THE ACIT, COCHIN vs. M/S.SUD CHEMIE INDIA P. LTD, ALUVA

Per CHANDRA POOJARI, ACCOUNTANT MEMBER:

These three appeals by the Revenue are directed against the different orders

of the CIT(A) for the assessment years 2008-09, 2009-10 and 2010-11.

together and are being disposed of by this common order.

I.T.A. Nos./ 3, 17 & 41/C/2017 3. The first common ground in I.T.A. No. 03/Coch/2017 and 17/Coch/2017 is

with regard to deletion of addition by CIT(A) on provision made towards MTM

loss on forwarding contracts in the year in which the provision was made in the

books of account.

assessee had provided for loss on forex derivatives amounting to

Rs.2,42,86,625/- for the assessment year 2008-09 and Rs.1,98,37,275/- for the

assessment year 2009-10. The Assessing Officer observed as follows:

2.1 “As per the statement of significant accounting policies (Schedule 21 : Notes forming part of accounts), exchange gain or loss on derivative instruments entered to hedge risks associated with foreign currency fluctuations and on forward exchange contracts, which are intended to hedge the foreign currency risks of future transactions in respect of which firm commitments are made or which are highly probable forecasts transactions, are determined by marking such contracts outstanding on balance sheet date to market. Exchange loss arising of such instruments/contracts is provided, in the accounts, which gains are not recognized.

As per the notes to accounts 7(c), the outstanding contracts as at balance sheet date, other than forward contracts to hedge existing receivables, to which accounting standard 11 “the Effects of changes in Foreign Exchange Rates” applies, have been marked to market as on 31st March, 2008 and the exchange loss arising on the same amounting to Rs.2,42,06,625/- have been provided in the accounts for the year, in accordance with the announcement of Accounting for Derivatives issued by the ICAI.

2.2 The losses on forex derivatives have been provided on marked to market basis and it only an anticipated loss, contingent on the happening of a future event. The loss has not actually arisen or been incurred; the provision made is in respect of open contracts.

2.3 No such provision has been made in earlier years.

I.T.A. Nos./ 3, 17 & 41/C/2017

2.4 The Supreme Court decision reported in 312 ITR 254 is distinguished on facts. The decision in that case was rendered in the context of AS 11. The Court observed that the assessee should give the same treatment for losses claimed to have accrued and to the gains that may accrue to it. In the instant case, the assessee provides for anticipated losses on MTM basis, but does not recognize the gains.

2.5 Reliance is placed on CBDT Instruction No 3/2010 dated 23/03,2010 on the treatment of notional losses on forex derivatives. It was noted that marked to market loss is a notional loss as no sale/conclusion/settlement of contract has taken place and the asset continues to be owned by the company.”

Similarly, the same is the position for assessment year 2009-10. On appeal, the

CIT(A) observed that it is business loss and allowed the claim of the assessee.

years.

similar view was taken in the ITAT Bangalore in Quality Engineering and

Software Technologies Pvt. Ltd. Vs. DCIT reported in 152 ITD 320 wherein it was

held as follows:-

“We have heard the rival contentions and perused and carefully considered the material on record, the submissions made and the judicial decisions placed reliance upon. It would be relevant to briefly examine the concept of "derivatives" and the underlying nature of these transactions before deciding whether they are "speculative transactions" or not; whether they represent "notional loss" or real loss and whether or not they are allowable as deduction. Simply put, a derivative is a financial instrument whose value depends on the values of the underlying exposure. The underlying exposure in the case of forex derivatives is the foreign exchange rates. The common foreign exchange derivatives are, forward contracts, option contracts and swap contracts, etc.

I.T.A. Nos./ 3, 17 & 41/C/2017 These instruments are used to hedge the currency risk on account of adverse currency movements.

