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Income Tax Appellate Tribunal, MUMBAI BENCH “C”, MUMBAI
Before: SHRI G.S.PANNU & SHRI PAWAN SINGH
O R D E R
PER PAWAN SINGH, JM:
The present appeal is filed by the assessee against the order of CIT(A)-9, Mumbai dated 24.09.2012 in respect of Assessment Year (AY) 2009-10. In the appeal the assessee has filed the appeal raising four grounds of appeal
, however, in our opinion only two basic issues are raised in the present appeal. (i) Upholding the addition of Rs. 29,05,000/- in respect of cancellation of forward contracts holding speculative in nature and not allowable as per the provisions of Sec. 43(5) of the Act. (ii) Upholding the addition of Rs. 3,20,000/- u/s. 40A(2)(b) on average basis.
2. The brief facts of the case are that the assessee who is engaged in the business of importing, manufacturing & exporting of diamonds, filed its return of income for AY- 2009-10 on 18.09.2009 declaring total income at Rs. 2,22,52,010/-. The case was selected for scrutiny and after serving the statutory notice, the Assessing Officer (AO) made the certain addition/disallowance including of disallowance u/s. 40A(2)(b) of Rs. 3,20,000/- and further disallowed a sum of Rs. 29,05,500/- as mark to market loss in the assessment order dated 26.12.2011 against which the appeal was filed before the CIT(A). The Ld. CIT(A) while dealing with the appeal of the assessee confirmed both the additions in its order dated 24.09.2012 against which the present appeal is filed before us.
We have heard Ld. Authorised Representative (AR) of the assessee and Ld. Departmental Representative (DR) for the Revenue and perused the material available on record.
The first ground for our consideration is Upholding the addition of Rs. 29,05,000/- in respect of cancellation of forward contracts holding speculative in nature and not allowable as per the provisions of Sec. 43(5) of the Act.
The AO while disallowing mark to market loss by observing the same as notional in nature and concluded that mark to market loss in case of derivatives, it had to be considered that these losses have not been accrued but are being reported merely that the same is required due to the accounting code to be followed apparently these loss are notional in nature and there is always possibility, there may be loss in balance-sheet but subsequently when the derivatives expired it may yield a gain and liability loss may ultimately seized to exist and further while referring the Circular/Instruction No. 3/2010 from CBDT and concluded that mark to market loss is in substance of mythology of seizing value to position held in a financial instrument basis on its market price on the closing day of the accounting or reporting record. The loss is a notional loss as no sale/settlement of contract has taken place and the asset continues to be owned by the company and thus a loss on account of mark to market loss is merely a notional and same was disallowed.
The CIT(A) while considering the disallowance has observed that the details available before him indicates that assessee has entered into several forward contract, which were cancelled during the year. The forward contract is an agreement between the buyer and seller and seller wholly debit the seller to deliver the specified asset of specified quality and quantity to the buyer on a specified date and place and the buyer is obliged to pay the seller a pre-negotiated price in exchange of delivery. The assessee is engaged in the business of manufacturing and exporting of diamond, who entered into forward contract in respect of foreign exchange receivable at the result of export. This was done to avoid the risk of loss due to foreign exchange fluctuation. The assessee at the time of contract for export took into consideration its cost in rupee and this considered the spot price of the rupee. Against the foreign exchange and when the actual export was made, the spot price may be different as against the rate without on the date on which assessee expected to export order. On the date of receipt of foreign exchange, if spot price of Rs. Against the foreign exchange increased the assessee would certainly be benefited and given an example that if assessee indicate to receipt the export order, if the value of 1 USD is INR 45 and when actual export is made the value of 1 USD may different and in case on the receipt of foreign exchange, the rate of 1 USD is INR 50, the assessee would be benefited by the INR 5 per USD and concluded that as per the provision of section 43(5) certain category of transaction which cannot be treated as speculative transaction. Exclusion is of transaction in respect of contract actual delivery of goods manufactured or merchandise sold by him and in case of assessee in respect of foreign exchange which is not goods manufacture by assessee, hence it cannot be said that transaction of settlement of foreign exchange contract settled without actual delivery can be considered to be covered u/s. 43(5) of the Act.
