Income Tax Appellate Tribunal - Hyderabad
Dcit, Circle-2(1), Hyderabad, ... vs Infotech Enterprises Limited, Hyd, ... on 28 February, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCH "A", HYDERABAD
BEFORE SMT P. MADHAVI DEVI, JUDICIAL MEMBER
AND SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER
ITA No. 474/Hyd/2015
Assessment Year: 2010-11
Dy. Commissioner of Income- vs. Cyient Ltd. (Formerly Infotech
tax, Circle - 2(1), Hyderabad. Enterprises Ltd.), Hyderabad
PAN - AAACI4487J
(Appellant) (Respondent)
ITA Nos. 475/Hyd/2015 and 597/Hyd/2016
Assessment Years: 2010-11 & 2011-12
Cyient Ltd. (Formerly Infotech vs. Dy. Commissioner of Income-
Enterprises Ltd.), Hyderabad. tax, Circle - 1(2), Hyderabad.
PAN - AAACI4487J
(Appellant) (Respondent)
Revenue by : Shri Dr. K. Srinivas Reddy
Assessee by : Shri Vijay Mehta
Date of hearing 21/02/2018
Date of pronouncement 28/02/2018
O RDE R
PER S. RIFAUR RAHMAN, A.M.:
Appeal Nos. 474 & 475/H/2015 are cross appeals filed by the assessee and revenue directed against the order dated 27/02/2015 passed u/s 143(3) rws 144C(13) of the Income Tax Act (in short 'the Act') for AY 2010-11. Appeal No. 597/H/2016 filed by the assessee against the order dated 29/02/2016 passed u/s 143(3) r.w.s. 144C of the Act for AY 2011-12.
2ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
ITA No. 474/Hyd/2015 by the revenue2. In this appeal, the revenue has raised the following ground of appeal:
1. The DRP erred on facts and in law in granting relief to the assessee.
2. Whether the communication charges shall not be excluded from Export Turnover especially when such expenditure cannot be part of the export turnover defined in clause [iv] of Explanation 2 to Section 10A of the Income Tax Act 1961, which clearly states that they need to be excluded.
3.Any other ground that may be taken up at the time of hearing."
3. On verification of the details in Forms 56F, the AO noticed that the assessee did not exclude communication charges, payments made abroad to foreign subsidiaries and forex realization beyond 6 months in 1 case related to Unit - 3 from the export turnover. The AO, therefore, excluded from the export turnover while computing deduction u/s 10A.
3.1 When the assessee objected the same before the DRP, the DRP directed the AO to reduce telecommunication charges not only from export turnover but also from the total turnover for the purpose of computing deduction u/s 10A.
4. Aggrieved by the order of DRP, the revenue is in appeal before us.
5. Considered the rival submissions and perused the material facts on record. The Hon'ble Courts and the coordinate benches of ITAT have consistently held that the internet charges have to be excluded both from the export turnover as well as from the total turnover while computing deduction u/s 10A of the Act. The Hon'ble Bombay High 3 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
Court in case of CIT vs. Gem Plus Jewellery (330 ITR 175) as well as different Benches of Tribunal including ITAT, Chennai Bench (SB) in the case of ITO vs. Sak Soft (313 ITR (AT) 853) have held that communication charges attributable directly to the export of article or thing outside India has to be excluded both from export turnover as well as total turnover while computing exemption u/s 10A of the Act. In view of the above, we are in agreement with the order of DRP and direct the AO to exclude the communication charges from the export turnover as well as total turnover while computing 10A deduction. Accordingly, the grounds raised by the revenue on this issue are dismissed.
6. In the result, appeal of the revenue is dismissed.
ITA No. 475/Hyd/2015 by the assessee for AY 2010-117. In this appeal, the assessee has raised the following grounds of appeal:
1) The order of the Dy. Commissioner of Income Tax, Circle - (2)(1), passed under section 143(3) r.w.s 144C of the I.T. Act is erroneous / unjust and contrary to the facts and law of the case.
