DCIT, CHENNAI V. Comstar Automotive Technologies Pvt. Ltd., Chengalput

ITA 815/CHNY/2015

• Counselvise Citation: [2016] 132 COUNSELVISE.COM (IT) 9079 (ITAT-CHENNAI)
• Duration Of Justice: 1 year(s) 2 month(s) 3 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 17-06-2016
• Appeal Filed By: Department
• Bench Allotted: B
• Next Hearing Date: 23-05-2016
• Assessment Year: 2009-2010
• Appeal Filed On: 13-04-2015
• Court: TRIBUNAL
• Department Lawyers: N V BALAJI
• Assessee Lawyers: ARUN C BHARAT
• Keywords: Capital asset; Business income; Depreciation; Business expenditure; Earning of tax free income; Cost of acquisition; Speculation loss; Unabsorbed depreciation
• Section: 37(1); 43(5); 32; 37; 56; 28

Judgement Text

, , IN THE INCOME TAX APPELLATE TRIBUNAL B BENCH : CHENNAI , ! ' ! # . $% & '( BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SHRI DUVVURU RL REDDY , JUDICIAL MEMBER ./ I.T.A.NO.771/MDS./2015 / ASSESSMENT YEAR : 2009-10 M/S.COMSTAR AUTOMOTIVE TECHNOLOGIES (P) LTD ., KEELAKARANAI VILLAGE, MALROSAPURAM POST,MARAIMALAI NAGAR,CHENGALPATTU 603 204 VS. THE DEPUTY COMMISSIONER OF INCOME TAX, CORPORATE CIRCLE 1(2), CHENNAI. [PAN AAACE 2284 P ] ( )* / APPELLANT) ( +,)* /RESPONDENT) ./ I.T.A.NO. 815/MDS./2015 / ASSESSMENT YEAR : 2009-10 THE DEPUTY COMMISSIONER OF INCOME TAX, CORPORATE CIRCLE 1(2), CHENNAI. VS. M/S.COMSTAR AUTOMOTIVE TECHNOLOGIES (P) LTD., KEELAKARANAI VILLAGE, MALROSAPURAM POST,MARAIMALAI NAGAR,CHENGALPATTU 603 204 [PAN AAACE 2284 P ] ( )* / APPELLANT) ( +,)* /RESPONDENT) / APPELLANT BY : MR.NV BALAJI,ADVOCATE /RESPONDENT BY : MR.ARUN C.BHARAT, CIT DR / DATE OF HEARING : 23 - 05 - 201 6 / DATE OF PRONOUNCEMENT : 17 - 0 6 - 2016 - / O R D E R ITA NOS.771 & 815/MDS./15 :- 2 -: PER CHANDRA POOJARI, ACCOUNTANT MEMBER THESE CROSS APPEALS ARE DIRECTED AGAINST THE ORDE R OF THE COMMISSIONER OF INCOME-TAX (APPEALS)-I, CHENNAI DAT ED 30.12.2014 PERTAINING TO ASSESSMENT YEAR 2009-10. 2. IN ASSESSEES APPEAL, THE FIRST GROUND IS WITH REGARD TO DISALLOWANCE U/S.14A OF THE ACT. THIS GROUND IS COM MON IN BOTH THE APPEALS. 2.1 THE REVENUE IS ALSO IN APPEAL BEFORE US WITH RE GARD TO DIRECTION OF THE CIT(A) THAT AO SHALL NOT ELIMINATE THE CURRE NT LIABILITIES IN ARRIVING AT THE TOTAL ASSETS FOR THE PURPOSE OF COM PUTING THE DISALLOWANCE UNDER RULE-8D(2)(II) OF THE INCOME TAX RULES. 3. THE BRIEF FACTS OF THE CASE ARE THAT THE ASSESS EE COMPANY IS ENGAGED IN MANUFACTURE AND SALE OF MOTOR VEHICLE PA RTS AND ACCESSORIES. THE ASSESSEE FILED ITS E-RETURN ON 29. 09.2009 FOR ASSESSMENT YEAR 2009-10 ADMITTING A LOSS OF ` 28,78,28,997/-. SUBSEQUENTLY, THE CASE WAS SELECTED FOR SCRUTINY AN D THE ASSESSMENT U/S.143(3) WAS COMPLETED ON 29.12.2011 AFTER MAKING CERTAIN DISALLOWANCES. 3.1 THE FACTS OF FIRST GROUND RELATES TO DISALLOWA NCE U/S.14A OF THE ACT TO THE TUNE OF ` 15,23,543/-. DURING THE COURSE OF ASSESSMENT PROCEEDINGS, THE AO HAD FOUND THAT THE ASSESSEE HAD INVESTMENT IN TAX FREE TERRITORY AMOUNTING TO ` 2,09,41,000/- AS ON 31.3.2008. THE INVESTMENT IN ITA NOS.771 & 815/MDS./15 :- 3 -: MUTUAL FUND HAD BEEN REDEEMED AND THE VALUE AS AT 31.3.2009 IS RS: NIL. THE ASSESSEE HAD GOT DIVIDEND INCOME OF ` 1.25 CRORES DURING THE YEAR WHICH IS EXEMPT U/S 10(35). THE AR SUBMITTED BEFORE THE AO THAT THE DISALLOWANCE IS UNCALLED FOR SINCE THE ASSESSEE HA S NOT INCURRED ANY EXPENDITURE TOWARDS OPERATING AND MAINTAINING THE S AME BY RELYING ON SERIES OF CASE LAWS DELIVERED IN ASSESSEES FAVOUR AND FURTHER CONTENDED THAT THE INTEREST PAYMENT IS FOR LOAN OBTAINED FOR SPEC IFIC PURPOSES AND NOT FOR INVESTMENTS. THE AR HAS ALSO CONTENDED BEFORE THE A O THAT THE ASSESSEE HAS ENORMOUS RESERVES & SURPLUS AND THE INVESTMENTS WERE OUT OF OWN FUNDS. HENCE, ACCORDING TO HIM, APPLYING RULE 8D IS UNTENABLE. THE AO WAS NOT SATISFIED WITH THE ARGUMENTS OF THE AR AND INVO KED THE PROVISIONS OF S.14A R.W. RULE 8D AND DISALLOWED ` 15,23,543/-. AGGRIEVED, THE ASSESSEE CARRIED THE APPEAL BEFORE THE LD.CIT(A). BEFORE CI T(A), THE ASSESSEE TOOK A PLEA THAT ASSESSEE HAS NOT INCURRED ANY EXPENDITURE IN EARNING EXEMPT INCOME. THE CIT(A) OBSERVED THAT THE ASSESSEE HAS NOT DISCHARGED THAT THE ASSESSEE HAS NOT INCURRED EXPENDITURE TOWARDS EXEMP T INCOME. SINCE THE ASSESSEE HAS NOT NOT FURNISHED DETAILS OF EXPENDITU RE, DIRECT OR INDIRECT, INTEREST EXPENDITURE, INVESTMENTS, USE OF OWN FUNDS , UTILITY OF SECURED LOANS, TRADE PROFITS OF THE ASSESSEE RELATABLE TO EXEMPT I NCOME AND TAXABLE INCOME IN THE FORM OF SEPARATE ACCOUNTS. ACCORDING TO CIT (A), THE AO IS JUSTIFIED IN INVOKING THE PROVISIONS OF RULE-8D(II) OF INCOME TA X RULES, 1962 SO AS TO DISALLOW THE EXPENDITURE INCURRED TO EARN EXEMPT IN COME. AGAINST HIS, THE ASSESSEE IS IN APPEAL BEFORE US. ITA NOS.771 & 815/MDS./15 :- 4 -: 3.2 FURTHER, THE CIT(A) OBSERVED THAT WHILE WORKING OUT THE INTEREST EXPENDITURE IN RELATION TO INVESTMENTS WHICH YIELD EXEMPT INCOME, WHICH DOES NOT FORM PART OF THE TOTAL INCOME, THE AVERAGE TOTAL ASSETS HAD TO BE TAKEN, BEFORE THE CURRENT LIABILITIES ARE REDUCED A S PER BALANCE SHEET PREPARED IN STRAIGHT LINE METHOD. AGAINST THIS, TH E REVENUE IS IN APPEAL BEFORE US. 3.3 ACCORDING TO LD.A.R, RULE 8D(II) IS NOT APPLIC ABLE TO THE ASSESSEES CASE SINCE THE ASSESSEE IS HAVING ITS OWN FUNDS TO MAKE INVESTMENTS WHICH YIELD EXEMPT INCOME. THE LD.A.R SUBMITTED THAT THE ASSESSEE HAS REALIZED THE VARIOUS INVESTMENTS, WHICH IS CARRIED FROM EARL IER YEARS AND THAT FUND USED FOR THE RE-INVESTMENTS IN THE ASSESSMENT UNDER CONSIDERATION AND THERE IS NO BORROWED FUNDS USED FOR THE PURPOSE OF INVEST MENTS WHICH YIELDS EXEMPT INCOME. FURTHER, HE SUBMITTED THAT THERE IS NO EXPENDITURE INCURRED DIRECTLY RELATING TO EARNING OF EXEMPT INCOME INCUR RED BY THE ASSESSEE. SIMILARLY, THERE IS NO INTEREST EXPENDITURE INCURRE D BY THE ASSESSEE TO MAKE INVESTMENTS WHICH YIELD EXEMPT INCOME. 