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Income Tax Appellate Tribunal, KOLKATA BENCH ‘C’, KOLKATA
Before: Shri N.V.Vasudevan, J.M. &Dr.A.L.Saini, A.M.)
ORDER Per Dr. A.L.Saini, A.M.: The captioned appeal filed by the assessee and the Cross appeal filed by the Revenue pertaining to assessment year 2008-09, are directed against the order passed by the Commissioner of Income-Tax (Appeals)-VI, Kolkata in appeal No.33/CIT(A)-VI/Cir-6/11-12/Kol, dated 21.12.2012, which in turn arises out of an order passed by the ld. Assessing Officer under section 143(3) of the Income Tax Act, 1961 (in short, ‘the Act’) dated 28th December, 2010.
& 578/Kol/2013 M/s. Nagreeka Exports Ltd.
The facts of the case are stated in brief. The assessee is a company incorporated under the Companies Act, 1956 and engaged, inter alia, in the manufacturing of yearn/ textile products. The assessee filed return of income on 1st October, 2008 declaring a total income of Rs.7,00,42,650/- and it was duly processed under section 143(1). Thereafter, the case was selected for scrutiny and notices were issued under sections 143(2)/ 142(1) of the Act, and Assessing Officer framed the assessment U/s 143(3).
Since the appeal filed by the assessee and cross appeal filed by the Revenue relate to the same assessee and involve common issues, therefore, these have been clubbed and heard together and a consolidated order is being passed for the sake of convenience and brevity.
First, we deal with the assessee’s appeal in which contains three grounds of appeal. The appeal filed by the Revenue in appeal ITA No.578/Kol/2013 wherein the Revenue has raised one ground of appeal which is identical and similar to ground No. 3 of asessee`s appeal therefore, the same will be merged with assessee`s appeal and adjudicated together. The assessee is assailing the decision of the Ld.CIT(A) in confirming the following additions which were made by the Assessing Officer: (1). That in the facts and circumstances of the case the Learned Commissioner of Income Tax (Appeals)-VI/Kol was not justified in upholding that A.O's action in treating the mark to market loss on account of Forex Derivatives amounting to Rs.1,58,94,821/-as notional loss and treating the same as unascertained liability. While upholding the action of the Assessing Officer the Learned CIT(A)-VI ignored the case laws relied upon by the Appellant.
(2). That in the facts and circumstances of the case the Learned Commissioner of Income Tax (Appeals)-VI/Kol was not justified in & 578/Kol/2013 M/s. Nagreeka Exports Ltd. upholding that A.O's action in treating the replacement cost of combers and ring frames of Rs.4,52,50,588/- as capital expenditure which was claimed by the Appellant Company as revenue expenditure under section 37(1).
(3). That in the facts and circumstances of the case the Learned Commissioner of Income Tax (Appeals)-VI/Kol was not justified in calculating the amount of disallowance under section 14A read with Rule 8D at Rs.2,83,604/-.
Ground No.1.Forex Derivatives amounting to Rs.1,58,94,821/- treating the same as unascertained liability and notional loss. As per Notes to accounts No. 14(b) (Schedule “O”), the company has charged an amount of Rs.1,58,94,821/- to the Profit & Loss a/c. in respect of derivative contracts outstanding as on 31st March, 2008. The Ld. AO did the addition of Rs. 1,58,94,821/- holding that mark to market loss on account of forex derivative is a notional loss, the date of settlement of the forex derivative falls beyond 31/03/2008 and the contract was not matured as on 31/03/2008. The Learned Assessing Officer completely ignored the submissions made before him by the assessee and disallowed the loss alleging it to be notional loss on unexpired contract. Aggrieved from the order of the Assessing Officer, the assessee filed an appeal before the Ld. CIT (A) –VI, Kolkata, who has confirmed the action of the Ld. Assessing Officer. Not being satisfied with the order of the Ld. CIT(A), the assessee is in further appeal before us.
