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Dcit, Circle 12(1), ... v. Givo Ltd., C/O Vinod...
Structured Summary of the Opinion (Beena A. Pillai, J.M.)
Factual and Procedural Background
The Revenue filed this appeal against the order dated 15.02.2013 passed by the learned CIT(A)-VIII, New Delhi, for the assessment year 2006-07. The assessee (a company engaged in manufacture, trading and job work of men's suits, jackets and trousers) filed its return declaring nil income on 30.11.2006; the return was processed under section 143(1) and selected for scrutiny. During assessment the Assessing Officer (AO) disallowed:
- Foreign exchange fluctuation loss claimed by the assessee of Rs. 28,45,070 on an external commercial borrowing (ECB) denominated in USD 3 million (AO disallowed on the ground that such loss is not actually suffered until remittance and relied upon Indian Overseas Bank and Karam Chand Thapar & Bros); and
- Depreciation claimed (related to capitalization of customs duty/security deposit of Rs. 11,65,797 paid in 1994-95) — the AO disallowed depreciation (in this assessment year claimed as Rs. 1,43,448) because the customs assessment by the Customs Department was still pending and the AO considered unilateral capitalization inappropriate.
The assessee appealed to the CIT(A). The CIT(A) allowed both claims: (1) accepting the assessee's position that the foreign exchange losses were revenue in nature and allowable under section 37(1) in view of accounting practice and judicial decisions, and (2) allowing depreciation by following earlier ITAT orders in the assessee's own case for earlier assessment years. The Revenue thereupon preferred the present appeal, which the court ultimately dismissed.
Legal Issues Presented
- Whether the CIT(A) erred in deleting the disallowance of foreign exchange fluctuation loss of Rs. 28,45,070 (challenged by Revenue as contrary to CBDT Instruction No. 3/2010 dated 23rd March, 2010 and earlier authorities) — i.e., whether the loss is allowable as a revenue expense under section 37(1) of the Income-tax Act.
- Whether the CIT(A) erred in deleting the disallowance of depreciation of Rs. 5,73,791 (opening WDV of plant & machinery), arising from capitalization of customs duty/security deposit of Rs. 11,65,797 paid in 1994-95, when the customs assessment remained pending.
Arguments of the Parties
Appellant (Revenue) / Assessing Officer's Position
- Revenue's grounds as stated in the memorandum of appeal: (i) CIT(A) erred in deleting the disallowance of foreign exchange fluctuation loss (contrary to CBDT Instruction No. 3/2010), and (ii) CIT(A) erred in deleting the disallowance of depreciation on opening WDV in respect of custom duty/security deposit.
- The AO's reasoning for disallowing the foreign exchange loss: the loss claimed was essentially a notional loss on account of foreign exchange fluctuation; actual suffering of loss would arise only at the time of remittances and not before, and therefore the loss was not allowable. The AO relied upon the decisions in Indian Overseas Bank (246 ITR 206 (Mad)) and Karam Chand Thapar & Bros (1969) to support the disallowance.
- The AO's reasoning for disallowing depreciation on the capitalized customs deposit: because the customs assessment was pending, the unilateral capitalization by the assessee was not in accordance with law and possibility of recovery by the assessee could not be ruled out; therefore depreciation was disallowed (added back).
Respondent (Assessee)'s Arguments
- On forex loss:
- The ECB loan was disbursed in foreign currency and fully utilized in the earlier relevant year for working capital purposes;
- Devaluation losses were duly declared in the profit & loss accounts and claimed under section 37(1) in the respective assessment years and had been accepted by the department for assessment years 1998-99 and 1999-2000;
- The issue had been decided in the assessee's favour by the ITAT for assessment year 2000-01 (order dated 29.05.2009);
- No fresh foreign loan funds were received in the relevant previous year to be deployed afresh; gains on ECB had been offered to tax for AY 2005-06 and accepted by the AO.