2) The TPO and Id DRP and the Assessing Officer erred in making the transfer pricing adjustments aggregating to Rs.58,95,082/- on account of Corporate Guarantees given by the appellant to The City National Bank, USA and Ordinance Survey, UK in favour of its foreign subsidiaries in USA and UK. At any rate, the addition made is excessive and unreasonable.
3) The Id DRP and Assessing Officer erred in denying the deduction for the amount of Rs. 9,04,8,526/- being the unrealized gain on foreign exchange forward contracts which has been reduced by the appellant in the computation of income.
i) The Id DRP and Assessing Officer ought to have realized that the claim for the deduction of Rs. 9,04,81,526/- is in conformity with the method of accounting consistently followed by the appellant. The appellant has been adding back the provisions for losses and offering to tax the final gains on settlement.4
ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
4) Any other ground that may be taken with the permission of the Court."
8. Ground No. 1 and 4 are general in nature, hence, need no adjudication.
9. As regards ground No. 2 relating to transfer pricing adjustment on account of corporate guarantee, the assessee had given two corporate guarantees, namely, the first one is for US $ 3.5 Million to City National Bank, USA on behalf of its Associated Enterprise, Infotech Enterprises America Inc. The TPO considered this as an international transaction and proposed to determine its arms length price at Rs. 35,66,500/-worked out @ 2% on the outstanding balance of the loan as on 1.4.2009 of Rs. 17,83,25,009/- as commission for providing bank guarantee. The second guarantee was given on behalf of its AE, Infotech Enterprises Limited, UK in favour of Ordinance Survey, UK for an amount of GBP 1.6 million. The TPO considered this also as an international transaction and proposed to determine its arm's length price at Rs. 23,31,552/- worked out @ 2% as commission on the outstanding balance of the loan as on 1.4.2009 of Rs. 11,65,77,600/-.
9.1 Before the DRP, the assessee submitted the ITAT in case of Glenmark Pharmaceutical case upheld the guarantee commission rate @ 0.53%. He, therefore, submitted that since the rate adopted by the TPO @ 2% is too high, the rate may be reduced suitably.
9.2 The DRP, however, confirmed the action of the TPO.
9.3 Considered the rival submissions and perused the material facts on record. Assessee has provided corporate guarantee to its AE in the current AY without charging any fees for the same. The term 'guarantee' was inserted in the definition of international transaction by inserting an explanation in the Finance Act, 2012 with retrospective effect from 01/04/2012. There is no dispute that the corporate guarantee is an international transaction and different 5 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
assessees are adopting different methods of treatment. Some assessees charges nominal rate to the AEs, whereas other assessees are treating this as shareholder service. Here, the assessee has objected to include this transaction as international transaction for the reason that the Finance Act, 2012, which has inserted an explanation, which will be applicable prospectively from AY 2013-14 and the corporate guarantee transaction will not be applicable to the current AY. The same view was upheld by the coordinate bench in the case of Dr. Reddy Laboratories and other benches of Tribunal. The findings given by the coordinate bench in the case of Dr. Reddy Laboratories (supra) are extracted below:
29. We have carefully considered the rival submissions and perused the record. The ITAT, Delhi Bench in the case of Bharati Airtel Ltd. (supra) has considered an identical issue which was re-affirmed in the case of Siro Clinpharma Pvt. Ltd., Vs. DCIT (order dated 31 st March, 2016). The bench observed that transfer pricing is a legislation seeking the tax-payers to organise their affairs in a manner compliant with the norms set-
out. In short, it is an anti abuse legislation which tells you as to what is the acceptable behaviour but it does not trigger levy of tax in a retrospective manner because no party can be asked to do an impossibility.. Analysing further the Bench observed that though Explanation to Section 92B is stated to be c1arificatory, it has to be necessarily treated as effective from the A.Y. 2013- 2014 and in this regard, relied upon the observations of the Hon'ble Delhi High Court in the case of Skies Satellite. We have also analysed the case law relied upon by the Ld. D.R. and also the provisions of the Act. In our considered opinion, the view taken by the Delhi Bench of ITAT in the case of Bharati Airtel Ltd., (supra) is one of the possible views on the matter and so long as there is no binding decision of any other Higher Forum taking a contrary view, the one which is favourable to the assessee has to be adopted even though other Benches have taken a different view. We, therefore, hold that the Explanation to Section 92B cannot be applied retrospectively and for the years under consideration the assessee having not incurred any costs in providing corporate guarantee it would not constitute "International Transaction" within the meaning of Section 92B of the Act and consequently, ALP adjustment is not warranted on this aspect."