The AR of the assessee has argued that the assessee has entered into forward contract for US $8,00,000/- and were pending maturity at the end of the year in respect of contract and assessee had recognized the loss of Rs.29,05,000/- by revaluing the same @ prevalent at the year ended which was done consistently from year to year basis in accordance with requirement of Accounting Standard- 11(AS-11), as at the end of year the assessee has outstanding export receivable in foreign currency of USD 40,43,463/- which is equivalent to Rs. 9.40 Crore which was restated as closing rate and notional gain of Rs. 1,11,67,890/- was recognized as income. As against these underline export receivable, the assessee had outstanding forward contract of USD 8,00,000/- which was disallowed by AO on the ground that it was notional and contingent which was misunderstood by the CIT(A) by considering this loss on account of cancellation of forward contract.
The DR of the revenue has supported the finding of authorities below.
Ld. AR of the assessee has relied upon the case of M/s Inter Jewel Pvt. Ltd. decided by the co-ordinate bench of this Tribunal (ITA No. 7013/Mum/2012) dt. 13.02.2015 & M/s Osia Diamonds (ITA No. 2163/Mum/2013 dated 31.07.2015, wherein the identical grounds were raised as under: 6.Ground No.2 relates to the confirmation of the addition made at Rs. 2,59,623/- being mark to market losses treating it as only notional and contingent. 7.While scrutinizing the return of income, the Ao noticed that there are 65 unmatured export forward contracts as on 31.03.2008, out of which only 17 contracts show gain on account of M to M computation. All other contracts show loss. The net result comes to Rs. 2,59,623/-. The assessee was asked to explain its stand. It was explained that following the Accounting Standard AS-11, the assessee has recognized net gain in respect to mark to market treatment and loss is at the end of the year and is an allowable loss in the light of the decision in the case of Woodward Governor India Pvt. Ltd. 294 ITR 451 294 ITR (Del.) Reliance was further placed on the decision of Special Bench of the Mumbai Tribunal in the case of bank of Bahrain & Kuwait in ITA No. 4404 & 1883/Mum/04. It was further explained that the assessee has earned net gain on account of mark to market treatment at Rs. 3,04,35,109/-, which has been shown separately. The net gain comes to Rs. 3,01,75,486/-. In effect the assessee has shown substantial gain from the mark to market treatment. The explanation of the assessee was dismissed by the AO., who was of the firm belief that the loss or gain is only notional and contingent. Drawing support from the CBDT Instruction No.3 of 2010 the AO disallowed Rs. 2,59,623/-. The assessee carried the matter before Ld. CIT(A), but without any success. 8.Before us, the Ld. Counsel for the assessee reiterated what has been stated before lower authorities. Ld. Counsel for the assessee pointed out that the Revenue Authorities have proceeded on a mistaken before the assessee has cancelled the forward contracts and, therefore, the contracts me speculative in nature, whereas the loss is on account of restatement of outstanding forward contract at the end of the year. Ld. Counsel for the assessee relied upon the decision of Woodward Governor India Pvt. Ltd. 312 ITR 254 (Se) and the Mumbai Tribunal 's Special Bench decision in the case of Bank of Bahrain & Kuwait,5 ITR (Ttib.) 301. Ld. counsel also relied upon number of decisions of the Tribunal which have followed the decision of the Hon'ble Supreme Court and Special Bench of the Tribunal. 9, Per contra, Ld OR strongly supported the findings of the Revenue Authorities 10. We have carefully perused the order of Ld. CIT(A) and the decisions brought to our notice. In our considered opinion and the undertaking of the facts we find that the Revenue Authorities have proceeded on a wrong assumption of facts. We find that the decision of the Tribunal’s Special Bench in the case of bank of Bahrain & Kuwait (supra) squarely apply on the facts of the case and also by the various judicial pronouncements like Kumbh Gems in H. Dipak & Co. in ITA No. 7659/Mum/2011, Bhavani Gems in ITA No. 2855/Mum/2010 and M/s. Sutariya Gems Pvt. Ltd. in 3361/Mum/2011. Therefore, we have no hesitation in setting aside the order of Ld. CIT(A) and in directing the AO to delete the addition of Rs. 2,59,623/-. Ground No.2 is allowed.
