ARJAV DIAMONDS,MUMBAI vs. PR CIT -19, MUMBAI

the learned CIT has erred in law and on facts in holding that the order passed by the Assessing Officer was erroneous and prejudicial to the interests of the revenue.

Briefly stated facts are that the assessee is engaged in the business of export, manufacturing and trading in rough and polished diamonds. The assessee filed its return of income on 27.09.2016, declaring total income at Rs. 1,24,30,750/- for the AY 2012-13. The original assessment was completed under section 143(3) of the Act vide order dated 12.02.2015 accepting the returned income. According to PCIT, on perusal of case records, he noticed that the amount of Rs. 77,88,482/- being an exchange difference on import had been debited and an amount of Rs. 89,27,734/- being an amount as exchange difference on export, and profit and loss account has been credited. According to him, the purchase of rough diamonds in the trading account 3 has been declared at Rs. 84,06,12,392/- (both local and import), the value of closing stock of rough diamond was declared at Rs. 18,56,67,324/- and of polished diamond at Rs. 54,600/-. He noted, after perusing the case records that the AO has not examined whether the amount of Rs. 77,88,482/- being exchange difference on import and Rs. 89,27,734/- being exchange different on exports had been taken into account for the purpose of valuation of closing stock of rough diamonds and polished diamonds. The PCIT noted the decision of Delhi Tribunal in the case of West Falia Separator India Pvt. Ltd. Vs. ACIT (52 taxmann.com 381 Delhi Trib), wherein it is held that forex gain or loss or trading transactions is part of price import or value of export transaction. On that basis, the PCIT noted that this exchange rate different should be taken into consideration while valuing closing stock of rough diamonds and polished diamonds. The PCIT directed the AO vide Para 4, 4.2 and 5 as under: - “4. On perusal of records and consideration of relevant facts as well as the submissions made by the assessee, it is found t:at during the course of assessment proceedings, the A.O. had failed consider that the expenditure on account of foreign exchange fluctuation should also comprise part of the value of closing stock. As neither the assesse nor the A.O. have considered the same, there is undervaluation of closing stock by Rs.77,88,482/- being exchange difference on import and Rs.89,27,734/- being exchange difference on exports Out of these amounts, the difference on account of actual payments of forex made during the previous year by the assessee are Rs.88,55,464. 10 on account of exports and Rs.

Aggrieved, assessee came in appeal before Tribunal. Before us, the learned Counsel for the assessee argued that the valuation of rough diamonds and polished diamonds are done in the following manner

The learned Counsel for the assessee stated that while valuing closing stock, the assessee has not considered the exchange difference as part of cost of goods since the same is considered as financial gain or loss whichever is shown in profit and loss account but was not part of trading account. He stated that the amount is not being included in the opening stock and also in closing stock. For this, he argued that the assessee has employed the consistent method of valuing the opening and closing stock of rough and polished diamonds. He stated that the method consistently followed cannot be disturbed if the method is one of the accepted methods of accounting. The learned counsel for the assessee referred the provisions of section 145A of the Act and stated that there is no mentioned of exchange rate difference to be added to the cost of goods in section 145A of the Act. The learned Counsel for the assessee stated that this issue has been considered by the decision of this Tribunal in the case of IBM Global Services India (P.) Ltd. vs. DCIT [2008] 113 TTJ 747 (Bangalore). We find that the Tribunal in the case of IBM Global Services India (P.) Ltd. (supra) has followed the decision of co-ordinate bench in the case of Yokogawa India Ltd. in 6 and 3444/Bang/04. According to the learned counsel, this decision of IBM Global Services India (P) Ltd. (supra) has been affirmed by Hon’ble Karnataka High Court. The learned Counsel for the assessee referred to the details of export exchange difference and details of import exchange difference which are amounting to Rs. 89,27,734/- and Rs. 77,88,492/- respectively. The learned Counsel for the assessee referred to pages 7 to 12 of assessee’s paper book, wherein the complete details are given. The learned Counsel for the assessee also relied on the decision of Hon’ble Supreme Court in the case of CIT vs. Woodward Governor India P. Ltd. (2009) 312 ITR 254 (SC).

