DCIT, CIR-4(1), KOLKATA, KOLKATA vs. M/S MCLEOD RUSSEL INDIA LTD., KOLKATA

4.2. I have considered the A/R's submissions and perused the observations & findings of the AO in the impugned order. I have also gone through the relevant Accounting Standard and Guidance Notes issued by the ICAI in respect of provision for employees' retirement benefits. From the material placed before me I find that the assessee had consistently been making provision for retirement benefits for Employees in its annual accounts in conformity with AS-15. In all the past assessments of the appellant, the AOs consistently allowed the deduction for provision for post retirement benefits debited in accounts in consonance with AS-15. I further note that prior to AY 2005-06 tea business of the appellant belonged to Eveready Industries India Limited. The appellant company succeeded to the tea business of Eveready Industries India Limited on account of the scheme of demerger approved by Calcutta High Court. Eveready Industries India Limited in its books made provision for post retirement benefits to Employees in conformity with AS-15. In income-tax assessments of the said company also the deduction was allowed by the AOs in all regular assessments except for AY 1997-98. The ITAT, Kolkata in its appellate order for AY 1997-98 in however allowed the assessee's claim for provision for post retirement benefits to Employees taking the view that the said provision was made in respect of a liability which accrued during the relevant year in relation to services performed by the employees although payable in future at unspecified date. The Tribunal further found that the provision for post retirement benefits was ascertained on the basis of actuarial valuation certificate obtained by the assessee. Such provision was made in conformity with AS-15 prescribed by the ICAI. The ITAT accordingly held that the deduction was allowable in computing the business income of the assessee. Following the ITAT decision for AY 1997-98, no disallowances were made in the case of Eveready Industries India Limited or the appellant till AY 2007-08 even though in the accounts of the relevant years the provision for Employee Retirement benefits was debited and deduction therefor was claimed.

4.3 From these facts it therefore appeared that in the past assessments the AOs in principle accepted that the deduction for provision for post retirement benefits was permissible in arriving at the taxable income of the assessee since the relevant liability was incurred during the relevant years in which the employees performed their services. While assessing total income in the past years the AOs also accepted that the provision was to be allowed in accordance with the method prescribed in AS-15 issued by I CAI even though no specific provision of the I. T. Act dealt with such claim. Yet in the past assessments deduction for such provision was allowable because retirement benefits were payable to employees in terms of contract of employment with the employees. 4.4 In the impugned order the AO disallowed the assessee's claim on one of the fact that the assessee did not debit Rs.11,00,14,367/- to its Profit & Loss Account. The assessee did not spell out the enabling provision of the Act under which the action was permissible in respect of a liability which was admittedly not charged during the relevant but which was to be paid at a future unspecified date. In other words in AO's opinion such liability was a contingent. The reasons adduced by the AO justifying the disallowance are apparently inconsistent with the Departmental stand in the earlier years and also contrary to the provisions of the Act. The AO's decision is also contrary to the judicial precedents available on the subject. As noted in the foregoing the appellant and its predecessor in business in the past years had made provision in its books for the post retirement employees' benefits in accordance with AS-15. In all the past assessments except for AY 1997-98 the deduction therefor was allowed. The disallowance made in AY 1997-98 was disapproved by the CIT(A) & ITAT. In the assessment orders of the past years, deduction for retirement benefits as debited in the accounts in accordance with AS- 15 was always allowed. On the basis of the principle of judicial consistency therefore the AO could not depart from the admitted position when there was no change in the factual matrix except for the fact that the ICAI had recommended revision in the method for ascertaining the liability. 4.5 The Supreme Court in the case of Radhasoami Satsang vs. CIT (193 ITR 321) has held as follows: "where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and the parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year." The principle of consistency has also been applied by the jurisdictional Calcutta High Court in the case of Russell Properties P Ltd vs. Addl CIT (109 ITR 229). I therefore find that if the provision for retirement benefits of employees made in accordance with AS-15 was considered as an allowable deduction in the past assessments, then apparently there was no reason for the AO to depart from the said position and take entirely a contrary view in AY 2008-09 so as to disallow the current year's liability of Rs.1,65,51,581/- 4.6. In the impugned order the AO justified the disallowance also on the ground that the appellant did not specify any specific provision of the I.T. Act under which deduction was permissible. In my considered opinion this reason is inappropriate. It is not disputed by the AO that in terms of the contract of employment, the assessee had assured certain benefits to employees which were payable either during the period of employment or at the time of retirement or during the post retirement period. The retirement benefits were payable by the assessee to Its employees only at the time of or after the employees retired from the active service. But in either case these benefits could not have been claimed by the employees while they were. in active service. However the fact remained that the retirement benefits were promised to be paid by the assessee employer in consideration for the services rendered or performed during their time when employees were in active service. It was apparent that the contract of employment envisaged payment of remuneration to employees which was partly payable during the period when they were in active of service and partly during the period when the employment came to an end. However both the components of the remuneration were payable in consideration of the services to be performed by the employees from year to year during the period when services were actually rendered. In the circumstances by applying the principle of matching of cost and benefit it was necessary for the appellant to make fair estimate of its liability to pay for the employees' retirement benefits though payable in future but for the period during which the services

