ASST CIT 15(1), MUMBAI vs. R T STAR SOLITAIRES, MUMBAI

"ी जो"ग"दर "संह, "या"यक सद"य एवं "ी अ"वनी तनेजा, लेखा सद"य, के सम" Before Shri Joginder Singh, Judicial Member, and Shri Ashwani Taneja, Accountant Member Assessment Year: 2009-10 Asst. CIT 15(1) R T Star Solitaires, R.No.104 Matru Mandir, 712M-A, Prasad बनाम/ 1st Floor, Tardeo RD, Chambers, TATA RD Vs. Mumbai-400007 No.2 Opera House, Mumbai-400004 (Assessee) (Revenue) P.A. No.AAGFR8565F Revenue by Capt. Pradeep S. Arya (Sr. DR) Respondent by None 29/06/2016 सुनवाई क" तार"ख / Date of Hearing : 22/07/2016 आदेश क" तार"ख /Date of Order: आदेश / O R D E R Per Ashwani Taneja (Accountant Member): This appeal has been filed by the revenue against order of Ld. Commissioner of Income Tax (Appeals) -26, Mumbai, {(in short ‘CIT(A)’}, passed against assessment order u/s 143(3) of the Act, for the A.Y 2009-10 on the following grounds:

2 R T Star Solitaires “1.On the facts and in the circumstances of the case and in law, the Ld. CIT(A) has erred in deleting the addition of Rs. 45,10,750/- made by the Assessing Officer on account of disallowance of loss on foreign exchange forward loss and not appreciating the fact that the said loss was a notional loss and thus cannot be allowed. '2.On the facts and in the circumstances of the case and in law, the Ld CIT('A) has erred in not following the ratio of the decision of the ITAT, 'E' Bench, Mumbai in dated 03-05-2013 in the case of S. Vinod Kumar Diamonds Pvt. Ltd.

3. The solitary issue raised by the revenue in this case is in regard to loss of foreign exchange contract which was disallowed by the AO but allowed by the Ld. CIT(A). 3.1. We have considered the submission made by Ld DR and orders passed by the lower authorities. 3.2. The brief facts and background of this case are that during the year under consideration, the assessee was in the business of import and export of jewellery. During the year, the export turnover was Rs.127.29 crore and import value was for Rs. 34.64 crore. It was submitted that the Reserve Bank of India, under its foreign exchange policy allow the exporters to take position in the forward market so as to cover and 3 R T Star Solitaires withstand the risks of fluctuations in the foreign exchange rate. Accordingly in view of its business necessity, the assessee did some transactions in foreign exchange market and in that it incurred some loss which was claimed by it its return of income. But, the AO did not agree with the justification given by the assessee and disallowed the loss on the ground that it was a notional loss which has not been realized. As per AO, any unrealized loss on forward contract and mark to margin is not to be allowed as deduction from the income. Accordingly, alleged unrealized loss on forward contract amounting to Rs.45,10,750/- was disallowed. 3.3. Being aggrieved, the assessee filed an appeal before the Ld. CIT(A) and made exhaustive submissions. It was submitted that the assessee had sufficiently proved that forward position was meant for sufficiently covering for export receivables of the business of the assessee and there was not even a single transaction done in the foreign exchange which was speculative in nature. It was further submitted that there was a global melt down in the international market and few banks also filed bankruptcy position in the USA, as a result of which there was a global cascading effect on the Indian forex market, causing huge loss to the Indian exporters due to bad debts on account of exports receivables or on account of not meeting the time commitments by the foreign debtors which resulted in the cancelation of the forex transactions with the bank, as a result of which impugned loss was incurred. It was submitted that under these circumstances, the foreign exchange forward loss could not have been considered as a notional loss. As the 4 R T Star Solitaires same had resulted from cost of cancellation of forward position due to mandatory conditions laid down by the Reserve Bank of India and authorized dealer. The Ld. CIT(A) asked the assessee as to further justify that the impugned loss was not a notional loss and it was allowable under the Income Tax Law. The assessee explained the factual and legal position in detail, and relevant part of the submissions is reproduced below:

“a) The AO has conveniently overlooked the assessee's submission made vide letter dated 30th December 2011 wherein they have submitted as under: i) The export turnover was Rs. 127.29 Crore; ii) The import turnover was Rs. 34.64 Crore; iii) The Reserve Bank allows the importer and exporter to take position in the forward market to withstand the fluctuations in exchange rate; iv) The assessee has sufficiently proved that the forward position is sufficiently covered for Export Receivable which from the business activities; v) There is not a single transaction in the forex which is of speculative nature; vi) There is sufficient underlying receivables which were considered for taking up forward position with the authorized dealers viz, banks; b) Further, Forex loss on cancellation of forward contracts is not a notional loss but it is an actual loss under section 37(1) of the Income tax Act, 1961 as held by Hon'ble Bombay High Court in the case of CIT Vs. Badridas Gauridu Pvt. Ltd., 261 ITR 256. c)As regards Mark to Market Loss (MTM loss) Appellant submits, whether on account of last year's entry or on account of revaluation of contracts pending at year end, as under : - i) It is only with an intention to mitigate the risk associated with business the appellant has entered into forward exchange contracts; ii) What needs to be seen is whether the risk which the 5 R T Star Solitaires appellant has hedged by way of a forward contract has an underlying asset or liability by way of debtors or creditors; iii) The forward contracts entered during the course of business creates a legal liability irrespective of the fact that whether it matures during the accounting period or beyond the accounting period; iv) It is incorrect to state that the contract does not result in an asset or a liability and hence its revaluation does not arise; When a legally tenable contract is in existence, v) duly supported by an underlying asset and the contract having been entered during the course of business and further that the exchange rate as on date of entering the contract and as at the yearend being ascertainable, due effect of the contract at the yearend has to be considered while assessing appellant income.; The entire gamut of the impugned transactions is an vi) integral to the appellant business and cannot be called a contingent transaction; vii) The AO failed to see that such events/transactions are part and parcel of the appellant business and not external to it; The appellant has been consistently following the mercantile system of accounting and has been valuing the year-end outstanding foreign exchange transaction in terms of Accounting Standard AS-1 1; In the case of Woodward Governor, Hon'ble Delhi High Court (294 ITR 451) has observed - (a) the liability arises out of already concluded contracts, (b) the liability already stands accrued the minute the contract was entered into, (c) the mere postponement of the payment to different date can not extinguish the liability and render it notional or contingent, (d) what should be certain is the incurring of the liability and it being estimated with reasonable certainty even it the exact quantification is not feasible and (e) if the liability is discharged at a future date it will nevertheless be a liability which is certain and not contingent. The above decision has been approved Hon. Supreme Court (312 ITR 254). In conclusion the Hon'ble Bench stated that in order to find out if an expenditure is deductible the 6 R T Star Solitaires following have to be taken into account - (a) whether the system of accounting followed by the assessee is mercantile - which brings into debit the expenditure amount for which a legal liability has been incurred before it is actually disbursed and brings into credit what is due immediately it becomes due and before it is actually received; (b) whether the same system is followed by the assessee from the very beginning; (c) whether the assessee has given the same treatment to losses claimed to have accrued and to the gains that may accrue; (d) whether the assessee has been consistent and definite in making entries in the account books in respect of losses and gains; (e) whether the method adopted by the assessee for making entries in the books both in respect of losses and gains is as per nationally accepted accounting standards and (f) whether the system adopted is fair and reasonable or is adopted only with a view to reducing the incidence of taxation. In the case of DCIT Vs. Bank of Baharain and Kuwait ( ITA 4404 & 1883/mum/2004, the Special Bench had occasion to consider the allowability of MTM loss and held that MTM loss in respect of forward foreign exchange is allowable. While allowing the same the Hon 'ble members have observed as under - a) A binding obligation accrued against the assessee the minute it entered into a forward contract; b) A consistent method of accounting followed by the assessee cannot be disregarded only on the ground that a better method could be adopted; c) The assessee has consistently followed the same method of accounting in regard to recognition of profit or loss both, in respect of forward foreign exchange contract as per rate prevailing on 31 March; d) A liability is to have crystallized when a pending obligation on the balance sheet date is determinable with a reasonable certainty. The consideration for accounting the income are entirely on different footing; e) As per AS-11, when the transaction is not settled in the same accounting period as that in which it occurred, the exchange difference arises over more than one accounting period; 7 R T Star Solitaires f) A binding obligation accrued against the assessee the minute it entered into a forward contract; g) The forward contracts have all the trappings of stock-in- trade; h) In ultimate analysis, there is no revenue effect and it is only the timing of the taxation of loss/profit. xii)In the case of ONGC Vs. CIT 322 ITR 180 the Hon'ble Supreme Court has reiterated the principles laid down above while answering the question in favour of the assessee. xiii) Further, the liabilities in foreign exchange were incurred during the normal course of business and the restatement of the forward contract obligation was done as per AS- 11 in a consistent manner over the years. In fact, when the gain earned on such revaluation was accepted and brought to tax in the respective years and there is no reason to arrive at a different conclusion merely because there is loss during the year. xiv)It is not out of place to mention that the Hon'ble Supreme Court, in the case of ONGC cited above, upheld the same principles that were laid down in the case of Woodward Governor, and the loss was held as allowable in similar circumstances particularly when the business of ONGC is not that of a foreign exchange dealer. What matters is whether the forward contract transaction was entered during the course of regular business and it is not a tainted transaction with a color of speculative transaction. xv) The issue of allowing the loss on account of revaluation of pending forward contracts was considered by the Hon'ble FIAT Mumbai bench in the case of M/s. Bhavani Gems vs. ACIT (ITA No. 2855/Mum/2010 dated 30-03-2011 for A Y 2006-07)”