On the other hand, the learned CIT DR Shri Anadi Verma, relied on the decision of Ballarpur Industries Ltd. vs. CIT (2017) 398 ITR 134 (Bom.), Vaibhavi Trading (P) Ltd vs. DCIT (2018) 89 taxmann.com 132 (Mumbai-Trib.) and Westfalia Separator India (P.) Ltd. Vs. ACIT (2014) 165 TTJ 56 (Delhi-Trib.) for this proposition that the exchange rate difference will be added to the valuation of stock.

We have heard the rival contentions and gone through the facts and circumstances of the case. We noted that the assessee has followed the closing stock of roughed diamonds at cost. The assessee also valued the closing stock of polished diamonds at estimated cost or reasonable value whichever is lower. The assessee following this method consistently. For this, we are noted from the Judgment of Hon’ble Supreme Court in the case of Woodward Governor India P. Ltd (supra), wherein it is clearly held that wherever there is a profit on account of exchange rate difference, the same will be considered as income and wherever there is a loss on account of exchange rate difference the same will be claimed as loss. Hon’ble Supreme Court has considered this issue in Para 18 and 19 as under: - 7 “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 8 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 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.

A company imports raw material worth US $ 250,000 on 15-1-2002 when the exchange rate was Rs. 46 per US $. The company records the transaction at that rate. The payment for the imports is made on 15-4-2002 when the exchange rate is 9 Rs. 49 per US $. However, on the balance sheet date, 31-3-2002, the rate of exchange is Rs. 50 per US $. In such a case, in terms of AS-11, the effect of the exchange difference has to be taken into P&L account. Sundry creditors is a monetary item and hence such item has to be valued at the closing rate, i.e., Rs. 50 at 31-3-2002, irrespective of the payment for the sale subsequently at a lower rate. The difference of Rs. 4 (50-46) per US $ is to be shown as an exchange loss in the P&L account and is not to be adjusted against the cost of raw materials.”

We noted that from the above and came to conclusion that the loss on account of foreign exchange fluctuation is recognized in terms of AS- 11. The said accounting standard clearly states that a foreign currency transaction should be recorded on initial recognition 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. It further states that each Balance Sheet date, foreign currency monetary items should be reported using the closing rate and non-monetary items which are carried in terms of historical cost denominated in a foreign currency should be reported using the exchange rate at the date of transaction. In other words, the revaluation of creditors or debtors or the loss incurred on the actual of payment is not to be considered for the purpose of reporting the non-monetary items, like closing stock. Secondly, the foreign exchange loss incurred is not an item of cost, and rather it is a revenue outflow or an expenditure provided by prudence depending on the date of payment or the Balance Sheet Date and therefore, it cannot be added to the cost of the inventory even under 10 the AS-2. Even for a moment it is accepted that the increase in foreign exchange rate would yield a higher value of the unsold stocks, still it would amount that it would go to add the realizable value and not the cost of the said stocks. Thus, considering the principle that as a matter of prudence stocks are valued at lower of the cost or the realizable value, such increase in realizable value has no bearing on the profits computed. Normally, the expenditure/ loss incurred due to foreign exchange fluctuation on account of actual payments would be a parameter kept in mind for deciding the sale piece of the stock that a prudent businessman would like to recover the said expenditure/ loss when the stocks are sold and would not increase the value of the closing stock and thereby increase the profits before actual realization of the same. Therefore, the foreign exchange fluctuation loss cannot be added to the cost of inventories. In view of the above, we are of the view that the Revision order carried out by PCIT is without any basis and on merits also the assessee has a case, hence, we set aside the revision order passed by PCIT and allow the appeal of the assessee.

In the result, the appeal of assessee is allowed.