The ACIT, Cochin V. M/s.SUD Chemie India P. Ltd, Cochin

ITA 41/COCH/2017

• Counselvise Citation: [2018] 126 COUNSELVISE.COM (IT) 4431 (ITAT-COCHIN)
• Duration Of Justice: 1 year(s) 17 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 28-02-2018
• Appeal Filed By: Department
• Order Result: Partly Allowed
• Bench Allotted: DB
• Assessment Year: 2010-2011
• Appeal Filed On: 10-02-2017
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: A DHANARAJ
• Assessee Lawyers: RADHESH BHAT
• Keywords: Capital asset; Business income; Depreciation; Business expenditure; Cost of acquisition; Speculation loss; Revenue expenditure; Capital expenditure
• Section: 14A; 37(1); 43(5); 37; 56

Judgement Text

1 IN THE INCOME TAX APPELLATE TRIBUNAL COCHIN BENCH, COCHIN BEFORE S/SHRI CHANDRA POOJARI , AM & GEORGE GEORGE K., JM I.T.A. NOS. 3, 17 & 41/COCH/2017 ASSESSMENT YEAR S : 2008 - 09, 2009 - 10 & 2010 - 11 THE ASSISTANT COMMISSIONER OF INCOME-TAX, CIRCLE-2(1), KOCHI VS. M/S. SUD CHEMIE INDIA PVT. LTD., EDAYAR INDUSTRIAL DEVELOPMENT AREA, BINANIPURAM, EDAYAR-683 502. [PAN : AAACU 3342E] (REVENUE - APPELLANT) (ASSESSEE - RESPONDENT) REVENUE BY SHRI A. DHANARAJ, SR. DR ASSESSEE BY SHRI RADHESH BHAT, CA DATE OF HEARING 27 /0 2 /2018 DATE OF PRONOUNCEMENT 28 / 0 2 /2018 O R D E R PER CHANDRA POOJARI, ACCOUNTANT MEMBER: THESE THREE APPEALS BY THE REVENUE ARE DIRECTED AG AINST THE DIFFERENT ORDERS OF THE CIT(A) FOR THE ASSESSMENT YEARS 2008-09, 200 9-10 AND 2010-11. 2. SINCE THE ISSUES INVOLVED IN THESE APPEALS ARE COMMON, THEY WERE HEARD TOGETHER AND ARE BEING DISPOSED OF BY THIS COMMON O RDER. I.T.A. NOS./ 3, 17 & 41/C/2017 2 3. THE FIRST COMMON GROUND IN I.T.A. NO. 03/COCH/2 017 AND 17/COCH/2017 IS WITH REGARD TO DELETION OF ADDITION BY CIT(A) ON PR OVISION MADE TOWARDS MTM LOSS ON FORWARDING CONTRACTS IN THE YEAR IN WHICH T HE PROVISION WAS MADE IN THE BOOKS OF ACCOUNT. 4. WE CONSIDER THE FACTS AS NARRATED FOR THE ASSES SMENT YEAR 2008-09. THE ASSESSEE HAD PROVIDED FOR LOSS ON FOREX DERIVATIVES AMOUNTING TO RS.2,42,86,625/- FOR THE ASSESSMENT YEAR 2008-09 AN D RS.1,98,37,275/- FOR THE ASSESSMENT YEAR 2009-10. THE ASSESSING OFFICER OBS ERVED AS FOLLOWS: 2.1 AS PER THE STATEMENT OF SIGNIFICANT ACCOUNTING POLICIES (SCHEDULE 21 : NOTES FORMING PART OF ACCOUNTS), EXCHANGE GAIN OR L OSS ON DERIVATIVE INSTRUMENTS ENTERED TO HEDGE RISKS ASSOCIATED WITH FOREIGN CURRENCY FLUCTUATIONS AND ON FORWARD EXCHANGE CONTRACTS, WHI CH ARE INTENDED TO HEDGE THE FOREIGN CURRENCY RISKS OF FUTURE TRANSACTIONS I N RESPECT OF WHICH FIRM COMMITMENTS ARE MADE OR WHICH ARE HIGHLY PROBABLE F ORECASTS TRANSACTIONS, ARE DETERMINED BY MARKING SUCH CONTRACTS OUTSTANDIN G ON BALANCE SHEET DATE TO MARKET. EXCHANGE LOSS ARISING OF SUCH INSTRUMENT S/CONTRACTS IS PROVIDED, IN THE ACCOUNTS, WHICH GAINS ARE NOT RECOGNIZED. AS PER THE NOTES TO ACCOUNTS 7(C), THE OUTSTANDING CONTRACTS AS AT BALANCE SHEET DATE, OTHER THAN FORWARD CONTRACTS TO HEDGE E XISTING RECEIVABLES, TO WHICH ACCOUNTING STANDARD 11 THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES APPLIES, HAVE BEEN MARKED TO MARKET AS ON 31 ST MARCH, 2008 AND THE EXCHANGE LOSS ARISING ON THE SAME AMOUNTING TO RS.2 ,42,06,625/- HAVE BEEN PROVIDED IN THE ACCOUNTS FOR THE YEAR, IN ACCORDANC E WITH THE ANNOUNCEMENT OF ACCOUNTING FOR DERIVATIVES ISSUED BY THE ICAI. 2.2 THE LOSSES ON FOREX DERIVATIVES HAVE BEEN PROV IDED ON MARKED TO MARKET BASIS AND IT ONLY AN ANTICIPATED LOSS, CONTINGENT O N THE HAPPENING OF A FUTURE EVENT. THE LOSS HAS NOT ACTUALLY ARISEN OR BEEN IN CURRED; THE PROVISION MADE IS IN RESPECT OF OPEN CONTRACTS. 2.3 NO SUCH PROVISION HAS BEEN MADE IN EARLIER YE ARS. I.T.A. NOS./ 3, 17 & 41/C/2017 3 2.4 THE SUPREME COURT DECISION REPORTED IN 312 IT R 254 IS DISTINGUISHED ON FACTS. THE DECISION IN THAT CASE WAS RENDERED IN T HE CONTEXT OF AS 11. THE COURT OBSERVED THAT THE ASSESSEE SHOULD GIVE THE SA ME TREATMENT FOR LOSSES CLAIMED TO HAVE ACCRUED AND TO THE GAINS THAT MAY A CCRUE TO IT. IN THE INSTANT CASE, THE ASSESSEE PROVIDES FOR ANTICIPATED LOSSES ON MTM BASIS, BUT DOES NOT RECOGNIZE THE GAINS. 2.5 RELIANCE IS PLACED ON CBDT INSTRUCTION NO 3/20 10 DATED 23/03,2010 ON THE TREATMENT OF NOTIONAL LOSSES ON FOREX DERIVATIV ES. IT WAS NOTED THAT MARKED TO MARKET LOSS IS A NOTIONAL LOSS AS NO SALE /CONCLUSION/SETTLEMENT OF CONTRACT HAS TAKEN PLACE AND THE ASSET CONTINUES TO BE OWNED BY THE COMPANY. SIMILARLY, THE SAME IS THE POSITION FOR ASSESSMENT YEAR 2009-10. ON APPEAL, THE CIT(A) OBSERVED THAT IT IS BUSINESS LOSS AND ALLOWE D THE CLAIM OF THE ASSESSEE. 5. AGAINST THIS, THE REVENUE IS IN APPEAL BEFORE US FOR BOTH THE ASSESSMENT YEARS. 6. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSE D THE MATERIAL ON RECORD. A SIMILAR VIEW WAS TAKEN IN THE ITAT BANGALORE IN QUA LITY ENGINEERING AND SOFTWARE TECHNOLOGIES PVT. LTD. VS. DCIT REPORTED I N 152 ITD 320 WHEREIN IT WAS HELD AS FOLLOWS:- WE HAVE HEARD THE RIVAL CONTENTIONS AND PERUSED AN D CAREFULLY CONSIDERED THE MATERIAL ON RECORD, THE SUBMISSIONS MADE AND THE JU DICIAL DECISIONS PLACED RELIANCE UPON. IT WOULD BE RELEVANT TO BRIEFLY EXAM INE THE CONCEPT OF 'DERIVATIVES' AND THE UNDERLYING NATURE OF THESE TR ANSACTIONS BEFORE DECIDING WHETHER THEY ARE 'SPECULATIVE TRANSACTIONS' OR NOT; WHETHER THEY REPRESENT 'NOTIONAL LOSS' OR REAL LOSS AND WHETHER OR NOT THE Y ARE ALLOWABLE AS DEDUCTION. SIMPLY PUT, A DERIVATIVE IS A FINANCIAL INSTRUMENT WHOSE VALUE DEPENDS ON THE VALUES OF THE UNDERLYING EXPOSURE. THE UNDERLYING E XPOSURE IN THE CASE OF FOREX DERIVATIVES IS THE FOREIGN EXCHANGE RATES. THE COMM ON FOREIGN EXCHANGE DERIVATIVES ARE, FORWARD CONTRACTS, OPTION CONTRACT S AND SWAP CONTRACTS, ETC. I.T.A. NOS./ 3, 17 & 41/C/2017 4 THESE INSTRUMENTS ARE USED TO HEDGE THE CURRENCY RI SK ON ACCOUNT OF ADVERSE CURRENCY MOVEMENTS. 