4.5.2 The term ‘Marked to Market' losses (MTM) refers to losses computed as on a particular date with reference to prevailing exchange rate in respect of contracts that have not matured (i.e. open contracts). As per the prescribed Accounting Standards, companies are required to account for the MTM losses in their books of account despite the fact that the contract has not yet matured as on the Balance Sheet date. 4.5.3 Foreign exchange Forward Contract means an agreement to exchange different currencies at a forward rate. Forward rate is the specified rate for exchange of currency at a specified future date. The assessee, in the case on hand, entered into a forward contract with the Bank to buy or sell foreign exchange at an agreed price on a future date in order to hedge against possible future financial loss due to fluctuation in the rate of foreign currency. Therefore;

(i) Firstly, the foreign exchange forward contract created a continuing, binding obligation on the date of contract against the assessee to fulfill the same on the date of maturity; and

(ii) Secondly, it is in the nature of a hedging contract because it is a contract entered into against possible future financial losses. It follows from the above that while it is true that the assessee would come to know of the actual profit I loss only on the date of maturity, unless there is any premature cancellation of the contract, it is equally true that the assessee could anticipate the loss on the valuation date, say 31 March, with reasonable accuracy. Prudent accounting and commercial principles require that all accrued losses have to be taken into account.

4.5.4 Having considered the nature of the contract; it needs to be examined whether on account of the existing obligation arising out of the contract, a liability accrued as per the provisions of the Income Tax Act. In this regard, it is necessary to consider and take into account some of the settled principles regarding accounting propositions, which are as under:

(i) Income is to be accounted for only when the right to receive the same has accrued in favour of the assessee, thereby creating a realisable debt in its favour; i.e. a legally enforceable right; (ii) All anticipated losses, which accrued on the date of balance sheet have to be accounted for as per prudent accounting policies; (iii) Stock-in-trade is valued at the end of the previous year in accordance with the matching principle in order to find out the true profit I/loss. (iv) The method of accounting consistently followed by the assessee should not be discarded casually without having good and sound reasons for the same.

4.5.5 The assessee contends that the forward contract was to be revalued in accordance with the Accounting Standards (AS) — 11 and therefore he has no option but to determine the profit / loss in regard to unmatured foreign

I.T.A. Nos./ 3, 17 & 41/C/2017 exchange forward contracts in accordance with the currency rates as on the valuation date viz. March 31st This contention of the assessee is not disputed. The Assessing Officer, however, is of the view that such treatment in the books of account per se did not give the assessee the right to claim the loss under the Income Tax Act. It is this contention of the Assessing Officer that requires to be examined, having regard to the fundamental commercial principles which have received judicial recognition. It is a settled principle, upheld in several decisions of the Courts, that deduction is allowable under the Act in respect of liabilities that have crystallised during the year. If an anticipated future liability is coupled with a present obligation, then that results in crystallised liability, even though the quantification may vary depending upon the terms of contract. A contingent liability depends purely on the happening or not happening of an event. Whereas, if an event has taken place, which in the case on hand was of entering into the contract and undertaking of the obligation to meet the liability, and only the consequential effect of the same is to be determined, then it cannot be said that it is in the nature of contingent liability. It is to be borne in mind that the issues relating to the accrual of income cannot be decided on the same footing and considerations on which issues relating to losses are to be decided. In the case of loss! expenditure, the concept of reasonable certainty to meet an existing obligation comes into play; which in legal terminology is referred to as "crystallization of liability". This is in keeping and consonance with the principle of prudence as considered by the Hon’ble Apex Court in the case of Woodward Governor India Pvt. Ltd. 312 ITR 254(SC). The substantial questions of law before the Hon'ble Apex Court for consideration as extracted from para 3 of its order is as under:

"3. In this batch of civil appeals, the following question arises for determination:

"(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 s. 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 cost 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 of law were elaborated by their Lordships at para 4 of the order which is extracted as under:-

"4. At the outset, for the sake of convenience, we may state that in this batch of civil appeals broadly we have before us two categories. In the first category, we are concerned with exchange differences arising in foreign currency transaction on revenue items. In such category, we are concerned with the assessee(s) incurring loss on revenue account. In that category, we are concerned with the provisions of ss. 28, 29, 37(1) and 145 of the IT Act, 1961 ("1961 Act"). In the second category of cases, we are

I.T.A. Nos./ 3, 17 & 41/C/2017 concerned with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets. In other words, in the second category of cases, we are concerned with the assessee(s) incurring liabilities on capital account. In such cases, we are required to consider the provisions of s. 43(1), 43A (both, before and after amendments vide Finance Act, 2002)."

