ASST CIT 16(3), MUMBAI vs. ALLIED GEMS CORPORATION (BOMBAY), MUMBAI

ORDER PER G.S.PANNU,A.M:

The captioned appeal filed by the assessee pertaining to assessment year 2009-10 is directed against an order passed by CIT(A)-27, Mumbai dated 24/01/2014, which in turn, arises out of an order passed by the Assessing Officer under section 143(3) of the Income Tax Act, 1961 (in short ‘the Act’) dated 30/12/2011.

(Assessment Year 2009-10) “Ground no. I "Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in allowing the loss of Rs 49.64 lacs, when infact the foreign exchange fluctuation gain on 31/03/2009 regarding the Sundry Debtors as per AS-II was a gain of Rs 1.14 crores.?" Ground no. 2 "Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in allowing the claim of loss of Rs 49.64 lacs, when what was valued was an asset in the Balance Sheet viz. Sundry Debtors and valuation of which had increased by Rs 1.14 crores.? " Ground no. 3 "Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in reducing the actual value realised between 01/04/09 to 07/09/09 of the Sundry Debtors from the valuation of the foreign exchange valuation gain of Rs 1.14 crores on 31/03/09, when infact such actual realisation was in the subsequent financial year. ?" Ground no. 4 "Whether on the facts and circumstances or the case and in law, the Ld. CIT(A) has erred in accepting the value of Sundry Debtors realised in a subsequent financial year and allowed as loss for AY 2009-10 as being in accordance with the principles of "Prudence" as contained in AS-I ?". Ground no. 5 " Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in allowing disallowance of foreign travel expenses of Rs 3.88 lacs even though the assessee had visited countries wherein IHI business connection of clients was found. ?" Ground no. 6 : "Whether on the facts and circumstances of the case and in law, the Ld. CIT(A) has erred in restricting disallowance of Rs 3.0 lacs foreign exchange expenses to Rs 50,000/- without appreciating the facts of the case" Ground no. 7: "Whether on the facts and circumstances of the case and in law, the Ld. CIT (A) has erred in restricting the disallowance under section.36(1)(iii) of the Income-tax Act 1961 to Rs 1,88,955/- instead of Rs 7,20,000/- made by the assessing officer. ?”

4. In brief, the relevant facts are that the respondent assessee is a partnership firm engaged in the business of dealing in cut & polished diamonds and precious & semi precious stones. In the course of assessment proceedings, it was noticed that assessee had claimed a loss of Rs.49,64,937/- on account of realization of export proceeds, which was outstanding as on 31/03/2009. It was noted by the Assessing Officer that though the said loss pertained to export receivable outstanding as on 31/3/2009, but the actual realization of the export proceeds took place in the subsequent financial year of 2009-10, corresponding to assessment year 2010-11. The Assessing Officer disallowed this claim of loss on the ground that the realization of outstanding export receivables was an event which took place in the subsequent assessment year and, therefore, such loss could not be allowed while computing the income for the instant assessment year.

4.1 In appeal before CIT(A), assessee assailed the order of the Assessing Officer on varied grounds. The CIT(A) has reproduced the elaborate submissions made by the assessee and has thereafter, held that the impugned loss was allowable considering the principles prudence. The CIT(A) noted that Assessing Officer did not doubt the amount short realized from the debtors amounting to Rs.49,64,937/-. The following discussion in the order of the CIT(A) is relevant:-

“2.4.12 The Principle of Prudence was again the subject matter of discussion before the Mumbai Tribunal in the case of Jamshri Ranjitsinghji Spinning and Weaving Mills Limited 41 ITD 142. The Tribunal was considering whether the notional benefit from import entitlements, under the DEEC scheme, available against exports could be treated as income accrued to the company in year in which the exports were made. The company had estimated the import entitlement benefits and recognized in its (Assessment Year 2009-10) books of account as income accrued the estimated amount, in the year in which the exports were made. The import entitlements were not utilized since no imports were effected during that year. The Counsel for the company arguing that though the company had accounted for the income, it had not in fact arisen. The Counsel quoted the Expert Advisory Opinion of the ICAI which has time and again opined that one of the major considerations governing the selection and application of accounting policies is Prudence, according to which profits are not anticipated but recognized only when realized in view of the uncertainty attached to future events. The Committee had therefore opined that no revenue should be recognized in respect of such import entitlements, till their utilization. On this reasoning the Tribunal held that no income had accrued to the company, as it had not received any tangible benefit in the form of 'Concession of duty in the year when the entitlements were accounted for in the books, thereby vindicating the Principle of Prudence.