4.5.2 THE TERM MARKED TO MARKET' LOSSES (MTM) REFE RS TO LOSSES COMPUTED AS ON A PARTICULAR DATE WITH REFERENCE TO PREVAILING EXCHANGE RATE IN RESPECT OF CONTRACTS THAT HAVE NOT MATURED (I.E. OPEN CONTRACT S). AS PER THE PRESCRIBED ACCOUNTING STANDARDS, COMPANIES ARE REQUIRED TO ACC OUNT FOR THE MTM LOSSES IN THEIR BOOKS OF ACCOUNT DESPITE THE FACT THAT THE CONTRACT HAS NOT YET MATURED AS ON THE BALANCE SHEET DATE. 4.5.3 FOREIGN EXCHANG E FORWARD CONTRACT MEANS AN AGREEMENT TO EXCHANGE DIFFERENT CURRENCIES AT A FORWARD RATE. FORWARD RATE IS THE SPECIFIED RATE FOR EXCHANGE OF CURRENCY AT A SPECIFIED FUTURE DATE. THE ASSESSEE, IN THE CASE ON HAND, ENTERED INTO A FORWA RD CONTRACT WITH THE BANK TO BUY OR SELL FOREIGN EXCHANGE AT AN AGREED PRICE ON A FUTURE DATE IN ORDER TO HEDGE AGAINST POSSIBLE FUTURE FINANCIAL LOSS DUE TO FLUCTUATION IN THE RATE OF FOREIGN CURRENCY. THEREFORE; (I) FIRSTLY, THE FOREIGN EXCHANGE FORWARD CO NTRACT CREATED A CONTINUING, BINDING OBLIGATION ON THE DATE OF CONTRACT AGAINST THE ASSESSEE TO FULFILL THE SAME ON THE DATE OF MATURITY; AND (II) SECONDLY, IT IS IN THE NATURE OF A HEDGING CON TRACT BECAUSE IT IS A CONTRACT ENTERED INTO AGAINST POSSIBLE FUTURE FINANCIAL LOSS ES. IT FOLLOWS FROM THE ABOVE THAT WHILE IT IS TRUE THA T THE ASSESSEE WOULD COME TO KNOW OF THE ACTUAL PROFIT I LOSS ONLY ON THE DATE O F MATURITY, UNLESS THERE IS ANY PREMATURE CANCELLATION OF THE CONTRACT, IT IS EQUAL LY TRUE THAT THE ASSESSEE COULD ANTICIPATE THE LOSS ON THE VALUATION DATE, SA Y 31 MARCH, WITH REASONABLE ACCURACY. PRUDENT ACCOUNTING AND COMMERCIAL PRINCIP LES REQUIRE THAT ALL ACCRUED LOSSES HAVE TO BE TAKEN INTO ACCOUNT. 4.5.4 HAVING CONSIDERED THE NATURE OF THE CONTRACT; IT NEEDS TO BE EXAMINED WHETHER ON ACCOUNT OF THE EXISTING OBLIGATION ARISI NG OUT OF THE CONTRACT, A LIABILITY ACCRUED AS PER THE PROVISIONS OF THE INCO ME TAX ACT. IN THIS REGARD, IT IS NECESSARY TO CONSIDER AND TAKE INTO ACCOUNT SOME OF THE SETTLED PRINCIPLES REGARDING ACCOUNTING PROPOSITIONS, WHICH ARE AS UND ER: (I) INCOME IS TO BE ACCOUNTED FOR ONLY WHEN THE RIG HT TO RECEIVE THE SAME HAS ACCRUED IN FAVOUR OF THE ASSESSEE, THEREBY CREATING A REALISABLE DEBT IN ITS FAVOUR; I.E. A LEGALLY ENFORCEABLE RIGHT; (II) ALL ANTICIPATED LOSSES, WHICH ACCRUED ON THE D ATE OF BALANCE SHEET HAVE TO BE ACCOUNTED FOR AS PER PRUDENT ACCOUNTING POLICIES ; (III) STOCK-IN-TRADE IS VALUED AT THE END OF THE PR EVIOUS YEAR IN ACCORDANCE WITH THE MATCHING PRINCIPLE IN ORDER TO FIND OUT THE TRU E PROFIT I/LOSS. (IV) THE METHOD OF ACCOUNTING CONSISTENTLY FOLLOWED BY THE ASSESSEE SHOULD NOT BE DISCARDED CASUALLY WITHOUT HAVING GOOD AND SOUND REASONS FOR THE SAME. 4.5.5 THE ASSESSEE CONTENDS THAT THE FORWARD CONTRA CT WAS TO BE REVALUED IN ACCORDANCE WITH THE ACCOUNTING STANDARDS (AS) 11 AND THEREFORE HE HAS NO OPTION BUT TO DETERMINE THE PROFIT / LOSS IN REGARD TO UNMATURED FOREIGN I.T.A. NOS./ 3, 17 & 41/C/2017 5 EXCHANGE FORWARD CONTRACTS IN ACCORDANCE WITH THE C URRENCY RATES AS ON THE VALUATION DATE VIZ. MARCH 31ST THIS CONTENTION OF T HE ASSESSEE IS NOT DISPUTED. THE ASSESSING OFFICER, HOWEVER, IS OF THE VIEW THAT SUCH TREATMENT IN THE BOOKS OF ACCOUNT PER SE DID NOT GIVE THE ASSESSEE THE RIG HT TO CLAIM THE LOSS UNDER THE INCOME TAX ACT. IT IS THIS CONTENTION OF THE AS SESSING OFFICER THAT REQUIRES TO BE EXAMINED, HAVING REGARD TO THE FUNDAMENTAL CO MMERCIAL PRINCIPLES WHICH HAVE RECEIVED JUDICIAL RECOGNITION. IT IS A SETTLED PRINCIPLE, UPHELD IN SEVERAL DECISIONS OF THE COURTS, THAT DEDUCTION IS ALLOWABL E UNDER THE ACT IN RESPECT OF LIABILITIES THAT HAVE CRYSTALLISED DURING THE YEAR. IF AN ANTICIPATED FUTURE LIABILITY IS COUPLED WITH A PRESENT OBLIGATION, THEN THAT RES ULTS IN CRYSTALLISED LIABILITY, EVEN THOUGH THE QUANTIFICATION MAY VARY DEPENDING U PON THE TERMS OF CONTRACT. A CONTINGENT LIABILITY DEPENDS PURELY ON THE HAPPENING OR NOT HAPPENING OF AN EVENT. WHEREAS, IF AN EVENT HAS TAK EN PLACE, WHICH IN THE CASE ON HAND WAS OF ENTERING INTO THE CONTRACT AND UNDER TAKING OF THE OBLIGATION TO MEET THE LIABILITY, AND ONLY THE CONSEQUENTIAL EFFE CT OF THE SAME IS TO BE DETERMINED, THEN IT CANNOT BE SAID THAT IT IS IN TH E NATURE OF CONTINGENT LIABILITY. IT IS TO BE BORNE IN MIND THAT THE ISSUES RELATING TO THE ACCRUAL OF INCOME CANNOT BE DECIDED ON THE SAME FOOTING AND CONSIDERA TIONS ON WHICH ISSUES RELATING TO LOSSES ARE TO BE DECIDED. IN THE CASE O F LOSS! EXPENDITURE, THE CONCEPT OF REASONABLE CERTAINTY TO MEET AN EXISTING OBLIGATION COMES INTO PLAY; WHICH IN LEGAL TERMINOLOGY IS REFERRED TO AS 'CRYST ALLIZATION OF LIABILITY'. THIS IS IN KEEPING AND CONSONANCE WITH THE PRINCIPLE OF PRUDEN CE AS CONSIDERED BY THE HONBLE APEX COURT IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. 312 ITR 254(SC). THE SUBSTANTIAL QUESTIONS OF LAW BEFORE TH E HON'BLE APEX COURT FOR CONSIDERATION AS EXTRACTED FROM PARA 3 OF ITS ORDER IS AS UNDER: '3. IN THIS BATCH OF CIVIL APPEALS, THE FOLLOWING Q UESTION ARISES FOR DETERMINATION: '(I) WHETHER, ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE ADDITIONAL LIABILITY ARISING ON ACCOUNT OF FLUCTUAT ION IN THE RATE OF EXCHANGE IN RESPECT OF LOANS TAKEN FOR REVENUE PURPOSES COULD BE ALLOWED AS DEDUCTION UNDER S. 37(1) IN THE YEAR OF FLUCTUATION IN THE RA TE OF EXCHANGE OR WHETHER THE SAME COULD ONLY BE ALLOWED IN THE YEAR OF REPAYMENT OF SUCH LOANS? (II) WHETHER THE ASSESSEE IS ENTITLED TO ADJUST THE ACTUAL COST OF IMPORTED ASSETS ACQUIRED IN FOREIGN CURRENCY ON ACCOUNT OF F LUCTUATION IN THE RATE OF EXCHANGE AT EACH BALANCE SHEET DATE, PENDING ACTUAL PAYMENT OF THE VARIED LIABILITY? THE ABOVE QUESTIONS OF LAW WERE ELABORAT ED BY THEIR LORDSHIPS AT PARA 4 OF THE ORDER WHICH IS EXTRACTED AS UNDER:- '4. AT THE OUTSET, FOR THE SAKE OF CONVENIENCE, WE MAY STATE THAT IN THIS BATCH OF CIVIL APPEALS BROADLY WE HAVE BEFORE US TWO CATE GORIES. IN THE FIRST CATEGORY, WE ARE CONCERNED WITH EXCHAN GE DIFFERENCES ARISING IN FOREIGN CURRENCY TRANSACTION ON REVENUE ITEMS. IN SUCH CATEGORY, WE ARE CONCERNED WITH THE ASSESSEE(S) INCURRING LOSS ON REVENUE ACCOUNT. IN THAT CATEGORY, WE ARE CONCERNED WITH THE PROVISIONS OF S S. 28, 29, 37(1) AND 145 OF THE IT ACT, 1961 ('1961 ACT'). IN THE SECOND CATEGO RY OF CASES, WE ARE I.T.A. NOS./ 3, 17 & 41/C/2017 6 CONCERNED WITH EXCHANGE DIFFERENCES ARISING ON REPA YMENT OF LIABILITIES INCURRED FOR THE PURPOSE OF ACQUIRING FIXED ASSETS. IN OTHER WORDS, IN THE SECOND CATEGORY OF CASES, WE ARE CONCERNED WITH THE ASSESSEE(S) INCURRING LIABILITIES ON CAPITAL ACCOUNT. IN SUCH CASES, WE A RE REQUIRED TO CONSIDER THE PROVISIONS OF S. 43(1), 43A (BOTH, BEFORE AND AFTER AMENDMENTS VIDE FINANCE ACT, 2002).' 