Respectfully following the above decision, we reject the treatment of corporate guarantee as international transaction and consequently, 6 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
ALP adjustment is not warranted on this aspect. Accordingly, the ground raised by assessee is allowed.
10. As regards ground no. 3 regarding unrealized gain on foreign exchange forward contracts of Rs. 9,04,81,526/-, the assessee deducted this amount in the computation of income. However, the AO added back the said amount to the income of the assessee on the ground that there was no reason to deduct the same in computation.
10.1 Before the DRP, the assessee argued that this gain represents unrealized gain and that it was arrived at only by making the contract to market and it is being a notional gain, the same was reduced from the computation of income, though, it was taken into accounts in the books and credited to the profit and loss account.
10.2 The DRP, however, upheld the action of the AO.
10.3 The ld. AR filed written submissions, wherein the following submissions were made:
Ground 3: Unrealised gains on foreign exchange forward contracts
16. This ground deals with the denial of the deduction by the Assessing Officer for the amount of Rs.9,04,81,526/- being the unrealized gain on foreign exchange forward contracts which has been reduced by the assessee in the computation of its income.
17. The assessee develops software for its foreign clients and so it has foreign exchange receivables. For protecting itself against foreign exchange fluctuations, it enters into foreign exchange forward contracts. Even before the forward contracts mature, the loss/gain on the contracts is booked in its accounts by marking them to market (MTM) as per the prescribed Accounting Standards. However, the unrealized losses booked in the accounts on outstanding contracts are not claimed for deduction while computing income taxable under the Act. In other words, such losses are added back in the computation of income for tax purposes. Similarly, the unrealized or MTM gains booked in the accounts are also not offered to tax. Such gains are reduced from income for tax purposes. The amount of Rs.7
ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
9,04,81,526/- is a notional or unrealized gain and in consistence with its method of computing taxable income under the Act, the appellant reduced the gains while computing its taxable income for A.Y.2010-11 even though it was credited in the P&L account.
18. The appellant has been consistently following the method of adding back provision for losses and claiming deduction for gains on outstanding contracts. It has been offering to tax gains and claiming deduction for losses on settled contracts.
19. The Ld. DRP rejected the claim for the deduction of the unrealized gain of Rs. 9,04,81,526/- with the following remarks:
"10.4 With regard to addition of Rs. 9,04,81,526/- related to the forward contracts, it is argued that this gain represents unrealized gain and it has been arrived only by making the contracts to market It being a notional gain the same is reduced from the computation of income though it is taken into accounts in the books and credited to the profit and loss account 10.5 On this issue, the panel is of the view that since assessee company is following mercantile system of accounting regularly, any gain or loss on forward contracts has to be considered in the computation of total income. As per Accounting Standards on this item both loss and gain are to be reckoned as an end of accounting period The AO has no option except to follow the prescribed procedure as per law. The panel do not interfere in his action as there is no infirmity. Accordingly, the assessee's objection is rejected"
20. It is submitted that there is a fallacy in the above decision of the Hon'ble DRP. The DRP having directed to allow loss on revaluation in A.Y.2010-11 which was not claimed in earlier year, by following the method of computing taxable income as per rule of consistency, the DRP ought to have directed to exclude profit/gain on foreign exchange transactions which were valued on 'mark to market' basis.
