DIAMONDS 'R' US,MUMBAI vs. JT.C.I.T. (OSD) CENTRAL CIRCLE 39, MUMBAI

Per P.K. Bansal, Vice President

2 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us 2. Both the parties agreed that the issue involved in both the assessment years in the appeals of both the parties are common except the figure and whatever decision the Tribunal may take in A.Y. 2009-10 the same may be taken in A.Y. 2010-11 although the number of grounds are different. The grounds of appeal taken by the parties for A.Y. 2009-10 are as under: - (Assessee’s appeal) “Being aggrieved by the order of the Commissioner of Income-tax (Appeals) - 41 [CIT (A)] under section 250 of the Income-tax Act, 1961, this appeal petition is submitted on the following grounds which may considered without prejudice to one another: - 1) On the facts and circumstances of the case and in law the learned CIT (A) erred in confirming disallowance of Rs. 9,84,36,555/- being proportionate interest debited to the Profit & Loss A/c under section 36(1))(iii) of the Act holding that the same is in relation to interest-free advances and ignoring that the Appellant has incurred interest of Rs 12,40,92,432/- only for the purpose of business. The disallowance being bad in law the same needs to be deleted. 2) Without prejudice to the above, on the facts and circumstances of the case and in law the learned CIT(A) erred in confirming the amount of disallowance of Rs 9,84,36,555 without appreciating the fact that the disallowance amounts to approximately 80% of the interest paid of Rs.12,40,92,432 and that interest should be computed on a daily basis and not on the closing balances.” (Revenue’s appeal) “(1) Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) is justified in allowing the claim of the assessee for deduction of Rs.56,25,38,852/- under section 10AA of the Income tax Act on the ground that activities of the assessee for importing diamonds and re-exporting the same amounts to proving services for the purpose of this section. (2) Whether on the facts and in the circumstances of the case and in law, the Ld. CIT(A) was justified in allowing the appeal of the assessee, as the Ld. CIT(A) has failed to appreciate that the loss claimed, on account of Foreign Exchange Forward Contract is only a restatement of opening positions of Foreign Exchange Forward Contracts, as per the rate prevailing on the balance sheet, as on 31.03.2009, thereby meaning that the loss claimed is only a notional liability and is not allowable under the Income Tax Act as the assessee is found to be following mercantile system."

3 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us 3. In A.Y. 2010-11 even though Revenue has taken various ground, as agreed by the learned D.R., the only issue involved is the same as in ground No. 1 for A.Y. 2009-10. Ground No. 1 in Revenue’s appeal relates to the claim of assessee’s deduction under Section 10AA of the Income Tax Act. Both the parties agreed that this issue is covered by the decision of this Tribunal in assessee’s own case for A.Y. 2007-08 in ITA No. 276/Mum/2012. After hearing the rival submissions and going through the order of this Tribunal in assessee’s own case in CO 276/Mum/2014 for A.Y. 2007-08 we noted that the issue involved in ground No. 1 of Revenue’s appeal has been considered by this Tribunal and ultimately this Tribunal while considering the same issue has confirmed the order of the CIT(A) allowing the claim of the assessee for deduction under Section 10AA by holding as under: -

