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Income Tax Appellate Tribunal, “C”, BENCH KOLKATA
Before: SHRI A.T.VARKEY, JM &DR. A.L.SAINI, AM
आदेश / O R D E R
Per Dr. A. L. Saini:
The captioned two appeals filed by the Assessee, pertaining to assessment years 2009-10, and 2010-11, are directed against separate orders passed by the learned Commissioner of Income Tax (Appeals), Kolkata (in short the ld. CIT(A)], which in turn arise out of separate assessment orders passed by the Assessing Officer u/s 143(3) of the Income Tax Act, 1961 ( in short the ‘Act’).
The appeal filed for Assessment Year 2009-10, is barred by limitation by 360 days. The assessee has moved a petition requesting the Bench to condone the Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 delay. We note that Mr.K.N. Bansal, who looks after taxation matters of the company submitted before the Benchan affidavit stating that he had under gone a heart bye-pas surgery therefore Doctor advised him to take bed rest for a long period. Besides, Mr. Naveen Singh, staff of the company, left the job without handing over all the documents pertaining to appeal for A.Y.2009-10 to Mr. K.N. Bansal and as a result, the appeal could not be filed on time before the Tribunal. We have heard both the parties on this preliminary issue. Having regard to the reasons given in the petition, we condone the delay and admit the appeal for hearing.
Since these two appeals filed by the Assessee pertaining to A.Y. 2009-10 and 2010-11 contain the identical and common issues, therefore, these have been clubbed and heard together and a consolidated order is being passed for the sake of convenience and brevity.
4.Although, these appeals filed by the Assessee for Assessment Year 2009-10 and A.Y.2010-11 contain multiple ground of appeals. However, at the time of hearing we have carefully perused all the grounds raised by the Assessee. Most of the grounds raised by the Assessee, are either academic in nature or contentious in nature. However, to meet the end of justice, we confine ourselves to the core of the controversy and main grievances of the Assessee. With this background, we summarize and concise the grounds raised by the Assessee as follows:
Grounds relating to derivatives:- (1).GroundNo.2 raised by the assessee in for assessment year 2009-10 and Ground No. 1 raised by the assessee in I.T.A. No. 947/Kol/2016 for assessment year 2010-11 are identical and common which relate to disallowance of crystallized losses of foreign exchange contracts, the details of which are given below. (i). Disallowance of crystallized losses of Rs. 78,51,250/- on Forex contracts, for assessment year 2009-10.
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 (ii).Disallowance of crystallized losses of Rs. 1,54,44,375/- on Forex contracts, for assessment year 2010-11.
(2). Foreign Exchange loss of Rs. 4,74,84,669/- on account of cancelled Forex Purchase contracts.
Other Grounds (1). Ground No. 1 raised by the assessee in for assessment year 2009-10 relates to disallowance of Rs. 1,00,000/-being prior period expenses the liability for which crystallized during the relevant previous year. (2). Ground No. 3 raised by the assessee in I.T.A. No. 906/Kol/2018, for assessment year 2009-10 relates to disallowance of Rs. 3,13,43,120/- being replacement cost of seven ring frames treated by the assessee as revenue expenditure u/s 37(1) of the Act, however, AO treated the same as capital expenditure.
Note: Ground No.3 raised by the assessee in A.Y. 2010-11 is not pressed by the assessee.
5.First we take grounds raised by the assessee, relating to derivatives. We note that all the grounds raised by the assessee, relating to derivatives are identical and common therefore for the sake of convenience the facts narrated in assessee`s appeal in for assessment year 2009-10 is taken as the lead case.