4 Mcleod Russel India Ltd., AY 2008-09 were actually performed by the employees. The liability on account of post retirement benefits represented contractual liabilities payable to employees according to their terms of employment. In the impugned order the Assessing Officer has allowed the deduction for emoluments paid to employees during the relevant year on being satisfied that the expenditure was incurred or laid out wholly for business purposes. In terms of the same contract of employment, the employees of the appellant were also entitled for the retirement benefits assured under the same contract of employment. The only difference was that such benefits were receivable by the employees in future upon retirement. However there being no material difference in the character of payment in the benefit receivable by the employees the AO could not disallow the provision for retirement benefits when the deduction was fully allowed in respect of remuneration paid to employees under the same contract of employment. 4.7. In order to disclose true & fair amount of Income earned, It was therefore mandatory for the assessee to determine its liability; which accrued during the impugned year. In respect of services performed by the employees during that period but which would be payable at future unspecified date The AS-15 methodology by which the assessee was required to make fair estimate of such future liability which accrued with reference to services performed employees during the relevant reporting period. AS-15 contained the Rules as the methodology to be followed by the enterprises in ascertaining the quantum of the liability for employee retirement benefits to be discharged in future. For ascertaining such liability, AS-15 mandated that the enterprise should obtain a report from the actuary estimating the liability. The actuarial valuation of a liability or expenditure is always based on assumptions which are statistically proven. The Supreme Court in the case of Bharat Earth Movers Limited Vs CIT (245 ITR 248) accepted that the liability for leave encashment though payable at future unspecified date yet the provision therefor made on scientific basis was allowable as deduction in computing the profits. The relevant observations of the Supreme Court were as follows: "The law is settled: if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the-liability-may-have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied, the liability is not a contingent one. The liability is in praesenti though it will be discharged at i future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain. Applying the principles laid down in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC) and Calcutta Co. Ltd. v. CIT [1959J 37 ITR 1 (Se), it must be held that the provision made by the assessee-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, would be allowable as deduction out of the gross receipts for the accounting year during which the provision was made for the liability. The liability was not a contingent liability. The High Court was not right in taking a view to the contrary. "

4.8 In this judgment the Supreme Court had relied on its earlier judgment in the case of Metal Box Company of India l.td vs Their Workmen (73 ITR 53). From these judgments it is evident that the Supreme Court in principle accepted that liability of a company payable at future unspecified date In relation to employee benefits can be allowed in the years in which the employees render the relevant services. The Supreme Court however observed that the liability can be allowed as a deduction if it can be estimated by following a method which has scientific basis. In the appellant's case such liability was ascertained by obtaining report from an actuary. In various judgments the Courts have accepted in principle that obtaining actuarial valuation report is the scientific way of ascertaining the quantum of an expenditure or liability. Moreover AS-15 issued by ICAI and which was mandatory u/s 209 of the Companies Act 1956 makes it compulsory that the reporting enterprise should obtain actuarial valuation of the post retirement employee benefit liability and based thereon provision should be made in the accounts. On these facts I agree with the AR's submissions that in arriving at the amount of business income which was to be assessed on the basis of generally accepted principle and method of accounting, the assessee was entitled to claim deduction for retirement benefits payable to employees.

4.9 The Supreme Court in the case of UP State Industrial Development Corporation (225 ITR 703) has observed as follows: “The accounting practice followed by the assessee in the instant case was in consonance with general principles of accountancy governing underwriting accounts. It is a well-accepted proposition that for the purposes of ascertaining profits and gains the ordinary principles of commercial accounting should be applied, so long as they do not conflict with any express provision of the relevant statute. The Tribunal, after referring to authoritative books on accountancy, had found that the assessee was maintaining the accounts correctly in accordance with the principles of accountancy applicable to underwriting accounts and keeping in view the said principles the underwriting commission on the shares which were not subscribed by the public and were purchased by the assessee could not be treated as profit earned by the assessee in the transaction and the said commission could only be treated as reducing the price of the shares purchased by the assessee. The Tribunal had also stated that there was no contrary provision in the Act. The revenue had not shown that the accountancy practice followed by the assessee was repugnant to any provision of the Act. In the circumstances, it must be held that the Tribunal and the High Court had not committed any error in taking the view that the underwriting commission earned by the assessee in respect of the shares which were riot subscribed by the public and were purchased by the assessee, would not be treated as a part of its taxable income.” From the above observations it is apparent that only where there is a conflict between the Accounting Standards or standard accounting principles with the provisions of IT Act then the provisions of the I. T. Act prevail with regard to assessment of total income. However, when there is no such conflict between the IT and the commercial principles of accounting then the income of the assessee is necessarily assessable with reference to accepted principle of accounting and the accounting standards recommended by ICAI which have been made mandatory under Section 209 of the Companies Act, 1956. From the impugned order it is noted that the sum of Rs.2,65,65,948/- disallowed inter alia included provision for leave encashment which is subject to application of Section 43B(f) of the Act. I find that in assessment order the AO has separately dealt with provision for leave encashment included in the said sum of Rs.12,65,65,948/- and made separate disallowance by invoking Section 43B(f) of the Act. The said disallowance is dealt with in Ground No. 12 of the present appeal. Save & except the item of leave encashment, there was no other employee benefit payable to retired employees' which was prohibited by any specific provision of the Act. Even the liability for leave encashment provided in terms of AS-15 was disallowed separately by the AO and therefore the AO could not have disallowed the same item again while dealing with the issue of provision as per AS-15. From the AR's submissions it appeared that the liability as provided in the accounts pertained to the period when the employees were in employment and benefit of their services had been availed by the appellant for carrying on its business. Applying the ratio laid down by the Supreme Court in the case of Bharat Earth Movers Limited Vs CIT (Supra) the assessee's own case in AY 1997-98 in I am therefore of the opinion that the assessee was entitled to claim deduction for provision for post retirement employees' benefits computed on the basis of actuarial valuation in terms of Sec 37 of the Act since such expenditure was incurred or laid out wholly for the assessee's business purposes and the benefits were payable to employees according to their contracts of employment with the appellant.

