Asst.C.I.T., Bangalore V. M/s Acer India Private Limited, Bangalore

ITA 119/BANG/2016

• Counselvise Citation: [2020] 110 COUNSELVISE.COM (IT) 2278 (ITAT-BANGALORE)
• Duration Of Justice: 4 year(s) 9 month(s) 29 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 02-12-2020
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: B
• Next Hearing Date: 05-11-2020
• Assessment Year: 2010-2011
• Appeal Filed On: 03-02-2016
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: MUZAFFAR HUSSAIN
• Keywords: Bonafide belief; Retrospective amendment; Permanent establishment; Question of law; Speculative transactions; TDS
• Section: 40(a)(ia); 43(5); 43; 13; 37

Judgement Text

ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE IN THE INCOME TAX APPELLATE TRIBUNAL BBENCH: BANGALORE BEFORE SHRI GEORGE GEORGE K., JUDICIAL MEMBER AND SHRI B.R. BASKARAN, ACCOUNTANT MEMBER ITA NO.119/BANG/2016 ASSESSMENT YEAR: 2010-11 ACIT CIRCLE-1(1)(1) BENGALURU VS. M/S. ACER INDIA PRIVATE LIMITED # 13, 6 TH FLOOR EMBASSY HEIGHTS MAGARATH ROAD NEXT TO HOSMAT HOSPITAL BANGALORE-560 025. PAN NO : AACCA1237A APPELLANT RESPONDENT APPELLANT BY : MR. MUZAFFAR HUSSAIN, D.R. RESPONDENT BY : SHRI SHARATH RAO, A.R. DATE OF HEARING : 05.11.2020 DATE OF PRONOUNCEMENT : 02.12.2020 O R D E R PER B.R. BASKARAN, ACCOUNTANT MEMBER: THIS APPEAL FILED BY THE REVENUE IS DIRECTED AGAINS T THE ORDER PASSED BY LD. CIT(A)-1, BENGALURU DATED 29.10.2015 AND IT RELATES TO THE ASSESSMENT YEAR 2010-11. THE GROUNDS URGED BY THE REVENUE RELATE TO THE FOLLOWING 3 ISSUES:- A. DISALLOWANCE MADE U/S 40(A)(I) OF THE INCOME-TAX ACT,1961 ['THE ACT' FOR SHORT] IN RESPECT OF SOFTWA RE PURCHASES. B. DISALLOWANCE OF PROVISION FOR WARRANTY EXPENSES. ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 2 OF 19 C. DISALLOWANCE ON FOREIGN EXCHANGE LOSS. 2. THE ASSESSEE IS ENGAGED IN THE BUSINESS OF MANUF ACTURE AND TRADING OF COMPUTER SYSTEMS AND PERIPHERALS. 3. THE FIRST ISSUE RELATES TO DISALLOWANCE OF PURCH ASE OF SOFTWARE MADE BY THE A.O. U/S 40(A)(I) OF THE ACT FOR NON-DE DUCTION OF TAX AT SOURCE. THE A.O. TREATED THE PURCHASES OF COMPUTER SOFTWARE AS PAYMENT IN THE NATURE OF ROYALTY. SINCE THE ASSESSE E DID NOT DEDUCT TAX AT SOURCE FROM THE PAYMENTS SO MADE, THE A.O. D ISALLOWED THE SAME U/S 40(A)(I) OF THE ACT. THE LD. CIT(A) HELD THAT THE PAYMENT MADE BY THE ASSESSEE FOR PURCHASE OF SOFTWARE WAS I N RESPECT OF COPY RIGHTED ARTICLE AND ACCORDINGLY HELD THAT DISA LLOWANCE U/S 40(A)(I) OF THE ACT IS NOT CALLED FOR. ACCORDINGLY , HE DELETED THE DISALLOWANCE. 4. WE HEARD THE PARTIES ON THIS ISSUE AND PERUSED T HE RECORD. THE LD. D.R. SUBMITTED THAT THE JURISDICTIONAL HIGH COURT HAS HELD IN THE CASE OF SAMSUNG ELECTRONICS COMPANY LTD. (34 5 ITR 494) THAT THE PAYMENT MADE FOR SOFTWARE PURCHASE IS IN T HE NATURE OF PAYMENT OF ROYALTY. ACCORDINGLY, THE LD. D.R. SUBM ITTED THAT THE ASSESSEE SHOULD HAVE DEDUCTED TAX AT SOURCE FROM TH E PAYMENT MADE FOR PURCHASE OF SOFTWARE. ACCORDINGLY, HE SUB MITTED THAT THE A.O. WAS JUSTIFIED IN MAKING DISALLOWANCE U/S 40(A) (I) OF THE ACT. 5. ON THE CONTRARY, THE LD. A.R. SUBMITTED THAT THE DECISION IN THE CASE OF SAMSUNG ELECTRONICS COMPANY LTD. WAS RE NDERED BY HONBLE JURISDICTIONAL HIGH COURT ON 15.10.2011. P RIOR TO THE SAID DECISION OF HONBLE HIGH COURT, CERTAIN TRIBUNAL DE CISIONS WERE AVAILABLE TO THE EFFECT THAT SOFTWARE PURCHASES ARE NOT IN THE NATURE OF ROYALTY. ONE SUCH DECISION IS RENDERED BY THE TR IBUNAL IN THE CASE OF SONATA INFORMATION TECHNOLOGIES LTD. VS. AC IT 103 ITD 324. ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 3 OF 19 THE LD. A.R. SUBMITTED THAT THE PAYMENTS MADE FOR P URCHASES OF SOFTWARE WERE MADE BY THE ASSESSEE DURING THE YEAR UNDER CONSIDERATION PRIOR TO THE DECISION RENDERED BY HON BLE JURISDICTIONAL KARNATAKA HIGH COURT IN THE CASE OF SAMSUNG ELECTRONICS COMPANY LTD (SUPRA). HENCE THE ASSESSE E WAS UNDER BONAFIDE BELIEF THAT THE PAYMENTS MADE FOR PURCHASE S OF SOFTWARE ARE NOT LIABLE FOR TDS OBLIGATIONS, IN VIEW OF THE CERTAIN DECISIONS HOLDING SO. IN THESE KINDS OF CASES, THE COORDINATE BENCHES OF TRIBUNAL HAVE HELD THAT THE ASSESSEE CANNOT BE FAST ENED THAT TDS LIABILITY ON ACCOUNT OF SUBSEQUENT AMENDMENT OR SUB SEQUENT RULING OF THE COURT AND ACCORDINGLY, THE DISALLOWANCE MADE U/S 40(A)(I) OF THE ACT WAS DELETED. IN SUPPORT OF THIS SUBMISSION , THE LD. A.R. RELIED ON THE FOLLOWING DECISIONS IN THIS REGARD:- A. TEEKAYS INTERIOR SOLUTIONS P LTD. (ITA NO.400/BANG/ 2017) B. INFINEON TECHNOLOGIES INDIA P LTD. (IT(TP)A NO.405/BANG/2015) C. GE MEDICAL SYSTEMS INDIA P LTD. (ITA 1368/BANG/2019 ) D. WS ATKINS INDIA P LTD. (2015) (41 ITR (T) 397) (BAN G. TRIB.) 6. WE HEARD RIVAL CONTENTIONS ON THIS ISSUE AND PER USED THE RECORD. WE NOTICE THAT AN IDENTICAL ISSUE WAS EXAM INED IN THE CASE OF INFENION TECHNOLOGIES PVT. LTD. (SUPRA) AND IT W AS DECIDED AS UNDER: 25. WE HAVE CAREFULLY CONSIDERED THE RIVAL SUBMISS IONS. THE PAYMENT IN QUESTION WAS MADE TO THE NON-RESIDENT IN THE PREVIO US YEAR