4.5.6 THE HON'BLE APEX COURT AFTER IT CONSIDERED AN D EXAMINED THE ISSUE, DECIDED AS AT PARAS 13 TO 21 OF ITS ORDER WHICH ARE EXTRACTED AS UNDER:'13. AS STATED ABOVE, ONE OF THE MAIN ARGUMENTS ADVANCED BY THE LEARNED ADDL. SOLICITOR GENERAL ON BEHALF OF THE DEPARTMENT BEFOR E US WAS THAT THE WORD 'EXPENDITURE' IN S. 37(1) CONNOTES 'WHAT IS PAID OU T' AND THAT WHICH HAS GONE IRRETRIEVABLY. IN THIS CONNECTION, HEAVY RELIANCE W AS PLACED ON THE JUDGMENT OF THIS COURT IN THE CASE OF INDIAN MOLASSES COMPANY. RELYING ON THE SAID JUDGMENT, IT WAS SOUGHT TO BE ARGUED THAT THE INCRE ASE IN LIABILITY AT ANY POINT OF TIME PRIOR TO THE DATE OF PAYMENT CANNOT BE SAID TO HAVE GONE IRRETRIEVABLY AS IT CAN ALWAYS COME BACK. ACCORDING TO THE LEARNE D COUNSEL, IN THE CASE OF INCREASE IN LIABILITY DUE TO FOREIGN EXCHANGE FLUCT UATIONS, IF THERE IS A REVALUATION OF THE RUPEE VIS--VIS FOREIGN EXCHANG E AT OR PRIOR TO THE POINT OF PAYMENT, THEN THERE WOULD BE NO QUESTION OF MONEY H AVING GONE IRRETRIEVABLY AND CONSEQUENTLY, THE REQUIREMENT OF 'EXPENDITURE' IS NOT MET. CONSEQUENTLY, THE ADDITIONAL LIABILITY ARISING ON ACCOUNT OF FLUC TUATION IN THE RATE OF FOREIGN EXCHANGE WAS MERELY A CONTINGENT/NOTIONAL LIABILITY WHICH DOES NOT CRYSTALLIZE TILL PAYMENT. IN THAT CASE, THE SUPREME COURT WAS C ONSIDERING THE MEANING OF THE EXPRESSION 'EXPENDITURE INCURRED' WHILE DEALING WITH THE QUESTION AS TO WHETHER THERE WAS A DISTINCTION BETWEEN THE ACTUAL LIABILITY IN PRAESENTI AND A LIABILITY DE FTITURO. THE WORD 'EXPENDITURE' IS NOT DEFINED IN THE 1961 ACT. THE WORD 'EXPENDITURE' IS, THEREFORE, REQUIRED TO BE UN DERSTOOD IN THE CONTEXT IN WHICH IT IS USED. SEC. 37 ENJOINS THAT ANY EXPENDIT URE NOT BEING EXPENDITURE OF THE NATURE DESCRIBED IN SS. 30 TO 36 LAID OUT OR EX PENDED WHOLLY AND EXCLUSIVELY FOR THE PURPOSES OF THE BUSINESS SHOULD BE ALLOWED IN COMPUTING THE INCOME CHARGEABLE UNDER THE HEAD 'PROFITS AND G AINS OF BUSINESS'. IN SS. 30 TO 36, THE EXPRESSIONS 'EXPENSES INCURRED' AS WE LL AS 'ALLOWANCES AND DEPRECIATION' HAS ALSO BEEN USED. FOR EXAMPLE, DEPR ECIATION AND ALLOWANCES ARE DEALT WITH IN S. 32. THEREFORE, PARLIAMENT HAS USED THE EXPRESSION 'ANY EXPENDITURE' IN S. 37 TO COVER BOTH. THEREFORE, THE EXPRESSION 'EXPENDITURE' AS USED IN S. 37 MAY, IN THE CIRCUMSTANCES OF A PARTIC ULAR CASE, COVER AN AMOUNT WHICH IS REALLY A 'LOSS' EVEN THOUGH THE SAID AMOUN T HAS NOT GONE OUT FROM THE POCKET OF THE ASSESSEE. 14. IN THE CASE OF M.P. FINANCIAL CORPORATION VS. C IT (1986) 51 CTR (MP) 249 (1987) 165 ITR 765 (MP) THE MADHYA PRADESH HIGH COURT HAS HELD THAT THE EXPRESSION 'EXPENDITURE' AS USED IN S. 37 MAY, IN THE CIRCUMST ANCES OF A PARTICULAR CASE, COVER AN AMOUNT WHICH IS A 'LOSS' EVEN THOUGH THE SAID AMOUN T HAS NOT GONE OUT FROM THE POCKET OF THE ASSESSEE. THIS VIEW OF THE MADHYA PRA DESH HIGH COURT HAS BEEN APPROVED BY THIS COURT IN THE CASE OF MADRAS INDUSTRIAL INVE STMENT CORPORATION LTD. VS. CIT (1997) 139 CTR (SC) 555 (1997) 225 ITR 802 (SC). AC CORDING TO THE LAW AND PRACTICE OF INCOME-TAX BY KANGA AND PALKHIVALA, S. 37(1) IS A RESIDUARY SECTION EXTENDING THE I.T.A. NOS./ 3, 17 & 41/C/2017 7 ALLOWANCE TO ITEMS OF BUSINESS EXPENDITURE NOT COVE RED BY SS. 30 TO 36. THIS SECTION, ACCORDING TO THE LEARNED AUTHOR, COVERS CASES OF BU SINESS EXPENDITURE ONLY, AND NOT OF BUSINESS LOSSES WHICH ARE, HOWEVER, DEDUCTIBLE ON O RDINARY PRINCIPLES OF COMMERCIAL ACCOUNTING. IT IS THIS PRINCIPLE WHICH ATTRACTS THE PROVISIONS OF S. 145. THAT SECTION RECOGNIZES THE RIGHTS OF A TRADER TO ADOPT EITHER T HE CASH SYSTEM OR THE MERCANTILE SYSTEM OF ACCOUNTING. THE QUANTUM OF ALLOWANCES PER MITTED TO BE DEDUCTED UNDER DIVERSE HEADS UNDER SS. 30 TO 43C FROM THE INCOME, PROFITS AND GAINS OF A BUSINESS WOULD DIFFER ACCORDING TO THE SYSTEM ADOPTED. THIS IS MADE CLEAR BY DEFINING THE WORD 'PAID' IN S. 43(2), WHICH IS USED IN SEVERAL SS. 30 TO 43C, AS MEANING ACTUALLY PAID OR INCURRED ACCORDING TO THE METHOD OF ACCOUNTING UPON THE BASIS ON WHICH PROFITS OR GAINS ARE COMPUTED UNDER S. 28/29. THAT IS WHY IN DECIDIN G THE QUESTION AS TO WHETHER THE WORD EXPENDITURE' IN S. 37(1) INCLUDES THE WORD 'LO SSLL ONE HAS TO READ S. 37(1) WITH S. 28, S. 29 AND S. 145(1). ONE MORE PRINCIPLE NEEDS T O BE KEPT IN MIND. ACCOUNTS REGULARLY MAINTAINED IN THE COURSE OF BUSINESS ARE TO BE TAKE N AS CORRECT UNLESS THERE ARE STRONG AND SUFFICIENT REASONS TO INDICATE THAT THEY ARE UN RELIABLE. ONE MORE ASPECT NEEDS TO BE HIGHLIGHTED. UNDER S. 28(I), ONE NEEDS TO DECIDE TH E PROFITS AND GAINS OF ANY BUSINESS WHICH IS CARRIED ON BY THE ASSESSEE DURING THE PREV IOUS YEAR. THEREFORE, ONE HAS TO TAKE INTO ACCOUNT STOCK-IN-TRADE FOR DETERMINATION OF PR OFITS. THE 1961 ACT MAKES NO PROVISION WITH REGARD TO VALUATION OF STOCK. BUT TH E ORDINARY PRINCIPLE OF COMMERCIAL ACCOUNTING REQUIRES THAT IN THE P&L A/C THE VALUE O F THE STOCK-IN-TRADE AT THE BEGINNING AND AT THE END OF THE YEAR SHOULD BE ENTERED AT COS T OR MARKET PRICE, WHICHEVER IS THE LOWER. THIS IS HOW BUSINESS PROFITS ARISING DURING THE YEAR NEEDS TO BE COMPUTED. THIS IS ONE MORE REASON FOR READING S. 37(1) WITH S.145. FO R VALUING THE CLOSING STOCK AT THE END OF A PARTICULAR YEAR, THE VALUE PREVAILING ON T HE LAST DATE IS RELEVANT. THIS IS BECAUSE PROFITS/LOSS IS EMBEDDED IN THE CLOSING STOCK. WHIL E ANTICIPATED LOSS IS TAKEN INTO ACCOUNT, ANTICIPATED PROFIT IN THE SHAPE OF APPRECI ATED VALUE OF THE CLOSING STOCK IS NOT BROUGHT INTO ACCOUNT, AS NO PRUDENT TRADER WOULD CA RE TO SHOW INCREASE PROFITS BEFORE ACTUAL REALIZATION. THIS IS THE THEORY UNDERLYING T HE RULE THAT CLOSING STOCK IS TO BE VALUED AT COST OR MARKET PRICE, WHICHEVER IS THE LOWER. AS PROFITS FOR INCOME-TAX PURPOSES ARE TO BE COMPUTED IN ACCORDANCE WITH ORDINARY PRINCIPLES OF COMMERCIAL ACCOUNTING, UNLESS, SUCH PRINCIPLES STAND SUPERSEDED OR MODIFIED BY LEG ISLATIVE ENACTMENTS, UNREALIZED PROFITS IN THE SHAPE OF