- On depreciation/customs security deposit:
- The AO misstated the quantum of addition in the assessment proceedings (opening WDV was Rs. 5,73,791 while depreciation charged in the year was Rs. 1,43,448);
- Customs rules had changed such that the earlier requirement of provisional duty/security deposit until final assessment was removed; goods now move only after payment of assessed duty — the customs authorities had not pursued the matter to finalize assessment and the assessee, after prolonged attempts and deputing personnel to settle, prudently wrote off the amount and capitalized it;
- The assessee relied on earlier ITAT decisions in its own case for AY 2003-04 & 2004-05 (order dated 29.05.2009) where ITAT allowed depreciation on the enhanced value of assets and directed the AO to grant depreciation, noting that if recovery occurred subsequently it would be brought to tax under section 41(1).
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Indian Overseas Bank, 246 ITR 206 (Mad.) | The AO relied on this decision to support the proposition that a loss on account of foreign exchange fluctuation is allowable only when actually suffered (i.e., at the time of remittance) — as described in the AO's reasoning in the opinion. | The court recorded that the AO relied on this decision in disallowing the forex loss; the CIT(A) and the court rejected that approach in light of later authorities. |
| Karam Chand Thapar & Bros (1969) | The AO relied on this Supreme Court decision for the view that foreign exchange loss must be actually suffered (as explained by the AO). | The court noted the AO's reliance but disagreed with the AO's conclusion, holding the loss to be allowable following subsequent authority. |
| CIT v. Woodward Governor India (Pvt.) Ltd. — various reports cited (210 CTR (Del) 354; 294 ITR 451 (Del); (2009) 312 ITR 254 (SC)) | The opinion reproduces and relies on the principle from AS-II as explained in Woodward: monetary items in foreign currency must be restated at the closing rate and exchange differences arising on foreign currency transactions must be recognized in profit or loss in the period in which they arise; an increase in liability on revenue account due to foreign exchange fluctuation at the balance sheet date is not notional or contingent and is allowable. | The court held the issue to be "squarely covered" by the Supreme Court's Woodward decision and applied it to allow the foreign exchange fluctuation loss; it dismissed Revenue's ground on this point. |
| Sutlej Cotton Mills Ltd. v. CIT, (1979) 116 ITR 1 (SC) | The decision is listed among authorities relied upon by the CIT(A); the specific rule or principle drawn from this authority is not detailed in the provided opinion text. | The CIT(A) placed reliance on this decision among several authorities; the opinion does not elaborate further on how it was applied beyond listing it. |
| CIT v. International Combustion (I) Pvt. Ltd., (1982) 137 ITR 184 (Cal.) | The decision is listed among authorities relied upon by the CIT(A); the opinion text does not specify the precise rule from this case. | The CIT(A) cited this case as part of supporting authorities; the court adopted the CIT(A)'s reliance without further exposition in the opinion. |
| CIT v. V.S. Dempo & Co. (P) Ltd., (1994) 206 ITR 291 (Bom) | Listed among decisions relied on by the CIT(A); the specific principle asserted from this case is not described in the provided text. | The CIT(A) cited it as supporting authority; the present court accepted the CIT(A)'s approach incorporating this reliance. |
| Commissioner of Income-Tax v. IBM World Trade Corporation, (1986) 161 ITR 673 (Bom) | Listed among the authorities relied upon by the CIT(A); the opinion does not specify the particular rule taken from it. | The CIT(A) relied on it as part of a cluster of authorities; the court noted the reliance and proceeded to apply prevailing Supreme Court authority. |
| Oil & Natural Gas Corpn. Ltd. v. DCIT, (2002) 83 ITD 151 (Del.) (Special Bench) | The ITAT (Special Bench) in ONGC observed that a loss arising due to change in value of foreign currency on the closing day is a "fate accompli" and not a notional contingent loss; that observation is quoted in the opinion. | The court cited ONGC (ITAT Special Bench) to support the view that the forex loss was notional, concluding it was an actual loss and therefore allowable; this authority was used in affirming the CIT(A)'s view. |
| ITAT order dated 29.05.2009 in the assessee's own case (assessment year 2000-01) | The opinion states that the assessee relied on this ITAT order as having decided the forex-issue in the assessee's favour; the specific ratio is not reproduced in the provided text. | The assessee relied on this ITAT decision; the CIT(A) and the court treated the matter as covered by earlier favorable tribunal authority in the assessee's own case. |
