Income Tax Appellate Tribunal - Chennai
Lanco Tanjore Power Company Ltd.,, ... vs Department Of Income Tax on 24 September, 2012
IN THE INCOME TAX APPELLATE TRIBUNAL
'C' BENCH, CHENNAI
BEFORE SHRI ABRAHAM P. GEORGE, ACCOUNTANT MEMBER
AND SHRI VIKAS AWASTHY, JUDICIAL MEMBER
I.T.A. No. 1322/Mds/2012
(Assessment Year : 2009-10)
The Assistant Commissioner of M/s Lanco Tanjore Power
Income Tax, Company Ltd.,
Company Circle - II(4), v. 3rd floor, No.25, G.N. Chetty Rd.,
Chennai - 600 034. T. Nagar, Chennai - 600 017.
PAN : AACCA4297N
(Appellant) (Respondent)
Appellant by : Shri S. Dasgupta, JCIT
Respondent by : Shri R. Vijayaraghavan, Advocate
Date of Hearing : 24.09.2012
Date of Pronouncement : 24.09.2012
O R D E R
PER ABRAHAM P. GEORGE, ACCOUNTANT MEMBER :
In this appeal filed by the Revenue, directed against order dated 21.3.2012 of Commissioner of Income Tax (Appeals)-III, Chennai, it has taken altogether five grounds of which, ground Nos.1 and 5 are general needing no adjudication.
2. Grievance raised by the Revenue in its ground No.2 is that CIT(Appeals) deleted an addition made by the A.O. disallowing a claim 2 I.T.A. No. 1322/Mds/12 for provision made towards exchange fluctuation loss on forward contracts.
3. Facts apropos are that assessee, engaged in power generation business, had made a provision of ` 61,78,500/- on unexpired foreign exchange contracts. During the course of assessment proceedings, it was noted by the Assessing Officer that this provisioning was done on the basis of an open position with reference to exchange rates prevailing at the end of the relevant previous year. As per the A.O., the forward contract had not become conclusive and being still open, any loss based on application of exchange rate at the end of the year was notional and anticipated only and such notional loss could not be allowed in view of CBDT Instruction No.03/2010 dated 23.3.2010. In this view of the matter, she disallowed the provision.
4. In its appeal before CIT(Appeals), argument of the assessee was that forward contract was taken by it for covering the risk on account of fluctuation in currency rate on a receivable amount of US $ 6,00,000 on account of power purchase agreement with TNEB. As per the assessee, the provision was arrived at after netting off loan liabilities to Power Finance Corporation and IOB. Assessee also submitted that it was obliged to follow Accounting Standard-11 of Institute of Chartered Accountants of India, and by virtue of Section 211(3C) of Companies 3 I.T.A. No. 1322/Mds/12 Act, 1956, it was obliged to make a market valuation of the forward contract cover. Reliance was placed by the assessee on the decision of Hon'ble Apex Court in the case of CIT v. Woodward Governor India P. Ltd. (312 ITR 254).
5. CIT(Appeals) was appreciative of above contentions of the assessee. According to him, anticipated loss on account of foreign currency variations could be booked based on an underlying rule that closing stock could be valued either at market rate or at cost, whichever was lower. As per the CIT(Appeals), forward contracts were on revenue account and not against any loans raised for acquisition of capital assets. CIT(Appeals) held that the claim of the assessee could not have been disallowed since Special Bench of this Tribunal in the case of DCIT v. Bank of Bahrain & Kuwait [(2010) 41 SOT 290] had held that loss on account of revaluation of contract based on exchange rates of last day of accounting period could be allowed.
6. Now before us, learned D.R. strongly assailing the order of CIT(Appeals), submitted that the A.O. had followed CBDT Instruction, which was binding on him. According to him, CBDT Instruction No.03/2010 dated 23.3.2010 clearly mentioned that loss on foreign exchange related transactions arising out of mark to market conversion, on the closing day of the accounting period, was only notional and could 4 I.T.A. No. 1322/Mds/12 not be allowed. As per learned D.R., Assessing Officer was bound to follow the said Instruction of CBDT and CIT(Appeals) fell in gross error in ignoring such Instruction and relying on decision of Hon'ble Apex Court in the case of Woodward Governor India P. Ltd. (supra) for giving relief to the assessee.