The Ld. A.R. for the assessee has submitted that as per Accounting Standard-11 “The Effects of Changes in Foreign Exchange Rates” the company is under mandate to account gain or loss of forward contract. Accounting Standard - 30 “Financial Instruments” deals with various derivative products. Normally, a company which is engaged in the import and export of goods takes a forward
ITA Nos.455 & 578/Kol/2013 M/s. Nagreeka Exports Ltd. contract to lock the prices against fluctuation of foreign exchange rates. The company may also enter into an option or cross currency swap to protect the risk of fluctuations in the interest rate and foreign exchange rates in respect of an underlying asset, and liability. In the instant case the company has entered into these forex derivative contracts to hedge the risk of interest in respect of Rupee Loan, therefore the underlying liability in the instant case is Rupee Loan. The Ld. AR for the revenue has relied on the decision of Hon`ble ITAT Kolkata Bench `B` in wherein the similar identical issues were adjudicated, vide para 25 and 26 of the said decision which are reproduced below:
“25. Applying the above observations to the facts and circumstances of present case, we find that the claimed loss under consideration occurred to the assessee on account of five unexpired forex forward contracts i.e a loss incurred on account of revaluation on contract on last day of accounting period before date of maturity of forward contract. The Ld. CIT-A observed that the assessee has been following a consistent accounting policy for determining loss under AS-11 and AS-30 as required under Companies Act and it is to be noted that the accounting standards were issued by the ICAI which has received judicial recognition. Accordingly, the assessee, the gain or loss on revaluation of the outstanding contracts was booked in the P.& L, a/c as per the mandatory requirements of RBI guidelines. The Hon`ble Supreme Court in the case of Woodward Governor India (P) Ltd. (supra) has observed at P.265 para 17 that the Central Government has made AS-11 mandatory. During the course of first appellate procedings that the CIT-A noticed that the AO allowed the loss of Rs. 85,70,425/- for 2010-11 which supports to show that the assessee has been following consistently accounting standards and the liability has been accrued for a pending obligation for every year i.e. the difference was arising for more than one accounting period.
We, accordingly, hold that disallowance made by AO treating the impugned amount of Rs. 54,23,955/- for A.Y. 2009-10 as contingent and notional loss is not justified and that the loss incurred to the assessee on account of five unexpired forex forward contracts on the last date of accounting period i.e. before the date of maturity of the forward contract is & 578/Kol/2013 M/s. Nagreeka Exports Ltd. not contingent and it is a actual loss, is allowable. Thus, respectfully, following the observations made by the Special Bench supra, the ground no- 2 raised by the appellant Revenue fails and the order of CIT-A is justified, consequently ground no-2 is dismissed.”
5.1 The Ld. AR for the assessee has vehemently submitted that the above cited decision of Hon`ble ITAT ,Kolkata is identical to the facts of the assessee under consideration. The treatment followed by the assessee company is in line with the matching concept of expenditure and liability since as at the close of the accounting year there was a liability which cannot be ignored or else the financial statements would not reflect a true and fair view of the assets and liabilities and corresponding profit for the year. In addition to this, the Ld. AR has also placed reliance on the following judgments:
1. 1. In the case of - Bank of Bahrain & Kuwait (J 32 TTJ 505) (Mumbai ITAT SB) wherein it has been held that Loss on account of valuation of forward contracts on the last day of accounting period is an allowable business loss.
2. Woodward Governor India (P) Ltd. (2009) 312 ITR 254 (SC).
5.2 The Ld. AR for the assessee stated that in view of detailed submissions made and case law cited above, it is clear that the business loss of Rs..1,58,94,8211- on account of Mark to Market of Unexpired Forex Derivatives Contracts is allowable and prayed that addition made on this account may be deleted.