Notional losses as well as gains should not be taken into account while computing taxable income
21. In the case of CIT vs. Indian Overseas Bank [151 ITR 446], the Hon'ble Madras High Court held that the unrealized losses on outstanding foreign exchange contracts are not allowable. Similarly, it held that unrealized gains on such outstanding contracts are not taxable. In this case the unrealized loss on 8 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
outstanding contracts was held allowable by the Tribunal but the Hon'ble Madras High Court did not agree with the Tribunal. It observed as under:
"The levy of income tax is on income and though the income tax Act has taken note of the twin points of time at which the liability to tax is attracted viz; the accrual of income or its receipt yet the substance of the matter is income and if income does not result at all there cannot be a tax, even though for purposes of book keeping, an entity is made about an hypothetical income which doesn't materialize and a mere book keeping entry cannot be income unless income has actually resulted. The question whether there is a loss or profit on foreign exchange transactions can be ascertained after the settlement of the forward contracts and not before and so long as that stage has not been reached the loss can only be notional and not actual or real and notional loss cannot be claimed as a deduction. Whether a loss or profit, the principal applicable would be the same and the estimated profit, till the statement of the forward foreign exchange contracts. could be regarded only as notional and not actual or real and such notional profits cannot be assessed"
Therefore, we are not in a position to agree with the Tribunal that the said sum of Rs. 9,20,125/- represented loss arising out of the outstanding unsettled contracts and therefore, it could be claimed as a deduction. But as already pointed out the contracts were not settled and whether they would result in a profit or loss can only be known at the time of settlement. So long as that stage has not reached the loss can only be notional and not real or actual. Such notional loss cannot be claimed as a deduction. " (Emphasis supplied)
22. The above case was followed by the Hon'ble Madras High Court in its subsequent decision in the case of the same party reported at Indian Overseas Bank vs CIT 183 ITR 200. In this case, unrealized gains on outstanding contracts were held as not taxable. It was observed as under:
"The levy of income tax is on income and though the income tax Act has taken note of the twin points of time at which the liability to tax is attracted viz, the accrual of income or its receipt, yet, the substance of the matter is income and if income does not result at all, there cannot be a tax- even though for purposes of book keeping, an entry is made about an hypothetical income which doesn't materialize and a mere book keeping entry cannot be income unless income has actually 9 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
resulted. The question whether there is a loss or profit on foreign exchange transactions can be ascertained after the settlement of the forward contracts and not before and so long as that stage has not been reached the loss can only be notional and not actual or real and notional loss cannot be claimed as a deduction. Whether a loss or profit, the principle applicable would be the same and the estimated profit, till the settlement of the forward foreign exchange contracts, could be regarded only as notional and not actual or real and such notional profits cannot be assessed" (Emphasis supplied)
23. It may kindly be observed that the Madras High Court has clearly held notional profit on outstanding contracts cannot be brought to tax. Till contracts are settled, there is no taxable gain nor allowable loss.
24. A similar view was taken by the CSOT in instruction No. 03/2010 dated 23/03/2010. In this instruction, the CSOT considered the issue of allowability of losses consequent to marking the foreign exchange forward contracts to market and it has observed as under:
"A 'Marked to Market' loss may be given different accounting treatment by different assesses. Some may reflect such loss as a balance sheet item without making any corresponding adjustment in the Profit and Loss Account Other may book the loss in the Profit and Loss Account which may result in the reduction of book profit In cases where no sale or settlement has actually taken place and the loss on Marked to Market basis has resulted in reduction of book profits such a notional loss would be contingent in nature and cannot be allowed to be set off against the taxable income. The same should therefore be added back for the purpose of computing the taxable income of an assessee. "
25. The above circular is based on the principle that a loss arising because of marking a contract to market is notional, the gain in such circumstances is also notional. It is submitted that if CBDT has instructed by applying the principle that a notional loss cannot be allowed while computing taxable income/ then by applying the same principle the notional gain also should not be brought to tax.