Brief facts qua the issue are that assessee is a limited company and engaged in the business of manufacturing and trading of Yarn and Fabrics. The assessee company is also engaged in exporting of Yarn and fabrics. In order to hedge the risks of foreign exchange fluctuation loss, the company entered into various derivative contracts. The assessing officer noted that during the previous year the assessee company had deductedfrom its computation of income of Rs. 78,51,250/- as foreign exchange loss amortized. During the assessment proceedings, the Page | 3
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 assessee was asked to submit the details regarding the foreign exchange loss amortized. In response, the assessee submitted the details. On perusal of the details of the forex loss of Rs. 78,51,250/-, it was noted by the Assessing Officer that the assessee had entered into the derivatives transactions which was option of European style, Tokiyo cut viz. and the said loss was incurred in derivatives of currency. The AO noted that the assessee had incurred loss in derivative which was not traded in the recognized stock exchange within the meaning of section 43(5)(d) of the Act, hence the AO treated this derivative transaction of Rs. 78,51,250/- to be speculative transaction and therefore not allowed the derivative loss to be set off form normal business income.
Aggrieved by the stand so taken by the Assessing Officer, the assessee carried the matter in appeal before the ld. CIT(A) who has confirmed the action of the Assessing Officer. The ld CIT(A) noted that onus was on the assessee to prove that the derivative transactions in question were not of a speculative nature. The booking of forward contract of currency was not in respect of specified export of goods and there was no actual delivery of foreign exchange. The ld CIT(A) therefore noted that forward contracts entered into by the assessee was not hedging transaction but was speculative in nature. The assessee also failed to establish the nexus between the forward contracts and specified export receivables, hence the ld CIT(A) confirmed the action of the Assessing Officer holding that the derivative transaction of Rs. 78,51,250/- is in the nature of speculative transaction and hence the assessee is not entitled to set off, said derivative loss form normal business income.
Aggrieved by the order of the ld CIT(A), the assessee is in appeal before us.
The ld. Counsel for the assessee begins by pointing out that the Assessee Company is engaged in the business of Export of Cotton Yarn, Cotton & Other various merchandise. A perusal of the Audited Financial Statements would indicate that Value of Exported Goods on FOB basis for the accounting year ended on 31/03/2009 was Rs.187.88 Crores. In order to hedge the risk of Exchange Page | 4
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 Fluctuations on Export Receivables the assessee company had entered into the above Long Term Forex Derivatives Contracts and thus the same is an admissible loss since it is already recovered by the Banker from the Assessee Company. The ld Counsel submitted that Loss of Rs.78,51,250/- was crystallized during the year which was related to Long Term Forex Derivatives Contracts (Period-60 Months). This loss was amortized in books but claimed as a deduction while filing Return of Income. The counsel filed before the Bench the evidences in support of above claim which are as under: a. Ledger Account of Foreign Currency Monetary Item Transaction Difference Account [FCMITD a/c] wherein there are both credits (income) as well as debits (losses). b. Bank Statements wherein the amounts were debited by Bank in the assessee`s bank account. c. USD/INR Export Hedging Term Sheet issued by ING Vysya Bank d. Copy of Derivatives Deal Confirmation issued by ING Vysya Bank.
These documents were submitted before the Assessing Officer but he did not consider the same and disallowed the loss of Rs.78,51,250/-. The counsel, therefore prayed the Bench that disallowance of loss of Rs.78,51,250/- should be deleted.
On the other hand, the ld. DR for the Revenue submitted before us that the assessee has claimed the fictitious loss by showing the cancellation of derivatives contracts. The ld. DR pointed out that this is the first year, the assessee has claimed the loss on account of cancellation of forward contract, whereas the assessee is in the business of export since long and had not entered with similar forward contract in earlier years. The ld. DR submitted that there is a complete mismatch between the cancellation of the forward contract and the invoices against which the forward contract has been cancelled. The ld. DR also pointed out that this is the planning of the assessee to avoid the taxes and to reduce the income tax liabilities by showing the fictitious loss on account of cancellation of Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 forward contracts. Therefore, the loss on account of cancellation of forward contract should be disallowed.