RELEVANT TO AY. 10-11. THEREFORE THE LAW AS ON 31.3.2010 THE LAST D ATE OF THE PREVIOUS YEAR WAS THAT PAYMENT FOR PURCHASE OF OFF SHELF SOFTWARE WAS NOT IN THE NATURE OF ROYALTY. IN SONATA INFORMATION TECHNOLOGY LTD. V. A CIT (103 ITD 324) DECISION RENDERED ON 31.1.2006, IT WAS HELD THAT PA YMENTS FOR SOFTWARE LICENSES DO NOT CONSTITUTE ROYALTY UNDER THE PROVIS IONS OF THE ACT AND HENCE DISALLOWANCE UNDER SECTION40(A) (IA) OF THE ACT WOU LD NOT BE APPLICABLE. THE CHANGE IN THE LEGAL POSITION ON TAXATION OF COM PUTER SOFTWARE WAS ON ACCOUNT OF THE RULING OF THE KARNATAKA HIGH COURT I N CIT V. SAMSUNG ELECTRONICS CO. LTD . (320 ITR 209), WHICH WAS PRONOUNCED ON 15.10.11 ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 4 OF 19 THAT IS MUCH LATER THAN THE CLOSURE OF THE FY 2010- 11. SUBSEQUENTLY, THE FINANCE ACT 2012 ALSO INTRODUCED, RETROSPECTIVELY, EXPLANATION 4 TO SECTION 9 (1 (VI) OF THE ACT TO CLARIFY THAT PAYMENTS FOR, IN TER ALIA. LICENSE TO USE COMPUTER SOFTWARE WOULD QUALIFY AS ROYALTY. DURING THE FY 10-11, THE ASSESSEE DID NOT HAVE THE BENEFIT OF CLARIFICAT ION BROUGHT BY THE RESPECTIVE AMENDMENT. AS SUCH, FOR THE FY 2010-11, IN LIGHT OF THE PROVISIONS OF SECTION 9(1)(VI) OF THE ACT READ WITH JUDICIAL GUIDANCE ON THE TAXATION OF COMPUTER SOFTWARE PAYMENTS, TAX WAS NOT REQUIRED TO BE DEDUCTED AT SOURCE. GIVEN THE PRACTICE IN PRIOR ASS ESSMENT YEARS, THE ASSESSEE WAS OF THE BONA FIDE VIEW THAT THE PAYMENT OF SOFTWARE LICENSE FEE WAS NOT SUBJECT TO TAX DEDUCTION AT SOURCE UNDER SE CTION1941/195 OF THE ACT. LIABILITY TO DEDUCT TAX AT SOURCE CANNOT BE FA STENED ON THE ASSESSEE ON THE BASIS OF RETROSPECTIVE AMENDMENT TO THE ACT (FINANCE ACT 2012 AMENDMENT THE DEFINITION OF ROYALTY WITH RETROSPECT IVE EFFECT FROM 01.04.1976) OR A SUBSEQUENT RULING OF A COURT (THE KARNATAKA HC IT(TP)A NOS.405 & 474/BANG/2015 IN CIT V SAMSUNG ELECTRONIC S CO. LTD. (16 TAXMANN.COM 141) WAS PASSED ON OCTOBER 15,2011). CO URTS HAVE CONSISTENTLY UPHELD THIS PRINCIPLE AS SEEN IN: ITO V. CLEAR WATER TECHNOLOGY SERVICES (P .) LTD. (52 TAXMANN.COM 115) KERALA VISION LTD. V. ACIT (46 TAXMANN.COM 50) SONIC BIOCHEM EXTRACTIONS (P.) LTD. V. ITO (35 TAXMANN.COM 463) CHANNEL GUIDE INDIA LTD. V. ACIT (25 TAXMANN.COM 2 5) DCI V. VIROLA INTERNATIONAL (20 14(2) TMI 653) CIT V. KOTAK SECURITIES LTD . (20 TAXMANN.COM 846). 26. THE ABOVE DECISIONS HAVE BEEN CONSIDERED AND DI SCUSSED IN THE CASE OF INGERSOLL RAND (INDIA) LTD. (SUPRA) BY THE BANGALOR E BENCH OF THE ITAT AND IT WAS HELD THEREIN THAT PRIOR TO THE DECISION OF HON'BLE JURISDICTIONAL HIGH COURT IN THE CASE OF CIT V. SAMSUNG ELECTRONICS CO. LTD . (SUPRA) WHICH WAS PASSED ON 15.10.2011 TRANSACTIONS CARRIED OUT ON PURCHASE OF OFF THE SHELF SOFTWARE ARE NOT LIABLE TO TDS AND HE NCE THERE CAN BE NO DISALLOWANCE U/S.40(A)(IA) OF THE ACT BASED ON SUBS EQUENT DEVELOPMENT OF LAW AFTER THE DATE ON WHICH PAYMENTS ARE MADE. 27. WE ARE OF THE VIEW THAT IN THE LIGHT OF LAW AS LAID DOWN BY THIS TRIBUNAL IN THE CASE OF INGERSOLL RAND (I) LTD. (SUPRA), THE RE CANNOT BE A RETROSPECTIVE OBLIGATION TO DEDUCT TAX AT SOURCE AN D THEREFORE AS ON THE DATE WHEN THE ASSESSEE MADE PAYMENTS TO THE NON-RES IDENT FOR ACQUIRING OFF-THE-SHELF SOFTWARE CANNOT BE REGARDED AS IN THE NATURE OF ROYALTY AND THEREFORE THERE WAS NO OBLIGATION ON THE PART OF AS SESSEE TO DEDUCT TAX AT SOURCE. THE PAYMENT WOULD BE IN THE NATURE OF BUSIN ESS PROFITS IN THE HANDS OF NON-RESIDENT AND SINCE ADMITTEDLY THE NON-RESIDE NT DOES NOT HAVE A PERMANENT ESTABLISHMENT IN INDIA, THE SUM IN QUESTI ON IS NOT CHARGEABLE TO TAX IN THE HANDS OF NON-RESIDENT. CONSEQUENTLY, THE DISALLOWANCE MADE ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 5 OF 19 IT(TP)A NOS.405 & 474/BANG/2015 U/S. 40(A)(IA) OF T HE ACT HAS TO BE DELETED. WE DIRECT ACCORDINGLY. GROUND NO.14 BY THE ASSESSEE IS ACCORDINGLY ALLOWED. 7. THE INSTANT CASE RELATES TO THE FINANCIAL YEAR 2 009-10 RELEVANT TO THE ASSESSMENT YEAR 2010-11 AND THE PAYMENTS HAV E BEEN MADE FOR PURCHASE OF SOFTWARE PRIOR TO THE DATE OF PRONO UNCEMENT OF THE DECISION BY HONBLE KARNATAKA HIGH COURT IN THE CAS E OF SAMSUNG ELECTRONICS COMPANY LTD. (15.10.11) AND ALSO PRIOR TO THE AMENDMENT OF SEC. 9(1)(VI) OF THE ACT. ACCORDINGLY , FOLLOWING THE ABOVE SAID DECISION RENDERED BY THE TRIBUNAL, WE HO LD THAT THE DISALLOWANCE U/S 40(A)(I) OF THE ACT CANNOT BE MADE IN THE FACTS OF THE PRESENT CASE. ACCORDINGLY, WE CONFIRM THE DECI SION RENDERED BY LD. CIT(A) ON THIS ISSUE ON THE ABOVE SAID REASONIN G. 8. THE NEXT ISSUE RELATES TO DISALLOWANCE OF PROVIS ION FOR WARRANTY. THE A.O. NOTICED THAT THE ASSESSEE HAS D EBITED A SUM OF RS.29.17 CRORES TOWARDS PROVISION FOR WARRANTY IN R ESPECT OF GOODS SOLD BY IT. THE A.O. NOTICED THAT THE DEDUCTIBILIT Y OF PROVISION FOR WARRANTY HAS BEEN EXAMINED BY THE HONBLE SUPREME C OURT IN THE CASE OF ROTORK CONTROLS INDIA P. LTD. (CIVIL APPEAL NO.3506 3510 OF 2009) AND CERTAIN GUIDELINES HAVE BEEN LAID DOWN. THE A.O. NOTICED THAT THE ASSESSEE IS MAKING PROVISION FOR WARRANTY OF HUGE AMOUNT EVERY YEAR AND ALSO REVERSING THE WARRANTY PROVISIO N IN SUBSEQUENT YEARS, WHICH WAS ALSO OF SIGNIFICANT AMOUNT. HENCE , THE A.O. TOOK THE VIEW THAT THE ASSESSEE IS NOT FOLLOWING SCIENTI FIC METHOD FOR CREATING PROVISION FOR WARRANTY AND ACCORDINGLY, HE DISALLOWED THE SAME. 9. THE LD. CIT(A) NOTICED THAT THE A.O. HAD MADE ID ENTICAL DISALLOWANCE IN ASSESSMENT YEARS 2004-05 TO 2006-07 AND THE JURISDICTIONAL INCOME TAX TRIBUNAL HAD DELETED THE SAME. ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 6 OF 19 ACCORDINGLY, THE LD. CIT(A), FOLLOWING THE DECISION RENDERED BY ITAT, DELETED THE DISALLOWANCE. 10. WE HEARD THE PARTIES ON THIS ISSUE. THE LD. A .R. SUBMITTED THAT THE ISSUE RELATING TO DISALLOWANCE OF PROVISIO N OF WARRANTY IN THE ASSESSEES OWN CASE HAS SINCE BEEN DECIDED IN F AVOUR OF THE ASSESSEE BY HONBLE KARNATAKA HIGH COURT IN ITA NO. 243/2012 DATED 25.6.2018 PASSED FOR ASSESSMENT YEAR 2006-07. 11. WE HEARD LD. D.R. AND PERUSED THE ORDER PASSED BY THE HONBLE KARNATAKA HIGH COURT. WE NOTICE THAT THIS ISSUE HAS BEEN DECIDED IN FAVOUR OF THE ASSESSEE BY HONBLE KARNAT AKA HIGH COURT IN THE ASSESSEES OWN CASE. FOR THE SAKE OF CONVEN IENCE, WE EXTRACT BELOW THE OPERATIVE PORTION OF THE ORDER PASSED BY HONBLE KARNATAKA HIGH COURT:- 8. HAVING HEARD THE LEARNED COUNSELS FOR THE PARTIE S, WE ARE OF THE CLEAR OPINION THAT NO SUBSTANTIAL QUESTION OF LAW ARISES IN THE PRESENT APPEAL FILED BY THE REVENUE. WE ARE SATISFIED THAT THE RES PONDENT-ASSESSEE COMPANY HAS CONSISTENTLY FOLLOWED THE SIMILAR PRACT ICE WITH REGARD TO MAKING PROVISION OF WARRANTY GIVEN TO THE CUSTOMERS FOR PROVIDING THEM FREE REPAIRS AND MAINTENANCE FOR THE COMPUTERS AND HARDWARE SUPPLIED TO THEM, WHICH IN THEIR ORDINARY COURSE OF BUSINESS, T HE RESPONDENT-COMPANY GAVE SUCH WARRANTEES. THE EXCESS PROVISION CREATED BY THE COMPANY ITSELF HAS BEEN REVERSED BY THE RESPONDENT-COMPANY AND ONL Y THE PROVISION TO THE EXTENT OF MAKING AN ADEQUATE PROVISION FOR MEET ING SUCH POSSIBLE EXPENSES FOR REPAIRS AND MAINTENANCE HAS BEEN DEBIT ED BY THE ASSESSEE- COMPANY IN ITS BOOKS OF ACCOUNTS OVER THE PERIOD OF SIX YEARS, THE DETAILS OF WHICH ARE GIVEN BY THE ASSESSING AUTHORITY ITSELF I N THE ASSESSMENT ORDER. 9. WE ARE ABSOLUTELY AT A LOSS TO UNDERSTAND HOW TH E ASSESSING AUTHORITY HAS FOUND THE SAID CONSISTENT PRACTICE OF THE ASSES SEE-COMPANY TO BE UNSCIENTIFIC AND UNTENABLE AND THEN PROCEEDED TO DI SALLOW THE ENTIRE CLAIM OF PROVISION MADE BY THE ASSESSEE-COMPANY IN THIS R EGARD. NEITHER ALLOWING THE PROVISION MADE FOR WARRANTEES NOR THE ACTUAL EXPENSES INCURRED BY THE COMPANY TO BE DEDUCTED FROM THE PRO FITS OF THE COMPANY DURING THE YEAR IS ABSOLUTELY ARBITRARY AND UNSCIEN TIFIC ON THE PART OF ASSESSING AUTHORITY, TO SAY THE LEAST. THERE WAS AB SOLUTELY NO BASIS FOR THE ASSESSING AUTHORITY TO MAKE BOTH THE DISALLOWANCES OF PROVISION FOR WARRANTY AS WELL AS ACTUAL EXPENSES AT THE SAME TIM E IN THE HANDS OF THE ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 7 OF 19 RESPONDENT-ASSESSEE. IN VIEW OF THE COMPARISON OF A CTUAL EXPENSES AND PROVISIONS MADE FOR WARRANTY, THE DETAILS OF WHICH ARE GIVEN IN THE ASSESSMENT ORDER ITSELF, WE DO NOT FIND ANY ABNORMA L FLUCTUATION OR EXCESS PROVISION MADE BY THE ASSESSEE-COMPANY ON THIS ACCO UNT. 10. WE EXPRESS OUR CONCERN AND DISSATISFACTION AT T HE MANNER IN WHICH THE ASSESSING AUTHORITY IN THE PRESENT CASE HAS VERY CA SUALLY DISALLOWED THE SAID CLAIM IN THE HANDS OF THE RESPONDENT-ASSESSEE. MOREOVER, WHEN THE HIGHER APPELLATE AUTHORITIES HAVE CORRECTED THE SAI D APPROACH OF THE ASSESSING AUTHORITY BY THE FIRST APPELLATE AUTHORIT Y ALLOWING THE APPEAL OF THE ASSESSEE AND THE TRIBUNAL DISMISSING THE APPEAL OF THE REVENUE, WE ARE ALL THE MORE PAINED TO SEE THAT THE REVENUE STILL F ELT DISSATISFIED AND HAS BROUGHT UP THE MATTER BEFORE THIS COURT UNDER SECTI ON 260-A OF THE ACT WITHOUT ACTUALLY ANY SUBSTANTIAL QUESTION OF LAW AR ISING IN THE MATTER. THIS REFLECTS THE IRRESPONSIBLE MANNER IN WHICH THE REVE NUE DEPARTMENT BECOMES A FRIVOLOUS LITIGANT IN CONSTITUTIONAL COUR TS, BY DRAGGING SUCH CASE, WASTING PUBLIC TIME AND MONEY. 11. AS IS WELL SETTLED, THE APPEAL UNDER SECTION 26 0-A OF THE ACT LIES BEFORE THIS COURT ONLY ON SUBSTANTIAL QUESTIONS OF LAW. TH E FINAL FACT FINDINGS OF THE TRIBUNAL UNDER THE ACT ARE BINDING ON THIS COUR T AND CANNOT BE DISTURBED UNLESS THEY ARE FOUND TO BE PERVERSE ON T HE BASIS OF ESTABLISHED MATERIAL ON RECORD. WE DO NOT FIND ANY SUCH CASE OF REVENUE IN THE PRESENT APPEAL. 