ASST CIT 16(3), MUMBAI V. K.P. SANGHVI & SONS, MUMBAI

ITA 4588/MUM/2014

• Counselvise Citation: [2016] 131 COUNSELVISE.COM (IT) 2656 (ITAT-MUMBAI)
• Duration Of Justice: 2 year(s) 2 month(s) 25 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 29-09-2016
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: A
• Next Hearing Date: 27-09-2016
• Assessment Year: 2009-2010
• Appeal Filed On: 04-07-2014
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: R P MEENA
• Keywords: Business income; Depreciation; Transfer pricing; Additional depreciation; Advance ruling; Speculation loss; Revenue expenditure
• Section: 37(1); 43(5)

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL A BENCH , MUMBAI BEFORE SRI MAHAVIR SINGH, JM AND SRI R AMIT KOCH AR , AM ITA NO . 4588 /MUM/201 4 (A.Y:2009 - 10 ) THE ASST. COMMISSIONER OF INCOME TAX - 16(3), MATRU MANDIR, TARDEO ROAD, MUMBAI - 400007 VS. M/S K P SANGHVI A ND SONS, 1301, PRASAD CHAMBERS, OPERA HOUSE,MUMBAI - 4 PAN:AAAFK8390F APPELLANT .. RESPONDENT APPELLANT BY .. SRI R P MEENA RESPONDENT BY .. SRI K SHIVRAM DATE OF HEARING .. 2 9 - 09 - 2016 DATE OF PRONOUNCEMENT .. 2 9 - 09 - 2016 O R D E R PER MAHAVIR SI NGH , JM : THIS APPEAL BY THE REVENUE IS ARISING OUT OF THE ORDER OF THE CIT (APPEALS) - 27 , MUMBAI IN APPEAL NO. C IT (A) - 27 / AC - 16 ( 3 ) / 135/13 - 14 DATED 22.4.2014 . ASSESSMEN T WAS FRAMED BY THE A C IT - CIRCLE 16 ( 3 ) , MUMBAI FOR THE ASSESSMENT YEAR 20 09 - 10 VIDE HIS ORD ER DATED 28.3.2013 U/S 14 3(3) OF THE INCOME TAX ACT, 1961 (HEREINAFTER THE ACT) . 2 . THE FIRST ISSUE IN THIS APPEAL OF REVENUE IS AGAINST THE ORDER OF THE CIT (A) IN DELETING THE DISALLOWANCE MADE BY THE AO OF 'MARK TO MARKET ON REVALUATION OF FORWARD EXCHANGE CONTRACTS WHICH WAS OUTSTANDING AS ON THE DATE OF BALANCE SHEET, TREATING THE SAME AS NOTIONAL LOSS. IN THIS APPEAL, THE REVENUE HAS RAISED FOLLOWING TWO GROUNDS: 1. 'WHETHER ON THE FACTS AND CIRCUMSTANCES AND IN LAW, THE ID. CIT(A) HAS ERRE D IN HOLDING THAT 'MARK TO MARKET' LOSS OF RS .18,80,94,300/ - ARISING ON VALUATION OF FORWARD EXCHANGE CONTRACTS ON THE CLOSING DATE OF ACCOUNTING YEAR IS NOT NOTION AL LOSS AND, THEREFORE ALLOWABLE. 2. WHETHER ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE ID.CIT(A ) WAS RIGHT IN NOT TAKING COGNIZANCE OF THE DECISION OF THE ITAT,'E' BENCH, MUMBAI IN ITA NO.506/MUM/2013 DT.03.05.2013 IN THE CASE OF M/S. S. VINODKUMAR DIAMOND PVT. LTD . ITA NO. 4588 /MUM/20 1 4 2 3 . BRIEFLY STATED FACTS ARE THAT THE ASSESSEE FIRM IS ENGAGED IN THE MANUFACTURING AND EXPORT OF CUT AND POLISHED DIAMONDS. THE AO DURING THE COURSE OF ASSESSMENT PROCEEDINGS NOTICE D THAT THE ASSESSEE HAS DEBITED A SUM OF RS. 18,80,94,300/ - AS LOSS ON ACCOUNT OF OUTSTANDING FOREIGN EXCHANGE FORWARD CONTRACTS. HE REQUI RED THE ASSESSEE TO EXPLAIN THE SAME AS TO WHY THE SAME SHOULD NOT BE DISALLOWED BY TREATING T HE SAME AS NOTIONAL LOSS. THE ASSESSEE EXPLAINED THAT THE LOSS ON ACCOUNT OF 'MARK TO MARKET REVALUATION OF FORWARD CONTRACTS AS PER RUPEE VALUE EQUIVALENT TO U S $ AS ON 31.3.2009 WAS CLAIMED. THE AO REQUIRED THE ASSESSEE TO FILE THE DETAILS OF THESE LOSSES. ACCORDING TO THE AO THESE LOSSES HAVE NOT BEEN CRYSTALLIZED AND HENCE AGAIN ASKED THE ASSESSEE AS TO WHY THE SAME SHOULD NOT BE DISALLOWED AS NOTIONAL LOSS ON VALUATION OF A LIABILITY. THE LD. AR EXPLAINED THAT AS PER ACCOUNTANCY PRUDE NCE AND IN VIEW OF ACCOUNTING STANDARD - 11 (AS - 11) GUIDELINES ISSUED BY ICAI THE ASSESSEE CLAIMED THESE LOSSES, SINCE THERE WAS A CONTRACTUAL LIABILITY ON THE PART OF THE ASSESS EE WITH THE BANKS TO BUY/SELL US $ AT A FUTURE DATE BEYOND 31.3.2009 AND ITS MAGNITUDE NEEDS TO BE ESTIMATED WITH REASONABLE CERTAINTY ON THE DATE OF BALANCE SHEET I.E. ON 31.3.2009. BUT THE AO REJECTED THE CLAIM OF THE ASSESSEE BY OBSERVING THAT THE FORE IGN EXCHANGE FORWARD CONTRACT COULD NOT BE ACCORDED USUAL ACCOUNTING TREATMENT OF REASONABLY ESTIMATING FOREIGN EXCHANGE FLUCTUATIONS BY ADOPTING T HE RATE OF US $ AS ON DATE OF B A LANCE - SHEET FOR THE REASONS THAT THESE ARE NOT ASCERTAINED LIABILIT IES . ACCORDINGLY, HE DISALLOWED THE CLAIM OF LOSS ON ACCOUNT OF REVALUATION OF US$ FOR OUTSTANDING FOREIGN EXCHANGE CONTRACTS TREATING THE SAME AS NOTIONAL LOSS OR CONTINGENT LIABILITY. AGGRIEVED ASSESSEE PREFERRED AN APPEAL BEFORE THE CIT (A) . THE CIT (A) CO NSIDERED THE ASSESSEES OUTSTANDING FOREIGN EXCHANGE EXPO RTS AND MONTHLY AVERAGE OF OUTSTANDING FOREIGN DEBTS AS UNDER : 1.0 FINANCIAL INFORMATION FOR AY 2009 - 2010 1.1 AS SUBMITTED EARLIER, THE APPELLANT IS A PARTNERSHIP FIRM, MAINLY ENGAGED IN TH E BUSI NESS OF IMPORT OF DIAMONDS, CUTTING AND POLISHING AND EXPORT OF CUT AN D POLISHED DIAMONDS. 1.2 THE TOTAL EXPORT TURNOVER DURING THE PREVIOUS YEAR 2008 - 2009 CORRESPONDING TO A Y 2009 - 2010, WAS RS.714.98 CRORES AND TOTAL ITA NO. 4588 /MUM/20 1 4 3 IMPORT OF DIAMONDS WAS RS.517.1 0 . CR ORES. APART FROM THE SAID IMPORT OF DIAMONDS, THE APPELLANT HAS ALSO PURCHASE DIAMONDS OF RS.20.66 CRORES LOCALLY THROUGH DIAMOND DOLLAR ACCOUNT, WHICH WE RE SETTLED IN FOREIGN CURRENCY. ACCORDINGLY, BOTH THE LIMBS OF TRANSACTIONS I.E. PURCHAS E AND SALES AR E IN FOREIGN CURRENCY. 1.3 AS ON 31 MARCH 2009, THE OUTSTANDING FOREIGN EXPOSURE OF THE APPELLANT IS A S UNDER: SR. NO . NATURE OF FOREIGN CURRENCY EXPOSURE AMOUNT (USD IN MILLION, 1 EXPORTS RECEIVABLES (I.E. OVERSEAS DEBTORS) 19.22 2 IMPOR TS PAYABLES (I.E. OVERSEAS CREDITORS) 9.31 3 BANK LOAN 65.78 4 ADVANCE FROM OVERSEAS CUSTOMERS 8.9 6 5 CLOSING STOCK FOR EXPORT 91. 4 4 TOTAL 194.7 2 FROM THE ABOVE, YOUR HONOR SHALL APPRECIATE THE FACT THAT THE TOTAL AMOUNT OF FOREIGN CURRENCY EXPOSURE AS ON 31 MARCH, 2009 AMOUNTS TO USD 194.71 MILLION APPROX. 1.4 CONSIDERING THE SUBSTANTIAL FOREIGN CURRENCY EXPOSURE AND DUE TO SUB STANTIAL FLUCTUATION IN FOREIGN CURRENCY RATES, THE APPELLANT ENTERED INTO THE FORWARD CONTRACTS (FCS) WITH TH E BANKS AS INTEGRAL PART OF THE EXPORT IMPORT BUSINESS WITH THE AIM TO HEDGE AND SAFEGUARD AGAINST THE FOREIGN EXCHANGE FLUCTUATION OF THE US DOLLER VIS - - VIS THE INDIAN CURRENCY, FROM TIME TO TIME. 2.0 DETAILS RELATING TO THE FORWARD CONTRACT UNDERTA KEN BY THE APPELLANT DU RING THE FINANCIAL YEAR ENDED 31 MARCH 2009 2.1 THE APPEL L ANT HEREWITH SUBMITS THE FOLLOWING DETAILS OF FOREIGN EXCHANGE GAIN (LOSS) MADE DURING THE YEAR ENDED 31 MARCH 2009, SUCH AS: SR. NO . PARTICULARS ANNEXURE 1 STATEMENT OF REVALUATION OF OUTSTANDING FORWARD - CONTRACT AS ON 31 MARCH 2009 FOR EXCHANGE LOSS OF RS. 18,80,94,300 A 2 STATEMENT OF GAIN / (LOSS) FOR FORWARD CONTRACTS OUTSTANDING AS ON 31 MARCH 2009 AND ITS EFFECT IN THE SUBSEQUENT YEAR ENDED 31 MARCH 201 0 B 2.2 THE APPELLANT FURTHER SUBMITS THAT THERE WAS HUGE VOLATILITY IN EXCHANGE RATE OF US DO LLAR VIZ. RUPEE FROM APRIL 2008 TO MARCH 2009. USD HAD REGISTERED AN APPRECIATION FROM RS. 39.7650 TO RS. 51.9700 DURING THE YEAR AS IS EVIDENT FROM THE Y EAR L Y GRAPH PLOTTING THE VOLATILITY MARKED AS ANNEXURE - C . ITA NO. 4588 /MUM/20 1 4 4 2.3 YOUR HONOUR WILL APPRECIATE THE FACT THAT THE APPELLANT HAS HEDGE THE UNDERLYING EXPOSURE IN FOREIGN CURRENCY. AS SUCH, IT IS HUMBLY SUBMITTED THAT THE FORWARD CONTRACTS ENTERED WERE FOR THE PURPOSE OF THE BUSINESS TO HEDGE AGAINST THE FOREX LOSS. THE APPEL L ANT HAS FOREX EXPOSURE ON ALL LIMBS ITS BUSINESS ACTIVITIES. THE FIRM HAS NOT ENTERED INTO THE FORWARD CONTRACTS WITH AN INTENTION TO EARN ANY GAIN DUE TO FLUCTUATION IN FOREIGN CURRENCY RATE BUT IT IS NECESSARY FOR IT TO ENTER INTO SUCH FORWARD CONTRACTS TO HEDGE AGAINST FOREIGN EXCHANGE RATE FLUCTUATION. THIS IS AN INTEGRAL PART OF THE BUSINESS UNDERTAKEN BY THE APPELLANT AND INCIDENTAL TO THE EXPORT AND IMPORT BUSINESS. IN THE ABSENCE OF SUCH FORWARD CONTRACTS, THE FIRM MAY SUSTAIN HUGE LOSSES. THEREFORE, IT BECOMES ESSENTIAL FOR THE FIRM TO BOOK SUCH FORWARD CONTRACTS AS A PRUDENT BUSINESS PRACTICES. FURTHER, YOU WILL APPRECIATE THAT THE APPEL L ANT IS ENGAGED IN THE BUSINESS OF DIAMONDS EXPORT AND NOT IN THE BUSINESS OF FOREIGN EXCHANGE. THIS IS EVIDENT FR OM THE FINANCIAL RESULTS OF THE FIRM AS W ELL AS THE OBJECTS OF THE FIRM AS MENTIONED IN THE PARTNERSHIP DEED. IN VIEW OF THE SAME, IT MAY BE APPRECIATED THAT THESE CONTRACTS ARE NOTHING BUT AN INTEGRAL PART OF ITS EXPORT AND IMPORT ACTIVITIES AND THE RESULTANT HEDGING DIFFERENCE ON THEIR REVALUATION CANNOT BE ISOLATED ARTIFICIALLY. 