We have heard both the parties and perused the material available on record. Before, we come to the final conclusion, let us first deal with the nature of transactions in derivatives and the treatment given to these transactions in the income tax Act, 1961. As to what is the nature of a derivative transaction, we find useful guidance from Hon’ble Madras High Court’s judgment in the case of Rajshree Sugars & Chemicals Ltd. vs. Axis Bank Ltd. reported in [2008] 8 MLJ 261, referred to with approval by Hon’ble Bombay High Court in the case of Bharat S.RuiaVs. CIT (2011) TIOL 238 HC), in the following terms: “What are these derivatives which have gains such a great deal of notoriety? In simple terms, derivatives are financial instruments whose values depend on the value of other underlying financial instruments. The International Accounting Standard (IAS) 39, (Now IFRS 9) defines "derivatives" as follows: “A derivative is a financial instrument (a) whose value changes in response to the change in a specified interest rate, security price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or similar variable (sometimes called the 'underlying'); (b) that requires no initial net investment or little initial net investment relative to other types of contracts that have a similar response to changes in market conditions; and (c) that is settled at a future date. " Actually, derivatives are assets, whose values are derived from values of underlying assets. These underlying assets can be commodities, metals, energy resources, and financial assets such as shares, bonds and foreign currencies.
Derivatives can be used as insurance cover against certain types of business risks such as fluctuations in the rate of foreign exchange, fluctuations in the rate of interest on borrowings, fluctuations in the value of specified assets etc. To take an Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 example, it is common knowledge that the price of gold keeps fluctuating. If a manufacturer of gold jewellery anticipates that he would require a particular quantity of gold at a specified distance of time, he may enter into a contract with the seller of gold bars for the supply of the same at a future date, at the rate specified in the contract. This contract reduces the risk for the buyer, against a possible steep rise in the price of gold. It equally reduces the risk of the seller against a steep fall in the price. Thus, the contract acts as an insurance cover. When the transaction goes through without any dispute, the contract is fulfilled. But when the transaction fails and the motive behind the transaction is not necessarily the sale and supply of gold, but the receipt or payment of the difference in the price (difference between the prevailing price and the price fixed in the contract), many eyebrows are raised and many questions are asked. This is the point where the transaction takes a detour from a simple contract of insurance.
Taking into account the dictum of Hon’ble Madras High Court in the case of Rajshree Sugars & Chemicals Ltd (supra), we note that the Assessee Company is engaged in the business of Export of Cotton Yarn, Cotton & Other various merchandise. A perusal of the Audited Financial Statements would indicate that Value of Exported Goods on FOB basis for the accounting year ended on 31/03/2009 was Rs.187.88 Crores. In order to hedge the risk of Exchange Fluctuations on Export Receivables the assessee company had entered into the Long Term Forex Derivatives Contracts and thus the same is an admissible loss since it is already recovered by the Banker from the Assessee Company. We note that the Loss of Rs.78,51,250/- was crystallized during the year which was related to Long Term Forex Derivatives Contracts. This loss was amortized in books but claimed as a deduction while filing Return of Income. The assessee submitted the following evidences in support of above claim which are as under: a. Ledger Account of Foreign Currency Monetary Item Transaction Difference Account [FCMITD A/C] wherein there are both credits (income) as well as debits (losses). b. Bank Statements wherein the amounts were debited by Bank in the assessee`s bank account. Page | 7
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 c. USD/INR Export Hedging Term Sheet issued by ING Vysya Bank d. Copy of Derivatives Deal Confirmation issued by ING Vysya Bank.
These documents and evidences were submitted before the Assessing Officer as well as during the appellate proceedings. We note that theassessee took the forward contract for the purpose of business, as the business of the assessee is to export textile goods therefore it is necessary to protect from the risk of fluctuations in foreign exchange currency, hence, to hedge the risk these forward contracts work like an insurance cover. Therefore, loss on account of these forward contracts are allowable expenditure.
