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PER PAWAN SINGH, JUDICIAL MEMBER:
This appeal by Revenue under section 253 of the Income-Tax Act (“The Act”) is directed against the order ld. CIT(A)-39, Mumbai dated 22.07.2014 for Assessment Year (AY) 2010-11. The Revenue has raised the following grounds of appeal:
"1. On the facts and in the circumstances, the CIT (A) has erred in deleting the addition made by the AO of Rs. 40,77,811/- u/s 36(1)(iii) related to outstanding balance of M/s. Eternity Jewels by holding that the transaction with the related party were in the normal course of the business and propelled by principles of commercial expediency. The CIT (A) has failed to appreciate that:-
- M/s Milan Jewellers a) M/s Eternity Jewels is a related party of the assessee and there was huge outstanding debit balances year after year. b) Since the assessee has continuously increased its stake without corresponding volume of transaction or benefit in the nature of interest charged, it is nothing but the diversion of business funds of the assessee. c) The assessee, at one hand, is claiming deduction of interest paid in its books, and on the other hand, is not charging any interest on debit balance of M/s. Eternity Jewels.
On the facts and in the circumstances, the CIT (A) has erred in deleting the addition on account of business loss of Rs. 5,79,54,450/- and the loss claimed on forward contracts of Rs. 1,12,50,614/-, aggregating to Rs. 6,92,05,064/-. The CIT(A) has failed to appreciate that:- a) The assessee, during the course of the assessment proceedings, failed to prove that the various debits made in the said group summary are exclusively on account of debtors/creditors and also the assessee failed to specify the identity of such debtors to prove the genuinity of the said adjustments. b) The assessee, during the course of the assessment proceedings, failed to explain the debit entry as on 1.4.2009 for Rs. 5,79,54,450/- with particulars as exchange difference (debtors) c) The business loss claimed by the assessee is actually a speculation loss. By perusing the group summary of Exchange Difference, the AO has found that the assessee has shown loss on forward contracts of Rs. 1,12,50,614/- and on perusal of corresponding ledger account, it was found that there are only receipt payment entries reflected in the account, which do not prove that the said forward contracts are entered on account of debtors/creditors.
For the above mentioned reason and any other reasons that may be urged at the time of hearing, it is requested that the order of the CIT(A) be quashed and that of the A. O. be restored.
- M/s Milan Jewellers 2. Brief facts of the case are that the assessee-company is engaged in the business of manufacturer and exporter of cut and polished diamonds, filed its return of income for Assessment Year 2010-11 on 24th September 2010 declaring taxable income of Rs. 6,29,073/-. The assessment was completed on 27th February 2013 under section 143(3). The Assessing Officer while passing Assessment Order, besides the other additions and disallowances made disallowance under section 36(1)(iii) for Rs.40,77,811/- and addition on account of foreign exchange difference of Rs. 6,92,05,064/- out of which Rs.1,12,50,614/- was treated as speculation loss and was allowed to carry forward for set off in subsequent years. On appeal before CIT(A)the disallowances under section 36(1)(iii) and additions of addition on account of foreign exchange difference of Rs. 6,92,05,064/-was deleted. Hence, aggrieved by the order of CIT(A)the Revenue has filed present appeal before us.
3. We have heard learned Departmental Representative (DR) for the Revenue and the learned Authorized Representative (AR) of the assessee and perused the material available on record. Ground No.1 relates to the deletion of disallowance under section 36(1)(iii). The learned DR for the Revenue submits that M/s Eternity Jewels is related party of the assessee, to which the assessee allowed to continue its debts from last four years. The debts were increased year after the year and no by stretch of imagination, the aforesaid connection may be considered as regular course of business. - M/s Milan Jewellers The arrangement between the assessee and M/s Eternity Jewels is not in the nature of normal course of business transaction. The assessee is claiming deduction of interest paid in its books, and on the other hand, is not charging an interest on debt liability form M/s Eternity Jewels, its related parties. The assessee was maintaining a consolidated account in respect of all its funds. The assessee has not proved the business expediency; however, the learned CIT(A)treated it for business consideration. On the other hand, learned AR of the assessee supported the order of ld. CIT(A).
The ld. AR for assessee submits that the assessee has recovered more than 70% of debt till March 2012. The ld. AR of assessee further submits that the assessee regularly supplies diamond to the M/s Eternity Jewels, these transactions are like other transaction with other unrelated parties in the regular course of business. The mere delay in realisation of debts is nothing and same cannot be considered as a loan transaction. The transactions with M/s Eternity Jewels are in the nature of sale of cut and polished diamonds and have been offered for taxation in respective years. The assessee is not in the business for financing. The assessee owned sufficient own funds in the form of partners capital account, approximately for more than Rs. 12.50 Crores and it cannot be presumed that partners fund are blocked in such group for long period.