4 . FURTHER, THE CIT (A) DELETED THE DISALLOWANCE AND ALLOWED THE CLAIM OF THE ASSESSEE BY OBSERVING IN F OLLOWING PARAGRAPHS : - 2.4.5 AS WILL BE SEEN IN THE SUBSEQUENT PARAGRAPHS, THE APPELLANT HAS BEEN REGULARLY FOLLOWING THE AS - 11 AS PER WHICH THE FORWARD EXCHANGE CONTRACTS OUTSTANDING ON THE BALANCE SHEET DATE HAS TO BE RESTATED AND THE PROFIT/GAIN HAS BEEN OFFERED TO TAX IN THE RESPECTIVE YEARS. THUS, IT WAS CLAIMED THAT THE LOSS ON ACCOUNT OF FLUCTUATION IN THE RATE OF FOREIGN EXCHANGE WHETHER REALIZED OR UNREALIZED HAS TO BE TREATED AS REVENUE EXPENDITURE AND SHOULD BE ALLOWED AS A DEDUCTION FROM THE TAXA BLE INCOME, IN THIS REGARD, THE APPELLANT HAS ALSO SUBMITTED THE DETAILS, OF OUTSTANDING FOREIGN EXCHANGE EXPOSURE AS AT THE END OF THE YEAR WHICH IS AS UNDER: - SR. NO . NATURE OF FOREIGN CURRENCY EXPOSURE AMOUNT (USD IN MILLION, 1 EXPORTS RE CEIVABLES (I.E. OVERSEAS DEBTORS) 19.22 2 IMPORTS PAYABLES (I.E. OVERSEAS CREDITORS) 9.31 3 BANK LOAN 65.78 4 ADVANCE FROM OVERSEAS CUSTOMERS 8.96 5 CLOSING STOCK FOR EXPORT 91.44 TOTAL 194.72 2.4.6 THE APPELLANT HAS ALSO GIVEN THE AVERAGE AND MONTH WISE EXPOSURE IN FOREIGN EXCHANGE DURING THE F.Y.2008 - 09 AS PER WHICH THE MONTHLY AVERAGE OF OUTSTANDING FOREIGN DEBTORS WAS US DOLLAR 40.86 MILLION. A L SO , STOCK AS ON 31.3.2004 WAS WORTH US DOLLAR 91.44 MILLION. THE SAID CHART IS REPRODUCED HER EIN BELOW: - ITA NO. 4588 /MUM/20 1 4 5 AVERAGE AND MONTH WISE EXPOSURE IN FOREIGN EXCHANGE DURING THE FINANCIAL YEAR 2008 - 09 MONTH OUTSTANDING FOREX DEBTORS AS ON MONTH END OUTSTANDING FORE X CREDITORS AS ON MONTH END OUTSTANDING BANK LOAN AS ON MONTH END ADVANCE FROM FROM CUSTOM ERS AS ON MONTH END STOCK AS ON MONTH END (EXPECTED FOREX RECEIVABLES) TOTAL FOREIGN EXCHANGE EXPOSURE AS ON CONTRACT APR - 08 44,816,959 31,288,490 75,534,866 21,008,529 112,410,918 285,059,763 MAY - 08 44, 781,311 41,323,348 73,532,621 18,919,110 113,654,0 36 292,210,425 JUN - 08 4 6,587,421 53,896,970 65,980,079 12,131,098 112,462,944 291,058,512 JULY - 08 51,339,913 51,149,907 68,528,680 20,569,801 120,631,271 312,219,572 AUG - 08 51,753,000 53,002,048 67,088,900 18,606,497 118,096,552 308,546,997 SEP -- 08 47, 781,111 59,348,072 69,039,634 12,656,252 118,864,305 307,689,375 OCT - 08 60,291,363 24,771,240 91,001,852 10,791,675 94,208,024 281,064,153 NOV - - 08 4 6,612,670 31,437,520 81,862,954 9,863,734 109,145,182 278,922,061 DEC - 08 35,229,699 30,221,002 61,068,826 10,453,065 105,600,941 242,573,533 JAN - 09 22,416,651 28,503,142 51,602,952 9,663,219 101,810,515 213,996,279 FEB - 08 19,570,135 35,551,859 39,181,671 9,239,317 92,294,245 195,837,227 MAR - 08 19,224,253 9,311,415 65,785,464 8,961,480 91,442,232 194,724,84 5 AVERAGE 40,867,041 37,483,751 67,517,375 13,571,982 107,551,764 266,991,912 2.4.7 TO UNDERSTAND THE CONCEPT OF A SPECULATIVE TRANSACTION , AT THIS STAGE, I MAY ALSO BE PROFITABLE TO READ SECTION 43(5) WHICH IS AS UNDER: SPECULATIVE TRANSACTION' ME ANS A TRANSACTION IN WHICH A CONTRACT FOR THE PURCHASE OR SALE OF ANY COMMODITY, INCLUDING STOCKS AND SHARES, IS PERIODICALLY OR ULTIMATELY SETTLED OTHERWISE THAN BY THE ACTUAL DELIVERY OR TRANSFER OF THE COMMODITY OR SCRIPS: PROVIDED THAT FOR THE PURPOSES OF THIS CLAUSE (A) A CONTRACT IN RESPECT OF RAW MATERIALS OR MERCHANDISE ENTERED INTO BY A PERSON IN THE COURSE OF HIS MANUFACTURING OR MERCHANTING BUSINESS TO GUARD AGAINST LOSS THROUGH FUTURE PRICE FLUCTUATIONS IN RESPECT OF HIS CONTRACTS FOR ACTUAL DE LIVERY OF GOODS MANUFACTURED BY HIM OR MERCHANDISE SOLD BY HIM; OR (B) A CONTRACT IN RESPECT OF STOCKS AND SHARES ENTERED INTO BY A DEALER OR INVESTOR THEREIN TO GUARD AGAINST LOSS IN HIS HOLDINGS OF STOCKS AND SHARES THROUGH PRICE FLUCTUATIONS; OR (C) A C ONTRACT ENTERED INTO BY A MEMBER OF A FORWARD MARKET OR A STOCK EXCHANGE IN THE COURSE OF ANY TRANSACTION IN THE NATURE OF JOBBING OR ARBITRAGE TO GUARD AGAINST LOSS WHICH MAY ARISE IN THE ORDINARY COURSE OF HIS BUSINESS AS SUCH MEMBER; 26 [OR] [(D) [EXPLANATION 1] ***** 2.4.8 JUSTIFYING THAT THIS LOSS ON REVALUATION WAS REAL, LD.AR FOR THE APPELLANT FURTHER CONTENDS THAT: (I) THERE IS NO DISPUTE ABOUT THE I NCURRENCE OF THIS LOSS (II) SIMILAR LY, THERE IS NO DISPUTE THAT THE METHOD OF ACCOUNTING FOLLOWED BY THE APPELLANT IS MERCANTILE AS THE LD. AO HAS RECORDED THIS FACT IN THE ASSESSMENT ORDER. ITA NO. 4588 /MUM/20 1 4 6 (III) IT IS NOT DISPUTED THAT THESE LOSSES HAVE BEEN RECOGNIZED BY THE APPELLANT IN ACCORDANCE WITH APPLICABLE ACCOUNTING STANDARDS/POLICIES IN THIS REGARD. ( IV) THE ID. AO HAS RAISED ONLY DISPUTE THAT THIS LOSS IS NOT ALLOWABLE AS A DEDUCTION IN THE YEAR OF INCURRENCE COMPUTED UNDER MERCANTILE SYSTEM BY FOLLOWING THE ACCOUNTING STANDARDS IN THIS RESPE CT. V) `THE APPELLANT WAS OBLIGED TO CONVERT OUTSTANDING BALANCE OF FORWARD CONTRACT AT THE YEAR END RATE, WHICH WERE EXECUTED AT HIGHER RATES, RESULTING IN CONSIDERABLE LOSS ON ACCOUNT OF YEAR END CONVERSION OF FORWARD CONTRACT POSITIONS 2.4.9 IT WA S ALSO STATED THAT THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA, THE LEGAL APEX BODY, ON ACCOUNTING MATTERS HAS ISSUED AN ACCOUNTING STANDARD 'ACCOUNTING FOR THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES (AS - 11) (REVISED)' WHICH IS REQUIRED TO BE COMP ULSORILY FOLLOWED FROM 1 ST APRIL 1995. IN ACCORDANCE WITH THE STIPULATIONS OF THIS STANDARD, ALL THE MONETARY ITEMS ARE REQUIRED TO BE VALUED AT THE CLOSING RATE AND THE PROFIT OR LOSS ARISING THERE FROM IS REQUIRED TO BE DEBITED OR CREDITED TO THE PROFIT AND LOSS ACCOUNT AS CAN BE SEEN FROM THE FOLLOWING EXCERPTS: AT EACH BALANCE SHEET DATE : 1. MONETARY ITEMS DENOMINATED IN A FOREIGN CURRENCY (E.G. FOREIGN CURRENCY NOTES AND LOANS DENOMINATED IN A .FOREIGN CURRENCY) SHOULD BE REPORTED USING THE CLOSI NG RATE . 2. EXCHANGE DIFFERENCE ARISING ON FOREIGN CURRENCY TRANSACTIONS SHOULD BE RECOGNIZED AS INCOME OR AS EXPENSE IN THE PERIOD IN WHICH THEY ARISE. ' 2.4.10 THE INTERNATIONAL ACCOUNTING STANDARD (IAS - 21) ALSO STIPULATES THE SAME METHODOLOGY AS C AN BE SEEN FROM THE FOLLOWING EXCERPTS: 3. AT EACH BALANCE SHEET DATE, THE FOREIGN CURRENCY MONETARY ITEMS THAT RESULT FROM TRANSACTIONS OF THE ENTITY SHOULD BE REPORTED AT THE CLOSING R ATE 4. EXCHANGE DIFFERENCE ARISING ON REPORTING AN ENTITY'S LONG TERM FOREIGN CURRENCY MONETARY ITEMS AT RATES DIFFERENT FROM THOSE AT WHICH THEY WERE RECORDED DURING THE PERIOD OR PRESENTED IN PREVIOUS FINANCIAL STATEMENTS SHOULD NORMALLY BE RECOGNIZED IN INCOME FOR THE PERIOD. ' 2.4.11 IN A NUTSHELL, THE SUMMARY OF THE APPELLANT'S SUBMISSIONS ARE AS UNDER: I) IN THE FIRST PLACE, THE L D. AO HAS FAILED TO APPRECIATE THE CHARACTERISTICS OF A FORWARD CONTRACT. EACH FORWARD CONTRACT IS ITA NO. 4588 /MUM/20 1 4 7 ALWAYS ASSIGNED WITH A VALUE THAT IS CONTRACTED WITH CREATION OF A FETTERED OBLIGATION O N THE ASSESSEE TO EXECUTE AND MEET AT A FUTURE CONTRACTED DATE. ALL THE CONTRACTS ARE ALWAYS ENFORCEABLE, IN AS MUCH AS REALIZABLE . II) THE POINT THAT THE ID. AO WAS MAKING WAS THAT ANTICIPATED LIABILITIES ARE NOT ALLOWABLE, WHICH ARE NOTIONAL IN NATURE. BUT , THE DISTINCTION IN CASE OF FORWARD CONTRACTS IS THAT IF AN ANTICIPATED LIABILITY IS COUPLED WITH PRESENT OBLIGATION AND ONLY QUANTIFICATION CAN VARY DEPENDING UPON THE TERMS OF CONTRACT, THEN A LIABILITY IS SAID TO HAVE CRYSTALLIZED O N THE REPORTING DATE I.E 31ST MARCH. III) ARGUMENT OF THE ID. AO THAT AN EVENT OF CONTRACT MATURITY CAN ONLY QUANTIFY CONTRACT VALUE IS TENUOUS AND WEAK. IN REA LITY, FORWARD CONTRACTS LOSSES / PROFITS ACCRUE ON DAILY BASIS DEPENDING ON THE FLUCTUATION OF US$ AND INDIAN RUPE E. ANY PRUDENT PERSON WOULD CONSTANTLY MONITOR THE POSITION OF FORWARD CONTRACT VALUE ON DAILY BASIS TO ASSESS THE IMPACT OF PROFIT OR LOSS. IT MAY BE APPRECIATED THAT VALUES OF OUTSTANDING POSITION OF FORWARD CONTRACT IS CLEARLY MEASURABLE BASED ON DAILY POSITION OF SPOT RATE OF US $ AGAINST THE RUPEE, SO IS IT ALSO MEASURABLE WITH COMPLETE ACCURACY, AS ON THE LAST DATE OF THE BALANCE SHEET. IV) CUT - OF F OF 31ST MARCH SPLITS PROFITS / LOSSES OF OUTSTANDING POSITION OF FORWARD CONTRACTS INTO TWO DIFFERENT A CCOUNTING PERIODS, AND THAT IS THE ONLY R ATIONAL WAY TO EVALUATE PROFIT / LOSS IN A GIVEN PERIOD. LOSS, ALTHOUGH PURPORTED TO BE STATED BY THE ID. AO TO BE NOTIONAL, IS ACTUAL AND QUANTIFIABLE. LOSS HAD OCCURRED AND ACCRUED, AS A RESULT OF CONVERSION. ONLY THING IS THAT SUCH A LOSS IN THE SUBSEQUENT PERIOD WOULD GET EITHER FURTHER AGGRAVATED OR GET PLACID, DEPENDING UPON THE FOREIGN EXCHANGE FLUCTUATION THAT MAY HAPPEN AGAINST THE RUPEE. V) FOREIGN EXCHANGE LOSS AS A RESULT OF CONVERSION OF OUTSTANDING PO SITION OF FORWARD CONTRACTS IS - REAL QUANTIFIABLE WITH PRECISION BASED ON COMMERCIAL ACCOUNTING PRINCIPLES AS A RESULT OF CUT - OFF IN CONSONANCE WITH THE ACCOUNTING STANDARD - 11 ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA ALLOWABLE 2.4. 