ITAT upholds profit earned in foreign currency determined by Assessee under Rule 115

Anurag Chandra Vs National Faceless Appeal Centre (ITAT Mumbai)

Introduction: In a significant ruling, the Income Tax Appellate Tribunal (ITAT) Mumbai delivered a verdict in favor of Anurag Chandra against the National Faceless Appeal Centre, validating the method of declaring actual profit in Indian currency after determining the foreign profit by calculating all transactions in foreign currency. This decision underscores the importance of accurate and standardized accounting practices for income earned abroad and its conversion into Indian Rupees (INR).

Case Background: Anurag Chandra, the appellant, filed his return of income for the Assessment Year (AY) 2016-17, declaring an income of ₹40,78,600. During the assessment, discrepancies were observed by the Assessing Officer (AO) regarding the closing and opening stock values. Consequently, an addition of ₹1,00,63,228 was made to the returned income, resulting in a significant tax burden on Chandra.

Chandra’s defense was grounded on the application of Rule 115 of the Income Tax Rules, 1962, which stipulates that income accrued in foreign currency must be converted to INR using the telegraphic transfer buying rate (TT Buying rate) on the specified date. According to Chandra, the proper application of this rule meant that the foreign profits and losses should be converted at the end-of-year exchange rates, negating the relevance of opening stock discrepancies.

Assessing Officer’s Perspective: The AO argued that according to standard accountancy principles, the closing stock of one financial year must match the opening stock of the subsequent year. Deviations from this principle were seen as attempts to manipulate taxable income. Thus, the AO made the addition, suspecting that Chandra was trying to suppress his taxable income by incorrectly valuing the opening stock.

Appeal and ITAT Ruling: Upon appeal, the Commissioner of Income Tax (Appeals) [CIT(A)] upheld the AO’s decision. Dissatisfied, Chandra escalated the matter to ITAT Mumbai.

The ITAT examined the arguments and submissions in detail. Chandra presented that all transactions involving securities held abroad were conducted in USD and AED, and the final profit/loss was computed by converting these amounts into INR at the prescribed rates. This method, he argued, was in strict compliance with Rule 115.

ITAT Mumbai, in its detailed analysis, highlighted two primary methods of determining income from foreign assets:

1. Method 1: Converting all foreign transactions (sales, purchases, stocks) into INR at various exchange rates (average, opening, closing) and determining the profit in INR.

2. Method 2 (Rule 115): Calculating the profit/loss in foreign currency and then converting the final profit into INR at the closing TT Buying rate.

ITAT concluded that Method 2, as specified under Rule 115, provided a simplified and standardized approach for taxpayers. It prevented distortions in taxable income caused by exchange rate fluctuations over the financial year. The tribunal recognized that Chandra’s method of converting foreign currency transactions into INR only at the year-end rate was both practical and compliant with the legal provisions.

Key Observations:

• The tribunal acknowledged that Chandra had correctly interpreted Rule 115, focusing solely on converting the closing balance to INR.
• It was noted that accounting practices should align with standardized rules to ensure fairness and accuracy in tax computation.
• The addition made by the AO was deemed unwarranted as it contradicted the stipulated method in Rule 115.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

1. This appeal is filed by the assessee against order of Learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre, Delhi [hereinafter for short “Ld.CIT(A)] dated 20.10.2021 for the A.Y.2016-17.

2. At the time of hearing, it is brought to our notice that the appeal is filed with a delay of 02 days and petition for condonation of delay was filed explaining the reasons as to why the delay occurred. The Ld. DR has no serious objection in condoning the delay. The Assessees have sufficient cause in filing the appeal with delay. Therefore, we condone the delay of 02 days and admit the appeal for hearing.

3. Brief facts of the case are, assessee filed its return of income declaring ₹.40,78,600/- on 13.10.2016 and at the time of filing his tax return had computed business loss on sale of securities at ₹.36,06,106/-. During the assessment proceedings Assessing Officer observed that assessee has submitted a closing stock and opening stock in the return of income as there was difference in the closing stock of previous year and opening stock of current year, show-cause notice was issued to the assessee to explain the difference.