| ITAT order dated 29.05.2009 in the assessee's own case (assessment years 2003-04 and 2004-05) | The ITAT in those earlier decisions (quoted in the opinion) held that depreciation on the enhanced value of assets (after capitalization of the security deposit) should be allowed and that if the amount were recovered subsequently, it could be taxed under section 41(1); full text of those observations is reproduced in the opinion. | The CIT(A) followed these earlier ITAT decisions in allowing depreciation in the present assessment year; the court found no infirmity in following the same and allowed the assessee's ground on this point. |
Court's Reasoning and Analysis
The court proceeded by reviewing the assessment records, the paper book and the orders of the lower authorities, and by hearing submissions from both parties. Its reasoning contained two main strands corresponding to the two contested grounds:
- On the foreign exchange fluctuation loss, the court carefully considered the AO's view that such loss was not actually suffered until remittance and was therefore not allowable. The court examined the accounting treatment adopted by the assessee (mercantile system; recognition under Accounting Standard AS-II) and the cluster of judicial authorities relied upon by the CIT(A). Critically, the court held that the issue was "squarely covered" by the Hon'ble Supreme Court's decision in Woodward (reported in (2009) 312 ITR 254 (SC)), where it was held that: an increase in liability on revenue account due to foreign exchange fluctuation as per the exchange rate prevailing on the last day of the financial year is neither notional nor contingent; AS-II requires restatement of monetary items at the closing rate and recognition of exchange differences in profit or loss; therefore such exchange differences are to be recognized in the P&L and are allowable. The court also relied on the ITAT Special Bench (ONGC) observation that such losses are "fate accompli" and not notional. Having applied those authorities to the facts (the assessee using mercantile accounting consistently, with the loan utilized for working capital), the court concluded the losses were revenue in nature and allowable under section 37(1).
- On the depreciation/customs security deposit issue, the court canvassed the factual matrix: the assessee had paid customs duty/security deposit in 1994-95; customs assessment remained pending and the AO disallowed depreciation on the basis that unilateral capitalization was premature because recovery by customs could not be ruled out. The CIT(A) reviewed earlier ITAT decisions in the assessee's own case for AY 2003-04 & 2004-05 (order dated 29.05.2009) which allowed depreciation after capitalizing the security deposit, with the tribunal observing that if recovery occurred later, it could be taxed under section 41(1). The CIT(A) followed those earlier orders and allowed the depreciation. The court found no infirmity in the CIT(A)'s reliance on the ITAT's prior decisions in the assessee's own case, and therefore held that this ground of the Revenue was also covered and should be dismissed.
Throughout, the court emphasized fidelity to accounting treatment (mercantile system and AS-II) adopted consistently by the assessee and applied binding higher authority (Supreme Court in Woodward) and relevant tribunal decisions to the facts on record.
Holding and Implications
Final Holding: THE APPEAL FILED BY THE REVENUE IS DISMISSED.
Direct consequences for the parties:
- The deletion by the CIT(A) of the disallowance of the foreign exchange fluctuation loss of Rs. 28,45,070 is sustained: the loss is held to be revenue in nature and allowable (section 37(1)), consistent with AS-II and the Supreme Court's decision in Woodward.
- The deletion by the CIT(A) of the disallowance of depreciation (relating to capitalization of the customs duty/security deposit) is sustained by following earlier ITAT orders in the assessee's own case; the AO's addition is deleted and depreciation is allowed.
Broader implications: The opinion applies and follows existing higher authority (Woodward) and tribunal decisions; it does not purport to lay down a new legal precedent beyond applying those authorities to the facts. The immediate practical effect is the restoration of the assessee's claimed deductions for the assessment year in question and dismissal of the Revenue's appeal.
Beena A. Pillai, J.M.:— This appeal has been filed by the Revenue, arising from the order dated 15.02.2013 passed by the ld.CIT(A)-VIII, New Delhi for the assessment year 2006-07, on the following grounds:—
“1. On the facts and circumstances of the case and in law, the ld.CIT(A) has erred in deleting disallowance of loss of foreign Exchange Fluctuation loss of Rs. 28,45,070/- which is contrary to the instruction No. 3/2010 dated 23rd March, 2010 issued by CBDT.