12. MOREOVER, WE ARE SATISFIED THAT THE PRACTICE OF MAKING A PROVISION FOR WARRANTY IN THE PRESENT CASE HAS BEEN FOUND TO BE C ONSISTENT, SCIENTIFIC AND REGULAR BY THE TWO APPELLATE AUTHORITIES BELOW IN C ONSONANCE WITH THE JUDGMENT OF THE HON'BLE SUPREME COURT IN THE CASE O F ROTORK CONTROLS INDIA (P) LTD. (SUPRA). THE HON'BLE SUPREME COURT I N THE AFORESAID CASE, DISCUSSED IN DETAIL HOW THE ACCOUNTING ENTRIES FOR PRODUCT WARRANTY ARE TO BE MADE BY THE ASSESSEES. WE QUOTE BELOW THE RELEVA NT PORTION OF THE JUDGMENT FOR READY REFERENCE: 10. WHAT IS A PROVISION? THIS IS THE QUESTION WHICH NEEDS TO BE ANSWERED. A PROVISION IS A LIABILITY WHICH CA N BE MEASURED ONLY BY USING A SUBSTANTIAL DEGREE OF ESTIMATION. A PROVISION IS RECOGNIZED WHEN: (A) AN ENTERPRISE HAS A PRESENT OBLIGATION AS A RESULT OF A PAST EVENT; (B) IT IS PROBABLE THAT AN OUTFLOW OF RESOUR CES WILL BE REQUIRED TO SETTLE THE OBLIGATION; AND (C) A REL IABLE ESTIMATE CAN BE MADE OF THE AMOUNT OF THE OBLIGATIO N. IF THESE CONDITIONS ARE NOT MET, NO PROVISION CAN BE RECOGNIZED. 11. LIABILITY IS DEFINED AS A PRESENT OBLIGATION AR ISING FROM PAST EVENTS, THE SETTLEMENT OF WHICH IS EXPECT ED TO ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 8 OF 19 RESULT IN AN OUTFLOW FROM THE ENTERPRISE OF RESOURC ES EMBODYING ECONOMIC BENEFITS. 12. A PAST EVENT THAT LEADS TO A PRESENT OBLIGATION IS CALLED AS AN OBLIGATING EVENT. THE OBLIGATING EVENT IS AN EVENT THAT CREATES AN OBLIGATION WHICH RESULTS IN AN OUTF LOW OF RESOURCES. IT IS ONLY THOSE OBLIGATIONS ARISING FRO M PAST EVENTS EXISTING INDEPENDENTLY OF THE FUTURE CONDUCT OF THE BUSINESS OF THE ENTERPRISE THAT IS RECOGNIZED AS PR OVISION. FOR A LIABILITY TO QUALIFY FOR RECOGNITION THERE MU ST BE NOT ONLY PRESENT OBLIGATION BUT ALSO THE PROBABILITY OF AN OUTFLOW OF RESOURCES TO SETTLE THAT OBLIGATION. WHE RE THERE ARE A NUMBER OF OBLIGATIONS (E.G. PRODUCT WARRANTIE S OR SIMILAR CONTRACTS) THE PROBABILITY THAT AN OUTFLOW WILL BE REQUIRED IN SETTLEMENT, IS DETERMINED BY CONSIDERIN G THE SAID OBLIGATIONS AS A WHOLE. IN THIS CONNECTION, IT MAY BE NOTED THAT IN THE CASE OF A MANUFACTURE AND SALE OF ONE SINGLE ITEM THE PROVISION FOR WARRANTY COULD CONSTI TUTE A CONTINGENT LIABILITY NOT ENTITLED TO DEDUCTION UNDE R SECTION 37 OF THE SAID ACT. HOWEVER, WHEN THERE IS MANUFACT URE AND SALE OF AN ARMY OF ITEMS RUNNING INTO THOUSANDS OF UNITS OF SOPHISTICATED GOODS, THE PAST EVENT OF DEF ECTS BEING DETECTED IN SOME OF SUCH ITEMS LEADS TO A PRE SENT OBLIGATION WHICH RESULTS IN AN ENTERPRISE HAVING NO ALTERNATIVE TO SETTLING THAT OBLIGATION. IN THE PRE SENT CASE, THE APPELLANT HAS BEEN MANUFACTURING AND SELLING VA LVE ACTUATORS. THEY ARE IN THE BUSINESS FROM ASSESSMENT YEARS 1983-84 ONWARDS. VALVE ACTUATORS ARE SOPHISTICATED GOODS. OVER THE YEARS APPELLANT HAS BEEN MANUFACTUR ING VALVE ACTUATORS IN LARGE NUMBERS. THE STATISTICAL D ATA INDICATES THAT EVERY YEAR SOME OF THESE MANUFACTURE D ACTUATORS ARE FOUND TO BE DEFECTIVE. THE STATISTICA L DATA OVER THE YEARS ALSO INDICATES THAT BEING SOPHISTICA TED ITEM NO CUSTOMER IS PREPARED TO BUY VALVE ACTUATOR WITHO UT A WARRANTY. THEREFORE, WARRANTY BECAME INTEGRAL PART OF THE SALE PRICE OF THE VALVE ACTUATOR(S). IN OTHER WORDS , WARRANTY STOOD ATTACHED TO THE SALE PRICE OF THE PR ODUCT. THESE ASPECTS ARE IMPORTANT. AS STATED ABOVE, OBLIG ATIONS ARISING FROM PAST EVENTS HAVE TO BE RECOGNIZED AS PROVISIONS. THESE PAST EVENTS ARE KNOWN AS OBLIGATI NG EVENTS. IN THE PRESENT CASE, THEREFORE, WARRANTY PR OVISION ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 9 OF 19 NEEDS TO BE RECOGNIZED BECAUSE THE APPELLANT IS AN ENTERPRISE HAVING A PRESENT OBLIGATION AS A RESULT OF PAST EVENTS RESULTING IN AN OUTFLOW OF RESOURCES. LASTLY , A RELIABLE ESTIMATE CAN BE MADE OF THE AMOUNT OF THE OBLIGATION. IN SHORT, ALL THREE CONDITIONS FOR RECO GNITION OF A PROVISION ARE SATISFIED IN THIS CASE. 13. IN THIS CASE WE ARE CONCERNED WITH PRODUCT WARRANTIES. TO GIVE AN EXAMPLE OF PRODUCT WARRANTIE S, A COMPANY DEALING IN COMPUTERS GIVES WARRANTY FOR A PERIOD OF 36 MONTHS FROM THE DATE OF SUPPLY. THE SA ID COMPANY CONSIDERS FOLLOWING OPTIONS : (A) ACCOUNT F OR WARRANTY EXPENSE IN THE YEAR IN WHICH IT IS INCURRE D; (B) IT MAKES A PROVISION FOR WARRANTY ONLY WHEN THE CUSTOM ER MAKES A CLAIM; AND (C) IT PROVIDES FOR WARRANTY AT 2% OF TURNOVER OF THE COMPANY BASED ON PAST EXPERIENCE (HISTORICAL TREND). THE FIRST OPTION IS UNSUSTAINAB LE SINCE IT WOULD TANTAMOUNT TO ACCOUNTING FOR WARRANTY EXPENSE S ON CASH BASIS, WHICH IS PROHIBITED BOTH UNDER THE COMP ANIES ACT AS WELL AS BY THE ACCOUNTING STANDARDS WHICH RE QUIRE ACCRUAL CONCEPT TO BE FOLLOWED. IN THE PRESENT CASE , THE DEPARTMENT IS INSISTING ON THE FIRST OPTION WHICH, AS STATED ABOVE, IS ERRONEOUS AS IT RULES OUT THE ACCRUAL CON CEPT. THE SECOND OPTION IS ALSO INAPPROPRIATE SINCE IT DO ES NOT REFLECT THE EXPECTED WARRANTY COSTS IN RESPECT OF R EVENUE ALREADY RECOGNIZED (ACCRUED). IN OTHER WORDS, IT IS NOT BASED ON MATCHING CONCEPT. UNDER THE MATCHING CONCE PT, IF REVENUE IS RECOGNIZED THE COST INCURRED TO EARN THAT REVENUE INCLUDING WARRANTY COSTS HAS TO BE FULLY PR OVIDED FOR. WHEN VALVE ACTUATORS ARE SOLD AND THE WARRANTY COSTS ARE AN INTEGRAL PART OF THAT SALE PRICE THEN THE AP PELLANT HAS TO PROVIDE FOR SUCH WARRANTY COSTS IN ITS ACCOU NT FOR THE RELEVANT YEAR, OTHERWISE THE MATCHING CONCEPT F AILS. IN SUCH A CASE THE SECOND OPTION IS ALSO INAPPROPRIATE . UNDER THE CIRCUMSTANCES, THE