APPRECIATED VALUE OF GOODS REMAINING UNSOLD AT THE END OF THE ACCOUNTING YEAR AND CARRIED OVER TO THE FOLLOWING Y EARS ACCOUNT IN A CONTINUING BUSINESS ARE NOT BROUGHT TO THE CHARGE AS A MATTER OF PRACTI CE, THOUGH, AS STATED ABOVE, LOSS DUE TO FALL IN THE PRICE BELOW COST IS ALLOWED EVEN THO UGH SUCH LOSS HAS NOT BEEN REALIZED ACTUALLY. AT THIS STAGE, WE NEED TO EMPHASISE ONCE AGAIN THAT THE ABOVE SYSTEM OF COMMERCIAL ACCOUNTING CAN BE SUPERSEDED OR MODIFIED BY LEGISLATIVE ENACTMENT. THIS IS WHERE S. 145(2) COMES INTO PLAY. UNDER THAT SECTION , THE CENTRAL GOVERNMENT IS EMPOWERED TO NOTIFY FROM TIME TO TIME THE ACCOUNTIN G STANDARDS TO BE FOLLOWED BY ANY CLASS OF ASSESSEES OR IN RESPECT OF ANY CLASS OF IN COME. ACCORDINGLY, UNDER S. 209 OF THE COMPANIES ACT, MERCANTILE SYSTEM OF ACCOUNTING IS M ADE MANDATORY FOR COMPANIES. IN OTHER WORDS, ACCOUNTING STANDARD WHICH IS CONTINUOU SLY ADOPTED BY AN ASSESSEE CAN BE SUPERSEDED OR MODIFIED BY LEGISLATIVE INTERVENTION. HOWEVER, BUT FOR SUCH INTERVENTION OR IN CASES FALLING UNDER S. 145(3), THE METHOD OF ACC OUNTING UNDERTAKEN BY THE ASSESSEE CONTINUOUSLY IS SUPREME. IN THE PRESENT BATCH OF CA SES, THERE IS NO FINDING GIVEN BY THE AO ON THE CORRECTNESS OR COMPLETENESS OF THE ACCOUN TS OF THE ASSESSEE. EQUALLY, THERE IS NO FINDING GIVEN BY THE AO STATING THAT THE ASSESSE E HAS NOT COMPLIED WITH THE ACCOUNTING STANDARDS. I.T.A. NOS./ 3, 17 & 41/C/2017 8 15. FOR THE REASONS GIVEN HEREINABOVE, WE HOLD THAT , IN THE PRESENT CASE, THE LOSS' SUFFERED BY THE ASSESSEE ON ACCOUNT OF THE EXCHANGE DIFFERENCE AS ON THE DATE OF THE BALANCE SHEET IS AN ITEM OF EXPENDITURE UNDER S. 37 (1) OF THE 1961 ACT. 16. IN THE LIGHT OF WHAT IS STATED HEREINABOVE, IT IS CLEAR THAT PROFITS AND GAINS OF THE PREVIOUS YEAR ARE REQUIRED TO BE COMPUTED IN ACCORD ANCE WITH THE RELEVANT ACCOUNTING STANDARD. IT IS IMPORTANT TO BEAR IN MIND THAT THE BASIS ON WHICH STOCK-IN-TRADE IS VALUED IS PART OF THE METHOD OF ACCOUNTING. IT IS WELL EST ABLISHED, THAT, ON GENERAL PRINCIPLES OF COMMERCIAL ACCOUNTING, IN THE P&L ACCOUNT, THE VALU ES OF THE STOCK-IN-TRADE AT THE BEGINNING AND AT THE END OF THE ACCOUNTING YEAR SHO ULD BE ENTERED AT COST OR MARKET VALUE, WHICHEVER IS LOWER THE MARKET VALUE BEING AS CERTAINED AS ON THE LAST DATE OF THE ACCOUNTING YEAR AND NOT AS ON ANY INTERMEDIATE DATE BETWEEN THE COMMENCEMENT AND THE CLOSING OF THE YEAR, FAILING WHICH IT WOULD NOT BE POSSIBLE TO ASCERTAIN THE TRUE AND CORRECT STATE OF AFFAIRS. NO GAIN OR PROFIT CAN ARI SE UNTIL A BALANCE IS STRUCK BETWEEN THE COST OF ACQUISITION AND THE PROCEEDS OF SALE. THE W ORD 'PROFIT' IMPLIES A COMPARISON BETWEEN THE STATE OF BUSINESS AT TWO SPECIFIC DATES , USUALLY SEPARATED BY AN INTERVAL OF TWELVE MONTHS. STOCK-IN-TRADE IS AN ASSET. IT IS A TRADING ASSET. THEREFORE, THE CONCEPT OF PROFIT AND GAINS MADE BY BUSINESS DURING THE YEA R CAN ONLY MATERIALIZE WHEN A COMPARISON OF THE ASSETS OF THE BUSINESS AT TWO DIF FERENT DATES IS TAKEN INTO ACCOUNT. SEC. 145(1) ENACTS THAT FOR THE PURPOSE OF S. 28 AN D S. 56 ALONE, INCOME, PROFITS AND GAINS MUST BE COMPUTED IN ACCORDANCE WITH THE METHO D OF ACCOUNTING REGULARLY EMPLOYED BY THE ASSESSEE. IN THIS CASE, WE ARE CONC ERNED WITH S. 28. THEREFORE, S. 145(1) IS ATTRACTED TO THE FACTS OF THE PRESENT CAS E. UNDER THE MERCANTILE SYSTEM OF ACCOUNTING, WHAT IS DUE IS BROUGHT INTO CREDIT BEFO RE IT IS ACTUALLY RECEIVED; IT BRINGS INTO DEBIT AN EXPENDITURE FOR WHICH A LEGAL LIABILITY HA S BEEN INCURRED BEFORE IT IS ACTUALLY DISBURSED, (JUDGMENT OF THIS COURT IN THE CASE OF U NITED COMMERCIAL BANK VS. CIT (1999) 156 CTR (SC) 380 : (1999) 240 ITR 355 (SC)). THEREF ORE, THE ACCOUNTING METHOD FOLLOWED BY AN ASSESSEE CONTINUOUSLY FOR A GIVEN PE RIOD OF TIME NEEDS TO BE PRESUMED TO BE CORRECT TILL THE AO COMES TO THE CONCLUSION F OR REASONS TO BE GIVEN THAT THE SYSTEM DOES NOT REFLECT TRUE AND CORRECT PROFITS. AS STATE D, THERE IS NO FINDING GIVEN BY THE AO ON THE CORRECTNESS OF THE ACCOUNTING STANDARD FOLLO WED BY THE ASSESSEE(S) IN THIS BATCH OF CIVIL APPEALS. 17. HAVING COME TO THE CONCLUSION THAT VALUATION IS A PART OF THE ACCOUNTING SYSTEM AND HAVING COME TO THE CONCLUSION THAT BUSINESS LOSSES ARE DEDUCTIBLE UNDER S. 37(1) ON THE BASIS OF ORDINARY PRINCIPLES OF COMMERCIAL ACCOUNTI NG AND HAVING COME TO THE CONCLUSION THAT THE CENTRAL GOVERNMENT HAS MADE ACCOUNTING STA NDARD-II MANDATORY, WE ARE NOW REQUIRED TO EXAMINE THE SAID ACCOUNTING STANDARD (' AS'). 18. AS-II DEALS WITH GIVING OF ACCOUNTING TREATMENT FOR THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES. AS-II DEALS WITH EFFECTS OF EXCHANG E DIFFERENCES. UNDER PARA 2, REPORTING CURRENCY IS DEFINED TO MEAN THE CURRENCY USED IN PRESENTING THE FINANCIAL STATEMENTS. SIMILARLY, THE WORDS 'MONETARY ITEMS' A RE DEFINED TO MEAN MONEY HELD AND ASSETS AND LIABILITIES TO BE RECEIVED OR PAID IN FI XED AMOUNTS, E.G., CASH, RECEIVABLES AND PAYABLES. THE WORD 'PAID' IS DEFINED UNDER S. 43(2) . THIS HAS BEEN DISCUSSED EARLIER. SIMILARLY, IT IS IMPORTANT TO NOTE THAT FOREIGN CUR RENCY NOTES, BALANCE IN BANK ACCOUNTS DENOMINATED IN A FOREIGN CURRENCY, AND RECEIVABLES/ PAYABLES AND LOANS DENOMINATED IN I.T.A. NOS./ 3, 17 & 41/C/2017 9 A FOREIGN CURRENCY AS WELL AS SUNDRY CREDITORS ARE ALL MONETARY ITEMS WHICH HAVE TO BE VALUED AT THE CLOSING RATE UNDER AS-II. UNDER PARA 5, A TRANSACTION IN A FOREIGN CURRENCY HAS TO BE RECORDED IN THE REPORTING CURRENCY BY APP LYING TO THE FOREIGN CURRENCY AMOUNT THE EXCHANGE RATE BETWEEN THE REPORTING CURRENCY AN D THE FOREIGN CURRENCY AT THE DATE OF THE TRANSACTION. THIS IS KNOWN AS RECORDING OF T RANSACTION ON INITIAL RECOGNITION. PARA 7 OF AS-II DEALS WITH REPORTING OF THE EFFECTS OF CHA NGES IN EXCHANGE RATES SUBSEQUENT TO INITIAL RECOGNITION. PARA 7(A) INTER ALIA STATES TH AT ON EACH BALANCE SHEET DATE MONETARY ITEMS, ENUMERATED ABOVE, DENOMINATED IN A FOREIGN C URRENCY SHOULD BE REPORTED USING THE CLOSING RATE. IN CASE OF REVENUE ITEMS FALLING UNDER S. 37(1), PARA 9 OF AS-II WHICH DEALS WITH RECOGNITION OF EXCHANGE DIFFERENCES, NEE DS TO BE CONSIDERED. UNDER THAT PARA, EXCHANGE DIFFERENCES ARISING ON