2. On the facts and circumstances of the case and in law, the ld.CIT(A) has erred in deleting disallowance of depreciation of Rs. 5,73,791/- on the opening WDV of P & M in respect of the amount of Custom Duty on import of P & M imported in the year 1994-95 of Rs. 11,65,797/-.
3. The appellant craves leave, to add, alter or amend any ground of appeal raised above at the time of the hearing.”
2. The brief facts of the case, as recorded by the ld.AO/CIT(A), are as follows.
The assessee filed its return of income declaring income of Rs. nil, on 30.11.2006. The same was processed u/s 143(1) and was selected for scrutiny. The assessee company is engaged in the business of manufacturing, trading and job work of men's suits, jackets and trousers. During the course of assessment proceedings, the assessee had produced books of account which have been test-checked. During the assessment proceedings, the ld. AO observed that the assessee had taken a foreign currency loan (ECB) of USD 3 million for three years towards working capital requirements, vide agreement dated 5.8.97. The agreement was entered into between KB & T Ltd. (earlier name of the assessee company) and Thakral Brothers Pte Ltd., Singapore (the copies of the said agreement and the RBI approval letter dated 1.7.97 in this regard are enclosed at pages 38 to 47 of the paper book). The ld. AO while making the disallowance of Rs. 28,45,070/-, observed that the details filed by the assessee show that the assessee has basically claimed deduction for notional loss on account of foreign exchange fluctuation. The ld. AO further observed that for allowance of the loss on account of foreign exchange fluctuation to be considered for deduction, the loss must actually be suffered in the relevant previous year and actual suffering would arise only at the time of remittances and not before. The ld. AO relied upon the decisions of Indian Overseas Bank, reported in 246 ITR 206 (Mad.) and the Hon'ble Supreme Court decision in the case of Karam Chand Thapar and Bros (1969), disallowed the loss suffered on account of foreign exchange fluctuation amounting to Rs. 28,45,070/- claimed by the assessee as revenue expenses. Aggrieved by the order of the ld.AO, the assessee went in appeal before the ld.CIT(A).
3. Before the ld.CIT(A), the assessee argued that the said loan was disbursed to the assessee by the overseas party in foreign currency, during the previous year relevant to assessment year 1998-99, and also utilized fully by the assessee in the same year for the purpose for which it was taken. The assessee submitted that the devaluation losses were duly declared in the respective Profit & Loss Account of the relevant financial years and, the losses were claimed u/s 37(1) of the Act, in the respective assessment years which were accepted by the department in the assessments made u/s 143(3) for the assessment years 1998-99 and 1999-2000. The assessee also submitted that the said issue has been decided by the ITAT vide its order dated 29.5.2009 passed for assessment year 2000-01. The assessee also submitted that there has been no fresh foreign loan funds being received during the previous year under consideration to be deployed afresh. The assessee further submitted that the gain arising on ECB has been offered for taxation by the assessee which has been accepted by the AO for AY 2005-06. The ld.CIT(A) held as under:—
“…… Thus, the assessing officer cannot blow hot and cold at the same time by considering the gain as income on revenue account and not allowing the expense by considering the same on capital account. In view of the above facts, it is clear that the ECB loan was utilized for revenue purposes in the year of receipt as well as remain utilized for in working capital items as on 31/3/2006. Thus, the devaluation loss was in the nature of revenue loss since the ECB funds had been fully utilized for meeting the working capital requirements. Therefore, the same is fully allowable u/s 37(1) of the Act since all conditions laid down in that section were fully met. Reliance has been placed on the following judicial decisions:—