4.10. In the impugned order the AO justified the disallowance also on the ground that the deduction claimed inter alia included the liability of the earlier years amounting to Rs.11,00,14,367/- and which was not debited to the P&L A/c but was debited to the General Reserve brought forward from the earlier years In this regard I find that the ICAI revised AS-15 and prescribed new methodology for determining the liability which the enterprise was required to provide in its books. The revised method prescribed was mandatory. Based on the revised methodology the enterprises were required to re- compute their existing liabilities. The ICAI was aware that revision of the existing liabilities would result in either increase or decrease in the quantum of the provision made in the accounts till the revision was made effective. The ICAI therefore recommended that where as a result of the revision enterprise was required to make additional provision in its books then the additional liability could

6 Mcleod Russel India Ltd., AY 2008-09 either be set off against the General Reserves or additional liability could be written off to the P&L A/c in five annual equal instalments. In the appellant’s case it followed the first option and debited Rs.11,00,14,367/- being additional liability for the period upto 31.03.2007 to its General Reserve. 4.11 In my opinion however the manner in which the assessee accounted the additional liability in its books was not material in deciding whether the assessee was eligible to claim deduction for Rs.11,00,14,367/- which represented additional liability provided in the accounts based on the revision in AS-15 and which pertained to period prior to 01.04.2007. The provision for post retirement employee' benefits for the period upto 31.03.2007 were always allowed as business expenditure in the past assessments. AS-15 only prescribed the methodology on the basis of which the liability for such expenditure was quantified in the books. In the earlier assessments, the deduction was allowed by the AOs on being satisfied that the expense was permissible as revenue deduction and for which liability accrued in the respective years. In the circumstances if the revised AS-15 was in force in the earlier years then the deduction for the expense quantified on the basis of the said methodology would have been allowed in the respective years. The material change, if any, which occurred during the previous year relevant to AY 2008-09 was revision in the methodology prescribed by ICAI for estimating the liability in accordance with revised AS-15. As a result of the revision in AS-15, the assessee was mandatorily required to recomputed or rework the quantum of its existing provision because the revision prescribed in AS-15 was retroactive in operation. Because of the retroactive revision not only the current years liability but entire liability of the company accruing upto the date of revision becoming effective was required to be quantified and provided in the accounts. As a consequence the assessee's liability to pay such expenditure went up by Rs.11,00,14,367/-. 4.12 Additional liability of Rs.11,00,14,367/- however got crystallised as a consequence of the revision of AS-15 made by ICAI and which came in force w.e.f. 01.04.2007. The crystallization of the liability pertained to an item of expenditure which was in nature. I therefore find that the liability of Rs.11,00,14,367/- crystallised during FY 2007-08. The revision in the quantum of liability did not bring about any change in the basis character or nature of the expenditure which was always considered in the past assessments to be revenue in the earlier year' assessments the deduction for the same expense was allowed by the AOs following pre-amended AS-15 and therefore there was no reason for AO to adopt contrary view with regard to allowability of the additional expenditure which accrued as a result of revision in AS-15. The revision in AS-15 having become effective during the relevant previous year, the deduction was permissible in the relevant year of the revision. , therefore hold that the assessee was entitled to claim deduction both for Rs.11,00,14,367/- and Rs.1,65,51,581/- which represented the assessee's liability to pay post retirement employees benefits based on revised AS-15. The AO is accordingly directed to re-compute the income after allowing the deduction for Rs.12,65,65,948/-. Ground Nos.1 to 6 are therefore allowed.”

Being aggrieved, Revenue is now in appeal before us against the foregoing finding of the Ld. CIT(A).

Staff Pension Rs.7,34,67,165/- Medical Reimbursement Rs.2,95,13,970/- Leave Encashment Rs.74,20,744/- Foreign Pension Rs.2,73,41,641/-

“10. As far as question no. (v) is concerned, Mr. Agarwal very strenuously argued that the provisions for Rs. 82, 64, 000/- was a benefit conferred on the employees on superannuation or was a retirement benefit.