12 TO SUMMARIZE, IT WAS STATED THAT (A) IT IS ONLY COINCIDENTAL THAT RUPEE WAS ALMOST AT THE PEAK AT THE BEGINNING OF THE. YEAR, WHILE IT WAS AT ITS BOTTOM AT THE END OF THE YEAR AGAINST THE US$ RESULTING IN LOSS ON THE OUTSTANDING VALUE OF FORWARD CONTRACTS AT THE YEAR - END. (B) THE ASSESSEE INCURRED LOSS ON ACCOUNT OF OUTSTANDING VALUE OF FORWARD CONTRACTS AT THE YEAR - END (31ST MARCH, 2009); WHILE IN PAST AND SUBSEQUENT YEARS, ASSESSEE HAD GAINED PROFITS ON SIMILAR ITA NO. 4588 /MUM/20 1 4 8 TRANSACTIONS. IN OTHE R YEARS, THE DEPARTMENT HAS ALWAYS ACCEPTED PROFIT ON YEAR - END CONVERSION OF OUTSTANDING VALUE OF FORWARD CONTRACTS. ON ANALOGY, ACCURACY AND CONSISTENCY PERSPECTIVE, THE DEPARTMENT NEEDS TO ACCEPT LOSS INCURRED ON CONVERSION OF THE OUTSTANDING VALUE OF FO RWARD CONTRACTS, PARTICULARLY IF IT HAS HAPPENED ON ACCOUNT OF CONTROLS BEYOND THE ASSESSEE . (C) ACCOUNTING STANDARD 11 DEALING WITH EFFECTS OF FOREIGN CURRENCY REQUIRES ASSESSEE TO ADJUST ITS MONETARY ASSETS AT THE YEAR END WITH THE YEAR - END CONVERSION RATE AND REFLECT PROFIT OR LOSS IN THE REVENUE STATEMENT. THEREFORE WHAT WE HAVE DONE IS WHAT WE ARE TECHNICALLY OBLIGED TO DO. (D) EVEN MERCANTILE SYSTEM OF ACCOUNTING AS RECOGNIZED UNDER SECTION 145 REQUIRES THAT AT THE YEAR END, AN ASSESSEE SHOULD MAK E PROVISION FOR ALL KNOWN LIABILITIES. 2.4.13 AS EVIDENT FROM THE ABOVE, IT WAS PLEADED' THAT SIMILAR QUESTION AROSE IN THE CASE OF CIT V. WOODWARD GOVERNOR INDIA (P.) LTD. [2009] 312 ITR 254 I 179 TAXMAN 326 (S C ) THAT WHETHER THE LOSS ARISING ON FLUCTUA TION OF EXCHANGE IN RESPECT OF LOAN TAKEN FOR REVENUE PURPOSED IS ALLOWABLE AS DEDUCTION IN THE YEAR OF FLUCTUATION OF EXCHANGE RATE OR WHETHER THE SAME COULD BE ALLOWED ONLY IN THE YEAR OF REPAYMENT OF SUCH LOAN. THE SUPREME COURT HELD THAT THE LOSS SUFFE RED BY THE ASSESSEE ON ACCOUNT OF EXCHANGE DIFFERENCE ON THE BALANCE SHEET DATE IS AN ITEM OF EXPENDITURE AS ON BALANCE SHEET DATE. IT FURTHER HELD THAT PROFITS OR LOSSES AS PER MERCANTILE SYSTEM OF ACCOUNTING AND AS PER THE APPLICABLE ACCOUNTING STANDARD IS ALLOWABLE AS DEDUCTION UNLESS THE SYSTEM OF ACCOUNTING IS SUPERSEDED OR MODIFIED BY THE LEGISLATIVE ENACTMENT. IT ALSO HELD THAT THE METHOD OF ACCOUNTING CONTINUOUSLY UNDERTAKEN BY THE ASSESSEE IS SUPREME AS THERE IS NO FINDING GIVEN BY THE AO ON THE CO RRECTNESS AND COMPLETENESS OF ACCOUNTS OR ANY FINDING TO THE CONTRARY THAT THE ASSESSEE HAD NOT COMPLIED WITH THE ACCOUNTING STANDARDS. IT WAS, INTER ALIA, CONCLUDED AS UNDER: ' IN ORDER TO FIND OUT IF AN EXPENDITURE IS DEDUCTIBLE THE FOLLOWING HAVE TO B E TAKEN INTO ACCOUNT: (I) WHETHER THE SYSTEM OF ACCOUNTING FOLLOWED BY THE ASSESSEE IS MERCANTILE SYSTEM WHICH BRINGS INTO DEBIT THE EXPENDITURE AMOUNT FOR WHICH A LEGAL LIABILITY HAS BEEN INCURRED BEFORE IT IS ACTUALLY DISBURSED AND BRINGS INTO CREDIT WHA T IS DUE, IMMEDIATELY IT BECOMES DUE AND BEFORE IT IS ACTUALLY RECEIVED; (II) WHETHER THE SAME SYSTEM IS FOLLOWED BY ASSESSEE FROM THE VERY BEGINNING AND IF THERE WAS A CHANGE IN THE SYSTEM, WHETHER THE CHANGE WAS BONA FIDE; (III) WHETHER THE ASSESSE E HAS GIVEN THE SAME TREATMENT TO LOSSES CLAIMED TO HAVE ACCRUED AND TO THE GAINS THAT MAY ACCRUE TO IT; ITA NO. 4588 /MUM/20 1 4 9 (IV) WHETHER THE ASSESSEE HAS BEEN CONSISTENT AND DEFINITE IN MAKING ENTRIES IN THE ACCOUNT BOOKS IN RESPECT OF LOSSES AND GAINS; (V) WHETHER THE METHOD ADOPTED BY THE ASSESSEE FOR MAKING ENTRIES IN THE ACCOUNT BOOKS BOTH IN RESPECT OF LOSSES AND GAINS IS AS PER NATIONALLY ACCEPTED ACCOUNTING STANDARDS; WHETHER THE SYSTEM ADOPTED BY ASSESSEE IS FAIR AND REASONABLE OR IS ADOPTED ONLY WITH A VIEW TO REDUCING THE INCIDENCE OF TAXATION' 2.4.14 IN FACT, EVEN IF THE LOSSES ARE ALLOWED IN THE YEAR OF REALISATION OF EXPORT PROCEEDS THAT WOULD TANTAMOUNT TO FOLLOWING CASH SYSTEM OF ACCOUNTING WHICH WILL BE CONTRARY TO SECTION 145(1) OF THE ACT -- CIT V. UP STATE INDUSTRIAL DEVELOPMENT CORPN. [1997] 225 ITR 703/92 TAXMAN 4 - 5 ( SC ). 2.4.15 SIMILARLY, AS PLEADED EARLIER, IN THE CASE OF DY. CIT (INTERNATIONAL TAXATION) V. BANK OF BAHRAIN & KUWAIT [2010] 41 SOT 290 , HON'BLE SPECIAL BENCH OF MUMBAI TRIBUNAL HEL D THAT LOSSES INCURRED BY THE APPELLANT ON ACCOUNT OF REVALUATION OF THE CONTRACT ON THE LAST DATE OF THE RELEVANT ACCOUNTING PERIOD BASED ON THE RBI GUIDELINES/APPLICABLE ACCOUNTING STANDARD IS ALLOWABLE AS DEDUCTION. IT HELD THAT SUCH LOSS IS NEITHER NOT IONAL NOR CONTINGENT LIABILITY IN WHICH THE MOMENT BINDING CONTRACT IS ENACTED, IT BECOMES ALLOWABLE. FURTHER REFERENCE COULD BE MADE TO BHARAT EARTH MOVERS V, CIT [2000] 245 ITR 4281 112 TAXMAN 61 (SC), METAL BOX CO. OF INDIA . LTD. V. THEIR WORKMEN [1969 ] 73 ITR 53 (SC) .AND CALCUTTA CO. LTD. V . CIT [1959] 37 ITR 1(SC) 2.4.16 IN THE CASE OF DCIT VIS BANK OF BAHRAIN & KUWAIT(SUPRA), FORWARD CONTRACTS WERE ENTERED OF AN AMOUNT TO PROTECT THE FLUCTUATIONS IN THE FOREIGN CURRENCY HELD AS STOCK - IN - TRADE. FO RWARD CONTRACTS VALUE ENTERED BY. BANK OF BAHRAIN & KUWAIT HAD NOTHING TO DO WITH THE FOREIGN CURRENCY HELD AS STOCK - IN - TRADE EXCEPT PROTECTING FLUCTUATIONS, WHILE OF COURSE DEALING WITH REPORTING IN INDIAN CURRENCY. ON THE SAME FOOTING, IN THE INSTANT CAS E OF THE APPELLANT STOCK. AS WELL AS RECEIVABLE MAINLY ARE DOLLAR DENOMINATED AND ARE REALIZABLE IN FOREIGN CURRENCY. TO HEDGE POSSIBLE FLUCTUATIONS IN US$ DENOMINATED STOCK, AS WELL AS RESULTANT DEBTORS OUT OF SUCH STOCK, THE APPELLANT HAD ENTERED INTO FO RWARD CONTRACTS. THE PROPOSITION IN THAT CASE, AS WELL AS IN THIS CASE IS STARKLY SIMILAR. THEY BEING BANK HAD 'MONEY' LYING IN FOREIGN CURRENCY AS THEIR STOCK - IN - TRADE, WHICH REQUIRED TRANSLATION INTO INDIAN CURRENCY FOR THE PURPOSE OF INDIAN REPORTING AN D INDIAN TAXATION, WHICH WOULD NATURALLY EXPOSE THEM TO FLUCTUATION RISK. TO HEDGE SUCH RISK, THEY HAD ENTERED INTO FORWARD CONTRACTS, AND HAD MADE YEAR - END CONVERSION ON OUTSTANDING POSITION OF THE FORWARD CONTRACTS, ALTHOUGH SUCH FORWARD CONTRACTS WERE N EVER REFLECTED IN THEIR BALANCE SHEET, AND LOSSES SO INCURRED AS A RESULT OF TRANSFER HAD REMAINED UNREALIZED AT THE POINT OF CONVERSION. ON THE SAME ANALOGY, THE APPELLANT'S STOCK, EVENTUALLY ALTHOUGH GETS REALIZED ITA NO. 4588 /MUM/20 1 4 10 MOSTLY IN TERMS OF FOREIGN CURRENCY, THE Y NEEDED TO TRANSLATE THE SAME INTO INDIAN CURRENCY FOR INDIAN REPORTING AND INDIAN TA X ATION. THIS EXPOSED THEM TO THE EXCHANGE FLUCTUATION RISK, IF THE RUPEE WOULD APPRECIATE AGAINST THE US$. IN BOTH THE CASES, THAT IS OF BANK OF BAHRAIN & KUWAIT AND THE PRESENT APPELLANT, FOREIGN CURRENCY POSITIONS WERE HEDGED BY ENTERING INTO FORWARD CONTRACTS, AND THEY HAD INCURRED YEAR - END FORWARD CONTRACT CONVERSION LOSSES. 2.4.17 IN THE CASE OF BHARAT EARTH MOVERS LTD (SUPRA ), THE COURT HAS DIFF E RE NTIATED BETWEEN W HAT IS ACCRUED LIABILITY AND CONTINGENT LIABILITY. THE RELEVANT PORTION OF THE PRINCIPLES LAID DOWN BY THE HON'BLE COURT ARE REPRODUCED AS UNDER: FOR AN ASSESSEE MAINT AINING HIS ACCOUNT ON THE MERCAN TILE SYSTEM, A LIABILITY ALREADY ACCRUED, THROUGH TO BE DISCHARGED AT FUTURE DATE WOULD BE A PR OPER DEDUCTION WHILE WORKING OUT THE PROFITS AND GAINS OF HIS BUSINESS, REGARD BE HAD TO THE ACCEPTED PRINCIPLES OF COMMERCIAL AND ACCOUNTANCY. IT IS NOT AS IF SUCH DEDUCTION IS PERMISSIBLE ONLY IN THE CASE OF AMO UNT ACTUALLY EXPEND ED OR PAID. JUST AS RECEIPTS THOUGH NOT ACTUAL RECEIPTS BUT ACCRUED AND DUE ARE BROUGHT IN FOR INCOME TAX ASSESSMENT SO ALSO LIABILITIES ACCRUED DUE WOULD BE TAKEN IN TO ACCOUNT WHILE WORKING OUT THE PROFITS AND GAINS OF THE BUSINES S. A CONDITION SUBSEQUENT,' THE FULFILLMENT OF WHICH MAY RESULT IN REDUCTION OR EVEN EXTINCTION OF THE LIABILITY, WOULD NOT HAVE THE EFFECT OF CONVERTING THAT LIABILITY INTO A CONTINGENT LIABILITY DISTINGUISHING AND DIFFERENTIATING CONTINGENT AND A CCRUED LIABILITY, IT WAS HELD THAT; IF A BUSINESS LIABILITY HAS DEFINITELY ARISEN IN THE ACCOUNTING YEAR, DEDUCTION SHOULD BE ALLOWED ALTHOUGH THE LIABILITY MAY HAVE TO QUANTIFIED AND DISCHARGED AT A FUTURE DATE. WHAT SHOULD BE CERTAIN IS THE INCURRING OF THE LIABILITY. IT SHOULD BE ALSO BE CAPABLE OF BEING ESTIMATED WITH REASONS CERTAINTY THOUGH THE ACTUAL QUANTIFICATION MAY NOT BE POSSIBLE. 2.4.18 FURTHER, IN THE CASE OF RUSABH DIAMONDS V. ASSISTANT COMMISSIONER INCOME - TAX - 15(1), MUMBAI [2013] 3 4 TAXMANN.COM 160 (MUMBAI - TRIB.) IN APPEAL NO. 7217 (MUM.)/2012 DATED APRIL 26, 2013, IT HAS BEEN, INTER ALIA, HELD, UNDER: '8.1 THE ASSESSEE CONSIDERED RS. 5,20, 70, 149 AS OPERATING INCOME ON ACCOUNT OF FOREIGN EXCHANGE GAIN ARISING ON FORWARD CONTRA CTS. THE ASSESSEE CONTENDED THAT THE EXCHANGE GAIN ARISING ON CANCELLATION FORWARD CONTRACTS ARE TO BE CONSIDERED ITA NO. 4588 /MUM/20 1 4 11 AS PART OF OPERATING PROFIT SINCE IT AN INTEGRAL PART OF THE BUSINESS OF BUYING AND SELLING OF THE DIAMONDS AL HENCE IS AN O PERATING INCOME. T HE TPO DID NOT ACCEPT THE CLAIM OF THE ASSESSEE FOR THE REASON THAT THE EXCHANGE GAIN EARNED ARE AGAINST CANCELLATION OF FORWARD CONTRACTS AND THE ASSESSEE HAS SEPARATELY DISCLOSED AS PROFITS AND GAINS FROM FOREIGN EXCHANGE FLUCTUATIONS, WHICH ARE NOT INCL UDED IN PURCHASES AND SALES. FURTHER, THE TPO WAS OF THE VIEW THAT THIS CONSTITUTES SPECULATIVE AND THEREFORE, THE SAME CANNOT BE TREATED AS PART OF THE MAIN BUSINESS ACTIVITY OF MANUFACTURING OF DIAMONDS OF THE ASSESSEE. 8.2 THE ORP CONCURRED WITH THE V IEW OF THE TPO ON THE GROUND THA T THE FOREIGN EXCHANGE EARNING ARE AGAINST CANCELLATION OF FORWARD CONTRACTS AND NOT INTEGRAL PART OF THE ASSESSEE'S BUSINESS. 