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Income Tax Appellate Tribunal, MUMBAI BENCH “F”, MUMBAI
Before: SHRI G.S. PANNU & SHRI SANJAY GARG
Per Sanjay Garg, Judicial Member:
The present appeal has been preferred by the Revenue against the order dated 05.02.2013 of the Commissioner of Income Tax (Appeals) [hereinafter referred to as the CIT(A)] relevant to assessment year 2009-10.
The Revenue has taken the following grounds of appeal: “1. Whether on the facts and circumstances of the case, the Id. CIT(A) has erred in holding that ‘Mark to market’ loss of Rs.4,03,05,856/- arising on re-valuation of creditors outstanding on the closing date of accounting year is not a notional loss and, therefore, allowable.
2 Whether on the facts and circumstances of the case, the Id. CIT(A) has erred in deleting addition made on revaluation of closing stock of Rs.1,72,95,930/- without appreciating the fact that payment on account of foreign exchange ought to be added to the actual cost of purchase of diamonds and closing stock revalued accordingly,
3 Whether on the facts and circumstances of the case, the Ld. CIT(A) has erred in deleting addition on account of sale of wastage and scrap value of Rs.1,01,11,946/- without appreciating the fact that such scrap is valuable and used in various industries
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4 The appellant craves leave to amend or alter any ground or add a new ground which may be necessary.
The appellant prays that the order of the CIT (A) on the above grounds be set aside and that of the Assessing Officer be restored.”
Ground No.1 3. Ground No.1 is in relation to the claim of mark to market’ loss on account of revaluation of creditors at the end of the year due to foreign exchange fluctuation. The Assessing Officer (hereinafter referred to as the AO) in his assessment order noted that assessee has debited an amount of Rs.8,23,15,161/- to the Profit and Loss Account on account of foreign exchange loss and out of the said loss, an amount of Rs.4,03,05,856/- was incurred due to revaluation of creditors outstanding at the year-end towards the imports made during the year. The AO observed that such loss was incurred merely on revaluation of the creditors at the closing foreign exchange rate prevalent on 31-03-2009 and therefore, such loss was not actually incurred and it was contingent in nature. Accordingly, the AO disallowed the aforesaid loss being a notional loss. The AO also observed that the impugned loss was not allowable u/s. 43A of the Act also since the provisions of section 43A speak about allowance of expenditure on account of fluctuation in foreign exchange on actual payment basis for acquisition of an asset and not otherwise.
The Ld. CIT(A), however, deleted the additions made by the AO observing as under: “5. I have carefully considered the contents of the assessment order and the appellant’s submissions. At the outset, it is noted that appellant has incurred foreign exchange loss on account of imports I creditors and registered gain on account of exports I debtors, by revaluing the same at the year end. Further, the loss incurred on imports was on account of loss realized on actual payment and also the revaluation of creditors at the year - end rate, being the exchange difference. The AO has accepted the gain on revaluation of the debtors at the year - end as appellant's income and further allowed the loss incurred on actual payment of creditors. In this regard, I note that the effects of changes in foreign exchange rates are accounted in terms of AS-11 and the said accounting standard stipulates
ITA No.3735/M/2013 3 Vinodkumar Jain (HUF) that on each balance sheet date foreign currency monetary items should be reported using the closing rate. Secondly, I note that allowing of the loss arising on such revaluation as deduction u/s. 37(1) of the Act was examined in detail by the Hon’ble Supreme Court in the case of CIT Vs. Woodward Governer, 312 ITR 354 and was held that such loss suffered on account of exchange difference as on the Balance Sheet date is an item of expenditure u/s. 37(1) of the Act. In this back ground, I do not find any good reason on the part of the A.O. to accept the gain arising on revaluation of the debtors on one hand and to disallow the loss incurred on similar revaluation of the creditors on the other hand. Thus, the stand taken by the AO is self contradictory and against the principles of accounting. Thirdly, in my considered opinion, the reference taken to the provisions of section 43A by the AO in the instant case is irrelevant for the reason that section 43A contemplates re- computation of the cost of the assets for the purpose of (a) depreciation u/s 32(1) and section 43(1), (b) capital assets used in scientific research u/s 35(1) (iv) and (C) regarding patent rights or copy rights u/s 35A. Therefore, the stocks purchased by the appellant through imports being trading assets, provisions of section 43A do not apply to the present case. In view of the above discussion and further relying upon the decision of the Hon'ble Supreme Court in the case of Woodward Governer, I am of the considered opinion that the loss of Rs.4,03,05,856/- arising on revaluation of creditors at the year-end exchange rate is allowable u/s 37(1) of the Act and accordingly, I hereby delete the disallowance made by the AO Appellant succeeds on this issue.”