4.5.6 The Hon'ble Apex Court after it considered and examined the issue, decided as at paras 13 to 21 of its order which are extracted as under:"13. As stated above, one of the main arguments advanced by the learned Addl. Solicitor General on behalf of the Department before us was that the word "expenditure" in s. 37(1) connotes "what is paid out" and that which has gone irretrievably. In this connection, heavy reliance was placed on the judgment of this Court in the case of Indian Molasses Company. Relying on the said judgment, it was sought to be argued that the increase in liability at any point of time prior to the date of payment cannot be said to have gone irretrievably as it can always come back. According to the learned counsel, in the case of increase in liability due to foreign exchange fluctuations, if there is a revaluation of the rupee vis-à-vis foreign exchange at or prior to the point of payment, then there would be no question of money having gone irretrievably and consequently, the requirement of "expenditure" is not met. Consequently, the additional liability arising on account of fluctuation in the rate of foreign exchange was merely a contingent/notional liability which does not crystallize till payment. In that case, the Supreme Court was considering the meaning of the expression "expenditure incurred" while dealing with the question as to whether there was a distinction between the actual liability in praesenti and a liability de ftituro. The word "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. Sec. 37 enjoins that any expenditure not being expenditure of the nature described in ss. 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 ss. 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 s. 32. Therefore, Parliament has used the expression "any expenditure" in s. 37 to cover both. Therefore, the expression "expenditure" as used in s. 37 may, in the circumstances of a particular case, cover an amount which is really a "loss" even though the said amount has not gone out from the pocket of the assessee.

I.T.A. Nos./ 3, 17 & 41/C/2017 allowance to items of business expenditure not covered by ss. 30 to 36. This section, according to the learned author, covers cases of business expenditure only, and not of business losses which are, however, deductible on ordinary principles of commercial accounting. It is this principle which attracts the provisions of s. 145. That section recognizes the rights of a trader to adopt either the cash system or the mercantile system of accounting. The quantum of allowances permitted to be deducted under diverse heads under ss. 30 to 43C from the income, profits and gains of a business would differ according to the system adopted. This is made clear by defining the word "paid" in s. 43(2), which is used in several ss. 30 to 43C, as meaning actually paid or incurred according to the method of accounting upon the basis on which profits or gains are computed under s. 28/29. That is why in deciding the question as to whether the word expenditure' in s. 37(1) includes the word "lossll one has to read s. 37(1) with S. 28, s. 29 and s. 145(1). One more principle needs to be kept in mind. Accounts regularly maintained in the course of business are to be taken as correct unless there are strong and sufficient reasons to indicate that they are unreliable. One more aspect needs to be highlighted. Under s. 28(i), one needs to decide the profits and gains of any business which is carried on by the assessee during the previous year. Therefore, one has to take into account stock-in-trade for determination of profits. The 1961 Act makes no provision with regard to valuation of stock. But the ordinary principle of commercial accounting requires that in the P&L a/c the value of the stock-in-trade at the beginning and at the end of the year should be entered at cost or market price, whichever is the lower. This is how business profits arising during the year needs to be computed. This is one more reason for reading s. 37(1) with s.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 system of commercial accounting can be superseded or modified by legislative enactment. This is where s. 145(2) comes into play. Under that section, the Central Government is empowered to notify from time to time the Accounting Standards to be followed by any class of assessees or in respect of any class of income. Accordingly, under s. 209 of the Companies Act, mercantile system of accounting is made mandatory for companies. In other words, Accounting Standard which is continuously adopted by an assessee can be superseded or modified by legislative intervention. However, but for such intervention or in cases falling under s. 145(3), the method of accounting undertaken by the assessee continuously is supreme. In the present batch of cases, there is no finding given by the AO on the correctness or completeness of the accounts of the assessee. Equally, there is no finding given by the AO stating that the assessee has not complied with the Accounting Standards.