9 . BEFORE US, THE ID SR . COUNSEL FOR THE ASSESSEE HAS SUBMITTED THAT THE ASSESSEE EARNED FOREI GN EXCHANGE ON CANCELLATION OF FORWARD CONTRACTS WHICH ARE CONNECTION OF ITS PURCHASE/SALES OF DIAMONDS. FOREIGN EXCHANGE GAIN IS DIRECTLY DEPENDENT ON THE ACTIVITY OF EXPORT OR IMPORT UNDERTAKEN BY THE ASSESSEE. THE ASSESSEE HAS ENTERED INTO FORWARD CONTR ACTS FOR THE PURPOSE OF REDUCING THE FOREIGN EXCHANGE RISK FACED BY IT IN RESPECT OF ITS TRANSACTIONS WITH AES. HE HAS FURTHER SUBMITTED THAT FOREIGN EXCHANGE FLUCTUATION GAIN HAS BEEN EARNED BY THE ASSESSEE UNDER THE HEDGING CONTRACT WHICH IS DULY BACKED BY THE SALES AND PURCHASE CONTRACT / ORDERS IN RESPECT OF DIAMONDS. THE ID SR COUNSEL HAS FURTHER CONTENDED THAT DEALING IN FOREIGN EXCHANGE BEING TREASURY TRANSACTION IS NOT PERMITTED BY THE RBI AND THEREFORE, THE GAIN ARISING FROM THE FORWARD CONTRACTS IS PART AND PARCEL OF OPERATING PROFIT OF THE - ASSESSEE, IN SUPPORT OF HIS CONTENTION HE HAS RELIED UPON THE DECISION OF THE BANGALORE BENCHES OF THE TRIBUNAL IN THE CASE OF SAP LABS INDIA (P.) V ACIT IN ITA NO.398IBANGI02;IN THE CASE OF BOMBAY DIAMOND CO LTD . V. DCIT IN ITA NO.7488 / MUM / 07; IN THE CASE OF C/R V. BADRIDAS GAURIDU (P.) LTD. [2003 ] 261 ITR 256 1[2004 ] 134 TAXMAN 376 (BOM). HE HAS FURTHER SUBMITTED THAT THE PREMIUM OR DISCOUNT ARISING AT THE 1NCEPTION OF FORWARD EXCHANGE CONTRACTS IS AMORTIZED AS EXPENSE OR INCOME OVER THE LIFE OF CONTRACT. THE EXCHANGE DIFFERENCE ON SUCH CONTRACT ARE RECOGNIZED IN THE PROFIT & LOSS ACCOUNT FOR THE YEAR IN WHICH THE EXCHANGE RATE CHANGES RESULTING IN THE PROFIT OR LOSS ARISING ON CANCELLATION OR RENEWAL OF FORWARD EXCHANGE CONTRACT IS RECOGNIZED AS INCOME OR AS EXPENSES. 9.1 THE ID OR ON THE OTHER HAND HAS SUBMITTED THAT AS PER DECD GUIDELINES ON THE TRANSFER PRICING, THE FOREIGN EXCHANGE GAIN OR LOSS SHOULD BE EXCLUDED OR INCLUDED DEPENDS ON WHETHER OR NOT THE TE STED PARTY IS RESPONSIBLE FOR THE SAME. HE HAS REFERRED PARAS 2.82 OF THE OECD GUIDELINES AND SUBMITTED THAT WHEN, AS PER THE CONTRACT BETWEEN AND ASSESSEE AND THE AE, THE AE HAS ASSUMED THE RISK OF FOREIGN EXCHANGE FLUCTUATION; THEN ITA NO. 4588 /MUM/20 1 4 12 EXCHANGE GAIN CANNOT B E INCLUDED IN THE PROFIT OF THE ASSESSEE FOR THE PURPOSE OF DETERMINATION OF NET MARGIN. THE ID OR HAS REFERRED THE TP STUDY AT PAGE 1.0 OF THE PAPER BOOK AND SUBMITTED THAT RISK O F FOREIGN EXCHANGE FLUCTUATION UPTO 3% IN USD IS TO BE EARNED BY THE AE. THE REFORE, THE SAME CANNOT BE INCLUDED TO THE PROFIT OF THE ASSESSEE FOR THE PURPOSE OF COMPUTATION OF OPERATING PROFIT OF THE ASSESSEE. 10. WE HAVE CONSIDERED THE RIVAL SUBMISSIONS AS WELL AS THE RELEVANT MATERIAL ON RECORD. THE ASSESSEE HAS ENTERED INTO FORWARD CONTRACTS FOR THE PURPOSE OF HEDGING OF FOREIGN CURRENCY EXPOSURE ON EXPORT AND IMPORT OF DIAMONDS WITH AES. THEREFORE, THE HEDGING OF FOREIGN CURRENCY HAS NEXUS WITH THE EXPORT AND IMPORT ACTIVITY OF THE ASSESSEE AND THE EXPOSURE OF THE ASSESSEE I N RELATION TO THE EXPORT AND IMPORT. THE OE C D GUIDELINES IN PARA 2.82 ARE AS UNDER; '2.82 WHETHER FOREIGN EXCHANGE GAINS AND LOSSES SHOULD BE INCLUDED OR EXCLUDED FROM THE DETERMINATION OF THE NET PROFIT INDICATOR RAISES A NUMBER OF DIFFICULT COMPARABIL ITY ISSUES. FIRST, IT NEEDS TO BE CONSIDERED WHETHER THE FOREIGN EXCHANGE GAINS AND LOSSES ARE OF A TRADING NATURE (E.G. EXCHANGE GAIN OR LOSS ON A TRACE RECEIVABLE OR PAYABLE) AND WHETHER OR NOT THE TESTED PARTY IS RESPONSIBLE FOR THEM. SECOND, ANY HEDGIN G OF FOREIGN CURRENCY EXPOSURE ON THE UNDERLYING TRADE RECEIVABLE OR PAYABLE ALSO NEEDS TO BE CONSIDERED AND TREATED IN THE SAME WAY IN DETERMINING THE NET PROFIT . IN EFFECT, IF A TRANSACTIONAL NET MARGIN APPLIED TO A TRANSACTION IN WHICH THE FOREIGN EXCHA NGE R R ISK IS BORNE BY THE TESTED PARTY, FOREIGN EXCHANGE GAINS OR LOSSES SHOULD BE CONSISTENTLY ACCOUNTED FOR (EITHER IN THE CALCULATION OF THE NET PROFIT INDICATOR OR SEPARATELY). ' 10.1 IT IS CLEAR THAT IN CASE OF HEDGING OF FOREIGN CURRENCY EXPOSURE O N THE UNDERLINING TRADE RECEIVABLE OR PAYABLE THE PROFIT OF LOSS WILL BE TREATED IN THE SAME WAY IN DETERMINING THE NET PROFIT. 10.2 IN VIEW OF THE FACTS THAT THE ASSESSEE HAS ENTERED INTO FORWARD CONTRACTS FOR THE PURPOSE OF HEDGING OF FOREIGN CURRENCY EXPOSURE ON THE EXPORT AND IMPORT OF DIAMOND, THE GAIN OR LOSS ARISING OF THE SAID, WILL BE TREATED AS PART AND PARCEL OF THE OPERATING PROFIT.' (EMPHASIS SUPPLIED) 2.4.19 IN A RECENT DECISION IN THE CASE OF SOCIETE GENERATE (2013 - ITS - 737 - ITAT), THE HO N'BLE MUMBAI TRIBUNAL HAS ALLOWED A SIMILAR CLAIM OF THE ASSESSEE FOR THE LOSS OF RS. 9.16 CRORES ON FOREIGN EXCHANGE CONTRACTS OUTSTANDING AS ON 31 - 3 - 1998 HOLDING THAT THIS ISSUE WAS SQUARELY COVERED IN FAVOUR OF THE ASSESSEE BY THE DECISION OF THE SPECIA L BENCH OF IT AT IN THE CASE OF BANK OF BAHRAIN & KUWAIT (SUPRA). ITA NO. 4588 /MUM/20 1 4 13 2.4.20 IN THE CASE OF ONGC VS CIT 322 ITR 180, HON'BLE SUPREME COURT HAS REITERATED THE PRINCIPLES LAID DOWN ABOVE WHILE ANSWERING THE QUESTION THAT WHEN THE ASSESSEE MAINTAINED THEIR ACCO UNTS ON MERCANTILE SYSTEM OF ACCOUNTING AND THERE WAS NO FINDING BY THE AO ON THE CORRECTNESS OR COMPLETENESS OF THE ACCOUNT AND WHEN THE ASSESSEE HAD COMPLIED WITH THE ACCOUNTING STANDARDS, LAID DOWN BY THE CENTRAL GOVERNMENT, THE 'LOSS' SUFFERED BY IT ON ACCOUNT OF FLUCTUATION IN THE RATE OF FOREIGN EXCHANGE AS ON THE DATE OF BALANCE - SHEET WAS TO BE ALLOWED AS AN EXPENDITURE UNDER SECTION 37(1) OF THE ACT NOTWITHSTANDING THE FACT THAT THE LIABILITY HAD NOT BEEN ACTUALLY DISCHARGED IN THE YEAR IN WHICH T HE FLUCTUATION IN THE RATE OF FOREIGN EXCHANGE HAD OCCURRED AND IT FINALLY DECIDED THAT THE LOSS INCURRED ON ACCOUNT OF RESTATEMENT OF THE LIABILITIES IN FOREIGN EXCHANGE WAS ALLOWABLE AND ANSWERED THE QUESTION IN FAVOUR OF THE ASSESSEE . 2.4.21 THUS, THE JUDICIAL DECISION OF THE HON. SUPREME COURT AND VARIOUS OTHER AUTHORITIES ARE CLEARLY IN FAVOUR OF THE APPELLANT ON THIS ISSUE. THAT APART, AS DISCUSSED EARLIER, THE LIABILITIES IN FOREIGN EXCHANGE. WERE INCURRED DURING THE NORMAL COURSE OF THE APPELLANT' S BUSINESS AND THE RESTATEMENT OF THE FORWARD CONTRACT OBLIGATIONS WAS DONE AS PER AS - 11 IN A CONSISTENT MANNER OVER THE YEARS. 2.4.22 IN FACT, THE GAIN EARNED ON SUCH REVALUATION WAS ACCEPTED AND BROUGHT TO TAX IN THE RESPECTIVE YEARS AND THERE WAS NO R EASON FOR THE LD. AO. TO ARRIVE AT A DIFFERENT CONCLUSION IN PRESENT CASE MERELY BECAUSE THERE WAS LOSS DURING THE YEAR APPARENTLY, THE ID. AO WAS OF THE VIEW THAT THE APPELLANT WAS NOT A DEALER IN FOREIGN EXCHANGE UNLIKE THE BANK OF BAHRAIN, AND THEREFORE THE SAID DECISION WAS HELD AS NOT APPLICABLE TO THE FACTS OF THE CASE. HOWEVER, AS SEEN EARLIER, THIS ISSUE IS NO MORE RES INTEGRA AND IS SETTLED BY A PLETHORA OF JUDICIAL DECISIONS. 2.4.23 IT IS NOT OUT OF PLACE TO MENTION THAT THE HON. SUPREME COURT, IN THE CASE OF ONGC (SUPRA), UPHELD THE SAME PRINCIPLES THAT WERE LAID DOWN IN THE CASE OF WOODWORD GOVERNORN (SUPRA), AND THE LOSS WAS HELD ALLOWABLE IN SIMILAR CIRCUMSTANCES, WHERE THE BUSINESS OF ONGC WAS NOT THAT OF A FOREIGN EXCHANGE DEALER. THEREFOR E, IT IS NOT THE NATURE OF BUSINESS OR THE STOCK DEALT WITH I.E., CURRENCY OR COMMODITIES OR GOODS LIKE DIAMONDS IN THE PRESENT CASE THAT MATTERS. 2.4.24 RECENTLY, HON'BLE MUMBAI ITAT 'H' BENCH IN THE CASE OF H. DIPAK & CO.,MUMBAI I.T.A. NO. 7629/MUM/201 1 ON 30 APRIL, 2013 HAS HELD THAT - 'WE HAVE HEARD THE ARGUMENTS OF BOTH THE SIDES AND ALSO PERUSED THE RELEVANT MATERIAL AVAILABLE ON RECORD. IT IS OBSERVED THAT A SIMILAR CLAIM FOR MARKED TO MARKET LOSS CLAIMED BY THE ASSESSEE IN RESPECT OF FORWARD FORE IGN EXCHANGE CONTRACT DEBITED TO THE P&L ACCOUNT HAS BEEN ALLOWED BY THE SPECIAL BENCH OF THIS TRIBUNAL IN THE CASE OF BANK OF BEHREIN & KUWAIT (SUPRA) AFTER DISCUSSING AND CONSIDERING ALL THE RELEVANT A SPECTS OF THE MATTER, AND THE RELEVANT ITA NO. 4588 /MUM/20 1 4 14 OBSERVATIONS OF THE TRIBUNAL RECORDED IN THIS CONTEXT ARE SUMMARIZED AS UNDER: - (I) A BINDING OBLIGATION ACCRUED AGAINST THE APPELLANT THE MINUTES ( SIC) IT ENTERED INTO FORWARD FOREIGN EXCHANGE CONTRACTS. (II) A CONSISTENT METHOD OF ACCOUNTING FOLLOWED BY THE APPE LLANT CANNOT BE DISREGARDED. THE APPELLANT HAS CONSISTENTLY FOLLOWED THE SAME METHOD OF ACCOUNTING IN REGARD TO RECOGNITION OF PROFIT OR LOSS BOTH, IN RESPECT OF FORWARD FOREIGN EXCHANGE CONTRACT AS PER THE RATE PREVAILING ON MARCH, 31, (III) A LIABILIT Y IS SAID TO HAVE ~CRYSTALLIZED WHEN A PENDING OBLIGATION ON THE BALANCE SHEET DATE IS DETERMINABLE WITH REASONABLE CERTAINTY. (IV) AS PER AS - 11 WHEN, THE TRANSACTION IS NOT SETTLED IN THE SAME ACCOUNTING PERIOD AS T HAT IN WHICH IT OCCURRED, THE EXCHANGE DIFFERENCE ARISES OVER MORE THAN ONE ACCOUNTING PERIOD. (V) IN VIEW OF THE DECISION, OF THE. SUPREME COURT IN THE CASE OF WOODWARD GOVERNO R INDIA (I) P LTD, THE APPELLANTS CLAIM IS ALLOWABLE. (VI) IN THE ULTIMATE ANALYSIS, THERE IS NO REVENUE EFFE CT AND IT IS ONLY THE TIMING OF TAXATION OF LOSS/PROFIT. 