We have gone through the above findings given by the Ld. CIT(A). The Ld. CIT(A) has rightly relied upon the decision of the Hon'ble Supreme Court in the case of ‘CIT v. Woodward Governor India (P.) Ltd.’ (2009) 179 Taxman 326, wherein, while dealing with the question as to whether the additional liability arising on account of fluctuation in the rate of exchange can be allowed to be adjusted pending actual payment of the varied, the Hon'ble Supreme Court has observed that "expenditure" as used in section 37 in Income Tax Act may in the circumstances of a particular case cover an amount which is a "loss" even though said amount has not been given from the pocket of the assessee. Further the ld. CIT(A) has also rightly held that section 43A is not applicable to the trading assets. The issue is thus, squarely covered in favour of the assessee. Ground No.1 of the appeal of the Revenue is, therefore, dismissed.
Ground No.2 6. Vide ground No.2, the Revenue has contested the action of the Ld. CIT(A) in deleting the addition made on revaluation of closing stock
ITA No.3735/M/2013 4 Vinodkumar Jain (HUF) contending that the payment on account of foreign exchange ought to have been added to the actual cost of purchase of diamonds and the closing stock should have been revalued accordingly.
The brief facts of the case are that the AO noted that assessee has been valuing the inventory of closing stock at cost or net releasable value in accordance with AS-2. The AO also noted that the cost of the cut and polished diamonds was taken as per the exchange rate prevailing on the date of purchase of goods and the cost incurred by the assessee on account of exchange rate fluctuation at the time of actual payment was not added thereto. According to the AO, the payment made on account of foreign exchange fluctuation would go to add to the actual cost incurred by the assessee and therefore, it should also go to add to the value of the closing stock. Accordingly, the AO has made an addition of Rs.1,72,95,930/- towards under valuation of closing stock being amount paid on account of exchange rate fluctuation 8. The Ld. CIT(A), however, deleted the said disallowance made by the AO observing as under “As regards the addition made by the AO towards the undervaluation of the closing stock on account of not loading the foreign exchange fluctuation loss incurred on actual payment to the value of the closing stock, I note that at the outset, the loss on account of foreign exchange fluctuation is recognized in terms of AS-11. The said accounting standard clearly states that a foreign currency transaction should be recorded on initial recognition in the reporting currency by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. It further states that at each Balance Sheet date, foreign currency monetary items should be reported using the closing rate and non-monetary items which are carried in terms of historical cost denominated in a foreign currency should be reported using the exchange rate at the date of transaction. In other words, the revaluation of creditors or debtors or the loss incurred on the actual payment is not to be considered for the purpose of reporting the non-monetary items, like closing stock. Secondly, the foreign exchange loss incurred is not an item of cost, and rather it is a revenue outflow or an expenditure provided by prudence depending on the date of payment or the Balance Sheet date and therefore, it cannot be added to the cost of the inventory even under the AS-2. Even for a moment it is accepted that the increase in foreign
ITA No.3735/M/2013 5 Vinodkumar Jain (HUF) exchange rate would yield a higher value of the unsold stocks, still it would amount that it would go to add to the realizable value and not to the cost of the said stocks. Thus, considering the principle that as a matter of prudence stocks are valued at lower of the cost or the realizable value, such increase in realizable value has no bearing on the profits computed. Normally, the expenditure/loss incurred due to foreign exchange fluctuation on account of actual payments would be a parameter kept in mind for deciding the sale price of the stocks that a prudent businessman would like to recover the said expenditure/loss when the stocks are sold and would not increase the value of the closing stock and thereby increase the profits before actual realization of the same.” He therefore held that the foreign exchange fluctuation loss can not be added to the cost of inventories. Being aggrieved by the order of the Ld. CIT(A) the Revenue has come in appeal before us.