We note that foreign currency rates fluctuate every day, for example in the assessee`s case under consideration, exports are done in dollar currency, exchange rate of USD/INR changes day by day, therefore the USD/INR rate which is prevailing on the date of export, does not remain same in future when the foreign receivable makes the payment. To guard against this fluctuation risk in the rate of USD/INR, the assessee enters into forward contractto hedge the foreign currency exposure for its entire export business. During the assessment stage, the detailed submissions were made by the assessee with documentary evidences before the Assessing Officer regarding the claim of Rs. 78,51,250/- as business loss. The assessee also filed before the Assessing Officer all the bank statements wherein the bank had recovered the amounts due from the assessee company.We note that the assessee has correctly accounted the loss on account of forwardcontract for hedging of foreign currency risk and is allowable business loss u/s 28 of the Act.
Coming to the stand of the assessing officer that loss of Rs.78,51,250/- on account of forward contract is a speculative loss therefore it should not be allowed to be set off against normal business income. We note that the assessee company accounted the loss on account of forward contract under section 28 of the Act, which states that the following conditions needs to be satisfied to claim the loss:
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 a. It should arise or spring directly from or be incidental to the carrying on of a business operation; b. There should be direct or proximate nexus between the business operation and the loss. c. It should be a real loss and not notional or fictitious. d. It should be a loss on revenue account and not on capital account. e. It must have actually arisen and been incurred, not merely anticipated as certain events to occur in future, and hence there should be no prohibition in the Act, express or implied, against the deductibility thereof.
We note that assessee company has satisfied all the conditions mentioned above, therefore, it is entitled to claim the loss of Rs.78,51,250/- on account of forward contract, for that we rely on the judgment of the coordinate bench of ITAT Mumbai in the case of JaiminJewellery Exports (P) Ltd Vs ACIT-5(2) Mumbai [2014] 43 taxmann.com 380, wherein it was held as follows: “Forward contracts which are integral part or incidental to core business of import/export of diamonds, in principle, constitute hedging transactions, and not speculative contracts. It was also held that it would be a business loss which can be set off against profit and gains of business.”
We also rely on the judgment of the coordinate bench of ITAT Mumbai in the case of DCIT v. Intergold (I) Ltd., (124 TTJ 337), wherein it was held that profits from cancellation of forward exchange contracts are business profits and not speculative profits. Our view is fortified by the judgment of the Hon`ble Calcutta High Court in the case of CIT v. Soorajmull Nagarmull, (129 ITR 169), wherein it was held that in the normal course of business of import and export of jute, the assessee entered into foreign exchange contract to cover up the losses and differences in exchange valuation, the transaction is not a speculative transaction.
We note that the Special Bench of ITAT Kolkata in the case of Shree Capital Services Ltd. v. ACIT, (121 ITD 498) has held that derivatives with underlying as shares and securities should be also considered as commodities as the underlying
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 shares and securities as specifically included within the term commodities. Accordingly, transactions in security derivatives are subject to the provisions of section 43(5) of the Act. However, a currency cannot be termed as a commodity so as to attract the provisions of section 43(5) of the Act. Therefore, loss from forex derivatives is a business loss and accordingly allowable u/s 28 of the Act and crystallized losses on account of forex derivative contract are not speculative in nature within the meaning of section 43(5) of the Act, as the definition for speculative transaction is an exhaustive one and the term ‘commodity’ does not include currency. Moreover, the CBDT Instruction No.3/2010 clarifying issues regarding allowability of losses on account of forex derivatives which remain outstanding as on the last day of the financial year is not applicable in the case of Assessee Company since all the Forward Forex Contracts have been crystallized during the current accounting year, i.e. all have been closed / cancelled and the loss is actual loss and not a provision for loss.
We note that the assessee also claimed a loss to the tune of Rs. 4,74,84,669/- on account of cancellation of foreign exchange forward contract, as business loss. As we mentioned above that the Assessee company is engaged in the business of Export of Cotton Yarn, Cotton & Other merchandise. A perusal of the Audited Financial Statements would indicate that Value of Exported Goods on FOB basis for the accounting year ended on 31/03/2010 was Rs.319.63 Crores. In order to hedge the risk of Exchange Fluctuations on Export Orders the Assessee Company had entered into the above Short Term Forex Sale Contracts (Purchase for Bankers) and thus the same is an admissible loss since it is already recovered by the Banker from the Assessee company on cancellation. The Assessee company upon cancellation of Export Orders cancelled their short- term contracts with bankers and thus the loss claimed is an admissible business loss at Rs.4,74,84,669/-. The ld counsel submitted before us following evidences and documents in support of above claim:
(a). Ledger Account of Foreign Exchange rate Difference a/c for March 2010. Page | 10
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 (b). Working Capital Term Loan Canara bank to cover forward contract losses. (c ). Bank Statements wherein the amounts were debited by Bank.