2 .4.25 ON THE BASIS OF FACTS OBTAINING IN THE IMPUGNED APPEAL AND THE ONE IN THE CASE OF H. DIPAK (SUPRA), FOLLOWING CHART SUMMARIZES THE SIMILARITIES IN THE TWO CASES: S.NO . PARTICULARS K.P. SANGHVI H DIPAK & CO. 1 CONSTITUTION PARTNERSHIP FIRM PARTNERSHIP FIRM 1 BUSINESS ACTIVITY ENGAGED IN THE BUSINESS OF IMPORT, MANUFACTURING AND EXPORT OF CUT & POLISHED DIAMONDS SIMILAR ACTIVITY I.E ENGAGED IN THE BUSINESS OF MANUFACTURING, T RADING AS WELL AS IMPORT AND EXPORT OF CUT AND POLISHED DIAMOND 2 IMPORT (USD) RS.517.10 CR RS.476.68 CR 3 EXPORT (USD) RS.714.98 CR. 4 % OF EXPORT SALES TO TOTAL SALES EXPORT 95% OF TOTAL SALES 5 CREDIT FACILITY FROM BANK ENJOYING FOREIGN CURRENCY LOAN FROM SAY PCFC LOAN FROM BANK ENJOYING FOREIGN CURRENCY LOAN SAY PCFC LOAN FROM BANK 6 ACCOUNTING POLICY FOR CURRENCY P O LICY FOLLOWED BY THE FIRM CLEARLY STATED IN POLICY FOLLOWED BY THE FIRM CLEARLY STATED IN ITA NO. 4588 /MUM/20 1 4 15 TRANSACTIONS . THE SIGNIFICANT ACCOUNTIN G POLICIES ON 'FOREIGN CURRENCY TRANSACTIONS' PARA 6 OF SCHEDULE - F OF BALANCE SHEET UNDER THE HEADING 'REPORTING ON NOTIFIED ACCOUNTING STANDARDS' 7 HEDGING THROUGH. FORWARD CONTRACT REQUIREMENT HAS ENTERED INTO OBLIGATION AT THE TIME OF ENTERING INTO THE FORWARD FOREIGN EXCHANGE CONTRACTS DEALT WITH EXPORT REALIZATION WITHOUT ANY SPECULATION. TRANSACTIONS SAME PURPOSES 8 H EDGING TRANSACTIONS V/S SPECULATIVE TRANSACTIONS AS PER PROVISO (A) OF THE SECTION 43(5) OF THE ACT TO BE GENUINE AND VALID HEDGING CONTRACTS OF SALE THE TOTAL OF SUCH TRANSACTIONS SHOULD NOT EX CEED THE VALUE OF TOTAL STOCK OF RAW MATERIAL OR THE MERC HANDISE ON HAND SAME SITUATION 9 METHOD OF ACCOUNTING CONSISTENTLY FOLLOWED THE METHOD OF ACCOUNTING WITH REGARD TO RECOGNITION OF PROFIT OF LOSS BOTH FOR FORWARD FOREIGN EXCHANGE CONTRACT AT THE RATE PREVAILING ON 31 ST MARCH SAME PRACTICE FOLLOWED 10 LIABILITY CRYSTALLIZED HAS CRYSTALLIZED ITS LIABILITY AS THE AMOUNT CAN BE DETERMINED WITH REASONABLE CERTAINTY SAME TREATMENT GIVEN 11 AS - 11 WHEN THE FC TRANSACTIONS NOT SETTLED IN THE SAME ACCOUNTING PERIOD, BOOK THE PROFIT/LOSS ON THE OUTSTANDING FO RWARD CONTRACTS AS ON 31 ST MARCH BY CONVERTING THE SAME AT CLOSING RATE SAME PRACTICE FOLLOWED 12 DECISION OF SC IN CASE OF WOODWARD GOVERNOR INDIA (I) P LTD. SC DECISION SQUARELY APPLICABLE IN APPELLATE CASE ON THE BASIS OF SC DECISION, APPELLANT S CLAIM IS ALLOWED 13 DY.CIT (INTERNATIONAL TAXATION) V/S BANK OF BAHARAIN AND KUWAIT (2010) 41 SOT 290 (MUM) HELD THAT, THE LOSS INCURRED BY THE ASSESSEE ON ACCOUNT OF EVALUATION OF THE CONTRACTS ON THE LAST DAY OF THE ACCOUNTING YEAR, IE. BEFORE THE DATE OF MATURITY OF THE FORWARD CONTRACT, IS ALLOWABLE DEDUCTION, WHICH EXACTLY MATCHES WITH THIS CASE. APPLICABLE TO THE APPELLANT ON THE BASIS OF SAME FACTS. 14 ONLY THE TIMING OF TAXATION OF PROFIT / LOSS THE UNMATURED CONTRACTS AT THE YEAR END, FO RWARDS CONTRACTS VALUE DATE THE YEAR END RA T E AND BOOKED EXCHANGE DIFFERENCE AT THE END OF THE UNMATURED CONTRACTS AT THE YEAR END, FORWARD CONTRACTS VALUED AT THE YEAR END RATE AND BOOKED EXCHANGE DIFFERENCE AT THE END OF THE YEAR WHICH ITA NO. 4588 /MUM/20 1 4 16 2.4.26 AT THIS STAGE, IT MAY ALSO BE PRUDENT TO REFER TO THE OBSERVATIONS OF AUTHORITY FOR ADVANCE RULING IN THE CASE OF SOPROPHA S A., IN RE (2004) 268 ITR 37 (AAR) WHERE THE SCOPE OF CENTRAL B OARD OF REVENUE (THE BOARD) CIRCULAR NO.23D (F NO.412/4/60/TPL DT 12 TH SEPT, 1960) HAS BEEN ANALYZED. IT WAS, INTER ALIA, HELD THEREIN AS UNDER: NOW THE SCOPE OF THE PROVISIONS OF THE ACT AND CIRCULAR OF T HE BOARD HAVE TO BE EXAMINED IN THE LIGHT OF MATERIAL PLACED BEFORE US. BEFORE THE ISSUE OF CIRCULAR OF THE BOARD, THE IT AUTHORITIES GAVE A RESTRICTIVE MEANING TO THE HEDGING TRANSACTIONS. THE SAID VIEW WAS ALSO CONFIRMED BY VARIOUS HIGH COURTS INCLUDING MADRAS HIGH COURT AND ALLAHABAD HIGH COURT I N THE CASES RELIED ON BEFORE US. IT WAS, HOWEVER, BROUGHT TO OUR NOTICE THAT IN THE CASE OF RAGHUNATH DAS PRAHLAD OAS (SUPRA); ALLAHABAD HIGH COURT FOLLOWED GUJARAT HIGH COURT'S DECISION IN THE CASE OF CHIMENLEL CHHOTALAL (SUPRA). HOWEVER, A LARGER BENCH O F GUJARAT HIGH COURT OVERRULED THE DECISION IN CHIMANLAL CHHOTALAL'S CASE IN THE CASE OF PANKAJ OIL M/!/S (SUPRA). THERE IS NO DOUBT THAT WITHIN THE MEANING OF PROVISO (A) TO S. 43(5) THE TRANSACTION PROPOSED TO BE UNDERTAKEN BY THE APPLICANT CANNOT BE TER MED AS 'HEDGING CONTRACTS' AT ALL, IT IS, THEREFORE, NECESSARY TO EXAMINE WHETHER THE CASE OF THE APPLICANT IS COVERED BY THE CONCESSION ALLOWED BY THE BOARD THROUGH ITS BENEFICIAL CIRCULAR NO. 230 WHICH IS BINDING ON THE OFFICERS OF THE DEPARTMENT. 22. FOR PROPER APPRECIATION OF THE SCOPE OF THE BOARD'S CIRCULAR, IT WILL BE USEFUL TO REFER TO THE OBSERVATIONS IN THE REPORT OF THE DIRECT TAXES ADMINISTRATION ENQU IRY COMMITTEE IN PARAS 3.55, 3.56 AND 3.58 OF CHAPTER ILL, WHICH READ AS UNDER: '3.55 DEFINI TION OF SPECULATIVE TRANSACTION - AN IMPORTANT CRITICISM MADE BY A LARGE NUMBER OF WITNESSES WHO APPEARED B EFORE US, HAD BEEN THAT THE ASSURANCE GIVEN BY SHRI C D DESHMUKH, WITH REGARD TO THE TREATMENT OF BONA FIDE HEDGING TRANSACTIONS AS ORDINARY BUSINESS, WAS NOT BEING DULY IMPLEMENTED. IT WAS STATED THAT THE SPIRIT OF THE AMENDMENTS HAD BEEN LOST SIGHT OF BY THE DEPARTMENT IN THE COURSE OF ADMINISTRATION OF THE PROVISO AND THAT SOMETIMES EVEN GENUINE HEDGING LOSSES WERE BEING TREATED AS SPECULATIVE LOSSES . IN THIS CONNECTION, THE DISTINCTION IN THE PHRASEOLOGY OF CLS. (A) AND (B) OF EXPLN. 2 TO S. 24(1) OF THE IT ACT, 1922, WAS BROUGHT TO OUR NOTICE. IT WAS POINTED OUT THAT WHILE ONE CLAUSE MADE A REFERENCE TO STOCKS HELD, THE OTHER DID NOT AND THAT SOME O FFICERS WERE TAKING A RESTRICTIVE VIEW AND DISALLOWING THE DEDUCTION OF HEDGING LOSSES IN COMMODITIES OTHER THAN STOCKS AND SHARES, IF THEY WERE NOT AGAINST STOCKS HELD BUT AGAINST PURCHASES. 3.56 WE HAVE EXAMINED THE SAME AT SOME LENGTH. WE FIND THAT EV EN THE CENTRAL BOARD OF REVENUE HAD PUT TOO RIGID AND RESTRICTIVE AN THE YEAR WHICH RESULTED IN LOSS. RESULTED IN LOSS OF RS.7.14 CR. ITA NO. 4588 /MUM/20 1 4 17 INTERPRETATION ON THIS PROVISION, WHICH IS NOT IN ACCORD WITH THE SPIRIT OF THE ASSURANCES GIVEN BY THE FINANCE MINISTER. IT DOES NOT, THEREFORE, SURPRISE US THAT THE AOS HAVE ALSO TAKEN AN UNDULY NARROW VIEW IN THE MATTER AND THE GENUINE BUSINESSMEN HAVE BEEN PUT TO CONSIDERABLE HARDSHIP. WE CERTAINLY APPRECIATE, AS WE HAVE DONE EARLIER, THE PRINCIPLE UNDERLYING THE PROVISO, BUT WE EQUALLY DISAPPROVE OF ITS WRONG APPLICATION FOR DENYING G ENUINE HEDGING LOSSES. WE FEEL THAT THE SOLUTION TO THE VARIOUS PROBLEMS WHICH HAVE BEEN BROUGHT TO OUR NOTICE IN RELATION TO THIS SUBJECT CAN BE FOUND BY EXPANDING EXPLN. 2 TO S. 24(1) SO AS TO CLASSIFY AND EXCLUDE SUCH TRANSACTIONS WHICH SHOULD NOT COME UNDER THE I MISCHIEF OF THIS SECTION. THE A O SHOULD FIRST EXAMINE WHETHER A HEDGING TRANSACTION IS GENUINE OR NOT. IF IT IS A GENUINE ONE, AND IT IS BY WAY OF FUTURE SALE OF A COMMODITY AGAINST STOCK OF THE SAME COMMODITY, THE LOSS ARISING OUT OF THIS TRA NSACTION SHOULD BE EXCLUDED FROM THE PURVIEW OF SPECULATION . . 3.58 THE HARDSHIP CAUSED BY A TOO LITERAL INTERPRETATION OF EXPLN. 2 TO S. 24(1) OF THE IT ACT WAS ILLUSTRATED TO US BY A CASE WHERE A DEALER HAVING READY CLOTH BUSINESS ENTERED INTO A CONTR ACT FOR THE PURCHASE OF 1000 BALES OF CLOTH FROM A MILL ON A FORWARD DELIVERY BASIS. ULTIMATELY, IT WAS FOUND THAT THE MILL COULD SUPPLY ONLY 980 BALES, THE REMAINING TWENTY BALES BEING REJECTED ON ACCOUNT OF SOME DEFECT AND THE SETTLEMENT WAS MADE BETWEEN THE DEALER AND THE MILL REGARDING THESE TWENTY BALES BY PAYMENT OF DIFFERENCE IN PRICE. IT WAS STATED EVEN SUCH A TRANSACTION WAS TAKEN BY THE AO TO FALL WITHIN THE MISCHIEF OF THE EXPLN. 2 TO S. 24(1) OF THE IT ACT ON THE GROUND THAT THERE WAS NO ACTUAL DELIVERY OF THE TWENTY BALES. WE ARE CERTAIN THAT THIS EXTREME VIEW COULD NEVER HAVE BEEN THE INTENTION OF THE LEGISLATURE WHILE INSERTING THE EXPLANATION. SINCE INSTANCES OF THIS TYPE HAVE BEEN BROUGHT TO OUR NOTICE, WE RECOMMEND THAT THE INTENTIONS OF TH E GOVERNMENT IN THE MATTER SHOULD BE CLARIFIED BY SUITABLE ADMINISTRATIVE INSTRUCTIONS. ' 23. THERE CAN BE NO DOUBT, THE CIRCULAR OF THE BOARD HAS EXPANDED THE SCOPE OF 'HEDGING TRANSACTIONS', BUT IT WOULD BE WRONG TO CONCLUDE THAT ALL THE SPECULATIVE T RANSACTIONS CAN BE TERMED AS 'HEDGING' SIMPLY BECAUSE THEY ARE IN THE COMMODITIES DEALT WITH BY AN ASSESSEE. THE BASIC PREMISE OF THE CIRCULAR IS THAT A HEDGING TRANSACTION IS GENUINE. THE ACT ORIGINALLY PROVIDES THAT WHERE AN ASSESSEE HAS ENTERED INTO A C ONTRACT OF SALE FOR ACTUAL DELIVERY ON A FUTURE DATE AND HE THEN ENTERS INTO A FORWARD CONTRACT OF PURCHASE TO MINIMIZE HIS LOSS DUE TO PRICE FLUCTUATIONS, SUCH A CONTRACT OF PURCHASE SHALL NOT BE REGARDED AS 'SPECULATIVE TRANSACTION'. IT WAS BROUGHT TO TH E NOTICE OF THE BOARD THAT A TRADER WHO HAS MERCHANDISE - IN - STOCK MAY ENTER INTO A TRANSACTION OF 'HEDGING SALES' WITH A VIEW TO GUARD AGAINST THE RISK TO MERCHENDISE - IN - STOCKS FALLING IN VALUE AND THEREAFTER T HE BOARD ISSUED THE SAID CIRCULAR AND EXPANDED THE SCOPE OF HEDGING TRANSACTIONS. 