3.4 ON THE OTHER HAND, LD.D.R SUBMITTED THAT ASSES SEE HAS INCURRED TOTAL INTEREST EXPENDITURE AT ` 2,14,50,000/- AND AVERAGE TOTAL ASSETS WAS ` 1,72,37,95,000/-. THE AVERAGE INVESTMENTS WAS WORK ED OUT AT ` 10,47,05,000/- AND ACCORDING TO HIM, WHEN APPLIED F ORMULA IN RULE 8D(II), THE TOTAL DISALLOWANCE SHOULD BE ` 13,02,894/- AND DISALLOWANCE UNDER RULE 8D(III) I.E. 0.5% OF THE AVERAGE INVESTMENTS OF ` 10,47,05,000/- WORKED OUT ` 5,23,525/-. THEN TOTAL DISALLOWANCE SHOULD BE ` 18,26,419/-. HE SUBMITTED THAT THE FINDINGS OF CIT(A) WITH REFERENCE OT APPLI CABILITY TO COMPONENT C IN ITA NOS.771 & 815/MDS./15 :- 5 -: FORMULA A X B C IN RULE 8D(II) IS ALSO IN-APPROP RIATE. THE, HE SUBMITTED THAT THE ORDER OF THE AO MAY BE CONFIRMED. 3.5 WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE MATERIAL ON RECORD. IN THIS CASE, THE ASSESSEE HAVING INVESTMENTS WHICH YIELDED EXEMPT INCOME AND WHICH DOES NOT FORM TOTAL INCOME OF ASSESSEE, T HEN THIS RULE-8D IS APPLICABLE. THE PLEA OF THE ASSESSEE IS THAT RULE- 8D(II) & (III) IS NOT APPLICABLE TO THE ASSESSEES CASE AS THE ASSESSEE I S HAVING OWN FUNDS. HOWEVER, THE ASSESSEE IS NOT ABLE TO DEMONSTRATE WH AT IS THE OWN FUNDS AVAILABLE TO THE ASSESSEE TO MAKE INVESTMENTS WHICH YIELDED EXEMPT INCOME. THE FUND FLOW FILED BY THE ASSESSEE DOES NOT SHOW D ATE ON WHICH THE ASSESSEE MADE INVESTMENTS OUT OF OWN FUNDS. BEING SO, THE ARGUMENT OF ASSESSEE CANNOT BE THE GOOD EXPLANATION TO HOLD THA T THE ASSESSEE IS NOT INCURRED INTEREST EXPENDITURE ON FUNDS USED FOR INV ESTMENTS, WHICH YIELD EXEMPT INCOME. 3.6 REGARDING COMPUTATION OF TOTAL ASSET, THE CIT( A) WRONGLY OBSERVED THAT TOTAL ASSETS TO BE TAKEN BEFORE THE CURRENT LI ABILITIES ARE REDUCED AS PER THE BALANCE SHEET. THERE IS O REASON FOR NOT REDUC ING THE CURRENT LIABILITIES. HOWEVER, WE MAKE IT CLEAR THAT TOTAL FIXED ASSETS A FTER DEPRECIATION PLUS NET CURRENT ASSETS TO BE CONSIDERED AS THE TOTAL ASSET, WHEN THE BALANCE SHEET IS PREPARED IN STRAIGHT LINE METHOD WHILE APPLYING THE FORMULA IN RULE -8D(II). 3.7 ACCORDINGLY, THE GROUND RAISED BY THE ASSESSEE IS DISMISSED AND THE GROUND RAISED BY THE REVENUE IS PARTLY ALLOWED. ITA NOS.771 & 815/MDS./15 :- 6 -: 4. THE NEXT GROUND IN ASSESSEES APPEAL IS WITH RE GARD TO TREATMENT OF UNABSORBED DEPRECIATION. 4.1 THE FACTS OF THE ISSUE ARE RELATED TO PRIORITY FOR DEDUCTION U/S.10B OF THE ACT OVER SET OFF OF BROUGHT FORWARD UNABSORBED DEPRECIATION ALLOWANCE OF ` 52,18,23,725/-. IN THE ASSESSMENT PROCEEDINGS FOR EARLIER ASSESSMENT YEARS, THE AO HAD NOT ACCEPTED THE APPROACH OF THE ASSESSEE OF CLAIMING DEDUCTION U/S.10B BEFORE SETTING OF THE BROUGHT FOR WARD UNABSORBED DEPRECIATION AGAINST THE BUSINESS INCOME OF THE REL EVANT ASSESSMENT YEAR. THE AO HAS FIRST SET OFF THE BROUGHT FORWARD LOSSES AND THEN GRANTED DEDUCTION U/S.10B ON THE BALANCE PROFITS AVAILABLE. CONSEQUENTLY, THE UNABSORBED DEPRECIATION HAD EXHAUSTED IN THE PRECED ING ASSESSMENT YEARS. THEREFORE,, THE AO WHILE DOING THE ASSESSMENT IN T HE PRESENT ASSESSMENT YEAR, IGNORED THE AMOUNT OF UNABSORBED DEPRECIATION LOSSES CARRIED FORWARD TO FUTURE ASSESSMENT YEARS. 4.2 WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE MATERIAL ON RECORD. THIS ISSUE IS SQUARELY COVERED BY THE JUDGEMENT OF SUPREME COURT IN THE CASE OF HIMATSINGKA SEIDE. IT IS HELD BY THE HONBLE KARNATAKA HIGH COURT IN THE CASE OF CIT VS. HIMATSINGKA SEIDE REPORTED IN 286 ITR 255 HELD THAT UNABSORBED DEPRECIATION HAS TO BE ADJUSTED AGAINST THE INCOME FOR THE PURPOSE OF EXEMPTION U/S.10B OF THE ACT; EXEMPTION U/S.10B CANNOT BE ALLOWED BY ADJUSTING ONLY A PORTION OF UNABSORBED D EPRECIATION OF AN EARLIER YEAR AGAINST THE INCOME OF THE EXPORT UNIT AND ADJU STED THE BALANCE OF UNABSORBED DEPRECIATION AGAINST OTHER BUSINESS INCO ME ONCE AGAIN ITA NOS.771 & 815/MDS./15 :- 7 -: TO SHOW NIL TAX LIABILITY. AGAINST THIS JUDGEMEN T, THE ASSESSEE CARRIED THE MATTER TO SUPREME COURT BY WAY OF SLP, WHICH WAS DI SMISSED BY THE SUPREME COURT. HENCE, WE ARE OF THE OPINION THAT L OWER AUTHORITIES HAVE TAKEN THE CORRECT VIEW OF THE FACTS OF THE CASE AND THIS GROUND OF ASSESSEE IS REJECTED. 5. THE NEXT GROUND IN REVENUES APPEAL IS WITH REGA RD TO MTM LOSSES ON FORWARD CONTRACTS ARE CONTINGENT IN NATURE AND A PR OVISION CREATED ON SUCH NOTIONAL LOSS CANNOT BE ALLOWED. 5.1 THE FACTS OF THE ISSUE ARE THAT THE ASSESSEE HA S FAILED TO ADD BACK PROVISION FOR MTM LOSSES OF ` 18.51 CRORS. DURING THE ASSESSMENT PROCEEDINGS, THE LD.A.R SUBMITTED THAT THE REMOVAL OF MTM LOSSES FROM THE PROFITS OF BUSINESS IS INCORRECT SINCE IT IS IRRETR IEVABLY LINKED TO THE BUSINESS OF THE ASSESSEE. AO OBSERVED THAT RE-STATEMENT OF E XPORT RECEIVABLES AS AT THE END OF THE FINANCIAL YEAR IS ACCEPTABLE, THOUGH NOTIONAL BECAUSE OF THE DECISION OF SUPREME COURT IN THE CASE WOODWARD GOVE RNOR LTD. REPORTED IN (2009) 312 ITR 254. IN CASE OF MTM LOSSES ON FORWAR D CONTRACTS, THE EXPORT RECEIVABLES ARE ALREADY RECEIVED BY THE ASSESSEE AT THE TIME OF ENTERING THE FORWARD CONTRACT AND THE TRANSACTION TRAVERSES FROM DEBTORS TO THAT OF THE BANKER. THEREFORE, THE TRANSACTIONS LOSE ITS IDENTI TY AS BUSINESS TRANSACTION. FURTHER, AO OBSERVED THAT LOSSES ON FORWARD CONTRAC TS WHEN THE SAME IS SQUARED UP BY DELIVERY OF EXPORT PROCEEDS RECEIVED (ACTUAL RECEIPT) IS ALSO ALLOWABLE. BUT, MTM LOSSES AS AT RESTATEMENT AT THE END OF THE FINANCIAL YEAR ARE NOT A BUSINESS TRANSACTION BUT ONLY A SPEC ULATIVE TRANSACTION. IT IS BECAUSE AS ON 31ST MARCH OF THE FINANCIAL YEAR ACTU AL DELIVERY OF FOREIGN ITA NOS.771 & 815/MDS./15 :- 8 -: CURRENCY DOES NOT HAPPEN. IT IS BASED ON THIS RATIO NALE THAT THE CENTRAL BOARD OF DIRECT TAXES VIDE INSTRUCTION NO.3/2010 DA TED. 23.03.2010, HAD CATEGORIZED THE MTM LOSSES ON ACCOUNT OF RESTATEMEN T OF FORWARD CONTRACTS AS AT 31ST MARCH OF THE FINANCIAL YEAR IS SPECULATI VE IN NATURE. IT DOES NOT FALL UNDER THE CLASSIFICATION OF ELIGIBLE TRANSACTI