“5. We find that similar issue came up in A.Y. 2006-07 in assessee’s own case wherein following the decision of the ITAT in in the case of Goenka Diamond & Jewellers Ltd. the issue has been decided in favour of the assessee by observing as under: - “We noted that learned CIT(A) has taken into considering the aspect and observation of the AO that deduction under Section 10AA is not allowable for the reason that the assessee has not carried out any manufacturing activity but has done trading of goods only. For this purpose, learned AO has placed reliance on the order of Hon’ble Delhi High Court. Learned CIT(A) has taken into consideration these observation of the AO and thereafter he found that the Government of India has issues a circular No.17 of 29.5-2006, which was issued by Export Promotion Council For EOUs & SEZ Unit (Ministry of Commerce & Industry, Government of India). The contents of the Circular have also been incorporated in the finding of the learned CIT(A), which have also been reproduced somewhere above in this order. Therefore, we are not repeating the contents of that circular issued by the Ministry of Commerce & Industry, Government of India). Under Section 51(1) of the SEZ Act, it has been clearly provided that the provision of this Act has overriding effect in case of contradiction between the SEZ Act and other Act. Hence, by virtue of Section 51 of the SEZ Act, the provision of SEZ Act and rules will have overriding effect over the provision contained in any other Act. Learned CIT(A) has taken into consideration this circular issued by Government of India and the provision of Section 51 of the SEZ Act and found that trading done by the assessee is a service 4 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us and, therefore, deduction under Section 10AA is allowable. We further noted that on similar facts in case of Goenka Diamonds and Jewellery Limited (supra), the Jaipur Bench of the Tribunal has discussed the issue in detail. The provisions of Section 51 of SEZ Act were also considered. The decision of the Hon’ble Supreme Court in the case of Tax Recovery Officer Vs. Custodian Appointed Under The Special Court, reported in the case of 211 CTR 369 (SC) and the decision of the Hon’ble Delhi High Court in the case of CIT Vs. Vasisth Chay Vyapar Ltd., reported in 238 CTR 142 (Delhi), were also taken into consideration and thereafter it was concluded that in view of the Instruction No.1 of 2006, dated 24- 3-2006 as modified by Instruction No.4 of 2006, dated 24- 5-2006 issued by the Ministry of Commerce & Industry, Government of India and the definition of service given in the SEZ Act, 2005, which overrides the word ‘service’ accruing in Section 10AA by virtue of Section 51 of the SEZ Act. The assessee engaged in trading in nature of re-export of imported goods and for the same the assessee was entitled deduction under Section 10AA of the Act. Facts are similar before us, as the assessee is engaged in trading of re-export of imported goods and, therefore, the assessee is entitled for deduction under Section 10AA of the Act. All the arguments advanced by the learned DR before us have also been taken care of by the Tribunal while discussing the appeal in the case of Goenka Diamonds and Jewellery Limited (supra). It is further noted that the main plank of argument of learned DR is that rules provided under the SEZ Act cannot partake the character of the Section of the Income Tax Act. We find that in the SEZ Act under Section 51, it has been clearly provided that the provision of SEZ Act will override the provision of any other Act, meaning thereby the provision provided under the SEZ Act has to override on the provision of Section 10AA of the Income Tax Act. Under the rules, it is not provided but under Section 51 of the SEZ Act, it is provided, therefore, in our view, the contention raised by the learned DR is not tenable. Moreover, the issue is squarely covered by the decision of the coordinate Bench in the case of Goenka Diamonds and Jewellery Limited (supra). Therefore, respectfully following the decision of the Tribunal in the case of Goenka Diamonds and Jewellery Limited (supra) and in view of the reasoning given by the learned CIT(A), we confirm his order.”

5 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us 4. No contrary decision was brought to our knowledge. Respectfully following the decision of the Tribunal in the case of the assessee we dismiss ground No. 1 taken by the Revenue.

“3.7 I have perused the submissions of the appellant and facts of the case carefully. It is noticed that the contention of the AR of the appellant is true that inadvertently the buyer's credit translation of Rs,53,60,17,299/- was erroneously considered as forward contract loss whereas in fact there was a gain of Rs.44,56,95,930/- in forward contract translation. It is also true that from these transactions the appellant has shown a net gain of Rs.55,90,915/- which is credit to the P & L a/c. Thus, it is a mistake apparent from the record which was due to typographic error. Regarding the argument of the AO that it is only a provision and not allowable, the Hon'ble Supreme Court has decided this issue in the case of CIT vs. Woodward Governor (India) P. Ltd. (supra) where it is held that the accounting method followed by an assessee continuously for a given period needs to be presumed to be correct till the AO comes to the conclusion for reasons to be given that system does not reflect true and correct profits. Secondly, the AO has treated this as a speculation transaction. On this issue, the Hon'ble Mumbai Tribunal (Special bench) in the case of Bank of Bahrain & Kuwait (supra) by following the decision of Hon'ble Supreme Court in case of Woodward Governor (India) P. Ltd. has held that where a forward contract is entered into by the assessee to sell the foreign currency at an agreed price at a future date falling beyond the last date of accounting period, the loss is incurred to the assessee on account of evaluation of the contract on the last date of the accounting period, i.e. before the due date of maturity of the forward contract is not a speculative transaction. In the present case, the assessee is also following the Mercantile system of accounting continuously and there is no change in the accounting system and the method of accounting. A.O. also could not brought on record any adverse finding that the assessee has changed the method in previous or subsequent years and the computation was of a complicated nature & does not reflect true and correct profits as held by the Apex Court. The Hon'ble Delhi Tribunal in the case of Munjal Showa Ltd. vs. DCIT has also held that the presumption of any speculative transaction is, therefore, directly rebutted in view of the legal impossibility and in view of the fact that foreign currency