26. It is further submitted that the Instructions issued by the CBDT are binding on the Department and therefore/ the Assessing Officer ought to followed the above circular and allowed the claim for deduction of Rs. 9,04,81,526/-.
10ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
Mark to Market losses are allowable as deduction and hence, the same should be allowed as deduction if the gain on Mark to Market transaction are subjected to tax
27. The view taken by the Madras High Court in its two decisions in the case of Indian Overseas Bank (supra) and the view taken by the CBDT in the above instruction are partly reversed by the Apex Court in its decision in the case of CIT Vs. Woodward Governor India (P) Ltd [312 ITR 254]. In this case/ the Apex Court has held that loss suffered by an assessee on account of foreign exchange difference as on date of Balance Sheet is an item of expenditure allowable u/s, 37 of the IT Act. It was also held that income has to be computed in the light of the Accounting Standard (AS) - 11. As per the relevant portion of the head note of this decision/it was observed as under:
'AS-11 deals with giving of accounting treatment for the effects of changes in foreign exchange rates. In case of the revenue items falling under section 37(1) para 9 of AS-11, which deals with recognition of exchange differences, needs to be considered. Under this para, exchange differences arising on foreign currency transactions have to be recognized as income or as expense in the period in which they arise. The important point to be noted is that AS-11 stipulates effect of changes in exchange rate vis-a-vis monetary items denominated in a foreign currency to be taken into account for giving 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, loss or gain arising on conversion of the said liability at the closing rate, should be recognized in the profit and loss account for the reporting period [Para 18]. "
Gains on Mark to market transactions are required to be ignored under well recognized "concept of prudence II / "convention of conservatism" of followed in mercantile system of accounting
28. Even if unrealized losses on outstanding foreign exchange contracts are allowable as deduction in view of the Apex court decision in the case of Woodward Governor India (P) Ltd (Supra), it does not follow that unrealized gains on outstanding contracts are necessarily to be taxed.
29. Even under the mercantile system of accounting, unrealized losses and unrealized gains on outstanding foreign exchange 11 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
forward contracts do not stand on the same footing. They have to be treated separately because of the "prudence concept" in the accounting. The concept of prudence dictates the recognition of unrealized losses but does not stipulate that unrealized/anticipated profits should also be recognized as 'revenue'/'income' of the accounting period. In other words, unless and until income is 'accrued', the same should not be treated as 'revenue'/'income' of the accounting period. In accounting, the convention of conservatism, also known as the doctrine of prudence, is a policy of recognizing the anticipating possible future losses but not future gains. It is reiterated that principle of prudence does not dictate the recognition of unrealized gains. The 'accrual concept' in accounting means that expenses and revenues are recorded in the period they occur, whether or not cash is involved. The benefit of the accrual approach is that financial statements reflect all the expenses associated with the reported revenues for an accounting period. Therefore, in case of transactions involving foreign exchange, the assets and liabilities are required to be restated as per AS-II and the income has to be recognized as per principle of prudence. This is the ratio of the decision of the Hon'ble Mumbai Bench of Tribunal in the case of Mili Consultants & Investment (P.) Ltd Vs. DCIT [2016] 72 Taxmann.com 141. In this case it was held that losses on open derivative contracts arrived at by marking them to market were allowable as deduction but the unrealized gain on such contracts would stand to be taxed only on settlement and not before. The Hon'ble Tribunal came to this conclusion after duly considering the decision of the Apex court in the case of CIT vs Woodward Governor India (P) Ltd. [2009] 312 ITR 254/179 Taxman 326.