2.4.13 The Mumbai Tribunal in the case Voltas Limited vs. DCIT, 64 ITD 232 ruled that whilst working out profits, all expected losses had to be accounted for in order to determine the real income of the company. It therefore allowed a claim made of deduction for warranty provisions. It held that since the income for which the projected expenditure had to be incurred was taxed as income, the expenditure to earn the income estimated on reasonable basis had to be allowed. 2.4.14 It is also observed that the Ld.A.O. has not doubted the short realization of the debtors amounting to Rs. 49,64,937/- and hence, it cannot be said that it was an improper claim. The appellant had shown this entry under the schedule 'K' of the Balance sheet and hence, the claim was apparent from balance sheet itself. What the appellant has done is only follow the principle of prudence and when a particular claim is known to have crystallized, the principle of prudence must hold precedence. Even the UK SSAP 2 explicitly says that where there is an apparent conflict between the Accruals concept and the concept of Prudence, the latter prevails. Similarly, even as per Indian AS-9, revenue is recognized only when measurability and collectability are reasonably certain. 2.4.15 In view of the Principle of Accountancy considered by the Hon'ble Supreme Court in the plethora of cases cited (supra) including the celebrated decision in the case of Bharat Earth Movers, 245 ITR 428 (SC) and Madras Industries & Investment Corporation, 225 ITR 802 (SC). I am of the considered opinion that the appellant was correct in following the principles of prudence as the sum of Rs.49,64,937/- was not ultimately realized. In any case, this loss would have to be allowed in the next year and therefore, it is only a question of timing which is in dispute. Accordingly, Ground No.1 is allowed.” 4.2 Against such decision of the CIT(A), Revenue is in appeal before us. Before us, the Ld. Departmental Representative has primarily reiterated the stand of the Assessing Officer in support of the case of the Revenue. The (Assessment Year 2009-10) singular point which has been emphasized by the Ld. Departmental Representative is that the said loss could not be said to have accrued as on 31/03/2009, since as on that date the corresponding export receivables were not actually realized, and that such realization happened in the subsequent year and, therefore, it is only at the time of actual realization that said loss is liable to be accounted for.

4.3 On the other hand, Ld. Representative for the assessee vehemently defended the order of the CIT(A) and in particular contended that the claim of the assessee is fully supported by the principle of prudence, which is an accepted concept even in Accounting Standard-1 notified by the Central Government under section 145(2) of the Act. It is pointed out that it is a well accepted principle of accountancy that provision should be made for all known liabilities and losses even though the amount may not be determined with certainty and represents only a best estimate in the light of available information. In this context, Ld. Representative for the assessee pointed out that so far as the reasonableness of the loss is concerned, there is no dispute that it has been suffered on account of actual short realization of export proceeds. The Ld. Representative for the assessee has placed reliance on the judgment of the Hon’ble Allahabad High Court in the case of CIT vs. U.B.S. Publishers and Distributors, 147 ITR 144(All)

4.4 We have carefully considered the rival submissions. It is quite well understood that section -4 of the Act, charges income tax in respect of the total income of a previous year relevant to the concerned assessment year. Section -5 of the Act, prescribes the scope of total income and so far as we are concerned, the dispute relates to the income chargeable under the head ‘profits and gains of business or profession’; which is liable to be computed