On the other hand, the ld. Departmental Representative for the Revenue has primarily reiterated the stand taken by the Ld. AO and the Ld. CIT(A) and cited before us the CBDT Circular No.3/2010 dated 23rd March, 2010, wherein the & 578/Kol/2013 M/s. Nagreeka Exports Ltd. CBDT has instructed to the department that mark to market losses which are in the nature of speculation should not be allowed as a business expenditure. Ld. DR stated that it is a notional loss which will be actually deductible from the income of the assessee on the maturity of the contract. The issue under consideration is in respect of unsettled contracts and moreover there is no any underlying assets and liability to hedge the risk. He further submitted that loss arising from mark to market position of financial instruments is different and cannot be considered allowable as deduction as such loss has not arisen so far in the normal course of business operation of the assessee. The exchange rates are still liable to fluctuate of the market in future, therefore, it is kind of a speculative transaction which settles otherwise than by the actual delivery within the meaning of sub-section 5 of Section 43 of the Income Tax Act, 1961. The Ld. DR also relied on the following judgments. 1). ACIT-vs- K. Mohan & Company Private Ltd., Bangalore ITAT 126 ITD 59 2) D. Kishore Commercial & Company, Mumbai ITAT, 2 SOT 769 3) S. Vinod Kumar –vs- ACIT, Mumbai ITAT in ITA No.506/Mum/13 All the Judgments cited above speak about the speculative transactions which do not have any underlying assets and liabilities to hedge and these transactions settle in future without actual delivery of goods.
Having heard the rival submissions, we are of the view that there is merit in the submissions of the Ld. AR for the assessee, since the proposition canvassed by Ld AR is supported by Hon`ble ITAT-Kolkata, cited supra. There is an underlying liability ( Loan) to hedge the risk and hence the derivative contract under consideration is for the purpose of business and not for the purpose to speculate the & 578/Kol/2013 M/s. Nagreeka Exports Ltd. transaction without and underlying assets and liabilities. In the instant case there is an underlying liability and purpose of this derivative contract is to minimise the business risk by way of hedging therefore it is not a speculative transaction as Ld. DR has pointed out (supra), hence we direct the Ld. CIT (A) to delete the addition.
In the result, the appeal filed by the assessee is allowed.
Ground No. 2 Replacement cost of combers and ring frames of Rs.4,52,50,588/- The issue contested by the assessee in the second ground of appeal relates to revenue expenditure of Rs. 4,52,50,588/- incurred by the assessee to replace combers and ring frames in the manufacturing department. In the audited accounts of the assessee, the replacement expenditure for combers and ring frames has been treated as capital expenditure. But in the computation of total income for income tax purpose the assessee has reduced the replacement cost of 4,52,50,588/- [5,32,06,580-79,55,992] for ring frames and combers from business income. That is, for the purpose of income tax, the assessee has charged the entire cost of replacement to profit and loss account ( Revenue expenditure), holding that each machine is an integral part of the spinning mill, and the same is objected by the Assessing Officer. The Assessing Officer held that each machine including the ring frame was an independent and separate machine capable of independent and specific function and therefore, the expenditure incurred for replacement of the new machine would not come within the meaning of the works `current repairs`. He has also relied upon two decisions of the Hon`ble Supreme Court in the case of M/s Saravana Spinning Mills Pvt. Ltd. [2007] 293 ITR 201 and M/s Sri mangayarkarasi Mills (P) Ltd [2009] 315 ITR 114 (SC) which support the view of the Assessing Officer. The Assessing Officer also noted that on the similar set of facts, the Hon`ble ITAT has upheld the action of the assessing officer in treating 7 & 578/Kol/2013 M/s. Nagreeka Exports Ltd. the expenditure incurred by the assessee as a capital in the assessment year 2005- 06 in the assessee`s own case, and the CIT (A) has also upheld the action of the Assessing Officer in treating the expenditure incurred by the assessee as a capital in the assessment year 2006-07 in the assessee`s own case. Aggrieved form the order of the Assessing Officer, the assessee filed an appeal before Ld. CIT (A)-VI, Kolkata, who has confirmed the action of the Assessing Officer. Not being satisfied from the order of the CIT(A), the assessee is in further appeal before us.