ONS DETAILED IN SEC. 43(5)(A). SUCH MTM LOSSES ON FORWARD CONTRACTS ARE CONTINGENT IN NATURE AND A PROVISION CREATED ON SUCH NOTIONAL LOSS, CANNOT BE ALLOWED AND HENCE THE PROFITS OF BUSINESS SHOULD NOT INCLUDE THE SPECULAT ION LOSS DUE TO MTM OF FORWARD CONTRACTS. HENCE, AO CAME TO A CONCLUSION T HAT THE MTM LOSSES WHICH ARE SPECULATIVE IN NATURE OF ` 18,50,96,905/- IS REDUCED FROM THE CLAIM OF EXPENDITURE IN ARRIVING AT THE LOSSES FOR THE YE AR. AGGRIEVED BY THE ACTION OF AO, THE ASSESSEE CARRIED THE APPEAL BEFORE THE L D.CIT(A). ON APPEAL, THE LD.CIT(A) OBSERVED THAT THE ISSUE IS TO DECIDE WHET HER HE FOREX LOSSES ON ACCOUNT OF MARKED TO MARKET (MTM) ARE TO BE ALLOWED AS A BUSINESS LOSSES OR DENIED AS SPECULATIVE LOSSES. THE BOARD IN ITS INSTRUCTION NO.3/2010 DATED 23.03.2010 MADE IT CLEAR THAT MTM LOSSES ARE NOTIONAL LOSSES, AS SUCH, THEY ARE NOT ALLOWABLE AS THEY ARE CONTINGENT IN NA TURE. HENCE, THE LD.CIT(A) DIRECTED THE AO TO WITHDRAW THE DISALLOWA NCE. AGAINST THIS, THE REVENUE IS IN APPEAL BEFORE US. 5.2 WE HAVE HEARD BOTH THE PARTIES AND PERUSED THE MATERIAL ON RECORD. A SIMILAR VIEW IS TAKEN IN THE ITAT BANGALORE IN QUAL ITY ENGINEERING AND SOFTWARE TECHNOLOGIES PVT. LTD. VS. DCIT REPORTED I N 152 ITD 320 WHEREIN HELD AS FOLLOWS:- ITA NOS.771 & 815/MDS./15 :- 9 -: WE HAVE HEARD THE RIVAL CONTENTIONS AND PERUSED AND CAREFULLY CONSIDERED THE MATERIAL ON RECORD, THE SUBMISSIONS MADE AND THE JUDICIAL DECISIONS PLACED RELIANCE UPON. IT WOULD B E RELEVANT TO BRIEFLY EXAMINE THE CONCEPT OF DERIVATIVES AND THE UNDERL YING NATURE OF THESE TRANSACTIONS BEFORE DECIDING WHETHER THEY ARE SPECULATIVE TRANSACTIONS OR NOT; WHETHER THEY REPRESENT NOTIO NAL LOSS OR REAL LOSS AND WHETHER OR NOT THEY ARE ALLOWABLE AS DEDUC TION. 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 R ATES. THE COMMON FOREIGN EXCHANGE DERIVATIVES ARE, FORWARD CONTRACTS , OPTION CONTRACTS AND SWAP CONTRACTS, ETC. THESE INSTRUMENTS ARE USED TO HEDGE THE CURRENCY RISK ON ACCOUNT OF ADVERSE CURRENCY MOVEME NTS. 4.5.2 THE TERM MARKED TO MARKET LOSSES (MTM) REF ERS 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 CONTRACTS). AS PER THE PRESCRIBED ACCOUNTING S TANDARDS, COMPANIES ARE REQUIRED TO ACCOUNT FOR THE MTM LOSSE S IN THEIR BOOKS OF ACCOUNT DESPITE THE FACT THAT THE CONTRACT HAS N OT YET MATURED AS ON THE BALANCE SHEET DATE. 4.5.3 FOREIGN EXCHANGE FORWARD CONTRACT MEANS AN AG REEMENT TO EXCHANGE DIFFERENT CURRENCIES AT A FORWARD RATE. FO RWARD RATE IS THE SPECIFIED RATE FOR EXCHANGE OF CURRENCY AT A SPECIF IED 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 AGRE ED PRICE ON A FUTURE DATE IN ORDER TO HEDGE AGAINST POSSIBLE FUTU RE FINANCIAL LOSS DUE TO FLUCTUATION IN THE RATE OF FOREIGN CURRENCY. THE REFORE; (I) FIRSTLY, THE FOREIGN EXCHANGE FORWARD CONTRACT 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 FINAN CIAL LOSSES. 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 TH E DATE OF MATURITY, UNLESS THERE IS ANY PREMATURE CANCELLATION OF THE C ONTRACT, IT IS EQUALLY TRUE THAT THE ASSESSEE COULD ANTICIPATE THE LOSS ON THE VALUATION DATE, SAY 3L MARCH, WITH REASONABLE ACCURACY. PRUDENT ACC OUNTING AND COMMERCIAL PRINCIPLES REQUIRE THAT ALL ACCRUED LOSS ES 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 OBLIGAT ION ARISING OUT OF THE CONTRACT, A LIABILITY ACCRUED AS PER THE PROVIS IONS OF THE INCOME TAX ACT. IN THIS REGARD, IT IS NECESSARY TO CONSIDE R AND TAKE INTO ACCOUNT SOME OF THE SETTLED PRINCIPLES REGARDING AC COUNTING PROPOSITIONS, WHICH ARE AS UNDER: ITA NOS.771 & 815/MDS./15 :- 10 - : (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 ENFOR CEABLE 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 TRUE PROFIT I/LOSS. (IV) THE METHOD OF ACCOUNTING CONSISTENTLY FOLLOWED BY THE ASSESSEE SHOULD NOT BE DISCARDED CASUALLY WITHOUT HAVING GOO D 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 STANDARD S (AS) 11 AND THEREFORE HE HAS NO OPTION BUT TO DETERMINE THE PRO FIT / LOSS IN REGARD TO UNMATURED FOREIGN EXCHANGE FORWARD CONTRACTS IN ACCORDANCE WITH THE CURRENCY RATES AS ON THE VALUATION DATE VIZ. MA RCH 31ST THIS CONTENTION OF THE ASSESSEE IS NOT DISPUTED. THE ASS ESSING OFFICER, HOWEVER, IS OF THE VIEW THAT SUCH TREATMENT IN THE BOOKS OF ACCOUNT PER SE DID NOT GIVE THE ASSESSEE THE RIGHT TO CLAIM THE LOSS UNDER THE INCOME TAX ACT. IT IS THIS CONTENTION OF THE ASSESS ING OFFICER THAT REQUIRES TO BE EXAMINED, HAVING REGARD TO THE FUNDA MENTAL COMMERCIAL PRINCIPLES WHICH HAVE RECEIVED JUDICIAL RECOGNITION. IT IS A SETTLED PRINCIPLE, UPHELD IN SEVERAL DECISIONS OF T HE COURTS, THAT DEDUCTION IS ALLOWABLE UNDER THE ACT IN RESPECT OF LIABILITIES THAT HAVE CRYSTALLISED DURING THE YEAR. IF AN ANTICIPATED FUT URE LIABILITY IS COUPLED WITH A PRESENT OBLIGATION, THEN THAT RESULTS IN CRY STALHSED HABILITY, 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 TAKEN PLACE, WHICH IN THE CASE ON HAND WAS OF ENTERING INTO THE CONTRACT AND UNDERTAKING OF THE OBLIGATION TO MEET THE LIABILITY , AND ONLY THE CONSEQUENTIAL EFFECT OF THE SAME IS TO BE DETERMINE D, THEN IT CANNOT BE SAID THAT IT IS IN THE NATURE OF CONTINGENT LIAB ILITY. IT IS TO BE BORNE IN MIND THAT THE ISSUES RELATING TO THE ACCRUAL OF INCOME CANNOT BE DECIDED ON THE SAME FOOTING AND CONSIDERATIONS ON W HICH ISSUES RELATING TO LOSSES ARE TO BE DECIDED. IN THE CASE O F LOSS! EXPENDITURE, THE CONCEPT OF REASONABLE CERTAINTY TO MEET AN EXIS TING OBLIGATION COMES INTO PLAY; WHICH IN LEGAL TERMINOLOGY IS REFE RRED TO AS CRYSTALLISATION OF LIABILITY. THIS IS IN KEEPING AND CONSONANCE WITH THE PRINCIPLE OF PRUDENCE AS CONSIDERED BY THE HON1BLE APEX COURT IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (SUPRA). THE SUBSTANTIAL QUESTIONS OF LAW BEFORE THE HONBLE APEX COURT FOR CONSIDERATION AS EXTRACTED FROM PARA 3 OF ITS ORDER IS AS UNDER:3. IN THIS BATCH OF CIVIL APPEALS, THE FOLLOWING QUESTION ARISES FOR DETERMINATION: (I) WHETHER, ON THE FACTS AND CIRCUMSTANCES OF THE CASE AND IN LAW, THE ADDITIONAL LIABILITY ARISING ON ACCOUNT OF FLUC TUATION IN THE RATE OF ITA NOS.771 & 815/MDS./15 :- 11 - : EXCHANGE IN RESPECT OF LOANS TAKEN FOR REVENUE PURP OSES COULD BE ALLOWED AS DEDUCTION UNDER S. 37(1) IN THE YEAR OF FLUCTUATION IN THE RATE 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 ACC OUNT OF FLUCTUATION IN THE RATE OF EXCHANGE AT EACH BALANCE SHEET DATE, PENDING ACTUAL PAYMENT OF THE VARIED LIABILITY?1 THE ABOVE QUESTIONS OF LAW WERE ELABORATED 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 CATEGORIES. 