24. KEEPING IN VIEW THE CIRCULAR NO. 230, AND THE DECISION OF THE GUJARAT HIGH COURT IN THE CASE OF PANKAJ OIL MILLS (SUPRA), IN THE ITA NO. 4588 /MUM/20 1 4 18 CASE OF A TRADER, THE FOL L OWING POSITION EMERGES IN REGARD TO SCOPE OF HEDGING CONTRAC TS: (1) HEDGING CONTRACTS CAN BE BOTH FOR PURCHASE AND SALE; (2) IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACT OF SALES, THE TOTAL OF SUCH' TRANSACTIONS SHOULD NOT EXCEED THE TOTAL STOCK OF THE RAW MATERIA L OR MERCHANDISE ON HAND; (3) IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACT OF PURCHASE, THERE SHOULD BE AN EXISTING FORWARD CONTRACT OF SALE BY ACTUAL DELIVERY. (4) THE HEDGING CONTRACTS 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 WE ACCORDINGLY RULE AS UNDER: Q.NO. 1 - LN VIEW OF THE MEANING ASSIGNED TO IT IN THE BOARD'S CIRCULAR NO. 23 D OF 12 TH SEPT., 1960,ON FACTS AND IN CIRCUMSTANCES OF THE CASE, FORWARD TRANSACTIONS IN WHI CH THE APPLICANT DEALS WILL BE IN THE NATURE OF HEDGING CONTRACTS. Q. NO. 2 - THOUGH THE EXISTENCE OF CONTRACT OF SALE IS A CONDITION PRECEDENT TO ATTRACT CL. (A) OF PROVISO TO S. 43(5) OF THE ACT, IT STANDS RELAXED TO THE EXTENT ALLOWED BYCIRCULAR NO. 23 0 OF 12TH SEPT., 1960. Q. NO. 3 - FORWARD SALE TRANSACTIONS, THOUGH NOT COVERED WITHIN THE MEANING OF HEDGING CONTRACTS AS PER PROVISO (A) TO S. 43(5), THEY ARE COVERED WITHIN THE EXTENDED MEANING GIVEN IN BOARD'S CIRCULAR NO. 230 OF 12TH SEPT., 1960. Q. NO. 4 - LN VIEW OF EXTENDED MEANING ASSIGNED. TO HEDGING TRANSACTIONS IN THE BOARD IN CIRCULAR NO. 230 OF 12TH SEPT., 1960, THE HEDGING CONTRACTS NEED NOT BE OF THE IDENTICAL QUALITY/QUANTITY OF THE GOODS HELD IN STOCK.' . (EMPHASIS SUPPLIED) 2.4.27 IN LIGHT OF THE ABOVE, WHILE CONSTRUING AS TO WHAT CONSTITUTES A 'HEDGING CONTRACT', WE MAY DERIVE GUIDANCE FROM THE OBSERVATIONS MADE BY HON'BLE SUPREME COURT, IN THE CASE CIT V. HINDUSTAN BULK CARRIERS [2003] 259 ITR 449/126 TAXMAN 321(SC) , AS FOLLOWS: A CONSTRUCTION WHICH REDUCES THE STATUTE TO A FUTILITY HAS TO BE AVOIDED. A STATUTE OR ANY ENACTING PROVISION THEREIN MUST BE SO CONSTRUED AS TO MAKE IT EFFECTIVE AND OPERATIVE ON THE PRINCIPLE EXPRESSED IN MAXIM UT RES MAGIS VALEAT QUAM PEREAT I.E., A LIB ERAL CONSTRUCTION SHOULD BE PUT UPON WRITTEN INSTRUMENTS, SO AS TO UPHOLD THEM, IF POSSIBLE, AND CARRY INTO EFFECT THE INTENTION OF THE PARTIES. [ SEE BROOM'S LEGAL MAXIMS (10TH EDITION), PAGE 361, CRAIES ON STATUTES (7TH ITA NO. 4588 /MUM/20 1 4 19 EDITION) PAGE 95 AND MAXWELL ON STA TUTES (11TH EDITION) PAGE 221 . ] A STATUTE IS DESIGNED TO BE WORKABLE AND THE INTERPRETATION THEREOF BY A COURT SH OULD BE TO SECURE THAT OBJECT UNLESS CRUCIAL OMISSION OR CLEAR DIRECTION MAKES THAT END UNATTAINABLE - WHITNEY V. COMMISSIONER OF INLAND RE V E NUE [1926] AC 07 P. 52 REFERRED TO IN CIT V. S. TEJA SINGH AIR 1959 SC 352, GURSAHAI SAIGAL V/S CIT AIR 1963 SC 1062. THE COURTS WILL HAVE TO REJECT THAT CONSTRUCTION WHICH WILL DEFEAT THE PLAIN INTENTION OF THE LEGISLATURE EVEN THOUGH THERE MAY BE SOM E INEXACTITUDE IN THE LANGUAGE USED - SALMON V. DUNCOMBE [1886]11 AC 627 P. 634 (PC), CURTIS V. STOVIN [1889]22 CBD 513 REFERRED TO IN S. TEJA SINGH' S CASE (SUPRA). IF THE CHOICE IS BETWEEN TWO INTERPRETATIONS, THE NARROWER OF WHICH WOULD FAIL TO ACHIEV E THE MANIFEST PURPOSE OF THE LEGISLATION WE SHOULD AVOID. WHENEVER IT IS POSSIBLE TO DO SO , IT MUST BE DONE TO CONSTRUE THE PROVISIONS WHICH APPEAR TO CONFLICT SO THAT THEY HARMONISE. IT SHOULD NOT BE LIGHTLY ASSUMED THAT PARLIAMENT HAD GIVEN WITH ONE H AND WHAT IT TOOK AWAY WITH THE OTHER .' 2.4.28 HON'BLE SUPREME COURT, IN THE CASE OF K.P. VARGHESE V. ITO [1981] 131 ITR 597/7 TAXMAN 13, HAS FURTHER HELD THAT THE TASK OF INTERPRETATION IS NOT A MECHANICAL TASK AND, QUOTED WITH APPROVAL, JUSTICE HAND'S O BSERVATION THAT 'IT IS ONE OF THE SUREST INDEXES OF A MATURE AND DEVELOPED JURISPRUDENCE NOT TO MAKE A FORTRESS OUT OF THE DICTIONARY BUT TO REMEMBER THAT STATUTES ALWAYS HAVE SOME PURPOSE OR OBJECT TO ACCOMPLISH, WHOSE SYMPATHETIC AND IMAGINATIVE DISCOVER Y IS THE SUREST GUIDE TO T HEIR MEANING'. THEIR LORDSHIPS, INTER ALIA, OBSERVED AS FOLLOWS: . THE TASK OF INTERPRETATION OF A STATUTORY ENACTMENT IS NOT A MECHANICAL TASK. IT IS MORE THAN A MERE READING OF MATHEMATICAL FORMULAE BECAUSE FEW WORDS POSSESS THE PRECISION OF MATHEMATICAL SYMBOLS. 1.1 IS AN ATTEMPT TO DISCOVER THE INTENT OF THE LEGISLATURE FROM THE LANGUAGE USED BY IT AND IT MUST ALWAYS BE REMEMBERED THAT LANGUAGE IS AT BEST AN IMPERFECT INSTRUMENT FOR THE EXPRESSION OF HUMAN THOUGHT AND, AS P OINTED OUT BY LORD DENNING, IT WOULD BE IDLE TO EXPECT EVERY STATUTORY PROVISION TO BE 'DRAFTED WITH DIVINE PRESCIENCE AND PERFECT CLARITY'. WE CAN DO NO BETTER THAN REPEAT THE FAMOUS WORDS OF JUDGE LEARNED HAND WHEN HE SAID: ' ... IT IS TRUE THAT THE WORDS USED, EVEN IN THEIR LITERAL SENSE, ARE THE PRIMARY AND ORDINARILY THE MOST RELIABLE SOURCE OF INTERPRETING THE MEANING OF ANY WRITING: BE IT A STATUTE, A CONTRACT OR ANYTHING ELSE. BUT IT IS ONE OF THE SUREST INDEXES OF A ITA NO. 4588 /MUM/20 1 4 20 MATURE AND DEVELOPED JURISPR UDENCE NOT TO MAKE A FORTRESS OUT OF THE DICTIONARY; BUT TO REMEMBER THAT STATUTES ALWAYS HAVE SOME PURPOSE OR OBJECT TO ECCOMPLLSH, WHOSE SYMPATHETIC AND IMAGINATIVE DISCOVERY IS THE SUREST GUIDE TO THEIR MEANING. ' WE MUST NOT ADOPT A STRICTLY LITERAL INTERPRETATION OF ... BUT WE MUST CONSTRUE ITS LANGUAGE HAVING REGARD TO THE OBJECT AND PURPOSE WHICH THE LEGISLATURE HAD IN VIEW IN ENACTING THAT PROVISION AND IN THE CONTEXT OF THE SETTING IN WHICH IT OCCURS. WE CANNOT IGNORE THE CONTEXT AND THE COLLECTI ON OF THE PROVISIONS IN WHICH . APPEARS, BECAUSE, AS POINTED OUT BY JUDGE LEARNED HAND IN THE MOST FELICITOUS LANGUAGE: INTERPRET ' ... THE M EANING OF SENTENCE MAY BE MORE THAN THAT OF THE SEPARATE WORDS, AS A MELODY IS MORE THAN THE NOTES, AND NO DEGREE OF PARTICULARITY CAN EVER OBVIATE RECOURSE TO THE SETTING IN WHICH ALL APPEAR, AND WHICH ALL COLLECTIVELY CREATE .. , 2.4. 29 IN THE ABOVE BACKGROUND , IT IS UNDISPUTED THAT THE APPELLANT IS IN THE BUSINESS OF EXPORTS OF DIAMONDS AND HAS CERTAIN RECEIVABLES IN FOREIGN EXCHANGE AND SUBSTANTIAL STOCK AT ANY POINT OF TIME DURING THE YEAR AND IT IS ALSO A FACT THAT THE APPELLANT IS CONSTANTLY EXPOSED TO RISK ARISING OUT OF FLUCTUATION IN THE FOREIGN EXCHANGE RATES AND SUCH A RISK IS INTEGRAL TO THE APPELLANT'S BU SINESS AND IT ARISES OUT OF AND IS ASSOCIATED WITH SUCH BUSINESS. IT IS ALSO A FACT THAT THE AFORESAID RISK IS NOT BOUGHT BY THE APPELLANT INDEPENDENT TO THE BUSINESS CARRIED BY HIM. IT IS ONLY WITH AN INTENTION TO MITIGATE THE RISK ASSOCIATED WITH BUSINES S THAT THE APPELLANT HAS ENTERED INTO FOREIGN EXCHANGE CONTRACTS. THEREFORE, AS PER THE PLEADINGS MADE BY THE LD. AR WHAT NEEDS TO BE SEEN IS WHETHER THE RISK THAT THE APPELLANT HAS HEDGED BY WAY OF A FORWARD CONTRACT HAS AN UNDERLYING ASSET/STOCKS OR LIAB ILITY, AS THE CASE MAY BE. IT IS IN THIS SENSE OF THE MATTER THAT THE VARIOUS COURTS HAVE HELD THAT THE PROFITS OR LOSS ARISING OUT OF FORWARD CONTRACTS FORMS PART OF THE BUSINESS INCOME. THIS PROPOSITION HAS BEEN DEALT WITH AT GREAT LENGTH IN THE PRECEDIN G PARAGRAPHS AFTER CONSIDERING IN DETAIL THE SUBMISSIONS MADE BY THE LD. AR AS ALSO THE VARIOUS CASE LAWS ON THE SUBJECT. IT IS, THEREFORE, APPROPRIATE TO UNDERSTAND AT THIS STAGE THAT THE APPELLANT'S PLEADINGS VEER AROUND THE PROPOSITION THAT THE FORWARD CONTRACTS ENTERED INTO BY IT DURING THE COURSE OF BUSINESS, CREATE A LEGAL LIABILITY IRRESPECTIVE OF THE FACT THAT WHETHER THESE CONTRACTS MATURE DURING THE ACCOUNTING YEAR OR BEYOND . 2.4.30 THE IMPUGNED TRANSACTIONS ARE TWO SIDES OF THE SAME COIN AND B Y IGNORING ONE SIDE, THE COIN LOSES ITS VALUE. THEREFORE, IN MY CONSIDERED OPINION, THE LD. AO CANNOT DETERMINE THE NATURE AND EFFECT OF A TRANSACTION BASED MERELY ON ITS PRESENTATION, WITHOUT GOING INTO ITS SUBSTANCE. WHEN A LEGALLY TENABLE CONTRACT IS IN EXISTENCE, DULY SUPPORTED BY AN UNDERLYING ASSET/STOCK AND THE CONTRACT HAVING BEEN ENTERED DURING THE COURSE OF BUSINESS AND FURTHER THAT THE EXCHANGE RATE AS ON DATE OF ENTERING THE CONTRACT AND AS AT THE YEAR - END BEING ASCERTAINABLE, DUE EFFECT OF THE CONTRACT AT THE YEAR - END HAS TO BE GIVEN WHILE ASSESSING THE APPELLANT'S INCOME. HERE, IT IS NOT OUT OF PLACE TO MENTION THAT THE ITA NO. 4588 /MUM/20 1 4 21 UPPER LIMITS OF EXPOSURE TO FORWARD CONTRACTS ARE REGULATED BY THE RBI GUIDELINES AND THAT THEY ARE ALLOWED ONLY TO CERTAIN E XTENT OF RECEIVABLES OR PAYABLES AND NOT TO THE FULL EXTENT. FURTHER, BANKS ALSO INSIST ON COLLECTING MARGINS IN CASE THE MOVEMENT OF FORWARD CONTRACTS BEFORE MATURITY IS AGAINST THE EXPORTER / IMPORTER. IN OTHER WORDS, THE ENTIRE GAMUT OF THE IMPUGNED TRANS ACTIONS IS INTEGRAL TO THE APPELLANT'S BUSINESS AND IT CANNOT BE CALLED A CONTINGENT TRANSACTION. THERE IS NO MERIT IN THE LD. AO'S ARGUMENT IN TREATING THE IM PUGNED TRANSACTION AS INDEPENDENT TO THAT OF APPELLANT'S BUSINESS AND TO STATE THAT THE FLOW OF BENEFIT IS NOT KNOWN OR IT DEPENDS ON ANY ONE OF THE VARIOUS EVENTS LISTED BY HIM. IN FACT THE LD. AO HAS FAILED TO SEE THAT SUCH EVENTS ARE PART AND PARCEL OF THE APPELLANT'S BUSINESS AND NOT EXTERNAL TO IT. THEREFORE, WHATEVER MAY BE THE RESULT OF THE EVENTS LISTED OUT BY THE LD. AO, SUCH RESULT HAS TO BE TREATED AS BUSINESS RESULT AT THE TIME OF ITS HAPPENING AND HENCE, THE EFFECT OF THE FORWARD CONTACT AS AT THE YEAR - END HAS TO BE CONSIDERED FOR THE PURPOSE OF ARRIVING AT THE APPELLANT'S INCOME. 