The Revenue cannot adopt dual standards while taxing losses and profit arising out of valuation of liabilities for transactions involving foreign exchange
30. It is submitted that as laid down by the Hon'ble Apex Court in the case of Woodward Governor India (P.) Ltd. [312 ITR 254] in para 10 to 17 (Pages 260265 of ITR), the Department having accepted the method consistently adopted by the appellant in earlier years, it cannot be permitted to adopt different view for the year under consideration to add only gains on revaluation but ignore losses on revaluation. In this case, the apex court has held that a method of accounting followed by the assessee continuously for a given period of time has to be presumed to be correct till AO comes to a conclusion for reasons to be given that the said system doesn't reflect true and correct profits. It has observed in para 10 of its order as under:
12ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
'10. As stated above, on facts in the case of M/s Woodward Governor India (P) Ltd the Department has disallowed the deduction/debit to the P&L account made by the assessee in the sum of Rs. 29-49-088/- being unrealized loss due to foreign exchange fluctuation. At the very outset it may be stated that there is no dispute that in the previous years whenever the dollar rate stood reduced the Department had taxed the gains which accrued to the assessee on the basis of accrual and it is only in the year in question when the dollar rate stood increased resulting in loss that the Department has disallowed the deduction/debit This fact is important It indicates the double standards adopted by the Department" (Emphasis supplied) While determining taxable income 'Rule of consistency' should prevail over other factors.
31. Even before and after the decision of the Apex Court in the case of Mrs Woodward Governor India (P) Ltd (Supra), there are various authorities in support of the proposition that a method of accounting as well as computation of income consistently followed by the assessee has to be respected by the revenue authorities.
32. In the case of ITO vs Chokshi Hirachand & Bros 37 TTJ 415 (Ahmedabad), it was held by the Tribunal that valuation of closing stock according to accounting system consistently followed and accepted by Revenue in earlier years cannot be rejected.
33. In the case of CIT v Jagatjit Industries Ltd (339 ITR 382), the Hon'ble Delhi High Court also held that a method of accounting consistently followed has to be respected. In this case, prior period expenses are held to be allowable even under the mercantile system of accounting. The relevant portion of the head note of this decision reads as under:
"On a scrutiny of the facts, that had been brought on record, it was discernible that the assessee had been claiming prior period expenses on the ground that the vouchers of such expenses from the employees/branch employees were received after 31st March of the financial year. It had also come as a matter of fact that the assessee had branch offices throughout the country. The assessee had been debiting the expenditure spillover to the subsequent years and the Assessing Officer had been allowing the same. The said accounting practice had been consistent~v followed ~v the assessee and accepted by the Department If a particular accounting system has been followed and accepted and there is no acceptable 13 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
reason to differ with the same, the doctrine of consistency would come into play. In the instant case, the said accounting system had been followed for a number of years and there was no proof that there had been any material change in the activities of the assessee as compared to the earlier years. Nothing had been brought on record to show that there had been distortion of profit or the books of account did not reflect the correct picture. In the absence of any reason whatsoever, there was no warrant or justification to depart from the previous accounting system which was accepted by the Department in respect of the previous years. [Para 16] Therefore, there was no merit in the instant appeal and the same was to be dismissed" (Emphasis supplied)
34. In the case of CIT V Margadarsi Chit Fund Private Limited (155 ITR 442), it has been held that before rejecting the system of accounting consistently followed by the assessee by several years and accepted by Department in the past, it must refer to inherent defects in the system and record a clear finding that the system of accounting followed by the assessee is such that correct profits cannot be deduced from books of account maintained by the assessee.
35. In the case of CIT Vs. Bilahari Investment (P) Ltd (299 ITR 0001), it was held as per the head note, as under:
"Every assessee is entitled to arrange its affairs and follow the method of account which the Department has earlier accepted It is only in those cases where the Department records a finding that the method adopted by the assessee results in distortion of profits that the Department can insist on substitution of the existing method':
36. The Appellant has been quite fair to the revenue by not claiming deduction for MTM losses and offering to tax MTM gains. It is submitted that the approach adopted by the Department to compute taxable income by ignoring MTM losses but to subject MTM gains to tax is self-contradictory. It si submitted that if the Department wants to tax MTM gain on the basis of mercantile method of accounting then under same principle the Department ought to allow MTM losses.