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) INC URRING LOSS ON REVENUE ACCOUNT. IN THAT CATEGORY, WE ARE CONCERNED WITH THE PROVISIONS OF SS. 28, 29, 37(1) AND 145 OF THE IT A CT, 1961 (1961 ACT). IN THE SECOND CATEGORY OF CASES, WE ARC CONC ERNED WITH EXCHANGE DIFFERENCES ARISING ON REPAYMENT OF LIABIL ITIES INCURRED FOR THE PURPOSE OF ACQUIRING FIXED ASSETS. IN OTHER WOR DS, IN THE SECOND CATEGORY OF CASES, WE ARE CONCERNED WITH THE ASSESS EE(S) INCURRING LIABILITIES ON CAPITAL ACCOUNT. IN SUCH CASES, WE ARE REQUIRED TO CONSIDER THE PROVISIONS OF S. 43(1), 43A (BOTH, BEFORE AND AFTER AMENDMENTS VI DE FINANCE ACT, 2002). 4.5.6 THE HONBLE APEX COURT AFTER IT CONSIDERED AN D EXAMINED THE ISSUE, DECIDED AS AT PARAS 13 TO 21 OF ITS ORDER WH ICH ARE EXTRACTED AS UNDER:13. AS STATED ABOVE, ONE OF THE MAIN ARGUMEN TS ADVANCED BY THE LEARNED ADDI. SOLICITOR GENERAL ON BEHALF OF THE DEPARTMENT BEFORE US WAS THAT THE WORD EXPENDITURE IN S. 37(1) CONNOTES W HAT IS PAID OUT AND THAT WHICH HAS GONE IRRETRIEVABLY. IN THIS CONN ECTION, HEAVY RELIANCE WAS PLACED ON THE JUDGMENT OF THIS COURT I N THE CASE OF INDIAN MOLASSES COMPANY. RELYING ON THE SAID JUDGME NT, IT WAS SOUGHT TO BE ARGUED THAT THE INCREASE 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 EXCHAN GE FLUCTUATIONS, IF THERE IS A REVALUATION OF THE RUPEE VIS-A-VIS FOREI GN EXCHANGE AT OR PRIOR TO THE POINT OF PAYMENT, THEN THERE WOULD BE NO QUESTION OF MONEY HAVING GONE IRRETRIEVABLY AND CONSEQUENTLY, T HE REQUIREMENT OF EXPENDITURE IS NOT MET. CONSEQUENTLY, THE ADDI TIONAL LIABILITY ARISING ON ACCOUNT OF FLUCTUATION IN THE RATE OF FO REIGN EXCHANGE WAS MERELY A CONTINGENT/NOTIONAL LIABILITY WHICH DOES N OT CRYSTALLIZE TILL PAYMENT. IN THAT CASE, THE SUPREME COURT WAS CONSID ERING THE MEANING OF THE EXPRESSION EXPENDITURE INCURRED WH ILE DEALING WITH THE QUESTION AS TO WHETHER THERE WAS A DISTINCTION BETWEEN THE ACTUAL ITA NOS.771 & 815/MDS./15 :- 12 - : LIABILITY IN PRAESENTI AND A LIABILITY DE FTITURO. THE WORD EXPENDITURE IS NOT DEFINED IN THE 1961 ACT. THE WORD EXPENDITU RE IS, THEREFORE, REQUIRED TO BE UNDERSTOOD IN THE CONTEXT IN WHICH I T IS USED. SEC. 37 ENJOINS THAT ANY EXPENDITURE NOT BEING EXPENDITURE OF THE NATURE DESCRIBED IN SS. 30 TO 36 LAID OUT OR EXPENDED WHOL LY AND EXCLUSIVELY FOR THE PURPOSES OF THE BUSINESS SHOULD BE ALLOWED IN COMPUTING THE INCOME CHARGEABLE UNDER THE HEAD PROFITS AND GAINS OF BUSINESS. IN SS. 30 TO 36, THE EXPRESSIONS EXPENSES INCURRED A S WELL AS ALLOWANCES AND DEPRECIATION HAS ALSO BEEN USED. F OR EXAMPLE, DEPRECIATION 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 PARTICULAR CASE, COV ER 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 CIRCUMSTANCES OF A PARTICULAR CASE, COVER AN AM OUNT WHICH IS A LOSS EVEN THOUGH THE SAID AMOUNT HAS NOT GONE OUT FROM THE POCKET OF THE ASSESSEE. THIS VIEW OF THE MADHYA PRADESH HI GH COURT HAS BEEN APPROVED BY THIS COURT IN THE CASE OF MADRAS I NDUSTRIAL INVESTMENT CORPORATION LTD. VS. CIT (1997) 139 CTR (SC) 555 (1997) 225 ITR 802 (SC). ACCORDING TO THE LAW AND P RACTICE OF INCOME-TAX BY KANGA AND PALKHIVALA, S. 37(1) IS A R ESIDUARY SECTION EXTENDING THE ALLOWANCE TO ITEMS OF BUSINESS EXPEND ITURE NOT COVERED BY SS. 30 TO 36. THIS SECTION, ACCORDING TO THE LEA RNED AUTHOR, COVERS CASES OF BUSINESS EXPENDITURE ONLY, AND NOT OF BUSI NESS LOSSES WHICH ARE, HOWEVER, DEDUCTIBLE ON ORDINARY 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 THE CASH SYSTEM OR THE MERCANTILE SYSTEM OF ACCOUNTING. THE QUANTUM OF ALLOWANCES PERMITTED TO BE DEDUCTED UNDER DIVERSE H EADS UNDER SS. 30 TO 43C FROM THE INCOME, PROFITS AND GAINS OF A B USINESS WOULD DIFFER ACCORDING TO THE SYSTEM ADOPTED. THIS IS MAD E CLEAR BY DEFINING THE WORD PAID IN S. 43(2), WHICH IS USED IN SEVER AL 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 DECIDING THE QUESTIO N AS TO WHETHER THE WORD EXPENDITURE IN S. 37(1) INCLUDES THE WORD LOSS11 ONE HAS TO READ S. 37(1) WITH S. 28, S. 29 AND S. 145(1). ONE MORE PRINCIPLE NEEDS TO BE KEPT IN MIND. ACCOUNTS REGULARLY MAINTA INED IN THE COURSE OF BUSINESS ARE TO BE TAKEN AS CORRECT UNLESS THERE ARE STRONG AND SUFFICIENT REASONS TO INDICATE THAT THEY ARE UNRELI ABLE. ONE MORE ASPECT NEEDS TO BE HIGHLIGHTED. UNDER S. 28(I), ONE NEEDS TO DECIDE THE PROFITS AND GAINS OF ANY BUSINESS WHICH IS CARR IED ON BY THE ASSESSEE DURING THE PREVIOUS YEAR. THEREFORE, ONE H AS TO TAKE INTO ITA NOS.771 & 815/MDS./15 :- 13 - : ACCOUNT STOCK-IN-TRADE FOR DETERMINATION OF PROFITS . THE 1961 ACT MAKES NO PROVISION WITH REGARD TO VALUATION OF STOC K. BUT THE ORDINARY PRINCIPLE OF COMMERCIAL ACCOUNTING REQUIRES THAT IN THE P&L A/C THE VALUE OF THE STOCK-IN-TRADE AT THE BEGINNING AND AT THE END OF THE YEAR SHOULD BE ENTERED AT COST OR MARKET PRICE, WHICHEVE R IS THE LOWER. THIS IS HOW BUSINESS PROFITS ARISING DURING THE YEA R NEEDS TO BE COMPUTED. THIS IS ONE MORE REASON FOR READING S. 37 (1) WITH S.145. FOR VALUING THE CLOSING STOCK AT THE END OF A PARTI CULAR YEAR, THE VALUE PREVAILING ON THE LAST DATE IS RELEVANT. THIS IS BE CAUSE PROFITS/LOSS IS EMBEDDED IN THE CLOSING STOCK. WHILE ANTICIPATED LO SS IS TAKEN INTO ACCOUNT, ANTICIPATED