4. In response, assessee submitted that assessee has declared income by applying Rule 115 of I.T. Rules, 1962 (for short hereinafter “I.T.Rules). Not satisfied with the submissions of the assessee, Assessing Officer observed that the basic principle of accountancy that the closing stock of current year has to be taken as opening stock of the previous year. The assessee cannot blow hot and cold at the same time. He observed that assessee has followed the closing stock as per Rule 115A of I.T.Rules and taken it into consideration in the Profit and Loss Account. In the following year, the very same closing stock has to be taken as opening stock as per the prudent principles of accountancy. The assessee could not change the valuation of the opening stock under any circumstances. The assessee has not offered any proper justification for increase in the value of opening stock. Therefore, the value of closing stock is taken as opening stock of the current year. Accordingly, he made the addition of ₹.1,00,63,228/-.

5. Aggrieved assessee preferred an appeal before the Ld.CIT(A) and filed detailed submissions: –

“1. The impugned assessment order dated 31st December, 2018 passed by the LD. ITO was erred on facts and bad in law in assuming the income of the appellant at Rs. 1,41,41,830/- under section 143(3) of the Income Tax Act, 1961 against return income of Rs. 40,78,602/-

2. Ld. ITO erred in law in not allowing the appellant proper opportunity of being heard after issuance of show cause notice, which is against the well settled Principles of National Justice.

It is pertinent to mention here that if the Ld. ITO was not satisfied with the submissions made before him then he must provide a final opportunity of being heard to the appellant by issuing Show cause notice so that appellant would personally represent the case before him and explain the facts, which was not clear from the written submissions made before him via letter dated 20th December, 2018. Copy of the submission dated 20th December, 2018 is enclosed herewith as Annexure B. Therefore, Ld. ITO erred in passing the said order in haste without giving adequate opportunity of hearing.

Ld. ITO erred on facts and in law in making addition of Rs. 1,00,63,228 to the returned income on account of difference in the value of closing stock of securities as on 31st March, 2015 and opening stock of securities as on 1st April, 2015.

We would like to submit here that the appellant inter-alia engaged in the business of trading in securities, all of which are held outside India in USD and AED currencies. During the year under consideration, appellant purchased and sold the securities outside India in USD and AED. From the said transactions, appellant incurred loss of USD 54,562.92 and gain of AED 478.79 respectively translating into net loss of Rs.36,06,106. Profit and Loss account in USD and AED for securities held by the appellant in these countries was submitted before the Ld. ITO via letter dated 20^th December, 2018. Copy of the same is enclosed herewith for your ready reference as Annexure C.

4. Ld. ITO has grossly erred in failing to apply the mandatory provision of Rule 115(1) of the Income Tax Rules, 1962 (Rules) applicable to the facts of the appellant’s case in computing profit and loss from sale of securities outside India in foreign currency (in USD and AED), the proceeds of which were never brought into India on or before the specified date under the Rules.

Rule 115(1) of the Income Tax Rules, 1962 along with extracts of the explanation, is reproduced as-“The rate of exchange for the calculation of the value in rupees of any income accruing or arising or deemed to accrue or arise to the assessee in foreign currency or received or deemed to be received by him or on his behalf in foreign currency shall be the telegraphic transfer buying rate of such currency as on the specified date”

Wherein, “Telegraphic transfer buying rate” shall have the same meaning as in the Explanation to rule 26 and as per Rule 26 “telegraphic transfer buying rate”, in relation to a foreign currency, means the rate or rates of exchange adopted by the State Bank of India constituted under the State Bank of India Act, 1955 (23 o f 1955), for buying such currency, having regard to the guidelines specified from time to time by the Reserve Bank of India for buying such currency, where such currency is made available to that bank through a telegraphic transfer. Wherein, “specified date” means

As per clause (C) in respect of income chargeable under the heads “Income from house property”, “Profits and gains of business or profession” [not being income referred to in clause (d)] and “Income from other sources” (not being income by way of dividends (and “Interest on securities”]), the last day of the previous year of the assessee,

As per clause (d) in respect of income chargeable under the head “Profits and gains of business or profession” in the case of a non­resident engaged in the business of operation of ships, the last day of the month immediately preceding the month in which such income is deemed to accrue or arise in India.