(Assessment Year 2009-10) in accordance with the methodology prescribed in section 145(1) of the Act i.e. either in terms of cash or mercantile system of accounting regularly employed by the assessee. Sub-section (2) of section 145 empowers the Central Government to notify Accounting Standards for any class of assessees or in respect of any class of income. In the present case, assessee firm has maintained its accounts on mercantile system and while computing income for the year under consideration, it claimed deduction for a sum of Rs.49,64,937/- representing loss on short realization of export proceeds, which were outstanding as on 31/3/2009, of-course, short realization having taken place in the subsequent period. The claim of the assessee is that the mercantile system of accounting adopted by the assessee justifies such adjustment and for that matter, reference is made to the principle of prudence, which has been emphasized in the Accounting Standard -1 notified under section 145(2) of the Act also. The principle of prudence seeks to ensure that provision ought to be made for all known liabilities and losses even though there may remain some uncertainty with its determination. So however, it has to be appreciated that what the principle of prudence signifies is that the probable losses should be immediately recognized. In the present context, the stand of the assessee is that though realization of export receivables took place in the subsequent period, but the loss could be accounted for in the instant year itself as it would be prudent in order to reflect the correct financial results. Factually speaking, Revenue does not dispute the short realization from debtors to the extent of Rs.49,64,937/- and, therefore, in so far as the quantification of the loss is concerned, the claim of the assessee cannot be assailed on grounds of uncertainty. Therefore, assessee is justified in determination of such loss on the basis of actual figures which were available while assessing its income in the instant assessment year. In the case

(Assessment Year 2009-10) of U.B.S. Publishers and Distributors (supra), which has been relied upon before us, the issue relates to the assessment year 1967-68 (previous year ending on 31/05/1966). In the assessment proceedings, it was found that assessee therein had claimed an expenditure by way of purchases of a sum of Rs.6,39,124/- representing additional liability towards foreign suppliers in respect of books imported on credit upto the end of 31/05/1966. The said additional claim was based on account of devaluation of Indian currency, which had taken place on 06/06/1966 i.e. after the close of the accounting year. Such a claim was disallowed on the ground that it did not pertain to the previous year ending 31/5/1966 and that the event of devaluation had taken place only on 06/06/1966, which was after the close of the accounting period. The claim of the Assessing Officer was that since assessee was maintaining its accounts on mercantile system, the liability on account of devaluation of the Indian currency could not be said to have accrued during the accounting period ending on 31/5/1966 as devaluation took place after the end of the accounting period. The Tribunal allowed the claim of the assessee holding that though devaluation of Indian currency took place after the end of the previous year, but assessee was justified in determining his liability on the basis of the actual figures available when accounts for that year were yet not finalized. The Hon’ble Allhabad High Court affirmed the decision of the Tribunal and noted that liability to pay in foreign exchange accrued with the import of books and was not as a result of devaluation. According to the High Court, since the actual figure of loss on account of devaluation was available when the accounts for 31/5/1966 ending were finalized, the same was an allowable deduction in assessment year 1967-68 itself. The parity of reasoning laid down by the Hon'ble Allahabad High Court is squarely applicable in the present case also. In the present case, short realization of export proceeds to the extent of (Assessment Year 2009-10) Rs.49,64,937/-, took place in next year but it related to export receivable for the instant year, and at the time of finalization of accounts for the instant year, the actual figure was available, and therefore, assessee made no mistake in considering it for the purposes of arriving at the taxable income.

4.5 Even otherwise, it has to be appreciated that income tax is a levy on income and that what is liable to be assessed is real income and while computing such real income, substance of the matter ought to be appreciated. Quite clearly, the assessee was aware while drawing up its accounts for the previous year relevant to the assessment year under consideration that the export receivables, outstanding as at the year- end were short recovered by a sum of Rs.49,64,937/-and, therefore, the real income for the instant year could only be deduced after deduction of such loss. Therefore, considering the entirety of facts and circumstances, in our view, the CIT(A) made no mistake in allowing the claim of the assessee, which we hereby affirm. Thus, in so far as Grounds of appeal No.1 to 4 are concerned, the same are dismissed.