We note that due to the fact that a substantial part of assessee company’s turnover comprises of sales by way of export of goods out of India and hedging of foreign currency is carried out by way of forward contracts / options / derivatives in order of minimize losses on realization. Hence, loss to the tune of Rs. 4,74,84,669/- on account of cancellation of foreign exchange forward contract, should be allowed as business loss, for that we rely on the judgment of the Coordinate Bench of ITAT Mumbai in the case of Reliance Industries Ltd. vs. CIT Large Taxpayers unit ITAT Mumbai Bench [2013] 40 taxmann.com 431(Mum-trib) wherein it was held that loss due to foreign exchange fluctuation in foreign currency transactions in derivatives has to be considered on last date of accounting year and it is deductible under section 31(1) of the Act. Further, the Coordinate Bench of Mumbai ITAT in the case of DCIT v. Intergold (l) Ltd., (124 TTJ 337) has held that profits from cancellation of forward exchange contracts are business profits and not speculative profits.
We note that ld. DR pointed out before the Bench that the assessee has claimed first time loss on account of cancellation of forward contract and it is kind of planning to avoid taxes.We do not agree with ld. DR for the revenue, as we have noted that the assessee’s export turnover on FOB basis for the assessment year 2010-11 is to the tune of Rs. 3,196,351,838/- whereas in the previous year the export turnover of the assessee was Rs. 1,878,799,618/-. We note that most of the turnover of the assessee is from export business therefore it is necessary for the assessee to take the forward contract in order to safeguard the loss which may arise due to fluctuation in the foreign exchange rates. Therefore, it is a decision of business man to minimize the losses on account of fluctuation in the foreign exchange rate and therefore it is very much connected with the assessee’s business. Since in assessment year 2010-11, the assesseecancelled some export orders and as a result, the forward contracts linked with the export ordersshould also be cancelled and therefore it is natural that the bank has charged the Page | 11
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 cancellation charges of the forward contract, which is nothing but a business loss. Therefore, since the forward contracts have been taken in connection with the business and for the purpose of business hence the loss arising on account of cancellation of forward contract would also be a business loss and therefore the assessee is entitled to claim the said loss in his books of accounts.
18.In view of the facts and precedents narrated above, it is abundantly clear that the Assessee Company has correctly accounted for the loss on account of Cancelled Forward Contract for hedging of Foreign Currency Risk and is an allowable Business Loss under section 28 of the Act. The loss on account of forward contract and loss on cancellation of forward contract, is a business loss and assessee is entitled to set offthe said loss against the business income, hence we delete the disallowance of following losses: (i). Disallowance of crystallized losses of Rs. 78,51,250/- on Forex contracts, for assessment year 2009-10. (ii). Disallowance of crystallized losses of Rs. 1,54,44,375/- on Forex contracts, for assessment year 2010-11. (iii). Foreign Exchange loss of Rs. 4,74,84,669/- on account of cancelled Forex Purchase contracts, assessment year 2010-11.
In the result, derivatives grounds raised by the assessee in A.Y.2009-10 and A.Y.2010-11 are allowed
Now we shall take Other Grounds raised by the assessee. (1). Ground No. 1 raised by the assessee in for assessment year 2009-10 relates to disallowance of Rs. 1,00,000/-being prior period expenses the liability for which crystallized during the relevant previous year.