Only real income can be brought to tax and not notional income.
14ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
37. It is well settled in law that only real of the assessee should be subjected to tax irrespective of the entries passed in the books of account of the assessee. As such, unrealized gain cannot be brought to tax in the light of the "real income" theory. In the case of Godhra Electricity Company v CIT (225 ITR 746), the apex court, as per the head note, has held as under:
"Income-tax is a levy on income. No doubt the income tax Act takes into account two points of time at which the liability to tax is attracted viz, the accrual of the income or its receipt but the substance of the matter is the income. If income does not result at all there cannot be tex even though in book-keeping, an entry is made about a hypothetical income, which does not materialize'.
38. In the case of CIT v V.T.C. Leasing and Finance Ltd (323 ITR 514) the Hon'ble Rajasthan High Court referred to the decision of the Hon'ble Supreme Court in the case of Andhra Bank V CIT (225 ITR 447) wherein it was held that there cannot be a tax if no income resulted, despite the entry in the book keeping and held that book entries are not conclusive and real income which alone can be brought to tax has to be considered with reference to commercial and business realities of the situation.
39. The MTM losses and gains on forward contracts are not real losses or incomes. There is no accrual of income in such cases till the contract is settled.
40. In the case of Hindustan Housing Land Development Trust Limited (161 ITR 524), the apex court laid down the following principle:
'Income may accrue to an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income the income can be said to have accrued to him though it may be received later on being ascertained, the basic conception is he must have acquired a right to receive the income. There must be a debt owed to him by somebody There must be otherwise expressed debitum in presenti solvendum in future unless and until there is created in favour of the assessee a debt due by somebody, it cannot be said that he acquired a right to receive the income or that income has accrued to him."
41. As per the above decision of Supreme Court, only the accrued gains can be bought to tax. In this case, the assessee was awarded compensation for the land acquired from him by 15 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
the government by the arbitrator but the government went in appeal against the award. As the matter was pending before the court, the Supreme Court held that the party could not be taxed on the amount awarded to it. In other words, even after the award of the arbitrator, it was held that the gains did not accrue as the matter was in dispute before the court.
42. Similarly, in the present case the maturity period of the contract is not over and the loss/gain is not actually ascertained. Whether a contract in question would yield profit or loss and quantum thereof are matters in the womb of future. So, there is no basis for the making addition of Rs. 9,04,81,526/- which is notional gain arising out of valuation of foreign exchange. Actual value of the gain would arise on maturity of contract. Therefore, notional gain added by the Assessing Officer on revaluation of forex liability may kindly be deleted.
Income can be said to have arisen only when the right to receive accrues
43. In the case of CIT v Dinesh Kumar Goyal (331 ITR 10), the Hon'ble Delhi High Court held that even when the accounting system followed is mercantile, there can be accrual of income only if the right to receive accrues. Till a forward exchange contract is settled, there is no right to receive the gain or liability to disburse the loss."
10.4 The ld. DR submitted that since assessee company is following mercantile system of accounting regularly, any gain or loss on forward contracts has to be considered in the computation of total income. As per accounting standards on this item both loss and gain are to be reckoned at the end of accounting period. He, therefore, submitted that the AO has no option except to follow the prescribed procedure as per law.