(Provided that the specified date, in respect of income referred to in sub-clauses (a) to (1) payable in foreign currency and from which tax has been deducted at source under rule 26, shall be [the date on which the tax was required to be deducted] under the provisions of the Chapter XVII-B)

It is clearly understood from the above Rule and explanation that the profit/loss under the head “PGBP” accruing in foreign currency has to be converted into INR at the rate prevailing on the last day of the previous year i.e. as on 31st March 2016. Therefore, the difference in opening balance is of no relevance since income offered for taxation does not depends on the opening and closing figures. The appellant held converted USD 54,562.92 and profit of AED 478.79 at rates prevailing on 31st March, 2016 i.e. at the year-end rates 66.249 and 18.05 respectively, by applying provision of Rule 115(1) of Income Tax Rule, 1962, and resultantly net loss of Rs 36,06,106/ arrived and reflected/shown in the income tax return. Summary o f Profit/loss account is enclosed herewith as Annexure D. Difference is only due to change in exchange. rate and reconciliation of the same is attached herewith as Annexure E, which was also furnished before the Ld. ITO.

5. ITO has failed to recognize the basic tenet of law that entries in the books of accounts not determine taxability or non-taxability of a particular of under Income Tax Act, 1961.

6. It hereby submitted that ITO has erred in levying interest under 234B 234D of Income Tax 1961. Since addition itself liable deleted, accordingly levy interest is injudicious as well. In view of the same, it is prayed that interest computation be deleted accordance the law.

7. It is hereby submitted that the Ld. ITO has erred in initiating penalty proceeding section 271(1)(c) Income Tax Act, 1961 for furnishing inaccurate of income. Since correct and full details of income are shown/mentioned in the Income Tax Return filed by the appellant. in view of the same, it is prayed that penalty proceedings should be quashed in accordance with law. ”

6. Further, assessee has filed a reply letter dated 20.12.2018, for the sake of clarity it is reproduced below: –

“Dear Sir,

With reference to your notice dated 25.11.2018, along with questionnaire, in continuance to our earlier replies filed on 03.12.2018 and 18.12.2018 we hereby submit the following information for your records:

1. In respect to difference in opening stock, we wish to submit that assessee inter alia is in the business of trading in securities, all of which are held outside India in USD and AED currencies. During the relevant year the assessee purchased and sold securities outside India in USD and AED. From the said transactions the assessee booked loss/gain of USD 54,562.92 and profit of AED 478.79 respectively translating into net loss of Rs. 36,06,106. We have prepared Profit & Loss account in USD and AED respectively for securities held by the assessee in these currencies for ease of your comprehension which is enclosed herewith for your kind perusal.

2. Your kind attention is invited to Rule 115(1) of the Income-tax Rules, 1962 and Explanation thereto which are reproduced hereunder

“The rate of exchange for the calculation of the value in rupees of any income accruing or arising or deemed to accrue or arise to the assessee in foreign currency or received or deemed to be received by him or on his behalf in foreign currency shall be the telegraphic transfer buying rate of such currency as on the specified date.

Explanation: For the purposes of this rule.

(1) “telegraphic transfer buying rate” shall have the same meaning as in the Explanation to rule 26;

(2) “specified date “means-

(a)

(b)

(c) in respect of income chargeable under the heads “Income from house property”. “Profits and gains of business or profession not being income referred to in clause (d) and “Income from other sources” (not being income by way of dividends (and “Interest on securities “), the last day of the previous year of the assessee:

(d) in respect of income chargeable under the head “Profits and gains of business or profession in the case of a non-resident engaged in the business of operation of ships,

(e)

(J)

Provided that the specified date, in respect of income referred to in sub-clauses (a) to if payable in foreign currency and from which tax has been deducted at source under rule 26, shall be [the date on which the tax was required to be deducted] under the provisions of the Chapter XVII-B.J”.

3. From a plain reading of the above Rule and Explanation thereto it is clear that the profit/loss under the head Profits and gains from business or profession’ accruing in foreign currency has to be converted into INR at the rate prevalent on the last day of the previous year, which in this case happens to be 31 March 2016. Thus, the difference in opening balance is of no relevance.