THIRD OPTION IS MOST APPROPRIATE BECAUSE IT FULFILLS ACCRUAL CONCEPT AS WELL AS THE MATCHING CONCEPT. FOR DETERMINING AN APPROPRIAT E HISTORICAL TREND, IT IS IMPORTANT THAT THE COMPANY HAS A PROPER ACCOUNTING SYSTEM FOR CAPTURING RELATIONSHIP BETWEEN THE NATURE OF THE SALES, THE WARRANTY PROVI SIONS MADE AND THE ACTUAL EXPENSES INCURRED AGAINST IT ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 10 OF 19 SUBSEQUENTLY. THUS, THE DECISION ON THE WARRANTY PROVISION SHOULD BE BASED ON PAST EXPERIENCE OF THE COMPANY. A DETAILED ASSESSMENT OF THE WARRANTY PROVISIONING POLICY IS REQUIRED PARTICULARLY IF THE EXPERIENCE SUGGESTS THAT WARRANTY PROVISIONS ARE GENERALLY REVERSED IF THEY REMAINED UNUTILIZED AT T HE END OF THE PERIOD PRESCRIBED IN THE WARRANTY. THEREFORE , THE COMPANY SHOULD SCRUTINIZE THE HISTORICAL TREND OF WARRANTY PROVISIONS MADE AND THE ACTUAL EXPENSES INCURRED AGAINST IT. ON THIS BASIS A SENSIBLE ESTIM ATE SHOULD BE MADE. THE WARRANTY PROVISION FOR THE PROD UCTS SHOULD BE BASED ON THE ESTIMATE AT YEAR END OF FUTU RE WARRANTY EXPENSES. SUCH ESTIMATES NEED REASSESSMENT EVERY YEAR. AS ONE REACHES CLOSE TO THE END OF THE WARRANTY PERIOD, THE PROBABILITY THAT THE WARRANTY EXPENSES WILL BE INCURRED IS CONSIDERABLY REDUCED A ND THAT SHOULD BE REFLECTED IN THE ESTIMATION AMOUNT. WHETHER THIS SHOULD BE DONE THROUGH A PRO RATA REVERSAL OR OTHERWISE WOULD REQUIRE ASSESSMENT OF HISTORICAL TR END. IF WARRANTY PROVISIONS ARE BASED ON EXPERIENCE AND HISTORICAL TREND(S) AND IF THE WORKING IS ROBUST TH EN THE QUESTION OF REVERSAL IN THE SUBSEQUENT TWO YEARS, I N THE ABOVE EXAMPLE, MAY NOT ARISE IN A SIGNIFICANT WAY. IN OUR VIEW, ON THE FACTS AND CIRCUMSTANCES OF THIS CASE, PROVISION FOR WARRANTY IS RIGHTLY MADE BY THE APPEL LANT- ENTERPRISE BECAUSE IT HAS INCURRED A PRESENT OBLIGA TION AS A RESULT OF PAST EVENTS. THERE IS ALSO AN OUTFLOW O F RESOURCES. A RELIABLE ESTIMATE OF THE OBLIGATION WA S ALSO POSSIBLE. THEREFORE, THE APPELLANT HAS INCURRED A L IABILITY, ON THE FACTS AND CIRCUMSTANCES OF THIS CASE, DURING THE RELEVANT ASSESSMENT YEAR WHICH WAS ENTITLED TO DEDU CTION UNDER SECTION 37 OF THE 1961 ACT. THEREFORE, ALL THE THREE CONDITIONS FOR RECOGNIZING A LIABILITY FOR THE PURP OSES OF PROVISIONING STANDS SATISFIED IN THIS CASE. IT IS I MPORTANT TO NOTE THAT THERE ARE FOUR IMPORTANT ASPECTS OF PROVI SIONING. THEY ARE - PROVISIONING WHICH RELATES TO PRESENT OBLIGATION, IT ARISES OUT OF OBLIGATING EVENTS, IT INVOLVES OUTFLOW OF RESOURCES AND LASTLY IT INVOLVES RELIABL E ESTIMATION OF OBLIGATION. KEEPING IN MIND ALL THE F OUR ASPECTS, WE ARE OF THE VIEW THAT THE HIGH COURT SHO ULD NOT ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 11 OF 19 TO HAVE INTERFERED WITH THE DECISION OF THE TRIBUNA L IN THIS CASE. 13. WE ARE, THEREFORE, SATISFIED THAT BOTH THE APPE LLATE AUTHORITIES BELOW WERE JUSTIFIED IN RETURNING THE PROPER FINDINGS OF FACTS ON THE RELEVANT MATERIAL BEFORE THEM AND HAVE RIGHTLY FOUND THAT TH E PROVISIONS OF WARRANTY MADE BY THE RESPONDENT-ASSESSEE COMPANY WAS ON THE BASIS OF THE SCIENTIFIC AND CONSISTENT METHOD AND THEREFORE, THE PRESENT APPEAL OF THE REVENUE DOES NOT GIVE RISE TO ANY SUBSTANTIAL QUEST ION OF LAW AND THE SAME DESERVES TO BE DISMISSED AND IS ACCORDINGLY DISMISS ED. 12. IN VIEW OF THE BINDING DECISION RENDERED BY HON BLE KARNATAKA HIGH COURT ON AN IDENTICAL ISSUE IN THE A SSESSEES OWN CASE, WE UPHOLD THE ORDER PASSED BY LD. CIT(A) ON T HIS ISSUE. 13. THE NEXT ISSUE RELATES TO DISALLOWANCE OF FOREI GN EXCHANGE LOSS ARISING ON REVALUATION OF FOREIGN EXCHANGE EXP OSURES AS AT THE YEAR END. THE A.O. NOTICED THAT THE ASSESSEE HAS R EVALUED ITS ASSETS AND LIABILITIES WITH FOREIGN EXCHANGE EXPOSU RE AS AT THE YEAR END ON MARKED TO MARKET BASIS AND DECLARED NET GAIN OF RS.6.97 CRORES. THE BREAKUP DETAILS ARE GIVEN BELOW: PARTICULARS AMOUNT GAIN ON ACCOUNT OF CREDITORS RESTATEMENT 13,91,07,4 44 FOREX GAIN ON TRADING ACTIVITIES 4,67,21,845 LOSS ON MTM FORWARD CONTRACT (11,60,53,872) TOTAL 6,97,75,417 14. THE A.O. DISALLOWED THE LOSS OF RS.11.60 CRORES CLAIMED BY THE ASSESSEE BY HOLDING THAT IT IS CONTINGENT IN NA TURE. THE LD. CIT(A) NOTICED THAT THE BENGALURU BENCH OF ITAT HAS ALLOWED FOREIGN EXCHANGE LOSSES AS DEDUCTION IN THE CASE OF QUALITY ENGINEERING AND SOFTWARE TECHNOLOGIES PVT. LTD. 52 TAXMANN.COM 515 AND ALSO IN THE CASE OF ACIT VS. HANUMAN WEAVING FACTORY (IT A NO.1112/2012). ACCORDINGLY, THE LD. CIT(A) DELETED DISALLOWANCE MADE BY THE A.O. ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 12 OF 19 15. WE HEARD THE PARTIES ON THIS ISSUE AND PERUSED THE RECORD. THE LD. A.R. SUBMITTED THAT THE A.O. HAS ASSESSED T HE FOREIGN EXCHANGE GAINS ARISING ON ACCOUNT OF REVALUATION OF CREDITORS AND OTHER TRADING ITEMS. HE SUBMITTED THAT THE FORWARD CONTRACTS HAVE BEEN ENTERED BY THE ASSESSEE IN RESPECT OF REVENUE ITEMS ONLY. HE FURTHER SUBMITTED THAT THE ASSESSEE HAS NOT IMPORTE D ANY FIXED ASSETS DURING THE YEAR UNDER CONSIDERATION AND HENC E, THERE DID NOT EXIST ANY FORWARD CONTRACT ON CAPITAL ACCOUNT. HE SUBMITTED THAT REVALUATION OF FORWARD CONTRACT RELATING TO REVENUE ITEM IS ALLOWABLE AS DEDUCTION AS HELD BY THE BENGALURU BENCH OF ITAT IN THE CASEOF QUALITY ENGINEERING & SOFTWARE TECHNOLOGIES PVT. LT D. 16. THE LD. D.R. SUBMITTED THAT MARKED TO MARKET LO SSES HAVE BEEN HELD AS NOTIONAL LOSS BY THE CBDT INSTRUCTION NO.3/2010 DATED 23.3.2010. ACCORDINGLY, HE SUBMITTED THAT TH E A.O. WAS JUSTIFIED IN MAKING THE DISALLOWANCE. 