7. Per contra, learned A.R. strongly supported the order of CIT(Appeals).
8. We have perused the orders and heard the rival submissions. Assessee was having receivables of US $ 6,00,000 per month due from TNEB, based on a power purchase agreement with them, for sale of power effected to it. Assessee also had foreign currency loan liabilities. To protect itself from fluctuation of currency rates, it had entered into a foreign exchange cover. Loss of ` 61,78,500/- arose out of marking to market, the amounts due to it, netted with amount due from it, based on foreign exchange contract cover. CBDT Instruction No.03/2010 dated 23.3.2010, relied on by the A.O., mentioned as under:-
"Foreign Exchange derivative transactions entered into by the corporate sector in India have witnessed a substantial growth in recent years. This combined with extreme volatility in the foreign exchange market in the last financial year is reported to have resulted in substantial losses to an assessee on account of trading in forex-derivatives. A large number of assessees are said to be reporting such losses on 'marked to market' basis either suo motu or in compliance of the Accounting Standard or advisory circular 5 I.T.A. No. 1322/Mds/12 issued by Institute of Chartered Accountants. The issue whether such losses on account of forex-derivatives can be allowed against the taxable income of an assessee has been considered by the Board. In this connection, I am directed to say that the Assessing Officers may follow the guidelines given below:
..............."
It is clear that the said Instruction applied to foreign exchange derivative transactions.
9. Notification No.FEMA 25/RB-2000 dated 3rd May, 2000 issued by Reserve Bank of India under Foreign Exchange Management (Foreign exchange derivative contracts) Regulations, 2000, defines foreign exchange derivative contract as under:-
"(v) 'Foreign exchange derivative contract' means a financial transaction or an arrangement in whatever form and by whatever name called, whose value is derived from price movement in one or more underlying assets, and includes,
(a) a transaction which involves at least one foreign currency other than currency of Nepal or Bhutan, or
(b) a transaction which involves at least one interest rate applicable to a foreign currency not being a currency of Nepal or Bhutan, or
(c) a forward contract, but does not include foreign exchange transaction for Cash or Tom or Spot deliveries;"
Thus, for a contract to be a foreign exchange derivative contract, its value should be derived from price movement in one or more underlying assets. Here, what the assessee had obtained was only a cover for the amount of foreign currency in respect of the fluctuations that could 6 I.T.A. No. 1322/Mds/12 happen. It could never be categorized as a foreign exchange derivative contract. Being not a foreign exchange derivative contract, in our opinion, CBDT Instruction No.03/2010 mentioned above, was not at all applicable. As against this, Hon'ble Apex Court in the case of Woodward Governor India P. Ltd. (supra) has clearly held that loss in foreign exchange, if any, at the end of the year, would be deductible by valuing the outstanding liability at the market rate as on the date of closing of accounts. We are, therefore, of the opinion that CIT(Appeals) was justified in allowing the claim of the assessee.
10. Ground No.2 of the Revenue is dismissed.
11. Vide its ground No.3, grievance raised by the Revenue is that CIT(Appeals) deleted an addition of ` 6.19 Crores made by the A.O. disallowing a provision made by the assessee for operations and maintenance.
12. Facts apropos are that assessee had entered into two agreements with one M/s GE Inc. USA for operations and maintenance of plant and another for long term maintenance of its main plant and for parts supply for preventive maintenance. Assessee had made provisions based on such agreements which, according to it, were worked out considering the actual factored fired hours of gas turbine and average factored hour 7 I.T.A. No. 1322/Mds/12 cost. Assessing Officer was of the opinion that as per the agreements the dues were determinable. Whereas, certain payments were periodical and fixed in nature, certain others were related to performance of the gas turbines. As per the A.O., payments due on account of maintenance and supply of spare parts were clearly determinable and there was no necessity for creating any provision for this at all. Assessee, in the opinion of the Assessing Officer, failed to adduce reasons why it had made a provision based on such agreements on an ad hoc basis, when actual amounts could be calculated. As per the A.O., there was no satisfactory explanation from the assessee to prove that expenditure on account of operations and maintenance were charged to its accounts on actual basis. As against this, provisions were made with reference to factors which could not be ascertained with reasonable accuracy. He, therefore, considered provision of ` 6,19,86,628/- as not admissible and made an addition of like amount.
13. In its appeal before CIT(Appeals), argument of the assessee was that the provisions made based on long term maintenance agreement and long term parts supply agreement with GE Inc. USA, were part of the cost for continuous maintenance of main plant and for supply of spares for preventive maintenance and meeting unplanned break down. Based on such agreements, monthly fixed fee had to be paid to M/s GE 8 I.T.A. No. 1322/Mds/12 Inc. USA. At the end of the year, in line with the agreements, provisions were made in the books based on actual factored fire hours of gas turbine. These were identified contractual obligation and assessee following mercantile system of accounting, was duty bound to account for such expenditure though actual payments were effected later.