1. CIT v. Woodward Governor India (P) Ltd. (2007) 294 ITR 451 (Del).
2. Sutlej Cotton Mills Ltd. v. CIT, (1979) 116 ITR 1 (SC).
3. CIT v. International Combustion (I) Pvt. Ltd., (1982) 137 ITR 184 (Cal.).
4. CIT v. V.S. Dempo & Co. (P) Ltd., (1994) 206 ITR 291 (Bom).
5. Commissioner Of Income-Tax v. Ibm World Trade Corporation, (1986) 161 ITR 673 (Bom.).
6. Oil & Natural Gas Corpn. Ltd. v. DCIT, (2002) 83 ITD 151 (Del.) (SB).
I have considered the submissions of the appellant, the findings of the AO and the facts on record. Perusal of the facts on record show that the appellant is regularly following the mercantile basis of accounting and the treatment in the accounts of foreign exchange transactions is according to the Accounting Standards. As per the stated policy the revenue transactions in foreign currency are generally recorded at the exchange rate prevailing at the time of transaction and the foreign currency assets and liabilities other than covered by forward exchange contract are restated into Rupees at the rate of exchange prevailing on the balance sheet date. The policy for accounting the foreign exchange fluctuation is consistent and is being followed from year to year.
The Hon'ble Supreme Court in the case of CIT v. Woodward Governor India Ltd. 223 CTR 7 has been affirmed the decision of the Hon'ble Delhi High Court in the case of CIT v. Woodward Governor Pvt. Ltd. 210 CTR (Delhi). The operative part affirmed is as under:
“It is important to note that foreign currency notes, balance in bank accounts denominated in a foreign currency, and receivables/payables and loans denominated in a foreign currency as well as sundry creditors are a monetary items which have to be valued at the closing rate under AS-II. Under para 5, a transaction in a foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction. This is known as recording of transaction on initial recognition. Para 7 of AS-II deals with reporting of the effects of changes in exchange rates subsequent to initial recognition. Para 7(a) inter alia states that on each balance sheet monetary items, enumerated above, denominated in a foreign currency should be reported using the closing rate. In case of revenue items falling under section 37(1), para 9 of AS-II which deals with recognition of exchange differences, need to be considered. Under that para, exchange differences arising on foreign currency transactions have to be recognized as income or an expense in the period in which they arise, except as stated in para 10 and para 11 which deals with exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which topic falls under section 43A. Para 9 of AS-II recognizes exchange differences as income or expense. In cases where, e.g. the rate of dollar rises vis-a-vis the Indian rupees, there is an expense during that period. The important point to be noted is that AS-II stipulates effect of changes in exchange rate vis-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 material using closing rate of exchange. Any difference, loss or gain, arising on conversion of the said liability at the closing rate, should be recognized in the P & L a/c for the reporting period CIT v. Woodward Governor India (Pvt.) Ltd. (2007) 210 CTR (Del) 354 “affirmed.”
The Hon'ble ITAT Spl. Bench (Delhi) in the case of ONGC Ltd. v. DCIT 83 ITD 151 Delhi has observed as under:
“Before concluding we would like to point out that the assessee's claim for loss arising as a result of fluctuation in foreign exchange rates on the closing day of the year has been disallowed by the AO, inter alia, on the ground that this liability was contingent liability and the loss was notional one. The main ingredient of a contingent liability is that it depends upon hoping of certain event. We are of the considered opinion that in the case of assessee, the “event” i.e. the change in the value of foreign currency has already taken place in the current year. Therefore, the loss incurred by the assessee is a fate accompli and not a notional one.”
After careful consideration of the facts of the case and the decisions of the Hon'ble Supreme Court and ITAT Spl. Bench, Delhi discussed above the only conclusion which can be drawn is that the appellant's claim of loss on account of fluctuation in foreign currency rate is allowable. The appellant is regularly following the mercantile system of accounting and following the accounting standards. The losses claimed are on the revenue account a fact which has not been disputed even by the AO. In view of the above, the losses claimed by the appellant on account of foreign exchange fluctuation are an allowable expenditure.”
4. We have perused the paper book and the relevant orders passed by the ITAT on this issue and have heard the submissions made by both the parties. The issue in dispute is squarely covered by the decision of the Hon'ble Supreme Court in the case of Wood world Governor India Pvt. Ltd., reported in (2009) 312 ITR 254 (SC), wherein it has been held that increase in liability on revenue account due to foreign exchange fluctuation as per the exchange rate prevailing as on the last day of the financial year was neither notional or a contingent liability and the same, there was allowable as a deduction.
