assessee as on 31.3.2002. Accordingly, the Ld A.R submitted that the assessee has written off the raw materials and finished goods as on 31.3.2002 itself in accordance with the accounting principles and accounting standards.
The Ld. DR supported the order passed by Ld CIT(A). He submitted that the decision to write off the raw materials and finished goods were taken in the month of October, 2002 and hence the cause of action arose only in the succeeding year. He submitted that the assessee has not brought any material on record to show that the materials became obsolete as on 31.3.2002 itself. The Ld D.R submitted that the assessee had submitted a letter dated 08-08- 2008 obtained from by the ACIT Central Excise Bengaluru II division before the AO in order to support its submission that the Dominion group has closed its business in 2002 itself. In the above said letter, it was mentioned that the Dominion group of companies have operated upto November, 2001 only. With regard to this letter, the Ld D.R submitted that the above said letter was obtained only in 2008 and it does not support the case of the assessee that the raw materials lying with Dominion group became obsolete as on 31.3.2002. The Ld. DR also submitted that, without prejudice, even if the claim of the assessee had to be accepted, then the same requires examination only in the financial year 2002-03 relevant to AY 2003-04.
We have heard rival submissions and perused the record. The key point for consideration here is Whether the claim for inventory write-off made by the assessee in the books of accounts as 31.03.2002 can be allowed as deduction during the year under consideration or not. We noticed that the evidences in the form of disposal notes furnished by the assessee are all dated in October, 2002, meaning thereby, the decision to write off these inventories have been taken only in October, 2002, i.e., in the succeeding year. The moot question is whether the impugned materials have become obsolete as on 31.3.2002 or not. As rightly observed by the AO, these authorization obtained from parent company may enable the assessee to write off the materials in the books of account, but it will not prove that the quality of the raw materials and finished goods have fully deteriorated as on 31.3.2002, particularly in view of the fact that there was a time gap of more than six months between the closure of the accounting year and the authorization. Further, the assessee itself has submitted before Ld CIT(A), some of the products were re-processed and exported in the succeeding year. This submission, in fact, would support the case of the revenue. Hence, we are of the view that the assessee has failed to bring any material to show that these materials got deteriorated by 31.3.2002 itself.
12.1 There is no dispute with regard to the fact that AS–2 mandates “Valuation of Inventory” at cost or net realizable value as at the Balance Sheet date. As observed by Ld CIT(A), there is no dispute on this accounting principle. However, the pertinent point to be noted here is, as observed by us earlier, the assessee has failed to prove that these materials got deteriorated as on 31.3.2002 itself. The assessee also placed reliance on AS-4, as per which the loss arising on account of contingencies and events occurring after the Balance sheet date should be recognized on the balance sheet date. However, the condition for invoking AS-4 is that there should exist a contingency as on the Balance Sheet date and the result of contingency, if known before the finalization of balance sheet, then the loss arising there from should be accounted for. In the instant case, it is not shown that the write off was related to the contingency that existed as on 31.3.2002. On the contrary, in the facts of the present case, there cannot be any contingency with regard to the raw material or finished goods. We therefore, based on our discussions made above, are in agreement with the stand taken by the CIT(A) in disallowing the claim of inventory in the assessment year 2002-03.
The next issue relates to the claim of Loss arising on account of foreign exchange fluctuation.
13.1. During the year under consideration, then assessee has claimed a sum of Rs.68,40,528/- on account of foreign exchange fluctuation loss. The AO noticed that, out of the above said claim, a sum Rs.44,00,768/- pertained to realized loss and the balance amount of Rs.24,39,760/- related to the loss arising on account of restatement of liabilities as at the year end. The assessee submitted the ledger account of the foreign exchange loss with a bifurcation between realized and unrealized exchange loss. However, the AO disallowed entire claim of Rs.68,40,528/- holding that the exchange fluctuation loss can be claimed as deduction only on actual incurring of loss at the time of payment.