FOREIGN CURRENCY TR ANSACTIONS HAVE TO BE RECOGNIZED AS INCOME OR AS EXPENSE IN THE PERIOD IN WHICH THEY AR ISE, EXCEPT AS STATED IN PARA 10 AND PARA 11 WHICH DEALS WITH EXCHANGE DIFFERENCES ARISI NG ON REPAYMENT OF LIABILITIES INCURRED FOR THE PURPOSE OF ACQUIRING FIXED ASSETS, WHICH TOPIC FALLS UNDER S. 43A OF THE 1961 ACT. AT THIS STAGE, WE ARE CONCERNED ONLY WITH PARA 9 WHICH DEALS WITH REVENUE ITEMS. PARA 9 OF AS-II RECOGNIZES EXCHANGE DIFFEREN CES AS INCOME OR EXPENSE. IN CASES WHERE, E.G., THE RATE OF DOLLAR RISES VIS--VIS TH E INDIAN RUPEE, THERE IS AN EXPENSE DURING THAT PERIOD. THE IMPORTANT POINT TO BE NOTED IS THAT AS-II STIPULATES EFFECT OF CHANGES IN EXCHANGE RATE VIS--VIS MONETARY ITEMS D ENOMINATED IN A FOREIGN CURRENCY TO BE TAKEN INTO ACCOUNT FOR GIVING ACCOUNTING TREATME NT ON THE BALANCE SHEET DATE. THEREFORE, AN ENTERPRISE HAS TO REPORT THE OUTSTAND ING LIABILITY RELATING TO IMPORT OF RAW MATERIALS USING CLOSING RATE OF EXCHANGE. ANY DIFFERENCE, LOSS OR GAIN, ARISING ON CONVERSION OF THE SAID LIABILITY AT THE CLOSING RATE, SHOULD BE RECOGNIZED IN THE P&L ACCOUNT FOR THE REP ORTING PERIOD. 19. A COMPANY IMPORTS RAW MATERIAL WORTH US $ 25000 0 ON 15TH JAN., 2002 WHEN THE EXCHANGE RATE WAS RS. 46 PER US $. THE COMPANY RECO RDS THE TRANSACTION AT THAT RATE. THE PAYMENT FOR THE IMPORTS IS MADE ON 15TH APRIL, 2002 WHEN THE EXCHANGE RATE IS RS. 49 PER US $. HOWEVER, ON THE BALANCE SHEET DATE, 31 ST MARCH, 2002, THE RATE OF EXCHANGE IS RS. 50 PER US $. IN SUCH A CASE, IN TER MS OF AS-II, THE EFFECT OF THE EXCHANGE DIFFERENCE HAS TO BE TAKEN INTO P&L ACCOUN T. SUNDRY CREDITORS IS A MONETARY ITEM AND HENCE SUCH ITEM HAS TO BE VALUED AT THE CL OSING RATE, I.E. RS. 50 AT 31ST MARCH, 2002, IRRESPECTIVE OF THE PAYMENT FOR THE SALE SUBS EQUENTLY AT A LOWER RATE. THE DIFFERENCE OF RS. 4 (50-46) PER US $ IS TO BE SHOWN AS AN EXCHANGE LOSS IN THE P&L ACCOUNT AND IS NOT TO BE ADJUSTED AGAINST THE COST OF RAW MATERIALS. 20. IN THE CASE OF SUTLEJ COTTON MILLS LTD. VS. CIT 1978 CTR (SC) 155 (1979) 116 ITR 1 (SC) THIS COURT HAS OBSERVED AS UNDER: 'THE LAW MAY, THEREFORE, NOW BE TAKEN TO BE WELL SE TTLED THAT WHERE PROFIT OR LOSS ARISES TO AN ASSESSEE ON ACCOUNT OF APPRECIATION OR DEPREC IATION IN THE VALUE AF FOREIGN CURRENCY HELD BY IT, ON CONVERSION INTO ANOTHER CUR RENCY, SUCH PROFIT OR LOSS WOULD ORDINARILY BE A TRADING PROFIT OR LOSS IF THE FOREI GN CURRENCY IS HELD BY THE ASSESSEE ON REVENUE ACCOUNT OR AS A TRADING ASSET OR AS A PART OF CIRCU LATING CAPITAL EMBARKED IN THE BUSINESS. BUT, IF ON THE OTHER HAND, THE FOREIGN CU RRENCY IS HELD AS A CAPITAL ASSET OR AS FIXED CAPITAL, SUCH PROFIT OR LOSS WOULD BE OF CAPI TAL NATURE.' I.T.A. NOS./ 3, 17 & 41/C/2017 10 21. IN CONCLUSION, WE MAY STATE THAT IN ORDER TO FI ND OUT IF AN EXPENDITURE IS DEDUCTIBLE THE FOLLOWING HAVE TO BE TAKEN INTO ACCOUNT (I) WHE THER THE SYSTEM OF ACCOUNTING FOLLOWED BY THE ASSESSEE IS MERCANTILE SYSTEM, WHIC H BRINGS INTO DEBIT THE EXPENDITURE AMOUNT FOR WHICH A LEGAL LIABILITY HAS BEEN INCURRE D BEFORE IT IS ACTUALLY DISBURSED AND BRINGS INTO CREDIT WHAT IS DUE, IMMEDIATELY IT BECO MES DUE AND BEFORE IT IS ACTUALLY RECEIVED; (II) WHETHER THE SAME SYSTEM IS FOLLOWED BY THE ASSESSEE FROM THE VERY BEGINNING AND IF THERE WAS A CHANGE IN THE SYSTEM, WHETHER THE CHANGE WAS BONA FIDE; (III) WHETHER THE ASSESSEE HAS GIVEN THE SAME TREAT MENT TO LOSSES CLAIMED TO HAVE ACCRUED AND TO THE GAINS THAT MAY ACCRUE TO IT; (IV ) WHETHER THE ASSESSEE HAS BEEN CONSISTENT AND DEFINITE IN MAKING ENTRIES IN THE AC COUNT BOOKS IN RESPECT OF LOSSES AND GAINS; (V) WHETHER THE METHOD ADOPTED BY THE ASSESS EE FOR MAKING ENTRIES IN THE BOOKS BOTH IN RESPECT OF LOSSES AND GAINS IS AS PER NATIO NALLY ACCEPTED ACCOUNTING STANDARDS; (VI) WHETHER THE SYSTEM ADOPTED BY THE ASSESSEE IS FAIR AND REASONABLE OR IS ADOPTED ONLY WITH A VIEW TO REDUCING THE INCIDENCE OF TAXAT ION.' 4.5.7 AS CAN BE SEEN FROM THE EXTRACTIONS REPRODUC ED ABOVE, THE DECISION IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (SUPRA) HAS BEEN RENDERED IN RESPECT OF 'MONETARY ITEMS', DENOMINATED IN FOREIGN CURRENCY WHICH INCLU DE TO MEAN MONEY HELD AND ASSETS AND LIABILITIES TO BE RECEIVED OR PAID IN FIXED AMO UNTS, E.G. CASH, FOREIGN CURRENCY NOTES, BALANCE IN BANK ACCOUNTS DENOMINATED IN A FOREIGN C URRENCY, RECEIVABLES / PAYABLES AND LOANS DENOMINATED IN A FOREIGN CURRENCY, SUNDRY CRE DITORS, ETC. ARE ALL MONETARY ITEMS. THE DECISION IS ALSO RELATED TO TRANSACTIONS IN WHI CH A LEGAL LIABILITY HAS BEEN INCURRED BEFORE IT IS ACTUALLY DISBURSED. WE ARE THEREFORE U NABLE TO CONCUR OR AGREE WITH THE VIEW OF THE LEARNED CIT (APPEALS), THAT LIABILITY COULD ARISE ONLY WHEN THE CONTRACT WOULD HAVE MATURED, AS SUCH A STAND IS TOTALLY DIVORCED FROM T HE ACCOUNTING PRINCIPLES AND IS IN VARIANCE WITH THE PRINCIPLE UPHELD BY THE HON'BLE A PEX COURT IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (SUPRA). IT CAN ALSO BE SE EN THAT THE DECISION IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (AS EXTRACTED ABO VE) HAS BEEN RENDERED WITH REGARD TO ITEMS IN THE REVENUE ACCOUNT AND CAPITAL ACCOUNT. THEREFORE, THE VIEW OF THE LEARNED CIT (APPEALS) THAT THIS DECISION OF THE HON'BLE APE X COURT RELATES TO ONLY RESTATEMENT OF EXISTING CURRENCY LIABILITIES AND ASSETS IS NOT COR RECT. 4.5.8 IN THE CASE ON HAND, IT IS NOT IN DISPUTE TH AT THE FORWARD CONTRACTS HAVE BEEN ENTERED INTO BY THE ASSESSEE IN ORDER TO PROTECT IT S INTEREST AGAINST FLUCTUATIONS IN FOREIGN CURRENCY, IN RESPECT OF CONSIDERATION FOR E XPORT PROCEEDS, WHICH IS A REVENUE ITEM. THEREFORE, IN SUM AND SUBSTANCE, IT HAS THE TRAPP INGS OF STOCK-IN-TRADE AND THE ASSESSEE HAS TO RESTATE OR REVALUE THE SAME AS ON T HE BALANCE SHEET DATE. THE CONSEQUENT EFFECT OF THIS ACCOUNTING TREATMENT WAS TO RECOGNIZE THE EXCHANGE FLUCTUATION GAIN OR LOSS IN THE PROFIT AND LOSS ACC OUNT AS ON THE VALUATION DATE. IN VIEW OF THE FACTS AND CIRCUMSTANCES OF THE CASE AS DISCUSSE D ABOVE, WE ARE OF THE CONSIDERED VIEW THAT THE APPEAL OF THE ASSESSEE ON THIS ISSUE, SUCCEEDS FOR THE FOLLOWING REASONS :- I) A BINDING OBLIGATION ACCRUED AGAINST THE