DCIT 3(2)(1), MUMBAI vs. LAVINO KAPUR COTTONS P. LTD, MUMBAI

Facts in brief are that assessee is engaged in manufacturing and export of absorbent cotton. During the course of scrutiny assessment, the AO on perusal of the Balance Sheet found that notional gain on forward contracts of Rs. 45,47,858/- on foreign currency forward contracts that were outstanding as on 31.03.2011 has not been offered for taxation. He gave a show-cause notice to the assessee on the above which has been extracted at para 6.1 of the assessment order. In compliance to it, the AR of the appellant filed a written submission dated 23.01.2014 which has been extracted by AO in para 6.2 of the assessment order. The AO was not convinced with the above explanation of the assessee in view of accounting standard -11, the decision in the case of CIT vs Woodward Governor India (P.) Ltd., Explanation 3 to section 43A and section 43(5). In view of the above, the AO concluded that the notional gain on forward contract is speculative gain in the case of the assessee and it has to be offered for taxation in the same accounting year and not on settlement of contracts as contended by the assessee. Based upon the mercantile system and matching principle of accounting, he considered the notional gains of Rs. 45,47,858/- as speculative business income liable to taxation during the year. Therefore, he added the above sum of Rs. 45,47,858/- to the total income of the assessee.

4. By the impugned order CIT(A) deleted the addition after observing as under:- The issue relates to the assessment made by the AO of the notional gain on foreign currency forward contracts of Rs. 45,47,858/-' as income for the year under consideration. I find that para 9 of schedule 20 (Principal Accounting Policies) of the appellant company as mentioned at page 31 of the annual report 2010-11 reads as under: "The company has entered into forward contracts in order to determine the realization for their future sales and accordingly sold dollars to the bank for delivery at forward dates. The aggregate value of contracts for forward sales to the bank outstanding as on 31.03.2011 was USD 45,00,000, GBP 1,200,000 and EURO 720,000. In respect of the said forward contracts, the notional gain as on 31.03.2011 is Rs.45,47,858/- by taking the difference of the forward rates available as on M/s. Lavino Kapur Cottons Pvt. Ltd., 31.03.2011, viz-a-viz the forward rates as per the contracts entered into by the Company. The said notional gain is not taken into the accounts as per practice regularly followed by the company. In respect of the said forward contracts outstanding as on 31.03.2010 there was notional gain ofRs.95,31,151/-." The AO has brought to tax the notional gain on forward contract of Rs. 45,47,858/ - not offered by the assessee for taxation. He has relied on the decision in the case of Cl'T vs Woodward Governor India (P) Ltd. 312 ITR 254 (SC). I find that in the above case, the Hon'ble Supreme Court held that loss suffered by an assessee in respect of a revenue liability on account of exchange difference as on the date of balance sheet is an item of expenditure allowable u/s. 37(1). Thus, the case of the assessee is distinguishable from the above decision relied on by the AO. I find that a similar issue arose before the Hon'ble Madras High Court in the case of Indian Overseas Bank vs CIT (1990) 183 ITR 200 (Mad). The head note of the above case is produced as under: "The levy of income-tax is on income and though the Income-tax Act has taken note of the twin points of time at which the liability to tax is attracted, viz., the accrual of income or its receipt, yet, the substance of the matter is income and if income does not result at all, there cannot be a tax, even though, for purposes of book- keeping, an entry is made about an hypothetical income which does not materialise and a mere book-keeping entry cannot be income unless income has actually resulted. The question whether there is a loss or profit on foreign exchange transactions can be ascertained only after the settlement of the forward contracts and not before and so long as that stage has not been reached, the loss can only be notional and not actual or real and a notional loss cannot be claimed as a deduction. Whether a loss or profit, the principle applicable would be the same and the estimated profit, till the settlement of the forward foreign exchange contracts, could be regarded only as notional and not actual or real and such notional profits cannot be assessed Held, that the amounts in question were only estimated anticipated income arrived at on the basis of the rates of M/s. Lavino Kapur Cottons Pvt. Ltd., exchange which prevailed, presumably on the last day of the accounting year, without an actual settlement of the forward contracts in foreign currencies having been brought about and, in that sense, the amounts in question represented merely notional profits and could not be subjected to tax." In view of the above decision, the addition of Rs. 45,47,858/ - made by the AO is deleted.

Against the above order of CIT(A), revenue is in further appeal before us.

We have considered rival contentions and carefully gone through the orders of the authorities below. We had also deliberated on the judicial pronouncements referred by lower authorities in their respective orders as well as cited by learned AR during the course of hearing before us.

From the record, we found that as per the practice followed by the assessee - company, the notional gain or loss on forward contract is debited or credited to the P&L account for the year in which the forward contract is settled. The fundamental principle of taxing income under the mercantile system of accounting is the time of accrual. It is not material whether the amount has been received at the time of accrual or not. The income is accrued when the assessee acquires the right to receive it.

While deleting the addition made on account of notional gain on forward contract the CIT(A) had taken note of the fact that in case of Woodward Governor India Pvt. Ltd., (supra), Hon’ble Supreme Court had dealt with the loss suffered by assessee in respect of revenue liability on account of exchange difference as on the date of balance sheet. Thereafter, considering the decision of Madras High Court in case of Indian Overseas Bank 183 ITR 200, CIT(A) concluded that estimated, anticipated income arrived at on the basis of rate of exchange which prevailed on the last date of forward contract in foreign currencies only represents notional profit and could not be subject to tax. Respectfully following the proposition laid down by Madras High Court, we do not find any infirmity in the order of CIT(A) for deleting the addition made by AO on account of notional gain on forward contract. However, AO is at a liberty to verify that this gain has been offered for taxation in the subsequent years when it actually arose. We direct accordingly.

In the result, appeal of the Revenue is dismissed in terms indicated hereinabove.