We have given the careful consideration to the observation made by the AO as well as CIT (A), while confirming the disallowance on account of marked to market loss, we found that lower authority has made their opinion on the basis of presumptions and the co-ordinate bench of this Tribunal has redressed the similar issue in M/s Inter Jewel Pvt. Ltd. and the same squarely covers this ground so, following the principle of consistency, we accept the appeal of the assessee and allow this ground.
Next issue for our consideration is addition of Rs. 3,20,000/- u/s. 40A(2)(b), the AO while dealing with the addition has observed that during the year under consideration, assessee purchased polished diamond of Rs. 5,00,000/- from its related party and AO asked the assessee as to why the disallowance should not be made as the purchase price appears to be on a higher side and the assessee made a statement before the AO that price paid to M/s Aura Jewels is reasonable having regard to the legitimate need of the business of the company which was not unresulted and as per quality of polished diamond and the same was not accepted by the AO on the ground that the assessee had opening stock of cut and polished diamond of 33197,48 carat which was valued at Rs. 39,88,42,225/- and the average rate per carat comes to Rs. 3646/- and similarly average rate per carat for purchase cut of polished diamond during the year was Rs. 7483.96/- whereas sales is Rs.11,453.77/- in respect of purchase from M/s Aura Jewels, the average per carat comes to Rs.41,666.66 (12 carat @ 5,00,000/-) and by deducting average rate from purchase made from M/s Aura Jewels a sum of Rs. 3,20,000/- was added back to the total income of assessee.
The CIT(A) while dealing with this ground concluded that M/s Aura Jewels is related party as defined u/s. 40A(2)(b) of the Act and the assessee had paid excessive consideration for the purchase of 12 carat on Diamond from other persons are much lower and the purchase rate from sister concern is unjustifiable and excessive and further concluded that AO has given substantial relief by comparing the purchase made from M/s Aura Jewels with the rate of 200% of the average purchase price made from outside and unrelated concern during the same financial year and confirmed the addition.
AR of the assessee has argued that AO as well as CIT(A) failed to appreciate that since no two Diamonds cannot be similar or identical and their value is based on various factors called colour, clarity, cut, carats etc. and average for comparison of price is not proper and appropriate as it would tend to distort the value and relied upon the judgment of jurisdictional High Court in case of CIT vs. Indo Saudi Services (Travel) (P) Ltd. reported vide 310 ITR 306 and decision of ITAT, Mumbai in titled as Indo Bearing Traders. The Ld. AR for assessee also argued that the percentage of the total income turnover in the case of related party firm is 1.94 , whereas in the case of assessee company ,it is 2.7. Applying the differential net profit percentage of 0.23% on turnover of Rs. 5 lac, the net profit of the assessee would have been higher by Rs. 1150/- and the difference of tax is merely of Rs.391/-however the disallowance u/s 40A(2)(b) was at Rs 3.20 lacs, hence made a emphasis rate that there was no motive of tax evasion in these transaction.
Ld. DR relied upon the order of authorities below.
We have perused the order of AO as well as CIT(A), no doubt the AO has assessed the value of related party transaction on the basis of its volume divided by cost and this calculated the difference of cost of Diamond per carat instead of finding the quality, color, clarity, cut and carats of the Diamond.
In CIT vs. Indo Saudi Arabia Travels P. Ltd., the Hon’ble Jurisdictional High Court while considering the similar issues has held that no disallowance is to be made in respect of payment to sister concern where there is no attempt to evade tax.