I.T.A. Nos./ 3, 17 & 41/C/2017

I.T.A. Nos./ 3, 17 & 41/C/2017 a foreign currency as well as sundry creditors are all monetary items which have to be valued at the closing rate under AS-II. 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-II 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 s. 37(1), para 9 of AS-II which deals with recognition of exchange differences, needs to be considered. Under that para, exchange differences arising on foreign currency transactions have to 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 s. 43A of the 1961 Act. At this stage, we are concerned only with para 9 which deals with revenue items. Para 9 of AS-II recognizes exchange differences as income or expense. In cases where, e.g., the rate of dollar rises vis-à-vis the Indian rupee, there is an expense during that period. The important point to be noted is that AS-II stipulates effect of changes in exchange rate vis-à-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.

I.T.A. Nos./ 3, 17 & 41/C/2017 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."

4.5.7 As can be seen from the extractions reproduced above, the decision in the case of Woodward Governor India Pvt. Ltd. (supra) has been rendered in respect of "monetary items", denominated in foreign currency which include to mean money held and assets and liabilities to be received or paid in fixed amounts, e.g. cash, foreign currency notes, balance in bank accounts denominated in a foreign currency, receivables / payables and loans denominated in a foreign currency, sundry creditors, etc. are all monetary items.

The decision is also related to transactions in which a legal liability has been incurred before it is actually disbursed. We are therefore unable to concur or agree with the view of the learned CIT (Appeals), that liability could arise only when the contract would have matured, as such a stand is totally divorced from the accounting principles and is in variance with the principle upheld by the Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra). It can also be seen that the decision in the case of Woodward Governor India Pvt. Ltd. (as extracted above) has been rendered with regard to items in the revenue account and capital account. Therefore, the view of the learned CIT (Appeals) that this decision of the Hon'ble Apex Court relates to only restatement of existing currency liabilities and assets is not correct. 4.5.8 In the case on hand, it is not in dispute that the forward contracts have been entered into by the assessee in order to protect its interest against fluctuations in foreign currency, in respect of consideration for export proceeds, which is a revenue item.

Therefore, in sum and substance, it has the trappings of stock-in-trade and the assessee has to restate or revalue the same as on the Balance Sheet date. The consequent effect of this accounting treatment was to recognize the exchange fluctuation gain or loss in the profit and loss account as on the valuation date. In view of the facts and circumstances of the case as discussed above, we are of the considered view that the appeal of the assessee on this issue, succeeds for the following reasons :-

i) A binding obligation accrued against the assessee when it entered into foreign exchange forward contracts; ii) The forward contracts are in respect of consideration for export proceeds, which are revenue items;

I.T.A. Nos./ 3, 17 & 41/C/2017 iii) The liability is determinable with reasonable certainty when an obligation is pending on the balance sheet date and such a liability cannot be said to be a contingent liability. iv) The accounting treatment is as per Accounting Standards and the ICAI Guidelines, v) The principles enunciated by the Hon'ble Apex Court in the case of Woodward Governor India Pvt. Ltd. (supra) are applicable to the facts of the case on hand.

4.5.9 We had earlier observed that the Assessing Officer had relied on the CBDTs Instruction No.3/2010. Paras land 3 of this Instruction reads as under: “1. Foreign Exchange derivative transactions entered into by the corporate sector in India have witnessed a substantial growth in recent years. This combined with extreme volatility in the foreign exchange market in the last financial year is reported to have resulted in substantial losses to an assessee on account of trading in forex-derivatives. A large number of assesses are said to be reporting such losses on 'marked to market' basis either suo motu or in compliance of the Accounting Standard or advisory circular issued by the Institute of Chartered Accountants. The issue whether such losses on account of forex-derivatives can be allowed against the taxable income of an assessee has been considered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below: 2 3. Treatment of loss from actual transactions in forex-derivatives. In a case where a loss on a forex-derivative transaction arises on actual settlement /conclusion of contract and is not a notional or marked to market book entry, a further question will arise as to whether such a loss is on account of a speculative transaction as contemplated in Section 43(5) of the Income tax Act. For determining whether loss from a transaction in respect of a forex derivative is a speculation loss or not, the Assessing Officers may refer to Proviso (d) below sub-section (5) of Section 43 inserted by the Finance Act, 2005, with effect from 1.4.2006. It lays down that any 'eligible transaction' in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956, that has been carried out in a recognized stock exchange shall not be treated as a speculative transaction. Further, an 'eligible transaction' for this purpose would be one that fulfils the conditions laid down in Explanation to Section 43(5)(d). Any loss in a speculative transaction can be set off only against profit from speculative transactions."