ASSESS EE WHEN IT ENTERED INTO FOREIGN EXCHANGE FORWARD CONTRACTS; II) THE FORWARD CONTRACTS ARE IN RESPECT OF CONSIDE RATION FOR EXPORT PROCEEDS, WHICH ARE REVENUE ITEMS; I.T.A. NOS./ 3, 17 & 41/C/2017 11 III) THE LIABILITY IS DETERMINABLE WITH REASONABLE CERTAINTY WHEN AN OBLIGATION IS PENDING ON THE BALANCE SHEET DATE AND SUCH A LIABILITY CANN OT BE SAID TO BE A CONTINGENT LIABILITY. IV) THE ACCOUNTING TREATMENT IS AS PER ACCOUNTING S TANDARDS AND THE ICAI GUIDELINES, V) THE PRINCIPLES ENUNCIATED BY THE HON'BLE APEX COURT IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (SUPRA) ARE APPLICABLE TO THE FACTS OF THE CASE ON HAND. 4.5.9 WE HAD EARLIER OBSERVED THAT THE ASSESSING OF FICER HAD RELIED ON THE CBDTS INSTRUCTION NO.3/2010. PARAS LAND 3 OF THIS INSTRUC TION READS AS UNDER: 1. FOREIGN EXCHANGE DERIVATIVE TRANSACTIONS ENTERE D INTO BY THE CORPORATE SECTOR IN INDIA HAVE WITNESSED A SUBSTANTIAL GROWTH IN RECENT YEARS. THIS COMBINED WITH EXTREME VOLATILITY IN THE FOREIGN EXCHANGE MARKET IN THE LA ST FINANCIAL YEAR IS REPORTED TO HAVE RESULTED IN SUBSTANTIAL LOSSES TO AN ASSESSEE ON AC COUNT OF TRADING IN FOREX-DERIVATIVES. A LARGE NUMBER OF ASSESSES ARE SAID TO BE REPORTING S UCH LOSSES ON 'MARKED TO MARKET' BASIS EITHER SUO MOTU OR IN COMPLIANCE OF THE ACCOU NTING STANDARD OR ADVISORY CIRCULAR ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS. T HE ISSUE WHETHER SUCH LOSSES ON ACCOUNT OF FOREX-DERIVATIVES CAN BE ALLOWED AGAINST THE TAXABLE INCOME OF AN ASSESSEE HAS BEEN CONSIDERED BY THE BOARD. IN THIS CONNECTIO N, 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-DERIVATIVE TRANSACTION ARISES ON ACTUAL SETTLEMENT /CONCLUSION OF CONTRACT AND IS NOT A NOTIONAL OR MARKED TO MARKET BOOK ENTRY, 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 DETERMININ G WHETHER LOSS FROM A TRANSACTION IN RESPECT OF A FOREX DERIVATIVE IS A SPECULATION LOSS OR NOT, THE ASSESSING OFFICERS MAY REFER TO PROVISO (D) BELOW SUB-SECTION (5) OF SECTION 43 INSERTED BY THE FINANCE ACT, 2005, WITH EFFECT FROM 1.4.2006. IT LAYS DOWN THAT ANY 'E LIGIBLE TRANSACTION' IN RESPECT OF TRADING IN DERIVATIVES REFERRED TO IN CLAUSE (AC) O F SECTION 2 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956, THAT HAS BEEN CARRIED OUT I N A RECOGNIZED STOCK EXCHANGE SHALL NOT BE TREATED AS A SPECULATIVE TRANSACTION. FURTHE R, AN 'ELIGIBLE TRANSACTION' FOR THIS PURPOSE WOULD BE ONE THAT FULFILS THE CONDITIONS LA ID DOWN IN EXPLANATION TO SECTION 43(5)(D). ANY LOSS IN A SPECULATIVE TRANSACTION CAN BE SET OFF ONLY 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 THAT THE LOSS ARISING OUT OF THE FORWARD CONTRACT I S NOT NOTIONAL. IN SUCH A CASE, THE CBDT INSTRUCTION REQUIRES THE ASSESSING OFFICER TO EXAMINE WHETHER SUCH A LOSS IS ON ACCOUNT OF A SPECULATIVE TRANSACTION AS CONTEMPLATE D IN SECTION 43(5) OF THE ACT. 4.5.10 THE ISSUE OF SPECULATIVE TRANSACTIONS AND HE DGING TRANSACTIONS HAS BEEN EXAMINED AND ANALYSED IN DETAIL IN THE DECISION OF THE ITAT, MUMBAI IN THE CASE OF S. VINOD KUMAR DIAMONDS (P) LTD. REPORTED IN (2013) 35 TAXMANN.COM 337 (MUMBAI - TRIB). THE RELEVANT PARAGRAPHS OF THIS ORDER ARE EX TRACTED 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 I.T.A. NOS./ 3, 17 & 41/C/2017 12 MEANS. IF A CONTRACT FOR SALE OR PURCHASE IS ULTIMA TELY SETTLED AND NO ACTUAL DELIVERY OF THE GOODS WAS EFFECTED UNDER THE SETTLEMENT THEN IT IS A SPECULATIVE TRANSACTION. THE REQUIREMENT OF SECTION 30 OF THE INDIAN CONTRACT AC T OF THE EXISTENCE OF THE INTENTION OF THE PARTIES EVEN AT THE TIME OF THE ORIGINAL CONTRA CT NOT TO GIVE OR TAKE DELIVERY OF THE GOODS IN ORDER TO MAKE IT A SPECULATIVE/WAGERING TR ANSACTION 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 THE PARTIES AT THE TIME OF THE CONTRACT BECOMES IM- MATERIAL. THUS, THE TRUE TEST IS DELIVERY OF COMMOD ITIES/GOODS AS PER THE CONTRACT, INCLUDING A FORWARDING CONTRACT. PROFIT/LOSS IN RES PECT OF UNPERFORMED CONTRACTS IS CONSIDERED SPECULATION PROFIT/LOSS. IN SHORT, IN OR DER THAT A TRANSACTION MAY FALL WITHIN THE SCOPE OF THE EXPRESSION 'SPECULATIVE TRANSACTIO N', 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 OTHERWISE THAN B Y 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 DET ERMINING THE TRUE SCOPE, WIDTH AND NATURE OF PROVISO (A) TO SECTIORI43(5). HEDGE CONTR ACTS ARE THOSE CONTRACTS WHICH HEDGE AGAINST PREJUDICIAL PRICE FLUCTUATIONS. IN SPECULAT IVE TRANSACTIONS THE MODUS OPERAND! OF PERSONS INDULGING IN THEM IS THAT WHEN ONE ENTERS I NTO A CONTRACT OF PURCHASE, HE ALSO SIMULTANEOUSLY ENTERS INTO ONE OR MORE CONTRACTS OF SALE AGAINST THE SAME QUANTITY DELIVERABLE AT THE SAME TIME EITHER TO THE ORIGINAL VENDOR OR TO SOMEONE ELSE, SO AS EITHER TO SECURE PROFIT OR TO MINIMIZE LOSS, BEFORE THE VAIDA DAY; AND SIMILARLY WHEN HE ENTERS INTO A CONTRACT OF SALE, HE SIMULTANEOUSLY E NTERS INTO ONE OR MORE CONTRACTS TO PURCHASE THE SAME QUANTITY BEFORE THE VAIDA DAY. TH E RESULT OF SUCH 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 UNDERSTOOD IN SIMPLE TERMS. IT IS SAID THAT THE HED GE CONTRACT IS SO CALLED BECAUSE IT ENABLES THE PERSONS DEALING WITH THE ACTUAL COMMODI TY TO HEDGE THEMSELVES, I.E., TO INSURE THEMSELVES AGAINST ADVERSE PRICE FLUCTUATION S. A DEALER OR A MERCHANT ENTERS INTO A HEDGE CONTRACT WHEN HE SELLS OR PURCHASES A COMMO DITY IN THE FORWARD MARKET FOR DELIVERY AT A FUTURE DATE. HIS TRANSACTION IN THE F ORWARD MARKET MAY CORRESPOND TO A PREVIOUS PURCHASE OR SALE IN THE READY MARKET OR HE MAY PROPOSE TO COVER IT LATER BY A CORRESPONDING TRANSACTION IN THE READY MARKET, OR H E MAY OFFSET IT BY A REVERSE TRANSACTION ON THE FORWARD MARKET ITSELF. HEDGING C ONTRACTS NEED NOT SUCCEED THE CONTRACTS FOR SALE AND ACTUAL DELIVERY OF GOODS MAN UFACTURED, BUT THE LATTER MAY BE SUBSEQUENTLY ENTERED INTO, PROVIDED THEY ARE WITHIN REASONABLE TIME. IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACTS OF SALES, THE T OTAL OF SUCH TRANSACTIONS SHOULD NOT EXCEED THE TOTAL 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 PURCHASE. AS PER THE ACCEPTED COMMERCIAL NORMS OBJE CT OF A HEDGING CONTRACT IS TO SECURE ONESELF