6 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us was neither commodity nor shares. Keeping in view all these facts and circumstances, it is held that it was a mistake apparent from the record and moreover, the facts of the case are covered by the decision of Supreme Court and the decision of Spl. Bench Mumbai & Delhi Tribunal that the assessee has not changed its method of accounting nor the A.O. could brought any adverse material or distinguish the facts of the present case to the facts decided by the Hon'ble Supreme Court. Secondly, the Mumbai Spl. Bench decision and the decision of Hon'ble Delhi Tribunal is also squarely covered the facts of the case where it is held that forward contract in case of foreign exchange transaction is not speculative transaction. Thus, the decision of the AO that it is a speculative income covered u/s. 43(5) & the provisions of section 73 is not correct because he could not submit any favourable decision on this issue. Therefore, the disallowance made by the AO is not sustainable, hence deleted. The ground of appeal is allowed.”

6. The learned D.R. before us vehemently relied on the order of the AO but could not adduce any cogent material for evidence which may prove that the fact stated by the CIT(A) that the assessee in fact has not incurred any loss on forward contracts but in fact there was a gain of `44,56,95,930/- in the forward contract transactions and the assessee has credited into the Profit & Loss Account net gain of `55,90,915/-. In view of this fact we do not find any illegality or infirmity in the order of the CIT(A) and we confirm the same. Thus, ground No. 2 taken by the Revenue stands dismissed.

7. Now coming to assessee’s ground Nos. 1 & 2, it relate to the common issue regarding to the disallowance of `9,84,36,555/-. The brief facts relating to this grounds are that the AO noted that the assessee has shown net interest income of `13,22,79,483/- in the Profit & Loss Account. He also observed on perusal of the Balance Sheet that the assessee has given interest free loans and advances of `95,25,15,572/- to its main person, Shri Nirav Modi. After considering the reply of the assessee, the AO noted that the assessee has earned gross interest and after reducing there from bank interest of `12,40,92,432/- shown net interest income at `13,22,68,483/-. The AO was of the view that the assessee has utilised borrowed funds for advancing interest free loans. Accordingly he disallowed proportionate interest amounting to `9,84,36,555/-. Assessee went in appeal before the CIT(A) and before the CIT(A) the assessee made

7 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us detailed submissions mentioning therein that Shri Nirav Modi is a partner in the partnership firm and it is not a case that money always remains debit but there was a credit balance also in the account of Shri Nirav Modi. In fact in the capital account of all the partners there was a credit balance as on 31st March, 2008 to the extent of `1,15,70,667/- and as on 31st March, 2009 at `58,16,76,653/-. Thus interest free funds were available to the assessee. Therefore it is not a case where the borrowed funds has been utilised for the purpose of being given to the partner Shri Nirav Modi. He also contended that not only the capital the assessee has interest free funds in the shape of sundry creditors to the extent of `57,91,37,315/- as well as amount received for the booking to the extent of `5,59,42,707/- and therefore the disallowance has simply been done on the presumption as if interest free funds has been advanced out of the borrowed funds. Reliance was placed before the CIT(A) on the decision in the cases of CIT vs. Abhishek Industries Ltd. 156 Taxman 257 (P&H), S.A. Builders Ltd. vs. CIT (SC) as well as Mujal Sales Corporation vs. CIT 168 Taxman 43 (SC). The CIT(A) did not agree with the submission of the assessee but upheld the proportionate disallowance by holding as under: -