9 Mcleod Russel India Ltd., AY 2008-09 basis and claimed on the basis formulated in AS-15. The Ld. AR also drew our attention to the fact that in the income-tax assessment orders passed u/s 143(3) for AYs 2010-11 and onwards the AO once again allowedthe assessee’s claim of deduction for provision for post retirement employee benefits u/s 37 of the Act on accrual basis. We therefore find force in the submissions of the Ld. AR that on the principle of judicial consistency the AO was not permitted to depart from the accepted position,which permeated in earlier years as well as subsequent years, without pointing out any change in the factual matrix or provisions of law in the relevant AY 2008-09. In this regard we may gainfully refer to the judgment of the Hon’ble Supreme Court in the case of RadhasoamiSatsang (193 ITR 321)wherein it was held as under: where a fundamental aspect permeating through the different assessment years has been found as a fact one way or the other and the parties have allowed that position to be sustained by not challenging the order, it would not be at all appropriate to allow the position to be changed in a subsequent year.

“Notwithstanding anything contained in any other provision of this Act, a deduction otherwise allowable under this Act in respect of— (a) any sum payable by the assessee by way of tax, duty, cess or fee, by whatever name called, under any law for the time being in force, or (b) any sum payable by the assessee as an employer by way of contribution to any provident fund or superannuation fund or gratuity fund or any other fund for the welfare of employees, or (c) any sum referred to in clause (ii) of sub-section (1) of section 36, or (d) any sum payable by the assessee as interest on any loan or borrowing from any public financial institution or a State financial corporation or a State industrial investment corporation, in accordance with the terms and conditions of the agreement governing such loan or borrowing, or 10 Mcleod Russel India Ltd., AY 2008-09 (e) any sum payable by the assessee as interest on any loan or advances from a scheduled bank or a co-operative bank other than a primary agricultural credit society or a primary co-operative agricultural and rural development bank in accordance with the terms and conditions of the agreement governing such loan or advances, or (f) any sum payable by the assessee as an employer in lieu of any leave at the credit of his employee.”

11. For the reasons set out above we do not find any infirmity in the reasoning and conclusions of the Ld. CIT(A) deleting the disallowance of provision for employees’ retirement benefits. This ground of the Revenue is therefore dismissed.

10.2 I have considered the submissions of the AR. I have also perused the Instruction No. 3 of 2010 issued by CBDT with reference to which the AO disallowed the loss of Rs. 65.56 lacs. I have also examined the documents with reference to which the assessee accounted MTM loss in its books. From the impugned order I find that the AO’s order is cryptic. The AO did not discuss the background facts leading to MTM loss which the appellant accounted in its books. The MTM loss of Rs. 65.56 lacs had two components comprising of Rs.26.01 lacs and Rs.39.55 lacs. Loss of Rs.26.01 lacs pertained to forex derivative transactions which the appellant entered into under interest swap arrangement with ICICI Bank Remaining loss of Rs.39.55 lacs was incurred on account of unsettled outstanding forward contracts which the appellant executed into in relation to its export sales. The main component of the loss thus pertained to open outstanding forward contracts pertaining to appellant’s export receivables. 10.3 From the audited accounts of the appellant, I find that during the relevant year the assessee’s exports were Rs.145.15 crores which proved that assessee carried on international trade on substantial scale. In the circumstances the assessee was exposed to the risk of exchange rate fluctuations and therefore it was in the appellant’s business interest that assessee hedged its exchange rate flutctuation risks by entering into forward contracts. In terms of AS-11 issued by the ICAI, values of outstanding open contracts as on 31.03.2008 were rested at the prevailing exchange rates. Any gain or loss incurred on restatement of the outstanding position was accounted in its books. The underlying transactions in relation to which the assessee executed forward were its export sales i.e. to say, revenue item. In the circumstances any gain or loss incurred on restatement of open forward contracts and where underlying security was the export receivables, represented revenue gain or revenue loss. The assessee followed accounting method of restating the unsettled open contracts on the last date of the previous year consistently and the gain or loss incurred was accounted in the books in conformity with AS-11. I therefore find that the loss which the assessee incurred was a definitive loss and it accrued on the last date of the previous year i.e. 31.03.2008. The loss 10.4 The issue as to whether exchange fluctuation loss accounted by an assessee with reference to exchange rate prevailing on the date of balance sheet is a notional or contingent loss or ascertained loss was considered and decided by the Hon’ble Apex Court in the case of CIT Vs Woodward Governor India Pvt. Ltd. (312 ITR 254). In this judgment the Supreme Court essentially considered the question whether the loss arising from restatement of an expenditure or liability pursuant to exchange fluctuation in respect of unpaid trade receivable or trade payable was allowable in computing business income of an assessee. In the case before the Supreme Court it was the Revenue’s argument that such loss was notional or hypothetical loss which could not be allowed to be deducted in computing the business income of the assessee. It was the Department’s argument that such loss can be allowed as a deduction only when the loss was actually incurred on excess payment and not otherwise. The Supreme Court however negated the Revenue’s contention and held that the loss accounted by an assessee with reference to exchange rate prevailing at the end of the pervious was a real and definitive loss and the same was admissible as a deduction in arriving at taxable income if the assessee had recognize such loss by debiting it to its P&L A/c in terms of mercantile system of accounting which the assessee constantly followed. In its judgment the Supreme Court discussed in detail the accounting method prescribed in AS-11 issued by the ICAI and held that such method of accounting if followed consistently by an assessee was supreme even for computation purposes and the Department was precluded from making the disallowance unless the Revenue proved that the accounting system followed by the assessee was incorrect. The Apex Court particularly held that loss recognized and accounted by an assessee on account of restatement of foreign exchange denominated liabilities was allowed as revenue deduction if the underlying for such transactions were revenue items such as trade receivables, trade payables or working capital. This view was reiterated by the same Court in its later decision in the case of CIT Vs. Oil & Natural Gas Corpn. Limited Vs CIT (322 ITR 180).