Before us, the Ld. AR for the assessee has submitted that the entire operation in the textile and spinning mills right from the blow room to the cone winding section of the mill is to be considered a single plant and the output from the various intermediate stages of production could not be sold or marketed and used for other purposes. Therefore, the Ring Frames cannot be worked independently but only as a part of the spinning unit. There is no new assets created in the process of replacement of worn out machines.
On the other hand, the Ld. DR for the revenue has submitted that each machine including the ring frame was an independent and separate machine capable of independent and specific function and therefore, the expenditure incurred for replacement of the new machine would not come within the meaning of the works `current repairs`. He has reiterated the stand taken by the Assessing Officer and relied upon two decisions of the Hon`ble Supreme Court in the case of M/s Saravana Spinning Mills Pvt. Ltd. [2007] 293 ITR 201 and M/s Sri mangayarkarasi Mills (P) Ltd [2009] 315 ITR 114 (SC). He also pointed out that on the similar set of facts, the Hon`ble ITAT has upheld the action of the assessing officer in treating the expenditure incurred by the assessee as a capital in the 8 & 578/Kol/2013 M/s. Nagreeka Exports Ltd. assessment year 2005-06 in the assessee`s own case, and the CIT (A) has also upheld the action of the Assessing Officer in treating the expenditure incurred by the assessee as a capital expenditure in the assessment year 2006-07 in the assessee`s own case.
Having heard the rival submissions, we are of the view that there is merit in the submissions of the Ld. DR for Revenue, since the proposition canvassed by Ld. DR, is supported by the two decisions of the Hon`ble Supreme Court referred above. Moreover,on the similar set of facts, the Hon`ble ITAT has upheld the action of the assessing officer in treating the expenditure incurred by the assessee as a capital expenditure in the assessment year 2005-06 in the assessee`s own case. Under these set of facts, we do not find any reason to interfere with the order passed by the LD.CIT (A).
In the result, the appeal filed by the assessee is dismissed.
Ground No. 3 of assessee`s appeal: Disallowance under section 14A read with Rule 8D at Rs.2,83,604/- Ground No. 1 of Revenue`s appeal in “On the facts and circumstances of the case and in law,when the Ld. CIT (A) has upheld the applicability of computation of the disallowance U/s 14A to be worked out as per the prescribed procedure U/s 8D, however, the Ld. CIT(A) grossly erred in giving leeway while considering the balance of investment, income from which does not or shall not form part of the total income, as on the last day of the previous year, when there is no such provision or relaxation U/s 8D (ii) & (iii).”
Assessing Officer disallowed Rs.30,00,514/- under section 14A of the I.T. Act,read with Rule 8D. The Assessee has suo-moto disallowed U/s 14A of the Act & 578/Kol/2013 M/s. Nagreeka Exports Ltd. at Rs. 1,80,880/- as STT paid on the investment. The assessee has earned dividend of Rs. 57500/- only.The assessee has opening balance of investment of Rs. 25,57,753/- and purchased share worth of Rs. 144,804,322/- on 26/03/2008. Aggrieved form the order of the Assessing Officer, the assessee filed an appeal before Ld. CIT (A)-VI, Kolkata, who has confirmed the action of the Assessing Officer. Not being satisfied from the order of the CIT(A), the assessee is in further appeal before us.