At the outset, the Ld. A.R. of the assessee, before us, has strongly relied upon the decision of the Bangalore Bench of the Tribunal in the case of “IBM Global Services India P. Ltd. vs. Deputy Commissioner of Income Tax” (2009) 316 ITR (AT) 364 (Bangalore) wherein the Tribunal, while adjudicating an identical issue and thereby relying upon the decision of the Tribunal in the case of “Yokogawa India Ltd.” order dated September 8, 2006 in ITA No.3443 & 3444/Bang/03, has held that at the time of purchase of the inventory, if the item has been purchased from a foreign country and the amount is payable in foreign exchange and if, the payment is deferred and the liability increases in Indian Rupees, then such liability cannot be termed to have increased the cost of the material. The cost price would be the original cost price and it cannot be increased due to subsequent foreign exchange fluctuation and increased liability on that account. The relevant part of the observation of the Tribunal for the sake of convenience is reproduced as under: “11. When an item is purchased then an appropriate entry is passed to show the item purchased in the stock and to credit the account of party from whom such purchase has been made. In case the payment is not made at the time of purchase then such payment is to be made subsequently. If subsequently interest is also paid then such interest cannot be considered as part of the cost. Cost means original cost to the assessee. It is an admitted fact that rate of interest on loans repayable in foreign currency is less as compared to the interest payable on foreign currency converted into rupees. The difference in foreign exchange fluctuation at the time of
ITA No.3735/M/2013 6 Vinodkumar Jain (HUF) receipt and at the time of repayment of the loan partly benefits the lender for the loss of interest in respect of rate. At the time of purchase of the inventory, if the item has been purchased from a foreign country then the amount is payable in foreign exchange. If the payment is deferred and the liability increases in Indian rupees then such liability can not to be termed to have increased the cost of the material. The learned Madras High Court in the case of Asher Textiles Ltd. v. C1T had an occasion to consider the meaning of the cost price. The learned High Court held that the cost price means the original cost price. In this case, the cost price for a particular item was Rs. 500 and market price at the end of the year was Rs. 300. The stock was valued at the end of the year at Rs. 300 as market price was low. In the subsequent year, the market price at the end of the year was Rs. 400. The assessee argued that the cost price at the end of the year was Rs. 300. The assessee argued that cost price of the item in the opening stock was Rs. 300 and therefore the same should be adopted as cost price in the subsequent year for valuation. This contention was rejected by the learned Madras High Court. It was submitted that one has to see the original cost price. The original cost price is Rs. 500 and at the end of the subsequent year, the market price was Rs. 400. The assessee was allowed to value at original cost or market value, whichever is less. When the assessee has purchased stock, the original cost price is to be seen. Subsequent effect in the increase in the liability of the assessee will not affect the original cost price of the inventory.
The learned Authorised Representative during the course of proceedings has pointed out that the assessee is consistently following the system of accounting vide which the foreign exchange fluctuations are not added to the cost. The amount has not been included in the value of the opening stock. Different methods cannot be employed to value the opening and closing stock. The method consistently followed cannot be disturbed if the method followed is one of the accepted methods of accounting. The learned Delhi High Court in the case of CIT v. Neo Poly Pack (P) Ltd. has held that consistency is to be maintained. The jurisdictional High Court in the case of CIT v. Sridev Enterprises observed as under:
‘Consistency and definiteness of approach by the Revenue is necessary in the matter of recognizing the nature of an account maintained by the assessee so that the basis of a concluded assessment would not be governed without actually reopening the assessment.’
Keeping in view the above discussions it. is held that foreign exchange fluctuation after the date of purchase will not affect the valuation of the stock, considering the consistent method followed by the assessee. Hence the additions made on this account are deleted.”
Keeping in view the decision of this Bench on this issue, it is held that the learned Commissioner of Income-tax (Appeals) was not justified in not allowing the loss of Rs.8,63,047.”
The Ld. A.R. has brought our attention to the decision of the Hon’ble Karnataka High Court in the case styled as “CIT & another vs. IBM Global
ITA No.3735/M/2013 7 Vinodkumar Jain (HUF) Services India P. Ltd.” (2014) 366 ITR 293 (Karn) and stated that the above findings of the Tribunal (supra) have been affirmed by the Hon’ble Karnataka High Court. Respectively relying upon the above decision of the Hon’ble Karnataka High Court, this issue is accordingly decided in favour of the assessee.