5.1 In the context of the aforesaid Grounds, the discussion in paras 4 & 5 of the assessment order reveal that disallowance of Rs.3,88,167/- out of foreign travel expenses have been made on the ground that it pertained to the visit of (Assessment Year 2009-10) partners to such countries where assessee has not done any business. The disallowance of Rs.3.00 lacs out of the foreign exchange purchased for use in foreign travel was made by the Assessing Officer on the ground that no details were filed to indicate how the foreign exchange was utilized during the course of foreign travel. The CIT(A) has noticed that the Assessing Officer could not enter into shoes of the assessee while examining the claim of expenses and noted that the partners of the appellant firm had actually visited the countries concerned and in fact, subsequently substantial business was generated from such countries. He, therefore, deleted the entire addition of Rs.3,88,167/- out of foreign travel expenses on the ground that it related to the purposes of business. With regard to the disallowance out of foreign exchange purchased for foreign travel, in the absence of details, the CIT(A) has found it fit to restrict the disallowance to Rs.50,000/- only.

5.2 Having heard the rival parties, we find no reason to interfere with above finding of the CIT(A) as no cogent reasoning has been brought out by the Ld. Departmental Representative before us. As a consequence, the finding of the CIT(A) is hereby affirmed and the Revenue fails on this aspect also.

6.1 In this context, the relevant facts are that assessee was found to have advanced a sum of Rs.60,00,000/- free of interest to M/s. Rough Diamond India Pvt. Ltd., a sister concern. The Assessing Officer has also noticed that there was no business transaction with the said concern during the year and (Assessment Year 2009-10) that assessee was otherwise incurring interest expenditure on borrowings even on the capital raised from the partners. Before the Assessing Officer assessee contended that the said advance was given in assessment year 2008- 09, which could not be adjusted against the labour bills nor could be recovered and in that assessment year proportionate interest of Rs.8,07,763/- was disallowed by the Assessing Officer which has since been reduced to Rs.1,60,000/- by the CIT(A). The Assessing Officer noted that the facts in this year were different and the partial relief allowed by the CIT(A) in 2008-09 could not be allowed in this year and that assessee was paying interest on borrowing @12%. Accordingly, the interest proportionate to the aforesaid interest free advance of Rs.60,00,000/- was determined at Rs.7,20,000/- and disallowed. The CIT(A) has since allowed partial relief to the assessee based on alternate plea that the disallowance be worked out on the basis of the methodology laid down by the CIT(A) in assessment year 2008-09 and which has been accepted by the Department.

6.2 Before us, Ld. Representative for the assessee pointed out that the order of the CIT(A) for assessment year 2008-09 is placed in the Paper Book at pages 42 to 44 and pointed out that the calculation of proportionate interest disallowable was made after considering the availability of non-interest bearing funds. In this manner the part relief allowed by the CIT(A), as per discussion in paras 2.4.19 to 2.4.21, is sought to be defended.

6.3 On the other hand, Ld. Departmental Representative has referred to the discussion in the assessment order, which we have already adverted to in the earlier para, and the same is not being repeated for the sake of brevity.

(Assessment Year 2009-10) 6.4 We have carefully considered the rival submissions. The relevant discussion in the assessment order reveals that as per the Assessing Officer assessee is paying interest on capital raised from the partners also and, therefore, even if the methodology laid down by the CIT(A) in assessment year 2008-09 is to be allowed, the funds to the extent of partner’s capital cannot be treated as an interest free fund, as assessee is paying interest on such funds. Be that as it may, the discussion by the CIT(A) is quite sketchy and is bereft of requisite details, therefore, we deem it fit and proper to set-aside the order of the CIT(A) and direct the Assessing Officer to recomputed the amount disallowable under section 36(1)(iii) of the Act bearing in mind the methodology approved by the CIT(A) in his order dated 02/08/2011 for assessment year 2008-09. Needless to say that the Assessing Officer shall carry out the aforesaid exercise after providing the assessee a reasonable opportunity of being heard. Thus, on this aspect Revenue succeeds for statistical purposes.