Before us, the Ld. AR for the assessee has submitted that Assessing officer has disallowed Rs.30,00,514/- arbitrarily without applying Rule 8D and without recording any satisfaction in the assessment order. The Ld. CIT (A) has deleted the addition of Rs. 30,00,514/- made by Assessing Officer but then worked out disallowance at Rs. 102,724/- by applying Rule 8D(2) (ii) and Rule 8D (2) (iii). The Revenue is in cross appeal against the deletion of Rs. 30,00,514/- and working out additional disallowance at Rs. 102,724/- In order to understand, how the Ld. CIT(A) has worked out the said additional disallowance, the relevant para Nos. 38, 39 and 40 of his order are reproduced below: “38. The appellant has submitted that by following the judgement of the Hon`ble ITAT, Kolkata in the case of Balarampur Chini Mills Ltd. Vs. DCIT (supra), the nexus between funds borrowed and investments made has to have a link or nexus for making disallowance. Therefore, the Rule 8D is applied only on the amount of Rs.25,57,753/- taking the opening value as the average investments due to the peculiar fact that a huge investment was done at the fag end of the year on 26-03-2008 only because of which the average value has increased to Rs. 7,47,,09,914/-. The Calculation of disallowance on the basis of Rs. 25,57,753/- taking the opening value as the average investments under Rule 8D (2) (ii) amounts to Rs. 89,936/- and under Rule 8D (2) (iii) amounts to Rs. 12,788/- thereby totaling to Rs. 1,02,724/- & 578/Kol/2013 M/s. Nagreeka Exports Ltd. 39.The appellant`s submissions that there is an increase in Reserves and Surplus,as compared to the immediately preceding previous year and Secured Term loans have reduced as compared to the immediately preceding previous year which signifies that no new investments were made out of secured borrowed funds. Further, that the working capital loans have increased as compared to immediately preceding previous year and this increase have been totally utilized for business purpose of the company since there is a corresponding increase in the net current assets as compared to immediately preceding previous year are not acceptable since it is a general observation and the funds for investments have been usedfrom common kitty. On the date of investment appellant had been paying interest on huge borrowings and there is no direct investment from any exclusive capital fund having any direct nexus of its origin and being invested as investments earning exempted income.Therefore, the appellant`s submission that its own capital fund free from interest has been invested is held to be devoid of merit.
Therefore, in the facts and circumstances as discussed and following the judgements of the Hon`ble Appellate Authorities including the Hon`ble jurisdictional High Court in the case of ISG Traders Ltd. Vs. CIT-III, Kolkata & Dhanuka & sons Vs. CIT ( Central)-1, the Hon`ble Special Bench of ITAT in the case of Cheminvest Ltd. V. Income Tax Officer, New Delhi and the Hon`ble ITAT Delhi Bench ‘H’ in the case of Technopak Advisors (P) Ltd V. Additional Commissioner of Income Tax, Range-16, New Delhi, the disallowance of Rs. 1,80,880/- as STT and Rs. 1,02,724/- totaling to Rs. 2,83,604/- as per Rule 6D read with section 14A is upheld. The ground of appeal is partly allowed.”
The above cited working of Ld CIT(A) as per section 14A , read with Rule 8D seems to be correct. He has rightly excluded the investment made by assessee on 26/03/2008 at Rs. 1,44,804,322 to compute the average amount because the investment was done by the assessee at the end of the accounting year. The Ld.CIT (A) worked out the disallowance as per Rule 8D (2) (ii) by taking opening balance of investment at Rs. 25,57,753/- therefore the total disallowance worked out by him was [ 25,57,753 x6,38,29029/1815274370] at Rs. 89,936/- whereas as per AO the disallowance was at Rs. 26,26,964/- And as per Rule 8D (2) (iii) the disallowance worked out by him was [ Rs.25,57,753 x 0.5] at Rs. 12788/- whereas as per AO the disallowance was at Rs.3,73,550/-. Thus, out of Rs.30,00,514/- the 11 & 578/Kol/2013 M/s. Nagreeka Exports Ltd. CIT(A) has deleted Rs.28,97,790 (3000514-102724) and retained the addition of Rs. 102724/-. The said working has been done by the Ld.CIT(A) as per the procedure laid down in section 14A read with Rule 8D, therefore we did not find any mistake in the disallowance made by Ld. CIT (A), hence we confirm the order of the Ld. CIT (A).
In the result, both the appeals filed by the assessee and revenue on this issue are dismissed.
Order Pronounced in the Open Court on 03-08-2016