In the case on hand, as discussed earlier, a contract has been concluded and a liability has crystallized. In this factual matrix, from the wordings of the Instruction, it follows that the loss arising out of the forward contract is not notional. In such a case, the CBDT Instruction requires the Assessing Officer to examine whether such a loss is on account of a speculative transaction as contemplated in section 43(5) of the Act.

4.5.10 The issue of speculative transactions and hedging transactions has been examined and analysed in detail in the decision of the ITAT, Mumbai in the case of S. Vinod Kumar Diamonds (P) Ltd. reported in (2013) 35 Taxmann.com 337 (Mumbai - Trib). The relevant paragraphs of this order are extracted hereunder and read as follows:

"5.2.1. The definition of 'speculative transaction' in section 43(5) of the Act, gives a simple test for deciding for the purpose of income-tax what a speculative transaction

I.T.A. Nos./ 3, 17 & 41/C/2017 means. If a contract for sale or purchase is ultimately settled and no actual delivery of the goods was effected under the settlement then it is a speculative transaction. The requirement of section 30 of the Indian Contract Act of the existence of the intention of the parties even at the time of the original contract not to give or take delivery of the goods in order to make it a speculative/wagering transaction is dispensed with for the purpose of the Act and if actual delivery is not given/taken under the settlement of contract, then the intention of the parties at the time of the contract becomes im- material. Thus, the true test is delivery of commodities/goods as per the contract, including a forwarding contract. Profit/loss in respect of unperformed contracts is considered speculation profit/loss. In short, in order that a transaction may fall within the scope of the expression 'speculative transaction', it must be a transaction in which a contract for 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.

5.2.2. Here, it would be useful to appreciate in proper perspective how hedge transactions are commercially understood before determining the true scope, width and nature of proviso (a) to sectiori43(5). Hedge contracts are those contracts which hedge against prejudicial price fluctuations. In speculative transactions the modus operand! of persons indulging in them is that when one enters into a contract of purchase, he also simultaneously enters into one or more contracts of sale against the same quantity deliverable at the same time either to the original vendor or to someone else, so as either to secure profit or to minimize loss, before the Vaida day; and similarly when he 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 valid hedging contracts of sales, the total of such transactions should not exceed the total stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchase. As per the accepted commercial norms object of a hedging contract is to secure oneself against loss in a future delivery contract, but such transactions cannot be regarded as inter-connected. Each one is independent of the other. So far as the profit or loss arising from a future delivery contract is concerned, it is determined on the date of actual delivery irrespective of the date on which the contract was entered into. In respect of a hedging contract, profit/loss arising there from can be ascertained or crystallized at fixed intervals of the term when the clearance takes place.

I.T.A. Nos./ 3, 17 & 41/C/2017 5.2.2.a. By resorting to counterbalancing transactions in the market for the ready commodity on the one hand and in the hedge market on the other hand, the hedger seeks to safeguard his position. The movement of prices in the two markets may not always follow an identical course and the hedger might at times gain and at times lose but such a gain or loss would be marginal and far less than what it would be if the person had not hedged at all. While, however, the hedging operation protects the hedger against loss arising from adverse fluctuations in prices, it also prevents him from making windfall profit owing to favourable fluctuations in prices as well. The forgoing of such a possible windfall profit is the price which he pays for the insurance against loss. This well-known technique, of hedge trading clearly implies forward contracts both ways, namely, for sale and purchase with a view to guarding against adverse price fluctuations. These forward contracts by way of hedge transactions usually afford a cover to a trader inasmuch as his loss in the ready market is offset by a profit in the forward market and vice versa. It, therefore, follows that in order to effectively hedge against adverse price fluctuations of the manufactured goods or merchandise, a manufacturer or merchant has necessarily to enter into forward transactions of sale and purchase both, and without these contracts of sale and purchase constituting hedge transactions, there would be no effective insurance against the risk of loss in the price fluctuations of the 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 stocks of the raw materials or the merchandise on hand which would include existing stocks as well as the stocks acquired under the firm contracts of purchases, (7) The hedging contract need not necessarily be in the same variety of the commodity they could be in connected commodities, e.g., one type of cotton against another type of cotton.