We have considered the rival submission of the parties and perused the orders of authorities below. During the assessment proceeding, the M/s Milan Jewellers Assessing Officer noted that there were certain large debit balance outstanding against several parties and one of the parties M/s Eternity Jewels is related party, therefore, the assessee was asked to explain the large debit balances. The assessee filed its explanation vide reply dated 5th Feb 2013 and contended that assessee is regularly supplying diamond to M/s Eternity Jewels and these transactions are just like any other transaction with unrelated party during the course of business. The assessee conceded that there was some delay in realisation of debt and nothing else and same cannot be considered as loan transaction. The assessee also contended that the connection with M/s Eternity Jewels are in the nature of sale of cut and polished diamonds and the same have been offered for taxation. The assessee also contended that assessee is having sufficient interest free funds in the form of partner’s capital account for more than Rs. 12.50 crore. The assessee also contended that they have recovered more than 70% of the debts till March 2012. The contention of the assessee was not accepted by Assessing Officer. The Assessing Officer concluded that Eternity Jewels is related party of the assessee. The Assessing Officer summarized the transaction entered by the assessee with Eternity Jewels and other parties. The Assessing Officer on the basis of summarized transactions further noted that the debits have been increased after year after the year. The said transaction cannot be considered as being in the regular course of business. Eternity Jewels has large brought forward losses ITA No. 6351/M/2014- M/s Milan Jewellers in its books, therefore, it is a colourable device is to claim the interest: from the books of the assessee. On the basis of his observation the Assessing Officer concluded that assessee has diverted borrowed fund to related party and therefore disallowance on account of interest under section 36(1)(iii)
was made. The Assessing Officer computed disallowance of interest at Rs. 40,77,811/-. The assessee made the similar contention before the ld. Commissioner (Appeals). The ld. CIT(A) summarized that the disallowance under section 36(1)(iii) has been made mainly by two regions. Firstly, that the related party M/s Eternity Jewels has been accorded undue extended credit facility by not charging and interest on the debit balance. Secondly, it appears to be a colourable device to reduce the tax burden of the assessee by using its fund in the business of related party which does not have any taxable income due to brought forward losses. For first reason, the ld. CIT(A)was of the view that the primary condition for allowability of interest on borrowed capital is that capital should have been borrowed for the purpose of business or profession. And on the basis of Hon’ble Apex Court decision in SA Builders Vs CIT [2007] 288 ITR 1(SC) concluded that Eternity Jewels is a group concern to whom the assessee made supplies diamonds and thus there is a business connection between two entity.
Therefore, the transaction between the related parties has to be examined from the prospective of principle of ordinary commercial trading. The ld. CIT(A) also examined the account of Eternity Jewels for Financial Year M/s Milan Jewellers 2006-07 till 2013-14 and concluded that opening outstanding in Financial Year 2013-14 was Rs. 9.16 Crore and closing outstanding was Rs. 2.52 Crore. The sales of Eternity Jewels was also examined by ld. CIT(A) for Assessment Year 2007-08 till 2010-11. The ld. CIT(A) concluded that out of total sale of assessee, the same made to related party is 1% to 4% compared to non-relative parties. The ld. CIT(A) also examined the partners capital, investment and the available working capital and concluded that interest bearing funds have not been part with related party.
The ld. CIT(A) is on the basis of his observation concluded that the transaction with the related parties are in the course of normal business transaction for commercial expediency and deleted the disallowance under section 36(1)(iii). We have noted that the ld. CIT(A) examined business expediencies, volume of sale with related vis-a-vis unrelated parties, availability of interest free fund in the capital account of partners and progress of recovery of the debt from the related parties and deleted the disallowance under section 36(1)(iii). The ld. DR has not shown any contrary material or any law to arrive on different conclusion. In our view, the finding of ld. CIT(A) does not require any further interference. In the result, ground no.1 of the appeal raised by the Revenue is dismissed.