“4.7 From the perusal of the submissions of the appellant and facts of the case, it is noticed that the assessee has shown net interest income of Rs.13,22,69,483/- after adjusting the bank interest paid of Rs.12,40,92,432/-. The assessee firm has given advances of Rs.92,25,15,572/- to Shri Nirav Modi. Thus, it is an undisputed fact that, the assessee firm has borrowed funds and paid interest of Rs.12,40,92,432/- and at the same time has given interest-free advances to Shri Nirav Modi amounting to Rs.92,25,15,572/-. When the AO has confronted that as per the provisions of section 36(1)(iii), the assessee has to prove that the borrowed funds have been utilized wholly and exclusively for the business purposes, the assessee has failed to submit any documentary evidence to prove this fact before the AO. As per the provisions of section 36(1)(iii), the onus is on the assessee to prove that the borrowed funds are utilized for business purposes. However, in the present case, the assessee has failed to submit any evidence before the AO and before me to prove this fact that the borrowed funds were utilized for the business purposes only and not for advancing interest-free loans to the partner of the firm. Moreover, the decisions relied on by the AO supra has clearly held that when the borrowed funds were utilized for the purpose of business, only then it is allowable as deduction u/s. 36(1)(iii).

8 & 4935/Mum/2012 ITA No. 2365& 3490/Mum/2014 M/s. Diamonds "R" Us Further, the decision of Hon'ble Madras High Court in the case of Mir Mohammed Ali vs. CIT (38 ITR 413) has been confirmed by the Hon’ble Supreme Court reported in 52 ITR 165 by holding that the onus is on the assessee to prove that the borrowed funds were utilized for business purposes only. Even the decisions relied on by the AR of the appellant also confirm this issue that onus is on the assessee to prove that the borrowed funds were utilized wholly and exclusively for business purposes otherwise, the deduction u/s. 36(1)(iii) is not allowable. Secondly, the AR of the appellant has submitted that no interest has been debited to the P & L A/c. and only net interest of Rs. 13,22,79,483/-was credited. On this issue of netting of interest, the Hon'ble Supreme Court in case of CIT vs. V.P. Gopinathan (248 ITR 449) has held that earning of interest and paying of interest are two different transactions. The interest received by the assessee from the bank was income in his hands. It could stand diminished only if there was provision in law which permits such diminution. There is none, therefore, the amount paid by the assessee as interest on loan that he took from the bank did not reduce his income by way of FD placed by him in the bank. Similarly, in case of K.S. Subbhi & Co. Vs. CIT (260 ITR 304) the Hon'ble Madras High Court has held that interest paid and claimed as deduction in computation of profit and gain of business cannot be set- off against interest received and computed under the income from other sources. In view of these circumstances, the second argument of the appellant that net interest has been credited to the P & L a/c. and not interest paid expenditure has been debited is also not acceptable because netting of interest is not allowable. In view of these facts and decisions of Hon’ble Courts, it is held that the assessee has failed to prove with any documentary evidence before the AO and before me that the borrowed funds were utilized wholly and exclusively for business purposes. Therefore, the disallowance made proportionately of Rs.9,84,36,555/- is upheld and the ground of appeal is dismissed.”

8. Before us the learned A.R. reiterated the submissions made before the CIT(A) as well as he submitted before us a chart showing the daily debit and credit balances of Shri Nirav Modi and on the basis of the debit and credit balances outstanding he has computed interest on fluctuating balances on daily basis @7%. On the basis of this calculation, we noted that the interest receivable by the assessee come to `43,46,101/- while the interest payable comes to `1,54,81,052/- and on that basis he contended that no addition should be made in the case of the assessee. He also drawn our attention towards the Balance Sheet and Profit & Loss Account as well as the schedule thereto appearing at pages 58, 59, 60 and 61 of the paper book.

10. After carefully considering the submissions of both the parties and material available on record, the AO is directed to compute the disallowance, if any, after considering the daily fluctuating balances outstanding and after deducting therefrom the capital balance of the partners available with the firm as on 01.04.2008 and calculating such interest by applying the rate of interest at which the assessee had borrowed funds. The assessee is directed to furnish all the necessary documents on which he may rely before the AO. Thus, this ground is statistically allowed in both the assessment years except that while computing disallowance in A.Y. 2010-11 he has to take the partner’s opening balance for the purpose of computation of disallowance as o 01.04.2009.