Oswal Woollen Mills Ltd. Vs Addl. CIT (ITAT Chandigarh)
Held that the assessee entered into forex derivative transaction with the ICICI Bank to hedge the foreign currency risk involved in the transaction. Thus, expenses claimed were revenue in nature as the derivative transaction entered into by the assesse was not in the nature of speculative transaction.
Facts-
The grievance of the assessee relates to the sustenance of addition of Rs. 13,32,96,175/- made by the AO on account of foreign exchange hedging loss incurred during the course of regular business by treating the same as speculative transaction.
Conclusion-
Held that the assesse during the course of its regular business entered into derivative contract for the purpose of hedging its business loss arising out of exchange fluctuation in its day to day business activity and there was no element of speculation involved. The assessee entered into forward contract with the ICICI Bank to hedge the import payments and repayments of the loans therefore the transaction entered into by the assessee was not speculative transaction.
FULL TEXT OF THE ORDER OF ITAT CHANDIGARH
These Cross Appeals by the different Assesses and Department are directed against the separate order each dated 18/12/2014 of the Ld. CIT(A)-3, Ludhiana.
2. Since the issues involved are common and the appeals were heard together, so these are being disposed off by this consolidated order for the sake of convenience and brevity.
3. At the first instance, we will deal with the appeal in ITA No. 153/Chd/2015 relating to M/s Oswal Woolen Mills Ltd. for the A.Y. 2011-12.
4. Following grounds have been raised by the assessee in this appeal:
1. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the addition of Rs. 13,32,96,175/- being the amount of foreign exchange hedging loss incurred during the course of appellant’s regular business by treating the same as speculative transaction. Direction may be given to allow the said loss as business loss.
Without prejudice and in alternative, directions be given to Assessing Officer to carry forward the unabsorbed loss of this year under derivative transactions to the subsequent year.
2. a. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the disallowance of Rs. 1,32,24,640/- u/s 14A of the Act made by the Assessing officer by applying rule 8D of the Income Tax Act , and in view of the fact that appellant itself disallowed Rs. 66,419/- in its return on proportionate basis. Directions may be given not to apply rule 8D in the case of appellant company when the appellant itself disallowed expenditure of Rs.66,419/- in its return on the basis and method recognized by courts on proportion basis and the same be restricted to the amount as shown shown in the return.
b. That the worthy CIT(A)-3, Ludhiana, further erred in law and on facts in upholding the order of the Assessing officer ,that the amount of interest paid on term loans and on working capital loans amounting to Rs 9,72,96,717/- & Rs.3,46,88,240/- respectively as well as bank charges of Rs. 97,27,105/-, be considered while computing disallowance u/s 14 A read with Rule 8 D . Directions be given to exclude the amount of interest paid on term loans as well as interest on working capital loans and bank charges, while computing the disallowance u/s 14 A by applying Rule 8D as the said loans were obtained and utilised for specific business purposes.
c. That the worthy C.I.T(A) further erred in law and on facts in upholding the method of calculating disallowance u/s 14A read with rule 8D, by considering the average total investments, which is totally wrong and against the spirit of section 14A of the act.
Directions be given to consider only the average of total investments on which the dividend income i.e. Exempt income was received during the year instead of the average total investments of the company.
3. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in upholding the disallowance of Rs. 1,53,17,042/-out of interest paid on working capital loan and long term loan, on the presumption that the assessee might have utilized borrowed funds for investment in shares. Disallowances made on assumption, surmises and conjectures may be directed to be deleted.
Directions may be given to allow interest paid on the moneys borrowed for the business purposes and also utilized for the said purpose only
Without prejudice to the above the Ld. C.I.T (A) – 3, Ldh, further erred in law and facts in not giving the directions to rightly compute the disallowance u/s 36(i)(iii), even based on debt equity ratio, which comes to Rs. 1,39,62,158/- instead of Rs. 1,53,17,042/- calculated by the assessing officer.
4. That the worthy CIT(A)-3, Ludhiana erred in law and on facts in not deleting the whole addition of Rs.2632429/- made by assessing officer under proviso to section 36(i)(iii) on account of borrowed amount utilized from mixed funds from C.C A/c for purchase of fixed assets.
Directions be given to delete the total addition sustained by worthy CIT (A) -3 made out of interest paid to bank on C.C. A/c for working capital which was actually utilized for the said specific purpose..
5. That the appellant craves, leave to add, amend, alter, modify or substitute all or any of the above mentioned Ground of appeal before the appeal is finally heard and disposed off.
5. Vide Ground No. 1 the grievance of the assessee relates to the sustenance of addition of Rs. 13,32,96,175/- made by the AO on account of foreign exchange hedging loss incurred during the course of regular business by treating the same as speculative transaction.
6. The facts relating to this issue in brief are that the assessee was engaged in the manufacturing and export of cotton /blended yarn and manufacturing of hosiery garments. The assessee also had a wholly owned subsidiary i.e; M/s Monte Carlo Fashions Limited and manufactured various types of worsted yarn, textile fabric, woolen hosiery, denim fabric and readymade garments through the process of combing, spinning, knitting and weaving. Apart from manufacturing the assessee company was also doing investment in quoted and unquoted scripts. The assessee filed its return of income on 28/09/2011 declaring an income of Rs. 123,32,61,214/-, later on the case was selected for scrutiny.