In other words unless the assessee shows that there was some existing contract in respect of which he was likely to suffer a loss because of future price fluctuations and that it was to safeguard against such loss that he entered into the forward contracts of sale, he could not claim the benefit of clause (a) of the proviso to section 43(5). With regard to speculative I hedging transactions we had benefit of perusing the judgments

I.T.A. Nos./ 3, 17 & 41/C/2017 of M.G. Bros. V CIT (1985) 1564 ITR 695/20 Taxman 90 (AP), Nuddea Mills Co. Ltd. V. CIT (1988) 171 ITR 169 (1987) 35 Taxman 3 (Cal), Delhi Flour Mills Co. Ltd. V CIT (1974) 95 ITR 151 (Del) and Pankaj Oil Mills V CIT (1978) 115 ITR 824 (Guj) delivered by the Hon'ble High Courts of Andhra Pradesh, Calcutta, Delhi and Gujarat respectively." 4.5.11 As discussed earlier, in the case on hand there has been an existing contract with a binding obligation accrued against the assessee when it entered into for-ex forward contracts. The forward contracts are in respect of consideration for exports proceeds, which are revenue items. There is an actual contract for sale of merchandise. In this factual matrix, it is clear in our view that the transaction in question will not qualify to be called as speculative transaction. In view of the facts and circumstances of the case on hand, as discussed above, we hold that the provision for losses on derivative contracts is allowable as expenditure. We, accordingly allow the Grounds at S.Nos. 1 to 9 raised by the assessee.”

6.1 In view of the above order of Tribunal, we are in agreement with the

proposition that the MTM loss on forward contracts is not contingent loss and it

is a business loss to set off against the business income of assessee. However,

the Assessing Officer has to consider the derivatives transaction equivalent to the

export turnover to determine the MTM loss and also if there is any premature

cancellation of forward contract of foreign exchange, it shall be excluded to

consider the business loss and these transactions to be treated as speculative

transaction.

6.2 Further, the Assessing Officer has to see the relevant copies of invoices

relating to imports in respect of each assessment year and authenticated

certificate from CA with regard to export/import turnover. If the assessee has

earned any profit on these transactions in the relevant assessment year, the

same have to be considered as business profit in respect of each assessment

I.T.A. Nos./ 3, 17 & 41/C/2017 year. With this observation, we remit this issue to the file of the Assessing Officer

for fresh consideration in accordance with law after affording reasonable

opportunity of hearing to the assessee. This ground of appeal of the Revenue is

partly allowed for statistical purposes.

regard to deletion of addition made on account of expenditure incurred on repair

and maintenance. The assessee incurred expenditure to the tune of

Rs.99,56,553/- and Rs.1,38,53, 153/- for the assessment years 2009-10 & 2010-

11 respectively. The Assessing Officer considered the expenditure as capital

expenditure and only allowed depreciation on it.

observed that it is repair and maintenance which is revenue expenditure and is

to be allowed as deduction while computing business income of the assessee.

attention to the various expenditure incurred by the assessee and the nature of

the expenditure shows that it is capital in nature which gives enduring benefit

and cannot be considered as revenue expenditure.

I.T.A. Nos./ 3, 17 & 41/C/2017 10. On the other hand, the Ld. AR submitted that the CIT(A) has considered

each item and given an elaborate finding that the expenditure is revenue in

nature. According to him, the expenditure incurred by the assessee is mere

repair and maintenance, cutting, painting, concreting, replacement of parts of

machinery, relocation of machinery of existing factory premises and none of the

expenditure has brought in any new asset to the assessee. The expenditure

resulted in better use of existing assets which is not a capital expenditure.

Finally he relied on the order of the CIT(A).