PROFIT IN THE SHAPE OF APPRECI ATED VALUE OF THE CLOSING STOCK IS NOT BROUGHT INTO ACCOUNT, AS NO PR UDENT TRADER WOULD CARE TO SHOW INCREASE PROFITS BEFORE ACTUAL REALIZA TION. THIS IS THE THEORY UNDERLYING THE RULE THAT CLOSING STOCK IS TO BE VALUED AT COST OR MARKET PRICE, WHICHEVER IS THE LOWER. AS PROFITS FO R INCOME-TAX PURPOSES ARE TO BE COMPUTED IN ACCORDANCE WITH ORDI NARY PRINCIPLES OF COMMERCIAL ACCOUNTING, UNLESS, SUCH PRINCIPLES STAN D SUPERSEDED OR MODIFIED BY LEGISLATIVE ENACTMENTS, UNREALIZED PROF ITS IN THE SHAPE OF APPRECIATED VALUE OF GOODS REMAINING UNSOLD AT THE END OF THE ACCOUNTING YEAR AND CARRIED OVER TO THE FOLLOWIRG Y EARS ACCOUNT IN A CONTINUING BUSINESS ARE NOT BROUGHT TO THE CHARGE A S A MATTER OF PRACTICE, THOUGH, AS STATED ABOVE, LOSS DUE TO FALL IN THE PRICE BELOW COST IS ALLOWED EVEN THOUGH 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 O R MODIFIED BY LEGISLATIVE ENACTMENT. THIS IS WHERE S. 145(2) COME S INTO PLAY. UNDER THAT SECTION, THE CENTRAL GOVERNMENT IS EMPOWERED T O NOTIFY FROM TIME TO TIME THE ACCOUNTING STANDARDS TO BE FOLLOWE D BY ANY CLASS OF ASSESSEES OR IN RESPECT OF ANY CLASS OF INCOME. ACC ORDINGLY, UNDER S. 209 OF THE COMPANIES ACT, MERCANTILE SYSTEM OF ACCO UNTING IS MADE MANDATORY FOR COMPANIES. IN OTHER WORDS, ACCOUNTING STANDARD WHICH IS CONTINUOUSLY ADOPTED BY AN ASSESSEE CAN BE SUPER SEDED OR MODIFIED BY LEGISLATIVE INTERVENTION. HOWEVER, BUT FOR SUCH INTERVENTION OR IN CASES FALLING UNDER S. 145(3), T HE METHOD OF ACCOUNTING UNDERTAKEN BY THE ASSESSEE CONTINUOUSLY IS SUPREME. IN THE PRESENT BATCH OF CASES, THERE IS NO FINDING GIV EN BY THE AO ON THE CORRECTNESS OR COMPLETENESS OF THE ACCOUNTS OF THE ASSESSEE. EQUALLY, THERE IS NO FINDING GIVEN BY THE AO STATING THAT TH E ASSESSEE HAS NOT COMPLIED WITH THE ACCOUNTING STANDARDS. 15. FOR THE REASONS GIVEN HEREINABOVE, WE HOLD THAT , IN THE PRESENT CASE, THE 9OSS SUFFERED BY THE ASSESSEE ON ACCOUN T OF THE EXCHANGE DIFFERENCE AS ON THE DATE OF THE BALANCE SHEET IS A N 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 C OMPUTED IN ACCORDANCE WITH THE RELEVANT ACCOUNTING STANDARD. I T IS IMPORTANT TO BEAR IN MIND THAT THE BASIS ON WHICH STOCK-IN-TRADE IS VALUED IS PART OF ITA NOS.771 & 815/MDS./15 :- 14 - : THE METHOD OF ACCOUNTING. IT IS WELL ESTABLISHED, T HAT, ON GENERAL PRINCIPLES OF COMMERCIAL ACCOUNTING, IN THE P&L ACC OUNT, THE VALUES OF THE STOCK-IN-TRADE AT THE BEGINNING AND AT THE END OF THE ACCOUNTING YEAR SHOULD BE ENTERED AT COST OR MARKET VALUE, WHI CHEVER IS LOWERTHE MARKET VALUE BEING ASCERTAINED AS ON THE LAST DATE OF THE ACCOUNTING YEAR AND NOT AS ON ANY INTERMEDIATE DATE BETWEEN TH E COMMENCEMENT AND THE CLOSING OF THE YEAR, FAILING W HICH IT WOULD NOT BE POSSIBLE TO ASCERTAIN THE TRUE AND CORRECT STATE OF AFFAIRS. NO GAIN OR PROFIT CAN ARISE UNTIL A BALANCE IS STRUCK BETWE EN THE COST OF ACQUISITION AND THE PROCEEDS OF SALE. THE WORD PRO FIT IMPLIES A COMPARISON BETWEEN THE STATE OF BUSINESS AT TWO SPE CIFIC DATES, USUALLY SEPARATED BY AN INTERVAL OF TWELVE MONTHS. STOCK-IN-TRADE IS AN ASET. IT IS A TRADING ASSET. THEREFORE, THE CONC EPT OF PROFIT AND GAINS MADE BY BUSINESS DURING THE YEAR CAN ONLY MAT ERIALIZE 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 AND S. 56 ALONE, INCOME, PROFITS AND GAINS MUST BE COMPUTED IN ACCORDANCE WITH THE METHOD OF ACCOUNTING REGULARLY EMPLOYED BY THE ASSESSEE. IN THIS CASE, WE ARE CONCERNED 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 BRO UGHT INTO CREDIT BEFORE IT IS ACTUALLY RECEIVED; IT BRINGS INTO DEBI T AN EXPENDITURE FOR WHICH A LEGAL LIABILITY HAS BEEN INCURRED BEFORE IT IS ACTUALLY DISBURSED. (JUDGMENT OF THIS COURT IN THE CASE OF UNITED COMME RCIAL BANK VS. CIT (1999) 156 CTR (SC) 380 : (1999) 240 ITR 355 (S C)). THEREFORE, THE ACCOUNTING METHOD FOLLOWED BY AN ASSESSEE CONTI NUOUSLY FOR A GIVEN PERIOD OF TIME NEEDS TO BE PRESUMED TO BE COR RECT TILL THE AO COMES TO THE CONCLUSION FOR REASONS TO BE GIVEN THA T THE SYSTEM DOES NOT REFLECT TRUE AND CORRECT PROFITS. AS STATED, TH ERE IS NO FINDING GIVEN BY THE AO ON THE CORRECTNESS OF THE ACCOUNTING STAN DARD FOLLOWED 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 O F ORDINARY PRINCIPLES OF COMMERCIAL ACCOUNTING AND HAVING COME TO THE CON CLUSION THAT THE CENTRAL GOVERNMENT HAS MADE ACCOUNTING STANDARD-IL MANDATORY, WE ARE NOW REQUIRED TO EXAMINE THE SAID ACCOUNTING STA NDARD (AS). 18. AS-IL DEALS WITH GIVING OF ACCOUNTING TREATMENT FOR THE EFFECTS OF CHANGES IN FOREIGN EXCHANGE RATES. AS-IL DEALS WITH EFFECTS OF EXCHANGE DIFFERENCES. UNDER PARA 2, REPORTING CURRE NCY IS DEFINED TO MEAN THE CURRENCY USED IN PRESENTING THE FINANCIAL STATEMENTS. SIMILARLY, THE WORDS MONETARY ITEMS ARE DEFINED T O MEAN MONEY HELD AND ASSETS AND LIABILITIES TO BE RECEIVED OR P AID IN FIXED AMOUNTS, E.G., CASH, RECEIVABLES AND PAYABLES. THE WORD PAI D IS DEFINED UNDER S. 43(2). THIS HAS BEEN DISCUSSED EARLIER. SIMILARL Y, IT IS IMPORTANT TO NOTE THAT FOREIGN CURRENCY NOTES, BALANCE IN BANK A CCOUNTS DENOMINATED IN A FOREIGN CURRENCY, AND RECEIVABLES/ PAYABLES AND ITA NOS.771 & 815/MDS./15 :- 15 - : LOANS DENOMINATED IN A FOREIGN CURRENCY AS WELL AS SUNDRY CREDITORS ARE ALL MONETARY ITEMS WHICH HAVE TO BE VALUED AT T HE CLOSING RATE UNDER AS-IL. UNDER PARA 5, A TRANSACTION IN A FOREI GN CURRENCY HAS TO BE RECORDED IN THE REPORTING CURRENCY BY APPLYING T O THE FOREIGN CURRENCY AMOUNT THE EXCHANGE RATE BETWEEN THE REPOR TING CURRENCY AND THE FOREIGN CURRENCY AT THE DATE OF THE TRANSAC TION. THIS IS KNOWN AS RECORDING OF TRANSACTION ON INITIAL RECOGNITION. PARA 7 OF AS-IL DEALS WITH REPORTING OF THE EFFECTS OF CHANGES IN EXCHANG E RATES SUBSEQUENT TO INITIAL RECOGNITION.PARA 7(A) INTER ALIA STATES THAT ON EACH BALANCE SHEET DATE MONETARY ITEMS, ENUMERATED ABOVE, DENOMI NATED IN A FOREIGN CURRENCY SHOULD BE REPORTED