10.5 The A/R’s reliance on the decisions of the ITAT, Delhi in the case of Bechtel India PVT. Ltd. Vs. Addl. CIT (32 Taxmann.com 123) and ITAT, Mumbai Special Bench in the case of DCIT v. Bank of Bahrain and Kuwait (41 SOT 290) also found to be relevant. In arriving at the finding that MTM losses were definitive and not notional or contingent, the ITAT Benches had taken into account not only the decisions of the Apex Court referred above but also the CBDT Instruction No. 3 of 2010 on which the AO placed reliance in the impugned order. Even after considering Instruction No. 3 of 2010, the ITAT Benches did not agree with the Department’s view that MTM loss accounted by the assessee in their books as per AS-11 was notional. On the contrary the ITAT Benches held that the Apex Court in its judgments in the cases of CIT Vs. Woodward Governor India Pvt. Ltd. (supra) CIT Vs. & Oil and Natural Gas Corpn. Limited (supra) had accorded judicial recognition to AS-11 and held that the loss on restatement of outstanding foreign exchange transactions were ascertained losses and could not considered to be notional or contingent one. In view of the binding judicial precedents therefore I have no hesitation in holding that loss of Rs.39.55 lacs accounted by the appellant in its books of account on restatement of outstanding forward contracts where underlying was exports receivable, was allowable in computing assessee’s business income.

10.6 The second component of MTM loss of Rs.26.01 lacs pertained to re0statement of unsettled derivative contracts booked under interest rate swap arrangement which the appellant entered with ICICI Bank. The assessee had obtained loan of Rs.40 crores from banks & institutions for its business purposes. Interest payable thereon was being claimed as business expenditure. The loans were obtained in Indian currency carrying interest @ 11.25%. Since interest rates globally were much lower, to reduce its servicing cost the assessee entered into interest rate swap arrangement with ICICI Bank with regard to loan of Rs.40 crores. Under this arrangement ICICI agreed to pay net interest @ 2% on Rs.40 crores by treating the loan amount being notionally swapped with deposit in Swiss Francs denomination. However under this arrangement the appellant incurred the risk of depreciation of Indian currency against Swiss Francs. From the AR’s explanation it was apparent that the purpose of entering into interest swap arrangement was to reduce effective cost of borrowing the dominant purpose for which the interest swap arrangement was entered into was not to obtain additional loan but to reduce effective cost of existing borrowing. In view of these facts therefore any loss or gain which arose from the interest rate swap arrangement was in the revenue field

13 Mcleod Russel India Ltd., AY 2008-09 since the underlying transaction for such an arrangement was interest payable which was a revenue item. Applying the principle laid down by Supreme Court in the cases of CIT Vs Woodward Governor India Pvt. Ltd. (supra) & Oil & Natural Gas Corpn. Limited Vs CIT (supra), such MTM loss of Rs.26.01 lacs incurred and accounted in the appellant’s books therefore constituted Revenue loss. 10.7 From the A/R’s submissions it further appeared that the assessee’s method of restatement of outstanding open foreign currency contracts was consistently followed in the subsequent years as well. The interest rate swap transactions were ultimately settled in the assessment year 2010-11. In the books for AY 2010-11 when the outstanding interest swap derivatives were ultimately settled the assessee accounted profit of Rs.97.39 lacs. Such profit was accounted after taking into account the opening provision for MTM loss from currency interest rate swaps amounting to Rs.788.77 lacs. The provision for MTM loss was made in the accounts for the AY 2008-09 & 2009-10 respectively. After taking into account loss of Rs.788.77 lacs accounted in the earlier years the assessee reported net gain of Rs. 97039 lacs in AY-2010-11 form interest rate swap transaction. From the assessment order for AY 2010-11, I find that even though loss of Rs. 788.77 lacs arising from restatement of interest rate swap derivatives was disallowed in AY 2008-09 and 2009-10, no deduction therefore was allowed in AY 2010-11 being the year in which the derivative transaction was ultimately settled. The gain of Rs. 97.39 lacs accounted as income in the books of that was however assessed as income of AY 2010-11. I therefore find that the year in which the derivatives transactions was ultimately settled, the AO did allow the deduction for the loss accounted in the books of prior years but the income reported in the relevant year was assessed without demure. I, therefore, find that while making assessment the AO did not even follow the CBDT Instructions No. 3 of 2010 in its true letter and spirit. 10.8 From the instruction No. 3 of 2010, it is apparent that the Board did not lay down a proposition that losses incurred from foreign exchange derivatives should be disallowed in all circumstances. The only proposition put forth in this instruction is that MTM loss which is considered by the Board to be notional or contingent should not be allowed from year to year but be allowed only in the year in which derivative contract is ultimately settled. Applying the letter and spirit of instruction No. 3 of 2010, the AO should have therefore, allowed the deduction for loss of Rs. 691.38 lacs in AY 2010-11. However from the assessment order of AY 2010-11, I find that the AO did not allow deduction for such loss even though in the year under consideration MTM loss was disallowed. I therefore find from the AR’s submissions that the AO did not follow CBDT’s Instruction No. 3 of 2010 and therefore, the AO’s reliance on the said instruction was inappropriate because the AO himself never faithfully acted in accord with the said instruction. 10.9 For the reasons set out in the foregoing therefore I have no hesitation in holding that the disallowance of Rs. 65.56 lacs made by the AO in the impugned order solely relying on Instruction No. 3 of 2010 was legally & factually inappropriate. Further since the loss was incurred by the appellant in relation to underlying transactions which were in the revenue field, the loss incurred on restatement of outstanding foreign exchange contracts or open derivative contract positions was in the revenue field and hence allowable. As per the ratio laid down by Supreme Court in the case of CIT vs Woodward Governor India Pvt. Ltd. (supra) & Oil & Natural Gas Corpn. Limited vs CIT (supra), MTM loss was not a contingent or notional loss but the same was real loss which was allowable in the year in which the loss was accounted in the appellant’s books. The AO is therefore directed to delete the disallowance of Rs. 65.56 lacs. Ground Nos. 15 & 16 are therefore allowed.”