For the assessment year 2009-10, the CIT(A) has broadly classified expenditure

as follows:

(i) “relocation expense of producer gas plant” costing Rs.20,54,814/- ii) “change of MS truss due to rust” costing Rs.7,19,292/- iii)”replacement of leaking sintex water tank” costing Rs.53,273/- iv)”replacement of damaged display boards costing Rs.92,812/- v) “replacement of copper reactor tank” costing Rs.1,39,850/- (vi)”replacement of SS duct” costing Rs.1,30,683/- (vii)”replacement of cyclones and scrubber columns” costing Rs.1,27,134/- (viii)”shifting of the existing fuel storage tank” costing Rs.43,470/- ix) “Tank shifting from existing to new location for process requirement” costing Rs.32,000/-

The above expenditure is required to be examined with reference to the

invoices/bills and specific finding by the Assessing Officer is to be required. If

the assessee constructed new road, new workshop, toilet, truss work, rest

room, rain water harvesting plant, new compound wall etc., it is to be considered

as a new capital asset and depreciation is to be granted on it. However, the

I.T.A. Nos./ 3, 17 & 41/C/2017 CIT(A), only by going through the chart filed by the assessee treated the

expenditure as revenue expenditure. In our opinion, it is appropriate to remit

the issue to the file of the Assessing Officer to go through each invoices/bills and

decide thereupon. Same is the position for the assessment year 2010-11.

Accordingly, the issue is remitted to the file of the Assessing Officer for

reexamination. This ground of appeal for both the assessment years is partly

allowed for statistical purposes.

deletion of addition u/s. 14A r.w. Rule 8D of the Income Tax Rules. For the

assessment year 2008-09, addition u/s. 14A was at Rs.21,09,259/-, Rs.

5,84,014/- for the assessment year 2009-10 and Rs.11,85,068/- for the

assessment year 2010-11. The CIT(A) deleted the additions by observing that

the Assessing Officer has not specifically shown with the support of evidence that

such expenditure was incurred to earn exempted income. The Assessing Officer’s

action was mechanical and without proper reason and responsibility. Section

14A(3) mandates that such satisfaction is to be recorded in a case where an

assessee claimed that no expenditure has been incurred by him in relation to

income which does not form part of the total income under this Act. Accordingly,

he deleted the additions made under section 14A of the Act for all the

assessment years.

I.T.A. Nos./ 3, 17 & 41/C/2017 13. Aggrieved, the Revenue is in appeal before us.

of the Ld. AR is that the assessee is having own funds in the form of share

capital and reserves to make investment which yielded exempted income.

Further, it was submitted that interest was incurred on borrowings which was

used for the purpose of assessee’s business and it cannot be considered for the

purpose of computing disallowance u/s. 14A of the I.T. Act. However, these

facts were not demonstrated by the assessee neither before the Assessing

Officer nor before the CIT(A). The CIT(A) has given relief to the assessee for

different reasons. In view of this, in our opinion, though interest on borrowings

used for the business purpose cannot be considered for computing disallowance

u/s. 14A of the Act, it is the duty of the assessee to prove that interest was

incurred on borrowings which was used for the specific purpose of business.

Similarly, the assessee has to prove that the assessee is having own funds to

make investment which yielded exempted income by furnishing cash flow

statement. This was not done by the assessee. Hence in the interest of justice,

we remit this issue to the file of the Assessing Officer for fresh consideration in

accordance with law after affording reasonable opportunity of hearing to the

assessee. This ground of appeal of the Revenue for the three assessment years

is partly allowed for statistical purposes.

I.T.A. Nos./ 3, 17 & 41/C/2017 15. In the result, the appeals of the Revenue are partly allowed for statistical

purposes. Pronounced in the open court on 28th February, 2018.

sd/- sd/- ( GEORGE GEORGE K.) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER Place: Kochi Dated: 28th February, 2018 GJ Copy to: 1. M/s. Sud Chemie India Pvt. Ltd., Edayar Industrial Development Area, Binanipuram, Edayar-683 502. 2. The Assistant Commissioner of Income-tax, Circle-2(1), Kochi. 3. The Commissioner of Income-tax(Appeals)-I, Kochi 4. The Pr. Commissioner of Income-tax, Kochi. 5. D.R., I.T.A.T., Cochin Bench, Cochin. 6. Guard File. By Order

(ASSISTANT REGISTRAR) I.T.A.T., Cochin