Ground No.2 relates to deleting the addition on account of business loss of Rs. 6,92,05,064/-. The ld. AR of the assessee submits that during the course of assessment proceeding the assessee failed to prove that various debits M/s Milan Jewellers made in the group summary are exclusively on account of debtors and creditors and that assessee failed specify the identify of such debtors to prove the genuinity of the adjustments. The business loss claimed by assessee is actually speculation loss. The Assessing Officer rightly identified the speculation loss and allowed to carry forward in subsequent Assessment Years. On the other hand, the ld. AR of the assessee supported the order of ld. CIT(A). The ld. AR submits that the assessee is consistently following the Accounting Standard-11 (AS-11) as a part of general accounting policy. The assessee has been revaluing its monetary and non- monetary item denominated in foreign currency at the end of year.
Following the same practice, the assessee has a net income of Rs. 11314284/- on account of exchange difference in the books of assessee- firm. The assessee furnished all necessary information and explanation with copy of ledger account and a summary of the gain/loss under each type of transaction of foreign currency. The Assessing Officer without asking any explanation about Accounting Treatment begun with analysis of each and every entry in the ledger account, the Assessing Officer assumed that the forward contract entered by the assessee to has its foreign currency risk against its outstanding debtors. The entry for loss in the exchange difference account was considered in isolation without co-relative with other Financial Year of the Balance-sheet and concluded the loss on forward account of Rs. 1,12,50,614/- has speculation loss settled during the M/s Milan Jewellers year on reversal entry of outstanding debtors as on 01.04.2009 for Rs. 5,79,54,450/- considering it as unexplained. The ld. AR further submits that details of exchange difference is filed vide page no. 71 of Paper Book, details of gain/loss on export exchange rate difference is filed on page no. 72 of Paper Book and trading profit & loss for year ended March 2009 is filed at page no. 81 of Paper Book. In support of his submission, the ld. AR of the assessee relied upon the decision of Co-ordinate Bench in Dharmanandan Diamonds Pvt. Ltd. vs. ACIT (ITA No. 3860/M/214 dated 17.03.2017) and submits that the bench held that there is no requirement to establish one to one correlation between forward contract and corresponding export import so long as the total forward contrary do not exceed to export plus outstanding receivable.
We have considered the rival submission of the parties and have perused the order of authorities below. The AO made the disallowance of loss on account of fluctuation in foreign currency of debtors for Rs. 57954450/- and treated the loss incurred on cancellation/maturity of forward contract during the year of Rs. 1,12,50,614/- as speculation loss. During the assessment, the AO noted that assessee has shown income on account of foreign exchange difference of Rs. 11314284/- in its Profit & Loss Account. The assessee has also shown exchange difference amounts in the list of debtors and creditors. The assessee was asked to submit the details and nature of exchange difference. The assessee vide reply dated ITA No. 6351/M/2014- M/s Milan Jewellers 30.11.2012 contended that the accounting policy qua exchange rate transaction are in consonance with AS-11. The assessee further contended that assessee-firm is mainly engaged in export business and to safeguard the business interest and specially for recovery from debtors, as a prudent businessman, the assessee entered into forward contract. The contract is entered against outstanding balance of debtors, to hedge the foreign currency risk. The assessee also contended that during the year there is gain of Rs. 99.73 Lakhs in respect of conversion of outstanding forward contract as on 31.03.2010. The amount of Rs. 113.14 Lakhs is in respect of exchange rate difference on conversion of forward contract and loan liabilities (secured loan), creditors for goods, premium on forward contract and gain/loss on forward contract exchange rate difference on export realization and year and conversion of outstanding debtors. The assessee also furnished the calculation sheet showing the detailed working of exchange difference. The assessee on 15.01.2013 was again asked about the provision for loss in outstanding future contract for Rs. 634 Lakhs made in Assessment Year 2009-10. The assessee filed its reply on 05.02.2013 and contended that the amount of Rs. 634 Lakhs is reflected in account exchange rate difference on forward contract which consist of entry of Rs. 53420177/- which is in respect of reversal of loss recognized as on 31.03.2009 in respect of forward contract outstanding as on back date and the same is inconsonance with AS-11, entry of Rs. 9973440/- (gain) was M/s Milan Jewellers passed in respect of forward contract outstanding as on 31.03.2010. The contention of assessee was not accepted by Assessing Officer with the following reasons:
i) The assessee has accepted that it had booked loss on forward contracts of Rs. 534.20 lakhs in A.Y. 2009-10, which entry was reversed as on 01.04.2009. Further there is a gain of Rs. 99.73 lakhs on forward contracts in current assessment year. Hence, it should have shown profit of Rs. 633.93 lakhs approx. in the current assessment year, however it has shown profit of Rs. 113.14 lakhs only in its P&L Account. ii) On perusal of Exchange Difference - Group Summary submitted by the assessee as reproduced above, it appears that the assessee has credited the said amount of Rs. 633.94 lakhs, but also debited/ credited many other items to arrive at the net profit figure of Rs. 113.14 lakhs. The entries made in corresponding ledger accounts of said items are not self explanatory and the assessee has failed to submit any explanation giving exact nature of each item. iii) The assessee has failed to prove that the various debits made in the said group summary are exclusively on account of debtors/ creditors and also failed to specify the identity of such debtors to prove the genuinity of said adjustments. iv) On perusal of ledger in respect of Gain/ Loss on Export Exchange Rate Diff. of Rs. 7,74,84,278, it appears therein that there is a debit entry as on 1-4-2009 for Rs. 5,79,54,450/- with particulars as 'Exchange Difference (Debtors)'. The said amount is completed unexplained as neither the assessee has made reference of said amount in any of its correspondence as above, nor submitted any explanation or calculation or co-relation with debtors of said amount. Further the assessee has separately reversed the entry in respect of exchange loss of last year at Rs. 5,34,20,177/- as referred above and hence this debit amount of Rs.