The co-ordinate bench of this Tribunal in the case of Indo Bearing Traders vs. ACIT, (ITA No. 7119/M/11 dated 10.10.2012) while following the judgement of the Hon'ble Jurisdictional High Court has held as under :
“2.4 It is clear that the objective of Section 40A(2) is to check evasion of tax through excessive or unreasonable payments to the associates concern and, therefore, this provision should not be applied in a manner which will create hardship in bonafide cases. The assessee has claimed and filed details before us showing that the recipient of the interest are paying the income tax at the highest rate and equivalent to the rate of tax at which the assessee's paying tax. To substantiate the contention, the learned AR of the assessee has relied upon the decision of the Hon'ble jurisdictional High Court in the case of CIT Vs. Indo Saudi Services (Travel) P. Ltd. (supra), wherein the Hon'ble High Court has observed in para 5 as under :- "5. In view of the aforesaid admitted facts we are of the view that the Tribunal was correct in coming to the conclusion that the Commissioner of Income-tax (Appeals) was wrong in disallowing half per cent commission to the sister concern of the assessee during the assessment years 1991-92 and 1992-93. The learned advocate appearing for the appellant is also not in a position to point out how the assessee evaded payment of tax by the alleged payment of higher commission to its sister concern since the sister concern was also paying tax at higher rate and copies of the payment orders of the sister concern were taken on record by the Tribunal." 2.5 Similarly, in the case of CIT Vs. V.S. Dempo & Co. (P.) Ltd.(supra), the Hon'ble High Court has held in para 4 as under :- "4. Clause (a) of sub-so (2) of s. 40A of the income-tax provides that where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in cl. (b) of the sub- section and the A 0 is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed a deduction. Clause (b) of sub-so (2) of S. 40A of the income-tax mentions the class of persons in respect of whom cl. (a) is attracted. Learned counsel for the respondent submits that M/s Dempo Mining Corporation (P) Ltd., (hereinafter referred to as "the subsidiary company'') from which the assessee purchased the iron ore is not one of the persons mentioned in cl. (b) of sub-so (2) of s. 40A and, therefore, sub-s. 2(a) was not attracted. In the alternative he submitted that the finding recorded by the CIT(A) as well as the Tribunal that the assessee had paid a little higher than the usual rate taking into consideration the fact that the assessee was assured a huge quantity of supply, as well as the quality of supply that it cannot be said that the rate was unjustified, was a finding of fact. In the absence of any perversity, the finding of fact recorded by the CIT(A) and confirmed by the Tribunal cannot be interfered with in an appeal under S. 260A of the Act. He further submitted that both the assessee, as well as the subsidiary were registered companies under the Companies Act, 1956 liable to pay the income-tax at the same rate. Therefore, there was no question of diversion of any funds. He invited our attention to the CBDT Circular No. 6-P dt. 6th July, 1968, which states that no disallowance is to be made under s. 4oA(2) in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax. He submitted that the CIT(A) as well as the Tribunal have also recorded a finding of fact that there was no attempt of evasion of tax and, therefore, in view of the CBDT circular dt. 6th July, 1968, S. 4oA(2) was not attracted and should not have been applied by the AO. The circular is binding on the Department and on this ground also the appeal should be dismissed”.
The principal enunciated in the judgement discussed above, clearly, establish that the payment made to the sister concern, should not be unreasonable or excessive, further there must not be an element to avoid tax. In the present case the AO calculated the price of diamonds at the average basis of its volume divided by cost and thus calculated the difference of cost of Diamond per carat instead of considering the quality the quality, colour, clarity, cut and carats of the Diamond.
7 M/s C. Dinesh & Company Pvt. Ltd.
We have also noticed that that the percentage of the total income turnover in the case of related party firm is 1.94 , whereas in the case of assessee company ,it is 2.7, applying the differential net profit percentage of 0.23% on turnover of Rs. 5 lac, the net profit of the assessee would have been higher by Rs. 1150/- and the difference of tax is merely of Rs.391.(emphasis supplied) 20. In view of the above discussion, ground no.2 raised in the present appeal is also allowed.
In the result, appeal filed by the assessee is allowed.
Order pronounced in the open court on this day of 29th February, 2016.