USING THE CLOSI NG RATE. IN CASE OF REVENUE ITEMS FALLING UNDER S. 37(1), PARA 9 OF AS- IL WHICH DEALS WITH RECOGNITION OF EXCHANGE DIFFERENCES, NEEDS TO BE CO NSIDERED. UNDER THAT PARA, EXCHANGE DIFFERENCES ARISING ON FOREIGN CURRENCY TRANSACTIONS HAVE TO BE RECOGNIZED AS INCOME OR AS EXPENSE IN THE PERIOD IN WHICH THEY ARISE, EXCEPT AS STATED IN PAR A 10 AND PARA 11 WHICH DEALS WITH EXCHANGE DIFFERENCES ARISING ON RE PAYMENT OF LIABILITIES INCURRED FOR THE PURPOSE OF ACQUIRING F IXED ASSETS, WHICH TOPIC FALLS UNDER S. 43A OF THE 1961 ACT. AT THIS S TAGE, WE ARE CONCERNED ONLY WITH PARA 9 WHICH DEALS WITH REVENUE ITEMS. PARA 9 OF AS-LI RECOGNISES EXCHANGE DIFFERENCES AS INCOME OR EXPENSE. IN CASES WHERE, E.G., THE RATE OF DOLLAR RISES VIS-A-VIS THE INDIAN RUPEE, THERE IS A N EXPENSE DURING THAT PERIOD. THE IMPORTANT POINT TO BE NOTED IS THAT AS- IL STIPULATES EFFECT OF CHANGES IN EXCHANGE RATE VIS-A-VIS MONETARY ITEM S DENOMINATED IN A FOREIGN CURRENCY TO BE TAKEN INTO ACCOUNT FOR GIV ING ACCOUNTING TREATMENT ON THE BALANCE SHEET DATE. THEREFORE, AN ENTERPRISE HAS TO REPORT THE OUTSTANDING LIABILITY RELATING TO IMPORT OF RAW MATERIALS USING CLOSING RATE OF EXCHANGE. ANY DIFFERENCE, LOS S OR GAIN, ARISING ON CONVERSION OF THE SAID LIABILITY AT THE CLOSING RAT E, SHOULD BE RECOGNIZED IN THE P&L ACCOUNT FOR THE REPORTING PER IOD. 19. A COMPANY IMPORTS RAW MATERIAL WORTH US $ 25000 0 ON 15TH JAN., 2002 WHEN THE EXCHANGE RATE WAS RS. 46 PER US $. TH E COMPANY RECORDS THE TRANSACTION AT THAT RATE. THE PAYMENT F OR THE IMPORTS IS MADE ON 15TH APRIL, 2002 WHEN THE EXCHANGE RATE IS RS. 49 PER US $. HOWEVER, ON THE BALANCE SHEET DATE, 31ST MARCH, 200 2, THE RATE OF EXCHANGE IS RS. 50 PER US $. IN SUCH A CASE, IN TER MS OF AS-IL, THE EFFECT OF THE EXCHANGE DIFFERENCE HAS TO BE TAKEN I NTO P&L ACCOUNT. SUNDRY CREDITORS IS A MONETARY ITEM AND HENCE SUCH ITEM HAS TO BE VALUED AT THE CLOSING RATE, I.E. RS. 50 AT 31ST MAR CH, 2002, IRRESPECTIVE OF THE PAYMENT FOR THE SALE SUBSEQUENTLY 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 A GAINST 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: ITA NOS.771 & 815/MDS./15 :- 16 - : 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 DEPRECIATION IN THE VALUE F FOREIGN CURRENCY HELD BY IT, ON CONVERSION INTO ANOTHER CURRENCY, SUCH PROFIT OR LOSS WOULD OR DINARILY BE A TRADING PROFIT OR LOSS IF THE FOREIGN CURRENCY IS HELD BY T HE ASSESSEE ON REVENUE ACCOUNT OR AS A TRADING ASSET OR AS A PART OF CIRCULATING CAPITAL EMBARKED IN THE BUSINESS. BUT, IF ON THE OT HER HAND, THE FOREIGN CURRENCY IS HELD AS A CAPITAL ASSET OR AS F IXED CAPITAL, SUCH PROFIT OR LOSS WOULD BE OF CAPITAL NATURE. 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) WHETHER THE SYSTEM OF ACCOUNTING FOLLOWED BY TH E ASSESSEE IS MERCANTILE SYSTEM, WHICH BRINGS INTO DEBIT THE EXPE NDITURE AMOUNT FOR WHICH A LEGAL LIABILITY HAS BEEN INCURRED BEFORE IT IS ACTUALLY DISBURSED AND BRINGS INTO CREDIT WHAT IS DUE, IMMEDIATELY IT BECOMES DUE AND BEFORE IT IS ACTUALLY RECEIVED; (II) WHETHER THE SA ME SYSTEM IS FOLLOWED BY THE ASSESSEE FROM THE VERY BEGINNING AND IF THER E WAS A CHANGE IN THE SYSTEM, WHETHER THE CHANGE WAS BONA FIDE; (III) WHETHER THE ASSESSEE HAS GIVEN THE SAME TREATMENT TO LOSSES CLA IMED 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 ACCOUNT BOOKS IN RESPECT OF LOSSES AND GAINS; (V) W HETHER THE METHOD ADOPTED BY THE ASSESSEE FOR MAKING ENTRIES IN THE B OOKS BOTH IN RESPECT OF LOSSES AND GAINS IS AS PER NATIONALLY AC CEPTED ACCOUNTING STANDARDS; (VI) WHETHER THE SYSTEM ADOPTED BY THE A SSESSEE IS FAIR AND REASONABLE OR IS ADOPTED ONLY WITH A VIEW TO RE DUCING THE INCIDENCE OF TAXATION. 4.5.7 AS CAN BE SEEN FROM THE EXTRACTIONS REPRODUCE D ABOVE, THE DECISION IN THE CASE OF WOODWARD GOVERNOR INDIA PVT . LTD. (SUPRA) HAS BEEN RENDERED IN RESPECT OF MONETARY ITEMS, DENOM INATED IN FOREIGN CURRENCY WHICH INCLUDE TO MEAN MONEY HELD AND ASSET S AND LIABILITIES TO BE RECEIVED OR PAID IN FIXED AMOUNTS, E.G. CASH, FOREIGN CURRENCY NOTES, BALANCE IN BANK ACCOUNTS DENOMINATED IN A FO REIGN CURRENCY, RECEIVABLES / PAYABLES AND LOANS DENOMINATED IN A F OREIGN CURRENCY, SUNDRY CREDITORS, 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 A RE THEREFORE UNABLE 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 THE ACCOUNTIN G PRINCIPLES AND IS IN VARIANCE WITH THE PRINCIPLE UPHELD BY THE HONBL E APEX COURT IN THE CASE OF WOODWPRD GOVERNOR INDIA PVT. LTD. (SUPRA). IT CAN ALSO BE SEEN THAT THE DECISION IN THE CASE OF WOODWARD GOVE RNOR INDIA PVT. LTD. (AS EXTRACTED ABOVE) HAS BEEN RENDERED WITH RE GARD TO ITEMS IN THE REVENUE ACCOUNT AND CAPITAL ACCOUNT. THEREFORE, THE VIEW OF THE LEARNED CIT (APPEALS) THAT THIS DECISION OF THE HON BLE APEX COURT ITA NOS.771 & 815/MDS./15 :- 17 - : RELATES TO ONLY RESTATEMENT OF EXISTING CURRENCY LI ABILITIES AND ASSETS IS NOT CORRECT. 4.5.8 IN THE CASE ON HAND, IT IS NOT IN DISPUTE THA T THE FORWARD CONTRACTS HAVE BEEN ENTERED INTO BY THE ASSESSEE IN ORDER TO PROTECT ITS INTEREST AGAINST FLUCTUATIONS IN FOREIGN CURREN CY, IN RESPECT OF CONSIDERATION FOR EXPORT PROCEEDS, WHICH IS A REVEN UE ITEM. THEREFORE, IN SUM AND SUBSTANCE, IT HAS THE TRAPPIN GS OF STOCK-IN- TRADE AND THE ASSESSEE HAS TO RESTATE OR REVALUE TH E SAME AS ON THE BALANCE SHEET DATE. THE CONSEQUENT EFFECT OF THIS A CCOUNTING TREATMENT WAS TO RECOGNIZE THE EXCHANGE FLUCTUATION GAIN OR LOSS IN THE PROFIT AND LOSS ACCOUNT AS ON THE VALUATION DAT E. IN VIEW OF THE FACTS AND CIRCUMSTANCES OF THE CASE AS DISCUSSED AB OVE, 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 ASSESSE E 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; III) THE LIABILITY IS DETERMINABLE WITH REASONABLE CERTAINTY WHEN AN OBLIGATION IS PENDING ON THE BALANCE SHEET DATE AND SUCH A LIABILITY CANNOT 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 