- M/s Milan Jewellers
5,79,54,450/- is completed unexplained. Hence the said amount of Rs. 5,79,54,450/- is added to the total income of the assessee. v) In the Group Summary of Exchange Difference, the assessee has shown Loss on forward contracts of Rs. 1,12,50,614/-. On perusal of corresponding ledger account, it appears that there are only receipt/ payment entries reflected in the account, which do not prove that the said forward contracts are entered on account of debtors/creditors. The assessee has failed to submit any separate details showing co-relation of said loss with the debtors/ creditors. Hence, the said loss is disallowed as business loss and treated as speculation loss of the assessee.”
On the basis of his observation, the Assessing Officer disallowed loss of Rs. 5,79,54,450/- and Rs. 1,12,50,614/-, thus total of Rs. 6,92,05,064/-. Out of which Rs. 1,12,50,614/- was treated as speculation loss and allowed to be carry forward for set off in subsequent Assessment Years.
Before the ld. CIT(A), the assessee explained that entry of Rs. 5,79,84,278/- is for reversal of immediate earlier years debtors restated at the balance- sheet dated as on 31.03.2009 which is in consonance with AS-11. The same had emerged as a loss in the concerned Assessment Years, there was a booking of corresponding income in immediately preceding Assessment Years. In view of the accounting practice mandated by AS-11. In case, the Assessing Officer has any doubt, he should have called data or to have gone through the previous year’s assessment file. For loss of forward contract of Rs. 1,12,50,614/-, the assessee explained that loss on settlement of all forward contract entered during the relevant Assessment Year. The forward contract, by its very nature, is granted against debtor/creditor and the 12 M/s Milan Jewellers observation of Assessing Officer is without any logic. The assessee had offered aggregate income of Rs. 1,13,14,284/- which covers exchange rate difference on realization, provision on debtors, creditors, forward contracts and working capital loans. This exchange rate difference, though shown in separate account is all interlinked and hence, the picking up the debit entry that is loss of disallowance was not warranted. The submission/explanation of assessee was forwarded to Assessing Officer for his remand report. The Assessing Officer furnished his remand report dated 26.06.2014 which is extracted below:
“In this case, the A.O. made an addition of Rs.6,92,05,064/- on account of exchange rate difference on forward contracts. The addition of the said amount on exchange rate difference is made on (a) On account of debit entry of Rs.5,79,54,450/- appearing in books on account of exchange difference(debtors) as on 01.04.2009. The assessee explained that this entry is nothing but a removal of outstanding debtors as on 31.03.2009. Para 36 of AS-11 interalia provides that exchange differences on such a contract should be recognized in the statement of profit and loss in reporting period with exchange rate changes taken into account. Thus, exchange difference on forward exchange contract entered into for hedging purpose should be recognized in P&L account in reporting period in with exchange rate charges.
As para 36 clearly states that this is just for hedging purpose, however there is nothing on file to prove that this was not speculation trading. There was no day to day status of creditors and debtors and outstanding exposure in foreign currency. So, it is difficult to say whether the transaction made was for hedging or speculation. 13 - M/s Milan Jewellers
Also, there are no forward contract notes submitted before the AO during assessment proceedings for him to verify. Also, there is nothing on record to verify the rate at which the forward contract was booked and what was the prevailing exchange rate and at what rate the conversion was made on 31.03.2009. (b) With regard to during the year loss of Rs.1,12,50,614/- again there is insufficient information on record to verify the nature of loss, whether the same was speculation or business loss as there is no day to day outstanding position of debtor/creditor and foreign currency exposure and also no forward contract notes. Thus, A.O. rightly added the amount of Rs.6.92 on the entries made which was not completely explained."