13.2 The CIT (A) relied on the judgment of the Hon’ble Supreme Court inthe case of CIT Vs. Woodward Governors India Pvt. Ltd., (2009) 312 ITR 254 (SC) and directed the AO to allow loss actually incurred during the year and disallow only unrealized loss arising on account of restatement of liabilities.
13.3 Before us the Ld.AR made submissions relying on the decision of the Hon’ble Supreme Court SC in the case of Woodwards Governors India Pvt. Ltd., (Supra) and also on the decision of the ITAT New Delhi in assessee’s own case for the assessment year 2001-02 in (101 ITD 450). The Ld. DR, on the contrary, supported the view expressed by the CIT(A)
13.4 We heard both the parties and perused the record. We notice that this issue is covered in favour of the assessee by the decision of the ITAT rendered in the assessee’s own case referred above, wherein it was held as under:-
“34. In the fifth ground of appeal the assessee has challenged the action of the Revenue authorities in disallowing a sum of Rs. 5,97,184 on account of foreign exchange fluctuation loss. In the grounds of appeal the assessee has however mentioned the figure at Rs. 73,17,184 which is a mistake as admitted by the learned Authorised Representative before us. As far as this issue is concerned, the total of the loss on foreign exchange fluctuation is given at p. 187 of assessee's paper book 1 which is as follows: Summary of foreign exchange loss transactions during the year 2000-01 Rs.
On account of technical know-how fees $ 2 Million 67,20,000.00 Imports 8,06,243.03 Expenses on travel, communication costs etc, (55,584.90) Loan 3,01,674.29 Administration Fee 4,55,148.00)
It is not in dispute that the assessee has been consistently following a system of accounting for recording the exchange variation both when it is a loss as well as when there is a gain as on the last day of every financial year. It is also not in dispute that the foreign exchange fluctuation is not on capital account. According to the Revenue authorities the loss or gain for foreign exchange should be taken only at the time of remittance and only then there can be an accrual. This issue has been considered by the Special Bench of the Tribunal in the case of Oil & Natural Gas Corporation Ltd. v. Dy. CIT (2002) 77 TTJ (Del)(SB) 387 : (2002) 83 ITD 151 (Del)(SB). The said Bench has held that in the case where an assessee consistently follows a system of accounting by which the fluctuation in foreign exchange currency is duly accounted for at the end of the accounting year, the same cannot be said to be notional and it cannot be said that the assessee could claim the fluctuation loss or gain only in the year when the loan was actually repaid. The Tribunal held that the loss was not a notional loss and was to be allowed as deduction. The Tribunal also referred to the AS-2 of the Institute of Chartered Accountants of India (the assessee in the present case follows such an accounting standard). In view of the above the loss on account of foreign exchange claimed by the assessee deserves to be allowed. The 5th ground of appeal is accordingly allowed.”
In the written submissions made before Ld CIT(A), the assessee has stated that the exchange difference does not pertain to any capital items. This fact was not disputed before us. Hence the loss arising on restatement of outstanding liabilities is on revenue items and the same is allowable as deduction as per the decision rendered by the co-ordinate bench in the assessee’s own case in an earlier year, referred supra. Accordingly, we set aside the order passed by Ld CIT(A) on this issue and direct the AO to allow the loss of Rs.24,39,760/- arising on account of restatement of liabilities of revenue items.
The assessee has raised an additional ground before us with respect to claim towards advance write off – Excise duty on exports of Rs.1,20,16,395/- It reads as under:- Ground no.4 : Claim towards Advance written off – excise duty on exports of INR 1,20,16,395 The Assessing officer (”learned AO”) and Commissioner of Income tax (Appeals) (“Learned CIT(A)”) has erred in law and on facts, in not granting deduction in respect of amount paid towards excise duty on exports of INR 1,20,16,395 in AY 2002-03, after having denied the Appellant’s claim for the same in AY 2007-08.
The Learned AO and Learned CIT(A), has erred in law and on facts, in not appreciating the fact that the Appellant was eligible for deduction in respect of amount paid towards excise duty on exports of INR 1,20,16,395 in AY 2002-03, but was recorded as receivable in the books of account, owing to its eligibility to claim duty draw-back rebate with the Excise Authorities, which was subsequently rejected.