17. WE HEARD THE PARTIES ON THIS ISSUE AND PERUSED THE RECORD. WE NOTICE THAT THIS ISSUE HAS BEEN DECIDED IN FAVOU R OF THE ASSESSEE BY COORDINATE BENCH OF TRIBUNAL IN THE CASE OF QUAL ITY ENGINEERING & SOFTWARE TECHNOLOGIES PVT. LTD. (SUPRA). FOR THE SAKE OF CONVENIENCE WE EXTRACT BELOW THE DECISION RENDERED BY THE COORDINATE BENCH IN THE ABOVE SAID CASE: 4.5.8 IN THE CASE ON HAND, IT IS NOT IN DISPUTE THAT THE FORWARD CONTRACTS HAVE BEEN ENTERED INTO BY THE ASSESSEE IN ORDER TO PROTECT ITS INTEREST AGAINST FLUCTUATIONS IN FOREIG N CURRENCY, IN RESPECT OF CONSIDERATION FOR EXPORT PROCEEDS, WHICH IS A REVENUE ITEM. THEREFORE, IN SUM AND SUBSTANCE, IT HAS THE T RAPPINGS OF STOCK-IN-TRADE AND THE ASSESSEE HAS TO RESTATE OR R EVALUE THE SAME AS ON THE BALANCE SHEET DATE. THE CONSEQUENT E FFECT OF THIS ACCOUNTING TREATMENT WAS TO RECOGNIZE THE EXCHANGE FLUCTUATION GAIN OR LOSS IN THE PROFIT AND LOSS ACCOUNT AS ON T HE VALUATION DATE. IN VIEW OF THE FACTS AND CIRCUMSTANCES OF THE CASE AS DISCUSSED ABOVE, WE ARE OF THE CONSIDERED VIEW THAT THE APPEAL ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 13 OF 19 OF THE ASSESSEE ON THIS ISSUE, SUCCEEDS FOR THE FOL LOWING REASONS : (I) A BINDING OBLIGATION ACCRUED AGAINST THE ASSESSEE W HEN IT ENTERED INTO FOREIGN EXCHANGE FORWARD CONTRACTS; (II) THE FORWARD CONTRACTS ARE IN RESPECT OF CONSIDERATI ON FOR EXPORT PROCEEDS, WHICH ARE REVENUE ITEMS; (III) THE LIABILITY IS DETERMINABLE WI TH REASONABLE CERTAINTY WHEN AN OBLIGATION IS PENDING ON THE BALANCE SHEET DATE AND SUCH A LIABILITY CANNOT BE SAID TO BE A CONTINGENT LIABILI TY. (IV) THE ACCOUNTING TREATMENT IS AS PER ACCOUNTING STAND ARDS AND THE ICAI GUIDELINES. (V) THE PRINCIPLES ENUNCIATED BY THE HON'BLE APEX COURT IN THE CASE OF WOODWARD GOVERNOR INDIA (P.) LTD. (SUPRA ) ARE APPLICABLE TO THE FACTS OF THE CASE ON HAND. 4.5.9 WE HAD EARLIER OBSERVED THAT THE ASSESSING OFFICER HAD RELIED ON THE CBDTS INSTRUCTION NO.3/2010. PARAS 1 AND 3 OF THIS INSTRUCTION READS AS UNDER : '1.FOREIGN EXCHANGE DERIVATIVE TRANSACTIONS ENTERED INTO BY THE CORPORATE SECTOR IN INDIA HAVE WITNESSED A SUBSTANT IAL GROWTH IN RECENT YEARS. THIS COMBINED WITH EXTREME VOLATILITY IN THE FOREIGN EXCHANGE MARKET IN THE LAST FINANCIAL YEAR IS REPORTED TO HAVE RESULTED IN SUBSTANTIAL LOSSES TO AN ASSESSEE ON ACCOUNT OF TRADING IN FOREX-DERIVATIVES. A LARGE NUMBER OF ASS ESSES ARE SAID TO BE REPORTING SUCH LOSSES ON 'MARKED TO MARKET' B ASIS EITHER SUO MOTU OR IN COMPLIANCE OF THE ACCOUNTING STANDAR D OR ADVISORY CIRCULAR ISSUED BY THE INSTITUTE OF CHARTE RED ACCOUNTANTS. THE ISSUE WHETHER SUCH LOSSES ON ACCOU NT OF FOREX- DERIVATIVES CAN BE ALLOWED AGAINST THE TAXABLE INCO ME OF AN ASSESSEE HAS BEEN CONSIDERED BY THE BOARD. IN THIS CONNECTION, I AM DIRECTED TO SAY THAT THE ASSESSING OFFICERS MAY FOLLOW THE GUIDELINES GIVEN BELOW: 2....... 3. TREATMENT OF LOSS FROM ACTUAL TRANSACTIONS IN FO REX- DERIVATIVES. IN A CASE WHERE A LOSS ON A FOREX-DERI VATIVE ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 14 OF 19 TRANSACTION ARISES ON ACTUAL SETTLEMENT / CONCLUSIO N OF CONTRACT AND IS NOT A NOTIONAL OR MARKED TO MARKET BOOK ENTR Y, A FURTHER QUESTION WILL ARISE AS TO WHETHER SUCH A LOSS IS ON ACCOUNT OF A SPECULATIVE TRANSACTION AS CONTEMPLATED IN SECTION 43(5) OF THE INCOME TAX ACT. FOR DETERMINING WHETHER LOSS FROM A TRANSACTION IN RESPECT OF A FOREX-DERIVATIVE IS A SPECULATION L OSS OR NOT, THE ASSESSING OFFICERS MAY REFER TO PROVISO (D) BELOW S UB-SECTION (5) OF SECTION 43 INSERTED BY THE FINANCE ACT, 2005 , WITH EFFECT FROM 1.4.2006. IT LAYS DOWN THAT ANY 'ELIGIBLE TRAN SACTION' IN RESPECT OF TRADING IN DERIVATIVES REFERRED TO IN CL AUSE (AC) OF SECTION 2 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956, THAT HAS BEEN CARRIED OUT IN A RECOGNIZED STOCK EXCHANGE SHALL NOT BE TREATED AS A SPECULATIVE TRANSACTION. FURTHER, AN ' ELIGIBLE TRANSACTION' FOR THIS PURPOSE WOULD BE ONE THAT FUL FILS THE CONDITIONS LAID DOWN IN EXPLANATION TO SECTION 43(5 )(D). ANY LOSS IN A SPECULATIVE TRANSACTION CAN BE SET OFF ON LY AGAINST PROFIT FROM SPECULATIVE TRANSACTIONS. IN THE CASE ON HAND, AS DISCUSSED EARLIER, A CONTRA CT HAS BEEN CONCLUDED AND A LIABILITY HAS CRYSTALLIZED. IN THIS FACTUAL MATRIX, FROM THE WORDINGS OF THE INSTRUCTION, IT FOLLOWS TH AT THE LOSS ARISING OUT OF THE FORWARD CONTRACT IS NOT NOTIONAL . IN SUCH A CASE, THE CBDT INSTRUCTION REQUIRES THE ASSESSING O FFICER TO EXAMINE WHETHER SUCH A LOSS IS ON ACCOUNT OF A SPEC ULATIVE TRANSACTION AS CONTEMPLATED