Being aggrieved by the order of the Ld. CIT(A), the Revenue is now in appeal before us.

- CIT vs D Chetan& Co (75 taxmann.com 300) (Bom HC) - Bechtel India (P) Ltd VsAddl CIT (33 taxmann.com 213) (ITAT Delhi) - Reliance Industries Ltd Vs CIT (40 taxmann.com 431) (ITAT Mumbai)

15. In respect of the interest rate derivatives, the Ld. AR submitted that the underlying of this derivative contract was the loan commitments. The interest paid on the borrowings was allowed by the AO as deduction from the business profits. He therefore contended that the interest rate derivative which was entered into in the ordinary course of business with a view to reduce the effective cost of borrowings, the MTM loss incurred on such derivative as on 31.03.2008 was real, crystallized and on revenue account. The Ld. AR also invited our attention to the fact that when the interest rate derivative was ultimately settled in FY 2009- 10 relevant to AY 2010-11andnet gain of Rs.97.39 lacs determined at the time of actual settlement was offered to tax in that year; such gain was computed after taking into consideration the re-aligned position of the interest rate swap for AYs 2008-09 & 2009-10. It was submitted that had the MTM losses of Rs.26.03 lacs and Rs.762.75 lacs not been recognized in AYs 2008-09 & 2009-10, then instead of gain of Rs.97.39 lacs there would have been a loss of Rs.691.36 lacs and consequently the taxable profit of AY 2010-11 would have been a lower by that amount. The Ld. AR submitted that the fact that AO who framed the income-tax assessment for AY 2010-11 did not dispute the exchange gain of Rs.97.39 lacs and the same amount was assessed as the appellant’s income with reference to the re-aligned position of the interest rate derivative, showed that the Revenue adopted selective approach to treat the gain derived from derivative contract to be true & real but 16 Mcleod Russel India Ltd., AY 2008-09 losses to be notional & contingent. The Ld. AR therefore submitted that the Ld. CIT(A) was justified in treating the MTM loss incurred on derivative contracts to be real & therefore allowable as deduction from business profits. He also argued that the reliance placed by the Ld. DR on the CBDT Instruction No. 3/2010 dated 23.3.2010 was misplaced in as much as it talks about losses arising to an assessee on account of trading in forex derivatives. Admittedly in the facts of the present case the assessee had not carried out trading in forexderivatives and thereforehe contended that the said Instruction No. 3/2010 had no application. The Ld. AR thus pleaded that the order of Ld. CIT(A) be upheld.

17 Mcleod Russel India Ltd., AY 2008-09 18. The facts on record demonstrate that the foreign exchange forward contracts were entered into by the assessee with reference to underlying which were export bills in the ordinary course of its business. In our considered view therefore any gain or loss arising on restatement ofsuch foreign exchange forward contracts alsoarose in the ordinary course of assessee’s business. Similarly we note that the intent & purpose of the interest rate derivative was to reduce effective interest cost in respect of loan of Rs.40 crores borrowed in the ordinary course of business. Interest paid on such loan has been allowed as revenue deduction by the AO. Accordingly any gain or loss arising from such interest rate derivative was also in the revenue field since the underlying was the interest payable on the loan. Now theissue as to whether the loss arising on account of restatement of foreign currency denominated trade payables or receivables arising from exchange rate variation is real or contingent has been dealt with by the Hon’ble Apex Court in in the case of Woodward Governor of India Ltd vs, CIT( 312 ITR 254) and CIT Vs. ONGC Ltd (322 ITR 180). In both these judgments the Hon’blethe Supreme Court categorically held that the loss debited in the P & L account by an assessee on account of restatement of foreign currency denominated trade payables or receivables pursuant to exchange rate variation at the year- end is defined or ascertained loss and not contingent loss and hence allowable as deduction from the business profits.Applying the ratio laid down in these judgments to the facts of the present case, in our considered view since the underlyings of thederivative contracts entered into by the assessee were export bills& loan commitments, the gain/loss arising its restatement as on 31st March was real in nature and in the revenue field.