14.1. The Ld A.R explained the facts relating to this issue. He submitted that, in the year relevant to AY 2002-03, the assessee had procured certain material from one of the supplier Dominion Chemicals Pvt Ltd and incurred excise duty of Rs.1,25.20,839/-. These goods were subsequently exported and hence, the assessee became eligible to claim rebate of the above said excise duty amount paid by it, as duty drawback. Hence, the assessee accounted the Excise duty payment amount as “receivables” under the head “Loans and Advances” in the Balance Sheet as at 31.3.2002, since it claimed rebate of duty draw-back. Otherwise the excise duty payment is allowable as deduction. The assessee, however, created a provision for doubtful advances for the same amount of Rs.1,25,20,839/- in the very same year, considering the time and the cumbersome procedure involved in obtaining the duty drawback. However while computing the total income for the AY 2002-03, the assessee has voluntarily disallowed the provision so created. In effect, the assessee did not claim deduction of excise duty payment, referred above.
14.2 Subsequently the claim of duty drawback was rejected by the central excise department at various levels and currently a writ petition has been filed before the Bombay High Court, which is pending for disposal. The assessee, in view of the litigation on duty drawback, wrote off an amount of Rs.1,20,16,395/- out of the above said amount during the financial year relevant to AY 2007-08 and claimed the same as a deduction in the computation of income of the said assessment year. The deduction claimed in the AY 2007-08 was disallowed by the AO and the same was also upheld by both the CIT(A) and the ITAT Bangalore Bench in IT(TP)A No.924/Bang/2012).
14.3. Accordingly, the Ld A.R submitted that the assessee did not claim deduction of excise duty payment in AY 2002-03 and its claim made in AY 2007-08 was also rejected. In effect, the excise duty paid by the assessee has not been allowed and it has caused great prejudice to the assessee. He submitted that the assessee did not claim the excise duty payment in AY 2002-03, even though it is allowable as deduction, only for the reason that it is eligible for duty draw back. In view of the developments that happened subsequently, the assessee is praying for deduction of the excise duty paid by it to the extent of Rs.1,20,16,395/- in AY 2002-03, since the assessee did not receive duty draw-back and further the claim made in AY 2007-08 was disallowed. He submitted that the above said claim of the assessee can be examined independently, dehors the developments that happened in AY 2007-08.
14.4 The Ld A.R also submitted that the assessee has filed additional evidences in support of the above said claim. He prayed for admission of additional evidences as well as additional evidences.
14.5 The Ld. DR submitted that the assessee has disputed the disallowance made in AY 2007-08 by filing appeal before Hon’ble Bombay High Court. Since the assessee has not accepted the disallowance in AY 2007-08 and further since matter is sub-judice, the claim of the assessee should not be entertained during the current year. 14.6 We have heard the parties and perused the record. The additional ground urged by the assessee is a new claim raised for the first time before us. It is the case of the assessee that the excise duty amount, referred above, was paid during the year and hence the same should be allowed as deduction. According to Ld A.R, the above said claim should be examined independently dehors the developments that took place in AY 2007-08, since the excise duty payment has been made in the year relevant to AY 2002-03. 14.7 Since the assessee is making a new claim in respect of excise duty paid by it for the first time before us, we are of the view that this issue requires examination at the end of AO. Accordingly, we restore this issue to the file of the AO for examining the same afresh. After affording adequate opportunity of being heard, the AO may take appropriate decision in accordance with law.
In the result, assessee’s appeal is partly allowed. Order pronounced in court on 4th February, 2022 Sd/- Sd/- (N. V. VASUDEVAN) (B R BASKARAN) VICE PRESIDENT Accountant Member Bangalore, Dated, 4th February, 2022 / vms / Copy to:
1. 1. The Applicant 2. The Respondent 3. The CIT 4. The CIT(A) 5. The DR, ITAT, Bangalore.