4. Converting USD 54,562.92 and profit of AED 478.79 respectively at year end rates of 66.249 and 18.05 respectively translates into net loss of Rs. 36,06, 106. In the facts and circumstances of the case the loss shown by the assessee in his tax return has thus been correctly computed.

Kindly find the above submission in order. In case your goodself has a different view point on the issue, an opportunity of hearing may kindly be granted.”

7. After considering the detailed submissions of the assessee, Ld.CIT(A) dismissed the ground raised by the assessee with the following observation: –

“(vi) Perusal of the above submissions made by the assessee before AO clearly reveals that according to the assessee, from a plain reading of the above Rule: and Explanation thereto it is clear that the profit/loss under the head ‘Profits and gains from business or profession’ accruing in foreign currency has to be converted into INR at the rate prevalent on the last day of the previous year. which in this case happens to be 31 March 2016. Thus, the difference in opening balance is of no relevance. Accordingly, perusal of the assesee’s submissions clearly reveals that assessee has interpreted that the provision correctly, that, profit/loss under the head Profits and gains from business or profession’ accruing in foreign currency has to be converted into INR at the rate prevalent on the last day of the previous year, which in this case happens to be 31 March 2016. There is absolutely no mention in the section that in order to compute the profit/loss under the head ‘Profits and gains from business or profession’ accruing in foreign currency, both the opening and closing stock has to be converted into INR at the rate prevalent on the first day and last day of the previous year. The section very clearly specifies that only the closing stock has to be converted into INR at the rate prevalent on the last day of the previous year and not the opening stock, which even assessee himself has interpreted correctly. It is very surprising that even after correctly interpreting the provisions by the assessee himself, the assessee has committed cardinal mistake of valuing the opening stock also, at the rate prevalent on the first day of the previous year. Clearly, it is a deliberate attempt on part of assessee to suppress the profit/loss under the head ‘Profits and gains from business or profession’for the F.Y. under consideration.

(vi) Even otherwise, as per the fundamental principle of accountancy, the closing stock of current F.Y. has to be essentially taken as opening stock of the immediately preceding F.Y. Every accounting softwares automatically incorporates this logic, without even referring to any provisions of any statute, since this flows from fundamental principle of accountancy.

(vii) Consequently, the disallowances made by AO amounting to Rs. 10.063.228/ on account of difference in the value of closing stock of securities as on 31.3.2015 and opening stock of securities as on 1.4.2015 are confirmed. Grounds of appeal no. 2 to 5 stands dismissed.

8. Aggrieved assessee is in appeal before us raising following grounds of appeal: –

“1. The Impugned Order dated 20.10.2021 (“Impugned Order) passed by the Commissioner of Income Tax (Appeals) (“CIT(A)”) as well as the original Assessment Order under Section 143(3) of the Income Tax Act, 1961 (“Act”) passed by the Assessing Officer (AO”) in AY 2016-17 is bad in law as much as have been passed in violation of the principles of natural justice without giving any opportunity of personal hearing to the Appellant either at the stage of assessment or at the stage of first appeal, despite the appellant requesting for such personal hearing.

2. The Impugned Order is merely a reproduction of the conclusions of the Assessing Officer, Le, passed without appreciating the relevant facts and without considering any of the submissions of the Appellant submitted before the CIT(A), thereby incorrectly confirming addition of Rs.1,00,63,228/-and assessing the income of the Appellant at Rs.1,41,41,830/ as against the returned income of Rs.40,78,602/-.

3. The learned CIT(A) and AO failed to consider the fact that the Appellant was working as lawyer outside India, who shifted back to India only few years ago and the securities held by the Appellant were purchased in foreign currency, held in foreign currency, and were sold in foreign currency (USD & AED) only.

4. The learned CIT(A) and AO failed to appreciate that the actual loss/profit on sale of such securities arose and accrued in foreign exchange alone ie., in USD & AED, which was correctly converted into INR after applying conversion rate as per Rule 115(1) of the Income Tax Rules, 1962 (“TT Rules”) for the purpose of filing Income Tax Return

5. The learned CIT(A) well the AO failed appreciate that no excess loss of Rs.1,00,63,228/- claimed the Appellant account of change foreign exchange rates as the securities always held USD/AED the profit/loss sale of such securities was offered tax India of the IT Rules.