2.4 .31 SECONDLY, THE ISSUE OF NOTIONAL LOSS IS LIKELY TO ARISE ONLY IN THE CONTEXT OF APPELLANT'S EXPOSURE TO FORWARD CONTRACTS EXCEEDING THE UNDERLYING ASSETS/LIABILITIES, WHICH MAY BE IN CASE OF LUMPSUM FORWARD CONTRACTS. THE LD. AR HAS EXPLAINED THAT THE L UMPSUM FORWARD CONTRACTS ARE ENTERED HAVING REGARD TO ITS DEBTORS, STOCKS AND THE LOANS IN DOLLAR TERMS ETC. AND NORMALLY THE FORWARD CONTRACTS ARE IMMEDIATELY COVERED BY THE VALUE OF SUBSEQUENT EXPORTS, THE APPELLANT HAD PLACED ON RECORD OF THE LD. AO, MO NTH WISE POSITION OF THE DEBTORS, CREDITORS, STOCK ETC., VIS - A - VIS, FORWARD CONTRACTS ENTERED IN DOLLAR TERMS, TO DEMONSTRATE THE ABOVE POSITION (REFER THE CHART AT PARA 2.4.6, SUPRA). FURTHER, TO REITERATE, THE APPELLANT HAS BEEN CONSISTENTLY FOLLOWING ME RCANTILE SYSTEM OF ACCOUNTING AND HAS BEEN VALUING THE YEAR - END OUTSTANDING FOREIGN EXCHANGE TRANSACTIONS IN TERMS OF THE ACCOUNTING STANDARD AS - 11. 2.4.32 AS SEEN EARLIER, IN THE CASE OF WOODWARD GOVERNOR 294 ITR 451, HON. DELHI HIGH COURT HAS OBSERVED AS UNDER: - 'IN THE INSTANT CASES, ON THE OTHER HAND, THE LIABILITY ARISES OUT OF ALREADY CONCLUDED CONTRACTS; THE LIABILITY ALREADY STANDS ACCRUED THE MINUTE THE CONTRACT WAS ENTERED INTO. THE MERE POSTPONEMENT OF THE PAYMENT TO DIFFERENT DATE CANNOT EXT INGUISH THE LIABILITY AND RENDER IT NOTIONAL OR CONTINGENT. THE DECISION OF HON. SUPREME COURT IN BHARAT EARTH MOVERS SETTLES THE POSITION. THAT DECISION EXPLAINS THAT WHAT SHOULD BE CERTAIN IS THE INCURRING OF THE LIABILITY AND IT BEING ESTIMATE WITH REAS ONABLE CERTAINTY EVEN IF THE EXACT QUANTIFICATION IS NOT FEASIBLE. EVEN IF THE LIABILITY IS DISCHARGED AT A FUTURE DATE, IT WILL NEVERTHELESS BE A LIABILITY WHICH IS CERTAIN AND NOT CONTINGENT. THIS APPROACH IS CONSISTENT WITH AND INFORMED BY THE ACCOU NTING PRACTICE IN THE MERCANTILE SYSTEM , WITH FURTHER GUIDANCE FROM THE ACCOUNTING STANDARDS OF ICAI WHICH HAVE RECEIVED JUDICIAL ACKNOWLEDGEMENT ITA NO. 4588 /MUM/20 1 4 22 2.4.33 SIMILARLY, AS DISCUSSED, THIS DECISION HAS BEEN APPROVED BY THE HON . SUPREME COURT IN CIT V WOODWARD GOVERNOR INDIA P LTD (312 ITR 254). 2.4.34 FURTHER, AS SEEN EARLIER, IN THE CASE OF DCIT V / S. BANK OF BAHRAIN AND KUWAIT (ITA NOS. 4404 & 1883/MUM./2004), THE SPECIAL BENCH OF JURISDICTIONAL MUMBAI ITAT HELD THAT MTM LOSSES IN RESPECT OF FORWARD FOREIGN EXCHANGE CONTRACTS DEBITED TO PROFIT AND LOSS ACCOUNT IS ALLOWABLE. 2.4.35 SIMILARLY, IN THE CASE OF ONGC VS CIT 322 ITR 180, HON'BLE SUPREME COURT HAS REITERATED THE PRINCIPLES LAID DOWN ABOVE WHILE ANSWERING THE QUESTION THAT WHEN THE ASSESSEE MAINTAI NED ITS ACCOUNTS ON MERCANTILE SYSTEM OF ACCOUNTING AND THERE WAS NO FINDING BY THE ASSESSING OFFICER ON THE CORRECTNESS OR COMPLETENESS OF THE ACCOUNT AND THAT THE ASSESSEE HAD COMPLIED WITH THE ACCOUNTING STANDARDS, LAID DOWN BY THE CENTRAL GOVERNMENT, T HE 'LOSS' SUFFERED BY IT ON ACCOUNT OF FLUCTUATION IN THE RATE OF FOREIGN EXCHANGE AS ON THE DATE OF BALANCE - SHEET IS AN ALLOWABLE EXPENDITURE UNDER SECTION 37(1) OF THE ACT NOTWITHSTANDING THE FACT THAT THE LIABILITY HAD NOT BEEN ACTUALLY DISCHARGED IN TH E YEAR IN WHICH THE FLUCTUATION IN THE RATE OF ' FOREIGN EXCHANGE HAD OCCURRED. 2.4.36 TO REITERATE, THUS THE JUDICIAL DECISIONS OF THE HON. SUPREME COURT AND VARIOUS OTHER AUTHORITIES ARE CLEARLY IN FAVOUR OF THE APPELLANT ON THIS ISSUE. THAT APART, AS DISCUSSED EARLIER, THE TRANSACTIONS IN FOREIGN EXCHANGE WERE CARRIED OUT DURING THE NORMAL COURSE OF THE APPELLANT'S BUSINESS AND THE RESTATEMENT OF THE FORWARD CONTRACT OBLIGATIONS WAS DONE AS PER AS - 11 IN A CONSISTENT MANNER OVER THE YEARS. IN FACT, THE GAIN EARNED ON SUCH REVALUATION WAS OFFERED TO TAX AND ACCEPTED BY THE LD AO IN THE RESPECTIVE YEARS AND THERE IS NO REASON TO ARRIVE AT A DIFFERENT CONCLUSION MERELY BECAUSE THERE WAS A LOSS DURING THE YEAR SO MUCH SO THAT IN AY. 2010 - 11, LD. A.O. HAS TAX ED THE GAIN OF RS. 15.18 CRORE ON ACCOUNT OF MTM PROFIT. WHAT MATTERS IS WHETHER THE FORWARD CONTRACT TRANSACTION WAS ENTERED DURING THE C OURSE OF APPELLANT'S REGULAR BUSINESS OR WHETHER IT IS TAINTED WITH A COLOUR OF SPEC ULATIVE TRANSACTION. FURTHER , THE AFORESAID ISSUE OF ALLOWING THE LOSS ON ACCOUNT REV ALUATION OF PENDING FORWARD CONTRACTS WAS CONSIDERED BY THE HONBLE. ITAT M UMBAI BENCH IN THE CASE OF M / S BHAVANI GEMS VS ACIT CC - 35 IN ITA NO.28 55/MUM/2010 DATED 30/3/2011 FOR A.Y 2006 - 07 AND THE SAID LOS S WAS ALLOWED AS BUSINESS LOSS AND THE ISSUE WAS HELD TO BE COVERED BY SPECIAL BENCH DECISION IN THE CASE OF DCIT VS. BANK OF BAHRAIN (SUPRA) . THEREFORE, IN MY CONSIDERED OPINION THE FACTS OF THE APPELLANT'S CASE ARE FULLY COVERED BY THE ABOVE CITED DECISI ONS OF THE HON. SUPREME COURT AND THE ITAT MUMBAI BENCH. 2.4.37 FOR THE REASONS SET OUT ABOVE AND KEEPING IN VIEW ALL THE DECIDED JUD GMENTS OF HON'BLE SUPREME COURT, VARIOUS HIGH COURTS/AAR AND INCOME TAX APPELLANT TRIBUNALS, I AM OF THE CONSIDERED VIEW THAT THE APPELLANT WAS INDEED. ELIGIBLE FOR INCURRING OF LOSSES OF BUSINESS BY WAY OF THE 'MARKED TO MARKET' LOSSES ON FORWARD CONTRACT FOR ASSESSMENT YEAR 2009 - 10. ACCORDINGLY, GROUND NO.2 IS ALLOWED. ITA NO. 4588 /MUM/20 1 4 23 5. IN THIS VIEW OF THE FACTS, THE CIT (A) DELETED TH E DISALLOWANCE AND ALLOWED THE CLAIM OF THE ASSESSEE. AGGRIEVED BY THE ORDER OF CIT (A) , REVENUE IS IN SECOND APPEAL BEFORE THE TRIBUNAL. BEFORE US, THE LD. CIT(DR) ONLY MADE THE ARGUMENT THAT THE CIT(A) HAS NOT CONSIDERED THE CO - ORDINATE BENCHS DECISION IN THE CASE OF S. VINODKUMAR DIAMONDS PVT. LTD. V/S ADDL. C.I.T. IN ITA NO. 506/MUM/2013(AY:2008 - 09) DATED 3.5.2013. 6 . ON THE OTHER HAND, THE LD.AR FOR THE ASSESSEE ARGUED THAT MORE THAN 90% OF THE ASSESSEES BUSINESS IS DERIVING INCOME FROM EXPORTS OF DIAMONDS AND MOST OF THE PURCHASES AND SALES WERE MADE IN FOREIGN CURRENCY. ACCORDING TO HIM, THE ASSESSEE HAD AVAILED SUBSTANTIAL BANKING CHANNELS IN FOREIGN CURRENCY AND HAD USED EXPO RT ON ACCOUNT OF FLUCTUATION IN FOREIGN CURRENCY RATES. HE ARGUED THA T IN ORDER TO MITIGATE THIS EXPORT IN FOREIGN CURRENCY RATE S THE ASSESSEE ENTERED INTO FORWARD CONTRACT TO HEDGE THE FLUCTUATION OF FOREIGN CURRENCY RATES IN RESPECT OF EXPORT AND IMPORT TRANSACTIONS, WHICH IS INTEGRAL PART OF INSTITUTIONAL TO THE EXPORTS BUSINESS UNDERTAKEN BY THE ASSESSEE. HE STATED THAT AS ON 31.3.2009, THE ASSESSEE REVALUED ALL THE MONITORY ASSETS AND LIABILITY OUTSTANDING BY FOLLOWING AS - 11 AND RECOGNIZED PROFIT AND LOSS ACCOUNT DURING T HE YEAR. SIMILARLY , IT ALSO RECOGNIZED MARK TO MARKET LOSS IN RESPECT OF OUTSTANDING FORWARD EXCHANGE CONTRACTS. IN OUR OPINION, THESE CONTRACTS ARE AS PER AS - 11 OF THE ICAI . HE STATED THAT THE CIT ( A) HAS CONSIDERED ALL THESE FACTS, WHICH ARE REPRODUCED IN THE ABOVE ORDER. THE LD. COUNSEL ALSO ST ATED THAT TRANSACTIONS IN FOREIGN EXCHANGE WERE CARRIED OUT DURING THE NORMAL COURSE OF B USINESS OF THE ASSESSEE AND RESTATEMENT OF THE FORWARD CONTRACTS APPLICATION WAS DONE AS PER AS - 11 IN CONSISTENT MANNER OVER THE YEARS. HE EXPLAINED THAT WHENEVER ACC OUNTS ARE REVALUED AND EXCESS, WHAT SO EVER , WAS OFFERED TO TAX AND ACCEPTED BY THE REVENUE IN THE RESPECTIVE YEARS. HE STATED TH AT THERE IS NO REASON TO TAKE A DIFFERENT VIEW OR CONCLUSION BECAUSE THERE WAS LOSS DURING THE YEAR. HE EXPLAINED THAT EVEN I N THE ASSESSMENT YEAR 2010 - 11, THE AO HAS TAKEN THE GAIN OF RS.15.18 CRORE S ON ACCOUNT OF FOREIGN EXCHANGE FLUCTUATION. IN THIS VIEW OF THE ARGUMENTS AND FACTS OF THE CASE THE LD. COUNSEL FOR THE ASSESSEE RELIED ON CERTAIN CASE LAWS AND STATED THAT THE CA SE LAW CITED BY THE REVENUE IN THE CASE OF S. ITA NO. 4588 /MUM/20 1 4 24 VINODKUMAR DIAMONDS PVT. LTD.(SUPRA) CANNOT OVERWRITE THE JUDGMENT OF HONBLE SUPREME COURT IN THE CASE OF CIT V. WOODWARD GOVERNOR INDIA (P.) LTD. [2009] 312 ITR 254 (SC). 