AGAINST LOSS IN A FUTURE DELIVERY CO NTRACT, BUT SUCH TRANSACTIONS CANNOT BE REGARDED AS INTER-CONNECTED. EACH ONE IS INDEPENDEN T OF THE OTHER. SO FAR AS THE PROFIT OR LOSS ARISING FROM A FUTURE DELIVERY CONTRACT IS CONCERNED, IT IS DETERMINED ON THE DATE OF ACTUAL DELIVERY IRRESPECTIVE OF THE DATE ON WHIC H THE CONTRACT WAS ENTERED INTO. IN RESPECT OF A HEDGING CONTRACT, PROFIT/LOSS ARISING THERE FROM CAN BE ASCERTAINED OR CRYSTALLIZED AT FIXED INTERVALS OF THE TERM WHEN TH E CLEARANCE TAKES PLACE. I.T.A. NOS./ 3, 17 & 41/C/2017 13 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 O N THE OTHER HAND, THE HEDGER SEEKS TO SAFEGUARD HIS POSITION. THE MOVEMENT OF PR ICES IN THE TWO MARKETS 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 WOULD BE MARGINAL AND FAR L ESS THAN WHAT IT WOULD BE IF THE PERSON HAD NOT HEDGED AT ALL. WHILE, HOWEVER, THE H EDGING OPERATION PROTECTS THE HEDGER AGAINST LOSS ARISING FROM ADVERSE FLUCTUATIO NS IN PRICES, IT ALSO PREVENTS HIM FROM MAKING WINDFALL PROFIT OWING TO FAVOURABLE FLUCTUAT IONS IN PRICES AS WELL. THE FORGOING 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 ADVERSE PRICE FLUCTUATIONS. THESE FORWARD CONTRACTS BY WAY OF HED GE TRANSACTIONS USUALLY AFFORD A COVER TO A TRADER INASMUCH AS HIS LOSS IN THE READY MARKET IS OFFSET BY A PROFIT IN THE FORWARD MARKET AND VICE VERSA. IT, THEREFORE, FOLLO WS THAT IN ORDER TO EFFECTIVELY HEDGE AGAINST ADVERSE PRICE FLUCTUATIONS OF THE MANUFACTU RED GOODS OR MERCHANDISE, A MANUFACTURER OR MERCHANT HAS NECESSARILY TO ENTER I NTO FORWARD TRANSACTIONS OF SALE AND PURCHASE BOTH, AND WITHOUT THESE CONTRACTS OF SALE AND PURCHASE CONSTITUTING HEDGE TRANSACTIONS, THERE WOULD 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 CONDITIONS ARE FULFILLED: (1) THERE IS A CONTRACT FOR ACTUAL DELIVERY OF GOOD S MANUFACTURED BY THE ASSESSEE /A MERCHANDISE SOLD BY IT, (2) ASSESSEE MUST BE A SUBSEQUENT TRANSACTION INTEN D TO GUARD AGAINST LOSSES THROUGH FUTURE PRICE FLUCTUATIONS IN RESPECT OF SUCH CONTRA CT, (3) TRANSACTION IN QUESTION MUST BE A CONTRACT ENTE RED INTO IN RESPECT OF RAW MATERIALS OR MERCHANDISE IN THE COURSE OF THE ASSESSEE'S MANU FACTURING BUSINESS AND IT SHOULD HAVE BEEN SETTLED OTHERWISE THAN BY ACTUAL DELIVERY OF GOODS, (4) HEDGING CONTRACTS MAY BE BOTH WITH REGARD TO SA LES AND PURCHASES, (5) HEDGING CONTRACTS NEED NOT SUCCEED THE CONTRACT S FOR SALE AND ACTUAL DELIVERY OF GOODS MANUFACTURED, BUT THE LATTER MAY BE SUBSEQUEN TLY ENTERED INTO, PROVIDED THEY ARE WITHIN THE REASONABLE TIME NOT EXCEEDING GENERALLY THE ASSESSMENT YEAR, (6) IN ORDER TO BE GENUINE AND VALID HEDGING CONTRA CTS OF SALES, THE TOTAL OF SUCH TRANSACTIONS SHOULD NOT EXCEED THE TOTAL STOCKS OF THE RAW MATERIALS OR THE MERCHANDISE ON HAND WHICH WOULD INCLUDE EXISTING STOCKS AS WELL AS THE STOCKS ACQUIRED 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 T YPE OF COTTON AGAINST ANOTHER TYPE OF COTTON. IN OTHER WORDS UNLESS THE ASSESSEE SHOWS THAT THERE WAS SOME EXISTING CONTRACT IN RESPECT OF WHICH HE WAS LIKELY TO SUFFER A LOSS BEC AUSE OF FUTURE PRICE FLUCTUATIONS AND THAT IT WAS TO SAFEGUARD AGAINST SUCH LOSS THAT HE ENTERED INTO THE FORWARD CONTRACTS OF SALE, HE COULD NOT CLAIM THE BENEFIT OF CLAUSE (A) OF THE PROVISO TO SECTION 43(5). WITH REGARD TO SPECULATIVE I HEDGING TRANSACTIONS WE HAD BENEFIT OF PERUSING THE JUDGMENTS I.T.A. NOS./ 3, 17 & 41/C/2017 14 OF M.G. BROS. V CIT (1985) 1564 ITR 695/20 TAXMAN 9 0 (AP), NUDDEA MILLS CO. LTD. V. CIT (1988) 171 ITR 169 (1987) 35 TAXMAN 3 (CAL), DE LHI FLOUR MILLS CO. LTD. V CIT (1974) 95 ITR 151 (DEL) AND PANKAJ OIL MILLS V CIT (1978) 115 ITR 824 (GUJ) DELIVERED BY THE HON'BLE HIGH COURTS OF ANDHRA PRADESH, CALCU TTA, DELHI AND GUJARAT RESPECTIVELY.' 4.5.11 AS DISCUSSED EARLIER, IN THE CASE ON HAND TH ERE HAS BEEN AN EXISTING CONTRACT WITH A BINDING OBLIGATION ACCRUED AGAINST THE ASSESSEE W HEN IT ENTERED INTO FOR-EX FORWARD CONTRACTS. THE FORWARD CONTRACTS ARE IN RESPECT OF CONSIDERATION FOR EXPORTS PROCEEDS, WHICH ARE REVENUE ITEMS. THERE IS AN ACTUAL CONTRACT FOR SALE OF MERC HANDISE. IN THIS FACTUAL MATRIX, IT IS CLEAR IN OUR VIEW THAT THE TR ANSACTION IN QUESTION WILL NOT QUALIFY TO BE CALLED AS SPECULATIVE TRANSACTION. IN VIEW OF THE F ACTS AND CIRCUMSTANCES OF THE CASE ON HAND, AS DISCUSSED ABOVE, WE HOLD THAT THE PROVISIO N FOR LOSSES ON DERIVATIVE CONTRACTS IS ALLOWABLE AS EXPENDITURE. WE, ACCORDINGLY ALLOW THE GROUNDS AT S.NOS. 1 TO 9 RAISED BY THE ASSESSEE. 6.1 IN VIEW OF THE ABOVE ORDER OF TRIBUNAL, WE ARE IN AGREEMENT WITH THE PROPOSITION THAT THE MTM LOSS ON FORWARD CONTRACTS IS NOT CONTINGENT LOSS AND IT IS A BUSINESS LOSS TO SET OFF AGAINST THE BUSINESS INCOME OF ASSESSEE. HOWEVER, THE ASSESSING OFFICER HAS TO CONSIDER THE DERIVATIV ES TRANSACTION EQUIVALENT TO THE EXPORT TURNOVER TO DETERMINE THE MTM LOSS AND ALSO IF THERE IS ANY PREMATURE CANCELLATION OF FORWARD CONTRACT OF FOREIGN EXCHANG E, IT SHALL BE EXCLUDED TO CONSIDER THE BUSINESS LOSS AND THESE TRANSACTIONS T O BE TREATED AS SPECULATIVE TRANSACTION. 6.2 FURTHER, THE ASSESSING OFFICER HAS TO SEE TH E RELEVANT COPIES OF INVOICES RELATING TO IMPORTS IN RESPECT OF EACH ASSESSMENT Y EAR AND AUTHENTICATED CERTIFICATE FROM CA WITH REGARD TO EXPORT/IMPORT TU RNOVER. IF THE ASSESSEE HAS EARNED ANY PROFIT ON THESE TRANSACTIONS IN THE RELE VANT ASSESSMENT YEAR, THE SAME HAVE TO BE CONSIDERED AS BUSINESS PROFIT IN RE SPECT OF EACH ASSESSMENT I.T.A. NOS./ 3, 17 & 41/C/2017 15 YEAR. WITH THIS OBSERVATION, WE REMIT THIS ISSUE TO THE FILE OF THE ASSESSING OFFICER FOR FRESH CONSIDERATION IN ACCORDANCE WITH LAW AFTE R AFFORDING REASONABLE OPPORTUNITY OF HEARING TO THE ASSESSEE. THIS GROUND OF APPEAL OF THE REVENUE IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. 7. THE NEXT COMMON GROUND IN I.T.A. NO. 17/COCH/20 17 & 41/COCH/2017 IS WITH REGARD TO DELETION OF ADDITION MADE ON ACCOUNT OF E XPENDITURE INCURRED ON REPAIR AND MAINTENANCE. THE ASSESSEE INCURRED EXPENDITURE TO THE TUNE OF RS.99,56,553/- AND RS.1,38,53, 153/- FOR THE ASSESS MENT YEARS 2009-10 & 2010- 11 RESPECTIVELY. THE ASSESSING OFFICER CONSIDERED T HE EXPENDITURE AS CAPITAL EXPENDITURE AND ONLY ALLOWED DEPRECIATION ON IT. 8. THE ASSESSEE CARRIED THE MATTER IN APPEAL BEFOR E THE CIT(A). THE CIT(A) OBSERVED THAT IT IS REPAIR AND MAINTENANCE WHICH IS REVENUE EXPENDITURE AND IS TO BE ALLOWED AS DEDUCTION WHILE COMPUTING BUSINESS INCOME OF THE ASSESSEE. 