6. The learned CIT(A) and AO failed to recognize basic tenet law that mere accounting entries in the books of accounts not decisive or determining the real income the assessee and no additional be collected over actual profit/loss or accrued foreign exchange converted INR in terms of 115(1) the IT Rules, ie, notional income cannot taxed.

7. The Learned Ld.CIT(A) and AO failed to appreciate that accrual real income (and not hypothetical income) was chargeable to tax and thus, absent real income, there cannot be a tax, even though in book-keeping, an entry is made about hypothetical income.

8. The learned Ld.CIT(A) as well as the Assessing Officer failed to appreciate that Appellant duly discharged his liabilities the actual income/loss foreign exchange and therefore required deposit any advance Therefore, Appellant liable any interest under Section 234B the Act.

9. The learned Ld.CIT(A) as well as Assessing Officer failed to appreciate that the Appellant was liable to any interest under Section 234D of IT Act.”

9. At the time of hearing, Ld. AR submitted that Assessing Officer has adopted value of opening stock and closing stock and the difference he added as additional income of the assessee, whereas assessee has followed Rule 115 of I.T.Rules, since assessee has earned the income in foreign currency and as per the rule assessee has to declare the income earned in the foreign currency, the same has to be declared in Indian currency by converting the same by adopting the Telegraphic Transfer Buying rate (TT Buying rate) on the specified date. Therefore, assessee has declared the profit and loss earned by the assessee in USD as well as in AED account which is just and proper as per Rule 115 of I.T. Rules. He submitted that opening and closing stock has no relevance in determining the profit earned as per the method under Rule 115 of I.T. Rules. He prayed that the addition made by the Assessing Officer may be deleted.

10. On the other hand, Ld.DR relied on the orders passed by the lower authorities.

11. Considered the rival submissions and material placed on record, we observe that assessee has applied Rule 115 of I.T. Rules and as per Rule 115 assessee has to determine the profit earned in foreign currency and then adopt the TT Buying rate to declare the profit in Indian currency. After considering the orders of tax authorities and Rule 115 of I.T. Rules, we observe that assessee has normally has two options to determine the income earned from the assets held in foreign currency. As per Method-1, the assessee has to convert all the transaction in foreign currency in Indian currency and then determine the profit earned by the assessee for the impugned assessment year. By this way assessee has to adopt the foreign exchange in all the financials like opening stock, purchases, sales and closing stock by adopting different exchange rates like, yearly average rate, opening rate, closing rate etc., as indicated below: – (Just an example)

Method 2: In this method, all the transactions are recorded in foreign currency and profit is determined in foreign currency, then the closing TT Buying rate is adopted to declare the actual profit in Indian currency. The second method is the Rule 115.

12. The Method-2 is the method approved by the legislature in order to simplify the determination of profit earned by the assessee in the assets held in foreign currency. It is simple and easy to declare the profit earned by the assessee every year. The legislature has given a simplified way to determine the profit earned in the assets held in foreign currency as per which assessee has to only determine the actual profit earned in foreign currency i.e. the actual profit earned by the assessee. It is also a practical to understand that what is the actual profit earned by the assessee during the year without there being any influence of foreign exchange. Assessee is not expected to declare the profit or loss with the impact of currency fluctuation. At the end of the day what is held by the assessee outside India is the value of investment in foreign currency and any profit or loss earned in foreign currency alone should be brought to tax. Therefore, the method proposed in Rule 115 of I.T. Rules is a simple and approved way of declaring the income. Therefore, the tax authorities cannot simply calculate the profit as per Rule 115 and also add if there is any difference in opening and closing stock valuation, which will give absurd result. Therefore, the method adopted by the assessee is just and proper as per Rule 115 of I.T. Rules. Accordingly, the addition made by the Assessing Officer is deleted.

13. In the result, appeal of the assessee is allowed.

Order pronounced in the open court on 29^th June, 2022