IN SECTION 43(5) OF THE ACT.' 4.5.10 THE ISSUE OF SPECULATIVE TRANSACTIONS AND HEDGING TRANSACTIONS HAS BEEN EXAMINED AND ANALYSED IN DETA IL IN THE DECISION OF THE ITAT, MUMBAI IN THE CASE OF S. VINO DKUMAR DIAMONDS (P) LTD. V. ADDL. CIT [2013] 35 TAXMANN.COM 337/59 SOT 124 . THE RELEVANT PARAGRAPHS OF THIS ORDER ARE EXTRACT ED HEREUNDER AND READ AS FOLLOWS : ' 5.2.1. THE DEFINITION OF 'SPECULATIVE TRANSACTION ' IN SECTION 43(5) OF THE ACT, GIVES A SIMPLE TEST FOR DECIDING FOR THE PURPOSE OF INCOME-TAX WHAT A SPECULATIVE TRANSACTION MEANS. IF A CONTRACT FOR SALE OR PURCHASE IS ULTIMATELY SETTLED AND NO ACTUAL DELIVERY OF THE GOODS WAS EFFECTED UNDER THE SETTLE MENT THEN IT IS A SPECULATIVE TRANSACTION. THE REQUIREMENT OF SECTI ON 30 OF THE INDIAN CONTRACT ACT OF THE EXISTENCE OF THE INTENTI ON OF THE PARTIES EVEN AT THE TIME OF THE ORIGINAL CONTRACT N OT TO GIVE OR TAKE DELIVERY OF THE GOODS IN ORDER TO MAKE IT A ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 15 OF 19 SPECULATIVE/WAGERING TRANSACTION IS DISPENSED WITH FOR THE PURPOSE OF THE ACT AND IF ACTUAL DELIVERY IS NOT GI VEN/TAKEN UNDER THE SETTLEMENT OF CONTRACT, THEN THE INTENTION OF T HE PARTIES AT THE TIME OF THE CONTRACT BECOMES IM-MATERIAL. THUS, THE TRUE TEST IS DELIVERY OF COMMODITIES/GOODS AS PER THE CONTRACT, INCLUDING A FORWARDING CONTRACT. PROFIT/LOSS IN RESPECT OF UNPE RFORMED CONTRACTS IS CONSIDERED SPECULATION PROFIT/LOSS. IN SHORT, IN ORDER THAT A TRANSACTION MAY FALL WITHIN THE SCOPE OF THE EXPRESSION 'SPECULATIVE TRANSACTION', IT MUST BE A TRANSACTION IN WHICH A CONTRACT FOR PURCHASE OR SALE OF ANY COMMODITY, INC LUDING STOCKS AND SHARES, IS PERIODICALLY OR ULTIMATELY SETTLED O THERWISE THAN BY THE ACTUAL DELIVERY OR TRANSFER OF THE COMMODITY OR SCRIPS. 5.2.2. HERE, IT WOULD BE USEFUL TO APPRECIATE IN PR OPER PERSPECTIVE HOW HEDGE TRANSACTIONS ARE COMMERCIALLY UNDERSTOOD BEFORE DETERMINING THE TRUE SCOPE, WIDTH AND NATURE OF PROVISO (A) TO SECTION43(5). HEDGE CONTRACTS ARE THOSE CONTRACTS WHICH HEDGE AGAINST PREJUDICIAL PRICE FLU CTUATIONS. IN SPECULATIVE TRANSACTIONS THE MODUS OPERANDI OF PERS ONS INDULGING IN THEM IS THAT WHEN ONE ENTERS INTO A CO NTRACT OF PURCHASE, HE ALSO SIMULTANEOUSLY ENTERS INTO ONE OR MORE CONTRACTS OF SALE AGAINST THE SAME QUANTITY DELIVER ABLE AT THE SAME TIME EITHER TO THE ORIGINAL VENDOR OR TO SOMEO NE ELSE, SO AS EITHER TO SECURE PROFIT OR TO MINIMIZE LOSS, BEFORE THE VAIDA DAY ; AND SIMILARLY WHEN HE ENTERS INTO A CONTRACT OF SAL E, HE SIMULTANEOUSLY ENTERS INTO ONE OR MORE CONTRACTS TO PURCHASE THE SAME QUANTITY BEFORE THE VAIDA DAY. THE RESULT OF S UCH DEALINGS, WHEN THE SALE AND PURCHASE ARE TO AND FROM THE SAME PERSON, HAS THE EFFECT OF CANCELLING THE CONTRACTS LEAVING ONLY DIFFERENCES TO BE PAID. THE TECHNIQUE OF HEDGE TRADING CAN BE U NDERSTOOD IN SIMPLE TERMS. IT IS SAID THAT THE HEDGE CONTRACT IS SO CALLED BECAUSE IT ENABLES THE PERSONS DEALING WITH THE ACT UAL COMMODITY TO HEDGE THEMSELVES, I.E., TO INSURE THEM SELVES AGAINST ADVERSE PRICE FLUCTUATIONS. A DEALER OR A M ERCHANT ENTERS INTO A HEDGE CONTRACT WHEN HE SELLS OR PURCH ASES A COMMODITY IN THE FORWARD MARKET FOR DELIVERY AT A F UTURE DATE. HIS TRANSACTION IN THE FORWARD MARKET MAY CORRESPON D TO A PREVIOUS PURCHASE OR SALE IN THE READY MARKET OR HE MAY PROPOSE TO COVER IT LATER BY A CORRESPONDING TRANSA CTION IN THE READY MARKET, OR HE MAY OFFSET IT BY A REVERSE TRAN SACTION ON THE FORWARD MARKET ITSELF. HEDGING CONTRACTS NEED NOT S UCCEED THE ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 16 OF 19 CONTRACTS FOR SALE AND ACTUAL DELIVERY OF GOODS MAN UFACTURED, BUT THE LATTER MAY BE SUBSEQUENTLY ENTERED INTO, PR OVIDED THEY ARE WITHIN REASONABLE TIME. IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACTS OF SALES, THE TOTAL OF SUCH TRANS ACTIONS SHOULD NOT EXCEED THE TOTAL STOCKS OF THE RAW MATERIALS OR THE MERCHANDISE ON HAND WHICH WOULD INCLUDE EXISTING ST OCKS AS WELL AS THE STOCKS ACQUIRED UNDER THE FIRM CONTRACT S OF PURCHASE. AS PER THE ACCEPTED COMMERCIAL NORMS OBJECT OF A HE DGING CONTRACT IS TO SECURE ONESELF AGAINST LOSS IN A FUT URE DELIVERY CONTRACT, BUT SUCH TRANSACTIONS CANNOT BE REGARDED AS INTER- CONNECTED. EACH ONE IS INDEPENDENT OF THE OTHER. SO FAR AS THE PROFIT OR LOSS ARISING FROM A FUTURE DELIVERY CONTR ACT IS CONCERNED, IT IS DETERMINED ON THE DATE OF ACTUAL D ELIVERY IRRESPECTIVE OF THE DATE ON WHICH THE CONTRACT WAS ENTERED INTO. IN RESPECT OF A HEDGING CONTRACT, PROFIT/LOSS ARISI NG THERE FROM CAN BE ASCERTAINED OR CRYSTALLISED AT FIXED INTERVA LS OF THE TERM WHEN THE CLEARANCE TAKES PLACE. 