3.4. The submissions made by the assessee were considered by the Ld. CIT(A) extensively, and the loss claimed by the assessee was allowed by him along with detailed findings. Relevant part of his observations is reproduced hereunder for ready reference: “3.2. I have carefully considered the findings of the A.O in the assessment order as well as the 8 R T Star Solitaires submissions of the appellant. It is an undisputed fact that the assessee is following the mercantile system of accounting and the loss in question has been worked out by the appellant on the basis of foreign exchange fluctuations in respect of the forward contracts in respect of unrealized export proceeds. Further, the assessee is following the same principle continuously where such gain or loss are offered either for taxation if there is some gain and declared as loss if fluctuation in rate is adverse to the assessee. Therefore, from these facts in the light of the case laws relied upon by the appellant it is clear that the loss in question is an ascertained liability existing as on 31.03.2009. In mercantile system of accounting for getting a clear picture of profit/loss, the appellant has correctly worked out the loss on foreign exchange fluctuations with reference to the forward contract which cannot be disallowed by holding it as a mere notional loss. Accordingly, the disallowance of the loss made by the A.O does not appear justified. Hence, the same is directed to be deleted.” 3.5. We have gone through the submission of the assessee and findings recorded by the Ld. CIT(A). We have also gone through the judgments relied upon by the Ld. Counsel before Ld. CIT(A). It is noted that Hon’ble Supreme Court has already dealt with this issue extensive in its judgment in the case of Woodward Governor, (supra). Further, the issues involved in this case were also addressed by Hon’ble Supreme Court in another judgment in the case of ONGC Ltd. v. CIT (supra). It is further noted by us that the identical issue with regard to allowability of Mark-to-Market loss (MTM loss) in respect of forward foreign exchange has been decided in favour of the assessee by Hon’ble Special Bench of the Tribunal in the case of DCIT vs. Bank of Baharain and Kuwait, (supra). During the course of hearing before us, no distinction could be made out 9 R T Star Solitaires by the Ld. DR in facts or in the position of law. No contrary judgment has been brought to our notice. Nothing wrong could be pointed in the findings recorded by the Ld. CIT(A). It is further noted by us on the basis of facts brought before us that the assessee has been following same principle and method of accounting consistently. It was stated by Ld Counsel, which remained un-rebutted from other side, that in past foreign exchange gains and losses, both, were offered in the return. In case gain was earned, then, the same was offered as part of income and taxed by the AO accordingly. Under these circumstances, if loss is incurred then the same should also be allowed and revenue cannot be permitted to follow double standards in this manner. Thus, we find that loss has been rightly allowed by the Ld. CIT(A). Thus, no interference is called for in the order of Ld. CIT(A) and the same is hereby upheld.