“The Revenue has urged the following question of law for our consideration:- “Whether on the facts and in the circumstances of th case and in law, the Tribunal was justified in deleting the addition of ‘Mark to Market’ Loss of Rs.78,10,000/- made by the Assessing Officer on account of disallowance of loss on foreign exchange forward 18 Mcleod Russel India Ltd., AY 2008-09 contract loss and not appreciating the fact that the said loss was a notional loss and hence cannot be allowed?”

7. The impugned order of the Tribunal has, while upholding the finding of the CIT (Appeals), independently. come to the conclusion that the transaction entered into by the Respondent assessee is not in the nature-of speculative activities. Further the hedging transactions were entered into so as to cover variation in foreign exchange rate which would impact its business of import and export of diamonds. These concurrent finding of facts are not shown to be perverse in any manner. In fact, the Assessing Officer also in the Assessment Order does not find that the transaction entered into by the Respondent assessee was speculative in nature. It further holds that at no point of time did Revenue challenge the assertion of the Respondent assessee that the activity of entering into forward contract was in the regular course of its business only to safe guard against the loss on account of foreign exchange variation. Even before the Tribunal, we find that there was no submission recorded on behalf of the Revenue that the Respondent assessee should be called upon to explain the nature of its transactions. Thus, the submission now being made is without any foundation as the stand of the assessee on facts was never disputed. So far as the reliance on Accounting Standard-l l is concerned, it would not by itself determine whether the activity was a part of the Respondent-assessee's regular business transaction or it was a speculative transaction. On present facts, it was never the Revenue's contention that the transaction was speculative butonly disallowed on the ground that it was notional. Lastly, the reliance placed on the decision in S. vinodkumar Diamonds (P) Ltd. (supra) in the Revenue's favour would not by itself govern the issues arising herein. This is so as every decision is rendered in the context of the facts which arise before the authority for adjudication. Mere conclusion in favour of the Revenue in another case by itself would not entitle a party to have an identical relief in this case. In fact, if the Revenue was of the view that the facts in S. Vinodkumar (supra) are identical/similar to the present facts, then reliance would have been placed by the Revenue upon it at the hearing before the Tribunal. The impugned order does not indicate any such reliance. It appears that in S. Vinodkumar Diamonds (P.) Ltd. (supra), the Tribunal held the forward contract on facts before it to be speculative in nature in view of Section 43(5) of the Act. However, it appears that the decision of this court in CITv. BadridasGauridu (P.) Ltd. [2003] 261 ITR 256/[2004] 134 Taxman 376 (Mum.) was not brought to the notice of the Tribunal when it rendered its decision in S. Vinodkumar Diamonds (P.) Ltd. (supra). In the above case, this court has held that forward contract in foreign exchange when incidental to carrying on business of cotton exporter and done to cover up losses on account of differences in foreign exchange valuations, would not be speculative activity but a business activity.

19 Mcleod Russel India Ltd., AY 2008-09 8. In the above view, the question of law, as formulated by the Revenue, does not give rise to any substantial of law. Thus, not entertained.” 20. We further find that the co-ordinate bench of this Tribunal in the case of Bechtel India Pvt Ltd Vs Addl. CIT (supra) had decided an identical issue in favour of the assessee after considering the Instruction No. 3/2010 wherein it was held as follows :-

8. Coming to the corporate additions i.e. disallowance of loss, it clearly emerges from the record that the assessee in respect of foreign exchange realization follows mercantile system of accounting and not cash system of accounting. The loss has been incurred for hedging of foreign currency fluctuation involved in sales invoices on the basis of forward contracts, which is a business decision to safeguard its interest. The loss has been incurred on the basis of scientific method in the ordinary course of business. The loss being based on a scientific method, on the basis of contractual liability with banks and on mercantile system has to be allowed to the assessee following Hon’ble Supreme Court judgment in the case of Woodward Governor India (P) Ltd. (supra). Our view is further fortified by the fact that DRP in its own order in subsequent year has itself held that the issue about the loss on mercantile system is pending dispute in AY 2008-09. Therefore, the allowability of the loss on actual payment in AY 2009-10 has been made subject to the allowability of the loss for AY 2008-09. This stand of the DRP itself negates the observations of assessing officer that it is a notional loss and establishes that it is a business loss incurred by the assessee on mercantile system which method is consistently followed by the assessee. Under these circumstances, we are inclined to allow the foreign exchange fluctuation loss to assessee in this year. This ground of the assessee is allowed.