The ld CIT(A) required the assessee to furnish his comment on the remand report of the Assessing Officer. In the reply to the remand report furnished by Assessing Officer, the assessee contended that the Assessing Officer did not call for any information or explanation from the assessee. During the remand period, the assessee followed up the matter with the Assessing Officer. The assessee was orally asked about the details of debtors and creditors vis-à-vis forward contract in a tabular form. The assessee provided the statement showing opening balance of forward contract, addition made during the month, contract cancelled during the month and closing balance of forward contract vis-à-vis debtors/creditors. Copy of those statement was also filed before the ld. CIT(A). The ld. CIT(A) after perusing the remand report, comments of the assessee observed that Assessing Officer has not made any comment with regard to the merit of issue at stake. Though the M/s Milan Jewellers copy of submission of the assessee and concerned ledger were forward to the Assessing Officer, no comments was made on accounting entries, the Assessing Officer has only reiterated the same position as recorded in Assessment Order. The Assessing Officer has not given any disagreement with the relevant details furnished by assessee. There is no comment of Assessing Officer on the material remanded for his specific comment, thus the ld. CIT(A) deem it appropriate to examine the matter independently of his own and concluded as under:
“The appellant had furnished the copies of the relevant ledger account to substantiate its claim and which had been forwarded to the Assessing Officer in the course of the remand proceedings. From the perusal of the details as submitted by the appellant it is observed that the said entry pertains to the con version of outstanding debtors as at the year ended 31.3.2009 and thus in net analysis, had been offered for taxation in the said year i.e. A.Y. 2009-10. The said entry is in fact passed for conversion of outstanding debtors as at the year end as per the mandate of AS-ll. Since this is an adjustment entry which is passed to meet the requirement of the AS 11, the same cannot be treated as unexplained. The said entry is passed at the year end to reflect the amount of debtors, denominated in foreign currency, that can be recovered at the year end and corresponding gains/loss on its conversion in Indian rupees. Since it is an adjustment entry, it is invariably reversed on the first day of the next financial year, which treatment is prescribed by AS 11. Further, the statement of monthly forward contracts vis-a-vis outstanding debtors/ creditors sufficiently proves that the appellant always had far more exposure m the form of outstanding debtors/creditors (in USD)compared to the value of forward contracts, which implies that entering into forward contract transactions was with the intention to hedge its - M/s Milan Jewellers outstanding position in debtors/creditors. The fact that the appellant had been consistently following the AS-11 year after year as well as the fact that the corresponding gain relating to the conversion of outstanding debtors as on 31.3.2009 had been offered to tax and assessed as such, cannot be lost sight of. It is also to be mentioned here that the claim of the appellant is covered by the decision of the Hon'b1e Supreme Court in the case of CIT vs. Woodword Governer Ltd. (2009) 179 Taxman 326(SC). In view of the said facts and circumstances and the prevailing law on the subject, I am unable to accede to the finding of the Assessing Officer that the amount is unexplained. The addition of Rs. 5,79,54,450/- is directed to be deleted.
7.13 With regard to the claim of loss on forward contract cancellation/maturity of Rs. 1,12,50,614/-, the Assessing Officer is of the opinion that the said transactions were of receipts and payments and that the transactions by themselves do not prove' that the forward contracts were entered into on account of debtors/creditors and that in the absence of any co-relation of the loss with debtors/ creditors, the same has to be disallowed as speculation loss. On the other hand, on a perusal of the details and explanation as submitted by the appellant in the course of the appellate proceedings, it is observed that the loss is incurred on account of cancellation of forward contracts and are actually bank transactions. A perusal of the ledger account as well as the statement of month-wise position of outstanding debtors/ creditors vis-a-vis exposure of forward contracts brings out the fact that it was not an exercise in speculation since the value of the underlying asset was far in excess of the exposure in forward contracts. The receipt and payment transactions are on account of actual gain/loss on the cancellation/maturity of the forward contracts at the respective dates and the said loss/gain on the cancellation of the forward contracts is a business loss/ gain. In the said view of the matter, I am unable to accept the action of the Assessing Officer and - M/s Milan Jewellers direct that the addition in respect to the claim of loss of Rs. 1,12,50,614/- by treating the same as speculation loss be deleted.”