HONBLE APEX CO URT IN THE CASE OF WOODWARD GOVERNOR INDIA PVT. LTD. (SUPRA) ARE APPLI CABLE 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 TH IS INSTRUCTION READS AS UNDER:1. FOREIGN EXCHANGE DERIVATIVE TRAN SACTIONS ENTERED INTO BY THE CORPORATE SECTOR IN INDIA HAVE WITNESSED A SUBSTANTIAL GROWTH IN RECENT YEARS. THIS COMBINED WITH EXTREME VOLATILITY IN THE FOREIG N EXCHANGE MARKET IN THE LAST FINANCIAL YEAR IS REPORTED TO HAVE RESU LTED IN SUBSTANTIAL LOSSES TO AN ASSESSEE ON ACCOUNT OF TRADING IN FORE X-DERIVATIVES. A LARGE NUMBER OF ASSESSES ARE SAID TO BE REPORTING S UCH LOSSES ON MARKED TO MARKET BASIS EITHER SUO MOTU OR IN COMP LIANCE OF THE ACCOUNTING STANDARD OR ADVISORY CIRCULAR ISSUED BY THE INSTITUTE OF CHARTERED ACCOUNTANTS. THE ISSUE WHETHER SUCH LOSSE S ON ACCOUNT OF FOREX-DERIVATIVES CAN BE ALLOWED AGAINST THE TAXABL E INCOME OF AN ASSESSEE HAS BEEN CONSIDERED BY THE BOARD. IN THIS CONNECTION, I AM DIRECTED TO SAY THAT THE ASSESSING OFFICERS MAY FOL LOW 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 / ITA NOS.771 & 815/MDS./15 :- 18 - : CONCLUSION OF CONTRACT AND IS NOT A NOTIONAL OR MAR KED TO MARKET BOOK ENTRY, A FURTHER QUESTION WILL ARISE AS TO WHETHER SUCH A LOSS IS ON ACCOUNT OF A SPECULATIVE TRANSACTION AS CONTEMPLATE D IN SECTION 43(5) OF THE INCOME TAX ACT. FOR DETERMINING WHETHER LOSS FROM A TRANSACTION IN RESPECT OF A FOREXDERIVATIVE IS A SP ECULATION LOSS OR NOT, THE ASSESSING OFFICERS MAY REFER TO PROVISO (D) BEL OW SUB-SECTION (5) OF SECTION 43 INSERTED BY THE FINANCE ACT, 2005, WI TH EFFECT FROM 1.4.2006. IT LAYS DOWN THAT ANY ELIGIBLE TRANSACTI ON IN RESPECT OF TRADING IN DERIVATIVES REFERRED TO IN CLAUSE (AC) O F SECTION 2 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956, THAT H AS BEEN CARRIED OUT IN A RECOGNIZED STOCK EXCHANGE SHALL NOT BE TREATED AS A SPECULATIVE TRANSACTION. FURTHER, AN ELIGIBLE TRANSACTION FOR THIS PURPOSE WOULD BE ONE THAT FULFILS THE CONDITIONS LAID DOWN IN EXPLAN ATION 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 TH E LOSS ARISING OUT OF THE FORWARD CONTRACT IS NOT NOTIONAL. IN SUCH A CAS E, THE CBDT INSTRUCTION REQUIRES THE ASSESSING OFFICER TO EXAMI NE WHETHER SUCH A LOSS IS ON ACCOUNT OF A SPECULATIVE TRANSACTION AS CONTEMPLATED 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 DIAMDNDS (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 P URPOSE OF INCOME-TAX WHAT A SPECULATIVE TRANSACTION MEANS. IF A CONTRACT FOR SALE OR PURCHASE IS ULTIMATELY SETTLED AND NO ACTUAL DELIVE RY OF THE GOODS WAS EFFECTED UNDER THE SETTLEMENT THEN IT IS A SPECULAT IVE 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 CONTRACT NOT TO GIVE OR TAKE DELIVERY OF THE GOODS IN ORDER TO MAKE IT A SPECULATIVE/WAGERING TRANSACTION IS DISPENSED WITH FOR THE PURPOSE OF THE ACT AND IF ACTUAL DELIVERY IS NOT GIVEN/TAKEN U NDER THE SETTLEMENT OF CONTRACT, THEN THE INTENTION OF THE PARTIES AT T HE TIME OF THE CONTRACT BECOMES IM-MATERIAL. THUS, THE TRUE TEST I S DELIVERY OF COMMODITIES/GOODS AS PER THE CONTRACT, INCLUDING A FORWARDING CONTRACT. PROFIT/LOSS IN RESPECT OF UNPERFORMED CON TRACTS IS CONSIDERED SPECULATION PROFIT/LOSS. IN SHORT, IN ORDER THAT A TRANSACTION MAY FALL WITHIN THE SCOPE OF THE EXPRESSION SPECULATIVE TRA NSACTION, IT MUST BE A TRANSACTION IN WHICH A CONTRACT FOR PURCHASE OR S ALE OF ANY ITA NOS.771 & 815/MDS./15 :- 19 - : COMMODITY, INCLUDING STOCKS AND SHARES, IS PERIODIC ALLY OR ULTIMATELY SETTLED OTHERWISE THAN BY THE ACTUAL DELIVERY OR TR ANSFER OF THE COMMODITY OR SCRIPS. 5.2.2. HERE, IT WOULD BE USEFUL TO APPRECIATE IN PR OPER PERSPECTIVE HOW HEDGE TRANSACTIONS ARE COMMERCIALLY UNDERSTOOD BEFORE DETERMINING THE TRUE SCOPE, WIDTH AND NATURE OF PRO VISO (A) TO SECTIORI43(5). HEDGE CONTRACTS ARE THOSE CONTRACTS WHICH HEDGE AGAINST PREJUDICIAL PRICE FLUCTUATIONS. IN SPECULAT IVE TRANSACTIONS THE MODUS OPERANDI OF PERSONS INDULGING IN THEM IS THAT WHEN ONE ENTERS INTO A CONTRACT OF PURCHASE, HE ALSO SIMULTANEOUSLY ENTERS INTO ONE OR MORE CONTRACTS OF SALE AGAINST THE SAME QUANTITY DE LIVERABLE AT THE SAME TIME EITHER TO THE ORIGINAL VENDOR OR TO SOMEO NE ELSE, SO AS EITHER TO SECURE PROFIT OR TO MINIMIZE LOSS, BEFORE THE VAIDA DAY ; AND SIMILARLY WHEN HE ENTERS INTO A CONTRACT OF SALE, H E SIMULTANEOUSLY ENTERS 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 FRO M THE SAME PERSON, HAS THE EFFECT OF CANCELLING THE CONTRACTS LEAVING ONLY DIFFERENCES TO BE PAID. THE TECHNIQUE OF HEDGE TRAD ING 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 COMMODITY TO HEDGE THEMSELVES, I.E., TO INSURE THEM SELVES AGAINST ADVERSE PRICE FLUCTUATIONS. A DEALER OR A MERCHANT ENTERS INTO A HEDGE CONTRACT WHEN HE SELLS OR PURCHASES A COMMODITY IN THE FORWARD MARKET FOR DELIVERY AT A FUTURE DATE. HIS TRANSACTI ON IN THE FORWARD MARKET MAY CORRESPOND TO A PREVIOUS PURCHASE OR SAL E IN THE READY MARKET OR HE MAY PROPOSE TO COVER IT LATER BY A COR RESPONDING TRANSACTION IN THE READY MARKET, OR HE MAY OFFSET I T BY A REVERSE TRANSACTION ON THE FORWARD MARKET ITSELF. HEDGING C ONTRACTS NEED NOT SUCCEED THE CONTRACTS FOR SALE AND ACTUAL DELIVERY OF GOODS MANUFACTURED, BUT THE LATTER MAY BE SUBSEQUENTLY EN TERED INTO, PROVIDED THEY ARE WITHIN REASONABLE TIME. IN ORDER TO BE GENUINE AND VALID HEDGING CONTRACTS 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 PURCHASE. AS P ER THE ACCEPTED COMMERCIAL NORMS OBJECT OF A HEDGING CONTRACT IS TO SECURE ONESELF AGAINST LOSS IN A FUTURE DELIVERY CONTRACT, BUT SUC H TRANSACTIONS CANNOT BE REGARDED AS INTER-CONNECTED. EACH ONE IS INDEPEN DENT 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 D ELIVERY IRRESPECTIVE OF THE DATE ON WHICH THE CONTRACT WAS ENTERED INTO. IN RESPECT OF A HEDGING CONTRACT, PROFIT/LOSS ARISING THERE FROM CA N BE ASCERTAINED OR CRYSTALLIED AT FIXED INTERVALS OF THE TERM WHEN THE CLEARANCE TAKES PLACE. 