14. CIT(Appeals) was appreciative of the above contentions of the assessee. According to him, liability had accrued during the year and assessee had made provisions on scientific basis. Assessee was maintaining books of accounts on mercantile basis and once liability had accrued, it was lawfully bound to account for it. As per CIT(Appeals), this liability was incurred and could be reasonably estimated and hence the claim could not have been disallowed. Relying on the decision of Hon'ble Apex Court in the case of Metal Box Co of India Ltd. v. Their Workmen (73 ITR 53) and that of Bharat Earth Movers v. CIT (245 ITR
428), CIT(Appeals) held that the claim was allowable and deleted the disallowance.
15. Now before us, learned D.R. submitted that assessee did not make the provision based on the agreements, but such provision was worked out on an ad hoc basis. According to him, had the provision been made scientifically, then there would not have been any substantial balance due to M/s GE Inc. USA, for various financial years starting from 9 I.T.A. No. 1322/Mds/12 2006-07 to 2010-11. A.O. had clearly brought that the actual provisioning was made on ad hoc basis and not scientifically. Therefore, according to him, CIT(Appeals) fell in error in deleting the disallowance made by the A.O.
16. Per contra, learned A.R. strongly supported the order of CIT(Appeals). According to him, assessee had made a provision based on scientific calculation, relying on agreements it had entered with M/s GE Inc. USA. As per such agreements, amounts were payable to M/s GE Inc. USA. The amounts, though shown as provision, were actual outstandings. Assessing Officer himself had given a finding that the amounts were clearly determinable. According to him, disallowance was made only for a reason that the term "provision" was used in the accounts. The amounts were actually due and there was no finding by the A.O. that any part of the amount was not due as per the agreements.
17. We have perused the orders and heard the rival submissions. It is not disputed that assessee was having two contracts with M/s GE Inc. USA. One was for long term maintenance of its main plant, second was for supply of spare parts for preventive maintenance and break down. As per the A.O., the provision made by the assessee for clearing the liability as per these agreements, was purely on an ad hoc basis and not based on any scientific work out. The A.O. in paras 7.6 and 7.7 of his 10 I.T.A. No. 1322/Mds/12 order has clearly given why he considered the provision to be ad hoc. These paras are reproduced hereunder:-
"7.6 Under these circumstances, provisions made by the assessee has to be treated as adhoc and excessive in nature without reference to the actuals. The said inference is furthered strengthened by a data presented in the following table:
Particulars Opening Current year Current year Closing Balance Balance provision payments Escalation payable 47,09,987 7474322.64 Nil 12184309.64 Incentive payable 1,49,92,486 9281486.19 2452730.00 21821242.19 Adder Provision (10768436) 35693144.88 Nil 24924708.88 Adder LTSA duty 35616842 19312695.50 Nil 54929537.50 provision Adder duty paid (39117657) Nil 9582766.00 (48700423.00) LTMA MOB (3503399) 334359.00 Nil (3169040.00) Advance LTMA/LTSA Qtrly 65252 32526710.80 32595670.00 (3707.20) Provisions Total 1995075.00 104622719.00 44631166.00 61986.628 7.7 The assessee has also given break up for provisions made for the relevant previous years which is extracted as under:
LTMA and LTSA provision vs. payment status for the various financial years from 200607 to 2010-11 Financial year Opening Balance Provision made Amount utilised Closing balance 2006-07 20690619 33068186 Nil 53758805 2007-08 53758805 48400870 85118500 17041175 2008-09 17041175 104622719 59677266 61986628 2009-10 61986628 80660363 77639698 65007293 2010-11 65007293 84313843 131969974 17351162 As against this, claim of the assessee is that provisions were made exactly in accordance with agreements, based on actual factored fire hours of gas turbine and average factored cost. Without doubt, the amounts whether claimed as provision or outstanding, if worked out 11 I.T.A. No. 1322/Mds/12 strictly in accordance with agreements, has to be allowed. This is because assessee is legally bound to pay to M/s GE Inc. USA the amounts due to it as per the agreements. Actual date of payment is irrelevant. Though assessee has argued that the provisioning done by it was in accordance with such agreements, the table extracted above, does not substantiate such contention. We are, therefore, of the opinion that the matter requires re-visit by the A.O. We set aside the orders of authorities below and remit the issue back to Assessing Officer for verifying the provisioning done by assessee vis-à-vis the agreements entered with M/s GE Inc. USA. If it is strictly in accordance with agreements, the amount shown as provision has to be allowed.