“..At the outset the Ld. AR of the assessee pointed out that this very issue was adjudicated in assessee’sfavour by the jurisdictional Hon’ble Calcutta High Court in assessee’s own case in its judgment rendered in ITAT No. 92 of 2013 dated 19.06.2018 for the AY 2007-08. The Ld. AR submitted that in AY 2007-08 also the assessee had earned interest from FDs and financial institutions which was assessed by the AO under the head ‘Other Sources’ and benefit of Rule 8 was denied to the assessee. On appeal the Ld. CIT(A) upheld the assessee’s contention by observing as follows: “14. I have carefully considered the submissions of the A/R and have perused the decision of the Jurisdictional High Court in the case of Eveready Industries (I) Ltd for the A.Y. 1991-92 & 1992-93. In the audited accounts for the year ended 31st March 2007 appellant had debited gross interest of Rs.43,44,53,000lacs and separately credited Rs.1,64,65,000, out of which Rs.4,74,687 being exempt interest, 21 Mcleod Russel India Ltd., AY 2008-09 i.e. Rs.1,59,90,313/- being gross interest received on loans and deposits. The net interest expenditure was therefore Rs.41,79,88,000/-. According to A.O. Rule-8 was not applicable to the interest received as it did not have any element of agricultural income. By the same logic, the entire interest debited in the Profit & Loss A/c also did not have element of expenditure incurred wholly & exclusively in relation to business of growing and manufacture of tea. In any business; fund position undergoes change on day- to-day& from moment to moment. Interest is a charge for use of funds. Interest income is a charge received for use of assessee's business funds by other persons. Similarly interest expenditure is a charge paid by the assessee for use of funds belonging to others. To determine the effective cost of borrowings; it is therefore necessary to set off the interest received against interest paid and only the net interest can be considered to be business expenditure for tax purposes. In the present case after setting off interest received against interest paid there was net interest expenditure of Rs.41,79,88,000/-. which was incurred in connection with business of growing and manufacture of tea to which Rule - 8 was applicable. I do not find substance in the AO's hypothesis that gross interest paid represented expenditure of tea business to which Rule - 8 was applicable whereas gross interest received represented non agricultural income to which Rule - 8 was not applicable. Having regard to the nature of business and composite nature of funds deployed, the only correct method was to set off interest received against interest paid. This proposition is accepted by the Jurisdictional Calcutta High Court in the case of Eveready Industries (I) Ltd in 1TA Nos 123 of 2000 dated 22.12.2009. In that case also the assessee engaged in business of growing and manufacture of tea had derived interest income which was assessed subject to application of Rule-8. In the regular income tax assessments, the AO did not assess interest income separately but considered the interest to be part of the composite business of growing and manufacture of tea & thereby assessed only 40% of such income under central income tax assessment. The C I T in his order u/s 263 directed to AO to assess gross interest received as fully chargeable to tax under Central Income Tax. The Order of the CIT u/s 263 was upheld by the Tribunal. On further appeal, the Calcutta High Court however held that the interest income was rightly treated by the AO to be part of assessee's business of growing and manufacture of tea subject to Rule - 8 and therefore only 40% of interest income could be brought to Central Income Tax.

7. On further appeal the coordinate Bench of this Tribunal reversed the Ld. CIT(A)’s
order and restored the AO’s order assessing interest income wholly to Central Income-tax without giving benefit of Rule 8. Being aggrieved the assessee carried the matter before the Hon’ble Calcutta High Court wherein the following the question was raised: "Whether the interest income derived from temporary investment of surplus borrowed funds for the business of growing and manufacturing of tea, would fall within the scope of Rule 8 of the Income Tax Rules, 1962? 8. In its judgment the Hon’ble Calcutta High Court found merit in the assessee’s case and set aside the decision of this Tribunal and restored the order of the Ld. CIT(A) holding that the interest income was liable to be set off against the interest expense and only the net interest expenditure was liable to be considered for assessing income from composite business to which Rule 8 was applicable. The Ld. AR also brought to our attention the decision of the coordinate Bench of this Tribunal in the case of Eveready Industries India Ltd for the AY 1997-98 in ITA No. 959/Kol/2002 wherein also the identical view was expressed by the Tribunal. The Tribunal held that since assessee paid interest on loans and also derived interest on deposits, the interest received had to be netted off against interest payment and only the net interest expenditure could be considered in computing the composite income of growing & manufacture of tea. Against this order of the Tribunal, an appeal u/s 260A was filed by the Revenue before the Hon’ble Calcutta High Court raising the following question of law : (iv) Whether, on the facts and in the circumstances of the case, the Income Tax Appellate Tribunal is correct in holding interest of Rs. 22, 07, 47, 000/- received as "Profits and Gains of Business" instead of "Income from other Sources", contrary to law, on the basis of its order for earlier years against which appeals under Section 260A of the Income Tax Act, 1961 have been admitted by the Hon'bleCourt ? 9. In its judgment dated 09.08.2018 in ITA No. 789 of 2004, the Hon’ble Calcutta High Court dismissed the appeal of the Revenue inter alia including the question raised above. The Ld. DR was unable to controvert the submissions of the Ld.

23 Mcleod Russel India Ltd., AY 2008-09 AR as also the findings of the Ld. CIT(A) which are in consonance with the view taken by the Hon’ble Calcutta High Court in assessee’s own case for AY 2007-08. Respectfully following the judgement of the Hon’ble Calcutta High Court rendered in assessee’s own case, we therefore see no reason to take any contrary view. Accordingly Ground No. 2 raised by the Revenue is rejected.”

24 Mcleod Russel India Ltd., AY 2008-09 is observed that the issue involved in this ground is similar to the Ground No. 2 of department appeal in A.Y. 2008-09. Following our conclusion in A.Y. 2008-09, we uphold the order of Ld. CIT(A) and dismiss this ground of the Revenue.