5.2.2.A. BY RESORTING TO COUNTERBALANCING TRANSACTI ONS IN THE MARKET FOR THE READY COMMODITY ON THE ONE HAND AND IN THE HEDGE MARKET ON ITA NOS.771 & 815/MDS./15 :- 20 - : THE OTHER HAND, THE HEDGER SEEKS TO SAFEGUARD HIS P OSITION. THE MOVEMENT OF PRICES IN THE TWO MARKETS MAY NOT ALWAY S FOLLOW AN IDENTICAL COURSE AND THE HEDGER MIGHT 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 HEDGING OPERATION PROTECTS THE HEDGER AGAINST LOSS ARISING FROM ADVERSE FLUCTUATIONS IN PRICES, IT ALSO PREVENTS HI M FROM MAKING WINDFALL PROFIT OWING TO FAVOURABLE FLUCTUATIONS 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 TEC HNIQUE, OF HEDGE TRADING CLEARLY IMPLIES FORWARD CONTRACTS BOTH WAYS , NAMELY, FOR SALE AND PURCHASE WITH A VIEW TO GUARDING AGAINST ADVERS E 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, FOLLOWS THAT IN ORDER TO EFFECTIVELY HED GE AGAINST ADVERSE PRICE FLUCTUATIONS OF THE MANUFACTURED GOODS OR MER CHANDISE, 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 TRANSACTION S, THERE WOULD BE NO EFFECTIVE INSURANCE AGAINST THE RISK OF LOSS IN THE PRICE FLUCTUATIONS OF THE COMMODITY, MANUFACTURED OR THE MERCHANDISE S OLD. 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 AR E 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 CONTRACT, (3) TRANSACTION IN QUESTION MUST BE A CONTRACT ENTE RED INTO IN RESPECT OF RAW MATERIALS OR MERCHANDISE IN THE COURSE OF TH E ASSESSEES MANUFACTURING BUSINESS AND IT SHOULD HAVE BEEN SETT LED OTHERWISE THAN BY ACTUAL DELIIERY OF GOODS, (4) HEDGING CONTRACTS MAY BE BOTH WITH REGARD TO SA LES AND PURCHASES, (5) HEDGING CONTRACTS NEED NOT SUCCEEED THE CONTRAC TS FOR SALE AND ACTUAL DELIVERY OF GOODS MANUFACTURED, BUT THE LATT ER MAY BE SUBSEQUENTLY 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 TO TAL STOCKS OF THE RAW MATERIALS OR THE MERCHANDISE ON HAND WHICH WOUL D INCLUDE EXISTING STOCKS AS WELL AS THE STOCKS ACQUIRED UNDE R THE FIRM CONTRACTS OF PURCHASES, ITA NOS.771 & 815/MDS./15 :- 21 - : (7) THE HEDGING CONTRACT NEED NOT NECESSARILY BE IN THE SAME VARIETY OF THE COMMODITY THEY COULD BE IN CONNECTED COMMODI TIES, E.G., ONE TYPE 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 BECAUSE OF FUTURE PRICE FLUCTUATIONS AND THAT IT WA S 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 TRANSAC TIONS WE HAD BENEFIT OF PERUSING THE JUDGMENTS OF M.G. BROS. V CIT (1985) 1564 ITR 695/20 TAXMAN 90 (AP), NUDDEA MILLS CO. LTD. V. CIT (1988) 171 ITR 169 (1987) 35 TAXMAN 3 (CAL), DELHI FLOUR MILLS CO. LTD. V CIT (1974) 95 ITR 151 (DEL) AND PA NKAJ OIL MILLS V CIT (1978) 115 ITR 824 (GUJ) DELIVERED BY THE HONBLE H IGH COURTS OF ANDHRA PRADESH, CALCUTTA, DELHI AND GUJARAT RESPECT IVELY. 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 WHEN IT ENTERED INTO FOR-EX FORWARD CONTRA CTS. THE FORWARD CONTRACTS ARE IN RESPECT OF CONSIDERATION FOR EXPOR TS PROCEEDS, WHICH ARE REVENUE ITEMS. THERE IS AN ACTUAL CONTRACT FOR SALE OF MERCHANDISE. IN THIS FACTUAL MATRIX, IT IS CLEAR IN OUR VIEW THAT THE TRANSACTION IN QUESTION WILL NOT QUALIFY TO BE CALL ED AS SPECULATIVE TRANSACTION. IN VIEW OF THE FACTS 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. W E, ACCORDINGLY ALLOW THE GROUNDS AT S.NOS.1 TO 9 RAISED BY THE ASSESSEE. 5.3 FURTHER, THE CO-ORDINATE BENCH OF THIS TRIBUNA L IN THE CASE OF M/S.COTTON BLOSSOM (I) PVT. LTD.,IN ITA NO.583/MDS. /2014 & 1531/MDS./2015 VIDE ORDER DATED 31.1.22015 AFTER CONSIDERING THE VARIOUS JUDGEMENTS OF THE CO-ORDINATE BENCH, IN THE CASE OF M/S. AISHWARYA & CO P. LTD IN ITA NO.860/MDS/2014, DATED 29.05.2015, WHEREIN THEY FOL LOWED THE JUDGMENT OF THE CALCUTTA HIGH COURT IN THE CASE OF M/S. BALJIT SECURITIES PVT. LTD. (88 CCH 313) HELD THAT THE ASSESSING OFFICER HAS TO CONSIDER THE FOREIGN EXCHANGE DERIVATIVE IN PROPORTION TO EXPORT TURNOVE R AS REGULAR BUSINESS TRANSACTION OF THE ASSESSEE. IF THE DERI VATIVE TRANSACTION ITA NOS.771 & 815/MDS./15 :- 22 - : UNDERTAKEN BY THE ASSESSEE IS IN EXCESS OF EXPORT TURNOVER THEN THAT LOSS SUFFERED IN RESPECT OF THAT PORTION OF EXCESS TRANSACTION HAS TO BE CONSIDERED AS SPECULATIVE LOSS ONLY AND THAT EXCESS DERIVATIVE TRANSACTION HAS NO PROXIMITY WITH EXPORT TURNOVER A ND THE ASSESSING OFFICER IS DIRECTED TO COMPUTE ACCORDINGLY. FURTHE R, THE ASSESSING OFFICER HAS TO SEE WHETHER THERE IS ANY PREMATURE C ANCELLATION OF FORWARD CONTRACT OF FOREIGN EXCHANGE AND THAT TRANS ACTION SHOULD BE TAKEN OUT FOR THE PURPOSE OF CONSIDERING THE BUSINE SS LOSS AND ONLY THE TRANSACTIONS WHICH ARE COMPLETED TO BE CONSIDERED F OR THE PURPOSE OF DETERMINING THE BUSINESS LOSS FROM THIS FOREIGN EXC HANGE FORWARD CONTRACT AND REMITTED THE MATTER TO ASSESSING OFFIC ER FOR FRESH CONSIDERATION. 5.3 IN VIEW OF THE ABOVE DISCUSSION, WE ARE IN AGR EE WITH THE PROPOSITION THAT THE MTM LOSS ON FORWARD CONTRACTS IS NOT CONTI NGENT LOSS AND IT IS A BUSINESS LOSS TO SET OFF AGAINST THE BUSINESS INCOM E OF ASSESSEE. HOWEVER, THE AO HAS TO CONSIDER THE TRANSACTION EQUIVALENT T O THE EXPORT TURNOVER TO DETERMINE THE MTM LOSS AND ALSO IF THERE IS ANY PREMATURE CANCELLATION OF FORWARD CONTRACT OF FOREIGN EXCHANGE, IT SHALL BE E XCLUDED TO CONSIDER THE BUSINESS LOSS AND THESE TRANSACTIONS ARE SPECUL ATIVE TRANSACTION. WITH THIS OBSERVATION, WE REMIT THE ISSUE TO THE FI LE OF AO FOR FRESH CONSIDERATION. ITA NOS.771 & 815/MDS./15 :- 23 - : 6. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS DI SMISSED AND THE APPEAL OF REVENUE IS PARTLY ALLOWED FOR STATISTICAL PURPOSES. ORDER PRONOUNCED IN THE OPEN COURT ON 17 TH JUNE, 2016, AT CHENNAI. SD/ - SD/ - ! ' # . $ %& ' ( DUVVURU RL REDDY ) ) & / JUDICIAL MEMBER ( ) (CHANDRA POOJARI) / ACCOUNTANT MEMBER () / CHENNAI *+ / DATED: 17 TH JUNE, 2016 K S SUNDARAM +,-- ./-0/ / COPY TO: - 1 . / APPELLANT 3. - 1-!' / CIT(A) 5. /23- 4 / DR 2. / RESPONDENT 4. - 1 / CIT 6. 3&-5 / GF