7 . WE FIND FROM THE FACTS OF THE CA SE THAT THE ASSESSEE IS A PARTNERSHIP FIRM, MAINLY ENGAGED IN THE BUSINESS OF IMPORT OF DIAMONDS, CUTTING AND POLISHING AND EXPORT OF CUT AND POLISHED DIAMONDS. THE TOTAL EXPORT TURNOVER DURING THE PREVIOUS YEAR 2008 - 2009 RELEVANT TO AY 2009 - 2010 UNDER CON SIDERATION, WAS RS.714.98 CRORES AND TOTAL IMPORT OF DIAMONDS WAS RS.517.10. CRORES. APART FROM THE SAID IMPORT OF DIAMONDS, THE ASSESSEE HAS ALSO PURCHASE DIAMONDS OF RS.20.66 CRORES LOCALLY THROUGH DIAMOND DOLLAR ACCOUNT, WHICH WERE SETTLED IN FOREIGN CU RRENCY. ACCORDINGLY, BOTH THE LIMBS OF TRANSACTIONS I.E. PURCHASE AND SALES ARE IN FOREIGN CURRENCY. AS ON 31 MARCH 2009, THE OUTSTANDING FOREIGN EXPOSURE OF THE A SSESSEE IS AS UNDER: SR. NO . NATURE OF FOREIGN CURRENCY EXPOSURE AMOUNT (USD IN MILL ION, 1 EXPORTS RECEIVABLES (I.E. OVERSEAS DEBTORS) 19.22 2 IMPORTS PAYABLES (I.E. OVERSEAS CREDITORS) 9.31 3 BANK LOAN 65.78 4 ADVANCE FROM OVERSEAS CUSTOMERS 8.96 5 CLOSING STOCK FOR EXPORT 91.44 TOTAL 194.72 FROM THE ABOVE FACTS , IT IS CLEAR THAT THE TOTAL AMOUNT OF FOREIGN CURRENCY EXPOSURE AS ON 31 MARCH, 2009 AMOUNTS TO USD 194.71 MILLION APPROX. CONSIDERING THE SUBSTANTIAL FOREIGN CURRENCY EXPOSURE AND DUE TO SUBSTANTIAL FLUCTUATION IN FOREIGN CURRENCY RATES, THE ASSESSEE ENTERE D INTO THE FORWARD CONTRACTS (FCS) WITH THE BANKS AS INTEGRAL PART OF THE EXPORT IMPORT BUSINESS WITH THE AIM TO HEDGE AND SAFEGUARD AGAINST THE FOREIGN EXCHANGE FLUCTUATION OF THE US $ VIS - - VIS THE INDIAN CURRENCY, FROM TIME TO TIME. 8. FROM THE DETAILS FILED BY THE ASSESSEE IT IS CLEAR THAT THERE WAS HUGE VOLATILITY IN EXCHANGE RATE OF US DOLLAR VIZ. RUPEE FROM APRIL 2008 TO MARCH 2009. US D OLLAR HAD REGISTERED AN APPRECIATION FROM RS. 39.7650 TO RS. 51.9700 DURING THE YEAR AS IS EVIDENT FROM THE YEARLY GRAPH PLOTTING THE VOLATILITY FILED BEFOR E US . WE FIND THAT THE ASSESSEE HAS HEDGE THE UNDERLYI NG EXPOSURE IN FOREIGN ITA NO. 4588 /MUM/20 1 4 25 CURRENCY AND A S SUCH, THE FORWARD CONTRACTS ENTERED WERE FOR THE PURPOSE OF THE BUSINESS TO HEDGE AGAINST THE FOREX LOSS. THE ASSE SSEE HAS FOREX EXPOSURE ON ALL LIMBS ITS BUSINESS ACTIVITIES. THE FIRM HAS NOT ENTERED INTO THE FORWARD CONTRACTS WITH AN INTENTION TO EARN ANY GAIN DUE TO FLUCTUATION IN FOREIGN CURRENCY RATE BUT IT IS NECESSARY FOR IT TO ENTER INTO SUCH FORWARD CONTRACTS TO HEDGE AGAINST FOREIGN EXCHANGE RATE FLUCTUATION. THIS IS AN INTEGRAL PART OF THE BUSINESS UNDERTAKEN BY THE A SSESSEE AND INCIDENTAL TO THE EXPORT AND IMPORT BUSINESS. IN THE ABSENCE OF SUCH FORWARD CONTRACTS, THE FIRM MAY SUSTAIN HUGE LOSSES. THEREFORE , IT BECOMES ESSENTIAL FOR THE FIRM TO BOOK SUCH FORWARD CONTRACTS AS A PRUDENT BUSINESS PRACTICES. FURTHER, WE FIND THAT THE ASSESSEE IS ENGAGED IN THE BUSINESS OF DIAMONDS EXPORT AND NOT IN THE BUSINESS OF FOREIGN EXCHANGE. THIS IS EVIDENT FROM THE FINAN CIAL RESULTS OF THE FIRM. IN VIEW OF THE SAME, WE ARE OF THE VIEW THAT THESE CONTRACTS ARE NOTHING BUT AN INTEGRAL PART OF ITS EXPORT AND IMPORT ACTIVITIES AND THE RESULTANT HEDGING DIFFERENCE ON THEIR REVALUATION CANNOT BE ISOLATED ARTIFICIALLY AS NOTIONA L LOSS . HENCE, WE CONFIRM THE ORDER OF CIT (A) AND THIS ISSUE OF REVENUES APPEAL IS DISMISSED. 9 . THE NEXT ISSUE IN THIS APPEAL OF THE REVENUE IS AGAINST THE ORDER OF CIT (A) DELETING THE DISALLOWANCE OF ADDITIONAL CLAIM OF DEPRECIATION. FOR THIS , T HE R EVENUE HAS TAKEN FOLLOWING GROUNDS OF APPEAL: 3. WHETHER ON THE FACTS AND CIRCUMSTANCES AND IN LAW, THE LD.CIT(A) HAS ERRED IN ALLOWING THE ADDITIONAL DEPRECIATION OF RS.29,38,884/ - 4. WHETHER ON FACTS AND CIRCUMSTANCES .OF THE CASE, THE LD.CIT(A) ERRED IN NOT APPRECIATING THE FACT THAT HON'BLE SUP REME COURT IN THE CASE OF CIT VS . GEM INDIA MANUFACTURING CO.(2001) 249 ITR 307 (SC) & HON'BLE HIGH COURT OF BOMBAY IN THE CASE OF LONDON STAR DIAMOND CO(I)LTD.213 ITR 517 (BOM) HAD HELD THAT THE DIAMOND CUTTIN G & POLISHING AMOUNTS TO PROCESSING OF GOODS AND NOT MANUFACTURING OF GOODS AND DECISION RELIED UPON IN THE CASE OF M/S SHEETAL MANUFACTURES HAS NOT BEEN ACCEPTED ON MERITS . 10 . WE HAVE HEARD THE RIVAL CONTENTIONS OF THE PARTIES AND PERUSED THE MATERI AL PLACED BEFORE US. WE FIND THAT THE CLAIM OF THE ASSESSEE IS THAT THE BUSINESS OF CUTTING AND POLISHING OF DIAMONDS IS MANUFACTURING AND PRODUCTION OF AN ARTICLE OR THING AS REQUIRED FOR CLAIMING ADDITIONAL DEPRECIATION U/S 32(1) (IIA) OF THE ACT. THE AO DISALLOWED THE CLAIM BY OBSERVING THAT THE ASSESSEE IS NOT ENGAGED IN ITA NO. 4588 /MUM/20 1 4 26 MANUFACTURING OR PRODUCTION OF ANY ARTICLE OR THING. THE CIT (A) RELYING ON THE DECISION OF THE HONBLE SUPREME COURT IN THE CASE OF ARIHANT TI LES & MARBLE PVT. LTD. 320 ITR 79 (SC) ALL OWED THE CLAIM OF THE ASSESSEE VIDE PARA 2.4.40 AS UNDER: - 2.4.40 IT IS SEEN THAT IN THE EARLIER YEAR, THIS CLAIM HAS BEEN ALLOWED FOLLOWING THE DECISION IN THE CASE OF SHEETAL DIAMONDS LTD. IN ITA NO.6687 TO 6689/MUM/2002 DATED 23.3.2011 WHERE THE ISSUE OF CUTTING AND POLISHING OF DIAMONDS WHETHER CONSTITUTED MANUFACTURING ACTIVITY OR NOT WAS CONSIDERED IN DETAIL BY THE HONBLE ITAT, MUMBAI BENCH. IN THE AFORESAID DECISION, REFERENCE WAS ALSO MADE TO THE DECISION OF HONBLE SUPREME COURT IN THE CASE OF GE N INDIA MFG. CO. 249 ITR 307 AND THE SUBSEQUENT DECISIONS OF THE APEX COURT IN THE CASE OF ARIHANT TILES AND MARBLE (P) LTD. 320 ITR 79 (SC), VIJAY SHIP BREAKING CORPN. 314 ITR 309 (SC) AND EMPEE POLY YARN PVT. LTD. 320 ITR 665 TO HOLD THAT T HE ASSESSEE W AS ENGAGED IN THE BUSINESS OF MANUFACTURING OF CUTTING AND POLISHING ROUGH DIAMONDS AND HENCE, IT WAS ELIGIBLE FOR DEDUCTION U/S 80 IA OF THE ACT. FOLLOWING THE ABOVE SAID DECISIONS, THE APPELLANTS CLAIM FOR ADDITIONAL DEPRECIATION U/S. 32(1) (II) OF THE ACT WAS ALLOWED. AS THE FACTS OBTAINING IN THE CURRENT YEAR ARE IN PARI MATERIAL WITH THE FACTS OBTAINING IN EARLIER YEAR IN RESPECT OF THE APPELLANTS CLAIM OF ADDITIONAL DEPRECIATION, THIS GROUND IS ALLOWED. 11. WE ALSO FIND THAT THE TRIBUNAL IN THE CA SE OF FLAWLESS DIAMOND INDIA LTD. VS ADDL. CIT (2014) 45 TAXMANN.COM 67 (MUM.) AFTER CONSIDERING T HE RECENT OF THE HONBLE SUPREME COURT HELD THAT CUTTING AND POLISHING OF DIAMONDS AMOUNTS TO MANUFACTURING OR PRODUCTION OF ARTICLE OR THING BY OBSERVING IN PARA 16 AS UNDER: - 16. THUS, FROM THE AFORESAID DECISION, IT CAN BE SAFELY INFERRED THAT, WHAT IS REQUIRED IS TH E PROCESS UNDERTAKEN FOR CONVERSION OF RAW / ROUGH DIAMONDS INTO SUPERIOR OR POLISHED DIAMOND. IN THIS CASE, AS STATED ABOVE, THE ASSESSEE HAS DULY PLACED ON RECORD THE ENTIRE PROCESS AND THE STAGES THROUGH WHICH THE ROUGH DIAMOND UNDERGOES FOR BECOMING THE POLISHED DIAMOND, WHICH IS A SEPARATE AND DISTINCT PRODUCT AND HAS DIFFERENT USAGE. SUCH A PROCESS HAS NEITHER BEEN REBUTTED BY THE REVENUE N OR ANY OTHER COUNTER - OPINION HAVE BEEN SOUGHT TO CONTRADICT THE ASSESSEES VERSION OF THE PROCESS. THUS, IN OUR OPINION, ONCE THE ENTIRE PROCESS OF CUTTING AND POLISHING OF DIAMOND HAVE NOT BEEN REBUTTED AND ALSO THE FACT THAT THE ROUGH AND POLISHED DIAMON D ARE TWO DISTINCT COMMODITY HAVING DIFFERENT USAGE, NOT ONLY IN THE COMMON PARLANCE BUT ALSO IN REAL SENSE, THEN IT HAS TO BE UNDERSTOOD THAT THE CUTTING AND POLISHING OF DIAMOND AMOUNTS TO MANUFACTURING OR PRODUCTION OF ARTICLE OR THING AS ENVISAGED FOR THE PURPOSE OF CLAIMING DEDUCTION UNDER SECTION 80 - IC. THUS, THE CONTENTION RAISED BY THE LEARNED COUNSEL BEFORE US IS ACCEPTED THAT SIMPLY RELYING ON THE DECISION OF GEM INDIA MFG. CO. ITA NO. 4588 /MUM/20 1 4 27 (SUPRA) BY THE REVENUE TO DENY THE CLAIM OF DEDUCTION IS UNCALLED FOR IN THE PRESENT CASE, ESPECIALLY IN THE WAKE OF LATER DECISION OF THE HONBLE SUPREME COURT IN HEAVENS DIAMOND (SUPRA) WHICH HAS CLARIFIED THIS POINT. ACCORDINGLY, THE DECISION AND THE CONCLUSION DRAWN BY THE LEARNED COMMISSIONER (APPEALS) FOR THE YEAR UNDE R APPEAL I.E., ASSESSMENT YEAR 2008 - 09 ARE SET ASIDE AND ASSESSEES CLAIM FOR DEDUCTION UNDER SECTION 80 - IC IS ALLOWED. RESPECTFULLY FOLLOWING THE COORDINATE BENCH DECISION IN THE CASE OF FLAWLESS DIAMOND INDIA LTD. (SUPRA), WE HOLD THAT CUTTING AND POL ISHING OF DIAMONDS AMOUNTS TO MANUFACTURING OR PRODUCTION OF ARTICLE OR THING AS ENVISAGED FOR THE PURPOSE OF CLAIMING ADDITIONAL DEPRECIATION U/S 32(1) (IIA) OF THE ACT. HENCE, WE CONFIRM THE ORDER OF THE CIT (A) ON THIS ISSUE AND DISMISS THE REVENUES AP PEAL. 12. I N THE RESULT, THE APPEAL OF THE REVENUE IS DISMISSED. ORDER PRONOUNCED IN THE OPEN COURT ON 2 9 - 09 - 2016 . SD/ - (RAMIT KOCHAR ) ACCONTANT MEMBER MUMBAI, DATED: 2 9 - 09 - 2016 SRL: SR.PS / LAKSHMIKANT DEKA/SR.PS SD/ - ( MAHAVIR SINGH ) JUDICIAL MEMBER ITA NO. 4588 /MUM/20 1 4 28 BY ORDER, ASSISTANT REGISTRAR ITAT, MUMBAI DATE INITIALS 1. DRAFT DICTATED ON 29.9.2016 SPS 2. DRAFT PLACED BEFORE AUTHOR 29.9. 2016 / 14.10.16 SPS 3. DRAFT PROPOSED & PLACED BEFORE THE SECOND MEMBER A M 4. DRAFT DISCUSSED/APPROVED BY SECOND MEMBER AM 5. APPROVED DRAFT COMES TO THE SR. PS SPS 6. KEPT FOR PRONOUNCEMENT ON SPS 7. FILE SENT TO THE BENCH CLERK SPS 8. DAT E ON WHICH FILE GOES TO THE HEAD CLERK 9. DATE ON WHICH FILE GOES TO A.R. 10. DATE OF DISPATCH OF ORDER COPY OF THE ORDER FORWARDED TO : 1. THE APPELLANT 2. THE RESPONDENT. 3. THE CIT (A), MUMBAI. 4. CIT 5. DR, ITAT , MUMBAI 6. GUARD FILE. //TRUE COPY//