The brief facts qua the issue are that as per tax audit report the assessee has paid Rs.1,00,000/- as transportation charges, during the assessment year under Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 consideration and claimed as an expense.However, assessing officer noted that the said amount was a prior period item therefore, he disallowed and added back to the total income of the assessee.On appeal by the assessee , the Ld. CIT(A) confirmed the additions made by the Assessing Officer. Aggrieved the assessee is in appeal before us.
We have heard both the parties and perused the material available on record, we note thatthe ld. Counsel for the assessee submitted before us that because of delay on the part of the party to submit the bill, the expenses could not be recorded during the previous year. The ld Counsel also submitted that the assessee came to know these expenses in the assessment year under consideration and therefore, the assessee is entitled to claim the expenses. The assessee incurred these expenses for the purpose of business. The ld. DR for the revenue has fairly agreed with the submissions of the ld. Counsel for the assessee. We note that the transportation charges of Rs.1,00,000/- paid to M/s Santosh Transport Services pertaining to assessment year 2007-08 and it was stated that there was a dispute regarding the bill amount therefore, it could not be paid in the year in which it was incurred. The dispute got resolved during the assessment year under consideration hence, it was finally paid. We not that assessee is following mercantile system of accounting and the assessee’s expenditure has got crystallized during the assessment year under consideration, therefore the assessee is entitled to claim the expenses. We note that the assessee had incurred the said expenditure for the purpose of business and liability has crystallized during the assessment year under consideration. Hence the addition made by the Assessing Officer and confirmed the ld. CIT(A) needs to be deleted, accordingly, we delete the addition of Rs.1,00,000/-.
23.Ground No. 3 raised by the assessee in for assessment year 2009-10 relates to disallowance of Rs. 3,13,43,120/- being replacement cost of seven ring frames treated by the assessee as revenue expenditure u/s 37(1) of the Act, however, AO treated the same as capital expenditure. Page | 13
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10
At the outset itself, the ld. Counsel for the assessee submitted before the Bench that this issue is squarely covered against the assessee by the Judgment of Hon’ble ITAT, Kolkata in for assessment year 2005-06 vide order dated 21.08.2009, wherein it was held as follows:
“Considering the above observation and the findings of the Hon’ble Apex Court in the above case, we hold that the replacement of nine ring frames by the assessee in the case before us give enduring advantage to the assessee as ring frames section constitute an independent machine with an independent function. Hence, the replacement of new ring framed by the assessee is not expenditure for current repairs, which could be allowed u/s 31(i) of the IT Act nor it is expenditure allowable u/s 37 of the Act. The Expenditure for replacement of a new ring frames is an addition to existing plant and machinery of the assessee giving enduring benefit and as such is capital in nature. However, we agree with the ld. AR that the treatment given by the assessee in its books of accounts of the expenses incurred could not be decisive to decide whether the claim of the assessee is allowable as revenue or capital in nature. In the case of the assessee before us, the nature of the expenditure incurred by the assessee is a capital expenditure and is not revenue, as the assessee has acquired the assets of capital in nature.”
We note that as the issue is squarely covered against the assessee by the judgment of the co-ordinate Bench in assessee’s own case (supra) and there is no change in facts and in law and the ld. Counsel for the assessee has failed to bring any cogent evidence on record or new facts to prove this otherwise. The ld. DR has fairly agreed that ld CIT(A) has rightly disallowed the claim of the assessee, as the said issue is covered against the assessee by the judgment of the ITAT, Kolkata in assessee’s own case (supra). That being so, we decline to interfere in the order passed by the coordinate bench of this Tribunal as no any new facts brought to our notice by the assessee and therefore we confirm the order passed by the ld. CIT(A), and dismiss the ground raised by the assessee.
In the result, the appeal filed by the assessee in for assessment year 2010-11 is allowed and the appeal filed by the assessee in I.T.A.
Nagreeka Exports Ltd. ITA No.906/Kol/2018 Assessment Years:2010-11 & 2009-10 No. 906/Kol/2018 for assessment year 2009-10 is partly allowed as per the discussion made (supra).
Order is pronounced in the open court on 08.02.2019.