9. AGAINST THIS, THE REVENUE IS IN APPEAL BEFORE US. THE LD. DR DREW OUR ATTENTION TO THE VARIOUS EXPENDITURE INCURRED BY TH E ASSESSEE AND THE NATURE OF THE EXPENDITURE SHOWS THAT IT IS CAPITAL IN NATURE WHICH GIVES ENDURING BENEFIT AND CANNOT BE CONSIDERED AS REVENUE EXPENDITURE. I.T.A. NOS./ 3, 17 & 41/C/2017 16 10. ON THE OTHER HAND, THE LD. AR SUBMITTED THAT T HE CIT(A) HAS CONSIDERED EACH ITEM AND GIVEN AN ELABORATE FINDING THAT THE E XPENDITURE IS REVENUE IN NATURE. ACCORDING TO HIM, THE EXPENDITURE INCURRED BY THE ASSESSEE IS MERE REPAIR AND MAINTENANCE, CUTTING, PAINTING, CONCRETI NG, REPLACEMENT OF PARTS OF MACHINERY, RELOCATION OF MACHINERY OF EXISTING FACT ORY PREMISES AND NONE OF THE EXPENDITURE HAS BROUGHT IN ANY NEW ASSET TO THE ASS ESSEE. THE EXPENDITURE RESULTED IN BETTER USE OF EXISTING ASSETS WHICH IS NOT A CAPITAL EXPENDITURE. FINALLY HE RELIED ON THE ORDER OF THE CIT(A). 11. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUS ED THE MATERIAL ON RECORD. FOR THE ASSESSMENT YEAR 2009-10, THE CIT(A) HAS BRO ADLY CLASSIFIED EXPENDITURE AS FOLLOWS: (I) RELOCATION EXPENSE OF PRODUCER GAS PLANT COST ING RS.20,54,814/- II) CHANGE OF MS TRUSS DUE TO RUST COSTING RS.7,1 9,292/- III)REPLACEMENT OF LEAKING SINTEX WATER TANK COST ING RS.53,273/- IV)REPLACEMENT OF DAMAGED DISPLAY BOARDS COSTING R S.92,812/- V) REPLACEMENT OF COPPER REACTOR TANK COSTING RS. 1,39,850/- (VI)REPLACEMENT OF SS DUCT COSTING RS.1,30,683/- (VII)REPLACEMENT OF CYCLONES AND SCRUBBER COLUMNS COSTING RS.1,27,134/- (VIII)SHIFTING OF THE EXISTING FUEL STORAGE TANK COSTING RS.43,470/- IX) TANK SHIFTING FROM EXISTING TO NEW LOCATION FO R PROCESS REQUIREMENT COSTING RS.32,000/- THE ABOVE EXPENDITURE IS REQUIRED TO BE EXAMINED WI TH REFERENCE TO THE INVOICES/BILLS AND SPECIFIC FINDING BY THE ASSESSIN G OFFICER IS TO BE REQUIRED. IF THE ASSESSEE CONSTRUCTED NEW ROAD, NEW WORKSHOP, TO ILET, TRUSS WORK, REST ROOM, RAIN WATER HARVESTING PLANT, NEW COMPOUND WAL L ETC., IT IS TO BE CONSIDERED AS A NEW CAPITAL ASSET AND DEPRECIATION IS TO BE GR ANTED ON IT. HOWEVER, THE I.T.A. NOS./ 3, 17 & 41/C/2017 17 CIT(A), ONLY BY GOING THROUGH THE CHART FILED BY TH E ASSESSEE TREATED THE EXPENDITURE AS REVENUE EXPENDITURE. IN OUR OPINION , IT IS APPROPRIATE TO REMIT THE ISSUE TO THE FILE OF THE ASSESSING OFFICER TO G O THROUGH EACH INVOICES/BILLS AND DECIDE THEREUPON. SAME IS THE POSITION FOR THE ASS ESSMENT YEAR 2010-11. ACCORDINGLY, THE ISSUE IS REMITTED TO THE FILE OF T HE ASSESSING OFFICER FOR REEXAMINATION. THIS GROUND OF APPEAL FOR BOTH THE A SSESSMENT YEARS IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. 12. THE NEXT GROUND FOR ALL THE THREE ASSESSMENT YEARS IS WITH REGARD TO DELETION OF ADDITION U/S. 14A R.W. RULE 8D OF THE I NCOME TAX RULES. FOR THE ASSESSMENT YEAR 2008-09, ADDITION U/S. 14A WAS AT R S.21,09,259/-, RS. 5,84,014/- FOR THE ASSESSMENT YEAR 2009-10 AND RS.1 1,85,068/- FOR THE ASSESSMENT YEAR 2010-11. THE CIT(A) DELETED THE AD DITIONS BY OBSERVING THAT THE ASSESSING OFFICER HAS NOT SPECIFICALLY SHOWN WI TH THE SUPPORT OF EVIDENCE THAT SUCH EXPENDITURE WAS INCURRED TO EARN EXEMPTED INCO ME. THE ASSESSING OFFICERS ACTION WAS MECHANICAL AND WITHOUT PROPER REASON AND RESPONSIBILITY. SECTION 14A(3) MANDATES THAT SUCH SATISFACTION IS TO BE REC ORDED IN A CASE WHERE AN ASSESSEE CLAIMED THAT NO EXPENDITURE HAS BEEN INCUR RED BY HIM IN RELATION TO INCOME WHICH DOES NOT FORM PART OF THE TOTAL INCOME UNDER THIS ACT. ACCORDINGLY, HE DELETED THE ADDITIONS MADE UNDER SECTION 14A OF THE ACT FOR ALL THE ASSESSMENT YEARS. I.T.A. NOS./ 3, 17 & 41/C/2017 18 13. AGGRIEVED, THE REVENUE IS IN APPEAL BEFORE US . 14. WE HAVE HEARD THE RIVAL CONTENTIONS AND SUBMI SSIONS. THE MAIN CONTENTION OF THE LD. AR IS THAT THE ASSESSEE IS HAVING OWN FU NDS IN THE FORM OF SHARE CAPITAL AND RESERVES TO MAKE INVESTMENT WHICH YIELD ED EXEMPTED INCOME. FURTHER, IT WAS SUBMITTED THAT INTEREST WAS INCURRE D ON BORROWINGS WHICH WAS USED FOR THE PURPOSE OF ASSESSEES BUSINESS AND IT CANNOT BE CONSIDERED FOR THE PURPOSE OF COMPUTING DISALLOWANCE U/S. 14A OF THE I .T. ACT. HOWEVER, THESE FACTS WERE NOT DEMONSTRATED BY THE ASSESSEE NEITHER BEFORE THE ASSESSING OFFICER NOR BEFORE THE CIT(A). THE CIT(A) HAS GIVEN RELIEF TO THE ASSESSEE FOR DIFFERENT REASONS. IN VIEW OF THIS, IN OUR OPINION , THOUGH INTEREST ON BORROWINGS USED FOR THE BUSINESS PURPOSE CANNOT BE CONSIDERED FOR COMPUTING DISALLOWANCE U/S. 14A OF THE ACT, IT IS THE DUTY OF THE ASSESSEE TO PROVE THAT INTEREST WAS INCURRED ON BORROWINGS WHICH WAS USED FOR THE SPECI FIC PURPOSE OF BUSINESS. SIMILARLY, THE ASSESSEE HAS TO PROVE THAT THE ASSES SEE IS HAVING OWN FUNDS TO MAKE INVESTMENT WHICH YIELDED EXEMPTED INCOME BY FU RNISHING CASH FLOW STATEMENT. THIS WAS NOT DONE BY THE ASSESSEE. HENC E IN THE INTEREST OF JUSTICE, WE REMIT THIS ISSUE TO THE FILE OF THE ASSESSING OF FICER FOR FRESH CONSIDERATION IN ACCORDANCE WITH LAW AFTER AFFORDING REASONABLE OPPO RTUNITY OF HEARING TO THE ASSESSEE. THIS GROUND OF APPEAL OF THE REVENUE FOR THE THREE ASSESSMENT YEARS IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. I.T.A. NOS./ 3, 17 & 41/C/2017 19 15. IN THE RESULT, THE APPEALS OF THE REVENUE AR E PARTLY ALLOWED FOR STATISTICAL PURPOSES. PRONOUNCED IN THE OPEN COURT ON 2 8 TH FEBRUARY, 2018. SD/- SD/- ( GEORGE GEORGE K.) (CHAN DRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER PLACE: KOCHI DATED: 28 TH FEBRUARY, 2018 GJ COPY TO: 1. M/S. SUD CHEMIE INDIA PVT. LTD., EDAYAR INDUSTRIA L DEVELOPMENT AREA, BINANIPURAM, EDAYAR-683 502. 2. THE ASSISTANT COMMISSIONER OF INCOME-TAX, CIRCLE -2(1), KOCHI. 3. THE COMMISSIONER OF INCOME-TAX(APPEALS)-I, KOCHI 4. THE PR. COMMISSIONER OF INCOME-TAX, KOCHI. 5. D.R., I.T.A.T., COCHIN BENCH, COCHIN. 6. GUARD FILE. BY ORDER (ASSISTANT REGISTRA R) I.T.A.T. , COCHIN