10.5 Considered the rival submissions and perused the material facts on record. It was brought to the notice by the ld. AR that assessee is consistently following accounting policy on foreign currency transactions, which is placed on record at page 105 of the paper book, as per which, all the derivative exchange contracts are valued at mark to market basis and any gain/loss on mark to market changes 16 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
on settlement is recognized in the profit & loss a/c and other forward exchange contracts or any other financial instruments, any exchange difference on such forward exchange contracts are recognized in the statement of P&L A/c in the reporting period in which the exchange are change. Therefore, the assessee is regularly following its accounting policies over a period of time and it does not charge any gain/loss of foreign exchange on notional basis. Further, we have noticed that DRP while adjudicating the provision of loss on forward contracts written back by the assessee in the earlier AY, DRP has allowed the contention of the assessee and at the same time, refused to grant unrealized gain on forward contract. In other words, the DRP has accepted with regard to loss written back and refused to recognize the accounting method followed by the assessee in the case of unrealized gain on forex. As far as the treatment of gain/loss on forex difference, assessee followed consistent method of accounting policies. It is a fact that the gain/loss determined by the assessee based on the closing rates based on mark to market are notional and not real loss or gain as the forward contracts were not concluded. Real gain/loss is only when the contracts are concluded. Therefore, recognition of this notional gain or loss depends upon accounting policies or method of accounting regularly followed by the assessee, since the assessee is following mercantile system of accounting, recognition of gain/loss are traceable over the years. Since, all the notional gain/loss are regularly declared by the assessee in its financial accounts. Therefore, in our opinion, assessee is consistently following a method of accounting and also discloses foreign currency transactions in its books of account and consistently following the same method of accounting over a period of time. Further, the Instruction No. 03/2010 dated 23/03/2010 issued by CBDT wherein it is clearly observed as under:
"A 'Marked to Market' loss may be given different accounting treatment by different assesses. Some may reflect such loss as a balance sheet item without making any corresponding adjustment in the Profit and Loss Account Other may book the 17 ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
loss in the Profit and Loss Account which may result in the reduction of book profit In cases where no sale or settlement has actually taken place and the loss on Marked to Market basis has resulted in reduction of book profits such a notional loss would be contingent in nature and cannot be allowed to be set off against the taxable income. The same should therefore be added back for the purpose of computing the taxable income of an assessee. "
As per the above instruction, notional losses are not allowed to set off against taxable income. Similarly, notional gain also should not be added to the taxable income. Therefore, in our considered view, assessee is allowed to follow its method of accounting followed by it consistently over the period and, therefore, notional gain on forex transaction should be allowed to reduce from the net profit, which is arrived for tax purpose. Accordingly, ground raised by the assessee is allowed.
11. In the result, appeal of the assessee is allowed.
ITA NO. 597/Hyd/2016 by the assessee for AY 2011-12
12. On perusal of record, we find that AO has passed Draft Assessment Order after considering the order u/s 92CA(3) of the I.T. Act, 1961. The assessee has filed an objection against the draft assessment order before DRP with a copy to AO. The DRP, vide its letter dated 09/02/2016, declined to adjudicate the objections filed by the assessee since the objections were filed belatedly beyond the time allowed u/s 144C(2) of the Act. Therefore, AO passed the final assessment. Since, the assessee has failed to file objection before the DRP and the assessment order is passed not as per directions of the DRP, assessee has no jurisdiction to file appeal before us. Hence, appeal filed by the assessee is not maintainable and accordingly dismissed.
18ITA Nos. 474 & 475 /Hyd/2015 and 597/Hyd/2016 Cyient Ltd.
13. In the result appeal is dismissed.
14. To sum up, appeal in ITA No. 474/Hyd/2015 by the revenue and appeal in ITA No. 597/Hyd/2016 by the assessee are dismissed and the appeal in ITA No. 475/Hyd/2015 by the assessee is allowed.
Pronounced in the open Court on 28 th February, 2018.
Sd/- Sd/-
(P. MADHAVI DEVI) (S. RIFAUR RAHMAN)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Hyderabad, Dated: 28 th February, 2018
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Copy to:-
1) M/s Cyient Ltd., 4 th Floor, A Wing, Plot No. 11, Software Units Layout, Infocity, Madhapur, Hyd. - 500 082.
2) DCIT, Circle 1(2), IT Towers, AC Guards, Hyderabad.
3) DRP, Hyd.
4) CIT, International Taxation, Hyd.
5) The Departmental Representative, I.T.A.T., Hyderabad.
6) Guard File