Ground No.3 11. The AO, noted that assessee had reported 34% yield of finished goods on cutting and polishing of rough diamonds. That in the this process of cutting and polishing diamonds, certain wastage/scrap arises which is highly valuable and is normally used in making watches, gold rings / bangles and other jewellery. The AO observed that the assessee has not offered any income to tax on such scrap/wastage generated in the manufacturing process and accordingly, estimated the income thereof being 5% of the purchase value of rough diamonds, resulting in an addition of Rs.1,01,11,946/-. Being aggrieved by the order of the AO, the assessee preferred appeal before the Ld. CIT(A). The Ld. CIT(A), however, deleted the said addition observing as under: “5.4 As regards the estimated addition made towards the sale of scrap, I note that there is no material brought on record by the AO to show that appellant was in possession of any such scrap / wastage and has received monies on sale of the same. It is pertinent to note that no evidence whatsoever was found in this direction at the time of survey u/s. 133A of the Act conducted at the appellant's premises during the financial year relevant to the assessment year under consideration. Further, the AO has not made any enquiry whatsoever with any of the karigars / labour contractors in this direction. Secondly, it is an accepted judicial position that the onus lies on the Revenue for bringing an item of income to tax, and in the present circumstances, I am of the considered opinion that such onus is not discharged by the AO. It is further noted that the yield of 34.6% is not only comparable to the earlier years’ results of the appellant but also comparable to the average yield re porte d in the diamond industry. It is also noted that the assessments for the earlier years were completed u/s. 143(3) of the Act and no finding was given as to generation of any scrap/wastage and no such income was brought to tax. At any rate, even if such income exists, there is no rationale for considering the same at 5% of the purchase value as done by the AO. It is also noted that there is no quarrel as to the final outcome of the survey proceedings and the AO himself acknowledged
ITA No.3735/M/2013 8 Vinodkumar Jain (HUF) that the disclosure made by the appellant of Rs.1.3 crores at the time of survey was duly offered to tax in the return of income filed. In such circumstances, I do not find any valid reason brought on record to assess the impugned income of Rs.1,01,11,946/- on an estimate basis. Accordingly, I delete the addition made by the A.O. Appellant succeeds on this ground also.”
Being aggrieved by the order of the Ld. CIT(A), the Revenue has come in appeal before us.
From the respective contentions of the Ld. Representatives of both the parties, it appears that the additions in relating to the above issue have been made by the AO on estimation basis. The AO was of the view that the assessee might have sold the wastage/scrap that had remained after manufacturing of cut and polished diamonds. The Ld. CIT(A), however, deleted the addition that there was no evidence that the assessee has ever sold such a scrap and that even no such evidence was found in this respect during survey action carried out under section 133A of the Act at the premises of the assessee. He, therefore, held that there was no justification on the part of the AO to estimate such an addition.
The Ld. D.R., before us, has stated that in case of diamonds, the normal yield is only 35% of the original product and 65% goes towards wastage. He has further stated that the wastage of diamonds cannot be ignored as that the item is very precious and even the wastage gets used in jewellery and for other purposes. Value of the wastage under such circumstances cannot be taken as nil. The said wastage might have yielded some income to the assessee.
On the other hand, the Ld. A.R. of the assessee has stated that the assessee itself does not carry out manufacturing process. Assessee is a diamond trader. That for the cut and polish works of the diamond, the work contract is given to the labour contractor in this respect and that whatever is the scrap out of the product that is left with the labour contractor only. The prices of the labour are so fixed that it takes care of the value of the scrap left with the labour contractor.
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After hearing both the Ld. Representatives of the parties on this issue, we find that the AO has made addition on certain assumptions that the scrap/wastage of the rough diamond must have fetched to the assessee an income. However, there is no evidence brought by him in this respect. He has just estimated the income at the rate of 5% of the purchase value of the rough diamonds. The Ld. CIT(A), however, has deleted the addition observing that there was no evidence of sale of scrap by the assessee. However, the Ld. CIT(A) has not given any finding as to what is done with the scrap and whether it has a nil value or it fetches some value to the assessee. The contention of the Ld. A.R., before us, is that the value of the scrap is taken into consideration while settling the rates with the labour contractor. We find that these facts have not been thoroughly examined by the lower authorities. We accordingly restore this issue to the file of the AO to decide it afresh after considering the evidences and explanations that may be furnished by the assessee in this respect.
In view of our above observations, the appeal of the Revenue is treated as partly allowed for statistical purposes.
Order pronounced in the open court on 29.06.2016.
Sd/- Sd/- (G.S. Pannu) (Sanjay Garg) ACCOUNTANT MEMBER JUDICIAL MEMBER Mumbai, Dated: 29 06.2016. * Kishore, Sr. P.S. Copy to: The Appellant The Respondent The CIT, Concerned, Mumbai The CIT (A) Concerned, Mumbai The DR Concerned Bench //True Copy// [ By Order
ITA No.3735/M/2013 10 Vinodkumar Jain (HUF)
Dy/Asstt. Registrar, ITAT, Mumbai.