5.2.2.A. BY RESORTING TO COUNTERBALANCING TRANSACTI ONS IN THE MARKET FOR THE READY COMMODITY ON THE ONE HAND AND IN THE HEDGE MARKET ON THE OTHER HAND, THE HEDGER SEEKS TO SAFEGUARD HIS POSITION. THE MOVEMENT OF PRICES IN THE TWO MAR KETS MAY NOT ALWAYS FOLLOW AN IDENTICAL COURSE AND THE HEDGER MI GHT AT TIMES GAIN AND AT TIMES LOSE BUT SUCH A GAIN OR LOSS WOUL D BE MARGINAL AND FAR LESS THAN WHAT IT WOULD BE IF THE PERSON HA D NOT HEDGED AT ALL. WHILE, HOWEVER, THE HEDGING OPERATION PROTE CTS THE HEDGER AGAINST LOSS ARISING FROM ADVERSE FLUCTUATIO NS IN PRICES, IT ALSO PREVENTS HIM FROM MAKING WINDFALL PROFIT OW ING TO FAVOURABLE FLUCTUATIONS IN PRICES AS WELL. THE FORG OING OF SUCH A POSSIBLE WINDFALL PROFIT IS THE PRICE WHICH HE PAYS FOR THE INSURANCE AGAINST LOSS. THIS WELL-KNOWN TECHNIQUE, OF HEDGE TRADING CLEARLY IMPLIES FORWARD CONTRACTS BOTH WAYS , NAMELY, FOR SALE AND PURCHASE WITH A VIEW TO GUARDING AGAINST A DVERSE PRICE FLUCTUATIONS. THESE FORWARD CONTRACTS BY WAY OF HED GE TRANSACTIONS USUALLY AFFORD A COVER TO A TRADER INA SMUCH AS HIS LOSS IN THE READY MARKET IS OFFSET BY A PROFIT IN T HE FORWARD MARKET AND VICE VERSA. IT, THEREFORE, FOLLOWS THAT IN ORDER TO EFFECTIVELY HEDGE AGAINST ADVERSE PRICE FLUCTUATION S OF THE MANUFACTURED GOODS OR MERCHANDISE, A MANUFACTURER O R MERCHANT HAS NECESSARILY TO ENTER INTO FORWARD TRAN SACTIONS OF SALE AND PURCHASE BOTH, AND WITHOUT THESE CONTRACTS OF SALE AND ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 17 OF 19 PURCHASE CONSTITUTING HEDGE TRANSACTIONS, THERE WOU LD BE NO EFFECTIVE INSURANCE AGAINST THE RISK OF LOSS IN THE PRICE FLUCTUATIONS OF THE COMMODITY, MANUFACTURED OR THE MERCHANDISE SOLD. 5.3. HEDGING CONTRACTS ARE DEALT IN CLAUSE (A) OF T HE PROVISO TO SECTION 43(5) OF THE ACT. FROM THE ABOVE DISCUSSION IT CAN SAFELY STATED THAT THE SAID CLAUSE APPLIES, IF FOLLOWING C ONDITIONS ARE FULFILLED: (1) THERE IS A CONTRACT FOR ACTUAL DELIVERY OF GOODS MA NUFACTURED BY THE ASSESSEE /A MERCHANDISE SOLD BY IT, (2) ASSESSEE MUST BE A SUBSEQUENT TRANSACTION INTEND TO GUARD AGAINST LOSSES THROUGH FUTURE PRICE FLUCTUATIONS IN RESPECT OF SUCH CONTRACT, (3) TRANSACTION IN QUESTION MUST BE A CONTRACT ENTERED INTO IN RESPECT OF RAW MATERIALS OR MERCHANDISE IN THE COUR SE OF THE ASSESSEE'S MANUFACTURING BUSINESS AND IT SHOULD HAV E BEEN SETTLED OTHERWISE THAN BY ACTUAL DELIVERY OF GOODS, (4) HEDGING CONTRACTS MAY BE BOTH WITH REGARD TO SALES AND PURCHASES, (5) HEDGING CONTRACTS NEED NOT SUCCEED THE CONTRACTS FO R SALE AND ACTUAL DELIVERY OF GOODS MANUFACTURED, BUT THE LATTER MAY BE SUBSEQUENTLY ENTERED INTO, PROVIDED THEY ARE WITHIN THE REASONABLE TIME NOT EXCEEDING GENERALLY THE ASSESSM ENT YEAR, (6) IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACTS OF SALES, THE TOTAL OF SUCH TRANSACTIONS SHOULD NOT EXCEED THE TO TA L STOCKS OF THE RAW MATERIALS OR THE MERCHANDISE ON HAND WHICH WOULD INCLUDE EXISTING STOCKS AS WELL AS THE STOCKS ACQUI RED UNDER THE FIRM CONTRACTS OF PURCHASES, (7) THE HEDGING CONTRACT NEED NOT NECESSARILY BE IN THE SAME VARIETY OF THE COMMODITY THEY COULD BE IN CONNECTED COMMODITIES, E.G., ONE TYPE OF COTTON AGAINST ANOTHER TYPE OF COTTON. IN OTHER WORDS UNLESS THE ASSESSEE SHOWS THAT THERE WAS SOME EXIST ING CONTRACT IN RESPECT OF WHICH HE WAS LIKELY TO SUFFER A LOSS BECAUSE OF FUTURE PRICE FLUCTUATI ONS AND THAT IT WAS TO SAFEGUARD AGAINST SUCH LOSS THAT HE ENTERED INTO THE FORWARD CONTRACT S OF SALE, HE COULD NOT CLAIM THE BENEFIT OF CLAUSE (A) OF THE PR OVISO TO SECTION ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 18 OF 19 43(5). WITH REGARD TO SPECULATIVE / HEDGING TRANSAC TIONS WE HAD BENEFIT OF PERUSING THE JUDGMENTS OF M.G.BROS. V. C IT [1985] 154 ITR 695/20 TAXMAN 90 (AP) , NUDDEA MILLS CO. LTD. V. CIT [1988] 171 ITR 169/[1987] 35 TAXMAN 3 (CAL.) , DELHI FLOUR MILLS CO. LTD. V CIT [1974] 95 ITR 151 (DELHI) AND PANKAJ OIL MILLS V CIT [1978] 115 ITR 824 (GUJ.) DELIVERED BY THE HON'BLE HIGH COURTS OF ANDHRA PRAD ESH, CALCUTTA, DELHI AND GUJARAT RESPECTIVELY.' 4.5.11 AS DISCUSSED EARLIER, IN THE CASE ON HAND, THERE HAS BEEN AN EXISTING CONTRACT WITH A BINDING OBLIGATION ACCR UED AGAINST THE ASSESSEE WHEN IT ENTERED INTO FOREX FORWARD CON TRACTS. THE FORWARD CONTRACTS ARE IN RESPECT OF CONSIDERATION F OR EXPORT PROCEEDS, WHICH ARE REVENUE ITEMS. THERE IS AN ACT UAL CONTRACT FOR SALE OF MERCHANDISE. IN THIS FACTUAL MATRIX, I T IS CLEAR IN OUR VIEW THAT THE TRANSACTION IN QUESTION WILL NOT QUAL IFY TO BE CALLED AS SPECULATIVE TRANSACTION. IN VIEW OF THE FACTS A ND CIRCUMSTANCES OF THE CASE ON HAND, AS DISCUSSED ABO VE, WE HOLD THAT THE PROVISION ON DERIVATIVE CONTRACTS IS ALLOW ABLE AS EXPENDITURE. WE, ACCORDINGLY ALLOW THE GROUNDS AT S. NOS. 1 TO 9 RAISED BY THE ASSESSEE. 18. SINCE LD. CIT(A) HAS RENDERED THE DECISION FOLL OWING THE DECISION RENDERED BY ITAT, WE DO NOT FIND ANY INFIR MITY IN HIS ORDER PASSED ON THIS ISSUE. 19. IN THE RESULT, THE APPEAL FILED BY THE REVENUE IS DISMISSED. ORDER PRONOUNCED IN THE OPEN COURT ON 2 ND DEC, 2020 SD/- (GEORGE GEORGE K.) JUDICIAL MEMBER SD/- (B.R. BASKARAN) ACCOUNTANT MEMBER BANGALORE, DATED 2 ND DEC, 2020. VG/SPS ITA NO.119/BANG/2016 M/S. ACER INDIA PRIVATE LIMITED, BANGALORE PAGE 19 OF 19 COPY TO: 1. THE APPLICANT 2. THE RESPONDENT 3. THE CIT 4. THE CIT(A) 5. THE DR, ITAT, BANGALORE. 6. GUARD FILE BY ORDER ASST. REGISTRAR, ITAT, BANGALORE.