Amounts in excess of what is payable as per the agreements, can be disallowed.
18. In the result, we set aside the orders of authorities below on this aspect and remit the issue back to the file of A.O. for consideration afresh, in accordance with law.
19. Ground No.3 is allowed for statistical purposes.
20. Vide its ground No.4, grievance raised by the Revenue is that CIT(Appeals) deleted the disallowance of ` 84.02 lakhs made by the 12 I.T.A. No. 1322/Mds/12 A.O. relying on Section 14A of the Act and Rule 8D of Income-tax Rules, 1962.
21. Facts apropos are that assessee had in its balance sheet shown investment under the head "mutual funds". The investment as on 31.3.2008, as per the A.O., was NIL. However, the A.O. found that assessee had secured loan of ` 2,11,89,72,434/- against which interest of ` 20,89,07,500/- was charged. As per the A.O., assessee would have incurred routine expenditure for maintaining its establishment and a portion thereof could be attributed to the activity of earning dividend on the investment made by it. He, therefore, applied Rule 8D and made disallowance of ` 84,02,068/- computed as under:-
(i) The amount of expenditure directly relating to NIL income which does not form part of total income
(ii) Interest expenses not directly attributable to any 75,35,195 particular income or receipt then A X B / C* (2,08,907,500 X 173374593 / 4806677798)
(iii) ½ % of the average of the value of investments, 8,66,873 income from which does not or shall not form part of the total income (0 + 346,749,186) / 2 Disallowance as per Rule 8D 84,02,068
22. In its appeal before CIT(Appeals), argument of the assessee was that in the earlier year, it had made short term investment in debt oriented mutual funds, but as on 31.3.2009, the balance was NIL. In other words, as per the assessee, investment in debt oriented mutual 13 I.T.A. No. 1322/Mds/12 funds, which stood at ` 34.67 Crores as on 1.4.2008, was reduced to nil by 31.3.2009. Assessee submitted that surplus on account of appreciation in Net Asset Value (NAV) on debt based mutual fund units, based on debt funds, was not exempt from tax. According to the assessee, the A.O. had applied Section 14A mechanically. Further, Assessing Officer had also not identified any expenditure corresponding to exempt income, nor shown that borrowed funds were invested in such tax-free investment.
23. CIT(Appeals) was appreciative of the contentions of assessee.
According to him, there was no dividend received by the assessee, nor was it having any tax-free investment. Investment in debt oriented mutual funds were sold giving rise to short term capital gains and assessee had offered such income. In this view of the matter, he deleted the disallowance made by the A.O.
24. Now before us, learned D.R., strongly assailing the order of CIT(Appeals), submitted that though the investment in mutual funds was reduced to '0' by the end of the relevant previous year, nothing has been brought on record by the assessee to show that income earned by such mutual funds were taxed. According to him, capital gains might have been taxed, but any dividend earned by the assessee on mutual funds would be exempt from tax and therefore, Section 14A applied. 14 I.T.A. No. 1322/Mds/12
25. Per contra, learned A.R. reiterated the stand taken before CIT(Appeals) that there were no tax-free investment made by the assessee.
26. We have perused the orders and heard the rival submissions. As per the assessee, its investments were all in mutual funds, which were based on debts. Surplus due to appreciation NAV, on sale of such mutual fund units were offered by it as capital gains. There is no doubt that as on the end of the relevant previous year, there were no investments in the books of the assessee. Whatever investment it had made, had come down to '0' by the end of the relevant previous year. If the claim of the assessee that investments were made in debt oriented mutual funds, is correct, and if the gains arising on sale thereof had been offered to tax, then of course, in our opinion, such investments could not be treated as giving rise to tax-free income. Section 14A will have no applicability. In our opinion whether the investments were only in debt oriented mutual funds which yielded no income other than capital gains, needs to be verified and only if this is proved to be correct, application of Section 14A can be ruled out. We, therefore, set aside the orders of authorities below and remit the issue back to the file of the A.O. for consideration afresh, in accordance with law. 15 I.T.A. No. 1322/Mds/12
27. In the result, appeal of the Revenue is partly allowed for statistical purposes.
The order was pronounced in the Court on Monday, the 24th of September, 2012, at Chennai.
sd/- sd/-
(Vikas Awasthy) (Abraham P. George)
Judicial Member Accountant Member
Chennai,
Dated the 24th September, 2012.
Kri.
Copy to: (1) Appellant
(2) Respondent
(3) CIT(A)-III, Chennai
(4) CIT, Chennai-I, Chennai
(5) D.R.
(6) Guard file