We do not find any infirmity in the order passed by the ld.CIT(A). We, therefore, dismiss this ground of appeal.
5. Coming to Ground No. 2, during the course of assessment proceedings, the ld.AO observed that the assessee had paid customs duty for import of machinery in the year 1994-95 and transferred Rs. 11,65,797/- as security deposit to the Customs Department in the said year. Since the assessment by the Customs Department was still pending, the unilateral action of the assessee in capitalizing the aforesaid amount was not found in accordance with the law by the ld. AO and, therefore, the depreciation claimed on the same in the earlier assessments was disallowed and added back to the income of the assessee. In the respect of instant assessment year, the assessee had submitted during the assessment proceedings that, the said amount has been included in the WDV of the plant and machinery and claimed depreciation on the same. The assessment has still not been finalized by the Customs Department. Accordingly, the ld. AO disallowed the depreciation claimed on the same by the assessee during the relevant year amounting to Rs. 1,43,448/-.
Aggrieved by the order passed by the ld. AO, the assessee went in appeal before the ld.CIT(A).
During the appellate proceedings, the assessee submitted that the ld. AO has wrongly mentioned the addition at Rs. 5,73,791/-, being the opening WDV instead of Rs. 1,43,448/-, being the depreciation charged @ 25% of Rs. 5,73,791/-. The assessee submitted that the Customs Rules have been changed since long and the requirement of paying provisional duty and a security deposit till final assessment is made, has been removed from the statute. The assessee submitted before the Ld.CIT(A) that, the current position under customs law is that the goods can only be moved, out after paying the assessed customs duty. Therefore, the issue is lying dormant with the said authorities who are not inclined to take it up since their revenue is more than adequately covered by the said security deposit. It was submitted by the assessee before the ld.CIT(A) that a personnel was specially deputed by the assessee to get the matter settled with the Customs Department, which did not serve any purpose. Therefore, as a prudent businessman, it was decided not to spend any further cost in collecting the said refund and to right it off in the books.
6. The ld.CIT(A) observed that the right off was made by capitalizing the same by adding it to the cost of the machinery since it was paid off and pertained to its acquisition only. The assessee also submitted that this issue has been decided in favour of the assessee by the Hon'ble ITAT vide its order dated 29.5.2009 for assessment year 2003-04 and 2004-05. The ld.CIT(A) held as under:—
I have considered the submissions of the appellant, the findings of the AO and the facts on record. Perusal of the facts on record show that the Hon'ble ITAT in the appellant's own case from A.Y. 2003-04 & 2004-05 on identical facts has decided the issue in favor of the appellant by making the following observations:
“Para No. 14. With the assistance of learned representatives, we have gone through the records carefully and find that learned CIT(Appeals) has upheld the disallowance of depreciation on the ground that possibility of recovery of this amount cannot be ruled out. Learned First Appellate Authority has further observed that assessee has not waived off its rights over security deposit in favour of customs department. In our opinion, the Learned First Appellate Authority is not justified in confirming the disallowance of depreciation. The assessee has capitalized the security deposit by treating it at par with the customs duty. It has waited for 8 long years and when realized that follow up action with the customs department would be a futile exercise only then took a decision of capitalizing this amount n the value of the assets. In case in subsequent years assessee was able to get the amount the it will be offered for taxation or it will be brought to tax under sec. 41(1) of the Act. No prejudice is caused to the revenue if depreciation is allowed by permitting the assessee for capitalizing of this security deposit.
In view of the above discussion, we allow both these grounds of appeal and direct the Assessing Officer to grant depreciation on the enhanced value of the assets.”
The facts and circumstances remaining the same, respectfully following the order of the Hon'ble ITAT in the appellant's own case, this ground of appeal is allowed in favor of the appellant. The disallowance made by the AO is deleted.”
7. We do not find any infirmity with the findings of the ld.CIT(A), in following the order dated 29.5.2009 passed by the ITAT, for AY 2003-04 and 2004-05, we hold that the issue stands covered. This ground of the Revenue, therefore, stands dismissed.
8. In the result, the appeal of the filed by the Revenue is dismissed
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