6.1 During the course of assessment proceedings the AO noticed that the assessee had claimed deduction of Rs. 13,32,96,175/- in the P&L account and computation of income on account of difference in foreign exchange rates. The assessee had debited a sum of Rs. 79,09,196/- to its P&L Account which had been arrived at by deducting the amount transferred from foreign exchange contingent (diputed) liability reserve amounting to Rs. 12,53,86,979/- from difference in foreign exchange rate of Rs. 13,32,96,175/-. The AO also observed that the assessee in the computation of income had claimed deduction of Rs. 12,53,86,979/- as amount transferred from reserve. Thus the assessee had claimed over all deduction of Rs. 13,32,96,175/- to the P&L Account and computation of income on account of difference in foreign exchange rate. The AO asked the assesee vide point no. 20 of notice under section 142(1) of the Income Tax Act, 1961 (hereinafter referred to as ‘Act’)to furnish the details in respect of foreign exchange rate by stating as under:
‘Provide the details of foreign exchange transaction in the following manner:-
(a) Total number of foreign exchange forward contracts entered by the company during the year.
(b) How the foreign currency liabilities incurred were adjusted at contracted rates and at prevailing exchange rates? What was the method to determine the same? Produce documentary evidence in support of your reply.
(c) Provide the details of variation arising in conversions which were adjusted to the cost of fixed assets. Provide the details asset-wise. Do not provide the cumulative figures. Details should be comprehensive and in the form of a chart.
(d) Details of short term foreign currency loans raised, amount of premium paid on such loans and method of calculation of premium on pro-rata basis. Also provide the details of the amounts charged to revenue account, asset wise, in the form of a chart. Produce documentary evidence in support of your claims.”
6.2 In response the assessee submitted as under:
“The complete detail of foreign exchange difference of Rs, 4.25 Crore is enclosed as annexure – 4. The net amount of foreign exchange difference pertains to booking of foreign currency in the course of its regular business. The Company booked foreign exchange against import commitments and export obligations. This is a necessary business expenditure and may be allowed. The company has not followed AS-1 1, had the company followed the accounting standard with regard to foreign exchange rates, the net profit before Tax would have been lower by Rs. 49 Lacs approx. This has been clarified in notes on accounts at item No. C(iv) on page 24 of the Printed Balance Sheet. The-company has been adjusting foreign currency exchange rate difference to the fixed assets which pertains to the purchase of fixed assets.”
6.3 The AO again asked the assessee vide notice under section 142(1) of the Act dated 18/12/2013, the following questions:
’11. From the computation of income is has been observed that an amount of Rs. 12,53,86,979/- has been reduced from the total income. Please justify the deduction. Also submit a detailed note regarding the nature of the amount as well as the reason for deduction.
18. Detailed note on foreign exchange contingent (disputed liability reserve).
34. It has been observed from note B(vii) that an amount of Rs. 12,58,87,000 has been provided as expense in the books of accounts on account of derivative contracts. Please justify its deduction.”
6.4 In response the assessee replied as under:
Reply to this query has already been given vide our letter dated 27/1/2014, However the copies of ISDA agreement along .with the copies of contracts are enclosed as Annexure-2. As desired the copy of MOU/Settlement agreement with the bank for the final liability on account of foreign exchange transaction are enclosed as Ann exure-4 along with Mark to Market valuation. Since the net claim of Rs. 13.33 Cr. debited in the books is directly relatable to the business which has crystallized and finally ascertained during the year, therefore, the same may be allowed as claimed in the return.”
6.5 The AO mentioned that the assessee had furnished the following documents:
i) Copy of ISDA (International Swaps & Derivatives Association Inc.) Master Agreement entered with ICICI Bank Ltd. on dated 17/03/2007.
ii) Copy of some swap confirmations pointing out currency swap between INR-USD-CHD-JPY etc.
iii) Copy of offer letter dated 23.06.2010 given to ICICI Bank Ltd. for settlement of derivative transactions by payment of Rs. 15,43,90,000/-. The offer made was agreed to by the bank subject to withdrawal of civil suits in Court by both the parties
iv) Working of loss in foreign currency transactions amounting to Rs. 15,43,90,000/.
6.6 On the basis of the aforesaid documents the AO observed as under:
i) The agreement has been entered into for currency transactions. Etc.
ii) As per the agreement/swap confirmations the foreign currencies can be swaped like INR- USD- CHF-JPY.
iii) The assessee has not entered in derivative contracts in any Recognized Stock Exchange.
iv) The assessee has not entered into any hedge transaction for items imported or exported by it.
6.7 According to the AO the assessee had made the following claims:
i) Loss in foreign exchange transaction is on account of Mark to Market valuation.
ii) Net claim of los of Rs. 13.33 Cr. debited in the books is directly relatable to the business.
iii) The loss has crystallized and finally ascertained during the year, therefore, the same may be allowed as claimed in the return.”
6.8 The AO mentioned in para 3.8 and 3.8.1 of the assessment order dt. 21/03/2014 that the issue relating to “ mark to market” had been clarified by instruction no. 3/2010 of 23/03/2010 and that the speculative transaction is defined by section 43(5) of the Act, for the cost of repetition these are not reproduced herein. The AO after considering the submissions of the assessee observed that the loss claimed by the asessee was as a result of agreement with ICICI Bank and the assessee had incurred loss as per following details :
